Thursday, July 29, 2010

Looming Changes at the Fed; Will the US Repeat Japan's Mistakes?

The Fed is mulling over its options for dealing with an outbreak of deflation. For a long time, Fed chairman Ben Bernanke dismissed the idea that deflation could be a problem because, as he noted, "The Fed has a technology called the printing press which allows the Fed to produce as many dollars as it wished at no cost." That's true, but increasing the money supply has not worked as planned. Bernanke has stuffed the banks with $1.7 trillion in reserves, but lending is still in the tank, consumer credit is shrinking at 5% per annum, and M3 has slipped into negative territory (- 6%). True, there's plenty of money, but it's not circulating fast enough (velocity) through the economy to produce a robust recovery. That's why Bernanke is looking for new ideas.

Last Thursday, James Bullard, President of the Federal Reserve Bank of St. Louis, issued a paper titled "Seven Faces of 'The Peril'" which warned that the US economy "may become enmeshed in a Japanese-style deflationary outcome within the next several years." The presentation surprised many because, up until then, Bullard had been more concerned about inflation. Now he's joined the deflationistas. As one of the central bank's brightest stars, Bullard's recommendations are worth considering as they are likely to shape future monetary policy.

Regrettably, Bullard is locked in the same ideological box as Bernanke and is equally committed to the same type of Friedmanite monetarism. Here's a key quote from the document which summarizes his analysis of the problem the economy faces: "I emphasize two main conclusions:

(1) The FOMC's "extended period" language may be increasing the probability of a Japanese-style outcome for the US, and

(2) on balance, the US quantitative easing program offers the best tool to avoid such an outcome." ("Seven Faces of 'The Peril'", James Bullard, The Federal Reserve Bank of St. Louis)

Bullard figures that the Fed's "extended period" (of zero rates) language is sending the wrong message to consumers and, thus, and lowering inflation expectations. This is critical, because the Fed wants people to believe that the currency in their wallets today will be worth less tomorrow. That way, they'll be more inclined to spend freely and give the economy a much-needed boost. But now--according to Bullard-- everyone assumes the Fed will keep rates at rock bottom for the foreseeable future, so the policy has become counterproductive. The solution: Change the language and adjust the policy so it reflects the Fed's determination to achieve its target rate of inflation. To do that, the Fed must "credibly raise the inflation target" which means restarting the Fed's bond purchasing program (quantitative easing).

Bullard is persuasive, but his analysis ignores the central problem, which is that people are so far in debt they need time to dig out before they can spend again. For Bullard, the fact that people are broke is a minor inconvenience that can be resolved by luring them into taking on more debt. In fact, the Fed's manipulation of inflation expectations is a subtle form of social engineering that works like this: The Fed expands its balance sheet by exchanging trillions in reserves for government (or, perhaps, corporate) bonds which scares the bejesus out of ordinary working people who figure the government is deliberately debasing the currency to create hyperinflation. Naturally, people figure that their best choice is to maximize their buying power by spending their money as soon as possible. This is the Bullard/Bernanke remedy; getting people to buy more things they don't need with money they don't have.

Bullard fails to mention that Bernanke's first round of quantitative easing never sparked a credit expansion or even increased inflation expectations. In fact, the dollar has grown stronger, bond yields have plunged, and deflationary pressures have continued to mount. Where's the beef? Bullard's thesis may sound convincing, but there's zero evidence that it will work.

Bullard does not put a price-tag on his plan, but the costs are bound to be significant. Every economist who has explored the issue, believes that to "credibly raise the inflation target" will require many trillions of dollars. Keep in mind, that the Fed's objective is to convince people that it is debauching the currency by "monetizing the debt". In reality, it is just exchanging one asset for another. The Fed can drain reserves as it pleases. There's no immediate danger of inflation.

As for the costs; here's an excerpt from a post by economist Bradford DeLong who puts a price on what is being called "QE2":

"The Federal Reserve has already increased the monetary base to a previously unimaginable extent and has doubled its balance sheet to $2 trillion. Even though there is good reason to think that further increases in the money stock alone will have little effect on the economy--that conventional monetary policy is tapped out--the Federal Reserve could always further increase its balance sheet to $3 trillion or $4 trillion. Such quantitative easing would be highly likely to eliminate fears of possible deflation or other lower tail risks and act as a powerful spur to investment. Such an enormous expansion of the balance sheet would produce a qualitative improvement in the assets held by the private sector, which would greatly reduce risk spreads and make funding available to American companies on much more attractive terms."

