The Fed's Money Trap
The Federal Reserve, and therefore the economy, is caught on the horns of a dilemma of our own making.
ZIRP (zero interest rate policy) and the aggressive pumping of money (upwards of $85 billion a month) into the financial system have tripled our money supply.
If it weren't for nearly stagnant money velocity (MZ), we would be seeing inflation / CPI in the 20% range or more.
This disruption of the money supply has sent confusing signals to both markets and Main Street, distorting prices and misallocating resources as the newly created dollars search for opportunities to earn a return.
Housing is perhaps the canary in the coal mine telling us that things are not going well and danger is close by.
Even with 3% 30 year mortgages and no money down, we have to go back to 1997 to see such such low levels of home ownership in America.
New housing starts, while showing some improvement, are still quite weak perhaps even stalling out. We now see a return to the Adjustable Rate Mortgage, a financial vehicle at least partially at fault for exacerbating the housing bubble.
Recently doctorhousingbubble had a terrific article on this strange phenomenon:
"At the same time, we find out that the home ownership rate continues to fall reaching a multi-decade low while rental vacancies slowly decline. All of this of course makes sense given a supply constrained market and a massive amount of investor buying over the last few years adding rental properties to the market (taking off market potential single-family homes for actual purchase). What is troubling about the data is the difficulty for first-time buyers to enter into this odd market. Having a larger share of our market as renters might make sense given economic constraints of household incomes yet it should be abundantly clear who the big winners were from all the Quantitative Easing that has occurred. Welcome to rental nation."
An increase in home prices but a recent and very pronounced slump in housing starts and softening demand for new mortgages! What's up with that? Essentially we are seeing banks sit on vacant properties and then very deliberately slow walk foreclosures through the system in order to both keep retail prices high by lowering inventories and to protect their balance sheets. In essence, if banks should err by releasing too many homes into the marketplace, housing prices will decline and so will the value of their assets, potentially putting them at risk of insolvency. At the same time, new housing is very soft, as too many young couples are both priced out of the market and are slogging through adverse economic currents that limit both opportunity and growth of income.
But now a new element has injected itself into the mix. Rising interest rates.
The most important number in the economy may be the yield on the ten year treasury. Factoring out the imbecility of the Jimmy Carter years, historically a 10 year yield has been around 5%. Now take a good look at the graph below. Notice that yield basically hit bottom last year. Frankly, it really could not go much lower than it was without going nearly zero, which is impractical.
Folks, rates really have no place to go but up. In the last few weeks the yield on a 10 year treasury has climbed significantly, and it seems on pace to break into 3% in the moderate future. But here is the fix we find ourselves in: it seems rates will have to come up, but if they do (and the side question is how much and how quickly), it will increase the cost of borrowing money for the government, potentially blowing up our budget and starting a debt spiral (see Greece for specific details). Rising rates also impact business investors, and private citizens.
What does this mean for housing? Basically rising rates mean purchasers can afford less home, meaning either prices have to come down or risky loans have to be pushed into the system.
If rates do not go up, a severe disconnect develops between the bond markets and the economy itself. Eventually the bond vigilantes will saddle their horses and as history has shown, they will have their way, and in the process destabilize arrogant governments. It has happened before, sometimes to the point of collapse.
Damned if we do. Damned if we don't.
This is what happens when we elect leaders who brazenly ignore mathematics and the laws of economics.
And you can take that, my friends, to the bank.