Consequences

When the Average Joe thinks about what's gone wrong with the war in Iraq, he thinks mainly about two things: the number of troops killed, and the cost (though of course the latter is nebulous to most). But it's important to understand that this war affects every American in a variety of indirect ways. Here's a window on that from USA Today:

For 45 years, Robert and Lorraine Brown have lived in their ranch-style home in Florissant, Mo. One of their four children was even born there. But for the past eight months, the couple have been locked in a sleep-wrecking race to keep up with their rising mortgage bills. They've switched to cheaper phone service, cut back on groceries and sometimes put off ordering medicine.

When they refinanced their home two years ago to pay off some bills, Robert, now 78, was working as a deliveryman. But his employer went out of business last April. Now he and Lorraine, 72, a retired nurse, are both seeking work. The rate on their mortgage has jumped from 7% to 10.5%.

"We were having a hard time meeting bills at the time we refinanced. It seems once you get behind, you do desperate things to catch up, and you never do," says Lorraine, trying to hold back tears. "At the time of the loan, they tell you, 'Well, it may go up, but it's probably going to go down.' You want it to be so, so you believe it."

They feel alone, but they're not. America's five-year real estate boom was fueled partly by a tempting array of cut-rate mortgages that helped millions of Americans qualify for home or refinance loans. To afford soaring home prices, many turned to adjustable-rate and other, riskier loans with low initial payments. The homeownership rate hit a record 70%.

Now, the real estate market is cooling, interest rates are rising and tens of thousands more Americans are starting to have trouble paying their mortgages. Nearly 25% of mortgages -- 10 million -- carry adjustable interest rates. And most of them went to people with subpar credit ratings who accepted higher interest rates, according to the Mortgage Bankers Association.

Last week, the Federal Reserve raised interest rates for the 15th time since June 2004 and signaled that at least one more increase is likely. That trend is ominous for borrowers who were seduced by adjustable-rate loans that offered interest-only payment options or teaser rates below 2% or that let the borrower pay less than the interest owed. They will face bigger payment shock once their loans reset to higher rates.

I've written in the past that I believe the Federal Reserve cannot stop raising rates as long as oil is over $60 and gold is staring at $600; if the Fed made it clear tomorrow that the "8th inning crowd" was finally about to be right after a year of being wrong, oil would shoot for $80 and higher and gold would rocket as well. Instead, the Fed will continue to understate inflation, continue to raise rates at a snail's pace to mollify foreign central banks, and---most importantly---continue to flood the financial system with liquidity to support the stock market.

But there's a problem with that, as Contrary Investor notes:

In our minds, if the Fed simply stops raising rates somewhere over the next three to four months, yet continues the excess liquidity pump, we believe very little to nothing is gained in terms of trying to stall accelerating energy and commodity prices ahead. And IF indeed this acceleration is not halted to some extent and these forces do show up in headline and core CPI as part of natural economic follow through in the quarters ahead, the Fed is going to have one big problem on its hands. They just might have to restart the rate increase cycle later in the year (assuming they pause in the interim) if CPI rates move north at the exact time that the markets have been acting to discount the demise of the rate increase cycle. If you ask us, we believe the Fed faces some very tough choices over the near term.

This is part of the "event horizon" I've posted about before. Due in large measure to the costs of Iraq, the Federal Reserve must continue to raise rates to keep foreigners---increasingly unwilling to underwrite our deficit spending and preemptive wars---from jumping ship. But as rates go higher, the crucial real estate market will continue to weaken and millions of voters like the elderly couple above will feel the pinch. That's not a good thing in a midterm election year when control of Congress is at stake and words like impeachment are getting thrown around. To ameliorate the pain of higher rates, the Fed continues to support the stock market with liquidity. But that same liquidity, of course, is why oil continues its inexorable march higher, gold sits at fresh quarter-century highs, and things we all need like food and clothing keep getting more expensive.

It's all about consequences, and the desire of the Fed and White House to avoid them. Remember, desperate statists do desperate things. Keeping in mind that geopolitical tension over Iran's nuclear program gives the Fed and White House much-needed cover for the way our fiscal and monetary policies are driving the price of oil higher---and Iran's oil represents our ability to print our way through painful consequences---what do you think happens next?