New mortgage regulations change how real estate markets work

The new mortgage regulations curtailed affordability products previously used to sustain sales volumes when prices became too high.

louie_lender_lampreyThe new mortgage regulations will prevent future housing bubbles (we hope), but we are witnessing the success of these new regulations in a surprising change in housing market behavior: high prices are hurting sales volume. Housing economists’ conventional wisdom states that rising house prices creates “escape velocity” as potential homebuyers become more motivated, they compete with one another, and they drive prices higher. The motivation may be there (kool aid is eternal), but the key enablers of this behavior are unable to play along; the new mortgage regulations curtailed affordability products.

When prices get too high and potential buyers can’t afford what they want, the first reaction of realtors and mortgage brokers is to suggest the buyer use an affordability product so they can borrow more money with the same payment. This keeps the deal alive, makes the realtor and the lender money, and puts the buyer in the home they want. What could be wrong with that? Well, take that approach to every buyer and every deal in the marketplace, and very soon, affordability products proliferate, prices inflate, and the entire market becomes unstable. Over the period of a few years, the lending market becomes saturated with amortizing ARMs, then interest-only ARMs, and finally Option ARMs.

Once financing crosses the Ponzi threshold of interest-only loans, the market destabilizes, mortgage defaults accelerate, and a credit crunch becomes imminent; it’s only a matter of time before lenders realize their folly and abruptly stop making bad loans. Once that happens, credit tightens, and lenders retreat to the stability of 30-year fixed-rate mortgages. Rather than repeat this cycle and endure another painful housing bubble, legislators passed the Dodd-Frank law and put in place new qualified mortgage rules and ability to repay rules (See: Will the “Ability to Repay” rules prevent reckless lending?).

The lack of affordability products is killing sales

Debt_demands_soulMany factors contribute to the unexpected decline in home sales volumes. The idiots at the NAr laughably blamed the weather (See: The housing recovery falters in 2014 because… the dog ate it), and realtors also blame the lack of available inventory, but this is also a red herring because despite low inventory, prices haven’t budged in several months (See: Coastal California housing market: Prices hover on low volume). The real reason sales volumes are declining is because more and more markets are hitting the affordability ceiling, and without toxic mortgage options to begin the bubble cycle over again, sales volumes decline.

When you think about it, sales volumes should decline with higher prices. Basic supply and demand theory says that at higher prices, a lower quantity of any good or service is demanded. For years housing behaved differently due to the credit cycle with affordability products. Now that these products are effectively banned, the housing market behaves as any other market would; new mortgage regulations changed how real estate markets work — thankfully. The cycle of bubbles needed to stop.

U.S. Housing Sector Is in Big Trouble

Christopher Whalen, MAR 10, 2014 10:00am ET

… While many parts of the U.S. economy are growing, the housing sector is increasingly a drag on consumption and job creation. The fault lies not with the market, however, but with ill-considered regulations and bank capital rules.

Chris Whalen often argues his own book of business, and the publication American Banker isn’t going to complain. The pain in the market is not due to ill-considered regulations, but rather with carefully-considered regulations that are working as they’re supposed to. If no new financial regulations were in place, and if affordability products were still widely available, buyers would almost certainly be using them to inflate another housing bubble.huge_debt

On the surface, things look o.k. Nationwide, house prices rose 1.2% in the fourth quarter of 2013 according to the Federal Housing Finance Agency’s index. This is the tenth consecutive quarterly price increase in the purchase-only, seasonally adjusted index.

But the FHFA’s principal economist, Andrew Leventis noted that the appreciation was “more modest than in recent periods,” and cautioned: “It is too early to know whether the lower quarterly growth rate represents the beginning of more normalized price appreciation patterns or a more significant slowdown.

I doubt we see a downturn because there is little must-sell inventory on the market. Must-sell shadow inventory has morphed into can’t-sell cloud inventory, and cloud inventory won’t push prices lower. It may hang over the market like pestilence, but it takes must-sell inventory to make prices go down.

Most housing indicators suggest that the overall rate of home price appreciation is slowing considerably, with a few of the more attractive markets around the country. accounting for most of the upward momentum. Home prices probably peaked overall in the second quarter of 2013, but the time delay in most of the major data series on housing masks this reality. …

Applications for home mortgages, including both new purchases and refinancings, are at the lowest levels in more than a decade.

Purchase applications hit a 19 year low, largely because rising prices and rising interest rates made housing much less affordable. Further, rising prices is causing investors to pull back, as evidenced by institutional investor home buys hit 22-month low.


While many observers blame rising interest rates for the paucity of new loan applications, factors such as a poor job market, flat to down consumer income and excessive regulation are probably more important….

They are all important factors. Rising interest rates had the greater short-term impact, but over the long term, the only housing market fundamentals that matter are job and wage growth. Chris put in his complaint about excessive regulation, but this is just red meat for bankers reading his article.

When home prices measures generally start to fall later this year, maybe our beloved public servants in Washington will start to get the message.

There is truth in his message: the new mortgage regulations are causing fewer mortgages to be underwritten today, and these restrictions will continue to inhibit sales volumes indefinitely; however, I believe this is a good thing. The regulations that reduce or eliminate destabilizing affordability products are a necessary step forward. Housing market pricing should be much more stable going forward. When prices get too high, sales volumes will decline, and prices will stop going up — which is how it should work. realtors, lenders, and anyone else making money on volume may not be happy about the new circumstances, but their self-serving concerns are outweighed by the greater good for a more stable housing market.


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