Rate Watch #760 The Housing Market

February 11, 2011
by Dick Lepre
dicklepre@rpm-mtg.com
www.loanmine.com

The report regarding what to do with FNMA and FHLMC is out.  This report is comical is that it misses the fact that the demise of the GSEs was at the hand of HUD which in 1994 created "The National Homeownership Strategy: Partners in the American Dream," which said (boldface added):

"For many potential homebuyers, the lack of cash available to accumulate the required downpayment and closing costs is the major impediment to purchasing a home. Other households do not have sufficient available income to make the monthly payments on mortgages financed at market interest rates for standard loan terms. Financing strategies, fueled by the creativity and resources of the private and public sectors, should address both of these financial barriers to homeownership."

Instead the report blames others and states that the GSEs were simply trying to catch up with private label subprime.  The report says that the GSEs did not get into Alt-A, subprime until 2006. But in fact from 2004 to 2006, the two purchased $434 billion in securities backed by subprime loans. This validated private label subprime. Check out this NYT article from 1999 or this Washington Post story. Today's report confuses jumping off a building (1999) with getting up to full speed and just about to hit the sidewalk (2006).

Bernanke reminded the House Committee that the federal deficit for the current year was a lot larger than QEII. Absent even semblance of a plan for fiscal sustainability it matter little what the Fed does. Massive deficits without corresponding large increases in GDP will inevitably spike inflation and interest rates. It is ludicrous for Congress to give the Fed the dual mandate of containing inflation and growing GDP with a $1.5 trillion deficit. At some time in the not too distant future Treasury's cost of borrowing will spike dramatically and we will see inflation and the necessity of a combination of decreasing government spending and raising taxes both of which hurt GDP. Massive deficit spending will make both parts of the dual mandate impossible.

The most annoying aspect is that QEII has not even been properly explained. QEII has, to this point in time, not expanded money supply. It has kept it from contracting. What the Fed has done is take the dollars which have come to it from payments and payoffs of the assets in its mortgage portfolio and pumped those into Treasuries. When QEII is finished the increase in money supply will be just less than half of the headlined $600 billion.

The Housing Market

The subprime/housing bubble mess caused a massive recession. Real dollar GDP for 4thQ2010 is almost exactly where it was 4thQ2007. The most savaged part of the economy has been the housing sector. 2,000,000 jobs in homebuilding have been lost.

Homebuilders are a confident bunch. I guess that optimism is a necessity in this industry. Bloomberg had a article this week about the confidence of homebuilders. It was a bit muted. The article said "The chief executive officers of six of the 10 largest U.S. homebuilders cited the potential of a sales comeback in the spring."

Zillow reports that 27% (15.9 million) of U.S. homeowners are underwater. That makes it difficult to trade up and keeps home sales down. There are several forces which are keeping the lid on home sales: flat prices removing the incentive to buy now, concern about jobs, stronger qualifying requirements, the folks underwater who cannot trade up, and the folks whose credit is impacted from foreclosures or short sales.

One interesting effect not discussed enough is that the folks who are still occupying home they are not making mortgage payments on are either spending that money or paying down credit card debt. The payments not being made amount to freeing up $90 billion a year. That is 8% of consumer discretionary spending on durable goods. A detailed discussion of this comes from Rick Davis of Consumer Metrics Institute.

In addition, discussion is starting about what to do with FNMA and FHLMC. This is where is gets awkward to be someone who comments on this. What is best for the economy in the long run may not be what is best for the housing and mortgage businesses at present. If an end to government guarantee of agency debt does occur it should translate into higher rates. The unknown is how much higher. The just-released report leaves the door opened for the worst possible case: government regulation forcing lenders to do more subprime at non-market rates/prices. This discussion is just beginning.

My personal view is that housing prices will be extremely flat for at least 3 more years. Banks have dragged out the foreclosure process because it makes no sense for them to create at present a massive inventory which would further depress prices and potentially cause more people to stop making their payments.

While these generalization may be correct I want to state that there are places where values have been so hard hit that homes are a bargain both for homeowners and for investors who can now find positive cash flows on investment properties.

Comments

[Laura Roderick]

Dick:
as an added comment/curiosity: to what degree do you feel that the perpetuation of insurance coverage and property taxes (in the case of defaulting home owners remaining in occupancy,) has an impact on the expediency with which the banks are moving on the foreclosure process? Once empty, those assets are all un-insured (potentially)with a accumulating tax burden once foreclosed on, too.Wondering about your opinion on this factor. At fist glance, it would be a pretty ugly expense to bear.Thoughts?

[Dick Lepre]

Laura,

I do not believe that this makes a big difference to the banks which will eventually own the properties. They are better off paying taxes so as to avoid penalties. The cash necessary to maintain tax payments and insurance is small compared to the cash which banks currently possess. The taxes must eventually be paid. As for insurance, if a bank owns enough properties it may make no difference whethre it insures or does not insure the properties because the expense is likely to be identical in either case.