Tag Archives: housing

I’ve Got Some Theories About The Real Estate Tax Credit

I read this post from Jacob Roche about what has happened in housing since the tax credit expiry.  There are a couple of surprising aspects to what we’re seeing so far.  First, a look at prices (emphasis, mine)

What I found was that on both a raw and population-weighted basis, prices increased after the tax credit expired, by about 5% in both measures. Most interestingly, on a dollar basis, prices increased by a raw $9,766.77 and a population-weighted $5,280.89 — very close to the $8,000 credit. This is extremely counter intuitive. If the tax credit expiration effectively raises all home prices by $8,000, why would sellers raise their prices roughly another $8,000, and why would buyers agree to it? In some areas, like New York, DC, and San Francisco, prices increased by the tens of thousands. Also interesting is that some of the biggest price declines occurred in Texas, although removing Texas from the population-weighted data changes the average by only a small amount — the biggest percentage decliner in the list is in Texas, but it’s also the smallest city in the list.

via Real estate prices, post tax credit.

The post goes on to look at the sale data (again, emphasis is mine):

Number of sales gives the data another dimension however. Roughly three-fifths of the cities in the list saw fewer sales post tax credit, and the declines in sales were generally much steeper than any of the increases. It’s regrettable Trulia doesn’t give the exact numbers, making it difficult to estimate how much money is flowing in or out of the market, but one could at least make a rough guess that the price increases are being offset by fewer sales. Interestingly, a couple of the cities with declining prices saw increased sales.

Now I have some theories about this behavior, purely using intuition and my own read of buyer and seller psychology.  On prices, I think the sales price increase is a sign sellers know the market is not as liquid now as it was with the tax credit.  So as a result they’re looking to maximize the price paid.  I would’ve thought prices would’ve been higher under the tax credit because both buyers and sellers would treat the credit as “found money.”  What I mean by that is if you find money that you had no expectation of getting, you’re more likely to splurge – to spend on things you may not have thought of getting before, but since you have the cash you decide to get it anyway.  Apparently it didn’t quite work out that way.

As for sales volumes, that’s not a surprise.  We figured sales would be lower as the market becomes less liquid.  And Jacob’s point about money flow is a good one.  Because ultimately that’s what it’s all about.  So when pundits talk about Case-Shiller price increases, my first question is how many sales-pairs made up the estimation?  Fewer transactions at higher prices can still result in negative money flow.

Overall, I think the tax credit did more harm than good.  Prices offered and prices bid are moving further away from each other, thereby resulting in fewer housing transactions which are actually done.  The market is becoming more illiquid and the process will take that much longer to heal itself and for transactions to clear in a meaningful way.  Plus, how much money was spent on this and did it get us the outcome we wanted?

Don’t think so…

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Commented on “Distressed Volatility”

Who’s the bidder? I suspect homebuilders in anticipation of having several months worth of extra work. The tax credit expires in the next week and I think it’s a rush to buy resources. In short, I think it’s a “hope & pray” trade.

Also, the timing of the credit expiration needs to be considered. It comes right at the start of peak homebuilding and home purchasing season. It’s timed to give the maximum lift, hoping that people will *believe* housing is in fact, better.

Let’s just say I’m skeptical…

Originally posted as a comment
by professorpinch
on Distressed Volatility using DISQUS.

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Scott Simon, the Twilight Zone MBS Market, and Why He’s Wrong

I spent some time this past weekend reading Scott Simon’s Q&A piece on the mortgage market.  It’s worthwhile to read, because he runs PIMCO’s mortgage and asset-backed securities teams and their portfolios.  But after reading the piece, I have to admit I think he’s wrong a good bit more than he’s right.

On the Fed’s recently completed MBS purchases:

We are unlikely to see a significant market disruption in the Agency market stemming from the Fed’s retreat. First, the retreat had been well advertised for months before the event. Investors knew exactly when the program was going to end and how much the Fed was buying. So it’s not as if anybody woke up and was surprised by the fact that the Fed had stopped buying.

Second, private buyers are in a much better position today than they had been before the Fed started buying. The private balance sheet was seriously impaired by the financial crisis at the time the Fed stepped in with its public balance sheet. But by October 2009 or so, the private balance sheet had improved. The Fed probably could have stopped buying at that point with about $850 billion in completed purchases, but it felt compelled to reach the previously announced total of $1.25 trillion, and so the next $400 billion in MBS drove prices higher.

I don’t think he’s seen this chart:

Banks have been buying MBS alongside the Fed.  The Fed gave them air cover in a sense because as the Fed purchased those MBS, the marks on those assets improved.  Assets that were sitting on bank balance sheets.  So the private buyers he’s referring to are most likely banks who have been bidding in size with the Fed.

