Tag Archives: Bubbles

The Oslo (Housing Bubble) Syndrome

OSLOThe Oslo Housing Bubble Syndrome
Mises Daily: Monday, January 07, 2013 by Mark Thornton (An important market to track in our study of booms and busts.)

The Stockholm syndrome is a psychological phenomenon whereby hostages develop irrational sympathy toward their captors even to the point of defending their captors in subsequent investigations and criminal trials. While this applies to individuals or small groups, the Oslo syndrome applies to whole national populations.

In The Oslo Syndrome: Delusions of a People under Siege (Smith and Kraus Global, 2005), Kenneth Levin describes a “psychological response common among chronically besieged populations, whether minorities subjected to defamation, discrimination and assault or small nations under persistent attack by their neighbors. People living under such stressful conditions often choose to accept at face value the indictments of their accusers in the hope of thereby escaping their predicament.”[1]

Actually, the Oslo syndrome applies to all people living in socialist states. The state tells people what to do, forces people into public schools to be indoctrinated, tells people what we can and cannot consume, uses police power, and punishes people who do not do what they are told, and throws people into prisons if they continue to live the way they choose. The state’s system leads most to just accept things as they are as if it were the only possible way of life. Given that the Oslo syndrome applies to an entire nation, and that Norway is living through what will hopefully be the final housing bubble of this cycle, I thought it appropriate to dub the psychological phenomenon associated with housing bubbles, the “Oslo housing bubble syndrome.” This psychological phenomenon is the “irrational” response of people living in a bubble economy. They ignore or dismiss signs of a bubble and instead attribute their good luck (i.e. higher home prices) to “fundamental factors” that appear to substantiate high prices in real estate or stocks.

Do not get me wrong. The business cycle is not a psychological phenomenon. However, it does impact mass psychology. If a central bank is intent on expanding the money supply with an easy money policy, then some bankers are going to make additional loans and seek out new clients to lend money to. The bankers will be rewarded and their clients will be happy. As the boom plays out, people make big gains and are euphoric and even manic. The boom eventually turns to bust. Many of the same people who were making big gains are now seeing their profits turn into losses, or even foreclosures or bankruptcies. As a result, they become depressed.

The reason that booms turn into busts is that the artificial expansion of credit leads entrepreneurs to embark on many new investment projects that expand the structure of production. The new investment projects eventually cause new constraints to develop. These new developments could not be anticipated by entrepreneurs as a whole.

First, all of these new investment projects place strains on the availability of resources and inputs. Therefore their costs are greater than they anticipated. For example, the price of oil and the wages of specialized labor increase as the bubble proceeds to the peak. Second, as the prices of things like food, energy, and other products with inelastic demand rises, customers have less income available to buy their products. Third, as more of these new investment projects come online and start supplying their products, they are faced with increased competition, again more than they could have anticipated. The result is that their investment projects are now faced with higher costs, fewer customers, and more competitors. This is a recipe for disaster that results in the realization of a cluster of entrepreneurial errors.
If your nation’s economy has not had a bubble in many years it is not surprising that people are shocked when the bubble bursts. However, Norwegians have surely noticed what has happened in the US and PIGS, or even closer to home, in Ireland, the UK, and Iceland. Despite what they have seen there are still those who claim that Norwegian housing prices are genuine. Norwegians have, in a sense, been “psychologically conditioned,” and, as with the Stockholm and Oslo syndromes, are doing precisely the opposite of what they should be doing. A similar phenomenon happened in the US, around 2005, when people were often heard to be saying that “housing prices never go down,” or that “you can’t lose money by investing in real estate.”

There appear to be housing bubbles across Europe with the exception of the PIIIGS (Portugal, Iceland, Ireland, Italy, Greece, and Spain), but the Norwegian bubble seems to be the strongest one. The chart below shows that housing prices in Norway have increased by nearly 300% in the last twenty years.

Oslo home prices

2012 © Statistics Norway
It should be clear from the following chart that the rise in home prices is not the result of rising costs of production or general price inflation, both of which have been relatively tame given the increase in construction and the general expansion in the Norwegian economy.

