Smart Real Estate News & Commentary by Chris McLaughlin June 21, 2011
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WSJ – government will stay in the housing market for a long time
A weak start to the spring housing season, which could be underscored later this week by reports on sales of new and previously owned homes, is raising the prospect that the U.S. government will dominate the mortgage market for a long time. The fragile housing market is complicating Washington’s stated goal of dialing back its support after it has reduced stakes in the financial-services and auto industries. The slide in home prices in turn is weighing on the economic recovery, and it threatens to hamper a bipartisan push to unwind the emergency support policymakers enacted three years ago. Falling prices are eroding consumer confidence and hindering job mobility by leaving millions of borrowers trapped in homes worth less than what they owe. A glut of bank-owned foreclosures has slowed residential construction, damping a major source of job growth. In some markets, the share of buyers paying in cash for homes has hit its highest levels in years, a red flag that prices could fall below “fair value” due to a lack of credit. Fannie Mae and Freddie Mac, government-sponsored entities intended to foster mortgage lending, face a hard balancing act. They are trying to restore sound lending standards without choking off access to mortgages.
Together with the Federal Housing Administration and federal agencies, Fannie and Freddie are behind nine in 10 new mortgages. The firms don’t make loans; instead, they buy them from lenders, repackage them for sale to investors as securities, and offer guarantees to make investors whole if borrowers default. Congress has boosted the size of loans that the firms can buy, making it easier for borrowers in more expensive coastal housing markets to qualify for loans. But those steps have crowded out the private sector, leaving investors with fewer loans to buy and either hold or pool into securities that don’t have government guarantees. The Obama administration and Republican lawmakers have embraced efforts to encourage private investors into the mortgage market by curbing the government’s role. Officials want to increase the fees that Fannie and Freddie charge lenders and reduce the maximum loan sizes eligible for government backing. The limits are set to decline modestly at the end of September to roughly $625,500 from the current $729,750 maximum in high-cost areas such as New York and Los Angeles.
But market advantages for government entities are only part of the problem. Stable housing prices, more than anything else, would make it easier for private lending to return. Moreover, the economics of securitization don’t work right now. Interest rates are low and investors are demanding high returns, which mean that mortgage-bond deals have made little if any profit for the firms that arrange them. Tight underwriting standards for “jumbo” mortgages—ones too large for government backing—have prompted banks to keep those relatively safe and profitable loans on their books. “There’s a misunderstanding in the market, an irrational belief that says private capital will emerge” if government-supported mortgage lending looks too expensive, says David Stevens, chief executive of the Mortgage Bankers Association who headed the FHA for two years until March. Trying to “crowd-in” private money could be dicey if there aren’t broader structural changes to rebuild confidence, so investors don’t have to price in a hefty “uncertainty premium.” To be sure, some academics say Fannie and Freddie should more aggressively reduce their role in supporting housing markets and test whether private investors will pick up the slack without substantially shocking housing markets. Historically, most mortgages that weren’t held on bank balance sheets were issued as securities and backed by Fannie, Freddie, or the FHA. During the past decade, investment and mortgage banks jumped in and began issuing their own mortgage-backed securities. These private-label bonds, issued by the likes of Bear Stearns and Countrywide Financial, comprised riskier loans.
Because the banking sector isn’t large enough to hold more mortgages without expanding its deposit base, securitization markets are an integral part of any lending expansion. The private-label market seized up four years ago as investors faced big losses on investments that turned out to be far riskier than advertised. Just two new privately issued mortgage-bond deals have come to market since, one in April 2010 and another in February, and both consisted of mortgages to extremely qualified borrowers. Investors are looking for standardized contracts that govern private-label deals, better loan disclosures and easily enforceable provisions to kick back loans that don’t meet agreed upon standards. They also want to eliminate conflicts of interest in the collection of loan payments, known as mortgage servicing. Lawsuits between bond insurers, investors and issuers over the soundness of the underlying mortgages, and disputes over whether ownership of mortgages was properly assigned, further underscore the market breakdown. “There’s pretty much nobody that’s not being sued,” said Ryan Stark, a director at Deutsche Bank Securities, at an industry seminar last month.Regulators have addressed some of those problems with a flurry of rules, but some of them could also complicate a revival.
Policymakers are right to worry over indefinite government stewardship of the mortgage market, which makes laying the foundation for a functioning market all the more pressing. If it’s lacking, housing won’t exit a destructive cycle: one where prices fall because credit isn’t flowing, and where credit doesn’t flow because housing is weak.
