Not Enough Recession
The problem with this recession, we’ve come to believe,
is that there isn’t enough of it.
Even a typical, post-WWII recession takes the number of
employed down 1.4%. So far, America has barely lost 1%
of its jobs. And as mentioned in this space yesterday,
auto sales hit a near record in October.
This recession is like a bad teenager. We’d like to send
him to reform school…but he hasn’t done anything bad
enough yet to qualify.
Consumers are still muddled and confident – spending
money they don’t have on things they don’t need. And
stocks are selling for prices that would scare away a
sensible man…but seem to attract plenty of insensible
ones. Barron’s tells us that the S&P is selling for 39
times earnings. And the S&P 400 is at 50 times earnings.
Barron’s also reports the extraordinary rise in 2nd home
prices in various parts of the country. You could have
bought a 1,500 square foot condo in one of the best
neighborhoods in Incline Village, Nevada, in 1999 for
about $500,000. Now, it is likely to be twice that much.
A similar place in Rehoboth Beach, Delaware, might have
set you back about $200,000 in 1999. Today, the price
“Call it the double bubble,” said a Business Week
editorial in September. A housing bubble may be
developing – right behind the NASDAQ bubble. Although
overall stock prices are down…average house prices are
rising at an annual rate of 8%. In fact, falling
equities have led many well-heeled investors to shift
money into residential real estate. Robert J. Shiller,
author of Irrational Exuberance, which predicted the
NASDAQ crash a year before it happened, now warns that a
psychological frenzy not unlike tech-mania is gripping
housing. It appears that the Federal Reserve’s dramatic
rate-cutting campaign to stimulate the economy may be
We don’t know if housing prices are overheating or
not…but they’re definitely getting warm.
“You forgot the bubble de jour,” comments a reader on
the Richard Russell website, ” – real estate. Where I
live in South Florida, the big topic at Xmas parties
this year is not the stock market but how much your
house is worth. Time was when houses were homes and you
bought them to live in. If you made a couple of bucks
when you sold them that was fine. But today with
speculation driving house prices through the roof,
people are buying perfectly good houses in my
neighborhood for 25% appreciation per year, tearing them
down and building lot-line houses at ridiculous prices.
This is very close to ending, and it will be even worse
when the market drops, because it will be much more
We wondered, yesterday, where all that hot money that
the Fed was creating would end up. We still do not know,
but at least we have a hypothesis – into a housing
bubble. Sales and prices have leveled off in the last
few weeks. Maybe the bubble has already begun to
deflate. Then again, maybe not.
Buying real estate in this market is not necessarily a
bad idea. Stocks yield barely 1% in dividends. It
doesn’t take much in rent to beat that. If you buy a
house for $300,000 and it saves you $2,000 per month in
rent, that’s equivalent to an 8% yield on your money. Of
course, there are tax considerations, maintenance and so
forth that have to be reckoned with, but you are likely
to end up with a better yield than you could get from
stocks or bonds.
But what most buyers are counting on is not the yield
but the capital appreciation. Investors, aware now that
stocks sometimes go down as well as up, still believe
that house prices only go in one direction – up. Unsure
that stocks still represent a reliable substitute for
savings, consumers believe they have found another one –
their own homes.
“Homeowners have become much more sophisticated
financially by taking out some of the equity due to the
appreciation in value of their homes,” said the nation’s
top central banker, Alan Greenspan, in his testimony to
Congress. “So-called ‘home equity wealth,'” he
continued, “is being mobilized and employed in all sorts
of household decisions.”
What homeowners are doing is mortgaging more and more of
their homes and using the cash for other things –
usually things that break after a few months…
“Investing” in residential real estate has become so
attractive that many people seem to have taken it up as
they once took up day trading stocks. An article in
Grant’s Interest Rate Observer noted that,
traditionally, there are about two existing houses to
every one new house sold. This year, the ratio jumped to
4 to 1. Why? Because people are not buying houses to
live in, but to trade. Grant’s suggests that the ratio
of existing house sales to new ones “constitutes a
measure of speculative activity” in real estate.
As long as interest rates keep falling and home prices
keep rising, the speculations pay off. Stockholders
thought they were getting rich as long as the market was
rising. So do housing investors. But people who “cash
out” the untapped equity in their homes may get a
surprise sometime in the future – when the recession
finally grows up and begins to mug them…already,
mortgage delinquencies are at record rates. But there is
no record that can’t be broken.
So far, the recession has been a mild nuisance. The
billions of dollars “cashed out” of real estate – thanks
to Greenspan’s low rates – have allowed homeowners to
keep up pretenses.
Sales of cars, houses, TVs…and so forth…have held
up, as though there were no recession. But that is the
problem with this recession. There is not enough
recession in it. At least not yet.
December 18, 2001
“The economy will recover early next year.”
Everyone says so. And most people seem to believe it.
Bloomberg reports that consumer confidence has risen
again this month – for the 3rd month in a row.
And analysts seem convinced that corporate
earnings are going up sharply in the new year.
We mention these points of view, of course, only to
point out that it ain’t necessarily so. But I’ll save
the argument for my letter, below, and let Eric tell
Wall Street’s story:
Eric Fry, reporting from New York City:
– The stock market dispensed more holiday cheer on Wall
Street yesterday. The Dow rose 81 points to 9,892, while
the Nasdaq climbed 34 points to 1,987.
– Visions of sugarplums may not be dancing in investor’s
heads, but hallucinations of economic recovery certainly
are. With each passing day, more and more investors
believe they see signs of recovery. The faith is
– The bond market, for one, has become an enthusiastic
convert. Ten-year bond yields soared again yesterday to
a new five-month high of 5.31%.
– Unfortunately, rising bond yields mean falling
mortgage refinancing activity. According to the Mortgage
Bankers Association (MBA), applications for mortgage
refinancings plunged 23% during the four weeks ending
December 7th, compared to the month prior. Consumers
might miss all that easy money.
– Not to worry! Numerous Wall Street economists –
especially the disciples of the financial gospel
according to Greenspan – cite chapter and verse to
support their belief in the coming economic revival.
– These economists point to the curative powers of a
negative “real fed funds rate” (Say “I believe!”) and a
rapidly growing “real M2” money supply (Do I hear an
– [A negative fed fund rate is one that is below the
rate of inflation, meaning that people can borrow money
– “The Federal Reserve’s very aggressive easing of
monetary policy has improved the outlook for 2002,” says
Moody’s John Lonski. “From year-end 2000 to year-end
2001, the federal funds rate has been slashed from 6.5%
to 1.75%…The real fed funds rate is now at minus 0.7%
– its lowest reading since 1977.”
– Lonski points out that one year after the real fed
funds rate hit a record low in 1977 GDP exploded by 6.2%
and corporate profits surged 21%.
– Article of faith #2: The money supply is soaring. Real
M2 appears headed for a 8.3% year-over-year increase in
2001’s final quarter. And as Lonski points out, since
1961, real M2 growth this rapid has always been followed
by a booming economy one year later.
– Northern Trust economist, Paul Kasriel, is also a true
believer. “We have faith in the two monetary-policy
components of the Conference Board’s Leading Economic
Indicator (LEI) Index,” he proclaims. Real M2 money
supply growth is one of them.
– “In November, the year-over-year change in the CPI-
adjusted M2 money supply was 8.4%. Although this is not
the fastest growth in real M2 in the past 40+ years, it
is the fastest growth in real M2 while in a recession.
– So that’s about all there is to it, say Lonski and
Kasriel – easy money will prevail over the forces of
economic darkness. Still, even true believers have
nagging doubts from time to time. Lonski concedes that
business sales are falling at the fastest rate in 20
years. “[This] helps to explain why the profits
from…non-financial corporations plummeted by 26.5%
yearly in 2001’s third quarter. The latter was the most
precipitous yearly drop by this measure of profitability
according to a record that commences in 1947.”
– Furthermore, Lonski’s colleague at Moody’s, John
Puchella observes that corporate indebtedness continues
to rise. “The non-financial debt-to-equity ratio has
climbed from 77.4% at the end of 2000 to 81.2% at the
end of September,” Puchella says. “Corporate financial
decisions are becoming increasingly conservative.” Does
there seem to be a pattern developing here? Will
indebted corporations be any more able to spend our
economy out of recession than indebted consumers?
– “One of the reasons the world economy is not being
particularly responsive to [monetary] stimulation,” says
Bridgewater associates, “is that businesses are in no
position to resume investing, even at low rates.
Industrial production growth is now slightly weaker than
[it was during] the bottom of the early 1980s recession.
Meanwhile, the leading index of industrial production
has also given no signs of a bottom.”
– Oh ye of little faith!
Back to Bill, in Paris…
*** “Banks get stingy with lower rates,” says an Arizona
Republic headline. The poor Fed! Going to all that
trouble to get money in the system…and the banks
*** Neither is the bond market. Bond vigilantes – on
guard against inflation – keep selling, driving up
prices on long-term bonds. Higher long-term rates
threaten to cut off the housing boom.
*** Hugo Chavez may have the answer to this problem. He
says if the banks in Venezuela refuse to make loans –
he’ll nationalize them!
*** Elizabeth and I went to another opera last night,
“La Belle Helene,” by Offenbach. I’ll tell you more
about it on Thursday.