This post first appeared on Minyanville.

After four years of searing pain, the US housing market is finally showing signs of life. And even as the causes and relative sustainability of this nascent “recovery” are being hotly debated, traditional buyers and investors alike are jumping into the market for homes with both feet.

It now appears that the biggest, baddest investor of them all, the one with infinitely deep pockets, is wading into the fray: Uncle Sam.

According to HousingWire, the US Department of Housing and Urban Development, or HUD, is giving state and local governments a total of $50 million to help deal with the onslaught of foreclosed homes, many of which lie vacant and blighted, ripe for vandalism, squatting, or worse. HUD has allocated chunks of cash to national development groups and local community organizations hoping to plug holes left by the private real estate investment market.

Funds are being distributed through the Neighborhood Stabilization Program which was established by former President George Bush in Economic Stimulus part one, which was then expanded by President Barack Obama earlier this year.

This investment directly into the real estate market highlights a new strategy in Washington’s fight against foreclosures, and one which is likely to grow in the coming years. That the federal government will increasingly be forced to take ownership — directly or indirectly through local organizations — is the subject of a recent piece I wrote on land banking for HousingWire, a mortgage and housing trade publication.

Land banks are publicly funded entities charged with taking ownership, rehabilitating, and putting back into use vacant or otherwise unwanted properties. The most well-known land bank in the country is run by Genesee County in Michigan, which is home to the woe begotten town of Flint.

Flint’s land banking initiatives began decades ago, as foreclosures and blight are not some new, post-housing bubble phenomenon. The program has gone a long way in providing Flint the chance at a future many of its Rust Belt neighbors can only dream of.

While as a loyal capitalist I loathe government meddling into the affairs of the private markets, to cry foul at bureaucrats for meddling in the housing market would redefine the old cliché of closing the barn door after the horses have left the barn. If taxpayer money is going to be heaped at our country’s ongoing housing nightmare, far better for it to go to community redevelopment than to the reckless inflation of the balance sheets, earnings, and salaries of the likes of JP Morgan Chase (JPM), Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C).

Initiatives like the recent allocation of money from HUD down to the local level do not represent some silver bullet to fix our housing woes, but seek to address some of the harsh realities of what, for most, is a foreclosure epidemic that plays itself out on CNBC and flashy websites like RealtyTrac or Foreclosure Radar: It just doesn’t seem real.

But drive through Oakland, California, Cape Coral, Florida, or Detroit and foreclosures aren’t just another statistic that evidences our dire economic situation. Foreclosures destroy neighborhoods, rip apart families, and set back years of what were otherwise positive improvements in some of the country’s most impoverished communities.

Real estate investors are reticent to put money to work in many of these areas because the risks simply don’t justify the rewards. Banks ignore many of these homes, abandoning the fight against looters and squatters, leaving the problems up to local police who are then dragged away from their regular beats. This isn’t a situation that benefits anyone.

It is, however, one of the uses for taxpayer money that can be reasonably justified. The list of government programs about which that cannot be said is far, far too long to list — and growing.

$50 million doesn’t even approach a drop in the bucket compared to what has already been spent bailing out AIG (AIG), Fannie Mae (FNM), Freddie Mac (FRE), General Motors (GM), Chrysler, Bank of America, Citigroup, and countless other, smaller firms that only now exist because taxpayers ponied up our hard-earned cash, whether we wanted to or not.

This $50 million is only the beginning. Lurking beneath the headlines of what many believe to be a respite from the Great Recession are neighborhoods with no hope of a recovery. The land banks, indeed, cometh.

This post first appeared on Minyanville.

It took the Wall Street Journal an entire survey to prove what readers of this column have known for months: The housing recovery, as it plays out, will be a localized event, varying greatly city to city, neighborhood to neighborhood, street to street.

The Journal, god bless them, compiled housing data to compare inventory changes, months supply, price drops, unemployment, and default rates across 28 US metro areas. Unsurprisingly, bubble markets like Las Vegas, Phoenix, and Miami look particularly horrid, whereas areas like Dallas (which avoided much of the housing mania) and cities like Charlotte and Seattle (which are just now seeing price declines accelerate) appear to be holding up rather nicely.

But drilling deeper into the raw data reveals a housing market that’s deeply bifurcated, even within individual cities.

