Bill Rayburn: Today, we’re going to be talking about commencements. Specifically, we’re going to be talking about Federal Reserve Chairman Ben Bernanke and his commencement speech.

Bob Dorsey: He gave a commencement speech to a small unit of Bard College. I actually didn’t know about this school.

Rayburn: Can you remember what your commencement speaker talked about? Can you remember when you graduated?

Dorsey: Uh… no. Way too long ago.

Rayburn: You were like me. You were so proud when you got that doctorate, and then you got to go to your first faculty graduation and you got to put your robe on again, and it was less cool the second time, and it was way less cool the third time. And then you tried to get out of it. So, the students were sitting out there listening to the chair of the board of governors. I bet they were thinking the same thing: “Would you finish?”

Dorsey: He basically was talking about innovation and what the future is likely to be for graduates, and was talking about the fact that a lot of people today say the IT revolution is not going to result in the same changes in lifestyle that occurred when the manufacturing revolution (took place).

Rayburn: If we go back to the manufacturing revolution, there were some huge advances.

Dorsey: As an example, he says, let’s take him, and go back 50 years to when he was nine years old in 1963, and then go back 50 years before that and compare those two 50-year periods. From 1913, which is 100 years ago, it’s very rural, or you lived in a dense city environment.

Rayburn: People were focused on getting food.

Dorsey: Food. Medical care wasn’t anything like it is today. Transportation wasn’t. That was a little before the Model T.

Rayburn: If we go back and look at the percentage of time that we spent in getting food and what we had to do to sustain ourselves from a food standpoint, that has changed drastically with technology innovation.

Dorsey: That’s correct. There’s been major improvements. What he said is that there have been huge changes from 100 years ago to 50 years ago, but look at what the changes are from 50 years ago to the present. His family, they lived in a nice house, they had a nice car, they had color TV. Basically, not a whole lot different than today. That’s why a lot of people are saying the IT revolution promised a lot more than it’s actually delivering. But he goes on to say that’s from the pessimist’s point of view.

Rayburn: That’s true. Productivity, in many cases, is way up.

Dorsey: Productivity has gone way up, and the other thing, he points out, correctly, is that people tend to overestimate new technology’s impact in the short run and underestimate it in the long run. So we’re seeing a lot of small changes – we have more TV stations now than we did 50 years ago.

Rayburn: More choice. More choice in housing than we did 50 years ago. More choice in finance than we did 50 years ago.

Dorsey: The nature of housing has changed, too. A hundred years ago, you were either rural or crammed into a city environment. Fifty years ago, there was the suburb development. Now, with the controls and pollution, there are a lot of people moving back. There’s an article today about these huge high-rise luxury apartments in New York and the huge demand for them right now, because everybody’s moving back into the city.

Rayburn: You want to remove some of the friction of the transportation. People are no longer willing to sit in their car for an hour commute each way.

Dorsey: The other thing that will likely happen is telecommuting. It’s just not as easy to telecommute as people would like it to be.

Rayburn: You want that face-to-face experience, but you want to be able to do it from wherever you are.

Dorsey: I think maybe in another 10 or 15 years there’ll be the ability to virtually be in the same room, and you’ll be able to talk to people and create a work environment that is virtually right together. Then, I predict there will be a movement for a lot of small communities across the country. People will move into those small communities and have the telecommuting capability there so they can work anywhere, even internationally.

Rayburn: And we’re seeing household size get smaller at the same time the birth rate is going up. These are averages, of course. People are waiting to get married; they’re deciding to stay single – that has big impact for housing.

Dorsey: The desirability for the big house with the big lot in suburbia is decreasing. Plus, on top of that is all the aging population of the baby boomers. I was just out in Tucson helping my parents move in to assisted living, and they were talking about the fact that assisted living in Tucson is a major growth industry.

Rayburn: How many assisted living facilities are you familiar with in Tucson?

Dorsey: About 40.

Rayburn: That’s amazing.

Dorsey: I’m sure I didn’t even begin to touch them all. How is that going to change in the future? I saw an article this weekend about using robots to provide medical service for aging people, particularly Alzheimer’s patients, and having robots follow the patient around and monitor what they’re doing. In 10-15 years, that’s going to be a big change.

Rayburn: That’s fascinating. Although I bet what was fascinating to those students listening to Chairman Bernanke was his conclusion.

Dorsey: Right.

Rayburn: This is FNC Morning View. Have a fantastic week.

Dorsey: David Blanchflower and Andrew Oswald had an article in the New York Times about how homeownership leads to increased unemployment.

Rayburn: Which, on its face, runs totally opposed to the whole U.S. mindset of the American Dream.

