Housing: Did We Learn Nothing from the Dotcom Bust? 11 comments
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"Study the past, if you would divine the future." (Confucius)
(Source: Irrational Exuberance, 2nd edition, by Robert Schiller)
The chart above (click to enlarge) illustrates what we have been saying all along - the housing market exploded to such heights that it must literally be destroyed before it finds a bottom; this is exactly the same thing that occurred during the internet mania which lasted from 1996-2000. As most individuals were able to buy houses with little to no money down, the biggest losers in this game are the banks and the many institutions that purchased these subprime mortgages from them.
(Notice the steep second uptrend line, because this chart has no individual price points; we are only able to put in two uptrend lines, but if it was plotted as a regular chart we are almost positive that we would be able to draw at least 4, if not 5, uptrend lines. The main uptrend line falls in the 110 ranges, and we feel that at the very least this index will have to pull back to that level if not lower. This index has already started to pull back, which is not reflected in the above chart, but it still has a pretty long way to go before it approaches the oversold range.)
Most of these individuals were buying houses instead of renting, so when they walk away from their homes, they are only risking their credit - but essentially nothing else. You then have the next category of those individuals who thought they could make a fortune by buying two, three, or even more, houses; again, for the most part, they were able to buy these houses with little or no money down, or use the leverage of the previous house purchased as collateral for the next house. A lot of individuals in the housing valuation sector were being pushed by banks to over-evaluate homes. Now, in the aftermath, this situation which borders on fraud is being investigated, when it should have been investigated and brought under control before the housing market went out of control. In the end, it comes to the same old story: greed seems to blind even the savviest of investors; bankers are known for being cautious, but during the housing mania, it appeared that they threw caution to the wind and just focused on today’s bottom line, instead of looking out into the near future.
The majority of the individuals who purchased homes with little to nothing down are not truly losing that much in terms of money. Look at it this way: they would still have to pay rent, and so the monthly mortgage payments could be viewed as monthly rental payments; in most cases, one could argue that if a small down payment was made, most of it was recovered when these individuals ceased to pay their mortgages; for these individuals are not losing that much money - what they are really giving up is the profit they could have once locked in had they sold their houses at the right time.
Yes, one's credit rating is important and valuable, but stupidity extracts a high price, and those that did not think or let greed rule will now need to have long intimate talks with the grim reaper. To an outsider it might look as if we are taking a light view on the situation, but we assure you that we are not. We know of individuals who did not even ask the mortgage brokers what their rates would be once the deceivingly low adjustable rates came to an end. There were numerous stories of individuals bidding up prices in the tens of thousands just because they thought they could more than make up this money in one to two years. At one point, apartments in Las Vegas with a view of the strip were commanding premiums of 50k plus; imagine this insanity: paying 50k more just to be able to look down at a stupid overlit strip. These individuals did not take the time to evaluate what they were getting into, or what they stood to lose if the housing market crumbled; they had only one thought in mind, and that was to make as much money as they possibly could.
For illustrative purposes we are going to provide very simple examples of how, in most cases, individuals did not really lose much except to sacrifice and, in most cases, destroy, their credit ratings.
Scenario 1
Let’s say that "couple 1" was renting for $1800 a month and then bought a home in 2005 with a very low adjustable mortgage of 2%; based on this, their monthly payments come in at, say, $1478 a month. At one point, they were even offering rates of between 0-1% for the first two to three years of the mortgage. They jumped because it looked, at the time, like they could own a home for less than what they were paying for in rent; stupid reasoning, since you never own the home 'till it’s paid of in full. Also, the adjustable rate was not taken into consideration; euphoria has a way of blinding everyone. When the low adjustable rates ended, mortgage payments in many case doubled. Let’s assume that this couple's credit was average; at one point, even individuals who had bankruptcies on their records could get a mortgage. So the house value falls, payments double; the math is simple, they walk away. What have they really lost? Other than their average credit, nothing much. Once again, we are not saying a person’s credit rating is not important, but we are looking at the situation from what one lost financially, and not from the emotional stress and trauma that comes about from destroying one’s credit.
