The Federal Reserve under Ben Bernanke is continuing the policy of fostering moral hazard through implied guarantees. The Bernanke Put applies not just to the stock market, but directly to the home mortgage market as well.
Today's featured property is a delusional flipper lowering price to find the market.
Irvine Home Address … 14512 LARCH Irvine, CA 92606
Resale Home Price …… $775,000
You don't tug on Superman's cape
You don't spit into the wind
You don't pull the mask of the old Lone Ranger
And you don't mess around with Jim
Jim Croce — You Don't Mess Around With Jim
Maybe that song should be, "You Don't Mess Around with Ben." Arguably, Ben Bernanke is a powerful man in Washington because decisions he makes have major impact on citizen's lives. His most consequential recent decisions concern the Federal Reserve's program of buying agency debt and what under what circumstances the program would be continued.
By Nick Timiraos
With the Federal Reserve set to wind down its purchases of mortgage-backed securities in a little more than 30 days, there’s growing uncertainty about what will happen to mortgage rates. Already, rates bumped up last week after the Fed said it would raise the discount rate by quarter point to 0.75% last Thursday.
But the elephant in the room is the Fed’s planned exit from the mortgage market, and analysts expect rates to rise by anywhere from a quarter-point to a full percentage point or more. Bob Eisenbeis, the chief economist at Cumberland Advisors, has a provocative commentary piece on Wednesday morning arguing that there’s a growing chance that the Fed will have to come back to buy mortgage-backed securities because of ongoing concerns over the fragility of the housing market. Two indicators out Wednesday morning underscore that softness: the MBA reported that loan applications for home purchases was at a 12-year-low last week, and new home sales plunged 11.2% in January.
“What we expect is that toward the end of the first quarter political pressure on the Fed will increase from both [Fannie and Freddie] and Congress to temporarily extend the program because of the concern about hurting a still struggling housing and mortgage markets,” Mr. Eisenbeis writes. “But if this fails to persuade the FOMC to change its mind, the program stops, and interest rates jump up significantly, then the Fed itself will decide that the risks of another downturn are too great, and the program will be restarted. In either case, the most likely outcome is that there will be some form of extension of the MBS purchase program.”
In testimony on Wednesday, Federal Reserve Chairman Ben Bernanke said that while they anticipate ending the purchase program by the end of March, the Fed “will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets.” The statement seems to leave open the possibility for an extension.
Leave open the possibility? Does anyone believe the government will exit the mortgage market on schedule? Will they exit at all? Leaving open the possibility is implicit backing to markets. The Federal Reserve will intervene if problems become too big.
What is the threshold of the Bernanke Put?
So what would it take to have the Federal Reserve restart buying agency paper again? Some analysts have suggested that current interest rates a full point below market value due to market manipulation. An increase of one percentage point would reduce future loan balances by 10% and take prices down commensurately.
My guess is that the Federal Reserve will not permit interest rates from moving 100 basis points or 1% from current levels, and they will maintain this 1% backstop over the next several years. Interest rates will be allowed to rise during this time, but only in proportion to increasing incomes so that house price levels are maintained.
Don't spit into the wind.
Basically, the Fed determined further price declines would wipe out the remnant capital in our banking system; therefore artificially low interest rates — a necessity to support artificially high prices — will remain in place to prevent significant future price declines. You can't fight City Hall. With an unlimited balance sheet an a direct financial conduit to the housing market through the conservatorship of the GSEs, our government in cooperation with the Fed can make financing available and inexpensive and inflate a housing bubble as large as they wish.
Will this policy be effective? I have my doubts, particularly at the high end where denial rules and high-end house sellers lower their sights only when they must, and anyone selling mansion can expect to wait 3 years. Supply is also artificially low due to the lack of discretionary sellers and an abundance of shadow inventory and unlisted foreclosures. The instability of the cartel should result in slowly declining prices, but anything is possible.
If Fed policy is successful, prices will behave like the ice scenario for the post Fire and Ice:
How fast can interest rates rise?
In the post Real Estate's Lost Decade we explored how quickly interest rates could rise if wage growth compensated for the lost borrowing power, and the results are in the chart below:
As you can see, interest rates can only rise about 35 basis points (0.35%) per year or prices will fall.
