Speculator Speculation

Speculator

(noun) A person who is willing to take large risks and sacrifice the safety of principal in return for potentially large gains. Certain decisions regarding securities clearly characterize a speculator. It must be added, however, that there is a big gray area in which speculation and investment are difficult to differentiate.

Investor

(noun) A person who purchases income-producing assets. An investor, as opposed to a speculator usually considers safety of principal to be of primary importance. In addition, investors frequently purchase assets with the expectation of holding them for a longer period of time than speculators.

Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott.

Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company.

***

It’s generally accepted that the conduct of certain housing market participants during this historic run-up in prices has been tantamount to speculation.

There were the “Flippers” who bought and sold new and existing homes and condos, performing minimal rehabilitation when needed, only to put them back on the market to turn a quick profit.

Builders, especially in the condo market, seem to have been making considerable “bets” that there would be a steady stream of affluent buyers willing to take on a $500K-plus debt obligation in order to “own” a luxury housing unit.

But what about the typical home buyer?

Clearly, housing is popularly know as a persons “best investment”, yet how well do buyers do in determining the reasonable value of their investment?

Using comparables, or “comps” as they are know (i.e. comparing a home to several equivalent homes in the area that have recently sold in order to establish a comparable value range), is the main method used to determine the value of a home.

In some respects, the purely comparative approach to valuing a home seems to be an especially, if not purely, speculative process.

Certainly, using the “comps” approach will successfully account for many of the basic “hidden” points of value such as location, square footage, and internal and external updates and amenities, but without incorporating any historical or underlying fundamental analysis, it seems that “comping” may greatly contribute to amplifying home prices, especially in a “hot” market where buyer interest, competition, and turnover is high.

Thus, it may be that “comping” generally yields the current price of a home rather than its real underlying, inherent or typical value.

Using basic comparable analysis to establish home values combined with the popular notion that home prices (seemingly confused with home values) generally trend up, appears to have established speculation as a normal process in home buying.

That is, to use, almost exclusively, the current market price of an asset to establish its value while having a great degree of confidence that the value will increase in the future (even in the near future) appears to be a more speculative then analytical activity.

So are all home buyers speculators?

Not in the typical sense, in that most people, when buying a home, probably do not intend on taking above average risks in order to turn a quick buck on their purchase.

But are home buyers actually investors?

The End of the Myth

Remember when they attempted to blame the Space Shuttle Columbia disaster on a single convoluted PowerPoint slide?

Never in the history of software engineering has there been such a controversial office productivity application.

Whether it’s being criticized by noted Yale Professor Edward Tuft for being analytically inept, blamed by the media for creating a shuttle disaster or embraced by David Byrne as a new medium for artistic expression, Microsoft PowerPoint never seems to be at a lose for contentious circumstances.

Possibly though, it’s the author, and how he chooses to “present” his information that should be the real focus of any criticism.

Looking back at the PowerPoint presentation given by David Lereah, Chief Economist for the National Association of Realtors, at last years “Leadership Summit”, it seems plainly obvious that it was an attempt to “spin” the circumstances of the nations real estate market to benefit inherent interests.

Entitled “The Real Story about Today’s Real Estate Boom”, the presentation both chronicles the nation’s meteoric housing boom as well as attempts to justify the legitimacy of its ascent.

It seems, at that time, the goal was to convince people of the inherent fundamentals driving the housing boom thus allaying any fears that there could ever be a painful pullback.

Slides dedicated to “Boomer” demographics, job creation, immigration, regional population growth, and building restrictions all seem to neatly explain why the boom was really just an expression of underlying factors that were not expected to change measurably.

There was even a slide denigrating various “chicken little’s”, as it termed them, for having questioned the soundness of the recent run-up.

The presentation concluded by declaring that there was NO coming danger of foreclosure in cities like Boston, San Diego, San Francisco, and Las Vegas, as well as making some pretty optimistic predictions about home sales for the coming 2006.

As all of us “Chicken Little’s” knew then (and are still committed to reporting now), the wheels were coming off the cart. The boom was a boom, plain and simple. Speculative in nature, founded on false hyper-optimistic herd-think, popularized by media and television, and supported by questionable national organizations and individuals with latent interests.

As was reported here last week, David Lereah’s “Leadership Summit” PowerPoint presentation this year spun quite a different story.

Whether the latest presentation was an attempt to backpedal in order to save face, or simply another in a series of shifting positions intended to exploit the market regardless of the direction its trending, one may never know.

What’s important though is that now the housing bubble is “officially” no longer a myth.

Not because a simple PowerPoint proved it, but because the presentation, representing the key facts distilled down to the very essence of the matter, even with an inherent slant, can no longer disguise what should have been so plainly obvious all along.

Ouch!!

Not to get too carried away with a boxing analogy but if the “new home” market were a prize fighter, it would be, at best, bloodied, bruised and confused, staggering aimlessly around the ring seemingly looking for the most comfortable piece of canvas to use for nighty-night.

