Tag Archives: housing bubble

Chinese real estate market start to collapse (Part 2)

The local governments relay on the prices and sales of houses to increase their GPD target, so they have incentive to support the real estate bubble and maintain the house prices. However, the new Chinese centre government limited loans provided by bank to those developers, this policy was determined by the centre bank in Beijing and no other local branches can disobey that. Thus the local government can’t help the real estate firms much even if they wished to.

However, a large scale bankruptcy of real estate development firms may not be acceptable. Reported in WSJ, (the current number bankruptcy) this is acceptable as long as not too many companies go broke at the same time and doesn’t result too much disruption, Mr. Chan added. In other words, they don’t want a “Lehman Brothers” moment. The real estate regulation is sure to be more influential to those developers who don’t have much fund support. Said by John Allen, chief executive officer of private investment firm Greater China Corporation in a later speech. “Bankruptcy is one of the healthiest things around. You want to get rid of the weak players.”

The current goal of Chinese centre government is to regulate real estate market and try to “shrink” the bubble, no one wants to cause a larger bubble or burst the bubble so early. The current situation is favored by Beijing, small real estate firms go bankruptcy in a moderate rate. According to WSJ, now that measures by Beijing to rein in the availability of credit and cool the housing market are beginning to bite, some developers are feeling pinched.

In 2010, Beijing start its curbing on lending to real estate developers, the centre government trust that the house market will be cooled in several years. For real estate property developers, the fund is most important thing for their sustainability. With enough fund, the house prices can stay high, without enough fund, the developers must sell their houses at a lower price because they must recollect the fund and pay the debt. The actual effect of policies from Beijing was quite effective. According to the chart from WSJ below, the difference between sold and construction has becoming larger. And the surging number of constructed houses stopped and went down at from the end of 2011.

No doubt that the downward trend of house market has already began, but there will still be few more years before the market returns to its normal health. The next question for Beijing is: how to minimize the harm caused by the burst of bubble.

Chinese real estate market start to collapse (Part 1)

Last month, one real estate developer Zhejiang Xingrun Real Estate Co. experienced an insolvency. It couldn’t pay 2.4 billion Yuan to bank and nearly 1.1 billion Yuan to other creditors, which was almost $600 million. This was the biggest ever real estate firm default since 2008. The local government in Fenghua hold a meeting to determine what to do with a default of such a huge amount of money. As reported in WSJ:

While China has seen developers default before, government officials have arranged bailouts for troubled firms that allow their underlying financial problems to fester. On Thursday, analysts argued that authorities have to be willing to address the other option: Let the companies go broke, and send a warning to markets, even if it leads to some financial turmoil in the near term.

It’s not a news that Chinese real estate market is slowing down, more and more people start to wait for a lower price. More potential house purchasers anticipated that the rapid growth of house market in China has comes to an end, as the new centre government carried out executions rigorously, now more and more small real estate developers can’t get enough support fund from bank, either they will go bankruptcy or refer to usury.

There are many reasons why more and more real estate firms in china are suffer from default. Few years ago, as Chinese house market start its surging in scale and price, more and more small real estate developers without much fund thought they could win a tons of money from the market. Some houses were built without enough fund support, so the properties developers thought of a new strategy: they sell the houses first, and use those huge amount of money from house purchasers to build their projects. Because the cost of construction is far lower than the price, this is a win-for-free strategy. However, now they are suffering from the risks they buried years before. With less and less people willing to buy houses at such a historical high price, now the properties developers can’t get enough fund to support their construction, which turns out to be “unfinished residential flats”. That is, the building projects are far away from available, developers has no money to continue construction, and those who already paid for their houses can’t either get the house or their money back, and they still have to pay their mortgage loans to bank. Witnessed more and more “unfinished residential flats” in China, Chinese house purchasers have more incentives to stop their purchase plan.

