The FOMC picked up another dissenter in its St. Louis branch, but the real consequences of trying to talk down bubbling, frothy markets are beginning to show up. Like the JGB market, UST volatility is dramatically higher (Bank of America Merrill Lynch’s MOVE index jumped from a record low/complacent 48.87 in May to 84.75 in early June). Perhaps the most visible fallout from rising bond yields is mortgage applications.

Applications for mortgage refinancings have collapsed since mortgage rates began to move higher in concert with treasury yields.

ABOOK June 2013 Housing Market Refi Index3

Applications were down 3.3% this week, continuing the trend since the week of May 5. Y/Y, applications have all but collapsed, 33.9% below the same week in 2012. Applications for purchases are also down recently, but only slightly and are up nearly 6% Y/Y.

ABOOK June 2013 Housing Market Purchase Index

However, since refis make up about 70% of the overall mortgage market, the sheer volume of the decrease puts a damper on the FOMC’s preferred transmission mechanism. It’s clear from the purchase index that mortgage-financed demand is not responsible for much of the overall price and volume increase in real estate seen since the beginning of 2012.

That has been the sole purview of investment vehicles such as hedge funds and REO-to-rental REIT’s. In search of hard information about monetary policy and the new housing system, I was poking around in the latest regulatory filing of one such REIT called American Homes 4 Rent. The REIT started operations in November 2012, taking over assets and title from American Homes LLC. That company began operations in 2011, “to take advantage of the dislocation in the single-family home market”.

In those two years, the company has acquired, through April 30, 2013, 14,210 single family residences, representing a $2.49 billion investment in this “dislocation”. When they describe the dislocation, they nominally mean what they consider an overshoot to the downside in real estate pricing after the housing bust. But that is not the full extent of the dislocation they seek to capitalize from.

The structure of the housing market in their estimation is as follows:

ABOOK June 2013 Housing Market EDGAR SEC

According to their estimates dated May 31, 2013, 14% of the total owned structures have negative equity. On the other side, there are 12.6 million vacant houses (an unfathomable 9.5% of ALL US houses), nearly all of which are classified here as “structural”. In their estimation, these are homes that were built in the housing bubble (the vast majority, anyway) that are now unoccupied – the infamous shadow inventory.

That is the crux of the legacy of past monetary mistakes, negative equity and shadow inventory (and thus lending capacity) tied up to artificial activity from the last decade. It’s a hell of a problem to try to actively fix by manipulating financial “inputs”. But, as this data shows, there has been little to no progress on it, as if supply and demand are both largely outside the bounds of intervention.

However, where monetary policy is less impotent: flush with equity capital, AH4R has purchased homes in concentrated markets, “As of April 30, 2013, approximately 38% of our properties were concentrated in only five states—Texas, Florida, Arizona, Illinois and Georgia.” But they are not the only participants in this space, as they helpfully note:

“Several REITs and other funds have recently deployed, and others are expected to deploy in the near future, significant amounts of capital to purchase single-family homes and may have investment objectives that overlap and compete with ours, including in our target markets. This activity has adversely impacted our level of purchases in certain of our target markets.” [emphasis added]

The company notes that investment-type activity has (past tense) already pushed them out of properties that they were targeting for their REO-to-rent portfolio. Further, the company is targeting not just specific regions and cities, but also,

“Our business plan involves acquiring single-family properties through the foreclosure auction process simultaneously in a number of markets, which involves monthly foreclosure auctions on the same day of the month in certain markets.”

Now of course this is just one company in the vast sea of the national housing market, but already we have two complications as they relate to the FOMC and tapering of QE. First, their note about crowding out, echoing the sentiment I expressed yesterday as it relates to price distortions and construction activity. In my estimation this has caught the attention of FOMC members, though we will have to wait 5 years for the transcript of the meeting to be released to confirm as much.

Second, the entire business plan for AH4R is to take Wall Street money and transmission it into the foreclosure market. While that has certainly been “good” for prices and “values”, in the context of monetary policy on the macro economy there is no transmission. AH4R is not buying the houses of negative equity homeowners, extracting them from past monetary mistakes and miscalculations so that they may become good little spenders again. Rather, these negative equity homeowners are the pool of potential renters and customers to the dislocation itself of which they are already on the wrong end of (not that they are wholly innocent or victims). “Money” is only flowing to banks, but not as making good on previous loans but only as defining their losses on bad legacy assets.

When Fed models get overly confused as to why monetary policy is not more effective, these distorted markets help explain the gap. So we get a dramatic mismatch between organic purchases of houses and investment purchases, pushing up prices in another unsustainable episode that requires taper talk to try to reign it back, while the monetary largesse of QE 3 goes indirectly through Wall Street banks (the purchasers of AH4R equity in only private placements) back to those same banks without intersecting the public at large at all – except as a large pool of new renters.

Again, this is just one anecdotal story of the housing rebound such that it exists now, but I think it is not a difficult leap to say that AH4R is not unique and is far more likely to represent the majority of what has transpired. While economists focus on parsing FOMC language, this is the real context to keep in mind as volatility floods from credit markets to other price inflated markets. The macro economy is just an abstract concept here.

 

Click here to sign up for our free weekly e-newsletter.

“Wealth preservation and accumulation through thoughtful investing.”

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, contact us at: jhudak@4kb.d43.myftpupload.com or 561-686-6844 . You can also book an appointment for a free, no-obligation consultation using our contact form.