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Happy Talk on Housing and Mortgages Masks Dangers

Over the last several months, analysts have become invested in the narrative of a recovery in housing, hyping positive data and downplaying either negative data or the explanations that temper the good news (the large amounts of uncounted shadow inventory, for example). This pervasive talk feels a lot like the bubble years, only we’re now talking about how the bottom for housing has been reached instead of marveling that prices will never go down again. And it’s led to a pernicious outcome – the selling off of housing stock to large investment groups who plan to rent it out.

There’s nothing inherently wrong with that, nor is it surprising. Rich investors were always going to buy up low-end housing stock if they felt it was undervalued. It’s the vehemence of this push in recent months, bolstered by federal policy on shifting REO (real estate owned) homes to rental units, that has scaled up the practice, so that instead of rich local developers you have massive Wall Street firms and hedge funds doing the purchasing. Mother Jones ran a nice piece last week on your new absentee landlord:

Earlier this year, Carrington (Investment Partners) announced a partnership with another hedge fund to buy nearly half a billion dollars worth of foreclosed single-family homes and convert them into rental properties. Carrington is by no means the only one doing this. Silicon Valley-based private equity firm GI Partners is investing more than $1 billion in similar ventures. Other foreclosure-to-rental players, according to Bloomberg, include the $19-billion investment fund Starwood Capital Group,* the billionaire media magnate Sam Zell, and Apollo Investment Management—the New York buyout firm led by the billionaire Leon Black.

Federal regulators see the foreclosure-to-rental frenzy as a way to resuscitate the moribund housing market. In February, the Federal Housing Finance Agency announced a pilot program to sell discounted batches of Fannie Mae-owned homes to large investors in six major urban areas on the condition that the buyers lease out the properties. Advocates claim the program will give blighted properties a makeover and provide displaced homeowners with more rental options. “If you are a distressed family coming off of a foreclosure, the last thing you need is escalating rental rates,” Rick Sharga, executive vice president of Carrington Mortgage Holdings, told the trade publication Housing Wire last month.

But housing experts worry that the trend could backfire if private equity magnates amass vast tracts of rental homes only to become white-glove slumlords. “That’s a big part of the concern,” says Tom Deyo, the deputy director for national initiatives for NeighborWorks America, a network of 235 nonprofit community redevelopment groups. “These investments in rental homes need to be seen as investments in communities, not just as data points on some spreadsheet.”

The trend is continuing. Yesterday the head of US housing strategy at Morgan Stanley left the firm to launch a “buy-to-rent” housing fund. He considers it “one of the most compelling investment opportunities available across all asset classes today.”

That sounds suspiciously like a re-inflation of the housing bubble, in a sense. The idea goes that investors swoop in and buy these vacant properties, pulling them off the market and converting them to rental units. The resulting restriction of supply ends up goosing housing prices, every home appreciates in value, and smiles all around.

Except there’s the aforementioned problem with absentee landlords screwing their tenants. And the rosy expectations built into this plan. Moreover, the happy talk on the effect of all of this on prices has led to a strong repurchase of toxic mortgage bonds, which seems really absurd.

While stock and high-yield bond markets have swooned in recent weeks, one unlikely fixed-income sector has been outperforming — non-agency residential mortgage-backed securities (RMBS).

The securities — which helped spark the financial crisis, and are mostly backed by the damaged mortgages that made “sub-prime” a household word — are enjoying a renaissance this year.

These are secondary trades – not many new mortgage bonds have been created post-crisis. This is the same toxic waste that plummeted in value and led to the meltdown, being traded again to investors looking for a yield. These are the same bonds, created with fraud and sold with misrepresentation, that multiple banks have been sued over, lawsuits that continue to flow into the judicial system, including a recent one by the FDIC. In fact, many lawsuits question whether the bonds are even tied to the underlying mortgages, because of improprieties in the initial handling of the securitization. Nevertheless, they’re now seen as a solid investment.

Everyone in the market claims that the bonds have been “loss-adjusted” to account for defaults and foreclosures. Presumably these are the same people who saw no problem with subprime bonds in 2005 and 2006. It all gives me a quite horrifying sense of deja vu.

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David Dayen

David Dayen