The Everything Bubble Bust Pt. 4: Housing

In a world embroiled in what could turn into World War III in which Russian President Vladimir Putin is repeatedly threatening nuclear missile attacks, a return to talking about the collapse of the Everything Bubble, especially the housing part of this collapse, seems mundane.

A black-swan event as big as the outburst of a war that could turn into WWIII clearly changes things. In fact, Putin’s War may have shifted the scenario for the collapse of the housing bubble because that collapse is based, in large part, on the collapse of the bond bubble; and Putin’s War may delay that. Recall that I have laid out as a caveat along the way the one thing that could save the US from parts of the collapse of the Everything Bubble (particularly the bonds part that interconnects with the Zombie Apocalypse and the Housing Bubble Collapse 2.0) would be if the US were to become “the best horse in the glue factory.”

And that is what we see happening right now — today especially, in fact. As money flees Eastern Europe and also seeks safe haven from around the world, it has poured suddenly into US treasuries, most notably today. That nullifies the effect of the Fed in backing out of the treasury market because suddenly robust foreign demand as large as the Fed, itself, is streaming in to hose up all those treasuries the Fed is walking away from. In a single day, that has delivered a plunge in bond yields.

The question is how long this rush to safe havens that is also sucking money out of US stocks will last. Says Jim Townsend, who managed Europe and NATO policy at the Pentagon during the Obama administration:

How long could we have this kind of risk? … I don’t see it ending.

MSN

He was speaking of the war risks in Ukraine, but as that war on Europe’s eastern flank goes — the worst since WWII — so goes flight risk from the EU to secure US treasuries. In other words, US treasuries could be supported by being the best of the bad that is out there for some time if the war keeps driving money from all over the world into US treasuries.

What does war matter to markets?

For the housing market, the answer there is simple. Lowering treasury yields equal declining mortgage rates again after months of rising rates. That softens downward pressure on housing prices because, with housing, people buy payments, not prices. Prices affect payments, of course, but so does interest. So, rising interest pushes prices down to keep payments at a level people will buy.

It is probably good that I waited until last to cover the housing bubble collapse, which I consider to the least dangerous part of the collapse in the Everything Bubble, because housing may get some reprieve from present horrific circumstances that have turned mortgage rates back down.

Some aspects of the Everything Bubble Bust may do better than what I described sans war, but others will be made worse. For example, the massive global sanctions assure higher inflation and a deepening recession. A deeper recession, in turn, puts downward pressure on US stocks by hurting anticipated earnings, though stocks could get a little “best horse” help as the Russian stock market gets almost completely destroyed. Money pulled out of Russian stocks may feed to US stocks (IF it even can, given bank sanctions). So might capital fleeing some neighboring countries whose stocks are collapsing. Today, however, US stocks got no support from capital flight. So far, the affect of the war has been mostly downward pressure on the US stock market, but also downward pressure on US bond yields, meaning rising bond values and better mortgage interest rates than the bad news we would be starting to see without this war effect.

The war changes the balance of how things will fall, pressing harder on some areas and providing relief in others. On the positive side for housing, look at how fast US treasury yields plunged today (Tuesday as I am finishing this):

U.S. Treasury yields fell sharply on Tuesday as investors remained focused on Russia’s attack on Ukraine and its potential impact on Federal Reserve rate hikes…. The yield on the benchmark 10-year Treasury note fell 11 basis points to 1.726% in afternoon trading and fell as low as 1.682%. The yield on the 30-year Treasury bond dropped 7 basis points to 2.11.

CNBC

In the world of normally stable US treasuries, an eleven-basis-point move within a day is a big plunge. I would argue, however, the move had less to do with the potential for Fed rate hikes and a lot more to do with capital flight. In fact, after stumbling into the knee-jerk response that the Fed is the cause, the article quoted catches its balance and moves on to identify the real culprit:

The Russian invasion of Ukraine has entered its sixth day. The attack has roiled global markets and seen investors look to safe haven investments like U.S. government bonds, pushing yields down.

“Until there is some sort of cease fire in Ukraine and the market no longer has to process additional sanctions and those impacts to the global economy, we will see geopolitical money flows continue to dominate the currency and bond markets, even with Fed Chair Powell’s testimony tomorrow and Thursday,” Tom Essaye of the Sevens Report said in a note to clients….

The big moves in benchmark U.S. Treasurys were mirrored across the yield curve and in foreign bond markets.

