Ladies Don’t Dance On Graves

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I am often asked why I would leave the freedom of being a columnist to subject myself to the confines of the Fed, a bureaucratic institution frozen in a mindset that was diametrically opposite my own. I had already escaped compliance once when I left New York after selling my book of business to Credit Suisse and signing a non-compete (something about “equities in Dallas.”) “Retiring” to write a column about the financial markets was truly a dream come true and proved to be deeply gratifying work. Thou shalt never besmirch The Fourth Estate. It should be the 11th Commandment.


Don’t get me wrong. Calling Greenspan to task as the subprime crisis hurtled at warp speed towards the world economy was not exactly well received by the public, or my publisher for that matter. But that was in 2004 and 2005 when home prices looked as if they would continue on their skyward trajectory indefinitely. At some point, though, my “crazed” predictions came to pass and hate mail writers began to pen apologies as they were, after all, losing their homes to foreclosure. That, I can assure you, was not what I had signed up for.

The dark humorists always claimed that the Fed had hired me for one sole purpose – to shut me up. My stock answer, aside from the honor of being called to serve my country, has always been that ladies don’t dance on graves. There was no satisfaction in being right. Better to try to do something about it by changing the minds of policymakers from the inside. Let’s just say I had no idea what I was getting myself into.

The day was September 29, 2006. To put into five words my state of mind: My hair was on fire. The housing crisis was coming and the only question was one of how to contain the damages that would ensue. My anti-schadenfreude and personal history of living through the S&L crisis in hand, I marched myself into the Fed to meet the oncoming crisis head on. Straight into a brick wall, that is.

The housing crisis was nowhere to be found in most economists’ play books – unless (inconveniently) the Great Depression was included in the time frame examined. The go-to stress test for Fannie and Freddie to gauge how bad things could possibly get was the S&L crisis in Texas. Suffice it to say, that benchmark was wiped off the planet as a point of reference within a matter of months as the housing market crashed, dragging the interconnected global financial system down with it.

I am sad to report that what was readily apparent to me was oblivious to the ingrained myopia that infected most Fed economists. Market historians will recall that on March 28, 2007, the following words were publically stated by one Ben S. Bernanke: 

“At this juncture, however, the impact on the broad economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency.”

To think that this statement was made nearly two months after HSBC, at the time the world’s third-largest bank, announced that its bad debt charges would be 20 percent higher than forecast due to the deteriorating state of subprime mortgages it held. Foreclosures were up 35 percent over 2006 and for a fifth straight month, more than 100,000 properties entered foreclosure because the owners couldn’t cover their payments. This situation was “contained”?

As incredulous as this rookie was at the depth of the pervasive blindness, what was to come would prove more unsettling yet and lay the groundwork for a housing market “recovery” that eludes to this day.

Over seven years ago, the housing bubble peaked and rolled over. Normalcy has yet to return. The latest case in point occurred in June when existing home sales hit an 8 ?-year high. The news was widely lauded by the economist community and in the media. But the composition of today’s buyers is no cause for celebration. Some 30 percent of homebuyers in June were first-timers. Moreover, the May to June increase in existing home sales was the weakest in seven years despite aging millennials who should be seguing from rentership to homeownership.

Think about that for a moment. June sales reflect contracts signed in April and May as many young families are contemplating such things as school districts and perhaps moving into their first home. First-timers should theoretically represent a disproportionate share of buyers as the school year is coming to an end. And yet they remain stubbornly conspicuous in their relative absence.

How things have changed in the short space of a few years. At the peak of the housing bubble, first-timers were over half of the buyer market, which was equally out of whack with a normal state in which 40 percent of buyers are first-timers. Back then, mortgage standards were ridiculously lax, which of course, led to the subprime fiasco and in turn snowballed into the financial crisis.

It was in the cleaning up the aftermath of the crisis that things went very wrong. No doubt, ripping the bandage off by standing back and allowing the market to clear would have led to a deeper recession, which is saying something. But maybe today housing would be a realistic option for more young Americans if more homes would have been sold at fire sale prices. That is not to even begin to suggest that foreclosure is a kind event in a homeowner’s life. But consider the fact that enough time has passed that many who lost their overvalued homes to foreclosure early on are once again now eligible to take out a mortgage.

Instead of market clearing, policymakers and politicians went out of their way to cushion the fall. Such was the height of this tall order that it took years to play out. Amid all manner of fanfare, one modification program after another was unveiled to “help” homeowners remain in homes they can still not afford. Even today, after all this time, one-quarter of bottom-tier homes are underwater; their mortgages still exceed the home’s value thus trapping the occupants.

As for the banks, they’ve been regulated and fined to kingdom come, which makes for great soundbites but does nothing for mortgage applicants. Lending standards are just now beginning to ease. The public might have been better served had they had the satisfaction of seeing even one perp walk on the evening news. Widespread mortgage fraud should have been convictable on some level. But that has yet to happen.

In the meantime, low interest rates invited a new breed of homebuyer to muscle its way into the market. Deep-pocketed private equity investors, armed with their price-ambivalent purchasing power, have been an immense driver of home price appreciation in recent years. In all, investors have amassed a stable of 2.6 million rental homes, which may not seem like much given the fact that there are 133.6 million homes out there. But ask any realtor and they will tell you that investors have had a tremendous effect on comparables. You don’t need too many homes sold above their true market price to affect the rest of the neighborhood.

And so it followed that home prices never did fall as much as history would have predicted. The white knight investors with their saddlebags filled with someone else’s gold rode in to save the day. Or at least that’s how the happy-ending version of the story is told. Try telling that to buyers who have been priced right out of the market. The median price of a home sold in June rose to $236,400, the highest on record.

If the stated goal of the Fed was to put a floor under home prices, I suppose policymakers can take a bow. But I doubt they applaud the effect of high prices and tight mortgage standards shutting out many first-time homebuyers. Instead of taking advantage of the cut-rate prices a market clearing would have produced, many millennials have instead made a prolonged stopover in the apartment rental market. Since homeownership peaked in late 2004, some 8.7 million renters have been created while the ranks of homeowners have contracted by 1.2 million.

With rent inflation running at the fastest pace in a decade and home prices at a record high, it’s safe to say we’ve returned to the heyday of the housing bubble, but not in a good way. Well-intended but predictably ill-conceived Fed policy has now managed to put housing out of reach for not one, but two, generations of Americans.

The parade of casualties does not end there though. The significance of a lost generation of first-time homeowners for the Baby Boomer generation and the economy’s prospects are undeniable. A 2012 study concluded that by 2030, some 26 million Baby Boomers would endeavor to sell their homes and retire. Success, however, hinges on move-up buyers in significant numbers lining up to buy Boomer’s high-end homes. The odds of a sufficient number of move-up buyers being created are slim to none given the absence of first-timers ready to trade up. Policymakers may lament the fact that so many millennials are living in their parent’s basements today. Just imagine how they’ll take the news that increasing numbers of Baby Boomers have simply switched places with their offspring.

Article by Danielle DiMartino Booth, Fed Up: An Insider’s Take on the Willful Ignorance and Elitism At the Federal Reserve

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