Why Housing is going to Struggle


I have written several times about the housing market from several different directions, and so I wanted to share another voice on the issue.  The following post is written by Adam Rust and is a cross-post from www.banktalk.org.  I would encourage everyone to follow his blog as well for more in-depth analysis of the financial world.

 

Today I am going to argue why housing prices are going to stall.

It is an argument based on a few “big stories.” The first reason is that people are not forming households like they have in the past. Unfortunately, the problems are compounded by a significant difference in the asset base of future buyers. Growth in household formation has been on hold. How long can people put off buying a home?

Today I am going to list a few reasons why housing prices are not going to recover anytime soon. There are a few problems in play. The root of the issue is household formation. If you think that people are finally going to start trying to set out on their own, then you are probably optimistic about housing. If you think it is the other way around – where people are going to stay put – then you are probably skeptical.

Household formation is a product of jobs. When a person gets a steady job with a decent paycheck, they can start looking for a place to live. It is also a product of household leverage. No one with student loans and no job decides to rent an apartment if they can instead live with their parents.

For a long time, more and more Americans have been setting off to have their own place. Back in the 50s, the average household consisted of 3.6 people. Now that number is just 2.6. It isn’t for a lack of room, either. Houses have been getting bigger. The idea that people are going to get a place to live just because they are tired of sleeping in a guest bedroom does not hold up.

The decision to move into a home of your own is driven by economics.

Economics is also the driver of whether or not you decide to buy a home or to rent. Sometimes people rent because they want to remain mobile, but more often they do so because they don’t have enough money saved to make a down payment.

The force of demography cannot be ignored: In the future, the renting or owning decision will be further factored by demographics. Simply put, the kinds of people who are going to be forming households in the near future are most likely going to be people without a lot of money. Harvard’s Joint Center for Housing Studies says that minorities will make up 7 of every 10 new households over the next decade. This is no knock against people of color. It is just an unfortunate fact that wealth isn’t distributed equally across lines of color. It actually growing more and more disparate. According to Pew, assets held by white households are now 19 times greater than those held by African-Americans and about 17 times that of Latinos.

Voila! More renters and fewer buyers. Homeownership rates are already less than half for Latinos and African-Americans.

Fewer immigrants are coming to America.

The jobs problem spills over to demographics, as well. According to the Census Bureau, the number of new immigrants has dropped during each of the last four years. There were 400,000 fewer new immigrant households coming to America by 2010, relative to 2007. If all of those people bought a home or rented a house, the pace of household creation would go up 25 percent. They didn’t, though, and home prices are going nowhere.

There is a cascading effect when first-time homebuyers are shut out of the market: It becomes a real problem for sellers when the people offering to buy your home can not put down three percent. The GSEs have abandoned that segment of the buyer market and private mortgage-backed securities seem unlikely to be the destination for those loans. In effect, new households won’t be home-buying households. They will be renting households.

That means that housing prices are going to stay depressed. Investors will move in as home prices fall, but the market for single-family rental housing is never going to reach an economy of scale that attracts real capital. Single-family renting is largely a habit of “mom-and-pops,” because it takes so much time to find tenants, collect rents, and maintain property. Black Rock and Goldman Sachs don’t want to own single-family housing. They will buy multi-family units where ongoing costs are lower, but they’ll need a lot of coaxing before they buy a scattered assortment of ranch homes in El Paso and Fayetteville.

Less capital means lower prices for homes.

Until we can find a way to reconcile the needs of the GSEs with the economic interest of the housing market, then home prices are going to be stay low. For the last several years, the GSEs have been doing their best to step away from low-down payment buyers. The Loan Level Pricing Adjustments have been under the radar ever since they were established in 2007, but they drive the forces that make it hard to get a loan. The LLPA rules make it difficult for anyone but 720 plus credit score borrowers to get a home with less than ten percent down.