As money is squeezed out of Russia to the extent it can move ahead of sanctions and flees other precarious nations, the US gains some float. This war, because of the greatest, fastest roll-out of global economic sanctions in history (see “Russian Ruble Turns to Rubble“) changes the economic landscape. Recognizing that it’s a little early only three days into those sanctions to fully understand their ramifications, let’s look at what was happening in the housing bubble, and then extrapolate in each case how the wartime trade and financial sanctions may soften the picture for housing.

Housing Bubble 2.0

In terms of where we stood just before Putin’s War, NO housing bubble has EVER been this extraordinarily expensive. It’s one colossal bubble that exceeds any other in historic perspective:

If you want to talk inflation, housing has clearly inflated more than just about anything with an obvious sharp increase that started in the second half of 2020 and then steepened even more in 2021. Prices have soared far faster than incomes have. In fact, incomes have recently gone back down due to the conclusion of various kinds of direct government stimulus checks. So, this bubble has the potential of a massive implosion, but there are a variety of mitigating factors.

This kind of imbalance is normally a sign of an impending crash in home sales, followed by a drop in prices. But that’s not happening.

Dollar Collapse

What would cause that to happen? Well, the only way people were able to afford to keep bidding home prices up that much above wage growth and above the last asking price was by interest setting record lows as it did when massive Fed money printing was being stuffed straight into buyers’ pockets by the federal government to help them develop bigger downpayments. It took extraordinarily low mortgage interest, created by the world’s greatest QE, to make it possible to realize monthly payments out of those prices that banks would keep financing based on debt-to-income ratios.

Of course, it is those very ratios that became drastically impaired when 1) that income started falling off as Fed funds ended and 2) mortgage interest started rising due to talk of Fed QE ending, and then especially, as you can see below, when the speed of the actual Fed’s taper of QE was doubled late in December:

The taper-caused rise in mortgage rates set in the perfect chemical reaction for a crash of the housing bubble. In only half a year, mortgage rates rose about .75 percentage points. The past month of that rise is reminiscent of the steepness of the Taper Tantrum.

Costs for 30-year loans hit a more than two-year high of 3.69% last week, rising about 20% just since Christmas. Further increases are expected as the Federal Reserve, trying to curb inflation, hikes its benchmark rate. That’s a daunting prospect for entry-level buyers when affordability is already at its worst since 2018.

Zero Hedge

There could be plenty more of that to come as the Fed ends QE this month and starts hiking rates:

As Mark Zandi, chief economist for Moody’s Analytics and a widely quoted voice on Wall Street, put it: “Housing affordability is set to get crushed.…” Zandi … expects 30-year rates to climb above 4% this year.

Zero Hedge

However, the sudden flow of investor money from all over the world coming out of this war into the US with the total crushing of the Russian economy (see “Russian Ruble Turns to Rubble“) could literally “buy” the housing bubble a little more time; however, being only a week into the war, it’s hard to say for sure how far the flight to safer havens will go. We also know from history that major wartime spending sometimes causes an economic boost, and we have no idea one week into this war, how much increased arms-production (the economic driver in a wartime economy) might result from the war. Probably not much, but that depends entirely on how this war drags out or spreads out.

The ARMed time bomb

One major component in the chemistry for the housing collapse that gave us the Great Recession was adjustable-rate mortgages (ARMs). Those turned out to be devastating time bombs back in 2008 because people who financed at a teaser rate were expecting a climate of eternally soaring housing prices back then that ensured they would be able to refinance at a beautiful fixed rate when the time came for the teaser to end because they would have so much equity in their house just from the rise in prices. They also thought they knew they’d be able to flip their home for a massive profit if they found they couldn’t refinance at a better rate — a profit that would easily cover their rent payments for a few years to come or downpayment on the next home — so what was there to lose? Banks thought they knew all of that, too.

But the fly in the ointment for that whole belief scenario was that it all depended on housing prices fulfilling the bargain by continuing to rise as was believed to be inevitable. Foreseeing that all of that would turn upside down if housing prices started to fall in an environment stacked full of ARMs as it was, I started warning people I knew to sell as quickly as they could. It was after I had seen housing prices fall for about six months during 2007 — with no evidence emerging to indicate the decline was just a slump and as news of the first few foreclosures due to these ARMs started to appear — that I gave my warnings.

I remember a real-estate agent arguing with me at a five-star Hawaiian resort where I managed properties that I was a nut for saying real estate would collapse soon. Real estate, by the consensus of short-sighted wisdom, never collapsed. “This is just a slump,” he said, turning away with a scoffing laugh. “This is Hawaii.” It couldn’t even penetrate his conception that housing prices would fall in Hawaii … at a five-star resort no less!

Well, fall they did.

