Housing Smoke and Mirrors (30)/Terminal Velocity (30)
We have reached the point where the Housing Smoke and Mirrors and Terminal Velocity series, which have been running in parallel, have now converged into one story which will be followed under the appropriately named title “Age of Wisdom, Age of Foolishness”.
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way”.
Housing Smoke and Mirrors (29) “First-Hand Evidence”observed the contemporary Tale of Two Cities developing as a consequence of the flawed strategy execution by the Treasury and the Fed. The “Two Cities” are each inhabited by those with assets and those without. Instead of those who were last being first, those who are first are getting even further ahead whilst those who are last are falling farther behind. The Mortgage Bond Daddy Lew Ranieri succinctly observed the duality of the situation, when he opined that credit conditions in the private credit mortgage market are now as tight as they were in the “Credit Crunch”. It is quite literally the best and worst of times as far as he can see[i]. The Fed’s balance sheet suggests that credit is abundant, but the primary mortgage market suggests the opposite. The IMF began preparing for the ensuing reign of terror by drafting its own abridged version; in which leaders will confiscate the wealth of the undeserving either directly or by inflation[ii].
The Obama Administration may be well ahead of the IMF; given its literary allusion of the “Gatsby Curve” reported back in Terminal Velocity (15) “Gatsbied”[iii]. The best of times for the rich is the worst of times for the Middle Class; and the Administration intends to redress the balance one way or another. This theme of wealth redistribution seems to be infectious. The Bond King Midas Bill Gross is its most famous latest victim; his last commentary opined that “the era of taxing ‘capital’ at lower rates than ‘labor’ should now end”[iv]. Perhaps this sudden act of contrition is really a symptom of fear; whereby the “One Percent” have realized that in order to survive they need to put something back before it is confiscated.
The most ironic twist in the tale comes from the fact that the alleged saviours of the asset poor are executing a salvation strategy that disproportionately favours the asset rich. The Federal Reserve is the agency of this poorly executed salvation; through the expansion of its balance sheet to accommodate the liabilities of the asset poor. The asset poor have thus become the overweighted asset class of the asset rich Fed. Terminal Velocity (28) “Disintermediation” explained how the Fed had replaced the banks to become the ultimate asset rich holder of asset poor liabilities. In doing so, the Fed has therefore directly aligned its financial interest with the asset rich by becoming the ultimate asset rich institution. The Fed now finds itself in the position in which it must execute policy to preserve the value of its own assets, whilst alleging that it is mitigating the liabilities of the asset poor. This scenario implies that the Fed cannot exit its QE programme by asset sales, without incurring huge losses, so that it must appear to exit by allowing the balance sheet assets to mature. In practice, these asset maturities must be funded by the creation of a permanent increase in the Federal Money Supply; which was a topic addressed in the Terminal Velocity sister series. It now falls to the Fed to prepare the markets to accept this non-exit strategy. “Bull Dudley” has already placed this notion in the market discounting mechanism. More recently, Janet Yellen’s own research department at the San Francisco Fed started to provide rational rhetoric for this strategy[v]. According to their logic, the Fed can avoid taking losses by allowing the mortgage bonds in its portfolio to mature. What will really sell this strategy to the Congress is that it allows the Fed to keep remitting “profits” to the Treasury. It’s win-win for the Fed and the Treasury. So far no-one has explained that this perpetual profit machine only works under conditions in which either the Fed keeps rolling over its portfolio, or if a permanent increase in the money supply is created to pay down the maturing bonds. It was therefore hardly surprising to see Rand Paul try and tie the nomination of Yellen to a vote to audit the Fed; he at least understands where the “profits” come from.
The recent evidence shows the emerging scenario in which the financial interest of the asset rich Fed has aligned with the asset rich “City”; at a time when the fundamentals of the housing market continue to deteriorate. The inference is that the Fed must now support the housing market, to which it has become overly exposed, so that it avoids the kind of losses associated with Lehman and Bear Stearns back in 2008.
RealtyTrac recently reported that investors have purchased $1 Trillion of houses since 2011. About 58% of these transactions were all cash and the proportion rises to 93% for transactions involving 1,000 or more units[vi].
Pending Home Sales fell for the third consecutive month in September; and have therefore registered the first annual decline in two years. Freddie Mac also reported its third monthly business decline in September[vii]; business is now at an 18 month low.
A new “Acronym” to support the housing market was unveiled to join the expanding list. This Acronym is called “FHA 203(k)”[viii]. Because the majority of the housing stock is more than twenty years old, it is allegedly dilapidated and in need of renovation. Dilapidated home buyers can avail themselves of “FHA 203(k)”, which will allow them to put the cost of renovation against the financing cost of acquisition. Reading between the lines, “FHA 203 (k)” seems to be aimed at the Zombie Homes that are derelict. It is logical to assume that “FHA 203(k)” will get expanded to encompass those still occupying homes that are more than twenty years old in addition to potential buyers, as a logical extension of the stimulus creep that is on-going, in a kind of “Cash for Zombies” equivalent to “Cash for Clunkers”.