Miami Real-Estate

Around the world, Miami is best known for its beaches and partying. But what many may not know, is that this city was one of the hardest-hit by the housing bubble. Not only was it negatively impacted when the housing bubble burst, but it saw some of the most rapid and significant rises in home prices in the country.

Since I have lived in Miami for many years now, I can give a personal example of just how aggressively prices changed within five years. When we bought our home in 2003, it was valued at around $300,000; with the housing bubble growing, the value of our house rose to about $700,000 by 2008. And after the bubble burst, it went down to around $400,000. Of course this relative change wasn’t equal all over the city and it varied by area and type of real estate. But this is just one example of the extent of the housing bubble.

A recent article in The Economist does a nice job of outlining the unique real estate market in Miami today. After the crash, the market has been steadily growing, and there is reason to believe that it will continue to do so in a stable and secure manner. In fact, the speed of Miami’s real estate recovery has surprised many. Condo prices are back near peak levels in areas with highest demand, and at 75%-80% everywhere else in Miami. The effect of the building boom seen before the crash, has now leveled off: the available supply of units is now around 6-9 months (range of time since the sale is made), from 40 months back in 2008. Only 3% of condos are unoccupied and the volume of sales of single-family homes are above pre-crisis levels throughout Miami-Dade County. And as far as avoiding another housing bubble, the article notes that “in a few years Miami has gone from the most- to the least-leveraged property market in America. Buyers of new condos typically have to put 50% down, half of that before building starts. Banks are loth to extend construction loans unless 60-75% of the units are already sold. In both residential and commercial projects, they require developers to put in much more equity than before.” Thankfully, the lesson was learned.

However, the interesting aspect of the Miami real-estate market is the fact that most of its demand comes from Latin Americans looking to invest (or live in) this area. Miami is sometimes called the “capital of Latin America,” and from personal experience I can say this is absolutely true. Though it varies by area within Miami, there are predominantly Hispanics throughout (myself included). Wealthy people from Brazil, Argentina, and Venezuela (among others) are flocking to Miami to get their share of paradise and/or investment opportunity. As the situation in these countries disfavor their status, more and more are looking to Miami. The area where I live, Doral, is especially unique because it is filled with Venezuelans. Doral is often referred to as Doralzuela because it is around 99% Hispanic, 40% of whom I would estimate to be from Venezuela (while the rest are from other Latin American countries). In Doral, there are now projects that are accepting payment (which is often in cash) in Bolivares, the Venezuelan currency.

The author of the article states “somebody said to me, ‘Give me three reasons why this will continue.’ My answer was: Maduro, Kirchner and De Blasio,” chuckles Marc Sarnoff, a Miami city commissioner, referring to the leaders of the capitalist-bashing regimes in Venezuela, Argentina and New York.” This is a very accurate prediction for Miami. As long as Latin Americans have reason to invest outside of their own country, or as long as they continue to join their friends and family in this wonderful city, the Miami real-estate market will continue to grow.

A Random Walk Down Wall St – Part I: Ignoring History

I hope to write my blog posts on our class reading, A Random Walk Down Wall Street by author Burton Malkiel, in a series of posts. In this first post, I will focus on the first part of the book where Malkiel leads the reader through a series of historical anecdotes. Ultimately, I hope to compare some of the historical examples to the recent housing bubble that led to the recent worldwide recession. It starts with acknowledging the irrationality of investing strategies.

Today in class, Professor Kimball referenced a ballpark 4% real interest rate that we can shoot for when investing for retirement. It was also well-noted that 4% is a worthy target but not always easily achieved. In these modest investing situations, it can be frustrating to see money stagnating in the market. When the opportunity arises to increase to 5%, 8%, or something much, much higher, it’s tempting to pull the trigger. If the risk seems modest enough, more of us than not are going to want to maximize our returns, especially while we are young. Much of the time, the risk isn’t going to be modest – it just seems so. Investing in these risky opportunities, and believing that they are indeed great opportunities – is a result of what Malkiel calls “irrational speculative enthusiasm.” It comes from the masses feeling invincible, and it happens quite often.

