Governmental mismanagement resulted in the great recession commencing in September 2008 and has continued unabated.
We went from the proliferation of bad mortgages bundled and blended with good mortgages into huge mortgage-backed securities which were sold by investment banks to greedy buyers throughout the world. The sales were possible because credit agencies rated them as needed by the bankers and the bonds were backstopped by credit default instruments (an insurance type product that escaped regulation requiring reserves, at the urging of a Texas Senator). All involved in this three-party debacle received their education from our elite educational institutions, then interned in Las Vegas before landing on Wall Street. Minimal government supervision even though a train wreck was visible and inevitable.
Not one person of significance who made tens of millions of dollars suffered any adverse financial repercussions nor time served in one of our penal institutions.
Fast forward to today. Lessons learned? Yes, but intentionally disregarded! A recent article in Fortune magazine provided a sobering summary of the intended (not unintended) consequences of Federal Reserve actions. The Fed disregarded the opinions of many economists including some who were former Fed members and Secretaries of the Treasury. They urged (begged) the Fed to commence raising interest rates gradually during the past two years after an extended period of promoting “rock-bottom” interest rates. All while Congress was pouring cash into the economy during and after the pandemic. Borrowers, flush with cash from governmental largesse could not resist borrowing as much money as possible to purchase homes with 2% and 3% mortgages. So lots of free cash was available.
Inflation should not have been a surprise when it rose suddenly and dramatically at a rate from 2% to over 10% per annum. However, the Fed, the Treasury Secretary and the President were surprised because they said this inflation was “transitory.” Obviously, they rehearsed this totally inaccurate, irrational declaration. Those were our leaders of fiscal and monetary policy and practically the only ones that believed inflation was transitory.
So free money from the Fed, lots of cash from Congress, remote work and supply chain problems combined to create very high construction cost increases, a tightening housing inventory and higher resale home prices in practically every market throughout the country. A housing boom developed which greatly benefitted mortgage lenders and other players in the housing industry. An example is the Rocket Mortgage Company. Sales of $5 billion in the second quarter of 2020 (yes – 3 months) compared with $1.6 billion in the same quarter of 2019. The result – a housing market on steroids.
Enter the Fed’s brilliant plan to curb the inflation which they caused after admitting publicly that they made a mistake - inflation was not transitory; it had been fueled by free money that they created and prolonged beyond being useful; thus creating very high inflation. The plan was simple. Raise rates suddenly, dramatically and for such a sustained period of time that the shock would set off a housing market recession which, in turn, would trigger the goal of a recession beyond housing. The domino effect of destroying demand was in play.
Residential housing investment has fallen for four straight quarters. Mortgage purchase applications decreased almost fifty percent (50%) on a year over year basis with refinance applications becoming as rare as the Mona Lisa. The existing/resale housing market became frozen and remains so for the most part. Sellers are not selling to go from a 3% mortgage to a 6.5% mortgage for a house not any better then their current home but at a much higher price. Consequently, a tight and extensive shortage of housing inventory is keeping home prices high. This scenario will not continue if the hard landing materializes. High home prices and high interest rates brought on by errant Fed policies have created an affordability crisis. Buyers desperate to purchase homes can no longer afford them. This man-made housing recession has been accompanied by higher prices for almost every other product, food item and service. The real problem is supply but the Fed’s solution for inflation is to crater demand.
Better governmental policies were clear and should have prevented the current financial debacle and the prior one in 2008. But the start and stop, roller coaster policies adopted by the Fed and Congress known to be irrational and harmful were pursued by Congress and the Federal Reserve. For sure, no members of Congress nor Federal Reserve members have been hurt.
Stay tuned for the next shoe to drop – the commercial office real estate market and small regional banks. Trillions of dollars in valuation declines resulting in unrealized balance sheet losses for these banks. Remote work and sudden higher interest rates have become and will continue to have a devastating effect on the economy. An interesting topic for our next article.