Ten Comments on Housing

1) The big question is how much further will housing prices fall, and when will the turn come. My guess is 2010 for the bottom, and a further compression of prices of 15% on average. Now there are views more pessimistic than that, but I can’t imagine that a 50% decline from the peak would not result in a depression-type scenario. (In that article, the UCLA projections are largely consistent with my views.) It is possible that we could overshoot to the downside. Markets do overshoot. At some level though, foreigners will find U.S. housing attractive as vacation/flight homes. After all, with the declining dollar, it is even cheaper to them. Businesses will buy up homes as rentals, only to sell them late, during the next boom.

2) But, the reconciliation process goes on, and with it, losses have to go somewhere. In some cases, the banks in foreclosure refuse to take the title. Wow, I guess the municipality auctions it off in that case, but I could be wrong. Or, they let the non-paying borrowers stay. I guess the banks do triage, and decide what offers the most value to act on first, given constraints in the courts, and constraints in their own resources. Then again, developers can reconcile the prices of the land that they speculated on to acquire. In this case, cash is king, and the servant is the one that needs cash. I just wonder what it implies for the major homebuilders, with their incredible shrinking book values. Forget the minor homebuilders… Can one be worse off? Supposedly my father-in-law’s father lost it all in the Great Depression because he was doing home equity lending. There are wipeouts happening there today as well. Add in the articles about unused HELOC capacity getting terminated (happened to two friends of mine recently), and you can see how second-lien lending is shrinking at just the point that many would want it.

3) The reconciliation process goes on in other ways also. Consider PennyMac, as they look to acquire mortgage loans cheaply, restructure, and service them. Or, consider Fannie (FNM) and Freddie (FRE), who are likely to raise more capital, and expand their market share, assuming guarantees don’t get the better of them. Or, consider the Fed, which has tilted the playing field against savers, and in favor of borrowers, particularly those with adjustable rate loans. No guarantee that the Fed can control LIBOR, though…

4) The reconciliation process steamrollers on. We’ve seen Bear Stearns (BSC) get flattened trying to pick up one more nickel, and maybe Countrywide (CFC) will get bought by Bank of America (BAC), but you also have banks with relatively large mortgage-lending platforms up for sale as well, like National City (NCC). Keycorp might bite (KEY), but I’ve seen Fifth Third (FITB) rumors as well. Then there is UBS (UBS) writing down their Alt-A book, along with a lot of other things.

5) A moment of silence for Triad Guaranty (TGIC). A friend of mine said that they were the worst underwriter of the mortgage insurers. Seems that way now. Another friend of mine suggested that MGIC would survive off of their current capital raise. They stand a better chance than the others, but who can really tell, particularly if housing prices drop another 15%.

6) Beyond that, the financial guarantors have their problems. FGIC goes to junk at S&P. MBIA goes to AA at the operating companies, and single-A at the holding company at Fitch. I personally think that both MBIA (MBI) and Ambac (ABK) will get downgraded to AA by S&P and Moody’s. I also think that the market will live with it and not panic over it. That said, BHAC (Berky), Assured Guaranty (AGO), and FSA (Dexia) will get to write the new business, while the others are in semi-runoff.

7) Now for the cheap stuff. Amazing to see vacancy rates on office space in San Diego rising. I think it is a harbinger for the rest of the U.S.

8) Buy the home, take the copper, abandon the home, make a profit. Or, just steal the copper.

9) Bill Gross. A great bond manager, but overrated as a policy wonk. Many would like to see home prices rise, but others would like to buy a home at the right price. How do we justify discriminating against those who would like to buy a cheap house?

10) “The prudent will have to pay for the profligate.” Well, yeah, that is much of life, in the short run. In the long run, the prudent do better, absent aggressive socialism. The habits of each lead to their rewards, and the ants eventually triumph over the grasshoppers.

Comments

[Danish Dude:]

Dear Mr. Merkel,

Thank you for the article - though I generally concur with your views, I really don't think we should be waiting for foreigners to provide a bottom for the US real estate markets.

A bunch of not-so-smart money HAS poured into New York and, so they say, Miami. What returns have these guys gotten this far? I live in an apartment in New York that I rent from an Irish lawyer. As far as I can tell, the dude is losing money on a monthly basis. I hope he financed with a dollar-loan - otherwise, he is getting raped by the exchange rates, too.

What is the utility for a doctor in London of a vacation-home in Florida? It is NONE! It is 10x easier, and 100x cheaper for him to rent for the two or four weeks he is going to spend there a year.

The only reason for the European buying in New York is, that US originated economic crises generally hit Europe with a 1-2 year delay, and that's about how much the real estate market over there is behind in its correction. Dumbos bought because they referenced their market conditions (already then in decline, but not obvious to the Ds, since it hadn't hit the front-pages yet) with "attractive" EUR prices in NYC and Miami, and thought they could make money buying real estate an ocean and several thousand miles away from their own location. When they realize the stupidity of the proposition, they are going to sell. It will likely take a little while before the realization arises - taking into account the psychological phenomenon of cognitive dissonance and the fact that distance shelters those folks from the factual reality that their investment is located in. Does anyone think that these guys have a competitive advantage when it comes to renting out that vacation home in its overbought location for the 48 weeks a year that they are not using it?

