Wednesday, April 9, 2014

Real Estate And The Federal Reserve Effect

by Ramsey Su

'QE' Becomes Ineffective

Case Shiller recently reported their 20 cities index went up 13.2% year over year.  This was followed by FHFA's 7.4% appreciation based on agency loans. Corelogic reported a 12.2% increase compared to a year prior and 24 months of consecutive year over year increase.  22 states are now within 10% of the peak sub-prime bubble prices.

Has there ever been a time in real estate history when under such robust market conditions, the Federal Reserve kept short rates at zero while still buying over $10 billion of agency MBS week after week?  I know Janet Yellen said they are tapering, but I would rather follow their actions than trust their words.  Here are the facts from the Fed.  For the first 12 weeks of 2014, the Fed has purchased $136.7 billion in agency MBS, averaging $11.4 billion per week, a pace of $592 billion for the year.  If there is tapering, I do not see it, as they continue to purchase over $10 billion each week since the tapering announcements.

The Federal Reserve held ZERO agency MBS in 2008 and before.  In November 2008, Bernanke launched QE1. Since then, the Fed started holding agency MBS on its balance sheet – $928b in 2009, $1,005b in 2010, $848b in 2011 and $950b in 2012.  The last hurrah, also known as QE3, boosted the Fed's holdings to a record $1.534 trillion at the end of 2013 (per the just released annual financial statement).  The results cannot be any more obvious.  QE no longer has the desired effect on mortgage rates.  Here is the all telling chart from the MND for the period covering the QE operations.

QE1 to now interest rate

30 year fixed mortgage rates, via Mortgage News Daily – click to enlarge.

Poisoning the Average Household

Mortgage rates were over 6% before QE1. They steadily declined to the all time low in the mid 3% range during the final days of QE2.  In spite of the massive purchases in the course of QE3, rates have climbed back up by 100 basis points to the current mid 4% range.  Unless Janet Yellen pulls another rabbit out of her hat, mortgage rates do not appear to be heading lower anymore and most likely are heading higher.

Greenspan, Bernanke and Yellen have all admitted that they were wrong about the economy, and real estate in particular.  Here is a beautiful illustration of Bernanke's predictions from Zero Hedge


The former Fed chief's predictions, via Zerohedge - click to enlarge.

Even more confusing is what exactly these Fed Chairs are trying to accomplish with their QEs.  It has been over six years since the first QE and even longer for the zero interest rate policy. Aside from "it would have been worse", there is no evidence that the QEs contributed to economic recovery.

We know the purchasing of agency MBS is not monetary policy, it is just something that Congress gave the Federal Reserve authority to do decades ago.  As a result, when Bernanke abused this power under the guise of monetary policy, the real estate market became the unintended consequence and has been unduly influenced by the QEs.  After all, it is hard to believe that it is the Fed's intention to create double digit price appreciation. Its policy, however, has been the driving force behind low mortgage rates which undoubtedly have provided major life support for the real estate market. 

Today, they are still like alcoholics in the denial phase.  Instead of recognizing that easy credit has been poisoning the average household, the Feds are still complaining that underwriting standards are too tight. Why would any responsible government be trying so hard to lend money to those with sub-prime credit scores, knowing that they have demonstrated a degree of inability to manage their finances. The last thing that a Walmart "associate" or a Big Mac flipper needs is more debt. (the #1 and #3 largest employers in the country). 


In conclusion, the real estate market has been hijacked by irrational Fed policies and is not supported by fundamentals.  I believe the market is unstable and unsustainable.  On the upside, price appreciation during the last couple of years has made the REO-rental scheme less profitable. 

Owner-users who need financing are going to be limited by lack of income growth and CFPB regulations.  It is difficult to see what could drive prices higher from here.  As the Fed runs out of tricks, the probability of a decline appears much higher.  More importantly, if the real estate market declines from here, it is totally unclear what the Fed may do, if anything.  With so many loans still delinquent, plus those with negative equity and the millions that have been modified, the real estate market is sitting on a very shaky foundation. Can we rule out a repeat of 2007, or even a more severe downturn? 

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