A Look Back at Real Estate
Brian Trumbore
President/Editor, StocksandNews.com

This column is about financial market history and on the topic of real estate and the current debacle in the housing industry, there is no shortage of material contained within my archives. Frankly, there is enough material on StocksandNews for a few books on just this single issue but I thought I would put together a few items from past commentaries, gleaned from my "Week in Review" (WIR) columns. Some day I'll delve more deeply into the evolution of the crisis.

[Unedited?I wanted to make sure there was context for some of the more trenchant comments.]

WIR 8/27/06

The market meandered downward, pressured by the latest dismal readings on housing as both sales of new and existing homes fell yet again in July while inventories soared. By one measurement the median home price is now up only 1% over the previous year as the comparisons continue to weaken. Merrill Lynch chief economist David Rosenberg believes the chances of a hard landing in real estate are now 40-80% and as housing is the "quintessential indicator," just as in the bursting of the tech bubble it spells big-time trouble.

WIR 9/16/06

Back in the U.S., housing analyst Ivy Zelman of Credit Suisse, who has been bang on in her analysis thus far, said "We believe that the housing market is still in the early innings of a hard landing that will likely take several years to develop."

WIR 10/07/06

However, before you go popping the Korbel (hey, it's not like Nasdaq hit a new high, you know), Federal Reserve Chairman Ben Bernanke told you this week, in his strongest words yet on the topic, that real estate was undergoing a "substantial correction" and that it would shave one percent off GDP the second half of the year and who knows how much in '07; admitting it was tough to predict the "dynamics" of housing and its overall impact.

And then Bernanke's vice chairman, Donald Kohn, said the falloff in real estate has "proven to have been more rapid and deeper than many economists had predicted."

Well I'm no economist (my sheepskin says poli-sci major and beer drinker), but anyone with half a brain knew real estate had long entered the frothy stage by last fall?.a full 12 months ago, Mr. Kohn?ergo, when bubbles pop, the fall can be rough. Or maybe Kohn forgot Nasdaq 5048. Moody's Economy.com also weighed in with research that predicts the average home price will decline about 4 percent in 2007, with far greater losses in the hotter markets.

But lest I get too smug, which I'm not entitled to be anyway because I thought the three major equity indexes would decline 3 to 7 percent this year, I do agree with Bernanke that it's tough to predict the dynamics of housing and its overall impact; which is why I muse about the psychological impact between $450 in the pocket and a $20,000 hit to the net worth [I was referring to savings at the gas pump vs. a hit in home value] as well as the fact that Americans, overall, are spending more on housing (including for real estate taxes, insurance and utilities) than ever before, according to the latest Census Bureau data.

WIR 10/28/06

I know I'm not telling you anything you don't already know, being the eagle-eyed observers that you are of your own local scene. But I spent a good deal of my time in the Tucson, Arizona, area driving around and all I saw were the big boys, building massive developments, with signs offering all kinds of incentives.

DR Horton, Clayton, Lennar, KB Home, US Home?these are some of the bigger ones I jotted down in my drive-thrus.

What the casual observer doesn't pick up on, but what you know all about from reading this column, is that the homebuilders haven't just been overdeveloping, they are liable for all that land that they may now opt not to build on. That's what keeps their managements up at night, I can guarantee you. So much of it was purchased at the very top, of course, with massive leverage.

Back in New Jersey, we've had a few instances of fairly sizable developers going Chapter 11 already, before any of the real bills come due.

So to those who say housing, and thus the U.S. economy, are going to fall softly, I say you have a hard time convincing me.

But?I do agree that for right now, when it comes to the consumer and sentiment, as the readings are proving in this regard, oil continues to trump real estate. In other words that little hypothetical of mine from weeks ago, hard annual savings of $450 at the pump versus a paper loss of $25,000 to $50,000 on your home, continues to carry more weight.

That will change too, however. Josh P. in San Diego passed along an observation concerning an exclusive development he has watched closely over the past year. A group of doctors purchased some spec properties, looking to make a killing, but then the market slammed to a halt. And now, no matter how much they slash prices, no one is biting.

What has amazed so many of us is how quickly psychology has changed. But it still has been slow to impact consumer spending and falling oil has had everything to do with it. One thing is very clear, however. The days of using one's home equity as a debit card or piggy bank are over. The official numbers don't reflect that yet, but they will. All together now?.wait 24 hours.

