Tuesday, August 30, 2022

FHFA Purchase Only House Price Index – What Goes Up, Must Come Down

Like this post? Consider subscribing to my Substack for additional insights and content today!

Today’s release of the Federal Housing Finance Administration (FHFA) House Price Index indicated that the Purchase Only repeat sale index of single family properties (similar to the Case-Shiller but with Fannie Mae and Freddie Mac home sale transactions) has begun to decelerate notably in recent months with the index falling to a still bubbly 16% annual percent change.

While prices are still rising notably, the trend appears to be abruptly changing as mortgage rates continue to climb bringing higher costs, tighter lending standards and more economic uncertainty.

Given the truly anomalous surge in home prices seen since the start to the pandemic, it appears pretty clear that we are now seeing an equal but opposite deceleration in prices that will more than likely end in a spectacular home price bust as inventories continue to mount and housing finance continues to tighten. 

The following data visualization (click for dynamic version) shows the Annual Percent Change of the Single Family Purchase Only Index (in blue).


Thursday, July 14, 2022

The Inflation Conflagration

Like this post? Consider subscribing to my Substack for additional insights and content today!

Once I lived the life of a millionaire 
Spending my money'n I did not care 
Carrying my friends out for a good time
Buyin’ bootleg liquor, champagne and wine

Lord but I got busted and I fell so low
Didn't have no money and nowhere to go
This is the truth, Lord, without a doubt
Nobody wants you when you're down and out

Lord, if I could get my hands on a dollar again
I would hold it till that eagle grins
I would try just for one little house
Nobody knows me when I'm down and out

- excerpt from Scrapper Blackwell’s “Nobody knows you when you are down and out”

The inflation that we are seeing today was not caused solely by recent exogenous shocks like China’s COVID lock-downs or the war in Ukraine or any other temporary event, but instead it has come as the result 15+ years of reckless monetary policy and 30+ years of moral hazard induced mal-investment. 

Like the misguided mindset of pre-1970s forest management, suppressing every fire in an effort to “protect” the forest, a process that Mother Nature was perfectly capable of performing for many millions of years without the “benefit” any human intervention, the “stewards” of our financial eco-system have consistently prevented the natural cleansing effect of major market downturns and financial crisis.


Worse yet, the Fed and their global central banker counterparts through their extraordinary “easy money” policies (i.e. ZIRP/NIRP, QE) literally spread combustible debris all over the global financial system in an foolish effort to manage a macro-economic “controlled burn” that only worked to warp our sense of value while simultaneously encouraging immense amounts of reckless speculative activity.

The “cause” of today’s inflation is the over-expansion of the monetary base and all associated money aggregates, the “effect” of inflation is rising prices, but between this basic relationship lies probably the most important stimulating factor, namely human psychology.

What makes a person pay an additional 9% for a consumer good this year than they did last year? Why would a prospective home buyer willingly compete in a bidding war that sends the final purchase price 30% over the original asking price and obviously out of line with the property’s historic valuation? Why would youth with nearly zero real wealth be pumping whatever meager “money” they do have into a stock trading app in the hopes of a quick payoff on shares of any company much less aging firms clearly in their twilight years? Why would an otherwise financially astute investor be duped into believing that he could purchase a tweet and further that it was worth nearly $5 million? How could an obviously strange deep-talking 19 year old Elizabeth Holmes con the venture capital community out of $700 million for a prospective innovation that could easily, with minimum due diligence, be shown to defy the limits of physical reality?

Delusions truly abound!

We are in an era where fantasy has replaced cold hard facts and market participants prefer to LARP their way through their life’s trajectory entertaining one outlandish concept or another rather than simply cultivating the real earned product of toil and time.

This outcome was not by accident either, but by the Fed (and their global central banking counterparts) and the Federal government’s choices. When the value of money is undermined, particularly as fundamentally as it has been over the last many decades, it distorts the human psyche and unleashes irrational wants, desires and perceptions leading to actions that would never be possible with harder earned real wealth in a more grounded real world.

In a high energy and highly preposterous environment like this, it only took the inevitable spark, the COVID-19 pandemic panic, to provide the final stimulus to light-up things and start an epic inflationary conflagration going and ultimately the greatest, most fundamental challenge of our time.

We need face up to this challenge and get back to the world of sound money and prudent behavior.

This coming economic reckoning holds the hope for a post-crisis reality that goes “back to basics” on many fronts albeit at the cost of massive asset price declines, a federal finance and budget catastrophe, a sharp increase in long term unemployment and a never ending list of financial (and real) suffering as the dreamy wild times of the bubble decades of the “Great Moderation” become distant memories.

The task at hand for the Fed at this critical moment, provided that they truly want to tackle inflation and right the wrongs of their prior policy, is to fully embrace a new era, the “Great Agitation”, and a shift of the macro-economy back in the direction of sound money.

This is no small task and is not accomplished with a rate hike here or there but rather a commitment to contract the monetary base, no matter how painful the process may be, stamping out speculative fevers while fully disabusing all market participants of the notion that “easy money” will ever been seen again in their lifetimes.

Painful as this process may be, it is the only true path forward to a world that retains the integrity of our traditional political and economic the systems.

If the Fed again panics in the face of the economic turmoil and pivots back to desperate money creation and inflation just to buy a measure more of “stability”, then we will be truly be repeating history as this latest empire simply degenerates into a modern Dark Age of meaningless chaos.

Monday, July 11, 2022

Forecasting the Coming Housing Collapse

Like this post? Consider subscribing to my Substack for additional insights and content today!

As the Fed’s rate tightening policy regime continues to put upward pressure on mortgage interest rates and the steadily worsening recessionary trends (and other notable economic headwinds) mount for the macro-economy, it’s becoming pretty obvious that the nation’s residential housing markets are in for a serious pullback.

The most important questions for the housing market now are when will we see the peak firmly established for home prices this cycle and what will be the pace and scale of the downturn?

I’ve developed a model to attempt to answer those questions using past trends as a general guide as well as a healthy dose of pure conjecture based on my first-hand experiences with our most recent past two housing downturns.

First, I want to note that while my outlook would probably be considered by many to be highly pessimistic, I had an equally pessimistic outlook for housing back in 2006 and, looking back on my posts from those years preceding the Great Recession, I think my take back then was actually spot inline or even a tad too optimistic for the times that were headed our way.

In general, my key principles for the dynamics of highly speculative and delusional markets and asset classes could be stated simply as “What goes up, must come down” as the bubble inflates and then, once the delusion has broken, the sentiment shifts to “The bigger they come, the harder they fall.”

