Journalism in the Public Interest

Forever Blowing Bubbles

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April 17: This post has been clarified.

Are we moving from the crash to the bubble, dispensing with that pesky economic recovery thing altogether?

The Federal Reserve is well into its third round of "quantitative easing," in which it buys longer-term assets to bring down long-term lending rates. We are about five and a half years into the Fed's extraordinary monetary policies (its out-of-the-box lending programs began before the crash, in late 2007).

The effect the central bank hopes to produce hasn't materialized. Despite modest growth, the economy remains a wellspring of misery, with mass unemployment, wage stagnation and factories going unused. In March, a smaller percentage of working-age people were actually working than at any other time since 1979.

Through its unconventional policies, the Fed is trying to alleviate the crisis. It has succeeded in driving down lending rates. Ben S. Bernanke and company would also like to kindle inflation expectations, spurring people to buy and companies to invest today instead of waiting until tomorrow. Supposedly, all of this will drive a self-sustaining economic recovery.

Instead, the Fed has kindled speculation. Investors are desperate for yield and are paying up for riskier assets. In areas like real estate, structured finance and equities, the markets are ahead of the fundamentals. It doesn't look to me like a bubble yet. But I would call it the Dysplasia Stage, abnormal growth that looks precancerous.

It's not just an economic or financial issue, it's cultural and psychological. We seem to have unlearned what real growth is and simply substituted speculative bubbles. Policy makers are either paralyzed or barrel forward because this is all they know how to do.

Let's first take the stock market. On the standard measures of looking at estimated earnings, the Standard & Poor's 500-stock index isn't particularly high. But that's misleading. Corporate earnings are extremely high as a percentage of the gross domestic product. Margins are high. Is that sustainable?

There are more reliable measures of stock market value, and they look frothy. One gauge, the price of stocks based on the past decade of earnings, is named after the Yale economist Robert J. Shiller. Using that, stocks are too expensive by 65 percent. Alternatively, many investors look at something called the Q, devised by the economist James Tobin, which compares stock prices with corporate net worth. The nonfinancial companies are overpriced by 57 percent. The stock market is not at 1999 or 1929 levels, but it has reached other previous peaks of 1906, 1936 and 1968, according to Smithers & Company, a London-based research shop.

To make stocks correctly priced, "either earnings have to explode heavensward for 10 years or else stock prices have to come in a lot," said Scott Frew, who runs Rockingham Capital Partners, a small hedge fund. He expects earnings to fall.

It's not just stocks. Investors are bidding up junk bonds, commercial mortgage-backed securities and bundles of corporate loans called collateralized loan obligations. Last month, investors were paying more for such loans than at any time in the last five years. They are snapping up billions of dollars in securities made up of subprime auto loans.

And the housing market isn't just rising, but roaring back so fast you can feel the G-force coming off the reports. Home prices in Phoenix went up 23 percent over the last year, according to the latest Standard & Poor's Case-Shiller index. More than one in four homes in Phoenix were purchased by investors who bought more than five homes apiece, up from 16 percent a year earlier.

"I am now starting to become less skeptical" about the worries over a new housing bubble, said Christopher J. Mayer, a real estate economist at Columbia University. When local money is on the sidelines and outside buyers come in to snap up real estate, that typically ends badly, he added.

So what's going on?

The Fed is engaged in "trickle-down monetary policy," said Daniel Alpert, managing partner of Westwood Capital, an investment bank. "This type of monetary policy is making the wealthy wealthier and hoping that it trickles down to the shop floor."

But "trickle down has never worked," he said. "The wealthy don't need to consume. And when there is oversupply of capacity, the wealthy don't need to invest in new capacity."

Has the Federal Reserve monetary policy reached the average American? To a certain degree, yes. Many Americans have been able to refinance their homes. Those auto loans may be helping people get to and from work.

But the economic effects are modest for the size and scope of the effort. Investors, meanwhile, glory in the asset inflation. The most pronounced effect of low mortgage rates has been to allow people with good credit and low debt to refinance multiple times over the last few years. Stock ownership is concentrated among the wealthy; junk bonds and collateralized loan obligations only more so.

Alpert says the first round of quantitative easing was necessary to alleviate the liquidity problem in the markets — the unwillingness of investors to conquer their fears and buy up assets. But the third round is "unnecessary," he said.

Others disagree. Dean Baker, an economist from the liberal-leaning Center for Economic and Policy Research who warned about the housing bubble much earlier than most, doesn't see a bubble yet. He advocates continuing quantitative easing.

Baker adds a note of caution, however. Regulators should move to high alert; Federal Reserve officials should start speaking out to signal that they are paying attention to the abnormalities. Eric S. Rosengren, the president of the Federal Reserve Bank of Boston, gave a recent speech raising areas of concern, only to dismiss them as not overly worrisome yet.

At least he was thinking about the issue. As with cancer, the key is to intervene early.

Clarification: A quote from real estate columnist Christopher J. Mayer has been clarified to read that he has "become less skeptical" about the worries over a new housing bubble, not less skeptical that we are moving toward a new housing bubble.

Michele Zimmerman

April 17, 2013, 2:57 p.m.

Yes, we seem doomed to repeat our mistakes: again and again. Why are the Politicians and Bureacrats not protecting the public, as opposed to concentrating on the Dow?

