For six years, ever since I introduced the two leaders of the discussion, the American Enterprise Institute (AEI) has conducted panel discussions twice a year to assess the state of the housing economy in the wake of the bursting of the housing bubble in 2007.
At this event, titled “Bubble bubble: Is the housing toil and trouble over?” the main question was whether the observed recovery in house prices nationwide means that a new housing bubble has developed thanks to the intervention of the Federal Reserve through an assortment of programs generally grouped under the heading of quantitative easing (QE).
In his introduction, AEI’s Alex Pollock observed that booms are usually accompanied by rhetoric about a “new era.” He showed a chart of housing prices getting back to their historic trend line of 3 percent annual increase, and that the relationship of median incomes to median house prices is back to its flat historical trend line. In fact, a recent Financial Times article characterized the U.S. housing market as “just plain hot.”
Pollock stated that one of the issues the panel would discuss was how much the performance of the U.S. housing market reflects what he called “amazing and unprecedented bond market manipulations” by the authorities.
The following is a summary of the remarks of the five expert panelists:
• Mark Fogarty, National Mortgage News. While the United States is having a new housing bubble, the question is whether it is merely a “dead cat bounce” or if it is really a new bubble. Traditional wisdom holds that a little inflation is good for real estate, boosting equity and bailing out poor underwriting. By the end of the year, every U.S. market will show increases in values, and many will be close to peaks.
Banks are back in South Florida condos, albeit with stricter underwriting, and the Phoenix market is especially active.
A third possibility is that the greater-than-normal recovery is the expected result of greater-than-normal decline. Also, there has been a resurgence in the jumbo mortgage market.
• Thomas Zimmerman, managing director of UBS Investment Bank. The housing market is surprisingly strong, but the mortgage finance market remains dysfunctional, and this will prevent a full-fledged recovery. There has been a very sharp drop in housing inventory. Values of mortgage-backed securities have soared from 30 percent to between 80 and 90 percent. Conversion of bank-owned properties to rentals is a big part of the comeback.
Foreclosure inventory is still enormous in the states that use a judicial foreclosure process, with California having just switched to a judicial process.
The volume of new house sales remains depressed — values are still 28 percent below their peak, up from -34 percent — and single-family rental rates are declining. The improvement in the market has taken the pressure off for reforming mortgage finance, and the Consumer Financial Protection Bureau (CFPB)’s Qualified Mortgage regulation increases reliance on the government-sponsored entities for mortgage finance.
The housing market will continue to be governed by social policy rather than by a free market.
• Jay Brinkmann, chief economist and senior vice president of research and education at the Mortgage Bankers Association. The market is reacting to five major drivers:
1. Higher severity costs will continue to lower acceptable default rates and thus tighten credit criteria.
2. Lending will be concentrated inside the CFPB safe-harbor definition for Qualified Mortgage or go to the Federal Housing Authority.
3. Cost of originating a mortgage will continue to go rise. Which business models will survive?
4. Banks will increasingly weigh the legal and reputational risks of mortgage banking against reduced volumes and profitability.
5. Securitization and servicing models are being challenged by new mortgage and capital rules.
• Desmond Lachman, AEI. The eurozone is continuing gradually to unravel. The analysis covers three aspects:
1. Economics. The European Union is still below its 2008 peak gross domestic product.
2. Politics. Extremists from both the right and left have gained based on opposition to the euro.
3. European Central Bank. The central bank will buy as many Italian and Spanish bonds as it needs to, with conditions. Until now, it has achieved desired spread reductions without actually having to buy the bonds. Leading central banks have been cutting rates aggressively, except for the one that most needs to, which is the Bundesbank. The peripheral countries will eventually have to leave the euro, but an alternative would be for the strong currency countries to leave. (Lachman will discuss this issue again at an AEI conference scheduled for April 23.)
• Chris Whalen, executive vice president and managing director for Carrington Investment Services. Key points are that Fed actions tending to create a housing bubble will be more than offset by regulatory factors, such as those outlined by Brinkmann, that will increase costs. Banks enjoy a low cost of funds, but they’re assets that are prepaying, and the banks are becoming more like utilities, so that earnings will be constricted.
The housing market will become smaller, and mortgage rates are headed toward 6 to 7 percent to take account of all of the risks that originators will not be able to lay off due to what some call a dysfunctional secondary market.
Heard on K Street
Brinkmann stated that as the administration puts together its second-term team for housing policy, it is likely to include some sort of “housing czar” to coordinate everything.
I was one of the first to float a number on the order of $15 trillion as the embedded cost of the ongoing financial crisis. More recent discussions indicate that the number may be more than double this figure, so that effectively the authorities are trying to hide $30 trillion. Without referring to the number, Fogarty mentioned that the playbook still calls for the banks to be allowed to “earn their way out” of this hole that affects the entire economy.
As the market tries to anticipate when the Fed might unwind QE, I am testing the theory that whatever number the market thinks is needed in terms of an interest rates rise, say 400 basis points, will come not in an orderly rate, but in a lump sum, either when the Fed signals a change in policy or when the Fed fails to act but the market takes charge.
Finally, it is time to assign some probability to the prospect that Jamie Dimon will be ousted at JPMorgan Chase. There are several ways this could be orchestrated, and while these articles will never give investment advice, the question of when and how the stock would react is a separate one.
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