One of the last housing bears roars “not if but when”
Mark Hanson believes the reflated housing bubble will also pop. I think we won’t see any significant price deflation going forward.
Mark Hanson is the Rodney Dangerfield of housing market economists; he doesn’t get much respect. John Burns, the local darling of the MSM, once said, “I give him zero credibility.” Ouch!
So when Mark Hanson argues the US is enmeshed in housing bubble 2.0, he’s dismissed as a perma-bear or a headline grabber who gets on TV. Housing pundits who don’t share Mark Hanson’s views find it easy to disregard him, which is unfortunate because his analysis is generally good. Unfortunately, I can’t agree with Mark’s conclusions this time.
Bag-Holder population is exploding
Real Estate is a highly “illiquid” asset class ‘most of the time’. It always has been and always will be. However, some times, such as now — and from 2003 to 2007 as a prime example — when liquidity is flowing like water, Real Estate’s illiquidity is masked. Speculators can do no wrong. Simply having access to short-term or mortgage capital to purchase Real Estate guaranties a double-digit return. This continues until one day, suddenly, it doesn’t. When capital markets tighten up a bit, or a lot, due to one reason, another, or another, the snap-back to the true, historical illiquid nature of the Real Estate sector happens suddenly and is amplified at first. This creates a snowball effect from which both house supply and illiquidity surge at the same time.
Here is the root of my disagreement with Mark. The next housing bust won’t be characterized by an increase in house supply; in fact, I expect the opposite. Banks learned last time that keeping supply off the MLS is paramount, so they will kick the can at the first sign of increasing inventory or a decline in house prices. That’s the moral hazard of what they learned during the last housing bust.
If we have an illiquid real estate environment after a period of irresponsible lending — something I think is actually encouraged by the moral hazard described above — then we will have another credit crunch, but it won’t coincide with an increase in housing supply. Perhaps it seems like a small difference, but it will make all the difference in the next housing bust. Sales may fall off a cliff, but prices won’t be allowed to.
Price then becomes the liquidity fulcrum and will drop, relentlessly ripping speculators faces off, until capital begins to view the asset class as a relative value once again. …
That’s certainly what happened last time.
These “correction” cycles can be tame, moderate, or extreme like from 2003 to 2007. In my opinion the severity of the correction is directly related to the amount energy that preceded it, meaning given the “all-in” global Central Bank monetary and Gov’t debt policies of the past 6-years, the next “correction” has the potential to make 2007 to 2010 look moderate.
I don’t think so. (See: Is housing headed for another stimulus hangover?)
Focus is no longer “if”, but “when” and “how much”
My job is no longer to prove a new mega-house price bubble has blown under everybody’s noses, but to time it’s ultimate top and inevitable retracement. I need look no further for evidence of Bubble 2.0 mania nationally, across all price levels. The past several quarters of wild anecdotes piling up on each other serve as icing that caps a couple of years of solid and compelling data collection and analysis all pointing conclusively in the same direction.
No more neighbors, friends whose past Real Estate experience is renting an apartment or buying a starter house, or stay-at-home moms flipping houses locally; young, flamboyant Realtors on reality, cable TV shows selling multi-million dollar trophy properties to those from abroad with briefcases of cash that until this year bought a lot relative to the ‘weak’ US dollar; 20-something Silicon kids paying $2,000/sq ft for a house they could buy 20 miles away for $500; large, institutional private equity firms buying 10s of thousands of single-family houses for rental purposes — sight unseens using computer programs — thinking a 3% yield is acceptable long-term and somehow, someday economies of scale will emerge; or individual / “family-style” speculators committing lending fraud at a pace that rivals 2006 chasing their share of the “easy money” in Real Estate, are needed to prove to me that Bubble 2.0 is not just a monster, greater in intensity and energy than Bubble 1.0, but will end the very same way, as the similarities and drivers to Bubble 1.0 are not just all present, but far outnumber yesteryear in egregiousness.
Although we’ve seen a resurgent of bullish sentiment in the astute observations of this blog, it’s nothing like it was in 2006, and lending isn’t anywhere near as loose. He is focusing on these anecdotes as evidence of a widespread mania, but I remember the mania of the early 00s, and in my opinion, what he have today is nowhere close.
I am now more convinced than ever before (even in 2006 when I was literally giving lunatic fringe seminars to the mortgage sector on what I believed was an impending mortgage and housing crash) and convicted to my “far out” analysis that US housing — locally, regionally, and nationally — is at the end stages of an epic bubble blow just looking for prick. And as the bubble has blown to epic proportions, armies of pricks have come out of the woodwork.
It simply isn’t different this time around. I am in full-blown, black-swan look-out mode over here. And Bubble 2.0 could end up being a lot more volatile than from 2008-10 due to the sheer amount of capital and liquidity in the sector that blew the bubble in addition to:
- Muscle memory; the second house price “correction” in 7-years will be taken more seriously, sooner, than the last time around causing inventory to rise substantially, earlier in the downturn.
