Everyone is on bubble watch nowadays, me included, as central banks flood their respective countries with mountains of money. While the US has done a ton of printing of dollars it is often overlooked that the Chinese have also printed a ton of Yuan as well. While there are definite differences in the economies of the US and China, we could argue those difference all day long, the one thing we could all agree on is that China a lot of flaws in its system. I would counter by saying their flaws are probably pretty severe, but no worse than the US.
Regardless, I have been reading a lot about the bubble in China, especially in their real estate prices. I do not doubt that as property values have gone parabolic in the country, some areas make the peak price increases in the US look like pathetic in comparison, but is it the same bubble that the US had? The answer is, no one really knows for sure because the data is spotty at best. My guess is that the price bubble is probably worse than the US, but I am willing to bet that mortgage fraud, home equity loans, securitization and the host of other issues that basically collapsed the world economy are not the same, at all.
So, at the end of the day, we will see a price collapse in China which will lead banks to have losses on their books, but it will end there. It will likely be as bad as the early 1990’s in the US banking system compared to the 2008 collapse that the US had and it will more than likely not spread globally like the US credit collapse did. However, it is problematic for the world to have the second, it surely has beat out Japan by now, largest economy approach a huge bubble so early in its quest for world domination, especially when it is the manufacturing center of the world.
If the bubble pops, which it will, it will take capital to fix which means that money will not be loaned out to manufacturers. When that happens the cost of capital will increase driving up prices which means your trip to Walmart will not be as cheap as it once was, especially if Washington forces the Chinese to strengthen its Yuan as well. That will be a problem for us and the rest of the world as China led the world out of the recession, if you believe it is actually over that is, so if China contracts it will lead the world right back into a recession, or make the one we are in even worse.
It is just interesting that Americans always assume that everyone acts like they do and spend all of their money. The Chinese are fanatical savers and it is highly unlikely that they would leverage their home, i.e. home equity loans or lines of credit, to buy junk they simply do not need like Americans do. I remember when Lay’s potato chips were trying to make headway into China and one women interviewed said why would I spend that kind of money on that when the same money can buy me potatoes for a month? That is their mentality and they do not spend what we do not have and pay for it later like what we do, that is what I admire about their culture. This is why if or when the bubble pops it will be a major problem, but nothing like what we saw here or in Europe.
With that in mind I am not crazy about investing in China because I believe that the bubble will pop and it will slow their growth down dramatically. Depending how the government handles the issue it could be a nonevent or a huge problem with, believe it or not, political instability. Plus, so much money has flowed into China through BRIC’s it is kind of crazy to keep money there right now. I am way more interested in India and Russia than China and Brazil, but all emerging markets have me a bit nervous because when everyone agrees that is where you should be, well, you know, do the opposite. Regardless, I believe the bubble will pop, but before the China bubble pops the US equity bubble will pop first.
In his efforts to make people forget about the AIG bonuses, Friends of Angelo’s mortgages, Freddie and Fannie and the fact the Senator Dodd has never held a real job outside of politics he is attempting to bribe the public with an $8,000 tax credit. I am referring to the first time home buyer tax credit, which is likely to be expanded to everyone through July of 2010 at an estimated $16.7B, which is up to its eyeballs in fraud I might add, but to hell with it, he needs to get reelected!
Clearly, Senator Dodd, who is garnering praise from Barney Frank, does that indicate how much he fears losing the 2010 election, worked very hard to keep the heroin in the housing market. However, what he is really doing, and why he needs to go, is keeping hardworking Americans from getting good deals on homes, he hates Americans! I jest of course, he merely just does not understand the real world. The housing market is still overvalued, according to Schiller, of the famed Case-Schiller Index, where he said certain areas look like bubbles, again.
There are others including Dave Rosenberg, Bill Gross, Whitney Tilson and me who say housing is overvalued by some 20% or more. This means more pain on the way down, but Washington through their programs to pump up failed credit bubbles refuses to let the bubble fully pop. By not letting the bubble pop this means they are letting people over pay for homes that should be much lower in price. So, now we are getting a fresh new wave of first time homeowners who will be underwater in a couple of years and what is worse is the US government, through the FHA, is underwriting the mortgages.
Not only are we losing money on the $8,000 tax credit, but we will ultimately lose money by having to bailout the FHA itself. Yet, here I am doing the right thing by looking and buying a home I knew I could afford in good times and bad, I should have known the government would hook me up, what was I thinking. Einstein, I believe it was, once said the definition of insanity is repeating the same thing expecting a different result, or something like that, but here we are doing exactly that. Except this time we are doing it bigger and better with all of our money, not just private investors, but public funds, it worked out so well the first time this time has to be different, right?
Ladies and gentlemen, this government is insane. It is totally out of control and needs to be brought to its senses. How in the world can we say that trying to repeat 2002-2005 is a good idea? Well, that is exactly what we are doing now, but bigger. All for what, so some political figure can look better or a few jobs could be created, that was what we spent a trillion dollars for, remember? I have no problem with extending unemployment insurance, which makes sense and the people deserve it, but a tax credit for a new house that someone probably can’t afford anyhow? No way. The cost just does not make sense and clearly Senator Dodd is trying to save his backside, but he should have thought of that before he signed that Friends of Angelo contract.
