ZIRP

Another housing market of cards

Posted on by j.giglio

Rising home prices have some concerned that we could be building another house of cards. Housing prices are up 8.1 percent over last year, according to the S&P/Case-Shiller price index.

Sales have been improving too. The National Association of Realtors estimates that 4.65 million previously owned homes were sold in 2012, up 9.2 percent from 2011. Some of the numbers are truly eye-popping. Phoenix home prices were up 37 percent, followed by Las Vegas, where prices rose by 30 percent.

The question is whether the housing recovery is caused by rising demand from people who are doing better economically, or big investment companies, private equity firms, hedge funds and foreign buyers betting on the housing market’s recovery by buying homes, renting them for short-term profit and holding them for long-term price appreciation.

They are buying in places like Florida, Georgia, Arizona, Nevada and Califomia,places where home prices fell the most during the Great Recession.

In the process, they are helping fuel the home price surge, bankrolled by cheap credit made available by the Fed’s zero interest rate policy. They are also shrinking inventory, crowding out local buyers, and making homes beyond the economic reach of first-time home buyers.

It’s like the story about a soapbox orator speaking to a Wall Street crowd about the evils of drugs. When he asked if there were any questions, an investment banker asked, “Who makes the needles?” Never  miss an opportunity.

In the early 2000s, America saw the creation of a housing bubble, encouraged by low interest rate policies implemented in the wake of the 2000 stock market crash and recession that was caused when the dot-com bubble burst. Low interest rates reduced mortgage costs. This stimulated demand for houses and drove up prices.

Rising prices led to the perception that houses were more than just a place to live, they were an investment whose value seemed likely to keep rising, building wealth and funding the homeowner’s retirement. That perception further increased demand for houses, driving prices still higher.

In 2005, Federal Reserve Chair Ben Bernanke said, “House prices have risen by nearly 25 percent over the past two years … at a national level these price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas.”

Since the consumer price index we use to measure inflation excludes assets like homes and securities, the index’s nearly flat trend during the middle of the last decade made it easy for the Fed to convince us to be more worried about deflation than inflation and helped justify its decision to keep interest rates low.

China and other low-wage countries were happy to help the Fed keep rates low. By exploiting their non­-union labor forces, they continually reduced the prices of their exports, which Americans bought in ever-increasing numbers. Then they took the proceeds and bought up the U.S. Treasury debt being issued to fund two wars in the wake of large Bush administration tax cuts.

Ours was a nation awash with capital, much of it debt-based, seeking investments that offered generous yields. Home prices peaked in May 2006, stalled and then fell. The American economy officially slipped into recession at the end of 2007.

The housing bubble burst in the fall of 2008, experiencing its Wile E. Coyote moment. Many financial institutions had to write off billions in toxic or worthless mortgage assets. All the large American financial institutions- including Bank of America, Citigroup, Wells Fargo and insurance giant AIG­ ended up getting bailed out by taxpayers. When the housing bubble burst, the 2008-09 recession affected nearly every business in the U.S. and then worldwide.

Let’s hope Wall Street’s speculative housing bet facilitated by the Federal Reserve’s zero interest rate policy doesn’t lead to another crash in which the rise in home prices is not supported by economic fundamentals and ordinary people ultimately bear the cost.

originally published: May 18, 2013

It’s a wonderful life

Posted on by j.giglio

Those of you who’ve seen Frank Capra’s classic 1946 movie “It’s a Wonderful Life” (at least once, since it’s been a Christmas Holiday perennial on television for decades) will remember one of its most famous sequences.

George Bailey (played by James Stewart) runs a one-horse Savings and Loan bank in the All-American town of Bedford Falls. And one day he’s confronted by a group of his depositors who’ve come to withdraw their savings money because they’ve become nervous about its safety, the classic run on the bank.

He tries to clue them in on the realities of the banking business, explaining that he doesn’t keep their savings in a safe in his back office. Instead, he’s used most of the money to grant each of them affordable mortgages on their homes.

Sam’s money is in Chuck’s house. And Chuck’s money is in Dick’s house. And Dick’s money is in Sam’s house … So it goes.

With each of them able to own the homes they live in instead of having to pay rent to Old Man Potter, the hard-hearted villain who owns the leading commercial bank and most everything else worth owning in town.

What George was trying to describe to his nervous depositors is how the home mortgage and banking business worked in the “Good Old Days.”

If “It’s a Wonderful Life” were made today, its description of banking would have to be updated to reflect last month’s goings on in Cyprus. To secure a 10 billion euro bailout, Cyprus slapped a tax on deposits that ranged from 9.9 percent on amounts above E100k to 6.75 percent on deposits under E100k which translates into $130,000 (the limit for deposit insurance). It then revised the terms of the proposed haircuts to reduce the levy on smaller depositors and raise them on larger ones. In other words, they would tax the bank accounts of citizens and businesses to recapitalize the banks. Afraid that the government was coming for their cash, Cypriots ran to the bank. Much was made of the government’s attempt to get its pound of flesh from bank accounts; people had to wonder if their own money was safe. We were told Cyprus was an isolated case and it could not happen here.

But how does Cyprus compare to what’s happening to American depositors and savers? The Federal Reserve’s zero interest rate policy (ZIRP) is not a tax, but it reaches into the average American’s pockets.

And it is done for the same reason as the bank bailout in Cyprus: to save the financial system. Average Americans are earning next to nothing on their bank deposits, which are actually losing ground to inflation. Yet they can’t borrow from the bank at these ridiculously low interest rates. Maybe Cyprus doesn’t look so bad after all.

ZIRP sets a dangerous precedent. It suggests that governments are not above taking money from depositors to pay for bailout packages. If deposits are not safe from politicians, why should you trust any bank?

ZIRP has been confiscating the savings of Americans for the past five years.

The average interest on a savings account is less than 0.25 percent, a 10-year government bond yields less than 2 percent and inflation adjusted returns on six-month bank CDs are 0 percent. Average Americans have no safe place to park their money and collect a decent return. Is the difference between these returns and normal interest rates equivalent to a tax? In Cyprus, it was a one- time hit to depositor, in America it happens more slowly.

This blow to traditional savers harms the working class, discourages savings and induces some to speculate in the stock market and reach for higher yields on riskier investments. In America, savers aren’t an endangered species; they’re all but extinct.

originally posted: April 20, 2013