I see no way this will happen. Lenders still haven’t stopped kicking the can from the last housing bubble. Why would they suddenly abandon this practice — a practice that’s worked for them — in favor of committing financial suicide?
- The record pace of “unorthodox demand with unorthodox capital” by a small slice of the population suddenly going to the “sidelines”, or rather “getting sidelined”, will hit demand much quicker than millions of end-users all changing sentiment over time like at the end of Bubble 1.0.
Again, this won’t happen either. The REO-to-rental companies he refers to will not suddenly start dumping properties if prices fall; in fact, if prices do fall, I believe they will start buying again because this asset class offers superior cash returns. REO-to-rental companies will contribute to demand not supply.
- The Fed and Gov’t have far fewer rates, stimulus, and modification tools at their disposal this time around.
- An entirely new generation of low-down payment, underwater homeowners created from all of the low-down FHA, Fannie and Freddie purchases done with over-inflated appraisals over the past few years.
And lenders will amend these loans and not permit them to sell short, effectively removing this distressed supply from the MLS, assuming they default.
- The record supply of non-owner occupied single and multi-fam “investment” props – and fraudulent loans for “vacation houses” that are really flips or rentals — owned by a small slice of the population will hit the supply chain much quicker than millions of foreclosures did from a wide base of the population in Bubble 1.0.
What evidence do we have of this occurring? We didn’t have liar loans, ninja loans, option ARMs, or other toxic products this time around.
- The Gov’t won’t be able to stop the private house for-sale supply flood like they did last time around vis a’ vi bank and servicer mortgage mods and foreclosure moratoria.
- New, large-scale, well-capitalized demand cohorts rising from the ashes — like institutional and private foreclosure buy-to-renters & flippers and foreigners with cheap relative dollars did post Bubble 1.0 explosion — will be tough to find.
Why? Foreign money always seems to find it’s way to the US because we are perceived as a safe haven. Why would the future be any different?
My proprietary Bubble 2.0 analysis of the contemporary housing data are compelling.
- Houses cost far more to the incremental, end-user, owner occupant buyer using the popular mortgage loan of this era versus 2003 to 2007 (SEE 5/3 NOTE COPIED BELOW).
My analysis completely disagrees with his. (See: Orange County Housing Market Update: May 2015)
- Hard-core speculation is back – some 40% of all transactions according to my calcs — complete with occupancy and appraisal fraud, process incompetence, willful blindness, and relationship-driven dissonance in lending, just like 2003 to 2007.
I see none of this.
- All cash transactions in this era have replaced exotic loans of Bubble 1.0 in bypassing the “mortgage-loan house-price governor”.
- Demand has been extremely weak relative to Bubble 1.0 – end-user, owner-occupied demand more/less flat since 2008 — yet price gains have been far more powerful; a divergence that cannot persist for any great length of time.
- Demand for primarily owner-occupied builder houses has remained far more depressed than resales, which attract a substantial percentage of speculators.
- “Stale listings”, another term for “houses priced too high to sell”, at record highs and a serious house price headwind.
- This end-user, owner-occupied “demandless” house price bubble proves something other than traditional, end-user, owner-occupant fundamentals are driving prices.
Bottom line: This all is big, potential trouble because for prices to remain in a positive trajectory, a wide base of fundamental and permanent demand is always needed and flippers, buy-to-renters, foreigners with volatile capital, high-tech kids, and lending fraud is not a foundation a true ”housing recovery” with “escape velocity” can be built upon.
Note, I have ZERO clue what happens next with housing. Maybe house prices double or triple. Maybe prices get cut in half. Everything here is a derivative of my research and my opinion only. I have been wrong for the past year calling a top but I believe very right about this being a bubble. Note, I was very wrong calling a mega-bubble in 2005/06 as well…for about 18 months.
In August of 2014, I covered Mark Hanson’s earlier prediction: housing is “likely to drop by 10% to 20% over the next 2 years, down more at the high-end.” If we even see half that drop, Mark will be hailed as a prescient genius because he is the only housing pundit prediction specific large-scale declines. So far, this hasn’t happened, and in my opinion, it won’t.
So what will prevent a price collapse? It boils down to supply management. There is still distressed supply in the market. The numbers are debatable, but few of the bulls debate the supply is there and that if it were released in an uncontrolled manner, prices would drop. Therefore, the bulls point to supply management conditions and techniques as the reason prices will go up despite the huge overhang of distressed supply.
Four reasons house prices won’t crash
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 are allowing 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 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. Eventually more owner-occupants will return to the housing market; some will emerge as people go back to work, and some will be recycled as they regain good credit after a foreclosure or short sale.
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; therefore, 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 early 2012, they have been quite successful at withholding inventory as evidenced by ongoing shortages 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 has forced prices to move higher. It worked, and for better or worse, I believe it will continue to work.