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We are still very much in a bubble, yet many "analysts" are preaching recovery. Why???
As many people focus on commercial real estate exposure, they forget
that we are only about halfway or so through the residential crash. The
$8k homebuyer tax credit did serve to support the lower end of the
residential market (from my anecdotal observations), but did very
little to solve the problem. Basically, prices must fall, credit must
be loosened or incomes must rise in order to stabilize home prices. With
10% plus unemployment (incomes have actually dropped
since the initial bubble burst) and banks holding on to cash tighter
than Fido grips his steak bone, you know what prices really need to do
to reach equilibrium. Click the graphs below to expand.
Unsustainable government policies prove.... Unsustainable, with very transient results
Most people, including so-called professionals don't get it. We are still very much in a protracted housing bubble.
Yes, housing prices collapsed. Yes, it hurt - a lot! Remember, housing
prices are a function of supply and demand. We have gobs of supply from
overbuilding - See "Who are ya gonna believe, the pundits or your lying eyes?" and "Who are you going to believe, the pundits or your lying eyes, part 2".
for a clear understandng of how bad off this vital urban and suburban
market actually is. We have decreased demand due to stingy banks
(tightened credit) and high unemployment. In terms of unemployment, we
are already breaching the worst case scenario projection of the
government's stress tests - two years into the future!
As you can see, the major driver of future bank credit losses has been
woefully underestimated, and thus the capital requirements of said
banks have been woefully underestimated, among other things. Now, what
happens to home prices when you have lower income? Well...
Yes, we are still very much in a bubble!Once you come to the
realization that we are still in a bubble that has yet to finish
bursting, you can come to grips with the realization that we are
already following in the Japanese "lost decade" footsteps, lockstep
even.
Reference "They ARE trying to kick the bad mortgages down the road, here's proof!" and "More on kicking that housing can down the road...".
We have government complicity in the purposeful opacity of the
values of the mortgage assets. See the FDIC "Prudent Commercial Real
Estate Loan Workouts" guidance issued Oct 30th, as reported by the WSJ:
Banks Hasten to Adopt New Loan Rules and the new FDIC guidance
that states performing loans "made to creditworthy borrowers" will not
require write downs "solely because the value of the underlying
collateral declined"). It really does appear that many have adopted this false sense of
security even as I tried to warn about in such a bombastic fashion in "You've Been Bamboozled, Hoodwinked and Lied To! Here's the Proof. What Are You Going to Do About It?".
Now, for those of you who believe that the government's "pretend and
extend" policy has any chance in hell of working (the prevailing logic
is that we hide the losses long enough for banks to earn their way out
of the hole) let's see how well that EXACT SAME tact worked for Japan.
There are nearly no Japanese banks in the
top 20 bank category on global basis by 2003 - NONE (save potentially
Nomura, which arguably survived in name, alone). As you can see, they
literally dominated 90% of the space in 1990!
Click to enlarge...
Source: Cap Gemini Banking M&A
With the government's explicit consent, we are doing exactly what the
Japanese did with their banks. Hiding losses and failing to take the
proper writedowns, hence condemning our stature as global banking
leaders. Our only saving grace is that this time around, the rest of
the world is in a very similar boat. We are definitely going to fall,
it is just that much of the other global banking centers are going to
fall with us!
There is little wonder that as Moody's is set to downgrades (belatedely) $143 Billion Of Jumbo RMBS,
as reported by Zerohedge, they are actually quite late to the party -
as usual. The pure mortgage insurers are getting creamed by claims and
losses, and the hybrids (Fannie, Freddie, etc.) are ready to ask for a
couple of hundred EXTRA billion from the taxpayer. I am at a loss to
see the improvement.
So, how far do we have to go? Well...
Recall "The Truth! The Truth? Banker's Can't Handle the Truth!!!"
