If only I could manufacture money in my basement and then give it to a friend to use it to buy securities in the open market.
Just think of the competitive advantage that friend would hold over other investors:
- He could outbid anyone else who had a cost of funds higher than he did.
- He could offer borrowers 'artificially' low interest rates.
- He could probably corner the market for certain asset classes.
- As long as he held the assets until maturity and retained a low funding cost, he should be able to make money.
Sound like a plan?
What I have just described, of course, is the lion's share of the US mortgage market as it exists today.
Ben Bernanke has been prining the money, and Tim Geithner has been using it to effectively nationalized the US mortgage market - and in the process, the two of them have crowded out private capital almost entirely for conforming mortgages.
Can Jumbos be far behind?
As we sit here today - Uncle Sam (and by extension commercial banks) is now the lender of first and last resort for conforming paper... because no-one else in the private markets can even touch his funding costs.
But let's consider the consequences of this dynamic on a mid-term basis.
Riddle me this?
- Is US real estate now being valued on fundamentals or is Uncle Sam's sub-5% mortgage rate just today's latest "teaser rate" - destined to reset higher once inflation resurfaces or once funding responsibility returns to the private market?
- Is it a good idea to artifically prop-up a long duration asset like housing with subsidized interest rates that fail to recognize the appropriate "risk premium" that should be attached to an asset class that typically experiences some level of default over time?
- How do you ever entice private capital back into the mortgage market when your pricing decisions are now deliberately excluding it from the party? How do you get Uncle Sam out of the mortgage business if you aren't pricing the money correctly?
- How will housing markets ever discover the fair, equilibrium price for a home based upon supply, demand, Price to Income, Price to Rent, or Replacement cost and a rational borrowing cost ex-a subsidy from Uncle Sam?
Certainly, the availablity of credit is a meaningful issue that would seem bona fide for the fed and the Treasury to tackle. For example, if a credit worthy borrower with appropriate collateral and/or income is unable to source funds....then the provision of liquidity absent some private source may indeed be justified.
However, the provision of credit should not arbitrarily be attached to a heavily discounted "money cost" that fails to adequately price the risk embedded in the loan.
The US Treasury may believe it can manipulate asset markets with Federal Reserve funded cheap funds...but ultimately, the private markets will have to determine the proper equilibrium price for money...and the assets that sit behind them.
Housing, of course, is no exception. Whether mortgage rates reset to 6% this year or 5 years from now...as the "proper" cost of money...the change of the value of the underlying asset will be inevitable.
Alternatively....Uncle Sam will have to remain the perpetual banker of first and last resort....because no-one else in the private markets will ever be able to compete with the cost of a bill run from a press.
Think about it for a second: Does it stand to reason that it should only cost 5% for a mortgage in the worst housing market of all time...?
Of course not. And yet now, US individuals are being encouraged by our government to buy houses because mortgage rates are so cheap.
The last time cheap savings and "artificially low interest rates" were tabled to consumers, real estate prices extended beyond their fundamental value by as much as 50%.
Today, Uncle Sam is simply taking the place of "Sub-prime lenders"/foreign savers by offering mortgage financing on terms that would otherwise be entirely uneconomic in any private market place.
Buyer Beware: If you buy a house today, odds are its price will decline in value if and when mortgage rates revert to their true, economic, cost in future.
Effectively, the Fed is financing the Treasury, that is now nationalizing formerly private finance in the public domain.
Unfotunately, this can only mean that the proper discovery of equilibrium pricing that would result from Adam Smith's free hand doing its job...has now been displaced/crowded out by a Marxist substitute - centrally planned by an economic agent that has no profit motive whatsoever.
One day...the bill will come due for homeowners, once and for all...but for now...the last round is on Mr. Bernanke and Mr. Geithner...
One has to wonder, however, if either of these two individuals have an exit strategy beyond printing more bills labeled "In God We Trust" !
Stock position: None.