Housing Bubbles: Exceptional Conditions and the Housing Bubble Point-Counterpoint

Mike Shedlock discusses whether the “Exceptional Conditions” in Europe should actually be considered exceptional, brings out the truth in a statement from ECB President Jean-Claude Trichet about ratecutting (it would lead to Housing Bubbles), and discusses the evidence for and against Housing Bubbles in the US.

WHAT HAPPENS WHEN “exceptional conditions” become the norm? I am sure that question is on the minds of European readers tuned into the Mish blog. Let’s take a look. Italy and Portugal faced EU wrath

over their deficits. Italy is supposedly in a “soft recession.” Will that condition become exceptional if it becomes a “hard recession”?
To the ire of Italian officials, the European Commission agreed on Tuesday to launch disciplinary action against Italy for flouting EU budget rules. EC officials also announced possible action against Portugal. The European Commission went on to say, “The excess of the deficit over the reference value is not exceptional, as defined by the Pact…nor is it the result of a severe economic downturn,” which may have gotten Rome a reprieve, the commission said.
Enquiring Mish readers want to know if there is a clear-cut definition of “exceptional” as well as clear-cut time frame in which exceptions MUST be addressed. I am not perfectly in tune with EC rules, so if someone has precise rules and time frames, please e-mail them to Greg.

Here is the key question: How long can Germany play the “reunification card” as “exceptional conditions”? From now until doomsday? I mean really, how long can an exception last before it becomes the rule rather than the exception?

What about France? What’s its excuse? Is France undergoing reunification? Is France undergoing a shortage of brie? I admit the latter would be a total and complete travesty of justice, but to the best of my knowledge, there is no brie shortage in France.

How long can a country with no perceptible “exceptional conditions” get away with playing the “exceptional conditions” card? I have no doubt now that Portugal will somehow be claiming “exceptional conditions” quite soon. I can’t wait to hear the excuse.
Is Italy even telling the truth about how bad it will miss EU stability pact agreements?
Let’s take a look. As reported on eubusiness.com, “Last year, the Italian government reported a deficit of 3% of GDP, just meeting the EU limit. But Eurostat, the European Union’s statistics arm, has refused to validate that figure. Brussels has forecast a budget deficit of 3.6% of GDP for Italy this year, and widening to 4.6% in 2006. Italian Finance Minister Domenico Siniscalco admitted on Tuesday that the deficit would exceed the European Union’s limit in 2005, remaining ‘under 4%.'” Is there any reason to believe the Italian government over Eurostat? Somehow, I doubt it. At any rate, someone please check my math: Is 4% under 3% or not?
Meanwhile, some people are worried about the spread of SARS or the bird flu virus. The real question to be answered is this: Is anyone paying attention to the rampant spread of “exceptional conditions”? Whatever strain of virus it is, it seems to be impervious to anti-viral efforts. Take a look a Germany. Wow! If the United States ever catches that strain of the ECV (exceptional condition virus), we are in trouble.
Then again, perhaps the United States has better news suppression techniques than the European Union. I wonder if we already have that disease but it has been purposely misdiagnosed as “The Greenspan Conundrum.” Has the U.S. Centers for Disease Control been alerted to this possibility?

Housing Bubbles: Mild Symptoms of ECV

Back in the European Commission, it sure seems that the biggest inflation hawks are now showing “mild symptoms” of ECV. I offer this as proof: “ECB Chief Economist Otmar Issing said on Monday a cut could not be ruled out, and [Jean-Claude] Trichet himself, apparently inadvertently, fanned speculation by telling a banking forum in Beijing earlier on Tuesday the European Central Bank would do all it can to bolster confidence.”

Quite frankly, that is startling. Indeed, a quick look at Euribor futures (Interest rate futures in the European Union) show them flat as a pancake for the next year. Given the time value of interest rate futures, that effectively means a rate CUT is now priced in.
Back on April 7, Trichet said that “Rate cuts are not an option at the moment.”

RTE reports, “Looking further ahead, the conditions remained in place for moderate economic growth to continue, Trichet insisted. Global growth remained solid, ‘providing a favorable environment for euro area exports.'” Favorable environment for euro exports? What about EU jobs? What is he smoking, anyway? Let me translate the text of this speech for you in terms that everyone can understand.
Here is the Mish interpretation of what Trichet REALLY wanted to say: “Conditions in the European Union are bad. They will remain bad. We do not really see a catalyst for growth in the European Union until long after Germany and France change their labor rules, and we really do not see that happening anytime soon. In the meantime, and even AFTER reform, unemployment in Germany and France will rise. No pain, no gain. If a rate cut would stimulate sustainable economic growth, we would be happy to do it. As it is, rate cuts will do nothing but propel us deeper into the deflationary death trap that Japan went through. In short, cutting rates would just fuel bubbles in housing, exactly as the Fed has done, but it will not do anything for lasting growth. Things will get a lot worse before they get any better, but at least we are not lying to you as Greenspan is doing in the United States.”
There, wasn’t that 100% understandable? The problem is that anyone who told the truth would be fired or not re-elected. People want to hear lies, even when those lies do nothing but make problems worse. However, it now is readily clear that Issing, and to a lesser extent Trichet, have both caught ECV. In light of that fact, I now confidently predict that the European Union will soon be on the way to ZIRP (zero interest rate policy), after Japan. The nature of the ZIRP game is such that the last one to hit zero wins.

Following is a graph of home prices versus rent prices, with thanks given to this article from creditunions.com:


That is clear evidence of a bubble, is it not? Personally, I think so. Home prices have soared well beyond rental values and wage growth.

