Today’s Economy: Are we in a recession? with Dr. Christopher Thornberg | Part 2

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Originally from upstate New York, Dr. Thornberg holds a Ph.D in Business Economics from The Anderson School at UCLA, and a B.S. degree in Business Administration from the State University  of New York at Buffalo.

Christopher Thornberg founded Beacon Economics LLC in 2006.  Dr. Thornberg also became  Director of the UC Riverside School of Business Center for Economic Forecasting and Development and an Adjunct Professor at the School.Prior to launching Beacon Economics, Dr. Thornberg was a senior economist with UCLA’s Anderson Forecast. He previously taught in the MBA program at UCLA’s Anderson School, in the Rady School of Business at UC San Diego, and at Thammasat University in Bangkok, Thailand

An expert in economic and revenue forecasting, regional economics, economic policy, and labor and real estate markets, Dr. Thornberg has consulted for private industry, cities, counties, and public agencies in Los Angeles, San Francisco and the Bay Area, San Diego, the Inland Empire, Seattle, Orange County, Sacramento, Nevada, and other geographies across the nation. Dr. Thornberg became nationally known for forecasting the subprime mortgage market crash that began in 2007, and was one of the few economists on record to predict the global economic recession that followed. Well known for his ability to capture and hold audiences, Dr. Thornberg has presented to hundreds of leading business, government, and nonprofit organizations across the globe including Chevron, The New Yorker, Colliers International, the California Chamber of Commerce, City National Bank, the California State Association of Counties, State Farm Insurance, the City of Los Angeles, the California and Nevada Credit Union League, and the  National Steel and Shipbuilding Company, among many others.

 

 

Episode Notes:

 

Narrator  This is The Norris Group’s real estate investor radio show the award-winning show dedicated to thought leaders shaping the real estate industry and local experts revealing their insider tips to succeed in an ever -changing real estate market hosted by author, investor, and hard money lender, Bruce Norris.

Bruce Norris  Hi thanks for joining us. My name is Bruce Norris. And today our special guest is once again Christopher Thornberg from Beacon Economics. All right, let’s, then let’s, because this is, like I said, when I introduced you, I get to ask questions I don’t know the answer to. So, let’s unpack the Fed balance sheet a little bit because I know that that’s used to be a trillion dollars, like for a long time, and then all of a sudden, you know, the 2008 popped in and you got, got to about four and they kind of grew. And then we backed off a little bit, and then all of a sudden the pandemic hit and now we’re between what 8.8 and 8.9.

Christopher Thornberg  Yeah, let me, let me, let me, let me, let me, let me I know you’re going with this, let me, let me give a brief principle, we have to understand Fed policy.

Bruce Norris  Okay.

Christopher Thornberg  So, the Fed uses the money supply to try and manipulate the economy, if it needs a little juice to give a little more money. If you need to cool it off, take a little money away, all right. So, it’s just as simple as that you’re just mixing in and out, in and out. Now, the traditional way you do that is through basically bank policy, your federal funds rate is the inner bank lending rate. If you raise it becomes more expensive to borrow banks hang on to more reserves and vice versa, you lower it they get more and more reserves, which was a it’s a reasonably shall we say soft tool, it doesn’t have super concrete results super quickly. But it’s you know, it’s what they’ve traditionally used. But when interest rates got very low and real in nominal terms, it became harder and harder to use it because you can only lower nominal interest rates so much you can’t have a negative nominal interest rate just doesn’t work. Ergo, what you end up doing here is going the next step, I still need to get money into the system, out of the system. Another way of doing it just for the Fed just to print money and buy bonds. Now, they can’t buy any kind of bond, they have to have specific characteristics legally. For example, they can only buy US Treasuries, and Fannie and Freddie backed real estate securities, those are the only things they’re legally allowed to purchase. Now, when you think about Ben Bernanke, Ben Bernanke, again, understands the difference between a depression and a recession is deflation. Deflation is often driven by a collapsing financial market when financial markets collapse. It creates deflationary pressure in a sense, falling asset prices takes money out of the economy. Hence, the Federal Reserve has to replace it. So, Ben Bernanke, over about six years used about three and a half trillion dollars of quantitative easing buying bonds, to add money into the economy, in order to offset the deflationary pressures of the collapse of the subprime bubble. And they did a marvelous job MT was nice and steady through that period of time. Now, you flash forward, and you no longer have an economist at the head of the Federal Reserve. You have a lawyer named Jerome Powell rose to the ranks of the New York Fed, I think is right. You’ll have a crew of people on the board who are, have been picked, because of the stories they tell because they fit particular, shall we say, holes? Oh, wait, we need to have this kind of person and that kind of person not. We didn’t hire smart bankers and people understand monetary economics we hired people had specific social views that we thought were important.

