Oct102013

Fed Chair Yellen best choice to reflate the housing bubble

Reflating the housing bubble requires copious quantities of cheap debt. Soon to be Fed Chair Janet Yellen’s loose monetary policies will likely keep the spigots of cheap money flowing into the economy, much of this directed specifically at housing through the federal reserve’s $45B monthly purchases of mortgage-backed securities. Yellen’s penchant for printing money provides the best opportunity for those desiring reflation of the housing bubble.

If Yellen continues to embrace the policies of Ben Bernanke, which seems likely, she will print too much money for too long. I wrote about this problem in How the federal reserve’s printing money impacts housing:

Icarus and endless quantitative easing

Rising interest rates will hurt the banks by making it more difficult to reflate the housing bubble. It will make life difficult for our government issuing all this debt the federal reserve is buying. Rising interest rates will make the debt-service payments on the US debt onerous. Further, rising interest rates will cool an already weak economy and might tip us back into recession. So why not print money indefinitely?

Printing money is dangerous. The only reason the federal reserve gets away with it now is because investors don’t believe their printing is causing inflation. Realistically, as long as we are still deleveraging and writing down copious amounts of mortgage debt, that is probably true. Investors will satisfy themselves with 2% yields on 10-year Treasuries as long as they believe the currency is losing value at less than 2% per year from printing money. In fact, with monetary deflation caused by debt deleveraging, many investors perceive that real interest rates (those adjusted for inflation) are still quite high. In short, as long as we have deflation, low yielding treasuries are a good investment.

Once consumer deleveraging stops and money is no longer being destroyed, further quantitative easing will be inflationary, and if investors believe inflation will exceed the yield they are getting on long-term debt, they won’t buy it. The lack of buyers causes bond prices to drop and interest rates to rise.

Icarus is a character from Greek mythology. He wanted to escape the island of Crete, so his father fashioned him wings made of wax and feathers and instructed him not to fly too close to the sun or the wax would melt and he would crash. Icarus did not heed his father’s warning, and when he flew too high, the wax melted, the feathers fell off, and he crashed back down to earth.

Quantitative easing is much like the flight of Icarus. When the economy got really bad, it was arguably the only way out of our predicament. If they print just the right amount, we can fly to safety. However, if they print too much, if they fly too close to the sun, the melting rays of inflation will cause investors to stop buying bonds, the federal reserve would lose control of long-term rates, and we could have a complete meltdown of the mortgage and housing markets.

This more than theoretical imagining. This is a very real danger.

If the federal reserve prints too much money, inflation expectation will cause investors to abandon the bond market, bond prices would crash, interest rates would spike, nobody could afford today’s house prices at 10% interest rates, and the resulting housing market crash would rival 2008.

I’m not the first to point out this problem. I covered Peter Schiff’s argument in Will the deflating bond bubble cause housing to crash again?.

Perhaps the federal reserve will get it just right. Perhaps they will print money until deflation stops and then an improving economy will make continued printing unnecessary. People will go back to work, earn money, buy homes, and everyone will live happily ever after… or not.

Some reporters are picking up on the problems associated with a Yellen Fed.

Rejoice: the Yellen Fed will print money forever to create jobs

By Ambrose Evans-Pritchard Last updated: October 9th, 2013

… The Fed will be looser for longer. The FOMC will continue to print money until the US economy creates enough jobs to reignite wage pressures and inflation, regardless of asset bubbles, or collateral damage along the way. …

His blunt assessment is accurate. I write daily about the collateral damage associated with our current housing policies geared toward reflating the housing bubble, but no matter what happens, it won’t stop the federal reserve from continuing on this course. Right now, the super low returns on nearly all investment classes is creating asset price inflation in everything. When the federal reserve does raise rates, every asset class will have to be revalued. The federal reserve will deduce it’s better to avoid any nominal price pain by continuing to print money. The inflation-adjusted prices of nearly everything will decline, but investors won’t see the massive paper losses many fear because the federal reserve will protect them — or at least they will try.

She later backed QE to the hilt, fighting a chorus of amateur alarmists who claimed that inflation was poised to take off. She was again proved right. Core inflation in the US is currently hovering near a half century low. The greater danger is still deflation.