Housing Bubbles: Exaggerated Bubble
Wait a minute, says the Cleveland Fed. The housing bubble is exaggerated, according to their study of owners’ equivalent rent. Let’s peek inside the Reuters article:When looking at a Census Bureau house price index that looks at new home sales, the authors found that the price-to-rent ratio had increased 7% since March 2001, instead of the 19% gain registered when using OFHEO data.“Meanwhile, in another paper recently published by the Cleveland Fed, economic adviser Paul Gomme said policymakers should step in to prick asset bubbles, particularly in stock markets, before they become large enough to cause a broad setback to the economy.”

“‘This apples-to-apples comparison suggests that much of the increase in home prices comes from higher quality, not speculative excess,’the authors wrote…

“There’s no talk of a housing bubble in Michigan as median prices dip below the national average…

“Five years ago, the median price for a home in Metro Detroit was $11,000 above the national average; today, it’s about $16,000 below average.

“‘It sounds like we live in a different world,’ said E’toile Libbett, an agent at Real Estate One in Southfield. ‘We’re leveling off … and in some cases even decreasing.’

“Nationwide, home prices rose 9.7% during the same period and heated up to 15.1% in April, according to the National Association of REALTORS…

“Dwight Labadie recently bought and resold a condominium near West Palm Beach, Fla., for a 30% profit. Meanwhile, his large family home in Grosse Pointe Woods has been on the market for six months.

“Labadie isn’t giving up on selling his four-bedroom colonial, despite a recent $15,000 price reduction and more than $30,000 in improvements.”

Housing Bubbles: Counterbalancing

That’s a nice case study, isn’t it? $30,000 was spent on improvements, and all the Michigan seller could manage was a $15,000 price reduction and home prices that have dropped for the last five years. Does that lend credence to the Cleveland Fed report or take it away? I suggest the latter.

Yes, there is no housing bubble in Detroit; that much is for sure. But bear in mind those Michigan price declines and Michigan improvements are being factored into the national averages and counterbalance “hot” areas, where people are doing nothing but flipping in get-rich-quick schemes.
“Without calling the overall national issue a bubble, it’s pretty clear that it’s an unsustainable underlying pattern,” Greenspan said last month. In a later speech to the Economic Club of New York, Greenspan went on to say that the Fed sees “a lot of local bubbles” in the booming housing sector, but that the central bank does not see a national housing bubble. “We don’t perceive that there is a national bubble, but it’s hard not to see that there are a lot of local bubbles.”
This is probably the only thing he has said for years that has made any sense. Perhaps that explains why no one is paying any attention. Unfortunately for Greenspan, 65% of the real estate total wealth is tied up in those “local bubbles.”

Nearly the entire state of California and Florida are “local bubbles.” Factor in the bubbles in Chicago, Boston, and New York. Does it really matter much if Danville, Ill., and Detroit, Mich., are not in bubble areas? The averages, if anything, smooth out just how enormous the bubbles have gotten in places like San Diego, Florida, Boston, and Las Vegas.
By the way, does the Fed have a consistent position these days? No one seems to know what inning we are in; why long-term interest rates are not rising; whether or not there is one big bubble or just a bunch of small ones; or, if you believe the nonsense from the Cleveland Fed, no bubble at all. Just what does the Fed agree on?

Let’s backtrack a moment to this comment, reported by Reuters: “Meanwhile, in another paper recently published by the Cleveland Fed, economic advisor Paul Gomme said policymakers should step in to prick asset bubbles, particularly in stock markets, before they become large enough to cause a broad setback to the economy.”

Is that comment supposed to be believable? When has this Greenspan-led Fed EVER acted to prevent a bubble from forming? Given that Greenspan now sees multiple local bubbles as well as “an unsustainable underlying pattern,” Greenspan has blown yet another bubble (multiple local bubbles, if you prefer), by his own admission. If the Fed wants to fight this bubble, it seems to me they are at least two years, and probably more, too late.

Housing Bubbles: Weighing the Evidence
Just to be sure, let’s weigh the evidence.
Factors that suggest there is no bubble:

  • Quality improvement analysis
  • Detroit, Mich., and other Rust Belt areas
  • Danville, Ill., and other sad Corn Belt areas

Factors suggesting there is a bubble:

  • Rampant flipping
  • Parabolic increase in real estate transactions
  • Parabolic increase in the numbers of real estate agents
  • 125% loans
  • Equity extraction
  • Home prices well beyond rental prices
  • Home prices well beyond wage growth
  • Books
  • Magazine covers
  • Hot media topics at parties
  • Real estate seminars
  • Investment clubs
  • Fear of being left out
  • Interest-only mortgages
  • 36% of homes sold in 2004 were for “investment” purposes or for second, third, or fourth homes
  • Rising foreclosures

In light of the above, the analysis by the Cleveland Fed suggesting there is no bubble is good for one thing only: a good laugh.

Mike Shedlock, “Mish”
June 14th, 2005

The increase comes from higher quality, not excesses? Is that supposed to be a joke? What extra quality is the average condo flipper in Florida or California providing? But let’s assume for a second that the increase is 100% due to “quality.” Does that change how much rent someone is getting? So what if someone put an extra $50,000 into a house if rental prices do not cover it.

Others have argued there is no national housing bubble. Well, in a sense that is absolutely correct. Let’s take a look at Detroit for example. No, on second thought let’s take a look at Michigan in general. According to this article by Detroit News, Michigan is missing out on soaring home values: