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Ben Bernanke's Misguided Focus on Housing is Like a Bad Joke

It's a little early for April Fools, but Ben Bernanke might just be a prankster at heart.

I say this because he recently told the Economic Club of Indiana in Indianapolis that the Fed's plans for QE3 would help create more economic activity and higher home prices. Then he added, almost as an afterthought, that this would help many more savers than it would hurt.

I was waiting for the punch line…or the laugh track…or maybe an old bada-boom from Paul Schaeffer's band offstage. Only it never came.

It's like he was making a bad joke, "but QE is good for savers. No, really! I swear…"

Why the Fed chief keeps linking housing prices to savings and, by implication, to an economic recovery defies logic.

No matter how hard he tries, he can't solve our nation's economic woes by making the same mistakes all over again.

Part of the reason housing blew up in the first place is that people began to view rising home prices as personal ATM machines. Now Bernanke is simply putting a new face on the same monster.

Think about it…

We already have a multi-year oversupply in homes on the market and ridiculous amounts of construction are still going on in parts of the country where there are quite literally no buyers. If you've been to Las Vegas or parts of Florida you know exactly what I'm talking about.

How many homes do we really need at a time when values remain 30%-50%, and in some places even 70% below their peak?

Certainly not the millions of new homes that Bernanke thinks we do while unemployment remains high and actual buying power has been dramatically reduced.

And millions of strapped American families two paychecks away from bankruptcy surely don't care.

Bernanke's False Bottom

Now I know the media is very excited about recent data showing a recovery in housing prices, but let's take a deep breath. Seasonal demand accounts for a good portion of the bump. So does bargain hunting.

This suggests a new round of speculators has entered the game — and those folks are buying with cash, making mortgages irrelevant.

As a result, prices are being bid up even though overall demand remains relatively constant.

Then there are the banks. All of them claim they want to lend money, yet find every excuse not to. While they will claim otherwise, practically speaking they're saying one thing and doing another.

This, too, speaks to a massive disconnect.

Banks aren't worried that mortgage holders won't be able to make their payments. What they're actually concerned about is that the underlying assets against which they're lending will lose value.

I saw this first hand in Japan in the 1990s when banks realized that real estate can and frequently does lose value as economic conditions change.

Besides, if banks thought otherwise and truly believed in a brighter housing market ahead, those institutions would be falling all over themselves in the name of profits. For example, lenders would be doing anything they could to make it easier for borrowers to obtain loans, like reducing down payments and adjusting credit score requirements.

Instead they're busy profiting from spreads that are actually higher now than they were before the financial crisis.

How much more? Sit down…according to the Financial Times, the interest banks pay on mortgage bonds has dropped from 2.36% on September 12, the day before the Fed announced its new program, to as low as 1.65% last week. It edged up to 1.85% on Monday.

Further, also according to the Financial Times, the profit banks earn from creating new mortgages and selling them into secondary markets has risen to 1.6%. That's up from the 1.44% they pocketed before QE3 and significantly higher than the 0.5% they earned on average in the decade between 2000 and 2010.

The banks would also be securitizing an entirely new batch of garbage mortgages to sell into global markets almost before the ink is dry. But they're not. And the Fed, not private buyers, remains the purchaser of last resort for mortgage-backed securities as QE3 continues.

It's no wonder that "bank" has become a four-letter word lately.

Where the Fed Gets it Wrong

Which brings me back to Ben Bernanke…what can he possibly be thinking?

I believe he is trapped in history and it's affecting his judgment.

At the end of WWII, our nation made the conscious decision to rebuild based on three things: cheap energy, cheap transportation and cheap housing.

So Washington created industries to support all three, but especially housing.

Our government built in mortgage deductibility and capital gains treatment for appreciation. We created the S&L industry to finance residential borrowing and enacted special rules that gave S&Ls the ability to lend lower while offering higher returns to their investors than traditional banks. Few people remember this, but at one time S&Ls – thrifts as they were called – could lend only within 50 miles of their home office.

Through its massive support of housing, our leaders essentially traded real growth for indirect government aid through interest rate manipulation as a means of engendering growth. Meanwhile, other nations, like Japan and Germany, for example, chose to rebuild based on manufacturing. Germany still maintains that posture today while Japan lost its way and embarked on a debt-driven orgy that has its roots in the early 1970s when that country unpegged the Yen.

Then, our leaders got greedy. They poured jet fuel on the fire in the 1970s and 1980s then again in the early 2000s by making gobs of debt available to compensate for shoddy market conditions and economic headwinds. Not surprisingly, real estate markets exploded.

Freddie Mac issued its first mortgage pass-through notes in 1971, calling them participation certificates. Ten years later, in 1981, Fannie Mae began bundling similar mortgage pass-throughs and called them mortgage-backed securities.

Then along came the Housing and Community Development Act of 1992, which amended the Fannie and Freddie charters. It mandated that both institutions meet affordable housing goals set by the Department of Housing and Urban Development (HUD).

Initially, the goal was for 30% of the combined portfolio to be comprised of low- and moderate-income mortgage purchases. By 2007, that figure had risen to 55%.

Somewhere along the line, the psychology of housing changed. I believe the hundreds of billions of securitized mortgages that were created out of thin air allowed people to view housing as an investment with fixed-income characteristics regardless of the underlying quality of the mortgages or the banks underwriting them.

In other words, houses stopped being simply homes and became the physical equivalent of fixed income instruments…investments by any other name.

If you buy into this – and I think Bernanke does – my theory makes sense.

Low real rates drive fixed income asset prices higher; therefore, when prices stagnate you buy more debt to induce price inflation. Which is, of course, exactly what Bernanke's doing via Operation Twist and his QE programs.

The problem is eventually the prices of the assets being purchased rise to levels that result in a negative yield to maturity. This means that buyers paying the inflated prices will lose money as maturity approaches because fixed-income yields rise at the same time.

Yet, the Fed buys anyway and so do many institutions. They do so because they are concerned with matching their liabilities so the losses they incur along the way are acceptable.

Individuals obviously don't have this luxury. They don't care about matching liabilities like the Fed does. Rather, they care about not having liabilities in the first place, especially when they are tied to assets that could decline over time, like their houses.

But don't houses always rise in price over time?

I know that's the conventionally held wisdom, which is why Bernanke may believe it, but the data suggests otherwise.

Low interest rates don't translate into higher housing prices. If anything, they move in reverse.

The Economist highlighted this dramatically in an article last April noting that while real interest rates have plunged to their lowest levels in the last quarter century, "this hasn't helped the housing market at all."

In fact, noted the article's author, Buttonwood, if you divide the last 24 years of U.S. housing price data into thirds, average housing gains were 32% higher when rates were higher and rising than when they were lower and falling.


Figure 1:

Naturally, there are those who dismiss this data, suggesting it somehow doesn't reflect the bigger picture.

They're right — it doesn't. The bigger picture is even more damning.

Over time, housing prices barely keep pace with inflation and even then for shorter periods only. This means they are not a proxy for personal savings, nor can they possibly contribute to long-term economic stability or even short-term growth.

What the Case-Shiller Index Really Says About Housing

You can see that very clearly in the Case-Shiller Index created by Yale economist Robert Shiller.

Dating all the way back to 1890, the Case-Shiller Index reflects the sale prices of existing houses rather than those of new construction so as to more cleanly track housing values as investments over time.

Using a base of 100, the index suggests that the value of a $100,000 home (adjusted for inflation in today's dollars) purchased in 1890 would sell for only $119,000 today, 122 years later. That's a mere 0.15% a year appreciation using simple math.

Worse, the data also suggests that prices have yet to fully revert to their average, which is 112.9263, versus the most recent index reading of 119.9263.

