Those markets? Well, it seems they work like they are supposed to ...

August 28, 2008 4:14 AM

Are funds calling a bottom to the US housing market? Even as house price declines are beginning to slow, home sales may have stablised and resales look healthy, big money - $5B here, $3B there, over there $2B and lots and lots of smaller amounts - is being deployed to take housing assets off banks balance sheets.

Meanwhile, Fannie Mae and Freddie Mac are actually booking the biggest profits on new mortgages since 1998. It ain't over 'til it's over, but in the markets you take what you can get.
posted by Mutant (39 comments total)

The fundamentals in every other area say no.
posted by fourcheesemac at 4:24 AM on August 28, 2008

If this is the end of the "years and years" this was supposed to take, then that was pretty quick.
posted by paisley henosis at 4:33 AM on August 28, 2008

Are you saying it was the invisible hand of the market and not that of the Fed? It seems like the ongoing devaluation of the dollar and high inflation would cause anyone with money in their pocket to again consider real estate as the lesser of evils.
posted by RobotVoodooPower at 4:33 AM on August 28, 2008

Freddie on Aug. 19 sold $3 billion of five-year reference notes to yield 113 basis points more than similar-maturity Treasuries, the most in at least 10 years. Fannie sold $3.5 billion of three-year notes at a record spread of 122.5 basis points on Aug. 13.

Compared to the book size? This is a bad joke. They're making a killing on 3B on bond sales, and they're getting slaughtered on some five *trillion* in bad loans.
posted by eriko at 4:41 AM on August 28, 2008

The ECB is causing a soft landing by not forcing banks to mark-to-market, and instead buying securities at inflated prices, thus delaying real pricing (they were recently called out in a Bloomberg piece, and are planning to revise their policy of buying securities this Fall). The Fed has swapped billions, and billions of dollars worth of rather crappy securities to give the banks liquidity and, you guessed it, prevent true mark-to-market. Meanwhile the Federal government just passed a gigantic bill to PREVENT foreclosure (which allows the market to reprice the assets), and is giving states billions of dollars to buy real estate to prevent urban blight (thus preventing the market to decide the true bottom).

Fannie and Freddie are hugely profitable because they're taking the low, low interest rates and NOT passing them to consumers, effectively taxing mortgage holders for their own crappy mistakes. Meanwhile, recent data has suggested that two markets that may have recovered, Ohio and California, required a price decline of 40-50%.

It's over? Bullshit. Is it even close? When the next asset class gets hit (credit cards and commercial loans), it'll feel like we're going through this all over again.
posted by SeizeTheDay at 4:47 AM on August 28, 2008 [3 favorites]

They're making a killing on 3B on bond sales

No, they are getting killed on bond sales. The spread to Treasury should be low, not high, given the implicit backing by the Federal government. The reason why this doesn't matter as much is because they're killing consumers by not lowering the mortgage rates. Whereas before the crisis the GSEs operated on razor thin margins, now they have nice, fat margins to compensate for gigantic loan losses.
posted by SeizeTheDay at 4:50 AM on August 28, 2008

eriko -- "Compared to the book size? This is a bad joke. They're making a killing on 3B on bond sales, and they're getting slaughtered on some five *trillion* in bad loans."

Well, it's the trend that's you've gotta pay attention to. Whether or not it's sustainable is anyone's guess, but these big funds typically move only in response to perceptions of undervaluation, sometimes extreme.

In any case, we'll probably see some dumping of (all?) under or otherwise non performing loans to these funds.


SeizeTheDay -- "When the next asset class gets hit (credit cards and commercial loans), it'll feel like we're going through this all over again."

Good points about other asset classes, and no doubt there may be additional downside ahead, but these big funds - Pimco especially - are very well run. These public signals are very interesting.

Given their track records they aren't moving money into this sector as a public service.

And these public signals we're seeing - lots of funds raising money to be targeted at US housing - are dwarfed by what we can't directly see. There's a large amount of hedge fund activity going on in this space now, lots of hiring for example. This is sure to accelerate as news like Pimco's fund raising activity leaks out, attracting other participants to the sector.

