Guest Post: The Unsafe Foundation of Our Housing 'Recovery'

Tyler Durden's picture

Submitted by Charles Hugh-Smith via Peak Prosperity,

What could go wrong with the housing 'recovery' in 2013?

To answer this question, we need to understand that housing is the key component in household wealth. And, that Central Planning policies are aimed at creating a resurgent “wealth effect,” as follows: When people perceive their wealth as rising, they tend to borrow and spend more freely. This is a major goal of U.S. Central Planning.

Another key goal of Central Planning is to strengthen the balance sheets of banks and households. And the broadest way to accomplish this is to boost the value of housing. This adds then collateral to banks holding mortgages and increases the equity of homeowners.

Some analysts have noted that housing construction and renovation has declined to a modest percentage of the gross domestic product (GDP). This perspective understates the importance of the family house as the largest asset for most households and housing’s critical role as collateral in the banking system.

The family home remains the core asset for all but the poorest and wealthiest Americans. Roughly two thirds of all households "own" a home, and primary residences comprised roughly 65% of household assets of the middle 60% of households – those between the bottom 20% and the top 20%, as measured by income. (The U.S. Census Bureau typically divides all households into five quintiles; i.e., 20% each.)

Since housing is the largest component of most households’ net worth, it is also the primary basis of their assessment of rising (or falling) wealth (i.e., the "wealth effect.") No wonder Central Planners are so anxious to reflate housing prices. With real incomes stagnant and stock ownership concentrated in the top 10%, there is no other lever for a broad-based wealth effect other than housing.

Extreme Measures

Given the preponderance of housing in bank assets, household wealth, and the perception of wealth, the key policies of Central Planning largely revolve around housing: keeping interest rates (and thus mortgage rates) low, flooding the banking sector with liquidity to ease lending, guaranteeing low-down-payment mortgages via FHA, and numerous other subsidies of homeownership.

At least three aspects of this broad-based support are historically unprecedented:

1) The purchase of $1.9 trillion of mortgage-backed securities (MBS) by the Federal Reserve.

The Fed purchased $1.1 trillion in mortgages in 2009-10 and it recently launched an open-ended program of buying $40+ billion in mortgages every month. Recent analysis by Ramsey Su found that Fed purchases have substantially exceeded the announced target sums; the Fed is on track to buy another $800 billion within the next year or so. This extraordinary program is, in effect, buying 100% of all newly-issued mortgages and a majority of refinancing mortgages.

Never before has the nation’s central bank directly bought almost 20% of all outstanding mortgages this raises the question: Why has the Fed intervened so aggressively in the mortgage market? There is no other plausible reason other than to take impaired mortgages off the books of insolvent lenders, freeing them to repair their balance sheets.

Regardless of the policy’s goal, the Fed now essentially controls a tremendous percentage of the mortgage market.

2) After the insolvency of the two agencies that backed many of the mortgages originated in the bubble years (Fannie Mae and Freddie Mac), the minor-league backer of mortgages (FHA) suddenly expanded to fill the void left by Fannie and Freddie.

Many of these mortgages require only 3% down in cash, just the sort of risky “no skin in the game” mortgages that melted down in 2008.

Given this mass issuance of low-collateral loans to marginal buyers, it is no surprise that the FHA will soon require a taxpayer bailout to cover its crushing losses from rising defaults.

In 2010, 97% (!!) of all mortgages were backed by government agencies, an unprecedented socialization of the mortgage market. (Source)

This raises two questions: Where would the mortgage and housing markets be if Central Planning hadn’t effectively socialized the entire mortgage market? What will happen to the market when Central Planning support is reduced?

3) Official measures of inflation are viewed by many with a healthy skepticism, but even this likely-understated rate has recently exceeded 2.5% annually.

In this context, it is unprecedented that one-year Treasury bonds have near-zero yields, effectively costing owners a 2%+ annual fee for the privilege of owning short-term Treasurys.

Even more astonishing, rates for conventional 15-year mortgages are comparable to official inflation (the Consumer Price Index, or "CPI"). Lenders are earning near-zero premiums on these mortgages. How sustainable is this imbalance of risk and return?

The enabler of these extremes is, once again, the Federal Reserve, which has purchased hundreds of billions of dollars in Treasury bonds and flooded the banking sector with zero-interest “free money.”

This formidable Central Planning support of housing has placed a bid (i.e., a floor) under housing, resulting in two bounces since the housing bubble popped in 2007-9.

The first heavily subsidized rise faltered. Will the latest pop also reverse? Or is the much-desired “housing bottom” in, from which prices will continue their ascent?

In the macro context, what housing bulls are counting on is the emergence of an “organic,” self-sustaining recovery in housing, based not on Central Planning subsidies but on private demand and non-agency mortgages.

