I want to thank Geoffrey Ching for spotting an error in my post How to Make More Returns on REITs.? He even came up with what I did wrong; my signal was off by one month, producing returns way too good to be true.? So is the strategy wrong?
No.? It’s still a good strategy, just not astounding.? Here’s the double quintile for mortgage REITs:
And for equity REITs:
Here’s the return graph for equity REITs:
And that for mortgage REITs:
It feels intuitively right that Mortgage REITs don’t beat equity REITs, even with a better strategy for both.? The momentum strategy boosts? the returns on mortgage REITs from 5.1% to 11.1%.? For Equity REITs it moves from 12.0% to 14.0%.
I don’t wonder at this result.? Indeed, my shame is that I didn’t probe the last result more.? This is still useful for those who would pursue momentum, just not as useful as the first article.? And with that, I apologize to my readers for my prior error.? It is my policy to correct errors once I am convinced of them.
Before I start this evening, I want to offer corrections to my last piece on REITs.? Sorry, data glitch, and the results are a little different but the conclusions are unchanged.
Here is the correct regression for Mortgage REITs:
And the the correct regression for equity REITs:
Why the change?? The main difficulty was that the first set of regressions was disaligned time-wise because the twenty-year Treasury yield was not estimated by the Fed for about ten years.? This calculation adjusts for that.? Interesting that when you use the correct data, mortgage REITs fit less well.? That’s an odd happenstance.? Equity REITs, are around the same — though the t-statistics look worse because I included two more points on the curve.
But now to the point of tonight’s piece.? After my last piece, one reader said:
This sounds like an interesting scenario to use your grid analysis, where your quantiles might be ranked using (1) equity/mortgage REIT spreads and (2) monetary policy (measured by either short term rates or yield curve slope).
I decided to try it, except for one thing.? I thought that using the spreads or yields in quintiles would have too much information about the future that if an investor knew the limits of how high or low yields could go, it would be too simple.? The surprise was this: I tried it for fun, and it was no better than what I will show you.
I chose two variables:
Yield curve slope, measured by twenty-year yield less one-year yield
Momentum, measured by amount the price is over the ten-month moving average.
I divided both up by quintiles, reasoning that an investor focused on momentum and the yield curve would have enough data from history prior to 1972 to generalize what would be favorable and unfavorable conditions for investment.
Here is what I found for Mortgage REITs:
and what I found for Equity REITs:
Both data series? confirmed one idea.? Momentum matters.? (Now the yield curve matters, but not so much.)? So I constructed a rule to be invested in REITs if they were in the third momentum quintile or higher, or be invested in one year Treasuries otherwise.
So what were the results?? Equity REITs:
The difference in returns is 20.8%/year following the strategy versus 12.0% not following the strategy.
Now what for Mortgage REITs, that properly despised subindustry group?
The difference in returns is 22.4%/year following the strategy versus 5.1% not following the strategy.
The bizarre result is that though equity REITs trounced mortgage REITs? over 38+ years as indexes, the momentum strategy makes mortgage REITs do better then equity REITs.? That is probably because the returns on mortgage REITs are more autocorrelated — they streak more.
I just say wow, and wonder at it all.? I have some daily models for interest-rate sensitive sectors that I haven’t trotted out yet, which switch between mean reversion and mean aversion that do better than this, but I don’t believe them because they are too good.? It is possible to trip onto something parsimonious that explains history if you are smart enough.? I prefer stuff where I have a theory behind it, as with momentum, where people are slow to catch on.
Now, after all of this, I will tell you I have no money riding on this.? None. Nada. Null.?? Part of this is that it would not be so good when implemented in real-time, and mortgage REITs are a thin industry.? More of it comes from an aversion to what might happen if/when momentum investing becomes pervasive.? We had a taste of that in Summer 2007, where momentum strategies blew up for a short time.? For those willing to see it through, though, it did not amount to much.
So long as? momentum is an incidental strategy to the market, it can work well.? It can never be the main strategy of the market lest matters go totally nuts.
When I think about REITs, I think about their asset-liability structure.? With equity REITs, they own buildings where rents adjust annually, within limits.? They borrow using mortgages with 10-year terms.? Most of their bond offerings have ten year maturities.
But when articles cite the yields of Equity REITs (from NAREIT) they usually compare it to the 10-year Treasury to ascertain cheapness/dearness.? But is that the best measure?
Possibly not.? In a multiple regression using 1, 5, 10 and 20-year Treasury yields, the coefficient for the 10-year yield is negative and significant.
Wait.? If you add up the coefficients for 5, 10, and 20 year yields, it is positive, where Equity REIT yields move 0.75% for every 1% move in the parallel move of 5, 10 and 20-year rates.