My favorite example given by Malkiel comes from what he classifies as the “South Sea Bubble.” In the late 17th century, stocks were new forms of wealth and exclusive to own in England. When the infamous South Sea Company made stock in their company available to the public, they were perceived as a one-way ticket to wealth. Prices rose and rose, and in the meantime the public threw money at new proposals ranging from square bullets to manufacturing boards from sawdust. These absurd ideas had little traction, but the get-rich-quick attitude persevered and induced many to invest. Of course, the bubbles were burst and many were left in dismay. At least next time they would know what is coming.

But the next time, everybody in America was making money investing in industrials. What came next? The Great Depression. More dismay. Hadn’t we learned?

So let’s jump ahead to the 21st century and talk about cell phones and nifty gadgets. A golden age for “Castle-in-the-Air” companies on the forefront of technology. And this time, our safety nets were what cost us. Land has been a traditional way to safely invest. Property values have continued to increase for decades. The model even seems to make sense – an ever-increasing population demands a fixed number of acres of land. But unknowingly to us, the housing bubble was about to burst.

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The U.S. housing bubble looks remarkably similar to events dating back more than four centuries. In all cases, irrational speculative confidence helped us build an aura of invincibility for our property.

Much of the Great Recession was sparked by the failure of mortgage-backed securities and irresponsible investing by banks. However, we saw once again that irrational speculative enthusiasm is present, especially in the financial sector. And if a bubble can happen to a safe investment like a home, can’t it happen to anything? Rather than denial through believing in “it’s a different time,” we can embrace the opportunity to learn from history and start using past mistakes to our advantage.

 

Housing Bubble in US and Japan

Housing bubble is a great concern in many countries. When the economy was at its peak, the housing price went up enormously. The book A Random Walk Down Wall Street by Burton G. Malkiel explains housing bubble extremely well. As the economy is at its peak, government policies and changed lending practices led to an enormous increase in the demand for houses, thus price increased rapidly as “supply” of housing is something that cannot be modified in a short term. Furthermore, as price of house increased rapidly, more people bought houses as a medium of “investment.” Some people burrowed money from the bank in order to buy houses, seeking for a greater return.

The graph of inflation-adjusted home prices is shown in page 103 of the book. It can be seen that in US, the house price index was doubled in early 2000s compared to year 1890. More interesting thing to note is that the Real Home Price Index was almost constant until early 1990s, and it increased rapidly since 1990s. As the graph shows the national average of house price index, some major cities such as New York experienced a more acute increase in housing price.

We all know that housing bubble eventually collapsed. Many home buyers found that the amount of their mortgage far exceeded the value of their home. They eventually defaulted and returned the houses to the money lender. Thus, home prices started to decline rapidly (decline by two-thirds), and destroyed real estate and resulted bankruptcy of many largest financial institutions in United States.

What is interesting to note is that Japan suffered housing bubble 15 years before the US housing bubble took place. The graph below, obtained from Comparing the US and Japanese Housing Bubbles compares the Japan and US housing bubble. It can be seen that Japan had a much bigger “bubble.” While US house price increased to 200%, Japan’s bubble was as big as 275%. The reason for this magnitude difference could come from the fact that Japan has more urban cities where population density is much higher, thus housing price increased more rapidly.

japanes-and-us-housing-bubbles

 

From the New York Times article Land Prices in Japan’s Largest Cities Rise for First Time in 6 Years, land prices in Japan’s largest cities rose for the first time in six years in 2013. As prime minister Shinzo Abe loosed monetary policy to boost the economy, it looks like people have purchased land as an asset. Commercial land price of major cities such as Tokyo, Osaka, and Nagoya rose 1.6 percent, but land price decreased by 1.7% in other smaller cities, for 22nd consecutive year.