Housing skeptics are looking for signs of what will happen when unprecedented support and intervention in the mortgage and housing markets is reduced or withdrawn.

The Foundation of Housing: Debt and Federal Subsidies

About two-thirds of all homeowners have mortgages. As I noted in The Rise and Fall of Phantom Housing Collateral, mortgage debt doubled from about $5 trillion in 1997, before the housing bubble, to $10.5 trillion in 2007, at the top of the bubble.

This reliance on debt informs the Central Planning policies of lowering interest rates and guaranteeing mortgages via Federal agencies such as the FHA. The only way debt can increase is if incomes rise or the costs and qualification standards of borrowing decline. Since income for 90% of households has been stagnant for decades, the only way debt can expand is by lowering interest rates and reducing the risk exposure of debt issuers via Federal guarantees.

These policies have been pushed to the maximum. As a result, the policy tool bag to further boost housing is now empty.

Now there is only one direction left for interest rates (up) and for housing subsidies and guarantees (down).

Another support of housing recovery is the restriction of homes on the market. Lenders are limiting the inventory of homes for sale by keeping many distressed/foreclosed homes in the off-market shadow inventory. This artificial restriction, coupled with low rates and government subsidies, has supported the modest recovery shown on this chart (courtesy of Lance Roberts) of total housing activity:

While housing has recovered to 2010 levels, what is not visible is the collapse in housing’s share of net worth displayed in this chart:

Housing equity as a percentage of total net worth declines when the stock market rises strongly while housing gains at a much lower rate (for example, during the Bull markets of 1952-1968 and 1982-2000) and rises as stock equity falls (for example, 1969-1981) while housing rose. In the 2001-2008 era, both equities and housing both climbed sharply, but since housing is the larger share of most households’ net assets, housing’s rise overshadowed the expansion of stock net worth, causing home equity to rise as a percentage of total net worth.

The collapse of the housing bubble and the stock market pushed home equity as a percentage of net worth to new lows. The subsequent doubling in the stock market has had little effect on the bottom 90% of households, as the top 10% of households own 85% to 90% of all stocks. (Source)

In broad brush, the wealth of middle class of homeowners has been influenced by four trends:

  1. The stagnation of real income
  2. A rapid rise in mortgage and other debt
  3. The use of debt to fund consumption
  4. The collapse of housing equity as the basis of debt-based consumption

In other words, Federal subsidies and Federal Reserve policies enabled a vast expansion of debt that masked the stagnation of income. Now that the housing bubble has burst, this substitution of housing-equity debt for income has ground to a halt.

This created a reverse wealth effect: The 70% between the bottom 20% and the top 10% have seen their net worth plummet while their debt load remains stubbornly elevated. 

Americans saw wealth plummet 40 percent from 2007 to 2010, Federal Reserve says. (Source)

This chart is nominal rather than real (adjusted), but the relative expansion of debt is clearly visible:

While charts like this lump all household debt and income together, this masks the reality that there is a clear divide between the top 10% and the bottom 90% in terms of income and debt. The debt load of the top 10% is considerably lighter than that of the bottom 90%, while income and wealth gains have flowed almost exclusively to the top 20%.

The top quintile accrued 89% of the total growth in wealth, while the bottom 80 percent accounted for 11%. (Source)

Unsustainable Pricing Will Introduce the "Poverty Effect"

If we put all this together, we get a picture of a middle class squeezed by historically high debt loads, stagnant incomes, and a net worth largely dependent on housing.

In response, Central Planners have pulled out all the stops to reflate housing as the only available means to spark a broad-based “wealth effect” that would support higher spending and an expansion of household debt.

This returns us to the key question: Are all these Central Planning interventions sustainable, or might they falter in 2013?  

Once markets become dependent on intervention and support to price risk and assets, they are intrinsically vulnerable to any reduction in that support.

Should these supports diminish or lose their effectiveness, it will be sink-or-swim for housing. Either organic demand rises without subsidies and lenders originate mortgages without agency guarantees, or the market could resume the fall in valuations Central Planning halted in 2009.

In Part II: The Forces That Will Reverse Housing's Recent Gains, we examine the statistical, historical, and demographic trends that suggest the market recovery is now dangerously vulnerable to a relapse, regardless of Central Planning intervention.

Should housing prices resume a protracted march downwards, as we've detailed here is quite possible, get ready for the "poverty effect" to drain the financial markets of their current euphoria. As the middle 60% of households begin losing a substantial percentage of their net worth, expect consumer spending to dry up and recessionary forces to return in force.  (Source: Part II)

Click here to read Part II of this report

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nope-1004's picture

Was "unsafe" before the crisis, built on easy lending and a credit binge.  Houses are places to live, not a commodity to flip.  Flippers have this unrealistic view that there is a never ending well of idiots standing ready to pay more than they did.


