Forget about bank doom loop stories over residential mortgages. Instead put the spotlight where it belongs.
Not Residential!
A reader asked me to comment on Peter Schiff: Banks Have a Bigger Real Estate Problem Today Than They Did in 2007.
Banks are more vulnerable to the housing market now than they were in 2007.
Most people in the mainstream will scoff at that statement. They’ll tell you that the situation is very different today. After all, we don’t have a big problem in the subprime mortgage market. We’re not seeing a big spike in defaults. That’s true. The problem is different this time. And it’s actually worse.
So, what’s the problem?
As Peter Schiff explained in a recent podcast, the problem this time is the mortgages themselves.
As Peter points out, a 3% mortgage is a huge asset for the borrower. But it’s a huge liability for the lender. So, defaults would benefit the banks. They could theoretically repossess the home and resell it to somebody else and write a mortgage at a much higher rate.
So, this is a very different crisis. But it’s worse because they’re losing money on every single mortgage they have whether or not they go into default. … So, this is bigger. It is a bigger problem for the banks. They’re losing more money, and they will lose more money now than they did in 2008. That means we’ll need an even bigger bailout. All these ‘too big to fail’ banks have an even bigger problem now than they did then, and it’s going to take an even bigger round of QE to bail them out. The problem is how’s the Fed going to do that when inflation is as high as it is and going higher?
Total Silliness
For starters, banks tend to securitize mortgages they originate or dump them on Fannie Mae.
Second, few will be walking away. There is too much equity for a default crisis as happened in 2007.
Third, the Fed has a liquidity program (BTFP explained below) to help banks paper over losses.
Runs on banks have stopped. If bank runs start again, it will not be due to residential mortgages.
Fed’s Emergency Liquidity Program
The Fed started the BTFP program in the wake of the collapse of Silicon Valley Bank.
Small regional banks overleveraged in long term treasuries and were clobbered by paper losses and then bank runs.
In response, the Fed agreed to shield the banks from losses by offering swaps at par value, ignoring the losses.
BTFP Terms
- Eligible Collateral—Direct obligations of certain U.S. government agencies, including the U.S. Department of the Treasury, government-sponsored enterprises such as Fannie Mae and Freddie Mac, and the Federal Home Loan Banks. In addition, mortgage-backed securities issued and/or fully guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac are eligible.
- Loan Terms—Institutions may borrow up to the value of eligible collateral pledged. Collateral is valued at par, i.e., with no haircuts. Loans can be prepaid at any time without penalty. The rate is fixed for the life of the loan (up to one year) and is calculated by adding 10 basis points to the overnight index swap rate. The rate is published daily on the Discount Window website. Advances will be available until March 11, 2024, or longer if the program is extended.
Liquidity, Not Solvency Issue
This is a liquidity issue, not a solvency issue. The US is not going to default and the treasuries are not worthless. The Fed wanted to stop bank runs and did so by a method that hides losses.
However, the paper losses are still real, even if hidden in reports. This has an impact on banks willingness to make loans in a rising interest rate environment.
For further discussion, please see The Fed’s Emergency Liquidity Program, BTFP, is Over $100 Billion, What’s Going On?
Commercial Real-Estate Doom Loop
The Wall Street Journal reports Real-Estate Doom Loop Threatens America’s Banks, but the loop is commercial.
Bank OZK had two branches in rural Arkansas when chief executive officer George Gleason bought it in 1979. The Little Rock lender today has billions of dollars in commercial real-estate loans, including for properties in Miami and Manhattan, where it is helping fund the construction of a 1,000-foot-tall office and luxury residential tower on Fifth Avenue.
Regional banks across the country followed a similar playbook, gorging on commercial real-estate loans and related investments in big cities over the past decade.
With the commercial real-estate market now in meltdown, those trillions of dollars in loans and investments are a looming threat for the banking industry—and potentially the broader economy. Banks’ exposure is even bigger than commonly reported. The banks are in danger of setting off a doom-loop scenario where losses on the loans trigger banks to cut lending, which leads to further drops in property prices and yet more losses.
The doom-loop scenario is starting to play out in big cities where office vacancies have soared. Real-estate investors that are unable to refinance their debt, or can only do it at high rates, are defaulting. The lenders, no longer getting the debt payments, often have to write down the value of those mortgages. Sometimes the bank ends up owning the property.
