"Winter Is Here" For Housing - Whalen Warns "The Crowd Of Buyers Is Thinning"

Following this morning's plunge in new home sales...


After household formation collapsed in June...

It appears Institutional Risk Analyst's Chris Whalen is spot on with his mortgage finance update: "Winter Is Here"...

After several weeks on the road talking to mortgage professionals and business owners, below is an update on the world of housing finance.  We hope to see all of the readers of The Institutional Risk Analyst in the mortgage business at the Americatalyst event in Austin, TX, next month.

The big picture on housing reflected in the mainstream media is one of caution, as illustrated in The Wall Street Journal. Borodovsky & Ramkumar ask the obvious question:  Are US homes overvalued? Short answer: Yes.  Send your cards and letters to Janet Yellen c/o the Federal Open Market Committee in Washington.  But the operating environment in the mortgage finance sector continues to be challenging to put it mildly.

As we’ve discussed in several forums over the past few years, home valuations are one of the clearest indicators of inflation in the US economy.  While members of the tenured world of economics somehow rationalize understating or ignoring the fact of double digit increases in home prices along the country’s affluent periphery, sure looks like asset price inflation to us.

In fact, since WWII home prices in the US have gone up four times the official inflation rate.

 “Houses weren't always this expensive,” notes CNBC. “In 1940, the median home value in the U.S. was just $2,938. In 1980, it was $47,200, and by 2000, it had risen to $119,600. Even adjusted for inflation, the median home price in 1940 would only have been $30,600 in 2000 dollars, according to data from the U.S. Census.”

Inflation, just to review, is defined as too many dollars chasing too few goods, in this case bona fide investment opportunities.  A combination of slow household formation and low levels of new home construction are seen as the proximate cause of the housing price squeeze, but higher prices also limit the level of existing home sales.  Many long-time residents of high priced markets like CA and NY cannot move without leaving the community entirely. So they get a home equity line or reverse mortgage, and shelter in place, thereby reducing the stock of available homes.

Two key indicators that especially worry us in the world of credit is the falling cost of defaults and the widening gap between asset pricing and cash flow.  Credit metrics for bank-owned single-family and multifamily loans are showing very low default rates.  More, loss-given default (LGD) remains in negative territory for the latter, suggesting a steady supply of greater fools ready to buy busted multifamily property developments above par value.  We can’t wait for the FDIC quarterly data for Q2 2017 to be released later today as we expect these credit metrics to skew even further.

Single-family exposures are likewise showing very low default rates and LGDs at 30-year lows, again suggesting a significant asset price bubble in 1-4 family homes.  The fact that many of these properties are well under water in terms of what the property could fetch as a rental also seasons our view that we are in the midst of a Fed-induced investment mania.

For every seller in high priced states that finds current prices impossible to resist, there are several ready buyers. But the crowd of buyers is thinning. Charles Kindleberger wrote in his classic book, “Manias, Panics and Crashes,” in 1978:

“Financial crises are associated with the peaks of business cycles. We are not interested in the business cycle as such, the rhythm of economic expansion and contraction, but only in the financial crisis that is the culmination of a period of expansion and leads to downturn.”

One of the interesting facts about the mortgage sector in 2017 is that even though average prices have more than recovered from the 2008 financial crisis, much of the housing stock away from the desirable periphery has not really bounced.  This is yet another reason why existing home sales at a bit over a million properties annually have gone sideways for months.  The 600,000 or so new housing starts is half of the peak levels in 2005, but today’s level may actually be sustainable.

We had the opportunity to hear from our friend Marina Walsh of the Mortgage Bankers Association at the Fay Servicing round table in Chicago last week.  Mortgage applications have been running ahead of last year’s levels, yet overall volumes are declining because of the sharp drop in refinancing volumes.  We disagree with the MBA about the direction of benchmarks such as the 10-year Treasury bond.  They see 3.5% yields by next year, but we’re still liking the bull trade.  But even a yield below 2% will not breath significant life into the refi market.