Gasoline down, but not going much lower
Gasoline prices have dropped to $3.64 a gallon nationally from a peak of $3.98 in mid-May, according to AAA. Diesel prices at the pump have fallen more slowly but are beginning to catch up and are now averaging $3.97 a gallon. “We may get down to that $3 to $3.25 neighborhood for some states that have lower taxes and cheaper supply,” said Tom Kloza, chief oil analyst at OPIS. But the coasts, specifically the Northeast, will not see as much relief because of its dependence on higher grade imported oil. The loss of Libya’s light sweet crude output continues to crimp those supplies. “The price of the sweetest, lightest, least troublesome crude is to a great extent determining the price of gasoline on the coast. I do think you’re going to see prices drop more in the nation’s interiors. Chicago, Detroit, Minneapolis, Ohio. They saw some of the most spectacular increases. They’re going to drop more. For the coasts, and the country as a whole, we’re not really going to drop that much unless we see Brent prices come off,” Kloza said.
Andy Lipow, president of Lipow Oil Associates, said gasoline could fall as much as another $0.10 a gallon nationally by July 4, but after that, the situation is uncertain. “We could see further declines, but I think that’s heavily dependent on how the situation in Greece pans out and affects the value of the euro to the dollar,” he said. He and Kloza said if Greece were to default, Brent would immediately drop because of the potential ripples across Europe’s economy. “If you’re hoping for $2.50 to $2.75 gas prices, you probably don’t realize it, but you’re hoping for a recession,” said Kloza. An improving economy could also keep prices high. Kloza said his concern is that oil and gasoline could be pricier next winter and spring, if the global economy improves and supplies tighten.
Olick – investors using cash, credit shrinking
“Nothing like getting to work on a Monday morning and finding no fewer than four dismal reports on the housing market in my ‘Inbox.’ It’s not like anyone thought housing recovered over the weekend (that was pretty clear from the precious few ‘Open House’ signs in my neighborhood at least), but the outlook is deteriorating, and we’re just a day away from getting what is expected to be a weak report on existing home sales for May. Let’s start with home prices from Fannie Mae’s Economics and Mortgage market Analysis Group, which predicts additional home price declines through the third quarter before flattening out at the end of 2011. ‘Ultimately, the labor market holds the key to a housing recovery, but job growth is needed in order to activate housing demand,’ said Fannie Mae Chief Economist Doug Duncan. ‘Hiring delays will continue to push out timing for the housing rebound.’ Okay, not exactly a shock, but never a good thing to hear analysts say, ‘growth is stalling.’
Now to a new point about investors, from the May Housing Market report from Campbell/Inside Mortgage Finance, which tracks several indices: ‘The closely-watched survey’s traffic index for first-time homebuyers fell from 51.7 in April to 45.3 in May, while the traffic index for current homeowners fell from 56.1 to 44.8. Meanwhile, the traffic index for investors fell from 55.3 to 54.6. Any index value less than 50 indicates a decrease in traffic from the previous month. The HousingPulse Survey’s Distressed Property Index, a key measure of the health of the U.S. housing market, fell slightly to 46.7% in April, although sales of distressed properties continued to account for nearly half of the market. The monthly HousingPulse Survey also showed the proportion of first-time homebuyers in the housing market rose to 37.3% in May, from 35.7% in April. First-time homebuyers have difficulty getting mortgage financing and current homeowners are often locked into properties with negative home equity. That leaves investors to take up the slack,’ says research director for Campbell, Thomas Popik.
The trouble is that investors can’t get financing easily and are largely forced to use cash. In fact 74% bought with cash in May. The survey found a drop in investor activity in May from 23% to just over 21% of purchases. Most investors are using personal funds, like retirement funds, home equity lines of credit and savings accounts, which in itself is concerning; hedge funds and other larger investors make up a much smaller share of buyers, mainly in coastal regions. All this weakness in housing continues to push more potential buyers to rent. ‘As we have previously predicted, the U.S. apartment market has been recovering at an astounding pace,’ said Dr. Peter Muoio, senior principal of Maximus Advisors. ‘The sector will continue to benefit from the growing preference for renting over homeownership as well as rapid growth of the young adult population. We predict that vacancies will continue to decline while effective rents grow robustly during the next two years due to limited development of new multifamily properties during the recession.’
And there’s your bright side, if you happen to be an investor in the multi-family sector. I do think that the rental phenomenon will be temporary, but by temporary I mean a decade, not a year. Housing affordability is already enticing enough to bring the buyers back. We are still waiting for the mortgage market to sort itself out.”
Debt situation is like the sub-prime crisis
Monetary policy has been “the great enabler” that central banks used to keep interest rates at “absurdly low levels for years now” and this has encouraged politicians to believe that sovereign debt is “a lot cheaper than it really is,” says David Stockman, former director of the Office of Management and Budget. “Politicians have not been willing to take the tough steps to impose the pain, the austerity and the tough trade offs that are required to control this,” Stockman said. But things are changing as the Chinese aren’t buying as much sovereign debt because they have to take care of “their own inflation spiral,” and the Federal Reserve will have to end its second round of money printing soon, he added. “The current situation is like the sub-prime mortgages crisis of a few years ago,” Stockman said.
