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The Daily Capitalist: Housing Market’s Still In Trouble
Since the biggest financial collapse in world history was built on credit related to housing, it’s pretty obvious that we should be paying very close attention to that market. The reasons are complex, but a recovery must be based on the liquidation of bad debt. The sooner that happens, the quicker a recovery will happen.
When we mean “liquidation of debt,” we are talking about a mountain of credit built on the housing bubble. This phony bubble wealth permeated the entire economy. When homeowners saw the price of their homes rising, they saw it as a source of capital to use for a variety of things — but let’s face it, most people spent it.
New stores opened, malls were built, financial institutions grew, cars and boats, second homes, vacations and restaurants all flourished. Credit card debt mushroomed. Home mortgages were increased to pull cash out for spending. Yes, some of it went to good things, such as our children’s education, helping our aged parents and paying off bills. But the reality was that our debt kept growing.
The clever lads created even more phony wealth under the guise of insurance, but as we found out, companies such as AIG really had no idea how large their obligations were for credit default swaps written against almost any financial risk. And these instruments were further leveraged without understanding the magnitude of these triple-counted obligations or their relationship to housing.
It all comes back to housing as the fuel for the 70 percent of our economy that was consumer spending. The thought was that housing has always gone up, and if it went down, it really never went down if you averaged growth since the post-World War II period. A drop of 10 percent? Never has happened. 20 percent? Not even a sixth deviation possibility.
My thesis has been that this was all fueled by the Fed through monetary policies that created and supported the bubble. Aided and abetted by governmental policies and financing schemes that favored housing and risky loans. This was not a “free market” phenomenon. Far, far from it.
My thesis also has been that we can’t recover until all this bad debt is liquidated, and capital generated by savings is created and ultimately invested in profitable enterprises. It would be a mistake to rekindle the bubble. But, as we know, that’s what our government is trying to do. The government creates uncertainty as it flails around with programs, spending and debt schemes to revive the economy. As a result, mark-to-market accounting is a thing of the past, and banks are guarding their balance sheets, corporations are sitting on a lot of cash, cutting costs and becoming leaner, and Mr. and Mrs. America still favor savings and debt instruments over equities and spending.
The big question: Is the housing market bottoming out? Because once it does, debtors and debt holders will then have a handle on how great their losses are. When the bottom is falling out, it is difficult to get lenders to lend if they are afraid their remaining cash reserves will be needed to shore up the bank because of loan losses. The holders of subprime debt find it difficult to value their assets while housing values are still dropping.
Lenders have been shepherding their cash, reducing debt obligations, and cutting back lending and new investments because they don’t know how deep their hole will be until housing bottoms out. Keynes called this a “liquidity trap.” More reasonable people, especially the Austrian school economists, call this a reasonable and necessary response to uncertainty.
The Fed and the federal government have been flogging this liquidity trap issue without let up, and basically credit is still drying up. A 0.25 percent Fed funds rate is basically a negative rate, and they still can’t get banks to lend. The Fed’s balance sheet is at a record high. It has bought $850 million of mortgage-backed securities. They are injecting cash into lenders. They have basically suspended mark-to-market accounting.
In the third quarter, the FDIC reported that bank lending still contracted by 3 percent: Loans and leases held by U.S. commercial banks have declined for 10 straight months, falling to $6.7 trillion as of Oct. 28 from $7.2 trillion at the end of 2008, according to a separate statistical release from the Fed. Commercial and industrial loans have dropped to $1.37 trillion from $1.6 trillion, commercial real-estate loans have declined to $1.66 trillion from $1.72 trillion, and consumer loans have fallen to $847 billion from $857 billion at the end of last year.
What do banks do? They have decided they would rather hold Treasury paper instead of make loans.
This is what makes Ben Bernanke, Timothy Geithner and Lawrence Summers lose sleep at night. ”It’s supposed to work, dammit!” Maybe this is why Summers is always falling asleep. No matter what they’ve tried, they can’t get banks to lend. I think they are very worried about this, and while they say the economy is recovering nicely, they are crossing their fingers at the same time.
Back to housing.
I have been saying that I think the housing market is finding a bottom. I thought that low prices and rising affordability were the main drivers of the housing market. If this were so, then housing prices would reflect real market valuations, and this would finally bring about the liquidation of assets and debt wastefully invested during the prior artificial credit cycle. Lenders would know where they stood financially and would liquidate bad assets and rebuild their balance sheets. No more waiting around wondering what the Fed or the government would do to save housing.
I was wrong.
The housing market I now believe is being sustained almost entirely by the Fed and the federal government. This rekindling of the housing bubble is counterproductive and will hinder a real recovery of the economy because an artificially backed market will delay the necessary liquidation of the prior cycle’s malinvestment of capital.