("A Keynesian voice crying in the wilderness", Bradford DeLong, Grasping Reality with Both Hands)

It is worth mentioning that Bullard rejects the Keynesian approach which would implement massive fiscal stimulus to sustain positive growth while the private sector repairs its balance sheet. The St. Louis Fed chief argues that to achieve that goal, the government would have to (credibly) "threaten to behave unreasonably" for a long period of time. (to change inflation expectations) Considering the gridlock on Capital Hill over budget deficits and "austerity measures", Bullard sees little possibility that congress would support such a strategy. He's probably right.

Bullard is correct in anticipating a "Japanese-style deflationary outcome", but his grasp of what happened in Japan appears to be sketchy at best. The Japanese tried quantitative easing, but the bond purchasing program failed to revive the economy or reignite consumer spending. Bullard thinks that Japan's central bank just threw in the towel too soon; that if they stuck with it, eventually the plan would have succeeded. But is the Fed really willing to make a multi-trillion dollar leap of faith on such flimsy evidence?

Nomura's chief economist, Richard C. Koo, has written brilliantly on Japan's battle with deflation, ("US Economy in Balance Sheet Recession: What the US can learn from Japan's Experience 1990-2005") labeling the phenomenon a "balance sheet recession", which means that people have reoriented their behavior from "profit maximization" to "debt minimization" strategies. Koo understands that consumer spending is not an inexhaustible resource that can be tapped into by merely lowering rates or adjusting inflation expectations. There are limits to how much debt people will take on. This is a lesson that neither Bullard nor Bernanke seem to grasp.

Koo's razor-sharp analysis is invaluable for anyone who wants to understand the present state of the economy. He provides a blueprint for easing the effects of deleveraging and for lifting GDP from the doldrums. His Keynesian solutions are the exact opposite of Bullard's, in fact, he states unequivocally that, "Fiscal policy is the only real remedy for balance sheet recession". Koo insists that once the government commits to fiscal stimulus, it must sustain deficit spending until the private sector has patched its collective balance sheet and is able to spend again at precrisis levels. That will take a long time and require political consensus.

The Fed doesn't have the tools to reverse the slide into deflation or to stop the hellstorm of debt liquidation and default. Low interest rates have lost their traction and another round of QE won't help. The economy has reset at a lower level of activity and monetary policy alone cannot create sufficient demand to sustain the recovery. When the private sector is deleveraging, fiscal remedies are needed to make up for flagging consumer spending and dwindling business investment. The best monetary policy can do, is make money cheaper (lower interest rates) and increase reserves at the banks by purchasing long-term government bonds. But increasing reserves does not put money in the hands of the people who will spend it and generate growth. In fact, there are times when people will not borrow no matter how cheap or available money is, which is why the Fed is unsuited for the task ahead. It's time for Obama to step up and do what's needed.

Koo notes that it took 15 years for Japan to muddle through its balance sheet recession, mainly because the problem had not really been understood before. "Now that the experience of Japan is available for anyone to see," Koo opines, "there's no reason for the US to repeat the same mistake."

Koo's "must read" report can be found here: "US Economy in Balance Sheet Recession: What the US can learn from Japan's Experience 1990-2005", Richard C. Koo, Chief Economist, Nomura Research Institute

(NB--Pay special attention to the graphs which show the effects of Quantitative Easing.)

Trillions for Wall Street---and zilch for you know who

On Tuesday, the 30-year fixed-rate for mortgages plunged to an all-time low of 4.56%. Rates are falling because investors are moving into risk-free liquid assets, like Treasuries. That's pushing down the yield on the 10-year note which is linked to mortgage rates. It's a sign of panic, which is the result of the Fed's failure to restore investor confidence. The flight-to-safety continues a full two years after Lehman Bros blew up.

Housing demand has fallen off a cliff in spite of the historic low rates. Purchases of new and existing homes are roughly 25% of what they were at their peak in 2006. It's a catastrophe. Case/Schiller reported on Monday that June new homes sales were the "worst on record", but the media twisted the story to create the impression that sales were booming. Here are a few of Monday's headlines:

"New Home Sales Bounce Back in June"--Los Angeles Times. "Builders Lifted by June New-home Sales", Marketwatch. "New Home Sales Rebound 24%", CNN. "June Sales of New Homes Climb more than Forecast", Bloomberg.