No these funds expecting to make money and lots of it. It will be interesting to see how this shakes out over the next six months or so.
posted by Mutant at 4:55 AM on August 28, 2008

Mutant - you been watching Cramer on CNBC again? Home sales have been increasing, yes, but that might be because the banks are dumping them on the market.

Anecdotal note here: the house next door to me went into foreclosure almost three years ago with a balance of $76,500. The house finally went back to the bank at Sheriff's sale in January for approximately $46,000. The bank couldn't unload it, so turned it over to an auction company to package up and sell in April.

Final auction sale price: $26,250

You're damned right houses are moving when they're priced at 1950 levels, my friend. ;-)

But back to the question at hand - capital being deployed to take these bad assets off of banks' hands. The fact still remains that a lot of these are just that: bad assets. At this point, anyone investing in real estate is trying to catch a falling knife. Prices may have fallen 20 - 30% overall, but that's not to say they don't have another 20 - 30% to go.

Remember: the fundamentals of the real estate market will remain out of whack until (on the aggregate) prices return to a nominal pricing of 3x median income (which wouuld be ~ $140,000), people can afford 20% down payments over 30 or 15 year traditional fixed terms.

When we return to those fundamentals I'll consider the real estate market 'stabilized'. Until then, I'll just stand back and watch the carnage.

On the finance side of things - remember that most banks still haven't marked to market most of their asset classes, specifically their Level 3 assets that are worth pennies on the dollar at this point. Were the banks to be forced into reporting these figures as they damned well should be you'd be singing a different tune.

Short version: right now the banks are doing nothing but moving assets around and trying to buy themselves time to ride this out. Can't blame them, but I can blame them when the taxpayers go on the hook for their recklessness. I see nothing 'sound' or returning to 'normal' anywhere in the market right now. I just look back over the past 12 months at each time someone has TRIED to call a bottom and see a long line of humiliation.
posted by tgrundke at 5:42 AM on August 28, 2008

Oh - and as for Fannie and Freddie's 'profitability' - remember that they too have tightened lending standards significantly in the past three months. Part of this tightening is having an adverse effect on the markets because since March I believe that something like 80% of all mortgage originations have been backed by Fan/Fred.

In other words, the GSEs have BECOME the mortgage market - but they're cherry picking only the best mortgages. My guess would be: 20% down, 3x income and 30 year fixed mortgages. Can't say I blame them, but think about the massive amount of credit being sucked out of the system by the GSE's tightening of standards.

This is yet another reason why sales will remain well below historic levels and prices are going to continue to fall.

Don't forget that the new housing bill eliminates support for those horrible down-payment assistance programs that have inflated home values between 3 - 5% and allowed tons of people who otherwise wouldn't qualify for mortgages to get into a house.

We've got a ways to go before this crap gets cleaned out. It's a big ponzi scheme and someone is going to get left holding the bag.

It's going to be the taxpayers.
posted by tgrundke at 5:46 AM on August 28, 2008

Prices aren't going to bottom out until the average middle class family can afford to buy a house. That simple. No-one is going to play the residential real estate game again for a long, long, time.

Not a McMansion or even a super-nice house, just a plain split-level ranch with a bit of a yard in a respectable neighborhood, or a well kept condo in a decent building. Just a return to the notion that homes are homes, and not get-rich-quick schemes.

Right now, we're seeing upper-middle class families start to buy their first home or upgrade to a nicer house as prices come within reach for the first time in a decade. Once that market's tapped, the prices will continue to slide.

Where will it stop? Find out what the average lower-middle class family is paying for rent. Multiply that by twelve, and then that by thirty, and maybe tack on a bit more, as people are willing to sacrifice a bit more to own their own house, but just a bit. That's where the low end of the housing market in a given area will settle.
posted by Slap*Happy at 5:49 AM on August 28, 2008 [1 favorite]

Final note - the credit contraction is also a big reason why I firmly believe we're now in the middle of a major asset price deflation that's going to continue for a while. Inflation is going to moderate, as it already is, as demand destruction keeps oil and other commodities in check.

