Is the Housing Bust Over?
Well, yes, if we believe former Fed Chair Alan Greenspan. Two months ago, he claimed "the housing market had already bottomed," citing a stabilization in mortgage application rates to buttress his view.
Uh, not so fast, Al.
Jeffrey Gundlach, chief investment officer and fixed-income expert at money-management firm TCW Group, differed with Easy Al in an interviewin Barron's. Gundlach said "Greenspan is out of his mind to declare a bottom in the housing market after just a six-month slide. This is the kind of silly optimism that one would expect from somebody who'd just passed his real-estate brokerage exam and was hoping to drum up some business."
"Gundlach, in contrast, sees lots of trouble ahead for U.S. residential real estate. In fact, he sees no bottom in the slump until at least 2008 and no meaningful recovery until at least 2010. Nor is he particularly sanguine about the economy, in light of this housing downturn. Among other things, he sees about a 60% probability of the U.S. falling into recession by the middle of next year with housing alone lopping off at least 1.5 percentage points in growth.
A weak housing market will hurt in a number of respects. Consumers are less likely to spend freely when their biggest asset is getting drilled. Then too, housing accounts for a major chunk of U.S. employment when one accounts for all the construction, finance and retail jobs that depend on a lusty new-construction and resale market. Nor with home prices stable or falling will as many U.S. consumers be able to avail themselves of cash-out refinancings to underwrite their lifestyles, says Gundlach."
While Gundlach may be talking his book -- he is a long-time bond fund manager, after all-- he is mnore knowledgable than most. Over two decades at Trust Co. of the West, he has chalked up an enviable record running fixed-income portfolios, particularly for mortgage-backed securities, the firm's specialty.
And his experince suggests that the housing bust is only in its early innings:
"For one thing, the unprecedented dimension of the preceding boom of the past five years dictates a longer and bloodier workout period.
Likewise, shoddy home-lending practices abounded as never before, amplifying the housing bubble, according to Gundlach. Property values were inflated by bogus appraisals. Borrowers were allowed to qualify for mortgages far beyond their financial means. Income and assets were rarely verified, particularly in the subprime lending market. New mortgages were confected, allowing borrowers to keep their monthly payments low by either repaying just interest or, in the case of the option-adjusted rate mortgage, not even having to cover the full interest payment in the loan's early years. Gundlach contemptuously labels such loose lending ploys as "shoe-horn financing."
Likewise, special fixed "teaser" rates in the first two to three years of the mortgage also kept monthly payments low before rates began to adjust upward for the remaining life of the mortgage. One could always refinance every couple of years to stay at the lower teaser rates and avoid the lash of high fully indexed rates. But now that game is likely over, says Gundlach. Teaser rates have moved sharply higher since the Fed tightening that's raised the fed-funds rate to 5.25%. Gundlach expects lenders to become timorous, especially with home appraisal values likely to fall."
Fascinating stuff!
>
Source:
Housing's Woes May Be in Early Innings
JONATHAN R. LAING
CURRENT YIELD
Barron's, December 4, 2006
http://online.barrons.com/article/SB116502082486638620.html
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All you have to do is drive around a florida city to know there is a lot of hidden inventory out there. flips that flopped now have "for rent" signs out front instead of "for sale."
The next step is "fore closure"
Posted by: rob | Dec 2, 2006 11:47:29 AM
Thinking about putting on some long-dated housing stock puts. Will have to do some research this weekend.
Anyone know off hand which stocks have the weakest/worst management?
Posted by: Michael C. | Dec 2, 2006 12:01:47 PM
Those teaser ratesc are recorded at the full rate as current income by lenders. Expect revisions.
Posted by: Robert Coté | Dec 2, 2006 12:13:05 PM
Why can't people who are long past their prime fade gracefully into retirement and quit messing up the world for the rest of us? That would include Sumner Redstone, Alan Greenspan, Henry Kissinger and Rupert Murdoch to name a few.
Posted by: Bob A | Dec 2, 2006 12:17:26 PM
Michael C queried:
"Anyone know off hand which stocks have the weakest/worst management?"
FWIW, WCI is at the top of my list. Jeff Starkey, CEO, is pretty arrogant and even said in the latest CC that condos cancelled by purchasers with 20% down - he fully expects to resell for 90% of the original contract price. Neat trick, huh?
Anyhow, apparently everybody else has the same opinion of WCI's fate; almost 50% of the float is shorted. So, yeah, if you buy puts, make sure they're VERY long dated.
