What's the biggest risk right now to the system? After listening to Fed Chief Jay Powell I would say it's non-bank lending. There are lot of non-banks that are making loans on homes that could collapse in pricing. These institutions came out of nowhere and they now control about 50% of the current mortgage market. That's one trillion dollars in mortgages.
The Fed Chief talked about these non-banks in his speech today and described them as being imprudent and that they could be a problem to the credit markets and the entire system. The largest non-banks are Quicken Loans, PennyMac (PFSI) and LoanDepot. I have no idea if those are the ones he is talking about. But if there are non-banks not playing by bank rules, lending with low or no documentation with little money down, I think they can cause a crisis if they are making half the mortgage loans in America.
So, what do you do if you are the Fed?
Do you raise rates a quarter of a percent or a half percent or a full percentage point to stop these non-banks from continuing to make poorly documented loans with little money down?
No, No, NO. You use regulatory policies and make all non-banks play by the same rules that govern JP Morgan (JPM) and Bank of America (BAC) . If there are outliers and reckless lenders you don't raise rates, you shut them down. The Fed has the power to do so. It should do it now.
What concerns me here is that once again the Fed will miss the mark as it did in 2006 when it could have said "we will not tolerate unsound lending" and disciplined the outfits like Indymac and Wachovia and Countrywide or Lehman and Bear. We would never have had a crisis if we had done this. Once again, we are not doing it now.
Why am I so worried about this? Because we are getting housing numbers that indicate that sales are collapsing and are running substantially behind last year's pace, to use the quote from the Mortgage Bankers Association's comments from a very worrisome housing report this morning, one that revealed that sales are 8.9% lower than previous month's figures. The median home price sale is 3.1% lower than a year ago although there are pockets that are far lower than that. There is more than 7.4 months of supply, an amount that's starting to go toward the levels we saw in housing's disastrous peak 12 years ago.
So, sales going down, supply going up, rates going up. That's a recipe for a disaster - no wonder Powell had to change his tune. Housing's hugely important in our economy and it's only one part of the broader weakness which includes, autos - thanks (GM) - oil and gas and higher end retail, not retail like Burlington (BURL) , the lowest end apparel company which saw it stock go up 18 points on good numbers.
We have so many examples of the housing slowdown.
Let me quote from the conference call of Redfin (RDFN) , the real estate database and brokerage outfit. This call is dated November 8th. " In our last call we said that the market was weaker than most analysts realize, especially in high-priced coastal cities. Since then rising rates and high home prices have caused buyers to become cautious industry-wide, a trend that we believe will continue." The company then talks about 20% declines in sales in places like Seattle, San Jose, Sacramento, Los Angeles and Orange County.
Since that report things have gotten much worse.
Let me remind you what happens at this juncture just as I did in 2007. When you get a great deal of inventory and prices start coming down while rates go up you get, essentially, a collapse in pricing as sellers are desperate to get out but few buyers can afford these homes because the mortgage rates are too high versus their current mortgage.
At that point owners who want to sell have no choice but to chase buyers further down. If the non-banks issued floating rate debt these sellers will default and we will have a repeat, albeit a smaller one, of 2007-2009 with tens of billions of dollars of defaulted housing loans by non-bank firms.
So while my larger takeaway, of course, is that Powell blinked and recognized he had been way too bullish about the economy in early October, as we repeatedly called out, it's now time for him to put his regulatory hat on and stop this nonsense with firm enforcement, not higher rates which will just push the non-banks over and hasten the crisis. We know it's happening. We see the ads. We know that there's been little to no regulation. I am not crying wolf. Crack down, and crack down now.