This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux

<< PREVIOUS

The belief that the Federal Reserve kept interest rates too low, for too long, is one which is now nearly universally held. Well, outside the Fed, that is. Here’s a smattering of quotes which show how the view of Greenspan’s loose monetary policy (and now Bernanke’s) varies from group to group, and from year to year.

“The best response to the housing bubble would have been regulatory, rather than monetary.”
- Fed Chairman Ben Bernanke, January 3, 2010

“Given the decloupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have prevented the housing bubble.”
- Former Fed Chairman Alan Greenspan, March 11, 2009

“The reason I wrote this book was so that the average person could understand the scope of the housing bubble, and what its bursting was going to mean and…where blame should be placed…at Greenspan’s Fed.”
- William Fleckenstein, on his book Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve

“Bernanke has done a great job, post-Lehman. But going into this crisis, he really was the architect, if not the co-collaborator, in creating some of the conditions in the economy that led to the recession.”
- Stephen Roach, chairman of Morgan Stanley Asia, Ltd, August 25, 2009

“We artificially lower interest rates. It’s been going on for 10 years and longer and now we’re bearing the fruits of that policy.”
- Ron Paul (R-TX) at Chairman Bernanke’s testimony to the Joint Economic Committee, Nov. 8, 2007

“American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.”
- Then-Fed Chairman Alan Greenspan, during a speech on February 23, 2004

(click to enlarge image)

NEXT >>

By ANDREW JEFFERY

This post first appeared on Minyanville.

Of the myriad highbrow economic debates currently raging throughout the world of punditry, academia and government policy, few are as contentious as the one over the future of prices: Inflation vs. Deflation.

Indeed, the endgame for this issue is not insignificant, as many believe our economic future hinges on the Federal Reserve’s ability to deftly engineer a return to steady, manageable inflation. To say the least, this is no easy task.

With the unemployment marching upwards, credit markets still largely frozen and global trade grinding to a halt, the American economy is in desperate need of a monetary jolt. The trouble for Fed Chairman Ben Bernanke is that with interest rates already at zero, he’s being forced to rely on so-called “quantitative easing” to pump money into our badly bruised financial system.

These efforts are being managed through the alphabet soup of new lending programs like TALF, TAF, CPFF and others.

Meanwhile, a glut of savings from the developing world coupled with reckless financial alchemy caused debt loads to skyrocket to unsustainable levels. The ongoing destruction of that debt, discussed often by Minyanville’s Kevin Depew and Mr. Practical, is now raging at full speed, as assets of all types have come screaming back to earth.

Bloomberg highlights the debate by focusing on 2 highly regarded economists with divergent views on inflation and its causes.

John Maynard Keynes, a 20th century British economist gained notoriety for his thesis that inflation was controlled by supply-demand fundamentals within an economy. He advanced the view that well-directed government spending could help a country balance economic growth with a moderate, healthy rise in prices.

Western politicians jumped on the Keynesian bandwagon during much of the last century to support a vast expansion in government spending and intrusion into the private sector.

Opposing Keynes was Milton Friedman, who instead believed that “inflation is always and everywhere a monetary phenomenon.” Friedman’s focus on monetary policy, that is, interest rates and controlling the flow of money through a country’s economy, clashed with the Keynesian view that inflation could be controlled with fiscal measures and legislation.

Bernanke is doubling down on Keynes, evidenced by recent lending initiatives, bailouts of financial institutions like American International Group (AIG) and his support of President Barack Obama’s massive fiscal spending program. The Fed’s involvement in cleaning up the balance sheets of Citigroup (C) and Bank of America (BAC), along with efforts to jumpstart the mortgage market have also diminished its ability to remain apolitical and tend solely to the needs of the economy.

The Fed’s gamble is a bold one, as inflating our way out of a deflationary debt unwind could lead to a rapid, uncontrollable rise in prices should the economy rebound sooner than expected.

For example, big oil companies like Exxon Mobil (XOM) and Chevron (CVX) will be reticent to invest in new technologies or drill new wells should crude prices remain low. Limited production capacity could squeeze supply when demand picks back up, leading to a rise in prices.

This trend of firms retrenching in response to rapidly waning demand for goods is being mirrored throughout the economy. And although the Fed promises to take back the monetary stimulus when the economic growth returns, the timing and political implications of such a move are anything but a slam dunk.

And unlike other more esoteric debates over economic ideology, the result of the inflation vs. deflation slugfest has real implications for all Americans.

Inflation, while generally viewed as a necessary evil for economic growth, lines the pockets of those invested in financial and other economic assets at the expense of those on the lower rungs of the economic ladder. If real incomes rose at the same rate prices did since the Fed was created in 1913, they would currently stand at $300,000 per year, six times the current median household income of around $50,000.

