The Bubble Recovery

One of the greatest travesties to this bubble is the incredible American deficit under the Bush administration. The deficit has ballooned by over $5T in a scant 8 years. We can all agree that this is highly fiscally irresponsible, but the question remains, “Where did all this money go?”

After all, Bush is a Republican, and the funds certainly were not spent on liberal causes such as welfare and education. Given the record price at the gas pump, the funds were not spent on alternative energies, or more energy efficient cars. In fact, I think that we can look back at the success of the Humvee as a unique product of the Bush administration.

So show me the MONEY. By all estimates, the war in Iraq has cost $500B, but let’s be generous and assume that all the money has been squandered and there is no economic return on the American economy. Furthermore, let’s round it up to $1T. So there is still $4T unaccounted.

The chart above explains a large portion of the Bush’s incredible $5T deficit. One of the first things Bush did as president was honoring his campaign promise to give huge tax cuts to the wealthy. This was signed into law in June 2001.

The impact was swift. Government tax revenues essentially fell off a cliff during Bush’s first term. Bush’s rationale was that the tax cuts would trickle down to the rest of the economy and create jobs. This chart suggests the opposite. If jobs had been created, then revenues would not have fallen. In fact, they should have gone up. Bush’s tax cuts to the wealthy did not create jobs. In fact, these tax cuts have substantially increased the deficit and perhaps was one of the underlying contributors to the bubble.

The Nikkei 225 is the Japanese version of the Dow Jones 500. This chart chronicles what is commonly referred to as the Japanese Asset Price Bubble. In addition to the run up in stocks, it was accompanied by a tremendous run up in real estate prices. Some places in Tokyo were being sold at over $100,000 a square foot. A square foot is the size of one floor tile, and it was selling for the price of an entire house. Sound familiar?

Once the bubble popped in 1989, the Japanese Federal Reserve continued to spur the economy by lowering interest rates and printing more money. These actions were ineffectual, and interest rates hit zero. Can you believe it? They were essentially giving away money and there were no takers. The credit crisis would not abate.

The last straw was when the government began to buy out failing banks and businesses creating what became known as zombie businesses. This era in Japanese history is known as the lost decade. Historians blame primarily the Japanese Feds insistence in lowering interest rates and bailing out failed institutions.

If you have not already figured out where this is going. We are repeating each and every mistake that happened in Japan beginning in the mid 80’s. We made the exact same mistakes as the Japanese that caused a stock and housing bubble. And now we are replicating their errors in resolving the problems. The end result for Japan was the lost decade, and perhaps the US is in store for a similar fate.

Measuring the Bubble (Depression Deja Vu)

The media is calling this bubble the worst since the Great Depression. That sure sounds scary, but where are the facts? What makes them believe this bubble is so severe relative to other bubbles? Are there any facts to feed the panic or just pure fear?

I decided to take a look at some of the facts to measure the bubble and finally set some expectations about the size of the bubble. First I looked at the average housing pricing for the last 45 years. I pulled all of the information from www.census.gov which is a terrific place to gather macro economic information.

Just quick look at the chart, and it is easy to see where the bubbles have occurred. There were indeed housing bubbles in 1969, 1980, and a slightly larger bubble in 1989. Once each bubble hit, the decline in housing prices never lasted more than one year. Until now.

It is clear from the data, that there was a tremendous spike in housing prices in 2005. Unbelievable as it might sound, housing prices jumped over 13% in one year! This was followed by a 9% jump in prices in 2006. Somebody was asleep at the wheel in the Federal Reserve. Warning bells were going off all around them, and they did nothing.

Perhaps the scariest part of the bubble is its sheer size. Not only are the spikes larger than any other historical precedent, the bubble has persisted longer than anything in the last 45 years.

The only good news on this chart is that median home prices appear to have peaked in 2007, and although the data is not yet in, it is a good bet that 2008 will be less than 2007. So it is clear that we are beginning the downswing, the only question is how long will it last. And how severe will it be?

Next let’s take a look at the same chart but including the average house price along side the median. There is some speculation that the root of the housing bubble is related to laws encouraging mortgages to minorities. This chart rebukes that theory.

There can only be one reason why the average is growing faster than the median. HIGH END HOUSING. Eyeballing the numbers, I would bet heavily that million dollar homes are driving the bubble, not $100K homes to minorities.

But wait, there is one more piece of bad news. The average house price was still growing rapidly in 2007. Note: that the median had hit a plateau. In fact, looking at previous bubbles, this is the first time that the average behaved differently than the median.

