Bread, O.J. - And Mortgages?

New home sales are at an all-time high, 69% of American families own a home – and yet the president wants to give tax breaks to an industry that has been setting record profits for the last four years. What’s wrong with this picture? Mike Shedlock explores…

What would you think if the government decided that that the price of bread was way too high and decided to open up a chain of bakeries to sell bread at the "correct" price? What if the government decided that Florida orange juice was priced too high and started selling orange juice by the barrel? If either of these things happened, would you be standing on top of a mountain and screaming with all your might about the insanity of it all? So would I.

So how come there is no screaming about this? The Washington Post reports that Housing and Urban Development Secretary Alphonso Jackson has a message to subprime lenders: "’We need to reach out’ to African-American, Hispanic, and other first-time buyers with better loan concepts, more flexible guidelines, and quicker service,’ said Jackson in an interview. ‘I am absolutely emphatic about winning back our share of the market’ that has slipped away to subprime lenders.’"

Excuse me! Since when is it the business of the federal government to "win back" market share on housing loans? How is this any different that the federal government opening up bakeries to compete against the outlandish price of bread baked by private bakeries?

Jackson has reasons for wanting first-time buyers to get FHA loans. FHA-insured mortgages made up 11% of the U.S. home market as recently as 1995, but bottomed out to 4.3% in 2003 and 3.3% in 2004.

Gee, that’s nice, but as for me, I do not want the government assuming market risk, especially after this run-up in housing. All of a sudden, with some areas appreciating 100% in as little as five years, the FHA thinks that the subprime sector is gouging. One way to take care of that problem would be to cap interest rates, but no!

FHA Market Share: "The Deflation Guarantee Act of 2005"

Instead, we see Congress pass the Deflation Guarantee Act of 2005, otherwise know as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This supposed "consumer protection act" does not cap interest rates, does not cap fees, and does not make allowances for loss of jobs, medical expenses or anything else. It is, in fact, the most anti-consumer act in the entire history of Congress. Rest assured whenever this Congress passes a law stipulating "protection" of anything, if you assume the opposite, you are 98% likely to be correct. If ever there were a case for needed reform, it would be in usury laws that might restrain the insane growth in credit. Instead, we see the FHA deciding to compete against private industry in a bloated housing market.

If that were not enough, President Bush is now urging tax credits for homebuilders! "To boost housing sales even more, Congress needs to pass my single-family homeownership tax credit," Bush told a meeting of the National Association of REALTORS. He said the credit would increase the supply of affordable single-family homes by as many as 50,000, with the aim of increasing the supply of affordable homes by 7 million over the next 10 years.

President Bush said surging real estate could be enhanced even further if Congress passes a tax credit to encourage homebuilders to target the middle class. The credit would be for around $2.5 billion over five years. In the speech, Bush said that homeownership set a record in 2004, with 69% of American families owning a home. "There are 74 million homeowners in America today. And that’s the most ever in our nation’s history," he said.

Just when you thought things could not get any sillier, they get sillier, much sillier. According to the Commerce Department’s most recent data, U.S. new home sales jumped 12% in March, to a record 1.431 million at seasonally adjusted annual rate. That figure smashed the previous record of 1.304 million homes, set in October. It was the largest percentage gain in nearly 12 years. Is that an industry that needs tax credits?

Let’s see. New home sales are at an all time high, 69% of American families own a home, prices have gone parabolic, but…the FHA wants to compete against subprime lenders, and the president wants to give tax breaks to an industry that has been setting record profits for the last four years. Is this blatantly stupid or what?

FHA Market Share: Mortgages for Anyone Who Can Breathe

Rest assured that housing would be more affordable if it were not for our "ownership society" policies that encourage Fannie Mae and Freddie Mac to grant 125% mortgages to anyone who can breathe. Combine that with loose lending practices based on the pure faith that Fannie and Freddie are too big to fail, and it is no wonder that home prices are going through the roof. Credit lending standards are in the gutter, but society says no matter how little economic sense it makes, we will try to give you the credit to make your purchase. Subprime lenders seem a bit worried (not worried enough, in my opinion), so they have raised their fees.

Now the government comes along and wants to compete with private industry. Is this a bad dream, or do we really have a Republican president with a Republican Congress doing these things?

For what it’s worth, I think the government has zero clue about how to get corporations to hire U.S. workers, so it is attempting to goose the one and only thing (housing) that is holding this whole ball of wax together. In the meantime, it is getting more and more costly to "own" anything.

But 2% of new mortgages in California were interest-only in 2001. By 2004, this number hit 49%. Obviously, the only way newcomers can "afford" housing is with the age-old trick of "how much monthly payment can you afford?" Were it not for the GSEs’ willingness to lend money to anyone, the government promoting "ownership," and absurdly low interest rates that intensified the housing bubble, we would not be in this mess in the first place. Now the FHA and Bush want to keep the insanity rolling by selling bread (home loans) at the "correct price."

Since there is no conceivable way this can possibly end well, I have a fail-safe prediction: It won’t.


Mike Shedlock
for The Daily Reckoning

May 25, 2005

Michael Shedlock (Mish) worked in the financial services industry for 20 years at some of the top institutions in the country including Harris Bank, the Bank of Montreal, Bank One, First National Bank of Chicago, and First Data Corp. Mish runs one of the more popular stock boards on the Motley Fool, Investment Analysis Clubs / Mishedlo and one of the more popular boards on Silicon Investor, Mish’s Global Economic Trend Analysis. You can see more of Mish’s writing on his blog also entitled Mish’s Global Economic Trend Analysis.

