Showing posts with label Housing. Show all posts
Showing posts with label Housing. Show all posts

Friday, June 3, 2011

Anchoring, the Current Housing Crisis and Why US Economic Growth will be Anemic

In the previous post I discussed anchoring and how it affects our personal finance decisions. In this post I’ll look at how anchoring’s is exacerbating the current housing crisis.

Most commentators agree the housing bubble was caused by a combination of factors including speculative fever (prices will only go up), overleveraging (requiring 0% down and no asset verification in the worst cases) and fraud (both by mortgagees who lied about their income and assets and lenders who fraudulently enticed owners to take our first, second and third mortgages with misrepresented terms). Add to the mix that many homeowners drew down their equity in attempting to maintain a standard of living that their incomes could no longer support.

When supply (builders were creating new homes at accelerating rates) finally surpassed demand, housing prices stopped rising and started to decline. Like a tiny pinprick in a fully-inflated balloon, it doesn’t take much to let all the air out of an asset bubble. Once prices stabilized (or declined), banks realized the gig was up and tried desperately to strengthen their balance sheets. A financial game of musical chairs ensued and as always seems to be the case, the taxpayers were the ones without a seat and ponied up billions to save the investment banks, AIG, and eventually GM and Chrysler. [To be more accurate, future taxpayers were the victims as there was no increase in taxes to pay for the bailouts.]

That was then; this is now: Homeowners and banks are both falling victim to anchoring errors. Until these are corrected, the economy will have a difficult time making much forward progress. Homeowners with positive equity (market value less mortgage is positive) are still anchoring on what they paid for their home. When evaluating a job offer in a different area, they decide they cannot afford to sell because they have lost money on their house. They fail to recognize that the money has already been lost whether or not they sell. This makes it harder for geographical imbalances in the labor market to correct.

Similarly, banks holding underwater mortgages (the market value of the house is less than the remaining mortgage) are often unwilling to take a loss on their mortgage if the owner finds a buyer willing to buy their house for fair market value (called in today’s parlance a “short sale”]. They too have already lost on their investment, but prefer to defer full recognition of their loss. One reason is anchoring—in this case they have not fully written off the lost value of the mortgage they hold.

In every market downturn, anchoring on historic housing prices lengthens the duration of the imbalance between asking prices and selling prices. Sooner or later, the strength of market forces brings the prices together and market stability returns.

The strength and length of the housing bubble means that the adjustment process will be longer than usual. The number of foreclosures that have and will occur has generated another perverse reason for lengthening the turmoil: the company that services the mortgage only earns money while the mortgage exists AND they earn even more money when it goes through foreclosure proceedings. The mortgage itself may have several owners as part of the Collateralized Mortgage Obligation market. The mortgage servicing agents have little incentive to reflect the economic interests of the homeowner or mortgage owner over their own.

A short sale in which the mortgage owner writes down the value of the mortgage to the net sales price might be the best thing for both homeowner and mortgage holder, but it stops the cash flow for the mortgage servicer and is therefore rejected. Even when the mortgage servicing agent and owner are the same financial institution, the employees are from separate departments and their compensation structures are not aligned to overall corporate goals, but to departmental goals.

In the meantime these two anchoring forces have bumped heads and eventually underwater homeowners realize they have already lost all of their equity. They reset their anchor and understand anything they pay to the bank is throwing good money after bad. They stop paying on their mortgage, ultimately being evicted from their house through foreclosure. They also stop paying real estate taxes, and maybe insurance too; both costs provide no benefits to them. The mortgage servicer ends up with increased fees and the mortgage owner doesn’t get his money until the house is eventually sold, usually at a much lower price than market value. By the time a house is foreclosed, the owner is usually over a year in arrears.

I’m a big fan of the blog Calculated Risk. It has frequent posts on the housing market and my extrapolation of their charts and graphs implies that we are still at least three years out from foreclosures returning to “normal” levels. The results of these overhangs are that housing prices continue to slip, and because of the excess inventory (supply greater than demand) new construction is at record lows as a percentage of housing stock.