CNBC comes out with "US to Push Mortgage Lenders To Modify More Home Loans:
The US Treasury announced plans to push lenders to modify more loans
after the administration's $75 billion housing rescue plan, called
Making Home Affordable, fell short and foreclosures continued rising."Hmmm... $75 billion is a lot of money. Mayhap the problem is that the
banks know how useless pushing on a string is, or mayhap $75 billion is
not enough to stem $304 billion (and counting) in Alt A and subprime
losses that are still in the pipeline (see graphic below).It gets worse though. Let's glance at the non-conforming loan losses
that have already occurred in comparison to the SCAP projections that
justified the return of TARP in many cases. Recovery rates had the
illusion of increasing ever so slightly due to an increase in prices as
illustrated by the Case Shiller index. I have expressed my doubts about
this housing price recovery for several reasons, the least of which is
the construction flaws in the index itself which fail to capture the
nature of the transient price increases, namely the activity of short
term investors and flippers (see On the Latest Housing Numbers).
There are some areas that have witnessed some firming of pricing
though, but that firmness is the result of the Fed and Treasury trying
to blow another bubble within a bursting bubble and is more than
outdone by the rampant deterioration in credit quality of loans that
result in the dumping of foreclosures -> REOs -> short turnaround
sales/flips (via investors, which are not captured by Case Shiller, hence the illusion of a firming market in the lower end of housing prices) all over the place.
Subprime delinquency, charge-off and foreclosure rates are still flying
through the roof - with many other categories rushing to keep up. This
is as I described from the beginning (2007) through the Asset Securitization Crisis series
- there was an underwriting induced crisis and never a true "subprime
crisis". As such, there is a very strong chance that many other loan
categories may outstrip subprime loans in terms of aggregate losses. It
hasn't happened yet, but the Alt-A category is hot on subprime's heels
(see below). Construction and CRE will follow up the rear with
unsecured consumer (ex. credit cards) and commercial loans fighting to
get into the race.
Below, you see the loss trend as of October 2009. These are losses that
have most likely NOT been claimed by the banks, and they are
significant. In addition, the credit deterioration trend is climbing,
not falling. If I am correct in my assumption on the validity of the
Case Shiller index in capturing true inventory price depreciation
across investor related sales and bank "hold outs", then prices will
soon start dropping again, killing recovery rates and causing losses to
spike even further.
The mainstream financial media has led many to believe that the
"subprime crisis" has passed. FRB and FDIC data actually show that
subprime credit deterioration is increasing in the face of lowered
interest rates through QE/dollar debasing and HAMP government efforts.
This is also despite certain bank policies that mask delinquencies,
such as lagging the time it takes to mark a loan delinquent. We found
Wells Fargo doing this last year with its HELOC portfolio.
As you can see, every reprieve seen since the crisis started has been
followed by a spike in delinquencies. I expect the same to occur for
2010.
As can be expected, ARMs sport more than twice the delinquency rate as
fixed rate loans. The drop in rates has caused a leveling of ARM
delinquencies, but it is clear that rates can't remain at zero forever,
and the bulk of these loans are close to if not passed the underwater
mark. Literally any move by interest rates in the direction of
equilibrium (read as the cessation or failure of the Fed's direct
intervention in the interest rate markets) will cause a flood of
delinquencies and foreclosures that are bound to overwhelm the banks.
This is an inevitable occurrence. It is not a matter of if, but a
matter of when. The interesting issue is that all of the categories are
at currently a level that scream solvency alert!
As excerpted from Thoughts on the June 2009 Case Shiller report: Are prices really improving?
Well, the Case Shiller index has finally produced a
positive print. Again, I will probably sound like a permabear, but this
may not be all that it is cracked up to be. I have warned readers two
years ago that the Case Shiller index, although an econometric marvel,
is far from perfect in terms of determining the state of residential
housing in the real world.The primary suspects are:
- It
ignores investment inventory which, when combined with poorly
underwritten easy credit loans, was the catalyst for the housing bust
in the first place. Investors simply walked away or were foreclosed
upon, en masse.- It ignores multi-family housing,
which is a significant portion of the stock in urban areas such as NYC.
