Why the Fed is Steering Us Straight Towards the Next Great Recession

Dave:
Hey, everyone. Welcome to On The Market. I’m your host, Dave Meyer, joined today by Kathy Fettke. Kathy, how are you?

Kathy:
I’m doing great. Excited for this interview.

Dave:
Yeah, same. I think we have a good one for everyone. We talk a whole lot about the Federal Reserve on this show, and today we have Danielle DiMartino Booth, who actually spent nine years at the Federal Reserve Bank of Dallas, where she served as the advisor to the Fed President Richard W. Fisher throughout the financial crisis.
We are going to get into insights from someone who was actually there during the financial crisis and who was part of the decision-making to introduce quantitative easing into the economy and set off a lot of the cascading events that have landed us in the economic environment we are today.

Kathy:
Can’t wait. I’ve personally never spoken to anyone who worked at the Fed, so this will be exciting.

Dave:
We talked to a lot of Fed watchers. We are Fed watchers, but now we actually get to talk to them. I do want to explain just a couple of terms that Danielle uses a lot throughout this episode that I just want to make sure everyone understands. The first one is quantitative easing. You’ve probably heard of this, but this is a monetary policy where a central bank purchases securities like bonds or mortgage-backed securities, and the intention is to introduce liquidity to the market. Basically imagine a bank owns a mortgage or a bond. The Federal Reserve just buys it from that bank using money they create out of thin air.
That’s why when people say the Fed is “printing money,” they’re not actually printing dollar bills, they’re just buying these securities and introducing… All of a sudden, on the bank that sold the asset, now there’s, whatever, another million or billion dollars in there. The reverse of quantitative easing is called quantitative tightening, which is where the Fed “shrinks their balance sheet.” This is where they sell the securities like mortgage-backed securities or bonds, and they sell them. And then when they get money from the bank, whoever buys it, they just, poof, make that money disappear. There is a way.
It is possible that the Fed can reverse some of the money printing that has been going on, and Danielle will talk about that a little bit in terms of the M2, which is the monetary supply. It’s a measurement for how much money there is circulating in the system. I think those are the main two. The other thing I just wanted to mention, she does mention something called the Fed put every once in a while, which is a term that just basically describes this attitude on Wall Street or among traders that the Fed is going to save the economy, so that basically traders are willing to take on excessive risk because they think if the stock market falls 10 or 20%, the Fed will jump in and do something.
Those are the terms that I think you just need to understand as we go into this interesting episode. And then I do want to say that Danielle, as we get towards the second half of the interview, provides some opinions that are different than I think of the ones that we talk about a lot here, and that’s the point. We want to bring on people who have differing opinions from me and Kathy and the rest of the crew. We encourage you to listen, and then Kathy and I at the end of the episode break down what we think about Danielle’s opinions, some of the things we like, some of the things we disagree with.
You definitely want to stick around to the end. With that, we are going to take a quick break, and then we’ll bring on Danielle DiMartino Booth from QI Research. Danielle DiMartino Booth, welcome to On The Market. Thanks so much for joining us.

Danielle:
Well, it’s great to be here today.

Dave:
For our audience who is unfamiliar with your work, can you tell us a little bit about your economic background?

Danielle:
I started my career on Wall Street at a traditional investment bank, DLJ, that’s no longer with us. It was sold out at the peak of the dot com bubble. It was an extraordinary time and place to be in New York and witness IPOs that you would never have sold your grandmother and the implosion of that bubble. Subsequent to that, I got my second master’s in journalism at night. I thought I was going to retire and write a column on the markets for the rest of my life and never go back into the world of finance, but just write about it tangentially. And that happened.
I ended up at the Dallas Morning News, signing a non-compete, leaving the industry, which taught me a lot about private equity, by the way, and high-yield. It was a unique bank in that sense, but Warren Buffett ended up calling. Off I went to Omaha, Nebraska and I got to spend more time with Charlie Munger, who has less of a filter than Warren Buffett. And then the Federal Reserve came calling. The research that I do today stems from the research that I did for Dallas Federal Reserve President Richard Fisher.
I would prepare markets briefings for him before he went off to FOMC meetings in Washington, DC. Basically what I do now for private clientele are the same types of briefings. We just do them every day and every week.

Dave:
Wow, that’s very impressive career. We talk a lot about the Federal Reserve on the show, but I don’t think we’ve had anyone previously who has experience with the Federal Reserve. Can you just tell us a little bit about what that was like?

