Legislation to extend unemployment benefits to 99 weeks is now stalled in both Houses of Congress. This is an unfortunate manifesation of our reliance on government spending. Advocates of extending the benefits cite nearly 1 million people who have had their benefits end. This is likely to result in more foreclosures and defaults on other types of debt. Opponents of the extension cite the out of control national debt and the fact that we just can’t keep doing the same thing and that the days of ‘Business as Usual’ are over. Sadly, there are no easy answers here.
Andy Sutton's Extemporania
Weekly Commentaries and Occasional Observations
Archives: June 2010
No Surprise in Housing’s Dive
Wall Street doubled over in anguish today as the latest numbers on existing home sales hit the news wires. I must say that I am totally confused as to why the decline was any kind of surprise, however. The mainstream press dutifully expressed every emotion from grief to even outrage as the number was reported and analyzed.
Most people have quickly forgotten that the biggest reason there were so many sales to begin with was due to the fact that Congress had waded into yet another market and propped it up with cash on the barrelhead for anyone willing to take the leap. When they lured all the first time buyers they could, they took the next logical step and offered the cash to pretty much everyone else. Couple those actions with the Fed’s active (and now passive) buying of mortgage backed securities and it was bubble mania all over again. Until it wasn’t. That point came at the end of April, when the tax cuts were mercifully allowed to expire, saving our children and grandchildren untold billions.
At that point, I began to have serious doubts as to whether this beaten market could even avoid another crash. I studied the Mortgage Bankers Association reports each Wednesday and watched applications for new purchases fall off a cliff. My contacts in that particular industry said their phones have never been so quiet regarding new purchases. The refinance business kept them busy, but nobody seemed interested in buying a house after April 30. At that point, I wondered how bad May’s numbers would be. It was pretty obvious that the end of the tax credit had pulled at least most of May’s agreements back into April; and quite likely some of June’s as well. Where demand would settle after that was anyone’s guess.
One of the problems with the report on existing homes released today is that the report is based on actual closings. So any one who was hurrying to get locked in during March and perhaps even the early part of April would have had their closing count in May’s number provided it happened before the end of the month. May’s actual purchases for existing homes (or lack thereof) will not hit the statistics until at least June and perhaps July. So the 2.2% drop, while not a surprise, does not reflect base demand for existing housing ex-stimulus. Unfortunately, this was the spin being applied by at least some folks in the MSM. They posited that housing can indeed survive and even thrive without further stimulus and declared the tax credits a smashing success and a fine example of the benefits of government intervention.
However, stimulus in the housing arena has taken on three forms; one fairly transparent; the other two much less so. The transparent stimulus was the tax credits. Many are in fact clamoring for a reinstatement of the credits. Unfortunately, this is an election year, and right now it just isn’t cool to be a big spender – at least not openly. Congress will actually forego having a budget for FY2011. If there is no budget, I guess there can be no budget deficit. Are we really that far along in this charade? We could go a long way down that road without ever finishing this point, however. The second type of stimulus with regard to housing is the ultra-low interest rates that have been created by the Federal Reserve and it’s illicit (and often illegal) actions. These actions have kept 30-year mortgage rates under 5% and that alone has been enticing many people into taking the plunge. In truth, the total amount repaid on a $200,000 mortgage will be over $20,000 less if you can get a 4.8% rate as opposed to 5.25%. The bottom line is that low rates trump tax credits any day of the week. The third type of stimulus – and one that is setting an alarming trend is the number of mortgages being essentially underwritten by the US Government. This number has been hovering somewhere around 50% on average depending on the week.
What must be asked, however, is how much lower mortgage rates can reasonably be expected to go? At the same time rates have been near historic lows, it is more difficult than any time during the last 20 years to actually obtain financing. Many lenders, still ringing from 2007 and 2008’s losses are demanding better financial situations lending in many areas. It is not odd to hear lenders requesting 20% down, which was virtually unheard of just a few years ago. The rest have pretty much been following suit despite the fact that they were made whole by the US Taxpayer.
With so many economists and policymakers hanging their hats on the return of the housing bull to fuel the next economic binge, it would seem that today’s number was maybe a small jolt. If today was a jolt, tomorrow’s new home purchases report is likely to act as a thunderbolt. Contrary to the manner in which existing sales are reported, new home numbers are tabulated based on when a contract is actually signed. In other words, tomorrow morning’s report will give us the first glimpse at the post stimulus housing market. Economists are expecting quite a drop – roughly 20%.
One point that is often overlooked is the fact that there are now so many publicly traded homebuilders. They even have their own index. Inventories have been a problem since the middle of 2006, but never once has anyone seriously mentioned a cessation to building. Sure, permits fluctuate, but most experts will readily agree that the quickest resolution to this crisis would have been to put a moratorium on homebuilding for a few months and let them inventory get worked down. However, how many public company CEO’s would be able to hold their job if they took a quarter off? How would a homebuilder’s stock fare if they hung up the shovels for 3 or 6 months? Answer: it wouldn’t. This is why the housing problem won’t get better, and in fact will probably get worse. Prices will adjust until it simply ceases to be profitable to build a house. Once that happens, the building will stop and the market can start to address its inventory problem.
