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2010 Year End Real Estate Observations
Ramsey Su December 2010
As the year draws to an end, it is time to revisit some of housing issues and examine what progress has been made.
The best quote of 2010:
"The real estate market is like a steamroller moving at 1 mph. You are standing in cement 100 yards away."
The Hidden Housing Subsidy
For the segment of the population who decided to, either voluntarily or involuntarily, stop making house payments, 2010 was a great year. HAMP and Robo-sign probably gave the average household a few extra months of free housing, on top of the free housing period that a normal foreclosure process provides.
This housing subsidy is expanding to include tenants. Lenders must serve 90 days notices to tenants of foreclosed properties. The tenant can still challenge the eviction in court, buying even more time. I see no reason why every foreclosure is not going to be occupied by a "tenant" in the future. In the mean time, lenders are offering very generous cash-for-keys programs.
I have not read any reports that quantify this subsidy. My estimate, via the proprietary cocktail napkin formula, is about $100 billion for 2010.
This subsidy is inversely correlated to foreclosures and subsequent evictions. The big servicers are ramping up foreclosures again, after fixing the robo-sign problems. As the number of completed foreclosures increases, the housing subsidy is automatically removed. I believe this subsidy provided significant support to the struggling economy in 2010. Withdrawing this support is going to be detrimental to society.
So far, displaced occupants seem to able to find alternative housing. No one knows what percentage moved in with relatives, doubled up with friends, staying at homeless shelters or simply became permanent renters. Enough time has elapsed since the real estate bubble popped. Compounded by long term unemployment, I believe there is a significant number of households that has exhausted all savings and alternatives. This may be one of the most challenging issues during 2011.
The Mortgage Subsidy
The rates are still low but stimulating effect is over. The market has adjusted and buyers are accustomed to these rates. More stimulus would require a lowering of the rate, probably down to the low 3% range to have any effect. Any rate reversal would put an end of the market, such as what we are experiencing, would put an end the market.
Bernanke spent almost $2 trillion initially to drive the long rates down.
The $600 billion QE2 has no effect to date and there is only a few months left. I am sure Bernanke would use the "it would have been much worse" argument and declare success. Reality is that there will be no QE3, not with Ron Paul now as watchdog of the Fed. Beside, Bernanke credibility is as negative as the equity of a house in Las Vegas.
Systemic Failure of the Secondary Market
Another year had gone by with absolutely no progress in FRE/FNM/FHA reform. Seems like no one wants to touch this hot potato. In order to keep the secondary market alive, the Treasury has to keep funding the losses and the Fed has no choice but to keep buying the junk. I believe neither the Democrats nor the Republicans appreciate the dire condition of the secondary market. I have not seen one single proposal that can stabilize FRE and FNM. The country, and the world, have no stomach for any more bail outs. I believe a collapse is imminent. It may happen the next time FRE and FNM ask for the handout and reveal the cost of robo-sign.
Where is that pent up demand?
Nationwide, the average cost of a home is comfortably below $200,000. Using a FHA loan, $10,000 can easily move a renter into a home and have money left over for some freshening up. Monthly mortgage payment is just over $1,000, lower than rent in many areas. This is an opportunity of a lifetime. Everyone who can buy are buying, or have already bought. The problem is there are not many in a position to buy, not enough to offset the excess inventory.
It is not a fluke that existing home sales is 25% below that of last year and prices are not going up.
What is the true demand? There is no shortage of experts who would tell you that if you average this over that, spread it over xx years, and, therefore, we have a housing shortage. Just use common sense. How many units do we need in 2011, 2012, 2013 ....? Bob Toll and Ara Hovnanian are two CEOs who regularly used the word demographics as definition for higher housing demand. They claimed baby boomers are going to retire and buy second homes, may be third homes. Population will keep growing and demand more housing. Now that the boomers are at the retirement age, reality is that they do not even have money to retire, no to mention that winter home in Florida, which is currently dirt cheap.
The country is going through structural changes in population growth and employment. The changing demographics actually reduce the demand for housing. Sooner or later, we must face the fact that the US economy does not need the current labor force. Furthermore, our labor force is not competitive against the rest of the world in terms of skills and cost. The nation has to decide whether to provide aid indefinitely or to pull the rug out from the unemployed. Regardless, the excess labor force is not going to be home buyers.
If we do not build a single house for the next three years, there will still be plenty of shelter for everyone. Every house constructed is just one added to the excess inventory, further delaying recovery.
Unintended Consequences of Low Mortgage Rate
Bernanke on 60 minutes recently openly admitted that he did not see the subprime crisis coming. If he cannot see the obvious, there is no chance that he would understanding some of the consequences of his actions. During the mid 2000s, almost the entire mortgage universe had been refinanced. This included many baby boomers who were at the last half of the 30 yr mortgage they took out when they purchased their home. The refinance bubble that resulted from the irresponsible actions of Greenspan reset the 30 year mortgage clock. All borrowers looked at was how the refinance lowered their house payment by $xxxx per month, without giving a second thought to the fact that they have also extended the term to a new 30 yr.
Another round of refinancing occurred when Bernanke pushed the rates down to the 4% range. The only borrowers left who have not refinanced are those with no equity and/or are facing foreclosure.
Boomers who are reaching the traditional retirement age find themselves strapped with 25+ years left on their mortgage. Instead of preparing for the mortgage burning party that their parents had when that generation retired, they are wondering how they can make house payments on a lower income upon retirement.
Since this is just the first year of the boomers reaching 65, this is going to be a negative drag on housing for years to come.
Conclusion
2010 was the year of the World Cup of Can Kicking. Greece, Ireland, UK, ECB and of course the US all kicked the can down the road. Unfortunately, the can is heavy and the kickers exhausted. Some type of catastrophic collapse is imminent. These are not predictions, these are facts. We know foreclosures are coming. We know rates have stopped going down. We know the Feds have no announced plans to support or drive mortgage rates down. Unknown is how extreme bailouts may be.
That said, I actually believe it would be positive if there are a few major mishaps. If Greece, or Ireland default on their bonds, it will free them of the ball and chain that hinders recovery. If the US real estate market collapses, may be there will be true fre/fnm reform, may be the builders would be forced to stop building and may be we can be on our way to true sustainable recovery under the new norm, and may be, just may be, Bernanke will resign.
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