Brad Setser

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Housing bubbles, the great plains and the coast

by Brad Setser
May 27, 2005

Not all parts of America are enjoying a housing bubble. $65,000 will buy a brick home with three bedrooms and a two car garage in Stafford Kansas, though maybe not ten acres of prairie as well.

Low interest rates are the common denominator linking together Greenspan’s frothy local housing markets, but local conditions can dominate low national, if not global, interest rates. If there are more houses than people, it is hard for housing prices to increase much — even if interest rates are low. Without new investors chasing the windfall gains from the initial surge in prices, there is not as much speculative froth. In those parts of the US where the population is shrinking and incomes are generally low (Note: Timothy Egan’s reporting on the plight of great plains small towns has been excellent), there does not seem to be much of a housing bubble.

To paraphrase Paul Kasriel’s summary of Greenspan, there is no housing bubble in Manhattan KS (where I grew up), but there is one in Manhattan New York (where I now live). That characterization is a bit off. Manhattan KS (a growing university town and regional medical center) is far more frothy than say Stafford or St. John’s KS, but it has a grain of truth.

Even within “bubble” America, there are differences. Interest-only markets like California seems to have a bit more froth than someplace like almost interest-only Washington DC. The rent to price ratio is a bit higher in California than in DC, where rental prices have trended up. All that homeland security and global-war-on-terror related work … The real estate bubble has generated big money — at least on paper. Dollar turnover in the housing market was equal to 10% of US GDP in q1. Housing accounts for 40% of all bubble job creation. The US real estate to GDP ratio is now approaching the US equities to GDP ratio back in 2000.

Update. Calculated Risk has drawn attention to this NY Times article, which notes that real estate may account for 25% of the US economy …

Since real estate is relatively widely owned, as far as financial assets go, the capital gains are probably not as concentrated as the (paper) gains from the .com bubble. But the surge in housing prices still has enormous distributional consequences. The net worth of those who already own homes — generally an older group — has gone up, along with the net worth of those lucky (or smart) enough to get in early. Those who don’t already own homes are worse off; the cost of buying a home has gone way up.

And there is a regional component — the coasts have generally had more real estate froth than the interior. Alan Greenspan’s everyday low interest rates have been kinder to blue states than red states.

John Berry rightly has highlighted the distributional consequences of the mortgage interest tax credit and other housing tax subsidies:

Altogether, the benefits from those tax breaks are wildly skewed according to income levels and where taxpayers live. In general, higher-income households that can easily afford to own a house without such subsidies get the bulk of the benefits.

Last year the National Bureau of Economic Research published a paper by two Wharton School economists, Todd Sinai and Joseph Gyourko, who used data for the U.S. 2000 Census and other sources to compute the subsidy per owner-occupied unit in each state in 1999.

That subsidy ranged from a low of $2,240 in North Dakota to $12,759 in Hawaii. Among metropolitan areas the disparity was much greater: $26,385 in San Francisco-San Mateo-Redwood City, California, and a scant $1,541 in McAllen-Edinburg-Pharr along Texas’s Mexican border. Some East Coast areas also had huge subsidies and many in states such as Tennessee, Ohio and Louisiana got little benefit.

Given what has happened to home prices on the two coasts since 1999, the unevenness of the value of the combined tax breaks has soared.

(Sinai-Gyourko paper here)

Of course, eliminating this tax deduction is about as politically viable as eliminating agricultural subsidies.

Indeed, there are some similarities between housing subsidies and agricultural subsidies, even if agricultural subsidies transfer income from urban to rural areas and housing subsidies transfer help urban at the expense of rural areas. So long as agricultural subsidies are linked to the amount produced, they transfer more to large landowners than small landowners. Set the price high of say wheat high enough to keep smaller farmers in business and bigger farmers will do very well, at least in the absence of some kind of cap. Tax subsidies for interest payments on housing are worth more if you have a big house with big interest payments and pay a high marginal rate than if you have a small house, small payments and are taxed a low rate.

Since salaries and housing prices both tend to be higher on the coasts, the net result is clear: this is a government policy that favors the haves on the coast over the haves in the interior, and haves over have-nots everywhere. There is no “rent” tax deduction last I checked.

My Midwestern chauvinist side always thought it was amusing that the big, sort-of-national daily papers waxed far more eloquent about eliminating farm subsidies than eliminating suburban housing subsidies. Everyone has constituents.

One last aside: US farm subsidies certainly do need to be reformed, particularly those that have a large impact on poor farmers in the world’s poorest countries. But I also wonder if low-interest rates have not made it more difficult, politically, to get rid of agricultural subsidies, not just housing subsidies. Low interest rates increase the present value of future farm subsidies. To the extent that the market assumes current agricultural subsidies will stick around, they should increase the value of “subsidy-generating” assets — like land. Alas, I don’t know enough to even try to test this hypothesis.


  • Posted by Stormy

    I read thru Brad’s links and followed one to The Environmental Working Group Public Interest Watchdog.

    Here you can find a wealth of material concerning subsidies, who gets them (complete list of recipients), how much, and for what…in any state in the union.

    As one who has experienced the “have-nots” on the coast, the have-nots in the heartland is an eye-opener, certainly Nebraska. No bubble there…

  • Posted by Movie Guy

    A top quality housing post.

    “Housing accounts for 40% of all bubble job creation.”