Posted by: winjr | Dec 2, 2006 1:01:43 PM
Not a homebulder but Countrywide has my attention. Mozillo is smart/lucky. So smart/lucky that as smart and luck would have it has cashed out more than $20m of CFC in November alone. With 5000 employees in on of the most expensive housing areas in the nation I fully expect an emergency reorginization/merger of equals hatever that guts their corporate staff and relocates. Unfortunately we all know what happens with those, the company stumbles over the massive shuffling of personell especially since these forced reloactions self select for the worst employees being retained. So, upper management divesting, phantom earnings on their held portfolio, industrywide slowdown, high expenses, their own real estate assets exposed to revaluation, etc. etc. Perfect storm in my (not investment advice) opinion.
Posted by: Robert Coté | Dec 2, 2006 1:14:45 PM
I think Greenspan is more of politician than he ever was an economist. You didn't have to be a perma-bear to know the housing market was over-inflated, much like stocks in 1999; mean reversion was long overdue. He just makes himself look stupid when he says things like that. I don't know why anyone pays any attention to him still. The FED head is politically appointed and is going to always err on the side where his bread is buttered.
Posted by: ml | Dec 2, 2006 1:32:24 PM
What troubles me is the lack of rationality behind the theory that a market can go higher over a 10 year period and exhibit signs of a bubble and then "correct" in the space of a year...
Things just don't work that way...
Posted by: SINGER | Dec 2, 2006 1:34:01 PM
Greenspan is just doing damage control. He would like to keep his speaking engagement rates up.
Posted by: KP | Dec 2, 2006 1:35:31 PM
Maybe Greenspan is a commie. He certainly had followed Lenin’s prescriptions for destroying the capitalism through creating and maintaining high inflation and devaluing USD.
Lenin about inflation and the destruction of capitalism:
“…The best way to destroy the capitalist system is to debauch the currency (this is what our government is doing). By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become 'profiteers,' who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery...”
If our government continues this inflationary nonsense and devaluing the dollar, Lenin will be certainly right. “The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
Posted by: V L | Dec 2, 2006 1:49:18 PM
SINGER
House prices in the UK suffered a sharp decline in the rate of growth but have subsequently rebounded. Click my name and scroll down to see the chart. While correlation is certainly not causation, the rebound in UK house prices does offer some crumb of comfort to those looking for some stabilization in the US.
Posted by: Macro Man | Dec 2, 2006 2:07:57 PM
Macro Man,
Do you mind me asking? Why do you think it will be like in England and not like in Japan?
"When the bubble burst, property prices plummeted more than 80%, undermining company balance sheets, wiping out many families' wealth and helping plunge the economy into 13 years of stagnation." ~ Financial Times, March 24, 2005, referring to Japan in the late 1980s.
Back in the late 1980s, the Japanese felt the same way about real estate investing as folks in the US do now. I checked the results of data on Japanese real estate going back to the 1950s, and I found that, with the exception of 1975, Japan home prices never had a losing year...
Never that is, until the bubble burst and the bust followed with 17 straight years of pain.
For example a guy in central Tokyo who borrowed $500,000 to buy an apartment still owes the full mortgage today, but his apartment has lost 80% of its value - $500,000+ mortgage and interest on a $100,000 apartment...
Posted by: V L | Dec 2, 2006 2:20:20 PM
Remember, this is the same Greenspan that told us not too long ago that there is no housing bubble but also said this a couple years prior:
"As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact--that is, when its bursting confirmed its existence."
-Alan Greenspan
Posted by: Someone | Dec 2, 2006 3:13:22 PM
Japan failed to close down the bankrupt financial institutions like the US did vis a vis the Resolution Trust. So these numerous Japanese banks just sat there disfunctional, not making any loans, and causing the real estate market to sink further. This was very painful for so many of its citizens, but it increased the savings rate of the country, helped maintained its manufacturing base, and allowed Japan to sustain its trade and current account surpluses. England's current account deficit is about 2% versus about 7% in the US, and unlike the US, they have huge foreign assets to equalize their external debts.
Posted by: Teddy | Dec 2, 2006 3:20:15 PM
....and in the far corner......in the red trunks......we have the fed.......and the banking interests it works for. They are not going to let this mess go down without a fight. These were the same guys that said they were not above monetizing everything(including corporate bonds etc.) if necessary to stave of a stock market debacle in the 90's(I think it was Bernanke himself who made the statement which is what earned him the title 'helicopter Ben').
Unless the banking interests have plans to take all those mortgages on the books and make all those 'owners' renters then they are probably sitting in the backrooms right now figuring out a way they are going to dig 'us' out of this mess.....with fees that will create a hefty profit for themselves of course
Posted by: DavidB | Dec 2, 2006 3:35:19 PM
"Fascinating stuff!" Indeed....! This is an affirmation of my own research thus, a slight conversion from theory to science. I agree whole heartedly that this housing slump will be drawn out over a period of years. However, I am also led to the conclusion that the consequences to the economy in general will be far more severe than those stated above.
