This Is What It Sounds Like, When Doves Cry

When even Eric Rosengren, Boston Fed President, is thinking about “tapering” you know something is a tad askew in FOMC-land. Again and again, these doves (including Charles Evans at the head of the Chicago Fed branch) had advocated the heaviest of hands of monetary intervention. QE 3 & 4 could not have been big enough for this cabal.

Now in justifying “tapering”, Rosengren pointed to his own forecast expectations of 7.25% unemployment and 3% GDP growth by year’s end. This year. Both of those factors would constitute “significant improvement” in the economic parameters that are acting as a benchmark for monetary policy in general and QE specifically. Apparently, President Rosengren is also aware that those expectations are in some places significantly higher than “private forecasts”.

Once again, if this is indeed a set of genuine expectations, we have a case of where Fed models expect success because of monetary policy. We have seen this over and over, where the mere act of QE causes expectations within policy circles to rise tremendously. In other words, the Fed’s doves expect dramatic improvement because of the actions of the Fed’s doves.

I suppose that Rosengren and Evans are that enamored with their own efforts, but as I noted yesterday, the “improvement” in labor and GDP are nothing like the “improvement” in housing and real estate. Cash is king and is acting against artificially limited supply to buoy prices into bubble proportions.

This morning the Wall Street Journal was kind enough to highlight the rising level of house flipping. In some markets, particularly California, flipping is already back to bubble levels. Indeed, the most flipped markets are the very markets, including Florida, where the first housing bubble was most apparent. Investors never learn, or at least the distortions by monetary doves prove just too irresistible for fallible human desires like greed and the allure of get-rich-quick. There must always be a greater fool.

On the other side of the “argument” are people like Jed Kolko, chief economist at Trulia, an “online real estate site”, who claim that there cannot be a bubble because, “A bubble is when prices are rising fast from high levels.” That is a truly absurd notion, a simplistic fallacy – a bubble cannot be a bubble unless there is already a bubble? Petitio principii, ie, begging the question.

Yet that is where we are across the monetary landscape. House flipping and systemic price increases of disproportionate levels are not a bubble because prices are not already in a bubble? But if that were the case, would Rosengren and Evans turn so cautious as to jeopardize the monetary illusion that QE has built? This includes not just the blistering pace of home price appreciation in California, Arizona and Nevada, it extends to every other market that has blistered in the past six months.

Bubbles themselves are not about how fast or from where prices are moving, but an imbalance of prices vs. value at any level. Bubbles occur when fundamentals do not justify current prices for whichever factors are driving the dichotomy. In the current case, the supply of homes for sale is artificially constrained due to foreclosure halts in those very same blistering markets, and the shadow supply of underwater owners that are simply awaiting prices to improve enough to get out without a loss. That was the essence of Fitch’s warning.

On the other side is artificial demand, but not from organic buyers. It has been investment buyers, including flippers and REO-to-rental, those with cash, that has pushed buying activity:

“Parviz Goshtasby, who moved to Southern California three years ago, is finding few homes available to entry-level buyers in Newport Beach, where starter homes can begin at $800,000. ‘I slowly realized that I can’t compete with these investors,’ said Dr. Goshtasby, a plastic surgeon.”

Tapering of QE is not about economic improvement or even irrational self-fulfilling expectations for future improvement. Tapering is about the policymaking, conventional economic class finally seeing the bright lights of all that was wrong with the very same policies from the last decade (and the decade before that). Misallocation in the extreme is what bubbles are about, and we see this almost everywhere now. Again, there is nothing “normal” about 20+% annual price increases in real estate markets absent a massive and unforeseen housing shortage (unless current estimates are extremely off, mass migration into California is not an existing “problem”).

The case for economic improvement as the primary reason for slowing down QE would be far more convincing with actual improvement, or at least a hint of inflation (in the “official” sense, which is the only measure the FOMC pays attention to). I find it far more plausible that “froth” and “exuberance” are words being bandied about in FOMC meetings, so much so that doves have been shaken into a quasi-hawkish stance.

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