Housing Smoke And Mirrors

by Adam Whitehead, KeySignals.com

The consensus opinion on the US Housing Market is that it is in recovery mode. Closer analysis of the data reveals that this recovery is artificial; and that the tools that made the recovery have built in a self-destruct mechanism.

The latest data comes from National Delinquency Survey (NDS) released by the Mortgage Bankers Association (MBA).

(Source: http://www.mortgagenewsdaily.co/02212013_national_delinquency_survey.asp)

The first general conclusion from the survey is that the delinquency rate is falling.

The 90+ Day delinquency rate remains flat and elevated however.

The general improvement is therefore a function of the Percent of Loans in Foreclosure. This statistic should alert attention to the fact that “something”, ongoing in the foreclosure process, is causing the dramatic improvement in the overall delinquency data. This “something” is the Federal housing stimulus and loan modification programmes, which are being forced through the banking system currently. These programmes have evolved from interest rate reductions, through principal modifications and reductions.

(Source: http://www.mortgagenewsdaily.com/02212013_servicer_settlement.asp)

To date, the programme is about $46 billion in size; and still growing.

The programmes involve the “usual suspects”, however attention must be drawn to Bank of America, which seems to be heavily represented in them. Wells Fargo also seems particularly highly represented. What we can conclude is that the delinquency improvement is being driven through the banks, by Federal Government. These programmes are therefore responsible for keeping delinquent houses off the market; which has the effect of reducing inventories, so that prices are rising. As Zillow recently opined: “House prices haven’t risen this fast since the housing bubble”.


Is this sustainable?

The data, when plotted suggests that the situation is not as dangerous as it was in 2008 and 2009.

The years 2013, 2012, 2011 and 2010 all seem to be following a similar pattern of gradual deterioration in the delinquency rate. It’s more of a slow death, than a crash; but the borrower still dies.

The slow death is easy to visualize. Loans with vintages from 2005-2007, when the bubble was inflating, were the first to have problems. Federal programmes have now got the delinquency rate of these 2005-2007 vintages falling. Loans taken out after 2008 are all accelerating into delinquency. This signals that borrowers since 2008 cannot afford to meet their current debt obligations. This could be because the economy is weak. It could also be because the size of the loans (i.e. the value of the underlying houses) is still too large. Federal programmes have stopped the market from falling; and combined with easy money have actually made prices rise. People buying with mortgages however still can’t really afford the current sales price. Only vultures with cash can afford the price, because they have no debt.

What this means therefore, is that the Federal programmes that are saving the 2005-2008 vintage borrowers, are killing the later borrowers from 2008 onwards. Bearing in mind that interest rates are at all-time lows, this means that any rise in interest rates from here will trigger a crash in the 2008+ vintage loans. The Fed will therefore have to keep interest rates lower for longer to accommodate the 2008+ borrowers. If the Federal Government then modifies the 2008+ borrowers, this problem can self-perpetuate until the Government runs out of money. What is more likely, is that the Fed just stays involved, until the value of principal reductions meets the value that new purchasers can afford to finance without any Federal support. Principal modification therefore sets an upward limit on how much house prices can rise. Currently, it seems that new buyers cannot afford the price of houses, hence they are becoming delinquent. The price of houses therefore has to fall; until a price is found at which the delinquency rate remains stable, as it has done for the prior to 2005 loan vintages. Alternatively, the economy has to grow so that new purchasers can afford to either pay cash, or take out an affordable mortgage to buy a house.

In relation to the “stable” pre-2005 vintages; the delinquency rate of above 20% may be stable however it is still elevated, which shows that even these borrowers are at risk from a deterioration in economic conditions. In relation to the 2005-2008 vintages; even though they have been stabilised, more than 50% of them are still delinquent. When these vintages are combined with the slow  delinquency accretion of 2010, 2011, 2012 and 2103, the situation is still very challenging. The headlines may indicate an improving delinquency situation, but it is anything from normal; and there is a long-term deterioration trajectory beneath the improving current picture. At some point within the next five years, the deteriorating 2010-2013 vintages will meet the improving/static 2005-2008 vintages. In addition, over this period there is potential for the 2013-2018 vintages, that have yet to be issued, to deteriorate also. The probability that these 2013+ vintages will deteriorate is high, based on the fact that the 2013 vintages are already deteriorating, even when they are issued at Federal Reserve manipulated low rates of interest. In fact, since lending standards have been raised, this has raised the real borrowing costs. This means that borrowers from 2013 onwards are already paying a higher rate of interest than they can sustain. When all these vintages converge, the system will become unstable again; and we will have our Debt Crisis of 2018. If the US economy can grow between now and 2018, the severity of the next crisis will be mitigated somewhat, depending on how strong the growth is. One can foresee that QE and Operation Twist in 2018, will involve the Fed buying mortgages; and even becoming the mortgage lender and modifier of first and last resort. Commercial banks will become nothing more than securitization vehicles; and the credit risk will be transferred to the Fed. The “Can” has been kicked down the road to somewhere between 2015 and 2018.

The current rising delinquency line, albeit less steep than in 2008 and 2009, still signals that the housing market is in stress and prices are still too high for buyers. Even with modifications and low interest rates, thanks to the Government and the Fed, the market remains unsustainable. The Federal Programmes and the Federal Reserve have prevented true price discovery from occurring in the present; this price discovery however cannot be avoided. They hope that the discovery will be made in conditions of economic growth, so that the adjustment to realistic market prices for houses is higher rather than lower. The housing market is therefore the hostage of economic growth and not the signal of economic growth.

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