ARMs are, however, the one reason I’ve said I don’t think this housing-bubble collapse is likely to be as severe as the bank-crushing, global-economy-decimating collapse that began in 2007 and fully materialized in 2008. We simply don’t have anywhere near as many ARMs ticking away and ready to explode in the US as we did then.

During the last few years, few mortgage borrowers have bothered with adjustable rate mortgages (ARMs). According to analysts at Ellie Mae, market share for the ARM mortgage is about four percent of all mortgages sold. That’s not really surprising. After all, when you can get a 30–year fixed mortgage at about 3.3 percent, as you could in 2012, why take on the risk of an ARM mortgage during the same time – at 2.74 percent?… Consider also that this was not long after the housing crisis, when homeowners learned they couldn’t count on being able to sell their houses within a few years of buying. That is, while the low, introductory rate for the ARM mortgage was still in effect.

The Mortgage Reports

Because home buyers learned the hard way that the perfect scenario was a fantasy, ARMs went out the window in great disfavor in the US after the last big housing bubble crash. Lock in low when you can; don’t trust the future to be what you think it will be. Besides there being so few ARMs in the US now…

Today’s ARM mortgage is different. Some of the riskiest features – prepayment penalties that keep borrowers locked into loans with expensive terms – are gone. Loans that qualify applicants based on artificially–low rates are no longer allowed. And the most popular ARM mortgage – the hybrid with introductory rates that can be fixed for three to ten years – is backstopped with caps in rate increases and lifetime limits to keep loans affordable.

So, the time bomb in the US has been defused, but that doesn’t mean there will be no slow compression of the housing bubble in the US, which would add more defaults to the bank problems I wrote about as likely developing in “The Big Bond Blowup.”

In the go-go years preceding the Great Recession, ARMs transformed to villain as risky versions of the loans pushed borrowers into foreclosure. These days, with fixed-rate mortgages at record lows, ARMs barely enter the picture at all.

Bankrate

That’s why I saved the housing bubble for last. I think it will be somewhat problematic, but not likely the worst part of the Everything Bubble Collapse that history has conditioned us to think housing will be. Notably, though, the bubble is so enormous that even deflating it as mortgage rates rise, making lower prices essential to get financing, will have a negative impact on the economy and on banks.

Of course, we have gone from standard 20-year mortgages when I was a kid to 30 years as the standard; so, we could always go to 50-year mortgages as Tokyo did long ago to keep the bubble rising. But, ehhh, it makes me nauseous to think about it. Let’s hope we don’t and we just let higher rates, when they come, press down prices toward a little less insanity. When you can let a perilous bubble deflate with just some economic suppression, why wouldn’t you? Well, I suppose because letting markets just be markets and self-adjust is not something we do anymore because we are greedy and demand upward growth and lots of it all the time at any longterm cost, while denying that cost will happen or anticipating other generations will have to pay it.

While I don’t see a sudden ARM time bomb for the US, this collapse will be bad in a more chronic way. It will happen on top of a bond-bubble bust and a stock-market crash and in an environment of scorching inflation and in a recession. So, the risk is that it times out to pile on top of that heap of troubles. It’s the dog-pile effect where two or three people on top of you makes it a little hard to breath, but, at some point one more person makes it impossible. The effect of this one last fat body sitting down on top of the pile will depend on when it piles on — how close we are to the limit of all we can handle. The timing of its impact looks to have been possibly delayed by the war sanctions based solely on mortgage rates, which means it could hit right as we’re exhausted by a lot of other things; but who knows, maybe not.

In just the last week, there has been a minuscule drop in mortgage rates due to the war piling money into bonds. It’s nothing more than a head nod, but the longer the war pushes money into US bonds, the more and the longer it could drive down mortgage rates even with the Fed backing out of the bond market.

Canada is a different world

In Canada, however, more than 50% of home loans are ARMs! Some parts of Canada like Vancouver have also seen home prices inflate way worse than the already bad US. In that sense, they are sitting on a somewhat similar time bomb to what the US was sitting on in 2007/2008, except their loans are structured differently as five-year loans amortized over 25 years that have to be refinanced every five years, and I’m not sure what the effect of that will be as I have never experienced what it is like to refinance those loans or what kinds of internal caps they have.

As you can see, during recent years, Canadians have been rapidly moving away from fixed-rate loans (blue solid line) and into variable-rate loans (red dotted line) to where the balance between the two has just flipped:

Consider the following:

Variable mortgage rates rise when central banks hike base rates, and half of the mortgages taken on in Canada last year were variable.

