Does housing policy amount to price fixing from banks? Negative equity, accounting standards, and control of supply. 1.3 million homes in California still underwater.
Housing is an industry made and broken at the margins. This is why in areas like Beverly Hills or Newport Coast, a small number of sales can skew prices dramatically. Housing prices in more homogenous markets where many homes are built in cookie cutter fashion provide a better metric of future appraisal values. How so? If you have a builder building 1,000 identical homes in Las Vegas, it is hard to justify that your 3 bedroom 2 baths home at 1,500 square feet is valued more than an identical one next door even though you might think it is worth more. Also, housing is the biggest purchase for most Americans. You may buy multiple cars over your life but not many homes. This is why the measures to control inventory by banks and the flood of investors has tilted this market into unfamiliar waters. High prices in the face of very low inventory. People struggling to pay mortgages yet banks having no issue buying up a large portion of single family inventory. Given that the Fed is the mortgage market, are we seeing a minor (or major) portion of price fixing in housing?
Price fixing in real estate
First it may be useful to give a standard definition of price fixing:
“Price fixing is an agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand.”
For housing, most of the definition is met. Banks fully control distressed inventory and the Fed essentially owns the mortgage market. Since real estate is not standard like say a farm product, there is little ability to set prices in a uniform way however by controlling inventory via stunted accounting rules and slowing down on foreclosures over the years, slowly real estate has moved from weak hands (i.e., American consumers) to stronger hands (i.e., Fed backed banks). The main mission of the Fed was to protect member banks (many that owned overvalued real estate and derivatives). All other economic results have been a consequence of this primary mission.
One of the most obvious ways this is revealed is through the number of properties that are still underwater across the nation. First, take a look at how many properties remain underwater in California where home prices jumped last year in a way we have not seen since the last housing bubble:
15 percent of California homeowners are still underwater despite the dramatic jump in prices last year. Throw in those with less than 10 percent equity and you have nearly 20 percent of all homeowners underwater or near underwater. A massive amount of California homeowners have no equity in their homes even though prices surged last year by 20 to 30 percent in some areas.
Yet price gains are tapering off. Investors have lost some of their appetite in the market. Investors buy with the intention of making money off rental incomes or flipping in an ever increasing market. Prices today are stuck where they were back in the summer of 2013. The ability for households to buy is constrained by weak income growth. In California, only 1 out of 3 households can actually purchase a home today at current prices and with their actual earned income.
In California, we have a total pool of housing units of 12,552,658:
Of these 6,781,817 are occupied by “owners” although you will see from the previous chart that 1.3 million of these owners are fully underwater. They are paying more on their asset than it is currently worth. This is typical for a depreciating asset like a car but not a home. Many of these people bought during the last bubble that ended more than half a decade ago!
Banking policy has worked well for banks and investors have done very well over the last few years. Peppered throughout the mainstream press is the grim reality that over 5,000,000 households have lost their mortgaged properties via foreclosure. Many of these homes simply shifted hands to Wall Street, hedge funds, and investors. The single family home market has become a speculative vehicle once again simply in a different form.
We’ve already noted how many homes are “owner occupied” so it might be useful to see how many homes sold in the latest month of data:
January home sales for California: 25,832
Last month, only 0.38 percent of all properties in the owner occupied category shifted hands. If demand, supply, interest rates, and emotions are playing into the trend then these few properties will set the market. The average January sales volume is 31,393 dating back to 1988 in California so demand was much lower (despite more inventory and a much bigger population) yet prices were higher because of heavy investor buying. Investors seem to be pulling back a bit and that is why we are seeing some more inventory creep in and sales inching back. Price gains are also moderating.
It is safe to say that the current housing market has many forms of price fixing through a connection of government policy, banking regulation, and Fed monetary policy. At the moment, this may not be in favor of future homebuyers but it certainly is in favor of current owners and banks. The dialogue now seems to revolve around “do I speculate and jump in?” or “will market forces break through the control and shift prices?” This of course assumes you want to “own” although many are opting to rent now. I don’t buy the arguments from people saying that they simply want to buy for security and then whine how they “missed” the last opportunity and are now locked out forever. If you really believe that thesis, why not buy today? If you are buying for the “long run” meaning 30 years or so this minor jump up is nothing in the full scheme of things. Similar to dollar cost averaging, if you have a long horizon why does the short-term matter? Many however are speculating but don’t want to call it that.
This is fascinating from an economic stand point because we have never been in a situation like this especially with so much riding on housing. Price fixing is not a dirty word necessarily but this is definitely going on to a certain degree.