“The plumbing is clogged right now,” said Scott Rechler, chief executive of real-estate investor RXR. “And that is going to create a backup that will eventually overflow on the commercial real-estate markets and on the banking system.”
US Regional and Small Banks’ CRE Exposure Could Pressure Ratings
Fitch reports US Regional and Small Banks’ CRE Exposure Could Pressure Ratings
U.S. banks with less than $100 billion in assets are more susceptible to deteriorating commercial real estate (CRE) fundamentals than larger banks, which could add to ratings pressure, given their higher relative exposure as a percentage of assets and total capital, Fitch Ratings says.
The tight monetary environment has placed pressure on most CRE properties’ collateral values and transaction volumes while structural changes in demand for office space have adversely impacted occupancy for that asset class. These factors increase credit risk for banks that have CRE loan concentrations, and are expected to have an impact on asset quality in CRE loan portfolios of U.S. banks.
Banks with more concentrated CRE exposure to office markets, particularly those with much weaker vacancy trends, face moderate stress over the near- to medium-term. For example, larger cities, including San Francisco, Houston, Dallas/Ft. Worth, Washington DC and Chicago had high office vacancy rates as of 1Q23.
BTFP Eligible Collateral
Look again at the BTFP eligible collateral. It includes Fannie Mae, Freddie Mac, Ginnie Mae. It does not include commercial real estate, or any other kind of bank loans.
CRE and other types of bank loans are solvency issues.
By shielding mortgages and Treasuries, the Fed contained any residential mortgage crisis.
The big problem for banks is commercial but the residential housing market is in shambles.
How the Fed Destroyed the Housing Market and Created Inflation in Pictures
The Fed has a big problem of its own making on its hands that will make inflation harder to control.
For discussion, please see How the Fed Destroyed the Housing Market and Created Inflation in Pictures.
The Fed destroyed the housing market, but this will have minimal impact on banks. Commercial real estate is the key issue.
Mish claims: “This is a liquidity issue, not a solvency issue. The US is not going to default and the treasuries are not worthless.”
Read my lips and slam dunk your WMD into your health care plan… “Promises” from octogenarian members of congress are absolutely worthless, and too many younger generations can’t afford to move out of their parents basement.
Treasuries are backed by the tax base, not by politics. As the tax base goes, so does the US ability to pay its debts.
Read my lips – You are clueless
No country that owes debt in its own currency has ever defaulted and never will.
I think I pressed the wrong reply button… below should have been in reply to you
Mish – your lips are confusing legal default with economic default. I never claimed the US would file Chapter 7. Go ahead and do a text search on my comment, I never used the phrase “chapter 7”. I was and am talking about an economic default.
According to every peer reviewed study on economic defaults, very few are 100% defaults. Almost all, public and private, pay at least a few “pennies on the dollar” (or whatever currency denomination you prefer). This was true for Enron, Penn Central Rail Road (and its various predecessors), the state of California, Continental Illinois Bank and Penn the nations of Argentina, France, Italy, England, Spain and … the list of economic defaults is endless.
If you know the first thing about US history, then you know FDR already defaulted on US debts. So did LBJ and Nixon. Ask your favorite Native American tribe if the US government always honored its treaties, sovereign promises, including financial promises – pick whatever tribe you want, the US defaulted to all of them at various times. You either failed history or you are allowing your personal beliefs to cloud your thinking if you believe the US has never economically defaulted whenever it was politically expedient. And it will continue to do so, only now on an empire scale comparable to the defaults of France or Spain or England or Sweden or
If you have traveled outside the USA during your life ( and if you are honest) then you have a container of “foreign coins” (foreign to the USA anyhow) that are no longer valid currency back in their country of issue.
France is on their fifth republic? 6th? They had five different Francs to prove it before they redenominated their debts (again) into Euros. Italy issued so many different Lira, even their citizenry lost count. Greek drachma. Argentinian pesos. Turkish Lira. The British defaulted after WW1 and again after WW2 – that’s before we mention the UK’s technical default and IMF bailout in the 1970s. When, not if, there is an economic default – the sovereign gives creditors a “new” currency, always worth less than the value they borrowed…. in other words, they pay pennies on the dollar, just like every other default.