CheapBastard's picture

More and more Flipping ads on TV and the radio every day. Lots moar correction downward to go I'm afraid.

smlbizman's picture

trust me...flippers are like gamblers they only tell you when they win.....

Stock Tips Investment's picture

With an economy so manipulated, it is likely that the increase in this sector continue a while longer. There are also some other factors that are helping this behavior. In some states, we see a strong demand from foreign investors.

Dingleberry's picture

People stopped "buying" houses long ago. They buy payments.  Which are largely dependent on the 10-yr.

Just like bonds. When interest rates rise, prices will fall.  At least in real terms.

Every homeowner (whose house is above water) needs to send Ben a thank-you card for keeping the market propped. He's doing it. No one else.

Cognitive Dissonance's picture

As Todd Harrison of first said back in 2008 they sold the car crash and bought the cancer. It looks like the cancer is kicking our ass. Terminal phase coming up.

<"Take two QE and call me in the morning." - Bernanke>

DaveyJones's picture

They've injected houses with GMO nutrition and it has rot away the very system

JustObserving's picture

And our equally unsafe recovery of stocks supported by $3.6 trillion of printing by the Fed.

What is doing well in this economy without intervention by the Fed?  

Tsar Pointless's picture

Porn was going to be my answer, but even it benefits.

So, I'm not sure.

Sach Mahoney's picture

Thousands, if not tens of thousands of homes are getting scooped up by private equity types and speculators thinking they found the bottom and that they can rent these things out until they sell them.  If you take these speculators and private equity types out of the buying equation, then we still have a market with no demand, is too expensive, has not available credit but for those with perfect credit  and has no fundamental reason to once again go higher.  As rates go higher, fewer will be able to afford a home without prices dropping and with rising rates, foreclosures will be priced more aggressively.   Housing is dead for a decade more.  

FecundaGoat's picture

"private equity types and speculators" understand the inflation brewing....Real Assets are going straight up and you can always raise rents to keep up with inflation.....

Get yourself locked into a cheap 30 year loan!!

reader2010's picture

When Greenspan openly urged marginal buyers into housing market using interest only mortgage, you would have thought they had run out of potential buyers. 

Poetic injustice's picture

Well, section 8 is constantly expanding and need new houses.

Cognitive Dissonance's picture

When the Fed and both political parties (begin to) see the whites of the enemy's eyes (a serious deflationary impulse) and their lives flash before their own professional and financial eyes they will finally bring out the big guns and massive stimulus shall begin. It will be do or die time for the Ponzi and they have no intention of dying without the mother of all fights.

In my opinion we ain't seen nuttin' yet.

McMolotov's picture

The New American Dream is to rent a small apartment with one of your Boomer parents, work a few part-time jobs, and have a leased GM automobile. If you can still "afford" an iPhone after that, you know you've hit it big.

Poetic injustice's picture

While really successful people take 100,000 loan for studies, spend it in nonstop parties, then apply for disabilities and other forms of aid without having to work even one day in their life.

Snoopy the Economist's picture

Iphones will be cheap compared to the phone and data plan

DaveyJones's picture

impossible to believe that as the middle class gets destroyed, the largest purchase they make suffers a similar consequence 

buzzsaw99's picture

As with everything else the banks get the profits and the gubbermint eats the losses.

tarsubil's picture

You mean the People eat the losses.

Cognitive Dissonance's picture

I've been told I can have a spoon full of sugar to help the medicine losses go down.

DeadFinks's picture

Or a broom handle to help the losses go up.

Cognitive Dissonance's picture

I was gonna mention that, but then I figured I would let someone else bring up the rear. :)

Alcoholic Native American's picture

Publically pooled debt, socialism at its finest.

espirit's picture

Gone full circle.  The Fed is the bagholder of last resort.

Gotta love it.

Cognitive Dissonance's picture

I can't wait until they declare the Fed to be the 'bad bank'. The good news is that by that time it will already be filled to the brim with all the bad 'assets'.

<"Those assets aren't bad, just misunderstood." - Bernanke>

DaveyJones's picture

just our wars

NumNutt's picture

I think it is time that the average Joe and his broke ass ex-middleclass friends start taking things into their own hands. How about forming small local groups that identify vacant foreclosed homes, then hit them with a bolt of jewish lightning in the middle of the night, and let them burn to the ground. Not hard to rig up a  delayed flaming device that can be easily obtained from your local hardware or walmart. (Break fluid in a paper milk carton sitting on a pile of crushed up pool chlorine comes to mind...). It is a simple supply and demand thing. You start eliminating the extra housing inventory in your area and at some point housing prices will start going up. The only loosers will be the banks, and the FEDs but oh well, we won't have to wait 20 years to see a positive result.

Shizzmoney's picture

The key for the average person: just refuse to take on the debt.

