Thursday, December 30, 2010

A Happy New Year message from Peter Schiff: The value of your house is still 20% too high.

When an economic bubble bursts, normalcy cannot return until the pricing excesses wrought by the bubble are wrung out of the market. A recession is often the painful but necessary market mechanism that corrects the pricing distortion and consequent misallocation of capital that occurs in a bubble. When misguided government intervention prevents the mispriced asset class from fully deflating, capital continues to be misallocated and economic malaise lingers on. This is the takeaway message from Peter Schiff's Wall Street Journal editorial this morning:
"By all accounts, the home price boom that began in January 1998, when the previous 1989 peak was finally surpassed, and topped out in June 2006 was extraordinary. The 173% gain in the Case-Shiller 10-City Index (the only monthly data metric that predates the year 2000) in those nine years averaged an eye-popping 19.2% per year. As we know now, those gains had very little to do with market fundamentals, and everything to do with distortionary government policies that mandated loans to marginal borrowers, and set off a national mania for real-estate wealth and a torrent of temporarily easy credit...

From my perspective, homes are still overvalued not just because of these long-term price trends, but from a sober analysis of the current economy. The country is overly indebted, savings-depleted and underemployed. Without government guarantees no private lenders would be active in the mortgage market, and without ridiculously low interest rates from the Federal Reserve any available credit would cost home buyers much more. These are not conditions that inspire confidence for a recovery in prices. In trying to maintain artificial prices, government policies are keeping new buyers from entering the market, exposing taxpayers to untold trillions in liabilities and delaying a real recovery. We should recognize this reality and not pin our hopes on a return to price normalcy that never was that normal to begin with."

Later, Schiff defended his thesis on CNBC:

"... if Schiff is right, homeowners are looking at pain.We know that Schiff is a tad dramatic – some would say alarmist – but his forecasts are not without merit. In late 2006, Schiff predicted the housing bubble and resulting subprime mortgage crisis and in late 2008, he predicted the automotive industry crisis and the crisis in the banking and financial market."
Schiff's holiday forecasts have become a regular feature on this blog. As long as his prognostications prove to be more right than wrong (as we've seen over the last five years) it is a tradition the Dividist will continue to observe. The Dividist does not find it particularly difficult to appreciate the wisdom in this particular common sense analysis. In fact, the Dividist finds it much more difficult to understand how anyone could expect that a problem that was:
  • Triggered by Federal government market-distorting social engineering policies intended to permit people to buy homes they cannot afford...
  • Enabled by Federal Reserve Bank expanding the money supply and keeping interest rates artificially low...
  • Fueled with massive deficit spending...
could be solved by:
  • More federal government market-distorting social engineering policies intended to allow people to to stay in homes they cannot afford...
  • Enabled by even more Federal Reserve Bank expansion of the money supply while artificially keeping interest rates even lower...
  • Fueling it all with even more massive deficit spending.
Definition of insanity anyone?

Divided and Balanced.™
Now that is fair.


Tully said...

Schiff is right, in essence if not neccessarily in scale. (I don't know how to judge the exact scale of the future pain -- no one does.)

As I've said all along, punting the problem down the road doesn't resolve the problem, and much of what TARP and gov't intervention did was just punt the resolution of those bad assets down the road, accompanied with major capital infusions (from the public treasury!) in an attempt to keep the bubble partially inflated while the bulge of bad assets works its way through the pipeline, in the hope that the pain can be spread out and absorbed more easily.

We've been here before (Resolution Trust Corp, anyone?) but despite having a successful model available for resolving things, the admin and Congress chose to go a different direction, and it'll end up costing and hurting us more than directly addressing the problem would have.

mw said...

Agreed. Although I sure wouldn't mind seeing Schiff get this one wrong.

Friday CNBC had Ron Insana on, specifically to refute Schiff. He basically is saying there is so much pent-up demand, and prices are so low, and the economy improving enough that the housing market will stabilize here. Video linked here.

Basically I think Insana may be right on a shorter term call (1 year?), with an economy feeling pretty good after the latest massive stimulus and QEII heroin injections. But sooner or later, the needle has to come out of the arm.

It won't feel so good then.