  • Posted by Navin

    ” The US real estate to GDP ratio is now approaching the US equities to GDP ratio back in 2000. ”

    This reminds me of Paul Krugmans statement .. the Fed keeps inventing one bubble after another , last time the Stock market bubble now the housing bubble !! But how badly the stock market bubble burst ?

  • Posted by Tom Marney

    MovieGuy, you’ve probably already seen this, but on the chance you haven’t:

  • Posted by Movie Guy


    Thanks. CR nails it down very well.

    CR’s recent posts at his blog add fuel to the fire. I believe that his concern that the potential housing rollover situation will have impact on the general economy is correct.

    We’re probably in for a rough ride.

  • Posted by js

    The combination of a low inflation target and a zeal for mitigating Federal outlays has generated an inherent risk of abnormally and unjustifiably low nominal interest rates. This is probably exacerbated by what Ferguson calls “search for yield” behavior. In a stable so-called low inflation environment coupled with a “global savings glut”, this entails a self reinforcing cycle of increased risk taking. In effect, policy makers are victims of their own success. By providing a benign investment environment, the desperation of capital for returns has undermined traditional financial stability and security. By changing the risk/reward equation of investment, policy makers have made obsolete institutions and safeguards that reflected older equations. To be fair, increasingly complex global financial flows have contributed to this obsolescence. But by now it should be clear that the cure for inflation and economic instability reflected in recent policies and their underlying assumptions might perhaps be more virulent than the malady.

    Massive resources have been diverted to unsustainable and nonproductive ends. While the older world America (ie industrializing centers of the 19th and early 20th centuries) still exhibits something of an exemption from the asset inflation consequences of late 20th century macroeconomic policy (but not from the consequences of globalization!), it will still fall prey to the systemic risk being incurred by the modernizing more populated parts of the nation, and in fact the entire world. The closing of factories of older world businesses, with pension plans and unions in demise, abandoning “embedded liberalism” is par for the course. It is part of the zeitgeist of our “benign” times. When you go to many of the parts of older America, the ghost of embedded liberalism still haunts the cheap housing, the dying factories, the cracking freeways and closing schools. We don’t have a national bubble because we don’t have a pervasive economic boom. We have a demographic, geographic and economic shift to contemporary flows of capital dominated by transnational entities, displacing provincial stability and fostering migration to urban transitory centers on a global scale. The pattern of housing bubbles reflects the interaction of fiscal and monetary policy with the economic evolution manifested in globalization, transnational entities, specialization and technological innovation.

  • Posted by BH

    “We have a demographic, geographic and economic shift to contemporary flows of capital dominated by transnational entities, displacing provincial stability and fostering migration to urban transitory centers on a global scale.”


  • Posted by jprime314

    Thoughts and questions….?

    Trend growth for the US over the past century is ~1.8%; since WWII its been around 3%…but in the past decade or two we’ve grown faster than either of these. Hence growth economists predict an eventual period of sub-trend growth which will bring us back in line with our long-term trends.

    So question: is this combination of low-interest rates, a hot housing market, record US debt, and dependence on foreign lenders priming us for sub-trend growth?

    Why this combination:

    -interest rates are low, allowing lots of people to buy houses they couldn’t otherwise afford (hmmmm…can they even afford the rising property taxes?)

    -if jobs get lost, then people won’t be able to afford mortgage payments or the property taxes

    -if China slumps OR US innovation slows OR interest rates spike, then jobs will get lost

    -since China’s peg sticks it with US monetary policy, and since China has poorly functioning economic & political institutions, then it is designed to overheat, or respond inefficiently to shocks (e.g. bird flu), and therefore eventually suffer a hard landing….and slump.

    -If China slumps, then demand for US capital goods and US debt will decline. This will cause US interest rates to spike and jobs to get lost (further hurting China?).

    -As US jobs & the economy slows, people can’t afford their houses or property taxes. But they will have trouble selling since housing markets are fractured and relatively imperfect. A potential market failure? A major drop in US consumption by first time home-owners not willing to part with their homes?

    -Since houses are fixed assets in imperfect markets, the economic losers here will seek redress in politics. Will Republicans be swepts away and Democrats be victorious…to the glee of social liberals but to the deteriment of free-market economists & economic prosperity? Even higher taxes & interest rates? A reinforcing downwards economic cycle and subtrend growth?

  • Posted by hbj

    What’s so dangerous here is that the policies FCBs have pursued to provide for stability domestically have also as a side effect provided a false and undeserved stability in the US.

    This has led to a sense of comfort and infallibility that has driven record deficits the US hasn’t really needed to take seriously, drastic overindebtedness, little attention to savings or investment, and massive speculation including many little-understood new instruments of leverage.
    Markets typically will adjust for imbalances and close gaps. But here certain markets have been prevented from operating (the dollar/renminbi being the biggest case), which puts the US in extreme peril. Should markets be freed, the US will be hopelessly underprepared, having essentially adapted its economy to the free money paradigm under which it’s currently operating.

    It is commonly believed that Europe is in trouble and that the US is healthy. I believe this a mistaken way to assess the situation. Europe is simply going through disinflationary adjustment as it should and must in a global economy when conditions warrant. The US is not so much healthy as simply being held back from needing to adjust due to the self-interest of many parties.

