Jun052014

Housing inventory manipulation overrides all bearish predictions

No matter how bad housing market conditions look, inventory restriction engineered by lenders will keep prices up and prevent a crash.

bankerBack during the financial mania, I enjoyed writing about the upcoming housing crash. As with any mania, people were irrational, and nobody wanted to believe a catastrophe was right around the corner, and people like me who sounded the alarm were dismissed as doom and gloomers who didn’t know what we were talking about.

Some writers are naturally bearish, and they enjoy the outsider role. Most often they are ridiculed on the fringe until a financial collapse vaults them to prominence. Many people thought I was a permabear until 2010 when I started telling people to buy Las Vegas real estate. I’m a market realist who looks at valuations, and by 2010, valuations were so low in Las Vegas that unabashed bullishness was warranted.

Today, there is a new crop of housing bears trying to gain attention by making very cogent arguments pointing out the myriad of problems facing US housing markets; unfortunately, they all overlook one problem: housing inventory manipulation overrides all bearish predictions.

Four reasons house prices won’t crash

House prices are not going to crash. No matter how good the argument, none of the conditions burdening the market are going to bring must-sell inventory to the MLS forcing prices down. As I noted back in October of 2012, The housing bears are right, but prices will go up anyway. So why is that true?

First, lenders are not being forced to liquidate. The suspension of mark-to-market accounting relieved any pressure on lenders to clean up their balance sheets. Lenders can continue to show loans on their books at any value they want, and they can even book phantom income on the interest payments they are supposed to receive but don’t. Lenders don’t have to recognize these losses until they foreclose on a property, and that provides them a huge disincentive to foreclose. So with no compelling reason to foreclose and some strong incentives not to, lenders aggressively modify loans to get some cashflow, and they allow millions of delinquent mortgage squatters to stay in their homes making no payments at all.

Second, lenders face almost no costs to carry non-performing loans on their books. Usually, lenders go bankrupt if they have a large number of non-performing assets because the cost of capital eats them up. Lenders have to borrow money from depositors and bondholders in addition to its equity capital in order to make loans. If lenders had to pay interest on these loans they take out, the cost would wipe them out; however, since the federal reserve lowered interest rates to zero, banks can borrow as much as they want for nothing from the federal reserve, and as a result, interest paid to depositors has fallen to near zero. Without financial pressure to remove non-performing loans from their balance sheets, lenders can survive on lower loan modification income, and they can carry the squatters indefinitely.

Third, mortgage interest rates are low and likely to stay that way. Low mortgage rates makes for excellent affordability, and it gives more people the ability to buy homes. As long as interest rates remain this low, the buyer pool should grow larger. Interest rates must remain at near record-low levels while the distressed inventory is liquidated, and despite fears interest rates would rise when the federal reserve began tapering its purchases, mortgage rates declined and sit at nine-month lows.

Fourth, withholding inventory is working. In a normal market, thousands of individual owners control the supply. However, once prices crashed and borrowers owed more than their mortgage balances, they required lender approval for a sale — an approval the lender can and does deny. Also, crashing prices and toxic mortgages caused so many borrowers to default that lenders began foreclosing and acquiring a large inventory of REO. Between the sales they must approve and the properties they directly own, lenders and government entities own or control a huge portion of the housing stock. With such control comes the ability to act as a cartel and manipulate price — and they have. In fact, since 2012, they have been quite successful at withholding inventory as evidenced by 40% or more reductions in for-sale inventories across most of the Southwest. A small uptick in demand, mostly caused by investors, coupled with a huge decline in supply forced prices to move higher.market_forces

It worked.

And it will continue to work.

No matter how bad things look, no matter how dire the housing market conditions are, as long as lenders maintain control of MLS inventory by loan modification and denying short sales, prices won’t go down.

Why the Housing Market Recovery Is Over

June 3, 2014, by Keith Jurow

Introduction

After more than a year of trumpeting the so-called housing recovery, pundits are beginning to show signs of worry. Existing home sales are weakening, new home sales are dismal, and even the Case-Shiller Index is showing signs that prices are leveling off. The Fed’s new Chairperson – Janet Yellen – has expressed her concern more than once.

(See: Top 10 reasons housing under-performs in 2014)

With all this anxiety, now is a good time to take another look at the true state of housing markets around the country.

The Basic Problem: Death of the Trade-Up Market

The pundits and Wall Street economists have not yet understood that this is the fundamental cause of the housing collapse. Let me summarize the problem for you.subprimechain

During the roughly 50 years of rising home prices, the first-time buyer was the foundation of the housing market boom. This younger buyer would purchase a home which was smaller and less expensive than most houses. That would enable the seller to “trade up” to a larger, nicer home. These trade-up sellers would then buy and enable another trade-up buyer to do the same.

