On U.S. Housing and Debased Lending Standards

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 |  Includes: IYR, KME
by: Economic Disconnect

What is the world coming to when Dell (NASDAQ:DELL) cannot even "beat the street" after massaged guidance? Things must be rough indeed.

Picking a Blog Title
Sometime a blog title really says something important. Other times they are random quips. My friend Stagflationary Mark runs the great site "Illusion of Prosperity" and I always liked that title. Thursday on Yahoo Finance I saw this article:
"The Illusion of Prosperity": U.S. Destined to Lag Rest of the World, Peter Boockvar Says
A perfect fit. I would argue that the title could have been "Economic Disconnect, the US and the Rest of the World" but I am the jealous sort.

Paying to Stash Cash
As noted by Zero Hedge and others Thursday, the action in T-Bills has become very negative. It seems many are back to paying other people to hold their money for short spans on the promise of getting it back. A look at action over the last 6 months:

Trending down with a serious move down as of late. For some perspective, here is the two year look of the same 13-week T-Bill:



Seems many are ready to take very little to safeguard their cash. Negative rates are still pretty rare (think Lehman (OTC:LEHMQ) collapse) and that is where we are at.

Economic Disconnect would like to offer services where I will stash your cash for 13 weeks for a small 0.02% haircut. Please leave your account numbers in the comments, or use the email listed at the left for more secure transactions. You can trust me, really.

Beware the Ides of March (Maybe)
As any Shakespeare buff knows, Julius Caesar was warned to "beware the ides of March" shortly before his murder. March may play a significant role in the markets next year as well, though as you may know there's many a slip twixt the cup and the lip (Thanks Young Guns).

The Fed has used their MBS purchase program (1.2 trillion strong and running) to support a collapsed market in mortgages. No bank wants to touch them, and no outside investors want to hold them. Never fear, the US government has stepped up to the plate and enlisted the FHA to juice things up even more.

So far the results have been mixed. While some rebound in housing had been seen, it has been muted and at the low end. At this point there does not seem to be renewed animal spirits in the housing mortgage market as memories of instant insolvency still are fresh wounds (The US government has no such fears of course).

As of now, the Fed MBS buying bonanza's sun will set in March 2010, or even before then. Some observers think that a mortgage rate increase of, get this, 30bps (that's .30% for you and I) will be the after effect of the support program. One may wonder how in the world mortgage rates, set by real world appetites for the product, will register such a minuscule rise after 80% of the buying power evaporates but smarter people than us all seem very confident. I would argue that the program is a colossal failure if that small a reduction in rate was all that could be done, and I think I am (and will be) right about that.

From the red hot blog Housing Doom, I was pointed to this article in Reason about the housing market that bears a closer look:

Government is Encouraging Lax Lending Standards
The Obama Administration is prepared to do anything, including dramatically lowering mortgage lending standards, to keep real estate prices inflated, as demonstrated by statements, reports and events in the month of October.

With an intro like that you know I am going to check it out:

First came the Federal Housing Authority inspector general's report on the FHA's lender approval process, which found that FHA was missing or ignoring relevant information, failing to document loans, not preventing convicted financial criminals from participating in its lending program, and in most other ways failing to "ensure that lenders met all applicable requirements." The IG's spot check revealed, for example, that just one out of 22 approved applications contained all the documentation needed to meet the FHA's own standard for guaranteeing a loan.

The FHA's much more serious offense against lending standards -- its dangerously low 3.5 percent down payment minimum for guaranteed loans -- became the focus of attention this month when the authority admitted it was shown to be close to bankruptcy, and Rep. Scott Garrett (R-New Jersey) introduced legislation to boost that minimum to 5 percent.

So far these are things many of us are well aware of. Disturbing, yes, surprising, no. Back to the article:

There is both anecdotal and statistical evidence that the debased lending standards being pushed by FHA and other government entities are creating a dangerous dead cat bounce in real estate markets. Anecdotally, here's a profile of a new home borrower who as of this month is paying 54 percent of her income on a house. Statistically, defaults on government-approved loans continue to rise, with Fannie Mae (FNM)-backed loans now breaking through a 3.3 percent delinquency rate.

So the market is this bad? I am sure banks, stretched as they are, will pile on and buy these mortgage securities without government support. I am very sure. NOT. As if we needed more;

How are people buying all this expensive real estate? With nearly the same ratio of debt to down payment as they had in 2005. According to NAR, the median down payment is 4 percent -- slightly above what it was earlier in the decade -- but a third of all U.S. houses are still being bought with no money down.

That's a bad bet for us, because we will be on the hook for the defaults. As this San Francisco Federal Reserve report notes, nearly all mortgage securitization is now being done by the nationalized government sponsored enterprises, and virtually none by the private sector. So lenders are not just gambling on bad credit risks, but gambling with your money. Not surprisingly, it's the administration that gets the benefit, as real estate prices, in marked contrast to unemployment, are doing better than the most-adverse projections of the bank stress test conducted earlier this year.

The bold faced lines are key, but in summary of the article:

Meanwhile, it appears that October may be remembered as the month that the evidence, and the statements of many officials, all pointed to the same conclusion: The Obama Administration has taken a no-parachute leap of faith that real estate will stay inflated. If you're keeping score at home, this is the precisely the behavior Sen. Obama used to blame on the "ethic of greed."

That's ball game folks.

In March when the support programs run out, the housing market will resume its travel toward equilibrium.

So go short all things banks, mortgages, housing and home improvement?
Au contraire mon frere.

In the face of a resumption of the housing downturn, which happens to be one of the only standouts of failed policies do you think:

-The government will allow DEFLATION on home prices to resume?
-Any presidential administration (and by extension congress) will allow the one centerpiece of success (albeit at the low end only) to go away?

It will not happen.

The entire game so far has been to extend the game until such a time that home prices would regain a chunk of their former bubble values, not all, but a good chunk. This will not happen. Any recovery now is at the low end (most gullible) and would take 2 spring selling seasons to percolate up the chain. This March is too soon. Nobody serious thinks other wise.

So, expect to see another MBS purchase program started (very little political backlash, nobody knows what this means or thinks it helps them indirectly anyways) and another Quantitative Easing campaign to begin in the February month.

With about 95% of the investment world looking for that monster dollar rally, things may be delayed (indefinitely?). What is the difference in the dollar at 74 on the index, or 68? What about 65? Think the world will end? It has not after a 20% plus drop, what's another 5-10% between friends?

I am looking for a New Year's celebration, not of new beginnings, but of old tricks. More funny money and more support for low rates. Expect stocks (do not like many on principle), oil (not my thing), gold (love it!), and silver (really in love) to run hard when the spigots get opened up once again.

What other choice is there? Let mortgage rates rise .30% (dreamers)? Impossible I say.