A Global Perspective On Home Ownership

From The St. Louis Fed On The Economy Blog

An excellent FED post which discusses the decoupling of home ownership from home price rises. We think the answer is simple: the financialisation of property and the availability of credit at low rates explains the phenomenon.

In the aftermath of WWII, several developed economies (such as the U.K. and the U.S.) had large housing booms fueled by significant increases in the homeownership rate. The length and the magnitude of the ownership boom varied by country, but many of these countries went from a nation of renters to a nation of owners by around the late 1970s to mid-1980s.

Historically, the cost of buying a house, relative to renting, has been positively correlated with the percent of households that own their home. From 1996 to 2006, both the price of houses and the homeownership rate increased in the U.S. This increasing trend ended abruptly with the global financial crisis that drove house prices and homeownership rates to historically low levels.

It is reasonable to expect prices and homeownership to move in the same direction. A decrease in the number of people who want to buy homes to live in could lead to a decrease in both prices and homeownership. Similarly, an increase in the number of people buying homes to live in could lead to an increase in both prices and homeownership.

However, recent evidence indicates that the cost of buying a home has increased relative to renting in several of the world’s largest economies, but the share of people owning homes has decreased. This pattern is occurring even in countries with diverging interest rate policies. It is important to delve into this fact and try to find potential explanations. (For trends in homeownership rates and price-to-rent ratios for several developed economies, see the figures at the end of this post.)

Increasing Cost of Housing

The price-to-rent ratio measures the cost of buying a home relative to the cost of renting. Factors like credit conditions or demand for homes as an investment asset affect the price of houses but not the price of rentals. These and other factors cause the price-to-rent ratio to move.

Over the period 1996-2006, the cost of buying a home grew more quickly than the cost of renting in many large economies. For example, the price-to-rent ratio in the U.S. increased by more than 30 percent between 2000 and 2006. Even larger increases occurred in the U.K. and France, where the price-to-rent ratio rose by nearly 80 percent over the same period.

The price-to-rent ratio declined in the wake of the housing crisis in the U.S., the eurozone, Spain and the U.K., but in the past few years, it has started to increase again. The price of houses is again increasing more quickly than the price of rentals.

Decreasing Homeownership

However, the homeownership rate has not increased along with the price-to-rent ratio. The homeownership rate (the percent of households that are owner-occupied) has fallen in several large economies:

  • In the U.S., the homeownership rate fell from around 69 percent before the recession to less than 64 percent in 2016.
  • In the U.K., the rate fell from nearly 69 percent to around 63 percent.
  • The homeownership rates in Germany and Italy have also fallen.

Diverging Policies

The pattern of increasing house prices and decreasing homeownership has occurred even in countries with diverging monetary policies:

  • By 2016, the Federal Reserve had ended quantitative easing and had begun raising rates in the U.S.
  • In contrast, the Bank of England and the European Central Bank continued quantitative easing throughout 2016 and reduced rates.

Nonetheless, the homeownership rate continued to fall in the U.S., the U.K. and many parts of Europe, while the price-to-rent ratio continued to increase.

Housing Supply

Several factors could be driving the decoupling of the price-to-rent ratio and the homeownership rate. From the housing supply side, there is a trend toward decreased construction of starter and midsize housing units.

Developers have increased the construction of large single-family homes at the expense of the other segments in the market. From 2010 to 2016, the fraction of new homes with four or more bedrooms increased from 38 percent to 51 percent.

This limited supply, particularly for starter homes, could result in increased prices for those homes and fewer new homeowners. One possible factor is regulatory change. The National Association of Home Builders claims that, on average, regulations account for 24.3 percent of the final price of a new single-family home. Recent increases in regulatory costs could have encouraged builders to focus on larger homes with higher margins. Supply may be just reacting to developments in demand that we discuss next.

Housing Demand

From the demand side, there are three leading explanations, which are likely complementary and self-reinforcing:

  • Changes in preferences toward homeownership
  • Changes in access to mortgage credit
  • Changes in the investment nature of real estate

Preferences for homeownership may have changed because households who lost their homes in foreclosure post-2006 may be reluctant to buy again. Also, younger generations may be less likely to own cars or houses and prefer to rent them.

Demand for ownership has also decreased because credit conditions are tighter in the post-Dodd Frank period.

Real Estate Investment

The previous demand arguments can explain why the price-to-rent ratio dropped post-2006. As rents grew relative to home prices, together with the low returns of safe assets, rental properties became a more attractive investment. This attracted real estate investors who bid up prices while depressing the homeownership rate.

Moreover, builders increased their supply of apartments and other multifamily developments. From 2006 to 2016, single-family construction projects declined from 81 percent to 67 percent of all housing starts.

There are several types of real estate investors:

  • “Mom and dad” investors looking for investment income
  • Foreign investors who have increased real estate prices in many of the major cities of the world
  • Institutional landlords like Invitation Homes or American Homes 4 Rent

In fact, since 2016 the real estate industry group has been elevated to the sector level, effective in the S&P U.S. Indices.

In addition, the widespread use of internet rental portals such as Airbnb and VRBO has increased the opportunity to offer short-term leases, increasing the revenue stream from rental housing.

There are several potential explanations, but more research is needed to determine the cause of the decoupling of house prices from homeownership rates and what it means for the economy.

Rent vs Owning in U.S.

Rent vs Owning in Eurozone

Rent vs Owning in Canada

Rent vs Owning in Spain

Rent vs Owning in Germany

Rent vs Owning in UK

Authors: Carlos Garriga, Vice President and Economist; Pedro Gete, IE Business School; and Daniel Eubanks, Senior Research Associate

FED To “Tailor” Leverage Ratios

In another sign of weakening banking supervision, the FED proposes new rules to  “tailor leverage ratio requirements“.  Tailoring appears to mean reduce!

