Notes from the 2nd Leir Conference on Bubbles and Government Policies

Leir Retreat - September 14 & 15, 2012

Arthur Hoffman began the Conference by speaking for a few minutes before lunch about the Leir Center’s focus on bubbles and the importance of this research for financial policies. He explained how Mr. Leir left Germany for Luxemburg in 1933 and then left Luxemburg in 1938 for the US where he founded and expanded an international metals business that he sold in 1968. He recognized the markets in the 1960s were experiencing a bubble and thus invested in Treasuries during the 1970s and avoided the collapse in the “nifty fifty”. He recognized this as bad time for investors given the collapse in US financial returns.

He would thus probably have recognized the current financial markets as being challenging since the assumptions concerning housing and stock prices and rates of returns have been undermined. This has created challenges for investors and those considering retirement.

Bill Rapp then began the 2d Leir Conference with a recap of the 2011 Conference and the new issues this conference would address related to bubbles and government policy. 

The Recap ran as follows:

1) Most bubbles have been recognized and analyzed specifically after the fact such as the recent financial crisis. The 2011 Leir Bubble Conference sought to develop metrics and methods to recognize them including the different types and stages for Bubbles. In this regard Bubbles were seen as rapid rises in real prices for an asset above its economic value and so not sustainable.

2) Rapid price increases for an asset relative to the general price level attracts speculator interest that further drives up prices. Signals are herding, more market volatility and high optimism. The initial paper by Dr. Chou argued a period of less volatility if the expected price increase was external (or irrational) but a revised paper shows an increase in the volatility of price action if the expected price increase is endogenously based on the price increase from the previous periods.

3) Speculators will in this case drive out value investors. When some speculators start to leave the market the price deceleration can signal a maturing and measurable loss of momentum. Policy makers are reluctant to act early, however, as they see benefits from the perceived economic prosperity while the Public is optimistic and enjoys the false sense of prosperity. Yet the eventual pain can be extreme when the bubble collapses. So there is a public policy need to manage bubbles. The excess optimism can be measured.

4) Some important Bubble types are Financial Bubbles in Stocks, Emerging Markets, Bonds, Real Estate, Commodities and New Technologies.

5) It is important to differentiate bubbles because disruptive technologies can attract risk capital whereas real estate lending booms financed by bank loans are always bad due to the leverage and credit risk involved. The former can avoid a financial crisis such as the Internet whereas the latter generally cannot as seen in the Great Recession. Government Regulations can initiate, manage and avoid some Bubbles since they require an open market system. A change in government objectives regarding home ownership for example played a role in the recent crisis that could have been avoided with more early action by the Fed.

6) Panics and crashes are usually caused when people have borrowed money to buy inflated assets. Therefore policy debate centers on when funding new ventures poses a risk to the inancial system due to banks’ exposure and leverage that can wipe out their capital base. Strict laws such as margin limits may work better than regulators.

7) The policy objective is keep the financial system especially banks sound while providing the funds needed to support economic growth and new technologies. Given their leverage banks should not provide risk capital. Rather other intermediaries can and should facilitate this such as brokers, insurance companies, VCs, investment banks, and asset managers. One way to test for this is stress tests that look for any spillover effects on the banks.

8) Part of this analytical and regulatory effort should focus on the assumptions of participants and regulators. That is what may make sense on a micro basis may not when it is done in volume through massive herding effects. Combining growth stocks and risk free assets in a portfolio was a sound financial asset management idea based on history but when it was done in volume by many asset managers it resulted in the “nifty fifty” boom & bust. Subprime mortgage lending may have made sense given stable or rising home prices but when it was done in volume it led to the housing boom and bust with foreclosure as a viable exit strategy actually foreclosed because of the number of homes hitting particular markets at the same time with no buyers due to both a reduction in lenders and potential borrowers.

