Everyone remembers the aftermath of 9/11/01 and how horrible those days were, but what sticks out in my mind, after the obvious, was what happened after words. The President said to get out and shop, and boy did we, but the thing most do not recall is what the auto industry did to boost sales, 0% financing. This was the beginning of the end for the auto industry simply because how can you ever raise financing costs after you go to 0%. The demand that 0% financing created meant that the automakers would have a heck of a time raising those rates and they needed the sales. It essentially created a major problem for the industry which help speed its way into bankruptcy.
We are seeing the same thing happen in housing with all the government help being injected into the market. We have tax credits to encourage buying, but we also see what the market looks like without those credits, see recent home sales data, and we have the Fed lowering mortgage rates like mad with QE. What happens when/if these programs stop? It will get ugly, just like when the automakers tried to stop 0% financing. If you do not let the markets work their magic, i.e. stop malinvestments, the pain is just prolonged. GM and Chrysler should have gone out of business a few years ago but that 0% financing helped keep them around, however it could not stop the inevitable.
The mistakes made by the automakers are being made by the government with the housing market. Homeowners already enjoy a ton of tax breaks, mortgage interest deductions, property tax deductions, etc. and the last thing they really needed was a tax credit to buy a home. It has helped, the data shows that, but the problem is these programs have to end and then what happens? As we have seen already, with limited data of course, is that housing does not move without that tax credit. Sure we can blame the weather or whatever external force we want, but that is ignoring the obvious, housing wants to go lower. That leads me to believe that more tax credits are on the way and QE is a permanent fixture at the Fed, see Japan.
When you incentivize buying to such a degree you create a major problem for yourself, or the country in this case, as you boost expectations on false hope. Once you remove those incentives and reality sets in you are stuck with doing nothing, clearly something government does not want to do now, or let the market sort things out, what should happen. Because the government has created false hope for a housing recovery they have created more problems than they solved. The sales we do see now are false demand, meaning it is only there because of the rich incentives, which means that many economists and market participants are creating strategies or projections around numbers that are not real. The fact is that without a natural housing recovery the economy cannot recover.
While the insane 0% financing hastened the decline of the automakers into bankruptcy, in my opinion, the government is simply slowing the fall of housing or kicking the can down the road a bit. The good news is that at least the incentives will not cause the government to go into bankruptcy, well on their own at least, but it is an enormous waste of money. The government should step back and stop what they are doing and the Fed needs to stop its QE program. If neither stop and they continue doing this the next leg down will be ugly and, the reality is, we do not need more incentives to buy houses, look at the tax breaks you get now. False demand creates false hope which lures investors into investments they ordinarily would not buy. When that false demand and hope disappear those investments decline in value, investors are being suckered.
All of this information about a housing recovery is just plain false. The biggest perpetrator of the housing recovery myth is CNBC and they actually ran this story today showing it is the lower priced homes moving, all other homes are just not moving, period.
There is simply no recovery in housing at this time and if this chart tells us anything is that the market will, at best, be flat for some time to come. However, I am inclined, as indicated in numerous other pieces I have written, that we still have a long way to go on the downside before things begin to level out. This means that banks, 81 YTD, are going to continue closing because they are losing money on these mortgages as people just walk away from homes that they cannot sell and are underwater in.
A full one third of all sales in July were of foreclosed properties, and as more foreclosures hit the market, you can only expect more downward pressure on prices. Foreclosures are only increasing, as we saw from yesterday’s Mortgage Bankers Association report, and that will mean more inventory.
I think that is proof enough that things are just not that good. I may have missed out on a couple of percentage points over the past week, but the market is going to come crashing down in the near future. Why, because all of the data supporting a bull run is over hyped and inaccurate at best. Housing is one of the data points supporting the bull’s case, but look at the data point and tell me that there is a recovery taking place.