But what the configuration points out? is that when the curve is humped, where 10-year yields are high relative to 5 and 20-year yields, equity REIT yields have tended to be low relative to 5-20 year Treasuries.? That would correspond in most cases to a time of monetary looseness.??? Monetary tightness, vice-versa.
Also note that equity REIT yields fall as the 1-year rate falls.? Rents tend to move in line with short yields.
The story isn’t much different for Mortgage REITs.? Mortgage REITs buy debt interests in real estate, often financing with equity and short debt. The debt interests are usually intermediate to long in length.? In principle, you would think that Mortgage REITs would be safer vehicles than Equity REITs.? Trouble is, the leverage is a lot higher on Mortgage REITs, which can lead to some spectacular flameouts.? (And even with Equity REITs, the less levered REITs with lower yields have tended to outperform.? I think this is another version of how moderate risk-taking tends to beat high risk-taking and low risk-taking.)
So is comparing the spread on mortgage yields versus the 10-year Treasury useful? Probably not.? In a multiple regression using 1, 5, 10 and 20-year Treasury yields, the coefficient for the 10-year yield is negative and significant.
But if you add up the coefficients for 5, 10, and 20 year yields, it is positive, where Equity REIT yields move 0.14% for every 1% move in the parallel move of 5, 10 and 20-year rates.
But what the configuration points out? is that when the curve is humped, where 10-year yields are high relative to 5 and 20-year yields, mortgage REIT yields have tended to be low relative to 5-20 year Treasuries.? That would correspond in most cases to a time of monetary looseness.??? Monetary tightness, vice-versa.
Summary
There are two quick conclusions to draw here:
1) Using the spread to the yield on the 10-year Treasury is probably not the best choice to illustrate REIT spreads.? That said, those wanting a simple measure may be unlikely to get anything better.? The average person would have a tough time following the results of? multiple regression.
2) Be wary of paying up for REITs during times of monetary looseness, and be willing to consider REITs during times of monetary tightness, when all seems lost.? I would only add don’t catch a falling knife; my worst loss ever came from a mortgage REIT.? This may be a glorified way of saying “Buy low, sell high,” but only where there is a margin of safety.? Perhaps apply a 200-day moving average rule to prevent stupidity; you won’t get the bottom, but you won’t find your capital permanently impaired.
Personal note: hey, this article turned out better than I thought it would. 😀
This is an unusual book, and a good book.? Unlike the book, “Outperform,” which reviews lesser known endowments, and endowment investing generally, this book reviews the Harvard and Yale endowments, which up until 2008, the year before the book was published, were among the best in terms of performance.
But this book is more than that.? It goes through the strategies of the major endowments, and looks for ways that average people can try to replicate the results.
But average investors don’t have the same set of investments available to them as the large endowments do.? If you aren’t a qualified investor who has access to the full range of investments ordinary mortals are denied — private limited partnerships (hedge? funds, private equity, commodity funds, etc), what can you do?? This book discloses investments that are similar if not equivalent, and versions that are lower cost through ETFs.
After that, the book takes a direction that would initially seem different than endowment investing.? It discusses trend following, which endowments do not in general use as a strategy.? Now, some hedge funds use it, but few endowments actively embrace it.? The book shows how return can be enhanced and volatility reduced by buying investments that are over their 200-day, or 10-month moving averages.? From my own research I can partially validate the approach.? It is a clever way of implementing a form of momentum investing, which may be a cheap way for average investors to mimic hedge funds who follow trends.
Then mimicry moves to a new level as the book goes through the basics of mining data out of 13F filings, where large investors file their long investments with the SEC.? Guess what?? Imitating bright people can help an investor beat the market — it can allow a bright person to mimic the long side of equity investing on the cheap, but with a lot of data analysis (or you can pay up for Alphaclone).
In one sense, the book seems like two books — one on endowment investing, and another on tools for clever investing available to average investors.? My way of reconciling the two is that the authors are clever guys who are trying to give their best ideas to retail investors so that they can do as well as sophisticated institutional investors who have a wider array of investments to choose from.? The retail investors don’t have the same array of investments to choose from, but they have the advantage of flexibility that institutions don’t and can more quickly trade out of investments that may be on the way to underperformance via trend-following.
And so with much effort, if you apply their ideas, you have the potential of doing as well in investing as the major endowments.? Or, absorb one of their passive strategies with little effort, and maybe you will do as well.? Strategies that have done well in the past may not do so in the future.
But on the whole, I heartily recommend this book.? There is a lot for investors of all types to learn from it.
Quibbles
Those reading the book should also read my essay, “Alternative Investments, Illiquidity, and Endowment Management. (Google it if there is no link)”? Taking on illiquidity is not a free lunch.? It can impose real costs when there is a need for cash among those endowed.? Personally, I think that ten years from now, illiquid investments will only be taken on by those that can lock them away.