By now it’s been well reported that the July New Home Sales results were poor but digging a little deeper into the report one finds some truly harsh figures.

First, take a look at the regional “New Houses Sold” numbers:

1. Northeast, down 42.9% as compared to July of 2005.
2. Midwest, down 35.4% as compared to July of 2005. In fact, the Midwest is down 21.3% just since this June!
3. South, down 12.4% as compared to July of 2005.
4. West, down 23.4% as compared to July of 2005.

Next, look at the national numbers for “New Houses (still) For Sale”:

1. 22.4% increase in new homes for sale as compared to July of 2005.
2. 54.8% increase in the number of “Months supply” which now stands at 6.5 months. So it would take 6.5 months to sell off the entire “New Home” inventory that is on the market as of today.

Now, look at the national numbers for “New Houses Sold” by price range:

1. For homes under $150,000, down 33% as compared to July of 2005.
2. For homes between $300,000 and $399,000, down 20% as compared to July of 2005.
3. For homes between $400,000 and $499,000, down 44% as compared to July of 2005.

So, I suppose this is what all the home builders were talking about. A very abrupt and striking collapse of the “new home” market seems well underway.

Considering that Toll, Pulte, Centex, KB Home and others are holding an unsold, and growing inventory of 568,000 new homes, I wonder how long it will be before they give up on offering buyer incentives and start getting down to the business of slashing prices.

One if by land, Two if by sea, Three if by impending Real Estate Collapse!

Krikies!

Thought last months housing numbers for Massachusetts looked bad?

This month has that “Grab your musket and hunker down behind a log” type of imminent doom feel to it. Things keep up like this and we’ll all have to start getting used to the taste of human flesh!

July posted the steepest single month decline in home sales since 1995!

Again, like last month, we have to keep in mind that we are coming off of an historic run-up in home prices fueled by a speculative loony-ness that has captivated our area for almost ten years.

The following statistics were compiled by The Warren Group directly from deed transactions and present a more complete view the market than the Massachusetts Association of Realtors MLS-only numbers.

As in months past, be on the lookout for the inflation adjusted charts produced by BostonBubble.com for an even more accurate "real" view of the current market trend.

Key Statistics for July 2006

1. Single Family Sales Down 26.9% as compared to July 2005
2. Single Family Median Price Down 6.1% as compared to July 2005
3. Condo Sales Down 23.5% as compared to July 2005
4. Condo Median Price Down 4.2% as compared to July 2005
5. Single Family average “Days On Market” stands at 109 days in June as compared to 77 days for July 2005
6. Condo average “Days On Market” stands at 108 days in June as compared to 77 days for July 2005

Key Facts

1. July marks the fourth consecutive month of declining sales.
2. Inventories have now risen for 17 consecutive months.
3. Boston leads the nation in price reductions with 46.4% of homes listed on the MLS having been reduced.
4. Residential housing (homes and condos) inventory has increased 23% over the past 12 months.

Lereah Mea Culpa?

A recently released PowerPoint presentation entitled “Reality Check” is probably as close to an admission of personal error that you’re going to get from the National Association of Realtors (NAR) Chief Economist David Lereah.

Apparently, first presented by Lereah at the NAR Leadership Summit on the 17^th and 18^th of August, this arrangement of slides seems to cover virtually every point that would be made to support the premise of a bursting housing bubble.

Of course, Lereah falls short of declaring a bursting bubble, instead favoring his “soft landing” position; yet, the presentation seems to depict about as accurate and stark a picture as could have been penned by the most enthusiastic bubble blogger.

Although not a total capitulation, this must be, at the very least, an indication that the data supporting a collapsing housing market has reached such a crescendo that even the most passionate real estate bulls can no longer continue to spin an optimistic picture.

Additionally, on a more ironic note, take a close look at the background of the PowerPoint slides… what to you see. Bubbles! Bubbles and more bubbles! Seems Lereah has a sense of humor after all.

Some points covered in the slides:

1. Boom is over
2. Homebuyer confidence has plunged
3. Buyers Market
4. Home sales plummet, prices lagging
5. High percentage of “exotic” loans
6. Days on the market increasing
7. Residential construction slowing
8. Condo depreciation – Especially significant in West and South
9. Inventory at “all time” high
10. High debt burdens unhealthy
11. Incomes detached from home prices
12. Unsustainable metro home prices
13. Mortgage obligation to income out of whack, even worrisome particularly in San Diego and Miami
14. Surging level of ARM loans, over 60% in the West, over 20% nationally
15. Prices expected to fall

The Gift that Keeps on Giving

In a seemingly “last ditched” attempt to provide loan products for desperate home buyers increasingly priced out of a historically inflated housing market, lenders in the UK are beginning to offer a loan nicknamed “the debt that never dies”.

