Monday, 28 March 2011 09:27

Did Bernanke Permanently Cripple the Butterfly That Is US Housing? The Answer Is More Obvious Than Many Want To Believe

Note: Tune into Bloomberg TV at 1:12 pm EST to see me discuss the ins and outs of real estate Hopium on the "Fast Forward With Lisa Murphy" segment.

Struggle is not only Good it is necessary for a healthy, functional market!   The Market Wants to Fly on its own!

Let's start this post off with a popular parable.

Once an academic and self proclaimed (albeit not necessarily mistaken) intellectual was playing outdoors and found a most exquisite caterpillar whose colors and patterns gave it a most fantastic presence. He carefully picked it up and took it home to show his colleagues and peers. Together, they studied this caterpillar and wrote papers and hyper-intellectual dissertations on it. They even went so far as to name it. They called it, "Keynesian!" and vowed to each other that they would take great care of it.

The intellectual spent the considerable resources available to him as the chairman of the most powerful hedge fund cum central bank in the world to cater to, and study this Creature called Keynesian. Every day he watched the caterpillar and brought it new plants to eat. One day the caterpillar climbed up the stick and started acting strangely. The academic worriedly called international colleagues and together they came to the understanding that the caterpillar was creating a cocoon. The academic  explained to his colleagues how the caterpillar was going to go through a metamorphosis and to become a butterfly.

The cadre of central banking colleagues were thrilled to hear about the changes this caterpillar known as Keynesian would go through. They watched every day, waiting for the butterfly to emerge. One day it happened, a small hole appeared in the cocoon and the butterfly started to struggle to come out [for those who are not following, thing bubble bust at this point]. At first the academic was excited, but soon he became quite concerned. "Keynesian" was struggling so very hard to get out! It looked like it couldn’t break free for its chrysalis! It looked desperate! It looked like it was making no progress whatsoever! As a matter of fact, to many academics, it looked as if it may actually fail.

The academic was so concerned he decided to help. He ran to his lab and pulled out (with assistant from his colleagues in the Treasury) an alphabet soup tools (see 10 Ways to say No, the Banks Have Not Paid Back Their Bailout and Buried Deep Within The Files That The Federal Reserve Released On Thier MBS Purchase Program, We Found TARP 2.0!!! More Taxpayer Money To The Banks!) to cut the cocoon to make the hole bigger and the butterfly quickly emerged! As a matter of fact, it emerged 100% quicker than any other butterfly that has been observed. As the butterfly came out the academic  was shocked at the result. "Keynesian"  had a swollen body and small, shriveled, non-functional wings. The academic continued to watch the butterfly, theorizing and expecting that, at any moment, the wings would dry out, enlarge and expand to support the swollen body. He just knew that in time the body would shrink and the butterfly’s wings would expand.

Well, guess what? Neither hypothetical actually occurred! "Keynesian" the hobbled butterfly, spent the rest of its life crawling around with a swollen body and shriveled wings. It never was able to fly on its own…

As the academic tried to figure out what had gone wrong,  Reggie Middleton suggested he consult with the owners of a healthy adroit butterfly named "Austrian". That butterfly's caretakers, with the assistance of Reggie, explained that the butterfly was SUPPOSED to struggle. In fact, the butterfly’s struggle to push its way through the tiny opening of the cocoon pushes the fluid out of its body and into its wings. Without the struggle, the butterfly was doomed to never, ever fly. The academic's good intentions severely, and most likely permanently, damaged the butterfly called "Keynesian".

Remember, in the Circle of Economic Life, struggling is an important part of any growth experience. In fact, it is the struggle that causes you to develop your ability to fly.

As excerpted from Do Black Swans Really Matter? Not As Much as the Circle of Life, The Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!, Bernanke et. al. have snipped the chrysalis of the US markets and economy one too many times. He has interrupted the circle of life...

I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the “Peak” phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality…

The result of this “Great Global Macro Experiment” is a market crash that never completed. BoomBustBlog subscribers should reference File Icon The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance. All four corners of the globe are currently “hobbling along on one leg”, under the pretense of a “global recovery”.

