“the Federal Reserve and the Federal Government were observed to be running swiftly into the housing market.”
The latest data, on the HOPE NOW programme, has confirmed that the ratio of modifications to foreclosures was two-to-one in the first quarter of this year.[iii]
Housing Smoke and Mirrors (6)[iv] suggested that the governance rules of the GSEs were about to be changed, so that they could modify mortgage principle values. This would then allow them to securitize their “Zombie Home” mortgages into MBS, that could then be bought by the Fed.
The GSEs are accelerating the process with their new Streamlined Modification Programme, which begins on July 1st. Fannie Mae and Freddie Mac borrowers, who are at least 90 days delinquent, but no more than 720 days past due, may be eligible for a modification that does not require the borrower to submit financial or hardship documentation. In its press release[v] Freddie said that:
“Today, Freddie Mac is giving a green light to its mortgage servicers to speed up financial relief for potentially thousands of families with delinquent mortgages across the nation. Now mortgage servicers can send eligible borrowers their Streamlined Modification trial period terms as soon as they are ready and borrowers can modify their loans by making the three trial period payments on time … Freddie Mac is focused on adding momentum to the housing recovery by giving distressed borrowers more options to avoid foreclosure.”
Freddie is even going the extra mile; and actually allowing borrowers to use their 401K plans as qualifying income.[vi] Clearly potential borrowers are light on income. Freddie’s qualifying rule is predicated on the Federal Reserve inflating the value of equity portfolios.
Thus not only will the Fed be buying these newly “Qualified” mortgages via the GSEs , it will also be qualifying them first by pumping up equity valuations with QE. A cursory look at the declining number of Americans who own equities (see graph above), suggests that this strategy may not actually work. If the 401Ks hold bonds, there may be some capital gains but there will not be much in the way of income. The Fed’s failed attempt to boost the “Wealth Effect” has been discussed in the related series entitled “Terminal Velocity”.[vii] In the example provided by Freddie Mac’s qualified 401K plans, the reader can see the practical failure of this strategy. As Sarah Bloom Raskin[viii] and the New York Fed[ix] have made clear, the consumer’s home has been his greatest source of wealth; and the related “Wealth Effect” has been destroyed by the “Credit Crunch”. Freddie’s 401K plan strategy may work at the margins, but something more indiscriminate is required to get things moving; which we have called “Bernanke’s Helicopter”.[x]
The logic behind this accelerated GSE modification process was explained by TransUnion. According to their analysis, the real problem that is keeping delinquency rates elevated is the time being taken to deal with them. According to TransUnion’s Tim Martin:
“It’s no longer a credit quality or home price depreciation issue, and we are not adding many new delinquent mortgage borrowers into the pool these days. Instead, it’s an issue of the timelines to cure or foreclose. We are simply not draining the pool very fast; and the size of the ‘drain’ varies significantly by state.”
This accelerated pace of activity has also picked up at Fannie Mae. In its latest Washington brief to realtors, Fannie updated them on the new “streamlining” procedures being undertaken in the REO process. Specific mention should be made to Fannie Mae’s own emphasis that the process would be accelerated for those with credit scores below 620. Clearly Fannie Mae is creating a “REO Firesale” process; the proceeds of which it can then be modified and passed on to the Fed.
There is one obstacle to the “REO Firesale” process however. This involves the practice of credit agencies marking down the credit score of the REO Seller, by the same margin as if it was a foreclosure sale. Clearly there will be inertia on the part of the sellers, based on this action; which will stay with them for seven years (as opposed to two years for a normal short sale) and cut them off from other credit which they may need to survive. This issue is particularly serious in the States that have been hit the hardest in the housing crisis, such as Florida. It is therefore no surprise that the Senator for Florida, Bill Nelson (D) is in correspondence with Edith Ramirez, Chairwoman of the Federal Trade Commission (FTC) and Richard Cordray, Director of the Consumer Financial Protection Bureau (CFPB) to remove this hurdle. This looks like a form of easing of lending standards by stealth.