In other words, speculative trends tend to overshoot, first on the up-side and then on the down but over long term, the primary function is ultimately a reversion to the mean.  In some cases, the “mean” might just be the zero-bound but in a fundamental asset class like housing; over the long haul, the trend should be a slow and steady (and far from exciting) random walk up and to the right, keeping up with inflation but no more and no less.  

As for the current moment, we are sitting at the nexus of a number of Fed induced “easy money” speculative delusions in the era of the “Everything Bubble”; Stocks, housing and alternative investments (cryptos, NFTs, SPACs, etc.) had all been (until recently) running white hot for at least the last two years while stocks and housing have been propped up and pumped full by ZIRP and QE policy for over the last thirteen years.

This makes comparing the current period for the housing market (or any other asset class for that matter) to past periods very difficult given that so much of the general economic activity that has surrounded us since 2008/09 is but a Fed induced fiction and we will never truly know what the fundamental trends would have looked like without all the market manipulation.

But, be that as it may, I have modeled out the trends using a simple quantitative approach that mirrors my “key principles” whereby I relate the size and scale of the boom to the extent of the bust and also, relate our current cycle to the past two cycles.

First, take a look at Robert Shiller’s long running nominal home price index (blue left axis) plotted with the year-over-year percent change (red right axis) monthly since 1953.  Note that this index is synthesized from several source indices as the S&P CoreLogic Case-Shiller only runs back to the 1980s.   

Notice that the scope and scale of each housing bubble since 1980s has been growing with each successive cycle.  Below is a table summarizing the 1980s, 2000s and the current 2022s cycle details:

Notice that the year-over-year (YOY) percent change for each cycle has been increasing by about a factor of 1.5 for each subsequent cycle.  While I don’t believe that this is some sort of magic factor, I’m going to take this as a general indicator that the current boom has just about reached is maximum upward thrust while also giving a sense of the scale of the minimum YOY when the downturn eventually kicks into gear.

Next, look at the chart below displaying the S&P CoreLogic Case-Shiller Home Price Index of the late 1980s era “Savings & Loan Crisis” boom bust cycle (a subset and not the full cycle) and notice that I have highlighted both the strongest monthly of year-over-year percent change (bright red bar at 2/1987) and the strongest monthly month-to-month percent change (bright green bar at 6/1987) as well as the weakest of both (most negative YOY percent change at 4/1991 and MTM at 11/1990).  

Let’s recall that while the Savings & Loan Crisis was a major event, the boom and bust primarily affected key cities of the east and west coast and their associated suburban property markets and did NOT generally express itself across the whole of the U.S. like the following “Great Housing Bubble” cycle ultimately did a decade later.

Since my plot is displaying the “National” S&P CoreLogic Case-Shiller Home Price Index and given that this home price boom and bust was largely regional, the cycle appears subdued by comparison to more recent cycles.

Next, look at the chart below displaying the S&P CoreLogic Case-Shiller Home Price Index of “Great Housing Bubble” boom bust cycle (a subset and not the full cycle) and notice again that I have highlighted both the strongest and weakest monthly YOY and MTM gains and losses.

Clearly, the “Great Housing Bubble” ran much longer, reached a much higher level and ultimately collapsed much harder than past cycles.  Remarkably, it took about 174 months to reach the peak and another 67 months to trough with a whopping 143% peak increase which was eventually reduced to a net 77% increase after a 27% decline during the bust.

Finally, look at the chart below which displaying the S&P CoreLogic Case-Shiller Home Price Index of “Everything Bubble” boom bust cycle (a subset and not the full cycle) with a projected price trend (all data within the yellow band) running all the way to 2030.

My forecast for the price trend going forward is pretty simple and involves the following key assumptions:

1. The Month-to-Month (MTM) percent change of 2.58% seen in March of 2022 will be the largest monthly increase we will see for this cycle given that the S&P CoreLogic Case-Shiller is a three month moving average and will now (going forward) start to capture price dynamics reflecting the increasing mortgage interest rates that began to surge in earnest during March.

2. We are very near the maximum Year-on-Year (YOY) percent change which I estimate will reach about 1.5x the maximum YOY percent change seen in the last cycle (14.5%) at 21-23% and will come later this year at which point all subsequent monthly YOY reads will trend continuously lower till they ultimately turn negative into the depth of the decline.

3. The general downtrend in prices will play out similarly to the “Great Housing Bubble” cycle with the exception that the monthly declines will be a bit more intense given the more aggressive price run-up and the abrupt reversal in mortgage rates.

I will continue to update this projection as new S&P CoreLogic Case-Shiller data settles as well as revise my overall thesis and key assumptions but at the moment it appears to me that the strongest monthly MTM change was seen in March, we are closing in on the largest annual YOY change coming likely this November and that the peak in prices will probably be some time next year based primarily on the effects that increasing mortgage rates have on market activity.

Wednesday, July 06, 2022

The Real Great Recession

Like this post? Consider subscribing to my Substack for additional insights and content today!

It’s time to face the facts, recession is here, not “officially” of course since it takes the NBER with a boat load of highly revised and settled macro-economic data to officiate that fact, but “technically” and in a fashion that is widely felt.

Q1 2022 registered a first negative real GDP print for this cycle (i.e. the cycle that started after the COVID pandemic induced mini-recession) and only the third (but most significant) time a quarter turned negative (if you leave off the COVID debacle) since the end of 2008’s Great Recession.

Add to that the fact that the Fed itself is now forecasting a second negative print for Q2 2022 and its becoming pretty evident that the economy is in the middle of a significant down shift that is only going to get worse with the full realization of the impact of each major headwind. 

The data visualization below (click for larger dynamic version) is displaying the Real GDP percent change from the preceding period (in blue on the left axis), the Atlanta Fed’s GDPNow Real GDP estimate annualized rate (in red on the left axis) and the Chicago Fed’s Brave-Butters-Kelly (BBKI) leading sub-component of GDP (green on the right axis).  In summary, Q1 saw an actual 1.6% contraction in real GDP from the preceding period, the Fed is currently estimating -2.0% annualized contraction in GDP while one of the Fed’s high frequency models is forecasting nearly a -3.0% going forward. 

The economy is currently contending with rising consumer prices primarily coming from general monetary inflation stimulated by the Fed’s own “easy money” policies over the last 13+ years, exploding food and energy costs with notable product shortages, an evolving stock market rout with an ever looming crash-out end-game, a quickly souring national housing market fragilized by speculation and loose lending and now traumatized by the abrupt reversal of interest rates, global uncertainty coming from the now obvious quagmire that is the war in Ukraine and a stymied supply chain from a China unwilling or unable to return to a post-COVID normal order.

That would be a sufficient array of challenging issues for even the most competent government and economic order to face up to but one gets the sense that our current “leadership” is woefully out-classed and simply incapable of even waging the most modest of effective responses to even just one of those many issues.

