The Unsafe Foundation of Our Housing 'Recovery'

Overdependence on subsidies, debt, and unfounded optimism
Monday, February 25, 2013, 5:55 PM

What could go wrong with the housing 'recovery' in 2013?

To answer this question, we need to understand that housing is the key component in household wealth. And, that Central Planning policies are aimed at creating a resurgent “wealth effect,” as follows: When people perceive their wealth as rising, they tend to borrow and spend more freely. This is a major goal of U.S. Central Planning.

Another key goal of Central Planning is to strengthen the balance sheets of banks and households. And the broadest way to accomplish this is to boost the value of housing. This then adds collateral to banks holding mortgages and increases the equity of homeowners.

Some analysts have noted that housing construction and renovation has declined to a modest percentage of the gross domestic product (GDP). This perspective understates the importance of the family house as the largest asset for most households and housing’s critical role as collateral in the banking system.

The family home remains the core asset for all but the poorest and wealthiest Americans. Roughly two thirds of all households "own" a home, and primary residences comprised roughly 65% of household assets of the middle 60% of households – those between the bottom 20% and the top 20%, as measured by income. (The U.S. Census Bureau typically divides all households into five quintiles; i.e., 20% each.)

Since housing is the largest component of most households’ net worth, it is also the primary basis of their assessment of rising (or falling) wealth (i.e., the "wealth effect.") No wonder Central Planners are so anxious to reflate housing prices. With real incomes stagnant and stock ownership concentrated in the top 10%, there is no other lever for a broad-based wealth effect other than housing.

Extreme Measures

Given the preponderance of housing in bank assets, household wealth, and the perception of wealth, the key policies of Central Planning largely revolve around housing: keeping interest rates (and thus mortgage rates) low, flooding the banking sector with liquidity to ease lending, guaranteeing low-down-payment mortgages via FHA, and numerous other subsidies of homeownership.

At least three aspects of this broad-based support are historically unprecedented:

1) The purchase of $1.9 trillion of mortgage-backed securities (MBS) by the Federal Reserve.

The Fed purchased $1.1 trillion in mortgages in 2009-10 and it recently launched an open-ended program of buying $40+ billion in mortgages every month. Recent analysis by Ramsey Su found that Fed purchases have substantially exceeded the announced target sums; the Fed is on track to buy another $800 billion within the next year or so. This extraordinary program is, in effect, buying 100% of all newly-issued mortgages and a majority of refinancing mortgages.

Never before has the nation’s central bank directly bought almost 20% of all outstanding mortgages this raises the question: Why has the Fed intervened so aggressively in the mortgage market? There is no other plausible reason other than to take impaired mortgages off the books of insolvent lenders, freeing them to repair their balance sheets.

Regardless of the policy’s goal, the Fed now essentially controls a tremendous percentage of the mortgage market.

2) After the insolvency of the two agencies that backed many of the mortgages originated in the bubble years (Fannie Mae and Freddie Mac), the minor-league backer of mortgages (FHA) suddenly expanded to fill the void left by Fannie and Freddie.

Many of these mortgages require only 3% down in cash, just the sort of risky “no skin in the game” mortgages that melted down in 2008.

Given this mass issuance of low-collateral loans to marginal buyers, it is no surprise that the FHA will soon require a taxpayer bailout to cover its crushing losses from rising defaults.

In 2010, 97% (!!) of all mortgages were backed by government agencies, an unprecedented socialization of the mortgage market. (Source)

This raises two questions: Where would the mortgage and housing markets be if Central Planning hadn’t effectively socialized the entire mortgage market? What will happen to the market when Central Planning support is reduced?

3) Official measures of inflation are viewed by many with a healthy skepticism, but even this likely-understated rate has recently exceeded 2.5% annually.

In this context, it is unprecedented that one-year Treasury bonds have near-zero yields, effectively costing owners a 2%+ annual fee for the privilege of owning short-term Treasurys.

Even more astonishing, rates for conventional 15-year mortgages are comparable to official inflation (the Consumer Price Index, or "CPI"). Lenders are earning near-zero premiums on these mortgages. How sustainable is this imbalance of risk and return?

The enabler of these extremes is, once again, the Federal Reserve, which has purchased hundreds of billions of dollars in Treasury bonds and flooded the banking sector with zero-interest “free money.”

This formidable Central Planning support of housing has placed a bid (i.e., a floor) under housing, resulting in two bounces since the housing bubble popped in 2007-9.

The first heavily subsidized rise faltered. Will the latest pop also reverse? Or is the much-desired “housing bottom” in, from which prices will continue their ascent?

In the macro context, what housing bulls are counting on is the emergence of an “organic,” self-sustaining recovery in housing, based not on Central Planning subsidies but on private demand and non-agency mortgages.

Housing skeptics are looking for signs of what will happen when unprecedented support and intervention in the mortgage and housing markets is reduced or withdrawn.

