FYI | Aug 18 2011
GaveKal offered the following observations this week:
One of the reasons for our recent caution has been that, despite hundreds of billions of dollars in fiscal stimulus and over a trillion dollars of QE, US policymakers have not been able to engineer a recovery. This is at least partially because the average American family (whose consumption drives GDP growth) continues to be worse off every day that house prices continue to decline. While QE worked for rich people by reflating equities (at least temporarily), the classic American family who earns $60k and owns a $200k house will not spend more if their house value has dropped by $60k already and it continues to drop by $10k per year – especially if gasoline prices remain elevated. This situation was reflected in the worse-than-expected 1Q and 2Q GDP numbers. And despite some good news among the current gloom (US C&I loan growth continues, consumer credit is rising again, and retail sales have proven surprisingly resilient), yesterday’s drop in the August Empire manufacturing survey back to -7.7 suggests growth remains muted.
There appears to be two problems (at least!). First, the monetary stimulus has been poorly targeted. Showering money from helicopters in the hope that it finds its way to the hands of those who need it (rather than opportunistic actors in the financial system) has not worked very well, and neither has suppressing the cost of capital to nearly zero. In fact, we are starting to see some strong dissent from within the ranks of the FOMC, as evidenced by Kansas City Fed President Hoenig’s rather direct critique of the current policies here.
Second, the US continue to follow a dramatically pro-cyclical housing policy. They cheered on the market as it rose, loosening regulations and keeping rates low – and now that the bubble has burst they are impeding any potential recovery. In order to reduce their cash calls on the Treasury, the GSEs are liquidating their inventory into an already depressed market. In H1 they sold 10% of the houses transacted across the entire country, and usually at a 20% discount to market (as they were previously foreclosed properties). While this reduces their immediate cash drain on the Treasury, fire-selling these assets at a loss is probably not good for the long-term fiscal position. Moreover, it forces house prices lower, and is in effect a negative stimulus. So while the Fed has concentrated on lowering mortgage rates, one arm of the government has more than offset these efforts by liquidating their inventory. Unsurprisingly, a 50bps cheaper mortgage rate doesn’t stimulate demand much when capital values are dropping -5% per year. While we have internal debates on the appropriate role for Government in the economy, we all agree that (a) the US should reduce the role of the GSEs over time, but (b) now is not the time to do it! After all, when the Authorities rescued the banking system they (rightly) did not liquidate these holdings as soon as markets began to recover in spring 2009…so why should they dump the housing inventory now while the US real estate market is still struggling?
Fortunately, the Treasury is now considering changing its housing policy. Last week the Treasury announced that it was seeking input on ideas for the disposition of the GSEs housing inventory. Their objective is to “explore alternatives for maximizing value to taxpayers and increasing private investment in the housing market, including approaches that support rental and affordable housing needs” (see here). While they clearly have not finalized their plans, this could be very good news.
Such a development will be most positive for US risk assets if the Treasury ensures that the program (1) is big enough to make an impact – this is not the time for trial programs; (2) encourages the private sector to make a profit from holding and renting the properties; (3) allows the Treasury to retain an ownership stake; and (4) uses the Fed’s balance sheet to help finance the operation, by shifting their portfolio from Treasuries or MBS into Agency Debt. While this is a long wish list, if the Administration implements a policy similar to this then we would expect to see the housing market stabilize, which, in turn, would be very positive for a US economy currently hovering dangerously close to double-dip territory.
The above expressed views are GaveKal's, not FNArena's (see our disclaimer). All copyright GaveKal.
GaveKal is a financial services firm that offers institutional investors and high net worth individuals fund management, independent research on global macro-economic trends and events, and independent advisory work on China and its impact on the global economy.
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