This loan product, which is essentially an “interest only” loan that has NO amortization, would provide the borrower a premium rate in exchange for a lifetime of interest payments.

Furthermore, the loan is a form of “inter-generational” or “inheritable” debt in that can be (or possibly has to be) passed down to children or other heirs upon the death of the borrower.

Touted as having tax benefits by providing a means of transferring a home to heirs without incurring the full penalty of inheritance tax, it seems questionable at best to opt for a lifetime of interest payments and possibly an enormous headache for your children simply to avoid paying taxes.

Obviously, borrowers considering this loan would presume that home prices would increase enough, at some point, to allow them to sell the home in order to settle the debt if needed, but with home prices at historically high levels, that option seems open to question.

Furthermore, heirs who don’t want to take on the mortgage would also need to settle the loan either by selling the home (which, again, assumes the home sale would cover the loan) or by some other means.

Interestingly, this style of “inheritable mortgage” is nothing new. Apparently, it was a very popular loan option offered in Japan at the height of their speculative housing mania of the 1980’s.

Then, as now, buyers were doing anything they could to keep up with the demands of an increasingly unaffordable housing market fueled by hyper-optimistic speculative market behavior.

As we all know, Japan’s housing market collapsed in 1989 and declined for 16 consecutive years, showing only meager sings of life in 2006. There are, apparently, many heirs in Japan that have inherited and continue to inherit loans for homes that are worth dramatically less than their associated mortgage debt.

It will be interesting to see both how popular this loan option becomes in the UK as well as how long it will take for a similar product to be offered in the US.

Recently, lenders in the US began offering a 50 year fully amortizing loan product which, in effect, is very similar to the “inheritable mortgage” with the exception that it does actually amortize, allowing the borrower to pay down the principle, albeit at a very slow rate.

Many thanks go to PaperMoney reader Bert (posted in the comments section on this blog) for having shared this interesting development in the UK housing market.

Weak Week

This week, housing should dominate the economic news if not for the fact that the slowdown is now firmly upon us and generally acknowledged by all, then, at least, for lack of inflation reports or Federal Reserve appearances.

Listening to CNBC, it’s pretty hard to miss the change in attitude. Nearly every other segment seems to be dominated by the specter of a housing led consumer recession.

Remember, just about this time last year there was some fairly rigorous debate as to whether there was going to be a housing slowdown at all.

Now, with what seems to be a daily torrent of mounting evidence pointing to a further and even more substantial decline of the housing market, debate has shifted to how deep the downturn will go.

While most housing optimists still maintain that, nationally, the slowdown has been “orderly” and is heading for a “soft-landing”, a recent report by the National Association of Realtors showed that 28 states and the District of Columbia have shown declining sales with the most significant losers being Arizona, Florida, California, Virginia and Nevada.

Additionally, home builders have reported previously and are now reaffirming record numbers of cancellations, substantially fewer orders, declining revenues, and land write-downs, all contributing to pushing builder confidence down to a 15 year low.

Furthermore, Foreclosure rates have been on the rise across the nation, showing particularly striking increases in the country’s bubbliest areas.

Although this week’s fallout should come as no surprise, especially given that some results were pre-released, be on the lookout for housing to dominate the nation’s economic news.

This weeks notable housing events:

Tuesday

- Toll Brothers released its third quarter earnings results showing a 19% drop in profits and a $23.9 million dollars in land write-downs.

Wednesday

- Existing Home Sales Report (10 am).

Thursday

- New Home Sales Report (10 am).

Today’s New Construction Report

Further demonstrating the obvious weakening trend of the US housing market, today’s “New Residential Construction Report”, shows significant, and even severe, declines across all monitored indicators.

Popularly reported as showing a 2.5% decline in housing starts from last months revised figure, the report, if viewed more thoroughly, displays many, far more significant declines.

Although housing starts have declined considerably, especially regionally in the Northeast and the West, more significantly are the declines in building permits which represent the most leading of all the indicators the report tracks.

Here are the statistics outlined in today’s report:

Housing Permits

Nationally

1. Single family housing permits down 6.1% from June, down 23.5% as compared to July 2005

Regionally

1. For the Northeast, single family housing permits down 2.9% from June, down 26.1% as compared to July 2005.
2. For the West, single family housing permits down 14.7% from June, down 33.5% as compared to July 2005.
3. For the Midwest, single family housing permits down 2.7% from June, down 24.8% as compared to July 2005.
4. For the South, single family housing permits down 3.3% from June, down 17.0% compared to July 2005.

Housing Starts

Nationally

2. Single family housing starts down 2.3% from June, down 16.6% as compared to July 2005.

Regionally

1. For the Northeast, single family housing starts down 12.2% from June, down 23.6% as compared to July 2005.
2. For the West, single family housing starts down 9.5% from June, down 25.8% as compared to July 2005.
3. For the Midwest, single family housing starts down 2.3% from June, down 18.9% as compared to July 2005.
4. For the South, single family housing starts down 0.5% from June, down 9.1% as compared to July 2005.

