The Fed Cut and Housing Markets

Sep.20.07 | About: Hovnanian Enterprises, (HOV)

If you want to know just how difficult it is to predict short term market events such as interest rate moves, just look at what happened over the last two weeks. I wrote back then that the futures market was pricing in a 50 basis point rate cut and postulated that the odds of no cut or only 25 basis points appeared to be much higher than the market was indicating. It turns out that neither the market nor my contrarian view turned out to be right.

By the time the Fed meeting came around Tuesday afternoon, the market was only expecting 25 basis points, which I obviously agreed with. Then out of nowhere we get a 50 basis point cut, the bulls getting ecstatic and the shorts getting burned big time. The end result was a 336 point jump on the Dow, the biggest single day point gain in about 5 years.

Rather than try and predict why the Fed did what they did, or what they will do in the future, let's focus on what Tuesday's action does. First and foremost it was a positive symbolic move that the Fed does have the market's back. We can argue if such a role is in their official job description or not, but that's another conversation entirely.

I'm not sure why they waited so long if they thought a dramatic 50 basis point cut was needed, but maybe they are hoping decisive action will prevent further deterioration that would require more cuts in the future.

An important point regarding rates and the effect on the housing and mortgage markets: Remember, for all of those home owners who will desperately be trying to refinance their adjustable rate mortgages into fixed rate loans, this rate cut won't help them. Fixed rate mortgage rates are based on long term bond rates, not the Fed Funds or Discount rate.

The move will help those with variable rate home equity loans and credit card debt (which are generally based on the Prime rate), but I don't think a half a point change, or even a full percentage point if we get more cuts later on, will dramatically alter the ability of consumers to pay their bills on time.

The main problem with the housing market is supply and demand and excessive pricing. Despite press reports to the contrary, most people can get a mortgage if they want to buy a house. For sub-prime borrowers who can't get a loan, now isn't the time they'll be looking for one anyway (they have already gone down that road). Instead, they will either be forced to pay their mortgage, refinance into a fixed rate mortgage (which the banks can make a profit on and therefore are willing to offer), or lose their home and begin renting again.

So what will really help the ailing housing market? In my view, above all else, it's reasonable pricing. Not only can most people still get loans, but another myth out there is that you can't sell your house. That's not really true. What is true is that you can't get top dollar for your house or always make a profit on every property that you purchase. However, if you price your home competitively, you will find buyers.

Want proof? How about what Hovnanian Enterprises (NYSE:HOV), one of the larger home builders in the country, did recently? HOV just completed a 3-day sale on their homes, which they dubbed the "The Deal of the Century," where they slashed prices by up to 25% or $100,000 in an effort to get rid of inventory. The results were beyond impressive. Hovnanian either sold or received deposits on 2,100 homes in just 72 hours. That compares with 2,539 homes sold in the entire quarter ending July 31st!

Now, some press reports compared these numbers directly to gauge the sale's impact, which is not correct given the 2,100 number was gross sales and 2,539 was a net sales figure. If you use HOV's most recent cancellation rate of 35% you get net 72-hour sales of 1,365 homes. But still, the implications are very strong. If you price your homes as aggressively as HOV did, there are plenty of willing buyers. By doing so, Hovnanian sold more than 6 weeks' worth of homes in only 72 hours.

Full Disclosure: No position in HOV at the time of writing.