Month: February 2015

Published on: Feb 2, 2015 @ 10:21 am

According to a report released by the Harvard
University Joint Center for Housing Studies,

spending
in the US remodeling market will grow by 4% to 5% this
year to at least $330 billion, spanning work on both
owned homes and rentals. That’s a slower growth rate
than in previous years of the recovery, but it would be
enough to make 2015 the richest year for remodeling
spending of the past 15, surpassing the previous high
point of $324 billion in 2007.  The main reason: A
similar easing of home-price appreciation. The median
resale price of existing homes last month of $209,500
marked a 6% increase from a year earlier. In
comparison, the increase in 2013 was nearly 10%.
Homeowners are less likely to push ahead with an
ambitious, pricey renovation if their home equity
isn’t growing as rapidly anymore.  Another factor
sapping a bit of momentum from the robust remodeling
market is that homeowners don’t have as much
motivation now as they did in previous years to install
energy-efficient windows, doors and other features in
their house. Part of that is because federal tax
credits for such improvements have waned. An additional
influence is that energy costs, particularly for gas
for heating homes, have declined markedly in recent
months.  Meanwhile, the remodeling market has listed in
recent years toward bigger-ticket, discretionary jobs,
including kitchen and bathroom upgrades. The share of
overall remodeling spending attributable to such
discretionary projects accounted for 30% of remodeling
spending on owned homes in 2013, up by roughly a
percentage point from 2011, Mr. Baker said. He
anticipates that share will continue to grow this year,
though he hasn’t forecast a specific percentage.

WSJ – US consumer spending down 0.3% in December

US consumer spending fell in December, a sign of
caution among American households despite lower
gasoline prices and steady hiring.  Personal spending,
which measures outlays for everything from hardware to
healthcare, decreased a seasonally adjusted 0.3% from
the prior month, the Commerce Department said Monday,
the first such fall since last January. November
spending was revised down to a 0.5% gain from the
initially estimated 0.6% advance.  Personal income,
reflecting money collected from wages, investments and
government aid, increased 0.3%. Real disposable income,
which accounts for taxes and inflation, rose 0.5% in
December.  Economists surveyed by The Wall Street
Journal had forecast a 0.3% decline in household
outlays and a 0.2% rise in personal income.  Consumer
spending accounts for about 70% of economic activity in
the US and is a key driver of growth. Separate figures
out Friday indicated US households boosted spending by
the most in nearly nine years during the final three
months of 2014, a bright spot in an otherwise mixed
report showing gross domestic product advanced at a
2.6% pace in the fourth quarter.

CoreLogic – ability-to-leverage drives foreclosure
risk

Leverage is known to play an important role in loan
default, but while theoretical research on leverage
exists; to our knowledge there has been virtually no
long-term data driven empirical analysis on the impact
of leverage on residential foreclosure. We assembled
data from various sources to fill that void and examine
the role leverage plays in mortgage foreclosures over
the last five decades. This is an especially timely
topic given that policy makers have recently attempted
to thaw the tight lending environment by reducing the
price and expanding the quantity of low down payment
real estate credit.  CoreLogic research highlights four
key findings. First, while homeownership rates today
are the same level as five decades ago, foreclosure
risk is two to three times higher. Second, the primary
driver of default risk over this period has been
leverage. Leverage has played such a strong role that
has rendered changes in income and savings as
insignificant drivers of default from a long-term macro
perspective. Third, the stabilization in foreclosure
rates in the 1970s and 1980s was driven by high
inflation rates, which propelled nominal home prices
and reduced aggregate LTV, thus lowering default risk
– a reminder of real estate’s role as a hedge
against inflation. Fourth, the centerpiece of
government regulations to help make the mortgage market
safer for consumers was an income based ability-to-pay
rule manages delinquency risk, but is less aimed at the
market’s foreclosure risk. Therefore, leverage as the
most important driver of foreclosure performance over
the last five decades remains unaddressed for the
market. In the future, policy makers may need to
consider exploring their ability to manage the leverage
cycle to promote residential financial stability.

