Housing Smoke and Mirrors (3) Update – April Fools
In Part 1,[i] it was concluded that the US Housing Market has a pattern of improving short term delinquency fundamentals; but also that there is a latent slower deteriorating trend that will converge upon the short term trend between now and 2016. This was summarised in the statement that:
“The housing market is therefore the hostage of economic growth and not the signal of economic growth.”
In Part 2[ii], this conclusion was upheld against a background of rising Judicial Foreclosures. The February Lender Processing Service (LPS) Survey provides the latest evolving picture.
The general pattern is one of improving delinquencies and foreclosures. However a more granular analysis reveals some interesting anomalies.
The 2010 to 2012 Mortgage Vintages are performing well. Presumably, these have been made with tighter lending standards; which involved a larger equity down-payment, in addition to low interest rates thanks to the Fed’s MBA purchase impact. 2009 is a watershed year and inflection point; at which mortgages begin to deteriorate. There was clearly something systemically wrong with the mortgages written in 2009. When one looks back to the economic conditions of 2009 (and what was going on with Countrywide and other lenders), it is clear that something risky and potentially fraudulent was going on at this time. The chickens have now come home to roost from these 2009 bad eggs. The 2006 to 2008 Vintages blew up in the Credit Crunch; and then have been stabilized, thanks to the Fed. The 2005 Vintage shows another systemic problem, like that in 2009; which corresponds to the last leg of the Housing Bubble. Thus far, attempts to stabilize the 2005 Vintage have been unable to get it on an improving delinquency trajectory. Clearly, the 2005 and 2009 Vintages present the systemic risk that is still challenging the housing market. Underwriting and fraud issues related to these two vintages are clearly still out there (perhaps off balance sheets); and represent a potent threat that has still not been addressed. The 2005 and 2009 Vintages are the smoking guns at a crime scene, which has remained un-investigated.
The February Lender Processing Service (LPS) Mortgage Monitor has also introduced a new dynamic of tightening housing market liquidity into the process. Rising Judicial Foreclosures are now combined with tightening liquidity, to strengthen the economic headwinds.
The back-up in US Treasury Yields and also the widening of credit spreads, has had the impact of raising mortgage interest rates. This has had the knock-on effect of reducing mortgage prepayments. This is the first source tighter liquidity.
The second source of tighter liquidity comes from the private sector. A seasonal pattern can be observed in mortgage delinquencies. Running into year-end, household finances become stretched, so that delinquency rates rise. This pattern is historically unwound in the New Year; however this year it is not happening. This new aberration was noted by LPS Applied Analytics Senior Vice President Herb Blecher. He stated:
“What stood out in this month’s data was where that increase was centered. February’s rise in cures was driven almost entirely by FHA loans, representing a 29 percent increase from January, and likely driven by revived modification activity related to the revisions to the FHA’s Loss Mitigation Home Retention options released late last year.
The majority of the increases in both Q3 and Q4 occurred in proprietary modifications as opposed to through the Home Affordable Modification Program. Given the current FHA activity, along with the FHFA’s recent announcement of its Streamlined Modification Initiative, we could see continued strength in modification volumes in the future.”
Foreclosures and One to Six Month Delinquencies are picking up; which then has the knock on effect of forcing the borrowers to seek Federal support and modification. The rise in Proprietary Modifications suggests that the banks are using their own models and processes to modify mortgages. Clearly these modifications are more onerous on borrowers than those under HAMP, because loans recently modified soon fall back into delinquency. It seems that the banks are forcing the borrowers into Federal programmes, so that the risk is being transferred directly to the Taxpayer. The banks are thus trying to pay back Federal bailouts and shareholdings; and transfer the risk back to the Taxpayer at the same time. The only reason that a bank would do this, is because it sees economic headwinds ahead and wishes to offload the risk directly to the Federal Government. The bank also sees no money to be made in the mortgage market, where interest rates are suppressed (by the Fed); at levels that do not provide an adequate risk adjusted return on capital invested. Banks can’t earn a spread, because the yield curve is too flat; so there is no business reason to be in the mortgage market. The latest earnings data from JP Morgan and Wells Fargo, confirm that the mortgage business is now a declining share of their loan portfolios[iii]. “Someone” must be in it however; and this “Someone” is the Taxpayer. Only governments can use Taxpayer funds in such charitable ways.
The first impulse wave of the next housing crisis can be seen, in the graph above, as the rise in Modification Volumes during Q3 and Q4 2012. If it is true that the banks are engineering the switching of risk to the Federal Government, then the brown HAMP bar in the graph should get bigger than the blue Proprietary bar going forward.
