Someone turned the light on and as a result the Chairman of the Fed, Ben Bernanke said changes in house prices could have a bigger affect on consumption than the traditional “wealth effect” suggests.
The Fed is telling us we are in a recession and that there will be continuing problems in the housing industry. The Fed has discovered that changes in house prices might influence the cost and availability of credit to consumers. Mr. Ben admits that “changes in home values may affect household borrowing and spending somewhat more than suggested by the conventional wealth effect.” He was particularly concerned about price falls in areas where people have little home equity. This is typically with a high proportion of subprime loans.
Mr. Bernanke says in areas of fixed rate mortgages, the effect of home price changes on access to credit overall may be muted. We have never seen so many mays, coulds or woulds. Couching tells us that Ben and the Fed know what is going to happen, but they are not about to tell you the truth about the situation. Remember, this is the same Fed that encouraged everyone to get an adjustable rate mortgage.
Now for the classic: Mr. Bernanke said he did not know whether the so-called “financial accelerator effect on household spending via access to credit was big enough to affect the overall economy.” Of course he knows. Any college freshman knows. If equity is falling and interest rates are rising and lending standards are tightened less equity and cash out loans will be made. Those loans have already fallen more than 50% over the last 1-1/2 years, and that means some $300 billion is no longer available to fuel the economy. This is the money the public used over the past four years to continue their lifestyles and spending sprees, because their wages and salaries did not come anywhere near covering the increases in inflation, which our government tells us is 2.4%. As a result of free trade, globalization, offshoring and outsourcing have produced productivity gains of only 0.6%, while higher interest rates erode and reduce the value of personal and corporate assets and cash flows. Ben gets it be just doesn’t want you to know the economy is in serious trouble and it is going to get much worse.
It has been six months since subprime and ALT-A lenders started to go bankrupt. At last count 82 had gone out of business. As a result tremors are stressing Wall Street, as investment funds that bought a stake in those loans are starting to wobble. The next 82 to bite the dust over the next two years will further constrict consumers with weak, subprime, ALT-A’s and those who have lost their jobs due to what has been done to our economy by transnational conglomerates, will have a difficult time ahead. The housing debacle is not going to end soon. It will be very prolonged. After inventory and prices finally achieve their full correction there will be a long period of large inventory and stagnant prices hindered mainly by higher interest rates.
The end of the housing bubble will force banks, hedge funds and pension plans to acknowledge substantial losses that have been hidden away in complex investment vehicles that only have a real value when they are liquidated. These events will be another factor that will limit the money available for mortgage lending.
The investment banks, such as Bear Stearns, which was a dominant player in the mortgage arena, is fighting for survival as they scramble to come up with more capital. $500 million is not chump change. We also see some big participants with big losses bailing out. Last week Barclays sold $3.6 billion in high-grade securities backed by subprime mortgages. The question is how can subprime CDOs be high grade? The question is will Bear Stearns’ fund collapse? If they do we are afraid others will follow.
Bear Sterns fund, High-Grade Structured Credit Strategies Enhanced Leverage Fund, fell 23% in value through April and it only started 10 months ago with $600 million, but it borrowed $6 billion. In May, the investors were frozen as the fund stopped redemptions. Normally the housing market would move slowly, but when you are leveraged 10 to 1 momentum quickly gains speed. Many investment managers just looked at the ratings and bought. The problem is the ratings were not correct. As the housing slump becomes a bust many more funds will take heavy losses and some will go under. That will have a serious affect on the use of leverage and future risk that will cause a pullback in borrowing as interest rates move higher. That, in 2 to 3 years, will eventually bring on deflation no matter how much liquidity is made available.
“No Child Left Behind” is another failed social experiment, which has actually left our brightest children behind. Above average children are not reaching their full potential. These are the kids who no longer matter to the elitists because they are achieving the minimal level that NCLB is striving for - teaching to the lowest common denominator. Those who achieve above standard get no help at all and the dumb get tutors. This is why our nation is falling so far behind.