    While it’s nearly infinitely difficult to predict how things will play out due to the immense complexity of the situation – the number of interested parties, the sheer scale of the numbers and the clear lack of historical precedents for guidance among other things – it’s equally hard to figure a scenario where the US comes out in any kind of good shape.

  • Posted by Stormy

    Jprime314 said: “…but to the detriment of free-market economists & and economic prosperity.”

    I guess the rejoinder is: This is a very selective and dangerous economic prosperity, even within the “frothy areas,” let alone Nebraska. In short, we have a very unbalanced economy. The housing bubble will certainly cease when the driving force for it—the real wealth pouring into these areas from the transnational and investment communities and tax breaks, not the interest rates—have sufficiently sated their desire for property. I am reminded of Lewis Black’s comment on how he would spend such wealth. Chuckle. The next bubble?

    And, its demise will ripple throughout the general economy. Those who tried to ride on the coattails of this new wealth through property speculation will be hurt. Those who are left holding interest-only mortgages will be in danger. (Already bankruptcies are up.) Moderate income earners will find their property taxes through the roof. The construction industry—and all who are tied to it, from raw materials to labor—will contract.

    I would love to know that free-market economists in favor of economic prosperity suggest for Nebraska and the heartland? Hey, they tried to get hi-tech companies to go there. Read the links in Brad’s posts.

    Suggestions, jprime314? Leave it to the prairie dogs?

  • Posted by anne

    Is Your House Overvalued?

    Four days after Alan Greenspan, the Federal Reserve chairman, pronounced the nation’s housing market frothy, a new report on home prices this week suggested that he might have been understating the situation. Even after one of the steepest run-ups on record, home prices have jumped another 15 percent over the last year.

    While gleeful about their apparent riches, homeowners in many of the hottest areas are also growing concerned. How, exactly, does one know if the family palace is sitting atop a bubble about to burst? …

  • Posted by brad

    interesting comments; hbj — no disagreement from me with your argument, including the argument that the real-estate induced surge in consumption over the past couple of years has generated a false picture of the underlying health of the US economy. Europe’s current account is in balance or perhaps even a slight deficit at $1.3 to the euro — the US is no where near balance. And if the US ever lost access to cheap financing, it is not obvious to me that the US has the industrial (or service exporting) base to respond quickly to the opportunities created by a weak dollar — that is the price of adjusting to a world of “nearly-free” money. Nearly free money seems to be spurring far more investment in real-estate and non-tradables than in the next generation of tradable good and service production.

    jpprime314 —

    “If China slumps, then demand for US capital goods and US debt will decline. This will cause US interest rates to spike and jobs to get lost (further hurting China?).”

    I agree with much of what you argued, but not this.

    US capital goods exports to China are pretty small. GE and boeing, that’s close to it. Annual US exports to china are in the $40b range — not so high. And a decent chunk of those exports are things like scrap iron and soybeans and bulk commodities. An impact — sure, a bit impact — probably not. at the end of the day, Europe matters more for US exports (leaving aside “indirect” US exports to China — i.e Brazil imports US capital goods with $ earned selling iron and soybeans to china)

    And a slump in China, ceterus paribus, implies falling investment and/ or falling consumption — both of which would tend to increase china’s domestic savings surplus. China’s current account surplus would balloon even more. It may be 8-9% of GDP this year as it is. That implies more money to lend to the usa. The only possible offsetting force might come if “hot money” stopped flowing into china/ flew china. That means China would have less reserve growth even if its current account surplus surged. But the $ not going into China would have to go somewhere (a friend who should remain anonymous deserves credit for this point0.

    what worries me is the protectionist response a 10-12% of GDP Chinese trade surplus (global)/ a 12-15% Chinese current account surplus might engender — if you run huge trade surpluses in (relatively) good times, the United States capacity to act as an importer of last resort in your “Bad times” may be constrained.

  • Posted by anne

    Is There a Bubble In Florida Waiting to Burst?

    LAKELAND, Fla.

    ERIC SITCHERAN, a New York City banker, has been researching the Florida housing market since 1999, looking for just the right time and place to buy. He waited through the uncertainties after Sept. 11 and delayed again as four hurricanes struck the state last year.

    While waiting, Mr. Sitcheran, 60, and his wife, Dawn, who are from Queens, and who plan to retire this summer, watched Florida housing prices outpace the increases across the nation. Hoping the market would take a breather long enough for them to decide on the right spot and builder, they nervously kept up with news about shortages of building materials and labor, dwindling inventories of available homes and lengthening delivery times for new construction….

  • Posted by DC

    thanks for the post brad.

    so many things to comment on. first:
    1) is it possible IO loans are rational for more people now than before? when i made my decision to get one the bottom line was this: I never ever planned to payoff the mortgage on this house and retire here. i think increased mobility has a part to do with this phenomenon. i mean, who ever hears of a “mortgage burning party” anymore?

    2) i’m still not sure what the tone of your post was actually. i read you saying that bubbles are not national. i’m glad to hear people talking about this now. doesn’t the absence of a national bubble reduce the claims that macro factors (i.e. IO loans, low rates etc) are the cause and culprit? it seems more to me that your explanation acknowledges more towards the fundamentals. i.e. national security spending in washington dc.

