'Secular Stagnation' Is Merely Government Intervention
In the middle of May 2014, the Information Management Network held a two-day conference at the Boca Raton Resort and Club, not far from our West Palm Beach office, dedicated to educating "investors" about the rental property fad. I did not attend and only bring it up because, as a Florida resident during the height of the housing bubble, these kinds of seminars were once daily events. So in one respect it was an aching reoccurrence to what was hoped to be a bygone age.
Without a doubt, there are many policymakers that wish for that to return with all its frenzy, excitement and "easy money", though hopefully this time without the heartache, pain and, in a lot of cases, utter ruin. The presenters advertised were about what you would expect, from executives of ratings agencies to typical Wall Street "analysts" to a Vice President from Fannie Mae; even a Senior Supervisory Financial Policy Analyst from the Federal Reserve Bank of Atlanta.
Still, even with the echoes of that past age, it was somewhat odd to rifle through a "housing" event dedicated to individual sessions of, "Small investors only: Do you own 25 or 50 houses and are you considering ramping up?" and, "Consider selling to larger aggregators." There were also topics like, "Will the single family market come to a complete stop or continue to speed?" and "Which markets are bank REO purchases over?"
That last one has been especially sticky given what has transpired in housing since last year's MBS rout. While overall home sales have rebounded only somewhat since March, sales at the lowest price end (those under $100k) have not - at all. That was where the short sales and foreclosures were taking place, a space that came to be dominated by new and unusual vehicles in the real estate "market." Since QE2, marginal MBS transactions, and even repo, was delivered by the growth in mortgage REIT's, which in turn feeding off QE's effects on production coupons helped give rise to the new rental arrangements that IMN's seminar was catering to.
In some very important respects, that is how it should be. Setting aside blame for the disaster momentarily, there has to come a point when markets clear imbalances and buyers emerge from the wreckage and begin to rebuild. In this case, however, rebuilding has tended almost exclusively toward rental properties; and where new supply is not needed due to the still-immense overhang of the previous level of bubble buildout there has been a rush of financial institutions becoming the largest landlords in since the Feudal Age.
Companies like American Homes 4 Rent and Blackrock purchased, often through specifically crafted financial vehicles, an estimated 200,000 homes in the past two years. As noted above, however, that pace of sales, conducted only in bulk at auctions, has come to a screeching halt this year. A wave of consolidation is looking increasingly likely, with some of the larger firms now buying out smaller competitors at hefty premiums rather than focusing on buying up more shadow housing inventory.
It is still interesting that the state of the lower ends of home inventory is so uniquely tied to these institutions right now, particularly since it was "forced" short sales and foreclosures dragging down systemically the prices of houses all over the nation, including locations that had little experience of real estate "froth" in the 2000's. In that respect, it seems like a highly beneficial practice to have had removed a tremendously negative price pressure regardless of how that was "engineered." Given that mainstream monetary theory believed (and still does) that negative equity is the primary predicate condition for a homeowner walking away and accepting foreclosure, breaking that cycle via any price mechanism is understandably a goal.
There has to be some account, however, of the circular nature of how it all occurred. The MBS intrusions of QE obviously sparked some kind of interest in mortgages, as the holdings of MREIT's since just 2011 have more than doubled to over $500 billion. MREIT's are not just the end of the line for mortgage loans, securitized GSE's or otherwise, they are also a purveyor of liquidity into, among other places, the repo market, particularly the dying segment of agency repo.
As with any pure monetary theory, the increase in liquidity due to MREIT's activities is an unalloyed "good", as that gained function or increase over past dysfunction likely spurred other activity in that space. With liquidity flowing institutionally, other institutions headed in exactly that direction as Wall Street turned landlord through what it saw, rightfully, as tremendous profit opportunity. The subsidy of MBS through QE rendered an artificial "stimulus" that acted, on the surface, exactly as intended.
Of course, real world function is not in any way free of complication. In fact, the huge rush of "money" into this area, colloquially known as REO-to-rent, was a bit too effective. Prices began to not just reverse and head higher, but in many markets with great speed. In fact, those markets with the quickest price acceleration "just happened to be" the very same as those caught up in the last frenzy - California, Las Vegas, Phoenix, and then some parts of Florida.
This is not to say that craziness was fully reborn and that the full-blown imbalance was reblown, but rather that prices were staging massive movements on only fractions of prior volume levels. It did not take very long before those same institutions began to reassess the viability of their own business model, which now includes far less explicit support of MBS corruptions (however they arrive at the end of the process). The very price acceleration that policy wanted and "needed" was in fact the very same end point for the mechanism by which it was all achieved - an oddity that speaks about the artificial state of all of this.