Dorsey: Homeownership is good. Everybody understands that if you look at various relationships, you see there’s less crime when there’s higher homeownership; people try to build up the community; there’s better graduation rates; less teenage pregnancy; all of those things are really positive. This article talks about the fact that they looked at a bunch of data and concluded that the higher the homeownership rate, in general, it would lead to increases in unemployment.

Rayburn: Was this just some data in search of a conclusion, or do you think there’s a real relationship here?

Dorsey: Well, I don’t think there’s a relationship, although they throw in some interesting arguments. First of all, if people are owning their home, they’re wanting improvements in the community. That leads to higher tax rates. They are less likely to be mobile, so if there is an increase in companies leaving, they may be less likely to move, so there would be more unemployment.

Rayburn: So they’re stuck.

Dorsey: Also, as the community develops and there’s more homeownership, people are less likely to move if the business moves. It may be that there are longer commutes to work. Another thing they mentioned is that as people want to build up the community, they may put in more zoning requirements, which may be unfavorable to business.

Rayburn: Let’s talk about the different concepts and premises you have raised relating to homeownership. The first is that rising levels of homeownership are more likely to be inhospitable to innovation.

Dorsey: I think their argument is that people who are homeowners are less likely to take risks. They’re wanting to maintain their relationship, their community. Innovation often takes place when people are willing to take risks related to people who don’t have much to lose. Typically, innovation is talked about with young people and people struggling and trying something new and going out on a limb, often because they have less to lose.

Rayburn: So the perception is if you own a home, you have something to lose. You have the equity in that home, you have your status in that community. Therefore, you’re not willing to put things at risk. Let’s talk about how that relates to job creation and move to the next concept. It appears as though innovation and job creation are closely linked and the arguments are similar, correct?

Dorsey: That’s part of it, but I think they’re also saying if you’re business that’s looking to come into a community, many times, some of these businesses are operating on a string and they may want to move into a community that does not have as strict zoning requirements or may have less prohibition. If there is a high degree of homeownership and a lot of community activity — that may not be as conducive to bringing in new business as one where those things don’t exist.

Rayburn: Right. Two of the points, labor mobility and longer commutes to work, I certainly see the possible correlation there. We’ve experienced this with some of our employees. They want to stay in the same community, they’re willing to commute farther, they’re willing to travel by air

Dorsey: We really don’t know in this case if these arguments can justify or rationalize any sort of conclusion. You can look for ways to really sort of explain it. We don’t know if it’s an issue of causation, or if it’s simply an issue of correlation. We’ve seen a lot of stuff in the literature lately where they’re talking about things that are correlated as though they are causative.

Rayburn: That’s right. The authors cite five states with the largest increase in homeownership from 1950-2010: Alabama, Georgia, Mississippi, South Carolina, and West Virginia. They had an unemployment rate in 2010 that was 6.31 percentage points higher than in 1950. Some of that’s your choice of year, correct?

Dorsey: Some of it’s the choice of year, but also, some of it is the type of industry in those states. Those are the southern states. One reason there’s a higher increase in homeownership is that there are a lot of people moving from the North into the South right now or over those timeframes. As they move into that, they’re buying houses.

Rayburn: They know that one of the opposing arguments to this whole conclusion, like you said, is that it’s pure correlation. They tried to look at some other markets beside the U.S. They looked at Finland.

Dorsey: There, they had a situation where the government, as a matter of policy, would move around the country regionally and change the laws basically to discourage homeownership. They felt like that showed that there was indeed a causative effect where homeownership, when it was forced to decrease, actually improved unemployment.

Rayburn: One of the things that has happened in this country is that the benefits of homeownership are taken for granted. Even today, that’s part of the American Dream. In many places in the world, you’re unable to do that.

Dorsey: That’s absolutely right, and as I said at the beginning there are lots of positive effects of homeownership. So this may be something that is correlated, not causative, or there may be some causative pieces of this. People need to be a little bit wary of any of these types of studies because there is this strong correlation effect. For example, GDP went down during the Great Depression. At the same time, the number of soup kitchens went way up. You could conclude that creating soup kitchens causes GDP to decline.

Rayburn: (laughs) We know that’s not the case. That’s just an amazing statement given correlation as opposed to causality.

Dorsey: Exactly. But people take that stuff for truth. For example, in the European countries right now, they are reducing the levels of support and basing that on some studies that showed that when you have a decline in GDP and an increase in government debt, those occur at about the same times. When there is a downturn in the economy, government programs that protect the poor, like unemployment, go up, so there is a natural increase in government debt when demand goes down. That’s correlated; it is not causative in the same sense.

Rayburn: Well, we’re out of time, Dr. Dorsey. We’re going to talk about the financial impact of all this at a future date. Go ahead?

Dorsey: I don’t think very many people read this, because the purchase index this past week is the highest level since May of 2010, and that’s good news.

