Ladies Don’t Dance on Graves

I am often asked why I would leave the freedom of being a columnist to subject myself to the confines of the Fed, a bureaucratic institution frozen in a mindset that was diametrically opposite my own. I had already escaped compliance once when I left New York after selling my book of business to Credit Suisse and signing a non-compete (something about “equities in Dallas.”) “Retiring” to write a column about the financial markets was truly a dream come true and proved to be deeply gratifying work. Thou shalt never besmirch The Fourth Estate. It should be the 11th Commandment.

Don’t get me wrong. Calling Greenspan to task as the subprime crisis hurtled at warp speed towards the world economy was not exactly well received by the public, or my publisher for that matter. But that was in 2004 and 2005 when home prices looked as if they would continue on their skyward trajectory indefinitely. At some point, though, my “crazed” predictions came to pass and hate mail writers began to pen apologies as they were, after all, losing their homes to foreclosure. That, I can assure you, was not what I had signed up for.

The dark humorists always claimed that the Fed had hired me for one sole purpose – to shut me up. My stock answer, aside from the honor of being called to serve my country, has always been that ladies don’t dance on graves. There was no satisfaction in being right. Better to try to do something about it by changing the minds of policymakers from the inside. Let’s just say I had no idea what I was getting myself into.

The day was September 29, 2006. To put into five words my state of mind: My hair was on fire. The housing crisis was coming and the only question was one of how to contain the damages that would ensue. My anti-schadenfreude and personal history of living through the S&L crisis in hand, I marched myself into the Fed to meet the oncoming crisis head on. Straight into a brick wall, that is.

The housing crisis was nowhere to be found in most economists’ play books – unless (inconveniently) the Great Depression was included in the time frame examined. The go-to stress test for Fannie and Freddie to gauge how bad things could possibly get was the S&L crisis in Texas. Suffice it to say, that benchmark was wiped off the planet as a point of reference within a matter of months as the housing market crashed, dragging the interconnected global financial system down with it.

I am sad to report that what was readily apparent to me was oblivious to the ingrained myopia that infected most Fed economists. Market historians will recall that on March 28, 2007, the following words were publically stated by one Ben S. Bernanke: 

“At this juncture, however, the impact on the broad economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency.”

To think that this statement was made nearly two months after HSBC, at the time the world’s third-largest bank, announced that its bad debt charges would be 20 percent higher than forecast due to the deteriorating state of subprime mortgages it held. Foreclosures were up 35 percent over 2006 and for a fifth straight month, more than 100,000 properties entered foreclosure because the owners couldn’t cover their payments. This situation was “contained”?

As incredulous as this rookie was at the depth of the pervasive blindness, what was to come would prove more unsettling yet and lay the groundwork for a housing market “recovery” that eludes to this day.

Over seven years ago, the housing bubble peaked and rolled over. Normalcy has yet to return. The latest case in point occurred in June when existing home sales hit an 8 ∏-year high. The news was widely lauded by the economist community and in the media. But the composition of today’s buyers is no cause for celebration. Some 30 percent of homebuyers in June were first-timers. Moreover, the May to June increase in existing home sales was the weakest in seven years despite aging millennials who should be seguing from rentership to homeownership.

Think about that for a moment. June sales reflect contracts signed in April and May as many young families are contemplating such things as school districts and perhaps moving into their first home. First-timers should theoretically represent a disproportionate share of buyers as the school year is coming to an end. And yet they remain stubbornly conspicuous in their relative absence.

How things have changed in the short space of a few years. At the peak of the housing bubble, first-timers were over half of the buyer market, which was equally out of whack with a normal state in which 40 percent of buyers are first-timers. Back then, mortgage standards were ridiculously lax, which of course, led to the subprime fiasco and in turn snowballed into the financial crisis.

It was in the cleaning up the aftermath of the crisis that things went very wrong. No doubt, ripping the bandage off by standing back and allowing the market to clear would have led to a deeper recession, which is saying something. But maybe today housing would be a realistic option for more young Americans if more homes would have been sold at fire sale prices. That is not to even begin to suggest that foreclosure is a kind event in a homeowner’s life. But consider the fact that enough time has passed that many who lost their overvalued homes to foreclosure early on are once again now eligible to take out a mortgage.

Instead of market clearing, policymakers and politicians went out of their way to cushion the fall. Such was the height of this tall order that it took years to play out. Amid all manner of fanfare, one modification program after another was unveiled to “help” homeowners remain in homes they can still not afford. Even today, after all this time, one-quarter of bottom-tier homes are underwater; their mortgages still exceed the home’s value thus trapping the occupants.

As for the banks, they’ve been regulated and fined to kingdom come, which makes for great soundbites but does nothing for mortgage applicants. Lending standards are just now beginning to ease. The public might have been better served had they had the satisfaction of seeing even one perp walk on the evening news. Widespread mortgage fraud should have been convictable on some level. But that has yet to happen.