Though prices in the residential home market remain positively frothy in coastal markets, profitability in the mortgage finance sector continues to drag.  Large banks earned a whole 15 basis points on mortgage origination in the most recent MBA data, while non-banks and smaller depositories fared much better at around 60-70bps.  But few players are really making money.

During our conversations over the past several weeks, we confirmed that the whole residential housing finance industry is suffering through some of the worst economic performance since the peak levels of 2012. The silent crisis in non-bank finance we described last year continues and, indeed, has intensified as origination margins have been squeezed by the market's post-election gyrations.

Looking at the MBA data, if you subtract the effects of mortgage servicing rights (MSR) from pre-tax income, most of the industry is operating at a significant loss.  The big driver of the industry’s woes is regulation, both as a result of the creation of the Consumer Finance Protection Bureau and the actions of the states.

Regulation has pushed the dollar cost of servicing a loan up four fold since 2008.  From less that $100 per loan in 2008, today the full-loaded cost of servicing is now $250, according to the MBA.  The cost of servicing performing loans is $163 vs over $2,000 for non-performing loans.

Source: MBA

As one colleague noted at the California Mortgage Banker’s technology conference in San Diego, “every loan is a different problem.” But nobody in the regulatory community seems to be concerned by the fact that the cost of servicing loans has quadrupled over the past eight years.  The elephant in the room is compliance costs, which accounts for 20% of the budget for most mortgage lending operations.

Technology Driving Down Costs

To some degree, technology can be used to address rising costs.  But when it comes to unique events spanning the range from legitimate consumer complaints to a phone call to follow-up on a past request or spurious inquiries, none of these tasks can be automated.  The obsession with the wants and needs of the consumer has led the mortgage industry to some truly strange behaviors, like Nationstar (NYSE:NSM) deciding to rename itself "Mr. Cooper."

Driven by the atmosphere of terror created by the CFPB, the trend in the mortgage industry is to automate the underwriting and servicing process, and make sure that all information used is documented and easily retrieved. The better-run mortgage companies in the US use common technology platforms to ensure a compliant process, but leave the compassion and empathy to humans.

By using computers to embed the rules into a business process that is compliant, big steps are being made in terms of efficiency. Trouble is, this year many mortgage lenders are seeing income levels that are half of that four and five years ago.  Cost cutting can only go so far to addressing the enormous expense inflation resulting from excessive regulation and revenue compression due to volatility in the bond market.

Avoiding errors and therefore the possibility of a consumer complaint (and a regulatory response) is really the top priority in the mortgage industry today. As one CEO opined: “Sometimes the best customer experience is consistency in terms of answering questions and quickly as possible and communicating in a courteous and effective fashion.”

All of this costs time and money, and then more money.  Our key takeaway from a number of firms The IRA spoke with over the past three weeks is that response time for meeting the needs of consumers and regulators is another paramount concern.

Being able to gather information, solve problems and then document the response to prove that the event was handled correctly is now required in the mortgage industry.  But as one senior executive noted: “Sometimes people are easier to change than systems.”

So in addition to the FOMC, banks and mortgage companies can also thank the CFPB and aspiring governors in the various states for inflating their operating costs for mortgage lending and servicing by an order of magnitude since the financial crisis.  This is all done in the name helping consumers, you understand, but at the end of the day it is consumers who pay for the inflation of living costs like housing.  Investors and consumers pay the cost of regulation.  

Over the past decade since the financial crisis, the chief accomplishment of Congress and regulators has been to raise the cost of buying or renting a home, while decreasing the profitability of firms engaged in any part of housing finance.  We continue to wonder whether certain large legacy servicing platforms -- Walter Investment Management (NYSE:WAC) comes to mind -- will make it to year-end, but then we said that last year.

