Why Record Low Rates Aren't Working

by: Markos Kaminis

Mortgage rates set new records again in the week ending July 20, falling across most classes of mortgage loans, and yet there was still no sign of life in applications for the purchases of homes. Despite what hopeful sector constituents keep saying, this data continues to point to a stagnant real estate market. With this article, we ask why.

The Mortgage Bankers Association (MBA) reported its Market Composite Index rose just 0.9% in the week ending July 20, despite record low rates among average fixed rate 30-year loans for conforming mortgage balances, FHA sponsored loans, 15-year fixed rate mortgage loans, and for 5/1 ARMS. Only 30-year fixed rate loans for jumbo balances increased (off record low levels) in the period, rising 0.01 percent. But even "jumbos" saw effective rate decline, as points decreased on average.

The MBA's Refinance Index increased 2%, as homeowners who could do so, took advantage of the situation. The Refinance Index hit a level not seen since April of 2009, as homeowners lowered their cost of homeownership. Still, even as the refinance index improved, it was only a marginal change from the prior week as the impact of decreasing mortgage rates seems to diminish. Federal Reserve Chairman Bernanke recently said as much could be expected from Fed efforts currently being employed.

The nation's largest mortgage lender, Bank of America (BAC), recently said it funded 3.6% less residential home loans in its just reported second quarter. This is despite record low mortgage rates. Tight bank lending was also evident in the 3% decrease in the MBA's seasonally adjusted Purchase Index, which measures mortgage applications tied to the purchases of homes.

There's some debate as to what's stopping the purchases of homes despite the affordability of homeownership today. Real estate associations like the National Association of Home Builders (NAHB) and National Association of Realtors (NAR) blame several factors for this. First, tight lending standards at the nation's largest mortgage lenders, including BofA, Wells Fargo (WFC), J.P. Morgan Chase (JPM), Citigroup (C), PHH Corp. (PHH), US Bancorp (USB) and all the rest are said to be constraining activity. Yet, with the "fiscal cliff" ahead, and with pressure from rating agencies and regulators high, banks have little incentive to take risk despite Bernanke's best efforts. Plus, unemployment remains relatively high as the economic outlook comes into serious question. Second, the appraisal values of the homes people are already living in are said to be unnaturally low, due to the inclusion of distressed property sales. This keeps them from moving out and into their new dream home. Homebuilders argue this also makes the homes they sell seem too expensive in comparison, though they clearly continue to appeal to those seeking only a brand new home.

Many publicly traded builders continue to report solid growth in revenues, orders, backlogs and earnings, with PulteGroup (PHM), the nation's largest builder, posting a favorable result last week. NVR, Inc. (NVR) rallied last week as well, on an operating announcement, though it was regaining ground lost from its prior week disappointment. Not all the EPS news has satisfied investors in the group. D.R. Horton (DHI), Standard Pacific (SPF) and Ryland Group (RYL) disappointed investors in one way or another with their reports last week. So, it would appear, homebuilders have fully priced in their latest operating rally, and the competitive advantage and market share gains they are making on the pain of smaller undercapitalized contractors.

Last Week's Select Builder Performance

Company & Ticker

Performance Last Week

SPDR S&P Homebuilders (XHB)




Ryland Group


Standard Pacific


NVR, Inc.


Meritage Homes (MTH)


Comstock Holdings (CHCI)


For Bank of America , J.P. Morgan and Citigroup to free up more capital some things are going to have to change. First, they must continue to sure up their own balance sheets, so that they can satisfy rating agencies like Moody's (MCO) and investors in their own shares. Then, perhaps, they might loosen lending standards, while still making good loans. Second, if the benefits of low mortgage rates have been exhausted in isolation, then the cure is obvious. Clarity must be restored to the fiscal outlook, and the economy must be set on a new growth path. Unemployment has to improve, and consumers have to gain confidence. Unfortunately, I see just the opposite developing for the economy and the real estate and financial sectors. Thus, it seems the deck is truly stacked against real estate.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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