Bruce Norris  Okay.

Christopher Thornberg  Which is ridiculous for federal bank, for a Fed Central Bank, ridiculous, but they did it. So, the pandemic hits, they’re all reading in the paper, these ridiculous stories, this thing’s gonna cause a depression, which again, is completely preposterous, completely preposterous. So, what happens? Well, Jerome Powell, over lunch, decides to do $3 trillion quantitative easing, seriously $3 trillion. Ben Bernanke did three and a half trillion over six years, he did $3 trillion, he decided in one day, and over the next month, they bought $3 trillion dollars in bonds. And then, despite the fact that there was no financial crisis, remember, Ben Bernanke was dealing with a real financial crisis. You had a loan right off the banking system 23% per quarter. You had home prices falling 15%. You had massive foreclosures, you had massive numbers of bankruptcies, the economy, the financial system was a disaster. This time around, none of those things happened. loan losses fell. There have been no foreclosures there have been no delinquencies. There have been no, there wasn’t no collapse in home prices or the stock market, they all took off, they went the exact opposite direction. And so of course, he logically said, Oh, we’re fine. So, therefore, I’m going to take some of this money out. Haha, that’s a joke. Of course he didn’t. He said, I’m going to 2 trillion more in quantitative easing. He didn’t, he loved 2 trillion more to the economy, despite the fact that there was no financial crisis. Honestly, if you look at this, from a historical standpoint, this has got to be one of the dumbest things the Federal Reserve has ever done. It’s insane. That with no financial crisis, you would love $5 trillion in the economy. But that’s what he did.

Bruce Norris  And doubled your debt.

Christopher Thornberg  And of course, what ended up happening? Well, that’s the Fed, that’s the federal government’s last resort. Yeah, but more or less what they did was basically monetize the debt, the federal deficit, the way to think about it is, the federal government borrowed 7 trillion and 5 trillion of that came from the Fed printing money. That’s basically what happened. Now, the result of this, of course, is one of the biggest expansions of money supply we’ve ever seen. M2 is up 40%, from where it was two years ago, four 40%. Now, to be clear, prices are the equilibrium between money and the size of the economy. If you increase them to, by 40%, holding all else equal, you can anticipate about a 40% increase in prices. We are now roughly 8% into it. And we have oh, roughly 32% ago?

Bruce Norris  Wow.

Christopher Thornberg  Exactly. So, the potential for inflation in front of us is vastly more than the inflation we’ve already seen behind us. And the only way to fix this is quantitative tightening, moving the federal funds rate up, I don’t care, two bits, three bits, whatever. You know, I just got to do, Oh, you’re going to do .75 again. So what? That’s not the, that’s not the gas pedal, he hit the brake, there is not going to help either.

Bruce Norris  I don’t know how many people understand how you unravel that in the real world. In other words, okay, you’re saying we have to reduce that 8.8 trillion to some other number? What’s the process? And how painful is that?

Christopher Thornberg  Well, people are complaining about interest rates right now, right? Oh, mortgage rates are almost 6%. Yeah, inflation is 8%. Ergo, the real interest rate on real estate is negative 2%.

Bruce Norris  Right.

Christopher Thornberg  They’re paying you to borrow money, still. So, until that gets positive, that is to say, they slam on the brakes to pull cash out of, out of it. So, what are they what are they going to do is going to start selling bonds. That’s how they got quantitative tightening. So, your turn around take treasuries. And as opposed to buying them off auctions, they’re going to dump them back on to auctions. They’re gonna take those real estate securities, and they’re going to dump back notch, and they’re going to absorb a lot of cash out of the system. Interest rates are gonna go up strongly inflation is going to cool off, ergo, real interest rates are going to go from negative to strongly positive.