Hiousing costs and consumer prices
2012 © Statistics Norway
What explains the large increase in prices is an increase in the demand for housing. Part of this increased demand takes the form of people simply being unwilling to put homes on the market in the face of persistently rising home prices. The increase in housing prices has been sustained for a very long time and this would seem to support the idea that the price increases are based on fundamental factors. In the US, housing prices rose much less and for a shorter period of time. According to an analysis by the Federal Reserve, prices have fallen about 40% in the US since peaking in 2006. Since that time housing prices in Norway have increased another 30%.
Real House Price Index

Real house prices
Sources: Shiller (2005) and Eitrheim and Erlandsen (2004, 2005).

The US has many fundamental flaws in its economy including a large government budget deficit, a large trade deficit, expanding national debt, and exploding, unfunded financial liabilities related to health care and retirees. In contrast, Norway has none of these problems and several factors that suggest that the Norwegian economy is fundamentally sound. It has a large trade surplus and government budget surplus (both have been averaging around 14% of GDP) due to substantial oil revenues that are also building a very large sovereign wealth fund. The fund is approaching $700 billion dollars (Norway’s population is approximately 5 million).

The unemployment rate in Norway has been averaging around 3% which would be considered well below the “natural unemployment rate” in the US (thought to be around 6%). Therefore, Norway has one of the best unemployment rates in its region, in Europe, and even globally. The C.P.I. measure of price inflation in Norway has been around 1%, again one of the best in the world. Real G.D.P. growth has been about 3% and is expected to continue on that path into the future. This growth rate would be consistent with full employment. It is almost too good to be true.

So the fundamental picture does support the impression that housing prices are real. Another factor that supports a “fundamental” view of housing prices is that Oslo, the capital city with almost 1/5th of the nation’s population, has land-use restrictions that keep much land unavailable for construction. This is the same fundamental case that was given for the severe housing bubble in Las Vegas: the government prevented land from being developed. Housing prices in Oslo, however, have not risen much more than the average increase. The largest increases have occurred in areas associated with the oil and oil exploration business.

We cannot know for certain that Norway is experiencing a bubble. However the reasons we suspect a bubble starts with their economy. Norway’s rosy economy is not the result of good policy, but of oil revenues that subsidize their socialist government. Norway ranks 40th on the Freedom Index, below Belgium (38) and Armenia (39), and only above countries like El Salvador (41) and Peru (42). A steep drop in oil prices would be a severe blow to their economy. However, as oil revenues are continuing to pour into the government budget and sovereign wealth fund, it makes the Norwegian economy look like a good bet.

That image is particularly compelling compared to other economies across the globe. All the world’s major economies (i.e., the US, EU, China, and Japan) appear to be tottering on the verge of disaster. Currencies seem to be particularly dangerous given the Bernanke regime of “coordinated” quantitative easing by central banks. The euro is considered most at risk because of a potential uncoordinated currency break up. This threat has resulted in a decreased demand for the euro and an increased demand for alternative currencies from safe countries, such as the Swiss franc and the Norwegian krone.

Instead of allowing the krone to increase in value with this increase in demand, the Norwegian central bank, the Norges Bank, has instead countered with an increase of supply. They have intentionally set interest rates artificial low. The overnight deposit rate has been set at 1.5 percent since last December. They are trying to prevent the krone from appreciating in value, but their efforts have not been completely successful. Preventing this appreciation of the krone is intended to protect exporters, including their national oil company. However, it also helps pump up the housing bubble.

Monetary inflation, as measured by Norway’s M2 measure of the money supply, has lately been running at 8%. During the economic crisis, circa 2007, it ran as high as 20%. From 2008 to the present monetary inflation has averaged about 7.5%.[2]

The result is that Norway is experiencing low price inflation, except in housing and there is still upward pressure on the value of the krone. With central banks around the globe setting interest rates outrageously low it makes it difficult for the Norges Bank to act to raise rates. Higher interest rates would help deflate the housing bubble, but they have failed to implement such a policy.[3] With central bankers embarking on an inflationary death march, the Norges Bank has found itself seemingly trapped into following their policy of ultra low interest rates and monetary inflation.

This is incongruous given that the Norway chose to keep its monetary independence and stay out of the euro zone. It is also unnecessary because the Norges Bank has a policy option.

If the central bank did act and raised interest rates and simply allowed their currency to float, the krone would appreciate and Norwegian savers would get a windfall as the value of their savings increased. This would encourage them to work more, save more, and become wealthy. Every krone would buy more goods from around the world and would buy even more goods tomorrow than today. This appreciation would indeed hurt exporters, such as oil and cheese exporters, but most importantly it would stop and reverse the housing bubble before things get even worse and more distorted.

