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Why The Housing Market Is (Still) In Trouble
From The Daily Capitalist
December 3, 2009
Since the biggest financial collapse in world history was built on credit related to housing, it is pretty obvious that we should be paying very close attention to that market. The reasons are complex, but a recovery must be based on the liquidation of bad debt. The sooner that happens the quicker a recovery will happen.
When we mean "liquidation of debt" we are talking about a mountain of credit built on the housing bubble. This phony bubble wealth permeated the entire economy. When home owners saw the price of their home rising, they saw it as a source of capital to use for a variety of things, but let's face it, most people spent it.
New stores opened, malls were built, financial institutions grew, cars and boats, second homes, vacations, and restaurants all flourished. Credit card debt mushroomed. Home mortgages were increased to pull cash out for spending. Yes, some of it went to good things, like our children's education, helping our aged parents, and paying off bills. But the reality was that our debt kept growing.
The clever lads created even more phony wealth under the guise of insurance, but as we found out, companies like AIG really had no idea how large their obligations were for credit default swaps written against almost any financial risk. And these instruments were further leveraged without understanding the magnitude of these triple-counted obligations or their relationship to housing.
It all comes back to housing as the fuel for the 70% of our economy that was consumer spending. The thought was that housing has always gone up, and if it went down, it really never went down if you averaged growth since the post-WWII-period. A drop of 10%? Never has happened. 20%? Not even a 6th deviation possibility.
My thesis has been that this was all fueled by the Fed through monetary policies that created and supported the bubble. Aided and abetted by governmental policies and financing schemes that favored housing and risky loans. This was not a "free market" phenomenon. Far, far from it.
My thesis has also been that we can't recover until all this bad debt is liquidated, and capital generated by savings is created and ultimately invested in profitable enterprises. It would be a mistake to rekindle the bubble. But, as we know, that's what our government is trying to do. The government creates uncertainty as it flails around with programs, spending, and debt schemes to revive the economy. As a result mark-to-market accounting is thing of the past and banks are guarding their balance sheets, corporations are sitting on a lot of cash, cutting costs, and becoming leaner, and Mr. and Mrs. America still favor savings and debt instruments over equities and spending.
The big question: is the housing market bottoming out? Because once it does, debtors and debt holders will then have a handle on how great their losses are. When the bottom is falling out, it is difficult to get lenders to lend if they are afraid their remaining cash reserves will be needed to shore up the bank because of loan losses. The holders of subprime debt find it difficult to value their assets while housing values are still dropping.
Lenders have been shepherding their cash, reducing debt obligations, and cutting back lending and new investments because they do not know how deep their hole will be until housing bottoms out. Keynes called this a "liquidity trap." More reasonable people, especially the Austrian school economists, call this a reasonable and necessary response to uncertainty.
The Fed and the federal government have been flogging this liquidity trap issue without let up and basically credit is still drying up. A 0.25% Fed Funds rate is basically a negative rate and they still can't get banks to lend. The Fed's balance sheet is at a record high. They have bought $850 million of mortgage backed securities. They are injecting cash into lenders. They have basically suspended mark-to-market accounting.
In Q3, the FDIC reported that bank lending still contracted by 3%:
Loans and leases held by U.S. commercial banks have declined for 10 straight months, falling to $6.7 trillion as of Oct. 28 from $7.2 trillion at the end of 2008, according to a separate statistical release from the Fed.
Commercial and industrial loans have dropped to $1.37 trillion from $1.6 trillion, commercial real-estate loans have declined to $1.66 trillion from $1.72 trillion, and consumer loans have fallen to $847 billion from $857 billion at the end of last year.
What do banks do? They have decided they would rather hold Treasury paper instead of make loans. This chart shows what's been happening. No wonder T-rates have stayed so low despite massive deficit financing.
This is what makes Bernanke, Geithner, and Summers lose sleep at night. "It's supposed to work, dammit!" Maybe this is why Summers is always falling asleep. No matter what they've tried, they can't get banks to lend. I think they are very worried about this and while they say the economy is recovering nicely, they are crossing their fingers at the same time.
Back to housing.
I have been saying that I think the housing market is finding a bottom. I thought that low prices and rising affordability was the main driver of the housing market. If this were so, then housing prices would reflect real market valuations and this would finally bring about the liquidation of assets and debt wastefully invested during the prior artificial credit cycle. Lenders would know where they stood financially and would liquidate bad assets and rebuild their balance sheets. No more waiting around wondering what the Fed or the government would do to save housing.
I was wrong.
The housing market I now believe is being sustained almost entirely by the Fed and the federal government. This rekindling of the housing bubble is counterproductive and will hinder a real recovery of the economy because an artificially backed market will delay the necessary liquidation of the prior cycle's malinvestment of capital.
Here is why I changed my mind:
First, 59% of new home buyers are relying on government-backed FHA, the Veterans Administration, and the Department of Agriculture loans. Most of these sales are driven by the first-time home buyers tax credit. The tax credit program has been extended through April, 2010.
Second, existing home sales are being driven by the tax credit and by foreclosure and short sales. Existing home sales are up 10.1%. Distressed sales -- mainly foreclosures and short sales -- accounted for 30% of transactions in the third quarter. And. according to the NAR, home sales are being driven by first time home buyers trying to make the previous November deadline.
This will have a negative impact on future sales. Like Cash for Clunkers, these government-driven sales may just be eating into sales that would have occurred in 2010. Many economists are referring to this phenomenon as "payback."
Third, mortgage rates are now at 30 year lows. Another Fed related gift to home buyers. The average 30-year mortgage rate was 4.95% in October, down from 5.06% in September, according to Freddie Mac. Today, Freddie said the rate was down to 4.7%.
