The Rude Awakening
Wall Street, New York
Tuesday, November 1, 2005
------------------------- - Six facts about the housing market worthy of
inclusion in any horror movie,
- Do you fall into any of the following categories?
And,
- Andrew Ascosi's ghoulish Halloween chart: Scary for
more than the obvious reason…
------------------------- [Joel's Note: Being in the United States for Halloween (or
any holiday for that matter) is quite an event for a young,
wandering antipodean. As with many things, some American's
tend to go to measures of extremes when it comes to
celebrating such occasions. Consider the copious amount of food consumed on
Thanksgiving Day, for example. Many people will eat until
they must resort to the 'buffet notch' on their belt. Then
they sleep, watch football, and return for a second and
even a third helping. I'm certainly no stranger at the table
myself. Last eve's festivities were no exception. As your junior
editor moseyed home from work around 8:30pm he was greeted
by countless teens, outfitted in all manner of freakish
costumes. Everyone looked to be having a night of ghastly
fun and we certainly have no qualms with that. These (relative) celebratory excesses are more to be
reveled in than afraid of. It was actually the essay that I had read just BEFORE
leaving the office, the one you will see below, that had me
more shaken up than any of the ghoulish costumes did.
Considering I don't even own any property, some of the
facts in this housing column will be of frightening
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By Eric J. Fry "I'm not a person that believes in the bubble so much,"
says Donald Trump, the billionaire TV star. "I have seen
real estate go up and down, but it always seems to go up
more than it goes down. I really think it is a good time to
purchase." Treasury Secretary John Snow agrees: "I think the bubble is
a gross misnomer," the former railroad man opines. "The
idea that we're going to see a collapse in the housing
market seems to me improbable." The National Association of Realtors, we suspect, would
also deny the presence of a housing bubble, as would the
Mortgage Bankers Association and the United Brotherhood of
Carpenter's and the American Society of Interior Designers
and every other entity that holds a large vested interest
in the housing market's well being. We are not sure we believe in the housing bubble either,
but neither are we sure we don't. At a minimum, we believe
in the housing market's vulnerability. We also believe that
bad things happen to leveraged speculators…and the
housing market has become a vast national repository of
leveraged speculation, masquerading behind the innocent
façade of "home-buying." For example, a family that commits 40% of it's annual
income to satisfying an interest-only mortgage, financed
with no money down, is not buying a house…It is
speculating. And as all seasoned financial market
participants know very well, leverage creates
surprises…usually bad surprises. It accentuates price
action in both directions. On the way up, the leveraged
speculator rarely neglects to credit his genius. But on the
way down, he rails against his bad luck. Hence, if/as/when
the housing market turns south, we might all be surprised
by the staggering number of geniuses who encounter bad
luck…and we might also be surprised by the ferocity of
the price declines, as the leveraged speculators rush to
"de-lever." Consider a few of the alarming facts that Merrill Lynch
analyst David Rosenberg has identified: - Housing affordability nationwide has dropped to a 13-year
low, while the household debt-service ratio has soared to a
record high.
- Over one-third of all homeowners devote more than 30% of
their incomes to monthly mortgage payments. Twelve percent
of homeowners devote over half of their incomes.
- Sub-prime borrowers accounted for 28% of all new mortgage
lending in the past six months, vs. 5% five years ago.
- In the first half of 2005, two-thirds of homebuyers
financed more than 80% of their purchase, according to SMR
Research.
- 17% of homeowners have a loan-to-value ratio (LTV) of
95% or more, versus only 3% one decade ago. (That means
that 17% own less than 5% of their home's value free, and
clear).
- About 42% of first-time buyers made NO down-payment on
their home purchases in 2004.
Each one of these facts is frightening, but taken together,
they are absolutely terrifying. At least they ought to
terrify every investor who possesses a faint knowledge of
financial market history and a 5th grade command of
mathematics. Frothy asset markets ALWAYS "correct" at some
point; such is the immutable law of the financial universe.