It's all spin. The media's cheerleading is only adding to the sense of uncertainty. When uncertainty grows, long-term expectations change and investment slows. Lying has an adverse effect on consumer confidence and, thus, on demand. This is from Bloomberg:

The Conference Board’s confidence index dropped to a 5-month low of 50.4 from 54.3 in June. According to Bloomberg News:

"Sentiment may be slow to improve until companies start adding to payrolls at a faster rate, and the Federal Reserve projects unemployment will take time to decline. Today’s figures showed income expectations at their lowest point in more than a year, posing a risk for consumer spending that accounts for 70 percent of the economy.

“Consumers’ faith in the economic recovery is failing,” said guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, whose forecast of 50.3 was the closest among economists surveyed by Bloomberg. “The job market is slow and volatile, and it’ll be 2013 before we see any semblance of normality in the labor market." (Bloomberg)

Confidence is falling because unemployment is soaring. The media's spin just make a bad situation worse. Notice that Bloomberg does not mention consumer worries over "curbing the deficits". In truth, the public has only a passing interest in the deficits. It's a fictitious problem invented by think-tank toadies who want to apply austerity measures so they can divert more public money to financial institutions and corporations . In the real world, consumer confidence depends on one thing alone--jobs. And when the jobs market stinks, confidence plummets. It's as simple as that. This is from another article by Bloomberg:

"Consumer borrowing in the U.S. dropped in May more than forecast, a sign Americans are less willing to take on debt without an improvement in the labor market.

The $9.1 billion decrease followed a revised $14.9 billion slump in April that was initially estimated as a $1 billion increase, the Federal Reserve reported today in Washington. Economists projected a $2.3 billion drop in the May measure of credit card debt and non-revolving loans, according to a Bloomberg News survey of 34 economists.

Borrowing that’s increased twice since the end of 2008 shows consumer spending, which accounts for about 70 percent of the economy, will be restrained as Americans pay down debt. Banks also continue to restrict lending following the collapse of the housing market, Fed officials said after their policy meeting last month" (Bloomberg)

Consumer confidence is falling, consumer credit is shrinking, and consumer spending is dwindling. Jobs, jobs, jobs---it's all about jobs. Budget deficits are irrelevant to the man who thinks he might lose his livelihood. All he cares about is keeping the wolves away from the door. Here's a quote from Yale professor Robert Schiller who was one of the first to predict the and the housing bubble:

"For me a double-dip is another recession before we've healed from this recession ... The probability of that kind of double-dip is more than 50 percent. I actually expect it."

The odds of a double dip are gradually increasing. But there's no need for the economy to head back into recession. Fed chairman Ben Bernanke knows what needs to be done; he knows how to counter deflationary pressures via bond purchasing programs etc. He even wrote a book about it. But Bernanke has chosen to do nothing. His intransigence is a political decision. By the November midterms, the economy will be contracting again, unemployment will be edging higher, and the slowdown will be visible everywhere in terms of excess capacity. The Obama economic plan will be repudiated as a flop and the Dems will be swept from office. Meanwhile, the slump will progressively deepen.

On Tuesday, a $38 billion Treasury auction drove 2-years bond-yields down to record lows. (0.665%) Investors are willing to take less than 1% on their money just for a government guarantee that they'll get the principal back. They'd be better served sticking their money in a mattress. Bond yields are a referendum on Bernanke's policies; a straightforward indictment of the Fed's strategy. 3 years into the crisis and investors are more anxious than ever. The flight to Treasuries is an indication that the retail investor has fled the market for good. It is a red flag signaling that the public's distrust has reached its zenith.

British economist John Maynard Keynes showed that the business cycle can be eased by government intervention; that the state can generate demand when consumers are forced to cut back on their spending. Presently, big business is awash in savings ($1.8 trillion) because consumers are on the ropes and demand is weak. The government's task is simple; make up for worker retrenchment by providing more fiscal and monetary stimulus. If private and public sector spending shrink at the same time, recession will become unavoidable. So, Go Big; create government work programs, help the states, rebuild infrastructure and support green technologies. The economy is not a sentient being; it makes no distinction between "productive" labor and "unproductive" labor. Spending is what counts, that's what keeps the apparatus operating as close to capacity as possible, that's what lowers unemployment and puts the country back to work. The time to worry about deficits is when the recovery is self sustaining and recession is in the reaerview mirror. Not now.

