In Housing Smoke and Mirrors (7), the headwind confronting the American housing market, from the slowing pace of rental increases, was observed to be at a critical point. Early investors in the rental sector were also seen to be cashing out via the IPO window. Lehman Brothers has been a little quicker off the mark than it was last time; and has started to unload its Residential REIT legacy shares[i]. It is instructive to look for the “slow witted” buyers, who are providing this liquidiy event; in order to understand the risks to markets and the economy going forward.
A recent survey, conducted by FICO and the Professional Risk Managers Association, showed that more than half of the risk management professionals surveyed, expect housing delinquencies to remain unchanged over the next six months.
They also expect access to credit to remain about the same; and to be sufficient to meet the demand of homebuyers. Interestingly, they also expect credit in other markets to perform the same way.
The consensus view held by the majority is that house prices will continue to rise at the current pace; which they deem to be sustainable.
This survey shows that professional advisers and fiduciaries will therefore be buying the IPO’s, under the impression that the rise in house prices is sustainable. They believe that the trend is their friend. Rising prices beget the expectation of further rising prices. None of these second round buyers suspects the motivations behind the selling of the first round investors.
It is quite logical to assume that Fannie Mae’s “economic and strategic research team” (Doug Duncan, Orawin T. Velz, and Brian Hughes-Cromwick), which recently produced its latest economic and housing outlook[ii], are also members of the same risk management professional population surveyed above. Their outlook, confirms the consensus view; and also opines that it is better to be a buyer than renter.
The team then compromises itself by saying that it is a sellers’ market. It is difficult to see who they are supposed to be advising. First they promote buying over renting; then they say that these buyers are creating a seller’s market. In our experience, a sellers’ market is one that should be sold; so presumably they are also advising the sellers to hit the bid. We note that this kind of conflicted behaviour was the classic symptom of the malaise of the last housing bubble. Clearly Fannie Mae just wants prices to go up; and doesn’t care how this is achieved. Their view supports the thesis from Housing Smoke and Mirrors (7), which suggested that greater emphasis was being placed on the buyer market; now that the rental market is running out of steam. Fannie Mae believes that this affordability is driven by low interest rates; and not rising incomes.
In addition to lower interest rates, Fannie Mae also sees an easing of lending standards driving the market higher. It is not clear if this easing of lending standards is due to rising incomes; but the implication is that lenders are just being more aggressive because they have lots of liquidity and confidence in the economy.
The report also sees some other important supply side drivers, which are;
- regulations about securitization; and
- housing finance reform.
We are coming to the conclusion that these regulations and reforms are nothing more than a return to the status quo during the bubble. This degeneration has been opined by Jeffrey Sachs[iii] and even the Special Inspector General of TARP (SIGTARP)[iv]; but these warnings have been lost in the price action. Housing Smoke and Mirrors (6)[v], 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. In Housing Smoke and Mirrors (7), the “Streamlining” process for mortgages at the GSEs was explained as the great facilitator for moving distressed mortgage vintages onto the Fed balance sheet. The research team at Fannie are therefore preparing the markets for this process, with their latest signals on supply side and securitization reforms. Once again, it looks like Fannie Mae is conflicted. We would suggest that the Federal regulators take a closer look at this kind of “sell side” research, when the institution clearly has a business agenda tied to the research perspective. Freddie Mac is at a more advanced stage; and has just announced that is has already securitized its first tranche of mortgages, which have been modified to qualify as current[vi]. No doubt these are already on the Fed’s balance sheet.
The Mortgage Bankers Association (MBA) has begun a new lobbying drive to increase Private Capital’s share of the revenues from the housing sector. This lobbying effort was launched behind the MBA’s latest publication, entitled “Up-Front Risk Sharing: Ensuring Private Capital Delivers for Consumers”[vii]. This new MBA drive should be compared and contrasted with a separate initiative from investors who wish to take the GSEs private. The MBA attack is camouflaged behind language that is full of rhetoric about the Un-American anti-competitive position of the Government ownership of the GSEs. The MBA would like the GSEs to share the risk in making loans to higher risk borrowers. This risk sharing, at the point of sale of the original loan, will allegedly allow private capital to provide loans to weaker borrowers, so that the housing market can be stimulated. Clearly the MBA sees the chance to unload some distressed mortgage vintages onto the Fed; and does not like the way that the GSEs have monopolised this easy-money profit driver. Currently, the GSEs require the credit enhancement process to occur once they have the assets on their books. In the new envisaged process, this credit enhancement step would occur at the origination level; and the risk would be shared by the GSEs and the lenders. The MBA claims that the current system is anti-competitive and crowds-out the private sector, to the detriment and cost to the consumer. What the MBA really means is that they wish to spread the risk from the lenders to the GSEs; and to subsidize their own cost of doing business in the process. This initiative ranks as nothing more than the suborning of the taxpayers’ funds and fiduciary interest by the private sector. The system doesn’t work without the GSE Federal guarantee; but for some reason (allegedly competition) the Federal guarantee should be shared with the private sector for no consideration in return.
