Will the reflating housing bubble also burst?
Few deny that we are reflating the housing bubble. Most use the comforting euphemism “recovery,” but this is not semantically correct. The housing bubble was characterized by an unprecedented detachment from fundamental values. The deflation of the housing bubble was the recovery. What we have now is a concerted attempt by lenders, the central bank, and government officials to reflate the bubble because the banks can’t afford the loss of capital associated with sales at “recovered” prices. Since banks stopped foreclosing on properties when the settlement agreement was reached, the MLS inventory dried up. Corresponding to this reduction in supply was a 30% decline in mortgage interest rates which greatly increased the ability of borrowers to bid up prices. Even though owner-occupant demand as measured by volume is still very weak, the demand that does exist can bid much higher to acquire properties, and since supply is down as much as 70% in some markets, buyers are being forced to bid higher to get properties. The result is a reflation of the housing bubble.
Many have named a U.S. housing recovery as a bright spot in a so-called broader domestic economic recovery.
And data seems to support this analysis, despite a slowdown in sales momentum at the end of the year. Existing home sales in December were up 12.8% from the same time in 2011, with the total number of sales in 2012 rising to the highest level in five years, according to the National Association of Realtors. Meanwhile, the annual price for existing homes also jumped to the highest level since 2005, with the median price of a home up 11.5% in December from the same period in 2011.
But David Stockman, former director of the Office of Management and Budget in the Reagan Administration sees little to get excited about.
He tells The Daily Ticker, “I would say we have a housing bubble…again.”
Stockman argues a combination of artificially low interest rates and speculation are to blame, not unlike the last boom and bust cycle in real estate.
“We don’t have a real organic sustainable recovery because in a world of medicated money by the central bank, things aren’t what they appear to be,” Stockman argues.
It’s so refreshing to read the comments of someone in the mainstream media who knows what they are talking about. It’s all too rare.
The artificially low interest rates create the circumstances where borrowers can bid up prices, and that will be largely responsible for reflating the bubble.
I’ve seen many comment on the evils of housing speculation, but that isn’t what’s reflating housing prices. Speculation during the bubble was widespread across every market. Dipshit realtors were flipping homes in Ladera Ranch until the music stopped. The speculation was fueled by no-money down loans and Option ARMs utilized in every market and at every market price point. The investment today is very different.
The hedge funds and others buying large amounts of property today are active in very specific markets and only at the lowest price points. They are buying all cash, and their demand is flowing to where the need is greatest — undervalued markets where supply still exceeds demand. This activity is how markets are supposed to bottom, the only difference is the activity of hedge funds whose capital was needed to stabilize prices in the most beaten down markets. Mom and pop investors couldn’t absorb all the inventory when prices fell, so more capital was needed, so hedge funds stepped in to fill the void. Their activities will cease as soon as prices rise to a point where cash returns no longer make sense.
And according to Stockman, it’s this medicated, cheap money being put to work by investors that’s driving the apparent healing in some of the hardest hit real estate markets in the country.
“It’s happening in the most speculative sub-prime markets, where massive amounts of ‘fast money’ is rolling in to buy, to rent, on a speculative basis for a quick trade,” he contends. “And as soon as they conclude prices have moved enough, they’ll be gone as fast as they came.”
We need to be clear on what “gone” means. These hedge funds will certainly stop buying when prices move higher, so if “gone” means they no longer contribute to demand, that is a true statement. However, what’s implied from this statement is that these hedge funds will actively sell their properties exiting their positions so they can be “gone” from the market. That is not going to happen. As long as the hedge funds are making the cash returns they expected from holding the properties, they will hold them. Rents are going up, so it isn’t likely they will exit their positions and dump their properties on the market. When prices have reached a point of exit, hedge funds will behave much like the banks are today metering out their sales in a way that flattens the market but doesn’t cause a crash.
