By Ramsey Su
The country is spending more than it makes, to the tune of over $1 trillion per year for the last four years and the foreseeable future. Households are spending more to keep up a lifestyle supported by borrowed money. To treat an addict who is using borrowed money to support the drug habit, lowering the borrowing cost so the addict can buy more drugs is not the answer. We are still on drugs. That is why real estate is in a bubble. Here are the specifics:
The first part of QE~ is the purchase of $45 billion of treasuries each month. To put this in perspective, the sequester in the news is $85 billion for this year and $1.2 trillion over 10 years. The sequester is less than what Bernanke finances in 2 months. Why worry about the sequester? Bernanke can just add $7 billion a month to the $45 billion and the debt would be covered.
The second part of QE~ is the purchase of $40 billion of agency MBS. The entire mortgage market is originating approximately $1.5 trillion loans per year, out of which about 70% are refinances, or $450 billion of new loan originations. Let us assume 90% of all originations are agency loans, then Bernanke is purchasing 100% of all agency originations and still has $75 billion left over, per year. Maybe he can just use that to offset the sequester.
The Fed already bought $1.2 trillion of agency MBS before QE~. The underlying mortgages are constantly prepaid via foreclosures, sales or refinances. Bernanke is replacing these prepayments with new purchases. Combined with the $40b per month under QE~, the Fed is purchasing at the rate of $16.8 billion per WEEK or $873 billion per year. Does that seem like a pretty large number to you?
Putting QEs in Perspective
Freddie, Fannie and FHA combined, by my rough estimate, should have between $5 -$6 trillion worth of loans with no big fluctuations expected in the next few years. By the first year anniversary of QE infinity, in September 2013, the Fed should have over $2 trillion agency MBS on its books. In other words, the Fed is going to own about one third of all agency MBS. Furthermore, Bernanke has openly stated that he will keep buying until the unemployment rate declines to 6.5%. Could the Fed soon end up owning the entire agency MBS portfolio?
The Magic HARP
Mozart may have the Magic Flute but we have the magic HARP. HARP is basically Freddie and Fannie refinancing programs for high LTV loans that would otherwise not qualify under normal refinancing guidelines. Since the inception date of April 2009, there have been over 2 million HARP refinances, over a million during 2012 alone. LPS estimates that there may be 2.6 million additional loans which are eligible for HARP 2. Whether you agree or disagree with the policy, the fact remains that HARP is a huge bailout. It reduces the borrowing costs of millions of borrowers and prevented an unknown number of foreclosures. How much is HARP contributing to the current shortage of for-sale inventory and appreciating real estate prices?
Fixed Income Investors
Another way of looking at HARP is through the eyes of fixed income investors. Would you invest in mortgages with >100% LTVs? If yes, would you accept the same low interest rates as if it is a low <80% LTV loan? Of course not, but with the agencies guaranteeing the loans, and with Bernanke buying them all, fixed income investors are forced to accept a few percents less in yield, or go chase yield with riskier investments elsewhere. Are they throwing money at the Blackstones or the Silver Bays (SBY) for REO to rental investments (see below)?
Short Sale Stimulus
Imagine someone dumb enough to lend you $700 back in September 2012 to buy a share of Apple. Today, Apple is trading at $430. It is somehow decided that you can simply sell your share at $430, give the money to the lender and your lender will take the $270 loss. What a bargain! Many are finding this option attractive and short sales now exceed foreclosure sales. Realtytrac recently released a report. You can see the details here. Per Realtytrac, the average "short" amount for a short sale is $81,621. I suspect foreclosures result in a higher "short". With almost a million combined foreclosures and short sales last year, that means $81 billion of household debt is wiped out.
Hidden Housing Subsidy
I wrote about the hidden housing subsidy repeatedly before. As per the latest LPS report, there are still 5,208,000 households receiving free housing by simply not paying their mortgage. It has been 6 years since the Greenspan sub-prime bubble burst. I have previously estimated that this subsidy could be as much as $100 billion per annum. Look at the following table, is a 7% delinquency rate something to cheer about?
Delinquencies, via LPS
Too Big to Fail
The Too Big to Fail Banks are now even bigger. Bernanke kept reassuring us that he had this under control. His reassurances are not very comforting, considering that they are coming from the same chairman who admitted he did not see the sub-prime fiasco coming. Pertaining to real estate, just three banks [Wells Fargo (WFC), Bank of America (BAC) and Chase (JPKCZ.OB)] now control over 50% of all mortgage originations. Wells alone is one third of the mortgage market. I cannot imagine the Fed allowing any of these banks to fail.
