Housing markets in Coastal California are dominated by high wage earners. In the more affluent markets, the GSE conforming loan limit is $625,000, yet the FHA limit is $729,750. GSE conforming loans can be obtained with only 5% down with private mortgage insurance of around 0.62%. FHA loans previously could be obtained with 3.5% down with an PHA insurance premium of 1.25%. The FHA loan which only requires 3.5% down instead of 5% has been very popular despite the onerous insurance premiums because after a massive debt binge and severe recession, most potential homebuyers are still broke.
The loan limits create large breakpoints where borrower costs escalate rather dramatically. Borrowing more than $625,000, the GSE loan limit, requires FHA insurance. At 1.25%, the cost is greater than property taxes here in California. Borrowing more than $729,750 requires 20% down and a higher interest rate. The 20% down requirement eliminates nearly all first-time buyers.
So where does that leave us? The first-time market is limited by the $729,750 FHA loan limit, and costs escalate quickly when loans exceed $625,000. Adding in a 3.5% or 5% down payment creates affordability cutoffs at $660,000 and $750,000. That’s why the market below $660,000 is so active while the market over $750,000 survives based on squatting (See: The move-up market will suffer for another decade). The transition zone between $660,000 and $750,000 is about to become more expensive and harder to penetrate. This will likely slow sales at these price points, and it may cause prices to weaken.
FHA to hike premiums on mortgages
By Les Christie @CNNMoney January 31, 2013: 2:10 PM ET
The Federal Housing Administration is raising premiums and taking other measures in order to bolster its capital reserves and reduce its exposure to risky loans.
NEW YORK (CNNMoney)
Government-insured mortgages are about to get more expensive.
The Federal Housing Administration, which is the largest insurer of low-down payment mortgages, announced Wednesday that it will raise premiums by 10 basis points, or 0.1%, on most of the new mortgages it insures.
Translation: A borrower opting for a 30-year, fixed-rate mortgage who puts 5% or more down will now pay an annual insurance premium of 1.3% of their outstanding balance. And someone who puts less than 5% down will pay a premium of 1.35%.
The agency said it will also raise premiums for borrowers with jumbo loans — or loans of $625,000 or more — by 5 basis points, or 0.05%, and increase the minimum down payment requirement on these loans to 5% from 3.5%.
The increase costs are noticable, but it’s the increase in down payments that will cause the most problems. The mandatory 5% down on loans between $625,000 and $729,750 will be a problem. Some will argue that another $10,000 down for a high wage earner shouldn’t be a problem, but in reality, it is. How much longer will borrowers have to save to scrape together another $10,000? Remember, these are first-time buyers mostly with high wages, but also large student loans, leased cars, credit cards, and expensive tastes. Even the austerity of $1,000 a month will delay many purchases for up to a year.
FHA said it will require most buyers to pay insurance premiums for the life of their loan. A policy that was put in place in 2001 allowed borrowers to cancel premium payments once their debt fell below 78% of the principal balance. One exception will be for borrowers who put more than 10% down at the time of purchase.
This is a deal-killer for me. We are at record low interest rates, so in all likelihood, mortgage rates will go higher from here. Although it may be possible to refinance later to eliminate the insurance premium, it may not be advantageous if refinancing carries a much higher interest rate. It’s very possible some of these borrowers may be paying that onerous FHA insurance premium for as long as they own their properties or up to 30 years.
I believe this will concentrate buying pressure in the $660,000 to $680,000 price range. Borrowers won’t want to go higher and use the FHA loan due to the high insurance rates, and most borrowers won’t have the savings to push much higher than that. Above $680,000, I believe the first-time buyer interest will dissipate considerably.
Additional new policies include a requirement that any mortgage for an applicant with less than a 620 credit score and debt-to-income ratio above 43% must be underwritten manually. Lenders who want to issue loans to these applicants must be able to adequately document why they decided to approve the loans.
In other words, “Lenders, don’t underwrite those loans.” Lenders who stray from those guidelines can expect buybacks when the loans go bad.
The agency also decided to put new restrictions on reverse mortgages, no longer permitting retirees to take such large, upfront payments.