Japan is well known example of a country which suffered from heavy housing bubble. And it was surprising that Japan’s housing price went up in main cities in year 2013, due to “Abenomics.” It can be a sign of economic recovery, but it is not very satisfying as price increase have only occurred in main cities. I recapped that a rise in housing price is driven from monetary policy from the book a Random walk Down Wall Street, so I expect that real estate market in Japan will continue to get better as long as “Abenomics” continue in 2014.

(Revised) Will the Real Estate Bubble Burst in China?

It’s always the hottest topic among Chinese people about the real estate price since the bubble is becoming bigger and bigger since the 1990s. We should know the definition of the bubble here: an unsustainable rise in the price of an asset, well above the market price given fundamentals. And the bubble is indicated by three indicators: gap between disposable income and home prices, rising inventory and number of properties per person.

Not like the United States, you cannot even imagine that for the majority of Chinese people they couldn’t even afford a house after working hard for the entire lifetime based on current real estate situation. The fact is that China’s real estate price have been undergoing a lot of changes with prices soaring in the past we now see an environment of declining prices. This phenomenon let investors question: will the real estate bubble really burst in China? (China’s Home Prices Rise to Record Levels)

Optimists insist that the prices won’t decrease a lot due to the large population and demand in China. They also mentioned that right now in the bubble, China’s residential mortgage debt was only 15% but U.S. always has a mortgage rate as high as 80%. (Why China’s property market isn’t in a bubble)

Also, from what I read from < A Random Walk Down Wall Street>, people are always willing to join the heated market though they are aware there are already a large crowd of people in it. It’s like the Tulip-Bulb Craze, like the South Sea Bubble, the greed of human beings make them step into a “promising” investment field. They only care about the increasing price but not the facts behind the scene. Greed makes people crazy as well as blind. However, according to the history facts shown in the book, we have to know: bubble will burst sooner or later. Early investors will gain profits from the market while crazy crowds will only be taught a blooding lesson in investments.

While pessimists don’t think so. They are arguing that as the mature of China’s financial market, people might be less likely to purchase houses because they would have more options for investment in future.

And then from population side, statistics show that the population will reach the peak in 2018 and labor force will shrink from 2015. Thus people predict that the property prices will start to fall between 2017 and 2018 thanks to the “one child policy” and China’s aging population composition. According to this information, pessimists predict a 40% decrease in the next five years since there will be fewer people willing to purchase a house but the supply is still large. Anther great concern of mine is the money chain of the real estate company because the majority of them burn a large percentage of loan. Once the supply is bigger than the demand, they’ll face a money chain rupture. They have to decrease the price attracting more buyers to save the company.

If the crash did come, it could cause a financial crisis like United States met in 2008: when housing prices declined steeply after peaking in mid-2006, it became more difficult for borrowers to refinance their loans. As adjustable-rate mortgages began to reset at higher interest rates (causing higher monthly payments), mortgage delinquencies soared. Securities backed with mortgages, including subprime mortgages, widely held by financial firms globally, lost most of their value. Global investors also drastically reduced purchases of mortgage-backed debt and other securities as part of a decline in the capacity and willingness of the private financial system to support lending. Concerns about the soundness of U.S. credit and financial markets led to tightening credit around the world and slowing economic growth in the U.S. and Europe. (subprime mortgage crisis)

To save the market, right now Chinese government is taking great efforts from policy intervention. Let’s have a brief look at China’s housing industry changes in recent years.

Before 2003, as developing with China’s economy, Chinese government regulated and supported the under developed housing market. From 2000, there was no more housing allocation existing in China any more and people had to purchase houses through housing companies. Then they enacted a series new rules and regulations such as a lower mortgage rates, reduced down payments, lower transaction rates and cuts in business to further stimulate the housing industry.

