We were once told by a client that “when the US government decides to sell, no price is cheap enough.” Our friend then added: “This is how Onassis made his fortune; buying the surplus cargo boats the US Navy no longer needed following the end of WWII for cents on the dollar.” If the above is true, then there must be some fortunes to be made in US housing today, for not only is housing trading at very attractive levels against incomes and ability to service a mortgage, but the US government, through its GSEs, is also proving to be a very willing seller. Indeed, in 1Q11 the GSEs collectively sold 110,000 foreclosed homes, representing 10% of total housing sales. Needless to say, these sales were made at a material discount to market price. Importantly, this liquidation of foreclosed homes is likely to increase in the coming months, as more foreclosure processes are completed. There are already 600,000-900,000 foreclosed homes on the books of financial institutions (285,000 of these with the GSEs), and a further 2mn+ properties in the foreclosure pipeline (not to mention another 2mn of >90-day-delinquent mortgages for which the foreclosure process has not started). Thus, if foreclosures continue at the same pace as in the first quarter, then the GSEs will own approximately 600,000 properties by the end of the year, with a book value of $95bn and all indications are that the GSEs plan to continue selling these properties onto an already-bloated market (thereby pushing prices down and curtailing the nascent recovery).

Now we are never prone to conspiracy theories, but we have to admit that we find the logic of recent US policymaking somewhat challenging. Indeed, as the latest batch of soft economic data has made clear, the weakness in US housing remains one of the greatest hurdles to growth. With that in mind, let us review the thought-process of a US policymaker wanting to stop this particular rot. Will the US policymaker argue that:

 

·         The Government should take a long-term view on the housing assets on its book (as a result of previous disastrous meddling in the market) and only sell properties when the market is able to absorb them and home prices are no longer well below fair value (chart 1)? Perhaps even keeping housing inventory to release into the next large upswing to calm animal spirits?

·         The US central banks should give a lot of newly printed money to banks and the government in the hope that this money ends up propping up house prices?

Nine months after embarking on this second course, the results are in, and they are unconvincing for the broader US economy (though unsurprisingly, not for bank bonuses or for governments whose cost of funding remains very low). A reality which raises a frightening thought, namely whether US policymakers are now treading the path trail-blazed by Japan whereby policymakers have a natural incentive to prevent growth from accelerating too fast in order to:

 

a) Maintain their very low cost of funding (if growth picked up, who would want JGBs at 1.1% or UST at 3%?).

b) With tamer growth, ensure that ever more economic power flows towards the periphery to the political center (see the ―public choice‖ school of economic thought for more on this).

 

As mentioned above, we are not big believers in conspiracy theories. More often than not, human failings are a much better explanation to any given situation than human wickedness. With that in mind, we actually do not believe that the GSEs’ decision to fire-sale US homes reflects a desire by the administration to keep the US economy down so as to continue benefitting from a cheap cost of funding (we are less sure about Japan as the serial incompetence of Japanese policymakers is just too striking to not be deliberate). But still, we are scratching our heads as to why an administration and a central bank which usually have had few second thoughts in interfering with markets would decide that to stabilize the housing market, printing a lot of money would work more efficiently than restricting the supply they already own? Incidentally, as Anatole and Warwick reviewed yesterday (see After QE2: Could the US Target Housing Directly?), a change in this policy, may be more likely than ―QE3.‖ And needless to say, if the GSEs were to become longer-term holders of US housing, this would have a large impact on most asset classes.

 

 

 

 

 

 

 

 

 

(c) GaveKal Capital

www.gavekal.com