Here is why I changed my mind:
First, 59 percent of new homebuyers are relying on government-backed FHA, Department of Veterans Affairs and Department of Agriculture loans. Most of these sales are driven by the first-time homebuyers tax credit. The tax credit program has been extended through April 2010.
Second, existing home sales are being driven by the tax credit and by foreclosure and short sales. Existing home sales are up 10.1 percent. Distressed sales — mainly foreclosures and short sales — accounted for 30 percent of transactions in the third quarter. And, according to the National Association of Realtors, home sales are being driven by first time homebuyers trying to make the previous November deadline.
This will have a negative impact on future sales. Like Cash for Clunkers, these government-driven sales may just be eating into sales that would have occurred in 2010. Many economists are referring to this phenomenon as “payback.”
Third, mortgage rates are now at 30-year lows. Another Fed-related gift to homebuyers. The average 30-year mortgage rate was 4.95 percent in October, down from 5.06 percent in September, according to Freddie Mac. On Thursday, Freddie said the rate was down to 4.7 percent.
But … home prices are still falling. The S&P/Case-Shiller index of prices fell 8.9 percent for the July-through-September period from a year earlier. That was an improvement from the 14.7 percent drop in the second quarter and the 19 percent decline in the first three months of 2009. Median prices of existing homes fell in 123 of 153 metropolitan areas during the third quarter compared with a year earlier. The national median price was $177,900, down 11.2 percent from the third quarter of 2008. (Don’t ask me to explain the disparity. Case-Shiller and NAR measure this differently.) Last month, the median price for an existing home was $173,100, down 7.1 percent from $186,400 in October 2008.
Thus, despite record interference in the housing market by the government, home prices are still falling. There are several reasons why it is likely that home prices will continue to fall.
Nearly 25 percent of homeowners are upside down with their mortgages. Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic. This shadow market is huge:
Home prices have fallen so far that 5.3 million U.S. households are tied to mortgages that are at least 20 percent higher than their home’s value, the First American report said. More than 520,000 of these borrowers have received a notice of default, according to First American.But negative equity “is an outstanding risk hanging over the mortgage market,” said Mark Fleming, chief economist of First American Core Logic. “It lowers homeowners’ mobility because they can’t sell, even if they want to move to get a new job.” Borrowers who owe more than 120 percent of their home’s value, he said, were more likely to default. Mortgage troubles are not limited to the unemployed. About 588,000 borrowers defaulted on mortgages last year even though they could afford to pay — more than double the number in 2007, according to a study by Experian and consulting firm Oliver Wyman. “The American consumer has had a long-held taboo against walking away from the home, and this crisis seems to be eroding that,” the study said.
This overhang will continue to drive prices down. There is no way the Feds can force lenders to modify enough loans to make a serious dent in this overhang. It’s imply too big. Eventually the losses from forced modifications will mount and the FHA or any other agency will not be able to pay off their guarantees to lender. Nor should they try.
Mark Zandi, who correctly predicted a crisis in the housing market, but not the crash, said Wednesday, “The housing crash is not over.” He said the lull in foreclosure sales for the past few months, due to the government’s pressure on lenders to modify loans, has resulting in higher prices. He expects Case-Shiller to bottom by the third quarter of 2010 with an overall price decline of 38 percent (now at 32 percent).
“Foreclosure sales will increase, and home prices will resume their decline by early 2010 as mortgage servicers figure out who will not qualify for a modification,” he said.
Zandi said 7.5 million foreclosure sales will have taken place from 2006 to 2011. The majority of these sales, however, have not emerged yet, with 4.8 million foreclosure sales expected from 2009 to 2011.
What this means is that the housing supply, now down to a seven-plus-month supply, will rise again, and prices will continue to decline. We haven’t seen the bottom yet.
— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, The Daily Capitalist.
» wrote on 12.06.09 @ 09:39 PM
Very good article. The big time news outlets won’t publish the truth about the housing market. I’m glad Noozhawk did.
It’s funny how local real estate investors still claim that Santa Barbara is basically immune to the downturn since Santa Barbara is so “special.”
Just because some folks made millions of dollars amassing property here back when it was dirt cheap doesn’t mean they have the slightest idea what they’re talking about.
» wrote on 12.07.09 @ 05:40 AM
The S.B -Goleta market has another 40% to fall before it hits bottom—way over-priced homes—hang-on…
» wrote on 12.07.09 @ 08:02 AM
Jeff - Given the above, what do you think will happen with mortgage rates in 2010?
