The Great Correction’s unfinished business

You gotta love this Great Correction. It's gotten so much bad press. And so many people are trying to stop it. But it just keeps going, doing its work. Barry Ritholtz:

There have been an average of 1.6 million nationwide foreclosure starts per year for the past five years. Foreclosure starts nationwide increased on an annual basis after 27 consecutive months of year-over-year declines. Bank repossessions are still down 18% year over year. Voluntary foreclosure freezes and increasing pre-foreclosure sales are the primary factors ... 2.8 million Americans are 12 months or more behind on their mortgages.

Isn't that terrible? No, it's just a correction correcting the overbuilding and overbuying in the US housing market. And here's more correcting...

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WASHINGTON (Reuters) - New claims for U.S. state jobless benefits rose for the fifth time in six weeks and consumer prices fell in May...

Terrible again, right? Wrong. The correction is doing what it's supposed to do. Bloomberg:

Americans are digging themselves out of mortgage debt.

Home equity in the first quarter rose to $6.7 trillion, the highest level since 2008, as homeowners taking advantage of record-low borrowing costs to refinance their loans brought cash to the table to pay down principal. The 7.3 percent gain was the biggest jump in more than 60 years, according to an analysis by Bloomberg of Federal Reserve data.

Residential mortgage debt peaked in 2007 at $10.6 trillion, doubling in six years, according to Fed data. Since then, it has fallen 7 percent as the value all residential property has dropped 23 percent.

More news from DR friends and colleagues. Here's Justice Litle:

"If you don't need the money, you can get it all day long. Thank you, Ben Bernanke."

~ Chris Hordan, business owner, via the WSJ.

There was an unintentional bit of comedy in the Wall Street Journal on Monday, titled "Fed Wrestles With How Best to Bridge U.S. Credit Divide".

See if you can spot what's funny:

The housing bust left behind millions of people with credit records damaged by plunging home prices, lost jobs, past overspending or bad luck. Many are now walled off from the low interest rates engineered by the Federal Reserve to spur the economy and remedy the aftereffects of the borrowing boom.

Millions with good credit, meanwhile, are taking advantage of the easy money, a windfall in many cases for people who don't especially need it.

Fed officials have been frustrated in the past year that low interest rate policies haven't reached enough Americans to spur stronger growth, the way economics textbooks say low rates should.

By reducing interest ratesthe cost of creditthe Fed encourages household spending, business investment and hiring, in addition to reducing the burden of past debts.

But the economy hasn't been working according to script

Okay, it's not necessarily funny. Infuriating is more like it. (What 'script' are these nitwits reading exactly?)

Except, at some point,you just have to laugh at the grand idiocy of it all. It's no good walking around mad all the time.

The Federal Reserve, at least in theory, is staffed by smart and capable people: all the right pedigrees, university diplomas, PhD theses and so on.

And yet, on certain matters of blinding obviousness, these technocrats behave like the biggest buffoons on the planet.

There is a difference between a business cycle downturn and a full-on deleveraging. It does not take a doctoral degree, or even a high school diploma, to grasp this.

In a normal downturn, belts get tightened for a bit. Debt levels are cut back but not from extreme levels. Consumers and businesses still have a little money saved. This enables a reasonable bounce back while the handful of businesses that fail see their assets distributed to stronger hands.

A normal downturn, in other words, is like a shallow setback. The cleansing process is healthy, and soon enough things are moving again. The economy heals itself.

In a full-on deleveraging, however which only occurs after years and years of rampant borrowing the problem is too much debt.

And the solution to 'too much debt' is not piling on more debt. If a man has a $300,000 underwater mortgage, and has just lost his $50,000 a year job, lower interest rates are not going to help him out.

The British have a saying for this: "coals to Newcastle". The offer of more debt does nothing for the indebted.

Or, to put it in terms a six-year-old could understand: The United States is like a fat man with a badly upset stomach, having eaten far too much. You do not improve matters by offering such a man more food.

But they only have one trick at the Fed. One solution to every problem. So they scratch their heads and act stumped when the solution doesn't work.

On Wednesday we may get more of the same. SocGen (the French investment bank) believes that $600bn in QE3 is coming. Federal Reserve Vice Chairman Janet Yellen has further spoken of the need to "insure against adverse shocks."There is consensus that QE3 will be here soon, if not this week.

If QE3 does come, we anticipate a short-lived euphoric stock market run-up with follow-on odds of a very sharp decline. The post-announcement rally could be brief possibly even blink-and-you'll-miss-it brief. The tired hope-jaggery is wearing thin.

In fact, according to our charting expert, John Burford, there could be "a big fall in the Dow" around the corner. He'stalking about a possible near-800-point (around 6%) drop. If he's right, the FTSE is likely to follow suit, perhaps losing 300 or more points in short order.

To see John's analysis and charts and to add your name to his free MoneyWeek Trader list, click here: Why I'm betting on a big fall in the Dow.

But the correction is not correcting the sector that needs correction most. The financial sector. Why? The feds protect it.

While the private sector digs out from under the burden of a debt bubble, the financial sector profits from federal giveaways. Wall Street CEO pay rose 20% in 2011.

Andclick here to see whatour new friend Barry Dyke isreporting and commenting on.

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