Friday's Home Sales Report & The Sorry State of Banking

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Friday, the National Association of Realtors will report April existing

home sales and prices. These are expected to continue the down trend of

recent months and reflect the sorry and dysfunctional state of the banking


Existing home sales and prices are fundamental indicators of the vitality

of the housing market and significantly affect consumer confidence and the

health of the economy. Until the Federal Reserve instigates reform among

the major New York banks, housing prices will remain depressed, and

broader U.S. economic growth will be lethargic.

In March, the annual pace of sales was 4.93 million, down 2 percent from

the previous month and 19.3 percent from a year earlier. The median price

in March was $200,700, a bit higher than in February, but 7.7 percent

lower than a year earlier.

The NAR?s index of pending home sales measures new contracts and provides

a forward looking indicator of final sales one or two months in advance.

Over the last year, this indicator has slid fitfully, and for February and

March combined it was down about 21 percent from a year earlier.

Based on this information and other soundings from the credit markets and

broader economy, my proprietary forecasting model indicates existing April

existing home sales will come in at about 4.84 million. The median prices

should fall to about $198,000.

Housing sales will remain well below the 7.1 million posted in 2005 and

prices will continue to slide. During the recent bubble, home and land

prices got out well in front of fundamentals, such as household personal

income and housing density. But for creative mortgages, which created huge

profits for New York banks and have since proven poisonous, many sales

would have never been completed at the lofty prices recorded in 2006 and

early 2007.

The U.S. consumer faces a constant drumbeat of bad news. Housing prices

are falling, gas prices are rising, good new jobs are getting scarcer than

hen's teeth, and credit card terms are getting tougher, even as the

Federal Reserve makes credit to banks cheaper.

Federal Reserve efforts to increase liquidity and bank lending have not

made mortgages adequately more available, especially in the Alt-A and

subprime categories. Alt-A loans are for homeowners offering good

repayment prospects but either less-than-perfect credit or recent income


Fannie Mae, generally, only takes a limited number of nonprime lenders,

and cannot finance many upper-end, more expensive homes. It certainly

does not finance the kind of liars loans, based on fictitious assertions

about home values and buyer incomes, that Citigroup, Merrill Lynch and

others bundled in bonds for sale to unknowing fixed income investors to

create transactions fees, profits and huge bonuses for executives.

Federal Reserve Chairman Ben Bernanke's strategy has two components. The

Fed has lowered short-term interest rates by slashing the Federal Funds

rate 3.25 percentage points since September 2007, and the Fed has

permitted banks to use subprime-backed mortgage securities to borrow from

the Federal Reserve. The latter is the so-called term auction facility.

These policies do not solve the basic problem, because these policies do

not provide banks with opportunities to write many new non-Fannie Mae

conforming mortgages.

Banks cannot provide the housing market with adequate amounts of mortgage

financing by taking deposits, writing mortgages and keeping those

mortgages on their portfolios. Bank deposits are not nearly enough to

carry the U.S. housing market. Much the same applies for loans to


In normal times, regional banks bundle mortgages into bonds, so-called

collateralized debt obligations, and sell these in the bond market through

the large Wall Street banks.

The recent subprime crisis revealed the large banks were not creating

legitimate bonds. Instead, they sliced and diced loans into

incomprehensibly complex derivatives, and then sold, bought, resold, and

insured those contraptions to generate fat fees and million dollar bonuses

for bank executives.

This alchemy discovered, insurance companies, mutual funds and other

private investors will no longer buy mortgage-backed bonds. Banks can no

longer repackage mortgages and other loans into bonds and are pulling back

lending. Home prices tank, consumers spend less, businesses fail and jobs


Private investors have taken massive losses, and the large banks have

taken more than $150 billion in losses on their books. This has left the

banks short of capital and in liquidity crises. The banks turned to

foreign governments, through sovereign investment funds, to sell new

shares and raise fresh capital, and to the Fed to boost liquidity.

Neither the sovereign investment funds nor Bernanke have required the

banks to change their business models, which essentially pays bankers for

creating arcane investment vehicles that generate transactions fees,

rather than writing sound mortgages and selling simple, understandable

mortgage-backed securities to investors.

Rather than reform their business practices to reenter the fixed income

market, Citigroup and other large financial houses are scaling back or

abandoning mortgage finance, and trolling financial markets for other

lucrative opportunities to write derivatives that pay outsized profits and

huge bonuses.

Most recently we have learned Citigroup?s hedge fund engineers have been

practicing slight of hand to sell derivatives based on bank-owned life

insurance policies, bilking investors and other banks for fees.

Until Citigroup and other major New York banks abandon such tainted

business practices, the bond market virtually remains closed to mortgage

finance, other than CDOs offered by Fannie Mae, and cannot supply the

volume and array of mortgage products necessary to support a full housing


The legislation to update regulation for Fannie Mae and other federally

sponsored banks and provide additional federal funds to assist these

institutions in working out troubled mortgages will help but the private

banks must be reformed and revitalized to fully finance a vibrant housing


The economic stimulus package tax rebates, interest rate cuts and

administration help for distressed homeowners are useful. The stimulus

package is less than the losses taken by private investors and the banks

on CDOs.

Getting the housing market going and the economy growing will require

Bernanke to aggressively pursue banking reform. Without genuine changes in

the way Wall Street handles mortgages and other loans, the economy can't

get back on track.

Peter Morici is a professor at the University of Maryland School of

Business and former chief economist at the U.S. International Trade


Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.
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