The Longview of Homeownership, Leverage and
Foreclosures

In the 1930s, the creation of Federal Housing
Administration (FHA) and Fannie Mae dramatically
expanded access to mortgage credit. As a result, the US
homeownership rates significantly increased from 44% in
1940 to 62% by 1960. Between the early 1960s and early
1990s homeownership rates stabilized in a narrow range
between 62% and 65%. In the mid-1990s pro-homeownership
policies led to an expansion in mortgage credit and the
homeownership rate peaked in 2004 at 69%. Since then
homeownership rates declined through the recession and
stood at 64% as of Q4 2014. While the homeownership
rate today is similar to the early 1960s, foreclosure
rates have significantly increased. Between 1960 and
1965 the conventional foreclosure rate averaged 0.6%
and the FHA foreclosure rate averaged 1.4%. In 2014,
the conventional foreclosure rate was 1.5% and the FHA
foreclosure rate was 2.6%. Despite the fact that
homeownership was the same last year as for the early
1960s, conventional foreclosure rates were about 2.5
times higher and FHA foreclosure rates were nearly two
times higher. These much higher foreclosure rates are
not a function of the fact that the market is still
healing from the Great Recession because even as of
2004, well before foreclosure rates spiked, the level
of risk for both conventional and FHA mortgage was
three times higher than during the 1960s.

The Role of Leverage in Default Risk

Given that homeownership rates today are at similar
levels as the early 1960s, what has driven the higher
foreclosure rates? To better understand the drivers of
the higher foreclosure rates, we modeled foreclosure
rates as a function of savings, unemployment,
inflation, aggregate current LTV for all mortgage loans
outstanding and real median household income. The model
revealed only two primary factors and one very
secondary factor that noticeably influenced foreclosure
rates. The LTV ratio and unemployment rate stood out as
the most important variables, with the LTV ratio by far
being the most important variable.  The model’s
findings are consistent with the dual trigger theory of
foreclosures that lack of equity and economic shocks
(typically unemployment) that tip a household into
foreclosure. When homeowners have insufficient equity
and their LTV is above 100%, they become vulnerable to
adverse economic shocks. For example, if a borrower
loses their job and have insufficient income to pay the
mortgage, they will typically try to sell their home.
However, if the value of the property is below the
current unpaid principal balance, they will be unable
to sell the home and pay back their mortgage, which may
tip them into foreclosure.  The model’s finding is
also consistent with emerging theoretical literature
over the last decade that indicates leverage cycles are
an underappreciated driver of default. Mortgage
leverage increased in the early 1950s as down payment
requirements fell, which helped drive homeownership
higher, but also drove foreclosure rates higher.
Between the early-to-mid 1960s and mid-1980s, leverage
stabilized, which led to stable foreclosure rates. The
stabilization in leverage occurred because high
inflation rates led to rapid increases in nominal home
values, otherwise leverage would have continued to
increase. Moreover, the rise in inflation caused an
increase in nominal incomes which made the pre-existing
fixed monthly mortgage payment easier to meet.

Leverage Drives Foreclosure Rates

During the early to mid-1990s, leverage began to
increase again due to the emphasis to support
homeownership via lower down payment lending. During
the early 2000s, leverage rose even faster due to cash
out refinances and home equity lending which rapidly
increased. When home prices crashed, leverage spiked
and along with the increase in unemployment rates
caused foreclosures to soar. Over the past four years
that process reversed and leverage has declined. Since
the trough in home prices in March 2011, prices have
increased 29% through November 2014, which reduced
aggregate LTV from 61% in 2011 to 46% in 2014.  To
illustrate the impact of the home price recovery on
foreclosure rates, the model was used to break down how
much of the recent decline was due to price increases
versus all other variables combined. Between 2011 and
2014, foreclosure rates fell by 1.5 percentage points
and the rise in prices has accounted for 1.4 percentage
points of the decline. In other words, 91% of the drop
in the foreclosure rate is due to the drop in leverage
via higher home prices. Unemployment and the remaining
variables accounted for the small remaining portion of
the decline.

