The dissonance observed in Housing Smoke and Mirrors “Re-tuning the HARP”, “Name That Tune” and “Dude Where’s My Housing Recovery” has started to become the familiar monotone of weakness.
Since the back up in mortgage interest rates, after the “Taper” talk began, only 12% of loans are now “Refinancible”; as many borrowers now have existing mortgages that are at a lower rate of interest than is currently available[i]. The refinancing window is now barely open.
Fannie Mae and Freddie Mac both reported continued declines in serious delinquencies throughout June; to the lowest rates on record since December 2008. The improving delinquency picture is having an asymmetric impact on the housing market however. In its latest National Consumer Credit Trends report, Equifax noted that the total balance for seriously delinquent first mortgages decreased to a five-year low thanks to the improvement in home equity[ii]. This improving home equity position seems to have brought out the sellers however. Redfin recently reported that the prospect of rising mortgage interest rates has prompted fears amongst homeowners that the rise in prices will not last[iii]. The combination of improving home equity and interest rate expectations has triggered the increase in inventory supply coming to market.
Existing Home Inventory is therefore running at an elevated level; which is tracking the crisis profile of 2010 which led to QE2[iv].
CoreLogic’s most recent Case Shiller report opined that the current “Seller’s Market” will not persist much longer[v]. Rising interest rates and rising house prices are expected to feedback into reduced demand. 2013 is projected to be the high-water mark for house prices; which is significantly lower than the 2005 peak. This correction in prices is however expected to sustain demand going forward; so that a repeat of the 2008 crash is avoided.
According to the Lender Processing Service there was an uptick in delinquencies in June; which was allegedly “seasonal”[vi]. This “seasonal” correction created a 10% spike in delinquencies for the month. Since this occurred against a backdrop of rising interest rates, the seasonal explanation may actually be incorrect; and something more fundamental may be starting. The rise in interest rates may already be triggering a fall in prices and a rise in delinquencies. Trulia commented that in addition to rising interest rates and rising prices, choking off demand that, falling investor interest was also limiting the rise in house prices[vii].
There was also a more disturbing development evident in June. The Federal Reserve Senior Loan Officer Report for June observed that bank lending standards had eased and that demand for credit had increased[viii]. This positive tone was undermined by the observation, by the Mortgage Bankers Association, that there had been an increase in Home Equity withdrawals; and that Subprime lending related to these withdrawals had increased[ix]. There are signs that speculative froth, similar to that seen before the crisis of 2008, was bubbling in the housing sector. It is to be hoped that the recent rise in interest rates, triggered by the Fed, has had the desired effect of purging the market of this speculative excess at this stage in the economic recovery.
The revanchist attitude of the financial sector and related Federal Government policy bodies, to the growing threat to their franchises from Eminent Domain, is becoming more vitriolic. The issue of Eminent Domain was introduced in Housing Smoke and Mirrors “Sell Your House in May and Go Away”[x]. The New York Fed has been instrumental in promoting it. Its paper, entitled “Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt”[xi], framed the issue as a legal solution to the derelict property problem. This solution is now starting to be applied by some local authorities, much to the annoyance of the Mortgage Bankers Association[xii].
Blackrock has been observed, subtly shifting its housing risk position away from direct home ownership towards lending exposure to the rental sector; as the dynamics of the sector and the economy slow. In Housing Smoke and Mirrors “Dude Where’s My Housing Recovery?” this situation was observed as follows:
In Housing Smoke and Mirrors “Style Drift” the strategy of the Blackstone Group was seen drifting, away from property ownership, towards lending against rental property assets[xiii]. This style drift has continued, with Blackstone Group now signalling its intentions to issue a covered bond against its rental property portfolio. Blackstone is hedging itself against a rise in interest rates that will reduce its profit margins; by effectively locking in its borrowing costs and maintaining the option on raising rents. Blackstone is not exiting the sector, so clearly it still believes in the early bubble thesis; it is however positioning for rising inflation and rising interest rates.
