Ben Bernanke is intentionally trying to devalue the US dollar to prop up the housing market. While I don’t agree with him doing this, I do understand why he is trying to destroy the dollar.
Deflation by itself isn’t really a problem. I know that the word deflation is always associated with the Great Depression, so it gets a bad rap. But what is really so bad with being able to buy stuff cheaper next year? The people that fear deflation will say deflation causes people to hold off of on purchases, causing a week economy. But electronics purchases prove otherwise. Electronics and computer products have experienced massive deflation, yet this category of products sees strong growth in sales, because people want the product now. So I don’t buy the wait for lower prices will hurt the economy theory.
But why would deflation be devastating to the housing market and the economy as it currently exists? Because homeowners are massively over leveraged. As of May 9th of 2011, Zillow reports that 28% of homeowners are “Underwater”. Meaning that 28% of homeowners owe more than their home is worth. (http://www.bloomberg.com/news/2011-05-09/u-s-underwater-homeowners-increase-to-28-percent-zillow-says.html)
This is a problem. A VERY BIG PROBLEM. While not everyone of these 28% will become a foreclosure, when a homeowner has no skin in the game they certainly are more likely to let their home go. Even if an owner can still afford their home, if they are stuck with a loan in excess of their value with an interest rate above market rates, they become a likely candidate for foreclosure. Lenders will usually not refi underwater mortgages, and the more underwater, the more feudal holding on for better times will seem.
This extreme leverage in the housing system is where deflation could be devastating. Right now it is fair to say that the housing market is treading water. The low rates, courtesy of Ben, has helped maintain home values, at the risk of causing present and future inflation. Ben said it himself, he wants inflation, with about 2% being about right, in his mind. Imagine if Ben did not provide massive liquidity to help prop up the housing market, might 50% percent of the houses be underwater.
Then the real problem becomes markets always tend to overshoot their highs and lows. Through a self reinforcing cycle, a complete disintegration of the housing market could be possible. If Ben doesn’t destroy the US dollar (cause inflation), then home prices go down, if home prices go down, more people are underwater, more homes go into foreclosure, and home prices go down more, and then more homes are underwater…..
Don’t get me wrong, I am not a fan of Ben Bernanke, nor do I support his easy money policies. Because it was exactly these easy money policies initially under Alan Greenspan that helped cause the housing bubble in the first place. But then this is exactly the strategy that governments often pursues. They break your leg, then offer to help you fix it.
As I said previously, if homeowners weren’t over leveraged in the first place, then deflation wouldn’t necessarily be a problem. Why would I be upset if I could by a home cheaper next year? I certainly would be happy as would many first time buyers. I might be able to buy a great rental property, or as a Real Estate Broker, I might sell even more homes. But with the over leveraged underwater housing market we have today, deflation can become the precursor to bank failures and civil unrest.
So while I don’t agree with Ben Bernanke and basically the idea of the Federal Reserve, which is basically trying to fix the problem that they created. I do understand why he is trying to destroy the value of a dollar. It is kind of like somebody that has lied, and told a lie to cover the first lie, then lied again and again to cover their trail of lies. It is easier in the short term to just perpetuate the fraud than to come clean.