The Federal Reserve Board and the Office of the Comptroller of the Currency (OCC) on Wednesday proposed a rule that would further tailor leverage ratio requirements to the business activities and risk profiles of the largest domestic firms.

Currently, firms that are required to comply with the “enhanced supplementary leverage ratio” are subject to a fixed leverage standard, regardless of their systemic footprint. The proposal would instead tie the standard to the risk-based capital surcharge of the firm, which is based on the firm’s individual characteristics. The resulting leverage standard would be more closely tailored to each firm.

The proposed changes seek to retain a meaningful calibration of the enhanced supplementary leverage ratio standards while not discouraging firms from participating in low-risk activities. The changes also correspond to recent changes proposed by the Basel Committee on Banking Supervision. Taking into account supervisory stress testing and existing capital requirements, agency staff estimate that the proposed changes would reduce the required amount of tier 1 capital for the holding companies of these firms by approximately $400 million, or approximately 0.04 percent in aggregate tier 1 capital.

Enhanced supplementary leverage ratio standards apply to all U.S. holding companies identified as global systemically important banking organizations (GSIBs), as well as the insured depository institution subsidiaries of those firms.

Currently, GSIBs must maintain a supplementary leverage ratio of more than 5 percent, which is the sum of the minimum 3 percent requirement plus a buffer of 2 percent, to avoid limitations on capital distributions and certain discretionary bonus payments. The insured depository institution subsidiaries of the GSIBs must maintain a supplementary leverage ratio of 6 percent to be considered “well capitalized” under the agencies’ prompt corrective action framework.

At the holding company level, the proposed rule would modify the fixed 2 percent buffer to be set to one half of each firm’s risk-based capital surcharge. For example, if a GSIB’s risk-based capital surcharge is 2 percent, it would now be required to maintain a supplementary leverage ratio of more than 4 percent, which is the sum of the unchanged minimum 3 percent requirement plus a modified buffer of 1 percent. The proposal would similarly tailor the current 6 percent requirement for the insured depository institution subsidiaries of GSIBs that are regulated by the Board and OCC.

The Housing Boom Is “Officially” Over – The Property Imperative 07 Apr 2018

Welcome to the Property Imperative Weekly to 07 April 2018.

Watch the video, or read the transcript.

In this week’s digest of finance and property news, we start with Paul Keating’s (he of the recession we had to have fame), comment that the housing boom is really over at the recent AFR conference.

He said that the banks were facing tighter controls as a result of the Basel rules on capital adequacy, while financial regulators had had a “gutful” of them. This was likely to lead to changes that would restrict the banks’ ability to lend. He cited APRA’s recent interventions in interest only loans as one example, as they restrict their growth. Keating also said the royal commission into misconduct in the banking and financial services sector would also “make life harder” for the banks and pointed out that banks did not really want to lend to business these days and would “rather just do housing loans”. Finally, he spoke of the “misincentives” within the big banks to grow their business by writing new mortgages, including having a high proportion of interest-only lending.

Anna Bligh speaking at the AFR event, marked last Tuesday her first year as CEO of the Australian Banking Association (ABA) – but said she feels “like 500 years” have already passed. Commenting on the Royal Commission she warned that credit could become tighter ahead. The was she said an opportunity for a major reset, not only in how we do banking but how we think about it, its place in our lives, its role in our economy and, most of all, it’s trustworthiness”.

At the same conference, Rod Simms the Chair of the ACCC speech “Synchronised swimming versus competition in banking” He discussed the results of their recent investigation into mortgage pricing, and also discussed the broader issues of competition versus financial stability in banking. He warned that the industry should be aware of, and respond to, the fact that the drive for consumers to get a better deal out of banking is shared by many beyond the ACCC. Every household in Australia is watching.  You can watch our video blog on this for more details.

He specifically called out a lack of vigorous mortgage price competition between the five big Banks, hence “synchronised swimming”. Indeed, he says discounting is not synonymous with vigorous price competition. They saw evidence of communications “referring to the need to avoid disrupting mutually beneficial pricing outcomes”.

He also said residential mortgages and personal banking more generally make one of the strongest cases for data portability and data access by customers to overcome the inertia of changing lenders.

Finally, on competition. he says if we continue to insulate our major banks from the consequences of their poor decisions, we risk stifling the cultural change many say is needed within our major banks to put the needs of their customers first. Vigorous competition is a powerful mechanism for driving improved efficiency, and also for driving improved price and service offerings to customers. It can in fact lead to better stability outcomes.

This puts the ACCC at odds with APRA who recent again stated their preference for financial stability over competition – yet in fact these two elements are not necessarily polar opposites!

Then there was the report from the good people at UBS has published further analysis of the mortgage market, arguing that the Royal Commission outcomes are likely to drive a further material tightening in mortgage underwriting. As a result, they think households “borrowing power” could drop by ~35%, mainly thanks to changes to analysis of expenses, as the HEM benchmark, so much critised in the Inquiry, is revised. Their starting point assumes a family of four has living expenses equal to the HEM ‘Basic’ benchmark of $32,400 p.a. (ie less than the Old Age Pension). This is broadly consistent with the Major banks’ lending practices through 2017. As a result, the borrowing limits provided by the banks’ home loan calculators fell by ~35% (Loan-to-Income ratio fell from ~5-6x to ~3-4x). This leads to a reduction in housing credit and a further potential fall in home prices.

Our latest mortgage stress data, which was picked by Channel Nine and 2GB, thanks to Ross Greenwood, Across Australia, more than 956,000 households are estimated to be now in mortgage stress (last month 924,500). This equates to 30.0% of households. In addition, more than 21,000 of these are in severe stress, no change from last month. We estimate that more than 55,000 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.8 basis points, though with losses in WA are higher at 4.9 basis points.  Flat wages growth, rising living costs and higher real mortgage rates are all adding to the burden. This is not sustainable and we are expecting lending growth to continue to moderate in the months ahead as underwriting standards are tightened and home prices fall further”. The latest household debt to income ratio is now at a record 188.6. You can watch our separate video blog on this important topic.