WIR 1/6/07

And if you thought I was too bearish last week in my housing comments for this coming year, I can thank home-builder Lennar for making me look good for one week at least.

The Miami developer announced it expects to report a fourth- quarter loss of around $500 million in the face of land-related write-downs. CEO Stuart Miller said "Market conditions continued to weaken throughout the fourth quarter, and we have not yet seen tangible evidence of a market recovery."

At the same time Lennar said it would sell a 62% stake it had in a 15,000 acre track in California, not exactly a ringing endorsement of prospects for a rebound anytime soon there. And Lennar admitted it is doing everything possible on the incentive side to move existing inventory, something to remember next time you see relatively sanguine new home sales data.

I was in Miami myself a few days this week for the Orange Bowl and not having been to the area in years I was floored by some of the high-rise condo developments. Now, granted, I was there over the holiday weekend but on Tuesday, when I expected to see workers back slaving away on the monstrosities lining the beaches and waterways, I saw virtually zero activity.

Coincidentally, I saw a Reuters piece by Jim Loney noting that developers are now pulling the plug on some of the biggest projects (a la Lennar's warning). In fact, Miami officials talk of 15 condo projects, representing 1,900 units, that have been officially pulled, but analysts agree the eventual number will be much higher, taking into consideration the rest of the overbuilt market over the entire state. In other words, there are going to be more than a few eyesores to stare at in the coming years, buildings half complete or giant pits, waiting to swallow up unsuspecting tourists.

There were also a number of tidbits this week regarding the New York City real estate market that foreshadow further softening rather than a bottom having been hit.

For example, construction permits declined for the first time since 1998, demand for office space appears to be hitting a wall (ignore some of the positive spin you may have seen), and the average sales price for a NYC apartment is now off 4% from a year ago; this last fact obviously doesn't represent a crash, but a pigeon in the mine nonetheless. [The Big Apple being an urban area and not exactly a haven for canaries?.then again it's been warm enough for the songbirds, but I digress.]

Of course New York's housing market will also be the recipient of much of Wall Street's largesse, so numbers over the coming months could be a bit out of whack, especially at the very high end, though the primary trend now appears to be in place.

WIR 2/10/07

Find me an 'expert' who says real estate has bottomed and I'll show you an idiot. How many times do some of us have to prove it? This week it was HSBC that admitted its overly aggressive salesmanship in going after the subprime mortgage market (i.e., those who can least afford it) had backfired in a huge way as it is writing off $10.5 billion in bad debts, or 20% more than the company itself expected just a short while ago. Delinquencies are accelerating in this segment and this is occurring in a strong economy.

How did this happen? One word. Affordability?and homeowners simply not understanding that they can't stretch beyond their means. It's a painful lesson everyone in life has to learn at some point, too much debt that is, but the problem in today's real estate market is that home values are not simply going to shoot back up and bail out those who are on the verge of going under today. Too many used their home as an ATM and the window has closed.

But it's not just a class of homeowners that are suffering. The real estate developers, who should know better, have been writing off land faster than the French did during World War II. So, no, we haven't hit bottom yet.

WIR 3/3/07

Countrywide Financial, the largest U.S. home mortgage lender, said late payments on its loans were rising rapidly, to 2.9% of prime home-equity loans, up from 1.6% a year earlier; while 19% of its subprime mortgage loans were now late, up from 15.2% at the end of 2005. Not a disaster for Countrywide, yet, but you can't ignore trends that are only going to worsen.

And then you throw in the derivatives angle. Years ago, Lewis Ranieri basically created the mortgage market. [He is best known to others for his central role in the 1989 book "Liar's Poker."] Ranieri was the man who came up with the idea of pooling mortgages, then slicing and dicing them to be resold as bonds to pension funds and institutional investors. It was the start of the derivatives market, in many respects.

So last weekend Ranieri told the Wall Street Journal's James Hagerty that the business has changed so much that if the housing market goes down much further, no one will know where all the bodies are buried, which has been my point on derivatives for years, frankly. Ranieri said "I don't know how to understand the ripple effects through the system today." If Lew Ranieri doesn't, do you think some fresh-faced trader does? I think not; let alone the fact there are two sides to every trade. Actually, in the derivatives market that's part of the problem. Often there isn't another side; it just floats out there in the Kuiper belt.

