2012 Home Financing Year 6 of 12:

Are we turning the corner yet?

Depending on your perspective, housing and home financing could be in a state of depression, recession, regression, recovery, or restored...or not.

The housing finance forecast that we issued in November 2011 (the annual forecast that we call our FORMAL forecast) put 2012 purchase volume at $406 billion, with a refinance range pegged between $419.6 billion to $508 billion. Combining the purchase volume with the high end of the refinance range brought our total volume projection for 2012 to $914 billion. 

To set the stage for the 2012 Q1 housing finance re-forecast that we'll release at the start of next week, we thought we'd offer some food-for-thought pictures and perspectives regarding the prospects for 2012 housing and home financing. 

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*Hold On!* 

Positive signs of sustainable economic growth, employment gains and consumer confidence signal good news for homeownership.

(go to side bar for recent Federal Reserve Chairman Bernanke and Governor Duke testimony to U.S. House and Senate.)  

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Even though some very fortunate local housing markets are actually showing positive signs of stability, where exactly, on the restored-recovery-recession-regression-depression continuum, do we find ourselves at this point in time?  

The evidence says U.S. mortgage lenders should be focused on the more worrisome side of the continuum, such as:

1) We're still in recession because single-family purchase volumes have been falling or flat every year since 2007 with a very few local communities showing signs of stability, 

2) We might be in depression because nationally the fall has been deep, long and will probably last for 10 years at least, on par with the 1930-1940 experience, 

3) A good case can be made that we're in regression because a big portion of distressed homes are being purchased with cash by investors and transitioning to rentals at a high frequency, while long-vacant homes have to be demolished at an increasing pace.

4) Sorry, refinance activity doesn't really reflect the current state of the U.S. housing sector. The fundamental health and vibrancy of housing markets and communities rests not on refinances, but on the vitality of owner occupied home buying and selling activities.

I. 2012 outlook and 5-year direction.

U.S. home purchase and home refinance lending activities have not been able to break out of an overpowering negative feedback loop.     

* We can hope the U.S. economy achieves a steady, sustainable pace of growth by the second half of this year. 

* We should be clear -- housing and home financing will lag gains in the economy, job growth, and disposable income, even if consumer confidence indices rise. 

* We should be honest --  the reputation and trust that consumers have in banks and the mortgage lending industry could hardly be worse right now, unless, of course, more types of consumer service problems are uncovered. 

* We should recognize the obvious -- the degree to which local communities (housing markets) recover or regress will be all over the board during the next five years.

Figure 1. Home purchase mortgage volumes have a long way to go to recover to the purchase levels of 2001. A classic post-bubble collapse curve has brought owner occupied purchase volumes to what we hope will be its low point. Instability, small movements and lack of traction are common frustrations at the bottom of any cyclical trough. 

Just when it looks like things are about to turn back towards long term historical trends (revert-back-to-the-mean), a series of on-again, off-again, up-and-down ebbs and flows rekindles household uncertainties and delays recovery in some markets and not others. That's one of the reasons owner occupied purchase mortgages may not reach 3,000,000 units annually until 2016 or later.

Figure 1

Population and household formation growth notwithstanding, the demographic trends that many mortgage banking executives believe will be the next propellants of a big leap forward in housing and home lending is a weak answer to some very big home financing and housing problems.

Figure 2

[iEmergent's proprietary PMGR metric blends a broad range of historical market data such as available household pools, household demographics, total mortgage debt ratios, income-debt ratios, new construction, housing turnover rates, default behaviors, foreclosures, underemployment levels, housing price movement, employment (job growth), loan transaction distribution patterns, etc. to produce a predictive indicator of a market's future purchase mortgage demand.]  

The absence of any signs of PMGR recovery means that PMGRs will continue to plumb the depths of mortgage lending activity for another year at least. 

Figure 3. Luckily for lenders, average loan sizes on purchase transactions have remained relatively high since 2008, even though housing prices have continued to fall almost everywhere we look. 

Financially confident households in upper income brackets have comprised a large portion of all purchase and refinance loans up to this point. Debt-challenged, depressed and cautious households are on the sidelines. In addition, the heavy dependence on low down payment FHA loans by all types and capabilities of home buyers has helped keep loan sizes elevated in the $200,000 range. 

Figure 3

Thus, falling purchase loan transaction counts have been offset by loan sizes that have been sticky on the upside; a great gift to the mortgage financing industry in terms total dollar volume. 

However, as the FHA increases its insurance and guaranty fees, tightens credit, demands adherence to strict documentation standards and pulls back further on their 2012 origination volume objectives in order to better manage their current and future risks, yet another obstacle to volume growth presents itself. Regardless, the great gift of steady loan sizes in the face of falling home prices will probably start to diminish sometime this year. 

Figure 4. Falling PMGRs in 2006-2007 were early indicators of what was about to happen to employment levels during 2008-2010. Later, even as employment levels began to rise (very slowly) in 2010 and 2011, PMGRs languished, indicating to us that job gains do not immediately translate into mortgages. 

