In the next 18 months, about 2.5 million households are supposed to be affected by mortgage rate adjustments. The total of the mortgages is about US$350 billion. First think about this: If the dollar were still worth what was worth five years ago, Americans could save about US$500 billion on their foreign purchases – in one single year! The value of all US assets is about, say, US$50 trillion. A 20% cut is equivalent to a loss of wealth equal to US$12.5 trillion…it is almost as if every single publicly traded company in the United States had gone broke.
Fed rate cuts are supposed to avoid a recession…so Americans don’t get poorer. But the lower dollar makes them poorer anyway.
Now, consider this: Most of those subprime mortgages will be adjusted, not based on the Fed funds rate, but on the London InterBank lending rate. And long-term mortgage rates are not the same as the short-term rates. When the Fed cuts rates, it signals to lenders that inflation will increase. This pushes up rates on long-term loans – such as mortgages. So, when the Fed announced its cut last week, long-term rates actually rose almost as much as the Fed’s half of a percentage point cut. Now, according to the Financial Times, the typical subprime mortgage will be reset to a rate around 10% – a huge increase in monthly expenses for the poor homeowner…and the effects (as we have seen) will be felt throughout the global economy.
Meanwhile, so many negative indicators are coming into Markets and Money headquarters that we feel we need to call in an exorcist. Is a recession on its way? It looks to us as though it has already begun:
Housing inventories are at an 18-year high.
Housing sales (resales) are at a 5-year low.
Housing prices, according to Case/Shiller, fell in America’s top 20 cities last month – 3.9%.
Late payments are running well above the historical average.
More than 150 mortgage companies have closed up shop.
While the value of Americans’ number one asset is going down, their living expenses are going up. And it looks to us as though they are going to go up a lot more. Why? Remember, there’s a war of prefixes going on. There is no doubt that we are living in a ‘flationary’ world. But what kind of ‘flation’? “In” or “de”? Each time we approach the question, we hesitate; but now we can give you a definitive answer: Both.
The ‘flation’ in the housing market clearly needs a ‘de’ in front of it. And so does the entire subprime US economy. Yes, dear reader, it is a subprime economy. Like the subprime homeowner, the whole US economy has too much debt, and a lifestyle it can’t really afford. The Fed’s grand gesture (offering more credit) looks good on TV (the yahoos watching James Cramer must love it) but it doesn’t make the debt go away…it can’t really stop the inevitable deflation of US financial assets…and it actually increases pressure on the typical household, because it forces up prices.
Markets and Money