How President Obama Is Rapidly Becoming A Gold Bug's Best Friend

In the latest note from the masters of the arcane at ConvergEx, Nick Colas' team looks at the historically very strong correlation between home prices (which recently hit an 8 year low: here and here) and unemployment, a foundation stone in every single QE episode as to the Chairman the only controlled variable to set the unemployment rate are average home prices, and flips it. In other words, in their Friday analysis ConvergEx try to extrapolate just by how much home prices need to rise to hit the Fed's projected unemployment rates of 8.7% in 2012 (absent the now generic labor participation rate fudge of course), 8.2% in 2013 and 7.7% in 2014. The answer is disturbing: "In order for unemployment to reach 8.7% in the Composite-10 next year (2012), home prices will have to rise by an average of 3.5%. To reach 8.2% in 2013, they will have to climb 9.4% from their current prices. For a 7.7% unemployment rate in 2014, the necessary rate of increase is 15.4%." It is disturbing because while Case Shiller predicts a 2.7% rise in 2012, we have now seen the 5th consecutive drop in home prices, and the largest sequential decline since March 2011. In other words, not only are home prices not rising, or even stabilizing, they are suddenly deteriorating at an alarming pace yet again. ConvergEx continues: "we have no doubt that the Fed knows these numbers. They know that the housing market only needs a little boost in prices and if historical correlations are trustworthy then the labor picture should begin to brighten. The biggest overhang to this relationship is, of course, the still dauntingly high level of foreclosures and still-empty houses. Only slightly less concerning is the incremental scrutiny all mortgage applications now receive from potential lenders."

And the conclusion for anyone who still does not see why upcoming paper dilution means a non-paper solution (in the form of hard assets) - "If it costs a QE III to get the 3.5% bump in real estate prices, or even a QE IV, then markets should not doubt that the current Federal Reserve will seriously consider it." At the end of the day, the only thing the Fed thinks it can control are asset prices for that most critical of assets: housing. And if rising home prices means diluting a few hundred billion more dollars, so be it. After all, we are now less than 12 months from the presidential election, and all bets are off. As SocGen predicted, expect to see massive monetary easing resume as soon as January when Obama realizes he needs something to go right or else he can kiss that second term good bye. Ironically, the lower the president's interim rating, the higher the price of gold will ultimately rise when all is said and done. Who would have thought that the worst president since Carter would be a gold bug's biggest friend.

Full note from ConvergEx:

When All You Have is a Hammer, Everything Looks Like a Nail

Summary: Even as economists and market watchers celebrate recent improvements in U.S. macroeconomic trends, both the residential housing and labor markets still appear moribund. That’s really no surprise, as the correlation between the two markets has been historically quite high. But is that correlation or causation? The Federal Reserve is clearly banking on the latter. So how much do house prices have to recover from current levels to get us to the Fed’s own forecast for unemployment in 2012 and beyond? Based on our analysis of the historical data, house prices - as measured by Case-Shiller - will have to increase by 3.5% over the next 12 months to reach the Fed’s projected unemployment rate of 8.7% for 2012. To hit the Fed’s unemployment targets in 2013 and 2014, the appreciation in residential housing will have to be on the order of 9.4% and 15.4% over those periods. These aren’t especially daunting numbers, but they do require an inflection point. House prices are still, after all, trending downward. If that requires a full blown QE III, so be it.

“During these 2 years business conditions had grown steadily worse, unemployment had increased, construction had practically reached a standstill, foreclosures had mounted rapidly, and commercial and banking failures had increased sharply…and appeals for direct governmental assistance for distressed home owners were pouring into the Nation's capital.”

Sound familiar? No, it’s not Fed Chairman Bernanke testifying in front on Congress – it’s the Federal Home Loan Bank Board’s Fifth Annual Report, published in 1937 (http://fraser.stlouisfed.org/publications/holc/issue/3011/download/40594...). In the years following the Great Depression, the report shows, mortgage delinquency rates soared as wide scale property price deflation increased the real value of outstanding mortgage debt and rising unemployment meant that more and more people were unable to make payments. Home prices also fell sharply, making it less likely that a homeowner could sell his property to pay the balance on his loan.

Almost seven decades later, we’re facing an eerily similar situation: continuing high unemployment, little new construction, an increasing number of foreclosures, bank failures, and, most notably, high mortgage delinquency rates and a seemingly endless decline in home prices.

