The Fed Inflates While Property Values Deflate

The Federal Reserve’s recent promise to purchase troubled mortgages kicked off a surge in re-financing, gave a boost to existing home sales in February and March, and drove mortgage interest rates below 4.75% for the first time in more than 50 years! And that was with only $250 Billion of guarantees! There is another $1Trillion coming from the Fed over the next year or so!
It’s pretty amazing what just 20% of the Fed’s promised relief has generated in the way of increased home sales and reduced mortgage rates. But buyers who think that rates will fall further may have a surprise in store. Fed Chairman Ben Bernanke stated last week that rates were not going to be driven further down by Fed action. There’s a reason for this in spite of the fact that the Fed has so much more money to print and spend! The Fed is having trouble finding buyers for loans that return less than 5 %. If rates were to fall below 4.5% the Fed would likely have to sell these loans with an premium to attract buyers. This premium would have to be at least one percent and would compound the Fed’s tidal wave of red ink. If there are no buyers for the Fed’s guaranteed loans, then the Fed will have to hold them to maturity which isn’t exactly what the Fed or Mr. Obama had in mind! The bottom line: Don’t expect mortgage rates to fall much further!
All this money being printed and spent by the Federal Reserve is highly inflationary. While the “I”-word is not in much usage of late, there will come a day of reckoning. Coupled with the recently passed Obama budget whose projections for 2010 through 2019 calls for a $5 Trillion increase in the national debt, we are heavily leveraging our future (and that of our grand-children). Just the interest on $5 Trillion would amount to $50B per year or about $1000 for a family of four for every year of their lives. Paying off the $5 Trillion itself would mean a debt of $17,000 for every man, woman and child in the country.
Both of these assessments tell me that the next year or two will be very good times to purchase real estate and other long-term investments.
Speaking of assessments, the Santa Clara County Tax Assessor has stated that more than 90,000 properties will have their assessed tax values reduced in 2009. This is the largest number of reductions in a single year since Proposition 13 was enacted in the late 1970s. The revenue loss to the county is expected to be on the order of $180M. Given that for every $1 reduction in property taxes, the assessed valuations have to drop by $100, an $180M tax revenue shortfall translates to assessed property values in the county falling at least $18B (or an average of $181,000 for each of the homes re-assessed in 2009)! Assessor Larry Stone concedes that this is much worse than expected and that additional reductions in assessed values will occur going forward. "It's going to get worse!", says Stone. Next time you wonder if there are fewer sheriff's deputies available or whether there are more potholes in our roads, you'll know the reason why!