Dow up 61 yesterday. Gold up $11.
Michael Milken was in The Wall Street Journal on Wednesday. We talked about his contributions to the junk bond market yesterday. He helped create it in the early ‘80s and then went to jail. He “understated the risks”, said the newspapers.
Thirty years later, the junk bond market is ten to 20 times bigger, and the risks are greater than ever. But now, the risks are not understated by Milken, but by central bank policy. Prices are guided by the Fed. And speculators believe they barely have to worry about losing money, not as long as the Fed provides an unlimited line of credit at near-zero cost.
But Milken never mentioned junk bonds yesterday. Instead, he was concerned with another grotesquery perpetrated by the feds.
We wondered about it while we were driving back up from South Carolina. The old houses we passed – setting aside the mansions – were small. Often charming. Some were even elegant. Newer houses – especially those built in the last ten years – were much bigger. But most had lost all grace and charm. Instead, they were ungainly, clumsy and supersized, like someone with a glandular disorder.
The typical house grew by 50% over the last 30 years, says Milken. But during this same time, the average family size was falling by 25%. Fewer people, more space.
And much more expense. First, the cost of construction goes up with the square footage. Then, it costs more to furnish it. And to heat and cool it. And to maintain it.
Is more space really better? It’s not for us to say. But Elizabeth had an opinion: “I wouldn’t want to rattle around in a big, empty house”, she observed, as we drove past a field full of recently planted McMansions.
“They must have put up these houses during the housing boom. But they must regret it now. They have to heat them. And who’s going to buy these white elephants?”
Bill Bonner on markets, economics & the madness of crowds
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Let’s go back to the question of why they bought them in the first place. Mr Milken has the answer: the housing market became another of the feds’ distortions.
In the housing-boom decade before 2007, many buyers decided that the largest-possible house (with an equally large mortgage) was a better idea than a retirement fund or their children’s education Houses were ATM machines. The bigger the house, the bigger the line of credit. Homeowners ‘took out’ the equity as fast as it accumulated.
But what was this equity? Where did it come from? Like the bounty of today’s stock market, the pre-2007 housing market was a monster created by the feds. According to Milken: “US mortgage holders receive bountiful tax benefits, loans that include no recourse against borrowers’ non-residential assets if they walk away, and loans that offer no protection for the lender if the borrower refinances the loan for a lower rate.”
And now the monster has become a zombie: unwanted and unnatural, kept alive by the Fed’s artificial interest rates. Norbert Michel of the Heritage Foundation adds: “The government guarantees we’ve had in the US housing market have distorted housing prices, encouraged debt, left taxpayers on the hook for trillions, and provided the is impetus for millions of home foreclosures.”
The poor homeowners are stuck with millions of ATM machines that no longer work. Despite a robust bounce last year, it is unlikely that increases in house prices will continue to exceed increases in the CPI (consumer price index). In other words, houses will go back to acting like they always did, shuffling along with the economy.
Both America’s landscape and its economy have been blemished and distorted. Risks have been seriously understated. So far, no central banker has been hauled up on charges. But we’re looking forward to it.
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