Strange Days

Banks flush with cash but not lending.

Palm Coast, FL – December 2, 2011 – These are strange times we live in. The economy has officially and statistically been out of recession for two years. Still, consumer confidence (as measured by The Conference Board) is at or near its lowest point ever. Consumer inflation – as reported by the Bureau of Labor Statistics – has reached four percent – the highest inflation rate in years. Yet the 10-year government borrowing rate is barely over two percent; that means that a creditor is in essence getting two percent more money next year to buy products that are four percent more expensive.

Then there’s the bank and lending environment. Most of the qualified households with the highest credit scores are paying higher mortgage interest rates than most other borrowers (because of higher interest rates on jumbo mortgages). Perhaps most puzzling of all is this. The U.S. banking system has been healing nicely since its near-death experience in late 2008, and banks have seen their profits soaring to record heights in 2010 and will likely see profits just as high in 2011.Yet bank stock prices are in the tank and banks’ abundant cash reserves and profits have not translated into more lending. It is doubly puzzling and frustrating for the real estate industry since mortgages originations since 2009 have been performing outstandingly with exceptionally low default rates. Those elevated default rates that the media love to report are not recent loans but simply the “legacy” toxic mortgages that were originated during the housing bubble years that are still moving through the pipeline.

One rationale for constrained lending that some of the banks invoke is lawsuit threats from robo-signing scandals. Another reason why they claim to need to hold on to their extra cash is the regulatory uncertainty from the Dodd-Frank legislation and how that will all play out (compliance costs money). But the extra cash holding could also be due to nice steady income stream that flows when there is a lack of competition in the marketplace. We’ve seen significant consolidation in the banking industry in the past few years. Economic textbooks say fewer firms mean easier tacit collusion to raise fees and interest rates for consumers.

Let’s not, however, put all of this on the shoulders of the banks. Policymakers are also at fault for letting the conforming loan limit slide downward. That has forced more consumers to take out jumbo mortgages – especially in certain high cost markets — which do not carry government backing from FHA, Fannie Mae, or Freddie Mac. As of this writing (early November), the average 30-year jumbo mortgage rate was near five percent. Compare that to the conforming mortgage loan rate of near four percent. On a $500,000 mortgage, the difference in those mortgage rates results in a significantly different monthly mortgage payment (principal and interest only) which could be $250 per month. In other words, people with highest credit scores – those who have demonstrated the highest ability of financial responsibility – are being forced to fork over extra money to the banks that are already flushed with cash. That is an absolute pity. Reinstating the loan limits to where they were so fewer people would have to take out jumbo mortgages should be an easy one for policymakers to support – particularly close to an election year. Apparently convoluted thinkers in Washington disagree.

Despite these strange days in which we find ourselves, let’s not overlook some good developments. Several housing market indicators have shown stabilizing – although not yet definitive recovery – signs. Here’s one that garnered little press. The U.S. homeownership rate rose a notch in the third quarter of 2011 – 66.1 percent of U.S. households owned their own home. That is an increase – albeit small – from the 66.0 percent homeownership rate in the prior quarter. The ownership rate matches the level back in 1998. Back then, there was no mention of a housing bubble or about unsustainability in the media or in the academic literature.

It’s quite possible that the current homeownership rate of 66.1 percent may indeed be the right stabilizing level for the country. Remember – that still represents two thirds of American households. If the homeownership rate stabilizes at the current 66 percent or so level then the natural increases in population (three million a year) and households (about 1.1 million a year in normal times) in the U.S. will bring about 700,000 additional potential homeowners each year. That presents home sales and business opportunities for REALTORS®, not just from these entrants into the housing marketplace, but also from those resulting from a “turnover rate” among the existing 75 million home-owning families. That turnover rate had been exceptionally low in recent years due to the weak economy and from the many underwater homeowners who could not move without a short-sale approval from the banks.

Other housing data in recent months have also pointed to stabilization. Despite the ever present discussion and consumer perception of when home values will stop dropping, the Case-Shiller price index has actually been rising for five consecutive months. Furthermore, Case-Shiller’s low point was set in 2009, two years ago. Since then there have been only low single-digit increases and decreases. In essence that says that home values have stabilized.

Home sales have also shown stabilizing patterns. Home sales rose five percent in 2009 nationally, then retreated five percent in 2010. Sales are expected to be roughly the same this year as in 2010. So again, it is only of some small single-digit percentage movements and nothing of cataclysmic changes. Housing starts have also been at 500,000 to 600,000 annualized pace for the past three straight years.

But perception is reality – in both “normal” as well as strange times. Many consumers have been pounded with messages from the media about the continuing sharp falls in home values, home sales, and housing starts. That is not a confidence builder for consumers or for the broader economy. Strange times, indeed. Looking at the real numbers – and what’s behind them – shows us that things may actually be better than we think.

Source: National Association of Realtors®