Eminent Domain is now creating a direct legal challenge and threat to Blackrock’s evolving business model and risk position. State and Local Government compulsory purchases of derelict housing is a new entrant and direct competitor to Blackrock; especially when these purchases are at significant discounts to the entry prices that Blackrock has been getting. Blackrock, with the help of PIMCO, has therefore begun the process of legally challenging Eminent Domain in the courts[xiv].
Private Capital has begun the challenge to Eminent Domain. This is a rational outcome, since Eminent Domain is a direct threat to the principles of Capitalism. What is more interesting to observe is the irrational behaviour of the Federal Government. Eminent Domain clearly threatens the Federal Government’s strategy to continue the Federal housing stimulus; whilst simultaneously appearing to reform the GSE’s, by making the Federal Footprint in them smaller. The FHFA[xv] and Freddie Mac[xvi] have wasted no time jumping on the bandwagon and attacking Eminent Domain. In the context of the Eminent Domain threat, it was therefore no surprise to see the Obama Administration reveal more of its intentions and capabilities in relation to reform of the housing market. The President outlined his general ideas on reduction of the Federal Housing Footprint; but it was light on the kind of detail in which the Devil is always found[xvii]. Broadly speaking, he is trying to adopt a bipartisan solution; which will inject greater private capital and the alleged discipline and risk management that comes with it. The Federal Reserve knows, from bitter experience of the various iterations of QE, that private capital and the aligned interest of the Federal Government are what created the lack of discipline in the first place. Going forward, the Fed is raising capital adequacy standards and regulatory oversight to such a degree, that it is doubtful that Private Capital will be able to turn a meaningful profit in any case. The Fed therefore understands that it will be its balance sheet, which eventually becomes the ultimate solution and stimulus for housing, once the GSEs have been wound down and Private Capital has priced itself out of the market. It is with this understanding that the Fed has set out to create the landscape of the housing market and its financing, which will fit the expanded balance sheet and regulatory primacy of its remit. It is becoming clear that the New York Fed has deliberately opened this Eminent Domain can of worms; in order to force a solution upon the banks and politicians who created the problem that has fallen to the Fed to solve. By opening this can or worms, the Fed has triggered a legal and constitutional battle between the Federal Government and State and Local Governments. The Fed will let the Federal and State lawmakers fight themselves into the ground; and then pick up the pieces, through its expanded balance sheet, on its own legal and financial terms.
Freddie Mac followed the President’s lead and elaborated on its plans for reform and private capital injection[xviii]. A cursory look at the numbers shows that the Federal Footprint has effectively doubled since the crisis began. Fannie Mae’s latest earnings report had to admit that 75% of its current portfolio had been created since 2008. A familiar trip down memory lane should also remind that it was the expanding Federal Footprint before the crisis that led to the Housing Bubble. Clearly, Private Capital would now like to shift this expanded Federal Footprint onto its own balance sheet; with cheap funding and capital loss protection features that will compensate for the increased capital requirements which will be needed to play in this sector. This huge Federal Footprint cannot be allowed to shrink in size, since this would mean an economic depression. It must therefore be reassigned to a new warehouse. Private Capital would like to be this warehouse on favourable financial and legal terms. The Federal Reserve understands that its balance sheet is effectively the guarantor and source of the cheap funding that creates the profits. The Fed currently returns these profits to the Taxpayer; and Private Capital would like to substitute itself for said Taxpayer on the same financial and legal terms. This is a political issue; so the Fed has therefore engineered the new dialectic between Federal Government, State and Local Government and GSEs, which bring legal clarity to the ownership of the warehouse. Currently, the Fed balance sheet is the warehouse which remits profits to the Federal Government. If the GSEs are taken out, then the Fed will effectively lose the Federal Guarantee of the mortgage assets on its balance sheet; which is a very serious legal (and pecuniary) issue. In preparation, the Fed is forcing the banks who will replace the GSEs to take on more capital buffers; in order to mitigate this new credit risk. It may also demand that the Federal Government also underwrites some of the future potential capital losses. If Eminent Domain becomes prevalent, the Fed will have State and Local credit risk; so it is now seeing how this issue plays out constitutionally.
