The Good News and the Bad News

The economy is picking up, but widespread home value recovery is still in the future.

Recent economic data is offering even more hope that a sustained recovery is underway. The U.S. gross domestic product grew at a 3.2% annual rate in the fourth quarter, according to January federal government reports. That's a healthy pace of growth which was fueled by a significant increase in consumer spending. The increased consumer spending is by itself a measure of improving consumer confidence, even though some of the recent consumer confidence surveys have not reflected significant improvements. If the economic growth continues it is likely to lead to new jobs which will in turn also help fuel a sustained recovery.

There has also been some recent good news for housing. Low mortgage interest rates and low prices sparked a 12% increase in December existing home sales according to research by the National Association of Realtors. While the number of homes sold is still low by historical standards, it represents a seventh consecutive month of improvement in home sales. Mortgage interest rates as low as 3% on 5 year ARMs with no closing costs were available at the end of January. According to RealtyTrac’s 2010 Year-End Metropolitan Foreclosure Market Report, the metro areas with the 10 highest foreclosure rates all saw foreclosure rates drop from 2009.

Congress’s retroactive extension of the private mortgage interest deduction for 2010 raises the hope that it will be extended into 2011 and beyond, helping home buyers who are unable or unwilling to make down payments of 20% or more. Despite the limited success of previous federal initiatives to reduce foreclosures, the Administration continues to try new approaches – the latest being an effort to create incentives for loan servicers to play a more constructive role in the process. All of these factors are positive as we prepare to enter the spring home real estate market.

Not all signs are positive in the housing sector, however. Many areas saw increased foreclosures (149 of the nation’s 206 metropolitan areas with a 200,000+ populations according to the 2010 RealtyTrac report) and/or saw double digit declines in home values. Expected deficit-driven federal, state, and local government spending cuts, while broadly supported and in everyone’s long run best interest, will certainly not add any short term stimulus to the recovery. And while President Obama did reiterate his support for continued infrastructure investment in his State of the Union address, he said nary a word about extending or redoubling efforts to help homeowners or reduce foreclosures. Lastly, major world economic and political challenges ranging from serious financial challenges besetting many European Union members to political rebellion in several Arab countries potentially threaten international stability and the health of every economic sector in every country.

Absent such international disasters the stars are now clearly aligned for a sustained long term recovery in the residential housing market, and we believe that it will start this spring if it’s not started already. A recent study by Trulia found that it is now cheaper to buy than rent a two bedroom home in 72% of the 50 largest U.S. cities they studied. Renting remains substantially less expensive only in New York, Seattle, Kansas City and San Francisco. At the same time the growing number of displaced former homeowners have had to move somewhere. Those that didn’t have families to help have moved to apartments, and the results have been predictable. Rents have started to increase significantly and apartment selling prices are increasing as a result.

There is nothing to indicate that the federal government will take any actions that are likely to significantly increase mortgage interest rates. In addition, there is very likely a significant amount of backlog housing demand from several sources. They include potential first time buyers who have been sitting on the sidelines in some cases for as long as three years, homeowners who have been waiting for a better market to put their homes on the market, and new future demand from the formerly unemployed who will be returning to the workforce.

At the same time, the attitude of consumers towards home ownership remains very positive, despite the heavy body blows taken by homeowners over the last three years. A January study “American Attitudes about Homeownership,” conducted by Harris Interactive for the National Association of Realtors® (NAR) showed that home ownership is still considered a smart financial decision. Among existing homeowners 77% believe that it will help them achieve their long-term financial goals. Among renters 72% believe that home ownership makes sense over the long term. About 2/3 of both groups also recognize that there are many non-financial benefits to owning a home as well.

“We believe that the convergence of all these factors is very likely to set the stage for recovery in the housing sector in most areas this year,” said American Homeowners Foundation President Bruce Hahn.

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Popping the Bubble

They all contributed to the problem.