Bruce Norris  Okay.

Christopher Thornberg  Indeed, I would argue that we way, way we’ll be seeing double digit mortgage rates in the next couple of years. Both from a combination of the momentum of inflation, combined with the Fed needing to get some of this cash out of the economy. 10% mortgage rate. Yeah, I can see that. Not a problem. Clearly, that’s where we’re heading.

Bruce Norris  Okay. Well, that’s great that you said that when you say not a problem, what does that mean? When you have a, let’s say, in California, medium price at 890. It’s not going to be a 10% mortgage rate that they can get.

Christopher Thornberg  Okay. Now, we got to circle around housing.

Bruce Norris  Yeah.

Christopher Thornberg  You are a housing guy, right? That’s what we’re here to talk about, we’ve been talking all over the map.

Bruce Norris  Oh, I think we need to talk about this to get…

Christopher Thornberg  Let’s, let, yeah, but let’s, let’s talk about what what housing is going to do. Now, with this in mind. I want to, I want to, I don’t know if I’ve told you this before Bruce. But my connection with real estate is, is fairly profound. And as much as my father was a real estate broker, in other words, I was raised eating commissions. And I remember I had a conversation with my dad and I said, what were the best years of your career as a real estate broker? And his answer was, believe it or not 1983 to 1985 when interest rates were double digits, so right off the bat, we started to start to realize that interest rates do not create or kill housing markets. It’s a different kind of conversation. Rather, interest rates are just part of the cost just like lumber and, and taxes and everything else and Once you adapt to whatever those costs are the economy, the real estate market can do just fine. So, if anybody’s out there is freaking out that I said, well, maybe 10 or 11% mortgage rates don’t. Because again, real estate can do just fine in those moments and how can it do so? Well has to have a couple things. First of all, if interest rates are higher, you use more equity and less debt. Well, guess what? We’re in great place for that. Because over the last decade, we’ve had a really low pace place, the lowest pace of mortgage debt growth in this country. Quality has been fantastic. And as a result of that, the one place you again, you see lots of money in our economy today, is in residential real estate.

Bruce Norris  Okay.  Absolutely.

Christopher Thornberg  Get this. At the peak of the great recession, the there is, before the Great Recession excuse me, there was about $14 trillion of equity in us real estate, and we had a debt to equity ratio of about 60%. Of course, all hell broke, loose home prices fell, we bottomed out at about $8 trillion of home household equity, with roughly the same debt to equity ratio, mainly because all those people are getting foreclosed on.  Now, where are we, as of the first quarter of this year, we have $28 trillion of household equity floating around the US economy 28trillion, 3 times where we were a decade ago. And by the way, the debt to equity ratio is the lowest it’s ever been or tide with the lowest it’s ever been, and roughly where it was in 1983, 1984, 1985. So, can this residential real estate market, by the way, we still have too little supply, we have two months supply of existing homes. Housing is fine. And it will do fine. Once we get out of the inflation mess, the issue here is not that housing is going to get clobbered, the economy’s going to get clobbered, as people have to face the reality, they are not as rich as they think they are. Nor should they be consuming as much as they are. That’s going to cause a real problem in the economy. Real Estate may well be a safe haven, in the midst of that chaos. And on the back end, when we finally emerge from the chaos, real estate almost assuredly after being stalled for a few years, because of the huge increase in real interest rates will assuredly get going again, in a relatively good pace. So, residential real estate, you got to be very worried about the big consumer cycle that’s in front of us. But you don’t have to worry about a real estate cycle. Because again, this time around, unlike the Great Recession, where real estate was ground zero, this time around real estate is peripheral to the underlying situation or our economy.

Bruce Norris  Okay. What’s interesting, too, that we’re facing what you’re saying could be, you know, interest rates that are get to 10%. What would prompt anybody to sell an existing home with a two or three or 4% mortgage? And that might in invariably lead to very little inventory available other than new housing?

Christopher Thornberg Yes. That’s why there’s too much supply out there right now, right. And that’s why the pressures continue, particularly for people trying to get into their first home, which a lot of people are trying to do right now. So, you know, that should spill over to the new home market. The problem is, new homes are expensive, particularly now because of all the fixed costs. That’s it’s hard for the new home market to really if you will meet the demands of those entry level buyers who trying to jump into homeownership right now. So yeah, you have that little, little bit of an issue. There’s no doubt about it. But nevertheless, when you have some of those secondary issues, you still have a market that has, shall we say, a pretty thick armor. And undoubtedly, we’ll be able to weather the broader economic storms relatively well.