In other words, Americans earn about 80% less, in real terms, than they did 100 years ago.

Deflation, while causing a drag on the economy at large, benefits those making less money as each additional dollar they earn stretches further. Meanwhile, at the top of the economic spectrum, the wealthy dislike deflation since their stocks, bonds, commodities, homes and Rolexes all fall in value.

As calls for a stock market bottom and impending economic recovery gain momentum, so too will predictions of rampant inflation. Ironically, Bernanke and fellow central bankers around the world are counting on the hangover from the financial crisis to be bad enough to forestall a resurgence in demand and enable them to slowly, carefully withdraw their monetary steroids.

Whether that will be possible, or even politically acceptable is anybody’s guess.

By ANDREW JEFFERY

This post first appeared on Minyanville.

“If at first you don’t succeed, try, try again” - and you certainly can’t fault lawmakers for a lack of persistence in trying to stem the epidemic foreclosures plaguing America’s housing market.

Sadly, they insist on trying the same failed strategies over and over again.

For more than 18 months now, Congress has resolutely believed loan modifications are the path out of the housing jungle. But despite a blitzkrieg of public-relations campaigns and benevolent-sounding foreclosure-prevention programs like “Hope for Homeowners,” “HOPE NOW” and the latest, the Federal Reserve’s “Homeownership Preservation Policy,” modification efforts continue to sputter.

Even private-sector programs announced by big banks like Citigroup (C) and Bank of America (BAC) have had only marginal success.

After months of relentless pressure from the House and Senate alike, the Fed’s new policy allows it to review loans supporting the assets it purchased after it rescued Bear Stearns and AIG (AIG) for potential modifications. Barney Frank, the House Financial Services Committee Chairman, told reporters yesterday, “This is a very big deal.”

Actually, Mr. Frank, it’s not.

The assets acquired when the Fed and Treasury Department backed the JPMorgan (JPM) buyout of Bear Stearns and nationalized AIG were derivatives, not actual loans. These mortgage-backed securities are supported by thousands of individual mortgages, while the interest in those underlying loans was sliced up and allocated to countless securities, derivatives, and derivatives of derivatives.

Securities owners can’t modify mortgages: The rules about altering loan terms are pre-determined in securitization documents. It’s left up to loan servicers to implement the rules, whether the security owners like it or not.

Nevertheless, according to Bloomberg, the Fed — after identifying which loans it holds a fractional interest in — will encourage the servicers of those residential mortgage-backed securities “to implement a loan modification program that is consistent with this policy.”

Congress, Treasury and now the Fed have been trying to months now to get servicers on board with modification efforts, to no avail. Even the FDIC, whose highly touted modification program is being tried out at defunct California thrift IndyMac, has been unable to successfully – and sustainably — modify loans en masse.

The reason modification efforts aren’t working — amid evidence that Washington continues to ignore the root of the housing problem — is that the vast majority of loan defaults are being caused by job losses and negative equity. Borrowers can’t get a new loan without a job, nor can they qualify for a modification if they owe more on their house than it’s worth.

According to data released by JPMorgan yesterday, average equity for subprime loans stands at less than 5%.


Click to enlarge

It’s negative for all Alt-A adjustable rate mortgages.



Click to enlarge

Average equity in jumbo prime loans, which are experiencing defaults at faster rates than either subprime or Alt-A, has tumbled from 45% in January 2006 to less than 20% at the end of last year.


Click to enlarge

And, even as regulators force mortgage rates down to record lows to encourage buyers to step in — catching the falling knife of tumbling home prices and risking financial ruin for the benefit of the rest of us — property values continue to fall.

Meanwhile, regulators and lawmakers continue to parade bold foreclosure-prevention efforts before the public. And they’ll keep trying - even if it bankrupts the country.

By ANDREW JEFFERY

This post first appeared on Minyanville.

In recent months, headlines have been popping up noting that rents – finally – are beginning to follow home prices into the abyss.

Since the housing market began to crumble, would-be homeowners were forced to become renters, keeping demand for rental units relatively strong even as home prices fell. Now, however, as landlords convert condos into rentals, supply is beginning to move in tenants’ favor.

And while this is welcome news for millions of renters around the country, its impact on consumer price measurements could materially impact mounting deflation expectations.

The reason can be found in the nuances of how the US Bureau of Labor Statistics measures the Consumer Price Index, or CPI. The CPI is the most widely quoted gauge of inflation, it being the easiest to explain to the consuming public. Tally up a basket of commonly purchased items, see how their prices compared to last month, then last year and voila! consumer prices at your fingertips.

In realty, of course, it’s a bit more complicated: Just take a gander at this sophomoric equation from a recent CPI release:

Riiiiiiiiiight.