Who would benefit from this book:
Those wanting to potentially mimic the high returns of the Harvard and Yale endowments could benefit from the book, but realize that a lot of the past is an accident, and that it might be difficult to achieve high returns in the future from strategies that worked in the past.? That said, the authors have offered strategies that take some degree of work to apply, so there may be barriers to entry for applying some of the strategies.
Full disclosure: I asked the publisher for this book, and they sent it to me.? I read and review ~80% of the books sent to me, but I never promise a review, or a? favorable review.
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.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
Before I start this evening, I just want to say that as a day progresses, if I find a good topic, I prepare for it. If I don’t, I plan on doing a book review. As it is, I have 15 books that I have read and not reviewed. The majority of them are poor. It is tough to do a bad book review, but I guess I will do a bunch of them.
=-=-=-=-=-==-=-=-=-=-=-=-=-=-
My review of this book was shaped by its coverage of my own industry.? I am an investment advisor, and a small one.? I learned far more from other sources regarding what I needed to do to comply with Dodd-Frank than this book did.? If I had had only this book to help guide me in my regulatory work, I would have been sunk.
Now, as I read through the book it struck me as being a perfunctory summary of the law, without a lot of insight.
The structure of the book is this:
Introduce the Act
Explain the history and main goals
Go through the Titles (main divisions) of the Act, and give brief explanations of the main points.
Explain how various institutions are affected at a high level.
Then talk about how the various studies that the Act demands will be done, and how regulatory rules will be created.
How it affects all existing agencies, and the new agencies that are created by the Act.
What impact it has globally (not much)
How it affects various financial professions
How it interacts with SOX and Basel (not much)
I found the book to be weak, given what I know about my industry, and other financial industries.? It read like someone went through the Act and excerpted it.
Quibbles
I have no quibbles, I only have objections.? This book was put out too fast, and with too little thought.
Who would benefit from this book:
Better you should read the act; it is bad, but not that bad, as Washington goes.? The act is long, so if you are looking for an easy introduction to the act this book could be helpful, but you could probably clip the highlights of the act yourself.? It is only a question of the value of your time.
Full disclosure: They asked me if I would like to get this book, and I said yes.? What a disappointment.
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.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
For those that have read me for years at The Aleph Blog, this book will impart little that is new.? But, you get a set of powerful arguments in one integrated slim package.
I really liked this book.? The author took a broad view of bubbles, and developed five lenses through which to analyze them:
Microeconomics
Macroeconomics
Psychology
Politics
Biological (contagion) analogies
This picks up the growth in debt, the misaligned short-term versus long-term incentives, crowd behavior, imitation, political agreement with booms, finger-pointing during busts, etc.
This book integrates the ideas of Keynes, Minsky, the Austrian economists, Soros (reflexivity), and others.? The author was very willing to interact with the view of those that might not fully agree with him, and yet bring out the areas where they do agree.
And the author tests the five lenses on five bubbles:
The tulip bubble
The Great Depression
Japan in the late 80s
The Asian crisis in 1997
The US Housing Crisis 2006-?
Not surprisingly the crises chosen support the theory.? It would be interesting to see what the author would say on other bubbles, like the South Sea Bubble, the Tech Bubble, etc.
And so the author summarizes his case, and I think he does it well. But then he takes it a step further, and effectively says, “Well, is there an obvious bubble to point out now?”? And so he points out China.? The debts, the manipulation, malinvestment, bad incentives, etc.? You can read it for yourself and draw your own conclusions.
My main verdict on this book is that it provides a firm basis for evaluating bubbles.? I place it behind “Manias, Panics, and Crashes,” and “Devil Take the Hindmost,” but not by much.? To the author: Great job.
Quibbles
I disagree with the idea that booms and busts are a capitalist phenomenon.? Command-and-control economies do have booms and busts — the Great Leap Forward was a boom followed by a tremendous bust.? The effort to plant cotton in the Soviet Union was short-lived, leading to declining yields and destruction of the ecology of the Aral Sea.? There are more examples than this; at least in capitalism, the boom yields some decent rewards.
Who would benefit from this book:
Anyone who wants a better understanding of the boom-bust cycle will benefit from this book.? The author has nailed it in my opinion.? This book will help you to properly skeptical in the next unsustainable boom, and minimize your exposure to the bust.
Full disclosure: I asked the publisher for the book, and they sent it to me.
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.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
The main idea is this: enough people benefit from credit bubbles in the short run that it is impossible to oppose credit bubbles once they get started.? They have political, economic, and societal support.? The nature of man is to seek free money, whether as consumers, businessmen, or politicians.? People are willing to suspend disbelief when times are good.
