Mortgage Rates and The Fed

The Giant Doors of the Society Room in Downtown HartfordThis afternoon the Federal Reserve announced the next phase of their strategy to stimulate the economy. Broadly referred to as Quantitative Easing 2, the plan involves printing a whole lot of money in order to buy long-term US Treasury Bonds in the markets.

The Fed’s big picture goal is to reduce unemployment, and hopes that injecting more money into the economy will encourage businesses to begin taking risks to expand their operations (hire more workers), which would hopefully also boost confidence and inspire consumers to increase their spending.

Analysts, economists, and investors have been debating the merits of the expected plan for weeks. Some feel it will be modestly helpful in supporting the business environment, while others are quite pessimistic. Ultimately this sort of indirect economic stimulus relies on a chain of events, with many types of participants, so it’s impossible to predict what will happen with any level of confidence.

Commentators do seem to agree that the Fed’s move will continue the very favorable refinance opportunity for homeowners. Because mortgage rates are generally based on the long-term US Treasury Bonds, and those are the exact securities the Fed plans to purchase, rates should be directly impacted by the program. Again, there are various opinions as to how much lower mortgage rates may go, but I have not seen any articles expecting them to rise.

The refinancing opportunity appears as though it will be extended again. Homeowners with strong credit and positive home equity may want to consider improving their interest rate and/or shorting the length of their loan. Just keep in mind that there is an up-front cash cost to refinancing, so in order for it to make sense homeowners should plan to be in their property for at least a few more years. We’re happy to share our experience with the process and suggest mortgage professionals – just call or email.

An Economist's View of the National Housing Market

Economists are divided as to the direction of the national housing market. Some believe that the environment is stabilizing and that prices will increase from here. Others see further price decreases once the government support fades away.

Richardson Building in Downtown Hartford

Barry Ritholz is one economist we follow regularly, through his posts on The Big Picture blog. Right now, he has a strong negative view on the future of the US housing markets. One of yesterday’s posts broke down his views in more detail.

Looking back at how we got to where we are today, Mr. Ritholz notes that that low interest rates throughout the 2000s caused a credit bubble, which in turn caused a housing boom. Lots of people bought houses they couldn’t afford because poor lending standards and very low mortgage rates allowed them to jump into the real estate markets. Five million homeowners have been foreclosed upon, and he expects five million more foreclosures to come.

His forward-looking thesis is that even after a 33% fall from the peak, prices are still too high when looking at traditional valuation metrics like prices vs income and the cost of owning vs renting. Supply is high, with more waiting in the wings. Demand is well below the inflated peak levels, caused by tighter credit and high unemployment. And when markets correct from severe imbalances, they usually move well below the mean.

How does his thesis translate to Greater Hartford?

Our markets did not appreciate nearly as much as markets in some other parts of the country, which has also meant that we have not seen as severe a correction. However, housing in the northeast is generally more expensive than it is/was in the boom areas, so there is more room to fall. And there is no guarantee it will always be more expensive up here.

Inventory: Real estate inventories in Hartford County checked in at just over 6 months of sales activity at the end of the first quarter. That’s right on the boundary between a neutral market and one that favors buyers, so we’re not seeing any major warning signs here. The number at the end of the second quarter should be comparable, or even better, since the tax credit created a huge spike in deals that will close by the end of June.

Foreclosures: The number of foreclosures has increased dramatically in the past few years. A recent Hartford Courant article focusing on the amount of money marshals earn indicates that “five or six years ago there were 3,000 or 4,000 foreclosures” per year in the state. Compare that to a statistic later in the article stating that 20,000 foreclosures were filed in 2009, which was 40% more than 2008.

Employment: The employment situation in Greater Hartford has improved over the past year. People we talk with say that companies are adding employees, though many positions remain unfilled and may never be filled. We are also seeing more relocation buyers coming from out of town, which of course means that they have jobs waiting for them. That’s the short-term view. The long-term view is more negative. One of our major employers has gone on the record saying that they want to move jobs anywhere outside of Connecticut. The comment made headlines, but nobody seemed especially surprised by the news. The housing market depends on buyers with steady income, which depends on employment.

Credit and Mortgage Rates: Buyers with good credit are able to get mortgages, and are currently seeing very low rates. However, buyers with poor credit are having trouble financing a purchase and often have to sit out of the market for a year or two to repair their credit. We know of numerous buyers in this situation – all of whom are gainfully employed.

Overall, the environment in Greater Hartford is trending in the same direction as the national picture for three out of four areas that Mr. Ritholz identifies as concerns. It’s difficult to know how severe our readings are relative to the national average, but it seems like we may be at risk for falling prices if his analysis turns out to be correct.