Danielle:
I was tweeting out this morning. We were talking about existing home inventories coming in at the lowest levels since the data has been collected in 1999. I tweeted out this morning, what was fascinating was in 2008, we were having a very heated debate. We were debating what quantitative easing should look like in the event that, oh, I don’t know, Lehman Brothers blew up and ignited systemic risk that was global. At the time though, there was a small contingency, that was the anti-Bernanke, anti-Yellin contingency, that was saying if we cross this Rubicon into credit easing, which is specifically in violation of the Federal Reserve Act of 1913, we could end up impairing mobility.
Somewhere down the pipeline, if we’re buying all these mortgage-backed securities as part of this big quantitative easing large scale asset purchase program, you could impair mobility to the detriment of the long-term health of the economy. I lost that debate obviously, because we kept going with QE and MBS. And then in the second iteration of it, after the pandemic hit, of course, the Fed ended up buying a third of the mortgage-backed securities market and now everything’s come home to roost that we were concerned about. In data back to 1948, we have never seen mobility be this impaired.
Nobody wants to get rid of a two and a half percent 30-year fixed mortgage, and that is the end result of the Fed buying a third of the market, was they artificially repressed mortgage rates. These are the kinds of experiences that I had at the Federal Reserve, which were just fascinating and we’re seeing play out today. When Jerome Powell was first on the board, I was very of the same mind that he was, that it would be very difficult to extricate from blowing up the balance sheet when the time came and that you could cause serious problems and oh, I don’t know, the entire credit market.
These things are actually coming to fruition. It was a fascinating almost decade that I spent at the Fed. It’s even more fascinating to watch the debates get settled in the marketplace, which is what’s happening now.

Kathy:
Fascinating is such a good description. I love the title of your book Fed Up. I’ve been a critic of the Fed for a long time, but never an insider like you, and it’s just so fascinating to hear what you have to say. What are your thoughts about having this central banking system? I mean, I know this is a big broad question, but this group of unelected officials having such an influence on our lives.

Danielle:
For the record, I am not the creature from Jekyll Island.

Kathy:
I did read that.

Danielle:
I think that book introduced some non-truths into the thinking about the Federal Reserve. I was actually just filming on Jekyll Island and learned a lot more about what happened at the time. We forget that it was as simple as J.P. Morgan himself saying, “I am fallible. I will die,” after the panic of 1907. We’re no longer an emerging market. We’re no longer a developing market. We’re a developed country, and it’s time for us to have a central bank. That in times of serious financial instability, there is an arbiter that can come in and stabilize the system.
And that’s exactly what we needed when we woke up and Lehman Brothers blew up and systemic risk had been ignited. The Fed did have to step in. Don’t get me wrong. I wrote a whole book about this. It was a situation they created in conjunction with everybody else who fed the housing market bubble from the credit rating agencies who looked the other way when subprime wasn’t really even any prime. There were many players who were responsible and the Federal Reserve was certainly complicit.
But at a time when systemic risk is unleashed worldwide, you have to have adults in the room who can come in and stabilize the financial system in the absence of somebody as strong as J.P. Morgan himself, who corralled a bunch of bankers into his parlor room in 1907 and said, “Nobody leaves until we come up with a solution.” You could do that back then. People always say, “Can’t we just live without the Federal Reserve?”? I’m like, well, we could, but think about what the Chinese have done with US intellectual property.
Think about that for a minute. Now, think about having a completely unguarded financial system that could just be corrupted and invaded by sovereign entities who want to see the United States fall. Think of what they could do to our financial system. Now, we need to rip the Federal Reserve down to its studs. Studs. It needs to be completely re-engineered. It needs to be made independent and apolitical once again. I would venture to say, I think Jay Powell’s a man on a mission to help see that vision through.

Dave:
Well, that was a great overview. I mean, now I’m going to ask you to basically recite your entire book now. But what do you think the right course is then? We’re in a situation where you said it was necessary in the fallout of the Great Recession to step in, but we’re in a place now where the Federal Reserve has too much power. Where do you think the point they went wrong was?

Danielle:
Well, I think the modern day error, if you will, was when Congress created the dual mandate in the late 1970s. Maximizing employment necessarily by economic definition conflicts with minimizing inflation. You simply cannot pursue the same two mandates at once and not kill one or the other. We’re watching today as we speak. With fresh data out on initial jobless claims, we have 90% of the US population living in a state with rising ranks of continuing unemployment beneficiaries three months running.
We’re watching live recession set in, and yet we’ve got Jay Powell saying, “I understand we’re going to have to hurt the labor market, but it’s going to be better in the long term if we get inflation back down.” He’s telling you, we can’t do both. We can’t do both. When it was too low for too long, it was so that they could bring every last person off the sidelines into the labor market. What did that do? Well, it inflamed inflation when that got going, when the fiscal authorities started throwing money into the hands of taxpayers directly depositing it, which is why we had inflation like we did.
People are always like, why couldn’t the Fed ignite inflation alone with quantitative easing? All of those years that Bernanke could not hit a 2% inflation target. If you gave him a bazooka, he couldn’t hit that inflation target. You had the banking system as an intermediary. You can lead a horse to drink. You cannot make that horse drink the water. And that’s what QE failed to do in terms of trying to bring inflation up to a 2% target. It’s that the easing got stuck in the financial system. Inflation was in asset prices.
But you bring Uncle Sam in and you bypass the banking system, you give trillions of dollars directly to individuals with the highest propensity to just spend, boom, you got inflation overnight. Did the Fed play a part? Yes, they monetized every last penny. But again, the combination of the two is what made the Federal Reserve as powerful as it’s been in conjunction with the fiscal authorities. They have to be together in order to create this crazy inflation.

