Monday, March 28, 2005

Is the end of cheap money nigh?

Ultra-loose monetary policy has been the fuel that has propelled the global economy�s recovery from the 2000-01 recession, particularly cheap money flooding the mortgage market. But signs of impending change are everywhere. The Fed just completed its seventh 25-basis-point hike in the federal funds rate, putting the Fed�s level at its highest since September 2001. Last week, nationally averaged rates on 30-year FRMs topped 6.0% for the first time since July 2004, and likewise, rates on one-year ARMs hit 4.24% last week, the third week in a row they have been above 4.19%, the ceiling of the zone in which they�ve traveled (with a few brief one-week exceptions) since November 2002. Stories of ultra-frothy US housing markets have been everywhere, the most recent in today�s Financial Times (sub. only) which traces out the serious consequences of the end of cheap money in a highly levered and dependent system.
Americans have come to see their homes much like cash machines, withdrawing Dollars 223bn (Pounds 119bn, Euros 171bn) last year from the equity in them. According to a recent speech by Alan Greenspan, chairman of the US Federal Reserve, approximately half of this money shows up in increased spending by consumers. If so, about 40 per cent of the 2004 increase in consumption rested on withdrawals from the housing market.

The worry is not simply that consumers will stop taking money out of their houses if appreciation stops or prices fall. They may also feel the need to bolster their savings accounts - again to the detriment of consumption.

. . . Ian Morris, US economist at HSBC . . . [notes that] declines in real house prices have tended to set in before interest rates or unemployment really start to rise. "Assets tend to be leading indicators while unemployment tends to lag behind other economic trends," he says. "We don't necessarily need a sharp rise in interest rates to undermine the housing market and economic growth."

The precedent of the Netherlands is particularly worrying for the US. There, after years of steep increases, house-price inflation tumbled back to zero in 2003 when interest rates and unemployment were coming down. This slowdown contributed to a consumer slump, with spending declining through most of 2003. The discomforting message from the Netherlands is that even the flattening of house-price inflation may have a more dramatic effect on consumers than expected.
We all know that Americans refuse to save out of income these days. In 2004 the personal savings rate was a pathetic 1.2%, the lowest level since 1934, and that thanks only to a special Microsoft dividend pay-out in December. Without Microsoft�s extraordinary intervention, the personal savings rate would have been around 0.9%, the lowest since 1932 and 1933 when, thanks to the Great Depression, personal saving was actually negative.

If the house-as-ATM path is blocked, HSBC estimates that
the US would need to create an additional 2m jobs to make up for an end to mortgage equity withdrawal. This is not a blow that the economy could easily take on the chin.
No kidding. That�s the total number of private sector jobs created in 2004. How another 2 million will materialize in the midst of a housing slump � and the sloughing off of hundreds of thousands of property related jobs from mortgage brokers to construction workers � is anybody�s guess.

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