    3) if you eliminate the mortgage interest deduction, will you eliminate the interest income tax as well? the housing subsidy as you call it is a direct result of the progressive tax code. hard to have it both ways it guess. the progressive tax is supposed to help the have-nots, but now its being characterized as anti-have-not?

    4) i dont have the data to support this, but: is it possible we’re missing out on acknowledging the “have” economy is BOOMING regardless of real estate? i think that have-nots are far worse than we think and the haves are far better. the aggregated GDP numbers aren’t showing that boston, la, dc, sf, sd etc are simply undergoing boom times. therefore, real estate in those areas is in higher demand. add to that low rates and here we are.

    5) the repricing that has taken place due to credit policies changing is not going to go away i think. the subprime/junk borrower market is not going to go anywhere. even as recently as the 80’s borrower default risk was housed by the local bank. now its dispersed across the globe.

    in sum it sounded to me, and please correct me if i am wrong, that your post leaned a little more towards fundamental/structural explanations for the real estate boom rather than pure interest rate driven speculative crazy behavior.

    all that being said: as the owner of a construction company, architecture firm, real estate brokerage and a full-time real estate developer –

    where should i be putting all my excess profits?

  • Posted by anne

    Take a look at the yields of public utilities or the Vanguard Utility Index. Also, there are the international drug companies or the Health Care Index. Though I have preferred the managed health care fund, the fund is closed to new investors. Always there is the GNMA Bond Fund simply to be highly conservative. All bonds in the portfolio are Treasury insured, low 2.8 year duration and about a 4.5% yield.

  • Posted by anne

    When the Numbers Don’t Match

    AS real estate prices have soared in recent months, some buyers have found that the apartments they’ve agreed to purchase were appraised for less than the sale price – with often knotty consequences.

    Sometimes, the collision of inflated prices and deflated expectations so unnerves buyers that they look for ways to get out of a deal. Other times, they still want to go ahead but are forced to find more cash or more creative financing, because a low appraisal means they can’t borrow as much in the form of a traditional mortgage….

  • Posted by brad

    dc — Chinese RMB and Malaysian ringgit t-bills, if you can find a way around their controls. What else could I say ..

    Do check out general glut’s post on this, noted by delong. the variance between the price to rent ratios in different cities has increased substantially over the past few years.

    Some of the gains acruing to the “haves” on the coast stem from the surge in real estate — there is a mutally reinforcing phenomenon. Regions that do well (at least at the top) see housing prices go up, particularly when interest rates are low. Higher housing prices = more people do well.

    that said, I am not in the “its all local” camp; low interest rates are a big, big factor in the strength of the rise. In someplace like Wichita KS (see William Polley’s blog), low interest rates make big new houses affordable, but they have not fueled a huge surge in the price of all housing. It is too easy to go out and build a new house not so far from the “economic” center of the city. In places where the supply of housing is more constrained, particularly in “hot” or desirable neighborhoods downtown, low interest rates plus decent incomes plus new residential financing technology (a point you have made that I think is important) = rising housing prices.

    But now i think we have entered into a phase where past increases in housing prices are leading people to expect further increases in housing prices — something that may well be possible on a sustained basis if interest rates go even lower. Better hope there is a global savings glut and it all really wants to flow to the US …

    Incidentally, the parts of the country that are not benefitting from the real estate boom (or, where, depending on your point of view, those without existing real estate have not been pushed out of the market) tend to be “rust belt” or “corn belt” states with substantial employment in the tradables sector of the economy. They would win from a big fall in the dollar that comes as part of the adjustment that reduces the trade deficit, and not be hurt as much by higher interest rates if the global savings glut dries up. Housing prices have not risen as much, so they don’t have as far to fall … The opposite is true of the coasts, or at least parts of the coasts. Some coastal cities are geared toward producing services for the domestic market, and all, even those with “export” sectors like LA or Seatle, have seen bigger surges in housing prices. They are more vulnerable to a surge in interest rates — hence my prediction that the coasts will demand protection from rising interest rates when the adjustment comes.

  • Posted by gillies

    there is plenty of precedent for the u s property loan situation. plenty.

    there is a book called something like ‘ agricultural fluctuations since the sixteenth century.’ it relates the story of big farmers able to get loans from the moneylenders – the earliest goldsmiths and primitive moneylending bankers in continental europe. note how even today the big farms are often on the good land – the small farms are on the poor land. you might expect to find it the other way around. it is an effect of ability to get loans. no one risked lending to the mountainy men.

    but time after time, when the three bad harvests in a row came, the moneylenders foreclosed on the big borrowers. the little guys up the hills quietly starved but kept the farm.

    ireland 1947. – ‘no hay in the shed. no bread on the table.’ later in this year of the big snow the army was sent out to help with the harvest.

  • Posted by gillies

    Abel, W.
    “Agricultural Fluctuations in Europe from the Thirteenth to the Twentieth Century.”

  • Posted by mycousindean

    Your “prediction that coasts will demand more protection from rising interest rates when the adjustment comes” is accurate only in so far as demands will be made, but action will not follow.

    The Republican controled government will remember that the two coasts voted “incorrectly” last November. Verbal sympathy, yes. Action, no.

    Any legislative/administrative protection would be seen politically as bailing out rich people who speculated poorly.

    Not-so-well-off red state middle america voters may silently enjoy seeing the high and mighty blue staters fall down a bit, tripped up by their greed.

