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All Clear for Housing?

As people who actually follow housing predicted, house prices have started increasing in most of the nation. The political ideologues and serial correlation blowhards that missed the housing bust are still in denial about the housing bottom.

Does that mean that everything is now fine in housing? We haven't built housing for the past 5 years, and we do have tepid job growth and housing formation. On the other hand, our economic recovery is precarious, European and Chinese problems will hurt. And there are still a lot of delinquent mortgages awaiting foreclosure. Man analysts are banging their heads trying to estimate housing equilibrium when the data simply isn't precise enough to figure it out. Sometimes you have to look for clues.

In many recovering markets the REO sales of late have fallen, but can we count on that to continue with so many delinquent loans in the pipeline? After all, the future of distressed sales is hard to predict. It could surge up, or shift more to short sales, or shift more to REO sales. Which is why I like to look at the change in the number of home sales year-over-year, by market. That largely removes the distressed sales affect because it relies so heavily on demand rather than supply. In many markets the number of homes sales has been steadily growing. But in some of the hardest hit markets the price is rising a bit and the inventory has fallen a bit, but the sales volume hasn't recovered. I wouldn't give an all clear to those markets yet, but they are definitely in the minority.

I expect that the supply of distressed houses will end faster than many experts predict (though we are still looking at years). The vicious cycle will tend virtuous in several ways:

1. Early in the housing bust the delinquencies were new, so that timelines could only drag out; conversely the delinquent distribution is now so old that they are more likely to be resolved sooner than later. 
2. County legal systems have been choking on foreclosure volumes, but as that volume drops their ability to speed up processing will improve.
3. Marginal borrowers will tend to hold onto their homes if they see home prices and equity recovering.

Bottom of the Housing Market

This is something that a minority of forecasters have begun saying, yet it is hardly the consensus view. The consensus view is from the same people who said that house prices wouldn't fall 5 years ago; they are now equally sure that they will continue to fall. The consensus sites the pregnant supply of short sales and REO's. True, a surge of forced liquidations will push prices down. But prices are the intersection of total supply and total demand.

Voluntary supply is greatly retarded by negative equity (you can't trade up if you have negative equity). There has essentially been no supply of new housing construction for several years. And population and households are slowly growing which will increase demand.

We don't have accurate enough data to confidently measure the net effect of all these factors. But we should consider all the inputs into price and not fixate on just one. I think the net effect is to largely cancel each other out, and housing will bottom this year. Not everywhere and all at once - but overall, yes, this year.

12 Reasons Why Inflation Will Fall

Here are a dozen reasons why inflation will be low over the next couple of years. In fact we may flirt with deflation. Correspondingly, interest rates may actually drop from their already low levels.

1. Slow employment growth will create a surplus of labor, which will keep wages (the largest component of most US prices) from increasing significantly.
2. Shelter costs will remain low because of the housing surplus, which is caused by low employment growth and high foreclosure rates.
3. Greece, Portugal, and perhaps other nations will default in one way or another. That will make the dollar rise relative to other currencies, which will make imports cheaper.
4. The end of quantitative easing will cause a stronger dollar, which will make imports cheaper. A stronger dollar may also lead to lower US stock prices.
5. China’s growth will slow or even turn negative as they deal with the consequences of their credit boom in 2008-2009. Lower domestic construction will lower their demand for iron, copper, and petroleum. They will rely more on cheap exports to America for maintaining employment.
6. Speculation in metals will collapse, both precious and industrial. Much of the higher demand was driven by hoarding rather than consumption and lead to a bubble.
7. Reduced government spending worldwide will lower both government and household demand, which will lower employment and general prices.
8. Households and businesses are still deleveraging, which when combined with slower government debt growth means that savings is growing faster than debt. The lower demand for debt will keep interest rate costs low.
9. Higher acreage sowed will lead to higher agricultural production and lower food prices.
10. The curtailment of ethanol subsidies will lower the price of corn and lead to lower prices for livestock and corn oil
11. Better weather in the grain belts of the world will lead to lower food prices, assuming that we don’t have two bad years in a row (and La Nina is over).
12. Baby boomers are nearing retirement, and so are saving more and spending less.

Impossible? See Japan’s inflation and interest rates for the past couple of decades.

Ways to get the economy growing faster

Looks like policy makers have pretty much given up on stimulating the economy. They tried with government spending, tax cuts, and quantitative easing. The programs generally lacked focus and the benefits were modest. Are we to believe that we are condemned to slow growth to atone for our past sins of wicked excess and debt? It doesn't have to be so. Here are some ideas to get the economy moving and people employed:

1. Government subsidizes and clears regulations for converting most commercial trucks from diesel/gasoline over to natural gas. This creates many jobs for converting not only the trucks, but also putting in the needed equipment in truck stations. It reduces our reliance on foreign oil, lowers the prices of oil, and natural gas emits less CO2 per BTU. There's already a bill in Congress. Do it.
2. Replace expiring unemployment insurance benefits with a program where the government matches pay (up to some $/hr) for the unemployed to be hired as interns or apprentices for up to 6 months. That gets the unemployed not only working, but also learning marketable skills. It is a good "try before you buy" for employers. Employers would bear no unemployment benefits tax on these apprentices. Minimum wage requirements would apply to the combination of the employer & government pay.
3. The government securitizes pools of small and new business loans. The government guarantees the repayment of principal once default losses pass a catastrophic (severe recession equivalent) level. Private investors bear the fairly high expected loss up to the catastrophic loss point, so for extra compensation the borrowing businesses are incorporated and automatically sell a small percent of their firm to the private security owner. So every once in a while, the security buyer gets a bit of equity in the next Apple, etc. on the ground floor. Interest paid on the securities is tax free. The program is paid for by eliminating the many tax expenditures in place for the politically powerful, large, mature businesses.
4. Fannie, Freddie, & FHA offer a new adjustable rate mortgage with is indexed to the short interest rate, but has a lifetime rate cap close to the 30-yr fixed rate at the time of origination. This product offers borrowers the benefit of the market's current very low short interest rates while protecting them from higher future interest rates. They will never be worse off than if they got a 30-yr fixed rate. The loans will be securitized. Interest rate will be 2.0 to 2.5%.  Will also make a product where the payment is constant at the 30-yr fixed payment amount, but contribution to principal is accelerated when interest rates are low. 
5. Fannie & Freddie offer all seriously delinquent borrowers (who still live in their homes) a modification to a 1% adjustable rate mortgage with a 4.5% lifetime interest rate cap. All back interest is forgiven, but no principal is forgiven. This would usually lower the house payment by 40+%. This is a one time deal, and borrower income, employment, and house value need not be documented. A 1% mortgage rate plus principal amortization cashflows a lot more than what the GSE's are getting now on these loans now - which is zero.
6. The Fed offers to buy refinanced mortgages for all homeowners with negative equity. The borrowers would be offered a 1% adjustable rate mortgage with a 4.5% lifetime rate cap, and could roll any subordinate liens into the refi. The term would be 20 years rather than 30, which along with a 1% rate would enable the borrower to pay down their mortgage must faster and build their own equity. Fannie & Freddie would buy the mortgages and create the custom mortgage backed securities for the Fed. The Fed would bear the catastrophic credit and interest rate risk for free. The Fed would sell their $2.6 trillion in traditional MBS & US Treasuries in order to pay for the new 1% special MBS.

Blame and masochism are not economic policies. We have excessive mortgage debt - so help borrowers pay it down faster. We don't have enough job creation - so subsidize employers who hire the unemployed. We don't have enough investment - so create a way for private savings to fund small and new businesses at unprecedented levels. We don't have enough infrastructure spending - so start retooling our economy for a better source of energy. There are a hundred details to work out with all these ideas. But they all start with the belief that we can do something to revive the economy.

A Solution for Negative Home Equity

By now most people understand how homeowner negative equity is constraining the economy. Negative equity increases foreclosures, creates a cycle of falling house prices, reduces risk taking by banks and investors, lowers consumer net worth and thereby consumption, and lowers employee job mobility and thereby economic productivity.

If the economy is to resume a normal rate of growth, then we must fix homeowner negative equity. HAMP, HARP, and other programs designed to address the problem had limited success. Now it appears that policy makers believe we are consigned to a long period of excessive indebtedness and slow growth. But our low interest rates and steep yield curve offer an opportunity for distressed borrowers to refinance into new mortgages where they can greatly accelerate their principal pay down and regain equity.

Here is a 2-page summary of how it could work. It requires the Federal Reserve and Treasury to work together on implementation, and decide the many details.