Bruce Norris  What do you think will be the impact of foreclosures or job losses, that type of thing if you have a recession?

Christopher Thornberg  Well, again, I look, there’s always going to be some foreclosures. But again, I think it’s going to be small. It’s going to be people who are facing individual, shall we say economic difficulties, not a broad collapse in real estate prices that make people go underwater. If you look at the 70s what you’ll see is as as as the market. The way think about the 70s is this, this is what real estate did. Real Estate got hit by the same fogbank everybody else did in real estate. It slowly, slowly, slowly, just basically slugged towards being flat throughout the whole economy did right. By late 70s, nothing was happening. The recession hits, everybody takes a bit of a bump ahead. But real estate actually was still pretty good. We didn’t see a lot of foreclosures, because there was lots of equity, there was lots of cushion. And people didn’t want to ground. They just, they just held that, you know, when you have a big liquidity cushion, you don’t accept nominal price declines. You just sit there, you don’t do anything. And the entire market goes illiquid.

Bruce Norris  So, they had an 8% mortgage, which was a deal at that time. Right?

Christopher Thornberg  Exactly.

Bruce Norris  Yeah.

Christopher Thornberg  But, you know, look, people have to move life goes on, you get into the 80s, the economy is moving. People are moving, I’ve got a new job and a new town, my kids move it out, I’m getting ready to retire, people are going to make decisions one way or the other. As long as you have an equity cushion that allows you to shall we say, you know, listen, I have an 80% mortgage. With a low interest rate, I can keep my payment the same by going to 60% loan to value at a higher interest rate, right? It’s gotten more we use more equity.

Bruce Norris  Right.

Christopher Thornberg  And that’s what people did in the 80s. So, people started moving and they move to more equity. And ultimately, the market did great.

Bruce Norris  And like you say, if we’re, if we’ve ever had equity, it’s pretty much right at the moment.

Christopher Thornberg  $28 trillion, Bruce.

Bruce Norris  Yeah.

Christopher Thornberg  And listen, prices are still going up. It’s decelerating. There’s no doubt about it as well, it should give it an a treasurer coming up. But it’s still a positive. I mean, a year from now, we may end up with $30 trillion in equity. So, again, you got an enormous cushion there.

Bruce Norris  So, you think, that’s interesting. So, you think, alright, well, you know, we’re in the home sales business, let’s say on occasion. And so it’s interesting that you say that. Because, you know, we did just go pending on a home a couple of days ago at full price. And that was okay, I’m happy to see that, you know, we’ve got a, in the next 12 months, there’s a fair amount of inventory. So, you know, right, when I sign up to take risks, I do a lot of calculation, as you can imagine.

Christopher Thornberg  Sure.

Bruce Norris  And I, you know, I land on the square of okay, what is this house rent for? What’s the payment on this at seven or eight? Or, you know, so I can correlate some decision process for the respective buyer. Well, you just go what I read or rent it 2800 or own at 2800? I think the answer on that will be quite often, yes.

Christopher Thornberg  Yeah.

Bruce Norris  So, interest rates, you know, since I was, I’ve been in real estate, I was I joined the fray and about the peak of the interest rate. So, I became a real estate investor by refinancing my house at 17 and a half percent. So, talk about bad timing that was about you could the worst you could do. But then for 40 years, it’s gone down. So, the trajectory going forward, there’s a, there’s a really good book I read. So, I’ll just take one your take on that the price of tomorrow. And it talks about the process of innovation, and how it ultimately is deflationary. So, I just wanted to know your take on that, let’s go out 10 years from now, where you say, Yeah, with all that sort of taken over the human need for borking.

