The Fed Fears a New Mortgage Crisis

by Claus Vogt 11-25-09

Although the number was just revised downward, the U.S. economy still expanded by 2.8 percent during the third quarter. So it definitely looks like the recession is history.

What’s more, last Thursday the Conference Board published its Leading Economic Indicator (LEI) for October. This indicator has a strong predictive history, having predicted each recession since the early 1960s as well as the one we’ve just gone through.

Right now the LEI is not forecasting a return of the recession. Quite to the contrary … the October reading was again very strong. Year over year the LEI was up by 4.2 percent, the seventh consecutive increase. And the LEI’s historical record strongly supports a continuation of economic growth during the coming quarter.

With so much good news, I have to ask …

What Does the Fed Fear, Then?

Why are Fed members continually reiterating the current zero percent interest rate policy?

Why are they assuring us that this policy will continue “for an extended period?”

What are they afraid of?

Do they see or know something we don’t?

Why are Fed members sticking to their zero percent interest rate policy?

The past few years have clearly demonstrated that the Fed members didn’t have a clue about the consequences of the real estate bubble, which they themselves inflated. And after the crisis hit, they kept underestimating it at each step along the way.

Moreover, if you had listened to Bernanke and his pals in regards to your personal finances, your losses would be huge!

This sad showing obviously did nothing to shake their self-efficacy or arrogance. They still want us to believe that they are the puppet masters behind the economy — at least in boom times. And during a bust they want us to believe that they alone are in possession of a remedy.

It seems as though they totally lack trust in the free market forces. Instead they desperately want to fix things by decree and money printing.

So why do they keep advertising an ultra lax monetary policy even now, after the economy is starting to recover?

Because They Know Another
Mortgage Mess Is in the Offing

The Fed is well aware of the mortgage reset schedule for the coming years. And they’re probably well aware of a major problem out there, too … a problem at least as severe as the subprime mess.

I’m talking about mortgages like Alt-A and Option-ARMs. A huge wave of resets is due to commence soon.

From the second quarter of 2010 until the fourth quarter of 2011, hundreds of billions of dollars in these mortgages will reset to much higher rates! And many of them will end up becoming delinquent.

Here’s why …

Mortgage resets are bound to increase the number of foreclosures.

Aggravating the situation is the fact that most of these mortgages were taken out when the housing bubble was at its height. So now, the loan-to-value ratios for many homes will be obscenely high.

This means a tsunami of write-downs for the banking sector, probably as huge as the subprime write-downs. And it means a huge wave of foreclosures on borrowers who can’t afford the new, higher monthly payments.

The ability to service a debt does not depend on rising GDP figures. It depends strongly on current income. That’s why high (and rising) unemployment rates are very bad news for the housing market and for the banks — again.

It’s still too early for this unavoidable, mortgage reset problem to derail the banking system and stop the economic rebound in its tracks. We can still be bullish on stocks for some time, as well.

Nevertheless, this looming problem goes a long way in possibly explaining the Fed’s reluctance to return to a more normal monetary policy. And it’s something you should keep in mind.

Best wishes,

Claus

The Sorry State of Modern Economics

by Claus Vogt 11-11-09

Since last year’s collapse of the banking system, hundreds of billions of dollars have been spent to bail out some of the major players. Additionally, governments all over the world, and their central banks, have implemented huge stimulus programs to combat the consequences of the burst real estate bubble.

Economic history is being written right before our eyes. Hence, I refer to this episode as the largest economic experiment since the implementation of communism. And here’s what really frightens me: None of the experimenters saw this crisis coming, but all of them claim to know the remedy!

At the same time politicians and economists are very busy explaining what they deem to be the reasons for the economic malaise …

Speculators, hedge funds, greedy bankers, and lax regulators are said to be responsible. And a lot of talk about a market failure is being presented as the alleged root of this crisis.

Sure, hedge funds, bankers, and regulators certainly played a role. But their reckless behavior is but a symptom of what had been going wrong and was not the cause. And the latter proposition is plain wrong. Let me explain why …

This Crisis Is Not a Market Failure.
It’s a Monumental Policy Failure!

Irrational central bank policies are the source of the current crisis.

By now, nobody — not even Greenspan or Bernanke — will deny that the U.S. housing market was a huge speculative bubble. And the bursting of this bubble triggered the banking problems and the recession.

So we have to look into what causes a speculative bubble to understand the real culprits of the current predicament. The answer is fairly straight forward: Expanding money supply and credit growth.

Since the central bank controls the money supply and credit growth, it’s obvious that the central bank is accountable for the evolution of bubbles and the consequences of their inescapable bursting.

You could easily conclude then, that an unsound monetary policy caused the real estate bubble. That means that the same unsound monetary policy is also accountable for the sad and predictable consequences of the bubble bursting.

Unfortunately we’re not hearing or reading much about this obvious truth. Instead, fairytales about market failure are dominating the media. And an old and cynical policy joke comes immediately to mind: “When the day of reckoning arrives there is but one policy solution: Lying, lying, lying.”

This seems to be the conclusion, the current credo of our politicians and the vast majority of economists. Many of whom are in the business of consulting politicians.

From Economists and Solar Eclipses …

To get a better understanding of what is going on let’s switch to an exemplary story: Suppose we were not dealing with economists but with another breed of scientists, let’s say astronomers. Nearly all of them are using the same theories and models. They’re highly regarded and some have even won the Nobel Prize.