Good. I think reverse mortgages are the worst financial instrument ever created. They are a financial cancer peddled to old people who don’t know any better.
Related: Where are the first-time homebuyers?
The changes are an effort to reduce the agency’s exposure to risky loans and bolster its financial reserves, which have been depleted due to high delinquency rates from the mortgage crisis. The agency did not say when the new rates will take effect.
Last spring, FHA increased both premiums and upfront costs on mortgages. Such hikes make it tougher for mortgage borrowers — especially first-time purchasers who can’t afford the large down payments most private lenders require today, according to Jaret Seiberg, a Washington policy analyst for Guggenheim Partners. “They are the ones most likely to turn to the FHA for credit,” he said.
And that could have a negative impact on the housing market overall. “You can’t have a healthy housing market without a constant influx of first-time buyers,” said Seiberg.
It will cause a weakening of sales and perhaps lower prices. Whether or not that’s a negative impact depends on your point of view. Less indebted borrowers with greater capacity to repay their loans is a good thing even if it means prices must be lower to accommodate.
Higher costs on government loans is a good thing
Taking a broader view of the situation, these increasing costs on government-backed loans are a good thing. Ultimately, we don’t want the government to back 95% of the loans in the housing market. The best way to reduce the government’s footprint is to increase the costs on these loans so that private lenders will find opportunities. For example, some time back I reported that FHA = subprime, 12.4% interest cost of FHA insurance, 50% risk premium. The cost of FHA insurance was akin to taking on a 12.4% second mortgage. As these premiums go up, so does the effective interest rate. Eventually, the cost will be so high that some lender will offer a second mortgage at 12% and make a profit. All the loan programs offered by the government could be replaced with private lending, and if politicians keep jacking up the fees, private money will find niches where it can return. In the end, that’s what we all want because without private lending, taxpayers will absorb the losses if markets become unstable again. We’ve paid enough this time around, so I’d rather not be on the hook for the next one.
Jumbo Market discounts are still steep
The jumbo loan market is where the bad loans are still concentrated. The move-up market will suffer for another decade. Banks are loathe to foreclose on these squatters because the market is so thin, and when they do foreclose, the discounts are large and the losses are too. Today’s featured REO is a peak purchase in Newport Coast. The property is asking 22% less than its peak purchase price, and it will likely be discounted further to find a buyer.
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Proprietary OC Housing News home purchase analysis
18 CORAL CAY Newport Coast, CA 92657
$2,975,000 …….. Asking Price
$3,824,000 ………. Purchase Price
10/6/2006 ………. Purchase Date
($849,000) ………. Gross Gain (Loss)
($238,000) ………… Commissions and Costs at 8%
============================================
($1,087,000) ………. Net Gain (Loss)
============================================
-22.2% ………. Gross Percent Change
-28.4% ………. Net Percent Change
-3.8% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$2,975,000 …….. Asking Price
$595,000 ………… 20% Down Conventional
4.11% …………. Mortgage Interest Rate
30 ……………… Number of Years
$2,380,000 …….. Mortgage
$605,588 ………. Income Requirement
$11,514 ………… Monthly Mortgage Payment
$2,578 ………… Property Tax at 1.04%
$208 ………… Mello Roos & Special Taxes
$744 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$600 ………… Homeowners Association Fees
============================================
$15,644 ………. Monthly Cash Outlays
($1,681) ………. Tax Savings
($3,362) ………. Equity Hidden in Payment
$863 ………….. Lost Income to Down Payment
$392 ………….. Maintenance and Replacement Reserves
============================================
$11,856 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$31,250 ………… Furnishing and Move In at 1% + $1,500
$31,250 ………… Closing Costs at 1% + $1,500
$23,800 ………… Interest Points
$595,000 ………… Down Payment
============================================
$681,300 ………. Total Cash Costs
$181,700 ………. Emergency Cash Reserves
============================================
$863,000 ………. Total Savings Needed
The property above is available for sale on the MLS.
Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
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41 Responses to “FHA insurance premium hikes will impact high wage earners most”
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“This is a deal-killer for me. We are at record low interest rates, so in all likelihood, mortgage rates will go higher from here.”
I think you are responsible, me, and most of the readers on this blog. However, I think ponzi borrowers will pay just about anything to get that house. They didn’t learn one thing from the last bubble, but they also didn’t any penalties too. But your are 110% right on the higher costs, if we have a FHA, then tax money should be used to fund this program. You a 3.5% down payment loan, then you need to pay the price.
You’re probably right that few learned any lessons from the housing bubble. I’m still waiting for the NAr to state the housing bubble crash was a once-in-a-lifetime anomaly and that we should expect 10%+ appreciation forever.
Some will pay any price to get a home. Those people can pay that FHA insurance for 30 years to make up for the losses from the loans made during the bust. Personally, I’ll pass.
FHA loans now will solely attract borrowers unable or unwilling to put 10%+ down on a purchase or refinance. So, FHA will make more money charging higher Annual MIPs and extending them for the life of the loan, but their borrower pools are going to degrade dramatically. Who is going to choose an FHA loan? It’s reverted to what FHA was before 2008 – a program for high-risk borrowers with little cash. Maybe that’s what it should be, but this reversion comes with risk. Hopefully they’re charging sufficiently to cover it.
“Who is going to choose an FHA loan?”
I think pre-2008 there were choices with sub-prime lenders, but right now I still FHA as the serious game in town. With qualified mortgages coming in 2014 I really only see FHA giving these low down payment loans. Funny how Fannie, Freddie, and FHA are automatically qualified mortgages.
The big problem for the many prospective OC sellers who’re waiting around for prices to return to peak (LOL) …. when the next crisis hits, ‘this’ will essentially be its starting point..
http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2013/01/foodstamps%20vs%20payrolls.jpg
At least the growth in food stamps is leveling off. That’s a good thing, right?
Good thing indeed. So you see, nobody can say and be taken seriously, that I have a ‘glass half empty’ bias
Do food stamps count as W-2 or 1099 income?
Consumer Confidence Held Back by Payroll Tax Hike
Consumer confidence picked up somewhat in January, but the recent payroll tax hike put a ceiling on any major gains, according to the latest survey of consumers from Thomson Reuters and the University of Michigan (UMich).
The Index of Consumer Sentiment climbed slightly to 73.8 in January from December’s 72.9. The index read 75.0 in January 2012.
Meanwhile, the two components of the index moved in opposite directions: The Expectations Index posted a gain to 66.6 in January from 63.8 in December, while the Current Conditions Index declined to 85.0 in January from 87.0 in December.
According to a release accompanying the survey, January’s potential gains were dulled by the payroll tax increase, which has had a significant impact on lower income households; most of January’s improvement in confidence actually came from households with incomes above $75,000.
“The personal finances of consumers has weakened considerably compared with the closing months of 2012,” Thomson Reuters/UMich said. “The January decline was due to households with incomes below $75,000 reporting more frequent losses than could be offset by upper income households.”
According to the survey, 13 percent of lower income households reported gains in disposable income in January (down from 21 percent in December) compared to 38 percent of upper income households (up from 25 percent).
While concern about disposable income has some households fretting their current situation, more consumers expressed optimism that economic conditions will improve rather than worsen in 2013. However, while respondents are less fearful of a downturn this year, nearly 60 percent expect a downturn sometime in the next five years.
Overall, consumers said they do not anticipate a significant decline in the unemployment rate in 2013, though they do anticipate a slowly falling rate.
Why the GSEs aren’t going anywhere
Remember when Spencer Bachus said that Fannie Mae and Freddie Mac should be in liquidation, not conservatorship?
The issue was discussed during a general session at the American Securitization Forum.
Yeah… About that… Well, the GSEs ain’t going anywhere. Here are just a few reasons:
Home prices are increasing.
Negative equity positions are declining.
Foreclosure rates are slowing.
Investment funds pining for more supply to fulfill REO-to-Rental targets.
Private-label securitization is slowing increasing.
The banks and GSEs are making nice again (see: BoA / Fannie settlement), though there’s still a ways to go.