By ‘fast money’, Stockman is referring to professional investors like hedge funds and private equity firms. To his point, global investment firm Blackstone (BX) has spent more that $2.5 billion on 16,000 homes to manage as rentals, according to Bloomberg. It’s now the country’s largest investor in single-family homes to manage as rentals, with properties in nine markets. And Blackstone is joined by others like Colony Capital LLC and Two Harbors Investment Corp. (SBY) in trying to turn this market into a new institutional asset class, Bloomberg reports.
That’s a lot of future liquidations….
Stockman argues the problem in housing is the two forces needed for a recovery, first-time buyers and trade-up buyers, are missing.
Yes they are. We know from the oft-repeated chart on mortgage originations that owner-occupant buying across the spectrum is down, and the move-up market will suffer for another decade.
With the combination of 7.9% unemployment and staggering student loan debt, he doesn’t see a young generation of new home buyers coming into the market. And with baby boomers heading for retirement with less than adequate savings, he thinks they’ll be trading down with their homes, not up.
He is right on all counts.
Stockman sees a rise in interest rates as the trigger for any kind of bust. He says you can’t have zero rates forever, referring to the Fed’s ZIRP and quantitative easing policies of the last several years.
“As soon as the Fed has to normalize interest rates, housing prices will stop appreciating and they’ll probably head down,” he explains.
That is the math.
“The fast money will sell as quickly as they can and the bubble will pop almost as rapidly as it’s appeared. I don’t know how many times we’re going to do this, and the only people who benefit are the top one percent – the hedge funds, the LBO funds, the fast money people who come in for a trade, make a quick buck, and move along to the next bubble.”
Mortgage rates, for their part, rose from an average 3.42 percent to 3.53 percent on Thursday, the sharpest increase in 10 months, according to the weekly survey of 30-year mortgages by Freddie Mac, the government-backed mortgage company. Even still, mortgage rates are hovering around their lowest levels in more than 30 years.
As for the “American Dream” of home ownership, Stockman argues the past model where the government was trying to get to 69% home ownership was a huge policy mistake that led to no-downpayment loans, liars loans, and a degradation of lending standards. He says the government should have no dog in the hunt when it comes to ownership versus renting.
“Let the market decide,” Stockman says.
[Hat tip to Tom R. for sending me this article]
What we will see going forward
There is little question that house prices will continue to move upward through most of 2013. We will see isolated deals in the jumbo market as lenders foreclose, but they will be careful to keep the inventory limited to prevent their activities from hurting neighborhood comps. Eventually, the headwinds facing the market will start to exert pressure on further price gains.
First, we may see more regulatory headwinds as G-fees increase, the rules for residential mortgages define a down payment requirement, and Congress debates putting a cap on tax deductions which will increase the cost of ownership for high wage earners. None of these upcoming policies will provide a boost to housing, and they may put a serious damper on borrowing which in turn will hurt housing.
Second, we will likely see higher interest rates which will increase borrowing costs, drive down mortgage balances, and put more pressure on housing.
Third, we will see more underwater borrowers reach the surface where they will likely sell to get out from under their onerous mortgages. Those who are squatting will finally get pushed out by the bank. The result of these changes will be less control of the supply by the lending cartel. If the lending cartel losses control of supply, their efforts to restrict supply will not force prices to move higher.
Fourth, hedge funds who are buying properties today will liquidate as prices approach limits of affordability. Their liquidations will cause prices to flatten but not fall as they dispose of the properties they purchased at the bottom.
I don’t think any of these headwinds will lead to a 30% to 50% crash like we saw in the housing bubble. Since most recent loans are fixed-rate mortgages, and since lenders still can restrict supply at lower price points, I believe we will enter a broad flattening phase were sellers resist selling at a loss. The “stickiness” of house prices to downward pressure that was much talked about prior to the crash (a phenomenon we saw in the 90s), will become a persistent backstop preventing a widespread crash. That being said, as we approach the peak, I could see prices flattening out for a better part of a decade as we transition back to a “normal” market characterized by gently rising prices based on wage inflation underpinned by private lending.