As low-end markets experience a sharp increase in buying activity due to supply shortages and vastly lower prices, illiquid high end markets are experiencing violent price swings — typically in the southward direction. This much is already known, and the Journal’s study simply shows what we’re told ad nauseam: Real estate is, in fact, local.

What’s far more applicable to home buyers and sellers around the country, however, isn’t what a few broad (yet important) data points show about what’s happening in a few hundred neighborhoods all lumped together. Instead, it’s where individual submarkets are headed. After all, owning a home is an investment in a neighborhood, a street, a community — not necessarily a metropolitan area at large.

Housing prices, by extension — when measured as broadly as a metro area — are basically meaningless.

Real estate, for all its intricacies, isn’t any different than any other market: Prices are set by the interplay between supply and demand. The trick, then, is isolating the key data points within an individual micro-market that tell us who has the upper hand — buyers (demand) or sellers (supply). This is the best short-term indicator of where prices are likely going in the near term.

Unfortunately — and one of the reasons bottom-calling in the current housing cycle is so dangerous — myriad behind-the-scenes deals between regulators and big banks like Citigroup (C), Wells Fargo (WFC), Bank of America (BAC), and JPMorgan Chase (JPM) are impacting markets in a material way.

There are a number of important measures of housing supply and demand. And because at Cirios Real Estate we take a bottom up approach to evaluating property values (i.e., house by house, rather than city by city), we pay close attention to the sales-price to list-price ratio.

This ratio simply measures the difference between where a home was listed and where it was sold. To be sure, this can get complicated in markets where price reductions are common. But comparing both original list price and most recent list price to the eventual sales price can yield important insights into a market’s true behavior.

As can be seen in the graph below, which measures this ratio in 2 towns in the San Francisco Bay Area, this ratio tends to follow housing booms and busts fairly closely.

All things being equal, as sellers gain the upper hand and buyers become more desperate, prices are bid up over list and this ratio will rise. On the flip side, as demand weakens and sellers scramble to unload their homes, price reductions and low-ball offers drive sales.

In markets with rising sales-price to list-price ratios that have been under pressure for months, if not years — like many distressed markets — we’d argue stabilization could be just around the corner. The big caveat, however, is that banks keep bleeding out their shadow inventory slowly, and don’t dump their massive bank-owned home portfolios onto the market. Keep in mind, also, that stabilization doesn’t imply appreciation.

High-end markets, on the other hand, are seeing massive list-price drops, and any sort of bottom is indeed very far away as forced sales and foreclosures creep into well-to-do communities.

In today’s market, this analysis further must be broken down between homes that are in move-in ready condition and those in need of rehab. The former, financeable by the various government-backed loan programs, is generally in short supply and high demand. The latter, which must be purchased with cash, appeal to a smaller world of buyers looking to turn a quick profit.

We find that in many areas, turn-key updated homes that pass muster with the FHA, along with Fannie Mae (FNM) and Freddie Mac (FRE), have a far higher sales-price to list-price ratio than do homes bought with cash (i.e., fixer-uppers).

This makes intuitive sense, since even if government-backed loan programs could be used to buy these rehab projects, few prospective homeowners in the current environment have the cash on hand for a down payment as well as a remodel project. Moving in with as little out-of-pocket expense as possible is of the utmost importance.

Taken together, often times the sales-price to list-price ratio in a given town or zip code hovers close to 100%. But dividing sales into “financeable” and “non-financeable” yields a far different result. In most cases, sellers of updated turn-key homes currently have a distinct upper hand over buyers, while buyers of fixer-uppers can still get low-ball bids accepted. Of course, there’s still the world of homes that are wildly over-priced — but those aren’t selling anyway.

There are many other ways to look at supply-demand fundamentals in local real estate markets. But if you don’t divide analysis between homes that can be financed through the FHA, Fannie, or Freddie and those that can’t, you may as well be comparing bombed out duplexes in Oakland to luxury condos in Manhattan.

Wait, never mind, bad example — those 2 markets share one unique characteristic: No one is buying.

This post first appeared on Minyanville.

We have truly become a bailout nation.

As regulators mull over the possibility of rescuing CIT Group (CIT) — a small-business lender that counts over 1 million US firms as customers — analysts debate whether the relatively small firm is deserving of a taxpayer-funded bailout. Or for that matter, a bailout at all.

After converting to a bank holding company last year, CIT received $2.3 billion in TARP money to help solidify its financial footing. Yet even this injection of taxpayer capital couldn’t prevent its financial position from deteriorating further, and the company now faces the maturity of over $1 billion in bonds next month. Without government support, CIT doesn’t believe it will survive the summer.

The specter for a CIT bailout is a tricky political issue: It pits those that argue Washington must step in wherever necessary to support the reeling US economy, against those who are starting to wonder when the bailouts will stop and when bureaucrats will step back and allow the free market to determine who survives.

Few would argue that CIT presents a systemic risk to the US financial system; with a balance sheet of around $75 billion, the company is one-eighth the size of Lehman Brothers, according to research firm BTIG.

CIT is, however, a key lender to small businesses around the country. This means its failure could threaten salary payments for millions of American workers if the company’s customers are unable to get lines of credit with other financial institutions. Under different circumstances, banks like Wells Fargo (WFC), Citigroup (C), and Bank of America (BAC) would be eagerly serving CIT’s clients. Instead, they’re focused on reining in lending of their own.

If CIT were to fail, it would mark the biggest bank failure since Washington Mutual — now part of JPMorgan Chase (JPM) — collapsed last September.

By letting CIT fail and coordinating an orderly shuttering of its operations, the Obama administration has the opportunity to re-establish an old precedent long since forgotten in these turbulent economic times: Firms that should fail actually fail.

If, instead, the government rescues CIT, the yardstick by which we measure “Too Big to Fail” will be severely shortened. This wouldn’t be a welcome development.

For the past year, government power brokers — rather than market forces — have picked the winners and losers as financial firms have been besieged by a massive deflationary debt unwind. Further, as Washington wades deeper and deeper into the day-to-day operations of American business, companies are starting to compete for government cash, not customers.

Moral hazard is a concept quickly brushed to the side during times of crisis, but it’s precisely during these trying times that market principles should be the most firmly upheld. Sadly, over the past 24 months, the opposite has held true.

This post first appeared on Minyanville.

Appraisers just can’t get it right.

During the housing boom, mortgage brokers, real-estate agents, and even borrowers sought out appraisals supporting the highest possible home price. Appraisers, fearful of losing business, inflated their valuation findings, which exacerbated the run-up in home prices.

Now, after nearly 4 years of home-price declines, appraisers are getting it wrong again — but in the other direction.

On May 1 — while the financial media focused on construing a blip up in housing data as signs of an imminent bottom — little was made of new appraisal guidelines that went live and immediately began to eat away at the core of the nascent housing “recovery.” To be sure, trade groups like the Mortgage Bankers Association and the National Association of Realtors (NAR) fought the revised rules, but to no avail.

Stemming from a lawsuit filed by New York Attorney General Andrew Cuomo alleging Washington Mutual (JPM) and First American Corp illegally conferred on the results of home appraisals with the goal of inflating prices, the new rules put up a Chinese wall between banks like Citigroup (C), Wells Fargo (WFC), Bank of America (BAC), and appraisers. The goal was to create an environment where appraisals would reflect an expert’s unbiased assessment of a home’s true value, rather than evaluations tailored to a lender’s desire to make a loan.

The new rules affect loans guaranteed by Fannie Mae (FNM) and Freddie Mac (FRE), but since the 2 government-run mortgage giants effectively control the secondary mortgage market, they’ve become the defacto guidelines for the entire industry.

In order to separate lenders and appraisers, appraisal-management companies (AMCs), cropped up, offering banks access to a network of appraisers around the country. This makes the appraiser selection process random, preventing collusion. And while AMCs claim appraisers are selected using proprietary scoring algorithms that evaluate performance, the reality is that jobs are handed out on the basis of fastest turnaround time and lowest cost.

In short, we’ve traded bias for incompetence.

Readers of this column know that I have little, if anything good to say about the NAR — which is not only the Realtors’ trade organization, but a powerful Washington lobby. Nevertheless, earlier this week, when the NAR released data on existing home sales, their statement about appraisers’ role in killing purchase transactions was dead on the mark:

“The increase in sales is less than expected because poor appraisals are stalling transactions. Pending home sales indicated much stronger activity, but some contracts are falling through from faulty valuations that keep buyers from getting a loan. Lenders are using appraisers who may not be familiar with a neighborhood, or who compare traditional homes with distressed and discounted sales.”