Like the army of the dead in the popular HBO series “Game of Thrones,” the legacy portion of the mortgage servicing industry somehow continues to limp along despite hostile regulators and unforgiving markets.  Profits are failing, equity returns are negative and there is no respite in sight.  Even once CFPB chief Richard Cordray picks up his carpet bag and scuttles off to Ohio for a rumored gubernatorial run, business conditions are unlikely to improve in the world of mortgage finance. Winter is here.


subversion Erek Wed, 08/23/2017 - 14:27 Permalink

Home buying usually slows down around September since most families don't want to move their kids while school is in.Of course the Chinese millionaires have changed that tune with their money stolen from the people of China, but it still holds true in areas they aren't buying up.Either way it's a mess and it's collapse is long overdue.

In reply to by Erek

QQQBall Erek Wed, 08/23/2017 - 16:18 Permalink

FNM letting banks use AVMs rather than physical appraisals. No property inspection required. IF the lender uses the AVM - wararnties and liability not applicable. Pretty BIG move and no MSM coverage?AVMs have and will continue to get better... the lack of a phyiscal inspection is odd - even 40 years ago they at least did drive-bys?-----Compliance costs? Use the WFC model and just pay a fine.-------The next drop in rates will be b/c the economy is in the shitter. No one will want to borrow unless it is to reduce the IR on an existing mortgage.

In reply to by Erek

Glyndwr will return Wed, 08/23/2017 - 14:25 Permalink

Ray Dalio says this feels like 1937In the US, in 1937, average wages were less than $3000 a year and average house prices were about $6000.A simple 2 to 1 ratio.Some way to go yet Ray, to get that 1937 feeling - or should I say that ratio!

NoWayJose Wed, 08/23/2017 - 14:31 Permalink

The real challenge is that stealth inflation has hit everything that goes into building a new home - from land, to labor, to materials, to government taxes (and permits & fees), to flooring, to appliances, etc, etc

There are many places where you cannot build a house for under $200,000 (and in some places that gets up over $300,000).

Any 'collapse' is going to have to hit land, lumber, building materials, etc -- and that is hard to see with QE asset inflation still going strong.

iLLivaniLLi19 NoWayJose Wed, 08/23/2017 - 15:40 Permalink

I did pretty well I think to build a 1500 square foot house in 2016 for ~$135,000 (not including land). But the way that property tax is applied is generational warfare. Basically, new homeowners have to pay property tax on the current assessed market value while the Boomers are paying property tax as it was assessed when they bought their houses 20+ years ago. I'm paying property taxes on $20,000 - $30,000 of real estate value that my neighbors in comparable homes are not. How is this not a ponzi scheme? The Boomers should be ashamed of what they have helped to create. 

In reply to by NoWayJose

Ron_Mexico iLLivaniLLi19 Wed, 08/23/2017 - 16:33 Permalink

I don't know where you are, but property taxes don't work that way. When properties are revalued for tax purposes by the municipality, ALL properties within their jurisdiction are re-evaluated at the same time. And then the higher tax bills come out, because even if they didn't raise your tax valuation they always seem to raise the tax rate. There are some places that give those aged 65+ a break on taxes, though. If I were you I'd check into what is going on, assuming that what you have said is correct.

In reply to by iLLivaniLLi19

BetterRalph Wed, 08/23/2017 - 14:31 Permalink

Does this mean better deals then? I guess.

I would love BLINK my eyes and FIND myself transported back in time, the $2700 1972 Mustang and $65,000 single story and 25 cents a gallon gas. I miss the simplicity of those days. No computers.

Mon T (not verified) Wed, 08/23/2017 - 14:42 Permalink

Vagued article.  How is it that Shepwave can call every turn in the markets and no one else seems to have a clue. Suspicious I think.

Paul Kersey Wed, 08/23/2017 - 14:42 Permalink

Here's what the article should have stated: The mortgage business is Government business.

"The United States government has taken total control of the mortgage markets in this country:

The payments on one of every four new residential mortgage loans are insured by the government.

The government buys 1 of every six residential mortgage loans issued for its own account.

Though the Government Sponsored Enterprises the government either owns or insures 3 of every 5 mortgage loans currently outstanding in the country.

