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If You Are in a Hole, Stop Digging
I often listen to CNBC when I am driving to work (if I am not on the
phone). I am amazed how often I hear (or read) about the bottom of the
housing market. Often we hear that the stock market is predicting the
bottom. I wonder if any of these cheerleaders actually looks at the
relevant statistics. Again, let's do some basic arithmetic so that even an
analyst can understand.
Yesterday we found out that new home sales are running at an annual rate
of 526,000, the lowest number in almost two decades. The supply of new
homes, in terms of the amount of time it would take to work through the
inventory available for sale was 8.4 months last October. It is now an
even 11 months. (source for data: www.weldononline.com)
How many homes did the home building industry start building last month?
Housing starts were running at an annual rate of 947,000. Permits for new
homes was 927,000. That means the industry is building over 400,000 more
homes than they are selling. Add in a million or so foreclosures. Kill the
subprime market. Really make it hard to get a loan securitized for
anything but government backed mortgages.
Home construction is going to drop precipitously before the inventory of
new homes is worked through. Those who are predicting a rebound this
quarter are simply not paying attention to the basic math. New home prices
are down 13.3% year over year. They are going much lower. Margins are
going to get squeezed. Now maybe the market is pricing all this in. But I
think there are better places to gamble than the home builders.
And More Write-offs to Come
And speaking of gambling, a few quick thoughts on the write-offs that we are
seeing in the banking industry. We have just seen the beginning of woes. We
are nowhere near close to the end, for three reasons. First, the estimated
amount of write-offs from the subprime crisis is now approaching $1 trillion
(courtesy of the IMF). We have seen (maybe) write-offs of about $250 billion.
Where is the other $750 billion?
Now, some of it – maybe even most of it - is in insurance companies, pension
funds and sovereign wealth funds. It will be years before we can even estimate
how much. There will be no press releases from the Central Bank of China
saying they are writing off $15 billion. Which pension fund investment
committee will announce their losses? We will only "see" it in lower
performance numbers.
But a lot is still in the banking system, having yet to be downgraded by the
rating agencies.
Secondly, the problems are spreading from subprime. Bill King called my
attention to this note from Housingwire.com. Quote (emphasis mine):
"Moody's Investors Service issued more Alt-A downgrades on Thursday morning,
this time taking a heavy hand to 32 different Aaa-rated tranches from 10
different Alt-A deals. Many of the downgrades even pushed former Aaa's into
non-investment grade categories - a stunning descent for top-rated Alt-A
mortgage bonds that underscores two key points.
"First, defaults are obviously accelerating. Second, many Alt-A deals were
issued with less in the way of overcollateralization - which, in plain
English, means that these deals will start to see downgrades sooner, compared
to the relative stress that a typical subprime RMBS deal can withstand before
the hits start coming at the Aaa level.
"The rating agency placed an additional 254
Aaa-rated Alt-A classes on negative ratings watch Wednesday."
Clearly the default disease is moving up into Alt-A loans. Do you think any
bank has written these loans off yet? There are more write-offs coming from
the mortgage space. It is not unrealistic that we could see as much (in total)
as we have already seen.
Third, we are in a recession. That means all sorts of business loans,
commercial real estate, credit cards, student loans, car loans and so on are
yet to default. Defaults on such loans are a lagging indicator. Those
write-offs occur closer to the end of the recession than the beginning and we
have not seen much of them yet. We will. Expect banks to continue to post ever
larger reserves for losses.
All in all, we are nowhere close to the bottom of the credit crisis. The cycle
of large write-downs and then going to the market for more capital is going to
continue for some time, perhaps longer than a year. Anyone who is putting
money in the financial stocks is gambling, not investing.
....
YET...some RE related ETFs/Funds are up 15-45% since the Jan low?
Sounds like another low is yet in the works?