Dave:
Just to clarify for everyone listening to this and just to make sure I’m following you, Danielle, the Federal Reserve as of the late 1970s has a dual mandate, which is to maximize employment and to ensure price stability, basically control inflation. What you’re saying is that those two things are essentially at odds with each other. Because to maximize employment, you need a hot economy, and inflation is a byproduct of a hot economy. It is impossible, at least in our financial system as exists today, for the Fed to do both of its jobs at once.
We’re just stuck in this balancing act where I think a lot of us feel like the Fed just turns the steering wheel all the way to one side and then it gets too far and then they swing it back in the other direction. You’re saying that’s just inherent in their mandate and there’s not really much other option. Did I get that right?

Danielle:
You got that 100% right. We have to think of the era in which the dual mandate was introduced. The Carter administration felt that it could not get employment under control. It was just a runaway train. They felt like they needed extra help in trying to get the unemployment rate down, but giving the Fed the authority to take that place was not the right route to take. In times of recession, fiscal authorities do step in. But in a capitalist nation, it is the job of the private sector to maximize employment.
Having the Fed step in to that role has corrupted the institution. But again, this was an act of Congress, and Congress tells the Federal Reserve Board in Washington, DC whose email addresses end in .gov. It is a full-blown federal government agency where the permanent voters live. It’s their job to do as Congress tells them to do.

Kathy:
I’m so glad you clarified that, because again, there has been so many conspiracy theories. All you have to do is type in Federal Reserve on YouTube and you can go down a deep dark hole. Just to hear, again, an insider’s viewpoint of how it can be fixed, is there a way to unwind the doing? I mean, here we are sitting on massive deficits, way overspending. The Fed coming in again to fix it, fix it, fix it, spending more money, buying more mortgage-backed securities, all the things, all the new tools. We’ve never been here before. How do you unwind it and what’s next?

Danielle:
Unwind it by being Jay Powell and by holding together your committee. We have become accustomed to and too low for too long. It’s how we are. The Fed’s got your back. Don’t fight the Fed. Well, right now, he has managed to create a higher for longer environment that most market participants continue to deny exists. We had a district president come out and say, “There won’t be any rate cuts until 2025.” The market’s like, that’s impossible. He’ll break the Fed put. Well, if you break the Fed put… People forget.
In 2018, when Powell first attempted to normalize monetary policy, shrink the balance sheet at the same time as raising interest rates, he got all the way to two and a half percent on the Fed funds rate and had to do a huge U-turn. Right now, he’s got more than two and a half percentage points of easing in the chamber. He’s got 300 basis points of easing in the chamber to stop at 2%. You said it’s a broken tool. You know what? Let’s throw it out of the toolbox. Zero interest rate policy, failed.
Let’s get rid of it. But he’s got enough latitude right now to lower rates as much as he did last time and stop at 2%. Get rid of zero interest rate policy, ZIRP as we called it. When he was asked at his most recent press conference, if you’re pausing, if you’re not going to raise interest rates, does that mean necessarily that we’re going to stop quantitative tightening, stop shrinking the Fed’s balance sheet? He was like, nope. Didn’t mean to imply that. Next question. He moved on very quickly, and he’s trying to tell us in his way, QE failed.
We don’t need to talk about when we might or might not do QE again because we need to remove it from the toolbox. It’s a failed tool. It’s a failed experiment. If he accomplishes these two things, you start to wake up in the morning, you pull up your Bloomberg headlines, and it says right now buzzards are moving in and buying private companies for 39 cents on the dollar. That’s what higher for longer looks like. It looks like actual price discovery.

Dave:
It sounds like you believe that the Federal Reserve and their committee currently understands their errors and some of the things that they’ve done wrong. Why don’t they just come out and say that? What’s with all the coded language? Why not just explain how you just explained it? What’s going on?

Danielle:
Let’s play Socrates for a minute. Let me ask you a question. Do you think that Jay Powell could have maintained this tightening stance for as long as he has if he woke up one day and said, “Let’s crash the markets,” or have a well-behaved financial markets, allowed him to continue to slowly boil the frog who doesn’t know he’s going to be boiled? You want to kill the frog quickly and the markets are going to throw up and he’ll be forced to stop. You’ll unleash systemic risk somewhere.
Some country will blow up that’s large. Some bank will blow up that’s large. And all of a sudden, you’re stuck, because financial stability is not something you can mess around with. But for you to trickle it out one month at a time, this is extraordinary what we’re witnessing right now, and people need to have a better appreciation for what’s being accomplished, because we’re watching commercial mortgage-backed security, that market, we’re watching securitization shut down.
We’re slowly seeing the economy flash recessionary signals, but we still have functioning capital markets, highly impaired, but functioning. As long as we have some semblance of functionality, he can keep going.