Congress’s bipartisan Financial Crisis Inquiry Commission released its report on the causes of the U.S. financial crisis on January 26. To the surprise of few the 18 month study concluded that Wall Street, mortgage lenders, the Federal Reserve, Fannie Mae and Freddie Mac all contributed to the meltdown. The report was approved by Commission Chairman and former California State Treasurer Phil Angelides and five other Commission Democrats but the Republican minority members on the panel rejected it.

The report was extremely critical of federal regulators for incompetence, inconsistency, and abdication of responsibility. There was reportedly general agreement among all the Commission members in this area. The Federal Reserve failed to intercede and reign in risky mortgage lending practices that put mortgage lenders’ stockholders and the economy at great risk. Those practices also doomed many low income and financially naïve borrowers, who would not have been approved for mortgages if sound underwriting practices been applied. It was also slow to address the growing challenges created by risky derivatives contracts. The Commission also took issue with Federal Reserve Chairman Ben Bernanke’s conclusion that the Federal Reserve did not have the authority to bail out Lehman Brothers, whose collapse acerbated what was already an acute problem.

The report singled out Goldman Sachs for its role in creating the subprime mortgage bubble. It found that Goldman provided subprime mortgage lenders billions of dollars, then bundled the resulting mortgages into investments whose true risks were not disclosed to investors who bought them. Next Goldman created separate investment products that tracked the value of those mortgage investments and in many cases bet against the investments it had created.

The report also singled out Merrill Lynch for failing to provide investors current information about the burgeoning risk of its large subprime mortgage exposure and its threat to the company’s viability, despite its knowledge of the problems and the legal requirement that it do so. The problem lead to the insolvency of Merrill Lynch and severe challenges for Bank of America, which subsequently acquired the firm.

Fannie Mae and Freddie Mac were not spared criticism either, although Republican members of the Commission felt that they played a much more important role in the problem than Democratic members. Both Freddie and Fannie were heavily leveraged, and both also jumped into the subprime market even though they were more followers than leaders. As government sponsored enterprises (GSEs) they also were also required by Congressional mandates to set money aside to back loans for low income and risky borrowers. Indeed it is not clear that the GSE’s role in the subprime market would have been enough to cause the subprime meltdown if Goldman and others had not chosen to put their stockholders assets at such great risk.

Republican panel members criticized the report as being mostly a recount of a series of events which did not effectively tie causes and effects. In addition they also pointed out that practices outside of the U.S. also played a role in this global crisis, making the relative guilt of all the major players that much more difficult to quantify. The American Homeowners Grassroots Alliance believes that the cause and effect in many areas is pretty clear however. “If you lend your stockholder’s money to someone who can’t pay it back, it’s pretty clear that you’ve ignored your fiduciary duty to them,” said AHGA President Bruce Hahn. Mortgage lenders were quick to point that out to policymakers when it was not profitable to make such loans, but for a small minority of them that unfortunately included the nation’s biggest lenders the tune changed when big short term bonuses could be had by playing roulette with their stockholders’ assets.

One thing is clear. Housing finance reform is going to take years to achieve. The Financial Crisis Inquiry Commission’s report exposes both the partisan differences and the complexity of this issue. There presently doesn’t appear to be any clear path towards political consensus and no matter what stand a legislator takes on housing finance reform, it is likely to inflame some segment of the electorate. Congress already has several controversial high profile issues that it must deal with before the 2012 election (budgets, the recent two year extension of the Bush tax cuts to name but two). There are also other major issues that are already on the agenda, such as the reconsideration of last year’s healthcare legislation.

For these reasons it is difficult to envision major housing finance reform passing in the current Congress. However, this issue must eventually be addressed because in future times of crisis we won’t have a reliable source of mortgage credit without some kind of government backing. Mortgage lenders and Wall Streeters who don’t recognize this reality are being short sighted and are also suffering from short term memory loss. After all it was many of them who called on Fannie and Freddie to bail them out from a financial crisis that they created.

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