Monday, April 24, 2006

"A Harvest of Financial Despair" or "The Most Calamitous Clustering of Financial Error in U.S. History"

...the common American does not understand he is being manipulated and impoverished by the Federal Reserve. When money is no longer real (i.e. fiat currency vs. gold and silver), then people may come to believe in the surreal, and a hyperreality emerges. In particular, during the reign of Alan Greenspan, money and credit – created out of thin air – rained upon Americans as if to assure us that crop failures and misfortune had been banished from U.S. soil. Hence, we came to live in a world of plenty where one may become wealthy by simply purchasing a house – with lots of borrowed money – and by "investing" in stocks for the long run. What a dream it is to become wealthy without effort. This mass delusion is only one step away from collectively believing that cotton candy is a cash crop. Alas, Americans will soon discover that housing values don’t grow to the sky and that heavy mortgage debt leads to a harvest of financial despair.

Because of the housing bubble, as engineered by the Federal Reserve, Americans are now drowning in mortgage debt while naïvely believing that living in a house is the path to wealth creation via long-term capital appreciation. Thus I am just going to come out and say it: countless American homeowners are already insolvent and simply don’t know it; and many of them continue to make ends meet by borrowing against credit cards and ever-shrinking home equity.

It is commonplace for me to see married couples with mortgage-debt-to-income ratios that are wildly askew. The hyperreality conjured by the Federal Reserve’s relentless inflation of the money supply is characterized by a populace which believes that a permanent plateau of prosperity has been attained. This is the boom phase of the trade cycle.

Let’s face it: highly leveraged Americans have little to no chance of ever paying back their enormous mortgage debts. All it will take is for a husband or a wife to lose a job, or for interest rates to go higher, in order for mortgage debt to become unmanageable. In the bust phase, mortgage defaults will become a deluge.

Earlier, I mentioned that the Federal Reserve "engineered" America’s housing bubble. To be sure, there are those who deny a housing bubble exists. Hence, such deniers argue there is no correlation between aggressive growth in M3 and the spectacular rise in housing prices across the United States – as if the Federal Reserve’s pounding down of interest rates occurred in a vacuum. To this I respond with a quote from page 1 of a September 2005 study sponsored by the Board of Governors of the Federal Reserve System titled House Prices and Monetary Policy: A Cross-Country Study [warning: PDF]. Here is the smoking-gun quote: "Like other asset prices, house prices are influenced by interest rates, and in some countries, the housing market is a key channel of monetary policy transmission."

As surely as night follows day, a credit-induced boom is followed by a bust.

This mortgage-debt bubble, as engendered by the Federal Reserve, is leading millions of Americans to financial ruin. This may become the most calamitous clustering of financial error in U.S. history. If anything positive comes out of this economic mess, perhaps it will be the demise of the Federal Reserve itself. Regrettably, the Fed’s failure will have come at an enormous price, including the possibility of volatile social unrest.
You can read the entire article here.

Oh, and Bill Fleckenstein declares the bubble as officially popped.

10 Comments:

Blogger anon said...

Ok, I’m sorry I have to disagree here. This post is just plain BS. Yes, no doubt the Fed is responsible for the additional liquidity in the financial system via lowered interest rates. But come on. Where was the fed when all these borrowers took out 100% financing and option ARM’s to get into a McMansion they knew they could never afford? Personal responsibility has to count for something and while I’m not arguing against the Fed making this possible, I certainly don’t blame them for all the sheeple out there taking on this risk with no regard for the consequences.

Market volatility is a bad thing. People would be loosing substantially more money in the financial system if it wasn’t for the Fed. Advocating for the Fed’s removal is a short sighted and highly destabilizing proposition. Ok, it’s not perfect, ok Greenspan was a bubble lover, but come on - It’s better that nothing (we’ll probably have to agree to disagree on this one), and the sooner we have an objective look at the financial system with the Fed, versus the financial system without it the better.

Bashing the Fed, for maintaining financial stability (no matter the consequences to housing) is un-productive and comes across as a little bitter.

Apr 24, 2006, 11:31:00 AM  
Blogger Marinite said...

This post is just plain BS.

Is the post BS or is the article BS?

The author suggests that the end-game might include the dissolution of the fed, not me (it's too bad he ends the article in that way). The article makes some otherwise very good and articulate points IMO that are worth thinking about at least for those for whom they are new. I don't want to 'throw out the baby with the bath water' here.

But come on. Where was the fed when all these borrowers took out 100% financing and option ARM’s to get into a McMansion they knew they could never afford

It is a matter of public record that Greenspan was advocating the increased use of ARMs at a time of ultra-low interest rates...an environment where rates could only go up. IMO that was incredibly irresponsible.

FWIW, I agree with you 100% that personal responsibility by people taking out loans must count for something.

Also, simply assigning blame (if that is what one must do) to a single entity (i.e., the Fed) is silly IMO. The blame is shared by many...the Fed, lenders, borrowers, appraisers, realtors, etc.