Kathy:
He can keep going as in tightening?

Danielle:
Yes. Every $50 billion that we wake up to on July whatever it’s going to be because of the holiday, and we see that another $50 billion of shrinkage has happened with that balance sheet, that’s one more small step towards success.

Kathy:
I love the way that you’re correcting me in my belief system around this because I keep saying that the only tool that they have is printing more money. What’s the truth around that?

Danielle:
That’s what everybody on my Twitter feed says. They’ll just print, print or go ber, ber, ber, and I’m like, not happening right now.

Kathy:
It’s not happening right no, because sometimes it looks like they’re using another tool so that we don’t know that’s what they’re really doing. Like Dave said, I wish they could just come out and tell us what they’re doing so we don’t have to have all these theories.

Danielle:
Well, again, it’s a controlled demolition. Silver Lake, Silicon Valley, First Republic, do you just let systemic risk get unleashed in the banking system, set up all the dominoes and let them fall over, and have to come in with emergency measures and quit what you’re doing? Or do you come in and say, “Okay, banks, you want some money? Fine.” What’s Congress grilling Jay Powell about right now? Congress is grilling Jay Powell right now about the quid pro quo. You want cheap money, you want 100 cents on the dollar, fine.
Congressmen are saying, “Not so fine. Why are you talking about raising capital requirements? You ogre. You can’t do that. The lobby is paying me money. I’m a kept man. I’m a kept woman. You can’t talk about raising capital requirements.” Jay Powell says quietly, “Watch me. People thought that this program that I implemented after was QE. Uh-uh. There’s no such thing as QE if there’s a price tag involved, if there’s recourse.” And that’s what he’s saying right now. You want the cheap money? Fine, hold more capital, which is a banker’s biggest nightmare.

Dave:
Danielle, you’ve talked a little bit about quantitative easing and then just briefly about quantitative tightening. Can you just explain to our audience a little bit how that works since you were there and how quantitative tightening can actually reverse some of the “money printing” that happened over the last couple of years?

Danielle:
We only have data back to 1930, but we’ve never seen since 1937 the movement of money, M2 growth. We’ve never seen it contracting at this level since the depths of the Great Depression. People do not understand that the stock of money in the system is irrelevant If you’re a market player. If you’re a market player, you want to know where the next dollar of stimulus is coming from. If it’s not, then you’re going in reverse, which is exactly what we’re seeing with the drain of liquidity out of the system with M2 as negative as we’re seeing it year over year.
Same with other deposits and liabilities at big US commercial banks. These are negative numbers that we… I just said, private companies are trading hands at 39 cents on the dollar. What’s that? That’s a manifestation of the opposite of liquidity coming into the system. It’s liquidity coming out of the system. That’s when all of your crazy speculative leveraged players are like, wait a minute, we’re not making the rules anymore. We’re not breaking the rules anymore. This is anarchy.
The inmates have taken over the asylum. There’s no leverage to be had. We’re not in a zero interest rate world anymore, and now we’re getting 39 cents on the dollar for all of the speculative actions that we took that never were going to have consequences because the Fed was always going to ride in to the rescue and lower rates back down to the zero bound before any damage was done. 39 cents on the dollar is pretty damn damaging.

Dave:
It sounds like your belief is that j Powell is doing the right thing and trying to reverse some of the mistakes that have happened. Do you think that the soft landing is possible, or how do you think this all plays out?

Kathy:
Oh boy!

Danielle:
No. Did I not just mention that we’ve had for three months in a row 90% of the US population living in a state with rising continuing jobless claims? We’re not debating recession. We’re debating how hard and deep the recession’s going to be. The soft landing thing is BS. It sounds good. He’s hiding behind seriously crappy data from the Bureau of Labor Statistics, which we know. You do not have an entire economist community. As little respect I have for the vast majority of PhDs, you can’t get all of them wrong for 14 months in a row. It doesn’t work that way.
Something’s wrong with the data. And yet, as long as something’s wrong with the data, Jay Powell can reference the data and hide behind it in order to continue one month at a time tightening policy. And that’s exactly what he’s doing. He’s lying to us, but he’s doing it on purpose. He’s not stupid. He’s a lawyer. He’s not a PhD in economics, and he understands exactly why he’s hiding behind extremely lagged, corrupted, bad data that will eventually be revised.

Kathy:
It’s interesting because there is a line of thinking that the Fed is really only supporting Wall Street and the wealthy. Are you agreeing with that or you’re not?

