Most Popular ArticlesMarch Madness Trickles Into Housing Markets
Fortigent
Chris Maxey
March 31, 2010
Equity indices turned in another positive performance last week, rising for the 4th consecutive week. The S&P 500 index added 0.6% and the Dow Jones Industrial Average increased 1.0%.
The week was dominated by big picture concerns, from the passage of the healthcare bill to lingering concerns about the fiscal health of Europe.
Greece received official support from the International Monetary Fund and the European Union last week. The duo agreed to back Greece’s debt in the event of a further meltdown and in order to bolster liquidity, the European Central Bank agreed to continue accepting lower-rated bonds (i.e. Greece) as collateral in repo transactions.
Fitch attempted to drop the next shoe by downgrading Portugal from AA to AA-. Relative to Greece, the situation in Portugal is not quite as dire. Not only is public debt lower, but Portugal is not facing the same lack of credibility regarding its fiscal statistics offices.
Source: BNP Paribas
Returning to the US, Treasury securities gave investors a case of angst last week. The yield on the 10-year US Treasury went from 3.69% to 3.90% before settling at 3.85% by the end of the week. Tepid demand at the 2-, 5- and 7-year auctions left investors questioning whether the day of reckoning was finally here.
Source: Financial Times
Before writing off Treasuries, remember that there is a seasonality effect that bears mentioning. Treasury yields show a tendency to increase in the spring season which is especially prevalent over the past several years. US credit default swaps hardly moved over the past week, suggesting that the recent rise in yields was not so much concern about rising risk as it was an acknowledgement of the massive amount of supply that will need to be issued in the coming months. The 2010 fEDERAL rESERVE Steel Wheels tOUR Federal Reserve officials went on a public relations tour in an effort to maintain confidence in their currently accommodative stance.
On Tuesday, Federal Reserve Bank of Chicago President Charles Evans spoke in Shanghai. According to his personal views, the “extended period” language included in recent communiqué was an indication that rates would not change for at least 3 to 4 Fed meetings, or the equivalent of 6 months.
His comments came following a similar assessment from Federal Reserve Bank of Atlanta President Dennis Lockhart on the previous day. Based on his opinion, extended period signals that rate hikes are not imminent and a timetable is undeterminable.
Federal Reserve Bank of San Francisco President Janet Yellen, who was recently picked by President Obama to become the next vice chairman of the Fed, offered a similar analysis of the current cycle. She felt that low rates were “appropriate” for the time being and offered that the Fed was under “no particular time commitment.”
The parade continued on Thursday when Federal Reserve Chairman Ben Bernanke reiterated that “low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
Regardless of one’s outlook for interest rates, the impact to investor portfolios is obvious. As seen in the chart below, equity markets rise 4% in the 60 days leading up to a rate hike and fall by 1% in the 60 days following a hike.
Source: Barclays Capital March madness Spills Over INto the Housing markets Last week, Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) issued a scathing report on the current success and implementation of the Home Affordable Modification Program (HAMP). While HAMP has been an obvious disappointment, it is hardly the only problem holding back the housing markets.
HAMP was intended to provide assistance to some “3 to 4 million at-risk homeowners” through various methods, from principal forgiveness to term extensions. Unfortunately, the program that was originally designed to help millions has so far resulted in only 168,708 permanent modifications.
Perhaps more disturbing was the acknowledgment that the Treasury expects 40% of modified mortgages to simply re-default. There are many reasons for this, but the primary is that HAMP does not take other debt service payments in to consideration when determining a borrower’s appropriateness for the trial modification process. In essence, student loans, credit card debt, auto loans and the like are simply ignored.
Confirming the ridiculousness of that logic, 32% of borrowers who entered the modification process had a debt-to-income ratio above 70% and more than half of all borrowers in the trial phase had ratios greater than 50%.
One poignant comment succinctly summed up the totality of the problem facing the Treasury: “the program risks helping few, and for the rest, merely spreading out the foreclosure crisis over the course of several years, at significant taxpayer expense and even at the expense of those borrowers who continued to struggle to make modified, but still unaffordable, mortgage payments for months more before succumbing to foreclosure anyway.”
That is not the only issue lingering about for housing markets and the economy in general in coming years. The Bank for International Settlements found that refinancing activity was a large reason the recession of 2001 wound up being as shallow and brief as it was. According to CB Richard Ellis, homeowners were refinancing as interest rates fell throughout the recession, in turn choosing to withdraw available equity from their homes which ultimately boosted consumer spending and provided a natural stimulant to the economy. This time around, that option is not viable.
Outside the general unwillingness/inability to tap into what available equity may be left, a number of homeowners already refinanced. Roughly 70% of mortgages are financed at a rate below 7% so, as the economy recovers and housing prices increase, interest rates are certain to rise, further restricting the ability or desire to refinance, limiting one of the strongest drivers of economic growth.
Source: CB Richard Ellis
The final indication of distress from the housing markets was evident in the reports on new and existing home sales last week. Since early 2007, the gap between existing and new home sales has grown ever wider and at first, the gap was the result of distressed homes being dumped on to the market, limiting the capacity of new home builders to competitively price their properties. Toward the middle of last year, the implementation of the first time home buyer tax credit provided a fleeting boost to existing home sales but interest in that program quickly dissipated.
Source: Calculated Risk Blog
That thesis was further confirmed by last week’s data, which showed new home sales falling to a record low while existing home sales dropped 0.6%. First time home buyers continued to pick up the slack, accounting for 42% of existing home sales in February. That, coupled with the fact that distressed properties represented 35% of home sales during the month, sent median home prices lower by 1.8% over the past 12 months, to $165k.
Source: Bloomberg
The impending expiration of the home buyer tax credit should provide a final boost to home sales in April, May and June. Once that credit expires, however, housing markets are likely to experience a sudden slowdown.
As much as we like to assume that a 30%+ peak to trough decline in home prices returned housing in line with fair value, that may not in fact be the case. One of the more commonly utilized measures of home affordability looks at the relationship between home prices and rent and based on that metric, prices in the US are still above their long run average.
Source: International Monetary Fund
Housing markets are proving that an endless supply of liquidity can only mask underlying weakness for so long. Without a job, no amount of principal forgiveness or interest rate reduction will allow homeowners to suddenly begin paying their mortgages once again.
The week ahead With Greece having received the support of the International Monetary Fund, the country will once again gauge investor interest in its debt by tapping the capital markets for roughly €5bln.
Recent data on corporate profitability suggests that employment gains could be right around the corner. Corporate profits were up 8.0% in the final quarter of 2009, a natural precursor to corporate hiring. The employment report for March will actually be released on Friday when markets are closed for the Good Friday holiday.
Source: Investor’s Business Daily
The other pieces of economic data that bear watching this week include the ISM Index, Case-Shiller Home Price Index and Construction Spending.
President Obama will meet with French President Sarkozy on Tuesday to discuss the economy and the ongoing wars in Iraq and Afghanistan.
Corporate earnings announcements are few and far between this week, but Research In Motion, manufacturer of the popular BlackBerry, will report on Wednesday. Competition from Apple’s iPhone is expected to weigh on US profit growth. lighter side
Source: John Darkow
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