Housing means QE is here to stay

January 6, 2011

James Saft is a Reuters columnist. The opinions expressed are his own.

A very poor outlook for housing will hold the U.S. economy back in coming months, making it very unlikely that the Federal Reserve will be able to step back from their emergency room monetary measures.

A genuinely encouraging run of data and very strong asset markets has encouraged some to argue that the Fed’s policy will prove to have been too much for too long, but housing stands out as the one asset market that has failed to respond encouragingly to the adrenaline of quantitative easing.

The Fed acknowledged this in the minutes of their December monetary policy meeting, listing a litany of factors holding housing back and stating:

“The recovery remained subject to some downside risks, such as the possibility of a more extended period of weak activity and lower prices in the housing sector and potential financial and economic spillovers if the banking and sovereign debt problems in Europe were to worsen.”

While it is hard to see how the European difficulties will be resolved happily, it is virtually impossible to work out a road map for 2011 in which housing is anything other than a drag and a risk.

Put as simply as possible there is simply too much debt secured against U.S. residential real estate and the debt is being serviced by people with too little income to subsidize an asset worth less than the debt by choice.

S&P/Case-Shiller said at the end of December that its index of house prices fell for the third month running and is now in negative territory on a year’s view for the first time in nine months.

Those figures too predate a sizable rise in mortgage interest rates in the past several weeks. According to a survey by Bankrate.com, average rates for a 30-year fixed mortgage topped 5.0 percent at the end of 2010, up from about 4.25 in the spring and 4.40 percent as recently as November.

While the backup in mortgage rates is partly a function of economic optimism, it is also the fruit of a Fed policy designed to goose financial asset markets.

That’s made stocks more attractive and encouraged funds to flow out of bonds.

It is important to understand that housing was as weak as it was last year even with 40-year lows in mortgage rates because employment was weak, supply high, and a foreclosure pipeline that remains very strong.  These are all factors that have proved to be fairly unresponsive to policy, either monetary policy or programs to provide mortgage relief.


Foreclosed properties are not just bad for housing because they represent supply, but because banks sell them quickly, often at prices well below recent comparable sales. That sets a precedent for the market, making sales at higher prices more difficult. It is also terribly depressing for homeowners carrying more debt on their houses than they are currently worth.

It is this group, many of whom are employed and able to make payments, who really represent a threat to prices in the coming year.

“Borrowers with good pay histories who aresubstantially underwater have shown that they, too, have a reasonable probability of transitioning to default,” mortgage analysts at Amherst Securities, led by Laurie Goodman, wrote in a recent report.

“Yet many bond investors, and a number of housing analysts, are focusing solely on non-performing loans; they ignore re-performing loans and seriously underwater borrowers. The market is underestimating the housing problem and potential losses to bondholders if further policy actions are not taken,” they said.

Amherst analyzed the non-conforming mortgage market, large or risky loans not made by Fannie Mae or Freddie Mac, and concluded that there is a large group of loans that now look good that may well turn sour.

One particular group is loans that had been non-performing but that have “cured,” returned to making payments. This accounts for about 15 percent of the non-conforming market, but the odds for these people are not good. After two years more than half will have re-defaulted, according to the study.

A potentially larger group is those who’ve always paid on time but who are servicing a mortgage that is bigger than their house is.

Looking at clean borrowers from a year ago whose mortgage was worth 120 percent of their house value, only about 77 percent remained current or paid the loan back in full.

Given declining home prices that argues for a continued gusher of foreclosures, foreclosures that will further weaken house prices and encourage yet more defaults.

Many of those defaults won’t be borne by the banking system, the risk having been transferred to the government, but they will suppress consumer sentiment and spending and probably mean that quantitative easing and very low rates will be with us for quite a while.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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I think the biggest economic mistake was the property market. The moment people considered their homes as merely assets and believed that property prices could only increase, then something came seriously amiss with the view of the housing market and the general economy.

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