The most heavily weighted item in the CPI is something known as Owners’ Equivalent Rent, or OER, which accounts for almost 24% of the total index. OER is the government bean counters’ preferred method for measuring the cost of owner occupied housing, calculated by figuring out how much the median homeowner in the country would have to pay to rent his or her family’s dwelling.

Many observers, Minyanville’s Professor Mish Shedlock included, believe the CPI has been understating inflation for years by ignoring housing prices. Now, that rents are beginning to fall, however, inflation readings could become dire.

As Professor Kevin Depew noted last week, the December CPI registered the lowest inflation reading since 1980. And while most media outlets touted the effect of dramatically lower energy prices, OER is quietly reversing a long-standing trend and contributing to the decline.

Examining the data, available on the BLS’ website, OER has been steadily trending upwards for years. Even though the housing market peaked in late 2005, OER rose in 2006, 2007 and even 2008. The rate of change, however, is slowing. Notably, in December 2008, OER rose just 0.08% from November, breaking from the rest of the year’s trend.

And while 1 month does not a trend make, the data support stories from Manhattan to Los Angeles of landlords giving in to thrifty tenants shopping for the best deal. With mounting job losses and weak economic conditions persisting, this will be an important trend to watch in coming months. Property liquidations by big banks like Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C) will add to housing supply, further pressuring rents.

CPI data matter, despite their myriad of potential problems, because of their effect on inflation expectations - or in this case, deflation expectations.

Federal Reserve officials, including Chairman Ben Bernanke, are wary of these expectations because they represent future consumer behavior. In a speech last summer, as energy prices rose to all-time highs, Bernanke said “Some indicators of longer-term inflation expectations have risen in recent months, which is a significant concern for the Federal Reserve.”

Fearful of higher prices in the future, consumers increase buying now, spurring demand and pushing prices up even further. The same is true the other way. If the public thinks prices will keep falling, they will delay purchases, waiting for a better deal down the road. This weakens aggregate demand, accelerating price declines.

So as rents, the largest component of the CPI, continue to fall, pricing measurements are likely to signal deflation, even as conventional wisdom calls for hyperinflation. And as a deflationist attitude gains currency, social mood continues to darken, and consumerism is shunned, lower prices will ultimately become a self-fulfilling prophecy.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Treasury Secretary Hank Paulson is hoping he’s found the magic bullet to solve the US housing market’s seemingly never-endless woes.

He hasn’t.

By throwing around the weight of recently nationalized mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), the Treasury Department is considering a plan to push interest rates on purchase money mortgages down to 4.5% - well below the current market rate of around 5.75%.

Artificially lowering rates so buyers can afford more house led us into this mess; it’s doubtful the same tactics will lead us out.

According to the Wall Street Journal, the plan is in the early stages of development, but officials expect the initiative to spur buying activity. The aim is to prop up home prices by enabling borrowers to afford more expensive houses. Columbia University economists believe such a program could help between 1.5 million and 2.5 million Americans buy new homes.

In order to qualify for the low rate, borrowers have to meet Fannie and Freddie’s now-stricter loan underwriting requirements. But even with more affordable monthly payments – the lower rate amounts to savings of $150 per month on a $200,000 loan — precious few prospective buyers are willing and able to pony up the tens of thousands dollars still required for a down payment.

Combined with the Federal Reserve’s recent $200 billion lending program for securities backed by newly originated mortgages, bureaucrats are pulling out all the stops to buoy falling property values.

This is the latest in a series of botched attempts to re-inflate the housing bubble. And like the others before it, the plan fails to address the root causes of ongoing home price declines: Negative equity, over-supply and mounting job losses.

The flood of recent loan modification programs championed by FDIC Chairman Sheila Bair and rolled out by JPMorgan (JPM), Citigroup (C) and Bank of America (BAC) also miss the point. Like any distressed market, the housing market badly needs price discovery. And like any other asset class, the true price of a house is only discovered when someone buys it on the open market.

By creating unnaturally low interest rates and allowing buyers to purchase bigger homes than they could normally afford, Paulson and Bernanke are preventing home prices from falling back to where responsible, fiscally minded Americans can buy without the crutch of government subsidies.

These continued distortions of the free market end up running in contrast to their intended goals: As long as the charade continues, as long as the real estate market is prevented from finding a natural bottom, home prices will continue to fall.

The silver lining — for those brave enough to uncover their eyes and look – is that just as it overshot on the way up, the housing market will likewise overshoot on the way down.

A protracted period of stabilization will ensue, during which time the opportunity to purchase high-quality residential real estate below its long-term intrinsic value will be extraordinary.
Savvy investors with the ability to identify attractively priced properties will, eventually, have the buying opportunity of a lifetime.