Opinion

The Great Debate

Housing double-dip threatens banks

By J Saft
September 2, 2010

Another dip in U.S. housing looks likely, bringing with it difficulties for banks and for their government guarantors.

What is perhaps worse: having chucked money at supporting asset markets in order to support banks the past two years, the policy options for handling another housing downturn and banking crisis would be greatly circumscribed.

If you think the debate about more fiscal stimulus is heated, wait until you see the venom which the prospect of another housing and banking bailout brings.

Despite absolutely massive official support, via the FHA, Fannie Mae, Freddie Mac, a now expired housing credit and other initiatives, air now appears to be leaking out of the housing market faster than it is being pumped in.

The recent run of data in the aftermath of the expiration of the housing credit has been terrible. Existing home sales fell 27 percent in July to an annual rate of 3.83 million, the lowest figure in the 11-year history of the data, leaving inventories above a year’s worth of sales even before you account for the shadow inventory of foreclosures and would-be short sales. Nearly 15 percent of all loans are past-due or in foreclosure and 23 percent of properties encumbered by a loan are in negative equity, meaning they have very good reason to default if they haven’t already. Another 5 percent of mortgaged homes have 5 percent equity or less.

Combine all this with a clearly weakening U.S. employment  scene and you have the potential for further substantial falls in the value of housing, which, last time I checked, is bad news for the loans that are the backbone of the financial system.

Meanwhile household formation, a key determinant of house prices over the medium term, is going in the wrong direction. When jobs are tough to find and house prices aren’t rising many people decide it is better to move back home with mom and dad.

To be sure, house prices are very sticky and it is hard to forecast where they will bottom. People hate selling at a loss, even if they can afford to write a check to their bank to be rid of a property, and so bad fundamentals may be slow to translate into steep price drops. As well, very low interest rates will give some the means, if not the motivation, to keep paying on underwater properties.

LOAN LOSSES AND MAGICAL THINKING

So, how well are banks prepared for a double-dip in U.S. housing?

A recent report from the Federal Deposit Insurance Corporation on profitability at insured institutions starts off promisingly enough, leading on the fact that profits were $21.6 billion in the second quarter, a $26 billion jump from the $4.4 billion net loss of the year before and the strongest showing by the industry since 2007.

Things in the release went rapidly downhill from that cheery start and my heart sank when I read that:

“The primary factor contributing to the year-over-year improvement in quarterly earnings was a reduction in provisions for loan losses. While quarterly provisions remained high, at $40.3 billion, they were $27.1 billion (40.2 percent) lower than a year earlier.”

Banks’ ratio of reserves to total loans and leases actually fell in the quarter, an outcome which would be fine if we were not possibly heading into another recession.

I realize that the performance of corporate loan books has been strong but commercial property is still a problem area. The fact is, with changes in accounting rules giving banks more leeway on how they classify assets, there is very little transparency in what those profits mean and if those provisions for losses are appropriate.

Even after a strong rally on Tuesday the KBW index of bank shares is down more than 10 percent in the past month, indicating that someone is drawing a connection between a deteriorating economy and banking profits.

So, we have a housing market which is well set up for a fall and a banking industry which may or may not be generating the kinds of real profits it needs to put it on a firm capital footing again. Nothing has to happen, and there are reasons why a muddle through may be the most likely outcome. The largest banks still benefit from an assumed government guarantee and may, even if housing relapses, simply take longer to reach health.

Here is the real risk: if banks do require another rescue the political consensus to do it quickly and effectively will not be there. The United States has squandered its opportunity to address the fundamental problems, choosing to extend and pretend and to prop up asset values.

It will be interesting to see what Plan B is.

Comments
7 comments so far | RSS Comments RSS

14% of all mortgages are either delinquent or in foreclosures

Posted by STORYBURNthere | Report as abusive
 

Sure a lot of mortgages are delinquent, and it will probably get worse. But there is a limit. When credit is scarce there may be reason to continue paying on an underwater property if you can’t get another mortgage and if the interest rate is low enough to make it cheaper than, or at least competitive with, renting.

Unless rents are also falling (and I don’t think they are) keeping your current mortgage may be the cheapest housing available, whatever the actual value of the house.

I would expect high end properties to fall in price more than lower end ones. None of this is guaranteed to save the banks.

Posted by Dafydd | Report as abusive
 

They will feed the pigs again. The 700 billion revolving TARP fund is still in existence. “Belly up to the trough, gentlemen, have a few more rum and cocaines on me.”…- Uncle Sam

Posted by cranston | Report as abusive
 

Mr. Saft, your articles are always edifying, and this one is no exception. I would only disagree with your conclusion, though. If there is one thing that Republicans and Democrats in Congress can absolutely agree upon, it is bailing out banks. Rest assured there will be plenty more to come. Sufficient numbers of Republicans will rant, rave, and rail to be able to gain additional political capital, but the party will fall in line, and the banks will get their trillions out of our hides.

Posted by JackMack | Report as abusive
 

Housing crisis? We have yet to see even a bit of a crisis. Jobs lost, upside-down home values, credit card debt, student load debt,sinking credit scores, and we produce very little of what we consume. The definition of the “American Dream” needs a drastic make-over. Buying homes makes little sense (unless you have liquid assets or are credit worthy), people are going in debt to pay for an education that will not pay them back, and to top it off retirement is a big question mark given our “leaders” handling of SS. The times have changed and we are still trying live like it is 1980. Lifeboat anyone?

Posted by GMartin73 | Report as abusive
 

“Nearly 15 percent of all loans are past-due or in foreclosure”. And the sad fact is that most banks still have not shown these loans as being losses on their books. As long as these loans are in the process of “renegotiation” or “pending litigation” then the bank does not have to take the hit on their books. That is why so many people I know are still living in their houses two years after they stopped making the monthly payments. It is easy to show a profit when you don’t have to declare your losses.

Posted by DaBear | Report as abusive
 

It’s actually worse…those that were enticed into the housing market by gov’t programs will feel just the latest ponz of the banking industry.

They’ll say you made rates low, you subsidized downpayments, you said “buy” I bought. Now foreclosures on my street are up and my downpayment is gone. I’m underwater and you say you can no longer help.

What’s the equivalent of the 1930′s farmer’s pitchfork? Anyone?

Posted by jeffersjr | Report as abusive
 

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