The Federal Reserve has made it mission number one to create a low interest rate environment. The PR campaign claimed that this was to help average indebted homeowners but in reality, it had more to do with providing incredible banking leverage and also to support our massive national debt. The Fed’s balance sheet recently crossed the $3 trillion mark.
In essence, the Fed became the bad bank without any open vote or congressional debate. That much is obvious but what isn’t certain is where things go from here. The ability of inflation to erode purchasing power is a real problem. Since the recession ended it is clear that profits in the financial sector have soared. Yet household incomes remain stagnant.
This is important to understand and Professor Robert Shiller has talked about being cautious about the unbridled optimism now being seen in the housing market. The housing market for the last few years has been supported by massive amounts of investor money. Is the Fed simply creating a different kind of speculative fervor this time around?
Exhibit Number One – The Fed Balance Sheet
One thing that seems to escape those that think this housing market is recovering organically is the gigantic Fed balance sheet. In essence, the Fed and government have become the housing market. When you think of a 30 year fixed rate mortgage at 3.6 percent they become giddy. Would you lend someone your hard earned $500,000 for 30 years at 3.6 percent? No freaking way. And apparently, the financial sector feels the same way:
This is the issue at hand. There is little private demand here. Those that are cheering on this kind of growth might as well take a trip to the former USSR yet ironically, these people claim to be “free market” thinkers. What we are essentially doing is favoring housing over other sectors of our economy. If we are going to subsidize something so deeply, better we do it in fields that will make us competitive globally and not a McMansion for a shrinking household. It is all fabricated and the Fed has not even adjusted its balance sheet since the recession ended way back in the summer of 2009 (in fact it has grown to record $3 trillion). Most of the current growth is coming from mortgage backed security (MBS) purchases. That is, the QE3 program directly targeted at the housing market that is now being engulfed by the same banks the Fed bailed out. The intent is to keep rates low although we might be hitting a lower bound here:
Rates on 30 year fixed rate mortgages have started creeping up although they are still at historical lows. Even in 2008 when rates were low we were at 6 percent. The problem however is that the market is now conditioned to these low rates. The Fed has to keep inflating its balance sheet to keep the gig going. Why? No other person in their right mind would fund a $500,000 loan at 3.6 percent especially when it is tied to housing. Since cheap money is abundant, we are now seeing unintended consequences where 20 to 30 percent of all purchase activity for the last few years has come from investment demand. This is a short-term phenomenon. When we say short-term we mean three to five years. People simply suffer from investment amnesia. We have flippers diving in head first in places in California and do not remember folks getting burned in 2008 or 2009. Those 5,000,000 completed foreclosures never really happened and happy days are here again. Who needs income growth when you have good old fashion leverage?
The Fed and unintended speculative fever
All of this action does come at a cost. We are seeing for example high yield bonds (in other words, junk bonds) pulling in very low rates for the associated risk. This is the issue of living in a negative rate environment. Large funds are buying up properties as rentals which tells you the hunger for yield is dramatic when you see Wall Street coming to Main Street to be your landlord.
It is safe to say that 2013 will not be like 2012 in regards to the blistering housing market. A couple of reasons for this:
-1. Low rates are unlikely to make any significant moves lower.
-2. Investor yields are being crushed with the rush to buy (harder to find deals).
-3. Ironically with prices up, more people are in a positive equity position so they can actually sell if needed.
The overall trend plays out like this:
The most recent median price is $193,800. This is up from $173,500 one year ago and down from the peak of $275,000 reached in June of 2006. You have to ask yourself how is it that the median price went up $20,000 in one year when US household incomes did not go up? All of this is coming from the Fed’s added leverage and speculative demand rushing into the market where inventory is at historical lows.
Some of the positive signs however include the following:
-1. Household formation is picking up. However, this is likely to pull many younger people into rentals first before purchasing homes.
-2. Housing starts are picking up. Good since supply is so low but a good number of these are for multi-family units.
-3. Household debt moving lower. Although more people are leveraging up with low down payment products like FHA insured loans.
It is clear that all of this hot money is causing unintended consequences. Inflation is hitting in many areas including higher education, health care, and energy. Just look at gas prices in Los Angeles:
We had a post about the true cost of commuting in California and it was interesting how many people justified commutes of 1 to 1.5 hours each way.
*Post courtesy of Doctor Housing Bubble.
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