Increasing the money supply does nothing when interest rates are at zero and consumers are already cutting back. Bernanke has added over $1.25 trillion to bank reserves but consumer borrowing, spending and confidence are still in the doldrums. The problem is demand, not the volume of money. And demand won't increase without rebalancing the economy, creating more jobs, and reducing inequality. This is from Calculated Risk:

"This report from the National League of Cities (NLC), National Association of Counties (NACo), and the U.S. Conference of Mayors (USCM) reveals that local government job losses in the current and next fiscal years will approach 500,000, with public safety, public works, public health, social services and parks and recreation hardest hit by the cutbacks.

The surveyed local governments report cutting 8.6 percent of total full-time equivalent (FTE) positions over the previous fiscal year to the next fiscal year (roughly 2009-2011). If applied to total local government employment nationwide, an 8.6 percent cut in the workforce would mean that 481,000 local government workers were, or will be, laid off over the two-year period."

The cutbacks will ravage local governments, state revenues and public services. Emergency facilities by the Fed provided $11.4 trillion for underwater banks and non banks, but nothing for the states. The GOP is helping the Fed strangle the states by opposing additional aid for Medicare payments and unemployment benefits. Many cities and counties will be forced into bankruptcy while Wall Street speculators rake in record profits on liquidity provided by American taxpayers.

On Wednesday, Moody's chief economist, Mark Zandi and former Fed vice chairman, Alan Binder released the first in-depth analysis of the government's emergency response to the financial crisis. The paper evaluates the effects of the TARP, Obama's $787 billion fiscal stimulus, and the Fed's liquidity facilities. Here's an excerpt from the New York Times:

"We find that the effects on real GDP, jobs, and inflation are huge, probably averting what would have been called Great Depression 2.0. For example, we estimate that, without the policy responses, GDP in 2010 would be about 6½% lower, payroll employment would be about 8½ million jobs lower, and the nation would now be experiencing deflation.

When we divide these effects into two components, one attributable to the various rounds of fiscal stimulus and the other attributable to the panoply of financial-market policies (including the TARP, the bank stress tests, and the Fed's quantitative easing), we estimate that the latter are substantially more powerful than the former. Nonetheless, our estimated effects of the fiscal stimulus policies alone are very substantial: In 2010, real GDP that is about 2% higher, an unemployment rate that is about 1½ points lower, and almost 2.7 million more jobs…. ("In Study, 2 Economists Say Intervention Helped Avert a 2nd Depression", Sewell Chan, New York Times)

The bottom line? When Wall Street is hurting, money's never a problem. But when the states are on the brink of default and 14 million workers are scrimping to feed their families, there's not a dime to be found. Explain that to your kids.

Shadow Banking Makes a Comeback

Credit conditions are improving for speculators and bubblemakers, but they continue to worsen for households, consumers and small businesses. An article in the Wall Street Journal confirms that the Fed's efforts to revive the so-called shadow banking system is showing signs of progress. Financial intermediaries have been taking advantage of low rates and easy terms to fund corporate bonds, stocks and mortgage-backed securities. Thus, the reflating of high-risk financial assets has resumed, thanks to the Fed's crisis-engendering monetary policy and extraordinary rescue operations.

Here's an excerpt from the Wall Street Journal:

"A new quarterly survey of lending by the Federal Reserve found that hedge funds and private-equity funds are getting better terms from lenders and that big banks have loosened lending standards generally in recent months. The survey, called the Senior Credit Officer Opinion Survey, focuses on wholesale credit markets, which the Fed said functioned better over the past quarter." ("Survey shows credit flows more freely", Sudeep Reddy, Wall Street Journal)

In contrast, bank lending and consumer loans continue to shrink at a rate of nearly 5 per cent per year. According to economist John Makin, there was a "sharp drop in credit growth, to a negative 9.7 per cent annual rate over the three months ending in May." Bottom line; the real economy is being strangled while unregulated shadow banks are re-leveraging their portfolios and skimming profits. Here's more from the WSJ:

"Two-thirds of dealers said hedge funds in particular pushed harder for better rates and looser nonprice terms, and they said some of the funds got better deals as a result....(while) The funding market for key consumer loans remained under stress, with a quarter of dealers reporting that liquidity and functioning in the market had deteriorated in recent months." ("Survey shows credit flows more freely", Sudeep Reddy, Wall Street Journal)

As the policymaking arm of the nation's biggest banks, the Fed's job is to enhance the profit-generating activities of its constituents. That's why Fed chair Ben Bernanke has worked tirelessly to restore the crisis-prone shadow banking system. As inequality grows and the depression deepens for working people, securitization and derivatives offer a viable way to increase earnings and drive up shares for financial institutions. The banks continue to post record profits even while the underlying economy is gripped by stagnation.

