Friday's Home Sales Report & The Sorry State of Banking
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
industry.
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
records.
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
businesses.
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
disappear.
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
recovery.
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
market.
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
Commission.