Keep in mind that this particular report does NOT factor in the cancellations that have been widely reported to be occurring in new construction.

As further reports are released, cancellations should show an even greater effect on permitting, starts and completions.

Boston Reduced!

Taking a closer look at the current listings in some of Middlesex county’s larger towns confirms some significant pricing weakness.

As the slowdown has extended into the summer months, not unexpectedly, the sellers that have been on the market longest have clearly given up the deepest price reductions.

But, more interestingly, now 53% of all single family homes listed with the MLS have price reductions. Even sellers that have just recently put their homes on the market are making significant price reductions.

Additionally, price reductions have been greatest, as a percentage, for homes originally listed above one million dollars.

The data was ferreted out using ZipRealty.com and includes the following Boston area towns:

Acton, Arlington, Bedford, Belmont, Cambridge, Chelmsford, Concord, Hudson, Lexington, Marlborough, Medford, Newton, Somerville, Sudbury, Waltham, Watertown, Winchester, Woburn.

The following data points now stand:

1. There was 1230 single family homes with price reductions out of a total of 2311 listed.
2. Homes listed between 5 and 30 “days on the market” showed an average price reduction of 3.9% with some showing in the range of 12% – 16%.
3. Homes listed between 175-600+ “days on the market” showed an average price reduction of 9.64%.
4. Homes originally listed above one million dollars had an average price reduction of 11.68%.
5. 8.7% of homes have been on the market for longer than 175 days.

There are some noticeable trends when looking at the individual listings as well.

First, although sellers still seem to be moving rather slowly at making significant price reductions, there are clear signs of price competition.

Irregular reductions, where sellers break from a consistent reduction pattern and reduce several times, sometimes in just a matter of days, are common.

Also, new sellers seem to be more educated to the state of the market as there are many sellers making their first reductions well within the first 30 days of their listing.

Glass Half Full

A widely reported theory suggests that the housing market need not crash in order to bring home prices back “in-line” with traditional fundamentals but, that it merely needs to tread water for a few years to let the fundamentals catch up with it.

This might be best termed the “Glass Half Full” theory of the housing cycle as it seems wrought with the very same hyper-optimism that so effectively got things out of whack in the first place.

The main prediction of this theory is that housing prices will flatten out (and possibly go down a little, but not dramatically of course) and remain flat for a few years, in which time, median incomes will “catch up” to median house prices.

Of course, there’s no suggestion for what would come next; most likely, given theses optimists attitudes, more expansion would ensue.

The fundamental problem with this line of thinking, though, is that wages have been relatively flat (along with inflation) for the last decade or more and median incomes and median home prices have become significantly awry, especially in the bubbliest markets.

To demonstrate this point, I have created a simple Excel spreadsheet that estimates that annualized rate of growth of income over the next 5, 10 and 15 years, that would be required to bring a specified towns current median income and median home prices back to a reasonable ratio.

In order to establish a “reasonable” ratio, I used the standard mortgage affordability “Rule of Thumb”, whereby no more than 29% of a households gross income should be allocated to PITI (Principle, Interest, Taxes, and Insurance).

Furthermore, I generated the estimates given the specified towns median home price with an assumed 20% down payment, financed with both a low 5.5% 30 year fixed rate as well as a more reasonable 6.5% 30 year fixed rate.

Poking in the numbers for a selection of towns in the Boston metro area resulted in an average income deficit of $73,766.83 (for a 6.5% loan), requiring either a 13.63% annual rate of income growth over 5 years, or an 6.55% annual rate of income growth over 10 years, or an 4.31% annual rate of income growth over 15 years to close.

The following is just some of towns that I used for my sample:

NOTE:

- Income deficit is the amount of additional income that would be needed for the median household income to justify the median home price given the 29% “Rule of Thumb”.

- The annual income growths specified indicate the rate of growth in household income needed in order to close the income deficit in the specified period of time.

