The Fed Engineers A Phony Recovery

Dave Cohen * Decline of the Empire

When mainstream propagandists tout the immaculate “recovery” in America’s economy, and particularly the miraculous “recovery” in the housing market which began in 2012, they almost invariably do so without referring to the extraordinary, historically unique actions of the Federal Reserve over the last four years. This is propaganda by omission.

Bloomberg’s Recovery in U.S. Saving 8 Million Underwater Homeowners gives us the housing story of Phoenix residents Maggie Medved and Wendy Thomas, who live together.

Maggie Medved was stuck with her Phoenix house for two years after the market crash wiped out the equity in the property.

Last year, as prices in the area rose by the most in the U.S., she and her partner were finally able to sell the 3-bedroom 1950’s style home and move to a larger place.

Move to a larger place?

“We were counting the days for when we could move,” said Medved, 40, who trains employees for weight loss company Jenny Craig Inc. “We definitely knew it was a waiting game because it would’ve been financial suicide if we had sold earlier.”

Medved was among the 12 million borrowers in the U.S. who at the peak of the real-estate downturn owed more on their mortgages than their houses were worth, blocking them from moving or saving money by taking advantage of the lowest borrowing costs on record to refinance. As prices recovered, the number of underwater borrowers fell by almost 4 million last year to 7 million, according to JP Morgan Chase, and could drop to 4 million within 2 years.

The housing market is rebounding faster than anyone thought possible…

Medved’s Phoenix home was on the market for two days before it sold for $85,000, just shy of the price paid in 1998.

She and her partner Wendy Thomas bought a larger property with a pool for $210,000 in Glendale, about 10 minutes away.

“We’d outgrown the house and the neighborhood took a turn we didn’t like,” Medved said. “Almost 12 years later we were in the hole $30,000. We couldn’t take that much of a loss and needed to stay regardless of what the neighborhood had become.”

Maggie and Wendy took a loss on a house they bought 15 years ago in 1998, but despite this unhappy experience, they moved into a larger house with a pool. How is this possible? Christopher Matthews explains what’s going on in Is The Housing Recovery Just an Illusion Created by the Federal Reserve?

… there’s plenty of data to choose from for a housing market bull to make his case. But even if these data clearly show an incipient recovery, what exactly is the reason for it? Tim Iacono of Iacono Research believes that most — if not all — of the recent rise in home prices is a direct result of efforts by the Federal Reserve to stimulate the economy.

The Federal Reserve has kept short term interest rates at near-zero since 2008…

One of the main ways this sort of action helps stimulate the economy is by increasing home values, for the reason that if you lower the interest rate you need to pay in order to finance the purchase of a particular asset, you raise the price at which a home buyer can afford to purchase it.

As Iacono points out, lower home mortgage interest rates can mean dramatically higher home prices. Iacano notes that with today’s record-low rates of 3.3%, a $1,100 per month mortgage payment can finance a house worth $280,000. He continues:

“Even if mortgage rates moved back up to their 20-year average rate of 6.5 percent (what many thought were simply unbelievable rates when they first dropped that low last decade), that same $1,100 mortgage payment would finance a home purchase of just $193,000, not the current $279,000. The difference between these two prices is nearly 50 percent!”

From Tim Iacono’s How Fed Policy Distorts Home Prices (cited above by Time)

Now you can understand why Maggie and Wendy were able to take a loss and buy a larger house.

Are you beginning to get the picture here? Ultra-low interest rates are allowing people to trade up in houses again. The irony is not lost on Tim Iacono.

This is starting to sound a lot like those 2005-era stories of people with $50,000 incomes buying $500,000 houses. How you end up there is much different (liar loans and interest-only loans versus super-low mortgage rates), but the underlying instability that this sort of financing creates is not all that different.

Americans like to pretend that the Good Times are coming back, and recent bullish talk about the miraculous “recovery” in the housing market fuels that delusional belief. What they conveniently forget is that the extraordinary but irresponsible actions of the Federal Reserve have distorted the housing market, and most other markets as well (look at the S&P 500, which stands at 1477.24 today, or the price of crude oil, where WTI is $95.16 and Brent is $111.20).

Houses, equities, crude oil—all these assets are overvalued. A genuine, bottom-up, demand-driven recovery in the U.S. economy is simply not possible for all the reasons I’ve cited on this blog (e.g. declining household income and hidden inflation costs). At the same time, the Fed is punishing savers for not spending their shrinking pile of shrinking dollars or putting them at risk (video below). There is nothing geniune about this “recovery” in housing.

The Fed must engineer a phony recovery to keep the “extend & pretend” game going. It is easy to fool the people, although it has taken four long years for the Fed to give some artificial lift to the housing market.

Don’t be fooled like Maggie and Wendy were.

Have a nice weekend.

Bonus Video — David Stockman talks about the Fed’s War on Savers (short, 1:39, worth watching)