Friday, September 06, 2013 - Fed Policy Creates Inequality

Fed Policy Creates Inequality

by Sinclair Noe

DOW – 14 = 14,922
SPX + .09 = 1655
NAS + 1 = 3660
10 YR YLD - .04 = 2.93%
OIL+ 1.86 = 110.23
GOLD + 21.10 = 1389.80
SILV + .63 = 23.94

The war hasn't started ..., yet.

This morning we got the big monthly jobs report. Nonfarm payrolls increased by 169,000 jobs last month falling short of the 175,000 to 180,000 Wall Street had expected. Not only did hiring miss expectations last month, but the job count for June and July was revised to show 74,000 fewer positions added than previously reported.

While the unemployment rate fell a tenth of a percentage point to 7.3 percent, its lowest level since December 2008, the decline reflected a drop in the share of working-age Americans who either have a job or are looking for one. That participation measure reached its lowest point since August 1978, a further sign of underlying economic weakness. The rate for men touched a record low.

U-6, a measure of underemployment that includes people who want a job but who have given up searching and those working part time because they cannot find full-time jobs fell three tenths of a percentage point to a 4-1/2-year low of 13.7 percent.

The private sector accounted for the bulk of the job gains last month, but government payrolls increased 17,000 as local governments hired teachers for the new school year. Factory employment rebounded after falling in July. Construction payrolls were flat as both residential and nonresidential construction jobs fell. There was another month of strong job gains in the retail sector. Leisure and hospitality employment also posted solid increases as did health care and social assistance.

So, a generally weak jobs report; there was still growth; we posted a positive number; not a negative, but it was weak growth. That got people wondering if the Federal Reserve would still taper this month. It's widely expected the Fed will cut back or taper its purchases of Treasuries and Mortgage backed securities; currently the Fed is purchasing $85 billion per month; the idea is to reduce purchases to just $70 billion, as they try to slowly get away from the QE purchases. Did today's jobs numbers change anything? Probably not. Certainly nothing that made an overwhelming case. It can be argued how much impact QE has had on jobs in the first place.

One area QE has had a big impact is in the mortgage market; 10-year Treasuries hit 3% briefly yesterday, and the 5% mortgage is likely not too far behind. Oddly enough, jumbo loans are actually now cheaper than conforming loans for the first time in anyone’s memory. The Federal Reserve has essentiallly subsidized the housing market with its mortgage backed securities purchases. And as QE maybe starts to unwind, we ask who won and who lost?

According to a new report from mortgage-backed securities analysts at Bank of America Merrill Lynch, “the cost burdens are disproportionately impacting low-income groups and renters.” Not exactly earth-shattering news unless you consider the source. (I've been saying it for years, but now BofA admits it.)

One important insight here is that “easy monetary policy,” as evidenced by QE, is correlated with the rise in income inequality over the past 35 years. The two periods over this time where inequality really shot up came right after recessions in 1991-93 and 2007-11. These two periods were characterized by aggressive monetary policy, including quantitative easing. Since the primary credit channel in the successive rounds of QE targeted assets for either the rich or near-rich, this stands to reason.

But the primary focus of the paper is housing, and the primary focus of the Fed's QE policy also appears to have been housing. The Fed basically created the conditions for a rise in home prices, thinking that would have great positive effects for the economy. BofA/Merrill cites a Harvard State of the Nation Housing report.

The report starts with comments on the benefits associated with housing’s revival, such as home equity accumulation, but it quickly turns to a starker reality, which is that “the number of households with severe housing cost burdens has set a new record.” This language would be more consistent with the view of housing expressed in gold terms – housing is not a good news story. Moreover, the report shows that the hardest hit in the population are renters and those at the low end of the income distribution. The share of renters in the population, now at 35%, has been rising in recent years, as the homeownership rate has steadily declined from the bubble peak in 2004. So not only are renters disproportionately sharing in increased housing costs, the percent of households in this category is increasing in the wake of the financial crisis.

The Harvard report defines two categories of households with respect to housing costs as a share of income: moderately burdened and severely burdened. Moderately burdened households pay 30%-50% of pre-tax income for housing; severely burdened households pay more than 50%. Rising home prices laid the burden primarily on owners between 2001 and 2007, but as home prices declined and credit tightened, the burden shifted to renters. Most importantly, in aggregate, between 2001 and 2011, there was a 35% increase in the number of burdened households, for a net addition of 11 million households to the burdened category. The percent of burdened households grew from 29.4% to 36.8%.

Even with mortgage rates plummeting from 7% to 4% from 2001 to 2011, 42 million households experienced moderate or severe housing costs. And the report doesn't take into account negative equity. Renters took the brunt of this stress in the later period; by 2011, an incredible 50% of all renters were burdened by high housing costs.

This impacts quality of life. If you spend most of your income just to keep a roof over your head, it means you spend less for other things like food, health care, transportation, and education. And that lead the banking analysts to conclude that the Fed was adding to inequality. Specifically, the report says:

If monetary policy is in fact responsible for increasing housing cost burdens through policies that have inflated home values, then it is also responsible for limiting the available dollars that lower income families have to spend on education. If unequal access to education is indeed a key driver of growing income inequality, then it appears as if the vicious cycle of rising home prices, higher housing costs, less money to spend on education and greater income inequality is poised to continue.

So today, when the jobs numbers came out weaker than expected, the speculation centered on whether the Fed would cut back on QE. When you consider that QE in reality is lip service and happy talk about full employment and stable prices, and the actual outcome is greater inequality, well, maybe something other than Fed monetary policy would be better.

The G20 wrapped up its summit in Russia. The summary was that the situation in the global economy looks better now than it did five years ago. Economic growth is recovering, but there are still risks, and saying it was too early to ease off government stimulus spending, in spite of recent positive economic news. The G20 now faces a multi-speed recovery with the US economy pushing ahead, Europe maybe finding a floor and developing economies facing blowback from the looming 'taper' by the Fed. Collateral damage from the Fed's easy monetary policies can be found in emerging market economies that enjoyed rapid growth with a flood of cheap dollars, only to see those easy dollars dry up with talk of taper.

The G20 Summit was designed to deal with economic issues, but this one got caught up in the Syrian situation. Obama persuaded nine other G20 nations plus Spain to join the United States in signing a statement calling for a strong international response, although it fell short of supporting military strikes. Obama and Putin talked but could not find agreement. Unable to win Security Council backing because of the opposition by veto-wielding Russia and China, Obama is seeking the support of Congress instead. He declined to speculate whether he would go ahead with a military strike in Syria if Congress opposed it but said most G20 leaders condemned the use of chemical weapons even if they disagreed whether to use force without going through the U.N..

Looking ahead to Monday, Congress reconvenes. This is the first day that both the Senate and the House are back in session after the long summer recess. There are many urgent issues waiting to be resolved — including the continuing resolution that will keep the US government open for business, and this thing with Syria. Sept. 17 & 18 is the next Fed FOMC meeting. And then as we wrap up September, Congress must pass a continuing resolution by Sept. 30 or the government will shut down Oct. 1. There is no chance that a complete 2014 budget can be passed before Oct.1, the start of 2014 fiscal year. A short-term, extension-type continuing resolution for government funding must be passed instead, before Oct. 1. The duration of the continuing resolution will likely be pretty short — say, a couple of months -- so that the Congress does not have to make tough decisions on issues such as sequesters for the 2014 fiscal year.

The war hasn't started..., yet.