In virtually every cycle of the economy there are developments that don’t completely make sense. Like the late actor Peter Falk in the television series “Columbo,” I often feel that, if I could ask just one more key question, everything would come into clear focus, and we could conclude the case, roll the credits and go to commercial! You see, there is just something I don’t understand.
Take, for example, residential real estate. It could not have been more than a few short years ago the market was in free fall, mortgage delinquencies soaring, foreclosures skyrocketing; get the picture? The mortgage banking meltdown in 2008 was a daily reminder that residential housing was a disaster on a global scale. Even the most optimistic amongst us were faced with the reality of double-digit unemployment, plummeting FICO scores a costly but largely ineffective government stimulus plan and banks loaded with illiquid non-performing loans. Was there any hope housing would ever recover? Taking a more general view, housing plays such a fundamental role in the domestic economy, could there ever be a traditional recovery of the business cycle without the participation of housing?
If you attempted to answer this basic question using such things as a Consumer Confidence survey, the level of debt at both the consumer and federal level, the stock prices of companies involved in housing, or just common sense, the answer would have been a simple NO WAY, JOS√â! But in this case, José was wrong.
As anyone who cares to know has already found out, the numbers on housing started to pop in the second half of last year. The word pop is appropriate here because whenever there is a shortage of supply, any meaningful uptick in demand and blamo!, up go prices. The authoritative S&P/Case-Shiller national index of housing prices increased 4.3% for the 12 months through October (this is the latest data) marking the sixth straight month of improvement. Off the bottom reached early last year, prices in the 20 major metropolitan areas covered have moved up just a touch under 9%. That, my friends, is real BLAMO!
Antidotal evidence back in the spring of 2012 held tails of bidding wars on the “few” properties offered for sale. Craigslist ads started chattering with “buy and flip” housing opportunities, not to mention a noticeable increase in ads for real estate sales trainees. The change in mood felt to this observer as sudden, obviously unexpected and definitely hard to explain. What was causing the mad world of real estate to suddenly become suspiciously manic?
Of course, those of you who have studied the real estate cycle are reminded of the biblical story: seven good years followed by the reverse. However, this down cycle only lasted 3 ¬Ω years. How could that happen? The 2008 financial meltdown was the worst debacle since the Great Depression, the largest number of mortgage delinquencies and foreclosures in history. And, yet it appears that none of these factoids is making a difference.
My theory is that the recovery in real estate is not real. Let’s call this theory “the billionaires’ bias.” Since 2008 there are 1.5 million fewer mortgages outstanding in this country. The decline has been persistent up to and including the most recently reported third quarter of 2012. Now keep in mind, this represents publically recorded mortgages of the Federal Reserve Board, not Dad and Mom loaning Junior a bunch of money to buy a home or apartment. It does, however, represent a huge chunk of the mortgage market and thus a reliable barometer of whatup dude.
This affirms the suspicion that the upswing in pricing has everything to do with cash. That would not require unique knowledge given the number of post foreclosure auctions that require settlement for cash, but it would not explain the rise in prices since most auctions are the low end of the price spectrum.
The New York Times‘ Michelle Higgins offered some clarity on this issue recently. In the article she pointed to a 40% rise in fourth quarter 2012 residential closings in Manhattan. The Corcoran Group residential survey for 2012 measured an impressive 8% price increase of the “average” Manhattan home at $836,000. Wow, at that price, a family has to be way above average in NYC just to be average. The read on their market, “rushing to close deals in anticipation of changes to tax laws, wealthy buyers helped push the total number of sales to 2,297 – 40 percent higher than in the fourth quarter of 2011, with the number of sales over $10 million (the luxury market starts around $5.0 million) rose 44 percent, with agents all over town being inundated with pressure to close.” (Before year-end 2012)
The prize for the biggest real estate recovery goes to Frank McCourt (former owner of the Los Angeles Dodgers) who filed for bankruptcy around 2010 but managed to come up with the $50 million asking price for a 5,000 square foot Fifth Avenue pied-a-terre paid for in cash. Manhattan may not be the best barometer of whatup, but it’s a reliable peek at “the billionaires’ bias.”
OK, well what about the rest of us mortal bastards? Or worst still, what about those folks that are still upside down on their mortgages, in default or worst yet, on the verge of foreclosure. So far, precious little has taken place. The Obama programs have been a joke. On January 7, 2013 an $18.6 billion settlement was reached between 10 major banks and the government. My old friends would call this amount “chump change” when compared with a mortgage market measured in the trillions. Most of this deal ($10.0 billion) is going to repurchase mortgages from Fannie Mae. At most, the average homeowner will receive only about $172,000 but only if they qualify. If past Obama programs are any indication, most of this $8.6 billion will be hanging around the US Treasury for quite a while.
No matter what the headlines say, the wide middle class swath of the housing market is still in a mess. Instead of renegotiating existing mortgages or god forbid writing new ones, banks are still mindlessly borrowing from the Federal Reserve at near zero cost and reinvesting in fixed income securities with near zero risk. And what rational person can fault them. The sluggish recovery in employment has left average incomes static while the cost of living continues to rise. And, just in time for the New Year celebration, payroll taxes will chip away a few more bucks.
A New Banking World is Emerging
Before putting pen to a suicide note, I presented my pessimistic economic assessment to two very real, real estate experts. The setting was lunch at the Southern California icon, La Costa Country Club. Admittedly this was not exactly the place to get close to the disappearing middle class, but its Ahi Tuna is first rate, and it was a nice place just the same. The first member of the group was a former CEO of one of the largest mortgage lenders in California, the other just a humble multi-millionaire real estate broker.
We started with the question: What would you do if you were in charge of Citibank, JP Morgan Chase or BofA? Before a minute passed, the topic of Internet Banking sprang forward. Internet banking got started back in the 1990s but was slow in getting traction. Slow Internet speeds, the lack of ATM access and a general shortfall in technology made the original product awkward. All that has changed with the evolution of mobile banking where deposits, transfers and other functions can be affected on virtually any Smartphone.
Initially, many of these institutions limited the scope of lending but recent years have recorded a broadening of products including mortgages that offer better rates than the traditional mortgage giants. And, why not? Internet banks have few, if any, of the real bricks and mortar costs of their giant rivals. My two experts agreed: with traditional banks in a static mode, the sun is really starting to shine on Internet Banking and the long-term outlook is excellent.
But the real buzz over lunch was peer-to-peer lending. P2P as it is known has only been around for the past 5-6 years. So far lending has been limited to unsecured personal loans, similar in nature to credit card loans. Typically, a loan maxes out at about $35,000. Here is what makes P2P lending different. Once a borrower completes an application the loan is graded and then offered to online investors. An investor can contribute any amount up to 100% of the borrower’s request or diversify over several loans at differing levels of risk.
What is the competitive edge here? The lack of bricks and mortar enables better rates for both borrower and lender than traditional institutions. The biggest player in the field presently is a company called the Lending Club followed by Prosper and then a collection of smaller players like Perpetuity Direct, Virgin Money and Peerform.
How real is the P2P business model? Up to this point, each of the companies are privately controlled. However, the Lending Club website claims in December 2012 to have funded $94.1 million in loans and to have passed the $1.2 billion level since inception. Keep in mind how many borrowers this represents if the average loan is $35,000 or less. At some point, the question of a public offering is inevitable. The company recently added former US Treasury Secretary Lawrence Summers to its board of directors. This makes a loud and clear statement about how major changes are destined for the banking industry.
What the Internet has meant for so many industries from publishing to retail is now happening to banking. Here is hoping it moves fast enough to help out the millions of families that are still in real estate limbo.