The hidden perils of lender policies that suppress housing supply

Saving the banks required reflating the housing bubble, trapping a generation in their starter homes and slowing sales in the housing market.

The reason fewer homeowners than usual list their homes for sale is due primarily to loss mitigation policies at lending institutions. Many homeowners face circumstances in their personal lives that would ordinarily compel them to sell, but due to the excessive amount of mortgage debt they carry relative to the value of their homes, these homeowners fail to list their homes for sale.DR-Horton-Short-Sale

Some homeowners don’t list because they are underwater and can’t sell for enough to pay off their loans. Some homeowners don’t list because they are barely above water and if they were to sell, they wouldn’t obtain an equity check large enough to make a move-up trade. Some homeowners don’t list because even if they have sufficient equity to do what they want, the payments on their low interest rate mortgage are so attractive, they don’t want to sell their homes and purchase another with higher-rate debt.

So how did these circumstances that hinder home listings come to pass?

First, lenders lost their collective minds and inflated a massive housing bubble from 2004-2006 using toxic mortgage products like the Option ARM that allowed buyers to leverage their income for double the amount a stable, 30-year fixed-rate mortgage would finance. This created a mountain of unstable and unsustainable debt. When the Ponzi scheme collapsed, home values fell back to pre-bubble levels, but the debt remained.

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Second, lenders refused to write down their bad debts for fear of insolvency or bankruptcy, and legislators and the federal reserve worked with these zombie lenders to conspire to preserve they bad debt and reinflate the housing bubble to restore collateral backing to these bad loans.

Third, the federal reserve moved quickly to lower mortgage rates by lowering the federal funds rate and embarking on Operation Twist to drive down mortgage rates to record lows. Lower mortgage rates make bubble-era home prices financeable and to allow insolvent borrowers to reduce their interest costs so they could afford to repay the unstable loan balances under stable loan terms.

Fourth, to deter and prevent borrower cram downs, lenders aggressively modified home mortgages to more stable terms, and they stopped approving short sales if the underwater borrower wanted to get out. These policies effectively trapped a generation of borrowers in their starter homes. Hopefully, the lower payments made this a gilded cage.


These manipulations carry a hidden cost: a lack of MLS listings and low sales volumes, disappointing two generations of would-be homeowners. If none of the problems outlined above would have occurred, or if our policies and actions toward those events had been different, we would not have the shortage of MLS listings we endure today.

For example, if lenders foreclosed on delinquent borrowers and resold the properties like they used to, mortgage debt levels would be far lower today, and so would house prices. Lower aggregate debt levels and lower house prices are a recipe for brisk sales because fewer people would be burdened by excessive debts, and more people could afford the properties available. We didn’t do this because lenders convinced lawmakers that forcing lenders to face the consequences for their actions would have hurt the economy by devastating the banking system. Perhaps they were right.

In any case, a lack of MLS supply and low sales volumes are not what real estate agents want to see, so naturally, they complain about it as the end of the world.

The next housing crisis is here

And it’s caused by our response to the last one

By Myles Udland, March 21, 2016dc-real-estate-promo-0924_296

And this time the crisis is all about one thing: supply.

Anything that stands in the way of a real estate commission must be a crisis, right?

First-time homebuyers are crowded out, with Trulia’s chief economist Ralph McLaughlin writing Monday that the number of starter homes on the market has declined 43.6% in the past four years.

Homeowners who want to move from a starter home to something better can’t afford the next step. McLaughlin notes that the number of “trade-up” homes on the market is also down about 40% over the same period.

On Monday, the latest report on existing-home sales showed the pace of sales in February fell 7.1% from January’s to an annualized rate of 5.08 million. …

Isn’t the lack of listings and low sales volumes proof of the cloud inventory hypothesis I described back in early 2013?

Also in Monday’s report, commentary from Lawrence Yun, chief economist for the National Association of Realtors — which publishes the report on existing-home sales — showed the kind of crisis the housing market is facing.

“The lull in contract signings in January from the large East Coast blizzard, along with the slump in the stock market, may have played a role in February’s lack of closings,” Yun said Monday.

The weather? Really? Passing off bullshit like that won’t help Yun’s dismal credibility much.


“However, the main issue continues to be a supply and affordability problem. Finding the right property at an affordable price is burdening many potential buyers.”

This is a problem typical of a manipulated market. If the law of supply and demand were working properly, we wouldn’t have a shortage of low-priced home and a glut of high-priced homes. In an unmanipulated market, prices would come down until supply and demand were balanced at all price points.4.2.7

Yun added (emphasis ours), “The overall demand for buying is still solid entering the busy spring season, but home prices and rents outpacing wages and anxiety about the health of the economy are holding back a segment of would-be buyers.”

That statement is bullshit by implication. He’s trying to suggest buyers are holding back by choice, but the reality of their meager incomes and high prices are forming a financial constraint, not a psychological one.

slow wage growth, rampant concern about the future, and an underbuilt low-end housing market have all kept renters renting.

If we take the view that the jobs being created aren’t that great … then what we’re going to see is a rising class of renters.

“These low paying jobs are not the type of job that are conducive to buying a home,” Tchir wrote.

(See: Tepid wage growth and rising house costs prices out low-income households)

“The first problem is saving for the down payment —a Herculean task in itself.

(See: Potential homebuyers can’t save for down payments with high rents)

The second problem, and the one that I think is addressed less frequently, is who really wants to commit to an area when the job isn’t that good and may not be stable?” …

unemployedI recently exchanged emails with a long-time reader who is unexpectedly changing jobs. A few years ago he was convinced his job was completely stable, as did many others before the bust. You never know in this economy how stable anything is.

The problem is there might not be enough houses, at the right price points, to go around.

This is the next crisis.

The only real long-term solution to the lack of inventory problem is higher house prices. Even if all excess debt were purged, homeowners wouldn’t possess the equity to execute a move-up trade. Given enough time, amortization will provide some equity, but to really motivate sellers, prices to rise enough to extricate the previous generation from their starter homes.

The policies that create cloud inventory put a minimum price on these houses because loss mitigation procedures prevent debt-burdened houses from ever transacting for less. Lenders already proved their willingness to wait as long as it takes to get out at breakeven, and homeowners want the extra equity for a move up.

These conditions will likely force lenders to keep mortgage rates low for a very long time because without rates at 4% or less, house prices won’t rise high enough to bail lenders out of their bad bubble era loans, and an entire generation will spend their adult lives in their entry-level house.


Come join us on Thursday

The homebuying season started early this year due to the low mortgage rates. If you or someone you know are considering buying this year, I invite you to come out to our event at JT Schmids on Thursday. We provide free appetizers and drinks and great presentations. I hope to see you there.


RSVP for event here.

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