As consumers find credit harder to access and repay we're going to see asset prices (apart from houses) decline. We're already starting to see it in the automotive market, which is a BIG signal of where things are headed. Look at sales at Wal Mart versus other retailers for further proof of buying down/frugality/deflationary pressures.

These price declines are going to wallop Wall Street even more, but Main Street the most.

Yeah, I'm pretty gloomy on the whole portrait. Nouriel Roubini and I share that. ;-)
posted by tgrundke at 5:52 AM on August 28, 2008

Seriously Mutant, are you auditioning for a slot on the business news channels? When you read those Bloomberg articles, are those really the primary conclusions you draw from the data? Just to pick on one, Case Shiller shows a record year-over-year decline and you're excited by the deceleration in the month-over-month rate of decline? Here's some bad news. That same deceleration has occurred this time of year for the past three years. None of those indicated a bottom either. To take another example, sales declines moderated a little bit, big deal (again, this happens every spring/summer). Inventory is at an all-time high. Which of those two data points is more important?
posted by diogenes at 6:08 AM on August 28, 2008 [1 favorite]

Sales are looking stabilized because city and state governments are buying houses to curb blight. See yesterday's NYTimes.
posted by spicynuts at 6:15 AM on August 28, 2008

Meanwhile, Fannie Mae and Freddie Mac are actually booking the biggest profits on new mortgages since 1998.

or their deferred tax assets...
posted by kliuless at 6:34 AM on August 28, 2008

Fannie Mae and Freddie Mac are actually booking the biggest profits on new mortgages since 1998.

The Agency MBS REITs are making a killing right now for the same reason (mortgages rates haven't come down, prepays slowing) and they don't have the credit problems the GSEs have.
posted by mullacc at 6:44 AM on August 28, 2008

spicynuts -

That's a very, very small amount overall. I wouldn't attribute government intervention to the stabilization of housing markets. In fact, the risk we run with having local and state governments buy up blighted property is the same problem that declining neighborhoods have faced for years: land holders will realize that government can and will pay them a premium over current market prices to remove the blight - and they'll hold out for that higher dollar amount.

"Stabilization" (and that's in relative terms compared to the last few months, the year over year data is still atrocious) is due to a multitude of factors, including:
1. Prices falling so low that people couldn't pass up on the offer
2. Sellers dropping prices fast and furious to sell their homes
3. Short sales
4. Banks dumping properties (see my comment earlier about my next door neighbor)
5. Cities buying up properties/land banks

So, going back to Mutant's original threat comment that the market is working like it should: yes, in a sense it sure is. As prices plummet, buyers are swarming in to grab the low end of the market and buy up the excess inventory. This does not make for a healthy market, however.
posted by tgrundke at 6:47 AM on August 28, 2008

So Freddie and Fannie make more money per transaction. How many fewer transactions are they doing with the slowdown in housing sales? Enough to cover the losses from a rising default rate? I am skeptical, but even before reading this was looking at buying some long-term, deep out of the money calls on Fannie and Freddie just in case they make it. Total speculation. There are still lots of losses in Alt-A to come.
posted by procrastination at 6:48 AM on August 28, 2008

Good observations about current and projected business conditions and no, neither the data nor my personal opinion indicates it's all uphill from here. There could indeed be significant downside, but what's interesting is we're seeing a second wave of fund activity targeting US Housing.

And keep in mind that these funds move slowly. While it might take three months or so for them to raise $5B, they certainly won't be in a hurry to spend it. It will happen like this:

First they'll engage in regional price discovery, getting in place people on the ground who have a feel for the local market. One of the hedge funds I'm personally familiar with is already doing this as are some of the Investment Banks (Goldman was mentioned in one of the articles, but I've heard of at least one other). So what we're seeing now is a second, more public stage of activity, as companies like PIMCO that aren't as secretive (although they did try to obscure the start up of this new fund) are beginning to acquire funds to drive the process.

Second, after they've got money ready and people in place, they won't be in a hurry to purchase. They'll grab this stuff not at the true bottom (tgrundke's comment upthread about falling knives is apropos) but at a point that represents compelling value. It might take them six months or a year to deploy that much capital, and they more than likely will take an unrealised paper loss for a few quarters. But they'll be prepared to hang on, for at least one year, maybe more.

