The Fed Fears New Mortgage Crisis Could Derail Economic Recovery

By: Claus_Vogt

Although the number was just revised downward, the U.S. economy still expanded by 2.8 percent during the third quarter. So it definitely looks like the recession is history.

What’s more, last Thursday the Conference Board published its Leading Economic Indicator (LEI) for October. This indicator has a strong predictive history, having predicted each recession since the early 1960s as well as the one we’ve just gone through.

Right now the LEI is not forecasting a return of the recession. Quite to the contrary … the October reading was again very strong. Year over year the LEI was up by 4.2 percent, the seventh consecutive increase. And the LEI’s historical record strongly supports a continuation of economic growth during the coming quarter.

With so much good news, I have to ask …

What Does the Fed Fear, Then?

Why are Fed members continually reiterating the current zero percent interest rate policy?

Why are they assuring us that this policy will continue “for an extended period?”

What are they afraid of?

Do they see or know something we don’t?

Why are Fed members sticking to their zero percent interest rate policy?

The past few years have clearly demonstrated that the Fed members didn’t have a clue about the consequences of the real estate bubble, which they themselves inflated. And after the crisis hit, they kept underestimating it at each step along the way.

Moreover, if you had listened to Bernanke and his pals in regards to your personal finances, your losses would be huge!

This sad showing obviously did nothing to shake their self-efficacy or arrogance. They still want us to believe that they are the puppet masters behind the economy — at least in boom times. And during a bust they want us to believe that they alone are in possession of a remedy.

It seems as though they totally lack trust in the free market forces. Instead they desperately want to fix things by decree and money printing.

So why do they keep advertising an ultra lax monetary policy even now, after the economy is starting to recover?

Because They Know Another Mortgage Mess Is in the Offing

The Fed is well aware of the mortgage reset schedule for the coming years. And they’re probably well aware of a major problem out there, too … a problem at least as severe as the subprime mess.

I’m talking about mortgages like Alt-A and Option-ARMs. A huge wave of resets is due to commence soon.

From the second quarter of 2010 until the fourth quarter of 2011, hundreds of billions of dollars in these mortgages will reset to much higher rates! And many of them will end up becoming delinquent.

Here’s why …

Mortgage resets are bound to increase the number of foreclosures.

Aggravating the situation is the fact that most of these mortgages were taken out when the housing bubble was at its height. So now, the loan-to-value ratios for many homes will be obscenely high.

This means a tsunami of write-downs for the banking sector, probably as huge as the subprime write-downs. And it means a huge wave of foreclosures on borrowers who can’t afford the new, higher monthly payments.

The ability to service a debt does not depend on rising GDP figures. It depends strongly on current income. That’s why high (and rising) unemployment rates are very bad news for the housing market and for the banks — again.

It’s still too early for this unavoidable, mortgage reset problem to derail the banking system and stop the economic rebound in its tracks. We can still be bullish on stocks for some time, as well.

Nevertheless, this looming problem goes a long way in possibly explaining the Fed’s reluctance to return to a more normal monetary policy. And it’s something you should keep in mind.

Best wishes,

Claus

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