Milken's Legacy and Concerns

Michael Milken was writing in the Wall Street Journal this week. The "Junk Bond King" passed on an important lesson for investors: Beware a market heavily distorted by government intervention. Things may not be as they first seem … 

Milken popularized the junk-bond market in the late 1970s and early 1980s. Then he went to jail for securities and tax fraud. He "understated the risks" associated with high-yield (junk) bonds, said the newspapers. 

Thirty years later, the junk bond market is 10 to 20 times bigger … and the risks greater than ever. But now, it's not Milken understating the risks to investors; it's central bank policy.  The Fed sets the price of credit. A certain class of speculators now believe that, as long as the Fed keeps borrowing costs on the floor, they don't have to worry about losing money. 

But Milken never mentioned junk bonds yesterday. Instead, he was concerned with another grotesquerie perpetrated by the feds – this time in the US housing market. 


Supersize Me

We wondered about it as we were driving back to Baltimore from South Carolina this week.  The old houses we passed (aside from the mansions) were small. Often charming. Some were even elegant. Newer houses – especially those built in the last 10 years – were much bigger. But most had lost all grace and charm. Instead, they were ungainly … clumsy … and super-sized – like someone with a glandular disorder. 

The typical house grew in size by 50% over the last 30 years, says Milken. Meanwhile, the average family size fell by 25%. Fewer people; more space.  And much more expense. First, the cost of construction goes up with the square footage. Then it costs more to furnish it. And to heat and cool it. And to maintain it. 
Is more space better? It's not for us to say. But wife Elizabeth had an opinion:

"I wouldn't want to rattle around in a big, empty house," she observed, as we drove past a field full of recently-planted McMansions. 

"They must have put up these houses during the housing boom. But they must regret it now. They have to heat them. And who's going to buy these white elephants?"


Another Fed Distortion

Let's go back to the question of why people bought them in the first place. Milken has the answer: The housing market became another of the feds' distortions. 


“[I]n the housing-boom decade before 2007, many buyers decided that the largest-possible house (with an equally large mortgage) was a better idea than a retirement fund or their children's education," he writes.


Houses were ATM machines. The bigger the house, the bigger the line of credit. Homeowners "took out" the equity as fast as it accumulated.  But what was this equity? Where did it come from? Like the bounty of today's stock market, the pre-2007 housing market was a Frankenstein monster created by the feds.

Says Milken: 


“US mortgage holders receive bountiful tax benefits, loans that include no recourse against borrowers' non-residential assets if they walk away, and loans that offer no protection for the lender if the borrower refinances the loan for a lower rate.”


And now the monster has become a zombie – unwanted and unnatural, kept alive by the Fed's artificial interest rates. Norbert Michel of the Heritage Foundation adds: 


“The government guarantees we've had in the US housing market have distorted housing prices, encouraged debt, left taxpayers on the hook for trillions, and provided the impetus for millions of home foreclosures.”


Poor homeowners are stuck with millions of ATM machines that no longer work. Despite a robust bounce last year, it is unlikely that increases in house prices will continue to exceed increases in consumer prices. In other words, houses will go back to acting like they always did: shuffling along with the economy. 

America's economy, like its landscape, has been blemished and distorted. Risks have been seriously understated. So far, no central banker has been hauled up on charges. 

But we're looking forward to it … 



The above article is from Diary of a Rogue Economist originally written for Bonner & Partners.

Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.





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