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9/27/2005
Greenspan and the Real Estate Speculators, by Victor Niederhoffer

1. Alan Greenspan's speech to the American Bankers Association today, in which he raised the specter of speculation's creating risk for the economy by undue reliance on unconventional mortgages and home appreciation, is based on a 51-page working paper he lead-authored with James Kennedy, "Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four-Family Residences." The paper contains eight charts covering data for 15 years, and one table with 365 rows showing the various components of mortgage originations classified by sector, 1991-2005. There are numerous linear equations in the paper, and corrections for biases in the data, seasonal adjustments, and cross-sectional and longitudinal regressions. This is "Doctor" Greenspan's first paper since 1996 when he wrote "Motor Vehicle Stocks, Scrappage and Sales."

   Commentators immediately indicated that this heroic effort demonstrated the seriousness of his concerns about the current real estate situation. However, I immediately think of the old lions who have lost their virility and snarl at the coalitions of young lions who are taking over their place in the pride. I also think of Cyril Burt gallantly escorting Barbara Jensen to the Underground at the age of 84. And I think of Keats who, in the poem "Endymion," has his fallen hero pine for the long-ago days when he could romance the damsels. And one thinks of what Caroline Baum calls the MacGuffins that the "Doctor" would always pull out for his Humphrey Hawkins testimony (the Employment Cost Index et al.) to serve the equally false purpose of showing a man attuned to every detail of manufacturing activity that could go awry and affect the economy aversely, a state of mind that led to his "irrational exuberance" speech, which planted the seeds for the Nasdaq crash dance.

   There's something so appropriate about his previous paper's being about motor vehicle scrappage, and this paper's being so transparently the work of his younger co-author, so old-hearted and grasping at the same time, and yet so pathetic.

2. Today's moves in the markets were the exact opposite of the August 29 moves in conjunction with Hurricane Katrina, when oil opened up 5% on the day at $70 a barrel and ended down 3% from there at $68 a barrel, and the S&P opened at 1195, down 1%, and ended at 1215, up 1%. Today, oil opened down 2% and ended up 2% and the S&P opened up 1%, moved to down 1/2% and closed about unchanged. But that's guaranteed to happen, as in both cases the public was behind the form, and those large, well-funded entities who took the opposite of the public's trade were able gain an overplus that according to the traditions of caneology they deposited in stately real estate sound as a rock to await the proper time for the canes to come out when the next squall occurs.
3. A tabulation by my colleague Mr. Duncan Coker of the 2005 returns of the 20 biggest markets around the world shows the U.S. to be third-worst of all, ahead only of Taiwan and China. The median appreciation of all 20 is about 12%. How long can the differential between the equity rate of return of 6% and the long-term bond return of 4% (see our work on the Fed Model) be gainsaid? I must tip the hat to the chronic bears who remember the salad days of 2000-2002 and still promulgate the view that stocks are far overvalued in terms of P/Es, bringing back terrible memories of 1929 and how the Crash really got bad in 1932 when the Dow moved back down to 50, a level which doubtless would be in the cards now, were it not for the nefarious work of the Plunge Protection Team.
4. One of the many reasons I believe commodity prices are likely to fall is that the demand for them is relatively inelastic, not rising or falling with income, and the risk of producing a commodity that has a stable demand is low, and thus competition is very high, and this brings the rate of return on investment to the risk-free rate. If the rate of return is close to the risk-free rate, and the quantity demanded doesn't change, how is the price going to go up, not even considering all the innovations and history that Julian Simon has documented as the cause of their chronic underperformance relative to equities? We have been referred to the work of Damodaran on this subject for a related capital asset argument and will report on it subsequently.

Steve Bal adds:

The demand for commodities may be inelastic but since they are traded in US funds and there is currently deep liquidity combined with modest speculation in oil, gold, lumber, this may be enough to keep prices at current levels or higher. As Keynes said, market irrationality can remain longer than most can remain solvent. Further there have been rotational moves between gold and oil for top place leading to excitement about commodities (leave it to the media to get investors' attention). I have developed a quantitative model of my expectations of the CRB Index.

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