Rayburn: Well, they may have read it as fiction. (laughs)

Bill Rayburn: I have, and there’s a fascinating article about how we forget. About “too big to fail,” and about curing banks that are believed to be too big to fail. Let’s talk about how long we remember bad events, good events … we’ve been through a big crash in ’07, ’08, ’09, and really it continues today in housing. We haven’t come back yet. Talk to us a little bit about how long of a memory does the market have, how long of a memory do banks have, and how long of a memory do appraisers have?

Dorsey: Let’s go down the list: How long of a memory does the market have? I think it’s about zero. Their memory is only as good as the next new opportunity. Banks’ memory is a little longer, because there is a delay period before they are able to take up the opportunity. Appraisers, interestingly enough, are always backward looking. They’re always basing their valuation on what has occurred in the past. Typically, as recent as possible, but certainly what’s happening in the past. I think the institutional memory comes from the regulators. They always respond to what’s happened in the past and the regulations stick around for a long time. When they create new regulations, that becomes the market’s memory. That’s what we’re going through right now.

Rayburn: If we talk about what happened in banking in the ‘20s, ‘30s, and ‘40s, we had walls put up between commercial banking and investment banking in the form of Glass-Steagall. Those walls came down because our memory went away because we said, “Hey, the market will cure the problem; we don’t need these regulatory walls anymore.”

Dorsey: There was this feeling that the world could change, that we no longer lived in the world that existed in the ‘30s. So we got the opportunity to totally repeat it.

Rayburn: In that case, we had a regulatory memory, a legislative memory, of probably 60 years. The market’s memory is not nearly that long because we have ups and downs in the market all the time if we talk about the stock or the bond market. Yet, if we look at the real estate markets, we have gone up since the ‘30s. Housing went up on an annual basis from the ‘30s to 2007-2008, and now we’ve had for the first time in roughly 75 years, down markets. How long is it going to take us to get over that?

Dorsey: I think it’s going to take a while because we’ve got to first get back up to where we were in terms of the long-term trend. The stock markets are back to where they were. The housing market is going to take longer. Now we have new regulations that are trying to address some of the problems that existed in the past. We’ve got the Dodd-Frank legislation that is going to take some time to be fully implemented. Until 2007, we had a very active private securitization market. That’s gone away and it’s going to take a while for that to come back. And now, the article you were talking about mentioned new proposed legislation to address the way banks act and the way they process financials with the Brown-Vitter proposed bill.

Rayburn: The idea is to basically do away with Basel III. A bank has to essentially hold eight percent capital. That’s a rough approximation. The Vitter legislation, if it passes… banks will essentially have to hold double the amount of capital. There’s a 15 percent capital requirement that banks will have to hold. That is stringent.

Dorsey: Right. And it’s not risk-adjusted. Whereas before, you could basically get the full credit without having to hold any equity for low-risk assets. Now, they’re going to have to do this on the basis of all their assets, including stuff that was off the books before. That’s going to have to be brought back on the books and they’re going to have to hold 15 percent of that. That’s a huge change, if that (legislation) actually passes.

Rayburn: The whole concept is that they’re trying to legislate away this concept of “too big to fail.” In other words, no one is too big to fail. Or if you are too big to fail, we’re going to make you hold sufficient capital so you won’t fail.

Dorsey: It’s going to really impact the big banks the most. Of course, the community banks are saying this will be great, because it now puts them on a more common playing field. It will make the cost of lending much higher for the big banks, and therefore more competitive with the community banks. Some people are in favor of it. A lot of people are coming out and saying this will cripple the economy because the big banks will hold so much they won’t have enough to lend.

Rayburn: The Times quoted the Standard & Poor’s paper that essentially said that.

Dorsey: There are some other changes that will have impact. We had the shadow banking system that was a significant player during the downturn. Now, now only are some of those assets going to have to be brought back under the big banks’ balance sheet, but this bill also prohibits any non-depository institution from having access to federal funds’ loans. That’s going to be a big change, as well.

Rayburn: It will be a big change. What impact do you think it will have on mortgage lending?

Dorsey: Who knows?

Rayburn: It’s very hard to know. If it increases the cost of credit, it’s going to crowd out borrowers at the end of the spectrum, right? If credit is more expensive, banks are going to be more self-selective in their underwriting, more so than they are now.

Dorsey: Of course the thing right now is that there’s a surplus of funds out there. Two things that are keeping lending restricted are the supply of available housing and the banks’ own internal memory of what has happened in the past, with the focus on the creditworthiness of the borrowers.

Rayburn: It appears as though every institution has got credit and risk on one hand and lending on the other, and it appears that the lenders are coming back to the forefront and credit/risk is beginning to subside just a little.

