Before I talk about Federal Reserve Chairman Ben Bernanke and how he is going to make Allen Greenspan’s real estate bubble seem like a warm up to what he’s got cooking, I would like take the the reader on a brief detour to the Bronx, specifically, the neighborhood called Parkchester.
Parkchester was built in the 1940s to provide affordable housing to middle class families. It is made up of 100 multistory buildings, currently occupied by both owners and tenants. So why am I talking about a Bronx neighborhood in an article that is clearly about the national economy? Because what makes Parkchester so unique is its apartment prices and how they got this way. You see, in Parkchester you can buy two-bedroom condo in a well-maintained buildings located in a relatively safe neighborhood for under $150,000. Nowhere in NYC will you come even close to that price for a condo, even in the worst areas.
How do Parkchester’s condo prices stay so low? As I recently discovered, the management organization that oversees Parkchester’s massive condo complexes does not allow apartments to be bought with traditional mortgages from private banks. There are only two ways to buy a condo there, one, is to be a first time home buyer and get a mortgage from Freddie Mac and Fannie May – the government-backed mortgage lenders that required massive bailouts in 2008, or buy it entirely in cash.
At first glance, this might seem like meddling with the free market. If buyers are not able to get mortgages to buy condos in the area then prices remain “artificially” low. However, I argue the opposite, prices in Parkchester reflect the true supply and demand, and it is prices everywhere else that are inflated because mortgage rates are artificially kept low by the government. Since buyers can borrow many times the amount of cash they actually have, sellers can demand higher prices.
The immediate costs to consumers is as follows:
Banks earn interest on inflated mortgage amounts whereas in Parkchester banks make nothing. While the interest borrowers pay is kept artificially low by the FED, it is nevertheless paid on artificially high sale prices. For example, in a free market not controlled by the FED a buyer might pay an 8% interest on a $200,000 loan, in a FED controlled market the interest might be 3.5% on a $400,000 loan.
In a free market more buyers would be able to buy assets without taking out loans, effectively cutting out lenders, but in a market with inflated prices buyers are forced to turn to banks who are stepping in between buyer and seller, while taking a large cut for themselves.
Interest on savings held in retail savings accounts stays artificially low.
With that said we can now talk about quantitative easing. There has been much discussion about quantitative easing in the national media and how it’s supposed to boost the economy, but what is it really? In simple terms, quantitative easing is when the Fed buys government debt and other securities from the market, most often from banks. How may you ask, does a government that is already 16 trillion dollars in debt find the money to do this? The answer is: they simply create it. The misconception is that the Fed has to print money to spend it, the reality however is that it simply punches in a few more 0s into a computer, and poof, it now has money to send to banks around the country. The goal of this operation is to supply banks with more money to lend, which should result in economic growth.
Unfortunately, the type of growth this often creates is fictitious because no real value is created, since value can only be created through physical or mental labor. Growth is achieved purely on paper as asset prices grow in response to the increased money supply. Coupled with runaway government debt the end result can only be, inflation. This is the inevitable byproduct of creating money from thin air. It won’t happen in every asset at the same time and at the same rate. Real estate might not increase in price as fast as food products, cars might not inflate as fast as gasoline, but staying on this pass will inevitably result in the dollar’s buying power diminishing greatly in comparison to past years. This prophecy has been sounded by many before, perhaps a few years too soon, however I do believe that high inflation is an inevitable reality in the very near future.
Gennady Favel has over eight years experience in trading for international hedge funds. He is the author of the book The Stock Market Philosopher, and has been featured in multiple financial and business publications. He is a member of the board of trustees at Mazel Day School – a not-for-profit Jewish school located in Brooklyn, NY.