Peter Schiff, the eternal provocateur, suggests the Fed’s extraordinary support of bond and housing markets will lead to a market crash as interest rates rise, leaving banks, mortgage originators, and lenders stuck with homes and low yielding loans as the economy slows, exacerbating the decline and throwing the economy into a deeper crisis.
Paradoxically, the housing market is firing on all cylinders right now, with homebuilders like KB Home and Lennar trading close to their 52-week highs. This is irrational exuberance, according to Schiff, as the market is fully subsidized by the Fed. “The U.S. government is guaranteeing all mortgages, and then buying them up,” explained Schiff, “it’s an artificial market, but the Fed, rather than Lehman Brothers, owns it.”
Schiff incredibly agrees with what has become a mainstream opinion: the Fed is behind this rally, both in stocks and bonds, and even in real estate markets. Yet Schiff differs in that, while most believe the Fed-induced rally has “training wheels” that can later come off, the Fed’s support “are the only wheels” keeping the market going, and removing them will spark a crash.
Pointing to housing markets, Schiff notes that “we are building more homes than we can afford,” as hedge funds and speculators gobble up hundreds of thousands of properties being cranked out by the homebuilders. Indeed, hedge fund manager Deepak Narula of Metacapital made $125 million last year buying up mortgages, delivering net returns north of 40% while the S&P 500 squeaked out about 14%; several hedge funds followed suit. The foreclosure process is stalled in several “judicial” states while banks are still sitting on massive inventories of housing. Major banks and mortgage originators haven’t gotten out of the mess they caused in the financial crisis: Bank of America, Wells Fargo, JPMorgan Chase, and Citigroup are still in the process of settling a nearly $20 billion tab with homeowners across 49 states.
The day of reckoning will come when the Fed starts to tighten, according to Schiff. “It is amazing Bernanke can admit he has no exit strategy,” he explained, noting the Fed will monetize some of its Treasury and mortgage holdings, but will have to sell a lot of both to normalize its monetary stance. Bernanke has made it clear they will telegraph the move to the market, but Schiff believes telling others they will sell “is the worst thing they can do [as] everyone will try to front-run the Fed.”
That is when “public selling will overwhelm the Fed,” Schiff says as “the big buyers are only there because the Fed is.” While the central bank is buying a big chunk of all debt issued by the Treasury, it holds only about 15% of debt outstanding Bernanke explained, rendering it unable to stop a run on Treasuries, which would lead to interest rates rising very quickly.
With bond prices falling and rates surging, banks will be left with depreciating assets (Treasuries) and stuck with low yielding long-term loans. As the “rug is pulled from under the banks,” the housing market will collapse as well, Schiff believes. The housing market will also breakdown.
During the crisis, “the Fed kept short rates low, supporting teaser rates and allowing subprime to gain traction,” explained Schiff, “now, instead of learning their lesson, they are concentrating on the 30-year fix.” Rising rates will make it more difficult for people to qualify for mortgages and get homes, while a cooling economy, as a consequence of tighter monetary conditions, will limit renters’ ability to pay. As the housing market stalls, the financial system will begin to seize up, resulting in a stock market collapse and a deeper recession than in 2008.
Investors can buy protection against this collapse, Schiff says, by stocking up on gold. The yellow metal is down nearly 7% in 2013, but Schiff attributes that to misplaced optimism. “People are as dumb as they’ve always been [but] the sentiment is wrong, they should be buying gold.”
At the end of the day, Peter Schiff’s views are based on a philosophical notion that fiat money, and the actions of central banks like the Federal Reserve, are destabilizing and bubble-inducing. Chairman Bernanke did admit they may have disrupted markets and created bubbles, in bond markets for example, but believes they are unwanted side effects of his policies aimed at propping up the economy and creating jobs. Only time will tell if Bernanke, or the Schiffs of the world are right. Until then, those siding with the latter can stockpile some gold.