Mortgage Credit News by Louis S Barnes - July 2, 2021

Economic change is coming so fast in so many places and out of pattern that it’s hard for the authorities to follow and adjust. In the lead of course is guessing at future inflation, and the strangely superheated housing market leading to itchy trigger fingers at the Fed.

Rates. Despite Fed rumblings, and a rapidly reopening US economy, long-term rates if anything are trying to fall again. The March-June range for the 10-year Treasury was 1.55%-1.75%, which in early June fell in to a new one, 1.44%-1.55%. The oddest thing about these ranges has been rare tests of the tops, just tests of the bottom. Downright weird, 10s today are 1.437% after a good report of new jobs.

Why? The world is not healing as fast as the US. The German 10-year is stuck at negative 0.23% despite a surge to US-level vaccination, and that yield more a reflection of the long-term prospects for ossified Europe. China is blustering itself into an unpopular corner, its working-age population shrinking while one-third of its people still live in deep poverty.

Australia is trying Covid life as North Korea, many there referring to itself as the new Hermit nation. Its Covid solution was total isolation, only 6% fully vaccinated, rejecting the AstraZeneca vaccine because of its risks -- on the order of 1/1,000th the risk of the virus itself. There are only 25 million Aussies, but adequate Pfizer/Moderna will not arrive for several months. Japan, desperate to hold the Olympics, is little better and same for South Korea, rich nations tangled in underwear.

Covid has exposed a crazy and incompetent streak in humankind a little wider than our normal follies.

Fed and Housing. Speaking of crazy....

The Fed since spring 2020 has bought monthly $80 billion in Treasurys and $40 billion in MBS. Going back to 2008, this would make Quantitative Easing Number Four. Inside and out of the Fed there is as much misunderstanding of QE4 as there was of QE1, much of it willful, and some embarrassing. The most widespread misunderstandings: that QE is designed to push down interest rates, and money-printing is always bad. The newest: MBS purchases have overstimulated housing. Corrections one at a time....

QE Purpose #1. The Fed’s most basic duty is orderly markets. Central banks have indifferent records as fine-tuners of economies, but superb results as the fire brigade. When panic descends on markets, and everyone is a seller, somebody must intercede, or we get Great Depression 2. In modern economies, every asset is in some way supported by credit, which panic collapses, new loans unavailable, old ones triggering firesales of collateral and death spiral. Understood since Walter Bagehot in 1873, the central bankers’ top duty is to be the lender of last resort.

Ben Bernanke in 2008 added: buyer of last resort. In the aftermath of the Lehman collapse in 2008, all of the Fed’s usual tools had failed to stop firesales and credit markets were freezing altogether. QE1 announced in November 2008 thawed markets instantly, economic recovery underway in just 90 days.

QE Purpose #2. A financial system damaged by firesales -- capital exhausted or impaired -- cannot provide adequate new credit. Bernanke maintained that quantitative easing is a misnomer (adding money to the system is a normal Fed function), and the real purpose of QE was easing of credit. QE pulls highest-quality IOUs from the system, which directly injects credit into the economy around crippled banks. The Fed tapered QE3 as soon as total bank credit began to expand on its own.

Willful misunderstanding: the legion of Wall Streeters selling money-supply scare stories, when the Fed’s adds are merely offsetting terminal collapse in monetary velocity.

QE Covid, Fed and Housing “Bubble.” I am a Fed fan, forgiving of its errors and its unfortunate blabbing because the job is infernally hard. But this week a collection of Fed officials including some of the more able ones have lost their minds.

Kaplan (Dallas), Harker (Philly), Rosengren (Boston), and of course Bullard the Idiot (St. Louis) have concluded that buying MBS is contributing to a housing bubble, and the Fed should taper or stop buying MBS, pronto.

The reason to buy MBS last year and now: in the March 2020 panic, mortgage markets went to firesale and lock-up just like 2008. They still have not fully healed. The Fed reports total bank credit weekly in data series H.8, and by category of credit. Line 11 shows real estate credit provided by banks is still shrinking. The Fed’s Z.1, the quarterly accounting of every dollar in the economy, L.218 One-to-Four Unit Mortgages, line 11, shows in the last year a most unusual outright drop in holdings by banks, $107 billion. New loan applications measured by the MBA collapsed last year, then recovery-spiked, but are back to pre-Covid normal, and roughly one-half the volume during the 2003-2008 bubble.

Whatever is going on in housing is not driven by credit. Calm and wise heads at the Fed (governor Brainard, SF’s Daly) tiredly point out that QE does not necessarily pull down on rates, and buying long-term IOUs... does not much matter what kind. An adequate supply of credit is the idea, orderly markets.

The cognitive dissonance among the MBS-worriers is awful. You think that any rapid rise in home prices is a bubble, and your duty to deflate? After all this time, all of your false-signal tightenings, you’d like a recession? A recession to make housing more affordable?

When this housing interval returns to normal, prices flat in most places, certainly some buyers will be marooned at purchase prices above market for several years. That will not be a blown bubble.

Blown bubbles result in downward cascades of prices. Bubbles have two essential characteristics: foolish credit, which as above is not present, and over-building by developers. The key player in post-bubble price-cascade is the builder with excess work in process and land, and must dump -- sometimes building at a loss in order to unload land. Those firesales undercut the value of all nearby, recently built homes, and put them underwater versus loans. A recession and job losses helps, too.

We have rapidly rising prices because we don’t have enough supply, perhaps because aspects of developer credit are too tight. These premature tighteners at the Fed are afraid of good news, logic MIA.

The 10-year T-note in the last six months. Break 1.43% going down, and there is no support on this chart until 1.20%:

Thanks to great graphics at www.calculatedriskblog.com, here are mortgage purchase applications going back to 1990. Note bubble. Note not-bubble:

Oxford’s World of Data https://ourworldindata.org/covid-vaccinations, percentage of population with at least one dose of vaccine. Percentages are low even among aggressive nations because we have barely begun to vaccinate teenagers, and younger not at all: