Housing Prices

Borrowing heavily from Albert Edwards "Ice Age" analogy of our new normal, PIMCO's Bill Gross, after explaining why he does not have a cell phone, discusses the "frigidly low" levels of "The New Neutral" in this week's letter. Confirming Ben Bernanke's "not in my lifetime" promise for low rates and a lack of normalization, Gross explains that the "the new neutral" real policy rate will be close to 0% as opposed to 2-3% (just as in Japan) leaving an increasingly small incremental rise in rates as potentially responsible for popping the bubble. Gross concludes, "if 'The New Neutral' rates stay low, it supports current prices of financial assets. They would appear to be less bubbly," clearly defending the valuation of bonds knowing that he can't expose stocks as 'bubbly' without exposing his firm to more outflows.

The housing "recovery" since 2010 can be summarized in four phrases: diminishing returns, unprecedented central state/bank intervention, unintended consequences, end-game. The unintended consequences of the Fed's unprecedented interventions will rip the heart and lungs out of the housing market

After the crisis, many expected that the blameworthy would be punished or at the least be required to return their ill-gotten gains—but they weren’t, and they didn’t. Many thought that those who were injured would be made whole, but most weren’t. And many hoped that there would be a restoration of the financial safety rules to ensure that industry leaders could no longer gamble the equity of their firms to the point of ruin. This didn’t happen, but it’s not too late. It is useful, then, to identify the persistent myths about the causes of the financial crisis and the resulting Dodd-Frank reform legislation and related implementation...."Plenty of people saw it coming, and said so. The problem wasn’t seeing, it was listening."

A simple way of grasping the precarious situation China has found itself in is with this useful diagram which summarizes the negative loop that China's economy (which essentially means housing market which as SocGen recently explained is indirectly responsible for 80% of local GDP) could fall into should the government not promptly move to address the emerging dangerous situation, i.e., resume aggressive easing.

One of the most deplorable aspects of Greenspan’s monetary central planning was the lame proposition that financial bubbles can’t be detected, and that the job of central banks is to wait until they crash and then flood the market with liquidity to contain the damage. In short, China didn’t “save ” America into a housing crisis; the Greenspan Fed printed America into a cheap debt binge that ended up impairing the residential housing market for years to come. In any event, for those Millennials who do manage to accumulate a down payment by the time they are in their early 30s there is precious little starter home inventory available.  The Greenspan mortgage debt serfs from the previous generation are blocking the way. Monetary central banking is an economy wrecker.  Here is just one more smoking gun of proof.

"You’re picking up pennies on a train track. You are not getting paid much but you are sure that there will be a very negative surprise at some point. The risk / reward profile is as bad as ’07." - Portfolio manager speaking to Citigroup

You would think that with all the surefire bets in housing that people would be dialing up their realtors and heading out every weekend to make those lustful multiple offers presented in PowerPoint format on properties. Yet the overall market data shows a different story. The house horniest of them all, investors, are clearly pulling out of markets including sunny and inflated California. Apparently home prices do matter when making investment decisions. Cash strapped hormonal buyers will keep on buying but housing prices are set on the margin. That margin is becoming razor thin on current volume. I find it interesting that the biggest housing supporter of them all, the National Association of Realtors is also somewhat tepid on this recovery. Why? Because home sales volume is pathetic. Keep in mind they make money on selling and buying. Volume is key. Their model doesn’t work so well with banks holding onto properties like Gollum holding onto the ring and the foreclosure process being dragged out like the forever college student enjoying year 10 at Santa Monica City College. You see this overarching trend occurring in many metro areas across the country. Investors have been propping up the market since 2008. They are now slowly pulling back. You are also starting to see a convergence of analysts putting out their predictions on how overvalued housing is and backing it up with mountains of data. The other side of the argument points to prices. Sure, they’ve gone up but value is created by actual price and that is sort of the point. The answer as always isn’t so simple but using your thinking cap it is important to understand that housing is not a “no brainer” decision in this market.

"New starts contracted 15% yoy (vs. -21.9% yoy in March); property sales fell 14.3% yoy (vs. -7.5% yoy); and land sales (by area) plunged 20.5% yoy (vs. -16.9% yoy previously). ... the housing market situation has undoubtedly turned quite gloomy. There has been a constant news stream of falling property prices everywhere, even in the 1-tier cities. A number of local governments, as we expected, have started to ease policy locally, especially relaxation of the home-purchase restrictions." - Soc Gen

There's not much good news for housing these days. For a little while, the Fed's suppression of interest rates juiced housing enough to distract Americans from weak job creation and stagnant real wages. Don't have a job? No problem! Just borrow against the appreciation of your house to feed your family. But Yellen's interest rate wand looks to be out of magic. The government had a pipe dream of white picket fences for everyone. But Americans can't refinance their way to wealth. Especially in the Greater Depression.

I do have a heightened sense of alertness to what may be in store should the hubris of the current market run fail to permeate into forecasts and expectation announcements over the coming months.

Simply put, there is overwhelming evidence of inflation during the decade long era in which the central bankers have been braying about “deflation”. What is more worrisome, David Stockman presents some startling evidence of the complicity of the government statistical mills in using the inflation that is not seen (i.e. “imputed”) to dilute and obscure the inflation that is seen (i.e. utility bills).

If one needed a flurry of "worse than expected" macro data to "explain" why European bourses and US futures are up, one got them: first with UK Q1 GDP printing at 0.8%, below the expected 0.9%, then German consumer prices falling 0.1% in April, and finally with Spanish unemployment actually rising from a revised 25.73% to 25.93%, above the 25.85% expected. All of this was "good enough" to allow Italy to price its latest batch of 10 Year paper at a yield of 3.22%, the lowest yield on record! Either way, something else had to catalyze what is shaping up as another 0.5% move higher in US stocks and that something is the old standby, the USDJPY, which ramped higher just before the European open and then ramped some more when European stocks opened for trading. Look for at least one or two more USDJPY momentum ignition moments at specific intervals before US stocks open for trading. But all of that is moot. Remember - the biggest catalyst of what promises to be the latest buying panic rampathon is simple: it's Tuesday (oh, and the $2-$2.5 billion POMO won't hurt).

While the Fed has clearly had a problem with reflating the broader housing bubble, one which would impact the middle class instead of just those who are already wealthier than ever before thanks to the Russel 200,000, one place which not only never suffered a housing bubble pop in the 2006-2008 years, but never looked back as it continued its diagonal bottom left to top right trajectory is Canada. As the chart below shows, the Canadian housing bubble has put all attempts at listening to Krugman and reflating yet another bubble to shame.

As we noted earlier, The Federal Open Market Committee (FOMC) has continuously been overly optimistic regarding its expectations for economic growth in the United States. A major reason for the FOMC’s overly optimistic forecast for economic growth and its incorrect view of the effectiveness of quantitative easing is the reliance on the so-called 'wealth effect'. However, "There may not be a wealth effect at all. If there is a wealth effect, it is very difficult to pin down..." Since the FOMC began quantitative easing in 2009, its balance sheet has increased more than $3 trillion. This increase may have boosted wealth, but the U.S. economy received no meaningful benefit. Furthermore, the FOMC has no idea what the ultimate outcome of such an increase will be or what a return to a ‘normal’ balance sheet might entail. Given all of this, we do not see any evidence for economic growth as robust at the FOMC predicts. Without a wealth effect, the stock market is not the “key player” in the economy, and no “virtuous circle” runs through the stock market.

So far we have experienced 7 million foreclosures. Beyond that there are still 9 million homeowners seriously underwater on their mortgages and there are millions more who are stranded in place because they don’t have enough positive equity to cover transactions costs and more stringent down payment requirements. And that’s before the next down-turn in housing prices - a development which will show-up any day. In short, the socio-economic mayhem implicit in the graph below is not the end of the line or a one-time nightmare that has subsided and is now working its way out of the system as the Kool-Aid drinkers would have you believe based on the “incoming data” conveyed in the chart. Instead, the serial bubble makers in the Eccles Building have already laid the ground-work for the next up-welling of busted mortgages, home foreclosures and the related wave of disposed families and social distress.