9) Increased prices that attract speculators may make lenders and regulators feel good and in turn will increase prices further attracting more participants through an interactive feedback. But once money becomes less available and some speculators leave the market, price volatility increases leading to more exits and some price decline or deceleration. This decline then at some point creates a panic and with a true price collapse there is a “crash”. Thus price action is the key to understanding a bubble’s evolution.

10) In the real world research indicates that News Stories play little role in creating a crash though they will certainly try to explain it after the fact. Rather prices in terms of market timing describe the bubble’s development where “Financial Innovations” should be suspect, increased leverage should be suspect, complexity should be suspect, concentrated underpriced risk should be suspect, and pro-cyclical regulation should be suspect. 

11) These situations are suspect because they all reflect excessive optimism not only by borrowers but also by lenders and regulators. This three-sided optimism is a bubble cornerstone. But once this over-confidence wanes, the prior greed is overcome by fear, and panic emerges along with loss of confidence, a crash, financial distress, disillusionment and a financial crisis if there is excessive leverage and bank exposure. Ironically this is when the government usually comes in to deal with the aftermath by bailing out the system or prosecuting the inevitable scams and scandals that emerge as the financial tide goes out.

12) Therefore from a policy or regulatory viewpoint there should be a sharp focus on potential banking losses or on other highly leveraged institutions that could impact the national or global financial system. [As discussed elsewhere in these Notes, Dodd-Frank has some of these provisions.] This generally would not include situations where only investor capital is at risk such as the Internet or recent Social Media Bubbles where high margin requirements limit the institutional risk. Conversely one reason the subprime mortgage crisis has been so disastrous is because the asset price risk was borne almost entirely by the banks and this was then extended through low margin derivatives [such as CDS] to the wider global financial system including the foreign exchange markets.

13) Generally regulators must lean against the wind to counter excessive optimism. However due to possible regulatory co-option using strict rules such as margin requirements or exchanges may be more effective than relying on regulators’ discretion. Such black-line rules should seek to control optimistic contracting through simplicity and transparency requirements that limit leverage through installments or balloon payments. In addition regulators need to monitor Aggregation Effects that can lead to concentration of credit risk and counterparty credit issues [Dodd-Frank appears to address some of these issues such as forcing certain transactions through exchanges or limiting single counterparty exposure]. 

14) Finally Ponzi Finance where financial costs are covered by increasing financial exposure must be stopped at an early stage especially when it has adverse foreign exchange and balance of payments effects as explained by Professor Aliber.

15) A more systematic policy approach to managing Bubbles as opposed to the current ad hoc one appears needed because bubbles are based in human behavior and market conditions that incorporate economic risk taking. This risk taking is in turn an important aspect of the growth process. At the same time as Colin Clark has explained and verified statistically and historically capital grows faster than other factors of production and economic activity. Thus at various times there will be an excess supply of capital driving down rates of return. This will lead investors to take on more risk seeking a higher return. New technologies, regulatory changes, etc. can attract this capital leading to bubbles that when they collapse return capital availability and pricing to more normal levels. 

Download a copy of the notes here.

2012 Chicago Federal Reserve Economic Symposium

Prior to attending the Chicago Fed’s Economic Outlook Symposium I downloaded and read the attached summary the Chicago Fed had posted on its website concerning a conference that they had organized on financial Bubbles. One particularly interesting observation was that many asset price Bubbles occur during periods of general price stability. At first this may seem somewhat contradictory since by definition asset bubbles involve a very rapid rise in the price of an asset. 

However, this does not mean that all prices are rising rapidly. Indeed as noted elsewhere on this website financial Bubbles involve people feeling they are getting rich without money illusion and an asset’s real price must rise rapidly. 

Therefore general price stability in conjunction with a rapid rise in the price of a specific asset helps promote the Bubble. Further general price stability will make Central bankers and other policymakers less concerned about the Bubble and may even promote a relatively easy money policy that further supports expansion of the Bubble. Such price stability can also contribute to a sense of optimism and excessive bank lending. 

