Executive Summary

• The Fed Won't Be Able To Soak Up Bad Mortgages Like It Once Did
• Chinese Capital Will Dry Up After Capital Controls Are Imposed
• The weakening petro-dollar will weaken demand for high-end housing
• The inevitable symmetry of bubbles will force a price mean-reversion

If you have not yet read Part 1: How Much Longer Can Our Unaffordable Housing Prices Last? available free to all readers, please click here to read it first.

In Part 1, we looked at factors that limit further home price appreciation—mortgage rates that can’t go much lower and stagnant household incomes—and factors that could continue to push prices higher in islands of strong job growth and global demand.

Here in Part II, we’ll look at several dynamics that could deflate the current Housing Bubble #2, even in areas currently experiencing high demand for housing such as New York City and San Francisco.

The Fed Will Encounter Political Headwinds in Pushing Money to the Wealthy

Setting aside cash buyers from overseas, a major factor in the inflation of Housing Bubble #2 was the Federal Reserve’s quantitative easing programs that expanded the pool of money available to the already-wealthy while prompting very little “trickling down” of this new money to the bottom 90% of households.

The one Fed policy that aided the bottom 90% was buying $1.75 trillion of home mortgages. This unprecedented buying spree helped push mortgage rates down to equally unprecedented lows.

But as this chart shows, the Fed is…

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Executive Summary

• The new drivers of the current housing price cycle
• Why investment capital, not normal household formation, has become primary for pricing
• What the implications of an investment-driven housing market are
• Why prices will fall & what homeowners (residents & investors) can do now

If you have not yet read The US Housing Market's Darkening Data, available free to all readers, please click here to read it first.

The The New Drivers of The Current Housing Cycle

1. Cash

First, we are currently seeing something in residential real estate markets that has not occurred in our lifetimes – the magnitude of all-cash offers. 40-50% of residential real estate purchases have been for cash in recent years. This phenomenon has no precedent in recent economic history. Why is this happening?  We need to remember that a primary goal of the Federal Reserve in setting short term interest rates near 0% was to induce investors to buy “risk assets” – think real estate and common stocks.  By eliminating rate of return in safe securities such as Treasury bonds, CD’s, etc., the Fed essentially forced formerly conservative investors to purchase higher risk assets in order to get any acceptable rate of return.

In good part, the all-cash offers are coming from investor’s intent on buying to rent. Intent on obtaining an acceptable cash on cash rate of return as yield can no longer be found in safer investments. This crosses the boundaries between investors in the asset accumulation phase of life and retirees starved for yield, draining formerly CD-centric bank accounts in order to purchase income-producing rental properties…

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Executive Summary

• Why stocks may average 0% return (!) for the next decade
• The depressing data in
  • Retail sales
  • Housing
  • Manufacturing
  • Consumer confidence
• Why the time to short the market is looking near

If you have not yet read The Stock Market's Shaky Foundation, available free to all readers, please click here to read it first.

To be sure, there is one piece of fundamental information that has supported equity prices; and that’s corporate earnings.

Those have vaulted to new highs, despite the weak economic recovery, on the back of ultra-cheap borrowing (which reduces interest costs which are deducted from earnings), government deficit spending, and low household savings:

While the parabolic rise in corporate earnings is quite impressive, they are also historically unprecedented and certainly unsustainable. 

When we look at the same chart seen above but on a percent change yr/yr basis we see that they have been slowing down remarkably and aren't that far above the zero mark…

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