Is the Fed Irrelevant?

This post is a continuation of “Lights out in Georgia,” the saga of Sonnypage, an Atlanta-area real estate broker. Sonnypage has this update to share, followed by my thoughts on the Fed, the economy, and housing:

Most of the regulars here know that my wife and I are REALTORS, a husband and wife team, who practice just north of Atlanta. Our business is still mostly in the towns of Roswell and Alpharetta, but now also increasingly further north, up into Cherokee and Forsyth counties, and up to Hall County on Lake Lanier. Our price range is all over the board, from a low within the last year of $125,000 and a high of $1,250,000. We are strictly residential, no commercial. We have incorporated ourselves, but are still independent contractors, as are most REALTORS. We are also affiliated with one of the major national franchises whose name everyone would recognize.

“On Fridays, if we are near the office, it’s ‘Thai Thai’ day. There is a Thai restaurant down on the terrace level of our office building. This past Friday, Rick, one of the primary mortgage lenders we work with, was in our office, so we invited him to join us for lunch at the Thai Thai. We are mostly talking real estate, as you would expect when you get REALTORS and lenders together. His question was, ‘How are your listings doing?’

“I shook my head and explained that we had 10, and just this week lost two, but will pick up another next week. Nothing is selling, and if we do get one under contract, it may well fall through before closing.

“Rick nodded and said that’s exactly what he’s hearing with every REALTOR he talks with, and he talks with plenty.

“In a normal year, I then explained, if I had nine listings on Aug. 1, I would be feeling great. I would anticipate that six or so would close by year-end, and probably six or so buyers would also pop up — that’s a dozen deals, a great finish for the year. This year, who knows?

“Contemplate this if you will. Most of those who work in my industry are fee based, not salaried. If I close a listing, they hand me a check. But it goes much further than that. If I don’t put a buyer under contract, then the home inspector we use does not get a call to come inspect the home. Rick, our mortgage lender friend, does not get a call to arrange a home loan. David, our handyman, does not get a call to come out and make the agreed-to repairs. Usually, a preclosing involves painters, perhaps a carpet vendor, and others. They never get a call if there is to be no closing. Jennifer, our closing attorney, does not earn a closing fee.

“Does she start to lay off staff when her closing volume drops sharply? Yet if a government bureaucrat drops by to ask if we are employed, well, yes, most of us are. We are earning a fraction of what we normally earn, but employed we are. My wife and I are fortunate enough to have been able to save during the good years, but I assure you that most REALTORS, and others in related industries, live check to check. Spending will surely fall sharply, and probably already is doing so. I am one REALTOR. The National Association of REALTORS claims a membership of 1.3 million. Multiply the train of events I portrayed above by a factor of 1.3 million. It’s not a pretty picture.

“Bernanke faces an interesting dilemma. Does he continue to raise rates to keep inflation in check and defend the dollar? Do that and you get, IMHO, a catastrophic housing-related recession in this country, and very soon, at that. It may already be baked in the cake. If he pauses in August, and continues to pause, does the dollar fall, perhaps precipitously? That will indeed generate inflation, because the cost of imports, including oil, will rise. I am very long gold.

“I need to post soon, and will, about the dilemma of our sellers, our listings. That also, in many cases, is not a pretty picture. Everyone, have a great week.



Reality has set in for Sonnypage. To his credit, he is not denying the truth. What supposedly could not happen in Atlanta seems to have happened, and like a shot out of the blue, too. The best year ever that Sonnypage had in January and February may turn out to be one of his worst years ever.

So what happened?:

1. People wanting to move from the Northeast to the South could not do so when their houses in the Northeast would not sell.
2. Companies expanding in the Atlanta area slowed.
3. The pool of greater fools finally dried up in Atlanta.
4. Higher interest rates are taking a toll.
5. Everyone decided to “cash out” their profits all at once.
6. Wage growth not keeping up with home price appreciation finally matters. 

Psychology Changed

There are probably several other ideas people could add to that list, but I can sum it all up in two words: Psychology changed. Perhaps a better way of expressing that idea, for the Austrian economists tuning in, is time preferences changed. The reality of that has yet to be factored into the stock market.

Economic Zugzwang

Sonnypage said the Fed faces a dilemma. Unfortunately, “dilemma” does not remotely begin to describe the problem Bernanke faces. Readers may wish to ponder “The Red Queen Race,” written on Feb. 21: 

“‘Well, in our country,’ said Alice, still panting a little, ‘you’d generally get to somewhere else — if you ran very fast for a long time, as we’ve been doing.’

“‘A slow sort of country!’ said the Queen. ‘Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!'” 

Oddly enough, right after I posted “The Red Queen Race,” Sonnypage sent me an e-mail and told me that that was my best blog ever. I wonder if he thought it was creative writing that simply did not pertain to him in any way, shape, or form. Perhaps in a future post, Sonnypage will explain his thoughts on that blog. 

Back on May 22, in “Billmon Gets It — Do You” (referencing “The Red Queen Race”), I wrote:

“Bernanke is trapped in ‘Wonderland,’ but, unlike Alice, has no way out.

“Bernanke gets to choose between hyperinflation and deflation.

