The Fed seems to have succeeded, at least in the housing markets realm, of re-engineering the good times that obtained before its carefully constructed house of financial cards collapsed. Or, so some folks seem to believe. According to a Bloomberg article, residential subprime mortgages are back, and in a big way. Traders in subprime mortgage-backed securities poured back in once it appeared to them that housing prices had stabilized. Presumably they believe that from here, American housing prices will have only a one-way trajectory—up–just like they presumed was the trajectory before the crash. Goldman Sachs jumped on the housing bandwagon and issued a report lauding the housing market’s potential, citing the stabilization of housing prices (amid, of course, massive government price supports). Now Goldman Sachs is nigh well never wrong, just look at Abby Joseph Cohen’s record as a stock market guru. So it really must be that Benjamin “Jack” Bernanke has planted some magical housing market beans, and the prices and markets will again ceaselessly grow to the sky.
My guess is that this rather muted uptick in prices has already almost run its course. Upticks in prices have happened several times since the crash, and there is no fundamental reason for a resurgence of housing demand—the population is barely growing and there is still plenty of excess housing to soak up what little population growth there is. The US economy is stalling along with its Asian and European peers (surely no one believes the US to exist in an economic vacuum), yet unemployment remains historically high, and will surely trend higher as the downturn snowballs. Except among the upper tier of society, whose wealth and income was little affected by the previous downturn, and will likely be little affected in this one (the Feds know who butters their bread) there is no basis for an expansion in housing demand. Eventually, probably not this time, but eventually, the upper tier of society will suffer the realization that their prosperity depends on an economically vibrant middle class, and that their fortunes will be severely and detrimentally impacted when the only economic “growth” that obtains is additions to the rolls of the poorest tiers of society, which, as recently released census data indicates, is presently the case. Regardless whether the plutocracy wishes to admit it, we really are all in this together. There is little hope for the rich to get much richer without which the poor don’t get much poorer.
The housing market bubble and bust, and possible reflation, provide a good example of how utterly fraudulent are the American socio-economic foundations. The Fed, internalizing the neo-Keynesian idea that prices should never decline, not even in the face of improved efficiencies, pursued a strategy over the last several decades (at least since Greenspan) of pumping ever greater quantities of money into the economic system to prevent price declines in the face of declining or stagnant demand, or of simply more efficient production. The fallacy of the strategy should have been apparent by late 2008, about the time that Lehman Brothers failed. Yet the Fed doubled down on its failed strategy, tripling the supply of money since 2008. It’s little wonder subprime mortgage securities are making a comeback. With so much money chasing so few opportunities, what else can be done to secure an annual yield somewhere north of 2-3% nominal, barely above negative on an after-inflation basis?
But why is it that rising prices are presumed to indicate economic health? As an economic system develops efficiencies in production, prices should come down, not perpetually increase. So how has it become an article of faith that housing price increases are a sign of market strength? And should perpetual price increases be the economic goal? Even in the face of vastly improved efficiencies in production? The materials comprising a house—the bricks, mortar, wood, glass, tile, nails, wiring, pipes, light fixtures, etc., have all enjoyed vast improvements in the efficiency of their production, not least over the last three or so decades, as information technologies were married to industrial processes to yield ever more output with the same or even fewer inputs. Even the process of putting all the components together to create a livable house has enjoyed enormous efficiency gains. A carpentry gang using power tools like pneumatic nail guns and skill saws can frame a 2,000 or so square foot house in a matter of about two to three days, where it might have taken their forebears of a half century ago a month or more. Roofers, applying pre-cut asphalt shingles can roof the same house in a third less time than it took the carpenters to frame it, whereas installing the materials commonly used in the past, like wood or clay shingles, would have taken weeks.
A market where costs are declining but prices aren’t is a market divorced from economic reality by some intervening force. Enter the Federal government and the Federal Reserve. The Federal government, believing a robust housing market (that is, a market where prices sustainably appreciate) to be an essential component of overall economic health (or at least such would be the more or less official political explanation for their actions, while the real reason might have more to do with the political contributions received of the housing industry), has poured gargantuan amounts of money into the housing market, particularly over the last three decades. It has provided massive sums on the purchase end of the transaction through its twin devils, Fannie Mae and Freddie Mac (and others, like Ginnie Mae), subsidizing the nominal rate of interest to be paid on the money borrowed to purchase a home through its formerly implicit, but now explicit, guarantee of the homeowner’s obligations. The two giants insured the repayment of, or were directly responsible for, roughly $5 trillion in residential mortgage debt as of the date of their takeover by the US Treasury in 2008. (In contrast, the FDIC insures bank deposits of about the same amount–$5 trillion). Since the takeovers of the two mortgage funding giants, the Federal Reserve has explicitly pursued policies aimed at decreasing even further the interest rates charged on residential mortgage loans, and they now stand at historic lows. And since the collapse of the housing market, the twin giants and their GSE brethren have underwritten virtually all (roughly 90%) of the newly-minted residential mortgage loans.
The subsidies do not end with the nominal interest to be charged the fledgling homeowner, but extend to allowing deduction from taxable income the interest paid on a home loan. For a borrower paying a nominal interest rate on a home loan of 5% whose income puts them in the 36% tax bracket, it means their effective interest rate on their home loan is only 3.2% (1-tax rate x interest rate).
If the price of money gets cheaper, then, ceteris paribus, the price of things bought with money becomes more dear. Thus the Federal government and Federal Reserve’s actions have operated to distort the housing market, causing higher housing prices than would otherwise obtain. If prices were simply a matter of quantity demanded equilibrating with quantity supplied, as costs of production declined, prices should have also. That prices declined anyway during the crisis, even with massive government efforts to prop them up, speaks to how outrageously the housing market supply and demand metrics had been distorted by government interference. Artificially high prices induced real oversupply, the reality of which was laid bare when investors fled the market like a stampeding herd of bison as soon as it was realized the whole thing stood upon the flimsy foundation of government-induced price distortions.
If in fact, housing enjoys a mini and artificially induced increase in the general price level, just like before, it can’t last. To be sure, it may cause the return of the same investors chasing yield (the guys Goldman was advising in its observation that housing was back) that exacerbated several fold a market already distorted by government interference, a situation which might make the “boom” last a bit longer than it should. If so, the ensuing bust will simply be that much more severe, because real (not monetarily driven) supply and demand metrics point to decreasing real prices. The process of supplying new housing stock becomes ever more cost reductive. The real demand for housing, driven by the underlying demographics, can only grow as fast as the population’s needs allow, and the population is expanding very slowly, less than 1% a year.
If housing is back, it might just be the nail that seals the coffin on any hope of real and sustainable economic growth. The Federal government has been running trillion-dollar deficits since the bust, and is expected to do so for the foreseeable future, so could hardly afford to pump several more trillions into a housing rescue. The Federal Reserve, permanently wedded to its zero interest rate policy since the bust, has no more magical beans to plant that might yield the illusion of prices that grow to the sky. Its cupboard is bare. When housing falls off a cliff this time, as it surely will if it booms like it did last time, there will be nothing to do but endure the economic pain that results.
(The most recent data for home sales show declines in both new and existing construction, while prices were little changed. The homeowner vacancy rate has declined to 2.2% from about 2.6% a year ago, which perhaps indicates expanding demand, but is still well below the historical average of about 1.8%, so demand has still not caught up with supply. Perhaps there’s hope yet.)