Figure 4

In fact, PMGRs will significantly lag near-term growth in population, households and net job gains. As a lagging indicator, the picture will tend to become more pronounced, even as employment grows and the financial situations of recovering households begin to stabilize. Eventually, the rates at which markets generate mortgages will catch up and become a coincident indicator of employment growth again. 

In the short run, simply because new households are forming or unemployed households are getting back to being employed again, does not mean that a new home financing binge is immediately immanent. 

Therefore, we believe that purchase mortgage volumes will remain subdued in 2012 and 2013.

Figure 5.  The PMGR was also a leading indicator of the path that the MBA's Purchase Application Index has taken. The sideways (and slight downward) movement of the Index during 2011 also reflects the same type of "bottom-of-the-trough" behavior seen with the PMGR. It should come as no surprise that 2012 total U.S. purchase mortgage volumes might end up mirroring 1995 levels of volume. Rational households are fully aware that they need not apply when they know they cannot buy.

Figure 5

Figure 6.  Existing home sales (assuming you have confidence in NAR's sales numbers?) spiked, died, recovered, dipped and then began rising again by the end of last year, but purchase applications and purchase mortgages failed to follow suit. Heavy cash buying of distressed properties by investors has kept purchase lending activity well below the three million annualized run-rate level in units. 

Figure 6 - Graph:  San Francisco Fed

II. Purchase activities (PMGRs) in local markets follow their own unique paths.

Westchester County NY

Flagler County FL

What might look like small differences in PMGRs can have big consequences for current and future loan volumes, competition, loan acquisition efficiency, loan officer coverage ratios and the concentration of referral sources that exist inside local markets.

Hamilton County IN

Many markets that were fortunate to avoid an over-inflated run-up during the big bubble also avoided the slings and arrows of a big collapse -- in housing prices, home ownership, and mortgage demand. 

Then again, many markets that had generated only modest bubbles, ended up falling off a cliff anyway due to economic events beyond their control. Irrespective of their size and previous housing dynamics, every community has its own unique story to tell about the changes they have faced. Many local markets known for their very prudent households, solid job history  and controlled growth are finding it hard to secure their base for future growth.  

U.S. households, as well as the entire mortgage industry, remain caught in a housing and home financing demand trap accentuated by an ongoing negative feedback loop. A shortage of household demand has been suppressing home financing demand in almost every community in America, but to widely varying degrees.

III. Refinances: The gift that keeps on giving -- for a while, at least. 

Figure 7. Recurring waves of refinancing have been a fee-generating, revenue bonanza to mortgage bankers since Thanksgiving of 2008, not to mention for most of 2002-2004. However, since 2009 each succeeding wave has been diminishing in its intensity and duration.

Figure 7

In our minds, not much has changed during the past two years that would trigger rapid growth for 2012-2013 mortgage volumes. Purchase and refinance volumes will be continue to be shaky and the shakiness will vary greatly between individual markets. 

National and local lenders will continue to face fragile and shifting lending opportunities almost anywhere they look. 

2012 housing and home financing will remain in a wide-spread recession. A long-lasting housing depression could materialize in many local markets, while regressive governing behaviors could cause a number of unstable housing markets to stall or collapse further.

2012 Households & Homeownership:

A Negative Feedback Loop Crisis

Figure 9. The number of U.S. households who are qualified, ready, willing, and able to finance the purchase of a home is currently at a 20-year low. Demand has been forced to take a holiday.

Figure 9

The list of reasons why 40% (or more) of all American households are sidelined and no longer in the 2012 Available Pools of U.S. Households is long and broadly systemic across all markets. 

Figure 10. The U.S employment-to-population ratio for workers in the prime working age of 25-54 years is in crisis and shows no consistent signs of recovery since its fall in 2008-2010. There was a small improvement in the ratio in January, but older workers in the range continue to be disadvantaged in finding employment compared to younger job seekers.

Figure 10

Figure 11. Not only are the U.S. unemployment (in the labor force and looking for work) and underemployment ("marginally attached to the labor force or working part-time for economic reasons") rates showing weak signs of improvement, the gap between the two rates has almost doubled from it's traditional relationship. The widening gap might not return to historical norms for some time, if ever.

Figure 11

When workers currently in the not-in-labor-force category are added to the combined official unemployment rate and the underemployment rate, the total under-utilization of U.S. labor rises above 20%. Under-utilization is an ongoing tragedy, not only for the U.S. economy and aggregate consumer demand, but most of all, to real people, real households and real housing recovery.  

Figure 12.  Mike Konczal of the Roosevelt Institute normalized growth in the not-in-labor-force category against the in-labor-force count and compared the two growth tracks starting back in 2007. 

Figure 12

The rapidly growing gap between the "shadow/submerged" not-in-labor-force and the "official" labor force is clear.  Not only has this shadow labor force been growing steadily since 2008, the size of the official labor force has been relatively flat since before the bust began, which is not a good sign for rapid growth in home financing.  

Figure 13. Today, at a 4:1 ratio -- down from a crippling 7:1 in 2009 --an average of four unemployed workers are in competition for each job opening. When the shadow labor force is included, the ratio of non-workers to job openings gets worse. As the high ratio persists due to lack of job openings, the not-in-labor-force count will continue to increase, further stifling utilization, consumer spending and housing growth.