  • Posted by anne


    I have a couple of Irish histories that were given to me, but I have not read any Irish history directly as opposed to literature references, so time to start.

  • Posted by anne

    There are Irish real estate investors from France to Spain and Portugal to South Africa.

  • Posted by DC

    thanks brad. this resource is truly sensational for someone like myself. my educational background is in economics and that of EM/LAT AM economics in particular. thanks for helping to keep me current. its awesome for cocktail parties and for making my wall street friends think i know something.

    one part of the general public’s analysis i dont like is the use of typical housing costs/income ratios. there has got to be reasons as to why people would be willing to pay a larger portion of their income to property. i know that manhattan in the 70’s doesn’t compare at all to it in the 2000’s. thus it seems rational to believe people would pay more of a portion of their income to live there. same thing goes for DC. even baltimore.

    i agree with most of all the arguments supporting the ‘froth’ issues. but i am just amazed at how many absolutely compelling fundamental reasons there are right now for real estate to be appreciating. its just astounding that all these factors have come together at this moment in time.

    who can put a figure on the value that ownership contains? what value is there to being able to modify your property, build, dig, whatever. all the things you can’t do when you rent. how to quantify that? it could explain, and should really compell there to be a premium paid to own the same property vis-a-vis renting it. no?

    do you have any feedback on my comment regarding the progressive tax code being the culprit for the ‘housing subsidy’ your wrote about?


    again – thanks for the blog and website that you a part of. it is a real treasure trove of information, dialogue and thought.

  • Posted by brad


    I would characterize it as the inevitable consequence of a tax deduction (i.e. something that reduces your taxable income) and a progressive tax structure. “deductions” against marginal income are worth more to folks with higher overall income, and thus folks subject to higher tax rate on the last dollar. Get rid of the deduction, and the tax code becomes even more progressive. more income gets taxed at the higher marginal rate.

    Give everyone a $1000 refundable tax credit against rent or mortgage interest and it becomes even more progressive — folks who don’t pay any taxes but pay rent or interest get money back … And of course if you pay more than $1000 in rent or mortgage interest, there is no subsidy at the margin.

    thanks for the feedback as well

  • Posted by anne

    Thanks, from me too, Brad 🙂


    Often I am in New York City, and have a house there, and I can offer every possible reason for for why prices have increased as they have, and I have seen neighborhoods transformed for the better as houses and apartments have seemed more desirable. But, there is something wrong with the trading, the flipping and the run in prices and I am cautiously worried.

  • Posted by aiontay

    I work as a planner for Moore, OK. For the last couple of years Moore has had a housing boom. We keep wondering how people can afford the housing and how long the housing boom can go on. Of course, the “high” house prices here would make folks on the coasts laugh, but then look at our median income. Something is not matching up. My boss lives in Oklahoma City (being single, she couldn’t find a house she could afford in Moore) and her house has gone up in assessed value $30,000 in the past couple of years. A similar situation applies in Tulsa, my hometown.

  • Posted by anne

    What is happening to property taxes? I expect there will be a successful wave of property tax cap initiatives in the near near future.

  • Posted by azurite

    At least one article I’ve read (Wall St. J, Businessweek) has indicated that of housing sales, up to 30%+ of real property purchases are second/vacation home (to be rented out when owners not using) or real property bought as investment(not necessarily to flip, but as rental property). So how accurate are some of the other statements I’ve seen: that more people than ever own their own home, etc.? When the surveys are done (and who does them?) how is it determined if the purchasers are buying a primary residence or have another purpose in mind? If there is, in fact, a housing bubble, will it make any difference in the effect of a collapse if 30+% of purchases are not primary residences?

    I don’t think the coastal states are strictly “blue”–last time I looked at a map of the US- Georgia, VA, Alabama, TX, FL, Louisiana are on a coast too. Michigan, IL, Minn., WI, and Indiana aren’t exactly coastal, but they are certainly near or on huge bodies of water, and some of their ports handle significant amounts of international shipping. In addition, it’s only some parts of the coastal states that are seeing the huge increases in prices. Oregon is a “coastal” state, but some towns in eastern OR have almost disappeared.

  • Posted by brad

    mycounsindean —


    Almost guarantees that not only will there be demands for protection from rising interest rates, but that both parties will have an incentive to act on those demands. I bet parts of the Carolinas are also a bit frothy — tho, like Oregon, there are probably big differences within the state. And while not as frothy as some other places, my guess is that there is a bit of forth even in some deep red states (see Oklahoma … )

    azurite — good points. Oregon and Washington are bisected by the Cascades, and from what I gather, the economy on either side is as different at the climate …

  • Posted by glory

    re: coasts vs. plains

    saw this on metafilter… ‘sweeping out the plains‘ with this map… whereas the coasts have their own problems

  • Posted by mycousindean


    Florida! You got me.

    On another item: You mention the role the deductability of home interest expense plays in encouraging new home buying. But I would add a couple of more things.

    One, note the $250,000 tax free gain per person ($500,000 per couple) on the sale of a home lived in for 2 of the prior 5 years. This creates a zero percent capital gains tax investment. Coupled with a low down payment and you have a highly leveraged tax exempt investment that also provides the current utility of a shelter.

    Two, the Alternative Minimum Tax eliminates or discounts many other tax deductions–but not home interest until very high limits.