It is also a much higher risk loan that shows more defaults in mortgage
portfolios.- It ignores condos and coops. See "Who are ya gonna believe, the pundits or your lying eyes?" and "Who are you going to believe, the pundits or your lying eyes, part 2".
for a clear understanding of how bad off this vital urban and suburban
market actually is. The recent Case Shiller condo numbers show a
statistical uptick, but as can be seen from the ground (reference
previous links), the inventory story is simply atrocious, and their is
plenty of additional inventory being built as I type this, which just
adds to the foreclosure and existing sales inventory issues.My
assumption is the government stimulus (which ends right about now)
offering $8k tax breaks, seasonality (as this uptick occurred in the
strongest historical selling season, the coming to market of larger
apartments as inventory is completed (remember, it appears as if this
index tracks gross prices, and not prices per square foot, which can be
quite misleading in terms of actual price appreciation), combined with
the GSE occupancy waiver (which very well may backfire as it brings
back the easy money credit days of lax underwriting) is responsible for
the trend. Will it last? We shall see, but the laws of supply and
demand will apparently have to be suspended.
- advertisements -
Agreed and nicely written. The DC machinations are intriguing to noodle on, but ultimately miss the point: Washington cannot re-inflate sufficiently and fast enough to avoid the whiplash of Treasury yields as the "exit strategy" and "recovery" drift and become viewed as the great extend & pretend. Honestly, would any business person try to operate under a balance sheet and P&L strategy such as the Fed is utilizing? Sure, they can print money, but in a world of developing superior national credits, it is inevitable that our paper will come to be viewed as second rate. Nothing Washington has done has been big enough, fast enough or directed enough to solve for the combined power of the wipe out of effective consumer "net worth", total housing inventory, reduction in consumer and commercial credit, real unemployment, collapse of European demand and growth in China's and India's internal demand.
Where did you get the case schiller data for each city? Would love to clear it up for just d.c. metro.
great post.
"there was an underwriting induced crisis and never a true 'subprime crisis'. As such, there is a very strong chance that many other loan categories may outstrip subprime loans in terms of aggregate losses."
Bingo. The pervasive fraud makes the distinction between "prime" and "subprime" as bogus as the distinction between the "AAA" and "mezzanine" tranches of asset-backed securities. The assets were all garbage, regardless of the order in which their investors received the bullet to the back of the head. The only thing "prime" means is that you have a bigger license to steal.
More and more people are standing up on their hind legs and saying it. We're farther from reality - and worse off in terms of future pain - than we were in summer 2006. The system will never be allowed to clean itself out until the rest of the world finally clotheslines the American Empire by cutting off Treasury monetization. Then I guess we do it ourselves and get the Weimar Germany experience, since we're obviously too stupid to learn from our own mistakes, let alone anyone else's.
Benanke doesnt control the rates which control mortgage rates..the ten year and 30 yr.
Rates are higher now than in march when QE was announced.. He gives nice speeches
but is insignificant, markets are too big for one Fed chairmen to manage.
Reggie: Appreciate all of your salient work. As a retired CRE investment banker ( which I did in Feb 09 as I knew I could not make a living at it anymore), I have argued with many that there are many hurdles to the CRE market recovery, many of them obvious and literally years from being overcome... but one of my biggest arguments is that the fuel to get to where we are in the CRE mess was the proliferation of CMBS. Without the $200Billion in annual liquidity to the market that we saw for a good part of the last decade, how do we ever get back to anything near the pace of expansion that we "enjoyed" until the crash? Answer: WE DONT! I have also argued that all the CMBS investors who have lost all their principal ( whether they know it or not) will not be buyers of new issuance anytime soon as they got whacked in the last round.... and yet, JPM just completes a $400ish MM CMBS offering for Flagler? How on earth does this happen today? Were the bonds just syndicated to peer banks who are sitting on taxpayer cash and this is just another scam to convince America that everything is rosy? Would like your thoughts on this.
$400 mm to DDRC and Goldman Sachs Commercial Mortgage Capital. But the only way these 2 companies got involved in this is because ALL the funds come from TALF.
The Squids favorite dinner meat: Taxpayer.
Amen, brother; you get it. The $8k homebuyer tax credit is rife with fraud; history will prove how few true, first-time homeowners utilized this travesty to actually purchase a home.
I experienced this scenario back in the early 80's, in TX, during the collapse in oil prices. 10cents on the dollar was not uncommon for homes. Tons of property in limbo right now - especially raw land; eventually, this crap will have to be put on SOMEONE'S books, and when it does - BOOOOMMM!
My advice is to wait until at least April of next year, for those looking to invest in RE; and I'm not talking about RMBS - Really Major Bull Shite!
