This essay, more than most, is going to generate some controversy and criticism. But someone needs to say it.
You cannot call a bottom in housing.
First of all, calling a bottom or any major market change is virtually impossible. There have been a number of exceptions: Richard Russell called a bottom to stocks in late-1974, Marc Faber called the crash of 1987, etc. However, these exceptions are few and far between.
As my friend and veteran trader Bill King says, it’s like trying to predict a hurricane hit on a particular day. You can certainly predict nasty weather or the likelihood of a hurricane… but calling the exact day that a hurricane will develop is more luck than anything else.
Calling a bottom in housing is particularly difficult. In fact, it’s impossible. I don’t care how sophisticated someone’s analysis is or how impressive his credentials are… it simply cannot be done.
And I’ll tell you why.
The housing industry is driven by one thing and one thing only: banks lending money for mortgages. This idea is so simple, but 99.9% of analysts fail to grasp it. Housing is not a standalone industry. It is an industry that is funded almost entirely by another industry: mortgage lending.
I wish I could take full credit for this. But many of these thoughts came from another friend of mine, Pat McAllister. I’ve quoted Pat on these pages before. He’s spent over 15 years working in real estate and housing: first as a contractor, then as a homebuilder, and now as a consultant. Pat is one of the sharpest guys I’ve ever met. And his views are always based on common sense and data, not sentiment. Pat says:
“The whole issue today is about credit and money supply. What I hear from most homebuilders is not that the buyers aren’t there, but that the buyers cannot get the money for a mortgage. Your average potential buyer has very little in savings. Thus, he or she cannot buy a house without a bank’s help.”
Pat raises an interesting point. And it’s one I have yet to hear anywhere in the mainstream financial media. Analyst after analyst keeps trying to call a bottom in housing stocks… but no one ever bothers explaining how housing sales are going to pick up while banks are shoring up their balance sheets instead of lending.
As Pat puts it,
Pat’s dead-on here. Total 1Q08 mortgage origination fell nearly 30% from the year before. And government-backed lenders— Fannie Mae, Freddie Mac— now account for nearly 80% of US mortgage originations.Everyone complains about the price of gas, but you don’t need to get a mortgage to pay for gas. You can pay for gas out of your weekly paycheck. Housing is a whole other matter. No one can pay for a house out of their paycheck. They have to get a mortgage to buy a house. And until the banking situation improves, people are not going to be able to get mortgages, housing inventory will remain high, and homebuilder earnings will fall.
Put another way, the US mortgage lending industry is essentially now a government run operation. And Uncle Sam is demanding much higher standards and higher fees at a time when most consumers are already strapped for cash due to high energy and food costs.
Both Fannie Mae and Freddie Mac now charge a 0.25% up front fee on every mortgage they originate. They’ve also added additional fees that are contingent on your credit score. And on top of this, they’re demanding higher down payments.
Given that the average American doesn’t exactly have a ton of savings, it’s small surprise that mortgage originations have fallen off a cliff. As Pat said before: until mortgage originations pick up, housing inventory will remain high, and homebuilders will lose money.
It’s that simple.
If you want to predict a bottom in housing, you first have to predict a bottom in the lending sector. Given that big banks still have billions more in future losses to go, as well as the toxic waste in their Level III assets, derivatives, and the rise in defaults on auto loans, credit card loans and more, it is impossible to predict this. It’d be like hitting a bull’s eye in pitch darkness without ever having seen the target’s location to begin with.
So the next time someone tells you homebuilders have hit a bottom, ask them to explain to you where the mortgages that will allow homebuilders to sell houses will come from. The silence that follows may be a little awkward, but it sure beats listening to a load of nonsense.
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This article has 20 comments:
la
Interesting, so you're saying that the banks decided to shoot themselves in the foot by not making mortgages to buyers? Therefore the banks could reverse the housing bust by approving more mortgages for buyers? When does supply and demand enter the equation?
Maybe your article is just over my head, care to expand on your argument?
In 2-3yrs, those savings will meet price corrections of another 20-25% from here, and then we'll bottom, then continue to appreciate in housing... at about the rate of inflation.... like the previous 100yrs leading up to this bubble.
er
The lending industry is critical to a lot of the market, not just homes. Everything from car loans to mergers are being affected by lending constraints.
When there is a bottom in lending, it may take months or years for housing to pick back up, especially if the now inflation conscious Fed has raised rates back up to reasonable levels.
We have a negative savings rates, an inflated dollar, a massive oversupply of homes, a slow economy, and bleeding financial companies. All of this impacts the home builder end home buyer in one way or another.
~X~
Let me take a whack at this. WINNER WINNER WINNER! You're exactly right! Your statement goes to the heart of bailouts: they are market distorting, NOT market balancing. Slow pain over a long time, made worse by the fact that NO ONE KNOWS WHAT TO DO; where should I invest? Is now the right time to buy? Or are those jackholes in Congress or the Fed or the ECB or the CFTC or the SEC going to change the game, again, somehow?
How can ANYONE make sound financial decisions when truth doesn't matter? Everyone waits for or tries to anticipate the next regulatory intrusion or the next taxpayer bailout or the next Fed cash-for-trash lending facility.
When investing becomes a fool's errand...
