Fed Worried About Real Estate Slowdown

by John M. Curtis
(310) 204-8700

Copyright May 14, 2014
All Rights Reserved.                                     

            With a growth rate of near zero, Federal Reserve Board Chairman Janet Yellen expressed concern about a fizzling real estate market.  While the real estate sector showed a pulse last year, loan originations dropped year-to-date over 60% causing real worries that the economy can’t count on a recovering real estate market.  Past economic recoveries counted heavily on real estate to help stabilize Wall Street that has had five-consecutive years of growth since bottoming out March 6, 2009 at 6,443.  At almost 10,000 point higher today, Wall Street can’t compensate for what Main Street can’t do, especially the real estate market.  Since the last real estate bubble burst in 2007-08, triggering a derivative sell-off in mortgage-backed securities, the economy has been stuck in neutral.  Economists hoped that Wall Street could pass the baton to the real estate market to cement recovery.

             Recovering from past recessions requires a strong response from Wall Street, something that’s happened beyond all expectations.  But once Wall Street does its job of providing publicly traded companies with sufficient cash to expand payrolls, it’s up to other industries to take the ball and run with it.  Since the U.S. Economy climbed out of recession of 2010, the economy has added some 8 million jobs, more than it lost in the great recession yet not enough to fuel the kind of recovery that adds to the nation’s gross domestic product.  Jobless recoveries or at least recoveries that don’t add enough jobs aren’t enough to spark GDP growth.  Mirroring the sluggish jobs growth, sales of new and existing homes, housing starts, mortgage originations and refinances have slowed to crawl in most parts of the country, spelling trouble for the economy.  Without the robust housing market, GDP heads south.

             With the Federal Funds Rate between zero and .25%, long-term treasury yields have been pushed to 2.6%, driving mortgage interest rates to near historic lows.  What differs today in the wake of the 2007-08 meltdown in sub-prime mortgages and federal takeover of mortgage giants Fannie Mae and Freddie Mac are such strict lending practices that the vast majority of self-employed borrowers have been squeezed out of the mortgage origination and refinance market.  Even fully employed individuals are required to have such low debt-to-income ratios that they also can’t quality for new mortgages or refinances.  Without some adjustment to government lending practices, the housing market—and indeed the entire economy—could be heading for a double-dip.  As housing falters under the weight of today’s excessive regulation, the jobs market can’t keep pace with the consumer economy.

             Considered about two-thirds of the nation’s economy, consumer spending can’t go forward without a robust jobs market.  Despite today’s 6.7 unemployment rate, the amount of the chronically unemployed no longer counted in the Labor Department statistics grows daily.  Without stable jobs growth, it’s difficult for consumers to continue the pace of spending needed to fuel lasting economic recovery.  At the rate consumers are spending, the economy can’t create enough product or service demand to keep expanding the jobs market and adding to the tax base.  Reducing its treasury purchases by some $15 billion monthly also could have disastrous consequences on the economy.  Already reduced by $30 billion a month, the Fed’s quantitative easing is already creates cash shortages in the banking system.  Yellen must decide to “taper the taper,” where she continues more quantitative easing.

             Going forward, Yellen must work with other Fed governors to loosen credit standards, squeezing otherwise qualified borrowers from getting mortgages.  California’s real estate sales have now deteriorated to 40% cash sales, since most borrowers can’t qualify under today’s restrictive borrowing standards.  New Federal Deposit Insurance Corporation data shows that credit is just as tight today as it was in 2009 when the Dow Jones Industrials bottomed March 6, 2009 at some 60% off its Oct. 9, 2007 high of 14,186, 20% less than today’s close of 16,614.  Among Yellen’s suggestions, she’d like Fannie Mae and Freddie Mac to allow qualified borrowers with good, but not excellent, FICO scores to qualify for mortgages.  While admitting to lax lending standards led to the 2007-08 bubble, Yellen wants federal lending authorities to go back to pro-growth lending practices.

             Watching the housing market deteriorate, the Fed wants federal lending authorities to rewrite the currently overly strict guidelines that prevent the lion’s share of qualified borrowers from getting new mortgages or refinancing.  Viewing housing as essential to GDP growth, Yellen seeks balance from the nation’s leading lenders that have taken an overly cautious approach since the 2007-08 housing bubble.  Wall Street already shows sign of deteriorating, potentially stalling the economic recovery that seems stuck at less than one percent GDP.  “The economy needs all tailwinds and virtually no headwinds, if the Fed expect the economy to return to its fullest potential and allow it, ultimately to restore policy to normal—whatever normal means in a post-crisis environment, “ said Yellen, hinting that the Fed must do more to keep the economic recovery going.