 

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Another Hurdle to Home Ownership


With all the talk about the QRM rule definition and the impact it will have on the housing market, another hurdle is flying under the radar.  Adam Rust from the Community Reinvestment Association of North Carolina (CRA-NC) has written a report about the other hurdle to home ownership, Loan Level Pricing Adjustments.

In short, these pricing adjustments are loan fees added to the cost of a loan that take into account the risk of the borrower.  This fee is designed to better assess the risk of a borrower and apply that cost to a loan.  The adjustment takes into consideration 5 key points: Credit Score, Property Type, Occupancy, Structure, and Equity.  Here is the breakdown of this adjustment as provided by Fannie Mae.

This adjustment does not take things like moving loans to FHA, the disparate impact on protected classes, and the use of private mortgage insurance into account.  Without taking these into account these adjustments can price out low wealth and minority communities from home ownership, and move more of the burden to FHA.  Just the QRM debate this also could have an impact on the rental market.

If you want to dig deeper into the topic I encourage you to read the report: The New Hurdle to Home Ownership

 

Senate Banking Committee Considers Small Bank Mortgage Lending


This post was written by Adam Rust and is a cross post from www.banktalk.org.

The Senate Committee for Banking, Housing and Urban Affairs is taking testimony this morning on how pulling back the role of the GSEs would impact small banks. Senator Tim Johnson (D-SD) is hearing from small bankers, credit unions and two policy advocates:

“What you really find out is not the down payment, it is really other things: what is your debt-to-income, how are your credit cards, where the down payment is coming from…you want to look at the probability of repayment,” said Jack Hartings. “What I saw was a person buying a home for $100,000. But they would raise the price to $115,000 and give the buyer a down payment.” Harting is saying the truth about down-payment contributions. It was actually a fairly common practice. It was most often something offered by builders seeking to sell homes in a recently finished subdivision.

The interesting thing about the testimony was how it showed a disconnect between small bankers and the current political narrative. The small bankers and one of the policy advocates voiced concerns about high down payment requirements in the qualified residential mortgage rule and that small banks would be put at a competitive disadvantage in a market where most mortgage securitization is arranged by the same four big banks that are also originating the mortgages.

Upon hearing testimony from Hartings, Dunn, and Staatz that downpayments, either as required currently by the GSEs or through potential versions of a qualified residential mortgage, would impose challenges to their balance sheets, Jake Reed responded with this question:

“I hear that paper work is a large problem, and you don’t have to be diplomatic, you don’t have to hold back….I hear from a lot of small bankers and these are the people that are in the community, they are the ones that are buying the little league uniforms. Is that at risk here?….are you finding that people are saying ‘we should get out of mortgages…’we should sell to a big bank’?”

Reed presented a vision of small town bankers working to expand availability of soccer uniforms and doubting whether they should continue to run their businesses — all because of paperwork.

The bankers glossed over that idea.

“Possibly,” to paraphrase Hartings, “but we’re really worried about liquidity for our balance sheets. Succession is an issue, because people are getting older and often there aren’t the right people in the small towns.”

“We want to be in the mortgage business,” added Staatz.

The bankers insist that they can only make mortgages with a GSE, or something like it, to make their balance sheets viable. Several floated the idea of a co-operative model for MBS. They might be coming to that resolution by looking to existing successful co-operative models that flourish in many small towns. Rural electric co-operatives and local agricultural co-ops make small towns viable places to live and work.

Other solutions were put forth as well. Skillern proposed a model similar to state housing finance agencies: no public subsidy but a consistent mission to expand access to credit. Dunn suggested a gradual reduction of GSE involvement driven by more risk-based pricing.

The 30-year fixed rate mortgage, a staple of small bank lending, is at risk in a world without some kind of public purpose entity. Investment advisors tell me that they have little interest in buying mortgage-backed securities in this market. They say that the return does not justify the risk. I can’t doubt their position. An MBS that offers a 4 percent rate of return should be very safe. Yet an MBS is plagued by long-term interest rate risk in an inflationary environment, by the high possibility of unemployment, and by uncertainty of future legal changes.