David E. Shellenberger

April 17, 2013, 3:09 p.m.

The Fed will always create booms and busts. The answer is “free banking,” i.e., a free market in banking and currency.

“We” are not making the mistakes. It is the Fed, an arm of the federal government.

“In March, a smaller percentage of working-age people were actually working than at any other time since 1979.”

I keep seeing this and without a further explanation, it infuriates me.

“The Civilian Labor Force Participation Rate” has as its denominator all the population (maybe excluding military) 16 years or older. All retirees, students (maybe disabled) etc are included. As our population ages or even if women decide to return to motherhood and stay at home wives, the rate will decline. Until they break out the data by categories it should be banned.

Abe, I haven’t had time to look the data through to draw any conclusions, but this looks like a good start on what you’re looking for:

Anyway, is this article perhaps meant to be sarcastic?  Because otherwise, it strikes me as naive.

“We” don’t have any control of the economy.  That’s what we learned in 2008, when the banks used terrorism, threatening the collapse of the economy and even martial law, if Congress didn’t cave to its insane demands for power and money.

And note, despite the chaos, and even ignoring the bailout, the banks made out like…well, bandits.  Every investigation has turned up executives testifying to the effect that they wouldn’t bet against it happening again.

So, the banks have a trick.  They rig the system and defraud the people.  In response, the people and small businesses are all but forced to go to the bank to make ends meet.  On top of that, they get to seize and sell assets.  And covering it all, the government treats the banks like victims and funds their next bubble with taxpayer money.

As a result, the banks get to concentrate and distribute wealth based wholly on their whims.

To suggest that it’s accidental—or worse, to suggest that it’s the fault of the people who take on loans to, y’know, eat and not freeze to death in the winter—is misguided at best, parroting the worst of the banks’ propaganda at worst.  Unless there’s proof that the banks are innocent bystanders in all this, of course, but somehow, I doubt it.

So what is the average (trying-to-be-informed) American who makes an average salary (or less, I’m a teacher) wants to be responsible with his/her finances to do with all this? How do we weather such storms?

@David E. Shellenberger

The Federal Reserve System is NOT an arm of the federal government.  It is a private institution.

To John:
Either I am unable to express an idea clearly, or there are those that are unable to comprehend or there are those that have something to say and simply disregard what has been said.

My comment had nothing to do with unemployment, which the link to which you referred responded. I was commenting on the “Civilian Labor Force Participation Rate”  (  I may have been somewhat loose in describing the denominator for the index. The definition for the “Civilian Labor Force” used by the BLS is “The Total Non-Institutionalized Population”. Still not quite sure what this is, but certainly retirees, students, disabled are all included in the “Civilian Labor Force”. So anytime a mother decides to remain home to raise her children or a 60 year old decides to retire, or my son decides to stay in school beyond the age of 16, it will reduce the participation rate.

You seem very much partaken with the banks and other PC that has been featured in the liberal press. So let’s check the facts. There were twelve organizations that received one billion or more from TARP. Of these, 7 were banks or insurance companies. All funds received were repaid in full and in addition the treasury received an additional profit of 30 billion dollars.

The remaining five were all politically favored institutions that still owe the government as follows (
Fannie Mae     81 Billion
Freddie Mac     42
GM             22
GMAC           10
Chrysler           1

Time to ask who are the favored and who are the rent seeking institutions.

David E. Shellenberger

April 18, 2013, 10:15 p.m.

Mike, this is false. It is a creature of Congress, and serves the interests of the federal government and its cronies.

John, in my mind the article is neither sarcastic or naive.  It’s a news analysis with a hard news peg, and given his experience, accountability, and past pieces, I take seriously Jesse Eisinger’s columns and reporting.

To me, he’s trying to thread his way through all the claims and counter-claims about how the recent changes in Fed policy are affecting the components of our economy.  As does your cogent criticism of how major US banks gamed the post-2008 outcome, he questions who has gained and lost, and accurately contrasts investment and speculation.  If the former has a bad rap, it’s because it has increasingly aped the latter. 

Lots of opinions always available, including mine.  But as a journalist, and to my mind a good one, Mr. Eisinger raises excellent questions and will continue, I hope, to discomfit all those who profit by dysfunction and deceit, in whatever role or institution.  May he, may we in such a spirit, carry on.

Michele Zimmerman

April 20, 2013, 2:42 p.m.

I agree with Greg.“dysfunction or deceit” is putting it kindly.

Greg, I normally agree, but this seems less decisive than Eisinger’s usual fare, and I more wonder why the comparative walking on eggshells than anything else.

Abe, sorry if I misinterpreted.  It sounded like you were looking for employment numbers divided by demographic ranges for a better picture than a single blanket assertion.  The link wasn’t intended as a dismissal of your questions, just a hopefully-reasonable starting point to get to the answers you want.

This isn’t trickle down….the Fed is creating the conditions for banks to not only clear their accounts of toxic subprime loans while at the same time profiting off of them, the Fed is creating the stagnant employment conditions domestically by allowing corporations to earn huge profits doing no work. Money made in the market is spent expanding overseas while keeping the labor market desperate….that maximizes profits. The Fed could care less about people.

Jesse Eisinger

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