Then in 2002, Land Public Building System was enacted. Following in 2004, all lands started to be publicly bid and auctioned. Those changes could be regarded as causes why housing prices rise. From 2004 to 2006, with Chinese government encouraging housing sales and offering lots of benefits to housing industry as well as stimulating the whole economic situation, prices of houses rose a lot not only in big cities but also in small inland cities. Housing industry boomed rapidly during this period.

In 2005, in order to control the increasing price, “Eight Rules,” “New Eight Rules” and “Opinion of Such Departments as the Ministry of Construction on Effectively Stabilizing House Prices” were enacted, marking central government’s first efforts to rein in home prices. But the trend seemed really hard to stop, for example, only in the year of 2005, average housing price in Beijing increased by 20% while the price increased only 0.78% from 2000 to 2004. It’s increasing higher and higher to form a bubble no matter what the government tried to stop it since then.

Later in 2010, China posted “Notice of the State Council on Resolutely Curbing the Soaring of Housing Prices in Some cities”  to require a down payment on second homes from 40% to 50%. In addition, banks must charge a minimum mortgage rate on second homes of 1.1 times the benchmark interest rate and increases down payments on first home larger 90 square meters from 20% to 30%. Then in 2011, China had “National Eight” real estate market regulations. On the other hand, Chinese government has started the property tax pilot program which I think is pretty useful seen in the market. The program asks for more tax if you buy more houses in China. And it has been started in Shanghai and Chongqing since 2011. (Many Chinese Welcome Idea of Property Taxes

Prices might be controllable in future thanks to the government policies and so far, recent policies have not been given deadlines. In short run, volatility may be seen due to uncertainty. 

Though we are not totally sure whether the bubble will burst or not, recent situation in China gave me a clue that perhaps the bubble is bursting.  According to the Securities Times newspaper, housing developers in the industrial city of Hangzhou cut prices this week by an average 19% in a scramble to sell about 120,000 newly-built apartments. The current inventory of new, unsold units now exceeds the total number of housing units offered for sale in Beijing and Shanghai combined. A study by Shanghai’s Tongji University said real estate has been especially shaky in the northeastern city of Wenzhou, where new-home prices have fallen every month for the last two years. 

Indicating from the information above, Personally I think the housing bubble will burst in a near future or actually it has been bursting already.

Is The Next Housing Bubble Upon Us?

Most bubbles have been associated with new technologies or with new business opportunities. When delving into the Internet bubble of the early 2000’s in A Random Walk Down Wall Street, Robert Shiller’s book is referred to as he describes bubbles in terms of “positive feedback loops.” For example, he states that a bubble starts when any group of stocks, in Shiller’s case those associated with the Internet, begin to rise. The updraft encourages more people to buy the stocks, which causes more TV and print coverage, which causes even more people to buy, thus creating big profits for early Internet stockholders. Stocks continue to rise even higher, pulling in a larger and larger group of investors. More and more investors must be found in order to buy the stock from the earlier investors (A Random Walk Down Wall Street, 81). The bubble eventually bursts when the pool of “greater fools” runs out.

Similarly, a housing bubble begins when changed government policies and changed lending practices lead to an enormous increase in the demand for houses. Fueled by easy credit, house prices begin to rise rapidly which encourages even more buyers. Buying houses appear to be risk free as house prices consistently go up (A Random Walk Down Wall Street, 102). Speculators can enter the market believing that profits can be made by short-term buying and selling. This continues to drive demand until there is a point where demand eventually decreases, thus resulting in a drop in prices and causing the bubble to burst.

Housing bubbles become visible when housing prices begin to diverge substantially from rental costs.

Home Price Index

As you can see, most recently, home prices peaked in 2006 and then started their plunge. Due to government housing policies, this bubble was caused by making it possible for many people to purchase homes with little or no money down. The “affordable housing” goals allowed mortgages with zero-down payments to be made to home buyers who were at or below the median income. By 2006, it was reported that 45% of first-time buyers put no money down; basically, anyone who could breathe could get a mortgage. Today, after the financial crisis, the recession and the slow recovery, it looks as if the bubble is beginning to grow again as measures have been implemented by the Fed to re-inflate home prices. Between 2011 and the third quarter of 2013, housing prices grew by 5.83%, exceeding the increase in rental costs which was 2%.