Best regards,
Econolicious
Posted by: ECONOMISTA NON GRATA | Dec 2, 2006 3:35:27 PM
Japan? I am a housing bear, and the last thing I expect is that. The US experience with the RTC is just the beginning. Pick whatever data you like to measure prices, incomes, banking reserves, you name it. I doubt you can find any parallels beyond a period of sustained price increases. Moreover, the US puts a huge tax subsidy under owner-occupied housing. That alone should keep it from ever declining too much in nominal terms. 80%? Never say never, but I really, really doubt it.
While I also do not believe the US property markets are likely to follow a UK-style rebound, it's possible. The last time the US had a property market as extended as the current one was the late '80s. That one kept on going for some time. Despite a slowing market and rising inventories, prices increased in line with incomes from '87-'89, then finally cracked.
I think Gundlach's points indicate why I agree it's probably not 1986. Housing will be a drag on production until inventories come into line with sales, and cash-out refinancing end with price rises and drags on consumption. Subprime lending standards have been too loose, and the various regulators have been issuing rules to tighten them. The likely result is a drawn-out adjustment in the housing market. No crash; housing moves slowly. Check nominal and real house prices and sales and construction employment and starts from '90-'94 for a likely prelude.
As for homebuilder puts, they are quite pricey. WCI's will set you back 50% implied volatility. I don't like paying up for vol unless I really feel I have an edge on timing, and don't here.
Posted by: wcw | Dec 2, 2006 3:43:02 PM
There is a rapidly growing glut of gas-oil supply in the US, and an even bigger and onrushing glut of global crude oil. Discounts from ~$5/bbl and ~$15/bbl for block trades in 100mmbbl lots, suggesting a lot of things. Probably need another "little war", to paraphrase Commander Chen'ster.
Them that reads history knows Iraq-Iran goes inverted.
Posted by: Tbone Snickens | Dec 2, 2006 4:09:42 PM
The US housing slump will probably not reach its bottom until 2010, if previous real estate cycles in the US are anything to rely on.
I am not saying that house prices will drop by 80% like in Japan but the prices have only started to decline here in the US and we are not even near the bottom yet.
I also will not be terribly surprised if we get something similar to what had happened in Japan only to a lesser extend.
1. By 1989 Japanese property markets blossomed and land prices soared. Four-fifths of bank loans were reckoned to be related to land, which was often used as collateral.
2. December 25th 1989, the BoJ decided to cool the party and raised interest rates.
3. Land dealings dried up and prices started to decline
4. For 4 years after, the optimism was high that asset values would pick up again and banks lend more to distressed borrowers in hopes that their land values will rebound
5. In late 1994 two credit corps (like Freddie Mac in the US) had to be bailed out by the taxpayers
6. By 1997 Japan's financial system appeared to be on the edge of a meltdown when three medium sized long-term credit banks had to be injected with private and public capital.
7. In Autumn of 1998 Long Term Credit Bank (LTCB), among the world's biggest banks at that time with $240 billion of assets collapsed
8. Etc ….
Posted by: V L | Dec 2, 2006 4:25:38 PM
My original thesis -- that Real Estate is more of an extended asset class that can correct 25 -35% than a full blown bubble -- can be seen here: Don't Buy Housing Bubble Propaganda
So far, that details in that commentary seem to be holding up pretty well
Posted by: Barry Ritholtz | Dec 2, 2006 4:55:11 PM
Big Al is a little more savvy than given credit. I doubt that he's as dumb as advertised on the perma bear blogs. No one really knows why he made that statement. I presume he's still got a little Fed Chair in him and knows his comments can move markets negatively.
But, if he was being straight up, he's just a little early. We are still in the deniable phase.
Mozillo is surely very smart but never underestimate being in the right place at the right time or an ability to take risk. As Bill Miller says in nearly every quarterly update he puts out, people are too averse to risk. Those who take prudent risks will always beat those with an IQ of Albert Einstein. Those who take prudent risks with an IQ of Albert Einstein should do frighteningly well. Were the first 10,000 Microsoft employees geniuses? Or Google's first 1,000? Because they all have more money than anyone on this board, likely including the blog king himself Mr. BR.
