Massive intervention by Federal agencies and the Federal Reserve have kept the market from discovering price and the risk premium in real estate. That sets up a “catch the falling knife” possibility for impatient real estate investors.
A substantial percentage of many households’ net worth is comprised of the equity in their home. With the beating home prices have taken since 2007, existing and soon-to-be homeowners are keen to know: Are prices stabilizing? Will they begin to recover from here? Or is the “knife” still falling?
To understand where housing prices are headed, we need to understand what drives them in the first place: policy, perception, and price discovery.
In my December 2011 look at housing, I examined systemic factors such as employment and demographics that represent ongoing structural impediments to the much-awaited recovery in housing valuations and sales. This time around, we’re going to consider policy factors that influence the housing market.
Yesterday while standing in line at our credit union I overheard another customer at a teller’s window request that her $100,000 Certificate of Deposit (CD) be withdrawn and placed in her checking account because, she said, “I’m not earning anything.” The woman was middle-aged and dressed for work in a professional white- collar environment — a typical member, perhaps, of the vanishing middle class.
Sadly, she is doing exactly what Ben Bernanke’s Federal Reserve policies are intended to push people into doing: abandoning capital accumulation (savings) in favor of consumption or trying for a higher yield in risk assets such as stocks and real estate.
It may strike younger readers as unbelievable that a few decades ago, in the low-inflation 1960s, savings accounts earned a government-stipulated minimum yield of 5.25%, regardless of where the Fed Funds Rate might be. Capital accumulation was widely understood to be the bedrock of household financial security and the source of productive lending, whether for 30-year home mortgages or loans taken on to expand an enterprise.
How times — and the US economy — have changed.
Now the explicit policy of the nation’s private central bank (the Federal Reserve) and the federal government’s myriad housing and mortgage agencies is to punish saving with essentially negative returns in favor of blatant speculation with borrowed money. Official inflation is around 3% and savings accounts earn less than 0.1%, leaving savers with a net loss of about 3% every year. Even worse — if that is possible — these same agencies have extended housing lenders trillions of dollars in bailouts, backstops and guarantees, creating institutionalized moral hazard on an unprecedented scale.
Recall that moral hazard simply means that the relationship between risk and return and has been severed, so risk can be taken in near-infinite amounts with the assurance that if that risk blows up, the gains remain in the hands of the speculator. Another way of describing this policy of government bailouts is “profits are private but losses are socialized.” That is, any profits earned from risky speculation are the speculator’s to keep, while all the losses are transferred to the public.
While the housing bubble was most certainly based on a credit bubble enabled by lax oversight and fraudulent practices, the aftermath can be fairly summarized as institutionalizing moral hazard.
Policy as Behavior Modification and Perception Management
Quasi-official pronouncements by Fed Board members suggest that the Fed’s stated policy of punishing savers with a zero-interest rate policy (ZIRP) is outwardly designed to lower the cost of refinancing mortgages and buying a house. The first is supposed to free up cash that households can then spend on consumption, thereby boosting the economy. With savings earning a negative yield, consuming more becomes a tangibly attractive alternative. (How keeping the factories in Asia humming will boost the American economy is left unstated.)
This near-complete destruction of investment income from household savings yields a rather poor return. Plausible estimates of the total gain that could be reaped by widespread refinancing hover around $40 billion a year, which is not much in a $15 trillion economy.
There are real-world limits on this policy as well. Since the Fed can’t actually force lenders to refinance underwater mortgages, millions of homeowners are unable to take advantage of lower rates. From the point of view of lenders, declining household incomes and mortgages that exceed the home value (so-called negative equity) have lowered the creditworthiness of many homeowners.
As a result, the stated Fed policy goal of lowering mortgage payments to boost consumer spending has met with limited success. Somewhat ironically, the mortgage industry’s well-known woes — extended time-frames for involuntary foreclosure, lenders’ hesitancy to concede to short sales (where the house is sold for less than the mortgage and the lender absorbs a loss), and strategic/voluntary defaults — may be putting an estimated $80 billion in “free cash” that once went to mortgages into defaulting consumer’s hands.