Dorsey: The lenders have been sort of locked in the back room for a while now. Some of them are starting to figure out how to unlock those doors. We’ve seen a lot of interest in ways the lenders can get more involved in this process and we’ve seen some evidence that lenders are starting to relax some of their constraints they’ve put on borrowing, so it’s opening up the door a little bit, at least a peek, to try and get some more volume through the door. We’ve seen some evidence of that in the recent mortgage application index. We’ve seen those indexes going up a bit, and that’s all good news.

Rayburn: Let’s talk about economic storms and learning from data. Talk to us about Big Data as we discuss where we go from here.

Dorsey: It’s very trendy right now to talk about Big Data.

Rayburn: What is Big Data, by the way?

Dorsey: There’s so much data being collected that you can interpret what’s going on from the mass of data. You can eke out what’s going on using various statistical tools that otherwise wasn’t obvious.

Rayburn: Instead of describing what’s happening, you can predict, because there’s so much (data).

Dorsey: There are two studies that a lot of policymakers in the U.S. depended on as truth, because these were academic studies by reputable economists. They were thought to be basically the truth, as you mentioned. One was a study done by Reinhart and Rogoff, both MIT professors. Basically, it showed that if you look historically at the data, when the national debt was at 90% of GDP or greater, the economy started really tanking. This was picked up by a lot of the state and federal legislators who talked about how we needed to really pull back and control our debt. More recently, they discovered that these results were driven primarily by a mistake in their Excel program…

Rayburn: That’s not cool.

Dorsey: And secondly, by a number of assumptions they made and weightings they put on the data.

Rayburn: In rebuttal, in the Wall Street Journal, they said the magnitude was all that was affected.

Dorsey: Nuh-uh. That’s not what the other people who looked at the data said. About ten other studies have looked at that data and said, “You guys were trying to get a result, and you manipulated the data to get that result.” There’s another one, Alesina and Ardagna, from back in 2010. That study said that if the government announces they’re going on an austerity program, they’re going to cut government spending – it’s going to build so much confidence that the economy is going to boom. It turns out that when they did the analysis of their data, they didn’t do any logical analysis; they just ran the statistics on the data. It turns out that when the economy is booming, your GDP goes up faster than the debt goes up. Therefore, the debt ratio goes down. (Alesina and Ardagna) were saying that was austerity. When they actually looked at the types of policy austerity, they found that result no longer held.

Rayburn: Today, we would call it common sense.

Dorsey: You would think it is common sense, but it has caused a lot of hardship across the world.

Rayburn: What do we do about all this big data?

Dorsey: It’s really a challenge. You may remember a few years ago, there was the JPMorgan London Whale problem caused by an Excel error again, where instead of using the average of two numbers, they used the sum of two numbers, and it caused a major change in the model and a huge loss to JPMorgan. It used to be that you had to run multiple tests, with multiple people doing the same thing validating results to make sure that the result was correct. Anymore, that’s not the case.

Rayburn: Now, we just accept it as truth.

Dorsey: They think that it’s truth, and they go with it. Particularly if it already confirms what they think.

Rayburn: Speaking of that, let’s transition and talk about this Washington Post article about housing prices going up where we believe the housing markets are stabilizing. And yet, we have some contradictory information. Unemployment remains extraordinarily high, housing prices appear to be firming – in fact, in some markets, there are shortages. How do we reconcile those two? Is that investors?

Dorsey: It appears to be investors. Frankly, if you look out there, there are not a lot of options for your money.

Rayburn: If there is, and investors are trying to diversify out of stocks and bonds and into real estate, this is one direct way to do that.

Dorsey: Right. There’s an interesting article in the New York Times this weekend about the historic booms and busts that have occurred. A lot of times, they have centered around land.

Rayburn: To set it straight, raw land.

Dorsey: Right, raw land where you’re going to create this big, new development and you advertise it and sell that stuff and make a whole new city. Those are typically localized.

Rayburn: Those are typically development loans, and they’re not owner occupied. What we have now returning to the markets, are investors. It’s still owner occupied. It appears as though we have shortages, but these houses are not being purchased for consumption by end users.

Dorsey: They’re buying up these properties, they’re renting them, they’re anticipating that the housing prices are going to come back…

Rayburn: And they’ll get a nice return.

Dorsey: We’ve had a number of those companies contact us to talk to us about data because they’re buying hundreds and thousands of properties.

Rayburn: Banks are loving that because they’re enabling them to clean up their balance sheets of all these properties that are delinquent and/or have defaulted. We’re just not seeing the consumer come back to the market. We need the employment to come back.

Dorsey: We’re back to where we were before. Some of the policy issues about cutting government expenditure were based upon the Reinhart-Rogoff thing, which was in error.

Rayburn: There were some articles out over the weekend speculating that the Fed is on hold until mid-2015. What do you think about that?

Dorsey: I think that’s likely, because the economy is very, very weak right now. Shiller was saying, in a reverse of what he usually says, that now is probably a really good time for people who are not looking at houses as a speculative investment, but who simply want a place to live, to get into houses. Interest rates are historically low and the prices may be bottomed out. The problem is, with the investors in there, there’s no supply. You have to take what you can get.

