Washington & Wall Street: Has the Fed's 'Quantitative Easing' Failed?

Are we seeing the peak of US home prices in 2013?  Last week the Case-Shiller 20 city index of US home prices was up over 12% year-over year through of June, one of the best results seen this year.  But as we have discussed in Washington & Wall Street previously, the indications for the future are decidedly mixed.  The fact of a still weak housing sector has big implications of the US economy and begs the question as to whether the Fed’s zero interest rate policies have failed.

On the positive side, Lender Processing Services (NYSE:LPS) reports that while mortgage loan origination volume had slowed slightly from May to June, overall activity remains relatively strong. According to LPS Data & Analytics Senior Vice President Herb Blecher, mortgage loan prepayment activity (historically a good indicator of mortgage refinances) is still largely driving origination volume, as has been the case for some time now.

But refinancing existing loans is not the same as home purchases, especially the first time home buyers who are crucial to sustaining housing prices.  Last week, the mortgage application index maintained by the Mortgage Bankers Association was down 2.5% vs. a year ago.  The index has been falling pretty steadily for weeks due to falling mortgage refinance volumes and tepid home purchases.   

The MBA noted last week: “The refinance share of mortgage activity decreased to 60 percent of total applications from 61 percent the previous week, which is the lowest share observed since April 2011.”  As one of my younger colleagues in the media said in response: “Millennials are not buying houses, they are buying cars.  Nobody my age has the money to buy a home.  A car is the major capital purchase for my generation.”

With the volume of mortgage refinance transactions falling and new home purchases growing at far lower rates, the sharp drop in total mortgage lending volume predicted by the MBA comes into sharper focus.  As we’ve noted in this column before, the MBA expects total mortgage lending in the US to go from $1.6 trillion this year to just $1.1 trillion in 2014, a 31% decrease.

The fact of lower lending volumes and a still large component of the market comprised of investors suggest that home prices may be nearing a peak in 2013.  Without the additional upward push from investors of all stripes, it is doubtful that the visible increase in home prices captured by national averages like Case Shiller would be up half as much as the numbers reported in the media. 

The slowing volumes in the mortgage lending channel are unfortunately confirmed by the most recent numbers released by the FDIC, which show that loan balances held by banks for 1-4 family homes are falling.  In the most recent Quarterly Banking Profile, the FDIC notes: “Balances of 1-to-4 family residential real estate loans declined by $31.9 billion (1.3 percent), with home equity lines falling by $9.8 billion (1.8 percent), and other 1-to-4 family residential real estate loans declining by $22.1 billion (1.2 percent).”

Of note, the fastest growth in bank lending was seen in autos and credit cards, while loan balances on 1-4 family homes was down.  Keep in mind that given the 12% year-over-year increase in home prices reported by Case-Shiller, loan portfolio balances ought to be growing a bit even with falling lending volumes.  Since new loans have far longer average lives (and thus lower prepayment rates) than older vintages, the fact that residential mortgage loan balances in the portfolios of US banks are falling is of even greater concern. 

That the amount of credit available to the housing sector from US banks continues to shrink raises some troubling questions for the Federal Open Market Committee.  If you recall that housing has been one of the most important engines for growth in the past half century or more, the numbers from the FDIC suggest that “quantitative easing” or “QE,” whereby the Fed buys tens of billions worth of Treasury bonds and mortgage securities every month, has failed. 

While US bank lending overall shows some signs of expansion, the poor results from housing – the key transmission belt for Fed monetary policy going back to WWII – lead this analyst to worry that the economy could turn down later this year.  Indeed, a worry expressed to me last night by an economist for one the biggest asset managers in the world is that interest rates will continue to rise despite all of the extraordinary actions by the US central bank. 

One of the more striking statistics in the most recent data release from the FDIC is the sharp decrease in securitization activity by US banks.  In Q2 2013, assets securitized and sold by all US banks fell 22% to $765 billion vs. $988 billion in the same period a year ago.  Students of economics know that credit expansion and job creation are closely linked, yet nobody on the FOMC seems to understand that the US credit markets are continuing to shrink despite QE. 

Perhaps it is time for the Fed to accept that current policies are not really helping to promote credit creation and that shrinking bank balance sheets are a red flag that warns of danger ahead for the US economy.