I have been writing about the bubble and mess in housing since February of 2007 and continue to be amazed at the willful denial about the depth and length of the problem by Wall Street. Two reports hitting the Street this week may finally push some of the bulls into rationality. John Burns Real Estate Consulting and Standard & Poor's Financial Services are both telling the world loan modifications don't work and the foreclosure rate is going to be very high for a long time. If I felt like regressing I would just say "duh."
John Burns believes roughly five million homeowners - houses and condos - already delinquent in their mortgages are ultimately headed for foreclosure. Other analysts, notably Laurie Goodman of Amherst Securities (a little less well known but whom I respect), have created a different number -- closer to seven million -- once you put some more data into play.
The first impact of these foreclosures is on prices. For almost a year, jawboning, state moratoriums and programs have slowed many foreclosures that can no longer be avoided. John Burns, who runs the firm named after him, believes if the country does not see a recovery and interest rates rise, "that's going to cause prices to fall further." Sorry, John, we are already about to begin a double dip in the real world and interest rates are going to rise a bit this year and a bit more next as the Fed pulls back from the RMBS market. Again, I turn to Laurie Goodman who sees another drop in home prices coming.
S&P says in its report an "overhang" of foreclosed homes will lead to lower home prices. It, too, sees owners currently in default as headed towards foreclosure - 70% of them.
Maybe the Street will begin to listen due to the data and reputation of Burns and S&P. Maybe the logic of the real world, of Main Street, will finally break through. The logic flow is simple and irresistible and has been in front of the Street for a long time, but let me recap why I am so negative, besides having passed math in the fourth grade:
- We have built too many houses; anybody disagree? Forty percent of new jobs created between 2000 and 2008 were in home construction leading to the building of 1.6 million new homes at the peak of the building bubble.
- We sold too many houses to too many people at too high a price with a funky mortgage they could not afford. The subprimers - but this is not about them.
- Their foreclosures, and the impact of the financial and housing crash on the economy, caused the Great Recession.
- The Great Recession has caused 20% unemployment - unemployed, part timers, discouraged and totally dropped out of the work force. This has prompted many people - prime borrowers - to default.
- Default rates are at an all time high. Rescue rates - the rate at which defaulting customers recover and begin paying their mortgage again - is at an all time low.
- One quarter of the people in the US with a mortgage now have a mortgage greater than the value of their home. And for this reason, for the first time ever, the people in default on their homes are paying credit card bills before paying mortgages.
- Mortgage lending standards are tighter than anyone can remember. There is no secondary mortgage market and only Fannie (FNM) and Freddie (FRE) are buying mortgages. But they are capped at how much they buy, could hit the cap next year, and between this cap and the Fed withdrawing from buying mortgages rates, will have to rise to bring other buyers of RMBS into the market - if they come back at all.
- Put this together with the continuing slide in home prices, and you have another seven million foreclosures coming in the next 30 months and reduced demand for new and existing homes.
Bottom line: a major drag on the economy for several years.
What to do? Avoid or short the homebuilders and forget the analysts saying they have bottomed. They used to say this when they were selling at a one million annual rate, and we are now at half that. They have no hope of real growth for several years and many have lingering and serious sheet issues. If you are into shorting, look at the XHB. The ETF for homebuilders and their suppliers puts are available, as are some homebuilders with nastier balance sheets like Hovnanian (HOV). I am also not a big fan of Pulte (PHM), Beazer (BZH) or KB Homes (KBH). Others at risk are suppliers such as Louisiana Pacific (LPX) and Universal Forest Products (UFPI).
Author's disclosure: none.