Scenario 2
"Couple 2" has good credit and are so-called "smart individuals". They purchased several homes and rented them out to use the rent to pay for the mortgage, but kept on doing this until the end, instead of bailing out when they were sitting on lovely gains. Some smart astute individuals did bail out, but the majority held, thinking that the party would never end. Look at some of the big housing names, such Beazer (BZH), Lennar (LEN), etc; many of them bought huge tracts of land for insanely inflated prices, and some even bought massive patches in the desert.
The picture is the same. Prices have fallen, rates have doubled, and they can’t make their payments. So what do they lose? A huge amount of potential profit and their very good credit status, but in terms of real money, they have not really lost that much.
There are other variations of this, but the picture is the same; in the end, it’s the institutions that gave these mortgage, and those that re purchased them that have lost the most.
Bottom line: the biggest losers were and still are the banks who issued these mortgages and the institutions that purchased these repackaged instruments. What the majority of the small investors lost was the possibility of owning a home and their credit rating, as they had over leveraged themselves to the hilt. Now, some would point to the tent cities cropping up, for example, in California as an illustration of the pain many of these individuals are feelings. Let’s examine this a bit more deeply. In many cases, these individuals were forced out of their homes and into the street because they lost their jobs, which means that even if they were renting they would have been thrown out of their homes for not being able to pay the rent. Indirectly, their jobs were affected by the downturn in the industry, but this would have happened regardless of whether they bought a house or not. If you lose your job, no one is going to let you live rent free. Had they, instead of taking this risk, decided to live one or two standards below their over inflated lifestyles and put this money into a savings account, they would have had something to fall back to on a rainy day.
What is causing their real pain? Well, the slowdown in the economy and the huge number of layoffs. Thus, the pain caused is not directly related to the purchase of their homes, but to the fact that many of them were indirectly employed by the housing sector. The real pain is once again being caused by overexuberance; everyone overinvested in one sector (housing sector), and as prices rose, they started to live like the rich and the famous. The pain that is being caused now is no different from the pain that was caused during the internet mania; in the end, some great bargains will be found, as was the case in the aftermath of the dotcom era.
While it may look tempting to purchase housing stocks right now, we would wait a bit longer, for it's far better to play safe then jump in too early, as one could be flying from the frying pan and straight into a smoldering fire; markets have a tendency to overshoot these days, and just as the housing sector overshot to the upside, it will most likely do the same on the downside. As an example, let’s take a look at LEN (click to enlarge):
From roughly January of 2000, LEN started to take off; the housing sector was in the first stages of a huge upward move, while the financial markets were embarking on the first leg of a massive correction. LEN soared from roughly $7 in January 2000 to a high of 68 dollars in July 05; it has since given up most of those gains and, like the internet bust, we feel that it, together with D.R. Horton (DHI), Pulte Homes (PHM), and the like, is probably going to, at the very least, test its pre-breakout prices. In Lennar’s case, this would equate to a price of roughly $7.
Friday’s article stating that a record 4 million (9% of total homeowners) homeowners were either behind on their payments or in foreclosure does not exactly bode well for this industry. It indicates that the worst is still not over, or more importantly, that the market has probably not yet priced in all the potentially negative news that could still emerge from this sector. Let’s not forget that not all adjustable rate mortgages have reset yet; census data indicates that roughly 2 million mortgages will reset from May 2008 to September 2008, almost double that of 2007.
New legislation which was passed to help homeowners will only affect a small percentage of the total, as the guidelines are rather strict. Most individuals are living from paycheck to paycheck, but let’s assume that they happen to have one to three months of reserve payments, and for argument's sake, let’s choose three months. Foreclosure times vary considerably from state to state, so let’s assume that an average period would be seven months. Thus, in roughly July of 2009, a whole wave of new foreclosures will hit the markets, and given the fact that it is taking roughly 11 months to sell a home now, we are left with this sobering thought: who would have the guts to go out and buy in the midst of all this chaos?
We think very few would be brave to venture out during such trying times. The real estate sector first needs to go through a stage where the amount of bad news coming out starts to slow down, and the number of foreclosures starts to drop; this means that, at the very least, the real estate market won’t put in a bottom until early 2010.