I worry about the underlying dynamics of our economy if the average is so much larger than the median. It suggest that the gap between rich and poor is growing. Living down here in Brazil, I believe that one of America’s strengths in the 60’s and 70’s was an extremely strong middle class.

But I don’t want to get off track. So the housing data looks bad. Of course, this was entirely preventable, but there is indeed some empirical evidence that this bubble could be equal to that of the Great Depresssion.

Lastly, let’s take a look at the Great Depression courtesy of Yahoo Finance. The Great Depression began in September 1929, when the Dow hit a peak of 380. The Dow did not hit bottom until close to three years later. Worse yet, it took over 25 years or a quarter of a century for the Dow to reach its pre-depression levels. Ouch! 25 years is a long time just to get back to break even on your stock portfolio.

Although there are some indications that this financial crisis could equal the Great Depression. I personally believe that we can do much better. But for the pessimists in the group (and the media as well), here is a simple forecast using the Great Depression as a guide line. Once we see these numbers, it is easy to see why some people decided to keep their money in a mattress. Much safer.

Why the Bailout Will Fail

Yesterday, the House of Representatives approved the $700B bailout plan, and President Bush quickly signed it into law. Sigh! What I dislike most about this bill was that everyone including the President was acting in a panic. No one was calmly analyzing the underlying magnitude of the credit crisis, and the fundamentals that would drive our great country so close to the edge of a cliff. I’ll try to do that here.

The first chart is a simple graph of the trend of our national debt. Bush inherited a $5.7T debt, and by the end of his presidency, it will most likely exceed $11T. In a short eight years, Bush and the Republicans have doubled the size of the deficit. Let’s put this another way. Bush created a deficit in eiqht years equal to all 42 presidents before him COMBINED. There are only two ways to create a disaster of this magnitude.

Create massive tax breaks. Not only must the tax breaks be massive, but they must provide little or no economic impact to the economy. This is no easy task, since normally tax breaks inherently give the economy a bump. Bush has proven with surgical accuracy that if you target the nation’s wealthiest citizens, as well as the wealthiest corporations such as Wall Street, oil companies, and pharmaceutical, it can be achieved. The key to Bush’s tax plans is to place as much money in as few hands as possible. Frankly, I would not have predicted it, but it appears to have worked like a charm.

Spend like there is no tomorrow. Once the Republicans took hold of both houses and the executive branch, it must have been like Dad giving the kids the keys to the summer home. LET’S PARTY! And party they did. There was no bill too expensive, and no earmark too small. Basically, there was no budget whatsoever. Of course, this bottomless-money-pit mentality also explains our stubbornness in exiting Iraq. In retrospect, it is amazing that the original budget for the war was $50B.

Look at the slope of the line during the last 7 years. We are in debt like we have never been in debt. America needs money and FAST!

Which brings me to the next graph. If we are plowing through money, and we have made a conscious effort to reduce revenue (through tax decreases), one would think that America would have high interest rates in an effort to attract capital. This is where things start falling apart. The exact opposite is true. While our need for other people’s money was reaching addictive levels, our price for that money (interest rates), was abnormally low.

It makes no sense. Think of a guy with a serious gambling problem. Let’s call him Uncle Sam and he is on a bad run of luck. Sam normally gets his cash from Louie the Shark, but Louie is getting nervous because each time Sam needs more and more money. So this time, Louie says No to Sam. So Sam has no choice but to request a loan from Bobby Ballbreaker. Do you think that Bobby is going to give Sam a better deal than Louie? Of course not.

Then why are our interest rates so low? Today’s interest rates are lower than the Clinton era and the Reagan era. Who benefits? When interest rates are low, perhaps the first to profit is Wall Street. Low interest rates drives money into the stock market where people can get a higher return. This is a normal market dynamic unless the interest rates are artificially low.

I had a good friend remark close to two year ago. America is awash in cash trying to find a home. I have received hundreds of calls from companies trying to refinance my home. Note: I don’t have a mortgage on either of my residences. On top of this, during the Bush era, my mailbox was stuffed with preapproved credit cards. We should have seen it as a sign of things to come, but there was way too much money trying to find a home.

It is clear that this excess liquidity found its way into the mortgage market. With interest rates so low, any nut job could get a mortgage. Basically, if you have a pulse and a social security number, here’s a brand new home. Using the bubble mentality, it really doesn’t matter if the owner defaults if the value of the house is worth more. Of course, the wheels fall off the bus, when housing prices decline.

