August 31, 2023
The average interest rate for a 30-year fixed-rate conforming mortgage loan has soared to 7.31%. That means borrowing costs are now at the highest level in 23 years, which has caused the demand for purchases to plunge to the lowest level in 28 years. In fact, mortgage purchase applications are 30% lower than they were one year ago, and applications to refinance an existing loan have cratered by 35% from the year-ago period. An all-time record-high bubble in real estate prices, combined with a surge in mortgage rates, is a bad omen for this economically crucial sector of the economy.
Now, what do you think the ever-loving response from Wall Street will be to fix the dysfunctional and frozen real estate market? Well, if you thought it would be to allow home prices to fall to a level that can be supported by the free market, you would be wrong. In a dramatic illustration that we have learned absolutely nothing from the previous collapse of the housing market and Great Recession circa 2008, the leading real estate marketplace company, Zillow, has launched a new program to help people buy a home who have no business taking out a mortgage in the first place. The real estate company’s Loan division is offering mortgages with a 1% down payment!
Zillow Home Loans’ senior macroeconomist Orphe Divounguy had this to say about the program: “For those who can afford higher rent payments but have been held back by the upfront costs associated with homeownership; down payment assistance can help to lower the barrier to entry and make the dream of owning a home a reality.” According to Zillow, this program will reduce the need for potential home buyers to go through the hassle of saving for a downpayment. Isn’t that nice? The cherry on top of this poop Sunday is that the eligible credit score to buy a home with just a 1% equity stake is 620. A home buyer with a 620 credit score is, by the way, a subprime borrower.
The conclusion is as clear as it is sad. Our government and financial system have set the economy up for another collapse of the real estate market. The Fed’s QE and ZIRP policies, which were in place for 11 of the past 15 years, have caused the home price-to-income ratio to soar to a record high. Yes, home prices are now far above the previous record set in 2006, both in nominal terms and in relation to incomes.
Of course, Wall Street is doing its best to keep the bubble inflating by offering mortgages to people with virtually no skin in the game. This sets us up for the jingle mail phenomenon to re-occur, where homeowners who are left with a much bigger mortgage than the home is worth simply mail their keys back to the bank. Thanks to Zillow, it will take just a one percent drop in home prices to wipe away all the equity in the home.
According to the S&P Case/Shiller home price index, the real estate bubble is still expanding. Home prices rose again in June, marking the fifth successive month of gains. I want to make one more point on the housing market. The number of potential homes that could be soon for sale is huge. This is because 25% of all single-family homes were purchased by investors in the post-pandemic era. These homes have skyrocketed in price by 43% in the past two years. This means many investors are sitting on a massive increase in perceived property appreciation. When the recession arrives and the unemployment rate rises, rental incomes will dry up, and prices will begin to fall. That could lead to a tidal wave of new listings as these investors seek to cash out on an asset that is now falling in price and is no longer generating income.
Turning to the economy, is it really any wonder why consumers feel sick? CONSUMER CONFIDENCE in August fell to 106.1 vs. 117.0 in July. Inflation is crushing their purchasing power, and they are also feeling less confident about the security of their job.
After all, if the economy and consumers were really as strong as the MSFM wanted you to believe, then why is the retail sector performing so badly? Foot Locker and Dick’s Sporting Goods both tell a tale of a of a consumer that is under increasing pressure. Foot Locker’s shares plunged 30% on their earnings announcement last week that included a drop in sales of 9.9% due to what the company says is, “consumer softness.”
Dick’s Sporting Goods shares tumbled 25% on its earnings release, as its profits dropped 23%. Here is what this company had to say: “Organized retail crime and theft in general is an increasingly serious issue impacting many retailers. Based on the results from our most recent physical inventory cycle, the impact of theft on our shrink was meaningful to both our Q2 results and our go-forward expectations for the balance of the year.”
This consumer angst is happening before student loan repayments resume in October and the excess pandemic stimulus savings runs dry in Q4. Consumers are feeling compelled to take on debt to offset rising inflation and, in a growing number of instances, have resorted to theft to make up for the fall in real incomes.
I’m not just cherry-picking a couple of bad retailers. Sure, there have been some very good retail earnings reports of late. But the overall retail sector is in terrible condition. This important consumer barometer, as measured by the SPDR S&P retail ETF (XRT) is down 32% since the start of ’22.
Sorry to inform the Atlanta Fed of this, but the economy is not growing anywhere close to the 5.9% Q3 annualized rate they project. The truth is tax receipts are falling, corporate profits are shrinking, and aggregate hours worked are unchanged so far this year. That means the economy is most likely static–at best–in nominal terms, and in real terms is most likely already in contraction.
There was a very refreshing and revealing bit of honesty on the part of Fed Chair Jerome Powell found during his Jackson Hole speech last week. He said that the Fed is navigating the direction of interest rates by viewing the stars, which are obscured by clouds. That statement should have shuddered Wall Street sycophants, who worship the purported omniscience of the FOMC. PPS is by no means omniscient, but at least we have a robust model to determine the ROC of inflation and GDP, as opposed to just star gazing.
So, let me try to part the clouds for Mr. Powell. The current debt-disabled and asset-bubble-impaired US economy is completely unviable under a regime of positive real interest rates. Therefore, the US is now heading for a crash landing—where asset bubbles are allowed to implode and debt levels get reset. This cathartic depression would indeed be terrible in the short-term, but it would lay the foundation for a free-market and viable economy to re-emerge on the other side once again.
Unfortunately, once the economy slams into the ground, the Fed will most likely continue with its long-held practice of monetizing every economic contraction away. Hence, it will condemn us towards a pathway of intractable inflation. Therefore, I will leave you with this thought in mind: sadly for Mr. Powell, even if he were able to clearly see those stars; he would still be navigating the USS Economy into the bottom of the sea.