“There is nothing like first-hand evidence.”
First-hand evidence is leading to the observation that the American housing market began losing steam in August. Further analysis leads to the conclusion that the Fed has created a problem for which it has no solution.
The sister series “Terminal Velocity” has concluded that the Fed’s strategy is to maintain an indefinitely expanded balance sheet to “disintermediate” the banks; so that they are ring-fenced from crisis and so that the Fed is in ultimate control of the economy. Ultimate control has been identified with the objective of the creation of a new permanent increase in the Money Supply to replace the temporary Reserves currently in the Federal Reserve System. “Housing Smoke and Mirrors” has observed this strategy through the barometer of the housing market. Some of the assets used as the basis for this permanent creation of money have been identified already as the “Acronyms” known as HARP, HAMP and HOPE NOW. The strategy involves the symbiotic relationship of the Treasury and the Federal Reserve. The Treasury finds the assets and hence the sectors of the economy that the Fed will permanently stimulate. The Obama Administration has prioritised the assets associated with the Middle Class.
There is a growing body of evidence which suggests that the execution of the strategy of the Obama Administration and the Fed is flawed. This is evident in the fact that those who are allegedly being stimulated are actually being undermined. The major beneficiaries are still evidently the holders of the majority of America’s capital wealth.
The FHFA is the first to be seen directly undermining the intended beneficiaries. HUD recently announced that the FHFA will tighten lending standards effective October 15th[i]. The major losers will therefore be those Americans with low incomes and few financial assets. The beneficiaries will be the wealthy. The housing market will therefore become dominated by the wealthy; which will see them becoming the landlords.
This shift towards renting can already be seen in the fact that rents are rising faster than the underlying rate of inflation[ii]. The “Acronyms” known as HARP and HAMP, effectively keep people in their homes; but they also keep properties that were formerly unaffordable to the owner off the market. HARP and HAMP therefore contribute to the lack of supply of homes on the market, which effectively raises the price of these homes and the rental income that they can command. Into this lack of supply has come a class of investors who are looking for income rather than capital gain. When the “Taper” was first mooted by the Fed it was believed that it would cap rising home prices and make them affordable. The speculators, who were looking for capital gains, were the first to bail out and place this cap on prices. This class of speculators has now been replaced by a new class of “rentier” landlords[iii].
In addition, these landlords are cash-rich so they can outbid the less wealthy buyers who have seen lending standards tightened by the banks and now the FHA. The housing market was initially driven by those speculators looking for capital gains; now it is driven by the cash-rich landlords. HARP and HAMP have reduced supply and raised prices, so that only the cash-rich can play the game. It was reported that in August the HARP share of the mortgage refinancing market spiked to 23%[iv]. Both Fannie and Freddie also recently announced that they will be expanding the scope of HARP eligibility. It is clear that HARP is now “unintentionally” supporting the cash-rich landlords as well as the “intended” distressed borrowers. The latest Lender Processing Service (LPS) survey showed that delinquencies rose in September[v]. These delinquencies are not however translating into foreclosures; because the “Acronyms” such as HARP and HAMP are allowing the distressed borrowers the chance to refinance when they get into trouble. Lawmakers are now skewing the playing field even further in favour of the cash-rich; as they now are in the process of reducing the size of mortgages that the GSE’s will guarantee[vi]. A smaller guarantee will further preclude less wealthy buyers who are relying on some borrowing.
It is therefore difficult to discern who is benefitting the most; the distressed borrowers or the cash-rich investors. What is certain is who is being penalised. New homebuyers hoping to find a free market in housing (and hence the housing market itself) have been penalised. Supply has been distorted by the “Acronyms”. In addition, builders have no incentive to capitalise on the higher prices, because they understand that these higher prices are a function of controlled supply. New demand has been distorted lower by the raising of lending standards. New entrants to the housing market have therefore been penalised in the interests of the cash-buyers and distressed borrowers. This political selection of economic winners and losers has wide reaching implications for the health of the housing market; and also the health of the economy which owes so much to the housing sector. The favouring of entrenched interests has guaranteed the future absence of new buyers. The Fed and the Obama Administration has consigned future American generations to be a nation of landlords and renters. Should the Fed ever wish to exit its balance sheet operations, this situation will change; however since this will create a huge capital loss for the Fed there is little incentive for it ever to exit. The mortgage market is therefore no longer of interest to the banks. Citibank is scaling back further by selling servicing rights to 21% of its portfolio[vii].
A look at a typical cash rich investor will illustrate just how lucrative this nexus of entrenched interests has become. Blackstone Group is the doyen of cash-rich investors; it now owns 40,000 rental homes and is in the process of raising debt capital to expand its position[viii]. The prospect of rising rental demand, as the nation becomes dominated by renters, creates the predictability of revenue to back a bond issue. In addition, the Fed itself is now underwriting all economic risk and buying all of the securities associated with this risk; so Blackstone’s business model can’t fail….. unless the Fed does!!! The arrogance emerging within this investor community was epitomised lately by Blackstone, when it actually paid a borrower to default on a loan so that it could profit from a credit default swap position it had taken out on the same borrower[ix]. One suspects that “Too Big To Fail” is taking a quantum step into a whole new dimension.
It is clear that the unintended consequence of QE and the selection of economic winners is the creation of the real class of winners who are large investors. The Fed is in the process of taking greater exposure to the intended winners; who are by definition distressed borrowers. The Fed increases its own risk further by allowing these distressed borrowers to reduce their borrowing costs through various “Acronyms”. The Fed therefore has a lower income stream that does not reflect the real risk associated with the assets it now owns. In the meantime, the banks transfer all the economic risk associated with these distressed borrowers to the Fed. The banks also scale back lending, so that there are no new borrowers creating debts reflecting the new private sector costs of borrowing which have been raised. The Fed then uses any perceived weakness in economic data to increase its own balance sheet exposure to the distressed borrowers. In the absence of economic growth, there will not be any creation of private sector credit to pay the interest and principal on the assets that the Fed owns. At this point, we suspect that there will be a permanent creation of new Federal currency so that the Fed can pay itself back. This process is already starting to occur in the “Acronyms” known as HARP, HAMP and HOPE NOW. Cash rich investors understand that at this point rents and also the value of the underlying properties can rise permanently. Distressed borrowers will then also be able to enjoy some positive equity and hit the bid. It all sounds so simple. Holders of interest bearing assets will be the losers and the holders of assets with pricing power will be the winners. Since the Fed is the one who will be holding most of the interest bearing assets it will be the biggest loser. In Terminal Velocity (29) “The Real Prize” the impact of this strategy on the real economy through the rise in energy prices was discussed. Bottom line is that anything American which uses energy will be a loser; so ultimately there will be no free ride. As usual, the loss falls disproportionately on those who are less wealthy. With this in mind, it was not surprising to see the IMF beginning to opine on the two choices of wealth confiscation or inflation as the alternative routes out of the Debt Crisis[x]. The IMF should have said that they were the two alternative routes out of the central banks’ expanded balance sheets, after they had assumed ownership of all the debt assets.