The recent CFPB release includes a specific 8-year plan for the role of Fannie Mae and Freddie Mac in the US housing market.
Most importantly… The GSEs are profitable now.
So what exactly is the problem? Nothing, unless you care how much the government is involved with the housing market. If you’re looking for re privatization of the mortgage market, with FHA dropping back to a 10-15% market share, there are a few promising signs.
FHFA mortgage guarantee fees (“g-fees”) are increasing over time.
Community banks are retaining more loans on their books. According to CUNA’s November 2012 report, residential first mortgages comprised more than 20% of their total lending portfolio. By 2005, that figure dropped to 9.8%. As of November 2012, that number inched upwards to 10.8%. Not an enormous change, but certainly moving off of its historical lows.
Fannie Mae & Freddie Mac are moving out on the risk curve, causing FHA to move out on the risk curve opening opportunities for the private market.
Pent up household demand. We have a cohort of 20s & 30-somethings that have been renting since leaving college during and after the housing crash.
Increasing household formation.
In the end, even the activity trends pushing mortgages back to the private market won’t overcome the overwhelming effects keeping the GSEs right where they are.
The affect of ZIRP and QE, bubbles all over the place.
JPMorgan Joins Rental Rush For Wealthy Clients: Mortgages
By Margaret Collins, John Gittelsohn & Heather Perlberg – Feb 4, 2013 7:21 AM PT
JPMorgan Chase & Co. (JPM) is giving its wealthiest clients the chance to invest in the single-family rental market after other investments linked to the U.S. housing recovery jumped in value.
The firm’s unit that caters to individuals and families with more than $5 million, put client money in a partnership that bought more than 5,000 single family homes to rent in Florida, Arizona, Nevada and California, said David Lyon, a managing director and investment specialist at J.P. Morgan Private Bank. Investors can expect returns of as much as 8 percent annually from rental income as well as part of the profits when the homes are sold, he said.
The bank’s wealthy clients are joining a growing number of private-equity firms and individuals buying rental homes in the regions hardest hit by the U.S. housing crash. Blackstone Group LP (BX) has spent $2.7 billion, and said last month it accelerated purchases as home prices rise faster than anticipated. Even after home values in November gained by the most in six years, investors are wagering on rental properties as an alternative to housing-related stocks and mortgage debt that’s already soared.
“The traditional places people might look — homebuilder stocks and appliance makers — probably aren’t the best places for new investments,” said John Buckingham, chief investment officer at Al Frank Asset Management in Aliso Viejo, California, which oversees about $4.5 billion. “They’ve had fantastic runs.”
Builders Gain
PulteGroup Inc., the largest homebuilder by market value, was the biggest gainer on the Standard & Poor’s 500 Index last year, rising 188 percent, helping an index of 11 builders more than double since the end of 2011, and raising concern among analysts including Michael Widner of Stifel Nicolaus & Co. that growth is already priced in.
Whirlpool Corp. (WHR), a home-appliance maker, was the third-best performing stock in the S&P 500 Index last year, rising 114 percent, and subprime-mortgage bonds gained more than 40 percent.
The investments rallied as the housing recovery strengthened through 2012 with the Federal Reserve pushing mortgage rates to record lows, and as institutional investors increased their purchases of foreclosed homes. Home prices in 20 U.S. cities rose 5.5 percent in November from a year earlier, the most in more than six years, an S&P/Case-Shiller index of property values showed last month.
Pooling Investments
New York-based JPMorgan, whose private bank oversees $877 billion, started pooling investments from its clients in mid- 2012 into a partnership to purchase distressed properties, betting that prices will rise over the next several years and provide investors with income from renters along the way, said Lyon. The firm uses a third-party manager to find homes, buy and manage them, he said, declining to name the firm.
The goal is to sell the houses within three to four years in one of three ways: through an initial public offering of a real estate investment trust, a sale to an existing REIT or to an institutional buyer such as a pension fund, Lyon, who’s based in San Francisco, said. Clients will receive a share of any price appreciation depending on the size of their investment.