ABS data this week showed The number of dwellings approved in Australia fell for the fifth straight month in February 2018 in trend terms with a 0.1 per cent decline. Approvals for private sector houses have remained stable at around 10,000 for a number of months. But unit approvals have fallen for five months. Overall, building activity continues to slow from its record high in 2016. And the sizeable fall in the number of apartments and high density dwellings being approved comes at a time when a near record volume are currently under construction. If you assume 18-24 months between approval and completion, then we still have 150,000 or more units, mainly in the eastern urban centres to come on stream. More downward pressure on home prices. This helps to explain the rise in 100% loans on offer via some developers plus additional incentives to try to shift already built, or under construction property.

CoreLogic reported  last week’s Easter period slowdown saw 670 homes taken to auction across the combined capital cities, down significantly on the week prior when a record number of auctions were held (3,990). The lower volumes last week returned a higher final clearance rate, with 64.8 per cent of homes selling, increasing on the 62.7 per cent the previous week.  Both clearance rate and auctions volumes fell across Melbourne last week, with only 152 held and 65.5 per cent clearing, down on the week prior when 2,071 auctions were held across the city returning a slightly higher 65.8 per cent success rate.

Sydney had the highest volume of auctions of all the capital city auction markets last week, with 394 held and a clearance rate of 67.9 per cent, increasing on the previous week’s 61.1 per cent across a higher 1,383 auctions.

Across the smaller capital cities, clearance rates improved week-on-week in Canberra, Perth and Tasmania; however, volumes were significantly lower across each market last week compared to the week prior.

Across the non-capital city auction markets, the Geelong region recorded the strongest clearance rate last week with 100 per cent of the 20 auction results reporting as successful.

The number of homes scheduled to go to auction this week will increase across the combined capital cities with 1,679 currently being tracked by CoreLogic, up from last week when only 670 auctions were held over the Easter period slowdown.

Melbourne is expected to see the most significant increase in volumes this, with 669 properties scheduled for auction, up from 152 auctions held last week. In Sydney, 725 homes are set to go to auction this week, increasing on the 394 held last week.

Outside of Sydney and Melbourne, each of the remaining capital cities will see a higher number of auctions this week compared to last week.

Overall auction activity is set to be lower than one year ago, when 3,517 were held over what was the pre-Easter week last year.

Finally, with local news all looking quite negative, let’s look across to the USA as the most powerful banker in the world, JPMorgan Chase CEO Jamie Dimon, just released his annual letter to shareholders.  Given his bank’s massive size (it earned $24.4 billion on $103.6 billion in revenue last year) and reach (it’s a giant in consumer/commercial banking, investment banking and wealth management), Dimon has his figure on the financial pulse.

He says that’s while the US economy seems healthy today and he’s bullish for the “next year or so” he admits that the US is facing some serious economic headwinds.

For one, he’s concerned the unwinding of quantitative easing (QE) could have unintended consequences. Remember- QE is just a fancy name for the trillions of dollars that the Federal Reserve conjured out of thin air.

He said – Since QE has never been done on this scale and we don’t completely know the myriad effects it has had on asset prices, confidence, capital expenditures and other factors, we cannot possibly know all of the effects of its reversal.

We have to deal with the possibility that at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate – reacting to the markets, not guiding the markets.

And of course the DOW finished the week on a down trend, down 2.34%, and wiping out all the value gained this year, and volatility is way up. Here is a plot of the DOW.

This extreme volatility does suggest the bull market is nearing its end… if it hasn’t ended already. Dimon seems pretty sure we’re in for more volatility and higher interest rates. One scenario that would require higher rates from the Fed is higher inflation:

If growth in America is accelerating, which it seems to be, and any remaining slack in the labor markets is disappearing – and wages start going up, as do commodity prices – then it is not an unreasonable possibility that inflation could go higher than people might expect.

As a result, the Federal Reserve will also need to raise rates faster and higher than people might expect. In this case, markets will get more volatile as all asset prices adjust to a new and maybe not-so-positive environment.

Now– here’s the important part. For the past ten years, the largest buyer of US government debt was the Federal Reserve. But now that QE has ended, the US government just lost its biggest lender.

Dimon thinks other major buyers, including foreign central banks, the Chinese, etc. could also reduce their purchases of US government debt. That, coupled with the US government’s ongoing trade deficits (which will be funded by issuing debt), could also lead to higher rates…

So we could be going into a situation where the Fed will have to raise rates faster and/ or sell more securities, which certainly could lead to more uncertainty and market volatility. Whether this would lead to a recession or not, we don’t know.

We’ll leave you with one final point from Jamie Dimon. He acknowledges markets have a mind of their own, regardless of what the fundamentals say. And he sees a real risk “that volatile and declining markets can lead to a market panic.”

Financial markets have a life of their own and are sometimes barely connected to the real economy (most people don’t pay much attention to the financial markets nor do the markets affect them very much). Volatile markets and/or declining markets generally have been a reaction to the economic environment. Most of the major downturns in the market since the Great Depression reflect negative future expectations due to a potential or real recession. In almost all of these cases, stock markets fell, credit losses increased and credit spreads rose, among other disruptions. The biggest negative effect of volatile markets is that it can create market panic, which could start to slow the growth of the real economy. Because the experience of 2009 is so recent, there is always a chance that people may overreact.

Dimon cautioned investors that interest rates could rise much sooner than they expect. If inflation suddenly comes roaring back. Indeed, it’s entirely possible the 10-year could break above 4% in the near future as inflation returns to 2% and the Fed shrinks its balance sheet.

