Fed Won't Save the US Housing Market 2008

By: Michael_Pento

Investors are anticipating that the Fed will continue its easy money policy into 2008, which is expected to relieve credit markets. As a result, the 10-year Treasury note yield has fallen to 4.02% from a high of 5.25% reached in the summer of last year. And as evidence that the fear among banks is easing, LIBOR spreads have narrowed-- although it is still well above the historical average as well as the lows seen in July of 2007. Many now believe that the Fed, in conjunction with foreign central banks, will rescue the consumer and allow the U.S. to avoid a recession.

So why am I not popping the champagne? Because lowering the cost of money is only part of the story. Normally, lower rates would benefit the housing market as it would allow more people to afford a home. However, such hope at this time ignores today's tightening of credit standards and higher costs associated with home loans. Lending standards have risen to a level that is more than enough to nullify the effect of lowered interest rates. According to the Mortgage Bankers Association, total mortgage production will be down 15% in 2007 to $2.31 trillion from $2.73 trillion in 2006. In 2008 total mortgage originations should decline another 18%!

We have to look no further than our own government for the reasons lending standards have become more restrictive, and recent rhetoric from the Fed, Treasury and Congress has only exacerbated the problem in credit markets. The House passed H.R. 3915, which holds mortgage origination companies responsible for the borrower's ability to repay loans while the White House and Treasury department are using tacit coercion to renegotiate private contracts on adjustable-rate loans. These have served to tighten lending standards beyond what the market would have done if left unfettered, as lenders now cannot confidently lend in such an environment. And some in Washington , including a few of the candidates for President, have even suggested a “moratorium” on home foreclosures!

Translation to lenders on that whopper: if you get stiffed by a borrower, you have no recourse!

Well who on earth would lend in that environment?!

Our pals in D.C. could end up wreaking more havoc on financial markets than we have seen to date, yet Wall Street mistakenly applauds falling interest rates as a cure for housing market ills.

All the while, the inflationary consequences of the Fed's actions continue to be ignored by many.

Going on bubble watch

While the Fed is able to influence the overnight lending rate between banks, it cannot direct where newly created money is loaned. Superfluous liquidity will not end up in increased mortgage lending, but most likely in a new bubble, one that is associated with runaway commodity prices.

The Fed has embarked on this inflationary course because propping up real estate prices and consumption is crucial to G.D.P. growth. Indeed, the current state of consumer balance sheets—which look worse every day—leaves little doubt as to the course the Fed will continue to take. With a negative savings rate, depreciating real estate prices, negative real equity market returns, flat income levels and a weakening job market the Fed will be aggressively lowering rates in 2008.

In his balancing act between keeping inflation in check and fueling economic growth, Ben Bernanke will focus on the maximum employment mandate and turn a blind eye towards the higher cost of living. Year-over-year increases in the C.P.I. are now at a two-year high and should continue to accelerate in 2008, as the Fed attempts to inflate real estate prices by further depreciating the dollar.  The problem is, the Fed can't prop up only real estate, but all hard assets if its inflationary tactics are successful.

Thus, investors need to focus less on whether or not the Government will save the housing market and more on where the next Fed-sponsored bubble will arise. Since the treasury market is currently yielding less than the rate of inflation, it is hard to make an argument for another banner year of bond market price appreciation.

Instead, a major repository for this new money being created should be in the commodity market; as my colleague wrote at the end of a recent article , commodities remain in the driver's seat.

Even though the commodity bull market has been in place this entire decade, look for precious metals, agriculture and energy to continue outperforming most other asset classes in 2008.

**NOTE : Investors can click here learn about the Inflation Protection Portfolio I personally manage for clients.

By Michael Pento
Senior Market Strategist
Delta Global Advisors, Inc.
866-772-1198
mpento@deltaga.com
www.DeltaGlobalAdvisors.com

A 15-year industry veteran whose career began as a trader on the floor of the New York Stock Exchange, Michael Pento served as a Vice President of Investments at Gunn Allen Financial before joining Delta Global. Previously, he managed individual portfolios as a Vice President for First Montauk Securities, where he focused on options management and advanced yield-enhancing strategies to increase portfolio returns. He is also a published theorist in the field of Austrian economics.

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