Jul252014
Zillow believes rising mortgage rates will slow home sales
In the absence of rising wages, when mortgage interest rates go up, one of two things will happen: either sales will fall, or prices will fall.
I recently wrote that higher mortgage interest rates would either slow sales or cause house prices to drop. Since most real estate analysts still consider declining home prices impossible, when forced to pick between the two potential outcomes, they pick slower home sales.
Assuming a consistent payment, higher mortgage rates decrease the size of the loan and reduce the amount borrowers can bid on real estate. While it is possible the federal reserve may print enough money to spark wage inflation, given the high levels of residual unemployment and a low labor participation rate, wage inflation is a long way off, almost certain to come later than rising mortgage rates. Therefore, if rising mortgage rates results in smaller loan balances, then either sales volumes will go down, or house prices will go down, or perhaps some combination of both. This isn’t speculation; it’s basic math.
So which outcome seems more likely? If we had a free market without government and lender manipulation, prices would fall, perhaps precipitously depending on the market; however, we don’t have a free market, and our government, federal reserve, and a cartel of too-big-too-fail lenders are manipulating the housing market in an effort to drive up house prices. Since must-sell shadow inventory morphed into can’t-sell cloud inventory, I think it likely that home sales will be depressed for several years.
Apparently, analysts at Zillow agree with me.
Why Rising Mortgage Rates Could Mean Falling Home Sales
Posted by: Aaron Terrazas , Posted date: July 17, 2014
Executive summary
- Over the next year, the underlying drivers of the housing market will approach a delicate handoff as a market driven by accommodative monetary policy gives way to one driven by macroeconomic fundamentals.
So far that delicate handoff has been a dismal failure.
- In this analysis, we estimate a model of Existing Home Sales to assess the contributions of monetary policy versus macroeconomic fundamentals to housing market activity: Under the median scenario, home sales are projected to fall slightly from their current level over the next year.
That is my assessment as well, and it directly contradicts the Pollyanna nonsense coming from most other housing analysts.
- As rates eventually rise above their five-year-earlier values, some homeowners may become reluctant to move as doing so would require them to assume a new mortgage at a higher interest rate—a phenomenon known as “mortgage rate lock-in.” This effect will become particularly prominent moving beyond fall 2015.
I don’t agree with this assessment.
- It is not clear that fundamentals will improve sufficiently strongly or rapidly to offset the expected rise in interest rates: If rates remain at their current levels, household income would have to grow by 4.2 percent over the next year, above its historic average of 3.9 percent.
I think it’s pretty clear fundamentals will not improve faster than rising mortgage rates hurt affordability. Wages are always the last thing to rise in any recovery, particularly with lingering high unemployment and a low labor participation rate representing a pent-up supply of discouraged workers.
Introduction
Existing home sales have recovered slowly and have struggled to gain momentum over the past half-decade as the United States economy emerges from the Great Recession. Countervailing economic currents have pushed existing home sales in opposite directions. Low and declining interest rates—the result of extraordinary monetary policy actions—have been broadly supportive of home sales, but broader economic trends—including low homeownership and household formation, high unemployment and slow income growth—have been a net drag on home sales.
However, the economic forces driving existing home sales are in flux. The Federal Reserve has embarked on a gradual retreat from its accommodative monetary policies of recent years, starting with an incremental reduction in the pace of monthly purchases of government and mortgage-backed securities initiated in December 2013, and interest rates have climbed from their historic lows. These decisions were made in response to the expectation that economic growth and inflation are poised to strengthen in the near-term—contributing to higher wage growth, faster household formation, and eventually, to higher homeownership rates.
The looming handoff—as the underlying economic motor of home sales shifts from accommodative monetary policy toward more traditional macroeconomic fundamentals—is contributing to considerable uncertainty in housing markets. In particular, as the cyclical boost to home sales from low interest rates wanes, it is not obvious that income growth and household formation will pick up sufficiently (or sufficiently quickly) to offset the drag from monetary policy. …
I think it’s pretty obvious this handoff will not be an easy one. I expect several more years of depressed home sales.
What is currently constraining sales?
