Robert Shiller's housing observations were captured by the article "Be Warned: Mr. Bubble's Worried Again," published by The New York Times on August 21, 2005. But, as usual, the Fed was too absorbed with its own theories that have proven to be incorrect far more often than not.
Today, nine years after his lunch with Mr. Greenspan and five years after the markets finally did crash, Mr. Shiller is sounding the same warning for real estate that he did for stocks. In speeches, in television and radio interviews and in a second edition of his prophetic 2000 book, "Irrational Exuberance," he is arguing that the housing craze is another bubble destined to end badly, just as every other real-estate boom on record has.
For the record, the stock market has never truly recovered. With every passing day, the Federal Reserve continues to seek the magic potion that will heal our economy, and housing is at the core of the institution's concerns. And rightly so, because without sustainable growth in the housing sector, we'll stay stuck in first gear, and switch into reverse at times. To highlight the point, and as reported by Bloomberg, "builders began work on fewer houses than forecast in December [2011], capping the worst year on record for single-family home construction and signaling recovery in the industry will take time." It appears that everyone at the Fed is singing in unison, and I follow with a few examples. From MarketWatch:
New York Fed President William Dudley, who also is the vice chairman of the interest-rate setting Federal Open Market Committee, said he would like to see "refinancing made broadly available on streamlined terms and with moderate fees to all prime conforming borrowers who are current on their payments."
Bloomberg's article, "Bernanke Doubles Down on Fed Bet Defied by Recession," added its two cents.
Ben S. Bernanke is signaling his willingness to double down on a three-year bet that's failed to revive housing, showing the extent of the Federal Reserve chairman's effort to wrest a recovery from the deepest recession. Since the Fed started buying $1.25 trillion of mortgage bonds in January 2009, the value of U.S. housing has fallen 4.1 percent, and is down 32 percent from its 2006 peak, according to an S&P/Case-Shiller index. The central bank is poised to buy about $200 billion this year, or more than 20 percent of new loans, as it reinvests debt that's being paid off. Some Fed officials have said they may support additional purchases that Barclays Capital estimates could total as much as $750 billion.
And even Fed hawks, such as Richmond Fed President Jeffrey Lacker, have joined the parade, as reported by MarketWatch.
While much progress has been made in adjusting to the post-financial-crisis environment, the housing market still has "substantial adjustment" ahead, he said. "Given sizeable oversupply and tighter credit standards, the housing market appears to be in for a lengthy adjustment process," Lacker said.
With mortgages rates at record lows, buyers are still on the sidelines, and while the reasons vary, negative sentiment is the key driver. And how would the population have a positive outlook on life, when the quotidian necessities force an increasing number to use their savings, as reported by Reuters.
In an ominous sign for America's economic growth prospects, workers are paring back contributions to college funds and growing numbers are borrowing from their retirement accounts. Some policymakers worry that a recent spike in credit card usage could mean that people, many of whom are struggling on incomes that have lagged inflation, are taking out new debt just to meet the costs of day-to-day living.
Thus, when I heard that the Fed extended its low rate pledge until the middle of 2013, I couldn't believe it, and Jeffrey Lacker was the only one to be against the defined time period. Mr. Lacker has it right, although I am not sure what is behind his reasoning.
I believe that by now the Fed is starting to understand that the one variable - consumer sentiment -- that it cannot control with its mechanical money exercises, is truly the key, and if the Fed is expecting a stock market rally to address the issue, they have it wrong. Capital resources are finite, and are shifted from asset class to asset class, and if the word on Main street is that John Doe's money should be in stocks, houses will not be purchased. Certainly a stock market rally will provide temporary sentiment relief, but the ongoing deflationary forces in the housing industry will keep the consumer fully aware that all is not well--and the market will adjust in due time.
Furthermore, the Fed is perpetuating the perception of an economy that will stay weak for the foreseeable future, which coupled with a continuing decline in home prices, removes the stimulation to jump into the real estate market. Yet, there lies the bright contradiction because that's exactly what the Fed wants.
The ongoing foreclosures and the respective unserviceable debt is not accounted for yet, and until the Fed faces the reality that debt must be written down, they can set interest rates at negative 10% and nothing will be resolved.
Yes, the institution is now more transparent, even providing an inflation target for whatever it's worth, but the exercise is designed to inflate the Fed's stature and counteract the institution's growing irrelevance, not provide guidance or address economic woes.
Thus, the Fed's "Donut Theory" is that the more donuts one eats, the fatter one gets, and it is bent on providing the delicious treats through large quantitative exercises. However, one must actually eat the donuts to put on some weight, and the Fed cannot force anyone to stuff the goodies down their throats.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