In the 1930s, the solution was the creation of a slew of federal government agencies which purchased distressed mortgages, offered a stable source of funds for loans, and issued over one million loans for residential-mortgage and economic development. These agencies brought the mortgage market back from the brink and saved many homeowners from crippling mortgage debts:

• FHLB – Federal Home Loan Bank System
• HOLC – Home Owners’ Loan Corporation
• FHA – Federal Housing Administration
• FSLIC – Federal Savings and Loan Insurance Corporation
• FNMA – Federal National Mortgage Association (a.k.a. Fannie Mae)

Today, the Federal Reserve is trying to emulate that success – albeit using a different set of tools. Consider the following statement from Chairman Ben Bernanke: “The housing sector has been a significant driver of recovery from most recessions in the US since WWII. But this time…” (August 26, 2011) This time, housing hasn’t rebounded. Many homeowners (some estimates place the percentage as high as half) are “underwater” on their mortgages, new home construction is at one-third of its pre-crisis level, and, most importantly, home prices continue to decline.

Several weeks ago, the Fed introduced “Operation Twist” – a plan to sell $400 billion worth of short-term holdings and use the proceeds to buy longer-term debt with the aim of pressuring long-term yields even lower. A primary purpose of the program was to push down 30-year fixed mortgage rates (FMR), which are tied to the 10-year Treasury bond yield, in order to make homes more affordable and refinancing more manageable for both current homeowners and new buyers. Almost immediately after the program was announced in late September, the average 30-year FMR ticked down from 4.09% (September 23) to just 3.94% in the week ending October 7. In the last few weeks, the rate has hovered around 4.00%, among the lowest levels ever recorded for the 30-year FMR.

There has been a good amount of backlash directed towards Bernanke and the Fed for choosing to influence the housing market rather than focusing on the letter of the institution’s famous “Dual mandate”: maximum employment in the context of stable prices. Clearly, Chairman Bernanke sees the housing market as cornerstone economic issue, and one that can (when properly pushed and prodded) help create a lasting economic recovery with attendant gains in domestic labor markets.

We decided to look more closely at home prices and unemployment to see what (if any) reason the Fed had to be focusing so heavily on the housing market in its pursuit of economic expansion. We compiled data from 1997 (the first year Case-Shiller kept records for their Composite-10 Index) to the present for both home prices and unemployment across 10 major metropolitan statistical areas (MSAs): Los Angeles, San Diego, San Francisco, Denver, Washington DC, Miami, Chicago, Boston, New York, and Las Vegas. Our findings are as follows:

• There is a clear and robust correlation between the historical trends for home prices and unemployment levels for the Composite-10. As the charts below indicate, the relationship between home prices and unemployment is inverse; that is, increases in home prices correlate directly with decreases in the unemployment rate and vice versa.
• This correlation also holds true at the individual metro-area level. Some MSAs, such as Boston and New York, experienced relatively moderate declines in home prices after April 2006, increases in the unemployment rate in those regions were also modest. Not surprisingly, those areas worst affected by the housing crisis suffered significantly higher unemployment rates.
• The increase in home prices during the housing boom from 2000 to the peak in April 2006 also correlates closely with the price decline following the bust. Among the Comp-10, home prices increased 107.59% from August 2000 until April 2006; conversely, prices declined by 32.23% after the bust. Most notably, those areas that saw the largest increase in home prices during the boom (Las Vegas, Miami, Los Angeles) also saw the steepest declines when the bubble burst. Essentially, every MSA in the Case-Shiller index exhibited strong and predictable mean-reversion as they went from boom to bust.

The most obvious dataset that supports the correlation between home prices and labor markets is construction employment. As the chart shows, those areas that experienced the largest decline in home prices also experienced the largest declines in construction employment during the years following the bust – homes in Phoenix, for example, lost 56.6% of their value, while construction employment dropped 53.5%. Correspondingly, those MSAs in which construction employment declined the least had similarly modest declines in home prices during this period; Dallas home prices only declined 7.12%, while construction employment only went down 0.34%.

These correlations serve to show that the Fed’s Operation Twist (and all that Quantitative Easing – past, present and future) is in fact directed towards one of its mandates: promoting maximum employment. Clearly, the Fed sees increasing home prices as a driver of economic recovery because increasing home prices are correlated with higher employment levels and overall better economic health. By decreasing mortgage rates, it hopes to drive up home prices which, in turn, according to this analysis, should also drive down unemployment. Yes, we know that correlation isn’t always causation, but we’ll flesh out that thought in a minute.