… As the chart below illustrates, holding all else equal, historically low interest rates have boosted existing home sales by a total of about 15 percent – mostly directly but also indirectly by making it more attractive for mortgage holders to move or refinance at a lower interest rate. However, the boost has not been sufficient to overcome the drag from other factors, which have held existing home sales below their historical average. …
In other words, the only fundamental supporting current pricing and sales is low mortgage interest rates.
As illustrated in the chart below, under the median scenario described above, existing home sales are projected to fall slightly from their current level by 1 percent over six months and by 4 percent over 12 months. Under the pessimistic scenario described above, existing home sales could fall by as much as 15 percent by the end of 2014 and by 20 percent through the end of 2015. However, under more optimistic assumptions, existing home sales would rise from their current levels by 17 percent over six months and by 15 percent over the year.
The broad range of outcomes projected by the model suggest that existing home sales are very likely to fall in the months ahead, even while existing home sales have increased strongly earlier this year. As the chart below illustrates, under the median scenario, existing home sales would essentially be flat over the next year. Under the pessimistic scenario, they would fall to levels comparable to levels observed during the worst months of the recession.
Risks and challenges moving forward
The analysis above suggests that as the underlying drivers of existing home sales shift from accommodative interest rates to more traditional fundamentals such as economic growth and household formation, the timing of the handoff is likely to be imperfect. Two competing perspectives on the monetary policy outlook hold broad implications for the trajectory of existing home sales.
In one view, interest rates will rise more rapidly than expected as the Fed withdraws from asset purchases, particularly since the Fed has been such a large portion of aggregate demand for Treasury and mortgage-backed securities in recent months. In this view, the Fed’s verbal commitments to maintain low interest rates for a protracted period of time will not prove credible, the jump in interest rates will hold back existing home sales, and mortgage rate lock-in will become an increasingly prominent challenge for housing markets. This view corresponds roughly to the pessimistic scenario described in the previous section.
I don’t side with the pessimists on this one. The only way mortgage interest rates will rise quickly is if the economy overheats, and that will boost underlying fundamentals making the pessimistic forecasts unlikely.
In a second view, interest rates will remain lower for a longer period of time than expected due to a structural shift in the equilibrium level of demand for credit (a perspective often labeled “secular stagnation”). If this viewpoint proves accurate, the historic relationship between interest rates and output will no longer hold and other variables would have to compensate as the stimulus from low interest rates wanes. This view corresponds roughly to the optimistic scenario described in the previous section.
I don’t think the optimistic scenario is likely either. We simply can’t push prices any higher and increase home sales without a dramatic increase in employment and wages. Nothing I’ve seen over the last several years, quarters, or months suggests that is going to happen.
Past relationships might not hold in the future
Some studies suggest that there has been a structural shift in the equilibrium level of demand for credit and that, as a result, the interest rate corresponding to an economy operating at full capacity has shifted downward.
If interest rates and other variables remain at their current levels, median household income would have to grow by 4.2 percent over the year ending in June 2015 for existing home sales to remain at their current level—well above its historic average of 3.9 percent. That level of median family income growth would correspond to Personal Consumption Expenditure (PCE) growth of 2.6 percent, beyond the upper end of the Fed’s range of projections for 2015 (2.4 percent). Moving forward six months to the end of 2015, the five-year change in interest rates would fall to zero and median family income would have to grow by 4.8 percent over the year, which would correspond to annual PCE growth of 2.9 percent. Given the Fed’s current commitment to a PCE target of 2.0 percent, it is difficult to imagine that the Fed would tolerate this rate of PCE growth without raising the Federal Funds Rate.
While the “lower for longer” rates assumed under this scenario would be better for home sales since the five-year interest rate differential associated with mortgage rate lock-in would remain negative (i.e., rates would continue to be near or below their five-year earlier value), low rates would likely be associated with slower income growth, itself a drag on home sales.
Exactly. The only way mortgage rates remain very low is due to slow income growth and persistent unemployment, which I think is likely.
Conclusion
Overall, over the next year, the underlying drivers of housing markets will experience a delicate handoff. As the recession-era stimulus from low interest rates wanes—and eventually becomes a headwind—many hope that the historic drivers of existing home sales—such as income growth and household formation—will recover sufficiently quickly and sufficiently robustly to compensate. However, historic experience suggests that this outcome will be difficult to achieve.
