Tag Archives: mortgage buyers

Mortgage Buyer – Three Big Reasons Why the Boom Will Not Last

Another day, another barrage of news headlines about the wonderful housing market.  Home values soared nearly 20% in some markets during 2012 compared to the prior year, inventory is low, foreclosures are down, and flippers are crawling all over each other to outbid competitors on nearly any kind of house.  For real estate investors, any mortgage  buyer, or people wanting a new home to live in, the future does indeed look bright.  Even I believe it more than likely that the next 12-24 months will sparkle for real estate, and my own mortgage buyer business has hit a higher gear as of late.  That said, housing is quickly becoming a bubble, which by definition must pop … again.

How do we keep this “recovery” going or can we?  All of my analyses plus my gut feeling tell me that we’re headed for another crash in real estate, and probably in stocks too.  There are lots of reasons for this, but I’ll sum them up in three main categories.
Falling House
1. Over-Extension of Credit
In an article called “Credit Supernova”, PIMCO’s Bill Gross notes that, in the 1980’s, it took $4 of new credit to generate $1 of GDP (gross domestic product).  Since 2006, it has taken $20 of new credit to generate that same dollar.  In other words, it takes increasing amounts of credit to actually produce anything.  Gross refers to this as Ponzi Finance, as the ongoing credit financing begins to consume itself.  If you or I pay off one credit card with another credit card and then get a personal loan to cover that card, we can pretend for a period of time that we have smooth sailing.  But at some point, interest payments get too big to manage and the resulting defaulted debt causes all sorts of collateral damage.

The biggest debtor of all is the U.S. government, and it has no way of ever paying off all of its obligations.  Instead, the bureaucrats (plus some states and cities) extend and pretend so that the ship doesn’t go down on their watch.  Most of the media has an aversion to digging deeply into issues, so they publish the happy talk from the so-called experts in government and on Wall Street.  Speaking of which …

2. Heavy-Handed Involvement of Government and Wall Street
As pointed out in Zero Hedge (The Echo Boom in Housing – Recovery Stocks, 2/4/13), actions by the Federal Reserve and the U.S. government have prevented housing from having an organic recovery.  The low interest rates pushed by the Fed are intended to encourage Americans to invest in riskier assets and allow the government to pay off debts for a longer period of time.  ZH notes that “high levels of speculative activity could be nurturing a false confidence.”  I would agree except that I’d replace the words “could be” with “are.”

The Federal Housing Administration (FHA) has insured more than 30 million homes, but has way too many risky loans and a high default rate.  It had a $16.3 billion shortfall in November.  Meanwhile, it continues to insure loans that have as little as a 3.5% down payment.  Along with Fannie and Freddie, these government entities are together involved with nearly every mortgage in the country.  Government manipulated economies and markets have a very poor track record over the course of history.

Meanwhile, hedge funds and private equity firms are buying companies and assets along every part of the housing supply chain.  Per CNN Money, Paulson and Co. bought up enough land in Arizona, California, and Nevada to build 25,000 homes.  Blackstone Group spent $2.7 billion last year to buy 17,000 homes post-foreclosure.  At some point, companies like these, which are only into real estate for a quick buck, will see signs of a downturn and try to rapidly sell their real estate holdings.  This will cause the housing bubble to collapse that much more quickly, as there are too many sellers and not enough buyers.

3. Poor Household Wealth
There are not enough buyers because unemployment remains high and household wealth continues to decline.  In states as diverse as Alaska, Alabama, California, and Arizona, food stamp usage has nearly doubled over the past five years.  Over 10% of the California population is on food stamps, numbering about 4 million people.  The Fiscal Times reported that nearly half of U.S. households (132.1 million people) could not financially handle a weather emergency or finance long-term needs like health care and college tuition.  They state “these people wouldn’t last three months if their income was suddenly depleted.  More than 30 percent don’t even have a savings account, and another 8 percent don’t bank at all.”  This is not just people near the poverty line either, as much of the middle class has joined the working poor and is dependent on some form of government assistance.