Central bank monetary policy is largely responsible for the worst financial crisis since the Great Depression. Low interest rates and an unwillingness to reign in over-leveraged banks and non-banks triggered a run on the shadow system that left many depository institutions insolvent. Eventually, the Fed was able to stop the bleeding by providing trillions of dollars in emergency relief and by issuing blanket government guarantees on complex bonds and securities that are currently worth roughly half of their original value. The Fed is now reconstructing this same system without any meaningful changes. The upward transfer of wealth continues as before.

The Federal Reserve Bank of New York's own report confirms that securitization and massive leveraging contributes to systemic instability. Here's an excerpt from the FRBNY's "The Shadow Banking System: Implications for Financial Regulation":

"The current financial crisis has highlighted the growing importance of the “shadow banking system,” which grew out of the securitization of assets and the integration of banking with capital market developments. This trend has been most pronounced in the United States, but it has had a profound influence on the global financial system.....Securitization was intended as a way to transfer credit risk to those better able to absorb losses, but instead it increased the fragility of the entire financial system by allowing banks and other intermediaries to “leverage up” by buying one another’s securities." ("The Shadow Banking System: Implications for Financial Regulation", Tobias Adrian and Hyun Song Shin, Federal Reserve Bank of New York)

The former President of FRBNY, William Dudley, made similar comments in a recent speech. He said, "This crisis was caused by the rapid growth of the so-called shadow banking system over the past few decades and its remarkable collapse over the past two years.”

The system can be fixed by imposing capital and liquidity requirements on shadow banks and by maintaining strict underwriting standards on loans. Regulators need additional powers to check up on institutions which presently operate outside their purview. Any institution that poses a risk to the rest of the system must be regulated by the state. Unfortunately, the Fed opposes such changes because they threaten the profit-margins of its constituents. The Fed is paving the way for another catastrophe.

Securitization creates strong incentives for fraud. Prior to the Lehman Bros. default, structured securities, like bundled loans, were in great demand because investors were looking for Triple-A bonds with higher yields than US Treasuries and CDs. Bogus ratings convinced investors that mortgage-backed securities, asset-backed securities, and collateralized debt obligations were "risk free" when, in fact, many of the loans were made to applicants who had no ability to repay their debts. As foreclosures soared, financial intermediaries demanded more collateral for the short-term loans which provided funding for the banks. That pushed asset prices down and slowed liquidity to a trickle. When the wholesale credit markets crashed, panicky investors ran for the exits. The meltdown in subprime was the spark that set the shadow system ablaze.

Even so, Bernanke has fought all attempts to strengthen regulations, raise capital requirements, or tighten lending standards. Thus, the pieces of the shadow system have been reassembled with no fundamental change. Now it appears that the Fed's bubblemaking efforts are starting to pay off. Here's a clip from an article in the Wall Street Journal which clarifies the point:

"Even as lenders struggle to pull themselves out of the credit crisis, signs of a new and potentially dangerous infatuation with risky borrowers are emerging. From credit cards to auto loans to mortgages, the hunger for new business as the crisis ebbs is causing some financial institutions to weaken lending standards and woo borrowers who mightn't be able to pay.....

“Credit-card issuers mailed 84.8 million offers of plastic to U.S. subprime borrowers in the first six months of this year...Fannie Mae, seized by the U.S. government in 2008 to avert the mortgage company's failure, launched an initiative in January that allows some first-time home buyers to get a loan with a down payment of as little as $1,000....The thawing securitization market for auto loans is helping AmeriCredit increase its loan staff and dealer network...Kathleen Day, a spokeswoman for the Center for Responsible Lending, said the consumer group is "seeing banks re-enter the subprime market at a steady clip and make loans to borrowers who don't have the ability to repay.

