The Housing Bubble

A weekend topic starting with the Richmond Times Dispatch. “Hot, Hot, Hot, accurately describes the current state of the commercial real estate market. The ongoing strength in the sector can be attributed to cheap and available capital. The conduit market, which was written off for dead two years ago, is poised to complete 2017 with the second-highest annual volume since the financial meltdown in 2008 and pricing that is close to post-recession lows. The combination of falling spreads and less volatility has made conduit lending very profitable.”

“The irony is that fewer conduit players are active today than two years ago when the market was petering out. So, while volume and profits are soaring, fewer market players are sitting at the table. Admittedly, those at the table are competing fiercely for deals. In addition to more conduit money fueling deals, more money is going into agency deals than in any prior year.”

“The production for Fannie Mae and Freddie Mac in 2017 is so strong that there is rumblings of huge cutbacks for 2018. The Federal Housing Finance Agency, which is charged with overseeing agency lending, has not made any announcements for 2018, but changes are expected. Jerome Powell, nominated this month by President Donald Trump to be the new chairman of the Federal Reserve, is an outspoken advocate of reforming the two government-sponsored enterprises.”

“Powel said in a speech earlier this year that more private capital needs to be in play and that the next few years may present ‘our last best chance to finish critical reforms’ and address systemic risk presented by the dominance of Fannie Mae and Freddie Mac in housing market finance. Not that the Fed chairman has a great deal of power over the Federal Housing Finance Agency, but the agencies are on pace to provide close to 50 percent of all multifamily mortgages this year, according to industry estimates, which far surpasses their lofty goals of providing 40 percent of the multifamily mortgages.”

From Vanity Fair. “The Republican tax bill that passed the House provides plenty to be worried about. Take, for instance, the proposed elimination of the deductibility of state and local taxes. That is obviously a cynical, politically motivated ploy on Donald Trump’s part to penalize voters who didn’t vote for him (for good reason) in high-tax blue states, such as New York and California, and to give a benefit to the red-state voters who did vote for him. (I get it, elections have consequences.)”

“Worse, a Wall Street executive says, it could lead to another housing crisis, just as the last one is (or should be) still fresh in our collective memories. Here’s his thinking (which is hard to refute): Since, generally speaking, one of the largest state taxes is on property—your home—eliminating the federal tax deduction for state property taxes will inevitably cause the cost of homeownership in states with high property taxes to go up. It follows, logically, that if the annual cost of home ownership goes up, then the value of the home—which is for most people their single most-valuable asset—must go down.”

“The National Association of Realtors commissioned a recent study that predicted that the elimination of the deduction for state and local taxes could result in a decrease in home valuations of between 10 percent and 17 percent. Lower home values could also lead to problems—again—for the government-sponsored entities Fannie Mae and Freddie Mac that have guaranteed some home mortgages, which are secured by homes worth materially less.”

From A Duopsony Built Around Rent-Seeking by Edward J. Pinto and Norbert Michel. “A recent Senate Banking Committee hearing explored ‘The Status of the Housing Finance System After Nine Years of Conservatorship.’ The title pretty much says it all — Congress has done nothing substantive on housing finance reform in almost a full decade.”

“Given the spectacular failure of Fannie Mae and Freddie Mac that led to the 2008 financial crisis, the fact that these Government-Sponsored Enterprises (GSEs) remain in government conservatorship might seem surprising. After all, during the crisis, Fannie Mae and Freddie Mac transformed from political untouchables in housing finance to pariahs.”

“Rather than seize that moment to shut down the GSEs to protect taxpayers and housing finance markets, Congress succumbed to an onslaught of special interests lobbying and fear-mongering aimed at protecting the GSEs’ duopsony — a market condition where there are only two large buyers for a specific product or service.”

“In virtually the blink of an eye, groups such as the Mortgage Bankers Association and the National Association of Home Builders convinced members of Congress that the housing finance market couldn’t function without some form of government backing. The worst propaganda was that only government guarantees could prevent interest rates from skyrocketing, home values from plummeting, and long-term fixed-rate mortgages from disappearing.”

“Now that the Trump administration has indicated it wants to reinvigorate the private housing finance system, it is facing the same resistance Congress did in 2008. The Housing Lobby argues for either a continuation of the status quo with the addition of an explicit government guarantee or some close hybrid. Supporters also incorporate an ‘affordable housing cookie jar’ in an effort to get buy-in from progressive lawmakers and lobby groups.”

“But these groups ignore the three major problems with our nationalized housing finance system. Americans have more debt than ever. After 50+ years of ‘affordability’ policies, homes are more expensive than ever, and notwithstanding trillions of dollars in subsidies, the current 63.9% homeownership rate is statistically no different than the average rate of 64.3% since 1964 (excludes bubble years).”

“Homeowners and taxpayers have little to show for the federal government’s largesse, except for mountains of mortgage debt and GSE bailout IOUs. An even bigger problem with defending the status quo is that the GSEs are not currently helping Americans of modest means buy homes. Data from 2016 clearly show that the bulk of the GSE business focuses elsewhere.”

“The nearby chart shows that while the GSEs accounted for two-thirds of government agency business in 2016, only 7% of total agency activity (comprising 11% of total GSE activity) served buyers of more modest homes with moderate downpayments. The rest went to cash out and no cash out refinancings (56% of total GSE activity), second homes and investor properties (6% of total GSE activity), purchase loans with downpayments of 15% or more (20% of total GSE activity), and higher priced homes with downpayments of less than (7% of total GSE activity).”

“The housing lobby cannot hide from these figures. The bulk of GSE activity simply is not doing anything to help make moderately-priced homes more affordable.”