The Fed has understood that it is the key driver for the future of the American economy. The Obama Administration also understands this; and is now trying to engineer political control of the Fed, so that its balance sheet can be used to compensate for the economic headwinds from the enforced fiscal discipline created by the political gridlock in Congress. The Federal Footprint can be made to appear to shrink, as the GSEs are shrunk, however the Footprint will be expanded by stealth, through the political control of the Fed. Administration housing stimuli have traditionally lurked behind eponymous acronyms, such as HOPE Now, HAMP and HARP; which beguile whilst offering emotive solutions. The President’s speech on housing reform, subtly hinted that HARP would expand even as the GSEs were shrunk.
Un-coincidentally, the Office of the Inspector General of HARP simultaneously gave its “first-half report” on the programme. The report was framed so that the main criteria for success were the size and the speed with which HARP can be deployed. The OIG HARP came to the swift conclusion that the programme had been successful to date, judged by these criteria; but that there was more room for improved speed and increased magnitude. The perspective and context of the Taxpayer, who actually pays the OIG’s wages, was treated with condescending equivocation. It was admitted that the success of HARP, based on the speed and volume criteria, actually reduced the income for the Taxpayer through refinancing of lower mortgage balances at lower rates of interest on the same underlying housing assets. No objective valuation of the increased risk or costs to the Taxpayer was made. This clearly illustrates the intentions and capabilities of the Administration to apply HARP going forward. HARP and other acronyms like it, are nothing more than Federal bailout and stimulus programmes. They are audited by criteria that actually incentivize them to be profligate and abusive. In future there will be no obvious signs of “TBTF”, because it will have been fully socialised within the institutional charter of the “Acronyms”. The Fed will then be captured or coerced into monetising the problem away. It is therefore clear that the Federal Footprint will not shrink; the shoes will simply change in name, but they will be the same size or even larger[xix]. The Fed’s monetary complicity is also required. The replacement for Bernanke will be a key driver of this process. The move of Bloom Raskin from Fed to Treasury, represents the tactical acme of skill in executing this strategy[xx]. There will also be additional Fed vacancies; coming from the retirement of Elizabeth Duke and the end of Jerome Powell’s tenure in a year’s time, which provide opportunities to advance the process. If Janet Yellen is overlooked, it is unlikely that she will stick around and be humiliated further; so another vacancy and opportunity may appear.
The Administration therefore has the opportunity to politicize the Fed; however this can break down in the nomination and confirmation process. It is our suspicion that the Fed has a few tricks of its own up its sleeve to maintain its independence and expand its control over the economy; and potentially the politicians also. The democratic process delivers gridlock and a political vacuum; into which the Fed can project itself as the custodian of America’s economic survival.
This projection of Fed power and influence has been very successful so far, despite the criticisms of those observers who are in denial of the facts; and still cling fondly to what they have been taught about efficient markets that are free from political intervention[xxi].
The July Fannie Mae National Housing Survey, signalled that the Taper talk, instigated by Bernanke back in April, has had the desired outcome of raising interest rate expectations without significantly lowering economic performance expectations.
Despite inflammatory headlines to the contrary, the Fed’s Communication Policy is working.
One should not however develop a false sense of security. The Fed has opined that it is data dependent; therefore the prudent economic actor should also adopt this position. In relation to the housing data, there have been some early warning signals of danger on the horizon. These early warning signals also indicate where the next crisis will show up. Not surprisingly, this crisis appears to be forming in the FHA; which is the warehouse being positioned by the Federal Government to replace the GSEs.
GSE REO inventory is declining in all cases except those involving the FHA. Clearly, the next crisis is being shifted to the FHA’s (Federal) balance sheet. Rising FHA inventory indicates that the banks (and Private Capital) are hitting the Federal Bid, well in advance of the next crisis.
Moving into the second half of this year, there have been early signals that the rise in house prices has cooled and reversed in some areas. There have also been signals of motivated sellers bringing inventory to market. Behind this increase in supply and falling prices, there has finally appeared a rise in delinquencies. It now remains to be seen, if this correction has been engineered by the Fed; or whether it is a systemic problem developing again that the Fed will ultimately have to apply even more of the balance sheet solution too in the future. Political ineptitude is also evident, as it was in 2008; but the Fed has stared into this void before and has seen a way through it.