With Stuart Varney on the Housing Market
I always seek to look below the headlines, assessing the underlying data in a more rigorous manner than you often see in the popular media and with a longer term perspective. Earlier this week I spoke with Stuart Varney on the Housing Market. The topic warrants a thorough discussion as it is such an impactful part of the US economy outside of its direct contribution to GDP.
Earlier this month we learned that the National Association of Homebuilders Housing Market index sagged to its lowest level in a year in May, declining to 45 from 46 in the prior 3 months vs expectations of a rise to 49. Existing home sales have increased a little since 2010, but are now falling dramatically, dropping 7.5% on a year-over-year basis in March. New housing starts also down by 5.9% in March on a year-over-year basis. According to Zillow, close to 1/5th of U.S. homeowners are underwater in their mortgages. Late last week we learned that sales of new U.S. single-family homes rose more than expected in April and the number of homes on the market hit a 3-1/2 year-high. Overall it’s been a mixed bag, but what exactly are we hoping to see and why?
Home ownership rates have fallen to where they were about 20 years ago at 64.8% in Q1. This is the lowest rate since Q2 1995. The rate peaked at 69.2% in June 2004. Such a decline sounds bad… or is it? Is a high level of home ownership really the Holy Grail for a society? Is more always better?
Our interpretation of the data indicates that the peak of home ownership is not something to which we ought to aspire. Not household should own the place in which they reside as the costs and risks cane easily outweigh the potential benefits. Home owners can’t easily move if they need to change jobs. We’ve seen the impact of this in the way the current labor market has been the most inflexible with respect to geography in history. They are unable to rapidly react to changing conditions in the economy that affect their household finances, not to mention the hassle of home ownership and all the costs that are unimaginable beforehand. As a home owner myself, I have seriously questioned the sanity of my purchase decision on many a Sunday spent nursing wounds, covered in Band-Aids post-umpteenth unsuccessful trip to Home Depot during one of my “I am so Bob Vila” weekends.
Why did home ownership rates increase so much pre-financial crisis, to levels that were clearly unsustainable and caused so much pain for so many? Was it just those evil, greedy bankers that somehow tricked people into buying homes? Well, that’s partially true, but is only part of the story and a misleading take on all that happened.
You can also thank the federal government for handing over another example of what I like to call, Lenore’s Law of Unintended Bureaucratic Consequences whereby that which a bureaucrat tries to help is ultimately harmed by the interference. Traditionally non-FHA mortgages required a minimum of 20% down, but in 1994 the Department of Housing and Urban Development (HUD) ordered Fannie Mae and Freddie Mac to supplement and eventually to far surpass the FHA’s efforts by directing 30% of their mortgages to low-income borrowers when previously the number had been much lower. This became pretty tough to do, so to meet that goal, Fannie Mae introduced 3% down mortgages in 1997.
In 2000 HUD increased the low income target to be 50% of all loans. Now think about that, what bank in their right mind would want to make 50% of their loans for the year to low income families with exceptionally low money down. That means 50% of your loans are in the riskiest category! To accomplish this Fannie launched a 10 year, 2 trillion dollar “American Dream Commitment” program to increase home ownership rates among those who previously had been unable to own homes. So when the government gets itself all focused on getting people into homes who previously couldn’t afford one, is it really all that shocking that home prices rose like crazy?
In 2002 Freddie joined with the “Catch the Dream” program to accomplish essentially the same thing. Then in 2005, HUD increased the target for low income loans again to 52%! Now here’s a bit of irony. The government wanted more people to own homes, so it makes it easier and easier to get a loan. Now we’ve got more people out in the market to buy homes. Son of gun prices go up. Well now isn’t that exciting! Buying a home looks like a really great investment because the prices are just going through the roof! But wait, rising home prices are great for only half the equation. They are great for the owner who looks to sell but not much fun for the person trying to buy. So in their attempt to increase home ownership by making it easier to buy a home, the government made homes even less affordable.
Oh but that’s OK as Fannie and Freddie are there to save the day and get you into that home that you really cannot afford with little to no money down and a variable rate mortgage that isn’t a ticking time bomb at all! All these subsidies increased the supply of mortgages to low income homeowners, but what was the source of the money to fund these loans? Welcome to the Mortgage Backed Security. Yes, those weapons of mass destruction. Banks would pool together mortgages that could then be sold as a MBS, and with HUD’s desire to get Fannie and Freddie to increase home ownership in the subprime areas, these two agencies were more than happy to back the MBS, which, because they are government sponsored entities, turned subprime loans with very little money down into AAA rated bonds! Serious fairy dust isn’t it? Now the banks were running around gobbling these things up like there’s no tomorrow. Why you ask? Well according to the Basel Accords, banks could seriously lower their reserve requirements by holding these GSE (Government Sponsored Entity) AAA rated bonds, which improved their profit margins.
So here we are supposed to all be fixated on getting us back to the essentially Fannie and Freddie heroin-like-induced excessively high levels of home ownership, when the household balance sheet is in no condition to go there. The personal savings rate is less than 4%, lower than it was in the 1930s and continuing to fall. It is at almost unprecedented low levels in the 81 years of data we have. Abysmal savings yet we want to induce people to buy homes?
The percentage of the population actually in the workforce is where it was over 30 years ago, so we have a lower percentage of the population working, but we want a higher percentage of the population buying a new home?
Oh but we’re told that households deleveraged, it’s all good. Well, if you look deeper into the data, households didn’t reduce debt other than mortgages and that reduction was mostly due to write-downs, meaning the bank got involved and things got a bit ugly for a while. Not exactly a healthy process for the economy.
What about those homebuyers?
- The first-time homebuyer in the US has been virtually non-existent. Housing bulls will assume that this means there is pent-up demand, which sound reasonable, unless the reasons behind this decline are deeper changes in the makeup of the demand for housing.
- New household formation is still exceptionally low, which is a key step in the process of buying a home.
- Young adults are living at home at higher rates, and polls show they are pretty comfortable living with Mom and Dad, unlike earlier generations that just couldn’t wait to get the out of there.
- There is a disturbing trend in homebuilders who are designing more and more homes with multiple entrances that make it more comfortable for multiple generations to live under the same roof. This is not a good sign if we want more people to own a home when we see a trend that increasing numbers of them are looking to share just one!
- Student loan debt is exploding while delinquency rates are also rising despite the story that the economy is improving. Want to know why? One reason may be we graduate more kids with degrees in psychology than in math, physics or engineering. The economy may be limping along, but maybe with all those newly minted psych majors maybe we won’t feel so bad about it?
- The MacArthur Foundation recently conducted a poll that found that renting is more appealing than buying a home by a 30% margin, consistent across all age brackets.
On May 29th, pending home sales look to be coming in lower, with soft foot traffic, rising prices and higher mortgage rates relative to last year are likely to continue to be headwinds to demand for new and existing homes sales.
Bottom Line: When investing it is critical to go into much greater detail than the headlines or lead story provide. At Meritas we go much deeper to understand the longer-term underlying trends and the critical factors that affect the headline topics. Housing has thankfully made a significant comeback in recent years, but we are skeptical that the improvements in 2013 will continue for the next few years without significant strengthening in the economy.