The failure of the Fed’s policies to increase household’s surplus income via ZIRP leads us to the second implicit goal, lowering the cost of home ownership via super-low mortgage rates, which serves both as behavior modification and perception management. If low-interest rate mortgages and subsidized Federal programs that offer low down payments drop the price of home ownership below that of renting an equivalent house, then there is a substantial financial incentive to buy rather than rent.
The implicit goal is to shape a general perception that the bottom is in, and it’s now safe to buy housing.
First-time home buying programs and FHA (Federal Housing Authority) and VA (Veterans Administration) loans all offer very low down-payment options to qualified buyers. This extends a form of moral hazard to buyers as well as lenders: If a buyer need only scrape up $2,000 to buy a house, their losses are limited should they default to this same modest sum. Meanwhile, lenders working under the guarantee of FHA- and VA-backed loans are also insured against losses.
The Fed’s desire to boost home sales by any means available is transparent. By boosting home sales, it hopes to stem the decline of house valuations and thus stop the hemorrhaging of bank losses from writing down impaired loan portfolios, and also stabilize remaining home equity for households, which has shrunk to a meager 38% of housing value.
As many have noted, given that about 30% of all homes are owned free and clear, the amount of equity residing in the 70% of homes with a mortgage may well be in the single digits. (Data on actual equity remaining in mortgaged homes is not readily available, and would be subject to wide differences of opinion on actual market valuations.)
Broadly speaking, housing as the bedrock of middle class financial security has been either destroyed (no equity) or severely impaired (limited equity). The oversupply of homes on the market and in the “shadow inventory” of defaulted/foreclosed homes awaiting auction has also impaired the ability of homeowners to sell their property; in this sense, any remaining equity is trapped, as selling is difficult and equity extraction via HELOCs (home equity lines of credit) has, for all intents and purposes, vanished.
The Fed’s strategy, in conjunction with the government-owned and -operated mortgage agencies that own or guarantee the majority of mortgages in the US (Fannie Mae, Freddie Mac, FHA, and the VA), is to stabilize the housing market through subsidizing the cost of mortgage borrowing by shifting hundreds of billions of dollars out of savers’ earnings with ZIRP.
Since roughly 60% of households either already own a home or are ensnared in the default/foreclosure process, then the pool of buyers boils down to two classes: buyers who would be marginal if not for government subsidies and super-low mortgage rates, and investors seeking some sort of return above that of US Treasury bonds. The Fed has handed investors two choices to risk a return above inflation: equities (the stock market) or real estate. Given the uneven track record of stocks since the 2009 meltdown, it is not much of a surprise that investors large and small have been seeking “deals” in real estate as a way to earn a return.
Recent data from the National Association of Realtors concludes that cash buyers (a proxy for investors) accounted for 31% of homes sold in December 2011. Even in the pricey San Francisco Bay Area, where median prices are still in the $350,000 range, investors accounted for 27% of all sales. Absentee buyers (again, a proxy for investors) paid a median price of around $225,000, substantially lower than the general median price.
This data suggests that “bargain” properties are being snapped up for cash, either as rental properties or in hopes of “flipping” for a profit after some modest cleanup and repair.
Price and Risk Premium Discovery
There is one lingering problem with the Fed and the federal housing agencies’ concerted campaigns to punish capital accumulation, push investors into equities or real estate, and subsidize marginal buyers to boost sales at current valuations. The market cannot “discover” price or establish a risk premium when the government and its proxies are, in essence, the market.
By some accounts, literally 99% of all mortgages in the U.S. are government-issued or -guaranteed. If any other sector was so completely owned by the federal government, most people would concede that it was a socialized industry. Yet we in the US maintain the fiction of a “free market” in mortgages and housing.
To establish a truly free and transparent market for mortgages and housing, we would have to end all federal subsidies and guarantees/backstops, and restore the market as sole arbiter of interest rates — i.e., remove that control from the Federal Reserve.
Everyone with a stake in the current market fears such a return to an open market because it is likely that prices would plummet once government subsidies, guarantees, and incentives were removed. Yet without such an open market, buyers can never be certain that price and risk have truly been discovered. Buyers in today’s market may feel that the government has removed all risk from buying, but they might find that they “caught the falling knife;” that is, bought into a false bottom in a market that has yet to reach transparent price discovery.
So, the key question still remains for anyone who owns a home or is looking to soon own one…how close are we to the bottom in housing prices?