Danielle:
Again, that is to be determined. If he succeeds in breaking the Fed put, then there’ll actually be a price to pay for taking risk, which we haven’t seen since August 12th, 1987 when Alan Greenspan marched into office and gave birth to the Fed put two months later when he came right into the rescue after the stock market crash of October 1987. It’s been a little while here since the Fed has been trying to make the wealthy wealthier.
But this is the first time that somebody who used to work at The Carlyle Group, founded that the industrials group in a private equity firm, and he’s telling his private equity buddies, “Hold please,” or sending them straight to voicemail. We’ve never seen this for almost 40 years, and yet you’re watching public pension funds say, “You know what? We don’t have to play the private equity game anymore. We can get into private credit. They’re the ones buying these companies for pennies on the dollar.
We can put 80% of our portfolio into 5% paying cash, put another 20% into companies that are not being levered up that still get us a great yield. We can tell all these private equity people who have held our feet to the fire for years with enormously high fees, high leverage, illiquidity, where they can go stick their next fund.” That is a manifestation of bringing the inequality divide back down if you don’t let the wealthy make the rules. And that’s what Jay Powell is attempting to do.

Kathy:
Wow. So many investors are listening to the show and probably wondering what in the world they should be doing. I think you just answered part of that. In one of my latest keynote speeches, I talked about liquidity being one of the main things we need to focus on. Because when you don’t have money, you can’t do the leverage deal. You just mentioned that liquidity is being pulled back out certainly in commercial banking. We have investors listening to the show who are in commercial real estate, in residential real estate, in business. What should they do?

Danielle:
Look, I’m hearing from some veteran investors who are like, you know what? We’re no longer looking for opportunities. We’re not opportunistic because we don’t know what the bottom is going to be. Right now we’re actually pulling money away from being opportunistic and paying down debt. Highly unusual circumstances right now that veteran investors see this as being a long, protracted chapter, as opposed to the Fed’s going to ride to the rescue really quickly, which is what this entire generation’s been used to.
If Jay Powell’s promising to keep rates higher for longer, then you can make money on your cash for longer than you have in your lifetime. There’s no shame in dry powder, especially when Truflation, which I keep on my screen, which traders follow like a hawk because nobody believes the BS and the CPI and the construct of it, but traders believe in Truflation, which is a billion prices tracked in real time at 2.39%. They know that they can pay down their debt and make more on their money, twice on their money what they can get.
They’re more than covering inflation. It’s really simple math right now. The fact that we have all these Airbnb jocks who are being forced to begin liquidating their portfolios of condos that they thought they were going to rent out forever at COVID high prices per week, and that ain’t happening. We know that residential is going to hit an air pocket and it’s going to be really ugly. We’re just not there yet. We know that commercial real estate distressed inventory is biblical, and it’s not just contained as Downtown San Francisco.
It’s a bigger story than that. There was fresh data out today that said that distressed commercial real estate inventory just hit a record high dollar level. Trepp told us that office delinquencies skipped north of 5%, moved 100 basis points in a month, and then they identified a whole bunch of really bad distressed properties that they see making that rate go higher than anything we’re used to. There is no shame right now in having dry powder because it pays and it pays you twice what inflation is.

Kathy:
You wouldn’t be aggressively looking for commercial real estate right now?

Danielle:
God no.

Kathy:
Just making that clear because I still see people doing it.

Danielle:
No. Over the weekend, Amazon announced that it was firing 9,000 more people. Walmart continues to close distribution centers. The industrial footprint, which that was the safe place to be. But first, it was multifamily. That was our big short in 2022 for our clients. This year for our clients, the big short is industrial. Again, you have to find the darling asset classes that are bulletproof. Once somebody says these prices cannot come down, then you know where the next target is.

Kathy:
Ooh, that’s what we’ve been saying. Residential can’t come down. People are locked into these 3% rates. They’ll never let go of those properties.

Danielle:
And that’s true, as long as there’s no death, divorce, tax, or job loss. Otherwise, it’s all good. But again, nobody’s talking about the inventory sitting in the hands of these Airbnb jocks or the fact that Starwood put 2,000 homes out of the 3,200 homes it had in its portfolio for sale a few days ago. It’s always the smart money that gets out first. These Airbnb jocks, VRBO jocks, “I’ve got a hundred properties.” I mean, there was some crazy YouTube meme going around 18 months ago. These guys have 0% mortgages. 0% mortgages. They don’t have equity in these homes. They have buccus.

Dave:
We probably know some of these people.

Kathy:
They’re going to hate this show.

Dave:
They’re not going to like this.

Danielle:
Watching these guys burn is not going to make me unhappy at all because assuming that… Well, you know what assuming does, right? Spell the word out. But assuming that you’re going to get these massive cash flows at Infinita, as the biggest players start to liquidate their portfolios and they’re like, “We’ll let those guys go down last,” they can get the pennies on the dollar. They can get the lowest prices. You’re seeing my hometown of Dallas, I’m in Indiana right now, but my hometown of Dallas, they just said no more short-term rentals.