» wrote on 12.07.09 @ 09:52 AM
This was a great article because it was written in plain English. Along with this article, I would like to see a graph depicting the pace of a typical two-income professional household employed in SB County versus the projected rate of decline in home values (based on monthly mortgage payments for housing in the more affordable areas in the region. My guess is that unless income and inflation rises across the board, home values will continue to decline in SFR neighborhoods until they make sense for people to afford the purchase with a conventional mortgage.
» wrote on 12.07.09 @ 10:39 AM
All I can say is I agree.
I believe we will see a 2nd drop in the economy starting in January, maybe February with severe inflation starting in 2011.
» wrote on 12.07.09 @ 02:03 PM
Hindsight is often 20:20.
Don’t remember any such vivid “bubble” warnings from the columnist back when his
“free market” was priming the pump for this big real estate and home-loan melt-down.
Do remember many kvetches that “over-regulation” was jeopardizing the boom, however.
Now we seem to be in Galileo-Newton land. What goes up must come down. How far, we still don’t know yet.
For people who view where they live as their Home, and not just a big part of their
investment portfolio, should ride it out okay, since they plan to be where they are for years to come.
Their only danger is if all workers in the household lose their jobs, and they have no cash flow at all to put toward that secure fixed-rate mortgage.
For speculators who invested in local property on margins, expecting to spin, flip,
or churn the structure, rather than reside in, or use it, themselves, they’re facing tougher times. Especially if they borrowed a lots of “cheap” bucks to do those spec deals, and now can’t service their debts.
But hey, those latter conditions are risks in Harding’s free market that selling at a
loss, or selling short, or going Chapter 13, are meant to smooth out. Right?
» wrote on 12.07.09 @ 11:38 PM
Well said, Jeff Harding - and it’s a good man who can admit he was wrong on calling a bottom to the tanking of residential real estate!
» wrote on 12.08.09 @ 12:35 AM
Great postings guys. How about apartment investments? Anyone have any clues as to when would be time to buy again?
» wrote on 12.08.09 @ 05:13 AM
First off. Liked most of this. I do not understand what Credit default swaps have to do with insurance. The derivatives are what got AIG in trouble. Both are misnomers like say oh the Sub Prime farce.
I don’t see how defaulting on what could be considered really bad terms. Could be dishonorable or even nothing less than smart. People don’t look before they leap. Nothing out there really tells, how bad the terms some of this debt really is. Pay day loans look good compared to whats considered conventional, great credit terms.
If the government would have made known how bad these terms are. Instead of selling them for the lenders and bankers. There would be no mess at all.
These banks want people to be upset all all of this. Rescue this system. The real shame in this is not the system in trouble now. But the way they took extreme advantage of the people that borrowed from them. That is never looked at. Never discussed. Never really disclosed.
I Like Barrack. However hes finding himself mired in this mess. Without saying look. Don’t make a bad deal here. Giving all this credit to first time home buyers is nothing short of insane on these really bad terms. (see what the experts recommend to him as a way out?)
The Realtors and roll-em out debt people love this. It’s nothing short of perpetuating instead of solving.
» wrote on 12.08.09 @ 08:51 AM
Long Time Resident - There were many predictions from reputable analysts regarding the housing bubble. There was even a local web site - SBHousingBubble or something. That the bubble deflated didn’t catch the weary by suprise - only those who only believed the housing and real estate interest’s advertisements (often pretending to be news articles).
Jeff gives a very good argument to the further decline of residential real estate. I won’t argue with him on this but still not convinced either. On the other hand commercial real estate in this area is poised for a long overdue price correction. Like the housing bubble we can’t predict when it will happen but only that it will.
» wrote on 12.08.09 @ 09:03 AM
Gee I certainly hope we haven’t seen the bottom…especially in the SF Bay Area where the property to still too overpriced. We’re sitting on the sidelines waiting for some realistic prices to emerge before we jump in.
» wrote on 12.08.09 @ 10:30 AM
One thing that was left out is that as more and more people are underwater or approach undewater, the potential pool of buyers for move on up homes dwindles, hence putting pressure on the mid to higher end home prices. Who is going to buy all the mcmansions and starter castles?
» wrote on 12.08.09 @ 12:08 PM
The biggest question for real estate, in CA and other areas that experienced bubble fever since about 1995, is what happens when the housing credit ends in April 2010, the Fed stops buying housing debt in March 2010, and the economic pain of job losses, starting in Fall 2008, finally all converge in the Summer / Fall 2010.
The elections in CA and elsewhere will see a roused, crazed beast (the sleeping masses) astir. Hopelessness will grow as the lack of jobs and prospects continues. A key issue that we of short memories readily forget is that a long recession creates a trauma, something well beyond a painful memory of a short term recession.
