Ben Bernanke’s Misguided Focus on Housing

Understanding the history of housing in the U.S. explains our policy

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It’s a little early for April Fools, but Ben Bernanke might just be a prankster at heart.

I say this because he recently told the Economic Club of Indiana in Indianapolis that the Fed’s plans for QE3 would help create more economic activity and higher home prices. Then he added, almost as an afterthought, that this would help many more savers than it would hurt.

I was waiting for the punch line … or the laugh track … or maybe an old bada-boom from Paul Schaeffer’s band offstage. Only it never came.

It’s like he was making a bad joke, “but QE is good for savers. No, really! I swear…”

Why the Fed chief keeps linking housing prices to savings and, by implication, to an economic recovery defies logic.

No matter how hard he tries, he can’t solve our nation’s economic woes by making the same mistakes all over again.

Part of the reason housing blew up in the first place is that people began to view rising home prices as personal ATM machines. Now Bernanke is simply putting a new face on the same monster.

Think about it…

We already have a multi-year oversupply in homes on the market and ridiculous amounts of construction is still going on in parts of the country where there are quite literally no buyers. If you’ve been to Las Vegas or parts of Florida you know exactly what I’m talking about.

How many homes do we really need at a time when values remain 30% to 50%, and in some places even 70% below their peak?

Certainly not the millions of new homes that Bernanke thinks we do while unemployment remains high and actual buying power has been dramatically reduced.

And millions of strapped American families two paychecks away from bankruptcy surely don’t care.

Bernanke’s False Bottom

Now I know the media is very excited about recent data showing a recovery in housing prices, but let’s take a deep breath. Seasonal demand accounts for a good portion of the bump. So does bargain hunting.

This suggests a new round of speculators has entered the game — and those folks are buying with cash, making mortgages irrelevant. As a result, prices are being bid up even though overall demand remains relatively constant.

Then there are the banks. All of them claim they want to lend money, yet find every excuse not to. While they will claim otherwise, practically speaking they’re saying one thing and doing another.

This, too, speaks to a massive disconnect. Banks aren’t worried that mortgage holders won’t be able to make their payments. What they’re actually concerned about is that the underlying assets against which they’re lending will lose value.

I saw this first hand in Japan in the 1990s when banks realized that real estate can and frequently does lose value as economic conditions change.

Besides, if banks thought otherwise and truly believed in a brighter housing market ahead, those institutions would be falling all over themselves in the name of profits. For example, lenders would be doing anything they could to make it easier for borrowers to obtain loans, like reducing down payments and adjusting credit score requirements.

Instead they’re busy profiting from spreads that are actually higher now than they were before the financial crisis.

How much more? Sit down…according to the Financial Times, the interest banks pay on mortgage bonds has dropped from 2.36% on September 12, the day before the Fed announced its new program, to as low as 1.65% last week. It edged up to 1.85% on Monday.

Further, also according to the Financial Times, the profit banks earn from creating new mortgages and selling them into secondary markets has risen to 1.6%. That’s up from the 1.44% they pocketed before QE3 and significantly higher than the 0.5% they earned on average in the decade between 2000 and 2010.

The banks would also be securitizing an entirely new batch of garbage mortgages to sell into global markets almost before the ink is dry. But they’re not. And the Fed, not private buyers, remains the purchaser of last resort for mortgage-backed securities as QE3 continues.

It’s no wonder that “bank” has become a four-letter word lately.

Where the Fed Gets it Wrong

Which brings me back to Ben Bernanke…what can he possibly be thinking?

I believe he is trapped in history and it’s affecting his judgment.

At the end of WWII, our nation made the conscious decision to rebuild based on three things: cheap energy, cheap transportation and cheap housing. So Washington created industries to support all three, but especially housing.

Our government built in mortgage deductibility and capital gains treatment for appreciation. We created the S&L industry to finance residential borrowing and enacted special rules that gave S&Ls the ability to lend lower while offering higher returns to their investors than traditional banks. Few people remember this, but at one time S&Ls — thrifts as they were called — could lend only within 50 miles of their home office.

Through its massive support of housing, our leaders essentially traded real growth for indirect government aid through interest rate manipulation as a means of engendering growth.

Meanwhile, other nations, like Japan and Germany, for example, chose to rebuild based on manufacturing. Germany still maintains that posture today while Japan lost its way and embarked on a debt-driven orgy that has its roots in the early 1970s when that country unpegged the Yen.

Then, our leaders got greedy. They poured jet fuel on the fire in the 1970s and 1980s then again in the early 2000s by making gobs of debt available to compensate for shoddy market conditions and economic headwinds. Not surprisingly, real estate markets exploded.

Freddie Mac issued its first mortgage pass-through notes in 1971, calling them participation certificates. Ten years later, in 1981, Fannie Mae began bundling similar mortgage pass-throughs and called them mortgage-backed securities.

Then along came the Housing and Community Development Act of 1992, which amended the Fannie and Freddie charters. It mandated that both institutions meet affordable housing goals set by the Department of Housing and Urban Development (HUD).

Initially, the goal was for 30% of the combined portfolio to be comprised of low- and moderate-income mortgage purchases. By 2007, that figure had risen to 55%.

Somewhere along the line, the psychology of housing changed. I believe the hundreds of billions of securitized mortgages that were created out of thin air allowed people to view housing as an investment with fixed-income characteristics regardless of the underlying quality of the mortgages or the banks underwriting them.

In other words, houses stopped being simply homes and became the physical equivalent of fixed income instruments…investments by any other name.


Article printed from InvestorPlace Media, http://investorplace.com/2012/10/ben-bernankes-misguided-focus-on-housing-is-like-a-bad-joke/.

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