I am sure you saw the housing numbers today, they were through the roof, no pun intended, and the talking heads were perplexed why the market did not like them. Again, it comes down to looking beyond the headline numbers which, surprisingly enough, traders are starting to do. All the action is in the lower priced homes or starter homes and almost all of the financing is being done through the FHA, and the USDA, see my previous post about that odd couple.
Essentially, the low or no money down mortgages are back and being financed by you and I through our tax dollars, I am a giving guy, but this is a bit ridiculous. I absolutely love the idea of a 3.5% down payment with a 31% debt to income ratio, a slightly weaker credit score than the normal and the ability to use that tax credit for the down payment it just makes sense because it’s not like we have ever seen this story blow up before. I hope that we see the FHA start loaning out even more than the value of the house, maybe 120% LTV so the new owner can furnish or renovate the property that would be great! Oh, wait they are doing that, fantastic.
Is there any question that the FHA will more than likely have to bailed out again to the tune of $54B according to some whistle blowers? Guess who dismisses the same folks who gave their stamp of approval on Freddie and Fannie, so I guess we have nothing to worry about. Essentially, without all of this government intervention we would have little activity in the housing sector and the proof of this is right in front of us, just look at the action in the $250K plus market, it is dead.
The average price of a home dropped, MoM, from $177K in August to $174K in September, but YoY it looks grim with a 9% drop from $191K to $177K with sales booming prices are dropping, that would make my economics professor scratch his head doubting his supply demand charts. Foreclosures are keeping the prices down, but with housing supplies drying up by 7% and total inventory dropping to 3.63M there is no reason for prices to be declining, right? There is a major problem and it is called the shadow inventory that banks are holding on to and the people know it is there. That is why prices are remaining low plus you have builders who have been recklessly pouring concrete trying to pretend they have buyers which have been adding to supply, not good.
Add fraud on top of the tax credit and we get a real mess on our hands and a perfect reason to let the market work itself out. Isn’t it bad enough that the banks received hundreds of billions and trillions in bailouts and cheap money, but now the taxpayers are being cheated by, well, other taxpayers? Chris Dodd, in an effort to save his Senate seat, is attempting to extend the tax credit to June 30, 2010 and expand the tax credit to all Americans for an additional expense of $16.7B. I guess we will have cash for socks in the near future, who knows, but when you have spent a trillion dollars to create no jobs what is another $16.7B in another failed policy?
As long as the government keeps interfering the longer the pain will continue and there are serious problems in housing as Whitney Tilson keeps pointing out, correctly so I might add. As the Wells Fargo earnings showed, there are major problems in the housing numbers, please see my notes on those earnings. We got option ARM’s, jumbo’s and a host of other real estate issues all about to explode on the scene which will drive prices lower, not higher. Let the market work because the lower the process go the better of the buyer will be and suckering them in at higher levels does no one any good except maybe the banks, but I guess when the banks finance your elections you need to keep them happy.
Diana Olick did another piece about foreclosures tonight and I find the data very interesting. I would like to reiterate my respect for Diana and her work Frankly, I believe she is one of the best CNBC has to offer and does not attempt to carry the water for anyone. The numbers just speak volumes to the problem at hand and the data is provided by Hope Now Alliance.
Apparently people were pretty tough on Diana claiming she was lying or shilling for the industry, which I find had to believe, but those were the claims being hurled at her. She was simply reporting on the information she had, just as most bloggers or people do when they repeat something, even though it was only from limited sources. I tend to think that she is probably getting only the best part of the data points from the banks, but no one really knows because there is no one source for data. Each state has different regulations and laws when it comes to foreclosures not to mention that the foreclosures are so high courts are simply backlogged and banks may not even know a home is foreclosed on.
Regardless, the new data she brought from the Hope Now Alliance will shed some pretty bright light on the subject, both good and bad. The good news is that there are more workouts, which means that the bank and homeowner are working out the problem, but workouts or modification plans rarely work in the long-term and people lose their homes anyhow. However, what really caught my eye was the prime and sub-prime foreclosure starts, this is a lot of data so bear with me.
From 3Q07 to July of 2009 there are a total of 5.03 million foreclosure starts, which means they bank begins proceedings, which is just astronomical for a 2 year period. Out of those 5 million starts the majority of them are prime loans, at 2.7 million, which are supposed to be the safe loans, and sub-prime came in at 2.2 million. Clearly this is not merely a sub-prime problem and goes into conforming 20% down conforming loans, which means banks have many more loans that they will have to take losses on in the future.
In July alone there were 283K foreclosure starts and when compared to a total of 744K for all of 2Q09 that is a significant number. Of those starts in July 211K were prime mortgages and only 71K were sub-prime. The problem is simply getting worse, not better.
