Oct202009

Is a hard crash better than a prolonged soft landing?

housing_crashThe mess in our housing and financial markets are slowly draining the life out of us. The powers-that-be are killing us softly with their endless song and dance. Our government and the Federal Reserve want to engineer the fabled “soft landing.” So how would we measure their success?

A soft landing for the FED would be a slow and controlled decline of house prices to levels sustainable by local incomes and free-market financing conditions. The reason they will let it drop is to shorten the time they have to support the market. The reason the Federal Reserve does not want to let it crash hard… they do not want their member banks to lose any more money. Wait, perhaps you thought it was because the US Government cares about you and your home prices… victim of the spin machine.

The FED’s mechanism for making the soft landing happen is the control of mortgage interest rates through direct purchase of agency paper. If the government insures it and the FED buys it, they could theoretically completely support the US housing market. There is no limit to the size of the Federal Reserve’s balance sheet. I doubt it would come to that.

The mechanism for recycling bad debt is (1) for the GSEs and the FHA to encase it in a new 30-year fixed loan at very low interest rates and (2) have the Federal Reserve buy that paper and hold it through maturity. The FED would not care about its actual value, it is merely stockpiling the detritus from the housing bubble… A toxic mortgage enema… The Federal Reserve’s Yucca Mountain… It will fester on the FEDs balance sheet — a pestilence contained in a paper sarcophagus where nobody looks and nobody cares.

Soft Landing?

Payments are now affordable with conventional financing on most properties, particularly those outside of Irvine. This is just a fact. The Federal Reserve has accomplished its primary market objective — stabilize prices through creating affordability. I believe prices will continue to fall for a number of other reasons, but payment affordability is no longer driving the price decline.

Now that we have reached payment affordability, how stable is that affordability? and what happens if the system collapses?

You get Las Vegas.

Hard Landing?

clark_county_median_home_price_1991-2011

Above is the Las Vegas S&P Case-Shiller Index with the conceptual stages of a bubble superimposed on it. Las Vegas landed hard; I am bullish on Las Vegas real estate. As you can see, the despair stage can go on for a while and prices can remain depressed and even fall further, but in my opinion, you have much greater downside risk in Orange County than you do in Las Vegas.

Soft Landing? or Hard Crash?

The most common metaphor for a soft or a hard landing is removing a band-aid quickly or slowly. You get the idea, but it doesn’t convey the emotional trauma of an economic recession. The soft landing — to continue the medical metaphor — is like a series painful bruises and abrasions. It isn’t life threatening, but there is nothing pleasant about daily pounding and skin scraping.

The hard crash is like a violent faceplant that is both humiliating and extremely painful — for a short period of time, but then it is over, and you can move on with your life.

In many ways, the hard crash is better. Which would you prefer?