when will the housing market stand on its own?

Rate Watch #693 When Will the Housing Market Stand on Its Own?

October 23, 2009
by Dick Lepre
dicklepre@rpm-mtg.com
www.loanmine.com

V) Is the Housing Market Ready to Stand on Its Own?

This past Monday I read an article by my friend Ilyce Glink. I started to write a reply and realized how complex this question was so I stopped, sent her an e-mail thanking her for the inspiration and started writing this. I also stole the name of this article from her. We mortgage folks are nothing if not shameless.

Let's enumerate what Federal Government supporting the housing market in manners that it did not three years ago:

1) First Time Home Buyer Tax Credits

2) Takeover of FHLMC and FNMA

3) Now taking losses on FHA. FHA traditional is for low down payment or higher risk borrowers.

4) TARP bailouts of banks to help them maintain the semblance of liquidity because they are near the front line of mortgage lending. TARP was about more than mortgages but mortgages a) caused the problem and b) benefited along with other forms of lending from TARP. Also, TARP was about more than banks,

5) Conforming loan limits which are $417,000 should really be much less according to the traditional method of calculating conforming based on median sales prices in October.

6) Jumbo-conforming to $729,750 in high-value counties to accommodate the total lack of private Jumbo securitization. This points to the fact that few, at present, are making any mortgages which are not guaranteed by the Federal government.

7) FHLMC/FNMA backed refinancings to 105% - Home Affordable Refinance Program, or HARP

8) Federal Reserve buying of FHLMC/FNMA paper. This is not chump change but about $1.5 trillion. This supports low rates which supports the housing market.

9) an easing of bank's ability to not write off mortgage debt per the traditional rules. In short, losses are deferred for the sake of pumping up balance sheets.

10) The Homeowner Affordability and Stability Plan HASP - plan to avoid foreclosures.

11) This week the Administration announced new support under the authority provided to Treasury by the Housing and Economic Recovery Act of 2008 (HERA) to provide funds to local housing agencies.

I started writing this list and was stunned with the size of it. I looked at it and it is intimidating. Let's go back and discuss a few of these. TARP did many things. One was to put about $205 billion into 700 capital-short banks. About $70 billion has been repaid. Confidence in the banking system has increased but the risks are still there. Commercial Mortgage losses have yet to be taken and item 9) the relaxation of accounting standards compromises the traditional standards for judging the health of individual banks and the banking system in general. TARP will end at the end of 2009 in the sense that no more money will go out. Congress and the administration could see the money coming back as a new pool of something to spend money on. TARP is a gigantic program with many aspects. It it the primary thing which has brought the banking system back from the brink but there is much about it to criticize. See this article for example.

Item #8 is of significance to us mortgage folks. If the Fed stops buying FHLMC/FNMA paper someone is going to have to start buying it. Mortgage rates will go up at least 0.5% I would guess but this step must occur before and of the other FHLMC/FNMA items are implemented. If a markets develops for FHLMC/FNMA paper then at some future time several years from now Treasury can consider returning FHLMC & FNMA to their former GSE status. This is not going to happen any time soon. The Fed has announced that they will stop buying agency paper at the end of 1stQ2010.

If the Fed stopped buying FHLMC/FNMA paper there would be a problem with the jumbo-conforming loans because the professional organizations of security dealers will not regard any FHLMC/FNMA pool with > 10% jumbo conforming to be classified as investment grade. This creates two difficult choices: 1) toss out jumbo conforming and send property values in California into the abyss or 2) have the Fed keep buying these jumbo-conforming.

In fact, I see no way that the Fed can stop buying mortgages at the end of 1stQ2010. The consequences would be disastrous. No one else is going to buy this paper and real estate prices here in California will dive. Added into this is the fact that we are just starting to see a second foreclosure wave from Option ARMs which are mainly jumbo. There is a TV piece from KGO Channel 7 (S.F. ABC affiliate) shot this past week addressing this wave of problems. I am the guy at the end of the piece.

Amherst Securities Group estimates that there is a housing overhang or shadow inventory of 7 million units will will come on the market in the next 2 years consequent to foreclosures. There is a capsule of the report on Yahoo.

Remember that the Fed does not borrow money, it creates it out of nowhere. It's only consequent concern is inflation resulting from expanded money supply. I spoke with my mentor, Jim Grauer, and he suggested that the Fed might continue to buy mortgages and stop or decrease its purchases of Treasuries instead.

The First Time Home Buyer Tax credits have been much discussed this past week. Really, all they do is move future sales into the present. Every one who buys a home under this program now is a buyer who will not be buying their first home in some future year. This, like cash for clunkers, causes Treasury to spend more money that it does not have with the sole purpose or dressing up the present data at the expense of future data.

HARP and HASP need to be phased out if the housing market is going to begin to think about standing on its own. These programs got off to poor starts and if they start to prove effective next year they could buy themselves more time. This is a WSJ article on HARP. The other problem with reworking the mortgages of those delinquent is the traditionally high recidivism rate.

Somewhere along the way what is going to happen is that all of the massive amount of money poured out there to cure the problem will cause inflation and interest rates will rise. This will be a painful part of the cycle but what could arise from this is jumbo mortgage securitization. The conforming loan limits will be parked at $417,000 for years and the jumbo-comforing if not already discarded will no longer be needed.

By the end of 2011 we should go back to the realistic way of allowing banks to mark their assets to market. Give that at least 2 quarters and terminate

I want to make a couple of summary points: 1) the timeline suggested above is intended as a starting point. The precise timing and the order in which to terminate these various programs should be in the hands of the Fed and Treasury. Going forward to restore the housing market to normalcy, politicians are more likely to contribute to the problem than the solution. 2) it is unlikely that the housing market will be able to stand on its own (meaning the way things were 3 years ago) at any time during the next five years.

When will the housing market stand on its own? More than five and less than ten years from now.

Second Order Effects

If the above sounds complicated consider this. One the Fed stops buying agency paper (FHLMC/FNMA/FHA) that paper will have to be purchased by investors who will be less inclined to buy equities. Perhaps some of the runup we have seen in equities has been caused by that $1.5 trillion than investors did not used to buy agency paper. The implication is that the Fed getting out of the agency paper market might cause a decline in equity prices.

If you have something to add to this discussion please post a comment on the blog.

 

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Dick Lepre
RPM - SF
580 Pacific Avenue
San Francisco, CA 94133
DRE License # 01143973
dicklepre@rpm-mtg.com
Web site: www.loanmine.com
Blog: economy.typepad.com
(415) 343.6789 (direct dial number)
(866) 488-2051 fax

 

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