In the meantime, low interest rates invited a new breed of homebuyer to muscle its way into the market. Deep-pocketed private equity investors, armed with their price-ambivalent purchasing power, have been an immense driver of home price appreciation in recent years. In all, investors have amassed a stable of 2.6 million rental homes, which may not seem like much given the fact that there are 133.6 million homes out there. But ask any realtor and they will tell you that investors have had a tremendous effect on comparables. You don’t need too many homes sold above their true market price to affect the rest of the neighborhood.

And so it followed that home prices never did fall as much as history would have predicted. The white knight investors with their saddlebags filled with someone else’s gold rode in to save the day. Or at least that’s how the happy-ending version of the story is told. Try telling that to buyers who have been priced right out of the market. The median price of a home sold in June rose to $236,400, the highest on record.

If the stated goal of the Fed was to put a floor under home prices, I suppose policymakers can take a bow. But I doubt they applaud the effect of high prices and tight mortgage standards shutting out many first-time homebuyers. Instead of taking advantage of the cut-rate prices a market clearing would have produced, many millennials have instead made a prolonged stopover in the apartment rental market. Since homeownership peaked in late 2004, some 8.7 million renters have been created while the ranks of homeowners have contracted by 1.2 million.

With rent inflation running at the fastest pace in a decade and home prices at a record high, it’s safe to say we’ve returned to the heyday of the housing bubble, but not in a good way. Well-intended but predictably ill-conceived Fed policy has now managed to put housing out of reach for not one, but two, generations of Americans.

The parade of casualties does not end there though. The significance of a lost generation of first-time homeowners for the Baby Boomer generation and the economy’s prospects are undeniable. A 2012 study concluded that by 2030, some 26 million Baby Boomers would endeavor to sell their homes and retire. Success, however, hinges on move-up buyers in significant numbers lining up to buy Boomer’s high-end homes. The odds of a sufficient number of move-up buyers being created are slim to none given the absence of first-timers ready to trade up. Policymakers may lament the fact that so many millennials are living in their parent’s basements today. Just imagine how they’ll take the news that increasing numbers of Baby Boomers have simply switched places with their offspring.

The Seven Dollar Cantaloupe

Existential crises are rarely brought on by produce. Consider me the exception. It was December 1996. One week after completing Donaldson, Lufkin & Jenrette’s MBA training program in New York, I found myself booted out of the posh accommodations that had been provided and holed up in a sunlight-starved apartment in midtown. A bit of budgetary math had revealed that my take home pay would just cover my rent, student loan, and almost nothing more. Hence my public meltdown at a corner deli upon discovering the same cantaloupe that sold for next to nothing from the backs of pick-up trucks on numerous street corners back home in Texas were commanding a princely seven dollars.

What to do on such a stretched budget? There were always the free lunches at roadshows for one internet startup after another that paraded their profitless wares on the IPO expressway that ran straight through our midtown office. Parental support would also prove critical those first few months, but what mom could spare tended to get my dry cleaning out of hock and little more. To say the incentive to overachieve was acute is an understatement. True grit and a healthy fear of delis and other purveyors of edibles pushed me to my limits. Within a year, my student debt had been paid in full and produce as luxury goods was no more, at least for me.

To take nothing away from the hard work required of me, nearly two decades later, I recognize that timing and luck also played a role in my success. But there was also the invisible hand of the Fed at the helm of Wall Street’s fleet of ships, and I, like many, was pulled along in its wake. Unbridled greed ruled the day. The movie “Wall Street” was required viewing on day one of the training program. As for macroprudential policies, they were nowhere to be found even as margin debt data screamed red alert and fruit stand operators day-traded stocks (was that how produce prices went parabolic?)

How the story ends is no surprise. In Greenspan’s mind, no actions could be undertaken to rein in the bubbly excesses; only the aftermath could be addressed by the tools available to central bankers. In the case of the Nasdaq crash, the policy solution was another period of exceptionally low interest rates that in turn inflated the next bubble – housing. No surprise, the unchecked speculation invited by ultra-loose monetary policy resulted in another crash, that of house prices. Did similarly disastrous outcomes prompt a shift in thinking among policymakers?

I’m distressed to report, but this flawed approach continues to drive Fed decision-making-by-model to this day. The consequence: cantaloupes, or whatever millennials hold sacred as the little extra in their lives, have never been so out of reach for new entrants to the workforce as skyrocketing rents have sentenced millions to their parent’s basements.

Harvard’s Joint Center for Housing Studies recently released its 2015 State of the Nation’s Housing report. In the decade to 2014, an average of 770,000 renter households have formed, the fastest pace since the late 1980s when Baby Boomer’s nests were emptying. This would not necessarily be bad news if it was purely a case of millennials moving out of their parent’s homes and into apartments as Generation X’ers moved up into their first home. But that is decidedly not the case for the 42.3 million Americans who rent today, many of whom would rather own their own slice of the supposed American Dream but remain trapped in rentership.