Currently embroiled in this very scenario, my firm, Cirios Real Estate, is witnessing first-hand just how bad the new appraisal rules are.

Assessing a property’s value in’t rocket science, despite appraisers’ claim that their extensive training and years of experience make them the only people qualified to determine home prices. All it takes is access to the right information, an understanding of what drives desirability, and a little pride in one’s work.

That last criterion is perhaps the most difficult to find. Appraisers earn a flat fee for their services, giving them little incentive to provide the best analysis possible. Knowing they can now earn repeat business by turning around jobs in 48 hours and charging less than their competitors, there’s little reason to go the extra mile to ensure appraisals take into consideration only the best information to come up with the best possible results.

Sure — there are good appraisers out there with integrity that offer up great analysis. But as lower priced, lower quality work becomes the norm (thanks to the new appraisal guidelines), the best appraisers will seek greener pastures - as well they should.

Lawrence Yun, the NAR Chief Economist, finally got it right when he said, “Sometimes policy can lead to unintended consequences.”

This post first appeared on Minyanville.

It’s the government, stupid.

As Washington expands its role in managing the day-to-day operations of American business, companies are increasingly turning their strategic focus to tapping federal cash and lending programs. And despite the strings often attached to government money, many are finding that Uncle Sam is the only game in town during these troubled economic times.

This morning’s Wall Street Journal highlights just how essential lawmakers and regulators have become in America’s new breed of government-directed capitalism. Hunting retailers, farm-equipment manufacturers, and, of course, banks (Bank of America (BAC), Citigroup (C), Wells Fargo (WFC)) and insurance companies are all sidling up to the government trough.

And even as public opinion slowly turns against bureaucrats’ massive intervention into the private economy, Washington insiders are raking in piles of cash. According to the Journal, spending on lobbyists in 2009 could reach $3.3 billion, equal to the total during the 2008 election year. And for good reason: Without representation in Washington, companies just can’t compete.

After the financing arm of Deere & Co. (DE) tapped the FDIC to guarantee $2 billion in debt last December, the Equipment Leasing and Finance Association, a trade group, leapt into action to protect other members. Deere rivals, including Caterpillar (CAT) and a host of smaller firms, weren’t eligible for government-supported debt issuances, so the group’s president asked the Federal Reserve to expand the Troubled Asset Lending Facility to include sales of farm equipment and other machinery.

The Fed acquiesced; the agricultural industry must also be too big to fail.

But not every company has the ear of the Washington power brokers, leaving those forced to go it alone at a distinct disadvantage. Credit is already precious for small businesses, and what little they do have is far more expensive than that of their larger, better-connected rivals. This doesn’t bode well for an economy struggling to drag itself out of recession, since small businesses account for the lion’s share of job growth on the other side of a downturn.

The eventual recovery, which a growing number of optimists predict is just around the corner, could yield a bitter pill for corners of the economy still heavily dependent on government handouts. Although lawmakers vow to support systemically vital companies and industries for as long as needed, at some point Washington must try to take back what it has so generously given.

Witness the market for home loans, where government purchases of mortgage-backed securities have helped keep rates abnormally low. Even without the Fed dumping its Fannie Mae (FNM) and Freddie Mac (FRE) bond portfolio onto the market, rates have risen sharply in the past month, threatening to forestall the nascent “recovery” in the housing market.

Were the Fed to pull back its support of the housing market, rates would skyrocket. This would be politically — not to mention economically — unacceptable.

And while the ideological debate rages over whether Washington bureaucrats are becoming too entrenched in the American economy, businessmen and -women still must get up each morning, head to work, and try to stay above water. And — insofar as lobbying for government money outstrips developing new technologies or innovating, producing and otherwise generating economic output — the economy suffers.

And green shoots or no, this economy already has enough cards stacked against it.

This post first appeared on Minyanville.

In early 2006, when subprime powerhouse New Century went bust, vulture investors began to salivate at the opportunities a collapsing mortgage market would offer up like manna from the trading gods. They started raising money. And lots of it.

Billions were poured into so-called “mortgage opportunity funds,” which planned to pick through the wreckage of the once-high-flying housing market. Some investors aimed to focus on mortgage-backed securities, hoping to buy in at pennies on the dollar so just a few bond payments would reap sizable returns. Others, however, delved into the realm of whole loans, buying troubled mortgages from floundering banks.

As noted in the Wall Street Journal this morning, an investment strategy that seemed like a slam dunk on paper — buying distressed mortgages on the cheap, and working out equitable arrangements with borrowers — has proven extremely difficult to execute.

The prevailing wisdom was that, as delinquencies rose, and banks amassed a seemingly limitless portfolio of troubled loans, the likes of JP Morgan Chase (JPM), Bank of America (BAC) and Citigroup (C) would be forced to unload assets at firesale prices. Because they were buying at super-low prices, investors expected to have the necessary cushion to forgive principal, lower interest rates, or otherwise get borrowers back on track. They would, of course, earn a hefty profit for the effort.

But the housing market, which tumbled further and faster than all but the most pessimistic experts thought possible, had other plans.

Throughout 2007, any player that dipped a toe into the market lost a foot. Property value declines accelerated, securities prices tumbled, and economic conditions continued to deteriorate. Sellers, hoping for a rebound, were reluctant to accept lowball prices. Few trades were executed, and the lack of liquidity drove the market to new lows.

Then, in 2008, as delinquencies began to spread from the subprime to the prime market, home prices continued to slide, and it became clear there would be no easy fix to the housing market’s woes, big banks recognized their need to raise capital by selling assets.

The market for distressed loans began to flourish as liquidity entered the market: Sellers accepted painfully low prices, and investors started deploying more capital. Prices for pools of mortgages in various stages of default began to stabilize, typically around $.50-$.60 on the dollar.

As 2008 rolled along, the wheels of the financial markets truly lost their grip on the road, Washington stepped in with the Troubled Asset Relief Program (or TARP) in October. In the distressed mortgage market, uncertainty became the rule of the day, as buyers and sellers alike ceased trading in expectation of new clearing prices created by an asset purchase program that never came.

Traders then sat on the sidelines as the election played out, waiting to see how front-runner Barack Obama’s promised foreclosure moratorium would impact the housing market.

Meanwhile, Uncle Sam poured capital into banks to try and jumpstart lending. With taxpayers bailing out the market’s most leveraged players, Morgan Stanley (MS), Goldman Sachs (GS) and other Wall Street firms got a reprieve from bets gone awry.

Distressed investors hoped banks would finally be willing accept low prices for their assets. Not so. Just when it looked like a few select sellers were going to test the waters of the distressed market, the new Treasury Secretary Tim Geithner announced the Public-Private Investment Program (or PPIP).

The PPIP — a bastardized version of TARP that employs leverage, and is purported to profit both taxpayers and private investors — is yet to materialize.

The distressed whole loan market remains largely frozen, as sellers hope for higher prices from buyer’s backed by cheap government money. Buyers, meanwhile, remain cautious, since, despite recent “positive” datapoints coming out of the housing market, real-estate prices remain volatile in most markets.

The private market for delinquent mortgages once held the potential for a market-based solution to the country’s housing woes. It was no magic bullet, to be sure. But by fostering an environment where private capital could seek out advantageous investments, housing markets would have started down the path towards true price discovery.

As it happened, however, massive government intervention into the market via TARP, the foreclosure moratorium, the PPIP, and other programs forestalled the inevitable, pushing the date of the eventual recovery years into the future.

This is good news for banks that survived the maelstrom of financial market turmoil, albeit based largely on trumped-up earnings and unrealistic asset prices still on their balance sheets. For homeowners, consumers, and the public in general, however, true hope for a legitimate stabilization in housing markets, and the economy in general, has been pushed further along the curve.

By ANDREW JEFFERY

This post first appeared on Minyanville.

The horses, pigs, cows, goats, sheep, llamas, ostriches, dromedaries and rhinos have all left the barn, yet the US Securities and Exchange Commission (SEC) still thinks it should be minding the door.

In light of its woeful inability to perform even the simplest of tasks — like making sure the biggest hedge fund in the world, I don’t know, makes a trade once every 13 years — the Obama administration is looking to strip the SEC of certain regulatory responsibilities.

And rightly so.

According to Bloomberg, plans could be announced as early as next week outlining just how watered down the SEC’s role in the new Obama regulatory regime could be. It’s expected the Federal Reserve may take over the SEC’s oversight of firms deemed “too big to fail.” Keeping tabs on mutual-fund operations could become the domain of certain banking regulators.

