Guest Post: The Federal Reserve's Cargo Cult Magic: Housing Will Lift the Economy (Again)

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

The Federal Reserve's Cargo Cult Magic: Housing Will Lift the Economy (Again)

The Federal Reserve is ultimately a Cargo Cult, founded on fantasy and a boundless faith that management perception will bring back the cargo ships of debt-based "growth."

I have often identified Keynesian economists and the Federal Reserve as cargo cults. After the U.S. won World War II in the Pacific Theater, its forces left huge stockpiles of goods behind on remote South Pacific islands because it wasn’t worth taking it all back to America. After the Americans left, some islanders, nostalgic for the seemingly endless fleet of ships loaded with technological goodies, started Cargo Cults that believed magical rituals and incantations would bring the ships of “free” wealth back. Some mimicked technology by painting radio dials on rocks and using the phantom radio to “call back” the “free wealth” ships.

The Keynesians are like deluded members of a Cargo Cult. They ignore the reality of debt, rising interest payments and the resulting debt-serfdom in their belief that money spent indiscriminately on friction, fraud, speculation and malinvestment will magically call back the fleet of rapid growth.

To the Keynesian, a Bridge to Nowhere is equally worthy of borrowed money as a high-tech factory. They are unable to distinguish between sterile sand and fertilizer, and unable to grasp the fact that ever-rising debt leaves America a nation of wealthy banks and increasingly impoverished debt-serfs.

The Keynsian Cargo Cult relies on an essentially magical belief that government give-aways will raise "aggregate demand," the "animal spirits" demand for more of everything, which will magically increase productivity, wealth, etc.

The Cargo Cult faithful do not understand diminishing returns: at some point, the interest on skyrocketing debt drains income and capital from potentially productive investments to pay for previous unproductive spending on fraud, friction and malinvestments. "Free money" creates moral hazard, which means that those who can borrow money for almost nothing and never have to pay it back act entirely differently from those paying market rates for money and backing their loan with real collateral that is at risk.

The Keynesian Cargo Cult is based on ever-expanding debt and fiscal moral hazard. The Federal Reserve Cargo Cult is based on ever-expanding debt and monetary moral hazard. The Fed loaned over $16 trillion to "too big to fail banks" at rates that are negative once inflation is accounted for, and it has essentially stolen hundreds of billions of dollars from savers and pension funds in order to subsidize the housing industry with artificially low-interest mortgages.

The Fed's plan to boost more consumer borrowing/spending via the "wealth effect" by elevating the stock market has failed. The "wealth effect" is classic Cargo Cult magic: if you make people feel richer by managing their perceptions, they will start acting richer, i.e. borrowing and spending more based on phantom assets.

Why is this perception-management a form of magic? Household incomes have declined. How can a debtor borrow and spend more if his income has declined? The "magic" only works if he can borrow money based on phantom collateral, and the rate of interest is so low that his impaired income enables him to leverage more debt--though any prudent banker would reject the debtor as a bad risk.

Borrowing money at near-zero rates with no collateral creates massive moral hazard. No skin in the game? Default is not just easy, it's rational: All praise to the new subprime – 1 out of 6 FHA insured loans is now delinquent (Dr. Housing Bubble).

The Fed has gone to considerable trouble and expense to goose the stock market to multi-year highs. Yet the economy is still stagnant. If you have any doubts about this, please study this article and these charts: The Lost Decade of the Middle Class (Pew Trust)

Real household income has declined:

Real household income by age bracket: only the 65+ group's income has increased.

Labor's share of the non-farm private-sector economy has fallen off a cliff:

Household debt has far outpaced wages: households are over-indebted and over-leveraged. Only the top 5% have reduced leverage. Remove their income and debt from the calculation and the "households are deleveraging" argument collapses.

The economy is 14 million jobs short of what's needed to support housing and spending:

The Fed's monetary policies of saving the "too big to fail banks" and stealing from savers to subsidize cheap mortgages and other debt has failed on multiple levels: The "wealth effect" it sought to create by manipulating the stock market ever higher has been limited to the top 5%, an easily predictable result (all you have to do is look at who owns most the nation's stocks and bonds--surprise, it's the top 5%).

The Fed's Cargo Cult faith held that this largesse to the banks and the wealthy would magically trickle down to the bottom 95%. It didn't, as anyone who actually lives in the real world could have predicted.