I think they overlook the very real possibility of declining home prices brought about by lowered affordability, but overall a cogent analysis. Kudos to the Zillow team.
[listing mls=”OC14155955″]
What would the Zillow-Trulia hookup mean for housing?
Zillow (Z) is seeking to acquire rival Trulia (TRLA) in a move that would create a Goliath of online real estate listings, and both company stocks surged on the news of the rumor.
o how is it going to affect the industry, consumers, and even the media?
For starters, these are two dot-coms in the classic sense, so what they are bringing to the table is their audience, which the two have in spades.
Right now, despite the big surge, neither company has been profitable.
For FY2013, Zillow had explosive revenue results, increasing 69% to a record $197.5 million. But the company posted an annual net loss of $12.5 million, mainly due to the cost of the advertising blitz the company put on. In FY2012, the company had a profit of $5.9 million.
It was a matter of investing in the long game, getting their brand out to consumers – spending money to make it.
Meanwhile, Trulia also saw a net loss in FY 2013. On rapidly growing gross revenues of $143.7 million, the company saw a net loss of $17.8 million.
It’s hard to tell if the two companies’ multiples mean this is a case of 0 + 0 =
Housing Market Slips
The national housing market moved slightly farther away from stability in May as applications for home purchase mortgages remained subdued.
Freddie Mac’s Multi-Indicator Market Index (MiMi) for the month slipped to a value of -2.64 in May, indicating a slightly weaker market than in April, when the index measured -2.59.
The index tracks national and state-level market data to gauge how the single-family housing market is faring against its long-term stable range based on home purchase applications, payment-to-income ratios, proportion of on-time mortgage payments, and local employment. An index value between -2 and 2 is considered to be in the ideal range between a weak market and one that is overheating beyond sustainable levels.
While the index has been relatively flat over the last few months, Freddie Mac notes yearly comparisons look more promising, with an increase of 0.86 points and improvement in most of the different indicators.
“When we look at the other MiMi indicators outside of mortgage purchase applications, the news remains positive—unemployment rates are coming down, more borrowers are paying their mortgages on time, and mortgage rates remain low,” said Frank Nothaft, chief economist at Freddie Mac. “So we remain cautiously optimistic the housing recovery will continue, albeit slowly, until we see more tightening in the labor markets to give personal incomes a much needed jolt.”
Also encouraging is the fact that more markets at the metro level are returning to their stable range of activity even as the country as a whole struggles to get out of “stall speed.”
The standout market in May, said deputy chief economist Len Kiefer, was Salt Lake City, which saw three of its four MiMi indicators climb into a stable range.
“In fact, on a yearly basis, the metro area find sits purchase applications are up,” Kiefer said. “The positive trend in home purchase applications reflects a strong local labor market, with employment growth in the Salt Lake City metro area about double the national average.”
Is ‘cautiously optimistic’ economist code for ‘I don’t have an f’n clue’?
Exactly. It’s also code for “conditions don’t warrant optimism, but I feel the need to project it anyway.”
The 7 Dumbest Big Purchases People Make
Retail therapy is no myth. Psychologists have found that there’s a real science behind the burst of joy we feel when we treat ourselves with a big, exciting purchase — no matter how impractical it may be.
1. 3D TVs
The majority of 3D television owners regret their purchase. It’s not that the technology isn’t cool. The leading complaint is that there just isn’t enough 3D content to make ownership of one of these futuristic devices worthwhile.
More than half the 50 movie titles offered in 3D in 2011 were kids’ flicks, while most blockbuster movie titles opted out of the 3D format altogether. When you’re coughing up between $2,000 and $12,000 for the TV plus another couple hundred bucks a pop for the glasses, that’s sort of a deal breaker.
That leads us to another popular complaint: It can be a major annoyance to wear the glasses that make the third dimension pop. Sort of like wearing your sun shades in the house.
2. Whirlpool Tub
It’s a vision of romance: Flower petals, candle light, a bottle of wine — and then you turn the thing on. Who wants to canoodle with that grumbling sound? Yeah, it’s a vision alright.
