I wanted to talk about the bond market so that we could better understand how the banks were going to use leverage their positions to borrow money from the FED at all time low rates and give their investors great returns on their portfolios. This is where the Mortgage Backed Securities came into play and they could loan more money than ever if they could also inflate the housing market much like they did the bond and stock markets. The way I see it, historically housing is usually always the last to fall during a recession because it has always been one of the safest investments banks could make when lending money to people. The problem we saw in 2008 is they got greedy and they were giving predatory loans without bothering to foresee that someday the homeowners would not be able to afford their mortgage. Even if they didn’t, you could always foreclose and take the equity to payoff the loan and collect extra profit. That didn’t happen.
Too many people defaulted on their mortgages at the same time but rather than stopping and fixing the issue, they would package them together as CDO’s (Collateralized Debt Obligations) and sell them based on how certain ratings agencies would label them. The issue was that there was a lot of fraudulent reporting with no government oversight and every party involved was embellishing material facts in order to make deals happen. This isn’t the case today by any means since the mortgage industry is heavily regulated so this wouldn’t necessarily be a catalyst for a real estate crash; however, hedge funds are not regulated by the same regulations and these rules don’t apply to “cash” transactions. What I mean by that, is even though these homes from 2020 to today were being acquired as cash transactions, that cash was definitely also borrowed and usually on margin by these funds looking for a vertical with heavy demand.
By controlling the supply and creating a demand, these funds and investors were overpaying for housing knowing that they could outbid most traditional buyers and offer favorable terms to the sellers because they already had almost free money from the FED to make it happen. When the big banks can buy 20% or more of total homes in many markets, they will always have the upper hand. This went on until recently and the plan was to get out as soon as the FED would no longer purchase MBS to give them more liquid cash to keep the cycle going. The rental rates have appreciated as well as may of these hedge funds were mostly looking for returns instead of quick sales. It was the most lucrative place for them to keep their cash reserves as nobody was paying favorable rates due to all the new money printed.
The other metric people need to look at is the reverse repo market and that’s where banks can sell back the cash on hand to the federal reserve and they will pay a low interest rate if they cannot find anything else to invest in. The daily reverse purchase agreements are currently exceeding 2 TRILLION USD per day and that shows that the lack of confidence in the US markets that banks are demonstrating. The other option was to find other assets to invest in to get larger returns, and thus they all went after real estate rentals.
We have seen rental rates almost double since the beginning of the pandemic and home prices paid the price for these investors taking advantage of the new demand for homes. Because these homes were climbing in value beyond buyers purchasing power, investment firms could just simply offer more than the traditional buyer could bring to the table. They made these outlandish offers knowing that by manipulating the real estate market they would have equity in very little time compared to what they could obtain elsewhere. This would last until another catalyst (mortgage rates) would catch up and price people out completely to these artificial values. So here’s the thing… we are now here as we see interest rates approaching 7% for traditional buyers and now hedge funds are seeing the MBS market completely freeze. Now that the market is turning, things will begin to move quickly and the hedge funds will sit and wait on the sidelines until they can get back in or stay out completely.
Next article I will discuss the Las Vegas market and get into analytics and stats dating back to 2019, where I saw the correction coming.