The Fed Is Capitulating On Housing

Posted 2010-12-23 10:07
by Karl Denninger
in Federal Reserve

As gauged by an aggregate of housing indexes dating to 1890, real home prices rose 85 percent to their highest level in August 2006. They have since declined 33 percent, falling short of most predictions for a cumulative correction of at least 40 percent.[1] In fact, home prices still must fall 23 percent if they are to revert to their long-term mean (Chart 1). The Federal Reserve’s purchases of Fannie Mae and Freddie Mac government-sponsored-entity bonds, which eased mortgage rates, supported home prices. Other measures included mortgage modification plans, which deferred foreclosures, and tax credits, which boosted entry-level home sales.

This, of course, was The Fed's intent - prevent reversion to the mean. But did they "prevent" it or is the other 23% decline - 40% of the total, roughly - still to come no matter whether they like it or not?

The fact that many mortgage holders have negative equity in their homes stymies modification efforts. In the case of HAMP, the cost of carrying a house must be reduced to 31 percent of the owner’s pretax income. Even if permanent modification is achieved, adding other debt payments to arrive at a total debt-to-income ratio boosts the average participant’s debt burden to 63.4 percent of income. In many cases, the financial innovations of the credit boom era, enabling owners to monetize home equity, encouraged high aggregate debt.

A study found that in a best-case outcome, 20 to 25 percent of modifications will become permanent.[5] In 2008, one in three homeowners devoted at least a third of household income to housing; one in eight was burdened with housing costs of 50 percent or more.[6] Failed modifications suggest that, without strong income growth, the bounds of affordability can be stretched only so far.

Ah, recognition! The problem isn't just mortgages. It's all debt, and unfortunately, the merchants didn't confine their infestation to homes. In point of fact this is the key item in the analysis - debt service requirements are simply too high, and debt has not been written off or defaulted to any material degree.

Until it is, we cannot recover. This has been my thesis since the outset of this mess and slowly, recognition is showing up at The Fed.

With nearly half of total bank assets backed by residential real estate, both homeowners on the cusp of negative equity and the banking system as a whole remain concerned amid the resumption of home price declines.[8] This unease highlights the housing market’s fragility and suggests there may be no pain-free path to the eventual righting of the market. No perfect solution to the housing crisis exists. The latest price declines will undoubtedly cause more economic dislocation. As the crisis enters its fifth year, uncertainty is as prevalent as ever and continues to hinder a more robust economic recovery. Given that time has not proven beneficial in rendering pricing clarity, allowing the market to clear may be the path of least distress.

I'll be damned.

I actually read something intelligent from a regional Fed publication.

Ps: The entirety of the stock market's bubble behavior over the last 18 months, particularly that in the financials, depends on this not happening. Ever. Consider yourself warned that The Fed is waking up to the inevitability of their chosen path's failure, and that eventually we have to "eat" these embedded - and hidden - losses.

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