Gazing into the future now makes us realize that all we can see is a haze / a multitude of clouds. Uncertainty creates psychic fear, a fear that the golden daze of the last 15 years is gone forever, coupled with the fear that we are in deep doodo.
Much to think about. Hmmmm! toady
» wrote on 12.08.09 @ 12:17 PM
Anybody else here confused? I just recently saw the Bloomberg article below that said that housing prices had RISEN for the 4th month in a row:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a_g_UIGaiSJE
I didn’t look through CS’s source data, so I’m not sure what is going on at the detail level, but I’m a little frustrated in trying to learn what is really going on in the real estate markets. Seems like a lot of conflicting information to me.
» wrote on 12.08.09 @ 03:07 PM
Good comments from all.
Carp Citizen: Mortgage rates are tied to the 10 year T-bond. One would think these rates would go up, but too many factors to predict, such as dollar, international crises, economic crises, etc.
Long-term: You are right, but I wasn’t blogging back in 2006.
Wannabe: I don’t give investment advice, but the bottom is dropping out of commercial RE. Rents are dropping in apts. because of vacant homes. SB is high, always has been.
Tork: Most of the big subprime holders (trusts) used CDS to insure their paper.
PDQ: All real estate is local. Case Shiller says one thing, NAR, Feds say something else. Most sales related to foreclosures and short sales. Case Shiller measures 20 cities only.
» wrote on 12.08.09 @ 06:52 PM
Jeff, I disagree. The collapse was caused by the free market. In 2005/2006 any standardization of the mortgage industry evaporated. The no income/no asset verification and no downpayment loan became the norm and wall street could not get enough of it. The Agencies stepped aside due to their accounting meltdown and standardization died. The the credit default swap became the bread and butter of the MBS market and mortgage finance world. The mortgage brokers could not produce mortgage paper fast enough to satiate Wall Street. When the financial products division of AIG took it further by wrapping credit default swaps in various package traunches and selling them to the highest bidder the feeding frenzy got out of hand. Overnight the run on the paper and devaluation caused Bear and Lehman to be pinched by a stock short sale and from there started the financial system meltdown. Mortgage collateral collapsed and any holders such as Merrill, BofA,Wachovia,WAMU, Citi, Wells etc were in big trouble Government regulation was not the cause by the unmitigated greed by folks at AIG and other financial institutions as well as mortgage brokers producing garbage loans.
» wrote on 12.09.09 @ 09:09 AM
Tork, credit default swaps ARE a form of insurance.
Local, ya got it right.
» wrote on 12.09.09 @ 05:33 PM
That was all you needed to get a loan and own a house—thanks liberals—pandering—Fire Dodd, Boxer Frank—Oversight??
» wrote on 12.09.09 @ 06:11 PM
This was not a liberal issue but a Wall Street greed issue. If someone robbed a bank would you blame the police for not catching him or the guys that held up the bank?
» wrote on 12.10.09 @ 07:38 PM
I LIVE IN THE NEW YORK SUBWAY. ITS FREE AND I HAVE A CAT SO NO RODENTS BOTHER ME! I GET TO ENJOY THE BIG APPLE AND
SHOWER AT THE YMCA AND GO TO FOOD PANTRIES AND FREE CLINICS FOR MEDICAL AND DENTAL…I ONCE HAD A GOOD JOB AND A MORTGAGE.BUT I AM ALIVE AND CHECKING OUT OF THE
RAT RACE FOR NOW.
» wrote on 12.13.09 @ 01:06 PM
i got a foreclosure house for 82k and am doing a complete gut of the property over time. not that it is in bad condition, everything is just older from the 80’s. i believe you are right as i heard the fed is buying billions of MBS paper to keep rates low and that ends early next year with the first time buyer credit(i got that too). i would have bought without that since prices in my area are so low. one thing i know is no one can predict the absolute low in the market. i plan to buy a second house cash in my area if i can find one for the same price or lower. i’ll sit on it for years renting it and waiting for the bommers to downsize. i can’t wait to sell it in a few years for a nice profit. don’t think those of us who saved during the crazy housing bubble will miss out by waiting too long again! everyone needs a place to own or rent!
» wrote on 12.13.09 @ 09:44 PM
Wannabe,
The time to buy multifamily housing is when your mortgage payments, property taxes, and other expenses can be covered by your rental income. It’s really that simple. Of course, if you’re buying a fixer upper that requires significant capital expenditure, it could be years before you make any profits. And no matter what, don’t buy expecting capital appreciation, because it might not happen for decades. And make sure to pick a good location. Location Location Location . . .
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