My neighbor buying a Porsche and a bunch of stuff made in China does not generate income for me unless I assemble Porsches or stuff in China or I own shares in Porsche and WalMart. Since Americans don't assemble things in Germany and China, and 95% don't own enough shares in any company to generate meaningful income, the Fed's policies failed miserably. The Fed's Cargo Cult "trickle down" magic was the equivalent of waving dead chickens and dancing the humba-humba around the campfire at midnight.

Having failed to create a useful "wealth effect" by goosing stocks, the Fed is trying once again to goose housing. Hey, it worked from 2002 to 2007: make money cheap and easy to borrow, accept phantom assets as collateral, lower down payments to near-zero, and housing prices soar, creating a bubblicious amount of equity that can be borrowed and blown.

In other words, the only mechanism the Fed has to spark a widespread "wealth effect" is to re-inflate housing. It has been trying to do so mightily for years, by stealing hundreds of billions from savers to subsidize low-interest mortgages and by buying $1 trillion of impaired mortgages off the banks, clearing their balance sheets and theoretically enabling them to originate more mortgages.

Lower rates were supposed to spark a re-financing boom that would free up billions of dollars as monthly mortgage payments dropped, but oops, very few homeowners are creditworthy now that having a pulse and the ability to lie are no longer sufficient to get a mortgage.

The Fed can funnel trillions to banks, but it can't force them to lend money to uncreditworthy borrowers putting up phantom collateral.

So the Fed is back to the game of goosing phantom assets higher with perception management. The Fed is hoping to generate a "virtuous cycle" in which higher home prices lead to millions of homeowners rising above water and having equity, which will make them feel wealthier (the wealth effect) and more energized ("animal spirits") to borrow and spend.

In a centrally managed economy and market, housing prices are manipulated higher by lowering rates, lowering credit standards, guaranteeing marginal borrowers can buy homes with 3% down payments and so on. The Federal government basically took over the mortgage market in 2009, and government-backed mortgages still account for over 95% of all mortgages. The mortgage market has been completely socialized as a means of subsidizing housing.

Note the Cargo Cult magic of the "wealth effect" has it backwards: income doesn't rise as a result of productive investments and higher productivity that's passed on to workers, it rises because phantom assets are inflated to justify workers taking on more debt to boost their spending.

How has the Fed's Master Plan been working so far? Hmm, not much bang for all those bucks.

The Fed Cargo Cult wants to paint dials on rocks and re-set the S-curve that guides all speculative bubbles and busts. This time we'll force people to buy houses for inflated prices and force lenders to make risky loans to credit-impaired buyers with our magic mind control!

The housing industry and its Fed backers were ecstatic with recent increases in the Case-Shiller index of housing prices. I've marked up the chart to reveal the underlying dynamics of this underwhelming reflation.

The entire Fed Cargo Cult depends on the "magic" of manipulating internal psychological states:

1. Boosting expectations of inflation so people will be encouraged to spend what money they have now.

2. Creating the perception that housing is recovering, as opposed to the truth that housing is only rising due to stupendous incentives created by subsidies paid by others and the banks' stealth campaign to lower supply by holding millions of defaulted homes off the market.

3. By stimulating demand and artifically reducing supply, the Fed and the banks hope to create phantom collateral (home equity) that can support another enormous wave of new borrowing and spending.

What nobody dares mention is the Cargo Cult is funneling trillions of dollars into unproductive malinvestments. Housing is a form of consumption; it is not a productive investment. It is subject to diminishing returns: all the trillions dumped into subsidizing housing have yielded a pathetically meager increase in phantom assets.

The Cargo Cult of the Federal Reserve has failed, and it should be abolished as the ultimate destroyer of wealth via its policies of manipulation, malinvestment and moral hazard.

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Cognitive Dissonance's picture

"Some mimicked technology by painting radio dials on rocks and using the phantom radio to “call back” the “free wealth” ships."

Ground control to Major Tom. Watch for falling fiat and put your helmet on.

Michael's picture

All Your Base Are Belong To Us says The Base(Al-Qaeda), English please.


Aziz's picture

During phases of weak growth there are always those who say that lower interest rates will not help. They overlook the fact that low interest rates act through several channels. For instance, more housing is built, which expands the building sector. You must ask the opposite question: why in the world shouldn’t you lower interest rates?