With all of that stated “gloom”, where do we go from here? The answer is pretty simple “doom” or in other words, “down”.  And not just a little down mind you, way back down to 2008 and beyond as genuine “fact” finally catches up with the Fed’s economic “fiction” and yields the compounded negative real return on the massively appalling mal-investment that was the mop-up of the Great Financial Crisis.

The “Real Great Recession” is now looming as the reckless policy response on the part of the Fed and the Federal government in the wake of the 2008 Great Recession, endlessly pumping, priming and backstopping in an effort to simply “kick the can down the road” thereby softening the blow for that era’s legion of weak hands is now realized to have come at an enormous expense of today’s totally FUBAR-ed bag-holders.

But this “doom” does not have to represent only misery and depression.

An epic economic reckoning will bring enormous opportunities as fundamental bouts of “creative destruction” run roughshod over a cornered economic system with no escape and the only path forward leading through the pain.

Business will go crash-out, households will go bust and paper wealth will vaporize and fade from memory taking with it the rampant fever for “easy money” fueled speculation while local, state and the federal governments, severely constrained, will be unable to do much more than simply attempting to manage keeping the peace.

Bleak outlook indeed, but as that famous Stoic philosopher, Seneca the Younger put it “Nothing lasts forever, few things even last for long, all are susceptible of decay in one way or another; moreover all that begins also ends.” Or as Semisonic more optimistically put it a little more recently, “Every new beginning comes from some other beginning's end.”

Tuesday, July 05, 2022

A Real Mean Reversion

Like this post? Consider subscribing to my Substack for additional insights and content today!


 One of the major differences between our current housing boom and the epic housing run-up and associated crash that ultimately led to the “Great Recession” is in the supposed quality of buyers, or more precisely, the underwriting standards lenders use when making home loans as well as the soundness of the loan products and features they offer.

Without a doubt, lending standards by 2005/06/07 had become completely detached from reality with 100% loan-to-value, no-interest, reverse amortization, no-income verification, sub-prime being some of the various means by which the housing finance system kept the party going (loan volume) even after prices had risen well out of reach for many prospective home buyers.

In the aftermath of the epic financial meltdown that ensued, there was a notable effort by Federal regulators to understand what went wrong, and further, to take measures to prevent such egregious activities in the future.

The Dodd-Frank “Wall Street Reform and Consumer Protection” Act had as a provision the “Mortgage Reform and Anti-Predatory Lending Act” which sought in part to tighten up the process of mortgage origination in order to:

It is the purpose of this section and section 129C to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive or abusive.

To that end there are the following two important sub-sections (NOTE: Dodd-Frank is an enormous act with many provisions; these are just two small samples of items focused specifically on mortgage origination standards):

Subtitle B: Minimum Standards for Mortgages

IN GENERAL.—In accordance with regulations prescribed by the Board, no creditor may make a residential mortgage loan unless the creditor makes a reasonable and good faith determination based on verified and documented information that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan, according to its terms, and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.

This section goes on to detail tighter rules for regulating, multiple loans (borrowers has subordinate loans on same property), income verification, no-interest options, negative amortization options and other lending phenomena that contributed to the mortgage mania of that era.

Subtitle F: Appraisal Activities

IN GENERAL.—A creditor may not extend credit in the form of a subprime mortgage to any consumer without first obtaining a written appraisal of the property to be mortgaged prepared in accordance with the requirements of this section. 

This section goes on to detail tighter rules for regulating the appraisal process of a property that will be financed using a “high-risk” subprime loan. 

Taken together, these two sub-sections point to one major flaw in the legislative financial regulatory process in that it is at best always backward looking, specifically addressing practices that occurred in the past that had led to financial crisis.

Whether there is any sense to even trying to regulate future financial activities, is not the topic of this post, but suffice to say, the Dodd-Frank mortgage origination related provisions focused heavily on the activities that led to the Great Recession and didn’t attempt to regulate other novel methods that might be employed in future speculative episodes.

One area that I have taken an interest in is in the non-conforming “jumbo” loan market and particularly in my own market of Boston where throughout 2020, 2021 and on into 2022, I have witnessed some truly reckless behavior on the part of borrowers and lenders.

Following up on my prior post on the subject, I dug a little deeper into the homes that I have highlighted previously to better understand the nature of the debt that financed these reckless purchases.

From a traditional mortgage lending perspective, these purchases appear pretty sound given that the average loan-to-value (LTV) was about 70% (i.e. 70% loan, 30% deposit), all mortgages were simple 30-year fixed rate loans (no risky options or even a single ARM) and I assume that all incomes were verified.

But considering that each of these buyers over-bid the listing price by on average a whopping 30%, one might draw a different conclusion.

First, below is a simple average model for pricing the Boston housing market that I developed using the S&P CoreLogic Case Shiller Home Price Index (CSI) for Boston.  This model, superimposed on a Zillow price history, simply uses the CSI to calculate the price trend line with 2016-2019 based on actual annual price changes and 2020-2022 based on an average annual price change from the trailing eight (8) years.

My general premise with this model is that 2020 through 2022 represented an absurdly anomalous period where lending rates were exceptionally low and buyers (as a result of COVID-19 hysteria) were simply not acting prudently.

As you can see from the model, there is a significant risk of “mean reversion” for the nation’s severely overheated housing markets as interest rates rise and prices fall meeting a more fundamental balance that, once materialized, will call into question the financial soundness of the loans backing up these properties.

If, given the emerging headwinds for the macro economy and housing specifically, we see a 25% pullback in home prices in Boston (not inconceivable given the ferocity of the price appreciation in just the last two years as well as the scale of prior pullbacks of about 16% after the late-80s S&L crisis and 18% after the Great Recession), then these homes would all have an average LTV of about 92%, a much less sound financial footing for these buyers and lenders.

Further, many of the homes could fall even more sharply given how far off the simple average price trend (the model) the buyers pushed the purchase with their manic bidding.  

The following is a selection of three homes from my original post, annotated with the simple average price model as well as the mortgage details to illustrate the point:



Note that I calculated the LTV as they stood on the day of settlement as well as what the LTVs would be after both a 25% pullback in prices as well as with respect to the simple average price model forecast of the more fundamentals-based value. 

The loophole in the lending standards for this cycle appears to have been that home appraisals were either unable to accurately account for the outlandish price appreciation occurring in the market or were simply roundly ignored given the fact that borrowers came to the table with 20%-30% down-payments and had good credit histories.

Prudent lenders would have evaluated the appraisal to determine a more fundamental valuation and either demanded more down-payment from the bid-happy borrowers to account for the additional risk or simply rejected the transactions outright.