The strategy is similar to institutional buyers including Blackstone, the world’s largest buyout firm, Thomas Barrack’s Colony Capital LLC, and Oaktree Capital Group LLC. (OAK) They’re aiming to profit from low prices on distressed properties, often those in foreclosure and sold at auction — and the demand for rentals from people who don’t want to own a home or can’t qualify for a mortgage.
I was ahead of the curve on getting people to invest in funds that buy and hold single-family detached homes.
I was behind the curve getting my Roth IRA ready to purchase one of those homes. That would have been awesome.
More on the ‘numeraire’…
Enjoy!
Rickards: ”gold is the real base money” …
http://jimrickards.blogspot.com/2013/02/central-banks-repatriating-gold.html
“…Remember, these are first-time buyers mostly with high wages, but also large student loans, leased cars, credit cards, and expensive tastes…”
When talking about higher-earners who buy these over-priced coastal CA homes, you left-out their biggest expense! Their biggest single expense is income and payroll taxes! I’m not making a political statement. It’s just fact. If you’re a professional making $100k+ married to another professional making $100k+, your federal and state payroll and income taxes are by far your largest expense.
After taxes, your rent or mortgage competes with your student loan payments for a distant second place…
Very true. Wait until they put a cap on deductions in place. That will seriously weaken the $600,000 to $800,000 market in Coastal California because it will drive everyone’s cost of financing much higher.
Don’t forget sales tax. In California the homebuying class can very easily send 50-60% of its gross income down the twin ratholes of Federal and state spending.
Really what has been learned by the housing market collapse?
With banks getting bailed out (Bush’s 0.75 trillion was too low, Barry’s 3.0 trillion was also too low, what the next give away/), non-recourse loans in CA, new ads claiming govt backed programs to get you out of FC and available 250% loans, $450 per month to drive away in a new luxury car, the siren songs of another govt assistance programs if you can’t afford to pay your mortage, 3.5% FHA backed loans,
With a 3.5% FHA, an overpayment of $100,000 is really only $3500 up front and can be though as rent insurance. If I don’t pay, I can squat for 2+ years for only $25,000. That’s real affordability — much lower than my rent of $34,000 per year.
Tell me, what lesson has been learned?
We’ve learned how to game the system. Moral hazard was an inevitable result of the bailouts, and over the next five to ten years, we will see the repercussions of the new rules in housing finance.
Don’t worry, the banksters will be the first to know how to game the systems because they help write the laws. They will also make it a little bit more diffcult to use the old rules to game the systems. You will need their help in that matter.
Your banksters would be powerless if they didn’t have a large class of customers who want a free lunch, and a big cadre of politicians who are very willing to promise it to them.
If citizens stopped believing it was possible to get something for nothing, none of these hucksters would have any power.
The power in govt is to give something that you’re not really entitled to and it is called discretionary spending. That goes not only in awarding contracts, pork spending, but also exemptions, tax breaks to their friends and punishing their enemies and those that don’t make the proper contributions. In the current housing market, it’s to cover their bad bets. Nothing new — in 1990′s one insurance company got the govt to cover their billions loss with one or two million in contributions. There was only one company that got this hand-out.
More bubble callers.
This Is Housing Bubble 2.0: David Stockman
Many have named a U.S. housing recovery as a bright spot in a so-called broader domestic economic recovery.
And data seems to support this analysis, despite a slowdown in sales momentum at the end of the year. Existing home sales in December were up 12.8% from the same time in 2011, with the total number of sales in 2012 rising to the highest level in five years, according to the National Association of Realtors. Meanwhile, the annual price for existing homes also jumped to the highest level since 2005, with the median price of a home up 11.5% in December from the same period in 2011.
But David Stockman, former director of the Office of Management and Budget in the Reagan Administration sees little to get excited about.
He tells The Daily Ticker, “I would say we have a housing bubble…again.”
Stockman argues a combination of artificially low interest rates and speculation are to blame, not unlike the last boom and bust cycle in real estate.
“We don’t have a real organic sustainable recovery because in a world of medicated money by the central bank, things aren’t what they appear to be,” Stockman argues.