Rayburn: That’s what we’ve got for you this morning. You all have a fantastic week.

Bob Dorsey: There’s an article in the New York Times this weekend by Robert Shiller. He’s getting ready to release the second edition of his book Irrational Exuberance. He’s updated his long-term housing-price theories and talks about the fact that housing, on a long-term basis, is very little different than inflation. On average, there’s about a 0.02% return per year on housing if you buy a house.

Rayburn: Some of these hedge funds and private equity firms are actually trading in housing. In the rental market now, they’re looking to rent those houses. What do you think about that as a strategy?

Dorsey: I think it’s probably a good strategy. Most other people who have looked at housing prices don’t agree with Shiller. They feel like his data is very biased and as a result, they think (housing) is a much more significant long term return on your investment. In fact, recent estimates I’ve seen are somewhere between 1.5 and 2% a year, when compared to 0.02%, makes a huge difference in the long run.

Rayburn: Yes it does. Housing represents such a large part of the economy. Let’s talk about the contribution to GDP and how it leads the economy back out of the recession and how that’s been different this time.

Dorsey: Historically, one of the first things that comes back in terms of the economy is housing. When companies start hiring workers to do construction, that’s a very large industry, and that starts driving other factors and driving the economy. That’s not been the case this time. Construction has not picked up the way it did. That was, in large part, because a big cause of the crash was housing this time, and we had a huge amount of existing stock that was available out there.

Rayburn: What you had in previous down cycles is, a lot of demand-driven things going in. In this demand cycle, you had both demand shocks and supply shocks occurring. The question is, when does all that bottom out, and are we seeing demand? I think in some markets, we are seeing demand come back in. That elusive equilibrium that you economists talk about – when will that come back, and when will we start to see a shortage? On the supply side, we have constrained the lead time to get new supply into the market, assuming we need new supply.

Dorsey: We are seeing shortages in a number of markets. I was in Dallas last week, talking to a number of people, and they were saying they had been bidding on a number of houses for personal use and every time they put in a bid, they were outbid. There just are not enough houses out there for several reasons. One, the prices haven’t come back up enough so that some people who had significant mortgages based upon the refi times – they haven’t gotten the price back up to where they can have equity and get out of their house yet. The other thing is, it takes a while for houses to be built. One thing Shiller talks about, which I think is interesting, is the fact that construction costs for housing have come down dramatically. Now we use plasterboard instead of doing hand plastering; we have all sorts of premanufactured components; all of those things. He goes on to speculate that in the future (housing prices) will even come down more because robots will be able to build houses in the way we now have 3D printers.

Rayburn: That’s a very interesting argument, and that’s one we need to pursue in the future. In the remaining time we have this morning, at the MBA Tech conference this morning, they’re concerned about how houses are financed. We saw that first mortgage origination went down about five percent in the first quarter. There is talk that the home equity market is going to come back. As you know, it has been nonexistent for the last 4-5 years because housing prices have come down, eroding consumers’ equity. Now we’re starting to see a flattening, or in some cases, an increasing of those markets. Do you think home equity will come back in the near future? If so, when?

Dorsey: That relates to the topic we started with today. A lot of lenders are looking at the long-term trend and saying, “OK, we certainly had a bubble in housing prices, and it’s going to come back down. At some point, we know it’s going to cross the long-term trend and really significantly come up. The question is, what is the long-term trend? Is it 0.02% per year, or is it 1.5% or 2% per year? In terms of the lenders I’ve been talking to, they all feel the home equity market is going to come back late this year or early next year because by then, prices will have turned around, or are already turned around in some markets. People are going to start tapping into that equity that they have in their house again. It just hasn’t existed until now. Once that price comes back up, they’ll be able to grab some of that equity again.

Rayburn: For a lender to be comfortable, prices do not have to go up – they just have to be flat. Or they have to keep from going down.

Dorsey: Right. Well, it has to be above the mortgage in order to get any equity.

Rayburn: Well, we’re about out of time. We want to remind you to get your taxes done. We hope you all have as fantastic of a day as you can have on tax day. This is FNC’s Morning View.

Bob Dorsey: In the Wall Street Journal, they’ve posted a blog. Olivier Blanchard, the chief economist of the IMF, was giving a talk at the London School of Economics and basically identified five things he felt economists should learn from the financial crisis.

Bill Rayburn: I like the first one the best.

Dorsey: He suggested humility is in order. He was one of the ones who fought the perception of what was really going on for a while.

Rayburn: Humility being in order is like saying, “I was wrong.”

Dorsey: What was frustrating to me was that there were a number of very reputable economists who were pointing out the problem early on in the financial crisis, and a lot of economists said, “We know better. Our models can’t be wrong.”