The Foundation of Housing: Debt and Federal Subsidies

About two-thirds of all homeowners have mortgages. As I noted in The Rise and Fall of Phantom Housing Collateral, mortgage debt doubled from about $5 trillion in 1997, before the housing bubble, to $10.5 trillion in 2007, at the top of the bubble.

This reliance on debt informs the Central Planning policies of lowering interest rates and guaranteeing mortgages via Federal agencies such as the FHA. The only way debt can increase is if incomes rise or the costs and qualification standards of borrowing decline. Since income for 90% of households has been stagnant for decades, the only way debt can expand is by lowering interest rates and reducing the risk exposure of debt issuers via Federal guarantees.

These policies have been pushed to the maximum. As a result, the policy tool bag to further boost housing is now empty.

Now there is only one direction left for interest rates (up) and for housing subsidies and guarantees (down).

Another support of housing recovery is the restriction of homes on the market. Lenders are limiting the inventory of homes for sale by keeping many distressed/foreclosed homes in the off-market shadow inventory. This artificial restriction, coupled with low rates and government subsidies, has supported the modest recovery shown on this chart (courtesy of Lance Roberts) of total housing activity:

While housing has recovered to 2010 levels, what is not visible is the collapse in housing’s share of net worth displayed in this chart:

Housing equity as a percentage of total net worth declines when the stock market rises strongly while housing gains at a much lower rate (for example, during the Bull markets of 1952-1968 and 1982-2000) and rises as stock equity falls (for example, 1969-1981) while housing rose. In the 2001-2008 era, both equities and housing both climbed sharply, but since housing is the larger share of most households’ net assets, housing’s rise overshadowed the expansion of stock net worth, causing home equity to rise as a percentage of total net worth.

The collapse of the housing bubble and the stock market pushed home equity as a percentage of net worth to new lows. The subsequent doubling in the stock market has had little effect on the bottom 90% of households, as the top 10% of households own 85% to 90% of all stocks. (Source)

In broad brush, the wealth of middle class of homeowners has been influenced by four trends:

  1. The stagnation of real income
  2. A rapid rise in mortgage and other debt
  3. The use of debt to fund consumption
  4. The collapse of housing equity as the basis of debt-based consumption

In other words, Federal subsidies and Federal Reserve policies enabled a vast expansion of debt that masked the stagnation of income. Now that the housing bubble has burst, this substitution of housing-equity debt for income has ground to a halt.

This created a reverse wealth effect: The 70% between the bottom 20% and the top 10% have seen their net worth plummet while their debt load remains stubbornly elevated. 

Americans saw wealth plummet 40 percent from 2007 to 2010, Federal Reserve says. (Source)

This chart is nominal rather than real (adjusted), but the relative expansion of debt is clearly visible:

While charts like this lump all household debt and income together, this masks the reality that there is a clear divide between the top 10% and the bottom 90% in terms of income and debt. The debt load of the top 10% is considerably lighter than that of the bottom 90%, while income and wealth gains have flowed almost exclusively to the top 20%.

The top quintile accrued 89% of the total growth in wealth, while the bottom 80 percent accounted for 11%. (Source)

Unsustainable Pricing Will Introduce the "Poverty Effect"

If we put all this together, we get a picture of a middle class squeezed by historically high debt loads, stagnant incomes, and a net worth largely dependent on housing.

In response, Central Planners have pulled out all the stops to reflate housing as the only available means to spark a broad-based “wealth effect” that would support higher spending and an expansion of household debt.

This returns us to the key question: Are all these Central Planning interventions sustainable, or might they falter in 2013?  

Once markets become dependent on intervention and support to price risk and assets, they are intrinsically vulnerable to any reduction in that support.

Should these supports diminish or lose their effectiveness, it will be sink-or-swim for housing. Either organic demand rises without subsidies and lenders originate mortgages without agency guarantees, or the market could resume the fall in valuations Central Planning halted in 2009.

In Part II: The Forces That Will Reverse Housing's Recent Gains, we examine the statistical, historical, and demographic trends that suggest the market recovery is now dangerously vulnerable to a relapse, regardless of Central Planning intervention.

Should housing prices resume a protracted march downwards, as we've detailed here is quite possible, get ready for the "poverty effect" to drain the financial markets of their current euphoria. As the middle 60% of households begin losing a substantial percentage of their net worth, expect consumer spending to dry up and recessionary forces to return in force.  (Source: Part II)

Click here to read Part II of this report (free executive summary; enrollment required for full access).

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Carlos P's picture
Carlos P
Status: Member (Offline)
Joined: Jan 26 2009
Posts: 13
Housing equity? No such thing exists

I struggle to understand the concept of housing equity.

In fact the actual asset a familiy own is the land were the house is located, because the construction itself is a depreciable asset. By the time a family actually pays down the mortgage, the net value of the house is residual. The construction itself only retains value if improvement works are made.