Conclusion
It’s for this reason that we have stated that we have to reach the stage of helplessness before this market puts in a bottom. Look back at those that purchased shares in internet companies; if you paid attention, you might have noticed that when CMGI (CMGI) dropped from $166 to $4, and Yahoo (YHOO) from over $124 to $20, people lost it; they gave up and just buried their heads in the sand, hoping against hope that some miraculous force would come and rescue them from their plight; their wait proved to be fruitless. For the record, CMGI traded as low as $1 and Yahoo as low as $4, before putting in a bottom. Something like this will hit the housing sector before it will start to put in a long term sustainable bottom. As an example, look at Priceline (PCLN); even though its drop was just as steep (over 90% at one point), it managed to rally from a low of $6 to a recent high of roughly $126. It is still nowhere near its old high, but who cares? If you bought anywhere from $6-20, you are sitting on massive gains; the same will hold true for the housing sector.
"Men nearly always follow the tracks made by others and proceed in their affairs by imitation, even though they cannot entirely keep to the tracks of others or emulate the prowess of their models. So a prudent man should always follow in the footsteps of great men and imitate those who have been outstanding. If his own prowess fails to compare with theirs, at least it has an air of greatness about it. He should behave like those archers who, if they are skilful, when the target seems too distant, know the capabilities of their bow and aim a good deal higher than their objective, not in order to shoot so high but so that by aiming high they can reach the target." (Niccolo Machiavelli (1469-1527), Italian Author, Statesman)
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This article has 11 comments:
It's insane that the government is helping the nothing down crowd who were effectively renting. I know a builder who cleared $4M by renting out his spec homes, keeping the rent and not paying the mortgage, who ultimately lost them to foreclosure. Of course he knew he was going to lose them all along and fought in court for as long as he could.
i remember 1999 when all the boiler room 'brokers' were calling me (wall street journal sold mailing lists to anyone with a boiler romm over their head) saying jack you gotta buy this dotcom that dotcom etc. i always asked does this turkey have any earnings? they always said earnings don't matter jack at which point i hung up the phone.
> jack
Another phenomena that might cause prices to over-correct on the downside is the waning enthusiasm for buying and owning a house.
With prices falling and not likely to appreciate anytime soon, a lot of people will be asking themselves why are they paying such a high premium for ownership over the cost of renting a comparable property? Up until the bust, most people would justify a premium for ownership cause they were getting a healthy amount for appreciation.
It's more expensive to rent assets that depreciate rather they buy them. Houses have been cheaper to rent than purchase because of the appreciation component. What happens to prices when the appreciation component buyers assign to a purchase is zero?
These days it's gotten difficult to ascertain whether there is a bottom forming or the bubble still has more to deflate. There will be a bottom and it could be the point where it becomes cheaper to rent then purchase.
Check out the home value forecasting tools based on time-tested fundamentals. Sell the Ceiling and buy the Floor. The Ceiling is the top level of prices where the income to home price ratio exceeds the historical norm for the area. So when prices reach or exceed the Ceiling, you'd be financially wise to sell and definitely not buy.
The Floor is the price level where buying makes sense due to the yield the rental income of the house could generate. If you buy the Floor there is limited downside risk to further price declines. UsHousingMeltdown.org/...
Also, ReEconomist, it is cheaper to rent than own/purchase. Are you not paying attention? Here is a neat trick, take the rent you pay or the rental listings and multiply them by 150. If they are above what house prices are going for, it is a bad time to buy that house because it will cost you more (fees, taxes, insurance, etc.s) than it would to rent.
What exactly did we learn? First we learned that as long as the perceived price of the asset continues to increase then you must be a genius. Who cares that there are 24 realtors for every one prospective homebuyers. What does it matter if a bank doesn’t require full documentation; they’re going to sell the loan to Fannie and Freddie anyway. This is reminiscent to the dot-com companies that were not profitable but had a market cap that exceed the combined value of 3M and Intel Corporation.
Next, if the value of your asset is threatened then find alternative means to fudge the numbers. No harm done if everyone else is doing it. After all, the federal government places any unpleasant expenses on the “off-budget” section of the ledger. If it is on the “off budget” section then it really doesn’t exist.
When the value of your company or asset is falling you should assure everyone that all is well. Tell your investors that you’ve got a plan to deal with the problem as soon as someone throws more money at you.
Finally, if someone questions your ability as a viable entity your first response should be to accuse whoever dare question you as a “speculator” and “short seller.” Never admit that you screwed up. Admission of guilt, problems, or incompetence are punishable by not ever getting financed for your next hair-brained, money losing enterprise.
Thankfully, we have learned an enormous amount from the dot-com bust.