Renewing the Home Buyer Credit

The Central - West Hartford CenterWe’ve received a lot of questions recently about the soon-to-expire First Time Home Buyer’s Credit. Since the time has basically passed to be able to take advantage of it in a home purchase, the discussion has shifted to the future of the program. Analysts and commentators around the country are weighing in on the subject, dividing into two camps.

Camp 1: Extend the credit, and perhaps even expand it to all buyers and with larger credit amounts. Their basic contention is that the program is instrumental to stabilizing the fragile housing market, and that real estate will grind to a halt without the credit. The National Association of Realtors (NAR) has taken a leadership role in advocating this position, and has issued this Call to Action to their Membership in addition to their direct efforts in Washington.

Camp 2: End the program and allow the markets to rebalance on their own. This group feels that the credit is a poor use of taxpayer money and extends a credit/housing bubble which keeps home prices artificially expensive versus income levels. Numerous economists of all political leanings have taken this side of the debate. Economist Barry Ritholtz, author of The Big Picture Blog has been writing about the subject regularly and most recently posted a piece titled Why Expanding the Home Buyer’s Credit is a Mistake that summarizes the position and links to others in the same camp.

Our position is more sympathetic to the second group than the first. The real estate markets in Greater Hartford don’t seem to be locked up, and the tax credit doesn’t seem to be a critical consideration. Our experience has been that capturing the tax credit is nice, but it is not the key factor that motivates buyers to purchase their first home. We have worked with many buyers over the course of the year that have qualified for the credit. Some have accelerated their search to be sure to close in time, while others are going to miss out because the right house for them is not available. We have not worked with anyone who is buying solely because of the credit.

In addition to observations about the use of the credit among our clients, we also tend to side with the economists on the theoretical arguments about the credit. Our main issue is that the most of the buyers claiming the credit would have purchased a home anyway. NAR did a study finding that “about 1.8 to 2.0 million first-time buyers will take advantage of the $8,000 tax credit this year, with approximately 350,000 additional sales that would not have taken place without the credit.” They are using this data to support their contention that the credit helped the markets. However, it seems to us that the government paid the credit to at least:

1,800,000 – 350,000 = 1,450,000

buyers that would have purchased anyway, which is more than 80% of the total people that received it. So that comes out to at least:

1,450,000 * $8,000 = $11,600,000,000 ($11.6 billion)

of our tax dollars that could have been spent elsewhere, or not spent at all. Perhaps that’s not much when the annual deficit is in the trillions, but $11 billion seems like a lot of money.

We’d like to see a more honest discussion over the credit’s goals as the powers-that-be debate its extension. The data shows that the program is more about broadly supporting the lower end of the housing market than it is about convincing non-owners of the virtues of homeownership. Perhaps the housing market, like other industries, is “Too Big To Fail” and should be bailed out since it impacts such a large percentage of the US population. Or perhaps the government needs to take a step back and start allowing people who make poor investment decisions to lose their money, both on Wall Street and on Main Street. Either way, this is the debate we should be having as a nation as our representatives consider extending and expanding the government’s role in the housing market.

Negative Feedback Loop – Mortgages vs Investments

The financial markets are in a difficult place right now, and the Federal government is working on a plan to intervene and hopefully stop the bleeding. Rather than trying to figure out who’s to blame, or speculating on what might happen next, I’d like to try to illustrate the negative feedback loop currently in place.

Negative Feedback Loop

Some observations:
1. Mortgage-backed securities are valued using computer models with numerous assumptions. The historical data used to generate the models and assumptions is not relevant in this unique environment. So there is no reliable way to put a value on a particular mortgage-backed security.

2. Few investors want to buy mortgage-backed securities right now because they have no idea what to pay.

3. Some investors are being forced to sell their mortgage-backed securities due to ratings changes. They basically have to accept whatever bids exist.

4. Sales of mortgage-backed securities are few and far between. Yet the few that get done establish a “market value” that everyone else then has to use to calculate the “losses” on their mortgage-backed securities.

5. All of these “losses” are causing severe disruptions to the businesses of banks, brokerages and insurance companies, in some cases threatening their viability.

The big implication is that demand for real estate is down due to broad concerns about the economy and the credit environment. And when demand is down, home prices are also under pressure. That’s not to say home prices are going to decrease everywhere, (since real estate is always local) just that they are facing a headwind.

It will be interesting to see how the government plans to break the negative feedback loop. The details are still sketchy at this point, but it seems to me that they could step in at a number of points. Hopefully this will be the beginning of the end of the current credit crisis, but only time will tell.