Since no court has legal jurisdiction, nations either negotiate with creditors or dictate to creditors. The economic debts are paid only in part, in whatever new currency. Not only do sovereign economic defaults happen – they are quite common.
Books, with hundreds of pages each, have been written about sovereign defaults Mish. Books PLURAL, several by authors who won international economics awards. Hundreds if not thousands of peer reviewed academic articles.
Politically minded “quasi-Keynesians” make the claim that economic defaults never happen…. ignoring centuries of sovereign economic defaults (in the currency of the debtor). The USA has economically defaulted at least twice in the last 100 years, while most other countries have economically defaulted more than the USA.
I don’t think you have done your homework on sovereign defaults Mish. You are usually a lot more careful.
CRE, in particular office buildings; must fall in value as the need for so much office space is gone, permanently.
Similar to how technological changes did away with the typing pool and the file clerks the current advances and societal changes will mean far less office space is needed. Less need means higher vacancies and higher vacancies means new leases will have a better position to bargain for cheap rents. Renewed leases will have similar bargaining power as the tenant might rent fewer floors or shut down entire sites.
My daughter is a HR manager, she now works from home 2 days a week and her company now hot desks for those days she goes in, her husband is similar. My sons girlfriend now works permanently from home or wherever she wants to be, like putting her laptop on my dining table. Just 5 years ago they would have each have had a dedicated desk, office or cubical and now their employers no longer need that much space for their staff. Multiply this by the millions of similar workers and that is tens of millions of now vacant office space.
And with fewer office workers going into the CBD each day what effect will that have on the coffee shops and similar that are seeing fewer patrons. So even a small negative for non office CRE.
Can office buildings be converted to apartments? Yes, some can and are being converted but others are just not suited for conversion.
Need to open a coffee shop next to your dining room table.
Saving & Loan crisis 2.0 ?? Is it better to pay your 3% mortgage and default on a car loan ? That’s what recent data suggest. Bank losses on mortgages – it takes time to securitize mortgages when being a smaller bank. First, it takes some time to build a portfolio and securitization process itself takes few weeks. This means that local lenders may have written mortgages which were loss making for them when they got sold off because interest rates were rising very fast. And they likely didn’t manage to sell 100%, they must keep “equity” tranche. Or has the market changed during past 15 years?
Savings and loan crisis wasn’t 15 years ago it was 30 years ago but yeah
40
Home prices fell during the GFC because Bernanke held the M1 money stock constant for 4 years, M1 NSA money stock peaked on 12/27/2004 @ 1467.7. It didn’t exceed that # until 10/27/2008 @ 1514.2.
In contrast, Powell has only held the money stock, means-of-payment money, constant for 18 months, from $4,812.8 3/1/22 to $4,903.9 on 8/1/23.
“Housing’s share of the economy remained at 15.8% at the end of the second quarter of 2023.”
Link: “HOUSING IS THE BUSINESS CYCLE” Edward E. Leamer
If you have half a trillion in retail MMMFs increase, and a trillion dollars in RRPs decrease, you get Atlanta’s GDPNow Latest estimate: 5.1 percent — October 10, 2023 How do you think last quarter’s trillion-dollar debt was paid? Higher interest rates forever.
A trillion US $100 Federal Reserve Notes is about 400,119 CUBIC FEET.
Figuring a note is about 0.003 inches thick.
That’s not a decimal point, it’s a comma.
Four hundred thousand one hundred and nineteen cubic feet.
In the now historic era of some 20 years ago, FED had facilities to deal with solvency of a single bank. In the new era, nothing but a facility to save the whole system will do: the SVB was a midsize bank and wasn’t known generally. That’s how explosive the system has become. Nice job.
BTFP is financed by printing billions of fresh fiat. I already sleep better.
If the truthful rate of inflation continues then US Treasuries are worthless.
Exactly true Wouldnt touch em myself
But are Treasuries worth less than Currency?
Commercial real-estate has always been a yo-yo more so than residential real-estate. If we take past crashes as examples, we have office buildings going for half what the price was in boom times and someone with cash comes in to pick them up. Banks have to sell repossessed properties because they don’t want manage them so they do and take the write off. Those people with cash step in and buy it for a song and when you buy cheap making money from them even in bad times is easy. Of course you don’t just buy anywhere and avoid future rust belts. Bankruptcy is a fantastic way to make unprofitable assets into profitable ones however with new owners.