In Part II: Determining the Housing Bottom for Your Local Market, we tackle that question head-on. Because local dynamics inevitably play such a large role in determining fair pricing for any given market, instead of giving a simple forecast, we instead offer a portfolio of tools and other resources for analyzing home values on a local basis. Our goal is to empower readers to calculate an informed estimate of “fair value” for their own markets — and then see how closely current local real estate prices fit (or deviate) from it.
Click here to access Part II of this report (free executive summary, enrollment required for full access).
This article was originally published on chrismartenson.com.
- A Simple Explanation Of The Federal Reserve Statement (January 25, 2012) (clewismortgage.wordpress.com)
- The Federal Reserve Meets Today: Mortgage Rates Expected To Move (edshort.wordpress.com)
- Deducting Mortgage Interest FAQs (turbotax.intuit.com)
- More homeowners staying current on their mortgages (freedommortgage.com)
- Federal Reserve Weighs In on Housing (eyeonhousing.wordpress.com)
- Homeowner tax code set to expire at year’s end (freedommortgage.com)
- Housing Help Will Run Up Against Lending Standards (blogs.wsj.com)
To pay for a two month extension in the payroll tax, Congress (both sides of the aisle), and the President have decided to tax real estate loans for the next ten years. This was voted in recently, and will now start affecting real estate transactions.
It’s not been publicized as a tax because it’s been identified as an increase in the agency’s “Guarantee Fee”. But the money does not go to the agency’s, it goes directly to the US Treasury. The fee is only 10bps(bps stands for “basis points” which means 1/100th of a percent, or .1%). But, when market factors come into play(like lock term, etc.), it will be more. The largest US mortgage lender said recently that some programs will be affected as much as 80 bps.
This will not be an additional fee on the Good Faith Estimate, but will be factored into pricing. Industry estimates conclude that the typical borrower will pay approximately $4,000 more during the life of their loan.
Let’s face it, this is a tax. A couple interesting thoughts come to mind when considering this new tax.
First, since Fannie Mae and Freddie Mac are now a funding source for the US budget this works against the goal of both parties to “wind them down”, or eliminate them and replace them with private funding sources.
Second, for those of you who will immediately jump on this as “liberal” spending….the “conservatives” were also in favor of this new tax, despite their signing of the “no new taxes” pledge.
Third, housing has led the economy out of recession historically. Housing is still hurting nationally. The Federal Reserve has kept interest rates low to stimulate the economy and just last week wrote a letter to Congress expressing the importance of housing in revitalizing the economy. It makes you wonder why all these “job creators” in Washington, D.C. are for this tax that will serve as an additional barrier to stimulating housing and create jobs.
It would appear that the Nation’s leaders have other priorities. What they are, who knows
- Fannie, Freddie overhaul unlikely, by Vicki Needham, Thehill.com (oregonrealestateroundtable.com)
- Fannie Mae Extends Mortgage Relief for the Unemployed (tominvestor.wordpress.com)
- Can anyone save Fannie Mae and Freddie Mac? (money.cnn.com)
- A Brief History of Fannie Mae and Freddie Mac (time.com)
- Fannie Mae CEO Exit Reveals Housing Policy Chaos (huffingtonpost.com)
- Bernanke Doubles Down on Fed Bet Defied by Recession: Mortgages (businessweek.com)
- Fannie, Freddie Turmoil Opens Market to Tough Mortgage Medicine (thestreet.com)
- The Fine Print – Home Buyers to Pay for the Payroll Tax Cut (legallyeasy.rocketlawyer.com)
- NCBA Applauds the GAO Recognition of the Cooperative Business Model as Solution for Restructuring Fannie Mae and Freddie Mac (prweb.com)
- What President Obama can do for the economy without Congress: Mass mortgage refinancing (dailykos.com)
An overhaul of Fannie Mae and Freddie Mac is unlikely again this year despite recent Republican efforts to move the issue up the agenda.
Congressional Republicans, along with some Democrats — and even GOP presidential candidate Newt Gingrich — are renewing calls to craft an agreement to reduce the involvement of Fannie and Freddie in the nation’s mortgage market.
But without a broader accord, passage of any legislation this year is slim, housing experts say.
Jim Tobin, senior vice president of government affairs for the National Association of Home Builders, concedes that despite a mix of Democratic and Republican proposals, including a push by the Obama administration last year, congressional leaders probably won’t get far this year on a plan for Fannie and Freddie, the government-controlled mortgage giants.