Rayburn: One of the flaws in their model had to do with housing prices. Since the ‘30s until ’07 or ’08, housing prices had not gone down.

Dorsey: We had a little blip with the savings and loans, but that was taken care of.

Rayburn: In fact, if you look at the savings and loan crisis, it was not owner-occupied residential real estate that caused the problem. It was commercial property.

Dorsey: In my opinion, they need to pay more attention to the research and writings of people who are seriously investigating these types of things.

Rayburn: That’s true. And then, we had all of the shadow banking. Let’s talk about the second point.

Dorsey: The second point is that financial institutions matter. A lot.

Rayburn: Let’s step back and look at the role of the economy. You have taught this in economics and I’ve taught this in finance courses. A financial institution does several things. One of the things they do is bring savers together with borrowers. Savers aggregate their money, and borrowers come. A bank also serves as a credit vetter, if you will. They vet the creditworthiness of firms and individuals. Some of that has been attempted to be replaced by some of the venture capital and private equity firms. However, banks do a great job of vetting the credit. And credit availability and capital formation are big components of growth.

Dorsey: One of the things (Blanchard) doesn’t mention is that all systems, at some point, have problems. They go out of bounds. You have to have some controls to detect when things are going out of bounds and fix them.

Rayburn: And Greenspan really had this concept of a Fed put.

Dorsey: Greenspan really didn’t believe any of this. A lot of economists, not just Greenspan, felt that banks are no longer going to go out of bounds.

Rayburn: It will be self regulating.

Dorsey: It will be a self-contained system.

Rayburn: For our listeners out there, the Greenspan put is this concept that you can take risks that your deposits are insured, and if you blow up, the government will take care of you. In essence, you can put your losses to the Fed. Another, third point?

Dorsey: That interconnectedness is important. People discovered the capital that’s shown on one person’s book might be heavily dependent on the capital shown on another person’s book.

Rayburn: It’s true for firms, and it’s also true for governments.

Dorsey: Right.

Rayburn: If we go back and look at the Lehman transaction, before Lehman failed, Paulson thought he had a deal to sell Lehman to Barclays. But he had to get it approved by the British banking regulatory authority, and they wouldn’t sign off on it. So interconnectedness matters on a government level.

Dorsey: And we certainly have seen this on the Euro market recently, with Cyprus, Greece, and now Portugal. All of these things are connected. Internally, we had the issue with AIG.

Rayburn: In the interest of time, let’s move to the fourth concept.

Dorsey: There’s this concept called macro-prudential tools. Let’s say you want the interest rate not to be impacted in a particular way, but you want to change the behavior of one sector. So you change some of the rules – lower the down payment or change the loan-to-value ratio, or put in a variety of other constraints.

Rayburn: It’s a very targeted approach to getting the industry back up and on its feet.

Dorsey: Basically, (Blanchard) says we don’t know how well they work. If you put a constraint here, there are ways to get around almost all of them.

Rayburn: There are consequences that we don’t always notice sometimes. Tell us about the last one.

Dorsey: The last one is that central bank independence wasn’t designed for what central banks are now asked to do.

Rayburn: Well, central banks around the world have fought long and hard to be independent. Now, they need to act in concert, in many times, with the governments, because they typically affect monetary policy and the governments affect fiscal policy.

Dorsey: Right. And it’s not just that, either, because when central banks were first developed, the idea was in terms of maintaining some control over inflation. However, central banks have gone way beyond that. The expectation now is that the central bank is going to maintain a consistently growing economy without the normal business cycles you would typically expect. The idea is that (central banks) maintain a constantly growing economy. That’s pretty tough to do. And, because they are using tools like the ones we just talked about that are specific to a particular market, there are political implications.

Rayburn: And it’s hard to fine-tune that.

Dorsey: Right. If they’re independent, do you want them to have that independence without the political oversight? That’s a big question, and there’s a lot to be said for the independence. On the other hand, only if they’re always doing what’s right.

Rayburn: Exactly. Every politician wants the interest rate to be zero. Well, we’re out of time. Have a fantastic week.

Bill Rayburn: Can you think of some good April Fools’ jokes or things to do? One of the things people do is put something on the phone receiver and call you, and when you put it to your ear…

Bob Dorsey: There are some worse ones out there.

Rayburn: When you were a kid, you undid the salt shaker in a restaurant. Having said all that, there are some April Fools’ jokes in the markets.

Dorsey: Speaking of April Fools’, there was a really good editorial by David Stockman yesterday in the New York Times. (Read more: State-Wrecked: The Corruption of Capitalism in America)

Rayburn: A former government official. He was budget director under Reagan.

Dorsey: He was talking about how horrible the economy is.

Rayburn: The economic data is either an April Fools’ joke or misleading.

