When Fake Wealth Disappears

The pillars of middle class living standards are beginning to crack and wobble...

(Source: Getty Images)

Bill Bonner, reckoning today from Baltimore, Maryland...

Jobs. And houses. Houses and jobs.

Those are the two pillars of US middle class living standards.

Jobs provide income. Houses are assets that can be readily sold. But it looks to us like the housing pillar is beginning to crack.    

Here’s the latest, from The Street:

More Americans Are Canceling Home Purchases. Here's Why.

For two years, home sellers have had all the leverage. Now, that may be changing, as more home buyers are canceling purchase contracts.

According to new data from Redfin, about 60,000 U.S. home sales fell through in June 2022. That’s about 15% of transactions that went into contract for the month, and it's the highest share of cancellations since April 2020.

Consumers are very sensitive to interest rate changes – and for good reason. The difference between a 3% mortgage on a $200,000 and today’s 5.8% is nearly $500 a month.

Which is why demand for refinancing has fallen 80% over the last year.  

Fake Wealth

We remind readers that in a healthy economy, wealth increases as goods and services are offered. But in the fake economy of the last 30 years, people enjoyed fake wealth by refinancing debt at lower and lower interest rates. 

Lenders don’t draw down savings; they create new money. This new money is what bids up asset prices – stocks, bonds, real estate. People feel richer when their assets go up in price. But it is a mirage. And then, when the refinancing stops, the fake wealth disappears.    

Let’s back up to get a better view.

The feds pumped up the supply of money and credit for decades – leading to today’s grotesque economy. Instead of encouraging saving and investment, the Fed’s ultra-low interest rates led to speculation, borrowing, and waste – with trillions of dollars squandered by the government and the private sector. The feds ‘invested’ in bailouts and boondoggles that would never produce a positive return.  Private investors funded businesses that lost money year after year… or bought cryptos that never produced any wealth in any form.

Then, in the Covid Panic, the feds went too far.  Cutting back on the supply of goods and services (lockdowns)… while printing trillions’ worth of new “demand” (stimmies, PPP, deficits, money printing)… was sure to lead to higher prices. Even former Treasury Secretary Larry Summers saw it coming. And now it is here. The latest readings showed inflation at 9.1% – highest in 41 years.

All of a sudden – but not surprisingly – the Fed finds itself ‘behind the curve.’  Consumer prices are rising. But the Fed’s lending rate is far below where it needs to be – about 700 basis points (7%) too low. So the Fed has begun a ‘tightening cycle’ – too little, too late. 

A Bull to Bear

Meanwhile, the return of consumer price inflation coincides, more or less, with two other major shifts. After 40+ years, the credit cycle is also finally rolling over. And the bull market in financial assets has turned into a bear market.  

Stocks turned down at the end of 2021. They had been going up for most of the last 4 decades. Now, they have given up about 15% of their value. There is nothing very noteworthy about this correction. Except! The other downturns – 2000 and 2008 – happened when the Fed was not so far ‘behind the curve.’ Then, the Fed could lower its key interest rates and get the party going again. 

This time, the Fed must raise its lending rate to fight inflation. In other words, it can’t jolly investors up with lower rates… nor can it make it easy for households to refinance their debt. This is the major difference between today and every other sell-off since 1982. This time, the correction will have to run its course. At least, for now.

That is why ‘buying the dip’ will probably not work. And it’s why US households may soon feel pinched.  

Bonds topped out about two years ago, with the yield on the 10-year T-note (which varies inversely with bond prices) at only 0.59%. It’s now over 3%, or 5 times higher. As the leg bone is connected to the ankle bone, mortgage rates are connected to bond yields. As recently as October, 2021, homebuyers could borrow below 3% for a 30-year mortgage. Now, they’ll pay 5.5%.

That’s a big difference. And the consequences are just beginning to show up. Here’s the Washington Post:

The US housing market is entering a 'deep freeze' as surging borrowing rates and sky-high home prices hit buyers, Moody's Zandi says

Data on Wednesday showed a drop in existing home sales to a two-year low in June. The National Association of Realtors reported seasonally adjusted sales hit a rate of 5.12 million last month, the lowest since June 2020, and below expectations for 5.38 million.

"It makes sense, with the higher mortgages conflating with higher house prices, first-time homebuyers just can't afford to buy in. They're locked out, and trade-up buyers, they're locked in because if they sell and buy, they've got to get another mortgage at a higher rate and their monthly payments are going to rise," Zandi told CNBC's "Power Lunch" on Wednesday.

Refinancing is history. So is, we predict, the bull market in house prices.

Stay tuned...

Bill Bonner