    Lastly, I know several very solvent capitalists who carry interest only home loans on the maximum possible principal. These guys do “deals” for a living and they view their home loans as a very low cost source of capital. They consider capital used more efficiently as the same thing as having more capital.

    Additionally, limiting the lender only to recource against the home in case of default further mitigates these capitalist’s risk position.

  • Posted by dc

    “Lastly, I know several very solvent capitalists who carry interest only home loans on the maximum possible principal. These guys do “deals” for a living and they view their home loans as a very low cost source of capital. They consider capital used more efficiently as the same thing as having more capital.”


    mycousindean: all these things you mention are what I call the ‘structural causes’ of the boom as opposed to fundamental or speculative. these a risk underwriting processes etc are not going to go away. nope. there has been a ‘repricing’ of property based on these factors. add to that the tectonic fundamental forces and here we are with a boom.

    what is interesting is that it could have been the fundamental/structural issues that took us this far and now maybe it will be speculative mania that takes us over the precipice.

    or not.

    everything could simply just mellow out and hit an equilibrium – no?

    brad: do you really see a forthcoming spike in short-term rates coming from the breakdown of BWII?

  • Posted by dc

    A Bane Amid The Housing Boom: Rising Foreclosures

    By Michael Powell
    Washington Post Staff Writer
    Monday, May 30, 2005; Page A01

    rising foreclosures. no stats, but i wonder if the growth in foreclosures is outpacing the growth in new home ownership.

    its a sad story but there will always be people on the margin who lose. but no one really cries when junk bond issuers go under do they? please remember thats what this is. bonds.

    new home equity should not be used for consumption or bills. its a problem that marginal borrowers, unsophisticated borrowers are using their equity for the wrong purposes.

    i use the money i save on my interest only mortgages for investment where my returns are greater than the 5.5% i’d pay on the loan(s).

    there are also many many unscrupulous lenders who work in conjuction with foreclosure predators. you make a HELOC loan to a someone with lots of equity in their home, usually a senior citizen. they dont realize that they have to make the payments and all of a sudden they are in foreclosure because of a $20k loan on $300k in equity. then the predator swwops in, offers to relive the debt. what the owner doesn’t realize is that they sign away the title to the home and become renters in their own home. eviction follows.

    this is one theme on many but this happens all the time in washington dc for sure.

  • Posted by brad

    glory — nice links. I was in one of those red counties on the map in central KS last week.

    dc — I think short-term rates are headed up independent of what happens with BW2. the fed has been pretty clear that it plans to tighten — and so long as the US economy continues to plow ahead, that’s what they will do.

    If bw2 disappeared, would it impact the long-rate . Yes, I think so — I don’t think 4% nominal compensates any private actor for the risk of future dollar depreciation, particularly in asia. But that is premised on the belief that I don’t think the US can continue to run a 6.5% of GDP trade and transfers deficit for the next few years (that trade and transfers deficit implies a larger current account deficit b/c of net interest payments, at least 7.5% of GDP by 08). Foreign investors should care less about inflation, and more about expected exchange rate moves. It is possible that the US external adjustment process will be inflationary (b/c of the falling dollar/ rising price of tradables) and that will constrain the Fed’s ability to cushion any adjustment with a return of low rates — but it is almost certain that the adjustment process (when it comes, which means when asia stops financing the US to avoid adjustment) will imply a large move in the dollar against those countries now running large current account surpluses (euro/ $ is a bit harder to predict)

  • Posted by dc

    is it possible:
    1) the economy is not that strong as evidenced by the stagnant stock market
    2) the economy and inflation are low as evidenced by the yield curve
    3) short term rate hikes are nearing an end
    4) stronger USD/Euro from interest rate differentials keeps inflation down as well as compells china to intervene more
    5) economy is really fundamentally weak and has been fueld soley by home equity cash outs and wealth effects

    what happens then?

  • Posted by brad

    1) is certainly possible. throw in low long-term rates as part of the evidence, and signs the export boom created by the dollar’s weakening is petering out — leaving the consumer as the sole driver of the expansion.
    2) long-term rates are low; inflation is not. And to be honest i increasingly think “core” inflation is misleading — it includes all the products were china is having a disinflationary or deflationary impact (traded goods) and excludes a decent share of the products where demand from china is having an inflationary impact (commodity grains, which feed into a range of foodstuff, oil … )
    3) the market thinks so — I don’t think the fed thinks so …
    4) Weak $ v. euro did not feed through to import prices, was just showing up in profit margins. expect Mercedes and BMW are happy about now — they may even want to lock in 1.25 if they can in the futures market … not sure how this compells China to intervene more — RMB is appreciating for the first time in years … China is intervening more b/c its trade surplus is ballooning on the back of slowing domestic demand in china as investment cools off a bit.
    5) Probably true — that is the Gross thesis, and he expects it to get weaker as those effects peter out …

    there are three broad possibilities — the subject for a future post. 1) Economy continues on its current trajectory, but in a slightly weaker way. Export growth slows as world economy slows, consumption growth slows as homeequity gets tapped out and future gains are limited, etc, etc. but basic structure of economy is unchanged — longer term interest rates stay low, commodity prices stay where they are now, trade deficit expands, china keeps financing the usa. problem with this scenario — there is no external adjustment, either in the us or abroad. if you think — as i do — that us external imbalance is reaching dangerous levels, that eventually triggers a correction. 2) external adjustment without higher short-term or long-term interest rates. in this scenario the $ falls. And the US economy cools on its own, even if the fed stops tightening pretty soon/ long-term interest rates stay the same/ even fall a bit. To get external adjustment in an economy that imports 60% more than it exports, tho, the $ really has to fall/ US consumption really has to slow … 3) external adjustment triggered by higher rates. whether higher policy rates as the fed tries to bring demand growth in line with supply growth (cannot emphasize enough now unusual 6% of GDP plus and growing trade deficits are — even for economies with larger export bases than the usa)/ the economy is a bit stronger than people think and consumption growth powers on an unsustainable pace pushing up inflation or b/c US external creditors tire of financing the USA at current rates, given rising external debt and a growing trade and current account deficit.