In summary, the economy and housing market are built on sand and are missing the basic foundation upon which to build.  As government becomes more heavily involved in everyday life and the average citizen becomes poorer and more dependent on handouts, true production and demand will wilt.  The U.S must jump off this train of being debt enamored if it is to get back on the right track.

The Rising Cost of Government

A few weeks ago in this space, I made the case for why real estate will perform poorly in the medium-term, driven by a variety of factors.  This trend will affect homebuyers, mortgage buyers, investors, banks, and anyone else with a financial interest in real estate.  Mortgage buyers like me need to be especially aware lest our mortgage notes go from having lots of equity to suddenly being underwater.  Fitch, a well-known international credit rating agency, believes that real estate values are overvalued now by at least 10% (per Housing Watch, 1/4/13), and there are good arguments for why it is overvalued more than that.

However, in the short-term, which I define as the next two years, housing should do well.  Certainly, real estate values improved significantly in many regions during 2012, and I expect the trend to continue through 2014.  A combination of low interest rates, limited housing inventory, and Wall Street and an influx of foreigners jumping in as investors have made near-term prospects look good.  Because the Feds have their mitts all over this change and have succeeded only in artificially propping up housing temporarily, another precipitous drop in property values is still in our future.

Interest rates have been kept low by the Federal Reserve, which has promised to keep them low for another couple of years.  Housing inventory is constrained by banks still holding shadow inventory, by Wall Street firms buying huge portfolios of properties, and because many underwater homeowners are unable to move.  Of course, once interest rates move up, Wall Street types get panicky, or any number of other events occurs, housing will return to its slide.  High unemployment, higher taxes, and economic uncertainly all suggest that the housing recovery has no legs.  The current economic mess is almost entirely caused by partisan bickering over the debt and related policy decisions, and shows no sign of changing.  The politicians know that any changes to spending and programs will infuriate some special interest group, which directly affects their chances of being reelected.

Congress and the President have shown no inclination to make any spending cuts, so seem destined to continue deficit spending well into the future.  The Democrats refuse to cut entitlement spending while the Republicans won’t consider reducing defense spending – both areas will need to be slashed to significantly reduce the debt.  The entitlement side is especially pressing, as CNS News reported that Social Security ran a $47.8 billion deficit in fiscal year 2012.  The number of workers collecting disability benefits hit a record of 8.8 million people in December – apparently, not having a job is quite detrimental to one’s health.  The ratio of workers to beneficiaries peaked in 1999 at 2.93 to 1, and now stands at 2.36 to 1.  Social security, like Medicare, is on an unsustainable exponential growth path of misery.

The federal government has greatly increased spending from 2000 to 2012.  Here are just a few examples of the percentage increase during that time (per Mish, 12/21/12):

Dept. of Defense                                          194%
Dept. of Education                                    160%
Dept. of Energy                                         160%
Dept. of Health & Human Services    128%

Meanwhile, Medicare and Medicaid have each risen about 140% during that time.  While there are certainly opportunities to increase revenues, by far the biggest problem is the greatly increased expenses and government infrastructure that goes with it.

Japan had a crisis with some similarities to ours over twenty years ago and is still a mess.  They were slower to throw money at the problem than has been the U.S., but their results have still been dismal.  The U.S. has a much larger economy than Japan and has certain advantages (like still having the world’s reserve currency) that will probably keep our fall from being as severe, but it is still interesting to see how Japanese real estate (per Dr. Housing Bubble) and its stock market (Nikkei 225 on the right, per tradingeconomics.com) did over the past few decades.

japan real estate land pricesHistorical Data Chart

This is what unconstrained spending and a dismal economy will do for you, and the U.S. is following the same path.  Keep this in mind when certain politicians and economists start yapping about how the government needs to spend more to get the economy healthy.