Dimon also cast a wary eye toward exchange-traded funds, which have seen their popularity multiply since the financial crisis. There are now many ETF products that are considerably more liquid than their underlying assets. In fact far more money than before (about $9 trillion of assets, which represents about 30% of total mutual fund long-term assets) is managed passively in index funds or ETFs (both of which are very easy to get out of). Some of these funds provide far more liquidity to the customer than the underlying assets in the fund, and it is reasonable to worry about what would happen if these funds went into large liquidation.

And Finally America’s net debt currently stands at 77% of GDP (this is already historically high but not unprecedented). The chart below also shows the Congressional Budget Office’s estimate of the total U.S. debt to GDP, assuming a 2% real GDP growth rate. Hopefully, with the right policies they can grow faster than 2%. But more debt does seem on the cards.

And to add to that perspective, we spoke about the recent Brookings report which highlighted the rise in non conforming housing debt in the USA. debt as lending standards are once again being loosened, and risks to mortgage services are rising.

The authors quote former Ginnie Mae president Ted Tozer concerning the stress between Ginnie Mae and their nonbank counterparties.

… Today almost two thirds of Ginnie Mae guaranteed securities are issued by independent mortgage banks. And independent mortgage bankers are using some of the most sophisticated financial engineering that this industry has ever seen. We are also seeing greater dependence on credit lines, securitization involving multiple players, and more frequent trading of servicing rights and all of these things have created a new and challenging environment for Ginnie Mae. . . . In other words, the risk is a lot higher and business models of our issuers are a lot more complex. Add in sharply higher annual volumes, and these risks are amplified many times over. . . . Also, we have depended on sheer luck. Luck that the economy does not fall into recession and increase mortgage delinquencies. Luck that our independent mortgage bankers remain able to access their lines of credit. And luck that nothing critical falls through the cracks…

They say that goldfish have the shortest memory in the Animal Kingdom… something like 3-seconds. But not even a decade after these loans nearly brought down the entire global economy, SUBPRIME IS BACK. In fact it’s one of the fastest growing investments among banks in the United States. Over the last twelve months the subprime volume among US banks doubled, and it’s already on pace to double again this year.

What could possibly go wrong?

Fed Lifts Commercial Real Estate Limit

In a further sign of loosening of rules in the US, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency issued a final rule that increases the threshold for commercial real estate transactions requiring an appraisal from $250,000 to $500,000.

They say the increased threshold will not pose a threat to the safety and soundness of financial institutions. “Commenters opposing an increase to the commercial real estate appraisal threshold asserted that an increase would elevate risks to financial institutions, the banking system, borrowers, small business owners, commercial property owners, and taxpayers. Several of these commenters asserted that the increased risk would not be justified by burden relief”.

The agencies originally proposed to raise the threshold, which has been in place since 1994, to $400,000, but determined that a $500,000 threshold will materially reduce regulatory burden and the number of transactions that require an appraisal. The agencies also determined that the increased threshold will not pose a threat to the safety and soundness of financial institutions.

The final rule allows a financial institution to use an evaluation rather than an appraisal for commercial real estate transactions exempted by the $500,000 threshold. Evaluations provide a market value estimate of the real estate pledged as collateral, but do not have to comply with the Uniform Standards of Professional Appraiser Practices and do not require completion by a state licensed or certified appraiser.

The final rule responds, in part, to concerns financial industry representatives raised that the current threshold level had not kept pace with price appreciation in the commercial real estate market in the 24 years since the threshold was established and about regulatory burden during the Economic Growth and Regulatory Paperwork Reduction Act review process completed in March 2017.

The Looming Mortgage Liquidity Crisis

From The Mises Wire.

Every 10 years or so there is a banking crisis. We are due. However, the furthest thing from most people’s minds with the Trump boom is a banking/financial crisis, except for a few folks at the Brookings Institution, who just released a paper entitled “Liquidity Crisis in the Mortgage Market.”

You Suk Kim, of the Federal Reserve Board; Steven M. Laufer, who also labors on the Federal Reserve Board along with Karen Pence, plus, Richard Stanton of the University of California, Berkeley, and Nancy Wallace, also of University of California, Berkeley, to give away the punchline from their paper’s abstract, write, “We describe in this paper how nonbank mortgage companies are vulnerable to liquidity pressures in both their loan origination and servicing activities, and we document that this sector in aggregate appears to have minimal resources to bring to bear in a stress scenario.”

John and Joan Q. Public believe the 2018 mortgage business is like George Bailey’s Building & Loan in “It’s a Wonderful Life.” People deposit money, bankers lend it out, keeping the mortgage on their books. Easy Peasy.

As the folks from Brookings point out, it’s not that easy in these dark days of financial engineering. George Bailey’s handshake, promise and maybe a few words on a document to be signed by the borrower which meant simply, “I’ll pay you back,” has become a financial instrument, to be traded and hypothecated by faceless financial bureaucrats, each one taking a sliver of profit off the top.

Everyone remembers the crash of 2008 and plenty explanations have been posited. What the writers for Brookings explain is,

The literature has been largely silent on the liquidity vulnerabilities of the short-term loans that funded nonbank mortgage origination in the pre-crisis period, as well as the liquidity pressures that are typical in mortgage servicing when defaults are high. These vulnerabilities in the mortgage market were also not the focus of regulatory attention in the aftermath of the crisis.

They continue,

Of particular importance, these liquidity vulnerabilities are still present in 2018, and arguably the potential for liquidity issues associated with mortgage servicing is even greater than pre-financial crisis. These liquidity issues have become more pressing because the nonbank sector is a larger part of the market than it was pre-crisis, especially for loans securitized in pools with guarantees by Ginnie Mae.

George Bailey and his little financial institution are nowhere to be found.