The SEC, for its part, under the new leadership of 20-year veteran of the agency, Mary Schapiro, is fighting back. Shapiro says she’s frustrated the SEC isn’t more involved in high-level negotiations with financial firms like Citigroup (C), Bank of America (BAC) and Goldman Sachs (GS), and is making great strides in repairing the regulator’s tattered image.

Commendable, but too little too late.

The SEC is widely viewed as having committed the biggest regulatory bonk in modern financial history, turning a blind eye to Bernie Madoff’s $65 billion Ponzi scheme, and failing to, even in the remotest way, protect investors from the implosion of the market for mortgage-backed securities and other structured financial products stemming from rampant fraud, scant disclosure and blatant conflicts of interest.

Oh, and just days before Bear Stearns collapsed into the waiting arms of JPMorgan Chase (JPM), then SEC Chairman Chris Cox went on national television, assuring the country Bear was in good shape. Oops.

The SEC is a case study in regulation gone bad. It’s one thing to have openly unregulated markets, where participants understand there’s no one guarding the hen house. But when markets are purportedly policed by a powerful government body, investors assume some level of basic integrity and honesty.

By violating this trust, the SEC proved that weak regulation — and more specifically, weak regulators — do more harm than any amount of deregulation could ever do.

The looming restructuring of the financial regulatory complex will be a messy, political, imperfect process. But if the first step is dismantling the SEC’s web of incompetence, then we’re off on the right foot.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Remember the good old days? Back when you and the credit crunch were young, and only those “subprime” people over on the other side of town — you know, the ones living wildly beyond their means, dependent on credit for the very necessities of life — had to deal with the harsh reality of life without free and easy credit?

Those happier times are long since passed, as the malaise continues to seep its way up the economic spectrum. Now, even the most creditworthy consumers who haven’t missed a payment in years are seeing credit lines cut, interest rates raised and finding it increasingly difficult to get a mortgage. They’d better get used to it - the free lunch is over.

Up in Washington, where economic rationale and populist rhetoric seem to be more mutually exclusive than ever these days, the Senate is voting on a widely debated new set of rules for the credit card industry.

According to the New York Times, although the legislation doesn’t cap the rates companies like Capital One (COF) and American Express (AXP) can charge their customers, they’ll be forced to up rates more slowly — and with more disclosure — meanwhile making it tougher to impose late fees on borrowers that can’t keep up. This will reduce lenders’ earning power, not to mention their inclination to give out credit lines to questionable borrowers.

While risky borrowers will bear the brunt of late fees, over-limit charges and slashed credit lines, the well-to-do are in for the biggest shock. Banks are considering curtailing or doing away entirely with rewards programs, grace periods before interest charges kick in and accounts without annual fees. Gone are the days when paying your bills on time was a path to free credit.

The country’s biggest banks, JPMorgan (JPM), Bank of America (BAC) and Citigroup (C) have already told Congress the new rules will force them to limit credit availability and increase fees. While this may bode well for profit margins in the near term, not so for the broader economy.

In light of the financial implosion wrought by too much debt supported by not enough real income, it’s hard to argue credit card companies shouldn’t be a bit less free-wheeling when handing out plastic. But analysts are quick to point out that paring down consumer credit will have a dastardly effect on our consumption-based economy.

For a country whose economy is two-thirds consumer spending, and whose consumer is (still) addicted to credit, the new legislation is like pumping the economy full of Xanex - everything will just slow down.

And while in the long run, less dependence on cheap and easy credit will help prevent the sorts of credit crisis like the one we’re experiencing right now, we’ll likely look back with 20/20 hindsight and say this legislation went too far, constricted credit too much. This is a shame, since before Congress even cooked up the idea of the new rules, the natural deleveraging cycle was already restricting credit on its own.

Debt isn’t in and of itself, bad. As Minyanville’s Kevin Depew wrote today, “real lending and economic activity will only improve when real savers see real value at the right level of risk. That will only occur in the short-run with vastly lower prices, or in the long run with stagnant prices and the benefit of time.” Indeed.

Credit allows a transfer of risk from those who want to take it, but can’t, to those who can take it, but need to be appropriately compensated for putting their cash on the line. This can foster healthy economic growth - when used properly.

