Housing Smoke and Mirrors (14) – “Style Drift”

Written by , KeySignals.com

Source: The Background of Style Analysis

In Housing Smoke and Mirrors “Sharing the Pain Cake”, the Federal Government’s drift towards GSE reform was observed at the worst possible timing against a backdrop of rising interest rates. It was assumed that the policy makers were basing their actions on the belief that the speculative rise in house prices still had momentum; and was now accepted as a fundamental confirmation of the strength in the economy.

The June Fannie May National Housing Survey provides an opportunity to benchmark the policy makers’ assumptions and actions[i].

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Source: June Fannie Mae National Housing Survey

The survey shows clearly that there is a strong consensus that interest rates are in a rising trend. There is also a weaker consensus that house prices will continue to rise. Fannie Mae admits that the rise in interest rates has forced buyers into the market; to lock in their fixed financing costs before they rise further. The expected rise in house prices should therefore be put into this technical squeeze context. This context is further supported by the survey results that show that the rate of house price rises is expected to slow. This inherent weakness is confirmed by the fall in the number of respondents who think that is a good time to sell and a good time to buy. The sellers may see rising interest rates weakening prices; and therefore do not wish to create more supply. The sellers may also see buyers jumping in to lock in mortgage costs and may therefore wish to pull inventory off the market to squeeze prices higher; as they have been doing since 2009. Buyers see that rising interest rates are softening house prices; and therefore do not fundamentally see a good reason to buy. It is at times like this that surveys such as this need to ask more difficult questions to provide a clearer picture. There is clearly some emerging counter-trend force developing, that needs greater understanding.

The dynamics of foreclosure show a corresponding ambiguity to the Fannie Mae data. The May CoreLogic survey reported a drop in foreclosure activity. The highlights showed that:

  1. Less than 5.6 Percent of Residential Mortgages Are Seriously Delinquent, the Lowest Level Since December 2008
  2. Shadow Inventory Falls Below 2 Million Homes – A First Since the Downturn in Fall 2008
  3. Completed Foreclosures Declined 27 Percent Year Over Year as of May 2013

The Mortgage Bankers Association also reported that lending standards eased in June[ii]. Moving from May to June, things seemed to be improving.

The ambiguity was introduced by RealtyTrac’s analysis of the June foreclosure activity[iii]. Whilst admitting that the foreclosure data was improving against longer term comparison points, the shorter term improvement was being challenged. This challenge is coming from a 34% year on year jump in Judicial Foreclosures in June. This observation was described as follows by RealtyTrac’s representative:

Daren Blomquist – Vice President at RealtyTrac, said –

“The increases in judicial foreclosure auctions demonstrate that these delayed foreclosure cases are now being moved more quickly through to foreclosure completion. Given the rising home prices in most of these markets, it is an opportune time for lenders to dispose of these distressed properties, either at the foreclosure auction to a third-party buyer, or by repossessing the property at the auction and subsequently selling it as a bank-owned home.”

It is clear that the banks have reacted to the Fed’s “Taper Talk” with alacrity; and started to sell into the price strength.

Further ambiguity was found in the latest FICO survey[iv]. The headline positively frames the data to show that 47% of bankers surveyed expect delinquencies to decline. This however implies that 53% of bankers do not expect delinquencies to decline. When looked at this way, the situation has hardly improved.

It has been observed that Private Capital has been the most significant driver of house price gains this year. Private Capital has looked to capitalize on the growing trend to renting rather than ownership; and the rising rental premiums that can be collected to exploit this situation. Blackstone Group, the doyen of Private Capital and its footprint in housing, gave off a strong signal of the ambiguity developing since the “Taper Talk” gained currency as interest rates rose[v]. Blackstone is taking a less risky position, by changing its strategy from owning rental properties to lending to investors who wish to own. Blackstone does not see an attractive risk adjusted return from chasing the offer side of the market; and wishes to let late-comers to the party assume this risk. Blackstone will finance the stampede; and seize the assets when the over-leveraged speculators cannot earn a rental income to cover their borrowing costs. The steepening yield curve, which has occurred since the Fed began the “Taper” process, now makes it more attractive to become a lender than an owner. An owner has real equity risk; the lender has a more protected capital position even though he may ultimately end up owning the asset. Since Blackstone always wanted the asset, it has found a less risky way to get its hands on it. Blackstone can borrow short and lend long against the investors it finances; achieving a greater return on equity. As interest rates rise, Blackstone can earn increased income as the loans it has made reset higher. If credit spreads widen and the yield curve steepens, it can earn an even higher risk adjusted return. Blackstone has become a bank, without all the regulatory costs of being a bank. Since the policy makers are now intent on applying Basel III, banks will no longer find it attractive to finance the housing market. Private Capital will become the new Shadow Banking System for housing. Since it will not have onerous capital adequacy standards applied, Private Capital will be able to enter the space that the Too Big to Fail banks are being regulated out of. When the housing bubble pops, Blackstone will “Bail-in” the speculators and enter the rental market through this liquidation phase.