Jacuzzi-style whirlpool tubs can be a real mood killer. Not only are they noisy, they’re time consuming to fill with water and prone to completely draining the hot water tank. Plus they’re expensive to operate, not to mention expensive to buy and install.
Bottom line: Most people don’t use them enough to outweigh the negatives.
3. A College Education (No, Really….)
Okay, so most people would say a college degree is a smart investment — but it can certainly be regrettable. A third of millennials say they would have been better off working than going to college, according to a Wells Fargo study. The reason? They’re drowning in debt.
More than half the 1,414 college grads surveyed by Wells Fargo said they afforded their education by taking out hefty student loans that have become the crux of their financial distress. Many said they think they’d have been better off with a less expensive, public education than a much more costly degree from a top-tier school.
If given $10,000, more than half of those surveyed said the first thing they would use the money for is to pay off student loans or credit card debt.
4. A Timeshare
The cost of owning a timeshare extends well beyond the mortgage. Annual maintenance fees, property taxes, and special assessments are piled on top — and they can be quite expensive.
Another major gripe among timeshare owners is that it’s not always easy to schedule their allotted time at the unit. In fact, it can be downright maddening. Some timeshare contracts have so severely misstated the ease in scheduling that several states have passed laws to punish these misrepresentations.
Timeshares are also difficult to unload. Few people are interested in purchasing a timeshare in the aftermarket, meaning you’re very likely to lose money even if you do find a buyer.
5. A Car They Didn’t Research
Nearly a third of all motorists regret their most recent car purchase, a consumer watchdog report found. Among the top triggers of dissatisfaction: The car is faulty, it costs more to run than they anticipated, or they simply didn’t do enough research.
A car is one of the most expensive purchases many of us will ever make. So before pulling the trigger on a flashy sport convertible or a clunker with the little engine that could, experts say it’s important to weigh all your options and do your homework.
Here are a couple good online resources to get you started: Edmund’s Guide for First-Time New Car Buyers and Popular Mechanic’s How to Buy a Used Car Without Getting Burned.
6. High-End Designer Bags, Clothes, and Shoes
Speaking of cars, a Gucci handbag can cost more than the down payment on your vehicle. Ditto that for many designer scarves, furs, and dresses. What you’re really paying for is an air of luxury and exclusivity.
Many of the clothes and accessories we find to be swoon-worthy at the store, high-end and otherwise, end up spending nearly their entire existence in storage. That’s because the average person wears only about 20% of the clothes in their closet, according to retail specialists.
Among the top reasons our garments go unworn? The items no longer seem as unique or important as when first purchased, or we realize it was an impulse buy rather than a smart, practical purchase.
7. A $5,000 Watch
So you got a big promotion at work. Why not reward yourself with a Rolex? You earned it. Plus, what’s more practical than a classic timepiece?
Ted Jenkins, who co-operates a financial advisory firm focused on generations X and Y, speaks from experience when he says: “Don’t do it!”
“The dumbest purchase I ever made was spending $5,000 on a watch,” Jenkins wrote on his financial literacy blog. “I wore two watches over the course of a year, one that cost $5,000 and one that cost $79. The $5,000 watch was a Panerai and the $79 was a Diesel… During that year, my compliment ratio was four to one in favor of the $79 Diesel watch. I never really cared that much about brand names and it taught me that nobody else really does as well. Now I don’t even wear a watch because my phone can tell time.”
Severity of Financial Crisis to Blame for Slow Wage Growth
The labor market has taken significant steps in the quest to return to pre-recession employment levels. Still, concerns remain among many about the quality of jobs being created. Wages have increased over the past year but at only a 2.3 percent growth rate, they lag behind the growth rate that they should be experiencing at this point in the business cycle. A change may be in the air.
Wells Fargo Economics Group released a report asserting that the slow growth in hourly earnings stemmed not from the composition of the jobs being created but from the ripple effects of the severe economic downturn that gripped the nation from 2007 to 2009. Specifically, the report cites the possibility that employers who were reluctant to make wage cuts and lay off employees in the middle of the recession are now restraining wage growth as a way to make up for that decision.