What the central planner really want is to artificially inflate the value of the land (not the house itself).

If the capital gains the real estate developers and promoters get from speculating with land values were taxed at say, 90%, you would eliminate the single most important factor in the worldwide real estate bubble.

The second thing to do would be to stop interfering with the market interest rates, which is also one of the most important factors that allowed RE developers and banks to bid up prices. Financial theory dictates that the net present value of an asset depends on 2 variables: time and return (interest) rate. So, a lower rate means that to achieve the same return the asset price must rise.

Returning to a true gold standard, with currency denominated in a fixed weight (not a fixed price) of gold would then take care of the rest and put banks and the financial system in its rightfull place as a facilitador (instead of a destructive and bloodsucking force) of the real economy.

Sounds simple.

I wonder why they don´t get started.

Bankers Slave's picture
Bankers Slave
Status: Silver Member (Offline)
Joined: Jul 26 2012
Posts: 122
That may not be correct

as the property that we own sits on their land and that is why we pay property taxes. In reality I do not think we actually own anything except the equity of the property itself. But I could be wrong.

Wendy S. Delmater's picture
Wendy S. Delmater
Status: Diamond Member (Offline)
Joined: Dec 13 2009
Posts: 1398
folks would do well

Folks would do well to consider thier house (or apartment) as merely a place to live, and no longer as an investment. The housing and mortgage credit bubbles are popping like a those in a glass of champagne as this house of cards falls in slow motion, but fall it will. I say this with 25 years in the construction industry: we are horridly overbuilt in all the wrong places. We have too many McMansions that we cannot afford to heat and cool, too many offices for jobs that will not come back, and too many chain stores that catered to people used to living in a growing economy - stores that will become increasingly shuttered. Many of these pieces of real estate have underwater mortgages. It's unsustainable. From what I see on the news the situation is the same in Spain, Dubai, Latvia, Ireland... - not just the USA.

And as far as I can tell, rich people, nation-states (think China and African land)  and corporations are driving up the cost of farm land, too. If you can in any way find a small, easily maintainted house one a largish piece of arable and and can afford it without debt, and avoid forclosure robosigning title nightmares...good for you. You'll be better off  than the average man on the street. The average guy is either in debt up to his (or her) eyeballs and either will lose their overpriced home and move in with relatives, if they have helpful relatives available, or wil lbe talkng in those relatives. 

Remeber all thoise big old houses that were turned into rooming houses during the Great Depression? Some McMansions might end up like that.

Don't let the mainstream media tell you housing is still and investment. Investments in these difficult times seem to be made of practical things, like the ability and SKILL to get and make food, energy, water, and a decent life for yourself and your community.

ericcrodriguez's picture
Status: Member (Offline)
Joined: Feb 27 2013
Posts: 1
stop with the advertised ideas

Housing. ..reasons to boost
Deflation would increase incomes of new buyers and renters...not the goal for central planners...they aim to steel... keep system stable till next crisis they need this flow to remain somewhat sustaining
Most boosting prices it creates an artificial asset class that provides competition to capital flows much like bonds away from precious metals and other non inflated real tangibles ...when the music stops...people duped will be under control
Just seriously think and it will be clear

daddy warbucks's picture
daddy warbucks
Status: Member (Offline)
Joined: Feb 27 2013
Posts: 1
Now enter the EPA
"If we put all this together, we get a picture of a middle class squeezed by historically high debt loads, stagnant incomes, and a net worth largely dependent on housing."
Enter the EPA>
The EPA, along with destroying businesses, granting millions of tax dollars to the UNU-ISP (UN), is about to destroy home ownership.
I would love to be a 'fly on the wall' at the next Blackstone meeting after they get wind of this:
"Additional costs will be added to how new homes are built, whereas the sales of older homes can be stopped in their tracks until they meet stringent government codes."
"The new federal EPA, HUD and DOE home regulations filter down to local inspectors who are required by law to impose them or fail the home inspection. Unnecessary and unreasonable code can be imposed on homeowners who find they “can’t fight code.” There is virtually no appeal."
“…the Environmental Protection Agency will have power to force many homeowners to virtually rebuild their homes to meet stringent environmental requirements before they can sell them. Living in a house that does not meet the EPA’s “green” regulations for roofing, windows, doors, insulation or heating and cooling systems will be slapped with fines. Electrical companies are now installing “smart monitoring systems” to track usage of energy by residents.”
This is part of a much bigger plan, when thousands of people are forced to 'walk away', and that includes the hedge funds like Blackstone that have been buying thousands of single family homes, the federal government will 'have no choice' but to seize the properties (Agenda 21). IMHO

Homeowners vs. EPA Home Invasion

Posted: 11 Feb 2013 04:02 PM PST
By: Sharon Sebastian

Tall's picture
Status: Silver Member (Offline)
Joined: Feb 18 2010
Posts: 242
Don't worry too much Daddy

Consider the source of this information.

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