Dorsey: A lot of the housing market data right now is positive.

Rayburn: There’s very little new construction. Do you think people would rather have a new house or a resale?

Dorsey: It’s funny. There’s some interesting analysis on new construction, and what causes people to have new construction is new household development. What drives that? Either foreign investment, people coming and buying houses from foreign countries, or job creation.

Rayburn: You also have household formation.

Dorsey: People creating their families for the first time. What’s interesting is that there is a big change in the demographics of that household formation. From 1994 to 2003, if you look at the group of people who are 55 and older and are not in the job market, it increased by about 4.3 million. From 2004 to the present, the same timeframe, instead of 4.3 million, it’s 8.1 million. There’s been a big increase. Several things happened, then. People typically want a smaller house. Household size decreases as you get older and older.

Rayburn: People leave, children leave home, spouses die.

Dorsey: When people are looking for new-to-them housing, that means they’re often looking for a smaller house. That’s driving some of the new construction. The other thing that seems to be driving new construction is foreign investment.

Rayburn: If you’ve got your Euros out of the Bank of Cyprus, you’re going to come over here and buy a house.

Dorsey: Right. A lot of people are doing it as an investment, too, even though housing is not generally a good investment on a long-term basis. In the short term, it can be, given the alternatives. Investing in Cyprus right now might not be a good idea.

Rayburn: Let’s step back a second and talk about where we go from here, given our current policies. It seems as though interest rates for the average American are very low, in nominal terms, anyway. Historically, on an inflation-adjusted basis, they’re very low. It’s not affordability.

Dorsey: Just this past week, Freddie Mac’s mortgage numbers indicated that the interest rate on the 30-year (fixed rate) mortgage went down; even the jumbos went down.

Rayburn: Let’s talk about mindset. Any (mortgage rate) below four percent is fantastic. Job creation seems to be coming up.

Dorsey: Twenty-two states in the last report had unemployment decrease.

Rayburn: There are several aspects to that. One is the absolute numbers. Two, as I see my company starting to hire, that means I have more confidence that my existing position is going to be there.

Dorsey: Right. Consumer sentiment went up.

Rayburn: I think that’s directly related.

Dorsey: In the press, all the end of last year and the first part of last year was about the deficit. Deficit, deficit, deficit. That was all you saw. Now, we haven’t seen significant strides in reducing the deficit, but it’s not in the press any more.

Rayburn: What did William Randolph Hearst say? “If it bleeds, it reads?”

Dorsey: Yeah. I just think it’s strange. Even the politicians, when they’re talking, it’s just not a big issue much anymore. All the projections are that the deficit is going to pretty much take care of itself, with the standard expectation of growth and jobs.

Rayburn: We’ve got to have one comment about the Final Four. Did you turn in a bracket?

Dorsey: No, I didn’t.

Rayburn: I turned in three, and they’re all doing terrible. I did pick Syracuse to be in the final game.

Dorsey: I think Louisville looks strong. It was terrible about that player (Kevin Ware) who broke his leg.

Rayburn: I think there are correlations between the Final Four and our housing market. People get very excited about the Final Four, and they get excited about buying a new house. Are you seeing some of that excitement come back in the market?

Dorsey: Over the weekend, there was a new tax proposal for the mortgage interest deduction.

Rayburn: Is that going to stay or go?

Dorsey: This is an alternative way of doing it, which I think is interesting. The way it is today, you can take whatever you pay in interest and deduct it as one of your deductions. For anybody who itemizes their deductions, they get that deduction. There’s no limit on it. What this proposal does is, whatever you pay in interest, you’re going to get fifteen percent of that as a tax credit. But there’s a cap on that at $500,000. That increases the number of people (from about 45 million to about 60 million) who can benefit from that, because so many people don’t itemize deductions.

Rayburn: It creates a broader base, and also puts a cap on it. Now, are you sure the changes to the mortgage interest deductions aren’t an April Fools’ joke?

Dorsey: Well, it’s a proposal that was done before April Fools’ Day.

Bob Dorsey: There are a lot of restrictions on money transfer from one country to another. Increasingly, starting in the ‘50s, there were reductions in the constraints on that, so there was money transfer going more and more between countries. What’s happened is, there’s a lot of big money out there, some of it not legitimate, but big money that then follows where they can get the best benefit from that money. Recently, Cyprus essentially opened the door to say, “Hey, we know nothing, we see nothing, we hear nothing. You can bring that money to us and we’ll pay you big returns on that money.”

Bill Rayburn: They attracted a lot of capital.

Dorsey: They did. They had bank assets of approximately eight times the country’s GDP. It was really a huge amount of money they came in. They were doing these round trips, particularly from Russia, they would take money out of these big companies, put it over in Cyprus, and have Cyprus put it back into the country.

Rayburn: That’s a way to launder it.