— Paul Krugman (May 2001)

akak's picture

Thank you, Aziz, for rolling out the Keynesian Klown Kar once again.


Now, if those Keynesian Klowns would only stop pointing their machine guns at us ...

Divided States of America's picture

The Federal Reserve needs to elevate housing? Well, then I think we should definitely get David Blaine as the next Fed Chairman because he specializes in levitation.

Concentrated power has always been the enemy of liberty.'s picture

Has this guy ever written a single article without the term "cargo cult"?

spastic_colon's picture

we all know exactly what is going to new buying, extention of ZIRP, and the boiler plate commentary.....thus allowing the markets to price in the next meetings QE announcement, and the next, and the next ad nauseum.


If things are so great, why are they still so dovish?  Clearly they should be getting more hawkish, right? 

economics9698's picture

"The Federal Reserve's Cargo Cult Magic"

ROLMAO  That is fucking classic.

gaoptimize's picture

Anyone who owns realestate in the Washington DC area is a cargo cultist.  Yes, I am a cargo cultist but I rationalize it by saying it is a nice island (many Money Magazine Best Places to Live) and I have a family to support on this island and everyone else is a cargo cultist.  But I don't know where I'ma gona go when the fiscal volcano blow.

TwoShortPlanks's picture

I was in the same shoes as you only 2 years ago. Different location tho. I made an informed and difficult decision which, now, I have come to realise was the best decision I have ever made. Now, more than ever, the medium to long term facts are staring you and everyone else in the face, only you have access to the opposite spin to the mass media spin. And since you're posting here on ZH you must surely grasp the fundumentals moreso than your neighbour who is most probably oblivious to anything beyond the mass media spin.

I think the question you should really be asking yourself is quite a simple one...why do you choose to stand at the Forward Edge Of the Battle Area (FEBA) while at the same time listening to the enemy's Artilery Guns in the distance 'Thump' hundreds of rounds into the air. It's a beautiful noise to hear, as the bombs tear the air aside high up into the sky, but that's the illusion...the calm before the storm.

ZeroAvatar's picture

No, but he has written a couple without the word 'pernicious'.

vast-dom's picture

you do realize that Krugman has zero savings, right? all his money is in PM's so of course he wants NIRP coupled with alien invasion.

i mean why in the world shouldn't we get paid to borrow and therefore stimulate the housing market on both builder and buyer side?

GFKjunior's picture

9-11 was a conspiracy. The towers never actually collapsed, I have proof. Don't trust the media.


Wake up sheeple. 

Michael's picture

Huffington Post is looking better then Zero Hedge these days. Check out the comments on this article;

Netanyahu Lashes Out At U.S. Over Iran Program 

Cognitive Dissonance's picture


The Huff Poo censors are just off their game today working like mad deleting all the "9/11 was an inside job" references.

They'll do better tomorrow........promise.

Michael's picture

But it's absolutely surreal over there today.

A top article called 11 years later has only about 1,100 comments, where normally they would get over 10k comments from their 25k posters, so you know that article is being heavily moderated.

But the Netanyahu and What Al-Qaeda looks like today articles are a free for all. One answer was the CIA.

Those real people over there are really with us. They know the same shit we do.

Michael's picture

9/11: Explosive Evidence - Experts Speak Out, Full-length, Pre-Release-v1.3; Low-Res.

akak's picture

The islanders were not actually trying to call back the 'wealth ships', they were merely trying to get clarification from the ghost of John Maynard on how ripping up and destroying all their crops, only to replant and regrow them, would increase their island's GDP and make them all more prosperous.

r00t61's picture

And Keynes' ghost replied,

"Your crops are barbarous relics.  Forget about them and start producing paper money instead; that is the only path to unlimited riches."

Cognitive Dissonance's picture

It worked at Easter Island.......didn't it?

hannah's picture

actually easter island collapsed because the people kept buying larger and larger statues with subprime statue loans. then the banks securitized those statue loans into SMBS (statue mortgage backed securities) and then the government..well actually the chief had to bail out the TBTF wompam banks and it just went downhill from there....oh...then they elected a new chief that couldnt prove his citizenship and lied about going to columbia university.

Cognitive Dissonance's picture

Now where have I heard that before? :)

hannah's picture

you better buy your statue now because they arent making anymore of really...this time they aint making any more of them.