Bashing the Fed, for maintaining financial stability (no matter the consequences to housing) is un-productive and comes across as a little bitter.

The ends justify the means?

Apr 24, 2006, 12:12:00 PM  
Blogger sf jack said...

"It is a matter of public record that Greenspan was advocating the increased use of ARMs at a time of ultra-low interest rates...an environment where rates could only go up. IMO that was incredibly irresponsible."

*****

I believe we need the, and I agree with much of anon's thoughts... though for the life of me, I could never figure out why Easy Al said that (above).

It just seemed beyond responsible, thinking about how the "average" American might respond to that (perhaps not the average, but those who might even know that Easy Al was Fed chair and what he meant at the time).

Looking back, the only word that comes to mind to describe it is "surreal."

Apr 24, 2006, 12:13:00 PM  
Blogger sf jack said...

Should say: "I believe we need the Fed..."

Apr 24, 2006, 12:13:00 PM  
Blogger anon said...

Is the post BS or is the article BS?

Sorry! The article. Your site rocks! The willingness of you to discuss this stuff is also awesome.

It is a matter of public record that Greenspan was advocating the increased use of ARMs at a time of ultra-low interest rates

Granted, but he was also very careful not to say that everyone should use this type of financing. It was the banks who provided it to anyone with a pulse - not Greenspan.

I also think his comments have been taken out of context. Looking back at his comments he was attempting to increase the flexibility of the real estate market with regards to financing. He never, ever stated that IO's, ARM's, etc should be used by the masses. Maybe he was shortsighted and a little naive to suggest that, but abolish the Fed for one mis-quoted mis-step... come on!

The blame is shared by many...the Fed, lenders, borrowers, appraisers, realtors, etc.

I agree 100%.

Apr 24, 2006, 2:11:00 PM  
Blogger Marinite said...

...but he was also very careful not to say that everyone should use this type of financing. It was the banks who provided it to anyone with a pulse - not Greenspan.

True. But I am not so sure if at that time it was taken that way.

I am also definately not advocating abolishing the Fed. It's just that there is some good info here and it is valuable to revisit the past every once and a while so that we keep in sight where we have been.

Apr 24, 2006, 3:00:00 PM  
Blogger marinmaven said...

I am reminded of the Internet and tech stock market bubbles of the 1990s.
I remember the emergence of companies as new paradigms that were beyond making profit.

I remember being told that I was crazy not to heavily invest in tech stocks in my retirement portfolio.

I remember all the hype even though Greenspan would grumble something about "irrational exuberance."

It's all about the populace's need for short term gratification, and the market and social forces that prey upon those needs. Get what you need now and worry about what happens later.

It is not just about personal responsibility to handle one's money more prudently, but the banks, the press, the analysts, the real estate companies, and our
culture.
In times of booms and bubbles, everyone drinks from the kool-aid bowl and conventional wisdom is created.
People who suggest caution are considered old-fashioned nay-sayers. The longer the inevitable disaster is delayed more people jump on the bandwagon and inflate the bubble.

In 1997, I knew the Internet bubble was not going to last (and couldn't last) and yet people were considering going back to school to learn web design.

This is true if you are talking about Netscape, PETS.COM, or real estate as the safe investment over stocks. The problem is human nature of greed. The only thing to do is make sure that there are enough safety nets and valves to soften the busts that always come.

It is really hard, because you want to hold someone accountable but the blame can be shared so broadly that I can't see how.

Apr 24, 2006, 5:21:00 PM  
Blogger Athena said...

What I always want to know is... when you know people are drinking the kool-aid... what image does that conjure up for you?

I remember how the original one ended and have come to the conclusion that any time there are masses and kool-aid involved, it is going to have the same ending and steer clear!

Apr 25, 2006, 12:13:00 AM  
Blogger Marinite said...

The only thing to do is make sure that there are enough safety nets and valves to soften the busts that always come.

maven -

Should there be "safety nets", etc? How are people going to learn if not by paying for their mistakes? If this were children we were talking about, then using such "safety nets" would ensue criticisms of 'spoiling the child by sparing the rod'.

It's been argued before that as long as we have fiat currencies and credit there will always be financial bubbles of one sort or another. It seems to me that the only way to lessen the chances of bubbles (assuming fiat currencies and credit remain in place) is by changing popular expectation and behavior. What better way to change popular psychology than taking the lumps they deserve?

Apr 25, 2006, 9:57:00 AM  
Blogger exvancouverite said...

"I believe we need the Fed..."


Maybe some required reading would include "The Creature From Jekyll Island". It's hard to believe that people root for an institution that robs them blind.


"Unfortunately, the common American does not understand he is being manipulated and impoverished by the Federal Reserve. When money is no longer real (i.e. fiat currency vs. gold and silver), then people may come to believe in the surreal, and a hyperreality emerges..."

http://www.financialsense.com/editorials/englund/2006/0422.html

Apr 25, 2006, 8:15:00 PM  

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