As talk increased this week of problems in housing and derivatives thereof, I couldn't help but think of how we are also seeing a worsening of the haves vs. the have nots. Many of the have nots are seeing their dreams go up in flames, while the haves, battered, are nonetheless still in fine mettle, overall. If a rising tide lifts all boats, some higher than others, a receding one carries out the dead, while leaving the rich still sipping pina coladas from their decks on shore.

WIR 3/10/07

So what should you care about these days? Let me put it to you this way. You know how Lucy Van Pelt told Charlie Brown the only thing she wanted at Christmas was real estate? She was last seen huddling with her real estate expert and accountant on how much further she needed to slash the sales price of the 600 condos she was intending to flip in order to stay solvent. It was a fun ride for Lucy on the way up?.but there is hell to pay on the way down, and lord knows Lucy isn't handling it well. [As for Charlie Brown he's chuckling over Lucy's problems, after all she did to him. The kid who once gave a home to a scrawny little tree put the standard 20% down on his first and only home years ago and is sleeping soundly today. Yes, good things do happen to good people.]

You see, today's crisis in the subprime market continues. In fact it's almost comical how some just a few weeks ago, let alone months, were trying to convince you the bottom was in. As John Wayne would say, gaze fixed on an unknowing target, "Well hold on there, pilgrim. You see a bottom?" "Ah, no, Mr. Wayne. Sorry I brought it up."

You know you have problems when the nation's second-largest subprime mortgage lender, New Century Financial, may have filed for bankruptcy by the time you read this. Or when every developer, like Hovnanian, or a bank such as HSBC, continues to speak of serious issues in the housing sector, overall, and not just subprime.

In fact as you've undoubtedly heard, but which I would be remiss in not mentioning at least for the archives, Donald Tomnitz, CEO of builder D.R. Horton, told investors in New York that "2007 is going to suck, all 12 months of the calendar year." Let me tell you?when this comment hit the tape, it did indeed move the market. Alan Greenspan? Pshaw. Donald Tomnitz? He rocks.

The more serious issue on an individual basis is of course the fact there is real pain out there in America and I truly feel for those who were either given bum advice or didn't know to ask the right questions. Mortgage lenders, like credit card companies, can be masters of deception when it comes to explaining loan or credit terms.

WIR 3/17/07

Credit Suisse analyst Ivy Zelman, another who has been bang on in calling the problems in real estate, sees another issue; a 20% drop in new-home sales. Her argument is if you can't sell your entry level home, you can't move up. Inventory levels will thus continue to soar.

WIR 3/24/07

The Housing Sector

Two weeks ago, March 10, I wrote that I was incredulous that some actually thought what former Federal Reserve Chairman Alan Greenspan had to say at a speaking engagement or two moved the markets.

"The man is irrelevant?and I see zero reason to bring him up in the future, unless it's about his earlier forecasts as chairman which fell woefully short of being accurate."

Well, Randall Forsyth had a terrific column in the March 19 edition of Barron's and on the issue of Greenspan, Forsyth writes:

"In a speech to the Fed's Community Affairs Research conference in April 2005, The Maestro sang the praises of 'technological advances' that 'have resulted in increased efficiency and scale within the financial services industry. Innovation has brought about a multitude of new products, such as subprime loans,' he continued, adding that technology had allowed lenders to size up the creditworthiness of borrowers more cheaply.

" 'Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today, subprime mortgages account for roughly 10% of the number of all mortgages outstanding, up from just 1% or 2% in the early 1990s.'

Forsyth:

"Since then, subprime mortgages have burgeoned to about twice that level, to around 20% of the total, according to most estimates. And the results are becoming apparent?.

"Yet among the avalanche of coverage of the subprime debacle, the deterioration of adjustable-rate mortgages - even of prime quality - is still more dramatic. But three years ago, Greenspan was touting ARMs for Everyman. 'American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,' he told the Credit Union National Association in 2004. 'To the degree that households are driven by fears of payment shocks, but are willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.'

"As Greenspan spoke, the Fed's key interest-rate target, the overnight federal-funds rate, stood at a mere 1%. Just over four months later, however, the Fed began tightening its monetary policy, eventually raising the funds rate 17 times, to the current 5.25% level.

"The impact on those who took Mr. G's advice has been dramatic. The latest data from the Mortgage Bankers Association show a sharp jump in delinquencies and foreclosures in the fourth quarter. People with ARMs with low 'teaser rates' at the beginning are getting into trouble once they adjust up to prevailing market rates?.