This trading up was possible because the seller almost always posted a profit on the sale of the house and could plow that into a more expensive home. When the bubble finally burst in late 2006, speculators dumped their properties on the market in metro after metro and prices no longer rose.

Listings soared and sales slowed down even in the hottest markets. Then prices began to decline. That posed a serious problem for the trade-up buyer. Many of them found that they had little or no profit with which to buy another home. A growing number found themselves “underwater.” Because they had put little or nothing down, the value of their home was less than the mortgage on the property.

Making matters worse was that after the sub-prime collapse in the spring of 2007, lenders finally tightened up their underwriting standards. They began to demand down payments as in the pre-boom days – 20% or even more. With little or no profit garnered from selling, would-be buyers could not come up with such a steep down payment. Nor could the first time buyer.

And so the trade-up game came to a screeching halt. It has never returned. You need to understand that it will not be coming back. Do I mean never? Not quite. My answer — not for a long, long time. …

Everything Keith states above is true. I stated back in early 2013 that the move-up market would languish for another decade. It will. However, the manipulation of housing inventory is working there too. While the buyer pool many be severely depleted, the supply is restricted even more, so prices still go up.

The Awful State of Housing Markets in Connecticut

I live in Connecticut where we have access to the most detailed and up-to-date housing market statistics in the nation. The firm Raveis & Co. is the largest family-owned brokerage firm in the northeast with offices in six states.

On the Raveis.com website, you can find monthly statistics on every town and city in five New England states and Westchester County in New York. I have posted statistics from the website in several articles. A recent search of the website enabled me to come up with these significant numbers for ten towns and cities in Connecticut. Take a good look.

Let me explain what the numbers tell us. Keep in mind that these are raw, unadjusted numbers – no indices. First, sales are weakening in many Connecticut towns. In doing my search, I found some towns whose April sales were lower than for March. That is terrible.

Second, year-over-year change in average price-per-square-foot (psf) for homes sold is down in a large majority of towns and cities. In Connecticut, we are not seeing a slowing of price increases as the mainstream media and the Case-Shiller Index show. What the raveis.com figures show is actual price declines.

Finally, inventory of homes for sale is rising rapidly. As I have predicted in several articles, homeowners who had waited have decided it is time to put their home on the market. This is also happening in other states covered by raveis.com. If you want to do some research yourself, just go to the raveis.com homepage and link to “Local Housing Data.”

Keith’s bearish predictions are coming true in Connecticut because it is a judicial foreclosure state that still has a huge backlog of foreclosures to process. In Connecticut and other judicial foreclosure states, they didn’t process near as many foreclosures as the non-judicial foreclosure states in 2008. They avoided the huge crash we had, but in the process, they encouraged a great deal of strategic default. Many borrowers simply refused to accept loan modifications because it was a better deal to simply squat and pay nothing. Lenders have to process more foreclosures now because they can’t get borrowers to play the loan modification game with them.

I rather doubt Keith’s more dire predictions of a 50% decline will come true, but he was correct in predicting a decline in prices, and right now, this decline is accelerating.

Don’t think this is limited to the northeast. Take a good look at this Redfin chart for six west coast metros.

Those are huge year-over-year declines in home sales. The growth in homes listed for sale is also very great.

In our markets, sales are down for reasons I described in A gilded age of low housing inventory. The rise in inventory looks dramatic on a percentage basis, but we are still well below historic norms. None of this foretells a crash in our markets.

Keith’s article goes on to describe the problem with recasting HELOCs, but as I pointed out the upcoming mortgage resets and recasts prompt more loan modification can-kicking, rendering the potential disaster meaningless.going_down

My Conclusion

I urge you not to listen to the pundits and Wall Street economists who continue to insist that we are on the path to housing recovery. If you follow them, you and your clients will make major investing mistakes that will cost plenty.

New home sales will not be picking up, so buying home builder stocks should be avoided.

If you are not sure whether your clients should sell their investment homes, my advice is to list them now before markets weaken further.

Finally, as I have made clear in previous writings, this is the time to sell mortgage REITs, not to buy them.

We had many readers blast Keith in the comments recently because they sold houses based on his prediction of a 50% drop. Personally, I believe he overstates the depth of the declines, but as the evidence from Connecticut clearly shows, prices are declining in his market.

Market pundits make forecasts and predictions all the time; some come true; some don’t. Each person is responsible for evaluating their own investment decisions. If Keith’s advice prompts people to act, it should be based on their own analysis and not his. Everyone is personally responsible for their own decisions and actions, and although people may be upset that they listened to one pundit over another, rather than blaming the pundit, they really need to look in the mirror.

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