Arlington

5.5% 30 year fixed

- Income deficit: $39,078.89

- Annual income growth to close deficit in 5 years: 8.96%

- Annual income growth to close deficit in 10 years: 4.39%

- Annual income growth to close deficit in 15 years: 2.90%

6.5% 30 year fixed

- Income deficit: $49,568.78

- Annual income growth to close deficit in 5 years: 10.93%

- Annual income growth to close deficit in 10 years: 5.32%

- Annual income growth to close deficit in 15 years: 3.52%

Cambridge

5.5% 30 year fixed

- Income deficit: $102,222.74

- Annual income growth to close deficit in 5 years: 23.88%

- Annual income growth to close deficit in 10 years: 11.30%

- Annual income growth to close deficit in 15 years: 7.40%

6.5% 30 year fixed

- Income deficit: $117,489.46

- Annual income growth to close deficit in 5 years: 26.22%

- Annual income growth to close deficit in 10 years: 12.35%

- Annual income growth to close deficit in 15 years: 8.07%

Belmont

5.5% 30 year fixed

- Income deficit: $72,963.06

- Annual income growth to close deficit in 5 years: 12.82%

- Annual income growth to close deficit in 10 years: 6.22%

- Annual income growth to close deficit in 15 years: 4.10%

6.5% 30 year fixed

- Income deficit: $87,846.79

- Annual income growth to close deficit in 5 years: 14.84%

- Annual income growth to close deficit in 10 years: 7.16%

- Annual income growth to close deficit in 15 years: 4.72%

Lexington

5.5% 30 year fixed

- Income deficit: $47,660.06

- Annual income growth to close deficit in 5 years: 7.55%

- Annual income growth to close deficit in 10 years: 3.71%

- Annual income growth to close deficit in 15 years: 2.46%

6.5% 30 year fixed

- Income deficit: $62,373.57

- Annual income growth to close deficit in 5 years: 9.50%

- Annual income growth to close deficit in 10 years: 4.64%

- Annual income growth to close deficit in 15 years: 3.07%

As you can see, even at ridiculously high rates of annual income growth, it would still take 5 to 10 years to make current housing values seem reasonable. In most towns I looked at, even the 15 year annual income growth rate was on the high side especially given the actual income growth rates of the last 10 years.

Here is a link to the spreadsheet. Download it and poke in your favorite town by simply:

1. Copy an existing row and paste as a new row.
2. Specify the town’s name.
3. Specify the town’s median home price
4. Specify the town’s average monthly property tax payment (or use $400 as a rough estimate).
5. Specify the town’s median income value.

At the end of the row will be calculated the income deficit values as well as the rates of growth needed over the next 5, 10, and 15 years to close the deficit.

Please let me know if you notice a discrepancies or simply would like to comment on the spreadsheet.

Housing Bust is Taking it’s Toll

Today, Toll Brothers, the nation's leading builder of luxury homes, announced it’s preliminary 3rd quarter results. The outcome, not surprisingly, are pretty ugly.

Showing a pronounced downward trend, revenue for the quarter was down only 0.5% to $1.53 billion versus $1.54 billion in 2005 while the “quarter end backlog” was down 13% and “signed contracts” were down 45%.

This quarter’s results are now very clearly showing a peak in revenues with distinct and severe drop-off in demand.

Additionally, the company has reduced its guidance, indicating that it will likely build 15% fewer homes in the 4th quarter than it had originally anticipated.

Furthermore, with the release of it’s final Q3 earnings report on August 22, the company will announce a number of land “write-downs”, whereby the they will reduce the “book value” of certain land assets, thus acknowledging that land they have purchased is now not worth what they paid.

Included with today’s report, CEO Robert Toll provides the following analysis:

"It appears that the current housing slowdown, which we first saw in September 2005, is somewhat unique: It is the first downturn in the forty years since we entered the business that was not precipitated by high interest rates, a weak economy, job losses or other macroeconomic factors. Instead, it seems to be the result of an oversupply of inventory and a decline in confidence: Speculative buyers who spurred demand in 2004 and 2005 are now sellers; builders that built speculative homes must now move their specs; and nervous buyers are canceling contracts for homes already under construction. The resulting excess supply has exacerbated the drop in consumer confidence, which first appeared last September, that was already a drag on new home sales."

"Because much of the overhang of finished and near-finished product is being marketed using advertised price reductions and increased sales incentives, many anxious consumers are delaying their purchase decisions as they wonder about the direction of home prices. With interest rates still relatively low, the economy basically healthy and household formations still increasing, we believe that once the current oversupply of homes is absorbed and buyers become confident that home prices have stabilized, the market will return to firm footing."

Lowdown on Zero Down

In a time when, arguably, the best remedy for what ails our national housing market should come in the form of regulatory cleansing of the numerous and prevalent “loose” lending and underwriting practices, the Federal Government seems bent, instead, on joining in the fray.

First, there was the FHA Manufactured Housing Modernization Act of 2006 (HR 4804, passed by the house overwhelmingly on July 25) that, if passed into law, would attempt to make the FHA more “competitive” be re-defining many of the limits and minimums needing to be met when qualifying a candidate for loan assistance.

Now, the sponsor of the FHA bill, Representative Patrick Tiberi (R-OH), has introduced another prospective legislative proposal, The Zero Downpayment Pilot Program Act of 2006.

Under the guidelines of this act, the Federal Government would insure a “zero-down” loan to first time buyers who meet the following basic requirements:

1. First time home buyer seeking to purchase a single unit home (i.e. single family home or single housing unit of up to a three family dwelling) as their primary residence.
2. Mortgage cannot exceed 100% of the appraised value of the home.
3. Borrower must receive preparatory counseling on various loan and housing related topics from an approved third party counseling entity.
4. Borrower’s credit must be evaluated using the Federal Housing Administration's Technology Open Scorecard (TOTAL) or a similar program.

