15 January 2011 – The Aleph Blog

Mid-2005 FOMC

Posted on 15 January 201116 January 2011 by David Merkel

In mid-2005 I wrote a piece that I knew would be controversial at RealMoney: Real Estate?s Top Looms.? I had debated about writing it sooner, but delayed, because the momentum felt wrong.? But by mid-2005, I concluded that the negative arb that investors in residential real estate had could not persist for long.? Markets that rely on capital gains tend to get capital losses.

So, when a friend of mine pointed me to the 2005 FOMC Transcripts this morning, I naively decided to look at the transcript closest to my June 2005 piece (graphs here) on the residential real estate markets to see what they were thinking then.? It was a two-day session, and they spent the whole first day on the… residential real estate markets!

Intrigued, I read the whole first day of that session, and skimmed the rest.? There were a few things that impressed me:

The lighthearted attitude that the FOMC took in the meeting.? Laughter was frequent.? That doesn’t impress me, given the seriousness of the task entrusted to them.? I know we are Americans, for whom nothing is truly serious, but the transcripts annoyed me with the frequency of humor in the midst of a serious situation.
They had three staff economists present contrasting views on residential real estate, but they were all optimistic compared to what eventually happened.
The Presidents and Governors spent too much time with minutiae of modeling.
They also spent too much time on arguments that were the equivalent of wish-fulfillment.
They also spent too much time on the price-to-rent ratio, which is a bogus concept.? Better to turn everything (bond manager style) into spreads — look at the difference between rental yields versus mortgage yields.
They spent too much time on what they could learn from Ag land prices to give them wisdom on urban land prices.

On the whole, I felt that our FOMC was not well-equipped intellectually to consider the concept of an asset bubble.? There was a genuine unwillingness to consider that monetary policy could have an impact on asset prices — we only have to worry about goods price inflation and unemployment!? Don’t give us another ball to juggle!

This set of statements from Ph. D. economist members of the FOMC helped confirm to me that the neoclassical view of economics, which biases people toward the idea that nothing ever matters — market structure is irrelevant, is wrong.? We might do better to staff the FOMC with random selection via social security numbers.

Did they consider the increasing level of indebtedness on residential real estate, or the effects of short term finance?? Not in any significant way.

Some people criticized me in 2005 for being too dismissive of the FOMC.? How can you be so bright, and this group of distinguished people on the FOMC be so dumb in your opinion?? Because they have the wrong theory on monetary policy.? The idea that monetary policy if properly implemented could assure prosperity was a bad goal.? Good monetary policy is not enough, and most concepts of good monetary policy leaned toward loose monetary policy.

Basic concepts like level of indebtedness were neglected in favor of other less demanding measures.? No wonder the residential real estate boom went foul.

Book Review: Inflated

Posted on 15 January 201120 June 2017 by David Merkel

This book was not what I expected.? I expected a book on the current crisis, and got a book on monetary/credit policy over the whole of the existence of the US.? What is more, unlike most books that cover a long sweep of history, this book is even, and does not overemphasize the recent past, which is a humble thing for an author to do, because we don’t know the full ramifications of recent actions yet.

Now, I respect the writings of Chris Whalen at Institutional Risk Analytics and elsewhere — a bright guy.? But this outperformed my high expectations.? Some books I glide through because I know the topic well.? This was a book where I thought I knew the topic well, but found that I did not know as much as I thought, and so I read more slowly than I usually do.

But this book changed my view on financial crises.? Whether one is under a gold standard or a fiat currency standard, the main order for assuring stability is the regulation of banks and credit.

In the same way that people need help in verifying whether a drug is effective or food is pure, they need to know that promises to pay will be honored.? It does not matter what backs the currency if banks are allowed to overlever, or mismatch assets long — there will be a financial panic, and it is not due to gold, silver, or fiat money necessarily, but that that banks made promises that could not be kept under all scenarios.

Yes, I think it is better to be under a gold standard, because it restricts the power of the government.? But that is not the main issue with financial crises; we need to restrict that ability of banks to borrow short and lend long; we also need to restrict their overall leverage.? Do that, and crises disappear — also, banks are far less profitable, and that is a good thing.? We will get fewer banks, and bright people will go to more useful places in the economy.

Other things that stood out to me were the First and Second National Banks of the US, and how their creation led to booms, and dissolution led to busts.? Lincoln is unique in every way, even in monetary policy terms, as he created unbacked paper money to fight the civil war, which funded a lot of it.? After the war, the return to the gold standard, much as it should have been done, was depressive, but it was an effect of paying off the war.

I came away from this book with a more balanced view of US politics — many of those I like came off worse, and those I did not like were shown to have been better than I thought — with the exception of Lincoln, who in hindsight seems to be a radical in most senses.? I am very glad that slavery is gone, but not the way that it got done.

Quibbles

Ignore Roubini’s introduction.? Better Whalen should have gotten a real intellect like James Grant or Caroline Baum.

Also, in the middle of the book, in WWII, the US spends far more than its GDP on the war.? I get it, but I think it would be more reasonable to classify defense spending inside GDP so that we can see what proportion of national output is going to the war effort.

Who would benefit from this book:

Anyone with a moderate intellect or better could learn from this balanced account of America’s monetary and credit policies.? It is very well written; those with little knowledge will learn much, but those with greater knowledge will still learn something.

If you want to, you can buy it here: Inflated: How Money and Debt Built the American Dream.

Full disclosure: This book was sent to me, because I asked for it.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

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