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Oops, We Did It Again: Banks and Houses Dominate the Recovery

One of the many, many lessons we should have learned from the 2009 crash is that an economy driven by inherently-unstable - and completely unproductive - things like rising home prices and bank trading profits can't be trusted.

And yet here we are again. Bloomberg reports that the Manhattan housing boom has spread to the boroughs:

Brooklyn Home Prices Rise to Record in N.Y. Sales Frenzy

Home prices in Brooklyn, New York's most populous borough, surged to a record as low interest rates and rising rents across the city swelled demand for homeownership amid a dwindling supply of properties for sale.

The median price of condominiums, co-ops and one- to three-family homes that sold in the second quarter was $550,000, up 15 percent from a year earlier and the highest in more than a decade of record keeping, New York-based appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate said in a report today. The inventory of listings fell 19 percent to 4,704, the lowest for a second quarter since Miller Samuel began tracking the data in 2008, said Jonathan Miller, the firm's president.

The median price of condominiums, co-ops and one- to three- family homes that sold in the second quarter was $550,000, up 15 percent.

"You choke off supply, you have a slowly improving economy, and prices rise," Miller said. "And then you compound it by widening your source of demand, when one of your competitors -- Manhattan -- is experiencing the same inventory problem."

Rent gains across New York coupled with mortgage rates at historical lows have helped push buyers into a sales market that's more affordable than Manhattan's, while owners are still holding back from listing their properties. Homeowners who bought during the previous peak, when Brooklyn prices hit a median of $540,000 in 2007, still don't have the equity to sell and come up with a down payment for something new, Miller said.

"You're not under duress, you didn't lose your job, you just can't make the move, so what do you do? Nothing," Miller said. "You just sit and wait for the market to improve."

Rising Rents

Apartment rents in Brooklyn have also accelerated, jumping 14 percent in June from a year earlier to a median of $2,737, the highest in records dating to 2008, Miller Samuel and Douglas Elliman said in a separate report today. In Manhattan, rents climbed 1.9 percent last month to $3,195, putting them 2.1 percent from the previous peak reached at the end of 2006.

Out on the left coast, according to San Diego real estate analyst Rich Toscano, things look pretty much the same:

May-June 2013 Data Rodeo -- Price Explosion

This chart of the Case-Shiller index (with my estimate based on median price per square foot over the last two months) shows just how different the character of this year has been:

San Diego home prices 2013

There was a plodding upwards of prices last year, for sure, but so far this year, prices haven't so much been plodding as exploding.

For a more granular look, here are the month to month changes in the median price per square foot:

San Diego square foot

The condo series is a bit of a wild animal so I usually ignore it; the underlying trend it better expressed by the more staid detached hom series (blue line). But even that has been on fire: the detached home median price per square foot is up 23% from a year ago, and up 16% in the first six months of 2013 alone.

This price surge has been due, as I've written about incessantly, to ridiculously low inventory and even ridiculously lower mortgage rates. One of those conditions persists; the other has changed somewhat drastically. More on that below; first, here are the above two charts starting at the peak of the bubble, followed by the same thing but for the regular median price (vs. price per square foot):

Meanwhile, the big banks are once again stars of earnings season:

Citigroup profit jumps, helped by home prices

Citigroup Inc on Monday reported a stronger-than-expected 26 percent rise in adjusted quarterly profit as stronger home prices reduced losses on mortgages and bond trading revenue jumped.

The biggest boosts in profit came from its securities and banking unit, where bond trading revenue rose 18 percent, while stock trading revenue soared 68 percent, and underwriting and advisory was up 21 percent.

At the Citi Holdings unit, which houses businesses and assets the bank is looking to shed, the bank set aside less money to cover bad mortgages as the U.S. housing market showed signs of recovery.

The results underscored how the bank is returning to normal after getting walloped during the financial crisis and needing three government rescues.

"Citi is a restructuring story and it is an emerging markets story," analyst Fred Cannon of Keefe, Bruyette & Woods said before the company reported results.

Adjusted net income at the third-largest U.S. bank by assets rose to $3.89 billion, or $1.25 per share, in the second quarter, from $3.08 billion, or $1 per share, a year earlier.

Citi's shares have risen about 28 percent this year through Friday's close, slightly better than the KBW index of bank stocks. They have doubled in value in the past year.

Some thoughts

Bank profits "jump" because of the real estate "frenzy" and price "explosion". Gee, it'll be interesting to see how this ends...

With interest rates up, it's possible that the end is already in sight. See Variable Rate World, Part 3: "This Horror Show Is Just the Beginning" for the impact of higher rates on bank bond portfolios. And here's Rich Toscano on higher mortgage rates and local housing:

This is big, in my view. Low rates have been a big driver of housing demand, for both investors (who are seeking out yield wherever they can find it) and residents (who are compelled to buy due to the favorable rent-vs-buy comparison enabled by super low rates). This rate increase will almost certainly undercut both sources of demand.

To what extent, I don't know, but this illustration helps demonstrate the impact: eyeballing it, the average mortgage rate prior to the recent surge was in the range of 3.5%. It's now about 4.5%. A buyer who is trying to hit a certain dollar-amount budget for a monthly payment just saw the size of the loan they can afford drop by over 11% in about two months.

That has got to have an impact. It could be slow to feed through to declining demand... in fact, there may have been an early opposite effect in which buyers feel like they should rush to buy before rates go up further (this is what drove the final peak-volume mania phase of the housing bubble in spring 2004). But it seems to me that this must cool off the housing market as buyers find they can afford less, and investors see that yields from other investments are less absurdly low. This is to say nothing of the impact that a tightening of credit conditions might have on our over-levered economy in general.


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