Contributing to that inventory problem are foreclosures, which are still running at all-time highs, tax sales, which are close to all-time highs in many locales, and the continued loss of quality jobs, which are driving people out of certain areas while not bringing anyone back in to replace them.
With so much of our economic prospects tied into housing, it will be very important to see how well this market stands on its own – if it can do so at all. Should the numbers start to falter, will the Congress race back in with more incentives? Are potential buyers expecting more tax credits? Will the Fed continue to keep rates in the cellar? My guess at this point is that, like so many other areas, it’ll go until it doesn’t. And then once again we’ll have to be reactive as opposed to proactive.
Life After Government Stimulus
There is perhaps no better example of the destructive nature of government intervention than the current housing and retail goods markets. For the past three years a spend-happy Congress lavished these areas with stimulus spending, tax credits, and other palliatives all aimed at papering over the structural defects in these markets. In the case of housing, the problem was years of easy money, sky-high prices, and zero-standards lending. In the case of retail goods, it was years of abuse of various types of credit to expand a spending bubble and increased reliance on foreign products. However, Congress has now buttoned up – in fear for their political existence in many cases. The public is aware and fearful of debt for the first time in recent memory. Living in a post-stimulus world; even if it is only until the next Congress is seated will be interesting to say the least.
The Housing Market’s Freefall
While the actual damage to the housing market in the near term cannot be totally assessed until later this month, there are some hints in the rate at which purchase applications for mortgages have plunged. The following data is compiled weekly and presented by the Mortgage Bankers Association:
During the past 4 weeks, purchase applications are down a whopping 35%. It is easy to see the spike at the end of April as the end of the tax credit lured May’s (and perhaps June’s too) sales back a month. The downward trend of new purchase applications has continued into June despite very low relative interest rates for home loans. These low rates boosted the Refinance portion of the index during May and remain low, the national average currently at 4.88% according to bankrate.com.
With an upcoming election, we will now likely get the first glimpse at the true state of the housing market. Granted there are still many programs in place at the Fannie/Freddie/FHA level that are encouraging purchases to varying degrees, but it is not likely that direct stimulus through tax credits will be used for at least the next few months. What is very disconcerting is that more than half of the purchasing blitz during March and April was done on the back of government mortgages. Much in the way the government nationalized the student loan business it is now similarly giving the heave ho to private lenders in the mortgage market. These actions virtually guarantee the perpetuation of the distortions currently seen in this critical area.
I had commented, perhaps cynically, to some friends back in 2005 that the housing bubble seemed to be little more than a giant property grab. With government now owning or guaranteeing the majority of mortgages (69 percent), it seems that very well could be the case. Unemployment is still high, decent paying jobs are difficult to come by, and people are still being laid off. Consumer debt burdens are causing the financial hardships endured by many to continue. Repossessions of houses just hit another all-time record high last month. When the government owns the mortgage and someone defaults, who gets the house? Some food for thought on a Friday afternoon.
Retail’s May Swoon
This morning’s retail sales report gave much more cause for concern than any of the recent month’s reports in this area. I’ve dissected these reports on several occasions for our paid subscribers to reveal the biases. Put simply the numbers are not what they seem and haven’t been for quite some time now. The biases, statistical and/or hedonic, tend to overstate retail sales.
Even those biases could not conceal last month’s drop. It is quite likely that the 1.2% decrease in sales was caused in no small part by the ‘Here we go again’ mindset when global stock markets began another round of liquidation. The media had been blaming a late Memorial Day for the potential downdraft in sales well in advance of the release of this morning’s report, which really makes no sense. The drop in sales speaks volumes about the delicate nature of consumer confidence. It is easily shaken these days, and it doesn’t take much. Granted the European (and spreading) debt crisis is a huge problem and will affect us eventually, however, that is not the impression the average person has thanks to the largely absentee media in this country. The crash of 2008, however, is still on people’s minds, and there is a general fear of a recurrence of those conditions. So when the markets act up, people slow spending and increase savings. It is one of the few things we’ve seen in recent memory that actually makes sense. Ironically, the University of Michigan’s consumer sentiment index is telling us that confidence is at the highest level since 2008. So much for our brief trip back to sanity.
The retail sector has not been without its share in the government stimulus binge of the past three years either. Most of the stimulus other than the checks sent out in early 2008 has been indirect, however, the benefits from foreclosure prevention tactics, strategic defaults, and hyper-extended unemployment benefits have perpetuated the spending bubble much in the same way the housing bubble has been prodded along. However, with more and more states such as Colorado and California having to borrow money to pay unemployment benefits and record repos of homes, it would seems likely as though the fuel for this leg of the spending bubble might be petering out somewhat.
Another weight on the consumer is the comparatively higher interest rates on credit cards. According to creditcards.com, the national average for credit cards in May 2010 was 14.31%, up from 12.75% just 6 months ago. So even as banks have been able to borrow from the Fed for essentially nothing, they’ve repaid the consumer for the hefty bailouts by jacking interest rates. Of course the selling line here is that so many consumer loans are in default. Small wonder. Maybe if the underwriting department hadn’t taken 5 years off this wouldn’t have happened.
In summary, the pressures on these two critical markets are increasing as the government’s ability to intervene is hampered by a broadening awareness of its own insolvent state. Granted, one or two months does not a trend make, but we need to be aware of the possible paradigm shift that is occurring – the end of the age of perpetual stimulus.
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