Tobin said there are “good ideas out there” and while he expects the House to put some bills on the floor and possibly pass legislation, the Senate is likely to remain in oversight mode without any “broad-based legislation on housing finance.”
“We’re bracing for a year where it’s difficult to break through on important policy issues,” he said this week.
While the issue makes for a good talking point, especially in an presidential election year, congressional efforts are largely being stymied by the housing market’s sluggish recovery, prohibiting the hand off between the government and private sector in mortgage financing, housing experts say.
David Crowe, chief economist with NAHB, said that the market has hit rock bottom and is now undergoing a “slow climb out of the hole.”
The House has taken the biggest steps so far — by mid-July the Financial Services Committee had approved 14 bills intended to jump-start reform of the government-sponsored enterprises.
“As we continue to move immediate reforms, our ultimate goal remains, to end the bailout of Fannie, Freddie and build a stronger housing finance system that no longer relies on government guarantees,” panel Chairman Spencer Bachus (R-Ala.) said last summer.
Meanwhile, a number of GOP and bipartisan measures have emerged — Democrats and Republicans generally agree Fannie and Freddie are in need of a fix but their ideas still widely vary.
There are a handful of bills floating around Congress, including one by Reps. John Campbell (R-Calif.) and Gary Peters (D-Mich.), and another by Reps. Gary Miller (R-Calif.) and Carolyn Maloney (D-N.Y), which would wind down Fannie and Freddie and create a new system of privately financed organizations to support the mortgage market.
“Every one of those approaches replaces them [Fannie and Freddie] with what they think is the best alternative to having a new system going forward that would really fix the problem and would really give certainty to the marketplace and allow housing finance to come back, and therefore housing to come back, as well,” Campbell said at a markup last month.
There’s another bill by Rep. Jeb Hensarling (R-Texas) and bills in the Senate being pushed by Sens. Bob Corker (R-Tenn.) and Johnny Isakson (R-Ga.).
Corker, a member of the Senate Banking Committee, made the case earlier this week for unwinding government support for the GSEs while promoting his 10-year plan that would put in place the “infrastructure for the private sector to step in behind it.”
“A big part of the problem right now is the private sector is on strike,” Corker said.
He has argued that his bill isn’t a silver bullet, rather a conversation starter to accelerate talks.
“So what we need to do is figure out an orderly wind-down,” Corker said in November. “And so we’ve been working on this for some time. We know that Fannie and Freddie cannot exist in the future.”
He suggested getting the federal government this year to gradually wind down the amount of the loans it guarantees from 90 percent to 80 percent and then to 70 percent.
“And as that drops down, we think the market will send signals as to what the difference in price is between what the government is actually guaranteeing and what they’re not,” he said.
Even Gingrich, who has taken heat for his involvement with taking money while doing consulting work for the GSEs, called for an unwinding during a December interview.
“I do, in fact, favor breaking both of them up,” he said on CBS’ Face the Nation. “I’ve said each of them should devolve into probably four or five companies. And they should be weaned off of the government endorsements, because it has given them both inappropriate advantages and because we now know from the history of how they evolved, that they abused that kind of responsibility.”
In a white paper on housing last week, the Federal Reserve argued that the mortgage giants should take a more active role in boosting the housing market, although they didn’t outline suggestions for how to fix the agencies.
The central bank did argue that “some actions that cause greater losses to be sustained by the GSEs in the near term might be in the interest of taxpayers to pursue if those actions result in a quicker and more vigorous economic recovery.”
Nearly a year ago, Treasury Secretary Timothy Geithner asked Congress to approve legislation overhauling Fannie Mae and Freddie Mac within two years — that deadline appears to be in jeopardy.
The Obama administration’s initial recommendations called for inviting private dollars to crowd out government support for home loans. The white paper released in February proposed three options for the nation’s housing market after Fannie and Freddie are wound down, with varying roles for the government to play.
About the same time last year, Bachus made ending the “taxpayer-funded bailout of Fannie and Freddie” the panel’s first priority.
While an overhaul remains stalled for now there is plenty of other activity on several fronts.
In November, the Financial Services panel overwhelmingly approved a measure to stop future bonuses and suspend the current multi-million dollar compensation packages for the top executives at the agencies.
