Why the Next Round of QE is Likely to Target Housing

Why the Next Round of QE is Likely to Target Housing

When QE2 launched,  we cited a WSJ op-ed by our friend and frequent guest Andy Kessler, where he made the case that Bernanke’s real motivation for QE2 was to prop up the woeful housing market:

I have a different explanation for the Fed’s latest easing program: Without another $600 billion floating through the economy, Mr. Bernanke must believe that real estate (residential and commercial) would quickly drop, endangering banks.

The 2009 quantitative easing lowered mortgage rates and helped home prices rise for a while. But last month housing starts plunged almost 12%. And in September, according to Core-Logic, home prices dropped 2.8% from 2009. Commercial real estate values are driven by job-creation and vacancy rates, both of which are heading the wrong way.

Because of unexpectedly bad construction loans, the staid Wilmington Trust was sold to M&T Bank earlier this month in a rare “takeunder”—what Wall Street calls a deal done below a company’s stock value, in this case by 40%.

If boosting housing was Bernake’s primary motivation, then he failed miserably!

Case Shiller housing index June 2011

Oops!  Decline in home prices accelerate as QE2 rolls out. (Source: Standard & Poor’s & FiServ – Click to Enlarge)

Many financial observers – myself included – believe that the Fed will embark on another money printing program of sorts when things get worse again (in the economy, or perhaps, just the financial markets – as we know how fond Bernanke is with pumping up stock prices).

Regular ContraryInvesting.com columnist Sy Harding writes in his latest Street Smart Report (just released minutes ago) that he believes housing will be the target of QE3…if and when it comes:

The Fed Will Not Interfere – At Least For Awhile.

Under similar circumstances last spring, when the economy began to slow and the stock market rolled over into a correction, the Fed did nothing.

It was only after the economy had slowed so much it raised fears that it was falling back into recession, and the S&P 500 was down 17%, and the Nasdaq down 19%, close to crossing the 20% threshold into recession, that the Fed stepped in with a promise of QE2.

Given the questionable success of QE2, why should we expect the Fed to jump in more quickly this time?

In fact, Fed Chairman Bernanke indicated the Fed has no intention of doing so. In a recent speech he said, “The U.S. economy is recovering from the worst finan- cial crisis and housing bust since the Great Depression, and it faces additional headwinds, ranging from the ef- fects of the Japanese disaster to global pressures in com- modity markets [inflation]. In this context, monetary pol- icy cannot be a panacea.”

That?s a strong hint that the Fed will allow the free- market system to function normally for awhile, allow economic growth to slow, if that is what consumer and business conditions and concerns dictate. And allow the stock market to adjust to that slowdown.

If, as seems likely, the economy continues to indicate it?s still not ready to stand on its own feet, and requires another round of stimulus, rather than the scattershot ap- proach of buying treasury bonds, hoping the excess li- quidity will settle into areas that will help the economy, new stimulus is likely to focus directly on the historical main engine for growth, and current largest drag on the economy and jobs – the housing industry.

But until then (short-term oversold rallies notwith- standing) we expect more economic weakness and a continuing significant market correction to lower lev- els (but not a bear market) over coming months, as the market’s unfavorable season continues.

Source: Sy Harding’s Street Smart Report

More on Housing: The “Second Derivative” Rolls Over Again…But ITB Holds