Dorsey: It actually turned out that Cyprus was the largest foreign investor in Russia. Now that’s from an economy that’s the size of Scranton, Pennsylvania. (laughs)

Rayburn: That just goes to show you the power of financial assets. Let’s talk about the limitations of that. They were the smallest member of the EU.

Dorsey: The European Union is struggling right now. They’ve been in a bad state for years. The problem is, they’ve joined together to have a common currency. They way these problems would normally be fixed is, you would have your own currency, and you would devalue your currency, no big deal. Having a common currency, the economies are linked. Iceland, Ireland, Greece, Portugal, Spain, Italy, and now Cyprus have all run into this same problem. Cyprus has had a big boom in real estate and everything is overvalued.

Rayburn: Let’s talk about that haircut. First we have a bailout deal on the table from the IMF and by the European Union and some other players.

Dorsey: About $13B dollars right now—

Rayburn: –which would allow them to keep their banks open—

Dorsey: Reopen. They’ve been closed since the 16th. Almost 10 days. Right now they’re saying the people who have less than $100,000 in their savings account will be able to get all their money. Above that, they’ll take a huge haircut.

Rayburn: The forecasts are for a huge haircut.

Dorsey: To get back to your question, if you had money in Cyprus because you were protecting it from taxes and other regulations –

Rayburn: You’re going to have a loss of principal. There’s not going to be return on principal.

Dorsey: You might not be happy with that. You might be looking to put it somewhere a little safer.

Rayburn: Maybe in Central Europe or in the U.S.

Dorsey: The U.S. has its own strong currency that’s perceived to be very safe.

Rayburn: Treasury bonds bid up as a result, mortgage rates down.

Dorsey: Right. But, here’s the other issue. One of the things that happened in our last real estate boom is that there was a lot of that money being invested in real estate in the U.S. and that’s one of the things that inflated the real estate prices. So, we may see a big return to that.

Rayburn: I know some investors who are ready. (laughs) You know the Realtor’s prayer.

Dorsey: Oh, yeah.

Rayburn: Dear God, please let there be one more boom. I promise not to throw it away this time. (laughs)

Dorsey: That’s true. And what’s always amazing to me when you get into this boom is that everybody seems to be blind to what’s going on.

Rayburn: They get so engrossed in what’s happening day to day, they miss the big picture. You’ve got some evidence of that.

Dorsey: Well, there was an article this morning in the Wall Street Journal about a recent academic study by a couple of folks, one at Penn – they went back to the American Securitization Forum, which met in Las Vegas in 2006, and they looked at all 1,200 attendees and got rid of the people who were not really involved in securitization and identified the people who actually did securitization. They matched them with a control group of people with similar income and looked at the legal papers and said, “What did these people in securitization actually do during that boom?” Read article at WSJ.com: Mortgage Securitizers Didn’t Know Housing Was Going Bust

Rayburn: You would think they would have the best knowledge.

Dorsey: Exactly. And if they were aware that there was a bubble –

Rayburn: — for our listeners out there, you would think if they had insider knowledge, insider trading is permitted in real estate. It’s not a security that’s defined by securities laws.

Dorsey: And so they looked at what they actually did. They were all increasing their home size; they didn’t seem to perceive that there was a bubble that was likely to crash.

Rayburn: That money was sweet and fast and flowing.

Dorsey: Exactly. You could say, “Well, it’s because they were making so much money on their bonuses and everything.” When the crash hit, they were selling their homes and getting out of those homes faster than the control group, or trying to, anyway. They seemed to be totally unaware of that bubble.

Rayburn: It sounds like what went in on Cyprus.

Dorsey: When times are good, you just go with the flow. Good people are going to hurt. One of the things that may come out of this is that there may be some new push to control the flow of money between countries.

Rayburn: That would probably not be good for trade.

Dorsey: It’s not good for trading. The whole reason they loosened those controls was to increase the opportunity, to make it better for business. The result has been that a whole series of bad occurrences going back to the ‘80s, down in South America, you had Brazil, Mexico that had problems. In the ‘90s, you had Malaysia, the U.S., and then recently they had the problems in Asia, Malaysia, Thailand, Korea, and then more recently now over in Europe.

Rayburn: If we don’t say bye now, we’ll have problems. Have a fantastic week.

]]> http://www.fncmorningview.com/2013/03/25/32513-fnc-morning-view/feed/ 0 http://www.fncmorningview.com/2013/03/18/31813-fnc-morning-view/ http://www.fncmorningview.com/2013/03/18/31813-fnc-morning-view/#comments Mon, 18 Mar 2013 07:30:51 +0000 norabrown http://www.fncmorningview.com/?p=1004 In today’s FNC Morning View, Bill and Bob discuss the return of Spring, the comeback of the housing market, and the eleventh straight month of housing price increases reported in the latest FNC Residential Price Index.