Figure 13

Figure 14. Recent job gains and an improvement in the U.S. unemployment rate - now at 8.3% - aren't signs that a rapid and sustained job recovery is unfolding. There is no analyst consensus on future unemployment trends and levels; not even close.  

Figure 14

 Figure 15. An inverted unemployment and household income dichotomy will not be able to turn around on a dime. Potential for growth in consumer spending will be held back. 

Figure 15

Figure 16. Wage/salary growth in the "bottom 90%" (oxymoron?) has been flat for two decades. For the lower 70%, though, wages have been steadily declining at the same time that the top 10% garner a greater share of all wages and salary. 

Figure 16

Figure 17. The middle class has been disappearing. As median household incomes fall, it's not much of a stretch to believe that 60% of all working households are finding it difficult to purchase the products and services that their jobs produce without relying on credit and debt.

Figure 17

Figure 18. Real household income has regressed to early 1990s levels (Center on Budget and Policy Priorities).  

Figure 18

Figure 19. Since early 2007, year-over-year wage growth has followed a decelerating trend (Employment Policy Institute). Wage growth in nominal, as well as real average hourly wages has deflated and flattened. The very households that are expected to start purchasing homes and helping to reduce the big overhang of middle and moderately priced homes are losing their purchasing power.

Figure 19

 Figure 20. Hopeful signs of a nascent recovery in household spending looks to be unsustainable. Stagnant/falling incomes have put an ever-increasing downward pressure on household finances. 

Real disposable income rose slightly in 2009 and then flattened during 2010-2011. The situation could have been much worse were it not for government transfer payments (the safety net + tax expenditures). During the same period, personal consumption expenditures (PCE) also increased, thereby helping GDP rise a bit.

However, increases in spending have been fueled by a downward trend in personal savings rates and an increase in consumer debt (credit card and installment loans). This doesn't bode well for a big acceleration in future consumer spending or home purchase activity.

Figure 20

Figure 21. Stagnant wages and falling real income also means that the ability of working families to reduce their high debt loads, especially their huge mortgage debt, will be severely limited. For the recurringly unemployed and the marginally attached, it's mostly impossible. The reduction in household mortgage debt has been driven primarily by bankruptcy, involuntary foreclosures, some loan modifications, by cash-in refinances, and making normal monthly payments; not by a household stampede to principal-reduction payments.   

Figure 21

 Figure 22. The U.S. homeownership rate is lower than the estimates provided by the Census Bureau. The real rate is much lower due to the high number of "shadow homeowners" -- those who are in long-term foreclosure, recurring foreclosure or serious delinquency status. Homeownership might still be the American dream, but it's a far off dream for a growing portion of U.S. households and a current nightmare for many.

Figure 22

Figure 23. Contrary to current political discourse, federal consumption expenditures and gross investment have been decreasing ever since the ARRA stimulus started to dissipate in 2010. State and local expenditures and investments have been falling at an even faster rate. 

Figure 23

 Figure 24. Piling on. Rapid reductions in state/local consumption and investment has had an expected, large negative impact on total U.S. job losses and un/under employment rates.

Figure 24

Figure 25. More piling on. Another potential 4% decline in housing prices/values during 2012 will further add to the $11.5 million mortgages that are already underwater. 

Figure 25

 Figure 26. Even more piling on in housing. The current shadow inventory represents a very big mountain of housing overhang that must eventually be absorbed. A decrease in home prices accompanied by an increase in underwater mortgages, followed by increases in serious delinquencies and foreclosures, means the mountain will keep on moving into future years. 

Figure 26

Our Q1 conclusions for 2012 prospects in home lending

National and local lenders will continue to face fragile, shifting lending opportunities everywhere they look. In 2012, U.S. housing and home financing will continue in a wide-spread recession, thus continuing to be a big drag on the U.S. economy.  

Depression-like conditions will be a fact of life for communities that are desperately struggling to find ways to stop the bleeding and exit the negative feedback loop that is holding their housing recoveries back. 

A number of hopeful housing markets are sitting on the precarious cusp between stability and renewed instability. Regressive economic behaviors and governance (austerity measures) could cause many of those metro markets and communities to suffer through another round of housing problems before they're able to turn upward.

In our minds, not much has changed during the past two years that would trigger a rapid growth path for 2012-2013 mortgage volumes. Fundamentally, a majority of working households are not in good positions to purchase and finance a home in 2012. 

Unfortunately, an ever-increasing number of households are slowly and silently slipping into a "working poor" designation, prevented from participating in the American dream anytime in the short-term future. It portends of structural economic problems in the long term that could be devastating for households and lenders alike, should they calcify into a new set of cultural norms for housing, communities and the economy.

A Poignant Paradox

Housing and home lending needs rapid and sustained economic growth in order to start on the road to recovery. But housing and home lending is a drag on the economic growth. But housing and home lending needs rapid and sustained economic growth.......
....but............housing.......is....drag........economy.......but.... 

The home financing demand trap is real. A negative feedback loop is still in control.