Moreover, the government is increasing its ownership and control every quarter. The primary reason this is happening is because the government is increasing its direct ownership of these loans.

Fannie Mae (FNMA/$1.80/Buy) and Freddie Mac (FMCC/$1.71/Buy) are at the top of the mortgage sector. They own or insure $4.6 trillion in residential mortgages or 45.9% of the market up from 41.9% in 2009.

The private sector is second largest. It controls $3.9 trillion in mortgages or 38.8% of the total loans outstanding. Its share is down from 52.3% in 2009.

At the bottom, and fastest growing, is Ginnie Mae. This wholly owned agency of the United States government owns $1.5 trillion in loans or 15.2% of the market up from 5.7% in 2009.

It is growing so fast that it is taking market share from both the GSEs and the private sector.'

rf80412 Wed, 08/23/2017 - 14:48 Permalink

 “Houses weren't always this expensive,” notes CNBC. “In 1940, the median home value in the U.S. was just $2,938. In 1980, it was $47,200, and by 2000, it had risen to $119,600. Even adjusted for inflation, the median home price in 1940 would only have been $30,600 in 2000 dollars, according to data from the U.S. Census.”

I would be curious to see how that compares to the average income in 1940.  Price inflation stats only tell half the story; were houses actually more affordable then, or was the average income so much lower that buying a house then was just as hard or even harder than it is now ... especially in high-demand markets (i.e. where the jobs are).

SeaMonkeys rf80412 Wed, 08/23/2017 - 15:26 Permalink

Asset price inflation took off in the 70's when the productive power of the U.S. moved overseas or became automated. Money searching for yeild in an economy where productive investment is declining always ends up in speculation. Land is always the principle asset, but financial assets come in second. Look at the bull market's long run and compare it to the loss of American manufacturing and productivity. They are directly and strongly correlated. Look at our twin deficits, balance of payments, and overall debt (government and private). Speculative money in this kind of environment will always corrupt government to change laws to give the crony-monied-speculators opportunity over the rest of us. This is how the momentum and direction of the country and its economy occurs - thru what seems to be apparent success (but only for a while).Season 2 of the TV show "True Detective" was about this very issue. The story centered around a murder that took place in the context of land use rights being sold to an inside bidder who was then going to take advantage of a future state-wide railroad that the corrupt politicians were going to broker. When money screams for de-regulation, what they really mean is re-regulation in favor of cronyism and to the disadvantage of the rest of us. 1940 is not the best year to use as a comparison. 1950 is probably much better. During America's post war productive boom, real estate in the beg cities, all things being equal, went slightly down. Productivity and land prices are inversely related in this light. Look at Germany today. German's spend less than half of what Americans do for housing. Education is free, healthcare free. They are far more productive as a nation than we are because finance in Germany is very highly regulated. 75% of Germany's 1,500 banks are non-profit and are restricted in their lending to local communities for productive investment - meaning jobs for entrepreneurs. Anglo finance is for whatever makes the quickest buck for the snake-oil bankers and money lenders. America is not a country but a shell corporation where the shareholders are the 1%. The next 9% are the Mandarin class that shills for the 1%. Blue or Red, it doesn't matter - they constantly shill for the status quo.The writer of this article is pleading for sympathy for an industry that is usury defined. It's like Wells Fargo complaining of too much regulation. Real estate, healthcare, and education are the big ticket items that all Americans are forced into purchasing, to one degree or another. Control the prices and lend into the bubble is the American way. We have become a nation of sniveling boot lickers who worship the wealthy without questioning how they got their wealth. 