That day will come again, but that day isn’t today.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Deflation, the economic beast many feared would devour the next decade, appears to have been vanquished.

Or has it?

Superficial signs of renewed inflation are everywhere: Oil prices appear to be stabilizing, and concern is growing about future supply shortages (which, by extension, could lead to higher prices at the pump). The stock market has staged an impressive rally, with expectant bulls and former bears finding for “green shoots” of economic growth everywhere. Home prices, if you look purely at the data and ignore fundamentals, are starting to slow their fantastic decline.

Even the consumer price index, or CPI, is looking tame. Well, except for last month’s drop, the largest in more than 50 years.

And herein lies the problem.

The CPI, the market’s favorite inflation gauge, has been masking the structural deflation in our midst since the housing market fell of its wheels almost 4 years ago. Given the precipitous drop in property values, one would naturally expect the housing component of the CPI to fall in kind. Not so.

The statistical alchemists, err, experts, at the Bureau of Labor Statistics use something called “owners equivalent rent,” OER, to measure consumer housing expenses. OER tries to approximate the cost to rent the country’s typical home, and according to the Wall Street Journal makes up 24% of the CPI and 31% of the core CPI, which backs out food and energy costs.

And since even as property values have slid in record-breaking fashion rents remained buoyant, OER has vastly understated the drop in home prices. This means the CPI — were it to reflect some sort of economic reality — would have fallen more than it actually has.

As the housing slump rolls on, the pain is increasingly being felt by landlords, not just owner occupiers. Rents in big cities like New York and San Francisco are already dropping, as would-be tenants demand concessions from property owners. Vacancies are increasing, as even those driven from the housing market by foreclosures and the tight mortgage market can’t fill up empty apartments, condos and track homes.

Drive around suburbia and “For Rent” signs are nearly as common as “For Sale” signs.

Rents are likely to keep falling and as a result, OER could begin to drag down the CPI. Of course, statisticians can and likely will play games with adjustments for volatile energy prices (renters often don’t pay for utilities, so energy costs are backed out of OER). Further, government bean counters are even considering adapting OER to reflect new, high levels of home ownership (just in time for a reversion to the historic mean, thanks for being ahead of the curve guys).

As long as construing economic data in a way that makes it seem more likely for effectively insolvent financial institutions like Bank of America (BAC) and Citigroup (C) to raise capital and remain in business, that will remain the status quo.

Meanwhile, back in reality, saving is now en vogue, deleveraging is ongoing and the repayment (and destruction) of dollar-denominated debt will keep inflation in check for the foreseeable future. More importantly, the recognition that smaller can be better and less can be more are becoming entrenched in the lives of ordinary Americans.

Don’t believe the hype: Deflation isn’t going away any time soon.

This post first appeared on Minyanville.

Freedom is back in vogue: Americans are finally growing tired of living in the shackles of debt.

According to the Wall Street Journal, government-led efforts to jumpstart lending are being derailed by weak demand for new loans. As the recession rolls on, an increasing percentage of consumers are opting to pay with cash or (gasp) save their hard-earned money.

Initiatives like the Term Asset-Backed Securities Loan Facility (TALF) aim to free up consumer credit by supporting the market for asset-backed securities. The Federal Reserve and Treasury Department hope their efforts will enable American consumers to start spending again.

During the boom, fixed-income investors snatched up bonds backed by all types of debt - credit cards, auto loans, and, of course, mortgages. High demand for these seemingly safe investments pushed down interest rates, which stretched consumers’ budgets to the brink - and beyond.

But now that investors have been badly burned by such investments, they’re shying away from the market almost entirely. Without Wall Street’s securitization machine, there’s simply nowhere to put new consumer loans.

After years of gorging on cheap credit, Americans are reverting to more responsible fiscal lifestyles. Savings are up, spending is down - which is as it should be. This is reducing the urge to borrow and thwarting Washington’s plans to pass the bailout buck down to taxpayers.

Every dollar we don’t spend or don’t borrow is another that could potentially be handed over to effectively insolvent financial firms like Citigroup (C), Bank of America (BAC) and American International Group (AIG), or failed automakers like General Motors (GM) and Chrysler.

That task is growing increasingly dicey, as it becomes clear that using debt to fix a system already crippled by debt is patently absurd. And even as the US government loads up on borrowing, consumers are doing the right thing: getting out of hock.