Richard X. Bove, Vice President Equity Research at Rafferty Capital Markets, highlights some breakthroughs needed in mortgage production, Fannie Mae and Freddie Mac’s mortgage pools accounted for an incredible 87.4% of the net fund flows.

### Core Issue

Housing activity has improved meaningfully from its low point in 2009, demand factors indicate that it could go much higher. The structure of the mortgage markets is looming as a potential impediment. The nation needs to build 1.5 million new units each year for the next 10 years and there is no indication where the mortgage money will come from to finance the potential buyers.

### Housing

**Housing Production**

In 2005, 1,726,000 single family housing units were started. This number fell off to 434,000 in 2011. From that low point, the market showed steady recovery to 713,000 units in 2015. It is at a run rate of 764,000 at present.

For comparative purposes, similar trends have been noted in total shelter production (single family starts plus multi-family starts plus mobile homes). There were 2,221,000 units created in 2005; 604,000 in 2009; and 1,165,000 in 2015. The present run rate is 1,200,000.

**Housing Sales**

Single Family home sales new and existing (excluding mobile homes and multifamily units) seem to be slowing, however. They were running at 7,449,000 in 2005; 4,103,000 in 2011; and 5,129,000 in 2015. Today’s run rate is 5,271,000.

### Demand Considerations

**Replacement Demand**

The first step in determining effective demand is to compare the number of housing starts with the estimated dilapidation data. The housing start figures come from the Commerce Department. The dilapidation estimate is based on an assumption that 0.75% of the existing housing stock becomes unusable each year. The 0.75% figure is based on the housing studies completed for the Omnibus Housing Act of 1968. (Sorry, I just do not have a better number).

What the comparison shows is that in 2005, the nation was producing 1,143,000 more units than it was losing. By 2009 it was losing 422,000 units more than it was producing. In fact, in aggregate from 2008 to 2014, an estimated 1,542,900 units were lost over and above production. By 2015, the nation was back to producing more units than it was losing.

**Population Considerations**

There was a significant shift in the population of people aged 25-44 in 1997. The number stopped growing. In fact it fell from 85,536,000 in 1997 to 82,135,000 in 2010. In 2011, this population anomaly shifted back to normal and the population of people in this cohort started to grow again. In fact from 2015 to 2025, the demographers estimate that there will be 8,772,000 people in this age group. There will be 4,269,000 additional people aged 45 to 64.

If one assumes that there will be 2.00 people per household in the younger group that implies a demand for 439,000 more housing units per year for these people. Similarly, if one assumes that there will be 1.80 people per unit in the older group; it would imply annual demand for 237,000 more units.

**Aggregate Demand**

Adding the need to replace approximately 1,000,000 units each year to the demographic demand for 675,000 new units suggests that the annual demand for new units is about 1,675,000 million a year. That, of course, assumes that there is no excess vacant units that need to be absorbed, but there are.

The current vacancy rate is 12.8%. This is down from 14.5% but history suggests that an 11.5% vacancy rate is closer to normal. Vacancies are needed to facilitate the mobility of the population. Assuming that there are 1.3% too many vacancies it would mean that over the next 10 years approximately 175,000 units must be absorbed annually.

This implies that the annual demand for housing is about 1,500,000 units per year. This is 400,000 more units than are being produced currently.

### Affordability

The numbers here are quite good. Assuming a 4.04%, 30-year fixed rate mortgage, with a 15% down payment, and a 25% payment to income index, the Rafferty Capital Markets Affordability Index is 1.74%. This is very high relative to the long-term past.

### Fannie Mae & Freddie Mac – Mortgage Money

Thus, it appears that there is significant demand for new housing. Plus, it is likely that the incomes are available to pay for the new units. The question is where is the mortgage money going to come from?

In 2005, the answer was simple. The private sector would come up with the funds. According to the Federal Reserve 68.3% of the net new money flowing into the mortgage market came from banks and the asset backed securities markets. Not so any more. Banks are still major buyers providing 30.7% of the industry’s fund flows but the ABS market is taking an amount equal to 55.8% out. Thus, the net from these two sources is now a negative 25.1%, although credit unions and REITs are filling most of this gap (23.8%).

If one can believe the Federal Reserve numbers in the fourth quarter of 2015 Agency and Fannie Mae and Freddie Mac mortgage pools accounted for an incredible 87.4% of the net fund flows into the mortgage market. If one adds the direct buying by the Fannie Mae and Freddie Mac and subtracts the net selling by ABS holders, the government accounts for 102.4% of the total market money inflows.

Today, the Agencies and Fannie Mae and Freddie Mac own or guarantee 60.9% of the existing loans. Three of every five mortgages in the country are either owned or guaranteed by the government and this does not count the FHA or VA guaranteed loans.

This is particularly unhealthy because the Fannie Mae and Freddie Mac are currently insolvent and they will be bankrupt by December 2017 under current regulations. This begs the question as to who or what will replace them? At this moment no one knows. Thus, housing could be throttled by a lack of mortgage money in 18 months.

These numbers make it hard to assume that the Fannie Mae and Freddie Mac will in fact be eliminated as currently planned. If they are it would appear that the mortgage markets would be thrown into chaos.