Take a look:
U.S. Existing Home Sales Yr/Yr
$0 – $100,000
Up 38.8%
100,000 – $250,000
Up 8.7%
$250,000 – $500,000
Down 6.2%
$500,000 – $750,000
Down 8.9%
$750,000 – $1,000,000
Down 10.6%
$1,000,000 – $2,000,000
Down 23.3%
$2,000,000 +
Down 32.4%
Source: National Association of Realtors
As I have said numerous times before, burying and hiding problems through bogus accounting will only make the problem worse long-term. Enron tried it, MCI tried it, now we have the banks trying it through lax mark-to-market regulations. The FASB enacted the mark-to-market because it made sense, if you had to sell a security today you cannot just wait for a nonexistent price to come along, which is what the new regulations let banks do for accounting purposes.
One last point about this, ever since mark-to-market went away bank earnings have all been good. Do you see the problem? Frankly, real estate is still their biggest problem and the above information supports that theory.
Correct me if I am wrong, but hasn’t real estate hit its bottom? According to CNBC, TV, Cramer said that real estate hit its bottom, ‘early’, in June and all other reports yesterday everything is fine and prices will go up,up,up! However, as usual, CNBC.com has conflicting stories for example, CNBC TV says bull market with hot economic growth and there is no risk in this bull market, but CNBC.com is awash with stories about the global markets are in trouble and real estate is in pretty bad shape. This is what makes me question the integrity of CNBC commentators, who I once respected.
Regardless, real estate is a mess and July was no exception with foreclosures setting yet another record. Remember this is ‘another’ record meaning it was worse than June which means more pressure on the residential market when or if banks put those homes on the market. That is the crux of the matter, banks are holding properties, often referred to as the shadow market, and we have no idea exactly what their inventories are. Therefore, the sales numbers and inventory numbers mean nothing as there is hidden supply out there, unless they continue to destroy foreclosed home, yes banks are doing that.
All of the programs in place are simply not working and I would chalk this up to a waste of time and money considering most modified loans still defaults. As hard as this is to say, we need to let these homes be foreclosed upon, yes I am serious. This is one way of cleaning up malinvestments and people need to understand how to live within their means instead of trying to keep up with the Jones’s. Now, before you call me cold hearted or insensitive I need to let you know that I did have a family member lose their home with horrible consequences, but it was a matter of too much house without enough resources.
The foreclosure rate for July was up 7% month-over-month and up 32% year-over-year. What this means is more moratoriums are on the way and more federal rescue plans which are merely a waste of money. These programs only postpone the inevitable and will make future reports look OK in the short-term, but longer term it will simply create more bad data points. The market is telling us to let housing depreciate and propping it up will only prolongs the pain moving forward.
This data also feeds into my belief that the markets are overbought to such a high degree that I fear the next leg down will be horrific. This is why I moved mostly to short treasuries, non US dollar assets and cash only keeping 35% total in equities, enough to let me participate if I am wrong, but if I am right it will not destroy my portfolio. Either way you feel I would strongly suggest you invest defensively for the short-term. As usual, do your own homework and invest according to your goals and needs.
Oh the media has been working overtime to convince everyone that things are great and there are green shoots everywhere. From a half backed GDP report, which revised 1Q09 down by .9% which you then add in inflated government spending and you magically have good news, to a fully backed jobs report they have managed to turn one bear into a green shoot advocate, Roubini.
In other news mortgage applications plunged again this month thanks to higher interest rates, not sure what to really think about a 5.38% mortgage rate being “high,” but somehow this was spun as sales contract numbers rose, slightly. Contracts really mean nothing as they have a high, relatively high, cancellation rate and I have never based any decisions about the market over this type of data point, it is really a nothing in the big scheme of things. Now if we were talking sales then that is a different story as sales means something. Regardless, mortgage applications dropped which should make yesterdays CNBC story about optimism in the housing market obsolete and defunct as the story was obviously spun to make things look better.
With Roubini now in the camp of the recession will end by December 31st, 2009 the bulls have declared victory and are dancing in the streets. They even got him to say that asset prices should go higher and the risk of a double dip recession is low, all of which is nonsense. After being misquoted a few times and constantly bashed by most people on CNBC it is clear that he has had enough and decided to side with the path of least resistance.