Optionally, the borrower may also allow the lender the right to notify the third party counseling entity should the mortgage ever become 60 days delinquent. This option would allow the borrower the opportunity to rectify the delinquency prior to any action of foreclosure.

Additionally, the act, which would remain in effect until September 10^th 2010, would insure a maximum of 50,000 loans per year but would require that the number of current “zero-down” loans to never exceed 10% of the FHA’s overall portfolio. Moreover, if the claim rate ever were to exceed 3.5%, the program would become suspended until the rate becomes 3.5% or less.

Given the overwhelming support shown to the FHA Modernization Act during its “roll call” vote on the floor of the House in July, this bill, positioned as a much needed assistance to lower income Americans who have been increasingly priced out of the competitive housing market, will probably generate little partisan debate.

Although, not all members of the House are without a disagreement to its passage as noted by the following excerpt of the dissenting view authored by Representative Ron Paul (R-TX):

The requirement that homebuyers make a downpayment ensures that a prospective homebuyer is a worthy credit risk and reduces the likelihood of default. After all, people are less likely to abandon property if they have invested substantial savings in the property in the form of a downpayment.

A friend of mine was informed by a mortgage broker that his business was experiencing an increase in defaults. According to this mortgage broker, one reason for this was the failure to require downpayments; private industry has excessively relied on credit history information instead of a downpayment to entice more people into the home market. H.R. 3043 authorizes the federal government to repeat this folly. Does anyone really believe the federal government will succeed where the private sector has failed? Before answering that question, my colleagues should consider that FHA foreclosure rates are already at record levels! Of course, if default rates rise, Congress can pass a new program making the taxpayers responsible for the monthly mortgage payments of holders of FHA insured loans.

H.R. 3043 will harm the economy by artificially increasing the demand for housing, causing resources to be diverted from other uses into housing to meet this government-created demand. Allocating resources based on market-distorting government programs insures that those resources will not be devoted to their highest-valued use. Thus, government interference in the economy results in a loss of economic efficiency and, more importantly, a lower standard of living for all citizens. The only policy guaranteed to maximize economic growth and the well being of citizens is to allow the actions of private individuals in a free-market to determine the allocation of resources.

Government polices have already artificially inflated the demand for housing, creating a housing bubble. While the temporary effect of this bubble may appear beneficial to homebuyers and homebuilders, eventually they will suffer when the housing bubble bursts. Encouraging more people to enter an already-inflated market will only increase the economic damage and human suffering the bursting of the housing bubble will cause.

As with the FHA Modernization bill that preceded it, this bill has the potential to benefit many first time home buyers, especially lower income buyers, who would otherwise be more susceptible to the viscous dealings of predatory lenders.

On the other hand, the “zero-down” loan, as a practice or product, is most likely the result of irrational expectations made commonplace during this particularly enthusiastic and hyper-optimistic housing cycle.

Keep in mind, these borrowers would be particularly susceptible to a housing market downturn as they, by definition, will have zero equity on the day of their closing, leaving foreclosure as the only escape route out of their loan obligation.

Should the Government really be getting into the business of reinforcing sloppy lending practices by guaranteeing loans to applicants who, during any other era, would not have been qualified?

Kindleberger’s Last Bubble

The famed economist, Charles P. Kindleberger, author of over 30 books, including the great title “Manias, Panics, and Crashes: A History of Financial Crises”, appears to have spent his final days clipping out newspaper articles in order to corroborate his intuition of a mounting real estate bubble.

This is no small bit of trivia as Kindleberger not only lived through the Great Deperssion, but was an active and astute economist publishing works throughout the 1930’s and onward.

The following is an excerpt from an interview with the Wall Street Journal published less than a year prior to Kindleberger death in July of 2003:

The object of his greatest fascination today is the real-estate market. For weeks, Mr. Kindleberger has been cutting out newspaper clippings that hint at a bubble in the housing market, most notably on the West Coast. Nationwide, median home prices are up about 7% from a year ago, even though the stock market has tanked and the economy has floundered. Over the long term, economists agree, housing prices can't continue to outpace growth in household incomes. Mr. Kindleberger says he isn't certain there is a housing bubble yet, "but I suspect it is."

The trick with spotting real-estate bubbles, he says, is that they don't always spread. In 1925, for instance, real-estate prices in Florida soared and crashed, but that didn't spread to the rest of the country. Yet he notes that something is distinctly different about the nation's housing market today, when compared with 1925. Fannie Mae and Freddie Mac, two large government-sponsored enterprises, own or guarantee nearly $3 trillion in mortgages, helping to keep the mortgage market liquid with cash. That is a boon to homeowners, but Mr. Kindleberger says he fears that Fannie Mae and Freddie Mac's deep nationwide presence in the market is fueling a speculative fire.