With this in mind, we looked at how much home prices would have to rise both nationally and regionally in order for unemployment rates to meet Fed projections for 2012, 2013, and 2014. The most conservative rate estimates given by the Fed at the latest FOMC meeting are:

• 8.7% in 2012
• 8.2% in 2013
• 7.7% in 2014

By comparing changes in the unemployment rate to percentage changes in home values both on average and individually for the Composite-10, we calculated a regression analysis through which we determined the percentage increase required in home prices to achieve a particular unemployment rate. Using this equation, we came to the following numbers:

• For every 5% increase in home prices for the Composite-10, the unemployment rate drops 0.4 points.
• In order for unemployment to reach 8.7% in the Composite-10 next year (2012), home prices will have to rise by an average of 3.5%. To reach 8.2% in 2013, they will have to climb 9.4% from their current prices. For a 7.7% unemployment rate in 2014, the necessary rate of increase is 15.4%.
• Case-Shiller predicts a 2.7% climb in home prices for next year. On the one hand, that seems a pretty positive outlook, since it takes us most of the way to the 3.5% increase that gets us to the Fed’s target unemployment rate. But – and it’s a big “but” – house prices are still declining. If you want to be generous, you might say they are “stabilizing.” But they are certainly not rising.

Now, we have no doubt that the Fed knows these numbers. They know that the housing market only needs a little boost in prices and if historical correlations are trustworthy then the labor picture should begin to brighten. The biggest overhang to this relationship is, of course, the still dauntingly high level of foreclosures and still-empty houses. Only slightly less concerning is the incremental scrutiny all mortgage applications now receive from potential lenders.

The essential point, however, is that the Fed knows it has to stop the deflationary cycle in the residential housing market. Chairman Bernanke is a student of the history we quoted at the top of this note. If it costs a QE III to get the 3.5% bump in real estate prices, or even a QE IV, then markets should not doubt that the current Federal Reserve will seriously consider it. Whether low interest rates will actually do the trick is another matter. Correlation and causation look the same when viewed in a historical context.

Comments

[Mitch Comestein]

This is a free opinion so take it for what it is worth.  Barring some analysis of the Brooklyn apartment market, you need to consider what is going to happen to the affordability of apartments when the bond market blows up.  Also, can she hold on to the apt if all hell breaks loose.  Third, what would her mortgage payment be.  If is would be $2400, then if may be a no brainer. 

I had those same thoughts, but I chose to buy.  I was worried about a currency or bond crisis making RE loan rates go thru the roof.  If that would happen, then RE prices will come down, but the cost of owning may/will go up,up,up.  In this scenario, landlords will raise prices.  I would.  A secondary thought for me was the availability of quality rentals.  The housing that is rented at the cost of my mortgage are dumps!!!!  I get a lot more comfort and utility out of owning.  Of course, owning is expensive.  Shit breaks.

Good luck.

[fonzanoon]

Thanks much appreciated. I wonder if mortgage rates could seperate from treasury rates. I spent two years waiting for the "bond market" to blow up. Now I am starting to think they may be able to artificially keep a lid on treasuries for a long time. If that were the case, could all other interest rates, mortgage rates included blow out and send all loan rates sky high.

[Bam_Man]

No, mortgage rates will not blow sky high until the Treasury market crashes. There is no private sector mortgage market anymore. It is almost 100% backstopped via FHA/FNMA/FHLMC guarantees. Private capital would not for a minute even think of lending for 30 years (against depreciating collateral!) at 4.00% or les without this government guarantee. As long as that guarantee is seen as being good, the rates will remain low. Once the government's credit comes into doubt, Katie bar the door.

[Implicit simplicit]

44% increase is huge and does not correlate with typical % rises in rent. There must be special circumstances involved for the landlords to be able to get this kind of increase. She should shop around for a comparable apt, before biting on that increase. perhaps get an extra roomate who can share the burden.

[fonzanoon]

Yeah it is a big increase, and there has to be more to it. But it got me thinking about where this is all going and if you are better off locking in a mortgage now so your cost would not rise (in nominal terms) in the future.

[sony1]

Sarkozy, Merkel May Not Reach Agreement Tomorrow, JDD Reports

http://www.bloomberg.com/news/2011-12-04/sarkozy-merkel-may-not-reach-ag...

[Mitch Comestein]

Apparently, ConvergEx did not get the memo.  All you have to do is drop the participation rate and you get the results you want.  Unemployment at 8.6%, one month ahead of schedule.  This is the great part, when only the president and congress are counted on the employment report, then we will be at full employment!  Long live statistics, sarc.

[Tegrat]

The housing crash started years ago in the Jimmy Carter years when they passed the Community Reinvestment Act, which started the practice of forcing banks to provide loans to those who could not afford them, with a promise that the taxpayers shall bail them out in the event of a default. This was continued by ALL admins since.The Bush admin was the first to point out the potential problems.

I suppose the minimum requirement to qualify as a liberal is to have a broken cause-effect logic circuit and to have an unlimited capacity for ignoring facts for decades. That's why the OWS crowd is foolishly standing outside of corporate buildings rather than the governement ones in DC.

[flattrader]

"Blame CRA" has been debunked over and over.