Great stuff, Reggie!
I waould have to say housing prices are a function of rent. Income does dictate demand, but so does rent as well, deflation in rent means deflation in real estate prices.IMHO.
Right on Demsco. From an investment property perspective.
But you have to remember rent is a function of income or subsidy(ex. section 8). So it's basically tied to income as section 8 is a shadow of normalized low income.
I totally agree that "deflation in rent means deflation in real estate prices". Here and now is when being a slumlord has it's advantages.
Looks like as soon as things start to turn they are going to ban short selling...so they fleeced the short sellers as they manipulated the market up and now they are going to prevent them from recovering their losses when it turns....
Reggie,
I ran into a broker this weekend in SW Florida while driving around looking at what is on the market in person. He deals directly with banks. He told me he had 5 or 6 banks he has worked with only on foreclosure for the last 20+ years. As I was talking with his client he walked away and came back with a stack of neatly typed,single spaced adresses and home descriptions. Probably 30 to a page. 75-100 pages.
These homes are ONLY from his client banks.
They have been through foreclosure but have never been listed on the MLS.
Thats a lotta homes for one broker. He seemed to think the banks were going to get serious after the first. He actually told me Christmas of next year will be better to buy.
I have 6 or 7 co-workers in Sarasota that haven't made a payment in 2 years.
The bloodbath is just getting started...
Chris
Nice summary, Reggie.
I always find the Case-Shiller chart above to be confusing, in that I can't separate out the different areas. I assume the SF area is the purplish line towards the top, and not the purplish line in the middle.
One thing of note is that prices in the SF bay area are way up YOY (about 10% lately). Sounds good, right? Nope. Inventory is about 1/3 of last years'. Supply is way down.
This Spring should be interesting, as I suspect that a lot of people have kept their houses off of the market in order wait for a better price. I also note that the number of houses going through the foreclosure process is generally equal to the number of houses on the market.
Income dictates demand. If you agree price is a function of income, then you are in agreement with the statement above.
Not true. Bankers know they are in big trouble. When revenue streams from real asset related products dry up, and eventually reverse, ex. foreclosures with negative equity, many banks will go belly up regardless of the accounting shenanigans put in place to postpone the inevitable. It is not as if we don't have a roadmap (in Japan) of how this will play out. I don't see inflation occuring until asset deflation truly comes to an end. If it does, inflation will roar, but the biggest and most immediate problem is a return to the mean of asset prices, which should eliminate quite a few banks that are still in business.
If bankers were really in big trouble you would not see the bonuses payout that we are seeing. You would see banks really trimming fat. It's not happening, Reggie.
What I was getting at, it's not as simple as you describe it. "Remember, housing prices are a function of supply and demand". The banks and the Fed are at the core of the supply and demand equation. Manipulating equilibrium of sick markets can work.
For example highly sought after US real estate is a bargain to Euro denominated buyers. Some Chinese tour companies offer real estate tours for Chinese speculators.
A loss to a bank via a foreclosure with negative equity is a partial asset as these tax losses can be bought up by the likes of Warren Buffet. And they still own the asset.
All they need to do is make the replacement cost of the assets materially higher than the peak bubble price and they will be solidly back in the green. Commodity Price Inflation. Force the people to pay more for commodities by creating a speculative bubble. Enter The Squid.
Thank you.
It sounds as if you actually believe the banks are strive to act in the best interest of the public, or even the shareholder. If that truly was the case we wouldn't have had a market collapse to begin with. It was very easy to see the consequences of writing mortgages that would not be paid, but banks did it anyway and went on to pay big bonuses off of that revenue. Banks will always award the biggest bonuses to themselves until literally forced to do otherwise. At that point they will look for alternative venues to compensate themselves as much as possible. It is the self-interested nature of the beast. Simply peer into the balance sheet of some of these banks and you will see murkiness, despite big bonuses - and that's with the sugar coating that the government has authorized.
If that's the case, where is the demand? Both the banks and the Fed want it, and it is currently not there. Supply is in abundance, though.
There is on Buffet, and there are hundreds of billions of dollars of foreclosures. There is a supply/demand imbalance there as well.