As usual, with policy decisions it is a matter of making a people wealthier or making a people poorer. In the case of the Oslo housing bubble syndrome, it looks like poorer will win out again.

http://www.mises.org/daily/6318/The-Oslo-Housing-Bubble-Syndrome

 

 

Emphasis on Global Crossing Case; Good Health

A conclusion is the place where you got tired of thinking. –Steven Wright

Every man who says frankly and fully what he things is so far doing a public service. We should be grateful to him for attacking most unsparingly our most cherished opinions. –Sir Leslie Stephen

Know The Global Crossing Case Cold

I joke while presenting the Global Crossing case, but you should spend time to really understand what happened and why.  Always in these situations there is much noise and hoopla over new technology, massive growth, booming profits, etc. But you have to stand back to listen: http://www.youtube.com/watch?v=1INb5FM_1lE&feature=related.  Obviously, growth does not occur without investment, and growth without profits is DESTRUCTIVE.

….And think strategically. A friend took out margin to buy a huge bundle of out of the money puts on Global Crossing and Level Three (LVLT).   See the chart on LVLT here—the collapse will take your breath away. http://www.scribd.com/doc/77916697/Lvlt-Chart.

I asked him, “Are you out of your $%^&*! Mind? What the heck is the matter with you?” He replied serenely, “Have you ever read The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail by Clayton M. Christensen and the Disk Drive Industry?” http://www.readinggroupguides.com/guides_i/innovators_dilemma3.asp

“No,” I said, “I am too busy reading the Lehman report on Global Crossing.”

Research by Lehman on Telecom, Fiber Optics and Global Crossing 1998 http://goodbadstrategy.com/wp-content/downloads/LehmanReport.pdf

“Too bad,” he replied. “Because it is the same situation with the telecom companies only worse.  (WHAT is the situation he is talking about____?) Ask yourself what is the WORST industry structure you could possibly design to destroy profits?  Sometimes it is easier to know which companies will face certain death than pick the winners. Also, here is the coup de grace—what happens when marginal costs decline to $0.00!?”

One more time: “Can anyone tell me in two or three words what is the first thing when looking at a company/industry? _____  _____  ______

At the end of the weekend, there will be an analysis of the Global Crossing Case.

So what happened to my friend? Here he is: http://www.youtube.com/watch?v=mmMS9nvi6eg&feature=related

Health

At the age of 97 years and 4 months, Shigeaki Hinohara is one of the world’s longest-serving physicians and educators. His secrets to a healthy long life:

http://www.japantimes.co.jp/print/fl20090129jk.html

Podcast on Why We Get Fat by Gary Taubes: http://www.lewrockwell.com/lewrockwell-show/2012/01/11/247-why-we-get-fat-and-what-to-do-about-it/

Strategic Logic Case Study Part 2 Global Crossing

 

If you think nobody cares about you, try missing a couple of payments. –S. Wright

Everything has been said before, but since nobody listens we have to keep going back and beginning all over again.” –Andre Gide

Part 1 of this case was presented yesterday here: http://wp.me/p1PgpH-hj

If readers don’t grasp the significance of this case then I will QUIT posting and join them: http://www.youtube.com/watch?v=J_kRDcfTKrg

Invest in Global Crossing February 2000

Part 2: You are about to meet the fund manager in 30 minutes to give your recommendation.  Take a glance at Global Crossing’s 10-K. http://www.scribd.com/doc/77824423/Global-Crossing-1999-10-K What’s it worth?  The price is near $61 or about $37 billion in market cap.

Forget the financials you think, after reading Gilder’s Technology Report (background on George Gilder, the Guru of the Telecosm: http://www.wired.com/wired/archive/10.07/gilder_pr.html) on the telecosmic Global Grossing, your confidence increases because growth will double every 100 days.

Since you leave nothing to chance, you call up David Cleevely, the managing director of Analysys, in Cambridge, England. Cleevely is a well-regarded observer of the new telecommunications economics.  He tells you, “The key thing to understand is the huge advantage of the fat pipe (or high-capacity fiber optic channels).  Remember that the cost of laying fiber is mainly the cost of right-of-way and digging or of laying it under the ocean. Recent advances let companies install enormous capacity at no more cost than building a narrow pipe. The economies of scale of the fat pipe are decisive. The fat pipe wins.”

Next you pull a slide from the company’s power point presentation on Where is the Company is Going.