Even Bigger than Too Big to Fail
I am of course referring to Fannie, Freddie and the FHA. Technically, Fannie and Freddie have already failed 4.5 years ago when they were put under conservatorship. For the last few years, the three entities probably funded over 90% of all mortgages. Here is the big picture of mortgage financing:
Three big banks originate 50% of all mortgages, 90% of these mortgages go to three lenders to be securitized, 100% of these mortgages are purchased by means of a paper entry at the Federal Reserve. So this is a housing recovery?
Here Comes Wall Street
The Greenspan sub-prime bubble would not have been possible without Wall Street. Junk loans would not have been stamped AAA and sold to townships in Norway. John Paulson would not be a rock star if Goldman Sachs had not created the derivatives for him to short. To help fuel the current bubble, Wall Street started in earnest about a year ago when Blackstone started their REO-to-rental strategy. Many have jumped on the bandwagon since then. Their last release claimed they have purchased 16,000 properties. I watched the short 2 minute video on Blackstone's website with curiosity. What is their expense factor? Hiring those thousands of workers to fix up these rentals must be costing a fortune. Traditionally, single family home investors are small and self managed. Maintenance and turnover are often performed by the owners. Just look at Craigslist and see how many listings are from private parties instead of management companies. How can Blackstone compete with its massive overhead?
Silver Bay Realty Trust
Silver Bay is the only publicly traded company with single family rentals as their only business. This is their first reporting quarter since the IPO. So far, Silver Bay has accumulated 3,400 single family properties. At the moment, there are too many properties still in the renovation phase so the overall numbers are not very meaningful. This is noteworthy though:
The Company achieved an occupancy rate of 96% and an average monthly rent of $1,148 on 1,779 properties that were stabilized as of December 31, 2012. Silver Bay reported an occupancy rate of 83% and an average monthly rent of $1,143 on 1,583 properties that were owned for a minimum of six months. A total of 1,705 single-family properties of the aggregate portfolio were leased as of December 31, 2012, resulting in an occupancy rate of 50%.
Silver Bay defines "stabilized" as "… those that we have acquired, renovated, marketed and leased for the first time. Properties acquired with in-place leases are considered stabilized." What that means is they have already lost 4% of their tenants. As for the 83% occupancy, or 17% vacancy rate for properties held over 6 months, that is going to blow a huge hole in their cash flow projections.
Going down their list, they have 410 vacancies in Phoenix, 415 in Tampa, 294 in Atlanta and 136 in Vegas. Silver Bay is only one relatively smaller player active in about a dozen of the more popular markets. How many units are these Wall Street investors adding to the single family rental pool? Can these markets handle thousands of rentals at one time? It seems to me that as they buy more, they will soon be cannibalizing themselves. Bubbles need OPM (other people's money). I think Wall Street has plenty right now.
What is actual housing demand?
Housing has finite demand. The market is constantly adjusting to changes in product type and rotating in geographical locations. As owner-users are squeezed out by investors, builders are once again building because they can sell, but not because of fundamentals. It is a zero sum game and we should soon see the results. As an example, Mr. and Mrs. Smith are renters and their landlord is in foreclosure. They want to buy the house, but a cash Wall Street buyer comes in with a better offer and squeezes them out. Frustrated, the Smiths buy a new house from Pulte down the street, paying a price that is unattractive to investors. The housing supply increases by one. There is no real demand for the Pulte home, it is just artificially created by the Wall Street investor. Now the investor has to find a new tenant somewhere when the Smiths move out.
Intent to Deceive
As bad as Greenspan was, there is no doubt that Bernanke is worse. Last week, Bernanke gave a speech on long term interest rates where he answered the question: Why are long-term interest rates so low in the United States and in other major industrial countries? Most of us can answer that question in three words – CENTRAL BANK INTERVENTION. Instead, Bernanke gave a big long convoluted answer with only a short mention of Large Scale Asset Purchases. I think I have illustrated above how large these purchases really are. Bernanke is a danger to society.
It is important to understand the magnitude of the stimulus that is propping up the market. With Wall Street's participation, using OPM, speculators are back in the market, buying not because of fundamentals but because they think they can sell at a higher price. The market should be at a euphoric high with all the drugs. It's like a free visit to the DEA's evidence room. Do not forget though that while the euphoric high makes you feel like you are on top of the world, you must be prepared for the consequences when you come down from the high.
This bubble is yet to be named, but Bernanke Bubble is clearly the front runner.