It is clear that Private Capital has seen the process by which the Fed buys mortgage bonds from the GSEs; and would like a piece of the action. One group would like to own the GSEs; and the other would like to get access to the GSEs’ low cost of funds and guarantees. Both groups claim that the “Federal Monopoly” of this process is damaging the housing market; however looking at the performance of house prices it is hard to understand how they have been harmed. If anything, Federal involvement has boosted prices far more than Private Capital ever could. It is also a fact that Private Capital has benefited from this boost in prices. What they mean is that the “Federal Monopoly” is now damaging their bottom lines; and forcing them to take more risk with house prices. Both camps would like to mitigate this risk by getting access to the Federal mother lode of funding and guarantees. What they both understand is that they still need the Federal guarantee however, to make the economics work by lowering funding and insurance costs. These GSE capture schemes are therefore another example of the way the Too Big to Fail (TBTF) Banks are using the implied Federal Bailout to lower their funding and operational costs.
It is by no means certain that Fannie Mae will play along with the Private Capital that is seeking to share its “Federal Monopoly”. The recent statements and posturing, suggest intentions and capabilities to continue to operate with its expanded footprint[viii]. Far from shrinking, Fannie Mae intends to get much Too Bigger to Fail. It is clear that Fannie Mae sees its role in the transfer of distressed mortgage vintages to the Fed as focal.
Private Capital may however not get things all its own way. A significant counter-offensive is being mounted by the Americans For Financial Reform. In a recent letter[ix], they called on Congress to stand against HR 1077, the bill being shepherded by Representative Huizenga(R-Ml) to obscure the language in mortgage documentation. The letter states that:
“The approach taken in this bill, which is misleadingly named the Consumer Mortgage Choice Act, is a flashback to the recent subprime crisis.
Households and communities across the country have yet to recover from the recent subprime lending crisis, and Congress should learn from the past instead of creating incentives to repeat these lending abuses.”
The list of signatories deserves to be reproduced, to reflect the gravitas of the matter; and also to show the members of “Main Street” who are being penalised again as “Wall Street” returns to the status quo. In Housing Smoke and Mirrors (6)[x], it was noted that parts of the housing market were beginning to evince signals associated with the previous bubble. The Americans For Financial Freedom provides further evidence that this is the case. We also raised the issue that:
“This thesis implies that the Fed has to buy “Zombie Mortgages” via its MBA purchases; so that it is therefore complicit in the process that has created misery for so many.”
It would be interesting to see what would happen if a letter like this one was sent to Bernanke for comment. Bernanke is a strong advocate of plain speech and full disclosure; so finding the Fed buying securities that are based on assets that do not conform to these principles will be an interesting conflict to observe. Will he compromise on his principles, in order to save the housing market, at the cost to this section of American society? We shall see in due course; because the question is not rhetorical.
The omens for any response with alacrity from Washington, to the Americans For Financial Reform are not good. The Washington Post summed up the mood best; in a piece that opined how lawmakers had decided to sit back and do nothing, since the Fed and the Sequester were running the country and the stock market was doing the proxy voting[xi]. Given this inertia, it is therefore not surprising that faster-witted bankers and lobbyists have been able to advance the situation back to the pre-crisis status quo. It appears that the lawmakers have forgotten that they live in a democracy that holds them accountable at the ballot box. They have also forgotten that the bull market in stocks is not being participated in by most Americans. When it is their turn to vote again, those who have missed the rally may feel even more inclined to punish those responsible for their loss off opportunity.
The banks are erecting elaborate defences for their franchises; and justifications for the return to the status quo. Goldman has been noticeably busy; and has just prepared an analysis that refutes the assertion that the Too Big to Fail Banks get an implied Federal discount on their funding costs[xii]. Goldman cherry picked the data, only going back as far as 1999, to then show that on average there is no discount. The whole point is that this discount only appeared after 2008 however. Bill Gross exposed the fallacy with simple logic, when he tweeted “Why can banks earn 25 bps with overnight repo while all others earn nothing? 3 billion dollar subsidy from #Fed!” Citigroup has been the most successful to date in the reversion back to status quo; having managed to write seventy of the eighty five lines in a watered down derivatives bill that sailed through the House Financial Services Committee[xiii]. Elizabeth Warren has detected a more insidious case of status quo creep from the banks[xiv]. She alleges that they are using global trade negotiations as a tool to weaken Dodd-Frank; by supporting foreign reservations about its application in non-US locations where they have operations.
