Saturday, January 26, 2013

Some Perspective in the 'Recovery' of Homes Sales

Housing is being heralded as 'in recovery,' unless you look carefully at the data. See how the headline frames a recovery despite not very promising data:

"Home Sales Recovery Holds Place" by Alan Zibel The Wall Street Journal Jan 26-27 p. A3

"New home sales rose by 20% last year . . . 

...last year was the third-worst on record for new-home sales, highlighting the long road to recovery for the industry. . . . December's results were down 7.3% on a monthly basis to a seasonally adjusted annual rate of 369,000, but figures for Sep through Nov were revised upwards."

Majia here: Now let us looking at housing stock. Do you see a mini-bubble here?

"Housing is Back - but Housing Stocks Are Due for a Fall" by Brett Arends WSJ Jan 26-27 p. B7

[Excerpted] At current levels, say analysts, homebuilding stocks have priced in much of the recovery ahead. As the chart shows, the Philadelphia Stock Exchange Housing Sector Index has rebounded far more significantly than housing itself. Shares of Dr. Horton now trade at 1.9 times the  per-share value of the company's net assets, approaching the 2.3 level seen in 2004-2005....

...Pulte Group has swelled to 3.7 times its per-share net assets, a record...[end]

Majia here: OK it looks like builders' stock prices are inflated. 

 I'm not saying that I think housing will collapse. What I'm saying is that there have been extraordinary efforts on the part of government and the financial industry to recover housing in order to re-inflate bank assets and household wealth, which for many people is stored in their house.

The Federal Reserve has been buying up the mortgages and this process alone has been cited as the reason for recent bank profits

"Banks Profits Up 6.6%" by Alan Zibel Dec 5, 2012 p. C3 The Wall Street Journal

[Excerpted] "Total profit of $37.6 billion, was up 6.6% or $2.3 billion, from the same quarter a year earlier....

...Banks are able to book gains by selling off refinanced loans to federally controlled mortgage giants Fannie Mae and Freddie Mac...

...In recent quarters, the industry has drawn most of its earnings improvements from small provisions to cover bad loans, and officials had flagged the trend as a concern. But in the third quarter, provisions for loan losses fell by 20.6%, to $14.8 billion, from a year earlier. [end excerpt]

Majia here: Let us look carefully at what this article is arguing.

It is stating that there are 2 main mechanism for growing profits in American banks:

1. Sales of re-financed loans to quasi-government agencies, Fannie and Freddie

2. Declining reserves (a.k.a. "provisions) for for loan losses

Majia here: This article provides evidence that bank profits are being driven by housing (and declining reserves).

How is it that banks are able to loosen their reserves?

WSJ: Rules for Lenders Relaxed: Regulators Agree to Ease Requirements for Meeting Guideline on Liquidity by David Enrich, Geoffrey T. Smith, and Andrew Morse Wall Street Journal Mon Jan 7 2013, p. C1, C3.

[Excerpted] Basel, Switzerland-Global banking regulators watered down a key element of their plan for creating a safer financial system, giving ground to banks that argued the rules were unworkable and financially risky... Bowing to two years of intense pressure from the banking industry, the regulators made it easier for banks to meet the rule, known as the 'liquidity coverage ratio,' and delayed its full implementation until 2019. 

It is the latest instance of regulators chipping away at their landmark 2010 response to the global financial crisis....
Majia here: Many of the banks remain technically INSOLVENT and that is why these liquidity rules are being loosened.

Why are they insolvent? The answer lies in the outstanding derivatives, whose worth has been compromised by debt defaults. Many of these derivatives are based in housing.

In 2011 there was $250 Trillion in Outstanding US Derivatives Contracts (consisting of Interest Rate, FX, Equity Contracts, Commodity and Credit Default Swaps). 5 Banks accounted for 96% of that derivatives exposure.

I think Max Keiser and Stacy Herbert provide the best analyses of how the banking system struggles to keep the juggling act going.

Moral of the Story: Beware of the Housing Market and the Too-Big-To-Fail Banks.

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