The deflation is a direct result of mortgage write downs. During the recession and shortly afterward, there were huge write downs in nearly every loan category, mostly due to Ponzis imploding when they were finally cut off. The mortgage write downs dwarf all others because the mortgage market is so much larger, and houses are so far underwater. Until aggregate mortgage debt starts to increase again, expect to see the federal reserve to continue to print money.

There is little doubt that the she is a dove in today’s circumstances. She tracks jobs. Her lodestar is the “non-accelerating inflation rate of unemployment” (NAIRU). When the rate is above NAIRU, she is a dove: when below, she is a hawk.

Everyone is worried about Janet Yellen because she is currently a dove, and they fear she always will be. Perhaps she is dovish because she believes it’s the right policy in today’s circumstances, but she has the wisdom and fortitude to change her mind and her policies as times change. I hope that’s the case.

My guess is that we are still a very, very long way for NAIRU. Yes, the Fed is committed to tapering QE to zero once the jobless level reaches 7pc (and raise rates once it hits to 6.5pc), and yes, this could in theory happen much sooner than the think want since the headline rate has already plummeted to 7.3pc.

But this headline rate is wildly misleading because so many workers have given up searching for a job. They have fallen off the rolls. The labour participation rate has collapsed to a 35-year low of 63.2pc. It is blindingly obvious that the real rate of unemployment is much higher than it looks. Some of these people have been driven out of the work force for ever, left behind by new technologies, but surely not all.

How will the federal reserve reconcile these facts? Will they use the bogus unemployment figures as an excuse to taper when they know full well we are nowhere near full employment? Or will they later change their policies and print money until both unemployment hits a certain threshold and the labor participation rates recovers? If they were really dovish, they would print money until everyone who wants a job goes back to work. That will be many years after the reported unemployment numbers hit 7%.

The next chairman of the Fed is going to track the labour participation rate. Money will stay loose. Markets have been spared again.

I recently asked How will the Federal Reserve’s continued printing money impact housing? It’s an important question, particularly since we now know that they will continue to print money. Obviously, the federal reserve hopes they can print money, lower mortgage rates, and reflate the housing bubble. It’s the only way they can save their member banks from enormous losses. It’s really not optional. If the bubble does not get reflated, our banking system is still in danger. Of course, they don’t want to alarm everyone by stating that directly, but that’s the reality out there. As long as house prices must go up to save the banks, the federal reserve will keep printing money. It’s really that simple.

[raw_html_snippet id=”newsletter”]

[idx-listing mlsnumber=”PW13202217″ showpricehistory=”true”]

2109 CANDIS Ave Santa Ana, CA 92706

$503,900 …….. Asking Price
$197,500 ………. Purchase Price
7/29/1999 ………. Purchase Date

$306,400 ………. Gross Gain (Loss)
($40,312) ………… Commissions and Costs at 8%
============================================
$266,088 ………. Net Gain (Loss)
============================================
155.1% ………. Gross Percent Change
134.7% ………. Net Percent Change
6.6% ………… Annual Appreciation

Cost of Home Ownership
——————————————————————————
$503,900 …….. Asking Price
$17,637 ………… 3.5% Down FHA Financing
4.25% …………. Mortgage Interest Rate
30 ……………… Number of Years
$486,264 …….. Mortgage
$134,743 ………. Income Requirement

$2,392 ………… Monthly Mortgage Payment
$437 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$105 ………… Homeowners Insurance at 0.25%
$547 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$3,481 ………. Monthly Cash Outlays

($614) ………. Tax Savings
($670) ………. Principal Amortization
$27 ………….. Opportunity Cost of Down Payment
$146 ………….. Maintenance and Replacement Reserves
============================================
$2,369 ………. Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$6,539 ………… Furnishing and Move-In Costs at 1% + $1,500
$6,539 ………… Closing Costs at 1% + $1,500
$4,863 ………… Interest Points at 1%
$17,637 ………… Down Payment
============================================
$35,577 ………. Total Cash Costs
$36,300 ………. Emergency Cash Reserves
============================================
$71,877 ………. Total Savings Needed
[raw_html_snippet id=”property”]