Rate Watch #764 More on the Housing Market

February 25, 2011
by Dick Lepre
[email protected]
www.loanmine.com

Fundamentals

2nd look at 4thQ2010 GDP was revised downward to 2.8% from a previously announced 3.2%. One of the reasons for the revision is that the initial quarterly GDP report only has 2 months of actual data for imports and exports and guesstimates the last month of each quarter.

U Michigan Consumer Confidence was 77.5 this month. The consumer's attitude may be just fine but the substantial increases in commodity prices (food, energy) may easily offset the consumer's ability to engage in discretionary spending.

Existing Home Sales in January rose to 5.36 million (annualized.)

New Home Sales for January were down 13% to 284,000. As foreclosures push the price of existing homes down those homes are relatively inexpensive making buying or building a new home a less attractive proposition. Home construction is a very big factor in GDP and we will not see significant economic recovery until home building picks up. New homes provide jobs not only for construction but for everything associated with a new home" building materials, carpet, furniture, appliances etc.

Initial Jobless Claims were 391,000. The employment picture is still bleak but at least not significantly worsening.

Durable Goods Orders were +2.7% overall and -3.6% ex-trans. Keep in mind that the biggest single U.S. export item (by dollars) is civilian aircraft. This report is mixed because it is the ex-trans number which represents investment by business. The overall benefits exports which reduces the trade deficit and increases GDP.

St. Louis Fed President Bullard suggested that the Fed should consider cutting the size of QEII. As I have said repeatedly QEII has been poorly explained and helped fuel inflation fears. QEII has essentially been a reinvestment of dollars received for mortgage payments on mortgages owned by the Fed back into Treasuries. It has not increased money supply.

Macroeconomics Advisers estimates that the unusually cold weather in December and January knocked 0.6% off GDP.

Analysis

The upheavals in the Middle East and North Africa are rooted in economic misery. Economic misery is usually regarded as the sum of inflation + unemployment rate. The proximate trigger may he sharply higher food prices. As I said few weeks ago, none of these leaders learned from Marie Antoinette's mistakes.

We are seeing higher commodity prices which usually is a consequence of a weak dollar. Most commodities are priced in dollars and as the dollar weakens on FOREX commodity prices rise.

Labor Unions

The discussion about what is happening in Wisconsin misses the point that public sector employment and private sector employment have differing dynamics. If you work for a private company you may well need a union to get an equitable deal from management. There is no similar dynamic for public sector employees. The employers of public sector workers are usually on the same side and seek only the political backing of those employees. Someone should be bargaining FOR the taxpayer and when a public sector union sits down with politicians that is not happening. If the employer (politician) bargains for his own benefit (endorsements and financial backing) then the rest of the public is getting screwed.

Since 2009 the majority of union members are public employees. Joe Hill is not a member of this union. The labor movement of the 1930's was noble. It was about the economic justice of workers getting a fair share. Now the labor movement has been taken over by public employees and the interests of the public are too often left out. State and local government do not have profits which employees can get a fair share of. Instead their revenues are taxes from the populace. A couple of not-exatctly Tea Party members: FDR and George Meaney (longtime head of the AFL-CIO) argued that public employees should not be allowed to unionize. Interestingly, it was Wisconsin in 1959 which first allowed unionization of government workers.

I am by no means suggesting that public employees should not have the right to unionize and bargain. I am saying that there should be a party, perhaps an arbitrator, who represents the people and has zero political stake in the outcome of the bargaining process.

Housing Market

Existing Home Sales in January rose to 5.36 million (annualized.) The median price of a home in January fell to a 9 year low. The price of any commodity has 3 dimensions: supply, demand and price. This is a case of prices being elastic enough to encourage demand. Yes, interest rates moved up but not enough to drive away buyers. There are enough people who believe that prices are at or near the bottom that they are finding present prices attractive.

The Mortgage Bankers Association Mortgage Applications Survey was +5.1% for purchases last week and +17.8% for refinancing.

The housing market is extremely important for economic growth. We will not have sustainable economic growth until home building picks up and home building will not pick up significantly until we clear the inventory of homes on the market and the "shadow inventory" of homes in the foreclosure process and those on which the borrowers are not making payments which will become the foreclosures of the near future. We should not be concerned that this is a foreclosure driven market because it is necessary to clear those foreclosures before we can have a "normal" market.