Why is that? In 1980, only 22.9 percent of the population ages 18 to 34 lived with their parents. Today, 30.3 percent of millennials, those born 1985-2004, find themselves in that same unmoored boat. The most obvious reason behind this troubling trend is the increase is student debt. The share of renters carrying student debt increased from 30 percent in 2004 to 41 percent in 2013, the latest year for which data are available. The kicker: the average amount of debt has risen nearly 50 percent to $30,700.

One of the most damaging legacies of the housing bubble is the wreckage that remains due to the lax lending standards which allowed parents to tap their swollen home equity to finance their children’s college costs. It’s plain that monetary policy has been impotent in staunching the continued rise in higher education inflation. Ergo, accruing student debt has been the only way for many millennials to stay the course. Their pricey educations are clearly not a gift that keeps on giving considering where so many are forced to call home.

One could argue that Fed policy has only had an inadvertent effect on the stratosphere-reaching cost of higher education. The ease with which student loans can be accessed and a cultural stubbornness that insists that every child should attend college, regardless of its value in the after-degree world, have both played their part in this debt-ridden tragedy.

What is undeniable is the direct effect Fed policy has had on runaway rental inflation. Eras of low interest rates never fail to attract investment dollars to anything with a discernible yield. Unlike less attractive commercial real estate sectors such as retail and industrial, in the years following the housing bust, multifamily developers enjoyed unencumbered access to cheap financing. This sector is “awash in capital” according to a recent report, which has catapulted multifamily to the top-performing commercial real estate sector: Multifamily property prices are 25 percent above their 2007 peak compared with an aggregate that captures all sectors which is up by 10 percent.

In keeping with Wall Street’s Michael Douglas’ character’s mantra that “Greed is Good,” a recent study found that 82 percent of the apartments that came to market from 2012 to 2014 have been high end properties that command lofty rents. Why should investors settle for less when they can chase major-market multifamily properties whose prices are up 47 percent, nearly double that of multifamily as a whole? It’s no wonder rents are out of control.  But don’t worry, the Fed tells us inflation is too low.

If optics are the objective, the Fed can claim to be “concerned” about low inflation to justify its extremely easy monetary policy stance. The fact is, policymakers can flatter their case by using an inflation metric that minimizes the influence of many of life’s necessities, especially rent, which is by far the biggest line item in a household budget. Other inflation gauges are less kind. The widely recognized consumer price index revealed that rents rose 0.4 percent in June. That works out to 3.5 percent over the last year and the fastest pace in a decade.

Axiometrics, a data provider that zeroes in specifically on apartments, has been tracking rent inflation since April 2009 (they exclude single-family rentals, which now account for a near-record 37 percent of the rental market). In June, they reported that rent growth had risen to a 5.1-percent annual rate, a four-year high. The quick pace extends 2015’s five-month streak of 5.0-plus growth to the longest in at least six years. Axiometrics had already crowned 2014 as “The Year of the Apartment” given its strength. It may be tough to come up with a better title for this year, all things considered

Economists continue to hope that the abundance of apartments coming online will cool rent inflation. They’ve got good reasons to be optimistic – there are more units under construction than at any time since 1974. That said, multifamily starts continue to surprise to the upside. The 29-percent spike in June starts put the ratio of single-family- to-multifamily starts at 1.4-to-1; that’s a far cry from the historic ratio of four-to-one. As for the economics of the distorted ratio, each multifamily unit started creates about two jobs, less than half the four to five created by a single-family housing start. Moreover, as a recent Bloomberg story rightly pointed out, homebuyers buy more stuff.

The Harvard study provides stark evidence of how monetary policy with a stated goal of making housing more affordable has perversely made renting more expensive than ever. Demographers break up millennials into two cohorts – 18-to-24 years old and those ages 25 to 34. Renters in the older group, traditional first-time homebuyers, have literally been hammered by decisions undertaken by the same central bankers mandated with curbing inflation: Over the past 10 years, the share who spend more than 30 percent of their income on rent has increased to 46 percent from 40 percent. Meanwhile, the share with “severe” burdens – they expend more than 50 percent of their income to rent the roof over their heads – has risen to 23 percent from 19 percent.

It’s hard to imagine these folks splurging on a cantaloupe, much less saving up for a down payment on their first home (or on that $7 cantaloupe). But the fact is, if these traditional homebuyers remain renters for too long, the middle tier move-up market will be the next victim to suffer at the omnipresent hand of ill-conceived Fed policy. And if a sufficient number of seasoned first-time homebuyers are absent when the time comes for move-up buyers to stake a For Sale sign in their front yard, it’s the McMansion-saddled Baby Boomers who will be the next casualty. They’re the ones banking on move-up buyers allowing them to sell their homes and retire in peace.