Dave:
They just banned it.

Danielle:
There are other major cities worldwide and here, Little Rock, Atlanta’s imposing restrictions. They’ve done studies. Crime’s higher, period, end. Philadelphia just had three people shot one night last weekend at these short-term one night rentals. Cities are ganging up against these entities and they’re like, well, we’ll just convert to long-term rentals. I’m like, that’ll work out well because you know don’t have any properties that are for rent sitting vacant in the City of Austin, except thousands and thousands and thousands of properties.
And that’s what we’re starting to see. We’re starting to see that the inventory story itself is something of a red herring because so many properties that have been purchased are sitting vacant. Yes, they’re for rent, but they’re vacant and/or you’re not able to get the same lease because renters right now are growing very savvy to the fact that they can up and move and get a lower lease. And they will and they are. You’ve also got 100% increase in the number of homes that were built to rent.
New properties. I just wrote about this week. You have massive subdivisions that have been built to rent. This fanciful notion, it’s correct. A baby boomer who’s liquid and flushed with a two and a half percent mortgage, they ain’t going anywhere, but their kids are moving in with them. I can guarantee you that.

Kathy:
Where are you getting this data? Because we represent over 70,000 investors at RealWealth, and I know BiggerPockets has over two million. I’m not personally seeing this. The properties are renting immediately. Maybe it’s the markets that we’re in. We are not seeing it.

Danielle:
I’ve got a few colleagues who are literally driving through neighborhoods. One of my friends made a four-minute video specifically in Austin. My son lives there. I used to live there. It’s imploding. Austin’s the weakest market in the country right now, so it’s imploding at the most violent pace. That didn’t exist in the prior housing bubble because the State of Texas had outlawed home equity lines of credit after the S&L crisis. That was why Texas was shielded. Texas is going to be ground zero right now.
Dallas, Houston, Austin, these areas are imploding under the weight of the shadow inventory and the vacant inventory. And then you have to look at other sources to see the subdivisions that had been built. Phoenix and Dallas are where you’ve got the most homes that have been built to rent. I’ve done two deep dives, the last of which was published yesterday, on the shadow inventory that’s lurking out there. You have to get down in the dirt and go one metro at a time, and then they’re just there.
They’re just sitting there staring at you. Again, it might be a Blackstone. It might be an Invitation Home. It might be a Starwood property that they’re liquidating. They are owned. They’re just not rented.

Kathy:
Yeah, that’s so interesting. We have a single family rental fund in North Dallas and we have wait lists for the property. Perhaps, again, it’s the areas that we’re in or maybe we’re just not feeling it, or they’re the right price. They’re affordable.

Danielle:
Or they’re the right price. Dallas is one of the few places where that two hour commute still exists, and people living in Prosper and God knows where else. I mean, Oklahoma practically, on the border, on the Red River. We’ve got great views of the river. But they’re living so much further and further north to get that affordability. And yet Dallas has the highest office vacancy rate in the country. It’s going to be highly problematic that market. Dallas I know the back of my hand, and we are hearing from people in Dallas that the price points are simply not working anymore.

Dave:
Danielle, I’m curious what you think, if there’s all this shadow inventory and the worst is yet to come, as you’ve said, what is the catalyst you think that will start making this more into the public view?

Danielle:
Dallas to 30A is no-brainer. I’ve raised four kids there. They’re now up here at a military academy, but that 10 to 12 hours drive to the Gulf Coast in Florida, that’s kind of what people from Dallas do. It’s also what people from Atlanta do. But to get these advertisements with greater frequency, “No longer seven night minimum, you can have it for three,” that started in April. It’s become more and more and more aggressive. It’s a simple matter of there is so much supply that’s owned by this short-term rental companies.
A lot of companies, a lot of families, excuse me, have done the math. They’re staying in a hotel, or there’s been a job loss. Where have job loss has been the worst? White collar. The wealthiest individuals on the income ladder have been the first to lose their jobs. They’re the people who can afford to spend $10,000 a week for a one-week rental who’ve just canceled the summer vacation for the family. And that’s why my email is bombarded with 30A emails saying…
I mean, two years ago in COVID, if I would’ve said, “Can I do five nights instead,” it would’ve been like, “Go pound sand. We’ve got somebody right behind you, sister.” Not the case.

Kathy:
Coming back to jobs when we’ve got over 10 million job openings and you said you don’t trust that data, what is it about that data you don’t trust?