Christopher Thornberg  It’s funny, because because I already said what you just said. Remember, prices are basically the equilibrium between the supply of money and the size of the economy. The kind of what you said was was when the real economy gets bigger, and prices are going to need to come down. And that’s why the Federal Reserve has to add a little money to the economy every year, to basically keep up with real with the real size of the economy. If you don’t increase the money supply in the face of real economic growth, you have deflationary pressures. This is one of the reasons why the gold standard is completely unworkable. In a true modern world. It’s a fixed amount of money, ergo every time you get a surge of growth, you end up with a surge of deflation, which is bad for the economy. So, so, a fiat currency is the way to go as long as you have a central bank that understands how to run the money supply accordingly. Well, again, I think we have pretty much proven that, that second part, that is to say having a reliable Federal Reserve is not a guarantee. I mean, when they, it, under Truman, remember prior to Truman, the Federal Reserve was actually a Department of the Treasury. It was under the control of the president. And it was under Truman, when a lot of conversations on the part of economists they said you know, you really shouldn’t do this. You really ought the Federal Reserve under the control of the Treasury, it should be its own independent base. And it was then when they changed it to make it hands off, Truman sigh although he had a lot of consternation, they managed to get Truman to do the right thing and make the Federal Reserve, functionally independent. And yeah, they weren’t great, but for the most part, they did okay. In the 70s there was clearly some mistakes being made. But it seemed as if in the early 80s, we, they gotten a grip Volcker came in he kind of clean house, we got to reset, which was nice, right? We, we, we had a free central bank called the Federal Reserve, they screwed up the first decade, we did the right thing and get 20-30 years of good policy. You know, you had Volcker, then you had Greenspan, then you had Bernanke. They did a hell of a job. But somewhere around 20 years ago, probably about the time when really our nation completely started to lose his collective mind. The political tax and the Federal Reserve began and we all remember even during the Great Recession, how all these posturing poising, you know, politicians in DC, ‘we don’t know what these guys do. Oh, what’s this clue? Who are you? Why do you get to make decisions? I’m the elected official here.’ And, and lo and behold, the Federal Reserve got sucked into the political narratives of the day. We have the qualified the board, the vast majority people on the board have no idea how monetary policy works.

Bruce Norris  Wow.

Christopher Thornberg  Not qualified to be there. And they’re making bad decisions. Okay. Ben, clearly, I’m never going to be invited ever to a Federal Reserve conference and the rest of my life.

Bruce Norris  Pretty clearly, or maybe they’ll come to their senses and put you on and say, Okay, what do we do?

Christopher Thornberg  Right.

Bruce Norris  You know, bout at a time, let me just ask you a pretty straightforward question. If you didn’t own a house right now, would you buy one?

Christopher Thornberg  Oh, hell, yeah.

Bruce Norris  Okay.

Christopher Thornberg  You know, your best investment is right now a 30 year fixed rate mortgage.

Bruce Norris  Wow, even now, that’s a..

Christopher Thornberg  …negative interest rate. It’s still negative interest rate.

Bruce Norris  A negative interest rate. I, you see, don’t don’t know, you know, you you think on a different plane. So, don’t know, don’t think that that’s like normal processing for most people. It’s not.

Christopher Thornberg  Well, that’s, and that’s, and that’s why the concept of homeless economists that people are rational, make rational decisions, is a little silly. Money illusion is the real deal. In money illusion is why dumping a bunch of economy, money on the economy first creates this sense of euphoria. And then, of course, the storm clouds come in, right. And that’s exactly what we’re dealing with. And the problem is, is is the inclination is you know, it’s not unlike, if you will, the the alcoholic, who was soon as they start to get the hangover immediately goes back to the bottle. And that’s the question here is, is will, will we have, will Jerome Powell have the political will to hold, to hold the line and actually continue to do what he needs to do while if he ever starts doing it on quantitative tightening? Will he actually hold that line? To be clear there was a movement in the United States to impeach Paul Volcker because of the terrible damage he was doing to our economy.

Bruce Norris  Yeah. And then we did good for a long time after that.

Christopher Thornberg  You know, when you look at the mirror, Bruce, the problem is, is us. It’s not the Federal Reserve, it’s us. We’re the ones who listen to the ridiculous stories of our politicians is populist nonsense. All your lives are terrible, and it’s because of the other party’s policies. So, they say it’s all driven by hatred and exclusion. And, and nobody can compromise. Everybody’s outraged all the time. We’re angry, and we have no reason to be.