“The moment he cannot run fast enough, the U.S. economy will implode.

“If he runs too fast, the value of the U.S. dollar, as well as the Fed’s power, will both come to a very abrupt stop…

“In effect, Bernanke is in zugzwang, and he does not even know it.

“Eventually, Bernanke (like the Bank of Japan) will have to choose deflation. The reason is simple: Hyperinflation will end the game, which in turn would eliminate the wealth of the Fed, as well as all of its power.”

The Fed is no longer in control of this economy (not that it ever really was in the first place). The U.S. consumer is in control (in conjunction with global wage arbitrage and other global factors, such as foreigners being willing to finance our debt, and at what interest rates). Simply put, if people decide to stop buying houses, there is nothing the Fed can do to make them. The Fed can encourage, but not force, speculation.

Two Myths

I believe we reached near-universal sentiment this year on two myths that are about to be shattered:

1. Nothing can or will affect U.S. consumers’ propensity to consume.
2. Home prices only go up.

Those beliefs are about to be sorely tested. What can Bernanke do about it? The answer is nothing. Oh, sure, he can cut the fed fund rate, but long-term mortgage rates have not really risen that much — perhaps a point or so. Is a pause, or even a one-point cut, going to be enough to get people to buy overpriced houses when real wages are falling for the masses? Of course not: Psychology (time preference) has changed.

If Bernanke starts slashing rates, is there any guarantee that long-term rates drop? I think not. It is even possible there is a revolt of some kind on the 10-year note and long rates go up. I do not think that is likely (on a sustained basis), but heaven help housing if I am wrong. Even IF long-term rates come crashing down, does that necessarily mean that mortgage rates follow? They always have. Does that mean they always will? Once again, I think not. I suspect mortgage rates will be reluctant to drop quickly because of rising defaults and foreclosures. Perhaps the best fixed rates will go only to those that can make a substantial downpayment. If so, first-time buyers may be shut out of this market for years to come simply because of affordability issues.

Who does not already have a house that wants one and can afford one?

In theory, the Fed can create hyperinflation by dropping money out of helicopters. In practice, the Fed is constrained by five factors:

1. Ability of consumers/corporations to take on more debt.
2. Willingness of consumers/corporations to take on more debt.
3. Willingness of banks/credit companies to extend more credit.
4. Ability of banks/credit companies to extend more credit.
5. Unwillingness of the Federal Reserve to print itself out of power.

The Crux of the Matter

· The Fed can print money, but it cannot dictate where the money goes.
· The consequences of the Fed attempting to control the long and the short end would likely be disastrous.
· Deflationary forces, such as global wage arbitrage and outsourcing, cannot be defeated by Fed policy.
· Consumer debt in conjunction with a housing bust is simply the nut that inflationists cannot crack. There just is no plausible scenario under which the government would bail out consumers at the expense of banks and creditors. The Bankruptcy Reform Act should be proof enough of that statement.
It has taken enormous stimulus just to get this economy running at a standstill. GDP near 2% is a standstill, because the first 2% or so of GDP is a mirage of imputed and hedonic activity that did not really occur.

What Now?

That, of course, is the key question. It always is. But given that housing and consumer spending make up well over three-fourths of the economy (heck, consumer spending alone is about 70%), I fail to see what can possibly replace housing as a jobs engine.

The administration can brag all it wants about the unemployment rate at 4.6%. But it pays to take a close “Look at the Numbers.” When it comes to unemployment, one needs to look at all the asterisks and footnotes, as I did in “Strike Three.” Even then, does that tell the full story?

Reality as described by Sonnypage is above.

Unless the Fed can pull some short-term miracle out of its hat, multitudes of those dependent on the real estate bubble are going to tighten their belts or go under or both.

How long did it take to flip the “lights out” switch in Atlanta? Based on Sonnypage’s posts, it is instantaneous. If it is happening in Florida, Atlanta, Phoenix, Boston, Las Vegas, San Diego, and D.C., exactly what is going to stop it from spreading elsewhere?

Things are likely falling apart in this economy much faster than meets the eye.

The California Department of Real Estate recently reported that the total number of agents in the state passed 500,000 in May for the first time. That’s one agent for every 55 adults in the state. That is a staggering number. How many of those “employed” real estate agents are actually making any money? Yet all those self-employed agents will show up in the “Household Survey.”

How many additional “self-employed” are trying to make a living on eBay or via “home networking” scams? As a practical matter, the unemployment rate is now totally out of whack with reality. Meanwhile, homebuilders keep building houses no one can afford, and banks (for now) are still willing to lend them money to do so. Alice is running as fast as she can, but is struggling to stay in one place.

It seems reality has finally sunk in for Sonnypage, even if it has not yet sunk in for the masses. Most people are still in denial over housing, and most still seem to think the Fed is some all-powerful economic force. Unfortunately, the damage caused by poor economic and political decisions over the last 20 years is simply not reversible by the Fed, or anyone else. The Fed is not really in control of our economy, but it sure wants you to believe it is. All things considered, the Fed is basically irrelevant. I wonder how long that bit of reality will take to set in, not just for the masses, but for the Fed itself. 

Mike Shedlock ~ “Mish”
August 2, 2006