Housing Bubble the Sequel on the Horizon

I have been puzzled by the fact that in my neighborhood we have several foreclosures that have been sitting empty and on the market for two years or more. These empty houses are not damaged and would need very little if any maintenance to become someone’s home once again. Then, taking a short drive less than a mile away there are new homes under construction. I believe many of these homes are being built on speculation because once completed they are put on the market and a significant number of them remain empty for an extended period of time. In addition to my own observations I have also been reading reports about how the housing market is making a comeback and sales for new and existing homes have begun to spike.

How is a housing recovery possible as this makes no economic sense based on the foreclosure inventory being held by the banks!

For example, in Nevada new housing permits are up 50% while 8% of existing homes sit empty? Clearly, the housing market has been distorted beyond recognition and no longer resembles what most Americans would associate with a traditional real estate market.

What’s going on in the housing market?

At a time when the official unemployment rate is around 7.5% but the U6 unemployment number [includes underemployed and discouraged workers who have stopped looking for work] is actually 14% it’s impossible to have a genuine housing recovery. So, who’s financing the construction of new homes, who’s buying new and existing homes and who owns the millions of empty properties that can be found all across the country?

Who is building new homes? New home construction is being done largely on speculation by major banks that have access to mountains of cheap capital and have seen an unprecedented increase in private depositor funds. For example, JPMorgan Chase saw their deposits increase $9 billion dollars to $1.25 trillion in just the fourth quarter of 2012. In addition to having huge influxes of dollars into private accounts major banks also have excess liquidity from the Federal Reserve’s QE [quantitative easing is the printing and digitizing of money] programs.

Banks are searching for a return on their cash reserves and those returns are not coming from a robust economy. Banks are also trying to limit their exposure to the cheap money [hot money] that is running up the stock market and creating another investor bubble. Housing at least provides a physical asset that is seen as having real value as opposed to the overpriced paper being sold on Wall Street.

Who owns the millions of homes that are sitting empty? The foreclosures [toxic assets] are owned by a variety of institutions. GSE’s [government sponsored enterprise] Fannie Mae, Freddie Mac and Ginnie Mae, large banks and the Federal Reserve hold the lion’s share of these foreclosures. Millions of foreclosures properties have been sidelined and held off the market to maintain housing values and those financial liabilities have been transferred [temporarily] off the books. Super low interest rates makes it possible for banks to “hold properties” without incurring any significant financial hardship. It’s important to understand, any spike in interest rates would be catastrophic for the entire financial system of the United States. Who is buying new and existing homes? With artificially low interest rates it’s an attractive market for anyone who is gainfully employed, has a downpayment of 20% and has an excellent credit score. However, that set of circumstances applies to fewer and fewer Americans as economic conditions continue to deteriorate.

The real movement in the housing market is because of institutional buyers and foreigners who are investing their money in the US real estate market. Europeans and Chinese constitute the two primary groups doing most of the buying and there’s speculation that they are actually divesting themselves of US dollars while simultaneously acquiring a physical asset. European buyers have the added benefit of acquiring an asset that is beyond the reach of the European bureaucracy and its confiscatory tax rates and regulations.

Interesting facts; 40% of homes are bought by investors who pay cash for the property and receive deep discounts for purchasing the home[s] outright and the other 60% of buyers are individuals purchasing the home as their primary residence. The homes purchased by investors (sometimes by the dozens) are turned into rental properties.

One of the most aggressive buyers of foreclosed homes is a company called Blackstone Real Estate. Black Stone’s business model is to buy foreclosed properties for cash and then turn most of their newly acquired properties into rentals with a significant number of those rentals committed to the section 8 housing program and then renting it back to the US government through various HUD programs.

From Bloomberg:
“The strategy is similar to institutional buyers including Blackstone, the world’s largest buyout firm, Thomas Barrack’s Colony Capital LLC, and Oaktree Capital Group LLC. (OAK) They are aiming to profit from low prices on distressed properties, often those in foreclosure and sold at auction — and the demand for rentals from people who don’t want to own a home or can’t qualify for a mortgage.”

“Blackstone’s investment in distressed properties has increased from $1 billion of new homes owned in October, when Blackstone Chairman Stephen Schwarzman said the company was spending $100 million a week on houses. Blackstone has spent more than more than $2.5 billion on 16,000 homes to manage as rentals, deploying capital from the $13.3 billion fund it.”

So what we are really looking at here is large financiers are the main players in the housing market, snapping up properties that the average American once owned. These financiers have access to piles of cheap capital and are renting homes back to people who have been forced into foreclosure or renting them to government agencies associated with HUD.

The primary culprit for the significant distortions in the housing market is the Federal Reserve’s ongoing liquidity programs, banks chasing investment opportunities with cheap capital, a contracting economy making traditional investments instruments unattractive or impossible to get a return on and artificially low interest rates. We would have been better off letting the market correct itself in 2008 and taken our lumps then.

I’m afraid we have another housing bubble forming which will eventually have to pop and potentially will cause more destruction to our economy then the 2008 bubble did.



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