Seeking Alpha

The important thing to note there is that, while long-term mortgage rates rise when bond yields rise, short-term (variable) mortgage rates rise when CBs hike their base interest rate. Neither the Federal Reserve nor the Bank of Canada have started raising their base rates yet, but what happens to the largest portion of Canada’s mortgage market will depend on what the BoC is pressed to do with its base rate to combat inflation. Given they have to refinance every five years anyway, one might say they are all variable-rate loans; it’s just some are scheduled to reprice to market interest every five years.

In the US, where there are not as many of those ARMs, the Fed’s imminent rise in its Fed Funds Rate — its basement interest target affecting short-term credit — will not have much of a time-bomb effect on the mortgage bubble, though it certainly will start letting air out of the bubble, but in Canada…

Well, look out if the Bank of Canada raises its base rate a lot to fight interest! ARM rates could move up quickly with this much inflation since they are affected most by the BoC’s base rate, which may have to move quickly to catch up with inflation. This may make it impossible for Canadian banks to offer the low-interest ARMs that have made it possible to buy homes in Canada in areas where prices are even more overstretched than in the US, such as Vancouver, BC. Then prices will have to come down.

Even fixed rates on homes that are forced to refi every five years are already being affected as all those contracts expire on their own termination dates. Refis in Canada actually cost more than loans for a new purchase because of mortgage insurance rules. With CBs expecting 5-7 quarter-point rate hikes in a year, there is a lot of room for interest to rise by the time your loan has to be refinanced.

Already, just the expectation of coming rate hikes has caused the 5-year Treasury yield (on which 5-year fixed Canadian mortgage rates are based) to rise to 1.72% and 5-year mortgage rates have increased 43% from 1.39 … to 2% today.

While five-year rates were this high back in 2019, housing prices in Canada were, as in the United States, about 30% lower back then! So, get ready for a rough ride and ask your US pals what it was like back in the day because Canada didn’t experience anything back then like the troubles the US went through. Of course, when the US sneezes, the rest of the world catches a cold, so indirectly Canada felt an icy downdraft like winds off the Canadian Shield, but Canada didn’t get the hit to housing that the US got.

Bonds have now priced in six Bank of Canada (BOC) hikes over the next year.

And, just as was completely the case for the US back in the Great Financial Crisis that delivered the entire world The Great Recession…

Lest anyone forget, housing has been the dominant driver of Canadian GDP growth for several years now.

So, get ready, Canada, for a possibly rough ride because, as your housing market goes down, the US will already be doing a lot more than sneezing under the bursting of the Everything Bubble. It’ll have COVID pneumonia!

Now, how far short the Bank of Canada will stop from the ~six rate hikes priced into the market once all this calamity starts to unfold because of Putin’s War and where the Fed will stop on the US side, who knows? They still have inflation to fight, and the wartime sanctions are almost certain to make that worse. It’s getting to be complicated.

Where were we just before the war began?

War is not the usual situation that causes us to ask “Where were we before this began,” but … where were we?

US mortgage applications, just before the storm, had taken their first big drop, an early indication of some possible trouble:

As you can see, that is the biggest plunge since the cliff-dive that happened with the first major lockdown of the COVIDcrisis that caused everyone to stop showing homes for more than a month. Homes did not open up as quickly as the economy when it came out of lockdown due to buyers remaining afraid to catch COVID from unfamiliar houses (when we were all being told by the CDC that COVID could live on counter surfaces for a couple of weeks), and sellers not wanting the risk of germy buyers sneezing all over their homes. Prior to that, you have to go a long way back to find this big of a drop in mortgage apps.

As MBA reports, the Refinance Index plunged 16% from the previous week and was 56% lower than the same week one year ago. But most notably, the seasonally adjusted Purchase Index tumbled 10% from one week earlier…. Higher mortgage rates have quickly shut off refinances, with activity down in six of the first seven weeks of 2022.

Zero Hedge

Refinances, of course, are not too indicative of the housing market because you never refinance unless you can move to better terms (or need cash). However, here is what was happening before the war in home prices (blue) as interest rates rose (the latter being inverted in red in the graph below):

With mortgage rates suddenly soaring from the start of 2022 (remember, the rates are inverted in the graph) due to treasury bond yields soaring because of the Fed’s taper, one would naturally expect to see a plunge in housing prices to shortly follow once they are reported. Now, with the war causing money to flee to US treasuries, it’s premature to say how much that will change. Of course, that means the risk of homes going back underwater and banks being under-collateralized.

Meanwhile, who is actually buying?

Well, it’s not the average independent home buyer.

