< meta name="DC.Date.Valid.End" content="20050825"> Amendment Nine: Housing Market: Lenders and Buyers

Sunday, August 07, 2005

Housing Market: Lenders and Buyers

Later in the week, we'll focus on the Al-Qaeda topic I posted below. For now though, let's keep going on the economy track. A lot of the conversation ended up over email instead of the comments section, but thats alright with me. Bankers keeping their cards close should tell us all something.

One section of the economy is always of keen importance, especially now since it has been the one steadily growing area of the economy for almost a decade: the housing market. Bubble talk is always big, and financial news outlets typically overdo it. No one though can deny that the housing prices have been appreciating to levels making even the most iron stomachs a little queezy, as the crest towards a downhill ride starts to swell under us. My mortgage broker keeps talking about "1989 all over again" as he guzzles a bottle of Maalox. And even the beige book points out that residential real estate "showed a few signs of cooling in some districts." Feel that? That's the wave pitching up and down.

Here's my assessment for what its worth. Mortgage lenders, not homeowners, stand the most to lose over whatever bubble popping we may be in store for. First of all, the widespread use of ARMs which everyone fears will create a cascading of rate resets is over-generalized. Most ARMs for the last 4-5 years have been hybrid loans, utilizing longer fixed periods and balancing rate increases. The results is a rate reset cycle of 3-5 years, instead of the 12 months everyone fears. This means the risk of rising rates is not rising rates per se, but cooled financing demand and the loss of fees associated with that. Banks with big, fat books will need to go on a diet and shed some of that fat as the lucrative fees which have been driving their business will dry up.

Secondly, home price deceleration will only chill the wealth effect, but its not as if that wealth will disappear (remember Mitya's third law, wealth is neither created nor destroyed, just moved around). If home price appreciation slows to say, 2-4%, where would you put your money? Probably in a savings account. It makes no sense any longer to keep paying as much of a mortgage payment as possible, and instead to increase your savings. Banks haven't had a big savings push in a long time, Americans are saving record low amounts (0% according to the last report); so to substitute the fees from mortgage origination with retail banking fees, some serious catch up work is required.

Thirdly, something like 15% of residential closings over the last year have been for investment purposes. That is a lot investment property. These double, triple mortgagers are the ones at risk, and it only reinforces point two above. Though people flipping properties may lose a little wealth, those aren't most people by any stretch. Coincidentally, investment properties are big money makers for banks who make moneyon all ends of the deal, stopping the flow of these will definitely cause some belt tightening.

So, while it is pretty clear to me that the housing market bubble pop is here (convincingly, turnover or existing home sales compared to housing stock is at 5%), the effect of a pullback in house appreciation rates will primarily pain the lending class ... at least for the next three years (now how's that for calculating economic cycles to the incumbent's advantage!)