Submitted by Mark Hanson via MHanson.com,
In order to achieve the greatest risk/reward asymmetryfrom the 2014 single-family housing stimulus “hangover”, or “reset”,happening right nowyoumust change the wayyouthink about this asset class. When doing so, clarityemerges (at least to me).
Things come into mind, such as;
When other asset classes go through periods of excessive price appreciation or returns, most reasonablepeopleworry that a “consolidation” or “correction” could happen at any time. In large part, this fearcan keepan asset pricehigher for longer than anybody ever thought possible. However, with respect to housing, when prices are moving higher, not a single soul will ever forecast a “consolidation” or “contraction”, rather periods of “less appreciation”.
Or, when”greater fool” trades consistingof highly populatedcohorts blowupthere are serious consequences like we saw when housing crashed in 2008-09. But, at least, because the demand base is so wide you have ‘some’ heads tohit the bidall the way down.However, whengreater fooltrade cohortsare razor thin like in “Housing Bubble 2.0″– local area private investors and a hand-full of giant PE firms –extreme volatility is almost certain.
In this short note,I outline where my research isgoing at the first of the year supporting ideas aboutwhy a “strong economy” is negative for this housing market;houses are far “more expensive” today then from 2003-2007 (i.e., “affordability” much worse); and how everybody has been “fooled by stimulus” and unprecedented monetary policy, yetagain.
This report — which I am in the process of turning into a ppt presentation — establishes what US housing has really become over the past 12-years andin my opinion makes itfar easiertotime its unprecedented volatility and forecast the outcomes that since 2002 havefooled most of the people most of the time.
This housing market is “resetting” right now;for the third time in six years.It might look and feel a little different, but as I detail in this note, it’s not really different this time around.
1) Overview, Housing Bubble 1.0 vs. Bubble 2.0; Same flicker, different actors
We can all agree that extraordinary monetary policy and excessive speculation can cause price distortions and potential bubbles in almost any asset class. I thinkwe can also agree that in 2006 housing was in a legitimate “bubble”.I contend thatthis housing marketis in a bubble, right here and now.
Mosthave completely forgotten — or are too young to remember — what the 2003 to 2007housing and finance era was all about. It’sso wild to me, for instance, whenI constantly hear economists or the media rattle off “affordability” comparisons between then and now; with such confidence that houses havenot been as affordable as they are todayin decades. Ofcourse, invariably, they assume everybody always used 30-year fixed rate loans when on the contrary, from 2003 to 2007, thesewere the “minority” of originations. Not acknowledging, or normalizing “affordability” to account for this, radicallychanges everything.
At the superficiallevel, the misguided belief about today’s superior “affordability”makes sensebecauseduring Bubble 1.0– when the economy and labor markets were doing great –’rates were higher’ than today. Hey, just look at a chart of Fannie Mae rates or 10-year UST, right? Yes, theyare right, technically; “rates were higher” then, than now.And house prices went through the roof. That’sthe correlation everybody is sticking too…strong economy + higher rates = higher house prices. But, this would be incorrect.
Inreality,on Main Street –totens of millions of homeowners– from 2003 to 07 mortgages were much cheaperon a monthly payment basisthan ever before in history and ever havebeen since. This statement is true, even when factoring in the much higher nominal house prices back then, and therecent Fed-induced sub-3.5% that lasted from 2011 through May 2013.Thiswas because the incremental– in fact, the “primary” in many regions around the nation — buyer, refinancer, and HELOC userused “other than” 30-year fixed rate money.
In contrast to the revisionist history being peddled today,the 2003-2007 era wasall about introducing extreme leverage-in-finance — incrementally increasing each year — through exotic lending. This made itsopeoplecould keep buying more expensive houses and refinancing at higher loan amounts on income that didn’t supportit.
The advent and increasingly exotic nature of mortgage loans from 2003 to 2007 enabled the greatest “greater fool” trade of all time.Despite “rates being higher” from 2003 to 2007,everybody always earned the amount necessary to qualify for a loan; it turned virtually every homeowner in America into a Real Estate speculator driving the market with reckless abandon.Then, in2008, when all the high-leverage loans went away at the same time, housing “reset” to what the fundamental, “organic” demand cohort could really “afford”using 30-year fixed rate, fully-amortizing financing andwhen made to prove their income and assets.