    by the way, have the new residential financing techniques for homes been stress tested in a high interest rate, slow economy scenario? They all were created in a low interest rate, weak economy environment …

  • Posted by jm

    The Joker in the pack will be who Shrub appoints to replace Greenspan. Will Snow move over from Treasury? Or will it be some other lackey who’ll do whatever Bush wants?

    I’m wondering whether we’re not going to need to increase our Japan-China trade deficit quite substantially — who else will have the money to buy the Fannie/Freddie Resolution Trust bonds?

  • Posted by js

    I live in downtown San Francisco, and at a cursory glance it looks like a strong economy. Cranes everywhere building new high rises housing pricey office space and muds topped with luxury condos. You drive down the road past packed expensive restaurants and get swarmed by Lexus, Mercedes and BMWs that don’t even have license plates yet…the consumption level is staggering. But when you ask where all that money is coming from it looks shakier. I’m tempted to stand in the doorway of one of these restaurants and announce that I need a Realtor and Mortgage Broker (would that be like yelling “fire!” in a crowded theater?)

    I know I’ve argued the inflation issue here before. I think there are a lot of people misreading the yield curve. The bias and mismeasurement case has been argued well by Gross and others, so no point in rehashing their far more eloquent and precise arguments, but I have to include this frank passage by BLS: “The CPI also has a significant impact on the finances of the Federal Government. It is used to adjust payments to Social Security recipients, to Federal and Military retirees, and for a number of entitlement programs such as food stamps and school lunches. An increase in the CPI increases Federal statutory obligations for these payments and programs. In addition individual income tax brackets and personal exemptions are adjusted for inflation using the CPI. In this case, an increase in CPI results in lower tax revenues. It is estimated, for example, in the fiscal year 1996 each 1-percent increase in the index produced a $5.7 billion increase in outlays and a $2.5 billion dollar decline in revenues.” To preface an annual overview of revisions with such a statement (and this is hardly the only BLS document that expresses such concerns) says it all. Notice also the implied worldview: one would expect, say in an ideological climate that was preserving embedded liberalism, a preface concerned with making sure that the population was well served by insuring they were getting their statutory share of the pie.

    One thing that concerns me is, if there is a deflationary bias in inflation measures, what will the Federal Reserve and Treasury policy consequences of overstating deflation be if the CPI starts running negative? Does Bernanke get in his helicopter sooner, and with more fresh bills, than he should? I am also curious to see, if there is a protracted (many years) low long term yield that US Central Bankers still view as threatening, how BLS and related agencies will orient their statistical objectives.

    Brad, in your second broad possibility, do you think there could be lowered US consumption at sustained low rates? How do you envision the mechanics of that scenario working? Do you think that scenario could make us end up looking like Japan?

    Jm – Interesting idea about the usefulness of the trade deficit. You have to wonder who in their right mind other than foreign CBs would want to touch Freddie/Fannie instruments anytime soon after reading:
    “The fact that Fannie Mae operated a faulty and inaccurate system for more than two decades reveals serious system weaknesses.”

  • Posted by dc

    no those instruments haven’t been stress tested. but what i like about the situation is that risk is held by the two entities most able to deal: owners of agency and mbs debt and individual borrowers.

    the systemic problem in the past was that it was the SnL’s that held the direct risk.

    re: non real estate economics: yes, many realtor and brokers have made lots of money these days. but come on, the white collar world is flourishing beyond real estate. have we heard of a recession in the legal profession? the financial world? big cap corporate america? nope. all the white collar industries are making cash. is it really then that they all just feel rich because their property portfolio is doing well?

    re: comment 2): how can globalization induced deflation be misleading? i guess because the yuan is supposed to be higher in value and thus a source of cheap products from abroad would be reduced?

    what if people just will never ever buy more US products than imports? i mean, never ever ever. quality, name brand, whatever – lack of production in the US – whatever it may be. what if people just WANT imported goods over domestic no matter what? especially! when the price is cheaper?

    what if we never have anything to export again? are we resolved in the fact that a country can never just be an importer of goods? are we certain that our measuring sticks of yesterday are useful today? is there a better system?

  • Posted by Guest

    my comment about realtors and mortgage brokers was really there for comedic value. but if you look at the numbers there is some truth underlying it: 43% post dot com labor increases in the housing industry. according to NAR there are now 1.4 million realtors. people have made a ton of money on real estate, both in the business and homeowners selling. look at the numbers on cash out mortgages, home equity lines, these real estate backed debt numbers are huge. i think it generates a massive amount of spending that spreads through many sectors of the economy, and that’s why i said at a cursory glance it looks like a strong economy.