“There is no doubt that the credit supply still is tight....But some lenders are starting to take more chances on consumer loans. Many financial institutions that survived the credit crisis and resulting recession are desperate for earnings growth." ("Signs of Risky Lending Emerge" Ruth Simon, Wall Street Journal)

Financial system instability is no accident. It's Central Bank policy. As financial institutions discover they can no longer count on organic growth in the real economy to increase profits, (because consumers are too strapped to spend freely) they will rely more heavily on dodgy accounting, bogus ratings, opaque debt-instruments, high-frequency trading and lax lending standards. This is the shadowy regime that Bernanke is trying so hard to rebuild. The Fed is laying the groundwork for another disaster.

Wednesday, July 28, 2010

A Decade of Declining Housing Prices

The housing depression will last for a decade or more. This is by design. The Fed has been working with the banks to withhold inventory so prices do not fall too fast or too far. That way the banks can manage their write-downs without slipping into insolvency. But what's good for the banks is bad for the country. Capital impairment at the banks means no credit expansion in the near-term. It means the economy will continue to contract, unemployment will remain high, and deflation will push down wages and prices. Everyone will pay for the mortgage-backed securities scam that was engineered by the banks.

Typically, personal consumption expenditures and real estate lead the way out of recession. But not this time. Both personal consumption and real estate will stay depressed and act as a drag on employment and growth. Last week, in testimony before the congress, Fed chair Ben Bernanke made it clear that the Central Bank has no intention of providing extra monetary stimulus to make up for rapidly-dissipating fiscal stimulus or the winding down of government subsidies for auto, home, and appliance purchases. The economy must muddle through on its own. But without additional pump-priming, disinflation will turn to outright deflation and the economy will sink into negative territory. Bernanke knows this, but he's absolved himself of any further responsibility. It's just a matter of time before the next slump.

Look at housing. The facts are grim. This is from Charles Hugh Smith:

“About two-thirds of U.S. households own a house (75 million); 51 million have a mortgage and 24 million own homes free and clear (no mortgage). Most of the other 36 million households are moderate/low income and have limited or no access to credit and limited or no assets.

“If we look up all the gory details in the fed Flow of Funds, we find that [the value of] household real estate fell from $23 trillion in 2006 to $16.5 trillion at the end of 2009. That is a decline of $6.5 trillion, more than half the total $11 trillion lost in the credit/housing bust. Home mortgages have fallen a negligible amount, from $10.48 trillion in 2007 to $10.26 trillion at the end of 2009. As of the end of 2009, total equity in household real estate was a paltry $6.24 trillion of which about $5.25 trillion was held in free-and-clear homes (32 per cent of all household real estate, i.e. 32 per cent of $16.5 trillion).

“That leaves about $1 trillion--a mere 1.85 per cent of the nation's total net worth-- of equity in the 51 million homes with mortgages. ...$6 trillion in wealth is gone ("What we know--and don't want to know-- about housing", Charles Hugh Smith, of two

What this spells out is that the bursting of the housing bubble wiped out the middle class. The nest-eggs they had stored up in the valuations of their properties volatilized in the crash. Now--even in the best case scenario--private sector deleveraging will continue for years to come. Baby boomers are not nearly as wealthy as they believed; they must slash spending and save for the future. US household debt as a share of disposable income, remains historically high (122 per cent) and will have to return-to-trend (100 per cent) before consumers loosen the purse-strings and resume spending. Repeat: 51 million homeowners have a meager $1 trillion in home equity. We're a nation of paupers.

More than 7 million homeowners are presently in some stage of foreclosure. Obama's mortgage modification program (HAMP) has been an utter failure. More than half the applicants default within the year. At the same time, mortgage purchase applications have fallen off a cliff. "The weekly applications index is at the lowest level since December 1996, and and the four week average is at the lowest level since September 1995 - almost 15 years ago." (calculated risk)

This is from the Wall Street Journal:

"How much should we worry about a new leg down in the housing market? If the number of foreclosed homes piling up at banks is any indication, there’s ample reason for concern.

As of March, banks had an inventory of about 1.1 million foreclosed homes, up 20 per cent from a year earlier, according to estimates from LPS Applied Analytics. Another 4.8 million mortgage holders were at least 60 days behind on their payments or in the foreclosure process, meaning their homes were well on their way to the inventory pile. That “shadow inventory” was up 30 per cent from a year earlier.