The authors quote former Ginnie Mae president Ted Tozer concerning the stress between Ginnie Mae and their nonbank counterparties.

… Today almost two thirds of Ginnie Mae guaranteed securities are issued by independent mortgage banks. And independent mortgage bankers are using some of the most sophisticated financial engineering that this industry has ever seen. We are also seeing greater dependence on credit lines, securitization involving multiple players, and more frequent trading of servicing rights and all of these things have created a new and challenging environment for Ginnie Mae. . . . In other words, the risk is a lot higher and business models of our issuers are a lot more complex. Add in sharply higher annual volumes, and these risks are amplified many times over. . . . Also, we have depended on sheer luck. Luck that the economy does not fall into recession and increase mortgage delinquencies. Luck that our independent mortgage bankers remain able to access their lines of credit. And luck that nothing critical falls through the cracks…

Tozer said these words in 2015. The mortgage engine is built for perfection: a thriving economy, with low interest rates, allowing everyone, from the mortgage borrowers to the credit line providers and securitizers to keep their promises.

However, the world is anything but perfect.

Nonbank mortgage providers essentially borrow short and lend long, using warehouse lines of credit from banks to fund mortgages. From 2012 to the third quarter of 2017, commitments on warehouse lines has increased 70 percent. Of course, if all goes well, a mortgage will be sold quickly into the secondary market (on average 15 days) and the line will be reduced.

The Brookings authors identify three vulnerabilities in the process.

1) margin calls due to aging risk (i.e., the time it takes the nonbank to sell the loans to a mortgage investor and repurchase the collateral) and/or mark-to-market devaluations, 2) roll-over risk and 3) covenant violations leading to cancellation of the lines.

These vulnerabilities are very real, should there be a sudden increase in interest rates or other significant change in the market that causes collateral values to drop. Most nonbank lenders have multiple warehouse lines. However, cross default provisions will trigger a scramble amongst warehouse lenders for a mortgage originator’s assets should it default on one of its lines.

The authors explain,

These sources of warehouse credit began to dry up rapidly in the run-up to the financial crisis as the slowdown in the securitization markets made it difficult for the nonbanks to move loan originations off the warehouse lines and the premiums paid for subprime warehoused loans evaporated. In 2006:Q4 there were 90 warehouse lenders in the U.S. with about $200 billion of outstanding committed warehouse lines; however, by 2008:Q2 there were only 40 warehouse lenders with outstanding committed lines of $20–25 billion, a decline exceeding 85%.34 By March of 2009, there were only 10 warehouse lenders in the U.S. In addition, runs on SIVs led to the collapse of this form of warehouse funding by the end of 2007 … and it has not returned as a funding source post-crisis.

Mortgage servicers have liquidity issues because they are required to continue making payments to investors, tax authorities, and insurers if mortgage borrowers quit making payments. Servicers are eventually reimbursed for these “servicing advances,” however, they need to finance the advances in the interim.


For example, servicers were stressed last year when hurricane victims were allowed payment forbearance by Ginnie Mae and the GSEs. Fortunately, the servicers were geographically diversified enough to manage through the strain.

Again, everything is dandy if borrowers make their payments. However, as Mike “Mish” Shedlock explains,

Nonbanks are vulnerable to macroeconomic shocks, rising interest rates, home price declines and job losses, often with a bare minimum down payment.

This is happening while debt-to-income DTI ratios are on the rise (Fannie Mae increased its DTI ceiling from 45 percent to 50 percent last July 29) and median FICO scores are dropping.

This is hardly surprising given homes are not affordable.

The crash clock is ticking.

Deja Vu All Over Again? Subprime MBS Demand “Oversubscribed” And S&P Says Risk Is “Contained”

From Zero Hedge.

The stock market is at record highs and people with FICO scores as low as 500 are once again happily obtaining mortgages. Not only that, but these mortgages are once again being securitized and are in demand by yield chasers.

All of the elements that are necessary for the 2008 subprime crisis to repeat itself are starting to fall back into place. Aside from the fact that we have inflated bubbles across basically all asset classes for the most part, not the least of which is evident in the stock market, the Financial Times reported today that not only are subprime mortgage backed securities becoming prominent again, but that the chase for yield was what fueling demand:

Issuance of securities backed by riskier US mortgages roughly doubled in the first quarter from a year earlier, as investors lapped up assets blamed for bringing the global financial system to the brink of collapse a decade ago. Home loans to people with scratches and dents in their credit histories dwindled to almost nothing in the aftermath of the crisis, as litigation-weary lenders retreated to patch up their balance sheets.

But over the past couple of years a group of specialist firms has begun to bring the loans back, navigating a dense web of new rules drawn up to protect borrowers and investors in the $9.3tn US home-loan market. Last year saw issuance of $4.1bn of securities backed by loans that would have been called “subprime” before the last financial crisis, according to figures from Inside Mortgage Finance, with the pace picking up in the latter half of the year. The momentum has continued into 2018, with deals worth $1.3bn in the first quarter — twice the $666m issued in the same period a year earlier.

Our central banks have done such a great job of getting us out of our last crisis that the recovery has prompted a mortgage originators and real estate investors to basically do the same exact thing that they were doing 2006 to 2007. After all, mortgage levels are already almost back to 2008 levels.

If that wasn’t disturbing enough, the hedge fund partner that FT quotes in the article says that the subprime market has “a lot of room to grow“ as if it were some type of new emerging market generating productivity, and not just a carbon copy repeat of exactly what happen nearly 10 years ago.

“The market is . . . starting from such a small base that it has a lot of room to grow,” said Jamshed Engineer, a partner at Axonic Capital, a New York hedge fund with more than $2bn in assets under management.

“[Investors] are definitely chasing yields. Whenever these deals come out, for the most part, they are oversubscribed.”