And according to Stockman, it’s this medicated, cheap money being put to work by investors that’s driving the apparent healing in some of the hardest hit real estate markets in the country.
“It’s happening in the most speculative sub-prime markets, where massive amounts of ‘fast money’ is rolling in to buy, to rent, on a speculative basis for a quick trade,” he contends. “And as soon as they conclude prices have moved enough, they’ll be gone as fast as they came.”
By ‘fast money’, Stockman is referring to professional investors like hedge funds and private equity firms. To his point, global investment firm Blackstone (BX) has spent more that $2.5 billion on 16,000 homes to manage as rentals, according to Bloomberg. It’s now the country’s largest investor in single-family homes to manage as rentals, with properties in nine markets. And Blackstone is joined by others like Colony Capital LLC and Two Harbors Investment Corp. (SBY) in trying to turn this market into a new institutional asset class, Bloomberg reports.
Stockman argues the problem in housing is the two forces needed for a recovery, first-time buyers and trade-up buyers, are missing. With the combination of 7.9% unemployment and staggering student loan debt, he doesn’t see a young generation of new home buyers coming into the market. And with baby boomers heading for retirement with less than adequate savings, he thinks they’ll be trading down with their homes, not up.
Stockman sees a rise in interest rates as the trigger for any kind of bust. He says you can’t have zero rates forever, referring to the Fed’s ZIRP and quantitative easing policies of the last several years.
“As soon as the Fed has to normalize interest rates, housing prices will stop appreciating and they’ll probably head down,” he explains. “The fast money will sell as quickly as they can and the bubble will pop almost as rapidly as it’s appeared. I don’t know how many times we’re going to do this, and the only people who benefit are the top one percent – the hedge funds, the LBO funds, the fast money people who come in for a trade, make a quick buck, and move along to the next bubble.”
Mortgage rates, for their part, rose from an average 3.42 percent to 3.53 percent on Thursday, the sharpest increase in 10 months, according to the weekly survey of 30-year mortgages by Freddie Mac, the government-backed mortgage company. Even still, mortgage rates are hovering around their lowest levels in more than 30 years.
““We don’t have a real organic sustainable recovery because in a world of medicated money by the central bank, things aren’t what they appear to be,” Stockman argues.”
He is exactly right. …
““As soon as the Fed has to normalize interest rates, housing prices will stop appreciating and they’ll probably head down,” he explains. “The fast money will sell as quickly as they can and the bubble will pop almost as rapidly as it’s appeared. I don’t know how many times we’re going to do this, and the only people who benefit are the top one percent – the hedge funds, the LBO funds, the fast money people who come in for a trade, make a quick buck, and move along to the next bubble.””
On both counts.
“…in a world of medicated money by the central bank, things aren’t what they appear to be…”
Just love that term “medicated money”. That’s priceless.
Its the first time I have seen that term used.
Yeah, in the world of financial crack cocaine, you have to keep increasing the dosages to keep getting numbed up.
“medicated money” It’s more like the meth money. It fast upper that will last a short while. Just like a tweeker, the Ponzi money addict only learn how to game the system. The crash is ugly in both cases.
Crack cocaine, is also a good analogy. Coke make makes the addict feel invinciable. Lots of WS were on cocaine. Crack was for the poor folk. The law through the book at the crack folks and gave many of the cocaine addicts a pass. Same with the Ponzi schemes.
Yeah, but who believes that interest rates will go up. Has anyone heard of Japan? We are Japan.
It’s entirely possible we will see record low interest rates through the end of 2015. Eventually, these rates have to rise, or the value of our currency will plummet. The main reason Paul Volcker raised interest rates in the late 1970s was to save the dollar.
Nobody wants to buy any more JAP CRAP…
http://www.zerohedge.com/news/2013-02-03/worlds-biggest-retirement-fund-considers-selling-its-japanese-bonds
US is number 3 on that graph, behind Greece.