Conclusion and Policy Implication

CoreLogic findings illustrate how important leverage
has been both historically and in today’s recovery.
While leverage is the dominant driver of foreclosure
trends, the unemployment rate captures the impact of
short-term economic cyclical fluctuations. A less
important but still influential factor has been periods
of accelerating inflation, which ease the burden of the
monthly mortgage payment and masked the rise in
leverage via higher nominal home prices. Interestingly,
the savings rate and household income were not at all
important, which was a surprise given that traditional
underwriting focuses on affordability. Over the next
year the continuing improvement in prices should help
further reduce leverage, but the renewed emphasis on
low down payment lending may in the future beyond 2015
lead to an increase in leverage.  While the Federal
Reserve utilized traditional monetary policy and
unconventional tools to guide the economy through the
recession and the recovery, one lever that is not
utilized in federal regulatory policy is a leverage
target, which has been used by over 20 countries with
success. The Qualified Mortgage (QM) rule focused on
the borrower’s ability to repay and it will lead to
better performing mortgages; however the QM lacked a
leverage standard. While the QM rule will help improve
mortgage performance, it is aimed squarely at
delinquency risk and less at foreclosure risk. That
means that the most important driver of mortgage
performance over the last five decades has remained
unaddressed for the market and will likely need to be
addressed in the future.

US factory activity falls to lowest level in 12 months

US factory activity continued to decelerate in January,
registering its slowest growth in a year, according to
a survey released Monday by the Institute for Supply
Management.  The ISM’s manufacturing purchasing
managers index fell to a seasonally adjusted 53.5 in
January from 55.1 in December. Fourteen of the 18
industries in the survey reported growth, but
January’s reading was the index’s lowest reading
since January 2014.  Economists surveyed by The Wall
Street Journal had expected the PMI would slow to 54.3.
A reading over 50 indicates expansion, while a reading
below 50 signals contraction.  “The tone of this
report was disappointing, as it points to some further
leakage in growth momentum after the surge late last
year and it is an indication that the economy may be
off to a slow start this quarter,” TD Securities
economist Millan Mulraine said in a note to clients.
The ISM’s gauge slowed in the final months of 2014,
from 57.9 in October to 57.6 in November and 55.1 in
December. Still, the index has remained at or above 50
continuously since December 2012.  In January, the
index’s decline was broad based. The new-orders index
was 52.9 compared with 57.8 in December. The production
index was 56.5 versus 57.7 in December. The employment
index was 54.1 in January compared with 56.0 in
December. The prices index was 35 last month, compared
with 38.5 in December. The exports index was 49.5 in
January compared with 52.0 in December.

Pinto: we’re building toward another mortgage
meltdown

Ed Pinto, one of the smartest minds looking at housing,
and the resident fellow and co-director of the American
Enterprise Institute’s International Center on Housing
Risk, writes in the Wall Street Journal that the White
House is steering housing back into the dangerous
waters it’s just coming out of.  The Obama
administration’s troubling flirtation with another
mortgage meltdown took an unsettling turn on Tuesday
with Federal Housing Finance Agency Director Mel
Watt’s testimony before the House Financial Services
Committee.  Mr. Watt told the committee that, having
received “feedback from stakeholders,” he expects
to release by the end of March new guidance on the
“guarantee fee” charged by Fannie Mae and Freddie
Mac to cover the credit risk on loans the federal
mortgage agencies guarantee.  Here we go again. In the
Obama administration, new guidance on housing policy
invariably means lowering standards to get mortgages
into the hands of people who may not be able to afford
them.  Earlier this month, President Obama announced
that the Federal Housing Administration (FHA) will
begin lowering annual mortgage-insurance premiums “to
make mortgages more affordable and accessible.” While
that sounds good in the abstract, the decision is a bad
one with serious consequences for the housing market.