Lead Story… Since the end of the Great Recession, it’s been well documented that, while borrowing costs dropped dramatically, access to credit for both builders and home owners have become much more stringent. The end result is that those who can access credit are doing better, actually much better. While those who can’t are left out in the figurative cold. This is no way for a market or economy to work properly but it is how we have been functioning for some time now. Nick Timiraos of the Wall Street Journal summed it up perfectly this weekend (emphasis mine):
U.S. consumers and businesses have enjoyed ultralow borrowing costs since the financial crisis because the Federal Reserve pinned interest rates near zero. At the same time, regulators and lenders intent on fortifying the financial system have clamped down on risk-taking, making it harder for many borrowers to get loans.
The result is that lending for housing, a pillar of the U.S. economy, has bifurcated. Well-off households and home builders have their choice of loans, while many others without solid credit or stable incomes are locked out.
That dynamic is one reason the U.S. has seen such anemic economic growth despite aggressive efforts to encourage investment. Money has been cheaper and more abundant than ever, but—for some—much harder to get.
Policy makers have focused on “lowering the cost of capital instead of increasing the availability of credit,” says Mr. Dobson, chief executive of Amherst Holdings, an investment firm in Austin, Texas.
What Timiraos outlined above is a classic example of policy picking winners and losers, even if inadvertently. Ironically, the inverse happened in the early to mid 2000s when credit standards were non existent, forming a bubble. Now the pendulum has swung too far in the opposite direction. There has to be a happy medium here but your guess as good as mine when it comes to if or when we will actually find it. The current state of the credit markets mean less home owners as evidenced by the ever-falling US home ownership rate. It also means that there is less competition in the home building business since smaller builders are having a very difficult time getting debt financing (in addition to having to cope with extremely expensive equity as I’ve laid out previously). Small builders are often more nimble, able to specialize more in specific regions or neighborhoods and able to take on smaller infill projects than their larger brethren. They can also frequently take on levels of risk that the publics simply can’t when it comes to entitling lots. Less potential buyers and less builder competition is a big reason why single family construction as a percentage of GDP looks like this:
The paradox is that if you don’t need credit, you can probably get a loan. If you need credit there is a good change that you can’t. This isn’t just a home building problem either. It’s been felt across the economy, but is perhaps most acute in the housing market because: 1) The role that housing played in the downturn led to more regulatory scrutiny than other industries; and 2) It’s high reliance on leverage for both builder and buyer means more exposure to those credit constraints. Banks have essentially said that life is too short for to deal with the credit challenges of small builders and retrenched to their largest most established clients where they can at least use scale to help offset the regulatory burden. More from the WSJ (emphasis mine):
Banks would rather extend more credit to large, established firms than make lots of smaller loans to mom-and-pop builders, many of which lost money during the downturn, says Charles Schetter, chief executive of Smith Douglas Homes Inc., a large, privately held builder in Atlanta.
“For the first time, the burden of regulation is setting up a threshold of scale,” says Mr. Schetter, whose company will sell 700 homes this year. He started out in the industry building homes with his father, “when anyone with a hammer, a pickup truck and access to local tradesmen” could start a company, which he says would be difficult today.
Consolidation in the home building and banking industries predated the financial crisis but accelerated during the downturn. Banks with more than $100 billion in assets held around two-thirds of construction loans in 2016, up from less than half during the housing bubble and less than one-third in 2000, according to the Mortgage Bankers Association.
One ironic aspect of this is that the federal government actually tried to loosen up standards a bit several years ago after it was becoming clear that the regulatory regime that had been put into place was suffocating the market. However, the battle-scarred banks have still been reluctant to meet the somewhat-relaxed government standards. Again from the WSJ (emphasis mine):
By late 2011, the Obama administration had grown worried about the cumulative effect of the new rules and ultimately prevailed on regulators to back off some of the most stringent proposals.
“There was a lot of concern that steps intended to protect the market would end up locking people out,” says James Parrott, a former White House official involved in those efforts who is now a mortgage-industry consultant.
Lenders have been reluctant to extend credit to the limits of what government programs allow because of concerns over lawsuits if loans ultimately default, and because the costs of managing delinquent mortgages have soared.
“If we had our druthers, we would never service a defaulted mortgage again,” said J.P. Morgan Chase & Co. Chief Executive James Dimon in a shareholder letter earlier this year. “We do not want be in the business of foreclosure because it is exceedingly painful for our customers…and our reputation.”
J.P. Morgan cut its mortgage offerings to 15, from 37, and said it had “dramatically reduced” its participation in low-down-payment lending through the FHA. “It is simply too costly and too risky to originate these kinds of mortgages,” said Mr. Dimon.
It will be very challenging for the home building business to once again become a growth driver in the US economy so long as Jamie Dimon’s sentiment from that last paragraph is a prevalent view in the banking world, which I believe it is. I am in no way advocating a return to the wild west days of 2004-2006. However, more relief is needed to limit the cost and regulatory burden to banks who offering mortgages and construction loans or the stagnation and bifurcation laid out above are both here to stay.
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