If only it were that easy. Accounting profit doesn't pay the bills. Ask WaMu, Bear Stearns, Lehman, of GGP. The defining event comes when one counterparty demands to be made whole by another counterparty who has been riding on accounting profit gains and phantom income. FASB and regulators may play that game, but did GS accept paper gains from AIG or did they demand cash?
As for foreigners buying real estate, many have learned their lesson by now. I live in NY and was into real estate. Foreigners bought stuff that was cheap with stronger dollars as the stuff they bought got a lot cheaper and their currency weakened. I have seen a lot of Europeans, middle easterns and asians get burned, even when considering currency. I even entertained some with my own assets for sale. They bid like crazy in 2006 and 2007, not so much now. Those Chinese tour buses weren't that prevalent, and I don't know of any now, either.
My observations inside the large financials is that they think that compensation is a cost of doing business and a necessity. They talk themselves into a belief that without the bonuses they will not retain talent and that talent is a differentiator
I do not agree. I think institutional contributions, more than individual ones now (in the last 20 years) form the majority of whatever value these institutions bring. Instensely system backed commodities barely differentiated by individuals ususally do not have have high pay. Neither did all but the partners prior to 1980.
For them inside, bonuses seem like a necessity right now. Later they will realize they are drinking kool aid of their own making ...but not now
Demand is a valve that is controlled by the availability of money. That valve is currently almost closed.
It has always been my contention that the RE boom was a result of the Fed's wish to reduce the size and power of sovereign wealth funds. The Global Pool of Money (GPM) doubled in a very short time to something like 64 Trillion in 2006. A lot of the GPM is in USD's as a result of US consumption and long term economic planning. The GPM is what bought up all the MBS and CMBS causing crazy inflation in 2005-07.
If readers have an interest, this is a good Ira Glass episode that drills into details from a layman's perspective. It's a radio show and enjoyable to listen to.
http://www.thislife.org/Radio_Episode.aspx?episode=355
Anyway, until The Squid and his friends can seduce the GPM back to the Street, demand is constrained by cash on hand. In order to qualify for that cash you have to be a shiny apple.
We are still in intermission and the actors must come up with a compelling Act II or this performance will get panned by the critics. Considering the stakes, I think Act II is going to be very interesting.
Thanks Reggie.
"you know what prices really need to do to reach equilibrium"
Walras' law is being completely violated by .gov intervention.
"Remember, housing prices are a function of supply and demand"
I partially disagree unless a home is paid for in cash, housing prices are a function of income.
"We have gobs of supply from overbuilding", but the banksters are keeping the majority of the supply out of the marketplace. In effect making supply tight.
We can therefore conclude that the economics of housing is just where the banksters want it. In a state of manipulated equilibrium as tight supply meets diminishing (qualified)demand, both of which they have an big part of controlling.
And unfortunately it can be kept here for a long time to come. Inflation is the answer, and it's going to be forced down our throats. Then the banksters can unload all the real estate and turn a profit... So if you look at the writing on the wall you can call for recovery.
Good article, but you could have stopped at this line, it says it all:
"Basically, prices must fall, credit must be loosened or incomes must rise in order to stabilize home prices."
I don't think a lot of people realize that reinflating or even sustaining the bubble requires the same loose credit conditions that existed in 2006 (or, as you say, a rise in incomes, which just ain't gonna happen).
Unless we start seeing stated income Option ARMs being originated again, house prices have further to drop.
As if on cue (http://finance.yahoo.com/news/Serious-US-mortgage-rb-2290442347.html?x=0...):
WASHINGTON (Reuters) - Serious delinquencies among U.S. prime mortgages rose nearly 20 percent in the third quarter from the prior quarter, as the percentage of current and performing mortgages fell for the sixth consecutive quarter, banking regulators said on Monday.
Rally on!
They're trying to hold out until they can get enough inflation into the system
There's so much friggin hot air in the joint now they can't even stop it......until it does and then will anyone hear it? Go Bubbles!
http://www.youtube.com/watch?v=U51cY6iod3U (THX LOTH!)
Great Job as usual Reggie! Happy Bubblidays!
Reggie, any thoughts on what the incremental increase in mortgage rates would translate into price drops for residential real estate. Obviously different markets/price points would have different sensitivities, but in general. Has their been any talk about what mortgage rates could do after MBS buying stops(if it stops)?