Mozillo has pretty much said the housing situation is going to get worse. He's not a cheerleading dimwit like Lereah. Not only is it going to get worse, but his company will likely suffer as much or more than home builders. Homebuilders are moving higher because the short killers are trying to root out some additional returns. Not because the smart money thinks they are a good value. I'm quite confident of that based on the action in the stocks and other correlated stocks which aren't moving along with the homebuilders. The housing boom is really more than five or six years old so it isn't going to mend itself in something like six months. The last six years were simply mania.
Japans' situation is NOT the same as the US. It's not even close. Japan's biggest problem was not a mania in housing but the Friedman orchestrated dollar move. Not that it couldn't get nearly as ugly here. No one really knows. But, that's pretty extreme. The reality is that most people are looking at the U.S. but that the bubble is more severe globally as is the concern over savings rates as is credit creation. So, while everyone squawks that the US is going down the shitter, the reality is, this is still the safest place to put your money regardless of where you live on the globe.
Posted by: BDG123 | Dec 2, 2006 5:07:28 PM
Not sure I would call it a housing bust, but no it is not over. it is about demographics, which is the single biggest reason for the slow down. The Gen X bought forward and will not need to buy another home for several years. Gen Y is just about old enough to buy but they can not afford to. Boomers the biggest group around and are not moving so much as staying put. The market will not be has good as it has been in the recent past and we will have to adapt.
Posted by: teresa boardman | Dec 2, 2006 5:36:06 PM
In 1989, Tokyo real estate was worth more than all of California real estate. In 1989, 100 year generation mortgages were available in Japan. In 1989, the Nikkei was also in the latter stages of a bubble. In 1989, real estate holdings formed a major part of the asset side of corproate and financial insitution balance sheets. In the early 90's, BOJ governor Mieno tightened policy as the various asset bubbles collapsed. None of the first four is relevant to the US today; we'll wait on the fifth.
Having lived through housing market "bubbles" in other countries which have subsequently recovered, I am naturally sceptical that a country as large as the US can see anything like a nationwide housing crisis. Are there localized bubbles where people feel pain? Sure.
But those markets do not represent the country as a whole. But in the latest Demographia housing affordability survey, 21 of the 24 most affordable housing markets in the US, UK, Ireland, Australia, and New Zealand were in the US. Granted, 9 of the top 10 most expensive housing markets were also in the US.
2006 2nd EDITION DEMOGRAPHIA INTERNATIONAL HOUSING AFFORDABILITY SURVEY
http://www.demographia.com/dhi-ix2005q3.pdf
But this illustrates a key point. There is no 'US housing market', merely a series of regional markets. By focusing on the extremes (Florida, Vegas, etc.) , one can lose sight of what is like in the like of Buffalo and Indianapolis.
I really do not know what will happen to the housing market. If I had to bet, I suspect that prices will flatline, inventory will get worked off, and a year from now prices will start edging slightly higher. That is based on my experience in other countries which, to my analysis, resemble the situation in the US.
I wonder if some of the current hysteria over housing represents some degree of hangover from the equity bubble a few years ago...
Posted by: Macro Man | Dec 2, 2006 7:06:56 PM
In case anybody is interested Calculated Risk has a very nice summary of the optimists, of their analytical 'challenges' and clear graphical analysis of the real data as well as pointers to his priors on the impacts on the economy. If you find it fascinating stuff highly reccomended: http://calculatedrisk.blogspot.com/2006/12/housing-optimists.html
It would seem to me with a 35% YTD rise in builder stocks that we're in a momentum market building on it's own energy but it's flattening. Having thought this unlikely I missed it. And it looks like the optimists are catching it at the wrong time. If individual stocks don't appeal what about puts or shorts on the ETFs ? For example IYR or somesuch ? Barry what do your techs tell you about that marketspace ? :).
The question that's not being put on the table is the lag structure of downturns in housing, construction employment and MEW. Which also means the rising risks to the economy, already widely accepted to be slowing, aren't in the general discussion either.
Times should be interesting. Think boaters call these small craft warnings and weather advisories.
Posted by: dblwyo | Dec 2, 2006 7:09:39 PM
Japan's stock and real estate mania were the result of the orchestrated dollar decline in 1987. Japan tried to counteract the Yen's rise by selling Yen and buying every currency in the world, but especially US dollars, and then purchasing real estate worldwide. The problem was that they didn't sterilize the money they created to accomplish this like they're doing now and it resulting in hyperinflation of their stock and real estate markets. Presently, they are in much better position than the US because they are a creditor, not a debtor. In the long run, the debtor usually loses. Since 80% of American business depends on the consumer, I suspect every trick in the book being tried to make the real estate market rise from the dead. Three months ago,Congress examined Freddie and Fannie and declared "shoe-horn financing" is ok.
Posted by: Teddy | Dec 2, 2006 9:41:12 PM
