This afternoon I will present a talk (Lord willing) at the Advanced Appraisal Seminar in Greensboro, NC. My topic will be the economic theory of real estate bubbles. I will borrow heavily from the work of Auburn University’s Roger Garrison, who has created a handy macroeconomic overview of how speculative bubbles arise.
At the core of the theory is the action of the Federal Reserve. In my talk I will point out that, between 2001 and 2004, the Fed lowered its federal funds rate (the rate at which banks can borrow from other banks to meet their reserve requirement) from 5.5% to 1%. The Fed also purchased bonds from commercial banks, which injected reserves into the banking system. The net effect was to increase the money supply and the amount of loanable funds. Borrowing from Neil Young, I call this phenomenon “the needle and the damage done,” because the resultant reduction in interest rates was not the natural, market result of consumer savings. In fact, as Fed policy artificially lowered rates, consumers actually saved less of their incomes, and began demanding immediately consumable goods. A great disconnect occurred in the economy: consumers’ time preferences rose (consume in the present) while investors’ time preferences fell (divert production to more roundabout, future-oriented enterprises).
By the end of 2007 most American consumers were so over-leveraged (using their home equity accounts as virtual ATM’s) they hit the proverbial wall. By mid-2008 it became manifest that investors had over-extended themselves in real estate projects, many which had to be abandoned. Those are the very basics dynamics of a “recession” (depression) – the natural and inevitable correction following a central bank induced “boom.”
Even as I sit in my office I can look out the window and see five construction cranes over the Charlotte skyline. Far from being harbingers of future growth, they represent to this appraiser future vacancy – the continued effect of malinvestment in real estate projects.
When you see retail shops close and the space going “dark” (as we say), don’t think, “business failure.” Rather, see it for what it is: overcapacity. Our economy has been on a heroine rush for years. The time for cold turkey has come, but the manipulative State, through the agency of the Fed, is continuing to pump liquidity into the blown economy. Those cranes, and the derelict skyscrapers they are raising, are the sobering evidence.
Sort of like pumping air into a blown tire.
The question is, will my fellow appraisers receive this theory? They ought to, seeing that the values they have placed on an untold number of properties have been exposed as inflated.
In the meantime, a public service announcement: contact your representatives and insist that they support a stand-alone version of H.R. 1207, the bill that will require an audit of the Federal Reserve. This represents a key first step toward exposing the Fed and, hopefully, bringing it down.