However…

That table is from the 4Q’09 Mortgage Metrics report.  So riddle me this, Batman: Why would you overpay for an asset when its fundamentals are deteriorating?  Either you’re stupid, or you’re looking to stop an asset valuation decline; to keep things suspended in mid-air until fundamentals can improve and asset values take off again.

But let’s continue. 

On Yields

As mentioned, the final $400 billion or so of Fed purchases were pricey, and some private investors, including PIMCO, sold a portion of their holdings to the Fed. Thus 2010 began with many money managers underweight mortgages.

So if and when we see mortgages cheapen, we expect to see private institutions stepping in to buy. Even a 15 basis point move could spark a flurry of buying. Therefore, we don’t expect a major widening of mortgage spreads, unless Fannie Mae and Freddie Mac sell some of their holdings, which would be something of a game-changer.

Because we expect investors will continue to buy on the dips, we don’t believe the Fed’s retreat will have a substantial impact on mortgage rates charged to homebuyers. Clearly, broader changes in interest rates will impact mortgage rates, but the end of the Fed’s buying program probably won’t have a significant effect.

Maybe he should look at that report.  Now… From the Q4 ’09 Mortgage Metrics report:

Overall, the percentage of current and performing mortgages fell for the seventh consecutive quarter to 86.4 percent at the end of 2009. The percentages of mortgages 30-59 days delinquent and 60-89 days delinquent were stable during the fourth quarter at 3.4 percent and 1.6 percent, respectively. However, the percentage of mortgages 90 or more days delinquent increased by more than 21 percent from the previous quarter to 4.7 percent, with more loans being held in a delinquent status for longer periods prior to entering the foreclosure process.

 Credit performance is getting worse.  Risks in mortgages should be exhibiting as higher rates because credit risk and liquidity risk premiums will increase.  Funny how that happens, isn’t it?  Where there’s good performance, there’s plenty of liquidity.  Bad perfomance?  No liquidity.  The Mortgage Bankers Association’s latest weekly survey showed a retrace from 5.31% last week to 5.17% this week, but that may be what we’re in for: heightened rate volatility, but directionally heading higher over the short to intermediate term.  The two week change in rates since the Fed ended its program is still an 11bp increase.

Investor Motivation

Money managers and other institutions have been sitting on the sidelines for quite a while, but cash yields are essentially zero, making it very tempting to move out the risk and duration spectrum. This is exactly what the Fed has meant to do with a fed funds rate near zero – make it so that investors can’t stand to be in cash any more. For banks, it makes the spread between cash and Agency mortgages look more attractive, and for investors, it makes risk-adjusted yields on Agencies look competitive.

This sounds like the Fed is brokering in a greater fool theory play.  Banks who bought mortgages alongside the Fed are supposed to be able to sell those holdings (if they want to sell them) to a massive pool of money managers and institutions with money to burn?  At prices higher than what they paid for them while the assets perform worse?  This is bizarro-world stuff.  Down is up, right is left, right is wrong, in is out and out is in.

Success of the Fed’s program

Again, the Fed stepped in when the private balance sheet was completely broken and mortgage spreads – and therefore rates for homeowners – were astronomically high. They fixed it by reversing those damaging trends. I argue the Fed essentially saved the market for medium- and lower-priced houses by halting home price declines. This likely has curbed foreclosures to a degree, although levels have remained elevated. So while not everything the Fed did was perfect, overall we believe the program was a major success.

Huh?  I don’t think the Fed’s actions did anything to stoke demand for housing, or at least nowhere nearly as much as the tax credits being given to first time homebuyers and others.  And seeing how some homeowners are behaving while small business lending pays the price (I’ll explain later), the extension of moral hazard into the Twilight Zone is not a good outcome from all of this. 

Where I Agree with Simon

Agency MBS look expensive vs. 10-year Treasuries but cheaper compared to two-year swaps. We never look at mortgage bonds in isolation, but compare prices against an array of other instruments, so I avoid being too specific about labeling them as cheap or expensive. However, I’ll go so far as to say Agency MBS peaked in richness in late December or early January and finished March still priced on the richer side of fair.

I’d agree, rates are at an extreme low at the front end of the curve, which begs the question of when rates start rising (and thus cheapening those 2 yr swaps), and the liquidity issues I think the MBS market will be in store for will make Treasuries look even cheaper.  So the flattening trade seems to be the one at least some credit folks are legging into.