Slack in the labor market has been an important key to keeping wages from growing at a more rapid rate. The glut of quality employees available to employers has weakened the bargaining power of employees, keeping wages lower than they should be. If Jim won’t do the job at a discounted rate, Ray, Susan, or Bob surely will.
There are signs of hope for employees, according to the report. Slack in the labor market has decreased significantly over the past year. The unemployment rate has dropped to 6.1 percent and quality employees are beginning to become scarcer in the marketplace, which in theory, will release a lot of pent up wage growth pressure.
“Growth in average hourly earnings in the top quintile has already risen from 1.6 percent a year ago to about 3 percent at present,” the report said. “Looking forward, there likely will be more acceleration, not only for top wage earners but for workers in other wage quintiles as well. Wage pressures should be mounting as slack in the labor market has broadly declined, illustrated by the further decline in the unemployment rate.”
Wells Fargo predicts that wages will grow gradually over the next year but barring some unforeseen jump in growth, it is unlikely that the Fed will be compelled to raise interest rates until sometime in the middle of 2015.
Four Indicted in Loan Modification Scam
Federal authorities indicted four California men Thursday in connection with a bogus loan modification program that reportedly bilked hundreds of struggling homeowners out of millions of dollars nationwide at the height of the financial crisis.
According to the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP), federal agents Tuesday arrested Samuel Paul Bain, 35, an owner and principal of U.S. Homeowners Relief in Orange County, Calif.; Aminullah Sarpas, a.k.a. David Sarpas, 32, another owner and principal of the businesses; Damon Grant Carriger, 36, the company’s principal sales manager; and Louis Saggiani, 64, the manager and chief accountant for the businesses. The men were charged in a 33-count indictment for a range of crimes, including conspiracy, mail fraud, wire fraud, and money laundering.
The arrests stemmed from a joint investigation by SIGTARP, the United States Postal Inspection Service and the Internal Revenue Service’s criminal investigation office.
“Bain, Sarpas, Carriger, and Saggiani are charged with ripping off homeowners struggling to keep a roof over their heads during the depths of the housing crisis,” said Christy Romero, Special Inspector General for TARP. According to the indictment, the quartet allegedly demanded upfront fees of up to $4,200 from homeowners in exchange for false promises of securing mortgage loan modifications on their behalf. The company touted a 97 percent success rate in securing these modifications and advertised money-back guarantees, as well as an affiliation with federal housing support programs, Romero said. “As a result, the indictment alleges that homeowners nationwide were ripped off by millions of dollars,” she said.
According to SIGTARP, customer complaints about a purported scam led the men to change the company’s name several times in an attempt to avoid attention. Originally doing business as Greenleaf Modify, the men allegedly operated a series of telemarketing “boiler rooms” that pitched loan modification services to distressed homeowners in the wake of the financial collapse in 2008 and operated multiple offices in Irvine, Santa Ana, Newport Beach, Garden Grove, and Westminster under a series of company names, including Waypoint Law Group and American Lending Review, from late 2008 to early 2010. SIGTARP said the men would shut down each company name once the business attracted too many consumer complaints at the Better Business Bureau or attracted too much attention from state regulators, such as the California Department of Justice.
According to the indictment, customers paid advance fees to obtain long-term modifications to their mortgage obligations that would lower monthly payments under federal mortgage relief programs (which, the indictment states, the men referred to as “the Obama Act”). The companies’ marketing materials implied that they were affiliated with government programs, but none of the companies were licensed real estate brokers, nor were they affiliated with any government entities, Romero said. The men generally spent consumers’ money on themselves or on payments to sales people and other business expenses, rather than place it in trust accounts as promised, she said.
The conspiracy charge carries a maximum five-year prison sentence, while the mail fraud, wire fraud, and money laundering charges each could mean as much as 20 years behind bars.
“SIGTARP and our law enforcement partners will aggressively investigate allegations of fraud that exploit TARP’s housing programs, and perpetrators of such crimes will be brought to justice,” Romero said.
Why mortgage rates haven’t risen as expected
“There’s not a big supply of mortgages being originated, so that in and of itself kind of keeps the rates down”
http://finance.yahoo.com/news/why-mortgage-rates-haven-t-145257442.html
Wait….what? Rates haven’t risen, in spite of the taper, because not enough people are buying homes and/or refinancing?
