When Bank Profits Hurt Home Sales

The US stock market posted another nice gain yesterday, as the US housing market recorded another dismal decline. The Dow Jones Industrial Average, for its part, added 110 points to 12,190. But the US housing market slipped deeper into the murky depths of uncharted territory.

Purchases of existing homes fell 3.8% in May from the prior month to an annual rate of 4.81 million homes. At that pace, sales this year would drop below last year’s 13-year low of 4.91 million.

Existing Home Sales, In Millions

At the same time, the price of the median home fell nearly 5% year-over-year to $166,700, which is roughly the same price of a median home nine years ago. “An unemployment rate hovering around 9% and tight credit standards,” Bloomberg News observes, “mean it may take years to absorb the 1.8 million distressed properties on the market that are weighing down home values.”

The National Association of Realtors (NAR) provides a more comprehensive explanation for the housing market’s persistent weakness – an explanation tinged with vitriol. In the NAR’s 18-page, lavishly illustrated “Realtors Confidence Index” report for May 2011, the Association’s Chief Economist, Lawrence Yun, blames both the soft economy and the “perverse new banking mindset” for the housing market’s difficulties.

“[T]he spring economy was basically OK,” Yun’s analysis begins placidly. “It was expanding, but at a low rate of growth…Jobs were being created, but perhaps not in the industries that generate the big bucks.”

But after a brief nod to the soft economy, Yun pillories the banking industry for its refusal to lend. “Adding to the challenge is the fact that banks are not lending,” he says flatly. “Banks are still hoarding cash and contracting lending activity…[They] are adding profits to their bottom lines, due partly from their ability to access money on the cheap, thanks to government backing of deposits, and by buying tradable assets such as realtors in government bonds. The inevitable too-big-too-fail taxpayer bailout if something were to go wrong is also quite reassuring for the large banks.

“In the ‘good old days,’” Yun continues, “there used to be a rule: the 3-6-3 banking rule. The bank would offer 3% interest to depositors, charge 6% on loans, and then be on the golf course by 3:00 p.m. That rubric has now been replaced with a new one: give nothing to depositors, give nothing to those who want to borrow, buy tradable assets, get an easy 3% yield from government bonds, and pretend to work long hours to justify a high salary and bonus. Partly because of this perverse new banking mindset…pending home sales in April took a tumble, falling 11% from the previous month.”

The substance of Yun’s scathing rebuke of the banking industry is not nearly as surprising as its source. Historically, the NAR and the banking industry relied on a close symbiosis to nourish themselves. Whatever was good for one of them was automatically good for the other. Easy credit nourished the housing bubble, just as the housing bubble fattened bank profits and provided the wherewithal to continue extending easy credit.

Yun’s analysis therefore, is not so much the clinical commentary of a dispassionate economist as it is the bitter musings of a rejected symbiont. But no matter his motive, Yun makes a compelling argument, especially in his concluding remarks:

Before I end this column – especially considering what some may view as a harsh take on bank profits – I don’t mean to suggest that profit per se is a bad thing…Profit has been the engine for economic prosperity in many countries.

A modern example is China. China was very poor when Chairman Mao came into power to create his “paradise on earth” by punishing and exterminating greedy profiteers and landlords. China remained very poor – some would say became even poorer – with about 50 million of its citizens dying of starvation by the time Mao died. After his death, China experienced an astonishing economic expansion – from profit being permitted and from the introduction of competition into the economy.

So the profit motive can serve a country’s economy quite well. But private profits that rely on taxpayer backing (as is the case with banks today or with Fanny Mae/Freddie Mac during the good years) clearly raise questions about economic fairness. If taxpayers support the banks, the banks should give back in responsible levels of homeowner lending.”

Yun does not state the opposing corollary: If taxpayers do not support the banks, the Free Market will quickly determine both the “market clearing” price of residential real estate and the true level of “responsible lending.”

Despite the perverse banking mindset that is impeding a recovery in the housing market, the perverse activities of the Federal Reserve are providing an unintended support to the real estate market.

Existing Family Homebuyers Who Paid All-Cash

The Fed’s monetary manipulations – which are both weakening the dollar and suppressing short-term interest rates – are drawing growing numbers of all-cash buyers into the housing market. Foreign all-cash buyers, in particular, are becoming a conspicuously large presence in several regional markets like South Florida. More on this developing story in tomorrow’s Daily Reckoning

Eric Fry
for The Daily Reckoning