The US Federal Reserve’s quantitative easing program has created a mismatch in interest rates, rates of return on various securities, and home prices, that has prompted big-money investors to place billion dollar bets on what is being called a “recovery” of the US housing market. But if there is a recovery, it’ll be a strange one that benefits only a relatively few well-heeled investors who are making speculative bets on these possible price gains.
Home prices are in fact rising again, according to various housing indices. Home values increased almost every month on a year-over-year basis in 2012 compared to 2011, but this doesn’t necessarily reflect an increased demand from would-be middle class home-buyers. Without an actual rise in real wages and a drop in unemployment, and with a continuing backlog of foreclosures in process, it looks as if the number homeowners in America is still falling. Renting, meanwhile, is becoming the only viable option for millions.
So if it’s not a housing recovery that involves getting American back into their homes as owner-occupiers, what kind of recovery is it?
The answer is that it’s a price recovery. The prices of homes as securities, or commodities if you prefer, are recovering, and they’re doing so in a way that is more or less independent of the actual welfare of the average American.
In September of 2012 the Fed announced that its third round of quantitative easing would include purchases of $40 billion in agency mortgage-backed securities every month into 2015, a buying spree that could total $800 billion. The goal of this, say the central bank’s policymakers, is to support the nascent housing market recovery, which is necessary for a more general economic recovery.
Buying up mortgage-backed securities drives up demand for the smaller pool of mortgage bond bundles in the market, thereby driving down the yields on these remaining bonds, and theoretically promoting reductions in lending rates for home-buyers. Seeing lower mortgage rates, more Americans are expected to buy a first, or second, or bigger home.
The Fed’s purchases of mortgage-backed securities on massive market-moving scale is expected to stimulate demand for securitized housing debt by the investors with capital in search of returns. This in turn should induce banks and other mortgage lenders to reduce rates for home-buyers, thereby tempting millions of renters to take the plunge into home ownership. And if consumers buy homes in droves, shouldn’t the prices rise also?
The funny thing is that home prices have already skipped upward, even though the mass demand has yet to be manifested.
While it’s too early to say if individual buyers will be coaxed back into the market by the Fed, or whether most Americans even have the financial resources left to make such a purchase, two other types of buyers have found the stimulus too tempting to pass up.
Some private equity firms see the historically low housing prices, and the Fed’s actions to drive these prices up, as an historic opportunity to arbitrage a big return for their wealthy clients. According to a recent study of the the burgeoning foreclosure-to-rental business by Keefe, Bruyette & Woods investment bank, firms like Blackstone, GI Partners, and Colony Capital have already allocated between $8 and $10 billion to purchase foreclosed and short sale single-family homes in markets like the San Francisco, Los Angeles, Phoenix, Chicago, Atlanta, Miami, Las Vegas, and other regions with large inventories of empty houses with rock bottom prices.
Blackstone calls its billion dollar housing buy a “single family home rental platform.” Like other private equity investors, Blackstone intends to rent out its housing portfolio to families, many of who recently lost their homes to foreclosure and cannot afford to buy. Bloomberg News reported recently that home prices have ticked upward so fast in some of Blackstone’s targeted markets that the firm is accelerating its purchases in a dash to establish as big a position as possible before the price gains slow.
Rental profits alone have been tempting enough for some of these new private equity landlords. Yields on other possible investments (equities, corporate bonds, government bonds) remain low compared to the profits that can be squeezed from the discrepancy between currently cheap single-family homes, high rental prices, and rising home values. The prices on much of the single family housing in markets like Atlanta, Las Vegas, and Phoenix is said to have “over-corrected” during the financial crisis.
If home prices do keep rising thanks to the Fed’s appetite for mortgage bonds, the new private equity landlords can also cash out, or “exit” their investment, as they say in industry parlance, and book double digit rates of profit. One private equity investor, Oakland, California-based McKinley Capital is buying homes partly for this pure arbitrage opportunity. “McKinley plans to resell the houses in about five years for double what it paid and is targeting 20% annualized returns for its investors, which include wealthy individuals,” explains a 2009 report from the Wall Street Journal.
One of the few publicly traded companies buying up thousands of single family homes, Silver Bay Realty, summarized its business strategy in a prospectus recently filed with the Securities and Exchange Commission; “We believe that rental rates will also increase in such a recovery due to the strong correlation between home prices and rents. This trend also leads us to believe that the single-family residential asset class will serve as a natural hedge to inflation.”
But why own physical real property when the price gains in housing can be harvested in cyberspace trades of synthetic credit derivatives?
The second major play on Wall Street in response to the recent rise in home prices involves financial speculation through some of the same instruments that sped up the housing market’s crash in 2007-08. Hedge fund managers and investment bank traders are currently betting on home price increases through credit default swap purchases, through the ABX.HE Index, and even through direct purchases of non-agency sub-prime mortgage backed securities.
In 2006 a few hedge fund operators used credit default swaps to short-sell subprime mortgage-backed securities. These prescient investors made billions on the trade, billions that were extracted from AIG and other counterparties who expected home prices to continue to rise. Now some of these same gamblers are going long in the same markets.
Goldman Sachs is recommending that its clients buy ABX.HE Index contracts to reap some of the price gains in housing. The ABX.HE Index tracks the prices of credit default swaps that insure against the default of various subprime mortgage-backed securities, many of which collapsed in value during the financial crisis.
Interestingly, the ABX.HE Index was created in 2006, just in time for hedge funds to speculate through it. A 2006 research brief from the Nomura investment bank plainly described the speculative nature of the ABX.HE Index: “As in the indices of corporate [credit default swaps], the synthetic ABS indices allow an investor to express a macro view of the home equity ABS sector by either taking a long or short position in the form of a CDS.” Nomura’s staff offered that investors “may use the index to manage risk and to take advantage of any temporary pricing discrepancies.” In 2006 and 2007 hedge funds and a few investment banks mostly used the Index to take advantage of pricing discrepancies in CDS contracts insuring the toxic bundles of mortgage bonds known as CMOs and CDOs. Prices indicated that these mortgage debts and the insurance contracts on them were safe and high, just as they were collapsing. Now again traders are using the ABX.HE Index to make speculative bets on pricing discrepancies, this time caused very much by the Fed’s intervention.
The Goldman Sachs trader who established that bank’s big bet against subprime debt, Josh Birnbaum, now runs a hedge fund called Tilden Park. Birnbaum has bought perhaps billions worth of mortgage-backed securities in expectations that the Fed’s policies will hike up their values. “Some of these recovery plays are compelling,” Birnbaum told Bloomberg News in October 2012 after it was reported that his fund has gained 30 percent on the year. Others who participated in the 2007’s ‘Big Short’ bet against subprime debts are loading up in the opposite direction now. John Paulson’s hedge fund is said to own billions in mortgage related securities, as is Kyle Bass’s Hayman Capital.
Lucrative returns like this may not be captured by the average American, however. According to the US Federal Reserve Bank of St. Louis home-ownership rates are at a 16 year low. Foreclosures remain a serious problem for many, even if they’ve slowed since the peak in 2008. According to CoreLogic, a firm that sells foreclosure data to the real estate industry, there have been 3.9 million foreclosures completed since September 2008. Fewer Americans will benefit from rising home equity. Instead these gains will accrue to a smaller population of homeowners, with some markets becoming dominated by landlords, including the private equity giants who are gobbling up as much housing as they can.