A Gift from the Greeks
The Federal Reserve Board will soon allow the price of long term mortgages to move higher, reversing their policy of the last seven years. This change has been widely anticipated for years but, for a variety of reasons, the Fed has been reluctant to act until now. The consensus at the central bank is the national economy, and the housing market, has recovered enough to absorb the effects of an increase in the cost of borrowed money.
Owners of real estate have been feasting on a rich banquet of cheap mortgages but the waiter is on his way with the check. Because the Fed has been so accommodative toward real estate, the nation’s housing market managed to survive The Great Recession, even though there were a great many casualties, crushed by the combined forces of deflation and debt. Inexpensive loans, made possible by Quantitative Easing, inflated real estate prices and staunched the flow of foreclosures. Now the Fed thinks residential markets have recovered to the point where they no longer need to be subsidized.
Because of this change, the local real estate universe is abuzz with chatter about potential doom or at least a minor catastrophe visiting the housing market. Even though interest rates are going to increase, the FRB will not allow residential prices to deflate. The Fed knows the nation’s economic recovery, while robust in some sectors and regions, is still a work in progress and probably cannot survive even a hint of falling home prices. It took years of 3% mortgages and a huge influx of Federal dollars to straighten out the last mess.
Housing gets a free pass as it is conventional economic wisdom that the rate of home sales leads the nation's economy into and out of recessions. During the darkest days for housing in 2008 and 2009, the Board committed to a policy of low-cost of 30-year fixed rate mortgages enabled by Quantitative Easing. By creating money to purchase certain types of long-term debt instruments, the Fed created an artificial shortage in the debt markets, driving up the price of bonds and their ilk. And as you remember from Econ class, yields on debt go down when the bond prices increase.
QE was appropriately phased out after home prices stabilized. Mortgage money will be more expensive by the end of the year, although I predict the increases will be in small increments to avoid upsetting the recovery in housing. The hard truth in San Diego is about 20% of homeowners have marginal or negative equity in their homes. If prices, which are now flirting with 2007 highs, begin to deflate many marginal borrowers could lost faith and initiate another sell-and-destroy mission. What keeps people, who struggle to make payments, in their homes is a belief in the California Dream---a profound conviction that in these parts real estate always gets more expensive.
The Greek Tragedy being acted out is remarkably similar to the ongoing dispute between the Feds and the angry lynch mob of debt scolds. In 2008 the Fed initiated a policy that eventually saved most of the American middle class from further economic pain dealt out by The Great Recession. No matter their motive, our Central Bank chose not to punish (read austerity) the citizenry too much for past excesses but instead provided an economic subsidy to fuel growth. Our economic betters were unwilling to subject the Americans to the kind of economic retribution and privation being endured by ordinary Greeks. The current and past Fed Chairs persevered in their policy in spite of being regularly keel-hauled by the business press, Fox News, and congressional sub-committees. In the end, they allowed millions of Americans to hang on to the one asset that will probably have to provide for most of their retirement income. I know about the moral hazard argument as well as the huge pile of assets sitting on the Fed’s balance sheet, but in 2008 we made the collective decision to spend and borrow our way out of The Great Recession and not embark on a program of austerity. This policy is the exact opposite of the new economic rules that will govern the Greek economy, at least until the next debt crisis.
I think the end result of the latest Greek experiment will bury the idea that you can grow an economy through austerity. It is entirely possible the German approach will work better (for the Germans) in the long run but I never thought the concept of debtor’s prison worked that well. Americans are still believers in Keynesian economics and second chances, which means real estate will not get any doses of Ms. Merkel's Restorative Potion. Rates will move up but at a very measured pace. If home prices start to falter, you can bet that your central bank will stabilize the market with another round of Quantitative Easing. The inevitable suffering being imposed on the Greeks will probably not do much to pay off their debts and I suspect another crisis is around the corner. This lesson will not be lost on the body politic here are home.