For example, for the first property above, the fundamental value of the home at the time of purchase was probably closer to about $1,300,000 but it was bid up to $1,720,000 or about $420,000 over its fundamental price.

If the lender had been more prudent, they would have either walked away from the transaction or demanded that the borrower come up with about $800,000 for the deposit instead of the meager $400,000 that the borrower actually paid.

This would have resulted in a loan of about $920,000 against an $800,000 deposit for a very healthy 53% LTV which would have been well fortified against any oncoming economic crisis-driven home price decline.

Obviously, the lender didn’t perform this level of due-diligence because the borrow could not afford the additional deposit and all parties involved (lender, broker, lawyers, buyer and seller) simply wanted to stack up another closed transaction.

I suspect that my small sample is clearly demonstrating something important about the housing market dynamics this cycle, namely that there is real, yet to be fully realized, systemic risk coming from the prime lending market particularly for the performance of privately funded “jumbo” loans.

Wednesday, June 29, 2022

Reflecting on Rates

Like this post? Consider subscribing to my Substack for additional insights and content today!

For the last few months now, I have been suggesting that the Fed needs to move the Fed Funds rate up much faster than they have been, arguing that they are not only “behind the curve” given their failed “transitory” position, but that they have totally lost the narrative as far as taking a “hawkish” stance is concerned.  

My suggested approach to rate hikes has been for the Fed to move in the range of +100 to +125 basis points at each scheduled meeting (of 2022) as well as implementing random “emergency” intra-meeting rate hikes and setting an overall target of at least 8.5% by as soon as conceivably possible.

Obviously, this may seem a bit extreme from the standpoint of the “recency bias” of our current distorted economic times as well as the current level of debt carried widely by households, firms and the Federal government, but historically, this approach is actually very modest.

The following chart displays the annual rate of change of the consumer price index (i.e. the inflation rate) (in blue), the 30-year fixed mortgage rate (in red) and the effective Federal Funds rate (green) as well as the upper-range target of the Fed funds rate (in light green) in order to present the Fed’s actual current target.

Traditionally, the Federal Funds rate (the green line on the chart above… click for larger interactive version) , particularly during periods where inflation was clearly “unmoored”, has always matched or been well above the rate of inflation as measured by the year-over-year change in the consumer price index (the blue line on the chart above… NOTE: you could also use the annual change of the PCE index, the Fed’s preferred inflation measure but CPI is historically the measure that is reported for inflation as well as the measure feeding into COLA calculations and the like, so I’ll stick with this comparison for now).  

Of course, there are notable exceptions, for example, during the two post-recessionary periods following both the “DotCom Recession” and the “Great Recession”, the Fed’s policy rate remained below the rate of inflation for extended periods in an attempt to breathe life back into the respective lackluster economic expansions.

But when it comes to periods where the immediate concern is NOT “deflation” but instead “inflation”, the Fed has either targeted or allowed the Fed Funds rate to float well above the rate of inflation in an effort to contract the money supply and thereby stamp out inflationary pressures.

Shifting our focus to the long-end of the yield curve, another important inflationary relationship is found in comparing the 30-year fixed mortgage rate (the red line on the chart above) to both the consumer price index (rate of annual change) and the Fed Funds rate.

Notice that since the mid-1970s, the 30-year fixed mortgage rate has ALWAYS been well-above the rate of inflation (as well as the Fed Funds rate), which is to be expected, when considering the lengthy maturity of these bonds and the fact that lenders are primarily concerned with the risk associated to the high probability of inflation when pricing this type of debt.

I say “always” but actually since March 2022, the inflation rate (i.e. annual CPI again) has been running above the 30-year fixed mortgage rate and WELL above the Fed Funds rate, a truly anomalous situation that is begging for a resolution.

Either the 30-year fixed mortgage rate has to go up considerably (minimally about 300-400 basis points to 8-9%) or the rate of inflation needs to come down considerably or a bit of both.

One thing is for certain though; the current 1.50% Fed Funds rate is way to low to make a notable difference in either bringing down the rate of inflation or influencing the yield curve enough to instigate the 30-year fixed mortgage rate to guide up.

Remember, I’m certainly not suggesting that raising rates this aggressively is convenient for either debtors (particularly massive ones like the Federal government) or the central bankers at the Fed and their global counterparts.

I’m only pointing out the very simple and sensible historic relationship of these rates and suggesting that since, as Chair Powell noted today, “[Central Bankers] now understand better how little we understand about inflation”, they should have now learned that their recent efforts are simply not enough.

They either want to stamp out inflation, or they don’t.

Tuesday, June 28, 2022

Jumbo Loans, Jumbo Problems

Like this post? Consider subscribing to my Substack for additional insights and content today!

Something stinks in jumbo mortgage-ville.

For all of my adult life, the interest rate for jumbo loans has been at least a quarter percent (or more) above the rate for conforming loans, but recently, this relationship has flipped.

Recall that the primary goal of the massive “Government Sponsored Enterprises” (GSEs) Fannie Mae, Freddie Mac and Ginnie Mae, is to provide more affordable housing financing to the American population.

The GSE mortgage backed securities (MBS) come with an implicit guarantee (that was shown to be actually “explicit” when Fannie and Freddie were taken into conservatorship during the worst years of the Great Recession) of the “full faith and credit” of the United States government, thereby allowing this market in mortgage securities to exhibit the preferential pricing of near-riskless investment grade securities to the benefit of borrowers seeking lower rates of interest.

By contrast, the private, “non-conforming” lending market (i.e. loans that do not conform to GSE limits/standards …the market in “Jumbo” loans) would logically demand higher rates of interest given that private lenders financing this market are shouldering the full credit risk and not gaining the benefit of an implicit or explicit government guarantee.

This generally meant that the private lenders would perform more due-diligence when originating loans, demanding more down-payment (i.e. more skin in the game), and were more critical of home appraisals, and, further, made the loans at higher interest rates as compared to GSE lending.

Since early 2022 though, this relationship appears to have flipped with jumbo loan rates falling below conforming rates in the range of 25bps – 100bps! In my market, a local bank lender is advertising jumbo loans at a full percentage less than conforming loan rates.

The following is the Fed FRED visualization (click for larger dynamic version) showing the relationship of the 30-year fixed rate conforming versus Jumbo loan rates since 2017.

Clearly there is a different risk-return calculus being performed in the current private lending market that appears to have significantly influenced the pricing of potential risk coming from the performance of these loans.

One explanation could be that the underwriting is very strict allowing private lenders to provide highly preferential interest rates but I have my doubts given some of the dynamics that I have observed in my local market (Boston… a real bellwether housing market) during this cycle.

