By John Maulden | 14 September 2008
The short answer is no, but let's look at the data from one of the most knowledgeable sources on that topic. John Burns of John Burns Real Estate Consulting consults with over 2000 of the largest banks and homebuilders in the country (his client list is a who's who of banks, builders, and hedge funds). He has a reputation for solid research and pulling no punches.
Some of his hedge fund clients were the ones you read about who made billions. (He wishes he had negotiated a percentage!) He is deeply involved in analyzing trends in the housing market. Click for his web site. He has graciously sent me the executive summary of his latest posting (a 27-page executive summary) that we will be looking at for the next few pages.
Let's start with a quote from John at the beginning of his report: "The prospects for the U.S. housing market have changed for the worse. It has become increasingly clear that the U.S. economy is on the brink of recession, as overall job growth has slowed to zero and retailers are reporting abysmal results. New home sales, traffic and pricing are all heading down according to the results of our survey of over 300 builder executives.
Resale [existing home] sales are starting to plateau in some markets, but pricing continues to fall as distressed sales dominate the market. The new housing bill will help in some ways, but will first serve a devastating blow to homebuilders, with the elimination of seller-funded down payment assistance, which "accounts for 17% of new home demand, by one estimate."
How far along are we? Burns thinks that home prices will drop by 22%, 12% of which has already occurred. His analysis differs from that of the Case-Shiller Indices, which suggests a much steeper decline [[and a much lower bottom, eg, 35% to 50%, from the peak: normxxx]]. Note in the graph below that the Case-Shiller Index shows home prices rising more than does Burns' work. Part of it is different methodology and part of it is that the CS index focuses on major markets and Burns' work is more broadly based.
Click Here, or on the image, to see a larger, undistorted image.
However you slice it, there has been a lot of pain. Shiller's work shows home prices in the areas he measures to be down about 17%. He said last week that he does not think it unlikely that we will see home prices drop by as much as 30%, or about the same as during the Depression of the '30s. Burns sees less of a drop, but from not as high a point, so they both end up close to the same end point. [[Anyway you slice it, both indicate we are only halfway through the drop in housing prices!: normxxx]]
The graph above shows Burns' projection for the next few years. He thinks it will be 2011 before housing prices begin to turn back up on a nationwide basis, with national prices continuing to fall into 2010. That will not sit well with the pundits who keep telling us each month that we have seen the bottom.
Click Here, or on the image, to see a larger, undistorted image.
For the difference in his numbers with Case-Shiller, he offers the following explanation: "The Case-Shiller national number, which is a 'paired sales' analysis, showed much more price appreciation than other indices based on median prices. We suspect that there was a shift in the mix of homes sold to lower priced homes in 2006 due to subprime lending, which depressed the median value and showed large percent increases in the paired sales index."
Sales volumes are suffering and will continue to suffer.
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Click Here, or on the image, to see a larger, undistorted image.
On a more optimistic note, he thinks new home prices, which started to correct much earlier than existing home prices, should bottom out in 2009, although some particularly overbuilt areas will suffer longer. [He thinks w]e are actually close to a bottom in new home construction, and we will be back to 900,000 new homes by 2012. That is a far cry from the 1.68 million in 2005, but it is also a more sustainable number.
There is a problem though, and that is that the recently enacted housing bill eliminated seller-funded down payments, and this was 17% of new home sales. Watch for a rise in the number of new homes sold in September, as the new law does not take effect until October. Home builders will be telling people to buy now before this ability to help with the down payment goes away. But cheerleaders on TV will be telling us the market has turned. They won't be saying that in November.
Alt-A Is The New Subprime
By now, everyone in the world is aware of how bad the subprime mortgage business was. But now it is time to get ready to hear the same tale, told again, about Alt-A mortgages. These are mortgages made to borrowers with better credit scores than subprime borrowers, but who 'could not' or 'decided not' to document their income. One estimate is that 70% of Alt-A borrowers may have [[grossly?: normxxx]] exaggerated their incomes (Wholesale Access). More than half of those were people who exaggerated their incomes by 50% or more! (Mortgage Asset Research Institute)
How much are we talking about? Around 3 million US borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of subprime loans outstanding. $400 billion of that was sold in 2006. Almost 16% of securitized Alt-A loans issued since January 2006 are at least 60 days late. Many of these loans (around $270 billion) were interest-only or with a low teaser rate, and the resets were at 3- and 5-year lengths.