Although mortgage rates have jumped a bit, to about 4.3% up from 3.5% in April, they are still near their lowest levels in history. While these adjustable-rate mortgages typically mean lower payments in the short-term, the interest rate that you are likely to face in five years or so down the road could be much higher than your initial rate. This means that you’ll be paying a high rate on a principle that has been largely undented. These adjustable-rate mortgages that led to the financial crisis could be indicating the next U.S. housing bubble. If this is in fact true, when the bubble bursts, the feedback loop will go into reverse. Prices will decline and many peoples’ mortgage indebtedness will exceed the value of their house. Credit will tighten and the negative feedback loop will lead to a recession (A Random Walk Down Wall Street, 105).

(Revised) The Housing Bubble: Fannie and Freddie

The system involving Fannie Mae and Freddie Mac needs to be reformed. According to the Wall Street Journal, “Many in Washington say they want to get rid of the [Fannie and Freddie], but they want to preserve many of the benefits that those companies enabled – namely, providing a steady source of relatively chap 30-year, fixed-rate mortgages”. Fannie and Freddie do not make loans, but package mortgages into securities that are sold to investors. As mortgage guarantors, Fannie and Freddie promise to pay investors back when the loans default. On the one hand, Fannie and Freddie serve an important role as middlemen bringing buyers and sellers together. On the other hand, Fannie and Freddie stick the government with a huge bill when loans default.

The government played a critical role in the housing bubble. Burton Malkiel writes in A Random Walk Down Wall Street, “The government itself played an active role in inflating the housing bubble. Under pressure by Congress to make mortgage loans easily available, the Federal Housing Administration was directed to guarantee the mortgages of low-income borrowers”. The government vehicle that guaranteed these loans was Fannie and Freddie. Creating a classic moral hazard problem, the government takes on a majority (if not all) of the risk. As a result, lenders loosened their standards and provided loans to noncredit worthy individuals because the government was there to assume the risk. Although there are many other factors that contributed to the housing bubble, an important factor was government policies that encouraged lenders to lower their standards.

After the initial increase in demand caused by low-income borrowers entering the market, the housing bubble continued to grow in size due to a positive feedback loop. According to Malkiel, “The initial rise in prices encouraged even more buyers. Buying houses or apartments appeared to be risk free as house prices appeared consistently to go up. And some buyers made their purchases with the objective not of finding a place to live but rather of quickly selling (flipping) the house to some future buyer at a higher price”. Speculators, who purchased real estate with the intention of selling for a profit, contributed to strong demand and further pushed prices upwards. The implicit government guarantee essentially eliminated credit risk for investors, which is the risk of default. The belief that prices will continue to rise created “castles in the air”.

As it always does, the bubble finally popped. Interest rates, which were low in the years prior to the financial crisis, began to rise (i.e. interest rate risk). Demand for houses slowed down and prices fell. Mortgages grew to exceed the value of the underlying asset (i.e. the house or apartment). As a result, homeowners chose to default and allow the lender to repossess the asset. The increase in the supply of homes caused prices to fall drastically. The burst of the housing bubble brought on the recent financial crisis in which Fannie and Freddie defaulted. In September 2008, the government bailed out Fannie and Freddie.

Fannie and Freddie caused many problems as quasi-public institutions. According to the Wall Street Journal,

In addition to serving as mortgage guarantors, the firms also amassed over the last two decades huge investment portfolios, which helped them generate larger returns to appease shareholders. The companies claimed that these portfolios helped reduce borrowing costs for homeowners, but critics argued that they simply used their implied government guarantee to profit between the spread on those investments and the cheaper debt-funding costs”.

