November 8, 2010

Fading Homeownership Bodes Ill for Fannie, Freddie: BofA-Merrill Economists

GSEs face continued earnings losses as underwater borrowers become renters

A report from Bank of America Merrill Lynch showing that U.S. homeownership is at its lowest point in over a decade suggests that Fannie Mae and Freddie Mac will continue to wrestle with earnings losses as long as housing demand remains weak.

U.S. Census Bureau statistics show that the homeownership rate fell to 66.7% in third-quarter 2010, its lowest rate since 1999, well below its peak of 69.2% in Q4 in 2004—and translating to a loss of 2.7 million homeowners. The rate is based on the total occupied housing stock of owners versus renters. With many underwater mortgage owners transitioning to rental units, both Fannie Mae and Freddie Mac face a persistent string of losses in the quarters to come.

Government-controlled mortgage buyer Fannie Mae on Nov. 5 reported a third-quarter net loss of $1.3 billion and asked for $2.5 billion in additional federal aid. The nation’s other government-sponsored enterprise (GSE) for mortgage lending, Freddie Mac, on Nov. 3 reported a net loss of $4.1 billion after the dividend payment of $1.6 billion on its senior preferred stock to the U.S. Department of the Treasury.

Meanwhile, underwater borrowers, meaning mortgage holders with negative equity because their asset's value has fallen below their loan balance, are expected to be renters rather than owners in the future, according to a “Housing Watch” report written by economist Michelle Meyer of the North American economics group at Bank of America Merrill Lynch Global Research

“We expect vacancy rates to remain high given the continued flood of foreclosures and the drop in household formation (the number of new independent family units),” Meyer wrote. “The Census Bureau’s population survey shows that household formation slowed to an average of 500,000 a year

from 2007 to 2010, from an average 1.1 million during the first part of the decade. This means there is a lot of ‘pent-up’ household formation. We expect household formation to pick up over the next few years, but it is likely to be slow given our forecast for a sluggish recovery with sticky high unemployment.”

While policymakers are unlikely to shift away from their belief in “homeownership for all,” the number of U.S. homeowners will drop off despite any policy action, Meyer noted, pointing to a recent paper by New York Federal Reserve economists that assumes all underwater borrowers will become renters over time.

“According to the latest Zillow report, 21.5% of single-family mortgage holders are underwater, which equates to 12.6 million,” Meyer said. “Subtracting these underwater borrowers yields an effective homeownership rate of 61.6%, which would be a record low for the data which goes back to 1965.”

The rate is on track to bottom at 65%, returning to mid-1990s levels, Meyer wrote. In a phone interview, she commented that the declining homeownership rate does not bode well for the GSEs.

“The natural link is that given that homeownership is falling and household formation remains weak, it is indicative of weak housing demand,” Meyer said. “Mortgage origination is Fannie and Freddie’s business, so as long as housing demand and home sales remain weak, it will impact Fannie and Freddie.”

Read about Freddie Mac’s $4.1 billion Q3 loss at AdvisorOne.com.

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