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More on interest rates and easy money

by JakeS Tue Apr 26th, 2011 at 02:34:17 PM EST

In the comment thread to my last diary, 'Bubbles' Greenspan came up. And while I despise Chairman Bubbles as much as the next guy, I think it's important to despise 'Bubbles' for the right reasons. To whit:

Greenspan took care of keeping interest rates low. This bred a series of asset bubbles, culminating in the real estate bubble which began deflating in 2007

Not quite.

Relaxation of lending standards and margin requirements make bubbles. Low interest rates have nothing to do with it. You get bubbles at 7 % rates. You get bubbles at 3 % rates. You get bubbles at 0 % rates. Hell, the broker's rate touched 12 % for a while during the spring of 1929. When you have that sort of short-term returns to speculative activity, fiddling with the rediscount rate barely amounts to a rounding error.


Yes, you can kill a debt bubble by jacking up interest rates, in the same way that you can kill inflation by jacking up interest rates: By killing your economy so dead that nobody has the confidence required for price increases or borrowing. That is the stupid way to do it.

The smart way to do it is by jacking up margin requirements, because that leaves interest rates unchanged for viable borrowers and sends them through the roof for Ponzi scams.

The "low interest rates lead to bubbles" narrative is a right-wing narrative. You do not want to push that. The reality-based narrative is "low margin requirements lead to bubbles."

Greenspan fueled the bubble by cheerleading on the bubble, by lobbying against all meaningful regulatory reform, by failing to police the Fed's member banks. He did not fuel the bubble by not killing the American economy completely dead in 2003, any more than convenience store clerks encourage robberies by not having capsules of sarin gas under the counter.

- Jake

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The "low interest rates lead to bubbles" narrative is a right-wing narrative. You do not want to push that. The reality-based narrative is "low margin requirements lead to bubbles."

That is a point that most are unlikely to get from reading today's mainstream media. I certainly didn't.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Apr 26th, 2011 at 03:27:11 PM EST
Questions, using Spain as an example for my understanding:

  1. Was Spain's construction/property bubble a result of low Spanish margin requirements?

  2. If not, then what?

2A) If international low margin requirements, what could Spain have done about it?
by Metatone (metatone [a|t] gmail (dot) com) on Wed Apr 27th, 2011 at 01:30:53 PM EST
Yes and no. The question of "what causes bubbles?" is actually not that interesting. We know that all monetary economies experience bubbles from time to time. The question is "how do you kill bubbles in the least painful way?"

Raising interest rates is usually more painful than raising margins.

Now, in the case of Spain, joining a currency union with one or more mercantilist members meant that there was no non-painful way for Spain to kill its bubble. Raising margin requirements would have been less painful (and in fact was done) than raising interest rates. But since Spain was locked in a death pact with the Bundesbank, it faced a tradeoff between suffering pain now or letting the bubble mask the pain now and suffer greater pain in the future.

From what I've read, and with the caveat that this is secondary sources in English, they have actually managed about as well as they could, given the shitty hand they were dealt by the Growth and Stupidity Pact.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Apr 27th, 2011 at 01:47:24 PM EST
[ Parent ]
Thanks.

For clarity - what were the features of the GSP that prevented killing the bubble in Spain?

by Metatone (metatone [a|t] gmail (dot) com) on Wed Apr 27th, 2011 at 02:19:20 PM EST
[ Parent ]
The cap on public expenditures. If Spain had been free to monetise their sovereign bonds at the ECB, they could have killed the housing bubble dead and kept demand from collapsing with public investments. Absent that ability, they had only bad options, because only the private sector was allowed to leverage, and it wanted to leverage its way into a bubble.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Apr 27th, 2011 at 02:34:55 PM EST
[ Parent ]
only the private sector was allowed to leverage, and it wanted to leverage its way into a bubble

There is plenty of evidence this is the way the Bundesbank likes it.

Both from the way the treaty sections on the ECB prohibit monetizing public debt but not private debt, and the way the ECB has actually monetised private debt without a peep while having the German members of the ECB council lie about whether buying bonds in the secondary market is monetizing them (it is not). And, to make things better, Germany has managed to prohibit the future European Stability Mechanism (to succeed the EFSF after the magical date of 2013) from buying sovereign bonds in the secondary market.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Wed Apr 27th, 2011 at 02:55:11 PM EST
[ Parent ]
Jake:
The question of "what causes bubbles?" is actually not that interesting.

For academic economists, perhaps not. But Metatone and I are both interested in the question. If it is "uninteresting" because it is untractable that might shed light on a blind spot. If it is uninteresting because it is simple and obvious, then it should be easy to explain.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 28th, 2011 at 08:11:47 PM EST
[ Parent ]
No, I actually meant that it's uninteresting from a practical perspective. It's very interesting from an academic perspective.

But we've pretty much narrowed it down to "either it is something fundamental in human nature that makes people buy into Ponzi scams or it's something fairly fundamental about money and credit instruments." And since we are not about to give up using money or alter basic human nature, for all practical purposes bubbles are a fact of life.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Apr 28th, 2011 at 11:54:04 PM EST
[ Parent ]
Bubbles are only a fact of life if you believe it is necessary for credit intermediaries to create credit as now.