Danielle:
It’s interesting that you asked that. Speaking of Dallas, the Dallas Fed and the St. Louis Fed did a joint paper about 18 months ago. If a job opening is written specifically for the purpose of hiring your competitors’ best employee, who then you have to pay them a little bit more, but you don’t have to spend the money to train them, 90% of job openings they found 18 months ago were for the specific purchase of poaching your competitor’s best employee. This paper was so revolutionary, it would’ve been presented at a federal open market committee meeting directly to Powell.
Powell’s like, “Got it. It’s garbage data. I’m still going to hide behind it because I want to tighten policy.” Look at Indeed.com. December 2021 we had job postings peak. We’re down 23% from that level, and it’s falling fast. What did Indeed tell us two weeks ago? They said that by the time we get to the end of 2024, based on the current rate at which wages are falling, we’ll be at 3.1% year over year for wage growth. When we were talking about triple those levels at the peak and Indeed said, it’s no longer white collar.
We’re seeing job openings fall the fastest for the lowest paying positions that enjoyed the most in the way of wage inflation in recent years. There is a small cohort of the economy, innovationtaxe.com, getyourrefund.com, the employee retention credit, which is the thing, it’s the buzz, it’s still going on. The IRS right now is investigating the simple level of fraud, but it is pumping $20 billion of excess stimulus into the US economy, has been every month.
It is supporting the people who are now basically fraudulently applying for this ERC credit because they’re being solicited and the companies are being paid a 30% contingency fee, which is a no-no. These are your tax dollars. This is not a lawyer chasing an ambulance. But yet now the IRS is being bombarded because of all the fraud. That’s something that Joe Biden extended that was born in the CARES Act. You are seeing toddlers in first class. Mom and dad are actually buying those first class seats because Uncle Sam has given them a tax refund that they didn’t deserve.

Kathy:
I’ve always wondered if those people are just the kids of the pilot or if they’re actually paying for those seats.

Danielle:
They’re paying for the seats with your taxpayer dollars because this slush fund has been going on for so long. When it hit the front page of The Wall Street Journal a few weeks ago, I said, okay, fine. Somebody’s finally cluing in right now to what this means.

Dave:
All right. Well, thank you so much, Danielle. This has been an absolutely eyeopening episode. I really appreciate your perspective on this. I’ve learned a lot here. Do you think there’s anything else that our audience should know just about your read of the economy and understanding of the Fed?

Danielle:
I think that something we have to bear in mind right now, two things, and the first is from a starting point in the current cycle, from a starting point, recoveries on leverage loans, which that was the darling asset class, they’re starting out at 33 cents on the dollar. That is lower than the depths of the great financial crisis. People need to understand that as credit continues to be disrupted, the recoveries that they’re going to have are going to be really low. If you think that you want to hold out, hold out.
If you want to get liquid, do it yesterday. Don’t wait to be the dumb money and be the last out of these markets. Liquidate and get the hell out, because recoveries from a starting point at the depths of the Great Recession, that’s telling you something. S&P Global came out a few days ago along with TransUnion, household delinquency rates at the beginning of recession are at the highest levels on record.
Again, these are highly unusual circumstances. Lending standards collapsed during the pandemic, and now we’re starting to pay the price. Everybody’s like, “I can buy a car now.” I’m like, no kidding, but that’s because the household debt cycle is kicking in, starting from prior record levels. We will rewrite the rules when it comes to pennies on the dollar recovered in commercial real estate, in corporate debt, and in household debt.

Dave:
All right. Well, thank you so much for your input and advice here, Danielle. We really appreciate it. If people want to follow your work and research, where should they do that?

Danielle:
For sure, follow me on Twitter if you don’t already, @dimartinobooth. Never boring. I’d love to have you come on as a client, dimartinobooth.substack.com. I’m easy to find.

Dave:
All right, great. Thank you so much to Danielle DiMartino Booth. She’s the CEO and chief strategist for QI Research. Kathy, what did you think of our conversation with Danielle?

Kathy:
Sobering in a lot of ways. I have been hoping for a soft landing and you’re starting to see more and more headlines stating that, and that’s probably because everybody’s been waiting for the economy to fall off a cliff all year and it just hasn’t. I think people are thinking maybe it just won’t, but it doesn’t mean it’s over. I think that’s her point is like, it’s not over yet, guys. Be cautious still. I love the part about paying off your debt, doing all the right things should a recession come or should there be another boom.
If your finances are tight and you’ve got plenty of cashflow to cover your assets so that if there are vacancies, if rents do decline a little bit, you’re going to be fine. Just making sure you’re all buttoned up and able to handle a downturn. I can tell you, I went through 2008 and there were certain properties that were totally unaffected and others that were just lambasted. From personal experience, I can say you got to be prepared for what could come, but not freak out.

