Declaring U.S. household finances in "reasonably good shape" at a community bankers convention on Tuesday, Federal Reserve chief Alan Greenspan tried to downplay "some analysts' concerns that high levels of debt might limit U.S. consumer spending in coming quarters."

Many analysts and economists are worried that housing prices are about to flatten, leading Greenspan to suggest that while some regions of the country have seen speculative price bubbles, "a national severe price distortion seems most unlikely in the United States, given its size and diversity."

A "sharp drop in incomes or home prices" could "quickly alter" Greenspan's assessment, he says, but "both scenarios appear unlikely in the quarters immediately ahead," if "lenders, including community bankers, continue their prudent lending practices, household financial conditions should be all the more likely to weather future challenges."

Greenspan's propensity for soothing the nervous public has contrarian consultant Eric Janzsen wondering what the Fed is up to. Janzsen, for those who follow stocks, was one of the few voices of reason to buck the irrationally exuberant thinking that helped put air in the tech bubble before the March 2001 collapse. He was among the early predictors of a major stock market correction back in 1999.

Now he's raising his voice again to question if real estate is experiencing similar speculation.

"As managing director of seed stage tech investment firm (Osborn Capital LLC) from 1998 until 2001, I took an interest in the stock market bubble for two reasons. I wanted to time our sales and warn the masses not to invest money in a speculative market that they could not afford to lose."

Bubbles are a sore spot with Janzsen. His father had speculated on tech stocks back in the 1960s and lost money when the stocks flattened, causing the family hardship for some years, he says.

"While I knew that a lot of individuals were going to get hurt by the collapsing stock bubble, the impact on the economy turned out to be less than I expected," says Janzsen. "As we all know now, but didn't know then, the reasons for the moderate macro economic impact are that the banking system and bond markets were not heavily invested with a lot of leverage in the stock market and because the Fed created the Housing "ATM," turning homes into a apparently endless sources of cash via quick sales and cash-out refinancings."

That's what makes a "bubble" in the real estate market a scary prospect.

"The banking system and bond markets are dependent on a healthy real estate market, and the economy is dependent on a healthy banking system and bond market," suggests Janzsen, "so I guess I have the same concerns as anyone with a home and a family: what's going to happen to the banking system, bond markets and economy when the real estate market bubble flattens out? Maybe the Fed has another rabbit in the hat...."

That rabbit's name could be wage inflation. Janzsen believes that Greenspan and company can manipulate inflation the way they manipulate money flow.

"Greenspan gives reasonable explanations of why things aren't as bad as they look which is what he did in 1999," says Janzsen. "Then he said a stock bubble wouldn't be such a big deal because 70 percent of wealth is in homes. If stock conks out, it will have a negative wealth effect, so an astute observer would say that's when Greenspan would leverage all the equity in homes which is exactly what he did. It isn't his job to say, 'Oh my God, look at all the mortgages we've underwritten.' It's his job to fix the economy if it goes south."

Janzsen says, based on Greenspan's behavior in the past, there may be hints already present in what he will do if things don't go well in the housing sector.

"He's the Ayn Rand free market soul who believes that things will work out if you leave them alone," speculates Janzsen, "his job is to clean up after they go south to keep the economy from collapsing. His job isn't to keep bubbles from forming. Ann Rand also referred to Greenspan as a social climber. He is also a politician representing the Fed part of the government, so he supports the existing administration, to keep his job. He's about to retire and he wants to leave with nice clean record, and the next guy can get blamed if anything goes wrong. I have a strong feeling his reputation is very important to him."

So what hints does Janzsen see?

"My interpretation is he would be willing to accept a high rate of inflation for a period of time," suggests Janzsen. "The Fed makes this perpetual money machine and as house values climb, that works well as a stimulant to the economy because people can borrow against their homes. But if real income is declining, then how are people going to afford their mortgages? So, if interest rate manipulation isn't working, then he can only play with income, so he will allow wage inflation to rise to a level which is considered unhealthy.

How does Greenspan get people to open their wallets and spend when jobs and raises are down?