The Financial Times article tries to couch the fact that all hell could be breaking loose yet again at some point soon by citing Dodd Frank reforms that we reported in March are already past the Senate. The key provisions of the rollback are:

  • Relaxes a host of reporting requirements for small – medium banks, and to a smaller extent, large banks
  • Eliminates a reporting requirement introduced by Dodd-Frank designed to avoid discriminatory lending
  • Relaxes stress testing requirements intended to show how banks would survive another financial crisis
  • Raises the threshold for banks which are not subject to enhanced liquidity requirements, stress tests, and enhanced risk management, from $50 billion to $250 billion – exempting several institutions which could pose systemic risks down the road.
  • Allows megabanks such as Citi to count municipal bonds as “highly liquid assets” that could be used towards the “liquidity coverage ratio,” – assets which can be quickly liquidated during a crisis.
  • Calls for a report on the risks and benefits of algorithmic trading within 18 months

Despite the fact that the FT states that 500 FICO scores are getting approved for mortgages, S&P, one of the willfully ignorant and blind rating agencies that missed the subprime crisis thinks that everything is going to be fine:

“The risk is contained, in our view,” said Mr Saha.

For the way that our Federal Reserve has addressed the problems of 2007 or 2008, these are the end results that they deserve, but the American people ultimately do not.

China Can Cope With US Tariffs, But Trade Risks Rising

The US government’s proposal to impose tariffs on USD50 billion-USD60 billion worth of imports from China is unlikely to have a significant impact on the Chinese or global economy, says Fitch Ratings.

The risk that piecemeal protectionist measures escalate into a more damaging trade war has risen in recent months, but China’s measured response so far and US indications of openness to negotiation suggest this scenario should still be avoided.

The US administration has proposed the tariffs in response to what it considers to be unfair Chinese trade policies that have led to the acquisition of US technologies – invoking the authority provided by Section 301 of the US Trade Act. Aerospace, information and communication technology, and machinery will be targeted, with details due within the next two weeks. The administration will also consider measures to block Chinese acquisition of US technology through M&A and press the World Trade Organization to examine China’s technology licensing practices.

USD60 billion is equivalent to around 2.5% of China’s total merchandise exports, or 0.5% of its GDP, but the impact of the tariffs on the Chinese economy would be much smaller. Some of these goods will still end up going to the US, given the lack of substitutes, while others could be diverted to different markets. Moreover, the domestic value-added content of China’s exports is typically only around two-thirds, or less than one-half in the case of ICT goods, which contain a high proportion of imported inputs. Overall, we would not expect these tariffs to create a drag on Chinese GDP growth of much more than 0.1 percentage point this year.

The bigger risk is that the US eventually imposes across-the-board tariffs on China, either because its bilateral trade deficit with China stays large or in the context of an escalating trade war between the two countries. The US accounts for almost one-fifth of China’s total exports, equivalent to 3.6% of Chinese GDP, so broader tariffs could have a sizeable impact on China’s economy, and would have knock-on effects for the supply chain across the rest of Asia. A China-US trade war would also undermine global investor sentiment.

This more severe scenario cannot be ruled out, but we still expect new policies, either from the US or China in retaliation, to continue to fall under sector-specific measures. China has announced its own tariffs targeting USD3 billion worth of US agricultural goods in response to previous US tariffs on steel and aluminium, but Premier Li Keqiang has stated that “a trade war does no good to either side”. Meanwhile, US President Donald Trump has stated that the US and China are in negotiations. In that respect, the 30-day consultation period following the release of US tariff details should temper the prospect of immediate escalation and could provide time for a compromise to be reached.

A more challenging external environment could add to the risk of Chinese policymakers falling back on credit-fuelled stimulus, which would also be a major setback to the deleveraging agenda. Strong external demand was a key factor behind the outperformance of China’s economy last year, which allowed the authorities to focus on addressing financial risks without jeopardising GDP growth targets.

The Financial Market Earthquakes – The Property Imperative Weekly 24 March 2018

Today we examine the recent Financial Market Earthquakes and ask, are these indicators of more trouble ahead?

Welcome to the Property Imperative Weekly to 24th March 2018. Watch the video or read the transcript.

In this week’s review of property and finance news we start with the recent market movements and consider the impact locally.

The Dow 30 has come back, slumping more than 1,100 points between Thursday and Friday, and ending the week in correction territory – meaning down more than 10% from its recent high.

The volatility index – the VIX which shows the perceived risks in the financial markets also rose, up 6.5% just yesterday to 24.8, not yet at the giddy heights it hit in February, but way higher than we have seen for a long time – so perceived risks are higher.

And the Aussie Dollar slipped against the US$ to below 77 cents from above 80, and it is likely to drift lower ahead, which may help our export trade, but will likely lead to higher costs for imports, which in turn will put pressure on inflation and the RBA to lift the cash rate. The local stock market was also down, significantly. Here is a plot of the S&P ASX 100 for the past year or so. We are back to levels last seen in October 2017. Expect more uncertainty ahead.

So, let’s look at the factors driving these market gyrations. First of course U.S. President Donald Trump’s signed an executive memorandum, imposing tariffs on up to $50 billion in Chinese imports and in response the Dow slumped more than 700 points on Thursday. There was a swift response from Beijing, who released a dossier of potential retaliation targets on 128 U.S. products. Targets include wine, fresh fruit, dried fruit and nuts, steel pipes, modified ethanol, and ginseng, all of which could see a 15% duty, while a 25% tariff could be imposed on U.S. pork and recycled aluminium goods. We also heard Australia’s exemptions from tariffs may only be temporary.

Some other factors also weighed on the market. Crude oil prices rose more than 5.5% this week as following an unexpected draw in U.S. crude supplies and rising geopolitical tensions in the middle east. Crude settled 2.5% higher on Friday after the Saudi Energy Minister said OPEC and non-OPEC members could extend production cuts into 2019 to reduce global oil inventories. Here is the plot of Brent Oil futures which tells the story.