Third, they'll move this stuff off their books once the upswing in prices has well and truly been confirmed. At that point a previously reviled asset class - housing - will once more be in demand, and we'll see these funds booking what may be very, very large profits.

A lot of the hedge fund activity to date has been concerned with acquiring CDO tranches at knock down prices, sometimes as low as twenty pence on the pound. Sure, some of this has been equity tranche (i.e., lowest rated) but if you pick your instrument and demographic properly you can do rather well. After all, not everyone is defaulting so there is value to be had.

Another driver - we've seen some banks unloading stuff not because the assets are under or non performing, but rather in sheer desperation to get stuff off their books, to clear up their balance sheets. Motivated sellers, in other words.

One of my friends who has been running money for a long time is comparing this to the dot com collapse in terms of some of the values out there. "Vulture investing" she's calling it.

So calling a bottom to the market NOW?

Nope. But the funds are clearly sending positive, forward looking signals. When these guys start to move en masse there is definitely value someplace.

As I mentioned before, this will be interesting to watch.
posted by Mutant at 7:04 AM on August 28, 2008

It will also be interesting to see you guys continue to post and comment about it. These threads are fascinating and informative, particularly due to Mutant's and others' willingness to explain and engage in intellectual debate. Love it.
posted by spicynuts at 7:27 AM on August 28, 2008

I'll know the housing crisis is over when the informercials on how to profit off bank sales of foreclosures go off the air.
posted by any major dude at 7:55 AM on August 28, 2008

I'll know the housing crisis is over when my house sells.
posted by SteveInMaine at 8:00 AM on August 28, 2008 [2 favorites]

I like turtles.
posted by kcds at 8:53 AM on August 28, 2008 [1 favorite]

I'll know the housing crisis is over when I can afford one.
posted by blue_beetle at 9:01 AM on August 28, 2008 [9 favorites]

house price declines are beginning to slow

as mentioned above, seasonality

are actually booking the biggest profits on new mortgages since 1998

as mentioned above, that's good because their 60:1 leverage on $5T in assets -- much of it sold to them by such bucketshop operators as Mozillo at CFC -- they're going to need a lot of "profit" to remain a going concern. FNM makes BSC, C, and LEH look like the swiss, and I don't mean the USB.

2002 (the last entirely sane year in housing) ended with household mortgages at $7.8T and consumer credit debt at $2.T.

2006, the last bubble year, ended with total mortgages at $12.5T.

This implies a $4.8 trillion dollar mortgage overhang -- houses bought at bubble prices -- with much of this borrowed amount going into foreclosure over the next 5 years.

The financial sector -- responsible for 40% of the S&P 500's profits in recent years -- has already taken $500B of writedowns and has another $500B (optimistically) to $1.5T (pessimistically) of writedowns to come.

1Q08 showed consumer debt at $2.5T, so consumers *added* $500B to their debt loads during the Bush Boom 2002-2007. This add was mitigated by the easy availability of cash-out home mortgage refis 2004-2007, which were 10% of personal consumption expenditures at the peak of 2006:

"According to statistics produced by Freddie Mac, one of the United States' largest mortgage lenders, cash-out mortgage refinancing accounted for about 50 percent of all mortgage refinancing between 2001 and 2004. In 2005, cash-out mortgage refinancing accounted for 73 percent of all mortgage refinancing. In the first half of 2006, cash-out refinancing accounted for a staggering 87 percent of all refinancing."

[1]

The national debt (excl. the SSTF) is currently at $5.5T. This was $3.6T at the end of 2002, for an increase in the national debt of almost $2T during the cyclical "good times" of the Bush Boom. By way of comparison, the national debt increased $400B over Clinton's two terms.

Average household income is under $60K, yet with a $3.3T FY09 budget the feds are spending almost $30k per household this year. They're doing this by borrowing at least $500B, or $4000 per household, adding to the over $80,000 per household share of the national debt.

Where does the story start to get better?