Janzsen predicts that the government will start cracking down on immigration.

"It isn't the Fed working alone - outsourcing and a liberal immigration policy also have an effect," explains Janzsen, "and different administrations have used immigration to great effect. If you want to constrain the labor market, you shut off immigration so there is less competition for jobs. The new wrinkle is outsourcing which has driven down rates, so the other lever that could get pulled is to stop outsourcing. They'll look like good guys by not having incentives for outsourcing, but when you have trade controls, you risk retaliatory stuff from other countries. The U.S. has been depreciating the dollar for years without a significant backlash and our partners buy treasuries with evidence coming out we aren't going to pay them back with the same dollars. They figure that's not as bad an outcome as our buying less of their stuff. The quid pro quo, it looks like a good deal to our trading partners."

What will happen to housing?

"It comes down to a range of possibilities," says Janzsen. "Greenspan was running his own consultancy before he joined the Fed, and at the time the savings and loan system was crashing and he was a big proponent of that system. Fifteen out of 17 of the S & Ls he supported went out of business, so he is prone to being overly optimistic about how well the banking system can withstand a correction in housing. He might be right that the more modern system where risk is spread out will keep housing from collapsing. Our banking system now is allowing Fannie Mae and Freddie Mac to create securities from mortgages and the risk in theory is spread out over more people."

What can cause the housing market to stop growing and what happens as a result?

"All speculative markets end," says Janzsen. "I can't tell you when or why, but there's evidence that the market is slowing. Houses don't decline as rapidly as stocks as they aren't as liquid - what declines is the number of transactions and then prices stagnate. The second part is why is the Fed so blind to the credit market? It rests on the theory that a lot of the risk is hedged, and there won't be a stoppage of lending. They won't experience the same sort of losses. The average price of homes is rising quickly on the coasts, but not in the rest of the country. Housing bubbles are regional, not national. People buy homes near high-paying jobs, so that's where you see speculation and where banks are willing to participate in speculative buying behavior.

"When the stock market became speculative, investors only wanted to know about price, not the products - that is the ultimate indicator and in some areas, housing speculation has already ended suddenly, like in Las Vegas. No one shows up. It's a very subtle change of psychology," he says.

"It's been said that markets are driven by greed and fear, "explains Janzsen. "I think they are motivated by fear and fear - fear you are going to lose money or fear of losing out on making money. There's a big difference in selling a home to make money and selling because you have to. That relates to unemployment and psychology, so the Fed has to do everything to prevent a rise in unemployment and a decline in wages. Households are indebted and it's about to get worse, because if the Fed ratio of household debt-to-asset isn't that bad. Assets have been appreciating so greatly, but what if that housing declines? Then banks are willing less to loan money in that situation to people in high debt situations, because the value of the underlying asset is declining. Then the pool of creditworthy borrowers begins to shrink and you have a buyer's market."

How possible is it that housing prices will decline significantly?

"I think the same thing has happened in us as Japan," says Janzsen. "The bubble popped in 1990, and rapid growth in real estate happened after that with low interest rates and real estate grew in value. Then housing prices declined for another 12 years, and now they are 40 percent of the value they were in 1990. The U.S. isn't Japan, but that's a data point, and it could happen here. The don't have same banking system. They don't have Freddie Mac and Fannie Mae helping people buy houses. The structure in Japan could explain why housing has continued to decline."

So what can be done?

"When your stock portfolio goes up and your house goes up in value," says Janzsen, "it makes you feel wealthy, but keep in mind this is wealth on paper - unrealized gains. If you bought a house for $300,000 and your neighbor's home is selling for $500,000, you feel $200,000 wealthier. You think of it as in the bank, but what happens if values start declining, how would you feel then about spending an unrealized gain? Most people won't borrow against, and they won't fix it up, and they stop spending. The only other thing the Fed could do to make you feel like you have money is to inflate wages. When your wages are going up, you'll feel like you have a lot of money again, and you'll feel better about spending it."

Published: October 22, 2004

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