These are called Option ARMs. That means starting next year we are going to see another wave of mortgages resetting to new rates. And it is no modest increase. Rates can jump 4% - 8% or more from teaser rates. Some Option ARMs are resetting at 12.25%. That can double a payment.
Wachovia and Washington Mutual were big sellers of Alt-A loans, and had $122 billion and $53 billion, respectively, on their books at the end of the second quarter. Is it any wonder their stocks are under pressure? That is why it is so hard to quantify how many more write-offs there will be. You [can't] write down a mortgage until it starts to develop problems. These problems may not show up for a few years. I continue to stress I do not want to own a financial stock that has exposure to mortgage paper.
Write-downs are going to continue to come for a long, long time. This means there will be a steady wave of foreclosures for the next two years in communities all over the US. As long as these homes keep coming onto the market, they are going to exert downward pressure on prices. Foreclosure sales are up by 109% from this time last year.
3.5 Million Unemployed And Counting
The number of people receiving unemployment benefits jumped to 3.525 million, the highest level since 2003. My friend, Chief Economist John Silvia at Wachovia forecasts that unemployment will rise to 6.7% in 2009 (from 5.5% today) and above 7% in 2010. Given the inability of US consumers to borrow against their homes, and with rising unemployment, is it any wonder that consumer spending data released this morning showed retail sales dropping 0.3% in August, for the second month in a row (July was down 0.5%)? Excluding automobiles, sales dropped 0.7% in August, the most this year.
Look at this chart from Greg Weldon. As he notes, retail sales are posting their worst reading since the last recession.
Click Here, or on the image, to see a larger, undistorted image.
Prices at the wholesale level actually fell. Silvia thinks the Consumer Price Index will be in the neighborhood of 2%. Right now, a lot of people think that sounds crazy; but I agree. First, remember that CPI measures changes from 12 months ago. As an example, look at the oil price chart below. Starting next spring, unless energy prices rise a lot, we are going to see year-over-year comparisons for energy prices that will be negative. If oil drops to $80, which it very well could, that would have the affect of decreasing inflation next summer, by a significant amount.
And given that Europe and Japan are well into a recession, and emerging markets have reduced demand because of high prices, thinking that oil in the short term could be lower is not unreasonable. (Long-term I think oil will go MUCH higher, but that is another story.) A 40% reduction in gas prices from their peak is not out of the question. That would impact inflation by pulling it down.
You can make the same case for a lot of commodities and some of the food complex as well. Year-over-year comparisons are going to start to look good in a few quarters. In absolute terms, looking back a few years, it will still feel like inflation, but the numbers don't have feelings.
With Europe and Great Britain central banks likely to cut rates, the dollar is going to get stronger (as predicted here long ago). That will also help hold inflation down. Consumer spending is going to continue to be under pressure, which will not be good for stocks, which means that those facing retirement are going to have to save more and spend less.
I think this time next year we will start to see stories about DEflation. I know, call me crazy, but given that we have seen two major bubbles burst in the last year (housing and credit), it is not out of the realm of reason. It is what SHOULD happen. Bursting bubbles are by definition DEflationary events.
Within a very few quarters the Fed will hardly be under pressure to raise rates, especially with rising unemployment and what is clearly an economy on the ropes. [[We are already seeing the leading edge of a bust in retail sales.: normxxx]] Further, the banks need lower rates in order to re-liquify. Home buyers will need lower rates as well. I think, as I have written for a long time, that the Fed is [[at least: normxxx]] on hold for a very long time. And I am not sanguine that the next move will be a rate hike. This time next year when inflation is seen as yesterday's problem and unemployment is rising, the drums will be pounding for a rate cut. We live in interesting times.
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Normxxx
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