John Mauldin translates the message Greenspan and the Federal Reserve are sending. Ignoring the Fed's mindset could be expensive.
Source: Thoughts from the Frontline By John Mauldin.
Greenspan is clearly saying that you should reduce your risk in your investments and business. He is saying that you should not project the current trend into the future. There is more risk than most investors are assuming. He is warning, in as clear as possible terms, that housing prices could easily go down. And in fact, he is all but saying that he intends to help them do just that!
He, and the rest of the Federal Reserve board, seems intent upon raising rates. We have had several speeches in the past few weeks by Fed governors making that clear. This seems to me like a mindset that suggests the Fed is going to do what they have historically done in the past. They raise rates until the economy slows down or the yield curve inverts, or both!
Why would they do that? Because they think the worse risk is letting the housing bubble continue. In the 1960s, William McChesney Martin described the Fed's role as taking away the punch bowl before the party really gets going. Greenspan is taking the punch bowl away in measured steps. He is being as transparent about his intentions as a Fed Chairman can be.
He started out using the word froth a few months ago and now he characterizes the housing market as an imbalance.
Who will get hit first? Speculators in housing markets that have borrowed with no (or little) money down at short term interest only rates. Look around at your home town. If there are a large percentage of homes being bought as "investment" property which could not be rented out on a positive cash flow basis, you are probably in a bubble. You should carefully weigh your options.
...the Fed is going to increase rates until the rampant speculation (no pun intended) in the housing market goes away. They are going to raise rates until housing slows down. Of course, since 40% of new jobs in the last 4 years have come from the new housing sector, and since a great deal of the increase in new consumer spending has come from cash out financing, this is likely to slow the economy as well. They are prepared for that.
When the housing bubble starts to deflate, when the speculators have been put away, when the economy starts to slow and roll over into recession, they will once again lower rates, slowly providing a prop to the real housing market that 90% of the country participates in. That $800,000 home in Orange County? It is going to be along time before that house will sell at that price again once the Fed is finished. But most of us will do just fine. And maybe we get to re-finance our homes at an even lower rate.
What should you do if you are in a bubble area? Think about how much equity you could get for your home today. How much income will that money generate in a bond or CD? Look around at your rental market. If you can rent a comparable home to what you have today for a good deal less than what you are paying plus the income you will get from your equity, then consider selling. My bet is you will get to buy another property back in your area at a much lower price in a few years.
All housing bubbles have this in common. At first, people refuse to sell at a loss (another common psychological trait). It takes a while, but as banks start to repossess properties in your area, they will put them on the market. Prices start to drop. Then the psychology changes. The same human beings that thought that houses could only go up now think they can only go down. They start waiting. Prices go lower. Inventories build.
The Fed starts lowering rates and you will get a chance to buy a home at a lower price at interest rates lower than they are today.
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