This week I am going to just make some comments on various topics relevant to the mortgage and real estate markets at present. In lieu of one of my off-topic thematic pieces it is good to concentrate on mortgages, real estate and the economy. Not as much fun but, hopefully, more relevant.
Mortgages
We will continue to see a modest increase in mortgage rates until the end of this year. This is based on both the technicals (StoMaster) and the reality that we will see one or 2 more Fed hikes and then enter an annoying gray period marked by uncertainty about whether the Fed's actions have hurt the economy. I believe that we shall once again find that the Fed knows what is doing. Nonetheless, much ink and blogging will be devoted to suggesting otherwise.
Mortgage Types
I have been doing mortgages for (I think) 14 years. I do not believe that I have ever seen a time when mortgage rates were flatter. By this I mean that the differences between fixed 30 year loans and the intermediate-term ARM's (the 5/1 and 7/1) and zero some days and 0.125% other days. There is not a lot of incentive to get an adjustable. Adjustables should offer mainly the advantage of lower rate and payment now for uncertainty later.
The flatness of mortgage rates is a consequence of the flat Treasury yield curve. The flat Treasury yield curve is a consequence of the Fed lifting the short end and the market keeping the long end fairly flat.
That Said...
We still see demand for both interest only loans and the Option ARMs. We have discussed this in the past but these are primarily for folks who are 1) buying a home now which they will be able to afford the payment on in a couple of years - folks with rising incomes 2) folks with incomes which vary significantly from month-to-month 3) folks who are buying homes which require fixing up 4) folks with income property which is costing them a few hundred bucks out of pocket to maintain 5) folks who may be buying a new home before they have sold their old home and need a break to carry two payments for a few months.
In short, it is not the rate that is selling ARMs but the low payment associated with interest only or the very low payments associated with the minimal payment of a negative amortization Option ARM.
Real Estate Prices
This has gotten enough coverage in the media. The media tends to be biased to "gloom and doom." Last week a writer in the S.F. Chronicle wrote and article on housing prices in the San Francisco Bay Area and said that the median housing price "tumbled" from $656,000 to $637,000. This may be a semantic thing but that is hardly what I would call a "tumble." It is a decrease of less than 3%. If that happens 5 months in a row we have a "tumble." (Dictionary says: tumble 1 a : to fall suddenly and helplessly b : to suffer a sudden downfall, overthrow, or defeat c : to decline suddenly and sharply (as in price).
The point here is that it is my hope that we see an extended period (say, five years) of relatively flat housing prices in those areas which have seen significant inflation in housing prices in the past 5-10 years. Folks are simply committing too large a portion of their income to housing payments at a time when wages are flat. That has to be taking a bite out of GDP and acting as a slowing force on the economy.
There is a lot more at stake here than folks may be willing to admit. Stability about housing prices may be seen as providing economic security to individuals. The fact is that a lot of folks have a great deal of their net worth tied up in the equity in their home. Collectively this is about the security of the banking system.
The following is almost seven years old but remains true: on April 22, 1999 Federal Reserve Governor Laurence Meyer in a speech in Annendale-on-the-Hudson, NY pointed out that asset price bubbles in real property were much more dangerous to the economy than inflated equity prices. To quote Meyer:
"There are two kinds of asset price bubbles. There is one which is centered on financial assets and equity markets. The other is when it stretches the real property market, and it is infinitely more dangerous. The U.S. economy can handle surely an equity kind of correction well. But when you have the kind of correction going on in Japan in property markets, you undermine the collateral of the banking system and you crush the value of banks."
If Meyer was concerned then I would think that the inflation in housing values since that time has given cause for more than a small amount of concern.
Apart from the real work of employees and employers the underlying infrastructure of our economy depends on confidence in the dollar and dollar denominated debt and on a healthy banking system. The real peril in the event of a serious bursting of a "housing bubble" is nothing less than the financial well-being of the banking system. In short, a collapse of the banking industry is much more serious than, say, a collapse of the domestic auto industry. I am by no means forecasting this. I very much doubt that anything like this would happen. I am only noting that instability of housing values would create a serious problem for banks. Meyers is correct that a collapse in housing values would be of far greater consequence for the banking system than any shop drop in equities.
To be fair, this issue is not so simple. Most mortgage debt is not owned by banks. The total amount of banks assets tied up in mortgage is about 20%. Of course, this is not uniform. It is still the case that any sharp drop in housing values will impact some banks and not others. In addition, the securitization of conforming mortgages by FNMA and FHLMC spreads the risk around geographically. In vales fall in Podunk the Bank of Podunk is not bearing all of the risk.
Economy. Big Picture.
I think that we will see sluggish GDP growth as the actions of the Fed intended to abate inflation take hold. From the Fed's perspective the biggest enemy of the economy is inflation. One year of GDP growth of less than 2% is better that core-CPI above 4%. That's simplistic but you get the idea.
- Dick Lepre
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