"Banks will make a mortgage and sell it to them. It means that the banks are ready to mortgage more and more and more and more. It's dangerous, I think," he says.

A Fannie Mae spokeswoman describes the argument as "preposterous," and notes Mr. Greenspan dismissed the chances of a housing bubble in testimony to Congress last week. Robert Van Order, chief international economist for Freddie Mac, says home prices might decelerate in the months ahead, but they're unlikely to crash because interest rates are so low, the inventory of unsold homes is also low and the economy has proven surprisingly resilient.

Yet Mr. Kindleberger isn't convinced. "If I was 30 years younger," he says, "I'd write a small book on Fannie Mae and Freddie Mac."

Given today’s real estate climate, the response by the Fannie Mae spokeswoman and the Chief Economist for Freddie Mac seem so ridiculously flimsy and comical.

It seems almost too perfect for Fannie Mae to offhandedly dismiss Kindleberger’s concern as “preposterous” by simply invoking the “Maestro said so” response.

There goes the “Mini-Boom”

Watching the decline of America’s greatest housing boom is such a compelling spectacle that it’s easy to forget that we are not alone.

It appears that almost every industrialized nation (except for Germany and Japan) has experienced a similar astronomical run-up in prices over roughly the same period as the US and are now experiencing a similar slowdown.

Evidently, the exceptionally low interest rate environment of the new millennium was not confined to our shores and fueled, among other things, a frenzy of speculative housing activity worldwide.

Likewise, now that central bankers are beginning to tightening rates in order to head off inflation, we are seeing a worldwide slumping trend.

In August of 2005, the Bank of England, concerned about a possible economic slowdown (including a weakening of home prices), actually cut thier benchmark rate 25 basis points for the first time in over a two year period.

The move appeared to be generally accepted given that the UK’s economy was noticeably weakening and the effect on housing (i.e. reinvigorating it as it was previously "white hot") was predicted to be minimal.

"… we do not believe that a modest reduction in interest rates over the coming months would cause the housing market to re-ignite, given that affordability ratios are still very stretched on several measures," said Howard Archer, chief UK economist at Global Insight

Enter the “Mini-Boom”.

Unfortunately, for many in the UK though, the rate cut did in fact signal home buyers to jump back in the pool creating what was termed a “mini-boom” that persisted through the first half of 2006.

Today, in a move that is sure to raise concerns about the stability of housing in the UK, the Bank of England unexpectedly raised their benchmark rate 25 basis points; back to the 4.75% it was at prior to the 2005 rate reduction.

Apparently only eight of thirty eight economists surveyed by Bloomberg predicted the increase.

So, it seems concerns over inflation are becoming a trend and with central bankers worldwide tightening up on the money supply, housing markets should continue to feel the pain.

Only time will tell but there may be much that we can learn about or own hyper inflated housing market by occasionally looking abroad.

Grabbing for Straws

This week the National Association of Realtors released its June “Pending Home Sales” report which showed that nationally, pending home sales had edged up 0.4%.

The National Association of Realtors developed the “Pending Home Sales” index as a leading indicator based on a random sampling of roughly 20% of the month’s transactions for exiting home sales and indexed to the average level of contract activity set during 2001.

In an effort to use any “positive” numbers as a means of appealing to buyers, David Lereah, NAR’s Chief Economist states, “A quieting in the movement of indicators should restore confidence to home buyers who’ve been on the sidelines, waiting for the right time to get into the market, and now is the best time we’ve seen since the 1990s in terms of housing choices and flexible terms.”

As usual, looking more closely at the results one might draw a less optimistic conclusion:

- Nationally the index was down 9.6% as compared to June 2005

- The Northeast region was down 6.3% in June and down 11.6% as compared to June 2005. Currently, this region has dropped below the average activity of 2001 for which the PHSI is based.

- The West region was unchanged in June and down 14.2% as compared to June 2005.

- The Midwest region was up 1.9% in June but down 11.9% as compared to June 2005.

- The South region was up 2.5% in June but down 4.8% as compared to June 2005.

So it appears that, year over year, contract activity is dropping rather sharply with all regions, particularly the West, Midwest and the Northeast, showing significant declines.

So much for a “quieting” of movement of this indicator.

The Good the Bad and the Ugly

Another interesting phenomenon that seems to be occurring at this point in the housing cycle is the inability of some to accept the bad with the good.

It seems that some of the real estate industry’s best cheerleaders have ingrained in their minds a certain number of half-truths and either intentionally, or as a side-effect of being deluded by the mania, continue to spout them off at any opportunity.

Sometimes these bits of deception can be fairly obvious, for example, David Lereah’s apparent inability to ever forecast a real estate market that depreciates.

Other times, the assertions can be a bit tricky as they hold some merit but quickly lose value upon closer inspection.

Here are just a few:

1. The housing market is NOT like the stock market.

David Lereah (Chief Economist for the National Association of realtors):

“If the house down the street is up for $50,000, but sells for $450,000, does that mean that the next-door neighbor's going to sell their house the next day because they're nervous?”