Given this situation does the current price stability in the US and the Fed’s easy money policy raise concerns about another emerging financial bubble? Based on the outlook put forward during the Symposium the answer is no. 

This is because the participants were definitely not bullish and there was little sense of optimism about the US economic outlook. Indeed one important reason there was little bullishness is because companies are not borrowing and are holding piles of cash waiting for more positive signs concerning the economic outlook and the fiscal cliff before committing to any new projects. My own forecast of 3% real growth during 2013 and 7.3% unemployment by the end of 2013 was among the most positive [top 10-15%], especially when combined with moderate inflation expectations of just below 2%. 

At the same time it was noted that the past year was in many ways a positive surprise compared to last year’s forecasts. That is on the whole last year’s forecasts were on average overly bearish compared to what actually happened and perhaps this year will prove to be the same. During 2012 inventories surged and then fell back but still they ended above forecasts. Consumption was also stronger than expected particularly for big- ticket items and housing even if this was off a very small base that has continued.

Interest rates also moved down compared to last year’s forecasts and this may have helped the bigger than expected bounce up in big-ticket items such as cars and housing. Further international trade was flat partly do to fact that oil is no longer the only energy story combined with a mild winter in the Northern US. This, off course, then left more money in consumers’ pockets which helped the better than expected increase in consumption.

Yet despite these recent positive surprises the current forecast does not expect the unemployment rate to fall that much, accentuating the overall pessimism that includes a conclusion that the restocking in industrial sector has come to an end. Further the consumer spending that was the recent surprise and that is expected to continue and get somewhat stronger is still below historical norms with housing at two-thirds of normal levels or 1.5 million units and cars a little over 15 million. 

On the other hand I would view this economic scenario as cautiously optimistic and an excellent investor buying opportunity since it indicates the US is still in a positive growth mode. Further oil prices are expected to be relatively stable along with inflation at around 2% and few forecasters feel there will be a downturn due to the fiscal cliff. Since only moderate growth is expected, there could be a real upside surprise given the amount of cash available. If this boost in demand is focused on an area such as infrastructure a investment bubble might start to develop. But it would occur two to three years from now.

It is unlikely a consumption-based bubble would emerge since consumers are still repairing balance sheets and this remains a drag on the economy. This is why housing unlike previous cycles has not led but has held back the recovery despite the recent improved numbers. Consumers are now reducing debt accumulation and household net worth is improving, though not yet back to pre-crisis levels especially for lower income families who had relied on increasing home net worth as their major source of savings. 

Housing is definitely in recovery mode but remains a long way from normal. Yet mortgage rates relative to housing prices creates a really great buying opportunity and thus attitudes toward home buying are improving along with household formation. One negative, though, is tat many younger buyers have large student debt and lenders are still cautious in making housing loans. Rather they are returning to traditional loan criteria such as a 20% down payment. This compares to the 2006 average down payment of 3.5%. Further the FHA cannot sustain its current position as the lender of last resort to fill the gap. Renting is therefore likely to remain strong for sometime to come.  

Further a significant portion of the jump in housing purchases in the most depressed markets has been by investors who are often buying bank-owned or foreclosed property.

Another growth negative is that it is lower income families that have seen the greatest drop in real incomes which when combined with the drop in real wealth due to the decline in home prices has hit these consumers relatively more. This has also worked to postpone retirement and keep older workers in the labor force. Indeed the US is seeing increased participation of those over 55 in the labor force even allowing for fact that some of these are part of the baby boom generation. This is thus a trend that needs to be watched since it will have important policy implications over the long term.

Yet it remains worrisome that employment has not bounced back relative to past downturns and has become a leading versus a lagging indicator in getting the economy back to self-sustaining growth. The problem arises especially if workers are out of work for a long time, become obsolete in terms of skills and then join the structurally unemployed, though some questioned whether this mismatch is real or as large as some labor economists have argued. 

