Christopher Whalen: “‘recovery’ in the housing sector is probably over”

Housing analyst and consultant Christopher Whalen is advising clients that home price appreciation passed its cyclical peak in mid 2013.

appreciation_celingIs the party over already? Kool aid flows, realtors promise double digit home price appreciation forever, and the financial media convinces everyone the so-called recovery is on solid ground. Happy days are here again: buyers brim with excitement; sellers count their equity; realtors imagine big commissions. Isn’t that the way it’s supposed to be in California?

Unfortunately, with the abrubt taper of institutional home buying, and the levling of home prices on low volume, the wild rally of 2012/2013 petered out, but the market will be “normal” now and appreciate slowly, won’t it?

Christopher Whalen: The single biggest question facing the mortgage space

March 17, 2014, Christopher Whalen

… First came the REO-to-Rent trade, where smart, early money swooped down out of the clouds and bought foreclosed homes at pennies on the dollar from besieged banks. This was in 2010 and 2011, a time when many people still were not sure whether or not the world would end. Names such as Ochs Ziff and Oak Tree come to mind.  This early smart money captured the lion’s share of the returns.homebuying_frenzy

Later, in 2012, a larger, naive but still eager group of investors poured into the REO trade, throwing piles of public and private cash into a strategy that was clearly mature.  About this time, the spread between REO properties and voluntary sales was closing, one reason that the visible indices of home prices began to show marked improvement.  Indeed, more than half of the increase in home price appreciation or “HPA” measured by indices such as Case-Shiller in 2012 and 2013 came from the end of the REO trade, causing one of Wall Street’s smartest mortgage asset managers to ridicule “stupid money” jumping late into the REO trade.

I don’t think we can conclusively say any of the appreciation came from the REO trade. Prices went up everywhere, even in those places where investors weren’t buying anything. Prices went up because lender can-kicking dried up the MLS inventory, and buyers enabled by record low interest rates competed over the available inventory to quickly drive up prices to limits of affordability.

The reason for appreciation matters less than the amount of it. Right now by my measure, house prices are not overvalued and poised to fall again.bought_at_peak

Fueled by cash raised from the equity markets, which was largely a function of the zero interest rate policy maintained by the Federal Open Market Committee, the late money spawned a series of public vehicles and real estate investment trusts designed that were designed to capture public investors into a strategy that was never really suitable.  …

Indeed, if you consider that Q2 2013 was probably the near-term top in HPA for this cycle, then most of these late arrivals were buying assets through the market top.

Of course, since most of the observers of the housing market use lagged data from the Federal Housing Administration or S&P Case Shiller, the public perception of housing prices is still decidedly rosy.  After all, U.S. house prices rose 1.2 percent in the fourth quarter of 2013 according to the Federal Housing Finance Agency  House Price Index, the  tenth consecutive quarterly price increase in the purchase-only, seasonally adjusted index. Case-Shiller was up almost 12% during 2013.

“Home price appreciation in the fourth quarter was considerable, but more modest than in recent periods,” said FHFA Principal Economist Andrew Leventis. “It is too early to know whether the lower quarterly growth rate represents the beginning of more normalized price appreciation patterns or a more significant slowdown.”  But is it really too early to know?  Really?


… the “recovery” in the housing sector is probably over. Most of the Street analysts this writer respects see HPA flat to down in 2014 and then down small in the next few years. Short supply of homes in many markets may keep the published HPA indices relatively stable, but the fact remains that if you are a manager buying NPLs or MSRs, you need to factor flat to down HPA into your valuation and strategy assumptions.

I agree that we may be headed for a multi-year period of slowly declining prices, but probably not yet. In my opinion, there is too much cash and too much kool aid for the brisk rally of last year to reverse and head south. I believe we will see a mini-bubble reflate from today’s prices and get overvalued in the next couple of years. Of course, this will mean sales volumes will remain low, but prices will still go up — then a slow grinding decline is more likely, particularly in the face of higher interest rates.

What will a long-term rise in interest rates do to home prices? Interest rates must rise from about 4.5% to 7% to reach historic norms. If this happens over a 7 year period — which is a very gentle rise — rental parity will still fall from its current level even as rents and fundamental values rise. Since rental parity will serve as a more rigid ceiling on appreciation in the future because future housing markets will be very interest rate sensitive, when prices rise beyond this barrier, it will serve as a major drag on appreciation.

Can Kicking from an Insider’s Perspective

Chris Whalen advised Carrington Mortgage on its non-performing loan portfolio, and he makes a living advising similar clients. From the above article, he provided this gem about can-kicking: [dfads params=’groups=4&limit=1&orderby=random’]

One of the attractive aspects of the NPL trade is that it depends largely on the skill of the servicer to maximize the value of the portfolio. This process includes the purchase of the loans, servicing and, most important, capturing any opportunities to refinance the assets once they have been modified. That last word is key because it is by keeping the borrower in the house via loan modification that the servicer can deliver the biggest value to investors. As I noted in a recent post on the Zero Hedge web site:

One of my favorite errors that you see constantly in the Big Media and from regulators like the CFPB and the State of New York is the idea that it is good business to push a home owner into foreclosure.  Anybody with even the slightest idea about the world of distressed servicing knows that the law now requires that loan modification is the first order of business when a borrower gets into trouble.  But apparently the folks at the CFPB and the State of New York, where it can take a creditor up to three years to foreclose on a house, have not gotten the memo.  If you actually know the world of distressed servicing, there are three golden rules when it comes to a non-performing loan.  First is keep the owner in the house.  Second is protect the asset and make sure that maintenance, taxes and insurance are current. And third is to preserve the cash flow of the loan via loan modification, if possible.  Keeping  the family in the house and protecting the asset and cash flow, even with a substantial modification, is always better for the note holder, whether that is Uncle Sam or a private investor.

The first rule, “keep the owner in the house” is something servicers couldn’t care less about, but they have to comply with the law and put a good public relations face on their work. The third rule about preserving cashflow gets to the heart of can-kicking. I’ve said many times, these lenders are squeezing a few pennies out of hopeless borrowers while everyone waits for house prices to rise. The owners of these non-performing loans with band-aid loan modifications know they can squeeze the borrowers a little harder if the borrower makes more money, and eventually they can squeeze the borrower out of the home and recover their capital. Private label loan modifications have no incentive to remain generous with their terms once house prices get back near the peak.


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