Dave:
Absolutely. I totally agree. I really enjoyed her discussion of the bind the Fed is in, because I think most people who understand what they’re doing recognize that they’re in a pretty tight spot. There’s not a lot of good options for them. I think the debate over, is the market going to crash, it sounds like Danielle clearly thinks that that’s going to happen. If you listen to this show, I think most of the people on this show have thought a more moderate correction is probably the more likely outcome.
It seems like the crux is like, will the Fed keep interest rates high for as long as Danielle thinks they were, which could be years from now, and to correct some of their errors and basically say they’re okay with a big crash. Or I guess the other side is most people think the Fed wants to get inflation down. They want to correct what’s gone on with quantitative easing, but they’re not willing to tank the economy. They’ll probably take a more measured approach. Clearly, Danielle thinks they’re going to go for it, but I personally wonder if that’s what’s going to happen.
I think there’s going to be a lot of pressure for the Fed to take their foot off the gas a little bit in the next year, and I guess we’ll just have to see whether they acquiesce.

Kathy:
It is really so hard to predict. I highly doubt that we would see them go above what they said they’re going to do. The Fed said that they’re going to do two more quarter point rate hikes this year, and I believe them. I think that will happen. Will anything happen after that? I think they’re either just going to hold it, or maybe, yeah, I really think that they’re just going to hold rates where they are through 2024.
That doesn’t scare me too much, but I also don’t know how bad things are, things I don’t know about that are happen happening behind the scenes. How are they saving these banks? I don’t know, but I imagine there’s more. But how are they saving them? I don’t know. Do you know?

Dave:
No, I do not know how they are saving these banks. But one question I had, I should have asked this, but I thought of it after she left was she’s saying rates are going to stay higher for longer. But at the same time, she’s also saying that unemployment is going up and we are entering a recession.
And to me, those two things are at odds. Because if we go into a recession, the Fed will probably cut rates because they’ve done what they need to do. I think this idea that both of those things could happen at the same time, where we have this higher for longer environment, we’re also in a deep recessionary environment, that to me doesn’t gel. I don’t know how you think about that.

Kathy:
100%. I see it where we are right now is like driving a stick shift car where you could really screw it up when you’re learning it.

Dave:
Oh, I have. I definitely have.

Kathy:
But if you just so ever so gently move both levers gently, you can have a smooth ride. That’s where I feel like they are, and I could be so wrong and it could just be my hope, but that maybe they’re learning. We do seem to have a lot of open positions, a lot of jobs. We have a lot of robots coming online. We have a lot of AI that will cut out certain jobs. I’m going to remain confident. I know one thing for sure is that people do prefer to live indoors. At least in my industry, I don’t think that all the kids are going to move back in with mom and dad or grandpa.
I just don’t see that happening. I feel really comfortable in my strategy, which is affordable housing and strong growth markets. I’m not personally worried about what she’s worried about, but yes. Are there groups, are there firms, are there people who went a little nuts? I think for institutional investors where they were probably on adjustable rate loans, they might be feeling it right now, but most individual investors aren’t. They’re on 30-year fixed.

Dave:
Yeah, I think that’s a big difference in looking at Starwood and trying to compare some of those people. Listen, I mean, she could be right. I personally have said I think prices will come down a little bit, but I just think the disaster scenario, while possible, is not the most likely scenario. I think a modest correction. We’ll probably see inventory come up, like she said. But I’ve never really bought into the shadow inventory narrative.
I don’t really understand the idea that there’s all this vacant stuff sitting on the market that’s all of a sudden all going to get put on the market at the same time. It just doesn’t make sense logically. Why would institutional investors buy properties and not put them on the market during the last several years when we’re at historically low vacancy rates and historically high rents? It doesn’t make any sense.

Kathy:
When you’ve got investors all over the place looking for those deals desperately, making offers all the time, no, I’m not buying it.

Dave:
Yeah, it doesn’t check out. And then I’ve also talked to a lot of people about this who are like, yeah, there’s 15 million vacant properties. There are, but there’s always been a lot of vacant properties. That has always been true. This idea that all of a sudden people who have neglected vacant properties are all going to sell them at once just also doesn’t make logical sense to me. I think it was a great conversation.
Listen, the show we do this on purpose. We bring on people with different perspectives to help everyone here understand different views of the economy and the housing market, so you can help make decisions for yourself, what you believe to be true. Hopefully everyone learned a lot and got a new set of information to think about.

Kathy:
Yeah, for sure. You know what? In five years we’ll know. This will be a legacy piece.

Dave:
Yes, exactly. We’ll revisit this. All right, well, Kathy, thank you so much for joining me today. This was a lot of fun. Everyone, we appreciate you listening. If you enjoyed this episode, please take a minute to write us a review either on Spotify or Apple. It means a lot to us. I know it might not seem like a big deal, but we love reviews and we would appreciate if you wrote one for us. Thank you if you do that. We will see you all for the next episode of On The Market.
On The Market is created by me, Dave Meyer, and Caitlin Bennett. Produced by Caitlin Bennett. Editing by Joel Esparza and Onyx Media. Researched by Pooja Jindal. Copywriting by Nate Weintraub. And a very special thanks to the entire BiggerPockets team. The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.