With respect to the fiscal cliff, it was not expected that the economy would go over I butt there could some negative impact in the first quarter that will affect the currently unemployed the most.

Looking at financial sector the conference participants saw US banks as well capitalized and most making money. However given lower leverage return on capital is lower so bank stocks may remain relatively depressed. Yet these returns are probably more real and more stable which bodes well for the financial system as a whole. Market volatility is also falling, which seems good. 

On the other hand regulatory reform and the implementation of Dodd-Frank are still greatly lagging legislative intent. Therefore the full landscape for banks and other financial institutions is not yet clear. Several big lawsuits involving toxic assets are also not yet settled. Further the strength in US banks may be currently overstated because hidden losses on housing loans have not yet been taken due to the lag in foreclosures. At the same time the banks may be right not to take more reserves since housing is recovering. Thus losses may be lower and as the banks reduce loan loss reserves they may realize a one-time bump up in earnings and capital.

Conversely European banks are in bad shape and thus have had to become very cautious. This is shown by an actual fall in lending and in deposits. This adverse situation has been compounded by political gridlock that makes the US system look very functional. The Europeans are not able to take some of the approaches that the Fed and the Treasury have taken. 

Does this mean Europe will bring down the US economy? The consensus view is that it will have some impact since one cannot expect the US to remain an island of prosperity but that the US should still grow positively. 

Along with recovery in the financial sector and housing the outlook for the very important auto sector also looks good. Worldwide demand particularly looks very good with sales of 80 million units expected due primarily to emerging markets where sales are now 30 million units or as much as Europe and US combined. For example China is still growing though its growth has slowed. As already noted the US is on gradual up trend though demand remains below the probably somewhat inflated levels of the early 2000s.

While the auto sector has come back much more strongly than most expected, Europe is again the dark spot since demand is expected to be only 18 million units down from 22 million at the high. Unfortunately in the face of this decline Europe has not gone through the same restructuring as the US and thus still has a lot of excess capacity. So there may be a shake out and some consolidation. Indeed subsequent to the Conference Opel announced lay-offs and plant closings. In the US Competition has already shifted and the US big three now have under 50% market share compared with over 60% in 2000 while Hyundai/Kia is up from 2% to 8%.  If something similar happens in Europe the impact on the weaker European producers could be sharp. 

The US light vehicle forecast for 2013 is for 14.3 million units up from 12+ million units in 2012. This is being partially driven by the fact vehicle age has been increasing and there will be replacement demand once consumer balance sheets and income levels improve. Further low mileage used vehicle prices are increasing along with better deals for new cars and improved job growth. In addition the housing market and vehicle sales often go together [including light and heavy trucks used in construction.] Replacement rates are up too and new models are being introduced at roughly an 18-month rate. Sandy should result in a short-term bump in make-up and replacement car and light truck sales as well. Combined total is 600,000 units [400K + 200K].

In sum given the strong market for low mileage used cars and a favorable lending environment for cars this sector does not face the credit headwinds found in the housing market, though one should note the banks are not heavily involved in these credit decisions but rather the car sellers. This link is clearly critical along with the fact that if a car is repossessed the strong used vehicle markets supports the credit unlike a foreclosed home.

Mandated fuel improvements and consumer attitudes towards fuel economy are also shifting and expanding demand patterns as consumers list gas economy as their top purchase criterion. Hybrids are now 3+% of the US market but represent about 15% of Toyota’s US market share [Prius have outsold all other hybrids combined].

Toyota is also working with Ford and BMW on several new vehicles some of which are designed to appeal to the 80 million Generation Y consumers [largest US population cohort compared to baby boomers] since this generation is not committed to cars in the same way as prior ones due to urban living [access public transportation], student debt, and telecommuting. 

Indeed surveys indicate Generation Y prefers Internet access to owning a car. Many do not have a driver’s license. When they do buy a car they are interested in fuel economy, eco-friendliness, stylish design, technical sophistication, and inexpensive to own.  Toyota feels well positioned to meet these criteria including the new US government mandated fuel standards. 