"But this latest fiasco goes beyond mortgages. 'Subprime is today's dot-com - the pin that pricks a much larger bubble,' writes Stephen Roach, Morgan Stanley's chief economist?'the actors have changed, but the plot is strikingly similar,' he continues. 'This time, it's the U.S. housing bubble that has burst, and the immediate repercussions have been concentrated in a relatively small segment of the market - subprime mortgage debt.

" 'As was the case seven years ago, I suspect a powerful dynamic has been set in motion by a small mispriced portion of a major asset class that will have surprisingly broad macro consequences for the U.S. economy as a whole,' Roach concludes."

James Grant, in an op-ed for the Washington Post:

"The top man at the Treasury Department urged calm last week in the face of losses on Wall Street brought on by fears of defaults on the riskier kinds of mortgages. Really, he said, the damage is easily containable.

"But of all people, Henry M. Paulson Jr., former head of the New York investment banking house of Goldman Sachs, should know just how reasonable this near-panic was. Easy credit has long been the American financial lifeblood. Anything resembling stringency on the part of our formerly carefree lenders would tend to set the economy on its ear.

"Easy credit financed the bull market in houses and the flood of home refinancings. Americans felt richer and spent as though they were. It stands to reason that the withdrawal of this manna will lead them to spend less - with substantial collateral damage to the housing-centered U.S. consumer economy, and, perhaps, well beyond. Our captains of industry owe as much to their lenders' leniency as does any subprime, or high-risk, home buyer. They, too, have been able to raise money on terms unimaginable only four years ago.

"All this sounds scary enough, and it is. But financial history offers some solace. The U.S. economy excels in the art of facing up to error - of identifying it, reappraising it and then repricing it. Loans, especially the risky kind, have been mispriced. They were, and are, too cheap. They will be repriced - as they were, for example, in the aftermath of the junk-bond and real estate troubles of the late 1980s and early 1990s. Borrowing costs will go up, and the value of the things that debt financed will tend to go down. In an attempt to ease the pain, the Federal Reserve will print more money?.

"But the ripples from this cold bath go even further than the $8 trillion mortgage market. The truth is that the no-down-payment, no-documentation, interest-only mortgage loan has its counterparts in most branches of American finance.

"The date of the last ceremonial burning of an American mortgage is lost in the mists of time. Outright, unencumbered ownership of a house, a building or a corporation is no longer an ideal that most Americans embrace. The new goal is to borrow as much as possible, as soon as possible, against any asset that could be financed. And these days - thanks to Wall Street's ingenuity - all manner of assets pass as good collateral for a loan?.

"Nowadays, loans rarely rest on the balance sheets of the lenders who make them. Rather, they are scooped up and fashioned into securities - 'asset-backed securities.' And these are gathered up and refashioned into still other securities - 'collateralized debt obligations.' And the CDOs, many of them dizzyingly complex, are sold to investors the world over. No bank regulator watches over these financial sausage-making operations. As the Federal Reserve has receded in importance in this worldwide financial system of ours, so has the U.S. banking system. A parallel kind of banking system has come into existence. Wall Street calls it the 'CDO machine.' ?.

"In a speech two years ago, Federal Reserve Chairman Ben Bernanke pointed to a curious coincidence: Growth in U.S. mortgage debt tracks closely with the growth in the trade deficit - that is, the difference between what we consume and what we produce. 'Over the past two decades,' he said, 'major innovations in the United States have improved the availability and lowered the costs of home mortgages. These developments likely spurred homeowners to tap increasing home equity to finance consumer expenditures beyond home purchase. In contrast, mortgage debt is not so readily available among our trading partners as a vehicle to finance consumption expenditures.'

"If I were the head of state of one of our trading partners, I would be asking myself if these 'major innovations' were as wholesome as they used to seem. Deciding not, I would command my minister of investments to unload U.S. mortgage holdings. And I would imagine that I would not be the only head of state to whom this thought had occurred."

You'd be hard-pressed to find someone who has written more than I have on the real estate bubble, and I'm continually amazed by those who offer we've already hit a bottom. Robert Froehlich of DWS Scudder went so far as to say the subprime mortgage crisis "will be the most hyped disaster that never occurred since Y2K." Right, Bob, but then you have mutual funds to hump so I'd expect nothing less. How the heck can you compare Y2K, which indeed proved to be nothing (though I was taken in by it myself) to a real estate debacle that has caused real pain to a broad class of Americans; those who can least afford it? It's that kind of irresponsible shillery (my word of the week) that gives Wall Street a bad name.