We continue to believe that lower-priced homes bottomed last year. Higher-priced homes should bottom later this year. If one labels recovery as prices rising dramatically, we do not foresee that anytime soon.

That seems like a given at this point…

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FT Alphaville » A second (lien) helping of Hamp

This is a great follow-up to my post last night about Hamp. I must say I was unaware of the details behind the mechanics of these programs, which to me, are stunning. Like this:

Because the borrower is paying the Hamp-modified first lien amount, and the full second lien amount, the second lien effectively becomes senior to the first. In fact, second lien lenders might even be thought of as benefiting from the first lien mortgage since they have a better chance of getting more of their money back from the borrower.

via FT Alphaville » A second (lien) helping of Hamp.

Seconds senior to firsts? Stunning.

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Calculated Risk: Report: HAMP Second Lien Modification Program “On Hold”

To call this an asinine idea would be insulting to asinine ideas:

The Second Lien Program announced today will work in tandem with first lien modifications offered under the Home Affordable Modification Program to deliver a comprehensive affordability solution for struggling borrowers. Second mortgages can create significant challenges in helping borrowers avoid foreclosure, even when a first lien is modified.

via Calculated Risk: Report: HAMP Second Lien Modification Program “On Hold”.

Here’s why: the seconds are all toast. They go up in smoke before the firsts because seconds only collect after first mortgages get their piece of the payout/distressed sale first. As an example if you bought a $300K house with an 80/15/5 strategy (80% 1st lien, 15% second, 5% equity), the second lien was in jeopardy as soon as the losses on the home’s value exceeded 5%. So in most areas, where we’ve seen 20-30% losses in home values, the second mortgages – i.e. the piggyback loans – are dead in the water and the first liens are taking their dents.

So if the seconds were taking losses before the program was initiated, we don’t really need to try and throw money at them now. That’s just pointless. Almost all of them have a 100% loss rate. Up in smoke. Kaput. Done. Light a fire with a stack of $100 bills, it will get you to the same place.

And these people are being paid to solve our “housing crisis?”

Please.

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Another Take on Existing Home Sales

Well, there may be a little reason to celebrate the existing home sales numbers. They’re higher than last month. After all, as the NAR reported, existing home sales rose 7.4 percent from a 6.09 million seasonally adjusted annual rate (SAAR) in October to a 6.54 million SAAR in November. So I guess there’s something to be said for putting the water pistol to the figurative head of the $8,500 tax credit for new homebuyers. If you suspect an incentive is going to expire relatively soon, you’re more likely to use it. Maybe that’s the strategy the government will operate under: spurring demand by continuously threatening to end incentives. But that will only work for so long.

But one thing disturbs me about the release. In the data they provide about median sales data, they say distressed sales “continue to downwardly distort the median price.”

Really? We’re still complaining about the dog eating our homework? After 4 years from the peak? De Nile is a river and it’s flowing through NAR headquarters. Still.

While 33 percent of the sales were distressed sales, I think calling them a downward distortion is disingenuous. The fraction of distressed sales compared to overall sales is an indicator of market health. It’s neither good nor bad, just a data point to fill in the moasic of the market. It’s just as telling about buyers as it is sellers. If there wasn’t a perception that a lot of distressed inventory was out there (i.e. supply), you wouldn’t see demand for a lot of distressed transactions.

But there is. And there will be more. Unless the government decides to nationalize housing. Oops, too late, they’re trying to do that with HAMP, HARP and MHA on top of FHA and VA programs. I’d like to offer another: the Crumbling Real estate Asset Plan (CRAP). But still, the foreclosure moratoriums and the alphabet soup of programs out there tells you just how much is sitting out there.

Another way to look at the data – in total – is to combine it and look at it as a measure of housing stock activity. What I did was take the SAAR and multiply it by the median sales price to look at what I call Housing Churn; which measures the level of housing transaction activity on an annually adjusted basis. Think of it as the annual value of housing stock circulating through the economy. This chart should put things into perspective:

In terms of activity, that shows the dollars circulating in the economy related to existing homes, we surpassed the nearest high-water mark in June ’08 and are back to levels we last saw in September ’07.

And we remember that as being such a cheery time, don’t we? At least back then we didn’t have a couple trillion dollars of taxpayer money trying to prop up the market.

The bottom line is this: with foreclosure activty looking to increase, mortgage delinquencies spreading into other asset classes, and moratoriums that might be getting ready to end along with Fed liquidity and tax credits, the bubble gum and chicken wire holding back distressed supply will break and will swamp the market with more supply.

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Wordless Wednesday 12-16-09 pt. 2

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