What SWF in its right mind would flush cash at a US investment bank right now? They'd have to be nuts. Capital is frozen because everyone is trying to hide the truth, avoid the truth, or delay the truth, and investing requires truth, and some reason to believe that the rules won't be changed against you in the future.
Reality # 1: Mortgages are readily available to "qualified buyers".
Myth # 2: 20% downpayment is required.
Reality # 2: 100% financing is still available for low to moderate income borrowers and reasonably priced homes.
Myth # 3: Housing bubble was caused in large part by subprime lending.
Reality # 3: The housing bubble was caused by widespread speculation on perpetual increases in real estate value without evr seeing market corrections. When the market corrections occurred the subprime house of cards fell apart.
spenser
BTW, I think many (reasonable) people were able to call the market top fairly accurately here in Los Angeles. I believe my next door neighbor sold at the perfect peak, as I would have too, had I seen my home merely as an investment. Maybe this has lead to a false sense of ability on my part, but I do hope to be able to see when the market is near bottom.
Most people here seem to agree that the market has yet to bottom out, are you saying we are all crazy to think we can see that?
Impediments are:
Inability -difficulty-to sell their-(buyers)-house to raise down payment
Banks have borrowed from the Fed at low interest, however since they are "Liguid"-(pl... of funds), they are not "Solvent" too many bad and reduced assement loans on the books that could show they do not meet their reserve limits. Therefore they are holding the funds to bolster their reserves.
The Inability of small banks to factor mortages up the line as before due to the above. This means they will "hold" the responsibility-(risk)-... and therefore are imposing strict limits which many buyers cannot meet.
Add to the above a built in Buyer reluctance to move, as he sees prices continuing to drop and more supply coming into the market. He has to really 'want' this house, at the 'bargain' price offered to be motivated.
Builders are finishing up projects already in the pipeline with money invested-(to cut their losses), but are reluctant to start new projects that are not pre-sold custom jobs.
When the Banks-(Big) reach a point of solvency=legitimate reserves, or go out of business.
The river of foreclousures dries up.
The existing market supply draws down.
The economic job market and wages insure legitimate buyers.
A measure of value/- equity returns to existing homes.
Trust returns to both mortgage brokers and assessors, and they re-attain a solid reputation.
Then one may say the criteria for a resumption in housing value has been met=bottom of the bubble, it's history.
As usual Graham an excellent article. Brings to light a vital segment of the housing industry.
No one will be talking about housing. It'll be boring and passe!!
The World is just getting ready. I feel we are only now getting to the real beginning.
Anyone else agree?
User 151885, if you are saying that we may be near or at the bottom and looking for a leveling off and eventual recovery then I agree with you. I said as much on my blog last night.blog.metro-real-estate.../
I suspect, although I hope I'm wrong, that this housing situation is now spreading to other countries.
This will be a Global meltdown.
This will put us in balance with historical ratios, never mind falling below them.
Housing will not hit bottom until that reversion to the mean takes place. Perhaps inflation will raise other nominal measures to return the balance, but it still is fundamentally true that we have squandered trillions of precious capital by placing it in "non productive" fixed long term investments. (E.g. granite counter tops; media rooms; extra bedrooms and baths, etc.). This capital "investment" will produce negative returns for quite a while (unless cash strapped owners of McMansions start taking in boarders!).
Years of heading in the wrong direction will not change overnight. This is a world calls blunder for the ages! You may die of old age waiting for a bottom in housing.
The condition of offering cash for rent and the deal structure designed to best recover the principal put at-risk depends on the financial state of a bank and the state of the economy -- Efficiency of Money and change in buying power per unit of currency.
When banks suffer from weak financial condition, bankers must act most cautious and rent cash only to those with the highest demonstrated record to pay service on debt.
When the Efficiency of Money -- the ratio of money in circulation (notes, coins) to New Commerical Credit Opportunty -- falls Big Dollar Holders bet on claims to future resources.
When this happens, jobs disappear as businesses lack means to expand or maintain open transaction relationships.
Once jobs disappear potential Cash Renters lack a way to pay for Rented Cash (mortgage).
nation's terms of trade is the ratio of what it must give up to get what it imports. The easiest way to understand the concept, at least for me, is to think of the number of hours of work necessary, at the average national hourly pay rate, to buy a barrel of oil – a real variable compared to another real variable
When buying power of the currency unit falls, folks must give up more claims on their time to foreigners for imports and locals for foodstuffs. When then value of time for workers fall, workers can apportion less money to pay on debt.
The condition of offering cash for rent and the deal structure designed to best recover the principal put at-risk depends on the financial state of a bank and the state of the economy -- Efficiency of Money and change in buying power per unit of currency.
When banks suffer from weak financial condition, bankers must act most cautious and rent cash only to those with the highest demonstrated record to pay service on debt.
When the Efficiency of Money -- the ratio of money in circulation (notes, coins) to New Commerical Credit Opportunty -- falls Big Dollar Holders bet on claims to future resources.
When this happens, jobs disappear as businesses lack means to expand or maintain open transaction relationships.
Once jobs disappear potential Cash Renters lack a way to pay for Rented Cash (mortgage).
When buying power of the currency unit falls, folks must give up more claims on their time to foreigners for imports and locals for foodstuffs. When then value of time for workers fall, workers can apportion less money to pay on debt.