In reply to by rf80412

SeaMonkeys ipso_facto Wed, 08/23/2017 - 23:28 Permalink

Housing in Germany is much, much lower than the U.S., so is healthcare, and so is education. I was too quick to type the words free. I stand corrected. I don't know the actual amount a person pays for these things, but they are basically free. What is it that you think these things cost for Germans? For example, if a German pays 30% of their income, on average for housing, and pays 10% of what an American pays for healthcare and education, is this a reason for you to complain? Is the German system that horrible that you would rather pay what amounts to hundreds of working hours worth of your income to make rent-seeking corporations richer? Where is the trade off that makes your high costs in America so worth fighting for? What are you gaining? Wouldn't you rather spend time with your family? Why are you defending the right of banks and corporations to move you like pawns on a chess board?Americans have no disposable income because everything that can be privatized has been or will be privatized. This means you pay thru the nose for things that other countries' citizens pay much less for or get for "free." The word free can have 2 meanings: 1) the cost is shared at no mark-ups. This is what the public sphere is for. America lost the public sphere ages ago. You sound like you want to defend the corporations that mark up costs that you end up paying for. Not good. Wouldn't you rather have access to public universities like your parents had, and for "free" like it was for them? Wouldn't you rather have access to quality healthcare at either a) transparent and affordable prices, as libertarians want or remove the insurance industry all together (at least for core medical services and medications) and make healthcare a public, no profit, institution?Too much complaining about regulation on Zero Hedge means that the monopolies have trained the little people well. Americans chant corporate mantras in their sleep.  2) Free can also mean zero cost to produce. Today's debt money costs nothing for banks to produce. They collect the interest and lend into inflating bubbles. You should know the story by now. That is free money that only banks enjoy. The same benefit, called seignorage, could be used by the country in the form of sovereign money. Not debt money, not money that has interest attached to it, but plain sovereign money. Look up Joseph Huber's website, https://www.sovereignmoney.eu/Also, if you want to understand German banking, read or watch videos by a German economist named Reichard E. Werner. He made a documentary titled, The Princes of the Yen.  https://www.youtube.com/watch?v=p5Ac7ap_MAYI apologize for typing without checking my numbers, but the substance is real. We Americans are getting shafted from both sides. Cheerlead for the GOP if you want to. I voted for Trump, and so far he sucks. I like Steve Bannon a lot, but I really disagree with him about China, patents, intellectual property and trade wars.If you want to understand the economic philosophy that Steve Bannon draws upon, stop cheerleading for the GOP, or the Democratic Party, or whoever and read about the 19th century German economist Friedrich List. The Asian Tigers, Japan, south Korea, Taiwan, Singapore, Hong Kong, and now China all use (or used, in the case of Japan) List's ideas. 

In reply to by ipso_facto

Mike Masr Wed, 08/23/2017 - 14:59 Permalink

Who would want to buy anything in that cesspool-sanctuary city Chicago?Outrageous property taxes....andThey have that stupid soda pop tax and grocery stores there charge for plastic bags.Murder capital of the USA and the ignorant mayor wants more criminal illegals.

south40_dreams Wed, 08/23/2017 - 15:00 Permalink

People tend not to commit to long term plans like cars and houses when the country is on the verge of civil war, death and destruction, at least, that's what the media screamers dish out 24/7/365

Stormtrooper Wed, 08/23/2017 - 15:16 Permalink

"Inflation, just to review, is defined as too many dollars chasing too few goods, in this case bona fide investment opportunities"No shit Sherlock!  The unlimited fiat currency supply, with no constraints from a gold standard, has increased in a parabolic curve upward since 1970 and people wonder why there has been huge increases in housing and equity prices along with a corresponding loss of jobs because of wage increases based on all of that funny money that have made American labor non-competitive.  Let's hear your next eureka discovery.

jughead Wed, 08/23/2017 - 15:25 Permalink

Not seeing that here.  Been trying to help a friend downsize and buy a home out here near us (and their son and new grandbaby) for months.  Each time we find something that meets their modest needs, it's pending sale within 24 hours.   The only homes that are not still selling here are the dumps, the problem-childs and the mega mcmansions.  

Benito_Camela Wed, 08/23/2017 - 15:32 Permalink

As someone who actually did just buy a house in June, pardon me for asking why there is no mention of the interest rate hike that occurred at the beginning of July. That seems like as good a reason as any for why home purchases declined.