First, while there is no comparison between now and 2006 (the height of insanity that was the Great Housing Bubble) in terms of “creative lending”, there appears to be another gremlin afoot.  

In 2006, there were a plethora of creative loan products allowing borrowers to stretch to reach ever higher home prices (i.e. affordability loans); the negative/reverse amortization loans, interest only options, low documentation or no documentation (liar loans) together were all complicit in pushing home prices to their maximum in an effort to keep the party going for borrowers/buyers and the loan volume for originators/lenders.

Today, you don’t see these types of loan products advertised widely though I’m sure there are some examples that can be cited. What you do see though, are completed sales like the following (I have calculated the over-list sale amount for convenience as well as obscured the exact addresses):









Notice that these homes, generally speaking, are fairly typical 3 and 4 bedroom homes (one 5) in the suburban Boston housing market.  From my perspective, these are NOT exceptional homes. They are the types of homes most middle to upper middle-class families should expect to be able to afford at some point in their financial life.

But look at the prices and, more importantly, the outstanding over-list bidding wars!

This is nothing short of insanity and there is NO WAY prudent due-diligence was properly exercised by the lenders during the appraisal and underwriting process of these transactions.

I believe that this anecdote is revealing the most important Achilles' heel of the latest cycle of booming real estate, namely, that private lenders fell back into the same trap as the Great Recession housing boom, over-lending with the assumption that residential real estate is immune from market downturn.

Buyers, for their part, clearly went hog-wild throwing nonsensical sums at bidding wars in an effort to win a property at any cost.  This is to be expected with inventories so low and mortgage rates so favorable over the last two years, but the gatekeeper to the sound financing of these transactions is the banking system which should have prevented such madness but appears to have, again, failed that systemically important function.

I have no doubt that we are about to witness a severe housing downturn as prices within property markets across the country briskly reset downward as the ongoing surge in interest rates continues.

It will take some time, of course, given the snails-paced speed with which transactions settle in the residential housing markets, but the lesson we will learn from this new Housing Bubble 2.0 is no different from what we learned the last go around, namely, what goes up, must come down!

Monday, June 27, 2022

Durable Goods Orders – Consumer Demand Destruction Imminent

Like this post? Consider subscribing to my Substack for additional insights and content today!


 Today’s release of the Durable Goods Manufacturers’ Shipments, Inventories and Orders Report (M3) showed that new orders for manufactured durable goods increased in May by $1.9 billion (adjusted for seasonality, but not for inflation) or 0.7 percent to $267.2 billion while new orders for durable consumer goods declined by 0.62% to $42.9 billion.

The relationship between consumer sentiment and manufacturers’ new orders for consumer durable goods is pretty obvious as a pullback in consumer sentiment generally precedes the destruction of demand for consumer durable goods.

Given the historic pullback in the University of Michigan’s Consumer Sentiment Survey, it appears clear that we are about to see a significant pullback in consumer durable goods spending.

While this is the precise demand destruction that the Fed is looking to achieve with their new “inflation fighting” interest rate policy, to date, the decline in consumer sentiment consumer durable goods spending is likely primarily coming as the result of higher consumer spending on non-durable goods as rising prices for food and energy are forcing consumers to make hard spending choices. 

The following data visualization (click for dynamic version) shows New Orders for Consumer Durable Goods (in blue) on the left axis and the University of Michigan Consumer Sentiment (in red) on the right.

Notice the significant gap that needs to close in order for the current level of new orders for consumer durable goods to match the current level of consumer sentiment.  

Obviously, we should look for a significant decline in new orders for consumer durable goods in the months ahead.

Wednesday, June 22, 2022

Reflation Gave Way to Inflation

Like this post? Consider subscribing to my Substack for additional insights and content today!


It is surprising how many macroeconomic commentators propagate the false notion that “quantitative easing doesn’t cause inflation” typically offering up some esoteric accounting of the Fed’s balance sheet or the difference between bank reserves and currency in circulation or the highly structured means by which the Fed implements QE or some other means of obfuscating, through needless complexity, the obvious goal of this unusual monetary policy tactic.

Let’s recount for a moment the reason the Fed began “quantitatively easing” in the first place.

Back in the fall of 2008, in the face of the almost continuous flow of horrific economic trends for housing and the wider economy and in the wake of the collapse of Bear Stearns and Lehman Brothers, the Fed finally “blinked” and went beyond their normal policy tools to engage the crisis head-on with an approach that was new to the American economic landscape, namely, Quantitative Easing (QE).

The following two articles (click for larger versions), published at the start of the Fed’s QE1, paint the picture well:


Note the air of crisis and desperation as American’s and those worldwide with economic interests tied to the American real estate markets were truly panicked over fate and fidelity of the American economy.

QE1 was a one-two punch of zero percent interest rate policy (ZIRP) on the short end of the yield curve (the Fed’s traditional Fed Funds rate policy) coupled with an ad-hoc targeted yield control tactic on the long-end by the Fed participating directly in the mortgage market through mortgage backed security (MBS) purchases from Fannie and Freddie, the large government sponsored entities (GSEs) that essentially make the conforming mortgage lending market.

It’s important to note that the Fed’s purchase of GSE MBS was NOT simply an effort to force mortgage rates lower but, by the fall of 2008, the mortgage market was essentially completely impaired leaving the Fed to literally step-in to replace the collapse in demand for these securities with their own artificial demand.

Losses coming from imploding sub-prime mortgages as well as near-prime and even prime were mounting steadily as vast swaths of new or recent home buyers (the top of the market buyers) decided to mail the keys back to the lender (jingle mail) rather than suffer the further downside coming from steadily falling home prices, thereby grinding the mortgage market to a halt.

This was a catastrophic outcome for the highly financialized and highly complex mortgage finance system and without the Fed’s artificial purchase of MBS re-liquefying the market in mortgage lending, home prices would have likely fallen on the order of 40%-50% nationally rather than the roughly 25% that the Fed successfully held it to.

So, put more directly, the Fed’s QE MBS policy not only work to depress rates for mortgages, it also LITTERALLY MADE THE MARKET for home loans from 2008-on as the Fed transformed from a lender-of-last-resort to, ultimately, a permanent fixture in mortgage finance.

By 2010 and on into 2011, it was becoming clear (at least to me here, here, here, and here) that QE was here to stay, a fact that would leave an indelible and fundamental mark on our economic landscape as our highly financialized debt markets would simply adapt to accommodate the Fed’s participation on an on-going basis, thereby allowing this falsehood to permeate deeply into the dynamics of the system.

In fact, it has been recently estimated that even today, roughly 30% of the overall U.S. mortgage market is directly financed by the Federal Reserve, a startling fact made even more alarming by the realization that the Fed’s QE was not just limited to the purchase of MBS but also Treasury securities thereby working to artificially finance Federal debt just like it worked to finance mortgage debt.