The crappy mortgage cos. responsible for this debacle weren't subject to CRA.

Try again.

Oh, and while were at it...

Too bad the "Bush Admin." didn't do a fucking thing about the likes of Countrywide eventhough the FBI warned.

So, again, try again.

[El Gordo]

As is usually the case, all it needs is a good leaving alone.  If TARP had never happened, the market had forced out the weak sisters and new blood stepped in to take their place, this would probably all be over by now.  But then again, as has been stated so often by our well meaning politicians - "Never let a good crisis go to waste."  Through clever retorich, selective cronyisn, personal greed, ego, ambition, drugs, and pussy, our leaders cling to cirses such as these praying that they never get resolved so they can keep on promising to make things better.  Just look at how the Democrats have managed to keep the blacks on their plantation for the past 60 years or so to see how it's done.  All promises for generations, yet nothing has improved.  Send those guy on vacation for a couple of years and do nothing - you'd be amazed at how fast it could sort itself out.

[sydneybound]

To look at the relationship between home prices and unemployment, one must break it down into two arguments:

1) Arguing that there is a causation effect (higher home prices causes lower unemployment rates (and the inverse)) based on arguments like the Phoenix one (prices down 50% and construction employement down by 50%) is too selective in its timeframe and uses a construction employment level at one point in time (severely elevated and abnormal) which facilitates their argument. Will increasing the house prices in Phoenix lead to more construction people being employed when there is still severe overcapacity in the house market?  I don't think so. That is similar to the argument that there is a causation effect between the number of elephants in a Kenyan reserve and the number of poachers, therefore we must cull the elephants to reduce the number of poachers.

2) The causation effect is there under 'normal' situations, but it is inverse to the one argued above. Home prices is based on the confidence of the home buyer to acquire.  You only acquire when you have the income available to do so (both because of confidence of being able to take on a mortgage, but also because a bank will usually only lend to you when you have a job).  Therefore, increase jobs and job security and home prices will slowly increase over time.  The run up to 2006 was an anomaly and shouldn't be used to build up any arguments for how to deal with increasing home prices or employment levels in the future. Places like Phoenix don't need more construction employees, it needs to get rid of its overcapacity first.  Simple supply/demand inbalance.

Will more money printing be done running into the presidential election? Probably, but I'm hoping it isn't justified by using the argument outlined above because it is simplistic and incorrect.

[Ned Zeppelin]

Real estate will be the last asset to reflate, and gold will be sky high before real estate rebounds if the Fed is hell bent on QEing the mess until real estate reflation occurs. 

[Peter Simple]

C'mon everbody. Enough of this defeatism! Basta. Don't you know that every crisis is an opportunity. Instead of imagining yourselves cringing in the mountains with your guns and chickens, get a plan: form a consensus.

This should include devaluing the dollar to a realistic level against gold (perhaps less than a tenth of where it is now) and getting back to work at real jobs UNTAXED, financed by real money UNTAXED. All the revenue needed by government for the few services you agree to entrust to it could be raised by a TAX ON CONSUMPTION, on quantity, not on quality, i.e. not a sales tax, and certainly not a V.A.T. For this to work, you'll first have to smash TPTB, smash them to smithereens. The starting point is THE IDEA OF REVOLUTION. Get on with it get organized!

[Dr. Gonzo]

You know what would help the real estate market recover in the U.S? Stop turning the place into George Orwell's 1984. Who wants to make the commitment of buying a house and planting roots in a prison state anyway? I'm not. I'll never buy more property here and if I get enough $ I might try to escape. 

[sydneybound]

n.m

[Snakeeyes]

Look at Italy versus the US. And then look at video from Government Gone Wild. This is all OUT OF CONTROL AND WILL CRASH!

Can Europe Control Its Spending And Save The Euro (or Gyro)? Don't Look To China As A Role Model For Economic Growth Either

http://confoundedinterest.wordpress.com

[loveyajimbo]

Nice for us gold bugs, but wouldn't it be easier to revise the basis for calculating unemployment... like they did so well on inflation??  Just remove people between the ages of 30 and 50 and the number will look just great!

[tony bonn]

obama is the worst president since george bush and there is no worse president than bush....

really the simplest way to solve falling housing prices (even though it truly is not a problem) is for the fed to start buying houses.....that's what qe3 should be all about charlie brown....

just buy houses at 50% more than market prices and you could bring euphoria to the criminal bankster class.....just think of the bonuses....

[michaelsmith_9]

Owners of gold should be rewarded well going into the end of the year.  Next year may prove to be difficult though for the metal as the global economy suffers.   http://bit.ly/rQWrsL

[michaelsmith_9]

Gold is likely head higher with equities through the end of the year.  http://bit.ly/v4mbzU