A snapshot of the housing picture as of now, before the release of the latest Case Shiller numbers

The latest shadow inventory calculations are now available to subscribers online. Here are a few observations that we have made regarding the March data. The last quarter of 2010 and portions of the first quarter of 2011 have seen a significant drop in foreclosure activity due to allegations and blatant discoveries of fraudulent practices in the mortgage industry.


This near cessation of foreclosure activity has materially dropped the shadow inventory numbers, but has done so in a way that is quite misleading. Those foreclosures either will happen and become REOs or distressed property sales that are currently averaging a discount of ~25% to conventional retail sales (thus further pressuring sales prices), or will result in the properties being put directly  on the market at steep discount (again, further pressuring sale prices). Basically, the foreclosure backlog is simply accumulating in the background and will print a very sharp spike upwards one way or another once the foreclosure and fraud issues of the banks are sorted out – even if they are sorted out to the detriment of the banks. Despite this reprieve in foreclosures, the ratio of shadow inventory to home sales is not decreasing. This is a double negative, for shadow inventory is decreasing (albeit for very artificial and temporary reasons). The reason for the lack of movement in this very key figure is that housing sales are actually declining both on a seasonally adjusted and non-adjusted basis – and if these figures were to be adjusted for “true” inflation, would look much worse. This leaves the ratio of delinquent and foreclosure activity to sales relatively static. One can surmise what happens when the foreclosure backlog that was caused by the bank’s myriad legal issues clear up.

The most valuable chart in the study just released to subscribers, File Icon Shadow Inventory Update -- March 2011 shows how quickly one can expect the shadow inventory to be consumed by the sale of homes. To make a long story short, we still have quite a ways to go before we reach the pre-bubble levels, and that is without taking into consideration the foreclosure moratoriums. Keep in mind that these numbers do not include the pent up shadow inventory that is being hidden by the foreclosure crisis. That additional inventory on top of a slowing housing sales metric can easily tack one to 4 years onto the inventory numbers.


As you can see, the credit (delinquency measures) metrics are actually moderating slightly over the last few quarters, but have increased over the last two. This is a negative sign considering all of the efforts that have been made by the government and the banks to reduce that figure. The foreclosure inventory, although lulled somewhat, is still slightly on the rise. This lull is synthetic and temporary, a by-product of congressional pressure and legal issues pressing the banks to undergo voluntary and involuntary moratoriums on foreclosure activity. The consequent movement to be expected as these moratoriums are lifted, the banks work out their legal issues, and the properties move one way or the other will cause a very dramatic spike in the shadow inventory numbers. This spike will occur on top of slowing housing sales, dramatically reduced housing prices metrics and potentially deteriorating credit metrics (if the most recent trend continues). If that is not enough good news for you, the Goldilocks scenario of the perfect interest rate environment for real estate needs to (and probably will in the near to medium term) come to an end. See The True Cause Of The 2008 Market Crash Looks Like It’s About To Rear Its Ugly Head Again, With A Vengeance Friday, March 11th, 2011. Our calculations available ot subscribers show a very bleak outlook for housing. It is not as if there is no precedence for such. Take a look at the Japanese situation, and this is not taking into consideration the recent issues of the earthquake, tsunami and radiation poisoning and nuclear meltdown. Few things are as detrimental to property values as radiation poisoning!

A lesson to be learned: Beware for when a true black swan event occurs...

Further reading:

  1. Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate Friday, February 25th, 2011
  2. In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse Wednesday, February 23rd, 2011
  3. Further Proof Of The Worsening Of The Real Estate Depression Thursday, February 24th, 2011
  4. You’ve Been Had! You’ve Been Took! Hoodwinked! Bamboozled! Led Astray! Run Amok! This Is What They Do! Monday, February 28th, 2011
  5. FASB Appears to Have Bent Over For The Final Time & Accuracy In Financial Reporting Dies An Ignominious Death!!! Wednesday, February 9th, 2011
  6. As JP Morgan & Other Banks Legal Costs Spike, Many Should Ask If It Was Not Obvious Years Ago That This Industry May Become The “New” Tobacco Companies Thursday, January 6th, 2011
  7. The Latest Case Shiller Index – Housing Continues Freefall In Aggressive Search For Equilibrium Monday, February 7th, 2011
  8. As Clearly Forecasted On BoomBustBlog, Housing Prices Commence Their Downward Price Movement In Search Of Equilibrium Scraping Depression Levels Tuesday, December 28th, 2010
Last modified on Tuesday, 17 January 2012 07:07


  • Comment Link Reggie Middleton Thursday, 31 March 2011 13:16 posted by Reggie Middleton

    Thank you very much.