The top executives came under fire for providing the bonuses but argued they need to do something to attract the talent necessary to oversee $5 trillion in mortgage assets.
Earlier this month, the Federal Housing Finance Agency announced that the head of Fannie received $5.6 million in compensation and the chief executive of Freddie received $5.4 million.
Under the bill, the top executives of Fannie and Freddie could only have earned $218,978 this year.
Last week, Fannie’s chief executive Michael Williams announced he would step down from his position once a successor is found. That comes only three months after Freddie’s CEO Charles Haldeman Jr. announced that he will leave his post this year.
The government is being tasked to find replacements, not only for the two mortgage giants which have cost taxpayers more than $150 billion since their government takeover in 2008, but there is talk that the Obama administration is looking to replace FHFA acting director Edward DeMarco, the overseer of the GSEs.
In a letter to President Obama earlier this week, more than two dozen House members said DeMarco simply hasn’t done enough to help struggling homeowners avoid foreclosure.
The lawmakers are pushing the president to name a permanent director “immediately.”
Also, in December, the Securities and Exchange Commission (SEC) sued six former executives at Fannie and Freddie, alleging they misled the public and investors about the amount of risky mortgages in their portfolio.
In the claims, the SEC contends that as the housing bubble began to burst, the executives suggested to investors that the GSEs were not substantially exposed to sub-prime mortgages that were defaulting across the country.
- Can anyone save Fannie Mae and Freddie Mac? (money.cnn.com)
- CEO who led Fannie Mae after government seizure to quit (usatoday.com)
- SEC Sues Former Fannie Mae And Freddie Mac Executives For Fraud (huffingtonpost.com)
- Fannie Mae CEO steps down during troubled times (agbeat.com)
- Fannie Mae CEO Steps Down, Despite Having “Long Way to Go in Housing” (inquisitr.com)
- The Future of Fannie Mae and Freddie Mac (money.usnews.com)
- Fannie, Freddie CEOs Took Millions, Far More Than Gingrich (pjmedia.com)
- Lawmakers slam Fannie Mae, Freddie Mac CEOs over pay and bonuses (latimesblogs.latimes.com)
The big story today seems to be the Fed’s comments about the housing bubble in transcripts from their meetings in 2006. The transcripts show what we already knew, that the Fed was never fully convinced there was a housing bubble, and asserted that even if there was the dmage could be contained — they could easily clean up after it pops without the economy suffering too much damage:
Greenspan image tarnished by newly released documents, by Zachary A. Goldfarb, Washington Post: The leaders of the Federal Reserve went around the room saluting Alan Greenspan during his last major meeting as chairman of the central bank Jan. 31, 2006. …
Some six years later, Greenspan’s record — sterling when he left the central bank after 18 years — looks much more mixed. Many economists and analysts say a range of Fed policies contributed to the financial crisis and resulting recession. These included keeping interest rates low for an extended period, failing to take action to stem the bubble in housing prices and inadequate oversight of financial firms.
The Thursday release of transcripts of Fed meetings in 2006 shows that top leaders of the Fed — several of whom continue to hold key positions today — had a limited awareness of the gravity of the threat that the weakness in the housing market posed to the rest of the economy. And they had what turned out to be an excessive optimism about how well things would turn out. …
A Fed economist reported in a 2006 meeting that “we have not seen — and don’t expect — a broad deterioration in mortgage credit quality.” That turned out to be incorrect.
- There Is No Bubble and Even if There Is It’s Not a Porblem… (economistsview.typepad.com)
- There Is No Bubble and Even if There Is It’s Not a Problem… (wallstreetpit.com)
- When Timothy Geithner Hearted Alan Greenspan (huffingtonpost.com)
- Documents Show Fed Missed Housing Bust (time.com)
- Documents show how Fed missed housing bust (mercurynews.com)
- Documents show how Fed missed housing bust (mercurynews.com)
- Newly released transcripts show how Fed missed housing bust – Fox News (foxnews.com)
- Documents Show How Fed Missed Housing Bust – TIME (time.com)
- Documents show Bernanke thought economy could pull off ‘soft landing’ from falling home prices (foxnews.com)
- Documents show how Fed missed housing bust (seattletimes.nwsource.com)