The Exquisitely Reengineered Frankenstein Housing Monster

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It’s back, a new and improved contraption, a synthetic structured security that on its polished surface looks like that triple-A rated mortgage-backed toxic waste that helped blow up the banks and your 401(k) in 2008. But this time, it’s different. It’s even worse.

American Homes 4 Rent, a highly leveraged REIT that went public last August with great hoopla and that owns 21,000 single-family homes it bought helter-skelter out of foreclosure since 2012 and is now desperately trying to rent out – well, that Wall Street darling, according to unnamed sources of the New York Times, is planning to hawk securities backed by $500 million of mortgage debt.

But this time, the mortgages aren’t on homes owned by regular folks who lied on their applications about their income and who refinanced the heck out of ever uptick in price to yank out cash. This time, the securities – if you can call them that – are backed by rental payments from single-family homes that are, hopefully, rented out, and will, hopefully, stay rented out.

The usual suspects are lined up to engineer these elegant products, the same ones that were bailed out last time: JPMorgan, Goldman Sachs, and Wells Fargo. The securities are to be sold during the first quarter to investors that have been driven to near insanity by the Fed’s repression of yield on even the riskiest crap – investors who’ve learned to hold their nose and ignore the risks no matter how large just to get a little extra yield.

Wall Street is licking its chops: the market for this type of synthetic monster is estimated to be $1.5 trillion. They’re hoping that $7 billion of these kinds of securities will be shoved out the door in 2014, and once the routine sets in, about $20 billion per year. Since 2012, when all this craziness started, mega-landlords have bought about 200,000 vacant, single-family homes out of foreclosure for which they’re now trying to find tenants.

If anyone at the Fed needed more proof that the US is in the midst of the largest and craziest credit bubble in history, here it is.

Private-equity mastodon Blackstone Group, whose entity Invitation Homes became the largest landlord in the country by gobbling up tens of thousands of vacant, foreclosed single-family homes since 2012, broke the ice last fall with its $479-million single-family rental securitization. Mutual funds, insurance companies, pension funds, etc. fell all over each other to buy them and stuff them into bond funds and other receptacles for iffy stuff.

Securitization has its benefits – for the mega-landlords. Banks usually require 40% equity for lines of credit on these rental properties. By slicing and dicing the debt and packaging it into securities, landlords can cut their equity down to maybe 25% – or less when no one is looking. In many of these markets where mega-landlords bought every vacant single-family home they could get their hands on, like Phoenix or Las Vegas, prices have jumped 25% or more in just one year. But these price gains can be ephemeral. When home prices drop to where they were a year or two earlier, and occupancy isn’t high enough to service the debt, those finely engineered securities will turn into toxic waste.

But securitization provides landlords with the most valuable drug on Wall Street these days: more leverage – so that they can gobble up more single-family homes.

The next step is to offer this kind of securitization to everyone, practically: speculators, flippers, mom-and-pop investors, private-equity funds, REITs, and other small and large investors. All based on the unreliable income streams, if any, from rentals. Cerberus Capital and Blackstone are already working on it. In the end, these rentals could all be packaged together, sliced into different tranches, sold indirectly to some unsuspecting pension fund participant.

With this business of slicing and dicing back in vogue, investors have a new source of cash and can take on more leverage to gobble up even more single-family homes and drive up prices even further, pushing regular homebuyers to the edge.

It has been showing up in a litany of numbers for months, with the volume of transactions heading the wrong way. And purchases by first-time home buyers – the crux of the housing market – dropped to just 27% of all purchases in December, from 28% in November, from 30% in December 2012, and from the 30-year average of 40%. It was the lowest ever recorded in the data series going back to 2008. First-time buyers have been pushed out by higher home prices, higher mortgage rates, and a veritable flood of cash buyers – in Florida, 62.5% of all buyers – many of whom are investors.

With the nearly free money that the Fed is still handing out, Wall Street is taking over the American Dream, driving up prices, shoving first-time buyers to the side, but then graciously allowing them to become tenants in their empires. To grab even more homes and drive up prices even further, they now have an exquisitely reengineered tool, single-family rental securitization, whose detritus – the actual bonds – will end up in people’s retirement funds and conservative-sounding bond funds. All along the way, fees are extracted, and risks are transferred, and down the line, when it all blows up again, it will complete the cycle of wealth transfer. Hallelujah, 5 years of unmitigated QE.

The Fed must have seen the relentlessly spiking margin debt. Leverage is a sign of investor confidence. The great accelerator. On the way up. And on the way down. And margin debt has a nasty, very consistent habit of peaking just when the stock market begins to crash. Read…. Stocks on Speed: Margin Debt Spikes, So Does Risk Of Crash

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