And when the inevitable correction arrives, leveraged
speculators ALWAYS fare very poorly…That's where the 5th
grade math comes in. For example, the 42% of recent buyers who put no money down
when buying their homes have accumulated no equity
whatsoever. Since zero minus anything is a negative number,
these folks would not be sitting pretty if prices began to
slip a bit. If these same borderline home "buyers" have been availing
themselves of interest-only loans to squeeze into their
dream homes, they would posses no protection whatsoever
against ANY kind of adverse twist of fate. "If their adjustable-rate mortgages were adjusting upward,"
observes James Grant, editor of Grant's Interest Rate
Observer, "as the value of their assets were ratcheting
downward, some mortgagors might chose to walk away, the
holy bonds of home-ownership notwithstanding. If so,
Countrywide [Financial], the nation's top adjustable-rate
lender, would stand to receive its share of the unwanted
keys." And so would many other lenders. It is not hard to
imagine, under such a scenario, that home prices might not
continue rising. Since we know that 17% of the nation's homeowners own less
than 5% of their home's value, and since we also know that
42% of first-time buyers made no down-payment on their home
purchases in 2004, we can confidently deduce that
speculation is INCREASING, even as home prices are also
increasing. And the history of markets informs us that
asset markets become ever more treacherous as the number of
leveraged participants increases. That's because leveraged
participants possess no capacity to withstand adverse
trends. They become forced sellers into a falling market,
which pressures prices even more, which forces more
speculators to sell into a falling market…and before you
know it, many financially frail home-owners begin to wish
they'd never moved out of Mom and Dad's guest house. The "Halloween-edition" chart below (enthusiastically
provided by our graphic arts department - Cheers to Andrew
Ascosi for this one) illustrates that home prices DO
sometimes fall, even in California. Between 1991 and 1996,
California home prices fell by about 12% in nominal terms.
That decline doesn't seem like much in retrospect,
especially since prices recovered and soared anew. But a
decline of similar magnitude today would feel like the end
of the world to California's highly leveraged homeowners. 
Never before have so many home buyers been so vulnerable to
so slight a dip in homes prices. Nearly 20% of ALL American
home-owners would see their home equity wiped out entirely
by a mere 5% decline in home prices.
Thus, if home prices were to slip even a little, the price
declines could pick up momentum quickly. One fifth of the
nation's housing stock could begin looking for buyers all
at the same time. Now THAT would be scary. We are not predicting such a doomsday scenario, merely
pointing out that leverage increases the odds of
catastrophic outcomes. The housing market's excesses may or
may not constitute a bubble, but they do clearly constitute
a risk. The American penchant to undersave and overspend has
contributed mightily to the housing boom. But this very
same habit will speed the housing market's demise, once the
trend turns. Therefore, as Jim Grant concludes, "There are
worse investment rules of thumb than to stand clear of
bubble-like markets." [Joel's Note: If you would argue that the current housing
market is built on a stable footing, solid financial
foundations and sound economics then you will, in no way,
be inclined to read this next report. If you have any doubt
whatsoever, it is wise to spend the next five minutes
learning how to prepare for what might just be a total,
catastrophic collapse. Click here to find out more: http://www.agora-inc.com/reports/DRI/EDRIFB05 --- Advertisement ---
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------------------------- [Joel's Final Utterance: So why was it that your Aussie
editor was walking home at 8:30pm rather than the regular
5:00pm bell time? One might attribute this to my assiduous
work ethic and vigilant attention to detail. You would
surely know better though. Only a very important project could keep me at my desk past
regular work hours. It just so happens that the Rude
Awakening is about to enjoy a 'rebirth' of sorts…a
metamorphosis even. Stay tuned this week as the plans
unfold and in the meantime, let me know what you think of
our humble little publication by dropping me a line at
aussiejoel@the-rude-awakening.com Cheers, jOEL And the Markets… | Monday | Friday | This week | Year-to-Date | DOW | 10,440 | 10,403 | 225 | -3.2% | S&P | 1,207 | 1,198 | 27 | -0.4% | NASDAQ | 2,120 | 2,090 | 38 | -2.5% | 10-year Treasury | 4.56 | 4.57 | 17.00 | 4.52 | 30-year Treasury | 4.75 | 4.77 | 15.00 | 4.70 | Russell 2000 | 646 | 635 | 14 | -0.8% | Gold | $465.95 | $473.50 | -$0.94 | 6.5% | Silver | $7.57 | $7.79 | -$0.09 | 11.1% | CRB | 316.29 | 322.13 | -6.22 | 11.4% | WTI NYMEX CRUDE | $59.80 | $61.22 | -$0.83 | 37.6% | Yen (YEN/USD) | JPY 116.38 | JPY 115.67 | -0.49 | -13.5% | Dollar (USD/EUR) | $1.1988 | $1.2068 | -39 | 11.6% | Dollar (USD/GBP) | $1.7704 | $1.7743 | -29 | 7.7% |
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