Luxury Housing for the Top One Percent Booms While the Rest of the Housing Market Stagnates

A luxury house along “Billionaire’s Row” in San Francisco.

The failed economic policies of the Obama administration have been evident in measures of every important fundamental for six years now. Dismal job growth. High unemployment. Weak consumer demand, and so on. The biggest failure of the Obama administration was arguably the refusal to write down mortgage debt and force the top one percent of wealth holders to share some of the losses sustained during the housing market crash. While monetary policies pursued by the Fed, and a bailout of the secondary housing market with taxpayer dollars, temporarily provided a shot in the arm for housing prices, these gains were artificial. They weren’t based on genuine demand for housing by the majority of Americans. The result is that the top one percent of the U.S. housing market, the luxury segment, is booming, while the rest of Americans are having trouble affording homes. Now the housing market appears to be stalling out, except for luxury purchases by the elite whose wealth was protected by virtually every economic policy advanced through the financial crisis.

A single family home in Oakland.

Let’s review the problem. In the 2000s the U.S. housing market was flooded with cheap credit. Lenders extended giant loans, many of them sub-prime, and the prices of houses shot upward in a bubble. But stagnating wages for American workers meant that the prices of real estate diverged from the reality of the ability of the average household to safely repay these loans. When the financial system imploded, the price of housing collapsed, and it was the borrowers who sustained the brunt of losses in the form of equity. The debt remained to be repaid, however, because Obama and his economic advisers chose to protect the wealth of the top one percent.

As economists Atif Mian and Amir Sufi have pointed out in their book House of Debt, the federal government could have taken over as the servicer of mortgage-backed securities and renegotiated millions of loans, dropping interests rates and principal balances. Or the government could have allowed bankruptcy judges to reduce mortgage debt burdens. The few principal reduction programs there were, like the Home Affordable Modification Program, could have been pushed much further. As is, programs like HAMP served only a small fraction of distressed borrowers with underwater loans. HAMP and other loan modification programs did not meet their original numerical goals.

By not making creditors share the pain of the collapse of real estate prices, the Obama administration enforced a giant wealth transfer from the majority of Americans to a small minority, literally the one percent who own the majority of stocks and bonds, particularly stocks in banks and mortgage servicing companies, and bonds backed by residential mortgage debt.

But the wealthy also cache their fortunes in non-housing related stocks and bonds, and the Obama administration’s quantitative easing program has been good for supporting the value of these securities. So the wealthy never took the same kind of hit the average American did with housing price dips and job losses. Then the wealthy benefited from federal programs that jacked up asset prices.

Should we be surprised then to learn that the top one percent of the residential housing market is booming while sales of literally every home priced below a luxury-grade are dropping? This is one consequence of the Obama administration’s housing and economic policies.

A new batch of numbers from the real estate research firm Redfin illustrates the consequences of the Obama administration’s economic policies by comparing the very top of the American real estate market to everything else. “Sales of the priciest 1 percent of homes are up 21.1 percent so far this year, following a gain of 35.7 percent in 2013,” writes Troy Martin of Refin. “Meanwhile, in the other 99 percent of the market, home sales have fallen 7.6 percent in 2014.”

“For the top 1 percent, the housing market is still booming. But for the rest of the market, the recovery is running out of gas,” concludes Martin. “As home prices have risen, wage and job growth have failed to keep up.”

Redfin’s research shows that in virtually every major metropolitan region the luxury segment of the housing market, the top one percent of homes in price terms, are selling fast and at higher prices. Not surprisingly, there’s considerable regional variation, but it’s a nation-wide phenomenon.

The real estate market in the San Francisco Bay Area is perhaps the most unequal and driven by sales to the super-rich. Luxury home purchases are way up in Oakland, San Jose and San Francisco, with Oakland and San Jose experiencing a virtual doubling of the luxury market over the past year. The top one percent of the market for Oakland, San Jose and San Francisco combined is priced at an average of $3.7 million, but San Francisco has pulled ahead of the rest of the nation with an average home price of $5.35 million for the top one percent of its market. Some of this is likely due to the booming tech sector which is creating thousands of millionaires in the region.

For the majority of Americans the problem boils down to household debt. There’s still too much debt for the average household to sustain purchasing power that would drive an economic recovery, including a recovery in the housing market. From 2003 to the peak of the housing bubble in the third quarter of 2008, total household debt shot upward by about $5.4 trillion, according to data compiled by the Federal Reserve Bank of New York. From the peak of the housing bubble to the present, total household debt only decreased by $1.5 trillion. That means that about $3.9 trillion in debt piled onto U.S. households during the housing bubble is still weighing down family budgets. Most of this debt, about $2.89 trillion, was mortgage debt.

Over the same time period wages remained flat for most Americans. The median household incomes in the year 2000 was approximately $42,000. In 2012 it was about $51,000. Accounting for inflation, the real value of household income actually declined over this period by $5,000.

The income and wealth gains at the top of America’s economic pyramid over this same time frame should be familiar by now, as they have been extensively explained in recent research. What’s important to point out, however, is that the the average household, the median Americans whose incomes dropped by $5,000, took on significant mortgage debt during the 2000s, altogether in the trillions of dollars, and the lenders of this capital, ultimately, are the top one percent households.

So that’s why we see the luxury housing market booming while virtually 99 percent, the rest of America is stagnating.

Playing the Housing ‘Recovery’

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.