The company will be in a market with EXPLOSIVE growth, competition, capacity on demand, no capital required from telecom carriers, and responsive to market demands.

Your secretary knocks on the door and asks whether you want to read about strategic logic from csinvesing?  You are handed some papers, and you immediately slam dunk the research into the circular file (waste-basket). “Who needs this bullsh@t,” you mutter.

Riches?

You are thinking of the riches you will make and what you will do with your new car: http://www.youtube.com/watch?v=uo5E-2_2mgg&feature=related

You know that economies of scale are important. The logic seems simple—the fat pipes of the new-wave telecom builders and operators gave them much lower average unit costs (Think about how average cost curves are formed). I sat back and thought a moment about fat pipes, scale economies, and telephone calls. What was the “cost” of moving one telephone call, or one megabyte of date, under the Atlantic Ocean?

But the thoughts of massive wealth kept interrupting my thoughts. “Would putting in a fur-lined sink be in bad taste?” I wondered.

What critical aspect of analysis is missing here? If you need a hint go back to the connection between industry structure and profit.

The time is late February 2000 and with your supporting materials and 10-K you wait here for the big boss to arrive. http://www.youtube.com/watch?v=TulxjdKsROI

Strategy Quiz and Case Study

Change is inevitable….except from vending machines.

A fool and his money are soon partying. –Steven Wright

Message

Dear Readers:

I know the three of you out there will be wondering about replies to your questions. This week requires traveling so please bear with me until I can reply properly.  Meanwhile, continue your work towards completing the Wal-Mart case study and Competition Demystified reading pages 1-110.

This quiz is meant to reinforce concepts you should be thinking about. Whenever you first look at an industry and/or company what should be one of the first questions that you ask______________________?

Research Question

Now, you have been asked to research a new company that has a product where the demand is estimated to increase 10 fold and you must advise your $2 billion hedge fund on Park Avenue, in New York whether to invest.  After two months of 18 hour days, you find out that the research on growth estimates was wrong!  The demand for the service will increase 1000x fold!  You are so excited you can barely wait to speak to the portfolio manager.  How great an investment will this be? What further MAJOR questions should you ask if demand will grow so rapidly. Take five minutes to frame your questions and what you will say to the big boss whom you will be meeting soon.

OK, scroll down and click on the cases below to learn what happened. Surprised?  Why or why not? Let me know your thoughts.

 

 

http://www.scribd.com/doc/77775204/Global-Crossing-A –sorry this had to be placed in the Value Vault under Global Crossing A (36 pages) due to security restrictions. If you do not have a key then email me at aldridge56@aol.com with VALUE VAULT in the subject line.

http://www.scribd.com/doc/77775347/Global-Crossing-CS-by-Univ-of-Edinburgh

For a different perspective and more context: http://www.scribd.com/doc/77780615/Bubbles-and-Gullibility-2008

Blame the Fed or Bond Bubble Anyone?

The sign says, “1. End Debt-based Fiat currencies. 2. End Fractional Reserve
and Compound Interest Banking. 3. End the Fed.

Studying Austrian economics may help you understand the distortions occurring in the economy. Think of the difficulty you, as an investor, face when normalizing earnings in this environment.

Blame the Fed for the Financial Crisis in today’s Wall Street Journal points
out the Fed’s devastating distortions in the economy. Bond Bubble Anyone?

http://online.wsj.com/article/SB10001424052970204346104576637290931614006.html

By RON PAUL

To know what is wrong with the Federal Reserve, one must first understand the nature of money. Money is like any other good in our economy that emerges from the market to satisfy the needs and wants of consumers. Its particular usefulness is that it helps facilitate indirect exchange, making it easier for us to buy and sell goods because there is a common way of measuring their value. Money is not a government phenomenon, and it need not and should not be managed by government. When central banks like the Fed manage money they are engaging in price-fixing, which leads not to prosperity but to disaster.

The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank’s creation in 1913. It pumps new money into the financial system to lower interest rates and spur the economy. Adding new money increases the supply of money, making the price of money over time—the interest rate—lower than the market would make it. These lower interest rates affect the allocation of resources, causing capital to be malinvested throughout the economy. So certain projects and ventures that appear profitable when funded at artificially low interest rates are not in fact the best use of those resources.

Eventually, the economic boom created by the Fed’s actions is found to be unsustainable, and the bust ensues as this malinvested capital manifests itself in a surplus of capital goods, inventory overhangs, etc. Until these misdirected resources are put to a more productive use—the uses the free market actually desires—the economy stagnates.