Since historically US producers have found smaller cars to be less profitable an important question is what is the impact of this increasing demand for smaller more fuel-efficient cars on profitability? Generally it will favor the more efficient producers such as Toyota. Further it should especially help those producing more fuel-efficient cars such as hybrids. TMC expects to launch 21 new hybrid models at different price points and styles [Prius plus Lexus] over the next few years. Further TMC will emphasize the use of different fuel sources with their hybrid engine system such as natural gas and diesel rather than just gasoline. TMC also expects working with other makers will bring down the costs of hybrids compared to other car options. 

Autos, housing and construction are of course closely related to steel. Thus it is not surprising the steel industry outlook is also mildly optimistic again excepting Europe. US capacity utilization has been relatively flat at around 70-80% for last several months and this should continue into 2013 with the recovery in utilization strongest in autos and oil services.

The energy market should use about 12 millions tons next year compared to 11 million this year because increased drilling will lead to increased transport demands including pipelines, tanker trucks, and RR tank cars. Other rail car demand is improving as well. Service Center inventories, though, should remain stable. Overall steel demand will be flat or slightly up with 2012 closing out at 96.5 million MT and 2013 at 100+MT. Yet this is still nothing to shout about since historically the “normal” US steel demand is around 115MT.

Moving away from the US not surprisingly the European outlook for steel looks bad and is continuing to decline. China was down for a while due to the government’s anti-inflation policies. However it is expected to pick up somewhat next year. Further despite the economic slowdown over the last three years steel consumption worldwide has set new world consumption records at over 1.4 billion MT. This should be true in 2013 too though this could be affected by the fiscal cliff, China having a soft landing, and Europe not getting much worse. This cautiously optimistic pro-growth scenario should lead to some increase in coking coal and iron ore demand worldwide.

One important factor in this outlook is that from a total cost standpoint the US is now a low cost competitive manufacturing location. So looking only at labor costs is becoming increasingly less relevant especially if energy is important. 

In fact natural gas, which the US seems to have in abundance is the new energy story that could affect everything, and king oil is being pushed aside. Historically the NG price rose sharply when it was thought to be in short supply but this has all changed. For 2013 a $3.10 average price per BTU is projected due to increased supply from drilling down vertically and then horizontally and then putting in lots of water and sand [each fracking stage requires 300,000 gallons of water and 200,000 cubic feet of sand] forcing out the gas.

Demand for NG will respond to this lower price and greater supply. This will come from several different sources. The chemical industry will be using it to produce fertilizer, plastics, and similar petrochemical products. This is making Europe uncompetitive because they price their chemicals off the oil price [another negative for the European economy]. US ethylene is enjoying a similar economic and competitive benefit. Further manufacturing generally will benefit because lower energy costs are offsetting lower labor costs especially because labor costs in China and India are rising rapidly. This advantage could be offset if Europe starts to frack their shale [but the political power of the Greens has opposed this with strong support from a Russia that wants to continuing selling its gas].

Another big source of Natural Gas demand over the next two or three years is as a substitute for dirty coal. Though clean coal could be a risk here, it would just drive NG prices lower. Conversely if it drives coal prices lower, it then will pay to innovate with respect to clean coal. Finally there should be export potential. However to do this will require DOE permission to convert existing import terminals to export where an expanded Panama Canal will facilitate this development. This proposal, though, has created a civil war between NG users [chemical companies] and NG producers.

As oil is the alternative ingredient in these demand situations, these energy forecasts critically depend on the price of oil. $95-$110 is the 2013 projection but is subject to great variation given various political risks including the US offshore permitting process. Since Gulf of Mexico exploration is returning to pre-BP spill levels, and the US remains attractive from a political, regulatory, and cost standpoint the last point should be OK as long as the Jones Act does not apply to these new development initiatives. Actually this is why US oil production is up 25% since 2008 and when combined with shale gas use this has reduced imports by $75 billion.