Bitcoins promising rally faded again.  Earlier Bitcoin rallied from a low of $7,240 to a high of $9175.20 thanks to easing fears that the G20 meeting Monday would encourage a crackdown on cryptocurrencies. Finance ministers and central bankers from the world’s 20 largest economies only called on regulators to “continue their monitoring of crypto-assets” and stopped short of any specific action to regulate cryptocurrencies. So Bitcoin rose 2% over the past seven days, Ripple XRP fell 8.93%and Ethereum fell 14.20%. Crypto currencies remain highly speculative. I am still working on my more detailed post, as the ground keeps shifting.

Gold prices enjoyed one of their best weeks in more than a month buoyed by a flight-to-safety as investors opted for a safe-haven thanks to the events we have discussed. However, the futures data shows many traders continued to slash their bullish bets on gold. So it may not go much higher. So there may be no relief here.

Then there was the Federal Reserve statement, which despite hiking rates by 0.25%, failed to add a fourth rate hike to its monetary policy projections and also scaled back its labour market expectations. Some argued that the Fed’s decision to raise its growth rate but keep its outlook on inflation relatively unchanged was dovish. Growth is expected to run at 3%, but core inflation is forecast for 2019 and 2020 at 2.10%.  They did, however, signal a faster pace of monetary policy tightening, upping its outlook on rates for both 2019 and 2020. You can watch our separate video blog on this. The “dots” chart also shows more to come, up to 8 lifts over two years, which would take the Fed rate to above 3%.  The supporting data shows the economy is running “hot” and inflation is expected to rise further. This will have global impact.  The era of low interest rates in ending. The QE experiment is also over, but the debt legacy will last a generation.

All this will have a significant impact on rates in the financial markets, putting more pressure on borrowing companies in the US, and the costs of Government debt. US mortgage interest rates rose again, a precursor to higher rates down the track.

Moodys’ said this week, that the U.S.’ still relatively low personal savings rate questions how easily consumers will absorb recent and any forthcoming price hikes. Moreover, the recent slide by Moody’s industrial metals price index amid dollar exchange rate weakness hints of a levelling off of global business activity.

The flow on effect of rate rises is already hitting the local banks in Australia.  To underscore that here is a plot of the A$ Bill/OIS Swap rate, a critical benchmark for bank funding. In fact, looking over the past month, the difference, or spread has grown by around 20 basis points, and is independent from any expectation of an RBA rate change.  The BBSW is the reference point used to set interest rates on most business loans, and also flows through to personal lending rates and mortgages.

As a result, there is increasing margin pressure on the banks. In the round, you can assume a 10 basis point rise in the spread will translate to a one basis point loss of margin, unless banks reduce yields on deposit accounts, or lift mortgage rates. Individual banks ae placed differently, with ANZ most insulated, thanks to their recent capital initiatives, and Suncorp the most exposed.

In fact, Suncorp already announced that Variable Owner Occupier Principal and Interest rates will rise by 5 basis points. Variable Investor Principal and Interest rates will increase by 8 basis points, and Variable Interest Only rates increase go up by 12 basis points. In addition, their variable Small Business rates will increase by 15 basis points and their business Line of Credit rates will increase by 25 basis points. Expect more ahead from other lenders.  The key takeaway is that funding costs in Australia are going up at a time when the RBA is stuck in neutral. It highlights how what happens with rates and in money markets overseas, and particularly in the US, can have repercussions here – repercussions that many are possibly unprepared for.

Locally, the latest Australian Bureau of Statistics showed that home prices to December 2017 fell in Sydney over the past quarter, along with Darwin. Other centres saw a rise, but the rotation is in hand. Overall, the price index for residential properties for the weighted average of the eight capital cities rose 1.0% in the December quarter 2017. The index rose 5.0% through the year to the December quarter 2017.

The capital city residential property price indexes rose in Melbourne (+2.6%), Perth (+1.1%), Brisbane (+0.9%), Hobart (+3.9%), Canberra (+1.7%) and Adelaide (+0.6%) and fell in Sydney (-0.1%) and Darwin (-1.5%). You can watch our separate video on this, where we also covered in more detail the January 2018 mortgage default data from Standard & Poor’s. It increased to 1.30% from 1.07% in December. No area was exempt from the increase with loans in arrears by more than 30 days increasing in January in every state and territory. Western Australia remains the home of the nation’s highest arrears, where loans in arrears more than 30 days rose to 2.44% in January from 2.08% in December, reaching a new record high. Conversely, New South Wales continues to have the lowest arrears among the more populous states at 0.98% in January. Moody’s is now expecting a 10% correction in some home prices this year.

According to latest figures released by the Australian Bureau of Statistics (ABS), the seasonally adjusted unemployment rate increased to 5.6 per cent and the labour force participation rate increased by less than 0.1 percentage points to 65.7 per cent.  The number of persons employed increased by 18,000 in February 2018. So no hints of any wage rises soon, as it is generally held that 5% unemployment would lead to higher wages – though even then, I am less convinced.

The latest final auction clearance results from CoreLogic, published last Thursday showed the final auction clearance rate across the combined capital cities rose to 66 per cent across a total of 3,136 auctions last week; making it the second busiest week for auctions this year, compared with 63.3 per cent the previous week, and still well down from 74.1 per cent a year ago. Although Melbourne recorded its busiest week for auctions so far this year with a total of 1,653 homes taken to auction, the final auction clearance rate across the city fell to 68.7 per cent, down from the 70.8 per cent over the week prior.  In Sydney, the final auction clearance rate increased to 64.8 per cent last week, from 62.2 per cent the week prior. Across the smaller auction markets, clearance rates improved in Brisbane, Perth and Tasmania, while Adelaide and Canberra both returned a lower success rate over the week. They say Geelong was the best performing non-capital city region last week, with 86.1 per cent of the 56 auctions successful. However, the Gold Coast region was host to the highest number of auctions (60). This week they are expecting a high 3,689 planned auctions today, so we will see where the numbers end up. I am still digging into the clearance rate question, and should be able to post on this soon. But remember that number, 3,689, because the baseline seems to shift when the results arrive.

