The U.S. housing market shows promising signs of recovery, so the conventional wisdom goes. But buried deep in a new report from the International Monetary Fund (IMF) is an analysis of mortgage real estate investment trusts (M-REITs) indicating the 100 basis point rise in interest rates resulting from the Fed’s taper communications, where they almost decided to slow monthly stimulus upon a promise of recovery.
Considered to be essential to U.S. economic recovery, home sales fuel myriad businesses and industries, including construction and building trades, home furnishings, appliance sales, home renovations, financial services and more.
A recent National Association of Realtors survey shows home prices rising an average 14% in nine of 10 major U.S. cities over the past year, reports The Financial Times. A May Forbes report indicated single-family home sales at 454,000, compared to 276,000 in July 2010. Median home price was $271,600, compared to $204,000 in July 2010. Housing inventories on the market dropped by more than half, and shortages of homes for sale were reported in some areas as banks hold property in various states of legal-limbo.
But according to the IMF’s Global Financial Stability Report, interest rate volatility could trigger “fire sales” of mortgage-backed securities (MBS) by mortgage REITs, leading to price deflation—lower asset values—which then support less cash lent against the MBS when the MBS are used as collateral.
In that situation, falling prices of MBS, and the falling prices of other assets no longer receiving the cash that would have otherwise been conjured, erode faith in any recovery and the printing that is always associated simultaneously, further destroys remaining consumer purchasing power—knocking the legs out from under the already wobbly recovery. As The Financial Times reports:
Until recently, the M-REITs were largely ignored because the sector was too small to have significant impact on the economy. But as good assets die, an original asset reused becomes a place to park excess cash, and acts as a displacement for price inflation elsewhere—think of the demand sequestered for gold by instead selling GLD’s unsecured claims. When banks tightened up their lending practices in the wake of the 2008 economic crisis, many institutional investors and banks with excess cash turned to M-REITs.
Although the sector is still relatively small, its business model is inherently unstable according to The Financial Times:
These qualities leave M-REITs vulnerable to further interest rate volatility alongside real economic degradation. Federal Reserve suggestion of starting “tapering” its quantitative easing program beginning in 2013 led M-REITs to sell off $30 billion worth of mortgage bonds in one week. Home loan finance costs jumped more than 100 basis points.
Here is ZeroHedge’s warning around REITs from early summer:
Or both. The massive spike in interest rates this year globally already kicked off serious contraction. M-REITs may very well be the trigger that lays bare the lie of economic recovery and the ultimate futility of continuing to re-inflate the bubble over and over again.
The knee-jerk response is to legislate that all assets need to be posted to a central counterparty that acts as the middle man, like tri-party, but with the taxpayer taking the "significant credit... [and] operational risks," as founder of hedge fund Citadel gleefully reminded at the NY Times 'Dealbook' conference.
The two other markets to get cash lent against your security (or cash balance.See chart on page 52/53 from U.S. Treasury) are the general collateral market (the smallest, for standardized collateral, centrally cleared), and the bi-lateral market where banks write contracts directly with clients, and remain responsible for the contracts they write (gasp!).
As we wrote earlier, many commentators in the gold space seem to be in a populist fervor reminiscent of the 'Money Trust' era as Dodd-Frank ‘Derivative Reforms’ offer up the end-game centralization of the monumental risk they fear, rather than letting the banks keep it: ow.ly/qSvFV