In bar-graph form, that looks like this:

Well, some of it is the average person, but a larger portion of the market is being taken over by corporations like Blackrock and smaller investors, too. Their deeper pockets make it hard for the average American to make a winning bid on the American Dream.

As one New Jersey woman told Bloomberg: “I’m screwed…I’ll be renting for the rest of my life.”

Zero Hedge

“Movers are feeling a big pinch. There is nowhere for them to run from increasing housing costs now that mortgage rates are rising and inflation has spread to the rental market,” said Redfin Chief Economist Daryl Fairweather.

Zero Hedge

“While record-high home prices are problematic for individual homebuyers, they’re one reason why investor demand is stronger than ever,” said Redfin economist Sheharyar Bokhari. “Investors are chasing rising prices because rental payments are also skyrocketing, incentivizing investors who plan to rent out the homes they buy. The supply shortage is also an advantage for landlords, as many people who can’t find a home to buy are forced to rent instead. Plus, investors who ‘flip’ homes see potential to turn a big profit as home prices soar.”

Zero Hedge

It is, as usual, Wall Street hitting Main Street that is the big problem for the little guy:

As with so many other things that shouldn’t be, the answer can be found at the intersection of Wall Street and easy money….

During the previous decade’s Great Recession, hedge funds and private equity firms figured out that they could borrow for next-to-nothing and buy up the houses that banks were repossessing, then rent those houses back to millions of newly homeless Americans for good returns. Combine these positive cash flows with massive recent price appreciation, and those foreclosed houses turned out to be phenominal investments.

Now Wall Street is doubling down, using hundreds of billions of essentially free money to outbid individual buyers for whatever houses are still avalable. In some cases investment giants like Blackrock buy up entire neighborhoods at big premiums to the asking price, pushing everyone else out of the market. Hence the disconnect between home prices and family incomes. 

Dollar Collapse

High prices, squeezing more buyers who can’t compete on the “above-asking” bids, are making homes more attractive to landlords because they are translating to high rents, which have been rising as follows (even though this strangely doesn’t shop up at this level in CPI, go figure):

Whew!

So, the bubble isn’t crashing yet.

Or is it?

Maybe. There is already a problem returning in the rental market. As rent payments have been going up, the ability to pay them has been going down:

It’s not hard to see why, and this could lead to its own defaults.

How do we rebuild when housing collapses?

When the housing bubble does start to come down, given the innate fear many have about a housing collapse because that was our last “big one,” my question is will we let it? Will the Fed, instead, risk hyperinflation by pumping the bubble up with more printed money once we are that far into the other economic destruction I believe will come first — recession, stock market crash, and bond bubble burst if bonds, as safe havens, don’t become the best warhorse in the glue factory? With so many complicating factors, it’s almost impossible to guess which path of destruction the Fed will choose.

Will we recognize that this housing collapse may be softer than the last and just let it settle as it wants, and will we redesign our economies to be less housing dependent as I described at the end of my book, “Downtime?” So far, we’ve always chosen the path of avoiding the pain a little longer — only to see it build up worse in these rinse-and-repeat cycles the next time around.

I’m not sure how there’s going to be a next time this time, but I suppose global banksters and their pocket politicians will figure out some way to try to pretend our economic system is not riddled with greedy flaws that assure constant cycles of greater collapse. They will use the fear of the screaming masses to get support for any rescue — or the present war — just as world leaders did with COVID, utterly transforming in a matter of months the entire social fabric of the world with the nearly full complicity of the masses.

The last housing bubble collapse was far worse than the dot-com bust. The Everything Bubble collapse will be worse still. The next big answer to our problems, in my estimation, will be a global central-bank economic scheme to answer a global cataclysm, and what sets that up now better than the global sanctions of this new war? On one side of the equation, those sanctions have made things tougher for every nation in a world already struggling economically due to the plague and our global responses to it, thereby begging for global solutions to these globally created and metastasizing problems. On the other side of the equation, the effectiveness of a global response to contain Putin from further aggression will demonstrate that global cooperation can work to punish imperial aggression.

I’m not suggesting this war was started with Putin’s cooperation as part of some conspiracy by any means; but it is here, and I believe many in the world are already begging for a more gobal economic system. For some, the effectiveness of global sanctions against Russian aggression will accelerate globalism. For other nations in conflict with the US, the desire to remove the risk of US dollar dominance when the dollar is weaponized, as it just has been, will increase their willingness to move to a globally controlled currency for international trade. I have some pretty good ideas of what that economic monster will look like, but that’s for another time far down the road.

The first article in this series was “The Everything Bubble Bust Pt. 1: How Far Will the Stock Avalanche Fall?“