Has The Fed Opened A Black Hole of Debt?

For the past year the American housing market has been looking better. Home prices have increased with new demand while the inventory of foreclosed homes and short sales has declined. Interest rates are up about a point since 2012 and yet existing home sales this year are likely to top five million units, an increase of 10 percent or so.

Behind this robust picture the real nature of the housing market is less clear. How  can real estate prices rise when household incomes are lower than they were in 1999? How many potential buyers will put off home purchases when even government salaries are uncertain?

The Federal Reserve
Before October’s government shutdown and near default the biggest debate on Wall Street concerned the Fed and when — not if — it would stop buying long-term securities at the rate of $85 billion per month. Many financial analysts argued  that “tapering” (buying fewer bonds) would begin in September, but the Fed confounded numerous analysts when it made no such decision.

It may well be that the Fed was about to reduce its monthly purchases in September but could not as a result of the political turmoil in Washington — turmoil which is likely to slow progress on the unemployment front and lead to an economic contraction.

More Fed Purchasing, Not Less?
Perhaps the most-provocative theory to arise from the shutdown and near default is the prediction by Marc Faber, publisher of The Gloom, Boom & Doom Report,  that the Fed will not taper its purchases at all. Instead, says Faber, the Fed  will buy even more mortgage-backed securities and long-term bonds.

“The question is not tapering,” Faber told CNBC. Rather than of purchases of $85 billion per month “the question is at what  point will they increase the asset purchases to say $150 (billion), $200 (billion), a trillion dollars a month.”

While Faber’s view represents an extreme vision of the future, there are a lot of people who agree that the Fed will at least continue to purchase long-term securities at current levels until January 15th — when another federal funding  deadline looms. You can see this in the marketplace where mortgage rates sank between mid-September through late October, existing home sale activity fell in September, pending home sales were down and Chinese authorities predictably called for a “de-Americanization” of the world financial system because of the shutdown and deficit crisis.

Meanwhile, we have a housing recovery which is fragile at best. Home values — while up during the past year — are still 9.6 percent below the 2007 peak. The October showdown in Washington was bad for the housing sector and bad for the economy. One can only guess how much worse things could  get if there is still another Capitol Hill death-match over the deficit in January.

Quantitative Easing Forever?
The bigger question raised by Faber is whether the Fed can ever stop its purchases, a process called “quantitative easing” or “QE.” He argues that “the Fed has boxed itself into a position where there is no exit strategy.”

Nomura chief economist Richard  Koo agrees and, according to the Business Insider, says the Fed has fallen  into a QE “trap.” Interestingly, a major French bank, Societe Generale, also says it’s possible that the Fed will increase monthly bond purchases rather than reduce them.

Imagine that the Fed has no choice but to buy even-more mortgage-backed securities and other long-term debt.

You have to wonder: Where would the Fed get $150 billion or a trillion dollars a month?  What would be the value of money? What happens if there are a lot of  foreclosures and the Fed’s hoard of mortgage-backed securities goes bad — who eats the losses? Do losses matter when an entity has the ability to create more money at will? Think of the rich kid who crashes a car — and instantly gets a new one from daddy.

If Faber and others are right there are a lot of economics textbooks that will have to be re-written.

Related News
The Quarterback of QE Spills the Beans on Fed’s Bond- Buying  Boondoggle
Federal Reserve Prolongs Quantitative Easing
Preparing for a World Without Record-Low Interest Rates

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