As interest rates rise, in a flat income environment, we expect the problems in the property and mortgage sector to show, which is why our forward default projections are higher ahead. We will update that data again at the end of the month. Household Financial Confidence also drifted lower again as we reported. It fell to 94.6 in February, down from 95.1 the previous month. This is in stark contrast to improved levels of business confidence as some have reported. Our latest video blog covered the results.

Finally, The Royal Commission of course took a lot of air time this week, and I did a separate piece on the outcomes yesterday, so I won’t repeat myself. But suffice it to say, we think the volume of unsuitable mortgage loans out there is clearly higher than the lenders want to admit. Mortgage Broking will also get a shake out as we discussed on the ABC this week.  And that’s before they touch on the wealth management sector!

We think there are a broader range of challenges for bankers, and their customers, as I discussed at the Customer Owned Banking Association conference this week.  There is a separate video available, in which you can hear about what the future of banking will look like and the importance of customer centricity. In short, more disruption ahead, but also significant opportunity, if you know where to look. I also make the point that ever more regulation is a poor substitute for the right cultural values.  At the end of the day, a CEO’s overriding responsibility is to define the right cultural values for the organisation, and the major banks have been found wanting. A quest for profit at any cost will ultimately destroy a business if in the process it harms customers, and encourages fraud and deceit. You simply cannot assume banks will do the right thing, unless the underlying corporate values are set right.  Remember Greenspans testimony after the GFC, when he said “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.”

U.S. Mobile Payments Survey Shows Banks Still Trying To Catch Paypal

JPMorgan Chase & Co. has work to do if it wants Chase Pay to have the same kind of customer adoption as PayPal Holdings Inc.’s digital wallet, based on the results of a recent survey commissioned by S&P Global Market Intelligence.

About 39% of the individuals that used a mobile payment app to pay for an in-store retail purchase in the 30 days prior to taking the survey had used PayPal, versus 13% for Chase Pay.

This was one of several findings of the survey, which began with 904 respondents. Of those, 405 had not used a mobile payment app in the past 30 days, which gave us insight into why respondents would not want to use such services. The 499 that did use mobile payment services, meanwhile, yielded clues on what people do with their apps, such as the aforementioned in-store retail purchases.

Despite offering alternative services, Chase Pay recently partnered with PayPal, letting clients link their cards to their PayPal accounts through Chase Pay to access the PayPal wallet. This is not uncommon, as PayPal partners with other large banks and credit card issuers, such as Bank of America Corp. and Citigroup Inc., to link customer cards to their app. And as our survey data illustrated, respondents often used more than one wallet service.

PayPal also dominated in the survey question regarding person-to-person payments. Nearly 70% of those that had transferred money to an individual used PayPal, and the third most-used app was Venmo, which PayPal also owns. 

Based on our survey, bank apps were slightly more popular than Venmo for person-to-person payments, with about 25% of respondents saying they had used a mobile bank app and about 23% saying they had used Venmo.

Elevated US Leverage and Rate Rises

Markets are beginning to ask whether companies will be capable of passing on higher costs to the U.S.’ less than financially robust middle class, according to Moodys.

The U.S.’ still relatively low personal savings rate questions how easily consumers will absorb recent and any forthcoming price hikes. Moreover, the recent slide by Moody’s industrial metals price index amid dollar exchange rate weakness hints of a leveling off of global business activity.

Missing from last week’s discussion of a record ratio of U.S. nonfinancial-corporate debt to GDP was any mention of 2017’s near-record high ratio of total U.S. private and public nonfinancial-sector debt relative to GDP. The yearlong averages of 2017 showed $49.05 trillion of total nonfinancial-sector debt and $19.74 trillion of nominal GDP that put nonfinancial-sector debt at 249% of GDP—or just a tad under 2016’s record 250%.

The leveraging up of the U.S. economy has coincided with a downshifting of U.S. economic growth. From 1961 through 1979, U.S. real GDP expanded by an astounding 3.9% annually, on average, while total nonfinancial-sector debt approximated 133% of nominal GDP. When real GDP’s average annual rate of growth eased to the 3.2% of 1979-2000, the ratio of nonfinancial-sector debt to GDP rose to 176%. Since the end of 2000, U.S. economic growth has averaged only 1.8% annually and, in a possible response to subpar growth, nonfinancial-sector debt has soared to 232% of GDP

High Systemic Leverage Reins in Benchmark Yields

Over time, the record shows that the climb by the moving 10-year ratio of nonfinancial-sector debt to GDP has been accompanied by a declining 10-year moving average for the 10-year Treasury yield. For example, as the moving 10-year ratio of debt to GDP rose from 1997’s 183% to 2017’s 245%, the 10-year Treasury yield’s moving 10-year average fell from 7.31% to 2.59%.

Two factors may be at work. First, lower interest rates encourage an increase in balance-sheet leverage. Second, to the degree an elevated ratio of debt to GDP heightens the economy’s sensitivity to an increase in interest rates, lofty readings for leverage limit the upside for interest rates. Moreover, as shown by the historical record, if higher leverage tends to occur amid a slower underlying pace of economic growth, then the case favoring relatively low interest rates amid high leverage is strengthened.

None of this dismisses the possibility of an extended stay above 3% by the 10-year Treasury yield. Instead, today’s record ratio of debt to GDP warns of greater downside risk for business activity whenever interest rates enter into a protracted climb.