This level of support was not just done in an effort to simply fend off “deflation” (a specifically expressed goal of the policy) but also to evoke a “reflation” of the markets and bubbly conditions that existed prior to the crisis in an effort to blunt the trauma felt widely by firms and households thereby working to sure-up systemic confidence.

The result of all of this Fed action is pretty clear as the crisis steadily abated and confidence and sentiment gradually improved throughout the 2010s leading to a notable and lengthy bull market in stocks, a steady reflation of the housing markets and a major improvement in outlook for the economy more generally.

But this “reflation” was, in fact, a form of inflation as it is quite clear that price levels of most asset classes (and probably even consumer prices) would be much lower today had the Fed not stepped up to “rescue” our economy from this notable bout with deflation.

Further complicating matters, by early 2020, the COVID-19 panic circumvented the Fed’s initial attempt to walk back some of this extraordinary support again putting the it directly in the position of “savior” of the economic system, for which again it leveraged ZIRP and QE to do battle with a major economic crisis.

But unlike in 2008, the post-COVID economy was already replete with hot money having benefited from over a decade of historically accommodative easy monetary policy and almost euphoric attitudes coming as a result of ongoing stock market and housing market “wealth effects” on firms and households.

The Fed’s COVID-era ZIRP and QE and the Federal government’s massive fiscal actions (PPP and various stimmies also funded by Fed Treasury QE) thereby worked to transform the prior economic “reflation” into literal, unadulterated “inflation” as economic participants caught in the volatility of the pandemic began to thrash wildly about throwing hot money at speculative absurdities like high-flying frothy stocks, endless cryptos, meme-stonks, NFTs, SPACs and a new wave of totally insane real estate speculation.

Now, with inflation clearly “unmoored” and with literally no easy pathway out of this maelstrom of economic insanity, the Fed and the economy more generally, will finally have to square off with the inescapable reality of this challenging period.

Saturday, June 18, 2022

Reality is an Unavoidable Imposition

Like this post? Consider subscribing to my Substack for additional insights and content today!

Arguably the most unique trait of the human condition is our unbridled inventiveness. 

Reading the transcript of Blake Lemoine’s “interview” with LaMDA, Google’s remarkable, and possibly sentient AI, makes that perfectly clear but also highlights the potential for this type of ingenuity to overrun the current limits of our capacity to forecast the impact and, ultimately, the cost of such creativeness.

Putting aside whether or not LaMDA is truly sentient for the moment, reading the exchanges got me thinking (with my software engineering consultant hat on… my day job) of the amazing ways that I could leverage a service like LaMDA within my existing software application domains and further, how it could redefine the role of the user within such applications.

More specifically, with a service capable of generating real original intelligence and insight (either about data analysis or protocols or policy or art or culture or whatever!) on demand, bolted into functional software applications, I began to wonder, where does the user fit-in within this equation?

In a sense, we already delegate our raw math and calculation needs over to the magical micro-processor that is far more capable than we at executing such tasks (almost magically so), once we can easily delegate intelligence just as effortlessly, what is left for the human to do?

My guess is that we “humans” will be more available to do the one thing that we have always excelled at… invent and re-invent anew.

But our inventiveness, whether in academia and philosophy, industrialization and finance or pure hard science and technology, has generally come with significant overshoots leading to natural, catastrophe-punctuated, growth spurts as new modes of operating usher in immense bouts of “creative destruction”, continuously laying waste to the ever outmoded present.

Nowhere is this “two-steps-forward and one-step-back” pattern more pronounced than in high-finance and the economic domain.

As I have pointed out previously, we have a great capacity to engineer financial matters; so much so, that we routinely overrun the bounds of prudent and sensible financial conduct and leverage our great means of financial inventiveness to irresponsible ends. 

The last several decades of financial inventiveness brought about a financial system that was so abstracted and structured and securitized and digitized and market-ized so as to allow for a massive expansion in general debt and then, once the economic picture soured sufficiently, allowed the Fed, with its supposed limitless access to new monetary base, to just drop in and engage in direct “open market operations” as the apex-lender/buyer of last resort bailing out the entirety of the economic system.

The idea that our central banks, albeit during an historic and painful financial meltdown, could essentially finance large portions of formerly functioning markets (mortgage backed securities) or even nations (the U.S. Treasury securities) was beyond ambitious… it was just plain reckless.

Reality though eventually imposes itself on all human ingenuity and in so doing, reacquaints us with the basic “real world” parameters by which we are all ultimately bound and forced to abide by over the long run.

The process of our current realization of this harsh reality, for the economy, appears to be playing out with each passing day.

The Fed and the Federal government choose to leverage our financial system’s integrity in order to bailout and backstop the 2008 Great Recession which further set the precedent for continuous use of such techniques since then and, finally, an epic second incarnation of this approach once the COVID pandemic panic set in.

Now, with real evidence of runaway monetary inflation and an abrupt pivot to a new policy regime, the Fed, challenged with living up to meet its primary mandate, is forced to do an extended and likely very painful battle to reestablish its credibility thereby regaining some measure of squandered systemic integrity.

As this rout unfolds, one has to wonder what the world will look like in two to five years after a major “one-step-back” has reacquainted our dreamy and inventive human sensibilities with the fundamental bounds of cold, hard reality.

Thursday, June 16, 2022

The Unmooring of Inflation Expectations

Like this post? Consider subscribing to my Substack for additional insights and content today!

It’s been so long since our last bout with entrenched inflation that many, if not most, Americans including policy makers and central bankers, have likely forgotten how inflation expectations become “unmoored” and what that truly means for the fight ahead.

Recently, Federal Reserve of St. Louis president James Bullard addressed current inflation and the potential downside risk:

“The current U.S. macroeconomic situation is straining the Fed’s credibility with respect to its inflation target,” Bullard said.

Bullard noted that, in the past year, near-term inflation expectations of financial markets, households and businesses have risen. He added that the current divergence between actual inflation readings and expected inflation based on Treasury Inflation-Protected Securities will have to be resolved, possibly resulting in still higher inflation expectations.

“In the 1970s, inflation expectations became unmoored, and it took years for the Fed to bring inflation back to lower levels. The real economy was also volatile during this process,” Bullard said.

Like a ship adrift on the open ocean, once inflation expectations have become “unmoored”, the population’s concern for inflation is free to float off aimlessly into the distance getting ever further from where it was once very stably anchored.

Then once blown about by the epic squall of emerging economic headwinds, re-anchoring inflation is no small task given the momentum it gains and the forces and erratic volatility that comes of it once it really starts to run wild. 