The fact is that it is straightforward to base credit directly on the use value of productive assets. I believe that we will see the rapid emergence of this 'creditary' technique which is essentially 'peer to peer' investment in the output of productive assets.

Note that banks in fact have an interest in adopting such a dis-intermediated architecture because their capital requirement as a risk manager, as opposed to risk intermediary, is minimal.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Apr 29th, 2011 at 08:22:53 AM EST
[ Parent ]
But if the problem is in the nature of credit itself, coupled with limited information by investors, then changing the way credit is issued won't solve it.

Mig has a neat model of rational bubbles, in which investors over-invest because there is a delay between the time when an investor commits to investment and the time when the product enters the market. So bubbles may well be fundamental to systems with limited information and delayed feedback.

Further, the existence of credit invalidates Say's hypothesis: As long as there is no credit, savings create demand, because in order to save you have to accumulate actually useful things. But in the presence of credit instruments you can instead accumulate credit instruments, thus net removing demand from the economy. As Keynes put it, credit instruments enable a person "to pile up claims to enjoyment which he does not intend to exercise at any definite time."

This is fundamental to credit. No scheme for issuing or regulating credit creation will prevent it. The best you can do is to remain vigilant and pop bubbles as soon as you see them form.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Apr 29th, 2011 at 11:47:32 AM EST
[ Parent ]
But we've pretty much narrowed it down to "either it is something fundamental in human nature that makes people buy into Ponzi scams or it's something fairly fundamental about money and credit instruments."

Given the power that the combination of both factors give both those who run Ponzi schemes and who control money supplies I would suspect it is both. Some would deny that there is a difference, especially over time scales of a century while others would deny that bubbles can even be identified. That last position would seem to indicate that not only are both factors at play but that those who most vociferously deny the ability to spot bubbles are, in fact, acutely aware of them but zealous to deny their existence due to the profits accruing to those early into the scheme.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Apr 29th, 2011 at 10:30:57 AM EST
[ Parent ]
Of course you can spot bubbles. And you can kill them before they do any great harm. You just very probably can't prevent them from forming.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Apr 29th, 2011 at 11:39:02 AM EST
[ Parent ]
Something similar is going on in Israel right now. The Governor of the Bank of Israel is at least trying to do something about it, reducing the percentage of the price you can borrow and other restrictions on the bank (as well as blaming parents for buying apartments for their children....), but nothing seems to be working so far.
by gk (gk (gk quattro due due sette @gmail.com)) on Wed Apr 27th, 2011 at 03:26:32 PM EST
[ Parent ]
Well, if they can raise the margin high enough that people don't end up underwater even after the correction, then they've solved the problem. Not as neatly or as painlessly as if they had been able to prevent a price bubble, but sometimes people want their Ponzi market and fundamentals be damned...

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Apr 27th, 2011 at 03:49:32 PM EST
[ Parent ]
Apparently it takes time for actions to work. I got this comment on a diary of the Swedish housing bubble:

ARGeezer:

Average time of sale is usually the first warning, sometimes a false warning, of an impending top. In 2005 in Los Angeles prices slowed their rate of increase in the early fall and average time of sale increased from the late fall into 2006. Prices peaked, IIRCC, in July of 2006 but it took until 2007 to confirm that prices had actually begun to decline.

Speaking of tha Swedish housing bubble, a small update: I recently saw statistics that price increase has been unproportionally in the bigger cities, so even though average price was only 20% overpriced (a year ago), units in bigger cities are probably unproportionally overpriced.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Thu Apr 28th, 2011 at 03:10:37 AM EST
[ Parent ]
That was the pattern in the USA from 2000-2007. Arkansas real estate went up mid single digits over that period, as did most southern and mid-western real estate, but the big markets -- Southern California, California Bay Area, Las Vegas, Miami, and others nearly tripled in value. Location, location, location!  :-)

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 28th, 2011 at 07:57:43 PM EST
[ Parent ]
Do you have data on Stockholm and one or two other "hot" Swedish real estate markets and data on a couple of mid sized cities that have not grown very much in the last 10 years?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 28th, 2011 at 08:02:11 PM EST
[ Parent ]
Not availble. Read some in dead tree version at easter, but is not able to locate the article online.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se
by A swedish kind of death on Fri Apr 29th, 2011 at 04:00:21 AM EST
[ Parent ]
Solution: increase "up to eleven" the regulatory capital requirements for holding mortgage loans in a bank's books.

One of the features of housing bubbles is overvaluation of homes as mortgage collateral. Normally it is assumed that loan-to-value doesn't exceed 80%. With an inflated value, a loan-to-value of 120% (where the mortgage covers even legal, administrative, tax and even physical customization costs of the purchase) can be turned into an 80% "book" loan to value. So, jack up the regulatory capital requirements by 75%.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Fri Apr 29th, 2011 at 02:23:36 PM EST
[ Parent ]
An additional thing he's just done is to limit the variable-rate part of a mortgage to 1/3 of the value, where variable-rate includes mortgages in foreign currency.
by gk (gk (gk quattro due due sette @gmail.com)) on Sun May 1st, 2011 at 02:36:32 PM EST
[ Parent ]


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