Today, thoselooking at 2006 house pricesas a benchmark for where house prices are headed — or assuming house prices are ‘safe’ or not back in a ‘bubble’ because they haven’t regained those prices –are looking at the wrong thing. That’s because house pricesnever can get back there unless employment surges and incomes rise double-digit percentage points with arespectable number in front. Or, unless all the exotic, high-leverage, no documentation loans come back.
In other words, for house prices to get back where theyonce were,something has to be introduced that brings back the leverage-in-finance lostwhen exotic loans went away and everybody suddenly went from earning $20k a month to their real incomes when qualify for a mortgage loan.
Certainly, if we are staring a multi-year economic recovery in the face that brings higherrates, the accompanyingjob and income growth over the next several years won’t hold a candle to the historical “affordability” from 2003 to 2007 using a “Pay Option ARM” or “stated income” loan.
2) 2003-2007 vs 2011-2013…a stark comparison
There is little differencebetween between 2003 – 2007, when housing went through “Ma and Pa America speculation-fever”and 2011 – 2013, when private and institutional “investors” caught speculation-fever. Of course, other thanthe actors being different; the primary monetary policy recipient and speculator cohort changed fromMa and Pa shelter speculator toDick& Son’sProperty Flippers and Blackstone.
This is obvious through a dozen different datasets, and especially in thesales volume divergence between”new” and “resale” houses. Even”resale”volume on an absolute basis highlights the lack of true “organic” demand when normalized for “distressed” and investors reselling flips and rentals, which can look like “organic” sales to most everybody when usingsurface level data.
The stimulus-induced housing marketpumps and subsequent “reset” periods 2003-2013:
a) Housing didn’t peak in 2006. Rather,they peaked with respect to “affordability”in 2002. That’s when the average house became “unaffordable” to the average household on a monthly payment basis using a 30-year fixed mortgage. To makes matters worse, rates surged in 2003
b) Viola’! Enter, high-leverage, exotic loans in 2003.Exotic loans removed the “fundamentals” and mortgage loan guidelines “governor” on house prices.
c) Using high-leverage, exotic loans from 2003-07Ma and Pa Americawere able to circumventthe fundamental laws of supply, demand, and affordability and became speculators.Suddenly, everybody in America got a substantial pay raise through the new found leverage-in-finance; they earned enough money permonth to buy whatever house they wanted using interest only, Pay Option ARMs, HELOC’s,or SISA’s and NINJA’s.
Bottom Line on 2003 – 07:”Bubble 1.0″ –the2003 to 2007 parabolic period –was mostlydue toexotic loan leverage-in-finance (easy credit) being introduced,which — because house prices follow the most readily available mortgage financing terms and guidelines –drove theincremental and primary buyer /refinancer speculator demand cohort, Ma and PAAmerica.In fact, in 2005-06 in CA 70% of all loans were “other than” 30-year fixed ratesloans.
d) Then in 2008 the housing market “reset” — when all the exotic, high-leverage loans went away at the same time — to fundamentals (what somebody could buy or qualify for using a 30-year fixed rate mortgage and guidelines looking atreal employment,income, assets, DTI, appraisal etc.)
e) Viola’! Enter, the 2009-10 “Homebuyer Tax-Credit, $8k nationally and $18k in CA.In 38 states the creditcould be monetized for the purposes of an FHA downpayment making it the first, best, and last chance hundreds of thousands of “first-time” buyers had to buy a house. In fact, first-time buyer volume has never been as high since. During the tax credit period there were”lines of buyers around the corner”, “multiple-offers”, and the Case-Shiller index went “vertical”. Everybody was convinced housing was in a “durable” recovery with “escape velocity”.Huge bets were made by well-known investors on’this’ recovery.
f) Then in 2010 the housing market “reset” — on the sunset of the Tax-Credit — to fundamentals (what somebody could buy or qualify for without the free downpayment, using a 30-year fixed rate mortgage and guidelines looking atreal employment,income, assets, DTI, appraisal etc.). Housing went into a technical “double-dip” in 2011.
g) Viola’! Enter, the summer of 2011 “Operation Twist” speculation that drove down mortgage rates and UST to historically low levels.Cheap cash starving for yieldon the back of years of ZIRP and on QE was mobilized. Just like Ma and Pa did in item b) and c) above, “all-cash” buyers, using flawed cap-rate models as a guide, removed the “fundamentals” and mortgage loan guidelines “governor” on house prices.