The beauty of the GSEs has been to provide credit enhancements to elevate the quality of MBS. The GSEs, by virtue of their stated underwriting rules, give small banks a better chance. It is hard to imagine a market where the four big banks make all of the mortgages, buy all of the mortgages, and service all of the mortgages. The FHA balances risk by charging a uniform risk premium for all loans. FHA is a counter-cyclical model that preserves access during down times.

Imagine a World Without the GSEs


This post was written by Adam Rust and is cross posted from www.banktalk.org.

The political current in Washington seems predisposed to wind down Fannie Mae and Freddie Mac. The drive is so strong that even a center-left group like the Center for American Progress has abandoned its support for some public-purpose entity. The climate is so hostile that supporting the GSEs, even in a very different and scaled-down orientation, is somewhat of a radical point of view.

The logic provided by the supporters of such a measure is that private investors will step in to buy mortgages on the secondary market. That might happen, because yields would go up for the loans that were formerly packaged into agency pass-throughs. At the same time, those loans would be stripped of their “implicit” government guarantee. Most wouldn’t have nearly the same credit rating. Thus, there might be more yield, but there it would come in step with more risk.

We need to look at this problem and at least give some consideration to the worst-case scenario. It isn’t implausible that investors won’t buy all of those mortgages. After all, the risk-reward proposition isn’t that much different now. Today, Fannie andFreddie are buying more than 60 percent of all conventional loans.

One of the few sources of private investment in MBS comes from insurance companies. Unfortunately, that demand would shrink in a post-GSE environment. Insurance companies can’t afford to pursue high-yield high-risk investments. They have to hold low-risk assets.

Our mortgage market is entirely driven by government demand for MBS. Treasury is buying $1.2 trillion of MBS. The government is backing FHA loans. This is really a product of risk aversion. Knowing that their appetite has limits, banks are originating scores of FHA loans for borrowers with risk profiles that don’t meet the standards in the Loan-Level Pricing Adjustment matrix. That risk aversion on the part of investors should inform any calculation of the probability that the worst-case scenario comes to fruition.

In the worst case scenario, a cascading series of bad things happen. First, interest rates go up. Way up. That will dampen the prices on housing. For every one percent increase in interest rates, the cost of borrowing goes up ten percent. Some people say that mortgage interest rates would head north of 7 percent. That implies another 25 percent drop in home prices.

That leads to the next problem. With higher interest rate prices, fewer people buy homes. We already have a nine-month supply of homes on the market and another few hundred thousand homes circulating through the shadow market.

Fewer people will qualify for a refinance. Remember that housing prices have fallen twenty-five percent. It is hard to imagine that there are going to be many people where loan-to-value is still below 75 percent.  The refi problem could mean that more people are trapped in unsustainable mortgages. That could bring about more foreclosures. Of course, very few people are going to want to qualify for a refinance, because new loans will cost a lot more than old loans.

Then this spills over to the job market. If it is hard to sell your home now, imagine what it will be like when borrowers can’t afford to borrow. This isn’t just a problem for employees. It is also going to frustrate employers. Imagine that you need a new mechanical engineer or a new school teacher. The pool of such workers is going to dwindle. It creates a real paradox: fewer people have jobs, but employers have to pay more for labor!

GSE “reform” isn’t taking place in a black box, either. Regulators are about to raise the minimum capital ratios for our biggest banks. (I agree with Tom Brown‘s thoughts on this!) How many banks are going to want to hold onto a 30-year mortgage? Banks make those loans because they can sell them. Mortgage origination is about fees, not long-term interest payment. Under a higher capital ratio environment, holding a mortgage loan eats up precious capital. No thanks.

Did I mention the 30-year mortgage? My mistake. There will be no such thing.