The view from the trenches inhabited by Americans is looking even more ominous. Existing Home Inventory has just started to converge rapidly on the trajectory it followed in 2010. That 2010 experience was also combined with an unfolding Eurozone crisis; which is another omen that is visible today. Back in 2010, James Bullard announced the beginning of the QE programme that targeted the mortgage security market; and is responsible for getting the bubble back to where it is today. If history is a useful guide, the Fed is now in the process of another bold programme that will modify and acquire all the delinquent mortgages that are behind the rise of the current Existing Home Inventory to the 2010 level.
The ominous signs from the Existing Homes Sector continued. The housing market has been classified as a sellers’ market in the rally. Zillow has however started to qualify this description. According to Zillow, there are 22 million homes in negative equity. The owners of these homes are unwilling to take the loss, so they are holding them off the market, in the hope that prices will increase[xv].
The rising Existing Home Inventory suggests that some owners are deciding to sell into the rising market. It is however more likely that it is the banks who are triggering these sales; and forcing the owners to become renters.
Even the FHFA has started to frame the positive news on rising home prices in less positive terms. In its latest Home Price Index it introduced a new tool, for relative performance measurement, that takes the distressed short sales out[xvi]. The summary conclusion was interesting:
‘FHFA’s “distress-free” house price indexes, which were recently released for 12 large metropolitan areas, generally report lower quarterly appreciation than FHFA’s traditional purchase-only indexes. In 11 of the 12 areas covered, the new series—which removes the direct effect of short sales and sales of bank-owned properties —shows lower appreciation in the latest quarter than the purchase-only series.’
The inclusion of distressed short-sales almost doubles the rate of price appreciation. The impressive 6.7% appreciation shown above is therefore only half this figure, if one deducts the impact of distressed short-sales. The rising blue bar depicts a return to bubble changes in house prices, but this bubble is being created by distressed short-sales. One can conclude that the bubble in housing is therefore a bubble in distressed short-sales. The signs from the rising inventory data, suggest that this bubble is about to deflate.
In Housing Smoke and Mirrors – “Schizophrenic US Housing Market”[xvii],[xviii], it was observed that distressed home prices were beginning to fall behind the broad market rise in prices. Now we find from the FHFA that it is these same distressed homes that have caused most of the increase in broad market prices. Combining these two inputs leads to the rational conclusion that the market is reaching a turning point, after which it heads lower.
The Home Builders are aggressively managing their own inventory to maintain the continued stellar rise in prices. They have adapted their business model to make profit on price rather than volume of houses sold. Consequently the Completion and Under Construction categories are beginning to taper off, whilst the Not Started category begins to rise.
Thus even though the recovery in the New Home sector is only at a level associated with the troughs of previous recessions, the shares of these companies suggest that the market is back at the crest of the wave.
The real threat to the housing market is however coming from the Fed. The recent communications have become equivocal about the timing and conditions of the exit from QE[xix]. Primary Dealers in the US Treasury Bond market are binary animals; who sell when there is doubt. The creeping doubt in their minds has caused a serious back-up in yields; that now not only threatens the housing market but also the whole economy. With falling inflation, rising real interest rates become even more burdensome. Flat incomes are rapidly consumed by rising real interest costs, on mortgages taken out at house prices inflated by the control of supply. Consumption is hit and the economy begins to slow. A point is then reached at which the economy slows and house prices fall, leading to negative equity again.
Zillow has begun to speak openly and honestly about the negative equity situation. In its recent report it stated that[xx]:
“The negative equity rate has been continually falling for the past four quarters, with the first quarter of 2013 being down significantly from the first quarter of 2012 at 31.4% – a decrease of 6 percentage points. In the first quarter of 2013, more than 730,000 American homeowners were freed from negative equity. However, 13 million homeowners with a mortgage remain underwater. Moreover, the effective negative equity rate nationally —where the loan-to-value ratio is more than 80%, making it difficult for a homeowner to afford the down payment on another home — is 43.6% of homeowners with a mortgage.”
Four years into an economic recovery 43 per cent of homes are still in negative equity.
Las Vegas and Phoenix look the most seriously afflicted in this respect.
According to its latest Volume Report for April[xxi], the overall delinquency rate in Freddie Mac’s portfolios dropped below 3 per cent for the first time since the beginning of the housing crisis, to 2.91 per cent. It was 3.03 per cent in March. The Non-credit enhanced delinquency rates dropped 9 basis points to 2.40 percent and the credit enhanced portion of the portfolio had a rate of 6.42 per cent compared to 6.74 per cent the previous month. Modification is now the major driver of Freddie Mac’s improving delinquency profile; and as was reported earlier these modifications are swiftly securitized and sold to the Fed.