There is no indication that these US energy trends will end or change any time soon since the North Dakota Bakken field may be the biggest oil find in US history and has for first time created an oil price differential within the US. In addition, there are other big fields on the horizon such as the Eagle–Ford and Utica fields. 

All these energy developments have created a pipeline shortage and in turn increased the demand for rail cars since rail cars can move gas or oil to the market with the highest price as opposed to a pipeline that moves it from point to point. There is also now a shortage of gas processing plants for which demand is exploding. This is has been accentuated by the flaring of NG in ND that has created a potential EPA issue. Since growth will literally be fueled by these developments there should also be increased demand for heavy machinery especially if the Obama Administration is successful in pushing through some sort of jobs program related to infrastructure. 

This would be another upward surprise because while overall CAT is currently forecasting positive numbers for the US construction industry it is pessimistic on infrastructure due to the current fiscal uncertainties.

In the emerging markets construction is driven by economic growth but in the advanced countries replacement demand has become more important. Clearly emerging markets are driven by growth because they do not have the existing infrastructure but in the advanced countries this situation is reversed. This is why the global purchasing manager index shows fluctuating periods of pessimism and optimism. 

Currently the 2012 figures do not predict a recession in 2013 whereas similar figures in 2007 did predict a recession in 2008 and since the economy is way below the prior peaks there is little over-heating indicated in the economy.

Rather one big concern for the construction machinery industry is that due to the Great Global Recession several governments have had budget cutbacks and infrastructure projects have been postponed or cancelled. 

Nevertheless CAT is forecasting some growth in 2013 and 2014. This is also true for metal mining but not coal due to the NG scenario explained above. Gold for example looks attractive since a cost of $750 per ounce to mine and refine is well below the $1750 market price even though the global inventory is huge. Copper also looks good on a cost to price basis. But Thermal Coal demand will drop 6% with the only good news being exports. One problem for coal versus NG is that coal requires utilities to keep large stockpiles especially during the winter while NG delivered by pipeline does not.

With respect to Europe CAT along with everyone else is pessimistic in that despite record low interest rates it does not see positive growth or growth policies. This is in contrast to China where bank lending in recent months has increased. Infrastructure investment too is increasing again. In total these trends should be reflected in a modest increase in CAT’s global sales of about 6% with the strongest performance in US, 13%, and the next best Latin America at 9%. 

Bottom line: even though risks remain everyone sees the US economy continuing to improve with some growth better than a recession. But how much as no one is jumping up and down singing “Good Times Are Here Again”.

The Quantitative Identification of Asset Bubbles - a Survey

[Author: Ben Chou, New Jersey Institute of Technology] 

The damage wrecked by the bursting of asset bubbles can have a devastating impact on investors' fortunes and the welfare of a society. Krueger (2005) points out that the rise and fall of internet stock prices during the internet bubble destroyed about $8 trillion of shareholders’ wealth. More recently, the bursting of the housing bubble and toxic financial assets created worldwide financial crises, impacting many nations and their economies. Therefore, understanding the recent developments in the techniques of identifying asset bubbles is an important first step for researchers and policy makers to develop preemptive policy measures to ameliorate the negative impacts of speculative bubbles before they get too big and collapse. 

Click here to download the complete paper.

Everything is Not a Bubble

[Author: William Rapp, New Jersey Institute of Technology] 

Many books written after a financial or economic crisis including the collapse of a major bubble seem primarily designed to shock and scare the reader with respect to the just past economic catastrophe and the one looming just around the corner. Indeed after an economic crisis such as the recent Great Recession there seems to have been a bubble in books about bubbles as each author competes with other experts in explaining how it happened, how that particular author saw it coming and how the next one can be avoided.