Please note: Unlike the presidential candidates, I do not believe this is a function of greed on Wall Street. It is a function of an interest rate that is lower than the underlying economics of the economy.

The last slide completes the picture. Who is the culprit? The Fed. There is only one way to pull off this economic illusion. As I discussed in Bubble Economics, the first thing is to greatly devalue the dollar. This ensures that America is an attractive place for foreign capital. Then the second piece is to expand the money supply to accommodate the influx of capital. Let’s make this clear. This was a conscious decision to expand the money supply to keep interest rates artificially low. As is painfully evident today, it created economic growth driven by the housing sector, but it was wholly unsustainable. There was only one outcome and it is the one that we are experiencing today.

Which brings us to the bailout. This bail out will fail for one reason alone. The US government is fighting the market. The underlying issue is that American interest rates are too damn LOW. The credit markets are frozen because they see an adjustment on the horizon. If we just let interest rates float as market dictates, credit would free up immediately, albeit at higher interest rates. This is the flaw. $700B can keep us at an artificially low interest rate for a period of time, but we cannot fight the market forever. Ultimately, interest rates must rise, and it will have a negative impact on the American economy, stock prices, and housing prices. $700B can delay the inevitable, but it cannot stop it from happening. For me, I would rather see it happen sooner rather than later so we can get on with our lives. Oh and we would also save $700B of taxpayer money. It is truly stunning that we think we can throw money at the problem, when the root issue is our free wheeling government.

Bubble Economics – Don’t Panic

I am shocked at what is happening to our country right now. It is like an incredibly bad dream. I put together the following two charts (see below). The first chart is the history of the Dow Jones Industrial Average for the last 18 years. I drew a line (just a guess) of the normal sustainable rate of growth of the American economy. Independent on where you draw the line, it is easy to see 2 bubbles in the last 18 years. The first one is commonly referred to as the internet bubble or the dot com bust. And the second is the mess that we are experiencing. When looking at the magnitudes of the bubbles, they are similar in size. It is true that the DJ is not a surrogate for the market as a whole, but certainly if there is excess liquidity driving the mortgage market, then the DJ would at least have a residual bubble from the liquidity.

Which brings me to the second chart. If you look at the decline in the dollar, it almost exactly coincides in the rise in the Dow! I estimate the date of the bubble to be March 2002. First there is good news here. Bush says that the bubble began over 10 years ago. I don’t think so, and obviously the longer a bubble persists, the larger its magnitude.

Now look at the dollar. It is clear that someone made a conscious decision to devalue the dollar. Now it makes sense to me! Here we have Republicans spending money like they won the lottery, and worse yet lowering taxes. But the kicker is that interest rates go DOWN! That makes no sense. Interest rates in Bush’s presidency are less than Clinton’s when we ran a surplus. How can that be? Something has to give, and it is the dollar.

Who would invest in the United States when interest rates are so low? No one. Of course, as the dollar weakens, investing in the US becomes more attractive so money flows into the economy. But this is all so upside down! People are investing in our country because we have a weak currency, not because we have a strong economy! Through out all of my life no matter what president, the dollar has always been strong. Until now. And not only has it fallen, it has fallen off a cliff. Why? It seems like there can only be one reason, to attract foreign capital. It is evident to anyone that this strategy is unsustainable and ultimately the bubble must burst.

There is one conclusion that I can make. This is not something that happened to us. This is something that someone consciously did. The root of this problem is our money supply. Someone has been increasing the money supply at a much faster rate than our underlying economy can support. This is very very dangerous and I don’t believe it has happened in my life time until now. I do not know why someone would do something so hazardous with our economy, but I can speculate.

When the money supply increases, credit loosens automatically, the economy gets a bump. It is an artificial unsustainable bump, but nevertheless a bump. It is good politics to show economic growth, and so the Bush administration continued to force the dollar lower to show artificial economic growth. During the internet boom, although there was a bubble, there was at the core true economic growth. American companies such as eBay, Google, Yahoo became worldwide leaders of the internet. Furthermore the global demand for the internet, further entrenched American companies such as Intel, Microsoft, and Dell into the global economy. The bubble popped but underneath the economy was strong. Plus our goal was not to create a bubble. The reality is that the Bush administration was using the bubble as a proxy for economic growth. So once the bubble pops, what do we got underneath? NADA.