Here’s an interesting article on the underlying inflation — meaning the devaluation of the dollar:
http://www.forbes.com/sites/johntamny/2013/02/03/ronald-reagan-would-not-be-tricked-by-todays-low-inflation/
The interesting point is that the destruction of the currency is a self-catalyzing destructive process, since it drives investment into “hard” assets (e.g. commodities and real estate) which, precisely because they are low risk, provide very little of the more speculative investment necessary for future economic growth. Every dollar a wealthy man or fund puts into real estate or oil futures is a dollar not lent to an entrepreneur to develop new technology to drive economic growth.
Hence inflation — currency devaluation — not only destroys savings, it starves the economy of exactly the forward-looking investment it needs to grow, so that it causes stagnation and low economic growth.
Seen that way, we can directly connect ZIRP and QE with the quarter after quarter of 2% GDP growth and the terrible unemployment numbers (which only robust economic growth can move).
The amazing irony is that the clowns now running the show claim that the ZIRP and QE are needed to “jumpstart” the economy — when in fact those policies are exactly what is preventing it from rebooting. As long as the dollar is being rapidly devalued, investment money will flow to “safe” = “non-jumpstarting” investments, and economic growth will be anemic. The effect is the opposite of what they claim to be aiming for.
Are they just stupid? Maybe. I think it more likely they are intellectually corrupt. These are people whose Number 1 concerns are “fairness” and other social-justice issues, which they see are best supervised by government. Their first goal is continuing importance of government, and its continuing ability to dominate the decisions of individuals. Economic growth is not only irrelevant to this goal, it actually works against it: the more people have good jobs, earning good pay, the less they are depending on the decisions of government, the more they question paying hefty taxes, the less they hang on the words and wishes of Secretaries of the Treasury, Majority Leaders, or Chairmen of the Federal Reserve.
I am still not sold that the central banks hopes of inflation will work. The idea that deflation, like that of the Great Depression, is going to get us rather then inflation is more likely. Think of the hundreds of trillions of derivatives (and the bubble that it has become) out there that are just one tumble away from blowing away the bank’s balance sheet and killing the zombies.
If deflation truly is the bigger danger, then the policies of the federal reserve are the right ones. Printing money is inflationary. If the larger forces are deflationary, then printing money offsets that problem. Only time will tell which policy is right.
Have you priced replacement parts to maintain rental property, automobiles? In the last 6 years, the price of materials have doubled. The durability of plumbing and HVAC has gone way down to make the effect of good inflate even harder too deal with. I have trouble passing on the cost to the renters due to stagnation of their wages.
Well, part of the problems is that more than one phenomenon goes under the heading of “inflation.”
You have wage and productivity driven inflation, in which a boost in productivity (e.g. the discovery of fracking) or surge in working-age population (e.g. demobilization of an army after war) or pent-up consumer demand (e.g. after wartime rationing is discontinued) which boosts wages or disposable income, which then bid up prices.
You have supply shock inflation, in which a sudden increase in the cost of some input (a drought boosting the price of food, an oil field runs dry) pushes up the prices of things that use that input, which filters through a little to increased wages of producers and the prices of related things (restaraunt meals).
And the most pernicious and destructive, which is the destruction of a currency, which makes the value of a currency, relative to the things it can buy, plummet. This hikes both wages and prices, but prices always more than wages, unfortunately.
By far the worst aspects of currency destruction inflation, however, is that it destroys rational investment. Since holding cash is no longer plausible, investors are forced into the nearest equivalents — gold, commodities, real estate, sometimes stocks and bonds — resulting in asset bubbles, in a desperate search for real return. If people in desperation finally give up on real return and settle for consumption, rather than see their savings simply evaporate, you get hyperinflation, as the currency becomes worthless relative even to consumption. With the abandonment of rational capital flows, the entire machinery of modern economics grinds to a halt, because without capital investment labor is worth approximately squat — what a cave man’s labor is worth.
The Democrats would like you to believe that the sources of “inflation” don’t matter — all that matters is the fact of rising prices. They want you to believe the third type of inflation (currency devaluation) can produce the same results as the first (wage driven). Their idea is that if prices can be made to rise, by whatever means, this will automatically mean wages will rise, and you get a “virtuous circle” of wage and price rises, which can be kept under control by a judicious control of interest rates.
