Thursday, September 2, 2010

The FED Game: Quoting Bernanke on the Housing Bubble, Mortgage Rates Set Yet Another Record Low

For those that are unaware, the privately owned Federal Reserve Bank has controlled the money supply of the United States since 1913. What does this have to do with Portland housing prices and asset values? Let's review some fairly recent quotes from the current chairman of the privately owned Federal Reserve Bank -Mr. Ben Bernanke:

Ben Bernanke - 5/17/07:

"We believe the effect of the troubles in the subprime sector on the broader housing market will be limited and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system"

Ben Bernanke - 9/2/2010:

"Even if monetary policy was not a principal cause of the housing bubble, some have argued that the Fed could have stopped the bubble at an earlier stage by more-aggressive interest rate increases," he said. "For several reasons, this was not a practical policy option. In this case, to significantly affect monthly payments and other measures of housing affordability, the FOMC likely would have had to increase interest rates quite sharply, at a time when the recovery was viewed as "jobless" and deflation was perceived as a threat"

If there's one thing the FED is concerned about it's deflation. In deflation, bad debt implodes, asset values drop toward parity with real incomes (cash purchasing power), and the banks lose big time on defaulted loans. Remember that the FED is owned by the largest of large banks.

The problem is that the more the FED increases the money supply to support debt based asset values, the more expensive commodities like food and energy (not part of the core CPI) increase in cost. Do you buy food or energy on a regular basis? Have you ever asked why those two items are no longer part of the core CPI (consumer price index) used by our government to measure price inflation?

Meanwhile, we have the FED executing QE (quantitative easing) to purchase US treasury debt, MBS (mortgage backed securities), and other 'assets' with freshly printed money to support debt based valuations on the balance sheets of the biggest of "too big to fail" banks. Just how much money has the privately owned Federal Reserve Bank printed recently to support asset values like houses and real estate?

The above graph suggests that debt backed asset values would be almost HALF of their current value were it not for the FED's intervention throughout the financial crisis. Meanwhile, in a shorter timeframe, the M2 money supply has been steadily goosed over the last year as well:

What does all this mean to housing and other debt based asset values? What does it mean for the purchasing power of the US dollar? It's really anybody's guess. Obviously the FED has made 'money' as cheap as possible by purchasing MBS / US treasuries and driving down interest rates to support the nominal value of debt based assets like real estate. Nominal valuations are one thing. What do real wage based valuations look like? rates set yet another record low today!

Bernake's printing of more paper/pixel money out of thin air can only work until the price of necessary commodities like food and energy rise to the point of economic pain (to reflect the devaluation of the currency due to the proportional increase in the freshly printed money supply). Every time the FED prints/QE's another dollar, the greenbacks in your wallet/bank account lose some purchasing power.

For the time being, the FED has printed in tune with what has has been destroyed by bad debts defaulting and blowing up on the balance sheets of banks. We currently have a slow controlled deflation not unlike that of Japan for the last 20 years. However, the value of the US dollar is precarious in that the more dollars the FED creates, the less valuable dollars become. That math cannot be avoided, regardless of the politics involved. Folks who ship oil and other hard assets to the US understand the game all too well. As do our foreign bond holders.

How many US dollars can the Federal Reserve Bank print out of thin air to support leveraged asset values before the purchasing power of the dollar causes economic pain via very high food and energy prices? Food and energy are divinely intertwined, and remember that the majority of America's oil is imported, and subject to foreign exchange rate arbitrage.

Ever heard the phrase "Don't fight the FED"? If the bankers have their way, inflation will rule the day. In the mean time, the free market is screaming deflation. Will the FED defend wages and the purchasing power of the US dollar, or will they support the leveraged asset values on the balance sheets of the banks by printing more money via QE 2.0?

Folks who are in debt will generally favor money printing and more inflation. Folks who are not in debt and have been prudent savers will generally favor deflation. Which will we have and for how long? Which is based on a free market? Do we have a 'free' market for assets anymore?

What will be best for the big banks? The FED? Follow the money!

Again I ask the question: Is Portland better off buying cheap houses with a strong currency, or expensive houses with a weak currency? How does your answer square up with food, energy, and housing prices? Does that answer reflect median free market wages in Portland today?

Is "affordable housing" better reflected by low interest rates (cheap money) and high home prices - or higher interest rates (strong money) and low home/food/energy prices?

We've all gotta eat to survive, we've all gotta stay warm through the winter, and we all need a roof over our heads when the rains come with the turning of the autumn leaves in the great Northwest. What's more important: the value of our debt, or the value of our money?

Seasons change, and so do debt based fiat paper currencies. Bernanke is dreaming if he thinks he can print his way out of this mess. Food and energy inflation would cripple any recovery, and there's just too much bad debt in the financial system. This is why home prices will continue to decline. The best we can hope for is a soft landing and a slow, steady, and controlled deflation. We'll be lucky if we slowly deflate like Japan.

Bernanke's dreaming of inflation, but dreams have never made my bed.