My Two Cents - "False Bottoms create Freefalls"

1/5/2007

As we rang in the New Year a few days back, no doubt there was a lot of toasting and clinking of champagne glasses in financial circles. Wall Street bonuses rival the salaries of professional athletes. Money is everywhere. Except in the average working man's pocket, but if nothing else, 2006 should be proof positive that the average man's financial health is of no concern to the Wall Street behemoths. He is nothing more than a springboard to an even bigger bonus, another yacht or perhaps a mansion in the Hamptons.

In the final week of 2006, we got the last set of housing data for the year. Sales of new and existing homes have hit bottom according to the spin-doctors. The Fed is the 21st century equivalent of the Babe. They called their shot. Congratulations on the soft landing guys. I credit Peter Schiff with accurately predicting this phenomenon some months ago, however. He ventured that the Fed might be able to engineer a soft landing by pumping so much money and credit into the system that the housing bubble would never actually deflate fully, but rather that homes would continue to decrease in value compared to REAL assets yet rise in nominal dollar terms. Anyone who has been reading my comments over the past few weeks has heard all about what prices are doing.

The damage, however, from another politically-driven monetary push will be felt for years to come. The government continues to bet that the average American will view a rising home market as 'good inflation' and will not realize that price of everything else is rising inordinately along with it. This has been the modus operandi for decades now. The public has been convinced that increases in price levels are a by-product of a strong economy, growth or their own greed. This couldn't be more wrong. Overall price levels aren't rising at all. Rather, it is the fact that the dollar has lost so much value that requires more be used to purchase something. This bit of reality has been beaten out of the American public by schools, the media, and Wall Street for the better part of a half-century.

By intervening and not allowing the housing market to properly correct itself, the Fed is guaranteeing that when it does correct (and it will - in REAL terms) that the pain will be that much worse. The problem is that each time a central planning authority gets away with something like this, the complacency and arrogance increase and they begin to feel that there is no stunt too big for them to orchestrate. This mentality is very dangerous for the average person's wallet.

By pumping money, the Fed can throw a floor under falling home prices. This is critical to the game. By propping up home prices, appraisals stay high and allow for additional equity extractions as well as keeping all these adjustable rate mortgages from going underwater (money owed > appraisal value). The only problem as I see it is rates. Rates are still not all that low. The bond market has been under a little pressure recently, and higher mortgage rates will make it harder for people to take on new debt. Or will it? The American Shopper didn't earn the honor of 'Person of the Year' on FOX for nothing. The consumer has been a pleasant surprise for economists and politicians alike because of his unending ability to keep spending money. Money that I contend he simply doesn't have.

As we begin 2007, look out for a new wave of hybrid loan products, teaser rates, negative-am mortgages, and 0% interest credit card offers. The fact of the matter though is that unlike the Wall Street big-shot, the average Joe is not in good shape. He is already loaded down with debt, has little or no savings, and is utilizing all of his available labor. Unlike the 70's, there is no housewife or housedad to send off to work to pick up the slack for rising expenses. That is the reality and there is a massive disconnect between how Wall Street perceives this reality and how Main Street is living it.

The Author holds an MBA in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics.

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