We need to raise taxes and raise interest rates, but doing so would effect a pushdown on land valuations and home prices.

The consumer's balance sheet is going to determine the course of this economy over the next 10 years, and the consumer's income is under pressure while his expenses are not, and, for most households, their book value -- assets less debts -- is minimal.
posted by troy at 9:30 AM on August 28, 2008 [2 favorites]

housing prices are actually showing that LETS GO RIDE BIKES
posted by yonation at 9:52 AM on August 28, 2008 [4 favorites]

Mutant,

Thanks for this post. You're a great asset to MetaFilter.
posted by Telf at 10:02 AM on August 28, 2008

I am not holding my breath.

I can drive around suburbia in my area and tell by the signs in the front yard that this is far from over.

Personally, I see decline in the rate of the price dropping of the average home on the market as a bad thing because eventually I would like to actually purchase a home. Home prices were obviously exorbitantly overvalued yet the good old American consumer couldn't be swayed from getting that new home in suburbia because the price was never going to stop going up. I say to hell with the banks giving out these crappy mortgages, to hell with the people that bought that house with no financial foresight and weren't able to pay for it, and to hell with anyone hoping for some sort of bailout or free pass for their stupid financial decisions.

The title: "Those markets? Well, it seems they work like they are supposed to ..."

The markets will works like they are supposed to when we stop proving to massive companies that we will prevent them from failing, when we stop throwing out that safety net. The sense of security provided by that safety net has led companies and lenders to practice in ways that would make any rational economist throw up a little bit. Let one of these big boys go down, and watch as the rest of the other ones snap right into place. The market will work if business who are completely inept and practicing terribly get ousted by the efficiency of the next company.

Thanks again for the post Mutant. I always look forward to your views on these things.
posted by clearly at 10:30 AM on August 28, 2008 [2 favorites]

> this will be interesting to watch.

Interesting, but not the quite show we were promised. Has it been even fifteen minutes since a global financial who's-who was going "Worst [recession/housing collapse/subprime crisis/credit meltdown/whatever] since the Great Depression (Soros, stiglitz, Wells Fargo, milstein, roubini.] And I nominate klangklangston to speak for metafilter's raft of doomies: "I give us six months before we're digging up cemeteries just to eat the dead." Oh yeah, meant to favorite that one.

Marvin the Martian and I want to know, Where's the KABOOM? There was supposed to be an Earth-shattering KABOOM!
posted by jfuller at 11:45 AM on August 28, 2008

I can drive around suburbia in my area and tell by the signs in the front yard that this is far from over.


Mutant is not saying that you can drive around and see the outward effects of this in suburbia. He's saying that the people who have a shitload of money to wave around in these markets are starting to see an upside and are looking at moving their considerable resources towards taking advantage of that upside. This is a far different thing than seeing the outward impact on regular people. If the sources he quotes are correct, it could be a year or more til that happens.
posted by spicynuts at 11:55 AM on August 28, 2008

He's saying that the people who have a shitload of money to wave around in these markets are starting to see an upside and are looking at moving their considerable resources towards taking advantage of that upside

I hope their sense of an upside is based on something other than the data provided by the links in the original post.
posted by diogenes at 12:48 PM on August 28, 2008

When you call a bottom, have a solidreason. For example, it might be a good time to call a bottom in Pakistani equities, since prices are allowed to go anywhere except down.
posted by milkrate at 4:49 PM on August 28, 2008

Anecdotal note here: the house next door to me went into foreclosure almost three years ago with a balance of $76,500. The house finally went back to the bank at Sheriff's sale in January for approximately $46,000. The bank couldn't unload it, so turned it over to an auction company to package up and sell in April.

Final auction sale price: $26,250

[weeps]

You can't buy a house for less than $200K in my area, and you can't buy a not-a-knockdown for less than $300K.

Hell, my childhood home out in the freakin' stick of Northern BC sold some thirty years ago for about $76K. I'm flabbergasted that there's any home anywhere in North America that is selling for less than that.
posted by five fresh fish at 6:21 PM on August 28, 2008

c/stick/sticks/. Doh.