The great contribution of the Austrian school of economics to economic theory was in its description of this business cycle: the process of booms and busts, and their origins in monetary intervention by
the government in cooperation with the banking system. Yet policy makers at the
Federal Reserve still fail to understand the causes of our most recent
financial crisis. So they find themselves unable to come up with an adequate
solution.

In many respects the governors of the Federal Reserve System and the members of the Federal Open Market Committee are like all other high-ranking powerful officials. Because they make decisions that profoundly affect the workings of the economy and because they have hundreds of bright economists working for them doing research and collecting data, they buy into the pretense of knowledge—the illusion that because they have all these resources at their fingertips they therefore have the ability to guide the economy as they see fit.

Nothing could be further from the truth. No attitude could be more destructive. What the Austrian economists Ludwig von Mises and Friedrich von Hayek victoriously asserted in the socialist calculation debate of the 1920s and 1930s—the notion that the marketplace, where people freely decide what they need and want to pay for, is the only effective way to allocate resources—may be obvious to many ordinary Americans. But it has not influenced government leaders today, who do not seem to see the importance of prices to the functioning of a market economy.

The manner of thinking of the Federal Reserve now is no different than that of the former Soviet Union, which employed hundreds of thousands of people to perform research and provide calculations in an attempt to mimic the price system of the West’s (relatively) free markets. Despite the obvious lesson to be drawn from the Soviet collapse, the U.S. still has not fully absorbed it.

The Fed fails to grasp that an interest rate is a price—the price of time—and that attempting to manipulate that price is as destructive as any other government price control. It fails to see that the price of housing was artificially inflated through the Fed’s monetary pumping
during the early 2000s, and that the only way to restore soundness to the
housing sector is to allow prices to return to sustainable market levels.
Instead, the Fed’s actions have had one aim—to keep prices elevated at bubble
levels—thus ensuring that bad debt remains on the books and failing firms
remain in business, albatrosses around the market’s neck.

The Fed’s quantitative easing programs increased the national debt by trillions of dollars. The debt is now so large that if the central bank begins to move away from its zero interest-rate policy, the rise in interest rates will result in the U.S. government having to pay hundreds of billions of dollars in additional interest on the national debt each year. Thus there is significant political pressure being placed on the Fed to keep interest rates low. The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to “just do something” often outweighs all other considerations.

What exactly the Fed will do is anyone’s guess, and it is no surprise that markets continue to founder as anticipation mounts. If the Fed would stop intervening and distorting the market, and would allow the functioning of a truly free market that deals with profit and loss, our economy could recover. The continued existence of an organization that can create trillions of dollars out of thin air to purchase financial assets and prop up a fundamentally insolvent banking system is a black mark on an economy that professes to be free.

For further detail Of the Austrian Business
Cycle Theory

As the Austrian business-cycle theory teaches, artificially cheap credit, not backed by real savings, creates intertemporal discoordination in production involving scarce resources that ultimately results in malivestment. As Roger Garrison explains,

An artificial boom is an instance in which the change in the interest-rate signal
and the change in resource availabilities are at odds with one another. If the
central bank pads the supply of loanable funds with newly created money, the
interest rate is lowered just as it is with an increase in saving. But in the
absence of an actual change in time preferences, no additional resources for
sustaining the policy-induced boom are freed up. In fact, facing a lower
interest rate, people will save less and spend more on current consumables. The
central bank’s credit expansion, then, results in an incompatible mix of market
forces.

Increased investment in longer-term projects is consistent with the underlying economic realities in a genuine saving-induced boom but not in a policy-induced artificial boom. The artificial boom is characterized by “malinvestment and overconsumption.”

The type of boom-and-bust cycle caused by cheap credit and overinvestment was reflected in the recent housing bubble as well as the dot-com bubble just over a decade ago. As former Fed chairman Alan Greenspan cut interest rates (to deal with his previous bubbles) he provided the credit and incentive to invest in such ventures as housing and Internet start-ups. Once these investments were not as profitable as they were originally, the bust begins.

Same Music, Different Players: A Bond Bubble

Timing is uncertain, but look at the charts below: Government Bonds have the potential for much pain with little gain. Real interest rates are negative! Fear, manipulation by the Federal Reserve, and investors’ conditioned response to a 30-year bull market in bonds may be some of the reasons bonds do not adequately reflect their true risk.