Using the implicit government guarantee to benefit in the market place is a misuse of power. Fannie and Freddie are a duopoly, which were able to reap huge profits before being bailed out. Currently, lawmakers are working on a new system in which the good aspects of Fannie and Freddie would be preserved. According to the Wall Street Journal, “The plan, by Senate Banking Committee leaders Tim Johnson (D.,S.D) and Mike Crapo (R., Idaho), calls for replacing Fannie and Freddie with a new system of federally insured mortgage securities in which private insurers would be required to take initial losses before any government guarantee would be triggered”. Forcing private insurers to face losses would hopefully discourage irrational risk taking by decreasing moral hazard. Although there is uncertainty surrounding the future of Fannie and Freddie, the need for change is clear and there are certain agreed upon principles – make the “implied” guarantee explicit, get rid of those investment portfolios, require more capital and tighter regulation.

The real questions is whether Fannie and Freddie will remain (in a reformed system) or will be replaced. If replaced, then who will be the successors? I believe this is a very tough question to answer. Although big banks could easily handle this role, this would intensify concerns about certain institutions being too-big-to-fail. I look forward to hearing more about the Senate Banking Committee’s plan.

The Housing Bubble: Fannie and Freddie

The government, particularly Fannie Mae, played a critical role in the housing crisis. Leading up to the financial crisis, Fannie Mae purchased a colossal amount of mortgage-backed securities (MBS) from Wall Street. Although the MBS originated from Wall Street’s investment bankers, the underlying mortgages came from lenders that provided the loan directly to the consumer. The lenders are responsible for assessing the creditworthiness of the consumer. Burton Malkiel writes in A Random Walk Down Wall Street, “The government itself played an active role in inflating the housing bubble. Under pressure by Congress to make mortgage loans easily available, the Federal Housing Administration was directed to guarantee the mortgages of low-income borrowers”. The government vehicle that guaranteed these loans was Fannie Mae, which assumed all the risk when it purchased the MBS. The government taking all the risk creates a classic moral hazard problem for Wall Street as well as the lenders. The lenders loosened their standards knowing that Wall Street would buy the mortgages (securitize them) and sell them to Fannie Mae. In short, the housing bubble can be traced to lenders that loosened their standards due to the government’s policies.

The housing bubble grew massive as demand pushed up prices. Low interest rates allowed an enormous amount of credit expansion, which supported the increase in demand. The increase in demand and rise in prices began to resemble a positive feedback loop. According to Malkiel, “The initial rise in prices encouraged even more buyers. Buying houses or apartments appeared to be risk free as house prices appeared consistently to go up. And some buyers made their purchases with the objective not of finding a place to live but rather of quickly selling (flipping) the house to some future buyer at a higher price”. The introduction of speculators who purchased real estate with the intention of selling for a profit is a classic sign of a bubble. Eventually the bubble popped (as it always does). In this case, mortgages grew to exceed the value of the underlying asset (i.e. the house or apartment). As a result, homeowners chose to default and allow the lender to repossess the house. The increase in the supply of homes caused prices to fall dramatically. The collapse in prices and burst of the housing bubble was, for lack of a better word, devastating.

Following the government bailout of Fannie and Freddie, I believe the need for reform is clear and the basis for the reform should include removing the implicit government guarantee. According to the Wall Street Journal, “Two key lawmakers on Tuesday said that they would soon propose legislation to eliminate the housing-finance giants. Highflying shares of Fannie and Freddie dropped sharply; Fannie lost nearly a third of its value”. As long as the government institutions such as Fannie and Freddie take on all the risk, moral hazard is going to distort financial markets. Fannie and Freddie, which are part pubic and part private, do not make any sense to me because of the looming perception that the government will not allow it to fail.