Put another way, existing home values have to fall another 6% before our nation comes into line with historical averages.


Figure 2: Source: Robert Shiller, Yale University

The other thing that's apparent if you look at Shiller's data is that housing prices return to their mean over time irrespective of changes in both building costs and population – both of which are frequently cited as key real estate investment drivers.

No doubt I am going to catch lots of flak for this from real estate professionals. I hear you guys…but hear me. I am not saying real estate is always a bad investment.

In fact, real estate can become significantly more valuable when its use changes and its economic density increases. For example, single family homes are more economically dense than wheat fields. High rises have a higher economic density than single homes. And so on.

What Ben Bernanke doesn't understand, or hasn't factored into his thinking, is that there is room for only so much economically dense property in this country.

Zero interest rates or not, if you strip out the debt that allows developers to construct projects that otherwise wouldn't exist, the cash on cash return for housing is about what inflation offers over time.

Ergo, real estate is not the building block the Fed's badly busted economic models think it is–at least not these days any way.

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About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at

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  1. david tarbuck | October 4, 2012

    Stripped of country girl emotion, the only merit in "home ownership" is but an ENFORCED savings (equity) plan.

    Those with the self discipline to put aside savings without the threat of foreclosure (coercion) can do much better by renting and putting the difference into other investments, not the least of which is individual entrepreneurial business.

  2. PHIL@STEINSCHNEIDER.COM | October 4, 2012

    Mr. Fitz-Gerald,

    As usual, you present an excellent and well-researched take on a subject that should be commonsensical, but has instead been distorted into something completely absurd by those who seek to mislead the public into believing that the way to riches is through real estate.

    Granted, if one buys and sells at the right time, or one buys at a very good price and only accepts positive cash flow from an investment property, real estate can be a great investment. More often than not, however, as "Rich Dad, Poor Dad's” Robert Kiyosaki taught me (I’m no sycophant of his, but he gets some things right), a home is a liability. Not an asset.

    The sooner the American people and Ben Bernanke learn that inflating asset prices through money-printing isn't the path to riches—only hard productive work is—the sooner we'll become a truly wealthy nation again.

    But you don't mention something else that was a glaring incongruity during the housing bubble that I tried to explain to everyone who'd listen to me during my Cassandra period: Historically, the price of a home has been between 2 to 3 times median family income. Therefore, when I saw homes in California going for between 5 and 10 times income, something was clearly out of whack.

    With median family income stagnating or declining at the moment, why should real estate prices be going up at all? The only explanation, of course, is asset inflation from money-printing.

    Oh wait. When "assets" go up it's called "appreciation."

    Anyone who believes the repackaged Greenspan Bubble into a Bernanke Bubble reflects the creation of real wealth should probably be also buying US Government bonds right now. Not!

  3. alex | October 4, 2012

    Actually a home bought in 1890 would have cost about $1000 or $1500 including the land. NOT 100,000, which was an outrageous amount of money at that time. It would have had NO mortgage, and its buyer would most likely have been a skilled tradesman who earned between $1000 and $1500 per annum.

    • Frank | October 9, 2012

      alex, as the author clearly states, the $100,000 figure was "adjusted for inflation in today's dollars." If you take that same skilled tradesman's 1890 annual salary and adjust it to today's dollars, it is unlikely he would be earning anywhere near $100,000 in 2012. Thus, housing inflation has exceeded income inflation, and the reason most working home buyers require mortgages, even with the reverse trend in housing prices since 2007-2008.

  4. Charles Leonard | October 4, 2012

    The article refers to the strange phenomenon whereby Banks claim that they want to issue mortgages but then don't.
    I was wondering if that is because of all the new Restrictions the Government has imposed on both sides of the process. (I have been told that it is quite difficult to Qualify for a Mortgage).

    Thank You for the thorough and insightful article.

  5. Lloyd Martin | October 4, 2012

    This article seems to ignore the fact that you buy something with a down payment, therefore you are leveraged.

  6. Jeff Pluim | October 4, 2012

    WOW!!! Kieth, you continually impress me with your analysis, but this one is over the top. Your grasp of the current economic situation is almost devine. I have not seen a single analyst come to the brilliant conclusions that you have reached in this article but I am sure that they will all start hopping on your wagon and claiming your analysis for themselves.
    How can we get your insight into the heads of our politicians and beurocrats?

  7. Lloyd Martin | October 4, 2012

    Reply to Alex: Pay attention Alex. The article says that it's in today's money not 120 years ago. This $100,000 is in today's money.

  8. Ed K. | October 4, 2012

    @Alex — the article says that the price quoted was adjusted to "today's dollars".
    @Charles Leonard — Romney alluded to this in the debate — one of the unintended consequences of Dodd – Frank was to make banks afraid to make mortgages because of some of the regulatory vaguenesses.

  9. Drew | October 4, 2012

    You hit the nail on the head when you mentioned "interest rate manipulation". It has long been my own opinion that if the government changed the way that banks calculate mortgage interest then homeowners would be able to stay in their homes and not be under water Home values remain stable and a lot of personal financial troubles go away. Foreclosures go down. And people would have more money to pump back in to the economy. This is where the real crime and thievery in this country lies.

  10. Jim Clark | October 4, 2012

    While it is hard to argue with your hard data from Case-Shiller; I have read that housing, and its componants, contribute 12-15% of GDP; so it is hard to see how the economy could robustly recover with this anchor, (the lack of new housing construction), weighing it down. I believe that after the Great Depression it took housing 20-25 years to recover its value, so given these things it would appear we are in for a very long haul.

  11. fallingman | October 4, 2012

    Thanks for telling the uncomfortable truth.

    When you wonder what the bernanke is thinking, however, it appears that you presume his intentions are, in fact, his stated intentions. I would suggest that they aren't. He doesn't give a hoot about reviving the economy or increasing employment. Everything he does is for the direct and sole benefit of his bankers sponsors. Fat spreads…easy gains on their bonds holdings…bailing out Euroland…playing along with the FASB rule changes so they can extend and pretend.

    The Fed exists to serve the banks…period. The rest is nothing but public relations fantasy.

  12. Erik | October 4, 2012

    Great article!

    To the previous comments, the point of the article is valid despite not incorporating every possible data point into the equation. If you include the costs of maintenance, taxes, school bonds, risk of loss, cost of insurance against that loss, and a host of other costs that are not captured in the data point of "today's home value"…the picture is even bleaker as to rate of return, owning versus renting, etc.

  13. Allen Novotny | October 4, 2012

    I was surprised that the housing market was still in the tank yet around the country. I live in the Phoenix area and read in this morning's newspaper that property values in our area are up 34% year over year.


  14. ricka | October 4, 2012

    It is not my nature to reply to any item that I see posted but this time I will make an exception.

    You wrote an exceptionally good piece on housing Bernanke etc. Especially good was the chart on housing prices since 1890. That is my favorite when it comes to the subject of housing and will remain so. For anyone who says that we are in housing recovery, they are dreaming!

    "Crapitalism" is the best one word description to the U.S. housing situation, current Federal Reserve Board actions, current federal tax structure, the budget deficit and dysfunctional politics of today.

  15. Global Rover | October 11, 2012

    The Fed has one agenda; the survival of the Primary Dealers of Treasuries. First by consolidation of the weakest, then by giving free money buying treasuries to play equities and commodities for profit, keeping down their cost of funds to compensate lost CDO margins. Now, by deleveraging their balance sheets of toxic RMBS while supporting the asset prices behind them, Ben pretends to be supporting the housing market for the good of the economy.

    The economy won't turn until Jamie Dimon says so. The time it will take is anyone's guess since the Dealers habit of gambling without risk of failure persists.

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