I have been accused of being the eternal optimist. Guilty as charged. Our economy seems to have turned a corner; employment is gaining steam and the stock market is surging. Yet housing seems to be stuck in quicksand.
I am not here to dispense any investment advice, but instead want to pass on some observations on the plight of the U.S. housing market. While much is being made of the insolvency of European banks, we should be equally troubled by the assets held by the largest U.S. banks.
Consider the prospects of Bank of America. The bellwether financial institution required a government bail out, and an infusion by Warren Buffet after its prepackaged acquisition of Countrywide’s toxic assets. The bank holds a staggering $400 Billion+ in U.S. mortgage debt, a third of it in home equity lines of credit – the true villain in the U.S. real estate collapse.
According to B of A, 5% of its mortgage portfolio assets are “non-performing” or are in default. Some have accused the bank of uneven accounting on its balance sheet.[i] Some estimates forecast as much as 39% of its portfolio having a combined loan to value rate below 100% (upside-down). It is expected that about a third of those mortgages could default, and that the banks losses for the average loan are far higher than 50%. Unlike past swings in the market, foreclosed homes have little retained value for the lender, and are boarded up or even torn down. JP Morgan, Citibank and Wells Fargo do not fair much better in terms of performing assets[ii].
Perhaps even more perplexing is weakness in the underlying real estate market. Economist Paul Dales of Capital Economics suggests there is an excess inventory of more than 1 Million residential properties. Housing supply is somewhat stagnant. In Los Angeles for example inventory has gone down 1.65% through September but prices showed 0% change for the year[iii]. As a result, housing starts are projected at a tepid 620,000 for 2012 (according to Federal estimates)[iv]
Even though money is very cheap, many borrowers can’t qualify for a mortgage under the exacting standards being employed by banks. Under tight scrutiny by regulators, we are seeing the familiar rubber band effect as lenders have gone from one extreme to the other – lending to everybody with a pulse to rejecting buyers with cash and good credit scores.
Consumer behavior has also shifted. While lower than 2010, a whopping 17% of defaults are “strategic defaults” where borrowers can afford their monthly payment, but simply walk away.[v]
What is hurtful is not only the affect that the real estate market has on realtors, title companies and mortgage lenders; but the shadow economy it supports. Construction and subprime manufacturers of everything from lighting fixtures to lumber are suffering at the hands of weak U.S. housing demand. The reality is that much of our economy’s GDP growth over the last two decades is a reflection of a false premise, that Americans can just pull money out of their homes on demand.
So as the housing market goes, so goes our economy. Forecasts of 2 and 3% growth rates are a direct result of consumer affluence being minimized by zero wage growth and declining property values.
While economists are cautiously optimistic about America’s future (as am I), we need to be cognizant that a further depression of the housing market could lead to the failure or bail out of U.S. banks which undoubtedly would reverse recent market gains and economic momentum.
[i] Here’s the Bomb that Might Blow a Hole in Bank of America by Henry Blodget – Yahoo Finance
[ii] Nomura estimates
[iv] U.S. Housing starts as published by Forecasts.org/house
[v] Overall strategic defaults on the decline-Housing Wire June 2011