- Mortgage credit remains tight.
- Programs to enhance new home activity this cycle are unlikely.
- Housing data indicates a smaller contribution to GDP growth this year.
Having sat on this article about housing for about two weeks, I began to wonder about the utility of its timing. Growing awareness of the lack of housing growth was getting serious play in the media, with more and more observers talking the sector down. I had decided to wait for the latest starts data this week, and my patience seems to have been rewarded by an estimate beat that should further fog the issue with judicious use of isolated figures.
There is quite a bit of speculation these days about why housing isn't doing better (cf. some of the reasons put forth by bond maven Jeff Gundlach), but the primary reason is credit availability. There is a reason why all-cash sales are approaching 50% of transactions, and it is mainly that credit criteria are more stringent than they've been in decades.
In my column of May 2nd ("Federal Reserve Policy and the Stock Market"), I observed that the institutional memory of lenders is such that when a sector blows up, there is practically nothing that can convince them to rush back into the sector. It's as simple as the old saying, "once burnt, twice shy." It wasn't just the US and its crisis - in the UK, where mortgage lending was at least every bit as mad as it was in the US (I would say worse), the rate of home ownership has fallen to its lowest level in 25 years.
UK housing markets are not quite the same as ours, but some of the parallels to the US are instructive - rising prices and tighter mortgage criteria are helping to keep the younger, first-time buyer out of the market. Central bank liquidity has helped lead investors back into the sector and fuel price appreciation, helping bubble-era buyers to recover much of the value, but leaving prices at less-accessible levels. So far as helping to restore prices, Federal Reserve policy has led to a similar outcome.
But prices are only part of the story. Though not at an all-time bottom, mortgage rates are nevertheless at levels that are historically low (in the UK they are even lower), a factor that shrinks the size of the mortgage payment in relation to incomes. That does contribute to upward pressure on prices, but not as much as would be the case if mortgage credit was more accessible: U.S. mortgage volume in the first quarter of 2014 was the lowest in 17 years, even lower on a per-capita basis. The problem is availability, beset by such factors as 20% down payments, spotless credit requirements, ponderous documentation and frequently, student loan burdens. The UK government attacked its own problem with a "Help to Buy" program designed to get buyers into what we would call conforming loans by using a 5% down payment.
There are problems with the UK program, the most immediate being that it is helping to fuel speculative price appreciation. Another is that London remains overly dependent on finance and real estate activity for prosperity, and as London goes so does (mostly) the UK. However, what's germane to our own shores is that it's quite unlikely such a program would get traction here in the current political environment. While the new GSE regulator, Mel Watt, has just expressed interest in seeing criteria ease, elements of the right and the private banking sector have never ended their ceaseless battle against the two agencies. Since the crash, their position has never been better.
Partisan efforts to divert blame from Wall Street onto Fannie (OTCQB:FNMA) and Freddie (OTCQB:FMCC) (e.g., Thomas Donlan's editorial in the latest Barron's) and the poor (when safe to do so) should translate into no UK-style program here for first-time buyers. I would be against such a program on economic grounds anyway - the Fed's program of liquidity, aided by massive investor-led buying (Blackstone and the like), has raised home prices at a much faster pace than the level of individual home buying could have accomplished on its own. Something that would inevitably fuel further double-digit annual gains would serve to increase speculative risk to dangerous levels.
No, the time for such a program was years ago. Now that we are in the latter stages of the economic cycle, such stimulus would lead to a short-term gain in activity and a longer-term payback in pain - home prices would soon retreat with the end of the cycle, leaving the late buyers underwater. That usually happens anyway, but newly subsidized program participants would appear to have been hornswoggled yet again, setting up lurid headlines and a golden opportunity for the all-government-is-evil set to push the pendulum back too far in the other direction. Better to wait for the bottom of the cycle, when the timing might be much more fortuitous.
This morning's release of April starts data has been abused in the usual way by market promoters. My favorite bit of misdirection is that April starts are up 26% year-on-year - one can hardly be blamed for saying, "wow!"
But all that glitters is not gold. There's also a reason why the homebuilders are not wowed, as evidenced by the decline in their sentiment index reading released the day before. It showed an unexpected decline to 45, against expectations it would be moving back up to the neutral line of 50.
A weather rebound in April homebuilding activity was expected two months ago, so hardly qualifies as news. The reason that homebuilders aren't celebrating is that through the first four months of the year, single-family starts (actual) are only up 1.7% from the same period in 2013. Total starts are up 5.7%. I expect that the summer will see some improvement in those rates, but the possibility of achieving last year's rate of 18.7% is nil. My own expectations had been for a high single-digits increase in 2014, based upon a starts growth rate of about 10% in the second half of 2013, but at present 7% looks more like the central tendency. Another fact that was not widely quoted is that single-family permits were down year-on-year in April and are down (-1.6%) through the first four months of 2014. New home sales, which tend to run a little lower than starts, declined on a year-over-year basis in the first quarter.
I don't see this data as a calamitous indicator, nor a reason to confuse matters with melodramatic blame of some governmental body, be it the Fed, the administration, House Republicans, or the Fish and Wildlife service. But I do see the phenomenon as revealing about the current economic cycle. Single-family home sales were widely assumed at the end of last year (though not by me) to experience 20% growth in 2014, which isn't even all that much in unit terms, considering 2013's low rate of 429,000. It doesn't appear now that even 10% will be achievable this year.
The conclusion I want you to draw from this is not that housing is a bust, or that the government or the banks have failed. It's that housing will remain subdued in this cycle and not make the linear contribution to growth that economists had built in to 2014 projections. Certainly the concentration of mortgage lending amongst the largest four banks - the ones also paying the biggest boom-related penalties - is a drawback to credit availability and thus home buying. But even if all of them were to announce plans to spin off their mortgage lending units tomorrow, by the time it happened the current economic cycle would either be over or nearly so.
The biggest hurdles to homebuying activity are going to remain in place in 2014: The 20% down payment requirement, and the mortgage-approval process that a CNBC guest recently described as a "financial colonoscopy." The latter has always been true of a busted sector in banking, but people outside of the business tend to forget such things as Texas energy loans or the junk bond-fueled S&L crash, if they ever knew about them to begin with. What's unusual about the current times is that housing was the guilty party, because we went over seventy years without a national housing bust. Of course, we also went almost seventy years without trying to pour a firehose of speculative credit into what is supposed to be a stodgy, illiquid, multi-decade acquisition.
If you're perplexed by the strength in multi-family housing, don't be. That lending goes to developers and doesn't have the same tourniquet around it. Keep in mind also that the dollar volume of construction of that sort is not a leading indicator - it always peaks just before a cyclical bust. Such construction will be a welcome offset in the current cycle to some of the weakness in single-family activity, but unlike single-family housing (until the crash, anyway), multi-family is a more volatile sector and tends to end its cycle with tales of half-finished buildings and local bank failures. It won't be a good mix when the current expansion ends - and by the way, all expansions do end, regardless of what equity fund strategists and managers may say. Didn't they tell you that in the prospectus?
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I have a position in Fannie Mae preferred stock