The annual Jackson Hole central banker extravaganza is in full swing and ZeroHedge notes a couple of important new factors in the ongoing taper drama. First, an academic “study” on how to withdraw QE without disrupting the real economy. In that study, the authors make the following claim:

“The Fed’s purchases of a substantial amount of the new issuance of MBS has [sic] led to a scarcity premium on the current coupon MBS, driving spreads on MBS relative to Treasury yields below zero. The scarcity of the current coupon MBS generates incentives for banks to originate more loans and relieve the shortage of the current coupon MBS. The lowering of secondary market MBS rates through both capital constraints and scarcity channels likely have [sic] had beneficial macroeconomic effects.”

Ignoring the effects on mortgage market liquidity from reducing collateral availability (actually the authors ignore the idea of collateral altogether), what is expected from QE 3 is that the reduction in interest rates on MBS below comparable treasuries had opened a kind of mortgage arbitrage opportunity. To take advantage, banks only needed to increase their mortgage originations and volume activity. That is what the Fed intended, expecting such a process would push housing market in the “right” direction.

Indeed it did. Just not in the way they wanted. To fill origination and MBS volume, Wall Street banks lent head over heels to institutional investors almost exclusively. That was a far different channel for monetary largesse to flow through, bypassing most retail investors completely. First time home buyers, for example, are conspicuously lacking.

The flood of institutional money has had an impact on real estate prices, no question. In what we might call a bubble, prices have far exceeded any rational fundamental valuation of true supply and demand. The distortion of channels, unexpected as it always is in government intervention, has had a number of impacts further down the line.

The last part of that quote above is typical economist-speak about how “money” or monetary policy becomes economic activity. In saying that these channels “likely have had beneficial macroeconomic effects” the economists are admitting that they have no idea how this “money” translates into the economy, just that they have unshakable faith that it does in some way that is positive toward GDP or some other economic account. That it might do so in the form of another bubble is likewise unconsidered.

Accompanying this academic view in the ZeroHedge post is a reference to an article in CNNMoney titled, How The Fed Can Taper Without Killing Housing. The title is all you need to know, particularly the disregard of something absolutely fundamental to conventional economics, rational expectations theory. In other words, by the mere mention of taper (in the course of trying out so-called transparent forward rate guidance) the market has already acted as if taper were happening now. It’s not very complicated; the bond market has responded in an almost textbook manner. Even the primary dealers acknowledge the effects of policy expectations in this historic, and ongoing, bond selloff.

In other words, the advice in the CNN article (derived from the paper cited above) on tapering is about five months too late. This taper drama may have already killed the housing rebound (which appeared to be peaking on price action before all this anyway), showing up in recent data as a real possibility. That includes today’s data on new home sales (not good).

ABOOK Aug 2013 Housing New Sales

The drop in the pace of sales included significant revisions to May and June (-20k for May, -42k for June).

ABOOK Aug 2013 Housing New Sales Y-Y

Year-over-year, new home sales grew by 6.8%, the slowest pace since December 2011. Home prices fell as well, continuing the trend begun, coincidentally, in May.

ABOOK Aug 2013 Housing New Sales Median History

The three-month drop in prices of 8% is the largest since September 2011.

ABOOK Aug 2013 Housing New Sales Median Recent

Together with recent home construction data, taper talk itself is far more relevant to the real estate market and construction activity (and thus the channel into the real economy) than the actual act of tapering. I suspect, given that I believe the Fed is aware of its bubble culpability this time, that was the point all along. However, these things are not easily controlled, no matter how much post hoc academic support is offered.

 

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