It’s a difficult time to be a housing bear. The chorus of cheerleaders in the financial media are keen to report on the supposed strength in housing, and locally prices are going straight up. Given those realities, are the rantings and ravings of housing bears just noise to be ignored? Mark Hanson, an independent housing market analyst, correctly and accurately predicted the crash in housing. He is one of the last remaining housing bears. Let’s take a careful look at the well-reasoned positions of housing bears and see if there is any merit to their concerns.
by Mark Hanson – April 6th, 2013, 4:00pm
Major housing market headwinds create flat to negative 2013 rates of change. Market forecasts and sector stock multiples are forecasting sales, price and home improvement gains similar to what we saw in 2012 YoY. This will not occur.
That is boldly and unapologetically bearish. No squishy caveats or weasel words to diminish it’s impact.
Summary: Following nearly 20 years of an unprecedented housing sector and mortgage credit expansion/bubble that resulted in the greatest housing and mortgage credit collapse in history one must be particularly optimistic or ignorant — or both — to think that 2012 was “the” durable bottom.
1) the Homebuyer tax credit of 2009/10 also created a “short squeeze” in the housing sector that everybody thought was a “durable bottom”;
I was still very bearish in 2009 and 2010. Prices and interest rates still hadn’t fallen to levels where housing was a good buy based on cost of ownership. The tax credit stimulus was obviously an artificial stimulus with a set termination date destined to pull demand forward and lead to a reversal once the stimulus ended. Many bulls watched the tape and believed the bottom was in. They were wrong.
2) at least 50% of all mortgage’d homeowners coast to coast are Zombies…dead to the housing market equation — unable to freely sell and rebuy – due to negative equity; “effective” negative equity (not enough equity to pay a Realtor 5% and put 10% to 20% down on a new house); or insufficient income or credit needed for a mortgage;
The mainstream media in its shallow or non-existent research likes to report the underwater numbers from Zillow as if that accurately captures the number of households that are effectively underwater. It doesn’t. In the real world, sellers need to pay an agent and closing costs that usually run about 8% of the final negotiated sales price. Therefore, anyone with less than 8% apparent equity cannot sell their house.
3) banks and the gov’t have turned up to 8 million legacy distressed borrowers into underwater renters of their own houses by the use of new-vintage, higher-leverage, worse-than-Subprime loans (aka Mortgage Mods) that redefault at about the same clip as legacy Subprime loans defaulted from in the first place;
Most people don’t understand this. Loan modifications are usually temporary payment reductions that mimick the worst features of the worst loans of the housing bubble. Since the interest rate reductions are temporary, loan modifications are essentially teaser rate loans destined to reset in the future. Many of these mods have interest-only features (banks don’t want to give up their income if they don’t have to). Further, the missed payments, fees, and other charges are merely added to the loan balance when the modification is approved. The growing loan balance is much like an Option ARM leaving the borrower worse off than when they started.
On top of all that, loan modifications do nothing for second loans or other consumer debts that burden loanowners. Even after modification, the back-end debt-to-income ratios of these borrowers is appalling. It shouldn’t be terribly surprising that about 40% of these loan modifications redefault each year.
The only thing that will improve these redefault numbers is rising prices. Some of these borrowers will be more motivated to hang on with the false hope of future equity, but most are so indebted that they simply won’t survive long enough to reach equity nirvana. Plus, even those that do face an uncertain future because the loan modification entitlement will be rescinded as prices near the peak.
4) thin and more transitory demand cohorts — the first-timer and institutional/private ‘buy and rent’ speculator “investor” – make up half housing demand;
The investor demand will not be sustained. The big players will stop purchasing when cashflow returns no longer make sense. Phoenix has already seen a dramatic decline in investor purchases because they drove prices up to that magic threshold.
5) and repeat buyers — historically housings’ primary demand AND supply cohort — remain structurally unable to carry the sector until significant legacy first and second lien de-leveraging occurs.
In my opinion, the move-up market will suffer for another decade. We know that delinquent jumbo loans in Coastal California pollute bank balance sheets. In a normal market unhindered by $1 trillion in overhanging debt, any increase in market prices would give everyone equity. Many sellers would take this equity and bid up prices in the move-up market. That isn’t going to happen this time around because 50% of the equity from rising prices is either going back to the bank to pay off an underwater loan, or it’s going to an investor who bought at the bottom.
As such, the CA housing data for February presented as follows highlight why calling “the bottom” is a risky (and early) proposition. I will agree the 2012 “bottom” (and 2010 “bottom”) are all part of a “bottoming process”. But so was the Homebuyer Tax Credit stimulus “hangover” of 2011 and the much larger Twist hangover that will grip housing in 2013/14.
CA Feb Home Sales…FLAT for 5-straight years. YoY rate of change now flat to negative. The first negative MoM and YoY print since 2008.
Bottom line: Beginning in Q3 2011 and continuing through late 2012 housing & finance enjoyed YoY comparables against very weak housing market activity — the severe hangover created by the perma- Homebuyer Tax Credit stimulus that sunsetted in mid-2010 – while at the exact same time being injected with the greatest rates jet fuel stimulus in the history of the known universe a la Twist. On the supply side, bank portfolio mortgage modifications — ultimate in legacy loan high-risk can-kicking that leaves homeowners as over-levered, underwater renters of their own house – surged to several million units.
Mark paints a pretty grim picture. The rest of his post is worth reading.
