Sunday, September 14, 2008

Lehman, Fannie, Freddie, WM, AIG

The failings of investment banks, banks, and GSEs are a natural occurence derived from the easy credit policy of the Federal Reserve and government promtion of a home ownership society.  When incentives are put into place that encourage excess investment, there will be a reversion to the mean investment to wipe out malinvestment.  

This is what is currently occurring.  Homes are essentially consumer goods linked to incomes.  Hence they should increase at about the same rate as GDP.  We can see that over the period of 1986-2000 rose at 3.5% annually.  Since 2000, when the Fed's monetary policy eased and lowered interest rates to abnormally low levels, home prices ascended at an incredible rate as shown by the home price indexes.  Residential construction grew to almost 5.5% of GDP compared to its average of 4.5%.  

No one knows when the current bust in home prices will end, but a good indication will be when the data shows some sort of mean reversion to be complete.  Markets tend to overshoot and correct, so I would anticipate prices to drop another 10-20% before continuing along its long term trend line according to the Case-Shiller Index.

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