At this point, I believe that it’s safe to say that the Fed has fully lost the narrative.  

Everywhere you go people are talking about inflation in one form or another; rising gas prices, food prices, new car availability and prices, used cars availability and prices, outlandish home sales bringing stunning bidding wars with $200K, $300K and even $500K over-list contests.  The effects of hot money appear to be everywhere!

It’s starting to really interfere with the normal operations too, as was well testified by a totally unsolicited discussion I recently had with an older, local restaurateur.  He seemed simply in pain as he recounted how difficult times have gotten.  After over two years of struggling to keep his business afloat throughout the pandemic, now he is stretched to the absolute limit by increasing prices.  My bill too, as it was easily up 30-40% over what I paid just about a year ago.

But this small anecdote pales in comparison to the damage done by the Fed’s inaction and the administration’s totally incompetent and confused approach to “leadership”.

The Fed’s insistence that inflation was “transitory” only to be forced to walk back that terminology back and pivot to a more nuanced language about Ukraine, China lockdown supply chain issues and ongoing COVID disruptions that only imply “transitory” represents a completely misjudged or misguided approach to managing market expectations.

Either the Fed does not understand that the inflation we are seeing today is general monetary inflation coming as the result of over 13 years of recklessly easy monetary policy (QE, ZIRP) and still believes that the current exogenous events are causing it or they fully understand the truth but are simply unwilling to indicate so publicly.

In the latter case, the Fed would have been wiser to have at least indicated early on that monetary inflation could be responsible while also citing the other causes that they preferred it be rather than going all in on exogenous “transitory” sources only to look completely out of touch once inflation persisted further than “transitory” could have ever implied.

Amazingly though, Powell and the other members of the FOMC have not appeared to have learned from this mistake, indicating yesterday that:

The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The invasion and related events are creating additional upward pressure on inflation and are weighing on global economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.

Again, they are essentially doubling down on “transitory” by placing such an emphasis on temporary conditions being the source of the persistent inflation while only vaguely implying that there is some other source by stating “creating additional upward pressure”… additional to what?

The “what” is exactly what they apparently do not want to discuss too openly, namely general monetary inflation that they themselves (including former Chair now Treasury Secretary Yellen) created in their effort to act as the apex-lender-of-last-resort after the Great Recession and ongoing to today.

By not being forthright about the cause of inflation, they will continue to appear hopelessly out of touch and uninformed, exactly the opposite of what is needed in order to truly regain the confidence of the markets.

The administration, on the other hand, has been nothing short of a total disaster attempting to control the inflation narrative like they would any purely partisan political issue.

Whether it’s an appearance on popular late night television or various inflation-themed photo ops, the administration appears to believe that you can just talk inflation down by assuring the public that the executive “feels their pain”, but this is absolutely the wrong approach. 

Like the Ford’s absurd “Whip Inflation Now” campaign or Carter’s sad and depressing fireside chats, trying to control inflation by simply messaging (regardless of the message) the public directly, is counterproductive at best.

What the public needs to see in order to be convinced that the administration is on the right track in the battle with inflation is simply one thing, action.  

This can come in many forms; a call for Congress to tighten the budget to avoid further deficits, reopening or expanding cancelled or stalled energy sources (pipeline, coal, gulf rig counts, Anwar oil fields, etc.), working to smooth disruptions in global trade and supply, negotiating new agreements with other trading partners, eliminating any vestige of pandemic related encumbrances.

But our current administration is missing this point entirely and thereby squandering this very brief moment where the inflation story is still not deeply ingrained within the American collective psyche.

Taken together, the Fed’s mischaracterization of the source of the inflation and the administration’s lack of leadership is currently working to seriously undermine confidence, thereby sowing the seeds of a prolonged bout of persistent entrenched inflation as the public learns to expect ever-present uncertainly, volatility, cost pressures and a lack of vision from the authorities tasked with leading the way out of this difficult period.

Wednesday, June 15, 2022

FOMC Statement Critique (June 15th 2020)

Like this post? Consider subscribing to my Substack for additional insights and content today!

The following is the complete text of today’s FOMC statement with my comments inline:

Overall economic activity appears to have picked up after edging down in the first quarter. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.

Sold: While the above is somewhat accurate, there have been many instances of inflation-driven headwinds coming from retailer earnings, slowing reported retails sales, historically low consumer confidence and CEO guidance.   Further, given that we are probably at the literal turning point for employment, the above sentiment seems a bit backward looking at this point.

The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The invasion and related events are creating additional upward pressure on inflation and are weighing on global economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.

Sold: While there is no doubt that the Ukraine affair and the continued COVID disruptions are contributing factors to the inflation that we are currently seeing, the above statement is a major misstep and shows a pretty significant lack of judgment.  

This rational is quickly becoming the new “transitory”, or “inflation peaking” charade as the Fed is looking to obviously temporary conditions for an explanation of the inflation that we are currently seeing.  Notice that they say “additional upward pressure” implying that these temporary conditions are only part of the explanation of inflation and that they don’t call out any other instigator.  

This is a risky move given that inflation will likely continue on beyond these temporary conditions or will show itself to be greater than what can be reasonably accounted for by these disruptions leaving the Fed, yet again, looking unprepared and out of touch with the economic climate.

Obviously, the inflationary instigator that the Fed wishes to avoid highlighting is the plain and simple monetary inflation that they themselves caused by 13+ years of reckless quantitative easing (QE) and zero-percent-interest-rate (ZIRP) policy.

Until the Fed, and particularly Powell, own up to exactly what we are facing, they are doomed to forever be behind the curve on confidence and credibility.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 1‑1/2 to 1-3/4 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.

Sold: This is a generally strong statement as the Fed is forcefully indicating their intent to continue moving forward with their balance sheet normalization plan but the Fed Funds rate range is so paltry compared to the latest reads on inflation.  

The following details where inflation is as of April:

  • Consumer Price Index (CPI) 8.5% 
  • Personal Consumption Expenditures (PCE) 4.9% 
  • University of Michigan inflation expectations 5.4% 

Bear in mind that these data-points are all a bit lagged and have likely to truly capture the intensity of the inflationary pressures coming from rising energy (particularly gasoline) prices as of late.  The Feds Federal Funds rate will need to get a lot closer to the general inflation rate in order to reach the 2% goal that the Fed currently purports to desire.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; James Bullard; Lisa D. Cook; Patrick Harker; Philip N. Jefferson; Loretta J. Mester; and Christopher J. Waller. Voting against this action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate by 0.5 percentage point to 1-1/4 percent to 1-1/2 percent. Patrick Harker voted as an alternate member at this meeting.