Buy stuff at low prices, then sell it at higher prices.
It’s a plan.
….Second, few will be walking away. There is too much equity for a default crisis as happened in 2007…
That equity will soon evaporate the moment house prices start to come down.
Suffices for one distressed sale to bring prices to same level for whole neighborhood. It’s spurious values, but home prices reflect the quantity of money injected by the Fed and unless that is withdrawn, prices will not come down.
Fed will not withdraw that money, if anything it’s itching to restart QE.
Their program of paying face value for impaired bonds to banks is downright criminal. Fed has been an outlaw for sometime now and if politicians aren’t questioning it is because either they all benefit somehow from them or Fed is truly our overlord and all the democratic structure is but a smokescreen.
You say total silliness, then go on to show how residential mortgages aren’t a problem. Peter Schiff explicitly says it isn’t residential, it’s commercial, and it isn’t defaults, it is the fact the prices of these mortgages are less than par, quite a bit less. Perversely, banks are hoping for defaults now so they get to reprice the mortgage at par. Yes, residential mortgages are collateral for Fed loans, but what about commercial? Just look at commercial MREIT prices to get a feel for the suffering soon to be felt. Throw in the fact the collateral values for offices are down 70%, yep banks are in trouble
I am wondering why a bank would be happy repossessing a house in a bad residential real-estate market in order to give another buyer a higher mortgage rate. The bank would be gambling on the 1) the real estate market being robust enough to find a new buyer and 2) that interest rates will drop back down to the ultra-low levels we had before. Might be better to sell the house at a price you can get and write off the loss and then wait for better times.
In Maine (believe it or not) our property value (and taxes) have gone up fully 100% in the last 2 years. Our lender is losing money every day on the jumbo mortgage they sold us, but I’d love for property values to drop 30%-40%.
What will eventually kill residential real estate will be the mounting costs of insurance, property taxes, and maintenance. It’s great to have a home go up in value from $300k to $600k until you realize your expenses all double too and they rarely go back down.
Another reason why social security won’t be enough to support retired folks and it will be a slow grind down to a nub.
I don’t think the items you point to will single handedly cause home prices to drop, but I would say they’re a major part of it. The question, as it’s been for the last 12 months, is timing. Personally, I think the economy & Joe Consumer (bottom 50%) don’t find themselves in deep doodoo until early 2025. And then the question becomes:
When the big recession actually arrives (6, 12, 18 months from now) do the 10M illegals living here in the US do, specifically the adult-male group? Do they start to self-deport like they did in W’s second term or do the turn to more suspect means of supporting themselves.
That’s when it gets really fun!
Taxes, Insurance, Maintenance will absolutely continue to drive the “cost” of a home up making it difficult to pay for anything else. Taxes will never go away and the place falls apart without some basic maintenance.
My “prediction” is you will begin to see those that outright ‘own’ their homes go ‘naked’ on insurance. (With the exception of maybe some liability coverage.) I think you will see the same for vehicles that are paid off. Liability only coverage just to keep the tags.
You can already see it in certain parts of the country where hurricanes and the wildfires out West have driven the price of insurance sky high if it is even offered as companies refuse to write in certain regions. People will have to set aside the insurance payment in some sort of savings that has a return and hope they never need it or just be prepared to lose it all if something happens. Some may even sell and move elsewhere with less risk.
And they say nobody wants to live in Maine I love Maine especially the lobsta and blueberries
…and the real maple syrup, and the chowdaa, definitely the chowdaa.
Here is the game. If you think inflation will continue to run hot for an extended period, then housing prices will increase and you want to own a single family home.
But, if you think deflation will take hold, then you should sell and rent because home prices will decrease.
Sometimes, I see people predicting home prices will fall while inflation runs hot. That is just wrong.
My forecast is for inflation will remain elevated for quite a few years. So, I doubt house prices will drop.