Bottom Line on 2011 – 13:”Bubble 2.0″ –the 2011 toMay 2013parabolic period –was mostlydueto easy and cheapcapital in search for yield turning private and institutional investors into theincremental buyer /speculator demand cohort. Like Ma and Pafrom 2003 to 2007(items b) and c)) above, theyhave been able to circumventthe fundamental laws of supply, demand, and affordability butthrough “all-cash”using flawed cap-rate models as a guide. The parallels are many. For example, in Bubble 1.0 hot spots, over half of all mortgage loans were “exotic” in nature.In Bubble 2.0 hot spots, over half of the buyers paid incash.
3) Housing responds well to “stimulus”; contracts when stimulus is removed. The next “Reset”
The point of itemsa -g above is clear; housing responds well to “stimulus” and “resets”when the stimulus dries up.
From 2011-13the “stimulus” was most utilized –not by end-users like from 2003 to 2007 and again from 2009-10 –but by ‘yield starved” investors. Which is exactly the “catalyst” for the next “reset”. That is,a movefrom “distressed”, which has ruled the market for years, back toan “organic”, or a “fundamental” based housing market– as the private and institutional investors leave –in which people use mortgage loans to buy will onceagain be “governed” by 30-year fixed rate mortgages, fundamentals,guidelines looking atreal employment,income, assets, DTI, appraisal etc.
And as in 2008, and again in 2010, when the “governor” is put back on, prices will”reset”. Right now, under house prices, there is an air-pocket equal to half the past 2 year gains.
4) My Favorite Datasets…Bubble 2.0 in Pictures
These following data show how “cheap” houses really werefrom 2003 to 2007 (affordability high) relative to today, for those using a mortgage loan to buy relative to today.
a) California Mega-Bubble 2.0
House pricesare down26% from peak 2006. Butit costs12% MORE on a monthly payment basis to buy today’s house. Say what!?!?
Or, put another way ifhouse prices were the same as 2006 today, usingtoday’s 4.625% 30 year fixed rate mortgageit would cost34% more per month to buy;one would have to earn 48% more to qualify. Astounding!
That’s because back then the primary buyer/refinancer/price pusher used “other than” fixed rate loans.In fact, in 2005 to 2007 over 60% of all mortgages were “other than” 30-year fixed-rate fully documented loans.
Masking the “unaffordability” of today’s housing market is “all-cash” buyers who are not “governed” by end-user fundamentals (what somebody could buy or qualify for using a 30-year fixed rate mortgage and guidelines looking atreal employment,income, assets, DTI, appraisal etc.)
Bottom line:as investors slow or shut down the buying and the market turns more “organic” — or normal — in nature, significant price pressure will present again.
b) The Smoking Gun
The red line in the chart represents the mortgage payment needed for the median priced CA house (black bar) from 2000 to 2013. This chart assumes that from 2003 to 2007 the primary purchase/refi/price pusher cohortused the popular loan programs of the time, “other than” 30-year fixed-rate fully-documented loans.
Bottom line: Houses firstbecame “unaffordable” in 2002. Then, exotic loans were introduced in 2003allowing people to keep buying more housewithout income following suit. When the exotic loans all went away at the same time in 2008 house prices “reset” to the real “affordability” using a 30-year fixed rate mortgages requiring proof of income and assets. The market ticked higher slightly in 2010 on the Homebuyer Tax-Credit then “double-dipped” as the stimulus was removed. Of course, the third major stimulus aimed at housing in the last 10 years came in Q4 2011, exactly when housing caught it’s most recent bid. The past two-year move was so fast and large that the subsequent “reset” should be ‘another’ one for the record books.
c) The Smoking Gun 2
Like the chart above, this shows the typical monthly payment for the median CA house from 2001 to 2013.
Bottom line: Houses have NEVER BEEN MORE EXPENSIVE” on a monthly payment basis than right now.