Distressed sales were 37% of the market and all-cash sales were 32% of the market. The all-cash may be driven to some extent by the physical condition (fixer-upper) of the large number of distressed properties. If folks were not making mortgage payments they probably were not maintaining the property adequately.

WSJ reports that there is a significant discrepancy (over 20%) between NAR (National Association of Realtors) and CoreLogic as to how many existing home sales happened last year. If CoreLogic is accurate then there is more housing overhang and it will take longer to clear the inventory. CoreLogic uses real data from recorders' offices. NAR uses a sample of sales data reported by local MLS. NAR also must correct for FSBO and that makes their model inherently more prone to sampling/correction error.

Estimating what housing starts will be face large unknowns: the dénouement of FNMA & FHLMC, willingness of investors to buy mortgage backed securities not guaranteed by the government, unemployment, and interest rates for starters.

One added dimension is that changing home prices have positive feedback. While values were increasing 20% a year there was considerable speculative buying. (Las Vegas was an epicenter.) That is not happening to any significant extent at present.

The reaction has been to make mortgage qualifying much more difficult than it was from 1995-2006. The present status (more difficult qualifying) constrains demand.

Supply will be affected by foreclosures. Federal Reserve Governor Elizabeth Duke reported in late November that five million mortgages were currently 90 days past due or more and that she expected approximately 4.25 million more foreclosure filings in the next two years, with two million plus expected in 2011 as well as in 2012, similar to the record amount of foreclosures that occurred during 2010. This has been made worse by interference by politicians and lawyers who are simply stringing out the foreclosure problem and delaying possibility of recovery.

Demand will be constrained by 1) rates and 2) underwriting standards.

At present the issue of underwriting standards is in flux because of the state of the GSEs. I favor elimination the GSEs and elimination of the government guarantee of anything except FHA and VA. I believe that if investment banks take over mortgage securitization they should preserve the present FNMA underwriting models. There can also be a resurgence of "classic subprime" featuring complete documentation and rates appropriate to risk. Wall Street perverted this with bogus bond ratings for subprime during the bubble. The irony is that we know how to do this correctly but simply stopped doing it correctly. That part was driven by the greed of bankers and Wall Street. There is nothing new to discover here abiut subprime lending. We simply go back to the way we did subprime pre-1995.

Until there is decision in D.C. as to then fate of mortgage securitization, the problem is that the mathematical uncertainty created by being unable to estimate how mortgage underwriting standards will affect demand renders any analysis of dubious value.

We are in stasis until there is a resolution regarding the GSEs. I do favor letting mortgage securitization become a free market. Many folks point to the GSEs as "stabilizing" forces. That is B.S. The GSEs sometimes change their rates twice a day. That is not my idea of stability. The only stabilizing force the GSEs had was access to low cost debt which they needed for the length of time required from the day they take a rate lock on a loan to the day they sell it as part of a MBS. That same stability could be provided by the Federal Reserve in the form of, say, 120 day lines of credit for the major Wall Street firms which aggregate mortgages. This money could only be used to make residential mortgages akin to those of the present GSEs.

Forecasting home buying has two other problems at present: unemployment and "geographically stuck." There are some folks who, because they are underwater on their mortgage are unwilling or unable to relocate to where they would have a better chance of employment. To these people, homeownership has become a curse. Also, cursed are those who had foreclosures or short sales because they will be unable to qualify for A-paper mortgages for as long as 7 years.

In short, housing demand will be constrained to the extent than investors feel comfortable buying mortgage debt post-FNMA. I am not nearly as pessimistic about that as someone like Bill Gross. I don't see why an absence of government guarantee would cause an increase in rates of anything more than 0.5%. Again, this is not just rates but, more importantly, underwriting standards. I would think that in a post-FNMA world if may take 2 years for investors to feel comfortable with mortgage debt.

 

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Dick Lepre
RPM - SF
1400 Van Ness Avenue
San Francisco, CA 94109
DRE License # 01143973
NMLS Individual ID 302379
[email protected]
Web site: www.loanmine.com
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