  • Posted by brad

    DC — a country can be an importer of goods (with no exports) under one of three conditions:

    1) it exports tons of services
    2) it is a big net creditor and can import goods using its extenral earnings from its external assets (i.e. interest payments)
    3) it can run up its external debt (export IOUs).

    US is no longer exporting tons of services — indeed, we are starting to import more. service trade surplus ain’t growing. US is a net debtor — so 2) doesn’t apply. no turn of the century british empire (big earnings on overseas investments) so that leaves 3.

    and in my view, the balance of payments remains a valid concept. if americans won’t buy american products at current prices, the price of imports has to rise — eventually foreign firms will start producing foreign brands in the usa. i don’t see white collar america shying away from mercedes suvs just ’cause they are made in the usa. but the adjustment process could be painful — no more american smugness toward europe if/ when the world stops accepting IOUs as payment for their goods …

    re 2) deflation. I was talking about core inflation — which leaves out food and energy. it seems to me like that measure includes those goods where china exerts deflationary pressure (not just in the usa, but globally) while it excludes those products (commodities like oil) where china exerts inflationary pressure.


  • Posted by brad

    js — yep, in that scenario the us looks a little like japan. low interest rates, low growth, low inflation (if not deflation) — but since rates are stable at low levels they are not creating asset price inflation to fuel consumption. indeed, you might even have some asset price deflation — with residential real estate playing the role commercial real estate played in japan …

    one obvious difference tho. USA is an external debtor, and a big one. Japan was an external creditor. that probably constrains how low us int. rates can go, unless the $ really, really falls (big fall = expected future appreciation, so incentive to hold dollars, but also inflation … via imports). low japanese rates can be interpreted as necessary to convince japanese to hold the dollars generated by the external surplus, given the exchange rate risk (this is a variant on mckinnon’s conflicted virtue argument). US won’t have an external surplus — but an external deficit that needs to be funded. so us rates have to be high enough to attract that inflow …

  • Posted by dc

    re2) thanks – finally got it. either include all of china’s impact or exclude it, but you can’t have it the easy way i.e. deflation only. whoa – ok so yeah cpi is understated then huh. i mean, its not like i didnt know inflation was out of control already in my business. i just consider those price increases to be demand drive price signals rather than symptoms of a vicious wage/price feedback loop. do you concur? is the ‘old’ inflation style dormant?

    [no signs of wage price inflation yet. real wage growth in usa is pretty stagnant. my argument is not that cpi is understated. cpi infludes oil/ food. my concern is with “core” cpi]

    re1) so the world stops taking IOUs, interest rates go up up up because creditors demand more. eventually we stop borrowing and turn towards domestic producers who will clearly be over run by demand. prices should escalate then too as there won’t be anyone to produce the stuff we need.

    but – how could the domestic producers compete if it stil is cheaper to buy plastic toys from china even though it costs 12% to borrow instead of the 4% today?

    [BWS comment: to make my life easier i’ll insert this here — simple, exchange rate adjustment! either the rmb dollar has to change, or inflation in china/ deflation in the us have to change relative prices the old fashioned way. though hopefully the usa will be able to export enough of something to afford to import plastic toys … ]

    sorry for my ignorance but i am really trying to work this through. though, i still hold on to the “its not different this time but rather its always different” theory.

    [true. the hard part is guessing what will be different and what won’t change]

  • Posted by dc

    does the pce deflator include both sides of the chinese equation?

    am i to understand that a case of run away inflation in china would help the US economy a great deal?

  • Posted by brad

    runaway inflation in china would generate a real appreciation without any change in the peg. Chinaese prices would rise in rmb terms, and with the dollar constant, they would rise in dollar terms as well. This is mckinnon’s preferred mechanism for external adjustment — higher inflation in china. so yes, the US tradables sector benefits.

    as for the PCE deflator, i don’t really know — but i would guess so.

    you mentioned Brazil on a different thread. I would note that Brazil carries with it a lot of indirect China risk, via the commodity market. See iron ore. For more, you need to hire me as a consultant … 🙂 gotta say that using an IO loan to conserve capital and then investing the saved capital in Brazilian real denominated t-bills is a pretty sophisticated carry trade. very global macro hedge fund … world class leverage is increasingly available to the individual investor?

  • Posted by dc

    so whatever the manchurian government can do to foster runaway inflation in china – they will do it.

    i must say brad, i’ve often considered your suggestion regarding consulting. my firm is more of a holding company whereby we allocate capital to its best use. today its real estate. i’m still trying to work on the tomorrow. with my background in LatAm/EM i often look there for opportunity. you most likely know some of my prior employers. they too have looked to brazil for gains. ah, the days of the 60 priced C bond are long gone for now.

    not only do i use IO loans to free up capital, but negative amortization as well. its cheaper than heloc’s. we are value investors – i.e. we create value in real estate through significant physical overhauls and improvements. then we borrow back on that newly created capital.

    but where to put it now?

  • Posted by dc

    speaking my language!

    Mr. Greenspan’s Cappuccino

    By BRIAN S. WESBURY,,SB111749811222546623,00.html?mod=opinion%5Fmain%5Fcommentaries

  • Posted by jm
  • Posted by Movie Guy

    What does the Fed do now?