Bruce Norris  Oh, we don’t you know, it’s…

Christopher Thornberg  And that’s, that’s what scares the death on me, Bruce.

Bruce Norris  At the end of the Nixon library event every year. I’ve said the same thing for a decade. What I want this year is for every elected official to act like an American not a Democrat or a Republican. Wouldn’t that solve a lot?

Christopher Thornberg  Well, and that’s more or less why Alexander Hamilton didn’t want parties. He recognized this centuries ago. You know why? Because he’s a student of history. He was a student history. And guess what? You know, what I’ve realized, over the last again, few years of my life is Yes, I have numbers. I have fancy econometrics. I have the technical training to do this kind of stuff. But if you really want to be a good forecast, you got to be historian. You got to watch the stories

Bruce Norris  We created, we created a metric called the moodometer. And it’s exactly that it doesn’t just calculate numbers, it calculates the mood of the participant. So, I can tell when you’re too happy for this asset and you’re too sad about it.

Christopher Thornberg  We need, and we need to, we need a lot of that at the national level. And tragically, politicians don’t get elected by telling people to stop being whiny little, you know, what’s.

Bruce Norris  You know, what’s interesting, one of the things that they could do, and one of the things that helped in the 80s was, we had a, you know, we had mortgage base that was 7 or 8 or 9%. And they allowed that to move forward to a new buyer.

Christopher Thornberg  Yeah.

Bruce Norris  You could change the dynamic of the real estate environment by letting that walk forward, because the equity position is huge. And, you know.

Christopher Thornberg  You have to keep in mind, you’re screwing the savers that much worse, there is a cost to doing that.

Bruce Norris  Screwing the savers. So unpack that for me.

Christopher Thornberg  Remember, well, again, inflation is higher than interest rates, ergo, if you buy a US Treasury.

Bruce Norris  You lose.

Christopher Thornberg  The value of that you’re losing money on that asset.

Bruce Norris  You’re right.

Christopher Thornberg  So, there’s an enormous shift in wealth from savers to borrowers in the US. And we have to be cautious about making that even worse with those kinds of policies. There are consequences to the decisions we make and you have to look at the entire situation to get a better balance on that.

Bruce Norris  What did the 10 year T bill get up to in the, in the early 80s? Is it like 12 or something?

Christopher Thornberg  I forget, I have to go back and look, I am not sure if it was but yeah, it got pretty high. And it made borrowing really, Oh, and you know, we didn’t really talk about the fiscal crisis we’re out to deal with too, because we have a trillion dollar structural deficit. And our debt to GDP is 130% which by the way is a heck of a lot higher than it was in 1979. It was 50% back then.

Bruce Norris  Well, you’re also because of inflation. You’re about to give everybody on Social Security a heck of a race.

Christopher Thornberg  Oh, yeah. So at some point out there, there’s a hole and don’t forget the cost of carrying all this federal debt is gonna go up tremendously. It’s been two and a half percent of GDP for the last 15, 16 years. Well, it’s about to go to three and a half to four and a half percent. Just interest rates…deficit viewers.

Bruce Norris  I’m glad I created a cover of a report that said 2% mortgage rates 40, 40 trillion in debt. That was pretty fortunate. Not at the same time period, though.

Christopher Thornberg  No. Yeah.

Bruce Norris  All right. Christopher, I have enjoyed it. As always and very informative. I took some notes that I will have to, I have to think of things differently. You know, that’s it’s fun. Thanks a lot. And you know what, Thanks for, thanks for sharing what you know, because you’ve had a really good impact on the audience’s that you talk to I think they all leave and go. ‘I hadn’t thought of that.’

Christopher Thornberg  But thank you, Bruce. And I always appreciate your time. And you’re…Yeah.

Bruce Norris  You got a visit from the cat. That’s cool.

Christopher Thornberg  I know, she’s actually, she’s been sitting here the whole time.

Bruce Norris  I know not to deal with that boy. All right, Chris. Thanks a lot.

Christopher Thornberg  All right Bruce, see you again.

Bruce Norris  All right. Well, bye.

Narrator  For more information on hard money, loans and upcoming events with The Norris Group, check out thenorrisgroup.com. For information on passive investing with trust deeds, visit tngtrustdeeds.com.

Aaron Norris  The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669.  For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.

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