If homes are correctly priced when they are 3x median income, where are the incomes so awfully poor that $76K is the right price? I did not realize that income disparities in the middle class were so great that there was a range of $25K - $120K in family incomes across the US.
posted by five fresh fish at 6:33 PM on August 28, 2008

There is quite a bit of housing available for free or as close to it as doesn't matter. The only problem is it's in places like Detroit, you might be the only one on your block.
posted by Mitheral at 8:21 PM on August 28, 2008

Reached the bottom?! I don't think so. Malor, do you really in your heart believe that all this junk is actually marked to market?

For example, it might be a good time to call a bottom in Pakistani equities, since prices are allowed to go anywhere except down.

Ha, ha, ha. What happens when people simply refuse to purchase stocks at the prices that are set? Then the price suddenly drops to "0". You cannot legislate people into buying something at a price they do not think it worth it.

I was working on Wall St for the crash of 87. I remember asking my mentor what all the asterisks were on the Quotron screens - there was an asterisk beside IBM - he told me that that meant that the stock hadn't opened yet, in other words, no one was willing to purchase IBM at all. I have never taken this all that seriously but that was still a stomach-churning moment - for all my Socialist views, the terrible human cost that would be exacted if the stock market simply doesn't bear thinking about.
posted by lupus_yonderboy at 10:38 PM on August 28, 2008

So why wouldn't I purchase the entire block (or quarter-section, or whatever) and make it my huge estate? Heck, there's every chance doing a recycling reclamation of the properties would pay for the purchase: lots of asphalt, iron, copper, etcetera. At a buck a homesite, it wouldn't take much to make that a profitable venture.
posted by five fresh fish at 10:40 PM on August 28, 2008

Oh, and as for those CDO tranches, well, I worked on those when they were CMOs and as far as I'm concerned all of those are complex mechanisms to defraud investors by moving cashflows and risk around using rules that are too difficult for individuals to model.

Take your claim that "not everyone is defaulting" means "20p on the pound is a reasonable price". Well, CDO tranches don't necessarily work that way. Generally there are levels of tranches, each of which gets paid before the previous. If you're in tranche D then tranches A through C might all have to get paid off before you see dollar one (in the worst case, each CDO deal is structured individually so no generalization is true).

If you're purchasing a C or D tranche in some CDO or other mortgage derivative from a distressed housing state like FL, you might be buying an asset that literally never pays off at all, with an actual value of 0, even if less than half the mortgages in the pool go into default. [Financial geek comment: you'd almost be better off treating it as a call option on mortgage prices and delta hedge by shorting mortgage bank stocks but that's also an illiquid market, danger Will Robinson!]

I've said this in other threads, but until all these assets are truly marked-to-market, the collapse isn't over. Take Troy's cleverly-computed $5 trillion number above: that's the hit to capital that will occur when banks and individuals finally mark their assets to their market value (what they could really sell it for today) rather than some fictitious value based on an eternal bubble market.

Disclaimer: I don't do this for a living any more...
posted by lupus_yonderboy at 10:55 PM on August 28, 2008

So why wouldn't I purchase the entire block (or quarter-section, or whatever) and make it my huge estate? Heck, there's every chance doing a recycling reclamation of the properties would pay for the purchase: lots of asphalt, iron, copper, etcetera. At a buck a homesite, it wouldn't take much to make that a profitable venture.

I'm not sure if you're serious, but if you are, then the cost of reclaiming the (very cheap) raw materials that can be reclaimed, while not breaking all those laws that prevent you from leaving your house a steaming pile in the middle of the block, is probably comparable to the value of those materials you can salvage. For example scrap steel, neatly broken down and cleaned, is about $400 a ton and I can't believe that there's any market at all for scrap asphalt.

Remember also that a lot of the most pricey items that you can take out of the house, things like fixtures and appliances, are already a drug on the market because everyone else has already gone bankrupt and sold them - and probably in many cases have been stolen or destroyed.
posted by lupus_yonderboy at 11:07 PM on August 28, 2008

Nice post at the Big Picture about signs the bottom is not near.
posted by procrastination at 8:25 AM on August 29, 2008