The FHFA has been silent on executive compensation for five years, so its sudden breach of silence on Tuesday was clearly coordinatd with the Federal momentum that is now driving the housing market. The FHFA issued a new proposal on GSE executive compensation in the Federal Register.[xi] As the departure of the obstacle known as Ed DeMarco[xii] is also accelerated, attention is now turning to whom should be running the GSEs; and how much they should be paid. Compensation schemes triggered the aberrant behaviour that precipitated the crisis; therefore many observers were looking for a clean break with the risky incentives of the past. Unfortunately there has been no clean break. Instead of being governed by rules, executive compensation will be driven by the subjective interpretation, of the following principles that have been termed “interim rules”, by DeMarco’s replacement:
- In general the Director may review compensation for an executive officer of the regulated entities and prohibit any that is not reasonable and comparable to compensation for similar businesses.
- No bonuses will be paid to any senior executive during the period of conservatorship.
- In determining reasonable and comparable the Director can take into consideration any factors he considers relevant including wrongdoing and abuse.
- The Director may not prescribe a set a specific level or range of compensation.
- Regulated entities must give 30 days’ written notice to the Director before entering into any written arrangement that provides a term of employment exceeding six months, provides compensation in connection with termination of employment, or pay for performance or incentive pay.
- Compensation offers for new hires require five days’ notice to the Director
- A GSE may not enter into an agreement or contract for payment of money or anything of value in connection with the termination of employment of an executive without advance approval of the Director except that contracts of this nature entered into before October 28, 1992 are not retroactively subject to such approval or disapproval. Renegotiation, amendment or change to these grandfathered agreements are subject to the Director’s approval.
Clearly executive pay will be in the hand of the well paid new Director. It is therefore very interesting to see that the proposed new Director Mel Watt,[xiii] is closely associated with the financial sector; where compensation schemes remain one of the greatest sources of systemic risk. Presumably, the new Director will opine that compensation needs to be generous in order to attract high quality people.
In her latest speech, Fed Governor Elizabeth Duke provided further support to the thesis that the banks are being facilitated to unload the toxic mortgage risk from their books to the Fed.[xiv] Duke’s analysis looks like further evidence of the return to the dangerous status quo that SIGTARP[xv] and Jeffrey Sachs[xvi] opined was happening in the banking community. The central theme in Duke’s analysis, is that Americans with what used to be termed Subprime credit scores are being denied credit. This demographic represents both those currently in delinquency and those who may become the first time buyers of the future. Her concern for this demographic is admirable; unfortunately her support for the private sector solution is less so.
The Credit Unions have also got up to speed. Going forward, they will no longer be doing any mortgage lending that is not “Qualified”. According to the recent “CU Times”, most Credit Unions will only be continuing with “Qualified” lending.[xvii] Clearly these mortgages are also destined for the Fed’s balance sheet.
It can be argued that all that is happening in this accelerated phase of streamlining is standardization. Consumers are being protected with a standard mortgage product offering, which is uniform; and that can be regulated even after it has been securitized and disintermediated. Ostensibly the system has become standardized; and therefore less risky. The problem with this view is that no investigation of the standards has been made by an external objective authority. Basically what has happened is that a tight confederation of housing industry regulators and financiers, who were asleep at the wheel the first time and did not get fired, have been allowed to design a new system. The system they have designed has been adapted to make the mistakes of the past fungible with new potential mistakes of the future, which can then be hidden on the Fed’s balance sheet. In the words of Jeffrey Sachs, a “Zombie” environment has been nurtured by –
“a docile president, a docile White House and a docile regulatory system that absolutely can’t find its voice” combined with Wall Street professionals who “are tough, greedy, aggressive and feel absolutely out of control in a quite literal sense” and who “have gamed the system to a remarkable extent”.[xviii]
As was opined in Housing Smoke and Mirrors (5), it is business as usual.[xix]
It would appear that even the warning of the State Inspector General of TARP (SIGTARP), that the situation was reverting back to the original risky status quo, has been largely ignored.[xx] This has been underlined by the fact that the new “standards” that the GSEs will be using to “Qualify” loans will default to those that the banks have used to “Qualify” them in the first place.[xxi]
If the reader remains unconvinced that it is business as usual for the banks, they should read what Lloyd Blankfein had to say on the issue of bank valuations and regulations.[xxii] He opined that he is bullish on valuations, because future clarity on regulations will favour them. Since the banks have lobbied hard and won the opportunity to draft these regulations, it is hardly surprising that these regulations are shareholder value creators for them.
