By Karl Smith, Contributor

From Mamta Badkar Bank of America’s Michelle Meyer and Justin Borst say that a “positive feedback loop has begun”. They argue that when people think home prices are rising, they think they will keep doing so and credit conditions will improve, and this increases demand for homes This dynamic – with special emphasis on the credit conditions aspect – is what I termed a criticality. This is borrowed from nuclear physics where a fission criticality occurs if on average each nucleus split induces at least 1.0 other split. The decimal is stuck on the end to remind us that one is not just a convenient lowish number but a precise boundary between subcritical and critical. Two key things 1) What is happening now is that the chain reaction is big enough to have noticeable effects. However, it likely began last year. You can see that in the Case-Shiller chart. What we see is a distinct trend break in the Year-over-Year growth rate. That implies that housing prices suddenly started growing at faster rate, that is accelerating. Yet, the acceleration itself is pretty smooth. That is the classic behavior of a system that has gone critical. I think we can even see the “summer disruption” around July, 2012. But, it doesn’t really affect the slope of the line, just the level. That implies it delayed but did not fundamentally alter the feedback loop or as I like to think of it criticality. 2) Once criticality has been breached, the runaway chain-reaction is extremely difficult to stop. Typically the cycle is broken one of three ways Dampening: In nuclear reactors control rods due this. In housing the Fed would likely play this role, but it has other things to goals and unfortunately only what real policy instrument. Burnup: This is when a key step in the feedback loop becomes maxed out. This is basically like running out of fuel. But, “fuel” as a metaphor in English usually refers to the underlying motive force, which is not how this dynamic works. I actually think that incorrectly attributing the intuition of thermodynamics to non-thermodynamic processes is a big part of why there is so much confusion around macroeconomic and monetary concepts. That may sound really geeky but its just saying people see something getting hot and think, “Fire!” However, not everything that heats up is fire. Yet, arguing that you are not dealing with fire and fire extinction techniques may cause perverse consequences leads folks to accuse you of believing in magic. See this Mike Shedlock post for an awesome example. Scroll down for the video. The speakers “How can pieces of paper be wealth!?” exclamation is a near prefect illustration of someone viewing the rejection of thermodynamic intuition as an implicit acceptance of magic. Meltdown: This stretches the analogy but essentially the conditions for sustaining the criticality can just breakdown. In a reactor, the containment structure may melt. In housing, financial intermediaries can become some highly levered that unexpected outcomes lead to rapid …read more
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