Every few weeks I have to repeat myself on a key point. When we do hit bottom in the real estate market, it is not just going to bounce right back up. Think of the plight of the Kansas City Royals baseball team. They last won 90 games in 1989 (92-70). They then stair-stepped down the next four seasons before flat- lining, with the worst period being the last five-year stretch, 2002-2006. Or, since Detroit's housing market is suffering as bad as any these days, think the Detroit Lions. We will bottom and stay there.

WIR 3/31/07

Merrill Lynch chief economist David Rosenberg summed up the current mood perfectly. "You either believe the housing story has more chapters to be written or you think it's over and done with."

I myself wrote on 12/30/06:

"Those who are trying to convince us housing has bottomed?are nuts. There is absolutely no way housing, at least as expressed by prices, has a good 2007."

WIR 5/19/07

Believe it or not, each week I try to avoid bringing up real estate, but for the archives I do have to note that housing starts for April were up 2.5%, a mild positive, but building permits (future starts) were down 9%, the worst such figure in 17 years. The median price across the country was also down, 1.8%, in the Jan.-Mar. period, the third such quarterly decline in a row. And an index of homebuilder confidence hit a new low.

But fear not, for Federal Reserve Chairman Ben Bernanke said "the financial system will absorb the losses from the subprime mortgage problems without serious problems."

Of course just a little while ago he was acting as if subprime would create zero problems, but who am I to argue with a man whose intelligence dwarfs all mortals'?

WIR 6/9/07

Stocks fell back to earth, after the Dow Jones and S&P 500 both hit all-time highs last Friday, while bond yields threatened to shoot into the stratosphere.

It was all about the 10-year Treasury as it rocketed through 5% and finished the week at 5.11%, the highest level in about a year. In a speech, Federal Reserve Chairman Ben Bernanke reiterated comments from the Fed's minutes of its May 9 meeting, admitting that housing will be a "drag on economic growth for somewhat longer than previously expected," while inflation was "somewhat elevated." Overall, though, Bernanke is optimistic the economy will pick itself up off the floor after a lousy first quarter and those looking for a rate cut will be deeply disappointed.

WIR 7/21/07

Wall Street?.Housing Debacle, Part XXVI

There are basically two schools of thought out there. The first says that the problems in the domestic housing sector will be contained and that the U.S. consumer will keep spending, even as their number one asset shrivels up, while the second says that housing and all the pieces of paper attached to it is far from bottoming and that eventually this will impact the health of the overall economy.

It's pretty funny how Federal Reserve Chairman Ben Bernanke, a bright guy with a lot of brainpower, just a few weeks ago was saying that the problems in housing would indeed be contained. But this week in his semi-annual congressional testimony he was far less sanguine, saying that housing "could get worse before it gets better," and that conditions in the subprime mortgage market "have deteriorated significantly." As the line from Meatloaf's "Paradise By The Dashboard Light" goes, "What's it gonna be, boy?"

Well, you certainly know where I've stood on this topic, consistency being one of my virtues, I'd like to think, so I'll let others do the talking first today; such as Freddie Mac CEO Richard Syron, who knows a thing or two about mortgages. In predicting the subprime crisis would deepen, Syron said in an interview with Bloomberg that "Unfortunately I don't think we have hit bottom. I think things are going to get worse," though Syron adds the crisis doesn't threaten "the stability of our financial system."

But noted fixed income manager Robert Rodriguez, who has been all over the mortgage debacle, told U.S. News & World Report, "We're set up for a storm that could be much larger than Long-Term Capital," referring to 1998's meltdown. "The elements are all there. The tinder is there. The question is: What will be the match to set it off?"

Of course the answer is contained in the subprime market itself and the $1.8 trillion in paper that was issued, including collateralized debt obligations, or CDOs. Fed Chairman Bernanke, when asked by a senator to quantify the potential losses, said $50-$100 billion*. But he doesn't have a clue. In fact I can guarantee all he was doing was parroting a story he saw in Bloomberg or the Wall Street Journal. I've passed along that number, too, as well as another one that said the losses would be up to $200 billion. Of course I don't have a clue either what the actual number will be; except for the archives I'll say it exceeds $200 billion when all is said and written off.

[*An article in the 10/25 edition of the Wall Street Journal put the figure at $400 billion?and counting.]

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Wall Street History returns next week.

Brian Trumbore

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