Fed Governor Elizabeth Duke also adopts the bankers’ perspective on the economic solution. Lenders are concerned about the risk of put-back of these loans by the GSEs. Lenders are also worried that defaulting borrowers will sue, for predatory lending. Finally lenders are worried that the servicing companies will charge them a higher fee for servicing these risky borrowers. Duke implies that these concerns must be addressed, to the satisfaction of private capital, going forward. Currently private capital avoids this sector of lending; or when obliged to do so charges punitive rates of interest, that the borrower has no chance of coping with. The excuse for the higher borrowing charges, is that they reflect these concerns and risks to the banks. Private capital, supported by Duke’s analysis, is therefore holding the housing market to ransom. A general watering down of the current legislation on consumer protection will encourage them to engage again. Effectively, the banks have got out of jail.
If the public becomes aware that the situation is returning back to the status quo, in which the banks are in the driving seat again, there will be blowback. With this in mind Richard Cordray, the Director of the Consumer Finance Protection Bureau, has interjected with the “Smoke and Mirrors” that will obscure and obsfuscate sufficiently to keep the public in the dark. He spoke to the National Association of Realtors recently,[xxiii] in vague terms; which sought to warn and reassure realtors that this time it is different, so that no abuse of buyers can occur. He has allegedly listened to realtors and taken on board what they have opined. He was however careful not to give any substance or details, on exactly what had changed in terms of rules and regulations. In particular, he was careful not to emphasize the valuable option to sue, that buyers who have been misled and defrauded can follow. It is this option, along with the GSE put-back option, that still remains an obstacle for the banks. His position is best summed up by the quote:
In the Dodd-Frank Act, Congress gave us a broad range of tools to address problems in the financial marketplace, and to fix them. We are learning how best to utilize these tools and we are working hard to make a real difference for American consumers in the years to come.
Cordray is therefore going to apply the rules delicately, in a way that does not inflame the situation further.
It looks as though private capital is no longer unanimously supporting the housing market however. The speculators, who have bought-to-rent, are headed for the casino exit via IPO liquidity events; to take profits and pass risk to slower witted private investors.[xxiv] In Housing Smoke and Mirrors (6) it was suggested that weak economic activity was capping rents. It was also suggested that it was these rents that had been driving the latest recovery in house prices. The stampede to the IPO exit is perhaps the biggest key signal that the housing market has become frothy again versus economic fundamentals.
The reason for this stampede to the IPO exit is clear. Recently the owners of the “StuyTown” development in Manhattan have tried to boost rents by thirty per cent.[xxv] This is reflective of the trend in the buy-to-rent investor community; who are facing two headwinds. First they have realised that they have paid up for the properties. In the old private equity days, before the crash, they would have leveraged up the asset and then taken the money out in egregious dividends. The rent hike represents the same principle as the dividend hike. Private Equity is back to business as usual. This time around, it is also hedging by cashing out and spreading the risk with an early IPO. The high rent will be shown on the prospectus as the juicy income stream, which will cause investors to pay a large multiple on the IPO date. Private Equity is also worried about a rise in interest rates; and therefore wishes to build in a cushion to mitigate the risk that a turn in the interest rate cycle will bring. There is evidence that the economy is not strong enough to take these latest hikes in rents.[xxvi] In Housing Smoke and Mirrors (6) it was suggested that a turning point was coming in rents, that would then prevent further improvement in home prices without a stronger economic recovery. “StuyTown” would seem to be the high-water mark, which indicates that this point has now been reached.
The recent NAHB data for May also suggests that the homebuilders are feeling the headwinds from weakening demand. The sector has recovered, but it has fallen short of the 50 level in the diffusion index that represents growth. It is also noteworthy that developers have been selling land and future inventory to Private Equity,[xxvii] in the absence of real buyers. Private Equity is buying the single-family pipeline in the hope of renting. Clearly a bubble has been created here also. This bubble shows just how frothy the market has become; with private capital paying a premium for illiquid land, based on its future hypothecated rental income. In the graph above, the gap between the red housing market index line and blue single family starts line, shows just how big the bubble has become. It also shows that the market is still overall in contraction mode. One can thus see that Private Equity is chasing the price of land and houses, when economic conditions signal that an investor should be patient and wait for the liquidations to come to them. The reality of a weak economy and capped rents will cause a lower asset revaluation and a sector re-rating.