However, I have to disagree with him on equity prices as I see it the S&P 500 have priced in perfection and has set itself up for a big fall. However, even I admit that the inflation of the money supply is making things unpredictable as much of that money ended up in equities. Even so, I think we are in for a wild ride in the near future.
With mortgage applications down and mortgage rates up I think it is safe to assume that the residential housing market will continue to languish in the near future. That is until the Fed magically lowers rates again through quantitative easing, monetizing our debt, but I am fairly convinced that will not do much to spur sales. People are funny, when they see prices continuing to fall they tend to stop buying to wait for a bottom which creates a paradox for the real estate market as they need buyers to stop prices from falling.
In a nutshell, things are tough and I am willing to bet we are in for much lower equity prices in the near future. While Roubini has been tamed and the media works on spinning the mortgage application data and claim that new contracts are indicative of potential sales, which they are not, to declare the real estate market “stabilized” I will continue with my bearish outlook until things fundamentally change. So far, I have seen the fundamentals weaken, not strengthen and there is simply no compelling reason to buy equities at these prices.
Many have come out to say that the housing supply is now under control, when that is the furthest thing from the truth. What people see as strong demand is nothing but first time home buyers taking advantage of lower home prices and tax credits. It is unlikely that the demand will sustain itself past November when the tax credit is currently set to expire.
Foreclosures
Foreclosures are still a major problem and there are no signs of that slowing in the near future especially if unemployment continues to climb. In fact, most foreclosed homes are sitting on the banks balance sheet because they do not want to flood the market with more homes. The recent stories about demand increasing and supply decreasing are stunningly misleading at best.
Considering some 50% of homes are projected to be underwater in their mortgages versus their values is why most banks are either sitting on the property or simply tearing them down. The home loan modification plan has not been very successful and many who qualify are those who really do not need a modification at all. I will admit that there is some stabilization of prices, but nowhere near what is being portrayed in the media. There is also an alarming rate of jumbo and conforming loans who are not only underwater, but also defaulting on their loans which will only increase foreclosed properties in the near future.
According to T2 Partners these jumbo loans are beginning their first reset now and will continue through 2011. Based on their predictions, who got most of the mortgage mess right before most economists or experts, then we are in for increasing foreclosures and inventory hitting the market over the next couple of years. I find the delinquencies in prime mortgages, which were conforming, the most alarming problem we have in the near-term as they, on paper at least, did the right thing.
Home Builders
As you may know home builders are building, reflected in new housing permits, which will do nothing but add more inventories to the market. Considering we already have a 9 month existing home inventory the mere fact that they are building just boggles the mind, although I realize they have shareholders to appease. However, more inventory is not what we need, we need less inventory.
Not only are homebuilders building more homes, they are cutting prices and offering unheard of incentives to lure people into buying. The length of time a home sits on the market is increasing, not decreasing. We are also heading into the slower time of year for home sales which is not good news as we sit on huge inventories and the above mentioned tax incentive runs out.
The bottom Line
We are not near the bottom yet and have a long ways to go, contrary to what you may be told. Just because Orlando had a bump in prices doesn’t mean anything as Miami, Las Vegas, Phoenix and California are still experiencing declining prices. I am not a real estate expert, but I do realize that when supply outweighs demand then prices will continue to decline.
Based on the highs of the market we still have a steep decline in housing prices to suffer through. We had never experienced such price increases as we saw from 2002-2006 and to assume a 20% decline is enough to offset those huge price increases is crazy. Even with cheaper prices the average home is selling for 6 times the average annual income of Americans, which makes housing unaffordable for many Americans.
Not to mention the fact that the demand is a direct result of government and Fed intervention through tax credits and cheap money, which got us here to begin with. Without the tax credit and cheap mortgage rates it is safe to assume that there would be very little demand for housing. At the end of the day artificial demand only props up prices for as long as the stimulus is in effect for. Once that stimulus is gone so is demand.
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