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011 Good Bad & Ugly - Totally Unpredictable Housing Market

Jordan Levine...

... Economist at the California Association of Realtors - an organization with over 180,000 members - provides clear insights based on consolidation of a vast array of public and proprietary sources of data sources regarding the housing market nationally and in California, in an information rich podcast.

The Good and the Bad

Tailwinds for the housing market include the government’s general orientation towards stimulating the economy and particularly in the banking sector. Post recession tightening of banking regulations through Dodd Frank and the Consumer Financial Protection Bureau, the CFPB, while good have probably swung too far and are unnecessarily limiting liquidity in the housing market by making it unreasonably difficult to get a mortgage. Seeing those regulations relaxed is likely to stimulate demand and help people become homeowners. Tax reductions and infrastructure spending will also bring liquidity to the markets on the demand side, further stimulating housing by putting more money in consumer’s pockets to go out and buy homes.

On the negative side, reducing government support of the GSEs like Fannie and Freddie could increase market risk in related securities, pushing interest rates up, and increasing the standard tax deduction could eliminate the benefits of the mortgage interest deduction, dis-incentivizing consumers from buying homes. At the same time though, those homes on the market may continue to increase in price if the economy continues to strengthen, pushing them out of reach of more and more consumers.

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Headed for a Correction?

This will further impact the affordability problem with the possibility that only 25% of households – in California and, presumably elsewhere to a lesser extent – will be able to afford to own a home. This would be an historic low, and, although Jordan did not talk about this, might signify not only limitations on housing industry growth, but could indicate we are heading for a correction.

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Forecast for the Industry - Deregulation, Fiscal Stimuli Good for the Industry

There is optimism that deregulation of industry across the economy, and particularly across banking, will be beneficial. Dodd Frank and the Consumer Financial Protection Bureau was designed to protect us from the same kind of downturn as we saw in 2007, but the pendulum has swung too far and now it is too difficult to get a mortgage. Some deregulation on the banking side may make it easier to get a loan and so boost housing demand. Potential tax cuts will be beneficial including personal as well as corporate rates coming down to levels more competitive from a global perspective. Infrastructure spending will also be beneficial to providing spending power to the consumer. Better trade with foreign countries could help California as a heavy trading state by stimulating economic growth that also filters down to the homeowner.

Interest Rate Risks

Some cautions.  The Government Sponsored Enterprises (GSEs), like Fannie Mae, Freddie Mac, are securitizing mortgages, currently with government backing. This means that they are guaranteed and so consequently rates remain low because risk is mitigated.  If these GSEs are privatized in any way, through the so-called ‘recap and release’ program or otherwise, this could drive up mortgage interest rates by adding layers of risk to the market by reducing government backing that, in turn, would need to be priced into rates to compensate for the enhanced risk.  Hence interest rates might go up by up to another 1% which could have a severe impact on the already problematic affordability of housing, especially in housing constrained states.

Mortgage Interest Deduction

Another red flag is the possibility that the benefit of the mortgage interest deduction (MID) could go away.  Owning a home has been a bedrock of American society with the idea that one sinks roots into a community, as well as being one of the best forms of wealth building over the long term.  Removing the mortgage interest deduction itself is not something that is being discussed, but by doubling the standard deduction to $25,000 or so, which is being discussed, this could eliminate the benefit of the MID.  This would mean that the MID would only kick in as being beneficial if a homeowner is carrying $650,000 or more in debt, hence a vast swath of the home-owning population across the nation would lose the benefit of the MID because their mortgage debt would not be high enough to matter.  This could dis-incentivize homeownership and, consequently, long term wealth building.

Triple Whammy

Growth is good, but with near full employment the downside is that mortgage rates are increasing.  With supply of housing as constrained as it is in California, economic growth is good, of course, but will drive up home prices even further.  This combined with increasing mortgage interest rates will further impact affordability – increasing rates with greater demand for housing is a double whammy for housing affordability and a big issue in California.  Immigration adds a third whammy to the equation in California as well as in other states that rely heavily on immigrant labor.  If there is some kind of dramatic reduction in immigration or mass deportations, the impact on California's 3 million immigrants could be to reduce demand for housing, on the one hand, but also hurt housing affordability in households where the primary wage earner is no longer contributing to the income of the household.

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