All for now.? Will write more in the next two days.? Remember, Japan has much bigger problems than the quakes and nuclear incidents, which should make you more bullish on Japan; the current problems will fade.
With this book review, I put a knife to my throat.? Alas, I have been investing in individual stocks for over 23 years, and have done well the whole way.? Is it time to abandon my craft?
No, and I think the author would agree.? He is making a relative argument but the title phrases it in absolute terms.? On average, the advantage of investing in stocks is smaller than commonly believed, and for investors that can’t keep their wits about them when all is going wrong, the results are worse still.
This book attempts to infuse common sense (ordinarily sorely lacking in investments) into readers who are retail investors.
One nice feature of the book is that the author recapitulates everything in each chapter in a closing section entitled “Boiling It Down.”
Another nice feature of the book is that the author went and interviewed clever asset managers to flesh out his own understanding of the topic.? That helped produce a much richer book.
Quibbles
I don’t go in for using stop losses.? I analyze risk, and there will be a tiny number that really hurt, but the cost of using stop losses is missing the frequent snapback rallies, which on average in my experience more than pay for the losses.
Also, in this environment, where everything is so correlated, because of ETFs, he recognizes the difficulty of achieving real diversification.? But in his asset allocation advice, it is as if he forgot this.? If I were rewriting his asset allocation chapter, I would have introduced the concept of the credit cycle, and why good asset allocators vary their positions based on the opportunity offered, rather than a more static view of asset allocation.
I also would have given a little more credit to value investing.? If you are going to be anything but a trader, you may as well focus on value.
But on the whole, this was a very good book, and these are quibbles.? He writes very well, far better than me.
Who would benefit from this book:
Most inexperienced to moderate investors would benefit from this book.? It would help them to avoid common mistakes in investing, as well as make them aware of modern problems in investing that classic texts would not have been aware.
Full disclosure: This book was sent to me, because I asked for it, after the publishers offered me a copy.
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.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
Information received since the Federal Open Market Committee met in November confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.
Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions.
Shades their view of unemployment to include the phenomenon of discouraged workers.
Household spending is increasing at a moderate pace, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.
Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.
Shades their view of the consumer upward, but I fear for no good reason.
Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls.
Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls.
Shades their view on business spending up, but I think they are too early.
The housing sector continues to be depressed.
The housing sector continues to be depressed.
No change.
Longer-term inflation expectations have remained stable, but measures of underlying inflation have continued to trend downward.
Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.
Notes the rise in commodity prices, and continues to misread both inflation and inflation expectations.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.
No change.
Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.
Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.
Translation: we have no idea why our policy is not working, and we don?t know what to do about it.? Monetary policy works with long and variable lags, so we won?t say that our policy isn?t working.? It?s just slow in taking effect.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.
No change.
The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.
In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.
No real change.
They will stealth-fund the US Government to the tune of $600 Billion.
The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.
The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.
No change to this meaningless sentence. What? You would do otherwise?
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
No change.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.
No change to this meaningless sentence.
Would you do otherwise?? If we know that the opposite is impossible, why have the sentence at all?
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Sarah Bloom Raskin; Eric S. Rosengren; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
Changing of the guard with the regional Fed Presidents.
Voting against the policy was Thomas M. Hoenig. In light of the improving economy, Mr. Hoenig was concerned that a continued high level of monetary accommodation would increase the risks of future economic and financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.
No dissent.? Interesting because because many pundits speculated over how many would dissent, such as Kocherlakota, Plosser and Fisher.
Comments
They shaded their views up on business and consumer spending, and commodity prices, and down on labor unemployment (i.e. unemployment will be harder to eradicate than they used to think.
No dissent this time; perhaps the new regional Fed Presidents are giving the Board members a pass at this first meeting of 2011.
They highlight that they have a ?statutory? mandate, and a ?dual? mandate.? They are trying to say that they are required by Congress to do these things, and that it is a tough job.? The flip side is that they admit the Congress has the right to tell them what to do, which Ron Paul may make clear as the Chair of the House?s subcommittee on Monetary Policy.
The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
Beyond that, if they succeed, how will it be received on Main Street, especially if price inflation is not accompanied by increases in employment, or is accompanied by higher interest rates or lower stock prices?? Stagflation is not popular.
That said the economy is not that strong.? In my opinion, policy should be tightened, but only because I think quantitative easing actually depresses an economy.? It does the opposite of stimulate; it helps make the banks lazy, and just lend to the government.
The question is this: will the mechanisms of credit transmit inflation to goods and services?? So far, it has not.? Lowering the policy rate does little to incent borrowing when enough people and financial institutions are worried about their solvency.
They have no idea why their policy is not working, and they don?t know what to do about it.? Monetary policy works with long and variable lags, so they won?t say that their policy isn?t working.? It?s just slow in taking effect.
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.