Suddenly something totally unexpected takes place, a total solar eclipse! None of our astronomers had seen this coming. After a short moment of shock and silence, they quickly regain their confidence.

Immediately they start explaining extensively why it had been impossible to predict this eclipse — in spite of the fact that some of their peers had done exactly that, although with an alternative theory.

But the audacity doesn’t stop here. These so-called experts also come up with a variety of necessary measures to make sure that — no more eclipses will happen in the future.

This story illustrates perfectly the sorry state of our current mainly Keynesian-dominated establishment of economists. Their behavior is totally unscientific. And it’s way off track, too.

More Bubbles to Come …

The next crisis will be much more severe than the current one.

As you can see, most politicians and economists haven’t learned anything from the near breakdown of the financial system. More of the same is their dangerous answer, much more.

Right now this policy is showing some desired effect: The housing market has stabilized, the stock market has risen and the economy has been growing again. But this short-term success has a dangerously high price …

Eventually this policy will again fail, like it did before. Already new bubbles are emerging, and the budget deficit is going through the roof! Now, however, the stakes are even larger, much larger. So the next crisis will be much more severe than the recent one.

My job now is to recognize when the current bounce is over and when the next act in this government-fueled crisis will begin. I’m confident that my models will again lead me successfully.

Right now I don’t see signs of renewed weakness. But we must stay constantly on the alert of changes for the worse. The next time down is unavoidable. And the outcome of this great experiment is clear.

Now the only question is: When?

Best wishes,

Claus

Fed Signals “All Systems Go” for More Inflation

by Mike Larson 11-06-09

I have been adamant recently in saying that the Federal Reserve would not … would NOT … signal an end to the easy money environment at this week’s policy meeting. These guys simply lack the political willpower and the inclination to do what’s right. They want to keep the booze flowing to inflate assets, the long-term consequences be darned.

Sure enough, the Fed reiterated Wednesday that it’s not worried at all about the surge in asset or commodity prices. It said,

“Substantial resource slack [is] likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.”

Not only that, the Fed also said it will keep rates low until the cows come home. Specifically, it said that it …

” … continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

The FOMC isn’t worried about inflation.

The only change the Fed did signal? That it’ll buy up to $175 billion in so-called “agency” debt, slightly below its previous target of $200 billion. But it’s still going to buy $1.25 trillion in mortgage-backed securities.

And it’s not buying fewer bonds issued by Fannie Mae and Freddie Mac because it suddenly realized the folly of “monetizing” U.S. debt obligations …

… it’s because of the “limited availability of agency debt” to buy. In other words, the Fed is afraid it’s cornering and distorting the market … which it is!

Never Forget: “Proactive” Is A
Dirty Word in Washington

Why have I been saying you should forget the empty talk you’re hearing about tighter policy? Because action is what counts. And it is abundantly clear to me that the Fed won’t take action until it’s forced to by a dollar crash, a bond market collapse, or some combination of both.

Those events would be important signals that the market has lost confidence in the Fed’s ability to control inflation and in the U.S. government’s willingness to preserve the value of the dollar, necessitating a policy response.

“Proactive” is quite simply a dirty word in Washington. Politicians (and this includes Fed members, no matter how much they like to pretend they’re not political creatures) don’t like to move before a crisis … only after one gives them the political cover to do so.

Indeed, history is clear: Rather than proactively tighten monetary policy in the late-1990s to quell the insane speculation in tech stocks, the Fed ignored the bubble until it gutted the portfolios of millions of investors. Then the Fed ignored the 2003-2006 housing bubble until it ruined the lives of millions of homeowners.

The Fed just told the markets to let the good times roll!

Now, the Fed is doing the same thing again, but on an even grander scale. It’s inflating virtually every asset under the sun — junk bonds, corporate bonds, gold, commodities, stocks, you name it. And rather than proactively taking steps to control the markets … before they get OUT of control … they just told the market this week to let the good times roll!

Regulators, Congress looked the other way while Fannie, Freddie, and mega-banks drove themselves off a cliff!

It’s not just Fed policymakers. It’s the banking regulators and Congress, too!

Look at Fannie Mae and Freddie Mac. People were warning for years that they were taking on too much risk … that they were too thinly capitalized … and that a housing crash would bury them.

But Washington allowed the two agencies to go on their merry way, piling up huge amounts of debt and risk. We all know what happened then: They blew up, requiring tens of billions of dollars in taxpayer-funded bailout money.

Ditto for the banks that were making reckless, high-risk home equity loans, mortgages, and commercial real estate loans. Many observers, including us, were shouting from the rooftops that this would end in disaster.

But rather than shut down the lenders making these loans, or FORCE them to cut back on their risky lending, all the regulators did was issue mealy-mouthed “guidance” letters. The banks ignored them because they had no teeth. And not too long after, those banks began to fall like dominoes.

Bottom line: I don’t LIKE the Fed’s current policy of asset inflation. I know it’s going to end in tears. But until those events I mentioned earlier (currency crash, bond crash, etc.) occur, forcing a change in policy and leading to a shift in momentum, the only thing we can do as individual investors is play along and try to make as much money as possible.

Until next time,

Mike