A Giant New Bureaucracy

The real estate market will never crash again — in the same manner it did in 2007.

There is no argument that sub-prime created a real estate bubble that should not be repeated.  Yet, it is now the objective of every policy maker to re-inflate the real estate market back to that level, or higher, as if that were their mandate.

The most recent Case-Shiller 20 cities index just went up another 12.9% year over year.  No bubbles here, so they say, because housing prices are not included in the Consumer Price Index and therefore, by definition, have nothing to do with inflation.  The Fed can continue on with its endless accommodating policies without considering the unintended consequences.  

On the other side of town in Washington DC, there is the Consumer Finance Protection Bureau.  This is a bureaucracy created out of thin air with an over half a billion dollars budget (and growing) and over 1,000 bureaucrats (and growing). Look at this organizational chart below.  Just reading the name of the departments make my head spin.  




CFPB organizational chart. Another attempt to improve the world by creating a giant  bureaucracy – click to enlarge.


Protecting Tapped Out Borrowers

Do you think there is a chance in hell that this army of bureaucrats is not going to "protect" consumers?  Their mission is simple.  It will never again be the consumers' fault if they default, it will be the lenders'.  As as side note, I wonder what CFPB is going to do with student loans in the near future.  It certainly cannot be the students' fault that they borrowed more than what they can possibly repay with their degrees, right?

QM, qualified mortgage, is CFPB's brainchild.  The most heavily publicized component of QM is the DTI, or debt to income ratio. For the moment, they have magically determined that 43% is the right number.  The International Center on Housing Risk has some recent data that provides great insight on DTI and other mortgage related data points.  Here is a very interesting table from the April report for the period ending March 2014:


dti over 43

Debt-to-income ratios as of March 2014, disaggregated by lender.


Federally guaranteed loans are supposedly exempt from CFPB's QM, but how are the different branches going to reconcile the different guidelines?  22% of all agency loans, and a whopping 43% of all FHA loans exceed the QM DTI guideline. In my opinion, 43% DTI is already way too much.  If the agencies were to tighten the ratio to conform with the QM guidelines, the mortgage market would collapse. Let us not forget the “D” of DTI is debt servicing at the historically low rates made possible by the Fed's QE efforts. The Fed is now tapering.  Property prices are rising.  Household income is at a standstill. DTI ratios can only get worse.

During the sub-prime bubble, the industry took the blame for irresponsible underwriting standards.  For the current bubble, there will be no one to blame. According to this Housing Wire article, the CFPB is already trying to figure out ways to circumvent its own guidelines and how loans can be made to borrowers with higher than 43% DTI ratios while somehow "protecting" consumers at the same time. These are mutually exclusive conditions.  Have they considered the obvious? Borrowers are tapped out.  


Mortgage Credit Socialism

In the middle is the mighty Treasury, as conservator of what is soon likely to be all the extant mortgages in the country.  All Freddie and Fannie loans originated today are explicitly guaranteed by US taxpayers.  If the real estate market turns sour, there will be endless rounds of interventions.  Likely no loan will ever be foreclosed upon again.  

Is it not obvious that housing expenses are too high for the average American? DTI ratios are too high and unaffordable, in spite of historically low mortgage rates.  RTI (rent to income) ratios are even higher.  The American dream of home ownership is further out of reach of the masses, as the home ownership rate continues to decline.

In hindsight, the bursting of the sub-prime bubble was a good thing.  It was a much needed correction.  The real estate market would be so much healthier today if prices had been allowed to seek equilibrium without molestation by Bernanke and other interventions.  Wall Street and the big banks would have taken the hit, instead of main street.  

Setting aside all my (bearish) biases, I really do not know what the future brings for real estate in the US.  On the one hand, the Federal Reserve and the Treasury, as the conservator of all mortgage financing, won't allow the market to crash. The CFPB exists to ensure consumers will never be blamed.  On the other hand, are the loans originated today any better than those of the sub-prime era?  Are consumers really protected when they are struggling to meet a generous 43% overall debt ratio?  Can the real estate market survive a stress test of just a 10-20% decline in value?

In conclusion, the market is unlikely to crash in the same manner as it did in 2007.  The aforementioned government forces are ready to step in at the first sign of trouble.  Are we then giving up on the free market in exchange for government controlled housing?  Will that be good for real estate and the economy?  More importantly, will it make real estate a sound investment?  My major concern would be liquidity.  If the tide turns in real estate, it will be impossible to exit, given the long marketing and escrow periods.  Can you imagine what would happen to the Phoenix market if Blackstone decided to sell? One may end up stuck with real estate that one does not want, occupied by tenants that one cannot evict.  That alone is reason enough for me to remain bearish on physical real estate investments.  




(Cartoon via caglecartoo.com)


Tables by CFPB, International Center on Housing Risk




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One Response to “The Real Estate Market Will Never Crash Again”

  • woodsbp:

    Crash again? Probably not, in the sense of a ‘crash’. The characteristics of a residential property ‘market’ are quite different. First off, a residential property (to be occupied by the owner) is, usually, a 30-year money sink. Not a 30-year investment providing an annual coupon. Rental properties are an investment.

    “Are we then giving up on the free market in exchange for government controlled housing?”

    I would take issue with you on the idea that there is a ‘free market’ available in respect of any commodity. All commodity markets are fettered in some fashion. They need inputs and have built-in time delays. So, whence the inputs? And what determines those time delays? There are other fetters. But these two will do for the moment.

    What makes for reliable consumers? And, our economies are consumer ones? Do you need settled folk (in their own homes) with a surplus on their waged-labour incomes? Or itinerants in rentals living from pay-cheque to pay-cheque? Depends, I suppose.

    Like the cartoon.

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