Shortly after QE3 was announced in September 2012, then-Fed Chairman Ben Bernanke spoke at the Economic Club of Indiana.
"A second observation is that savers often wear many economic hats. Many savers are also homeowners; indeed, a family's home may be its most important financial asset. Many savers are working, or would like to be. Some savers own businesses, and-through pension funds and 401(k) accounts-they often own stocks and other assets. The crisis and recession have led to very low interest rates, it is true, but these events have also destroyed jobs, hamstrung economic growth, and led to sharp declines in the values of many homes and businesses. What can be done to address all of these concerns simultaneously? The best and most comprehensive solution is to find ways to a stronger economy. Only a strong economy can create higher asset values and sustainably good returns for savers. And only a strong economy will allow people who need jobs to find them. Without a job, it is difficult to save for retirement or to buy a home or to pay for an education, irrespective of the current level of interest rates."
This is a theme that came to dominate the last stretches of Bernanke's tenure, as the costs of QE and ZIRP began to build up without a clear payoff. The logic being used here is somewhat contradictory, however, in that he says we want higher interest rates but we have to accept very low interest rates to achieve them. He also notes, offhand, that the "crisis and recession have led to very low interest rates" which speaks to this disconnect.
To see it more clearly, Chairman Bernanke used much the same argument, including the allusion to higher interest rates as projected from economic strength, in Congressional testimony in May 2013 that many mark as the catalyst toward the drastic bond and dollar drama that followed.
"Recognizing the drawbacks of persistently low rates, the FOMC actively seeks economic conditions consistent with sustainably higher interest rates. Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets."
It's funny that he referred to "extended periods of lower, not higher, interest rates" as that is exactly how the last seven years have developed. Ever since the first catastrophic shift in financial function on August 9, 2007, interest rates have gone lower and remained there. So he proclaimed that low interest rates are necessary to gain economic traction in order to have high interest rates, but that after seven years (six to that point) we still need low and zero rates which "tend to be associated" with economic problems. At what point do low rates and economic traction no longer associate?
In 1998, Milton Friedman severely criticized the Bank of Japan for falling into an "interest rate fallacy" whereby low (though not yet zero at that time) and falling interest rates are taken as a signal of "loose" monetary conditions. In Bernanke's revised formulation, low interest rates are "loose" and accommodative and high interest rates are the ultimate goal, denoting the success of accommodation further in time. But in the case of Japan, now into its sixteenth year of ZIRP and at least ten QE "accommodations" along the way, low interest rates mean nothing of the sort. There has been no credible path to economic health engineered as yet, with the current malaise now realistically stretching to at least three decades with nary a sniff at higher rates of returns.
Somewhere between the Great Inflation and the current age, Friedman's script was altered to view liquidity as all-encompassing, including its permissiveness toward economic function. Since the modern monetary view is all about debt and more debt, liquidity takes on an enhanced role in greasing the system toward that financialized goal. On a liquidity basis, it is believed, low (rates) is better and that better liquidity is the key toward restoring credit, which itself turns the economy back upward.
But that isn't quite the full description, as the economy in the orthodox bend is thought to be "held back" by "shocks." A recession cycle is the temporary interruption, in the orthodox view, of a permanent upward trend in economic growth. This potential track forms an attraction to whatever economic reality manifests by factors near and far. Thus, should the economy fall off into recession, the central bank need only clear liquidity to restore credit and allow the economy its natural ascent.
That seems to have been what was accomplished in the US housing market via all those institutional bypasses worked up since QE2 began. In fact, financial operation far and wide looks to be something of restored to prior heights, a condition that is usually among the first "accomplishments" denoted by any policymaker in trying to distract from actual economic station (which is supposed to be the primary objective). This is an observation that stands not just in the US (as though GDP and other accounts may have some intermittent positive numbers, and a real income problem, economic trajectory has decidedly not been restored) but extends pretty much globally.
In Europe yesterday, the ECB may have confirmed this myopic view by lengthening its own experimentation with nominally negative interest rates, all in the course of liquidity and financial function. My own views on their rate corridor can't help but notice that there is seemingly an inexorable drive to reunite Eonia with the Main Refinancing Operation (MRO) rate. If you have some knowledge of European wholesale interworkings, that is a damn curious position to be in. Interest rate targeting is supposed to work in the opposite direction, as the central bank is supposed to set a target (the MRO and its upper and lower bounds; the lower of which is now more deeply negative while the MRO itself is barely positive) by which the market respects and reacts to. Instead, it very much looks like the interest rate target itself is chasing the "market" rate of Eonia.