"foreigners will find U.S. housing attractive as vacation/flight homes" - really?? If you live in Paris, do you want to own a vacation place 6 time zones and 8 hours of flight-time away in Miami - or take the TGV to southern France? The food is better there, too.

As for other economic ills, will Santa Claus come and make our credit card debts, the zero-down financing of consumer items and the car loan on that stupid-looking SUV away, too?

This will stop when we pay our bills. Balanced budget, no trade deficit, interest rates that makes sense (i.e., higher than inflation), and house prices that are affordable to the people that actually live in the relevant area. We've got a ways to go, and all this bail-out s... isn't helping. It is just passing to bill, not paying it.

Best regards,

LJ

2008 Apr 06 08:14 AM

[I should know:]

Danish Dude wrote: “If you live in Paris, do you want to own a vacation place 6 time zones and 8 hours of flight-time away in Miami - or take the TGV to southern France? The food is better there, too.”

While I am not agreeing or disagreeing with most of your comments, I would ask you this; would you call it unlikely and a bad investment for somebody on the Eastern seaboard of America to have purchased real estate (second home or rental property) in Hawaii 5 or 10 years ago; we are 6 timezones away? I would neither call that possibility unlikely or imprudent. Also, food in Hawaii is not nearly as good as food in New York City, Washington DC, or Miami Florida.

2008 Apr 06 12:32 PM

[cfish:]

I, too, don't think foreigners will snatch up properties here. Nobody can time the market but I do plan to start looking at the end of 2009. As of what's going to happen to abandoned houses? The sheriff's office will take it to the auction block for the tax owed on it and a reservation price of the same. At this point, I don't know if the second lien (the bank's interest) will apply. Hopefull investors are smart enough to figure out this portion, or there's going to be a lot more drama.

haha.

2008 Apr 06 12:42 PM

[348s:]

Re: Eastecoaster buying vacation/investment properties in Hawaii

Yes--it generally has been (and will continue to be) a bad economic decision.

2008 Apr 06 12:49 PM

[Mr Mortgage:]

Good story but housing prices will fall further that you suspect, especially in jumbo bubble states like CA. Since we have lost all the exotic programs and are back to pre 1990's mortgage lending, you have to apply historic prices multiples and the best is the 100-year 3-4 time household income. In CA, were are still sitting at 7-10 times household income in most zip codes.

2008 Apr 06 02:30 PM

[westwest888:]

15% is a complete and total pipe dream, even for nationwide prices. I could see it falling 15% per year for two or three years for close to a 40% drop, then leveling off to a rate of home price appreciation that doesn't keep up with inflation. Any place where a starter home is approaching $500,000 is going to see a 50% haircut guaranteed. Until the manager of Pizza Hut can buy a house in David Merkel's zip code with a 30 year fixed DTI 36% and 20% down, it's too expensive.

Think about people born after 1978 who are unlikely to be current homeowners because they were in school and finding a spouse. These people are the foundation of buyers as the nation's housing stock increases in size. Until it is fiscally possible for 80% of them to buy with a legitimate mortgage product, the crisis has no end in sight. Even when they can buy, who's going to want to when the social mood is so sour? Real estate is going to be about a popular as YHOO in 2001. Contrarians will be buying real estate. Real people will run for the hills.

2015 is an optimistic time for 12 months of continuous year over year home price increases that outpace inflation.

2008 Apr 06 05:26 PM

[bearfund:]

“The prudent will have to pay for the profligate.”

I refuse, sorry. Their misbehaviour did me too little good, I'm too young, and the bill is too large; stick me with it now and I'll never recover. If you insist, I'll buy more gold. If you keep insisting, I'll put it in a briefcase and leave the country with it. If you can't handle that, I'll arm myself heavily and smuggle it out. A nation of looters has no chance and I'm not going down with your ship.

2008 Apr 06 09:46 PM

[columbus:]

I think you are too pessimistic.
I live in South Florida-very hard hit with subprime mess and overbuilding- but home prices are stabilizing at about a 15%-20% maximum decline.
I see flat prices for an extended period of 2-3 years with a good percentage of foreclosed houses being demolished which will stabilize the prices of those "still standing".
The taxpayers will provide this bailout" .

2008 Apr 06 10:47 PM

[Danish Dude:]

To the man in the know:

I believe anyone who bought real estate in any of the bubble markets pre-bubble inflation would have done well at this point. The prices are still far above historical GDP-adjusted averages. This may change over time as the correction continues - I would think, until this country and its citizens are again paying their bills.
I really think it is that simple. Currently, we are not paying our bills. At some point in the future, we will be paying - we will have to.
Would you think that buying Hawaian real estate on speculation would be a winning investment strategy today?

2008 Apr 07 04:38 AM

[po_folks:]

One type of homeowner assistance I can be enthusiastic about would be extra federal tax rebates for real estate taxes paid...everyone eligible.

2008 Apr 07 11:31 AM

[H2O:]

Under the gize of National security - The manidesto's are once again - Selling out Americans.

President Bush on Monday sent Congress a controversial free trade agreement with Colombia

2008 Apr 07 02:18 PM