So who is responsible? Who would increase the money supply? There is only one person that has this responsibility. Federal Chairman, Alan Greenspan. Dude, what were you thinking? This is more than bad judgment, and I really can’t believe that greed would be a factor. What were you thinking? I do find it strange that as the entire country is running around like chickens without heads, that you remain silent.

I am not an economist. I am just a really concerned citizen, that wants to inject some analysis and thought into a dialog that appears to be lacking of both. Here are some conclusions. Take them for what they are worth.

Numbers. Economics are all about numbers. Economists are hard core mathematicians. But whenever we discuss this problem or the bailout, no one is quantifying anything. When did this problem begin? How large was the bubble? This is why I did my little quickie analysis, because it is a huge hole in our plan. The answer to this problem is in the numbers and no one is looking at the numbers. The only number we get to know is $700B. This is beyond pathetic. It is reckless and irresponsible.

Bubble size. Just based on my numbers, it seems that the relative size of the two bubbles are comparable. I agree that the Dow Jones is not a surrogate for the economy as a whole, but the last bubble burst without a bailout and we ended up OK. What is driving the panic? What makes us think that this is the worst since the Great Depression? Again, where are the numbers? We had a saying at Gateway, “In God We Trust, all others bring data.” Give us data that backs up the panic.

Responsibility. Let me make a key point. This should never happen. Never, never, never. It is someone’s job to watch critical indicators (also called fundamentals) such as the price of the dollar, unemployment, in flows of capital, and so on. The warning bells have been going off for years and no one has done anything to fix it. Worse yet, it is clear that the bad acts just continued unabated. Not only was this 100% preventable, it was easily preventable. We need to know who and why before we can trust again. This guy Paulson wants $700B of our money. Before this all happened, I had know idea who he was. Was he part of the problem? Or maybe he is incompetent? These questions must be asked, and no one Republican nor Democrat should be offended when they get asked.

Spending. What is the root of the problem? The Republicans from 2000-2006 have spent like no other Congress in the history of the nation. We have the biggest, humongous, behemoth government in the history of the WORLD. The waste turns my stomach, plus it is 100% contrary to the vision of the great Ronald Reagan. The smaller the government, the lower our taxes, and the less intrusion in our lives. The people in power are NOT Republicans nor are they Democrats, they are the worst of everything, and in my view, THEY ALL SHOULD LOSE THEIR JOBS. I am appalled by the spending in Washington as if God wrote a blank check, and said “Go have fun kids.” Geez.

Taxes. Then on top of that, they lower taxes. This is an abomination. Furthermore, anyone that opposes tax decreases, is labeled as UnAmerican or Liberal. These guys are so clueless. Every American has to balance a checkbook, and spend within their means. Is it so much to ask our government to do the same thing?

Balanced Budget. We have to demand that our officials live within their means. Increased spending should NEVER be coupled with lower taxes. It does not work that way in the real world. Does it bother anyone that the war was supposed to cost $50B and now we are going on $1000B? We need to instill a discipline in Washington that somehow has been thrown out the window in the last 8 years. This is the most important thing we can do.

I am going to say it out loud. People. America is BROKE. We are not the richest country in the world. Not even close. Why is our currency falling off a cliff? Because we do not have the money to peg our currency. All of our wealth has been squandered away. It is all gone. The only hope is that we start living within our means.

Panic. Stop the panic. Stop the panic. I do not want the people responsible for our economy in a panic. I want them thinking clear and looking at lots and lots of numbers. We need clear thinking and unemotional leaders looking for solutions. Not just quick fixes but real solutions. The Dow fell 700 points in a day. Big deal. We are dealing issues with much larger than that. I as a citizen want to know the root cause. I want assurances that we will never get in this situation again.

Let me say it again. I hate the panic. The chances we find an intelligent solution diminish greatly the more our leaders panic.

Conclusion In conclusion, I am not seeing evidence for the panic we are seeing from our leaders right now. Yes, we have a problem, and yes it will be painful. But we should not panic. If we made it through the internet bubble, can you not survive this bubble as well?

I have not yet heard anything from our leaders that indicates that anyone understands the true underlying problem, and I feel like they are just shooting in the dark. Lastly, I do not trust this man Paulsen with $700B of our money when he is the prototype Wall Street insider. Kudos to the Republicans for killing the $700B Panic Bailout Plan. There is a better solution out there if we only take the time to find it.

Why did I write this? Because I am disgusted to see how the President and Congress are behaving. It’s like watching Romper Room. We deserve better and we should demand it. If you agree, please pass this post on to as many people as possible. Thanks for reading.

Rob