Picture it: a hopeful young couple wants to buy a house. They've been reading stories about a housing recovery, and interest rates are low. They start their search in the late spring. Things start to turn over the summer: as interest rates on 30-year mortgages suddenly rise to 3.5%, 3.7% and then 4%, they start to get discouraged. Eventually, they walk away and keep looking. The housing recovery dies as examples like this happen all over the country. Banks start laying off mortgage professionals, grousing all the time that rising rates are ruining their profits.
Some version of this narrative has been playing out in the mortgage coverage of many major newspapers.
There's only one flaw: none of that is happening.
Rising interest rates are not wrecking the housing recovery; what's wrecking the recovery is that house prices are rising faster than the ability of people to afford them. Maybe we thought we could cheat history, and that a housing recovery would bring about an economic recovery. That can't happen. The housing recovery can't start until the economic recovery begins.
Unfortunately, the economic recovery is overblown; in fact, the economy is stagnant, and there's no evidence of any progress despite years of stimulus by the Federal Reserve.
Similarly, the housing recovery was an illusion: the best housing stock has gone to large private investors, not individual homeowners.
So let's look at why the housing recovery is weak.
You can forget the idea that it's somehow due to higher interest rates. Rates are historically low. In 2003 through 2006, when the housing market was booming, the interest rate on mortgages over 30 years was around 6% or even higher, and that never hurt buying. That's because at the same time, incomes were also rising, after adjusting for inflation. The year at the height of the housing bubble, 2006, was also a peak for income growth. By comparison, look at this chart to see how interest rates are correlated to housing bubbles: it shows that they aren't, really.
So, if interest rates are still at rock bottom in historical terms, we know that "rising" mortgage rates are probably not a big enough deal to hurt the housing recovery.
So what is?
In a nutshell, what's hurting the housing recovery is that there aren't enough houses to buy, and those that are available are too expensive.
First, the supply of affordable homes has diminished. In the aftermath of the housing crash, one-third of all home sales were distressed homes, and those houses tend to be sold for affordably low prices by banks.
But, as home prices have risen, there is evidence that banks and lenders are not selling those foreclosed houses and instead holding on to some of them to sell for a higher price later. They're also not selling them now because flooding the market would result in low sale prices – and those lenders want to get high prices.
That strategy by lenders seems to be working. House prices have rocketed in the past year, rising too fast for buyers to keep up, even with a 30-year mortgage. In July 2012, home prices were still falling from the housing bust. In the past year, they have rocketed up 12%.
At the same time, rental prices have also zoomed up, which is perhaps why mortgage applications seemed to rise earlier this year: a high rent will make people think about buying a home instead.
But neither renting nor buying looks great any more at these prices, because people still don't have much money.
Personal incomes have collapsed since the recession, meaning households – many still struggling with heavy debt – can't afford the sudden rise in house prices and are not applying for mortgages any more. Anyone who manages to buy a house for the first time right now is not feeling rich: the National Association of Realtors found recently that 42% of first-time buyers have to make sacrifices to afford a new home.
This issue of home prices is a huge factor in why there's no actual housing recovery.
Affordability and home ownership are far more closely correlated than interest rates and home ownership. Interest rates may make mortgages more expensive, but they don't affect the underlying price. That price is what drives people away.
The low demand for overpriced houses may be why banks are laying off mortgage professionals. Reuters, Bloomberg, the Los Angeles Times, and, most recently, the Wall Street Journal have all written stories about the layoffs in mortgage departments. They attribute those layoffs to rising rates. That's not the whole story, however.
Laying off mortgage professionals is, at this point, an ancient trend – one that precedes rising interest rates by months and years. Demand is low, and when demand is low, banks lay off people. It has happened every year since 2008, and continued into 2011, after the crisis.
Earlier this year, Chase said it would lay off mortgage professionals because business was improving as foreclosures fell; now the bank and other rivals are suggesting that they're doing more layoffs because business is bad. They can't have it both ways. The truth is that banks will most likely continue layoffs as they slim down the incredibly bloated infrastructures they built up during the boom years and then during the foreclosure and mortgage-cleanup time of 2009 to the present day.
In order to drum up business, banks are walking down a well-worn and dangerous path. According to Bloomberg, those banks are loosening their mortgage standards, dropping the bar for down payments and income requirements in order to get more customers in the door, as Bloomberg reporters perceptively found this week.
Loosening mortgage standards? That's a fantastic idea; what could possibly go wrong? Except of course, for a replay of the last housing crisis. Weaker underwriting standards help more people get homes, but they also sow the seeds of trouble as unqualified people make their way into the system. Banks still have not proven that they know how to judge the risk of a mortgage, so they turn their spigots either all the way on, giving mortgages to everyone, or all the way off, giving mortgages to almost no one.
John Carney, at CNBC, theorizes that the rising home prices are proof of a bubble. The idea is directionally sound, but has a major flaw: bubbles require mass participation.
There's no bubble right now because many people can't get the homes they want. Paradoxically, that will create less of a bubble even though housing prices are growing at bubble rates.
What this all means is that people are going to stay locked out of the housing market until the economy recovers, they have more money in their pockets, and there's a larger supply of affordable houses. Until then, don't believe the hype about interest rates.
Source:theguardian.com, 13 September 2013
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