The good news is that current construction is near all-time lows for housing stock. Continued population growth (and eventual household formation) means that demand will grow to meet supply and the dearth of new construction will hasten that day.
However, construction is usually a key driver of new jobs in economic recoveries. Job growth has been anemic is this recovery, largely (but not entirely) because of the paucity of new construction. New construction employs not only builders, but those who supply building products, appliances, etc. The leveraging of one new job within our economy has the effect of creating four or five total jobs.

Economists may determine economic cycles based on increases and decreases in macroeconomic statistics such as GDP (gross domestic product) or perhaps the more indicative GDI (gross domestic income). Nominal GDP is higher now than it has ever been. Even real GDP (nominal GDP adjusted for inflation) is near or at an all-time high. So what’s the problem?

People (voters) based their understanding on microeconomic values. Can they buy as much as they used to? NO. Are they being paid higher wages for the same amount of work? NO. The population continues to grow and per capita GDP is still below all-time record levels. And remember, we humans anchor at the best of times…

But wait a minute: if that’s all true, why is it that I noted in my last post that at the end of April 2011 my net worth had almost returned to its all-time high? (Note: May and the first few days of June have not been as kind and perhaps April will turn into a new temporary anchor for me!)

Loosely speaking, stock markets have done well because corporate profits have soared. Bond markets have done well because the Fed has kept interest rates very, very low. These corporate profits have not been uniformly distributed across the economy—only those with substantial assets have benefited. Real wages continue to decline for most working Americans; corporate executives, for whom real wages are once again increasing, are the exception.

In the next post, I’ll talk about why this imbalance, unless corrected, will put a hobble on the economy.

~ Jim

Tuesday, October 12, 2010

More Thoughts on the Mortgage Crisis

The politicians are all hot and lathered about the latest bone-headed moves by banks that submitted faulty documents as part of their foreclosure process. I watched the debate between the Democratic and Republican candidates for Michigan governor Sunday night. The Democrat beat his breast about how we needed a moratorium on all foreclosures because of the banks’ misdeeds. The Republican suggested that since the rules the banks and their employees should follow do work, we should punish the rule-breakers, not suspend the process.

In the election hot air, many politicians are willing to ignore any and all economists in order to play to the crowd—even when the solution they propose (in this case a holiday from all foreclosures) will only worsen our overall economic situation.

With an exception here and there to prove the rule, the right houses are being foreclosed by the right banks because homeowners are not meeting their mortgage obligations. Do I condone the sloppiness of those who try to circumvent the legal process? No – see my comments on the subject. Those banks should stop their foreclosure processes until they have their paperwork in order. However, anything that artificially slows down the adjustment process hurts everyone. If politicians impose a moratorium, people will not ultimately keep houses they otherwise would lose. They will still lose them; it only delays the day of reckoning.

Furthermore, until the massive supply of foreclosures is cleared out of the system, we cannot regain market equilibrium. With the huge volume of overhanging foreclosures, who can say for sure what the market price of a home is? Certainly those people being foreclosed are not willing sellers, and banks who have already written off their losses tend to sell properties at a lower price than the rest of us. Why would housing prices increase (or even stabilize) until this overburden of foreclosed houses becomes a de minimus part of the overall market? It’s like asking people to pay full price when the store is proclaiming in big letters: CLEARANCE SALE COMING SOON. Only when we return to willing buyers and willing sellers can a fair market value be determined.

Many of those who will be foreclosed have lost their jobs. As long as they “own” a house—particularly one that costs them little to maintain because they have stopped making mortgage payments and investing in upkeep—they are less likely to move to another area to take a new job. This too inhibits the recovery process because the job market has an added inefficiency.

Whenever governments artificially prop up a market it involves a transfer of wealth to the benefactors from everyone else. Sometimes the cost is worth the benefit. Not this time. The best thing we can do for the housing market is to have it function with minimal governmental interference. We humans are very adaptable, but resistant to change. Putting off the inevitable delays healing. As sick as I feel for those who are losing their homes, they aren’t going to start to heal until they move on; nor will the market heal until it transcends the foreclosure tsunami.

~ Jim

Monday, August 23, 2010

Another Damper on Housing Prices

In case there weren’t enough reasons for housing prices to stay low for many years, I recently read about one more. On August 2, 2010, I discussed the law of supply and demand concerning housing. One area of supply I did not include is this:

In many areas of the country, the percentage of home sales to absentee buyers has increased dramatically. For example, the LA Times reports that in the Inland Empire area of California the rate has increased from 19% at the end of 2008 to 30%.