In addition the popularity of the word appears to result in every economic and financial problem becoming a bubble including the Euro Crisis centered in Greece but also involving Ireland, Portugal, Spain, Italy and even France. It is in this way that many financial gurus can identify several bubbles affecting the US or global economy that will come together to create a massive and coordinated bubble and crash that only they can help investors and policy makers avoid. 

However, from the perspective of analyzing bubbles generally or a specific bubble such as the one leading to the Great Recession, there are several problems with this general labeling and analysis especially if it is to be used as an investment or regulatory strategy. 

Click here to download the complete paper.

Evaluating the Relationship Between Earnings Management And Financial Bubbles

[Authors: Wei Xu, New Jersey Institute of Technology; Michael Ehrlich, New Jersey Institute of Technology]

When Supreme Court Justice Potter Stewart was confronted with the challenge of ruling on an 1964 obscenity case, he conceded that an objective definition of pornography was hard to produce, but “I know it when I see it”. Economists and academicians have treated financial bubbles the same way for most of recent history. Charles Kindleberger and Robert Aliber in their seminal work, Manias, Panics, and Crashes: a History of Financial Crises (1978) defined a bubble as “an upward price movement over an extended range that then implodes” (p.16) 

While the Kindleberger definition relies on price movements that accelerate unsustainably to identify financial bubbles, this definition ignores traditional pricing theory that suggests prices are based on the present value of expected future cash flows, also known as intrinsic value. An alternative definition suggests that a financial bubble exists when the price of an asset exceeds its intrinsic value as determined by market fundamentals. However, financial bubbles seem to have relatively long lives and the market fundamentals that determine equilibrium pricing are unobservable.

Click here to download the complete paper.

The Mortgage Crisis and Current Housing Market: Practical and Complete Recommended Solution

[Authors: Charles F. Beauchamp, Assistant Professor, Middle Tennessee State University; Michael Ehrlich, Assistant Professor of Finance, New Jersey Institute of Technology; Robert Atra CFA, Professor of Finance, Chair - Department of Finance, Lewis University; Lee Hayes CFA, Founder - Genesee Investments; Steve Patrick, Founder - BID Consulting Services; Rawley Thomas, Former VP - Practitioner Services of the Financial Management Association, President & Co-Founder - LifeCycle Returns. 

With Contributions by: Linda Halton, President & Founder - Adaptive Finance; Gary Lundeen, Short Sale Attorney; Greg Stewart, Home Property Appraiser] 

Introducing a little discussed concept to mortgage markets termed Price Appreciation Rights; this proposal presents a practical private sector, non-partisan solution to the ongoing housing and mortgage crisis plaguing the United States economy. Under this plan, financially distressed home owners present a deed-in-lieu of foreclosure as an alternative to default and agree to rent the property from the loan servicer at an affordable rate. This arrangement prevents vacated property decay and maintains the value of the rented property and that of its neighboring properties. In addition to the rental payment, qualifying renters may also make equity payments into the property with the goal of reaching a 20% equity stake. Upon financial recovery of the renter and after reaching the 20% equity stake, the renter can then repurchase the home for the value of the property at that time. In return for assuming 100% of the risk in the rent-repurchase agreement, the loan servicer is entitled to 75% of the increase in the home’s value realized during the rental phase, i.e. Price Appreciation Rights. The renter is entitled to 25% of the Price Appreciation Rights. This solution can be administered in similar forms to first time home buyers and other subprime market participants. If properly implemented, the proposed solution should return proper clearing mechanisms to both the housing and mortgage markets. As a result of returning to functional mortgage and housing markets, housing demand and prices should begin to increase leading to economic recovery including higher levels of employment.

Click here to download the complete paper.

Leir Center for Financial Bubble Research Opens at NJIT

Past economic bubbles have been inflated by visions of wealth from tulips (yes, tulips), international trade, railroads, biotechnology and the Internet. Their bursting has been disastrous for individuals and entire nations. The U.S. and other countries are still reeling from the collapse of the recent housing bubble.

Read the entire press release here.