Four reasons house prices won’t crash
I don’t disagree with anything Mark has written, yet I don’t think prices are going down. I first wrote about this in The housing bears are right, but prices will go up anyway:
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. Right now, most of the growth in the buyer pool is coming from hedge funds, but 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. The key here is that interest rates must remain at near record-low levels while the distressed inventory is liquidated. This was a big sticking point for me until Ben Bernanke came out and pledged to buy $40 billion of mortgage-backed securities every month for as long as it takes to turn around the housing market and reduce unemployment. With an open-ended stimulus guarantee in place, the risk of crumbling affordability reversing prices is taken off the table.
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, in 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 has forced prices to move higher. It worked. And most bulls believe it will continue to work. That’s why despite the fact that the bears are right, prices will go up anyway.
What it takes to be a bear
To be bearish on housing, one needs to take the view that one or more of the factors I listed above will change.
1. How likely is it that lenders will be forced to liquidate?
Back in April of 2009, banking regulators allowed mark-to-fantasy accounting to disguise how bad the situation really was for banks. By reporting fantasy values rather than real values for their bad loans, banks are under no pressure to liquidate to maintain capital ratios. With $1 trillion in unsecured mortgage debt, the probability of forced liquidation is essentially zero. Lenders will be given as much time as they need to kick the can until house prices rise and they can liquidate without a loss.
2. and 3. How likely is a rise in interest rates?
Rising interest rates would hit lenders two ways. First, they would face higher carrying costs because they would have to start paying depositors something more than the pittance they part with now. Second, rising rates would lower housing affordability and slow the rise in house prices they need to restore collateral value to their bad loans. Again, with the pressures on banks due to the huge dollar amount of unsecured debt, the federal reserve will do everything possible to keep rates as low as they can for as long as they can. So how likely is a sudden rise in rates? Will the deflating bond bubble cause housing to crash again? While the probability is not zero, the federal reserve will do everything in its power to stop this from happening.
4. How likely is it that lenders will lose control of the MLS listings and flood the market with inventory?
Similar to #1 above, why would banks do this? They are under no pressure to liquidate, and if they simply make their underwater loanowners wait until house prices reflate before they sell, the bank can avoid recognizing any losses. Given those circumstances, lenders will wait, forever if necessary.
Given the forces at work manipulating the market and the obvious success they’ve been having of late (See: Las Vegas: a case study in successful housing market manipulation), it’s hard to be bearish. I wouldn’t consider my view bullish because I believe the entire market recovery is an artificial construct, but given the reality of rising prices and high affordability, I believe prices will continue to push higher on low inventory availability until circumstances change, and I don’t see any signs these conditions will change any time soon.
$500,000+ on a $10,000 investment
Who says real estate is a bad investment. The former Ponzi who owned today’s featured property put about $10,000 into the place, and over the course of 11 years, he extracted over $500,000. That’s a great ROI!
Of course, this investment strategy requires good timing and a bank stupid enough to loan a Ponzi 100% of the inflated value of his property, but it worked once, so it may work again, right?
- This property was purchased on 7/25/1995 for $226,500. The owner used a $215,100 first mortgage and a $11,400 down payment.
- On 11/21/1996 he refinanced with a $203,400 first mortgage.
- On 12/30/1997 he refinanced with a $201,500 first mortgage.
- On 11/18/1998 he refinanced with a $199,750 first mortgage. Based on these first three refinances (his mortgage broker loved him), he was not a Ponzi borrower. It was something he embraced later on.
- On 2/19/1999 he opened a $40,000 HELOC and got his first taste of free money. He must have liked it because his behavior goes downhill quickly from here.
- On 4/22/2002 he refinanced with a $290,000 first mortgage.
- On 12/31/2002 he refinanced with a $320,000 first mortgage.
- On 10/30/2003 he refinanced with a $380,000 first mortgage.
- On 3/25/2004 obtained a $100,000 HELOC.
- On 10/18/2005 he refinanced with a $600,000 first mortgage.
- On 12/12/2006 he refinanced with a $645,000 first mortgage.
- On 12/28/2006 he opened a $88,500 HELOC.
- Assuming he maxed out the final HELOC, the total property debt was $733,500 and his total mortgage equity withdrawal was $518,400.
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Proprietary OC Housing News home purchase analysis
$570,000 …….. Asking Price
$226,500 ………. Purchase Price
7/25/1995 ………. Purchase Date
$343,500 ………. Gross Gain (Loss)
($45,600) ………… Commissions and Costs at 8%
$297,900 ………. Net Gain (Loss)
151.7% ………. Gross Percent Change
131.5% ………. Net Percent Change
5.3% ………… Annual Appreciation
Cost of Home Ownership
$570,000 …….. Asking Price
$114,000 ………… 20% Down Conventional
3.57% …………. Mortgage Interest Rate
30 ……………… Number of Years
$456,000 …….. Mortgage
$103,674 ………. Income Requirement
$2,066 ………… Monthly Mortgage Payment
$494 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$119 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,678 ………. Monthly Cash Outlays
($321) ………. Tax Savings
($709) ………. Principal Amortization
$131 ………….. Opportunity Cost of Down Payment
$163 ………….. Maintenance and Replacement Reserves
$1,942 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$7,200 ………… Furnishing and Move-In Costs at 1% + $1,500
$7,200 ………… Closing Costs at 1% + $1,500
$4,560 ………… Interest Points at 1%
$114,000 ………… Down Payment
$132,960 ………. Total Cash Costs
$29,700 ………. Emergency Cash Reserves
$162,660 ………. Total Savings Needed