Housing Smoke and Mirrors (21) – “I’ll Be Back”

Written by , KeySignals.com

The sector reports from July signal the point at which the rise in interest rates started to erode the strength of the housing market. The most attrition was evident in the mortgage lending business itself.

Mortgage Daily’s Mortgage Employment Index reported that a net three thousand jobs were lost in the mortgage industry i during the second quarter. From April to June, the mortgage industry experienced 9,950 job losses, whilst creating 6,969 new positions; leading to a net 2,981 layoffs. This level of job cuts represents the biggest total drop since the first quarter of 2009. Wells Fargo announced that it will be cutting 20% of its mortgage production staff ii. The cuts are expected to fall mainly in the refinancing unit; because of the drop off in activity as a consequence of higher interest rates. The Mortgage Bankers Association confirmed the bleak outlook iii. Mortgage business profitability was reported to have fallen 14% in the second quarter of the year. This drop was driven by the fall in refinancing activity. As refinancing fell, purchase loans increased from 45% to make up 52% of mortgage business volumes.

Drilling down into the purchase business data, the July New Home Sales data plunged dramatically; suggesting that higher interest rates were taking their toll here also.

The S&P Case-Shiller data for July showed a levelling-off in the rate of price appreciation in most Metro areas iv.

Pending Home Sales also declined in August; confirming that the contagion from higher interest rates was pervasive.

Looking further into the interest rate affected dynamics of the purchase market, it was noted that the cash component in transactions was rising.

In July, RealtyTrac saw cash buyers driving the purchase market; as rising interest rates forced out leveraged buyers v.

RealtyTrac also saw distressed sales, via the Short Sale process, continuing to run at elevated levels. It is therefore clear that the housing market is still in distress; and that cash speculators are now beginning to command pricing power.

July seems to have been a point at which house price momentum was significantly lost. Against this deteriorating backdrop, it was therefore interesting to observe the swift back-pedalling of the regulators in relation to Dodd-Frank. The loss in price momentum suggests the loss in improvement in bank mortgage portfolios; and also GSE and Fed balance sheet derivative mortgage backed asset positions. The mortgage industry is re-entering a pre-crisis phase; similar to that which led to the sudden realization that it was in trouble in 2008.

The Fed has done its bit to head off this inflection point; but has undermined this work with the “Taper”. It is now time for the regulators to roll back the systemic risk strengthening process, which has been on-going since 2008, so that the banks and GSEs can once again sit on losses without having to trigger capital market volatility and raise risk capital. The Board of Governors of the Federal Reserve System, the Department of Housing and Urban Development, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission all issued amendments to the original proposals for Dodd-Frank vi.

Original Dodd-Frank proposals had required banks to keep more “skin in the game” and hence more capital employed; by requiring them to retain securitized mortgages on their books. This retention scheme was supposed to encourage enlightened underwriting standards. Risk was intended to be calculated on the face value (par value) of said underwritten mortgages. The latest proposals water down this provision to allow risk to be evaluated at “market prices”. Clearly the banks have now got the housing market to recover to a level at which they can mark to market; which effectively makes them over-capitalized in risk terms.

Suddenly loss provisions can be brought back “on-balance sheet” to boost earnings in a period challenged by economic slowdown as a consequence of the “Taper”. The unintended consequence is that capital adequacy standards and lending standards are weakened. Whilst this weakening in standards may then boost the lending business, to sustain the economy, it will beget inherent systemic risk. The real chance is that the banks just book higher profits through smaller loss provisions; and avoid future lending in the challenged economic environment.

In relation to the GSE’s, the new amendments actually allow them to use their Federal Guarantees as retained risk “skin in the game”. The GSE’s are therefore gifted zero cost risk capital, from the taxpayer, in addition to the taxpayer funds used to take them into Federal custody. Rather than recapitalize the GSEs with real money, the Federal Guarantee is being used as “hypothecated” risk capital.

Given the lay-offs in the mortgage industry and the dramatic revisions proposed to Dodd-Frank, one can conclude that policy makers see the housing market retracing the steps it made just before the bubble collapsed. The “Terminator” is back.


i http://www.dsnews.com/articles/mortgage-industry-loses-nearly-3k-jobs-in-q2-2013-08-27

ii http://www.mortgagenewsdaily.com/08212013_wells_fargo.asp

iii http://www.mortgagenewsdaily.com/08302013_mortgage_origination.asp

iv http://www.mortgagenewsdaily.com/08272013_case_shiller_home_prices.asp

v http://www.mortgagenewsdaily.com/08282013_realtytrac_home_sales.asp

vi http://www.federalreserve.gov/newsevents/press/bcreg/20130828a.htm

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