Sold: Apparently Esther George concluded that a 50bps hike was sufficient either given the yet to be fully realized effects of the two prior hikes or as a result of the obvious impact that these hikes have been having on financial markets, but in any event, the consensus was for the more substantial hike.

Frankly the Fed should have gone with an even bigger +100bps or +125bps hike given that “inflation physiology” is in full swing among the general population.  Going in to today’s meeting, the Fed was clearly behind the curve, coming out, it appears that at best they singled their willingness to take up the fight but with inflation raging and the narrative fully unmoored, it is hard to truly see today’s announcement as actually catching up. 

Monday, June 13, 2022

The Great Moderation Gives Way to the Great Agitation

Like this post? Consider subscribing to my Substack for additional insights and content today!

When Ben Bernanke in 2004 (prior to his chairmanship but as a Fed governor) detailed his thoughts on the various causes of the “Great Moderation” to the Eastern Economic Association, little did he know that he was, ironically, right on the precipice of the beginning of the end of this unique period.

Generally defined as a period of decreasing volatility where firms, households and institutions could rely on a steadier, stable and predictable macroeconomic backdrop, the Great Moderation is generally accepted to have begun in 1984 after the Fed’s successful defeat of the rampant stagflationary period of the 1970s.

As recounted by Bernanke:

“In particular, output volatility in the United States, at a high level in the immediate postwar era, declined significantly between 1955 and 1970, a period in which inflation volatility was low. Both output volatility and inflation volatility rose significantly in the 1970s and early 1980s and, as I have noted, both fell sharply after about 1984. Economists generally agree that the 1970s, the period of highest volatility in both output and inflation, was also a period in which monetary policy performed quite poorly, relative to both earlier and later periods.  Few disagree that monetary policy has played a large part in stabilizing inflation, and so the fact that output volatility has declined in parallel with inflation volatility, both in the United States and abroad, suggests that monetary policy may have helped moderate the variability of output as well.”

Bernanke then goes on to detail various possible causes of this period of stability, digressing into voluminous explanations involving the Taylor Curve, and ends by roughly concluding that “improved performance of macroeconomic policies, particularly monetary policy” was likely the main instigator: 

“I have argued today that improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation (which is not particularly controversial) but to the reduced volatility of output as well. Moreover, because a change in the monetary policy regime has pervasive effects, I have suggested that some of the effects of improved monetary policies may have been misidentified as exogenous changes in economic structure or in the distribution of economic shocks. This conclusion on my part makes me optimistic for the future, because I am confident that monetary policymakers will not forget the lessons of the 1970s.”

What is completely absent from Bernanke’s assessment though are the significant instances where the Fed itself worked specifically to moderate volatility thus thwarting normal market function in the name of a new implied Fed mandate of “economic stability” and, over the long run, setting up the circumstances for a new emerging era of significant, possibly uncontrollable, volatility and tumult.

In response to the “Crash of 1987” then Fed Chair Alan Greenspan, barely two months in office,  snapped into action directing the Fed to function in its role as “lender of last resort” supplying liquidity through their open market operations and issuing a statement providing, in clear and unequivocal terms, the Feds position on the matter.

“The Federal Reserve, consistent with its responsibilities as the Nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system".

And with that one statement Greenspan, singlehandedly, created the “Fed Put” (once called the Greenspan Put), an implied guarantee that the Fed would always work to place a floor under the stock market in the interest of maintaining the stability of the financial system.

The “moral hazard” created by this single Fed policy change is hard to overstate.  

Markets are nothing if not a risk discounting mechanism and by injecting itself into the downside portion of the risk calculus, the Fed severely disrupted normal market function, distorted investor’s perception of risk and particularly kneecapped the process of creative destruction.

From that point on, the Fed assumed a new implied mandate, namely maintaining “economic stability”, to add to their existing primary functions of maintaining “stable prices” and “maximum employment”.

But Greeenspan did not stop there, with the Fed’s new implied “economic stability” mandate expanding in 1989 from simply covering systemic shocks coming as a result of stock market loss to also providing a bailout backstop against losses incurred by banking and financial interests, specifically the savings and loan thrifts of the late-1980s “Savings and Loan Crisis”, in an effort to contain the impact of numerous insolvent institutions on the financial system. 

“Arrangements have been established for the provision of liquidity support to savings and loan associations by the Federal Reserve Banks and the Federal Home Loan Banks,” Greenspan said in February 1989 in a joint statement with M. Danny Wall, chairman of the bank board.

Expanding this implied mandate even further still, Greenspan in 1998, in an effort to contain the potential systemic shocks coming from the abrupt collapse of the highly leveraged hedge fund Long Term Capital Management, brokered a private $3.6 billion dollar bailout by a number of financial institutions.

“Had the failure of LTCM triggered the seizing up of markets, substantial damage could have been inflicted on many market participants, including some not directly involved with the firm, and could have potentially impaired the economies of many nations, including our own,” Greenspan said.

Yet, Bernanke speaking in 2004, never mentions this obviously consequential shift in Fed policy in his analysis of the causes of the Great Moderation’s lower volatility and, not surprisingly, once confronted with similar systemically damaging circumstances as Greenspan faced, Chairman Bernanke blinked in the face of the fear of the fallout coming from the collapse of the massive housing bubble in 2008 and took the Fed to epic levels of support, backstopping and bailing to an extent that Greenspan probably could have scarcely imagined.

Finally, over a decade later, the COVID-19 panic was met by current Fed Chairman Powell with more of the same, seeing the Fed immediately slash their primary policy rate to the zero-bound and re-engaging the quantitative easing schemes created by Bernanke in an effort to specifically to ensure against economic instability coming from this outsized exogenous shock.

But now, after 35 years of bailing and backstopping and freighting levels of monetary creation, inflation is finally raging and the actual cost of all of this “moderation” is coming due.

The “Great Moderation” era has finally and fully relented to a new, polar opposite age, the “Great Agitation”, where not only will the Fed not have the ability to moderate volatility but, instead, will be forced to create volatility by imposing “tight” monetary policy. 

While many believe that the Fed will ultimately have to give up its aim of tamping down inflation and ultimately continue expanding the monetary base in support of the stability of the economic system and the solvency of the Federal government, my sense is that this perspective is misguided.

If the Fed were to continue to attempt to expand the monetary base in the face of rampant inflation and against a backdrop of an inflation narrative that they have completely lost control of, it would be a system ending maneuver.  There would be no more need for additional accommodation since there would be no remaining vestige of a legitimate economic system to protect.

What we can expect from the coming years of “agitation” should be pretty predictable as volatility generally brings unrest and resentment and societal tumult, and while there is a plausible, even likely possibility of a positive outcome from this reckoning, clearly, the pain will be widely felt and the stakes are very high.