In Housing Smoke and Mirrors “The Mendacity of HOPE (and HARP and HAMP)” the use of various “Federal Acronyms” to launch another economic stimulus by stealth through the housing market was introduced. This strategy can be seen as a response to the current political grid-lock which is blocking further fiscal stimulus. To be executed successfully, this strategy involves the complicity of the Federal Reserve to provide monetary stimulus through its balance sheet. The nomination of Sarah Bloom Raskin to Treasury Deputy Secretary was a key signal in this process[i]. This strategy should be put into the overall context of the Administration’s attempts to focus economic policy on the Middle Class; which was covered by a related discussion in Terminal Velocity “Gatsbied”[ii].
The “Audacity of HOPE NOW” was evident in its latest communication on this programme[iii]. Foreclosure Starts were down 30 percent in Q2 from Q1; and Foreclosures Sales were down 2 percent for the same period. The annual comparisons were even more telling. Permanent modifications were up 12 percent in Q2/2013 versus Q2/2012. Foreclosure Starts were down 38 percent year-over-year and Foreclosure Sales declined by 15 percent. HOPE NOW has become the main driver of the mortgage modification process which is supporting the housing market. By keeping people in homes, it keeps homes off the market; and therefore contributes to the tight inventory that is boosting prices. HOPE NOW is therefore a significant driver of house price inflation. To sustain this process, the modified mortgages that derive from these houses must be securitised by the GSEs and monetised by the Fed balance sheet.
The banks have been happy to enrole voluntarily in HOPE NOW and HAMP for the very reason that it has supported the value of the majority of their mortgage portfolios which are not in the programme. Thus far, there has been aligned interest between the banks and the Government to maintain house prices. The loss of interest and principal to the banks, on modified mortgages, has been much less than the boost in house prices and value of unmodified mortgages. HOPE NOW can be seen as a tool to leverage the value of house prices. It starts to fail at the point when the rise in houses prices requires more modifications than there are mortgages that remain unmodified. At this tipping point the HOPE NOW programme is literally cannibalising the mortgage assets of the banks in the programme and destroying value in their portfolios. HOPE NOW then becomes the equivalent of an enforced prepayment cycle. At such a tipping point, one can expect the banks to suddenly become averse to participating voluntarily in the programme. At this point they will start to hit the bid on the Short Sales more aggressively and the housing market will begin to implode again. The recent rise in interest rates must have made the banks more trigger happy.
There are signs that the power of the HOPE NOW monetary machine is failing. The FNC Residential Price Index suggests that price appreciation has been far more modest than that shown by other publicised data[iv]. One reason for this discrepancy is that the other data sources use repeat sales of distressed properties; which therefore have a lower base effect that is compounded by multiple re-sales. Closer inspection of the data also shows that price increases peaked in January 2013. The big rally from January 2012 has run out of steam. In the absence of further stimulus by the Federal Government and/or the Federal Reserve, the deceleration could become a sell-off; especially if interest rates continue to rise. Against this background of deceleration, it is clear why the Federal Government is reaching for a new stimulus strategy. It remains to be seen if this strategy is embraced by the banks. Should the banks not embrace it the inference is that the tipping point has been reached.
The “Audacity of the FHA” was signalled in its latest “Back to Work” campaign launch[v]. The name itself resonates with the Administration’s call to arms to defend the Middle Class. Current accepted business practice, in the credit rating industry, effectively blacklists individuals who have fallen on hard times through job loss and inability to meet debt payments. Even after working their way back into a position of ability to pay, these individuals still find their credit history blacklisted; so that they cannot get affordable credit going forward. The period in this Debtors’ Purgatory is anywhere from three to seven years. In economic terms, this is a three to seven year hole in potential consumer demand. The “Back to Work” programme will allow these people to erase this bad credit story from their records; if they can prove with documentation that they were “victims” of the recession. There are various boxes to be ticked to qualify as a “victim”; however the sheet is designed to be inclusive, so that there should be no shortage of bodies. “Audacity of the FHA” meets the “Mendacity” of those who provide the “documentation” to erase the very real credit event of the recession from the officially recorded history. In the Monopoly analogy, that we have used to illustrate Housing Smoke and Mirrors from time to time, this is the analogy of a Get out of Jail card. The data footprint of the recession is erased permanently; as if it had never happened. Suddenly all the quants and risk managers, who are supposed to model the behaviour of capital markets’ prices to avoid another crash, are faced with “garbage in”; and so the cycle of boom and bust can repeat itself. At the same time they are finding that the interest and principle, they valued on their mortgage portfolios, is being reduced by HAMP. In order to create more valuable assets (and hence profits and bonuses) they will have to accept the new “garbage in” credit story; to replace the lost modified income and principle with new assets. The cruel irony is that they will be lending to the very same individuals who are modifying their mortgages. Some banks, if they have any sense, will get out of this business and find something less risky. Those that do not get out of the business will perpetuate the boom and bust cycle. Efficient Markets Hypothesis and Capital Asset Pricing Models, which still form the basis of these rudimentary models, are undermined furthermore by political and pecuniary behaviour. It is amusing to watch this dynamic interplay of “Audacity” and “Mendacity” as the President calls on regulators to swiftly enact “TBTF” banking reforms[vi]; whilst the FHA is erasing the real data inputs that are critical for success of this reform.
“Audacity” meets “Mendacity” full on in the GSEs. On the 19th August a Government auditor opined that the two GSEs had failed to account for overdue payments for the last three years[vii]. This accounting inertia is alleged to be due to a failure to implement the appropriate accounting system during this time. The GSEs have failed to provision for these delinquent loans; and have instead paid the provision money straight back to the Treasury and called it profit. This kind of fraud is only possible in Government accounting systems and ownership; since there is no law or statute that covers it. The President’s call for Wall Street reform sounds a little more “Audacious” and “Mendacious” when one sees what is going on at the unreformed GSEs. The Federal Footprint has got larger and deeper into the red in accounting terms, whilst the GSEs have effectively erased this increased loss from their books for the last three years. In the meantime, there has been some greatly publicised initiative to shrink the size of the Federal Footprint in the GSEs. One wonders what price a private investor in the GSEs will pay for them, after doing due diligence on this three year rolling loss. Presumably this three year off-balance sheet loss is destined for HOPE and HAMP restructuring and then the Fed’s balance sheet.