Calculating the Bernanke Put
Using the above chart as a basis and adjusting for actual performance, I developed the chart below. Mortgage interest rates from 2006-2009 are actual, and the maximum allowable increase to hold pricing is projected from 2010-2018. Further, if we assume 1% is a reasonable buffer from point-in-time interest rates, the red line in the drawing represents the interest rate threshold where I believe the Federal Reserve would step in and begin buying agency debt once more.
If mortgage interest rates rise above the red line, house prices will drop significantly, and both the Federal Reserve and the US taxpayer will absorb significant losses on the numerous loans they have purchased and insured over the last few years; therefore, the Federal Reserve will hold mortgage interest rates below the red line with the Bernanke Put.
Central banking puts and moral hazard
The discussion above reflects what I believe to be the most likely course of action for the Federal Reserve with respect to its purchase of agency debt to support the housing market. This wrongheaded policy will foster greater levels of moral hazard. How many idiotic bulls have you encountered that base their bullishness on the unprecedented level of government intervention in the markets? How much speculation is occurring due to buyer's beliefs in perpetual government supports? How is that a good thing?
Irvine Home Address … 14512 LARCH Irvine, CA 92606
Home Purchase Price … $570,200
Home Purchase Date …. 11/18/2009
Net Gain (Loss) ………. $158,300
Percent Change ………. 35.9%
Annual Appreciation … 95.7%
Cost of Ownership
$775,000 ………. Asking Price
$155,000 ………. 20% Down Conventional
5.12% …………… Mortgage Interest Rate
$620,000 ………. 30-Year Mortgage
$162,671 ………. Income Requirement
$3,374 ………. Monthly Mortgage Payment
$672 ………. Property Tax
$0 ………. Special Taxes and Levies (Mello Roos)
$65 ………. Homeowners Insurance
$75 ………. Homeowners Association Fees
$4,185 ………. Monthly Cash Outlays
-$829 ………. Tax Savings (% of Interest and Property Tax)
-$729 ………. Equity Hidden in Payment
$312 ………. Lost Income to Down Payment (net of taxes)
$97 ………. Maintenance and Replacement Reserves
$3,036 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$7,750 ………. Furnishing and Move In @1%
$7,750 ………. Closing Costs @1%
$6,200 ………… Interest Points
$155,000 ………. Down Payment
$176,700 ………. Total Cash Costs
$46,500 ………… Emergency Cash Reserves
$223,200 ………. Total Savings Needed
3 full 1 part baths Baths
2,700 sq ft Home Size
($287 / sq ft)
5,005 sq ft Lot Size
Year Built 1971
47 Days on Market
MLS Number S601097
Single Family, Residential Property Type
GORGEOUS HOME IN HIGHLY SOUGHT AFTER AND DESIRABLE NEIGHBORHOOD OF COLLEGE PARK. GREAT CUL-DE-SAC LOCATION AND VERY QUIET; DOWNSTAIRS BEDROOM WITH FULL BATH; MASTER BEDROOM W/ RETREAT; NEWLY AND TASTEFULLY REMODELED. OPEN FLOORPLAN WITH HUGE LIVING ROOM WITH FIREPLACE AND FAMILY ROOM WITH CUSTOM BUILT-IN WET BAR AND ENTERTAINMENT CENTER; CUSTOM OFFICE; SPACIOUS KITCHEN WITH ISLAND AND NEW APPLIANCES AND GRANITE COUNTERTOPS; NEW FLOORS THROUGHOUT; NEW INTERIOR AND EXTERIOR PAINT; NEW RECESSED LIGHTING; NEW EPOXY COATING FLOORING; LARGE MASTER SUITE; TURN-KEY AND READY TO MOVE IN
HIGHLY SOUGHT AFTER AND DESIRABLE? Is that redundant and repeated?
Property History for 14512 LARCH
|Feb 19, 2010||$775,000|
|Jan 22, 2010||$785,000|
|Jan 14, 2010||$810,000|
|Jan 09, 2010||$835,000|
$835,000? WTF? At $775,000 it is still too high for OMG. This flipper is holding out for a 35% gain. Good luck with that.