He is also a new contributor to Whiskey and Gunpowder, a free e-newsletter, from Dan Denning and Byron King (among others) that covers resources, oil, geopolitics, military history, geology and personal freedom.

There’s a time and a place for everything.

Somewhere, it must be a bright, sunny spring day. But here in London, the sky is gray. The wind blows. It is a day that could pass for mid-winter in most parts of the world.

But to the English, it is fine weather…and they’re determined to enjoy it. While tourists shiver in their overcoats, the hardy Londoners go about in short sleeves as though they were in Florida.

The front page of today’s International Herald Tribune tells us that China is building huge shopping malls – three times the size of the Mall of America in Minnesota. If you want to invest in a booming economy, dear reader, go to Asia. But hold onto your hat; the place is a whirlwind, with many a boom and bust coming.

America, in comparison, is in decline. Wages rise nearly 10% per year in China; in America, they are stagnant. New factories, airports, highways, office towers, and shopping malls are going up all over China; in America only residential housing – a consumer item – is going up. The Chinese are studying math and engineering; Americans study gender issues and finance.

But this doesn’t mean you can’t live well or make a lot of money in America – even if the empire has peaked out. No country with cable television ever experienced a violent revolution. And no economy with interest-only mortgage financing ever experienced a depression. So we have nothing to worry about. Besides, Ramsay Macmullen’s study of the decline of Rome explains that the process was extremely variable and took place over an extremely long time. Some parts of the homeland flourished hundreds of years after Roman power had begun to ebb away. People were generally unaware that Rome was in decline. Things changed. Some got rich; some got poor. Some lived happily; others suffered. It wasn’t until very recently that historians looked back on the whole period and saw the pattern we describe today as "the decline of the Roman Empire." Still, houses in Rome must have fallen sharply when Alaric showed up at the city’s gates, with an army of ‘barbarians’ behind him.

In America, the number of real estate investment clubs is soaring. There were 44 in 2002, says USA Today. Now there are 177. And not a single member of any club expects barbarians at the gates. We don’t either. But we are prepared to bet that real estate investors have under priced the chance of some sort of fat tail event that takes down property values.

"Fat tails are extremely unlikely events," colleague Dan Denning elaborated yesterday. "But they are also events that are extremely damaging." It’s not very likely that your house will catch fire. But the effects are so devastating that you take precautions anyway.

What would take down house prices in America? A recession!

Bonds are rising. Commodities have slipped (more below…). The yield curve is flattening out; yields on 10-year Treasury notes look as though they could fall below 4%…just when Alan Greenspan is raising short-term rates. Gold, too, has fallen below our target buying price of $425. The dollar has strengthened. And leading indicators have turned down. All these things are signs of a slowdown in the economy. They are signs of a recessionary bust, not an inflationary boom.

A recession is not a fat tail event. Recessions happen fairly regularly. But the Greenspan Fed has made the likely effects of a recession far more dangerous. By increasing personal debt levels and causing a bubble in housing, the Fed raised the cost of recession. More people will have to cut back more than usual. Contracts to buy will be dropped. Mortgages will be abandoned. The result could be that an ordinary recession could turn into a fat tail credit implosion – a deflationary collapse.

Or…a Japan-style slump.

Long time Daily Reckoning sufferers will recognize this as the same forecast we have been making for the last several years. We’ll stick with our forecast – until it proves out…or until people start laughing at us.

More news, from our team at The Rude Awakening…


Dan Denning, reporting from London:

"As the summer draws near, we might find ourselves parched for liquidity – not the type that fills a frosty glass with iced tea, but the type that fills a frothy stock market with buy orders."


Bill Bonner, with more thoughts about various things:

*** Poor Zimbabwe. The Zim dollar has fallen to 25,000 to the U.S. dollar on the black market. Food has disappeared from the stores. The only way to get it is to go to the street vendors – selling at black market prices. And now the government is rounding them up.

Zimbabwe shows why empires are so nice. The place was much better when it was still named after the English colonialist who developed it, Cecil Rhodes, when the British Empire still existed, and when Rhodesia was a part of it. Now it is a free, democratic nation, bearing its dreary independence like a war wound.

*** There is "Less to the Dollar Rally Than Meets the Eye," according to Dan Denning.

"You can’t keep a bad currency down, the dollar bulls would have you believe. After reeling off an 8% rally against the euro since the beginning of 2005, and making a new seven-month high, are global currency traders telling us the buck is back?

"Not quite.

"On May 29th, the French go to the polls to vote on the European Constitutions. The Dutch follow three days later. And earlier this week, Gerhard Schroeder’s Social Democratic party lost elections in Germany’s North Rhine-Westphalia region. Political defeats for the key proponents of the European Union (Schroder and French President Jacques Chirac) are virtual defeats for the euro as a world reserve currency to rival the dollar.

"What’s more, as a paper currency backed by over-spending governments, the euro is no more fundamentally sound than the dollar. In fact, there are many bad things one could say about the euro, including ‘non.’ But if markets are even moderately efficient, much of the bad news is already ‘priced in’ to the euro. How much higher can the dollar go by virtue of not being the euro?"

Not much, says Dan. He notes that foreign central banks – even Japan and China – are cutting back on Treasury bonds. U.S. deficits are increasing funded by hedge funds who have no long term interest in the strength of the dollar or the balance of trade between America and Asia. They’ll drop the dollar in a flash…as soon as their trades turn against them.

Feeling lucky, dear reader? Buy the euro. Worried about a fat tail? Buy gold and Newmont Mining.

The Daily Reckoning