Unless there is a significant event of some sort, the FED will keep the Fed Funds rate low to Q1, 2011. So the overall effect of the cost of credit from the FED will remain low. How the Fed Funds rate control Mortgage rates is a bit of a misnomer, with the FHA taking the lead in backing very low interest mortgages, and easy terms. So at this time, the real driver for low rates seems to be the FHA and not the FED. This will be the prevailing way rates will be set for at least another 6 months.
The only other potentially viable way to influence rates is through another government program, Like Making Home Affordable. With any refinance the issue is setting price, relative to the amount of equity in the home and the real market value.
In summation, real estate price and mortgage rates do not necessarily correlate when the government is willing to underwrite over priced real estate. Essentially, the government is willing to risk loss to try and stimulate market activity.
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The FEDs massive purchasing of RMBS, CMBS, and agency paper, is an interesting tactic. Never really tried before on this scale. From the FED web site, the reason for the RMBS purchase is to stabilize real estate prices. However, this seems a little ridiculous given the size of the potential debt, and how the market dynamics can amplify the effects of debt. Basically, a debt moving target, hard to pin down. Also, the ineffective nature of this price control can be seen in real estate prices not substantially increasing given the amount of investment so far, $1.25T. A monumental waste of investment on buying bad debt.
What makes a little more sense to me is that the MBS buy through the GSEs is just a conduit for bad paper from the big banks. The GSEs are just a clearing house for big bank toxic assets to the FED balance sheet.
My point is, that the FED approach cannot ultimately control real estate price and the FED knows it. Price is secondary, helping the big banks de-leverage was the top priority.
Also, there is the question of what does the FED do with all those over priced MBSs? Essentially, the FED has no way to tighten properly, and understands rev repos are problematic. So when this FED MBS paper bids out, what is the effect on real estate prices?
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Without the government agencies and special programs, mortgage rates would be substantially higher. Banks do not understand how to price the asset, so to write a mortgage without the FHA, the terms would be very harsh.
Mark Beck
MBS buying is supporting the mortgage market, and by extension the residential real estate market. Cessation of said activities or a deliberate rise in rates will drag housing prices past their mean values, in near real time.
Bernanke knows this, which is why he clearly states that rates will remain low for the foreseeable future. The dilemma is that the housing and CRE prices will have to drop in order for business to continue as usual. The synthetic elevation of prices by extend and pretent simply intensifies the velocity of the drop that will eventually have to arrive.
We are witnessing perhaps the greatest lie and con job in the financial history of the USA. It's a full court press.
I'm looking forward to what the pundits will say when it comes crashing down. and it will. we have a massive house of cards.
our leaders are so stupid.
oh well.
Reggie,
Very well done and thanks for posting at ZH. I have a front row seat to this whole debacle. As the proud owner of a nice home in a small manufacturing based community located in the upper midwest I have been trying to sell for 2 years. Chasing price drops does not work as there are no buyers to be found at any level. I have since moved on and now have a nice "cabin" up north.
The Government is just delaying the inevitable with these tax credit schemes.
Jack The Trader
.
Excelent article. It gathers alot of what we've been reading about so far.
What could trigger the market in reacting with conformity with these fundamentals?
a) Black swan event?
b) Fed turning of the liquidity tap; which according to what you've stated is actually a reason for the same Fed policy to continue well into 2010.
c) China (and others) simply decide not to participate in the weekly Treasury auctions and shunt the USD?
d) Some big players calls it quits and triggers a sell-off and back to reality becomes the new mantra?
Prechter said before the downturn started that house prices would decline 90%. I didn't believe him then. I do now. Those stupid idiots in charge of economic policy don't know that manipulating the market is only going to make things worse in the long run. Once all those artificial props are removed the defationary spiral resumes. Only with more force than before.
Once all those artificial props are removed the defationary spiral resumes.
Deflationary spiral on real estate, sure, but on everything else that speaks to the American standard of living... inflation, not deflation, is our future - by summer '10 it'll be visable to all.
We're going to see food prices spike early in '10 and come summer I anticipate an energy price spike which will of course set off across the board inflation.
BILL