Based on the rate at which banks have been selling those foreclosed homes over the past few months, all that inventory, real and shadow, would take 103 months to unload. That’s nearly nine years. Of course, banks could pick up the pace of sales, but the added supply of distressed homes would weigh heavily on prices — and thus boost their losses." ("Number of the Week: 103 Months to Clear Housing Inventory", Mark Whitehouse Wall Street Journal)

A 9-year backlog of homes. No wonder the yield on the 10-year Treasury is under 3 per cent. The country is in a Depression.

Housing prices have already fallen 30 per cent from their peak in 2006, but they temporarily stabilized during the period that the Fed was exchanging toxic mortgage-backed securities (MBS) for $1.25 trillion in reserves. The banks collaborated with the Fed (I believe) to hold back supply so the public would be duped into thinking that Bernanke's cash-for-trash (Quantitative Easing) program was actually supporting the market. But it wasn't. Prices stayed flat because the banks were deliberately withholding supply. The Fed's action did nothing. Now that Bernanke has ended the program, inventory is rising. How far prices drop will depend on the rate at which the banks dump their backlog of homes onto market. The longer the process is dragged out, the longer the recession will persist.

The housing market has been nationalized. More than 95 per cent of the funding for new mortgages comes from the government--mainly Fannie Mae, Freddie Mac, FHA guarantees or VA loans. There is no market in housing--it's all central planning with the Fed acting as the financial Politburo. It's all designed to stealthily transfer the losses of the Kleptocrats onto the taxpayer. Subprime lending continues behind the mask of FHA-backed mortgages. FHA underwrites mortgages with as little as 3.5 per cent down and credit scores in the high 500-range. It's a joke. The lending system is designed to implode and it will, leaving more red ink for the public to mop up. Nothing has changed.

Anyone who is thinking about buying a house should mull over the facts before making a final decision. The market is so distorted by the buildup of shadow inventory there's no way of knowing whether prices are fair or not. It's a crapshoot. An article in titled "Banks can't hold back high-end mortgage repos for long" is a "must read" for anyone presently looking to buy. Here's an excerpt:

"Let's begin with Chicago.....As of July 15, RealtyTrac listed 28,829 properties which had been foreclosed and repossessed by lenders. Some have been owned by the bank as long as 2½ years without having been placed on the market. Roughly half have been repossessed by the lender since late January 2010.

“This year, banks in the Chicago area have foreclosed on a huge number of expensive homes. RealtyTrac lists 2,650 repossessed homes for more than $300,000 and 169 for more than $1 million.... Out of 28,829 repossessed properties, there were only 1,292 listed by lenders as ‘for sale.’ The vast majority of these available homes were inexpensive. A mere 29 homes over $300,000 were for sale. In other words, the banks have withheld from the market 2,621 properties listed at $300,000 or higher." ("Banks can't hold back high-end mortgage repos for long", Keith Jurow,

We can see that the banks are deliberately keeping homes off the market to keep prices artificially high so they don't have to write down the losses. Clearly, the Fed knows what's going on.

Here's more from

“In Miami-Dade County, the same thing—‘Out of 10,858 bank-owned homes, a mere 983 were listed for sale.... Orange County, same deal—’ Asof July 16, RealtyTrac listed 6,270 repossessed properties.... very few foreclosed homes in Orange County are listed for sale - 227. (and even more interesting) ‘650 of theses repossessed homes are priced at more than $1 million. Yet not a single home over $1 million is currently on the market.’” ( "Banks can't hold back high-end mortgage repos for long", Keith Jurow,

Now that the Fed's mortgage-backed securities buyback program (QE) is over, the banks are stepping up foreclosures and short sales. Expect more homes to flood the market pushing down prices. But whether the banks release more of their shadow inventory or not, it will still take years before the market returns to a (normal) 5 to 6 month backlog.

There are remedies for our housing woes, but they require massive government intervention. Mortgages must be restructured in a way that keeps as many people as possible in their homes. That means bondholders and banks will have to take a sizable haircut, which is the way capitalism is supposed to work when risky investments blow up. The write-downs will force many of the banks into bankruptcy, so the Obama administration will have to resurrect the Resolution Trust Corporation (RTC) to resolve the banks, replace management, and auction off their downgraded assets. It's all been done before. When the toxic assets and non performing loans have been purged from bank balance sheets, the banks will be able to fulfill their function as providers of credit to consumers, households and small businesses. Credit expansion will lower unemployment, reduce excess capacity and increase GDP. The economy will begin to grow again. Regrettably, Bernanke has chosen the path of deception and deflation.