Watch the system crumble if this happened en masse. 

TrumpXVI's picture

Unfortunately, one cannot even do that.  Because the backstop of final resort is the taxpayer.  Even if you are carrying zero personal debt, you will still end up on the hook (in the form of taxes) for all the debt which will be socialized by the criminal government.

g speed's picture

More propaganda--you can hide assets--and you can hide income--- and yoou can be like a banker or a politico and just lie-- don't believe for a minuite that the gov't is omnipotent--it is not--the US is becoming more and more like Greece every day so just play the Greek National Game -- If you don't have debt you can live quite nicely-- and do what you were put on earth for-(to smell the roses)

TrumpXVI's picture

Well actually, I agree with you.  The government is fucking incompetent, but that doesn't mean they will go quietly, or without first doing an incredible amount of damage.  And it's little use to hide assets if you must liquidate them in the end in order to pay property taxes; where the fuck do you think you're going to live?

Snoopy the Economist's picture

"just refuse to take on the debt"

There will always be plenty of losers to take on the debt that they never intend to repay. Sadly, the banks will continue to give it to them so they can continue the game.

DoChenRollingBearing's picture

O/T but of interest to anyone wanting more income or interest.  Barron's looked at energy MLPs last weekend, it took some time for me to read the article and digest it, but this class of investments is worth a look.  They are more complex than I had thought in the past, that is why I needed time to understand them better.

"Barron's Article on MLPs -- 25 Feb 2013"

slightlyskeptical's picture

I'll wait until they are all paying near 8% again, thank you very much.

slightlyskeptical's picture

Blah. blah, blah. The government just needs to take ownership of the primary housing market. We already back it, let's just buy the bonds. Refinance them, help out the consumer, and we still get paid back ALL the money put out for the program. If anyone in the Fed or the governemnt really cared about us, then this would already be a done deal. Buy the bonds...send a letter....done deal. Who would refuse principal reduction and lower payments? It's a moral hazard not do this.

Then let social security fund take over the future lending in the primary mortgage market. Trying stiffing them when they control your future payments.

g speed's picture

blah blah back at ya--troll--

 you are for sure another full of shit realestate agent.

Tsar Pointless's picture

Actually, I'm going to pat myself on the back here for gaming the system as well as I did.

Back in January 2010, I took full advantage of the "first-time home buyer" 10% tax credit and purchased my first home. At that time, I was paying $550/month in rent. By now, that same apartment is likely around $600/mo.

My mortgage is $510/mo, and my interest rate is 5.5%. I didn't allow my eyes to become larger than my debt-to-loan ratio, purchasing an all-brick home with hardwood floors and a built-in one-car garage for under $60,000. And, the three-year penalty period has expired, so I am literally home free.

Yeah, I know. You never technically "own" a home (taxes), but I am not throwing $600 down the toilet every month, either.

socalbeach's picture

CHS obviously doesn't understand how the monetary system works.  From the article,

"Even more astonishing, rates for conventional 15-year mortgages are comparable to official inflation (the Consumer Price Index, or "CPI"). Lenders are earning near-zero premiums on these mortgages. How sustainable is this imbalance of risk and return?"

Banks get to borrow for nearly 0%, so if they're loaning at 3.5% they're making lots of money on their loans at current inflation rates.  It's the savers, bank depositors, who are losing.  The banking system as a whole mostly loans out multiples of customer deposits.

Peter Pan's picture

Any wealth effect engineered by manipulating house prices will be short lived. If you want to see a real and sustainable wealth effect you need to create secure and well paying jobs and people need to buy houses with at least 25% deposit. Failure to do so makes them potential debt slaves and bankruptcy candidates.

In addition housing needs to become smaller and less lavish to avoid the previous ill conceived notion that houses were somehow a spring of eternal wealth.

g speed's picture

There is no "weath effect" in a ball and chain. At least you see that smaller is the trend and are agreeing with it-- 


Peter Pan's picture

You have misread my comment.

We DID have a welth effect from housing while it was going through a false boom. A boom of course that was not predicated on undamentals but on low lending standrds and cheap rates.

akak's picture

Fundamentally, of course, there was and is no such thing as a "wealth effect", as mere (paper) valuations are not wealth.

What we had in the housing market was the illusion of rising wealth.

If my bank suddenly tells me one day that I have $1,000,000 in my checking account, when in reality I have only $1000, and then later does an about-face and tells me that it was all a mistake and that that $1,000,000 was never really there, did I ever truly experience any real if temporary 'gain' --- or any real loss?

Peter Pan's picture

Once again, I have to insist that there was a wealth effect for the early birds who geared themselves and bought property with both hands as their prices rose. As their debt lost value they did in fact experience a wealth effect at least based on valuation. Those that sold out actually realised the wealth effect of the scam that was being played out.