The latest Weekly Mortgage Bankers Association data shows a significant fall in purchase and refinance activity. Some of this has been due to the rise in interest rates; however there is also a third factor that has tightened liquidity. This factor comes from the public sector. According to Mike Fratantoni, MBA Vice President of Research and Economics:
“Following the April 1 increase in FHA mortgage insurance premiums, government purchase applications fell by almost 14 percent, to their lowest level since February 2013. On the other hand, applications for conventional purchase loans increased by more than 5 percent, bringing the conventional purchase index to its highest level since October 2009 and the highest level since the expiration of the homebuyer tax credit. With these changes, the government share of all purchase loans fell to 30 percent, the lowest level since we began tracking this series in 2011.”
The rise in private mortgage applications was not enough to overcome the decline in FHA assisted applications. This confirms that the Federal Government is the real driver of the Housing Market. It also suggests that the Federal Government has just inadvertently tightened liquidity in the mortgage market (on April Fool’s Day!), by raising mortgage insurance premiums; and choked off the housing recovery. Having established itself as the driver of the housing market, it then took the perverse step of pricing its involvement out of the market. Only a government could be so equivocal and self-defeating. Clearly, the Federal Government is (or rather was until April Fool’s Day!) now the main arbiter of the housing recovery. Since housing is the missing growth factor from the general economic recovery, it is logical to assume that the Federal Government will move to enhance its involvement in this sector. As we can see from the behaviour of the banks, they too are keen to remove the Federal Government as a shareholder and reposition it as the underwriter and price risk taker in the housing market. Thus despite words to the contrary, the Federal Government has every intention to deepen its involvement in housing. It will do this through the agency of the FHA, rather than through stakes in the banks. It is this move that is presumably being frustrated by Ed DeMarco at the FHA; which is why the knives are out for him in Washington. There are signs that this pressure is working; and that DeMarco is getting with the programme. On the announcement that the HARP programme is being extended to 2015[iv], he opined:
“More than 2 million homeowners have refinanced through HARP, proving it a useful tool for reducing risk. We are extending the program so more underwater borrowers can benefit from lower interest rates.”
The Federal Government is now racing against the clock to get more heavily into the housing market before it begins to implode. The House Financial Services Subcommittee is now on its third hearing for proposed FHA reforms[v]. These hearings consist of industry insiders from the National Association of Homebuilders (NAHB), the Urban Institute (UI) and the Mortgage Bankers Association (MBA) using a mixture of macro-prudential spin and fear mongering to lobby for the FHA to fill the void (and then some) left by Fannie and Freddie.
There are signs that the Obama Administration understands the imperative for the Federal Government to get more involved in the housing market. The proposed 2014 Budget sees an almost 10% increase in funding for HUD[vi]. In these times of fiscal austerity, it may be questioned where the funding will come from. The answer to this question shows the insidious pecuniary incentives and flows of funds, which sustain the Federal Government’s intentions and capabilities to expand into this sector.
Firstly, the Federal Government is earning a healthy income from the Federal Reserve’s remittances of the profits earned from monetizing Mortgage Backed Assets (MBA’s). It is therefore of little surprise that the Fed envisioned increasing its role in the MBA market , by holding these assets until maturity rather than selling them outright, at the recent FOMC[vii]. The second insidious signal came from the recent 2014 Budget proposal. The Administration envisions using the Chained CPI to index Federal Liabilities. Since this Chained CPI is much lower than the regular CPI, this will lead to an immediate saving. The funds saved can thus finance the Federal Government’s expansion back into housing.
The result will be that the Federal Government never leaves the housing market; and the Federal Reserve never leaves the MBA market. The Taxpayer will however incur greater risk to the housing market, as this risk is transferred from the banks to the FHA. This risk will allegedly be mitigated by the “profits” of QE, which are returned to the Treasury by the Fed, rather than dividends from the Government-owned banks. The Smoke and Mirrors have been used to show the image of a recovering housing market, which will allow the banks to switch the risk back to the Taxpayer. The Fed’s Bullard signalled the return to the status quo of permanent structural “Federal” engagement in housing; in his latest speech, warning those involved to learn from the mistakes of the recent past[viii].
The US Taxpayer has thus become a hostage of a housing market that is in turn a hostage of economic growth – and not the signal of economic growth. The Federal Government is desperately trying to get back into the housing market; however as is always the case, it will take a market crisis to convince the Taxpayer that such an involvement is necessary. The US Taxpayer is therefore about to experience another unpleasant truth, about the state of the housing market, in order to mobilize his/her taxes.