  • Comment Link Mike Melanson Thursday, 31 March 2011 12:58 posted by Mike Melanson

    I am only a biologist of little brain, and generally wary of analogies, but this butterfly analogy is spot on. I thoroughly enjoy your analyses.

  • Comment Link Jim Monday, 28 March 2011 16:52 posted by Jim

    I too wish that we were through this quicker, but the commercial mess will clean up differently than residential, when rates begin to significantly rise again and the government continues to pressure lenders. While prime mortgages are exposed to sinking with home prices, that pain will be concentrated along with many of its economic effects in certain cities, states and regions. The government and more concentrated banks it supports both will be interested in spreading the losses from places like the SW and SE into bigger pools that include less volatile Midwestern and Northwestern assets, for example. The national residential market will recover with jobs in the 2013-2016 range, while some places never catch up (think Cleveland and Detroit).

    This is a generational re-alignment, not simply a long workout of debts. The size of these losses are going to create winners and losers among communities and regions for decades to come. This is where the US likely will not look like Japan, namely in the regional concentration of winners and losers. The government intervention likely will concentrate the "winner-take-all" nature of shocks and rewards at cross-currents at the moment. With the 2012 election, it is possible (although hardly certain) that a new order will coalesce that clarifies the direction of the government and business interaction, which largely are dancing in the dark at the moment.

    As for commercial real estate? Well, there is little consumer pressure of the kind impinging on consumer mortgages in the public debate over lowering rates, capital, government backing, etc. It will depend far more on government rates, the shake-out in the financial industry, and retail patterns. You did us all a favor in pointing to the downsizing of retailers a couple of months ahead of the Wall Street Journal. If you are right about Android, then a lot will hinge on the speed of maturity in digital wallet and other retail/financial arrangements. I'll look forward to reading about it.

  • Comment Link Reggie Middleton Monday, 28 March 2011 16:23 posted by Reggie Middleton

    There's a lot that goes into the equation besides what you mentioned. Subprime ARMs are but a fraction of Prime ARMs which are in just about as much trouble. CRE, which has a high correlation to RRE, then there's the built up supply (fraudclosure) in the shadow inventory discussed above, as well as... Well, you get the picture. There is plenty of negative news to go around with thought the economic doom and gloomer's input.

    If rates would have been allowed to rise and bubble blowing would have ceased, we may have reached a trough by now, but alas, they didn't and we haven't.

  • Comment Link Jim Monday, 28 March 2011 16:14 posted by Jim

    The bulge in sub-prime 5-year ARM's ends precipitously at the end of 2-3Q2011 AND foreclosures are running about 5 quarters. Add one to four years of overhang and that puts us back to the bottom of your comparison with Japan around 2016 or a little later, certainly not in 2026. Sure, a lot can happen between here and there, but what is interesting is that you keep coming up with 2016 as the bottom of the toilet bowl - no matter how you calculate it. Trust your numbers, Reggie, because you really know real estate. Leave the economic gloom and doom to Raja, Roubini, and Talib.

  • Comment Link Frank Shoemaker Monday, 28 March 2011 11:06 posted by Frank Shoemaker


    I like your metaphor with some reservations. The caterpillar has to go through the physical processes in order to reproduce. We as a species have self determination. We can chose to put our economy under stresses that duplicate and reproduce the processes that would happen if we left things well enough alone but at the same time we can have full employment and a growing economy.

    This is my dream.


  • Comment Link Mark Hankins Monday, 28 March 2011 10:03 posted by Mark Hankins

    1. Bulldog or export marginal housing units.

    2. Stabilize marginal homeowners.

    3. Bring in skilled immigrants.

    Playing with the money dials doesn't fix the guts.

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