It’s a theory which has zero historical and empirical support. Every time currency has been devaluated, it has not led to economic growth. It leads, on the contrary, to stagnation, asset bubbles, and a crash in real rates of return and the real value of labor — crashing wages, however they are priced in nominal terms.
The essential problem is a confusion of the symptom — inflation, the rising of prices — with the cause (either surging productivity or currency devaluation), and to fantasize that anything that produces the same symptoms must ipso facto produce the same result as the cause in which you would like to believe.
This is similar to the fallacy being exhibited in Argentina today, where El Suprema Kirchner has decreed a freeze on prices. She confuses the symptom of rising prices with a cause, and believes if she forceably controls the symptom (by freezing prices) she can control the underlying causes. This makes no more sense than taking aspirin to treat a raging infection, thinking that bringing down the fever will eliminate the underlying cause.
It may be worth pointing out that currency devaluation can have a real and helpful economic impact if you have a large external economy from which you can “steal” wealth by devaluing your currency relative to theirs. This has been used many times by “developing” countries, including the United States in the 1930s, and the Japanese in the 1980s and the Chinese more recently. If you devalue your currency relative to someone else’s, you can cause real capital to flow into your economy. Unfortunately, when as now all the major economies are playing this zero-sum game, there can be no lasting winner.
I agree that there is inflation in certain goods like food, energy and certain building materials, but at the same time we have massive deflation in certain other assets (housing), which overall push everything towards deflation. Add to that the salary deflation and not just purchasing power loss due to inflation of consumer goods.
That is the major problem. While there are new jobs created they are lower salaried if not lowered skilled jobs.
The other side to this is the huge derivatives market is hanging in the balance and a 10% loss on that could be 70 trillion minimum (assumming a 700 trillion dollar derivative market, which is conservative). There are not enough printing presses in the world to replace that amount of value, and that is only a 10% loss.
This is the true fear that the FED is worried about. Now is that right, that is a different question.
What are you talking about? You sound like you’ve been drinking The Bernank’s Kool-Ade. There’s no deflation in RE prices, because of a pull-back in demand. You had a ridiculous asset bubble that eventually exceeded even the greater fool’s ability to borrow and therefore popped. The organic demand for houses qua houses — places to lived — never changed at all, so far as anyone I know has said. So there was never any deflation in their prices. What you had was a scramble for houses as investments that eventually ended, returning the bubblicious prices of houses to something arguable approaching normal (but probably not yet, still).
Furthermore, it’s absurd to add together a reduction in price of this asset with a rising price of this commodity and say, oh well, on average it balances — so there is no inflation!
Wrong. Just because you can add two numbers mathematically doesn’t mean it makes any sense at all to do so. If I lose my $50,000/year job but my two neighbors down the street get $25,000 raises, it is it meaningful to say well on average we’re all just as well off as before?
Both the rise in prices of commodities and the existence of asset bubbles point to the same underlying cause — devaluation of a currency. Both tell you that the value of cash in hand is declining rapidly, which means (1) it takes more dollars to buy the same value of milk and gasoline, and (2) people will hunt avidly for “hard” assets for which they can trade their increasingly worthless dollars.
It is another asset bubble that I am reffering to. The derivative instrument asset bubble, which is what the FED is afraid will burst and bring everything down.
Do I agree with them, that we should be saving the investors (mostly banks / hedge funds and large corps) at the price of the regular citizen? No. I am just telling you why he is doing this and that it will fail.
Once that bubble deflation worse then the one that hit during the depression will hit and the savers will finally get their day in the sun (if any will be left after the inflation that is preceding the deflationary cycle we are due).
An asset bubble is the result of inflation, not deflation. The popping of an asset bubble is not deflation. It’s just a bubble popping.
Look at it this way. If bonds crash, it is NOT going to drive down the price of milk and gas. So that crash is not deflation. In deflation, e.g. during the Great Depression, the price of nearly everything comes down.
Carl,
Your comments are amazing. I’m glad you share your insights with blog readers. Thanks.
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