Fortunately, lawmakers are devising an alternative that would remove Fannie and Freddie from the picture. According to the Wall Street Journal, “The plan, by Senate Banking Committee leaders Tim Johnson (D.,S.D) and Mike Crapo (R., Idaho), calls for replacing Fannie and Freddie with a new system of federally insured mortgage securities in which private insurers would be required to take initial losses before any government guarantee would be triggered”. I think this might be a good plan because moral hazard would be decreased. Forcing private insurers to face losses should discourage dangerous risk taking, which would eliminate the implicit promise of government backing and decrease moral hazard.

Bernanke’s Legacy: Not Yet Determined

After eight turbulent years, Ben Bernanke’s term as Chairman of the Federal Reserve has finally come to an end. According to the Wall Street Journal, “[Bernanke’s term] spanned the tail end of a boom, a bust that threatened to rival the Great Depression and a weak recovery”. I think this is quite an accurate summary of the past eight years, however, it glances over the tough decisions Bernanke had to make. As Fed Chairman, Bernanke was in charge of determining the appropriate monetary policies for each of these situations.

Although Bernanke’s legacy will be better assessed a few years down the road, there are some interesting statistics we can consider from during his tenure. The first statistic is that of stock market returns. According to the Wall Street Journal, “The S&P 500 gained about 39%. An average annual return of 4.2% is nothing to sneeze at given the roughly 2,000-point swing in the index from peak to trough to recent peak”. The stock market was able to rally to new heights following a dramatic collapse during the financial crisis of 2008-2009. The volatility of the S&P 500 is representative of the business cycle from the perspective of financial markets.

Another important statistic from Bernanke’s tenure is regarding the Fed’s swelling balance sheet. According to the Wall Street Journal, “When Mr. Bernanke became chairman, it was $863 billion. Upon his leaving, it was $4.14 trillion”. The expanding of the Fed’s balance sheet can be primarily contributed to large-scale asset purchases (known as quantitative easing). Quantitative easing, however, is a large source of controversy. Despite his intentions to flatten the yield curve, Bernanke’s decision to conduct unconventional monetary policy caused the Fed’s balance sheet to become larger than ever. Bernanke was forced to take this route because he could not make interest rates negative. A large reason for the disapproval of Bernanke is probably due to quantitative easing, which I think this is reflected in a Gallup poll of 1,020 adults taken January 25-26. According to the Wall Street Journal, “Democrats, Republicans and independents all liked Mr. Greenspan in 2006. This time around, Gallup found, opinions of Mr. Bernanke split along party lines: Democrats approve of him, Republicans don’t and independents are divided. Households making $90,000 or more a year tend to approve of the job Mr. Bernanke’s done, 54% to 35%, while lower-income families are more even equally divided on his performance”. I think the disapproval by Republicans is due to their preference of smaller government. The Fed’s massive balance sheet is a risk to the taxpayer and the large-scale asset purchases represents significant government intervention into the economy. I think the approval by households making $90,000 or more a year is because wealthier families have felt more of the recovery (especially if they have been invested in financial markets).

Alan Greenspan, who was Fed Chairman before Bernanke, was more popular than Bernanke when he left office. Greenspan’s Fed did not experience anything remotely like the financial crisis of 2008-2009. Thus, Greenspan’s Fed was able to stick to conventional monetary policy. Unlike Greenspan, Bernanke’s Fed undertook a number of controversial and unorthodox policies in order to prevent another Great Depression. Looking back, it seems that Bernanke should be credited with saving the U.S. economy. If he was, then his approval rating would likely rise.

Regardless, I think it is way to early to assess Bernanke’s legacy. We must watch and see how the economy performs and how the Fed unwinds its massive balance sheet. For example, soon after Greenspan left office the housing bubble exploded. The calm years of his tenure culminated in the financial crisis. Although it is hard to identify the exact source of the housing bubble, there are a few reasons to place some fault on Greenspan’s Fed. Greenspan kept interest rates low for an extended period, which some believe allowed the housing bubble to form. In conclusion, time will play a vital component in Bernanke’s legacy.