Smart Money is positioning itself for the next crisis. This crisis will see even more Americans forced to rent, but will give the investors a less risky price entry point. On the positive side, American Taxpayers will not have to “Bail-out” any more Too Big to Fail Banks. One hopes that the likes of Blackstone do not do another Long Term Capital and force a “Bail-out” by the same banks who they have replaced as the main lender to the housing market. One suspects however that this is what will happen; as new crises create policy flip-flops and profitable opportunities for a Wall Street that always falls between the regulatory cracks.

The boundaries of these regulatory cracks are currently being drawn, by policy makers who are anxious to get ahead of the next crisis which approaches as the Fed gets closer to its exit from QE. Senators McCain and Warren are busy resuscitating Glass-Steagall[vi]. Representative Hensarling has begun his own “holistic” model for the GSE’s in Congress. In his model, the banks would retain all their mortgages on their books and issue covered bonds against them. The GSE’s would be little more than a utility to facilitate the covered bond syndication process; and there would be no implicit Federal Guarantees. With no guarantee and the rise in capital adequacy from Basel III, the housing market becomes very unattractive to bankers. As we have seen, Private Capital is waiting on the side-lines to take their place. Private Capital however does not intend to pay up for something that will have inherent private capital risk, once the Federal Guarantees and implicit “Bail-outs” have gone. Private Capital is also upset at the way the bankers have squeezed housing inventories and prices; so that Private Capital has not had the great vulture fire sale to pick up assets that it anticipated when it raised its war chest from 2009 to date. Private Capital and the banks are at odds with each other; and Private Capital is now positioning itself for the next crisis that will allow it take over the traditional bankers’ franchise. The housing sector is the most important driver of the US Economy; so the prize is worth fighting over.

The bankers themselves are fighting back against this attack from policy makers and Private Capital. The Mortgage Bankers Association (MBA) eviscerated the attempts of the FHFA at securitization and reduction of the Federal footprint in housing[vii]. The bankers say that the FHFA process lacks clarity and purpose. By implication, the FHFA is executing a covert housing stimulus by the Government rather than any genuine reform. The bankers therefore are demanding a seat at the table in the creation of the new rules and architecture for the housing market. In effect, they wish to level the playing field that is now tipping heavily towards Private Capital on the side-lines. Money (or rather capital) talks more than words however. The banks have no capital, so they have nothing to bargain with. In fact they are in a position of weakness; because they have legacy housing assets against which they must maintain expensive equity capital. Private Capital is what it says it is; pure unencumbered equity capital. The banks must either sell themselves, or their asset books, to Private Capital. It is unlikely that Private Capital will buy banks, since it would then need to put up more equity capital to maintain the business. It is much more likely that the banks will get broken up and sell the businesses which are too capital intensive to maintain under the new Basel III regime. The buyers will be non-banks who don’t need the regulatory capital to maintain the assets.

The latest new Age of Capital is upon us, in which the provision of public services (of which US Housing Policy is the prime example) goes into the private sector. Federal budget deficits will shrink, as the assets are transferred to Private Capital. The banks will find a way to survive by lending to the Private Capital owners of the new privatized businesses. Leveraged exposure to Private Capital will then build up in the banks. When this bubble bursts, Private Capital will then turn to the Federal Government and ask for a “Bail-out”. Private Capital will threaten that there will be a Depression and collapse of public service (which it now owns) provision unless Federal Funds are used to bail it out. The banks will no doubt foreclose on Private Capital and take some of these assets back. Ultimately the Taxpayer will end up paying for the mistakes of Private Capital and the banks again; and possibly owning these assets again until some time when Private Capital has gathered the funds to take them back.

There will however be notable exceptions and outsize winners in this asset transfer. These winners are termed Smart Money. Blackstone Group can be viewed as the exception, since its objective has always been to buy into the housing market. It has positioned itself in anticipation of acquiring the housing market during the next liquidation phase, after the housing bubble bursts again. Blackstone will earn rising income on the increase in interest rates that triggers the next crisis; and will then liquidate its borrowers to acquire the underlying housing assets during the crisis. Blackstone is being paid for its patience and will be rewarded with a cheap entry into a dominant scale position in the sector. One hopes that “Basel IV” will have taken account of Blackstone’s systemic profile when the time comes.



  1. Rising Prices, Rates Could Force Some Buyers off Fence
  2. Mortgage Credit Eased Slightly in June MBA Says
  3. Foreclosure Filings Hit Six-and-a-Half-Year Low in June
  4. Survey: 47% of Bankers Expect Mortgage Delinquencies to Decrease
  5. Blackstone Raises $5 Billion Rental Bet With Lending Arm
  6. Warren Joins McCain to Push New Glass-Steagall Law for Banks
  7. MBA Highlights Growing Concerns Over FHFA’s Execution of Securitization Plan


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