Cognitive Dissonance's picture

Have I got a deal for you. Today only. Step right up before they're gone. Pre-owned statues going for a song and a (Ponzi) dance.

Ben at work

Men Ben at work!

hannah's picture

i bought a fleet of chevy volts and buried them like at the cadillac ranch....they are my statues.

Cognitive Dissonance's picture

Cash for (Electric) Clunkers 2

Only this time we don't have to junk them because they come pre-junk(ed).

Cognitive Dissonance's picture

The penthouse suites are red. Will that do?

PMs only. I don't want no stinking fiat.


Dr. Engali's picture

LOL.... I'll take the second from the left and the broken one on end for  my wife.

insanelysane's picture

Can I finance it over 1,000 years?

hannah's picture

only if your german.....

pavman's picture

only if your german.....

Or an Irish beer brewer.

Colonel Klink's picture

Careful they'll rehypothicate your statues!!!!

CDS and MBS, collateralized debt statues and mortgage backed statues.  And of course if you're using them for commerical purposes, CMBS.

Buyer beware!!

So if you do buy, make sure you take physical possession!

akak's picture

And we have a winner!


(PS: You forgot to mention the magical lightning-powered time-traveling flying rickshaw of Benjamin Franklin inventionism which allowed George Washington to introduce 'US Citizenism' into Easter Island society, thereby blobbing-up all their resources while offuscationalizing the real cause of their society's collapse.)

Cognitive Dissonance's picture

This thread is exactly why I'm addicted to ZH. :)

<"But I can stop at any time" said Big Ben to the council of twelve.>

Colonel Klink's picture

Sorry they no longer call it Easter Island, the PC police now require you call it Reanimated Island.

Praetorian Guard's picture

Actually I see years of stagnation, no signifiacnt drop or increase, just stagnation, and drip, drip drip of bank released REO's....

asteroids's picture

Goosing the housing market would be a stupid mistake by the FED. Simply study demographics and look at the Japanese example. Housing is severely over valued. We ain't seen nothing yet.

Mr Lennon Hendrix's picture

You don't own your house.....

....your house owns you.

old naughty's picture

"Your house owns you."

So, your house the cultor and you are the cultee?

lotsoffun's picture

but...  my dad (and friends) built his house.  i swear he did.  it's still there.  i can see it and touch it.  i think obama helped also, but i was young.  i don't remember seeing him.  and i think my father paid people to help.  and pour concrete and stuff.  oh - and i forgot.  i helped my father add on to his second house.  was that big bad bama brought us a cold one the end of the day once?  i'm old.  my memory fails me.  geez.  that bama guy has us all covered.  infact - if bama hadn't built the roads, we would have had to carry all this stuff home from the lumber yard through forests and swamps.

i'm so glad bama made this all possible.  i hope he stays rich and successful forever, i really don't know how i can ever repay him.


GFKjunior's picture

Uhmm we have global riots now.


England, arab spring, bahrian, canada, hundreds every year in rural china.

gaoptimize's picture

But the effects of the drought caused poor harvest in the US will be greatest spring 2013.

mikla's picture

This article is correct -- The Fed (and followers) are Cargo-Cult worshippers, that have no idea what they are doing.

However, that makes the HUGE ASSUMPTION that the Fed "wants" what the Fed publicly CLAIMS that it "wants".

That assumption is wrong.  Like all those "in-power", The Fed is there to control the people, reward friends and punish enemies, "skim" from the movements of the winds-and-the-tides (e.g., international money flows), and benefit from self-enrichment (more money and power) from its control of money and power.

Frankly, I find it comical that the, "lay-person" could believe anything else.

"You think the Fed LOVES you just as much as your Mom loves you?  It wants to help you?  Really??!!??"

Archduke's picture

Seriously ZH fire this guy

Once again CHS opens his mouth and proves he's an eejit.
Has he even read Keynes? This so- called Keynesian label
usually is nothing close.

Cognitive Dissonance's picture

Considering that Tyler is guest posting Charles Smith's articles several times a week (CHS is not a contributor that I know of, thus he is unable to post on ZH what he wants when he wants) in order to "fire" CHS Tyler would need to fire Tyler.

How many Tylers are there anyway and will the Ponzi collapse if Tyler fires Tyler?