Monetary stimulus, or quantitative easing, is officially due to end at the end of the month and talk of more stimulus has been rife, though to date Ben Bernanke, Federal Reserve chairman has kept silent on the issue, despite the debt ceiling deadline of August 2 nearing for Congress to agree on raising it further.
“The day of reckoning is rolling in, it may not be today or this week or this month but we’re very much towards the end of what can be sustained,” Stockman warned. “In other words the balance sheets of the big countries have been used up. We’ve used ours, we don’t have any balance sheet room left. The ability of the central banks to monetize this debt which they have is coming to an end,” he added.
Prices up and down in midsize markets
Mid-sized cities, much like their larger counterparts, are experiencing a similar phenomenon where home prices are constantly fluctuating up and down. It’s called a catfish recovery, Altos Research said yesterday. And in a catfish recovery, home prices bob up and down, making it hard to predict when a real recovery or downturn will officially take hold. In Altos’ 20-city composite report on mid-sized cities, the research agency found home prices increased in 19 of 21 mid-cities surveyed last month. The mid-cities median price rose 1.11% in May, hitting $254,046, compared to $251,247 in April. The mid-sized cities experiencing the largest increases were Orlando, Fla., Boise, Idaho, and Boulder, Colo., all of which saw price gains above 5.5%. Altos concluded in its latest report that “headlines are still talking about a double-dip in housing and the mid-cities numbers provide further evidence of strength in prices across the board. The S&P/Case-Shiller numbers will report the same price strength in the late summer and early fall.” The only mid-sized markets to report declines in the past three months were Honolulu, with price declines in the 2.64% range; Reno, Nev., which experienced a 0.33% decline; and Charleston, S.C. with a 0.24% drop.
See you at the top!
Chris McLaughlin
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Standard & Poor’s (S&P) says it expects losses on loans behind mortgage securities to rise to as high as 40% and the dire assessment could “significantly impact” bonds with AAA rating. S&P increased its loss projections for subprime loans made in 2006 to 32% and for 2007 loans to 40%. The housing market is currently at its lowest level since 1930s and investors have seen a significant decline in the market value of their debt over the last couple of years. A rating downgrade could mean a further reduction in the market value of the securities. S&P expects loss severities, including the cost of foreclosure and liquidation, and decline in property values, to increase to 70% for subprime bonds issued in 2006 and 2007. For Alt-A bonds issued in 2006 and 2007, S&P expects loss severities to rise to 60%. “We have observed increases in loss severities and we expect them to continue to rise until we reach the trough of the market value decline, which we believe will be in the first half of 2010,” S&P said in a report.
PMI Group, the fourth- largest mortgage insurer in the U.S., expects home prices to drop in more than 50% of the largest cities in the U.S. through the first quarter of 2011. The decline will be across “all regions of the nation” from California, Florida, Nevada and Arizona, the states most affected by the housing downturn. “The housing market has been hit by a demand shock of high unemployment and a supply shock of distressed foreclosure sales,” said LaVaughn Henry, senior economist at PMI. Analysts believe prices have to fall further in many areas before home values reach their trough. According to PMI, some 15 areas including Miami, Fort Lauderdale, West Palm Beach, Orlando, Tampa and Jacksonville in Florida; Riverside, Los Angeles, Santa Ana, Sacramento and San Diego in California; Las Vegas; Phoenix; Providence, Rhode Island; and Detroit have a 99% probability of lower prices in 2011. The areas with the lowest probability (of 6%) of lower prices in 2011 include Cleveland; Pittsburgh; Columbus, Ohio; San Antonio; Houston; Dallas, and Fort Worth, Texas.
Bonds issued by the Golden State are anything but gold now. Fitch Ratings, a credit rating agency, has downgraded California’s long-term debt to “BBB,” just one category above junk status. Fitch has cited California’s budget woes as the main reason for the downgrade. “[I]nstitutional gridlock could persist, further aggravating the state’s already severe economic, revenue and liquidity challenges,” Fitch said in a release. The state’s budget gap of $26.3 billion forced it to issue IOUs last week for the first time in 17 years. Consequently, many county agencies will get paid in paper. “The fact that they have to take this step shows how tight the state’s cash became and how limited their options are in the absence of a budget solution,” said Douglas Offerman, Fitch credit analyst. “Without a budget, [the controller's] flexibility gets more and more reduced over time.” Will California default on its debt obligations? “It won’t happen,” says Tom Dresslar, spokesman for California Treasurer Bill Lockyer. California has a lot to worry about regarding the rating of its bonds. If its bonds are reduced to “junk,” the state’s debt raising capability may be severely impaired.