How many people had to “originate mortgages” in the 80s to keep rates over 10%? 😛
I’d have to agree with you.. Their explanation is circular and doesn’t make any sense.
There are some carry trade going on like borrowing the euro at low rates to buy dollar or us assets and get a higher return and the same for the yen. It make sense that when the FED hike the rates, asset prices will still continue to go up due to this carry trade (there might be an initial correction at first). I’ve read about it in the past but Martin Armstrong explain it real well. This trade will continue to work as long as rates in Japan or EU doesn’t go up. My other rationale is there is more confident in US treasury plus low (negative) growth in Q2 means rates will be subdued for a whee longer.
“In the absence of rising wages, when mortgage interest rates go up…”
In any symbiotic relationship, the health of the host is what matters most. The parasite, here, the financial industry, can only grow apace with the rest of the economy. If businesses aren’t expanding and wages aren’t rising, how will banks be able to charge higher rents for the same amount of money?
If banks charge too high a rate, then the purchasing power falls. The buyer then can’t transact on the home and the mortgage isn’t created. So the bank has just screwed themselves out of a 4% return, to try and get a 5% return. Smart, real smart.
Soon, transaction volumes fall, and the banks find themselves sitting on a mountain of capital they need to deploy. So they start competing for loan with their competitors. The rates fall to the level where transaction volume rises, and the loans are made. When the available capital starts to dry up, the banks become more selective and the rates rise to a new equilibrium. Free market economics at work.
Now, let’s say that wages start to rise faster than rates because the FED has kept the rates artificially low for an extended time (six years for instance). As wages naturally rise, rates, if allowed to, would be expected to rise with them. If, however, the FED keeps its thumb on the scale, rates will remain lower than normal economic equilibrium dictates. This imbalance between wages and rates would create even greater price and wage momentum, driving up inflation, prices and wages even further.
In other words, the degree to which wage growth and rate growth trajectories diverge matters. The greater the divergence, the faster the economic expansion and the quicker the recovery. Nothing fuels an economic boom like cheap money. So, what is the FED going to do? Are they going to err on the side of loose or tight monetary policy?
I think their statements make it clear that the last thing they want to do is hobble the horse before it leaves the gate. I think they will let the economy run a little bit, and get up some speed before they pull on the reins.
The FED has spent the last six years setting up this situation where unemployment is falling, thereby creating wage pressure, which will drive up prices, create inflation, and “inflate away the debt.” If they wanted prices to fall and wipe out the excess bad debts via defaults, this could have happened in 2009.
Wages are going to rise before rates rise because that is the plan. Rates can only rise faster than wages if the FED chooses to (like Volcker did in the early ’80s). Wage growth will pull rates up with it (as it did in the ’70s). Double-digit wage growth makes double-digit rates bearable.
Now, sometimes rates appear to shoot up faster than wages. But that is only because they are out of balance with wages (usually from being held too low for too long).
“Wages are always the last thing to rise in any recovery, particularly with lingering high unemployment and a low labor participation rate representing a pent-up supply of discouraged workers.”
About half of the low labor participation rate is traceable to baby boomer retirements. As more retire of this demographic cohort retire, the labor participation rate will fall because of the disproportion size of this generation. But, then again, baby boomers aren’t the one’s buying most of the homes. Especially not starter homes. So, as these high salaries return to the wage pool in large number, wage growth can accelerate for those “participating” in the workforce. Entry-level salaries and even positions can rise as the more experienced workers retire. If the great recession hadn’t forestalled so many retirements, wage growth for lower level workers would be better than present.
Great comment.
We didn’t see wage growth outpace rates after the 80 recession, the 92 recession or the 01 recession. The rate hikes in 94 were particularly harsh and delayed a housing rebound for three years. If the federal reserve can manage to stoke wage inflation without raising rates, things will play out as you describe. Perhaps since we are past the bottom of the interest rate cycle, the wage-rate relationship will be different than the last few recessions because we were in a declining phase of the rate cycle.
[…] Further, with a likely rise in mortgage rates forthcoming, the problem will likely get worse, and sales volumes may be weak for several more […]