In that area, almost one-third of all home sales are to investors who are planning to flip the houses. The good news regarding the influx of professional investors into buying property at auction is that they are bidding prices higher, building a bit of a floor under current prices. The bad news is that these houses will be back on the market in the next year and a half or so. Thus July’s reported 10+ month inventory (which will go higher this month for sure) is understated in the sense that all of these flipping houses (if you’ll pardon the term) are deferred inventory.

As we look out over the next several years, flippers will continue to add inventory as they finish rehabbing foreclosed properties they acquired. More supply means lower prices—all things equal.

~ Jim

Monday, August 2, 2010

The Housing Bubble Continues

I suspect many areas of the country have not seen the lows in housing prices. As with other goods and services, in the long term housing prices are subject to the laws of supply and demand. Right now there is lots of supply and not much demand, which implies a future decrease in prices.

Available housing is still overabundant, with a 10+ month supply, and it will continue to worsen. In a few cities, like Detroit, there is an oversupply that will not be matched by demand because of migration from the area. In most places, the oversupply can eventually clear, either through price declines or increases in demand.

Let’s look at both sides of the supply/demand curve starting with the demand for housing:

Interest rates are at generational lows, which means mortgage costs are relatively low. That’s already priced into the current market, so unless interest rates decline further, this will not increase demand.

The US population continues to grow and form additional family units. Eventually this will require additional housing. However, many families have substantial elasticity on when a new household is formed. Children return to parental homes after college; roommates rent together for longer periods before taking separate residences. Parents go and live with their children. Over the long term, this will boost demand for housing, but the long term can, and I think will be, several years out.

The ill-conceived $8,000 tax credit for new homebuyers frontloaded demand. Any first-time home buyer who was close to being ready to buy a house had an $8,000 incentive to close the deal before the end of June. People who might have bought houses later in the year, or even in the first few months of next year, accelerated their plans to make an earlier purchase. The credit was ill-conceived because it did not change demand a whit; it only moved it forward and rewarded one lucky class of home buyers at the expense of future taxpayers (not at the expense of current taxpayers since no taxes were raised to pay for the largess).

Job growth is paltry, and wage growth for those employed is also low.

Turning now to the supply for housing:

Foreclosures continue and are starting to include those who negotiated revised terms with their banks.

The percentage of homeownership for the 75+ age cohort has increased since the housing bust. This suggests deferred listings. This group may be unwilling (at least for now) to sell their homes at prices they perceive as “too low.” Eventually, death, morbidity or decreased financial circumstances will force these sales. When that happens, more inventory will dump onto the market.

Not all current inventory is being counted in the supply figures, particularly in the condo market. This takes two forms. Rentals are replacing sales as developers hope to generate sufficient cash flow to hold off creditors until the market turns around, when they can again sell at a profit. I recently read reports indicating entire developments in some cities stand empty and unlisted. Furthermore, houses in the midst of repossession may be abandoned but have not yet reached formal listing.

While Congress recently extended unemployment benefits, that extension did not increase the time jobless benefits are paid. With the dismal job creation, more families are running out of those benefits as their unemployment has extended past the limit for payments. Many of these families will be forced to move.

Lastly, builders continue to construct new units. They are sitting on expensive land with mortgages that must be paid or they too will be foreclosed. Many of these builders are in survival mode and will build smaller houses with less expensive accoutrements in order to meet lower price points (and appear to be decreasing prices.) While they may hope to earn modest returns on these houses, their real economic drive is to reduce debt burdens by selling parcels. I suspect those with deep pockets can find some very attractive deals on raw land currently—which undercuts the market price much the same way distressed sales depress the prices for all completed homes.

As housing prices continue to tumble, Congress may consider a second round of support. I don’t think anything will pass, but the possibility will keep first-time buyers on the sidelines. Why buy now when prices continue to decline and it’s possible the government may throw money at you later?

A grim picture, indeed. This too shall pass. Eventually the continued weakness in the housing market will flush the remaining weak owners and builders from the system. Once that is done, housing prices will stabilize and start to rise. Just don’t hold your breath.