Now, the foreclosure starts are the beginning of the proceedings which means nothing happens to the property until it is sorted out through the foreclosure process. The other side of that coin is foreclosure sales which means the property has been ‘sold’ back to the bank or the bank retook possession of the property. From 3Q07 to July of 2009 there were a total of 1.7 million foreclosure sales, bank repossessions, which has been widely reported, now are you seeing the difference between the 5 million foreclosure starts and 1.7 million repossessions? It’s pretty significant and shows that there will indeed be a massive second wave of foreclosures in the near future.
Not to mention that in 2Q09 there were a total of 235K repossessions and in July the total number was 89K of repossessions which is on track for a substantial increase in 3Q09 over 2Q09. Out of those repossessions we see that prime mortgages are still leading sub-prime in both 2Q09, with 153K prime repossessed and only 82K sub-prime repossessed, and in July we see 59K prime and 29 sub-prime repossessed. Clearly the supply of foreclosures is building and will hit the market in the future, whenever that might be, and sub-prime is not the problem.
One could argue that there were more prime loans made which would explain the discrepancy, but that is not correct. Simply put, there are just so few sub-prime properties to foreclose on now then 2 years ago which explains that problem. However, there were more problems with prime mortgages then sub-prime mortgages with the exception of a few quarters. At the end of the day it really doesn’t matter, but based on these numbers sub-prime was a smaller part of the problem than we may have thought previously. No matter how we cut the data the one thing we know for sure is that foreclosures are here to stay for the foreseeable future and that means no recovery in real estate for now.
Apparently I was wrong about the impact of foreclosures when I said that banks were holding onto the properties and not placing them on the market. It came to light via Diana Olick, who I respect at CNBC, in a report earlier today. It is not that banks are simply holding onto the properties, they are just so backlogged that they cannot get them into the market fast enough.
According to the report banks are waiting as long as possible to try keeping people in their homes by using the Obama Making Home Affordable plan. Unfortunately, people cannot simply refinance when you are unemployed or underemployed which is the primary problem now. Bank of America told Diana that since most of the properties are owned by third party investors the bank has an obligation to place properties on the market as soon as possible.
However, the sheer numbers of foreclosures are the problem and slowing the process down of getting the inventory on the market. What the report did not comment on are the homes that the banks still hold the mortgages on. For example my bank actually holds my mortgage, but if I was foreclosed on the bank might not place my home on the market and hold it until the market improved. Clearly, most banks do not hold these mortgages now as they were securitized, but it raises the question that if banks actually held the mortgages would we have these problems to begin with. Furthermore, if the banks held these mortgages would the loans have been made and if they were made would the bank work harder to keep people in their homes.
I think the answer is clear, if banks held these mortgages we would have less pain because foolish loans would not have been made. Its funny how banks become more conservative with their own money than they are when they package the mortgages up and sell them off to yield hungry investors. Unfortunately we will never have a true answer to that question as banks, mostly, sold these mortgages off and continue to do so.
Here is what LPS Applied Analytics had to say:
He says there is no clear evidence of purposeful accumulation by the banks of these foreclosed properties. They are, he believes, working through the huge onslaught of new defaults as fast as possible, but it takes time. He says they are selling REOs at a fast clip as well, within about three months of taking them as REO.
Then he offered the following very detailed chart of what’s called “roll rates” or the rate at which troubled loans are moving through the system. Note the “average” is a four year average, and two of those years were the worst ever in the mortgage market, so as Jadlos notes: Just getting to the average isn’t saying all that much. We need to be close to the four year low to be fully entrenched in a meaningful recovery. Based upon foreclosure and REO timelines, it’s going to take at least 18 months to flush the system of our current problems. But to flush the problems in only 18 months, more problem loans need to leave the system relative to the new problem loans of today and tomorrow. That does not appear to be the case right now—we aren’t clearing faster than new problems are emerging.
Regardless, the foreclosed homes on the market are approximately 1.5 million, which sounds like a lot, and it is. However, the numbers of problem homes that are ‘seriously delinquent’ total an astounding 3.5 million. Unfortunately unemployment is still on the rise and that number should easily increase in the near future which is a major problem. It also indicates that the real estate market is still not even remotely healthy and there will be more pain on the way. Once that tax credit is gone I think we will see just how weak the real estate market is.
Let us not forget we still have commercial real estate to contend with which even the Fed is worried about. That market is much larger than the residential market and there are lots of institutions that hold these bonds. It is said that the majority of CRE outstanding will not be able to refinance because values have dropped so badly, 36% or so year-over-year. Ordinarily the rollover of commercial property into new debt or loans was not a problem, but when the existing loan value is so much higher than the value of the property no one will refinance it. Actually, I am betting the Fed will figure some way out to refinance these properties, why not at this point it’s only our money they are playing with.
The bottom line is that there are still major problems and while some data looks positive the remaining data is negative. The negative data pretty much trumps the positive data and points to lower prices. I know we will get a much better view of this when the incentives go away in November. However, I am willing to bet there will be another program rolled out in either early winter or spring to boost sales again. I am wondering how many people are suffering from buyer’s remorse about their new home purchase especially when they get the property tax bill.
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