The April Housing Starts data provided some more signals that the new home market was being distorted.
Housing Permits were up, but these were not being converted into Starts at the same rate.
It appears that Private Equity has created the spike in permits, however inventory is now being carefully managed in the face of rental and sales conditions that are not as aggressive. By keeping inventory low, Private Equity hopes to support rents and push them higher.
The collapse in the single-family to multi-family ratio has raised the alarm in some quarters that the renting game is over.[xxviii]
CoreLogic took great care not to call the recent rise in prices a bubble. It could not however deny the fact that prices have been driven by investors (speculators) through 2012 and early 2013. It reported that:
“Cities at epicenter of housing bubble/crash are clocking highest rate of appreciation, largely driven by investor demand.”
The graph released with this analysis appears to represent a strong rally towards the end of this year followed by a gentle fall throughout 2014; and the use of the words “bubble/crash” would seem to suggest some concern. It seems that CoreLogic has decided to deflate the “bubble” slowly in 2014. What seems to be implied is that the current “bubble” has pulled demand forward from 2014. This demand then picks up again in 2015, but then strangely seems to taper off into a flat trajectory of constant demand after this point. House prices, like interest rates, just seem to exist at a constant level in this idealised stable future, which is supposed to emerge out of the crisis. It all looks very contrived, rather than rationally thought out. Presumably, the projected 5% growth rate, from 2015 out, is supposed to be some kind of rule of thumb that is allegedly attractive versus inflation expectations.
The note of optimism sounded by Corelogic was repeated in more cheerleading, from those in the sector that rely on the bandwagon rolling to sustain their revenues. Having seen signs of weakness in the rental sector, it is time to pass the baton to the buyers.
Eager for business and mindful of this new stealth move to ease lending standards, the National Association of Realtors (NAR) added to the momentum. Laurence Yun, the Chief Economist at NAR, pitched in with his own subjectively framed analysis; that it may be time to “dial down credit stringnecy” in order to facilitate more buying and less renting.[xxix] The “core logic” behind Yun’s analysis, is that home sales would jump twenty percent if “normal buyers” could get a credit score of 720 and FHA buyers one of 660. Yun advocates simply weakening lending standards to achieve this. Having struggled to pay the mortgage, individuals who were forced to rent are now struggling to make this payment also. A fall in house prices would allow them to afford a house, but this is not in the interest of the NAR; since brokers are paid on commission on the value of the sale. The brokers’ solution is therefore to drop lending standards to make the house appear affordable. This is exactly what happened in the years from 2003 to 2007. Combining this move by the NAR with Senator Bill Nelson’s move on credit scores, in relation to REO Shortsales, one can see the bar being lowered on lending standards quite significantly by stealth.
The rental market is clearly running out of steam, so a new source of liquidity is required to keep the bubble inflating. This liquidity will come from buyers, who have been “Qualified” through “modified” credit scores.
Zillow expanded its “breakeven analysis” to metro-areas; and found out in two thirds of cases, that buying was now cheaper than renting.[xxx] This was of course framed as a great time to buy, using the rental data as the basis. Framing it the other way, one could easily assert that renting is more expensive than buying. It all depends on one’s perspective; and how one gets paid.
It is becoming obvious that the real estate industry is trying to return conditions to the status quo that existed before the crash. In order to achieve this, it needs the complicity of the lawmakers and then the blind participation of the consumers. The Center for Responsible Lending has sounded the alarm, in its latest criticism of the amendments to the Consumer Mortgage Choice Act (HR 1077) currently taking place.[xxxi] These amendments are being overseen by the Honourable Robert Huizenga (R-Ml). If allowed to continue, they will obfuscate the hidden charges, fees and interest costs lurking in mortgage documentation. More importantly, from the perspective of this report, it would allow these mortgages to be “Qualified”; so that they can be repackaged by the GSEs and unloaded onto the Fed. A combination of “modified” credit scores and “modified” mortgages, will then be “Qualified” by the banks and sold to the GSEs, who then repackage them and stuff them into the Fed.