Fed Indicates Asset Prices Must Come Down

According to this article in Bloomberg, the Fed indicates in their latest remarks that there is an asset price bubble and that asset prices (e.g., housing prices) must come down for the sake of the economy.

Speculators*: be afraid, be very afraid. Why? For many reasons. A big one, as this article points out, is that in past housing busts the majority of owners had traditional fixed-rate loans and we didn't see a flood of houses on the market because many folks could just "wait it out" since mortgages don't get "called" like a put or a call in the stock market. But today "it's different this time", a significant number of people are using ARMs or exotic "name-your-own-payment" type loans; speculators certainly don't take out a fixed-rate mortgage because that just doesn't make sense if you are going to "flip" the property or you plan to sell in less than five or so years. But what is really scary is that in bubble areas like the Bay Area at large, such exotic loans are the majority because they are the only way most people can buy a house these days. These folks will get burned and the buy-up chain reaction will break down.

*I consider a speculator to be (1) anyone who buys a house other than the one they live in -- a vacation house, a house for "investment" reasons, etc., or (2) anyone who buys a property (regardless of whether it is the house they actually live in) with an ARM or exotic loan because these loans by their very nature are short-sighted and only make sense in an increasing asset price environment and are therefore speculative, or (3) anyone who decided to buy a house because "prices only go up, the rate of return on housing is greater than stocks", etc. and who would otherwise not have purchased a house. What do you, the three readers, think is the proper definition of "speculator"?

Some choice quotes:

"The Federal Reserve is paying closer attention to the rising values of assets such as stocks, bonds and homes, as low interest rates encourage more risk-taking, Fed Chairman Alan Greenspan said."

"Investors are accepting ever-lower compensation for risk as economic stability convinces them that their investments are less risky, he said. While that has helped push up asset prices and supported consumer and business spending, Greenspan said the increases ``can readily disappear.''"

"``History has not dealt kindly with the aftermath of protracted periods of low risk premiums,'' Greenspan said. ``Such an increase in market value is too often viewed by market participants as structural and permanent.''"

"``We have a housing valuation issue,'' said Kurt Karl, chief U.S. economist at Swiss Reinsurance in New York, in an interview. ``The time is now for raising interest rates and defuse these problems potentially by slowing down the economy a bit and avoid a big necessary increase later and a consequential recession. The froth here really raises the risk that he'll [Greenspan] continue to raise rates.''"

"``If we can maintain an adequate degree of flexibility, some of American's economic imbalances, most notably the large current account deficit and the housing boom, can be rectified by adjustments in prices, interest rates and exchange rates rather than through more wrenching changes in output, incomes and employment,'' he [Greenspan] said."

"Greenspan's comments come as a growing chorus of economists, including Stephen Roach of Morgan Stanley and David Rosenberg of Merrill Lynch & Co, have criticized the Fed chairman for remaining sanguine in the face of what they say is a dangerous bubble in the U.S. housing market."

"``We have experienced asset bubbles, and we now have an economy that is more highly leveraged than it ever has been in the post-World War II period,'' Kasriel said in an interview before the speech. ``Greenspan has been instrumental in bringing about this high leverage.''"

The rest of the article is about Greenspan defending his economic philosophy and why he did the things that he did. CYA.