Well, there was no crash in the markets last week. Throw in the lovely weekend weather here in Melbourne and we nearly forgot the financial world still teeters on the edge of massive volatility. Expect more teetering.
It’s an especially big week for data on the US economy. No data will be more important than house prices and sales. The New York Times reported this weekend that US median home prices will fall on a year-over-year basis for the first time ever (or since the US became addicted to data on such matters).
“House prices don’t really fall, they just grow less fast.” We remember hearing this time after time when doing radio interviews in 2004 and 2005 from skeptical hosts. “You say there’s going to be a house price crash Mr. Denning, but real estate prices are local, not national. How can there be a national price crash? It’s impossible, by definition.” And so on. Puke. Yawn.
But they were all morons, or at least badly misinformed by conventional wisdom. The bubble in US house prices went from local to national through the mortgage market. You could more accurately describe the whole thing as a mortgage lending bubble, the most obvious symptom of which was bloated house prices.
Bubbles are like buboes; inflamed, swollen areas of flesh. Lance them and you may clear up the infection. Let them grow, and they could kill you. What makes the mortgage bubble historically unique is that there aren’t any real buboes to lance.
The Fed can raise interest rates, true. But the packaging up and re-selling of individual mortgages through the RMBS and CDO market means there aren’t any big fat boils to lance. The plague of subprime debt spread through the bond market onto thousands of other smaller balance sheets. Ben Bernanke’s monetary policy is far too blunt a scalpel to do the job correctly. It is a disease with no apparent cure; not even a fleet of Fed helicopters could do the job, although a government bailout is possible, as Bill Gross of bond-giant Pimco suggested last week.
Gross told George Bush to get busy and “start writing checks” to prevent two million US homeowners from losing their homes, and unleashing a string of negative consequences in America’s consumption-driven economy. It’s a handy theory, especially for a guy who manages US$625 million in bonds. Is it probable?
If the US government steps up to bail out homeowners in danger of losing their home, it will be popular politically, but a disaster for the dollar. If you think the dollar has crashed since 2003 (and really, if you read Adrian Ash’s piece on the website, the dollar HAS crashed) wait until you see what happens with a taxpayer-sponsored bailout. It will mean more debt. That means more Treasury bonds issued. Will China once again step up to bail out its best customer? Hmm.
The Fed – which meets in just a few weeks – has a tough choice. It can try to save homeowners or it can try and save the dollar. It probably can’t do either. But it definitely can’t do both.
Markets and Money