Alan Greenspan (Former Federal Reserve Chief):

"Any analogy to stock market pricing behavior and bubbles is a rather larges stretch,"

This assertion seems to be made to substantiate the stability (or lack of volatility) of the housing market versus the stock market. On the face of it, it seems plainly true. People don’t (and can’t) just trade housing like stocks.

But what does this really say about price stability?

It’s important to remember that prices are set by the participants that ARE actually buying and selling not by the one sitting on the sidelines.

This is especially true for real estate where valuations are “fuzzy” and are generally based solely on comparing (i.e. “comps”) a particular property to others that have sold recently in the same neighborhood. In a down real estate market, a small number of transactions can force prices lower as sellers compete for fewer buyers.

This is why we are now seeing an increasing number of reports of neighbors getting into ugly squabbles with each other as they disagree over listing prices. All sales reflect on all other properties in the same neighborhood.

What is more, Sellers all have different interests, some can try to hold out for the top price, others want to cut and run but given the relatively low volume of transactions and the standard of “comping”, prices can be brought down dramatically while owners who don’t sell can only look on.

So, it is true that as the housing market continues to slow, some home owners can turn a blind eye and continue to live happily in there homes without giving it a second thought, but does that mean the housing market is less volatile than the stock market?

2. There is NO national housing market.

Michael Youngblood (Veteran Analyst of Friedman Billings Ramsey & Co.):

“The housing bubble argument is overblown, because there is no national housing market, so there can't be a national house-price bubble. However, there are bubbles in 75 of the 379 markets studied.”

Alan Greenspan:

"There is no national housing market in the United States. Local conditions dominate, even though mortgage interest rates are similar throughout the country. Home prices in Portland, Maine, do not arbitrage those in Portland, Ore. Thus, any bubbles that might occur would tend to be local, not national, in scope."

This assertion seems to be made generally to allay any fears that a deflating housing bubble might take the whole of the economy with it.

In most other eras, this statement seems to hold muster as there has apparently not been a housing correction that affected the whole of the United States since the Great Depression.

All the other well known housing corrections, such as Florida real estate bubble of the 1920’s and the east and west coast corrections of the late 1980’s were generally localized to specific markets.

In fact, in many parts of the country, the local real estate markets are considered to be “non-cyclical” as they have historically not shown the typical boom and bust pattern so well known to the coastal metro markets.

But what does this really say about the current housing bubble?

By many metrics, this current run-up is more exaggerated than any in history. In many major metro markets it’s nearing ten years since prices dramatically diverged from such basic fundamental factors as wages, rents and building costs.

By many industry insiders own admission, the real estate market surged in the “low interest” environment following the dot-com crash, and propped up the economy, creating jobs and wealth and thus preventing an even deeper recession.

It seems that almost every major metropolitan region of the United States, and frankly most of the rest of the industrialized world has experienced a similar dramatic run-up in housing prices over this period.

Are we to think that if all these “local” bubbles were to deflate simultaneously the economy would be able to easily absorb the fallout?

Additionally, the National Association of Realtors relies heavily on national housing numbers as a means establishing the state of the housing market in their periodic reports. Granted, they also produce regional numbers (east, west, central, south) but the national numbers are generally the “top line” numbers picked up and reported by the news media.

It seems obvious to most that changes in the national median home price might have little in connection with changes in the median price of one of the US’s more hyper-inflated cities such as Boston or San Francisco.

Why would industry insiders play both sides of the picture? That is, assert that there is NO national market when addressing the possibility of a housing bubble, but rely on national numbers when reporting on the status of the housing market.

3. The historic run-up in the housing market propped up the economy during the 2001 – 2002 recession, but won’t drive it in to recession as it deflates.

David Lereah:

“The recent U.S. real estate boom has made money for an incredible number of households in America. In fact, in 2001 and 2002, many economists (including me) claimed that real estate was the only sector propping up the economy and keeping it from full-blown free fall.”

“During the first four years of this decade (2000-2004), home owners and investors in residential real estate collectively enjoyed a $4.6 trillion increase in the value of their properties!”

“housing contributed to 68 percent of economic growth last year, which is just an incredible statistic. So can it support and prop up the economy?”

This one just seems to be an exercise in wishful thinking as the numbers are truly astounding no matter how you look at them.

Housing and related activities in the form of home construction, real estate transactions, banking, and other services accounted for 20% of GDP for every year since 2001.

As the pace of the housing market continues to slow, many industries in the sector will hit upon hard times. Home construction has already taken a significant beating that has yet to fully work its way through the general economy. Stories of stalled projects, massive cancellations, unpaid construction workers, layoffs etc. are just starting to emerge.

Only time will tell what the overall effect of the housing slowdown will be but it’s probably best, as a rule, to accept some downs with the ups.