No Good Reason to Wait
This year home prices and sales have slightly declined in most San Diego markets. Although the rate of foreclosures and default filings are lower than 2010, these numbers shed little light on the future of local residential real estate. Going forward I think we should use a different standard to evaluate the market ; winning should be defined as not losing. Price stability, with moderate or little appreciation, is the new benchmark of success in real estate, and this market will achieve that standard over the next five years.
This recession has gone viral. Most of the denizens of Western economies are in the woodshed, taking a licking for living large on cheap debt. In addition, First World governments have under taxed and over promised--plus the ugly hangover from ladling out too many fat retirement packages neither businesses nor governments can long endure. There is a direct line between allowing Greeks to retire at 58 with nearly a full salary and your neighbor’s underemployment. Like it or not, when French banks stumble everyone in this country is suddenly poorer.
In spite of all of this, I am optimistic about the safety and economic viability of San Diego real estate. Our central bankers are implementing policies designed to protect the existing price structure of real estate; this is needed to protect the nation’s recovering banking system.
The first of these is that mortgage and interest rates will be kept low for at least the next three years. The Fed can print money, as it has done with QE1 and QE2, and thereby push bond prices up and interest rates down. People getting new loans over the next few years and those with variable rate loans will be huge winners. I think this policy will remain in effect until the unemployment rate drops below 7%.
Second, the troika setting economic policy has figured out that the real estate correction has gone far enough and that prices should be stabilized. If real estate continues to deflate, there will be no meaningful recovery or job growth, perhaps leading to an American version of Japan’s Lost Decade. Ordinarily the economic impact of rising housing sales and prices has led the country out of past recessions. The customary monetary tool used to invigorate home sales is low interest rates, but this time around this usually reliable panacea has not delivered.
Already there appears to be a new policy amongst lenders to restrict the supply of foreclosed properties on the marketplace. Loan servicers are delaying foreclosures and lenders are holding seized properties in their inventory for a longer period of time. In addition, the idea that holders of failed mortgages, mainly FNMA and FHMC, should become long-term landlords is gaining political traction and if fully implemented would do wonders for arresting future price declines. None of this is going on without the implicit consent of the Fed and the FDIC.
The FDIC may also force lenders to modify their underwriting standards so that those who need newer and cheaper mortgages can qualify and avoid default. There is a natural reluctance at the Fed, not to mention Congress, to let the banks off of their short leash; we all know what happened last time they set the rules.
The Administration in late August proposed such a plan. It is based on recognizing the reality on the ground and two lessons from history which suggest these two approaches above could work. The Resolution Trust Corporation debacle of 1991-94 illustrates the foolhardiness of dumping failed properties willy-nilly on the marketplace. And during the Depression, the New Deal’s Home Owners Loan Corporation refinanced homes with generous terms and staved off thousands of foreclosures. When the agency was finished in 1951, it not only protected families and neighborhoods, it also turned a profit. It was a simple idea; give a temporary hand to those in need and collect the cost on resale.
Third, the Fed has a doomsday weapon-- adjusting its’ inflation target. This is a way to stabilize house prices by discouraging strategic defaults. There is risk in a policy that will move up the target inflation rate to 4 to 6% , so it will be employed only as a weapon of last resort. This is an unilateral loan-write down for creditors, both foreign and domestic. They will not be pleased.
I have heard all of the arguments against these ideas, but the boat is foundering and it makes little sense to worry about the moral hazard of bailing out failed homeowners or the Tea Party aversion to big government. Owners of bad mortgages are loathe to manage property but we should make them do so. There is a qualified work force in place as there are thousands of licensed property management firms in this country. It may take ten years to bleed out hidden bank inventories, but that is a small cost when considering the alternative. The current strategy of thoughtlessly dumping seized homes on the market only depresses prices further.
Residential and apartment investments have far better prospects than everything else that competes for your investment dollars. I recognize renting appeals to many discretionary buyers, but the Fed is making home purchasing very attractive. Consider this: taxpayers will subsidize your house payment by allowing you to deduct mortgage interest and property taxes. The Fed will keep a floor under the current price levels by restricting the supply of bank-owned homes or by inflating the dollar. Prices have drifted to 2004 levels. So why wait?