The only reason for doing so would be not to actually clear liquidity hurdles that remain despite the presence of low and zero interest rates, but to make it appear as if those hurdles have been removed - as if that would suddenly convince banks in the system to openly and capriciously revert to prior and intended form and operation. Again, the effectiveness of these low rates is not only questionable in an economic sense, where Europe is again poised on the precipice of recession without recovery, but very much in even the narrow constitution of liquidity.
In terms of economic theory, then, there are a couple of apparently intractable problems given this arrangement. The Great Recession was a global event, a fact that itself suggests more than a "shock" to have achieved so much economic dysfunction for so long. As the march of time continues to advance without having regained prior trend, again globally, it gets much harder for monetary theory to hold that the economy's relation to credit and liquidity is the key variable in assigning relative health. That is further stretched by the apparently broken correlation between interest rates and liquidity in the first place.
And where Europe and the ECB may be the most obvious place to see that last "disappointment" up close and in action, it also extends to the US as I have noted on many occasions - not only is there a real repo problem inside dollar systemic function that remains to this day, last year's violent credit reaction to tapering threats was very much a rebuke of "resilience" and "normalcy" despite whatever the current "forward guidance" suggests, cajoles or sets for interest rates.
While the Federal Reserve and other central banks may not publicly admit as much, there is growing evidence that they recognize this state of affairs. The idea of "secular stagnation" has already spread throughout the orthodox structure all over the globe, in what can only be described as admitting failure without admitting failure. In other words, central bankers and orthodox economists may be coming closer to Friedman's critique in that interest rates and liquidity are not by themselves the key variables in the economy. Of course, economists being what they are, they instead are trying to find reasons to blame the economy itself, actively groping for explanations as to why "potential" has been reduced which would give academic cover.
A key insight that eludes this desperation is a variation on Friedman's theme - that low interest rates are not themselves monolithic. The Fed's intent in terms of housing, , as noted toward the outset here, was, to be overly simplistic, to try to reinvent what took place in the middle of the last decade. They wanted anything to create a positive price pressure and to restore at least the appearance of normalcy in real estate. They got as much but in a fashion that is very much different than what existed before. That may ultimately be a good outcome, or it might be the end of the world, we don't know yet. The fact that marginal housing has flowed to Wall Street hands might be the "right" course, or it might turn out to be another impulse toward concentration and the current political construction of "inequality."
My point here is not to surmise which is what, only to point out that the reconstituted system of "liquidity" for real estate is wholly different now, and that difference was and is itself a creature of only monetary intrusion and not true market forces of profit and loss. So where low interest rates (QE's and all) and liquidity seem to have correlation, that is only on the surface as there are myriad complications underneath that are as yet understood; featuring their own unique strengths and weaknesses that may not become fully appreciated until it is, one more time, too late.
In the case of Europe and the ECB's seeming quixotic quest to "tame" Eonia, or at least the spread with the MRO, the same generalized observations apply. The liquidity system appeared to be similar to pre-crisis operations, notably interest rates including bond prices almost everywhere, but what it has taken to achieve that appearance is nothing like operational frameworks that existed before. Again, that might turn out to be a huge positive, as clearly the last regime was wholly flawed and ultimately tended toward disorder far too easily, but I very strongly suspect, in my own analysis, that not to be the case.
If current mainstream economic theory is flawed, and I don't think there is much doubt about that given the turn of events this century, it is the curious lack of curiosity about how and why systems develop as they do. To a central banker all that matters is a certain target is reached at a certain point; no consideration is ever remitted toward a systemic approach. I think that too extends not just to financial construction and reconstruction, but also economic intrusion itself. If artificial manipulation of liquidity leads to reconstituting liquidity in far different manners, then why wouldn't the same be true of manipulation in the real economy?
Ultimately, the idea of secular stagnation holds great promise, but not for the reasons intended by its current proponents. It represents an admission that something far greater is wrong in the global workings, and that there is importantly a high degree of impotence on the part of artificial intrusions under such constraint. If that leads to honest study about imbalances and misdirections, then we can at least hope that some insight into actual function beyond the surface might provide an answer as to why economic trends may have become so impaired in the first place.