But ... home prices are still falling. The S&P/Case-Shiller index of prices fell 8.9% for the July-through-September period from a year earlier. That was an improvement from the 14.7% drop in the second quarter and the 19% decline in the first three months of 2009. Median prices of existing homes fell in 123 of 153 metropolitan areas during the third quarter compared with a year earlier. The national median price was $177,900, down 11.2% from the third quarter of 2008. [Don't ask me to explain the disparity. Case-Shiller and NAR measure this differently.] Last month the median price for an existing home was $173,100, down 7.1% from $186,400 in October 2008.
Thus, despite record interference in the housing market by the government, home prices are still falling. There are several reasons why it is likely that home prices will continue to fall.
Almost 25% of home owners are upside down with their mortgages. Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic. This shadow market is huge:
Home prices have fallen so far that 5.3 million U.S. households are tied to mortgages that are at least 20% higher than their home's value, the First American report said. More than 520,000 of these borrowers have received a notice of default, according to First American. ...
But negative equity "is an outstanding risk hanging over the mortgage market," said Mark Fleming, chief economist of First American Core Logic. "It lowers homeowners' mobility because they can't sell, even if they want to move to get a new job." Borrowers who owe more than 120% of their home's value, he said, were more likely to default.
Mortgage troubles are not limited to the unemployed. About 588,000 borrowers defaulted on mortgages last year even though they could afford to pay -- more than double the number in 2007, according to a study by Experian and consulting firm Oliver Wyman. "The American consumer has had a long-held taboo against walking away from the home, and this crisis seems to be eroding that," the study said.
This overhang will continue to drive prices down. There is no way the Feds can force lenders to modify enough loans to make a serious dent in this overhang. It's imply too big. Eventually the losses from forced modifications will mount and the FHA or any other agency will not be able to pay off their guarantees to lender. Nor should they try.
Mark Zandi, who correctly predicted a crisis in the housing market, but not the Crash, said on Wednesday, "The housing crash is not over." He said the lull in foreclosure sales for the past few months, due to the government's pressure on lenders to modify loans, has resulting in higher prices. He expects Case-Shiller to bottom by Q3 2010 with an overall price decline of 38% (now at 32%).
"Foreclosure sales will increase, and home prices will resume their decline by early 2010 as mortgage servicers figure out who will not qualify for a modification," he said.
Zandi said 7.5 million foreclosure sales will have taken place between 2006 and 2011. The majority of these sales, however, have not emerged yet, with 4.8 million foreclosure sales expected between 2009 and 2011.
What this means is that the housing supply, now down to a 7+ months supply, will rise again, and prices will continue to decline. We haven't seen the bottom yet.
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All of texas had the least bubble of any major state due to the homestead laws on cash outs - the state restricted the fees that could be collected on a cash out on a homestead property. and the state WOULD enforce those laws, even on national lenders.
that kept the subprime leeches away since they couldn't scalp the borrowers for 5 points and lessened the bubble.
don't say you guys learned nothing from the S&L crisis.
In addition, backward old Texas would not allow a HELOC + first to exceed 80% LTV, which also kept the wheels from coming off.
How about that, government regulation that turned out to be in the best interest of its citizens and foiled the desires of private mortgage lending sleazeballs to prey on financially unsophisticated Texans. I was wondering how Texas had largely ducked this bubble/meltdown.
Things are so much worse in housing than is being reported. It is all a game of keeping these grossly over-valued home prices propped up, so the banks dont have to take more losses.
Problem is, people are wising up! Why allow a criminal banking institution to keep that rapidly depreciating and horribly overvalued asset tied around your neck like an albatross? All of these transparent attempts to "help homeowners refinance" are just sad attempts to keep prices at artifically-inflated levels, and tie these poor suckers to these huge loans they have no hope of repaying.
There are SO many homes in the MD and VA area that people paid 6-800K for, and they are maybe now worth between 3-400K
There is so much more pain to come!
Agreed, there is a lot more pain to come, but I think that pain will be realized sooner rather than later, see my post below. Banks are finally capitulating and agreeing to short sales and starting foreclosure proceedings, not just letting people go delinquent for years on end.
You are correct in that trend will bring out a lot more people to go delinquent, especially as they see short sales being executed -for some reason, people are much more willing to do a short sale than go into foreclosure, even through the credit hit is the same.
But as people see their neighbors execute short sales, they will do the same - as you say, why continue paying $4K a month when you can rent the same house that someone else bought at a short sale for $2K a month? Doesn't make sense.
As an investor the question is to what extent have those who will suffer the losses reserved for those losses. My guess is the answer varies greatly across the financial landscape. Some players will be wiped out by the losses, in particular I would suspect some of the financial guarantors and mortgage insurers are not prepared for what is to come.
Nice assessment.
The Government needs to FORCE the banks to start marking to market their huge REO inventory. (Banks are holding on to an estimated 60% of these REOs right and are still valuing them at 2006 prices) They would rather see another govt program enacted so TAXPAYERS take these losses than write them down, and that is the real crime!
With unemployment, plummeting wages, and 50% of Americans warning they are about 2 paychecks away from total ruin, they will be giving houses away before it is all said and done.
Let the market forces dictate price, and get the F out of the way!
Another thing to consider is that now we have falling rental rates as well. This has three effects.
1) Gives underwater homeowners a larger incentive to walk away and go rent.
2) Gives renters less of an incentive to become a first time home buyer.
3) Moves investment properties from cash flow positive to the liability column. Investors can ignore that they have negative equity until the rent received no longer covers their mortgage/maintenance etc.
Unless banks get serious about renegotiating loans the foreclosure river will continue to flow.
"The housing market I now believe is being sustained almost entirely by the Fed and the federal government."
Ding ding ding.
When the supports are removed - or kicked out - the trainwreck will resume and 2008 will look like a fond memory.