Animal spirits

On Tuesday the US Fed, which is like the Bank of Canada but run by a guy with a beard (which makes him cool) (and smart), will announce changes to monetary policy. Zzzzzzz, right?

Actually, not so much. This could be a big deal. The American central bank might let it be known that a new movie, Stimulate 2, is about to start playing. This would mean a few hundred billion spent on something called ‘quantitative easing’ or QE (feel free to use that at Tim’s).

The idea is to use new money created by the Fed to buy bonds previously issued by the Fed. If this sounds like having a whizz in your own corn flakes, you understand monetary policy perfectly. The US is in such a pickle that it must inject gobs more public money into the economy, although this will just make things worse in the future when the debt chickens come home to roost.

Notwithstanding that this is lousy public policy, it makes good politics. The actual unemployment rate in the US is now around 20%. Housing is a disaster and getting worse. Deflation fears abound. And there’s a big election in 90 days in which Obama’s butt may well be kicked, since he stands a good chance of losing control of the Congress and, thus, the economic agenda. Maybe his job in 2012. So, Washington’s set to turn on the spending taps yet again.

What does this mean in Richmond or Etobicoke?

Well, first I’d like you to read these few words published yesterday in a US financial magazine: “For many years, buying a house was touted to be the best investment a person could make. Beyond just being a place of shelter, your home could always be counted on, especially when all other investments, including the stock market, faltered. But instead of becoming a source of stability, houses have become a leading reason of financial anguish for millions.”

American real estate values have now declined for 14 consecutive quarters. Almost 25% of all single family homes are in negative equity, and the majority of those people did not borrow at subprime rates. They just had the misfortune of purchasing after 2005 – and house prices in some cities have return to late-90s prices.

I mention this because Canada is not different. Just slow. And we are still secretly, and dangerously, worshipping the Property God.

Jason works for a university in Western Canada. He wrote me this note today:

I’m now ready and able but not willing to purchase a condo given the state of the nation. I’ve been researching real estate for the last 2 years and have noticed mostly everything you’ve been saying come into fruition.

At the University I work at we’ve had a couple rounds of major cuts which was a result of the feds cutting funding. Luckily, I’m fairly secure as one can be in life and still have my job. Anyway, we’ve sold our meager home and are going to rent the first floor of a house for under $1,000 starting in September and wait and see what happens.

My question is given the state of the economy, falling real estate prices, etc, etc. Will the lower prices start greedy investors once again buying everything up, thus artificially pushing prices up. This in turn prevents regular, working people like myself from ever being able to afford a home.

What your take on this?

My take is that some people will do this, absolutely. In fact if real estate values across Canada decline by an average of 15% by the end of the year, then panic will grip every real estate board and federal politician. The response will be a pre-emptive strike to try and reflate housing, and a massive industry push to herald a buyer’s market as a one-time opportunity. Today only, 15% off!

Yeah, Jason, a bunch of people will fall for that. They’ll think they’re bottom-feeding, buying houses in Vancouver for $800,000 that used to be $1.1 million, or in Greektown for $650,000 than used to be eight. But it won’t revive the market. And it won’t last long. They will end up being greater fools.

So, back to this monetary policy thing.

More action by the Fed to spend billions nobody has is an admission deflation is winning. Hell, when 20% of people have no job and one in four families has had their equity wiped out, is there any question? And how, exactly, will Canada avoid the spray from all this?

Interest rates don’t matter anymore – US mortgages are at the lowest level ever and it’s doing no good. Tax credits and free money don’t matter, because people worried about their jobs don’t take on mortgages. Low house prices don’t matter, because if they did America would be the busiest housing market on earth.

And why should any of those things matter anymore in Canada? It’s all about confidence and perception, and the reality’s finally set in that real estate is yesterday’s new black. It’s now tinged with danger and uncertainty. It accelerated in value because everybody wanted it. Housing will decelerate just as rapidly, with the potential for a bung in Edmonton as unloved as a ranch split in Tucson.

This is the animal spirits portion of economics at work. The most powerful branch.

Bulls make money, Jason. Bears, too. Pigs get slaughtered. Then we vultch.