Maybe both are right. Galloping inflation and house prices increasing but at a much lower rate. Houses going up in nominal terms but down in real inflation adjusted terms. If true, it may be wise to leverage up on 30 year fixed rate mortgages with 10% down. Your return on equity would be high even with slowly rising house prices
The best scenario for housing at this point would be for home prices (and rents) to remain flat (less than 1% annual growth) for three to five years.
Home prices may increase in dollar terms but crash in real money terms(gold) if the US can’t get its house in order
While the housing price will rise, it could underperform inflation. That happens. But, most people are putting only 10% or 20% down. So the 5 to 10 leverage still results in you gaining in both nominal and real terms. The leverage is what makes this profitable for the majority of buyers.
The ONLY reason prices are what they are today is due to the zero interest rate polices of the past. Those are gone for the foreseeable future. Inflation itself will not lift or sustain home prices. You need incomes to rise too. But with stagflation in the cards, real estate doesn’t stand a chance.
The residential housing market’s perceived equity is based on zero interest rates. Just because the feds have effectively stopped transactions doesn’t mean that is the end of the story.
Exactly. Housing is going down, and it will accelerate over the winter as panic sets in.
Housing is going up since anyone with a 3% mortgage is never, ever selling. Only desperate sellers are selling, and once they clear out, prices are only going higher. Throw in a good chance rates are going much lower next year, and bar the door
The only way rates go lower is if inflation breaks, and it’s not going to for the foreseeable future until a recession arrives. Companies as still mostly posting nice profit margins. They’re still handing out raises, so the wage spiral continues al be it at a slower pace.
The only thing that kills the wage spiral is a recession, and the only way rates are going down are through a recession. Now if you think the next recession will have extremely limited unemployment consequences, then go right ahead and forecast an ever-increasing home prices which is ludicrous.
Home prices have to correct towards the mean at some point. You act like this housing bull run has at least 10 years or more to run which is utterly crazy!
Get your head out of the sand, Greg! Nothing lasts forever.
The other possibility is that housing prices stagnate at current levels for say 10 years and rampant inflation of 5+% simply brings down the price level due to inflation.
If inflation does run at 5% it only takes 14 years for the value of a house to be worth half what it is now.
Greg or estates, divorces , bankruptcy It’s going to get ugly
Agreed I think residential will bring pain as well eventually
How does current state of the housing market make it more difficult for the fed to control inflation?
I explained by cutting rates to zero mortgage rates dipped below 3%, people who refinanced have a ton of extra money every month. Renters who want to buy cannot afford mortgages.
Full details
link to mishtalk.com
In response, the Fed agreed to shield the banks from losses by offering swaps at par value, ignoring the losses.”
The banks accessing BTLP have to pay interest equal to the 1 year overnight swap rate plus 10 basis points, easily over 5% annually. If a banks bond portfolio was down 10% this past March it’s probably down at least 15% today. Add in annual interest payment of 5+% and they just doubled their loses. BTFP is just extend and pretend. Unless/until the FED starts QE again these banks using BTLP banks bond portfolio’s are compounding their pain.
Office, lodging & retail is where the major pain points are and with nearly $1 trillion in loans that need to be refinanced in 2024 and 2025, it could get real ugly.
link to cred-iq.com
There were some great articles on Dallas and Atlanta commercial real estate. Two areas where ‘back to office’ is highest and most buildings are still 50% empty. The reason is there were too many office buildings built and there are no more people to fill them.
This is what happens when you have a fiat currency financial system, meaning one that is based up a multitude of lies and frauds and other crimes. It’s all looking great for nearly everyone, the party is in full swing with food and drinks aplenty, and then, suddenly, the music stops, a fire is raging and everyone is running in a blind panic for the nearest exit point from the Matrix!! But, the doors have all been blocked and locked, so only the windows are left, but the party is hundreds of feet high up in the building!! So, do the partiers jump to their sure death, or do they stay inside and have a few last swigs of expensive champagne until they choke on the smoke?
Over the last 20 years at the least, I have written papers about this very thing happening, but no one wanted to listen to me, they all thought that going to that huge party that is based upon nothing but lies was a good idea, because the cost of entry was so low. One moron said that I didn’t know what I was talking about, because I don’t have a degree in economics from a major university! But it is the ones who DO have those worthless degrees from major universities that have thrown this big party, and then set the fires after they locked the doors!!