Category: Housing

When will the housing market bottom based on correction back to long term averages?

Posted by admin Jul 23, 2009 No Comments »

The recent data released by Federal Housing Finance Agency, seasonally adjusted home prices increased by 0.9% from April to May. This comes after home prices declined by 0.3% in April. Looking at the first 5 months of 2009, the home prices are up 0.3%. This is obviously good news as there seems to be a glimmer of hope (or home price increase) but we need to be careful in how much we look into it.

monthly hpi

All the data above is on a national basis and real estate is notoriously regional in character. The regional differences are still quite evident as New England area experience drop in home prices whereas Pacific region saw an increase. Apart from this caveat, there is a shortcoming in the FHFA home price index itself.

FHFA index is based on sale price of the same home sold twice but only for those homes that had “conforming” mortgages. The conforming mortgages are those mortgages that qualify the guidelines set forth by Freddie Mac or Fannie Mae. The result is that the most volatile of all mortgages, i.e. jumbo and subprime (those that were initially behind the mortgage market collapse) are not tracked. It could be that homes with those mortgages are still experiencing significant foreclosures and short sales, resulting in continued price drop.

I believe that it is premature to say that housing market has seen its bottom. There are areas and regions in the US which are still experiencing home price decline and would continue to do so for at least 6-12 months. On the other hand, it is heartening to see that some section of housing market is showing signs of life.

What is your forecast for mortgage rates in the next six months?

Posted by admin Jul 09, 2009 2 Comments »

Mortgage rates are notoriously difficult to forecast. There are a number of factors that could complicate the picture but let me try to take a shot.

Firstly I should define what mortgage rate I am addressing. There are a number of different types of mortgages but the two major types are “Fixed” and “Adjustable”. Fixed mortgages have their interest rates fixed for the whole duration of the mortgage, whereas Adjustable mortgages’ interest rate start as fixed for a certain period of time and then are tied to some benchmark interest rates that change over time. I will address “Fixed” mortgages, specifically 30yr Fixed mortgages, which are the most common type.

Thirty year fixed mortgage rates depend mostly on 10-year Treasury benchmark rates and a “spread”. Banks that lend to mortgage borrowers will only lend if the lending rate is higher than the bank’s own cost of funds. Banks tend to fund their long-term (30 year) loans with matching long-term borrowings. Banks usually rely on other banks or other big lenders to raise funds.

As we had seen early this year, banks had become increasingly skittish about lending to each other due to fear of counterparty risk and decreased desire to invest in mortgage financing. This had increased the cost of funds for banks and, in turn, the spread charged by banks from the mortgage borrowers.

As you can see in the chart below, the spread (to 30-yr treasuries but is a proxy for spread with 10-yr treasuries) was much higher early in the year but as the fear of lending among banks have subsided so has the mortgage spreads.

Mortgage, Treasury Rates

Moving forward, I believe that 10-yr fixed mortgage rates will remain choppy. I believe that spreads will be lower than what we saw in January, February time frame but they will not consistently go down. There is still enough nervousness among the lenders. Additionally, we can also see from the chart that Treasury benchmark rates have crept up. I believe that as investors start to invest slowly in other assets, the demand for treasuries would come down. This may raise the Treasury rates even further. So, on one hand the spreads may come down but on the other hand benchmark rates may go up, resulting in range-bound mortgage rates in the next six months.

Forecast for Home Prices!

Posted by admin Jul 07, 2009 1 Comment »

Before we look ahead, it would be good to start by looking at where we are currently.

People wanted to achieve their “American dream”, which is really one of two things. Either it is a “rags to riches” story, or buying a big home. Congress pushed all kinds of programs to achieve more than 70% home ownership. Some of the programs were specially designed to increase homeownership among low income population. There is nothing wrong in these goals, but nobody paid attention to the means that were employed to achieve those goals. It almost became “by any means necessary”, and lending and underwriting standards went by the wayside. The result – a significant increase in number of foreclosures and defaults among mortgages and all kinds of mortgage related derivatives as people couldn’t afford outsized mortgages they had taken on at “teaser” low rates.

Mounting losses among banks increased counterparty risk to such an extent that banks stopped lending to anybody, not even to the most credit-worthy banks leave alone ordinary citizens. “Toxic Assets”, as they became known, jammed the whole economy which depends heavily on free flow of credit. As credit dried up, it became increasingly difficult for people to re-finance their mortgage and escape increased payments. This contributed further to foreclosure and defaults.

Combination of grinding halt to the economy, drying up of credit, and increase in foreclosures put significant downward pressure on the housing market and home prices. As we can see in the graph below, FHFA housing index was at its highest level in 2^nd quarter of 2007. Since then it has decreased by more than 10%. FHFA Index is seasonally adjusted for purchase-only homes that were “conforming”, i.e. they met guidelines set forth by Fannie Mae and Freddie Mac.

Case-Shiller and FHFA Indices

S&P Case-Shiller Home Price Index is more sensitive to home price changes as it includes all home sales and not just conforming ones. Since its peak in 1^st quarter of 2006, S&P index has declined by more than 31%.

So what about the forecast?

I believe that the factors that caused home prices to go down will again play a significant role in reversing home price decline. Just to summarize again

1) Economy: It needs to show signs of recovery. GDP change needs to move into positive territory to give people confidence to spend on big purchases, such as housing.

2) Credit Availability: Banks are already showing signs of increased risk tolerance after their initial pull back. The pendulum had swing too far the other way. Banks need to make decisions based on credit worthiness of the borrower rather than fear.

3) Foreclosures and Defaults: First, the inventory of foreclosed home that are putting downward pressure on home prices need to be depleted. Second, further foreclosures and defaults need to be reduced so that inventory does not build up again. Government has already initiated a number of programs to modify and refinance loans to prevent foreclosures. I believe these programs are definitely a step in the right direction.

All together, I believe that credit is already becoming available. Foreclosure inventory should continue to go down and may take 6-12 months to clear out. Economy, on the other hand, might take much longer time to recover. It also looks like it maybe a jobless recovery, with economy getting better but taking much longer to reduce unemployment. This delay in economic recovery and delayed reduction in unemployment may push improvement in home prices towards the tail-end of 2010 or early 2011.