Events in the Ukraine have been distracting the global financial markets, but for investors and financial institutions in the U.S., the deteriorating economic fundamentals in the housing sector are probably a more urgent concern.
While many parts of the U.S. economy are growing, the housing sector is increasingly a drag on consumption and job creation. The fault lies not with the market, however, but with ill-considered regulations and bank capital rules.
On the surface, things look OK. Nationwide, house prices rose 1.2% in the fourth quarter of 2013 according to the Federal Housing Finance Agency's index. This is the tenth consecutive quarterly price increase in the purchase-only, seasonally adjusted index.
But the FHFA's principal economist, Andrew Leventis noted that the appreciation was "more modest than in recent periods," and cautioned: “It is too early to know whether the lower quarterly growth rate represents the beginning of more normalized price appreciation patterns or a more significant slowdown.”
Most housing indicators suggest that the overall rate of home price appreciation is slowing considerably, with a few of the more attractive markets around the country accounting for most of the upward momentum. Home prices probably peaked overall in the second quarter of 2013, but the time delay in most of the major data series on housing masks this reality.
For example, the National Association of Realtors reports that existing home sales and median home price information showed gains of 10.4% in prices in January compared to a year earlier, "a slight acceleration from the 9.7% year-over-year gains in December but notably slower than trends in early summer/fall 2013."
The Realtors report the median price of all homes that have sold while FHFA and Case-Shiller report the results of a weighted repeat-sales index. Because home sales among higher priced properties have been growing more than among lower-price tiers, the Realtors' median price had risen by more than the weighted repeat sales index, which computes price change based on repeat sales of the same property.
Only six cities—Dallas, Las Vegas, Miami, San Francisco, Tampa and Washington—posted gains for the month of December, according to the 20-city Case Shiller Index. While average home prices have returned to 2004 levels, 20% to 30% of American homeowners remain either underwater on their mortgages or have too little equity to sell their homes. A lack of supply of homes is actually driving appreciation in many of the hottest markets, but sales volumes remain well below pre-2007 levels.
Applications for home mortgages, including both new purchases and refinancings, are at the lowest levels in more than a decade. While many observers blame rising interest rates for the paucity of new loan applications, factors such as a poor job market, flat to down consumer income and excessive regulation are probably more important. Commercial banks are fleeing the mortgage lending and loan servicing businesses, in large part because of punitive regulations and new Basel III capital requirements which demonize private mortgage lending.
"Rules enacted last year appear to be steadily forcing banks to exit the mortgage servicing business, transferring such rights to nonbanks," Victoria Finkle writes in American Banker. "The situation is stoking fears on Capitol Hill and elsewhere that regulators went too far." Those fears are well founded.
The latest data from the Federal Deposit Insurance Corp. confirms that the loan portfolios of commercial banks devoted to housing are running off. For example, the total of 1-4 family loans securitized by all U.S. banks fell almost 5% in the fourth quarter of 2013 to a mere $610 billion. Real estate loans secured by 1-4 family properties held in bank portfolios as of the fourth quarter fell to $2.4 trillion in the last quarter, the lowest level since the fourth quarter of 2004. The FDIC reports that the amount of 1-4 family loans sold into securitizations exceeded originations by almost $30 billion.
As 2014 unfolds, look for lending volumes in 1-4 family mortgages to continue to fall as a lack of demand from consumers and draconian regulations force many lenders out of the market. While leaders such as Wells Fargo have indicated that they will write loans with credit scores in the low 600s range, there are not enough borrowers in the below prime category to make up for the dearth of consumers seeking a mortgage overall. When home prices measures generally start to fall later this year, maybe our beloved public servants in Washington will start to get the message.
Christopher Whalen is an author and investment banker who lives in New York.