Thursday, August 31, 2006

'Exotic' mortgages seen losing their allure

einmal mehr ein bericht über die bei uns nicht vorstellbaren zustände in sachen kreditmentalität in den usa. die quituung kommt langsam aber sicher immer näher.
man muß die fakten wirklich zweimal lesen um zu fassen das es an der tagesordnung ist
(in bubblehochburgen sogar der reglefall) das kredite mit ner negativen tilgung verkauft werden.

Many homeowners with nontraditional loans are in for a payment shock


"Joe" is a homeowner who did not want to give his full name for this story because he’s ashamed to admit that he soon won’t be able to afford his monthly mortgage payments

In order to get the $800,000 house he bought early last year in California’s Silicon Valley, Joe got an “option ARM,” an adjustable-rate loan that lets him choose from a variety of payments every month. The smallest payment included no principal and less than 100 percent of the interest due. The unpaid interest was tacked onto the principal, creating “negative amortization.”

Joe is not an atypical homebuyer in the Bay Area or other now-bursting bubble markets across the country. Nearly half of the homebuyers and thirty percent of people refinancing mortgages in California chose interest-only loans last year, according to research firm LoanPerformance. The nationwide numbers are not so high — 32 percent for homebuyers and 20 percent for refinancings — but they do reflect the country’s increasing reliance on these so-called “exotic” mortgages.

Nationwide, approximately $400 billion of [home-purchase adjustable-rate mortgages] are scheduled to reset at some point in 2006," said Frank Nothaft, chief economist with Freddie Mac in McLean, Va. "A significant number of homeowners will face some adjustments." In fact, the ARMs with scheduled payment increases this year work out to about 5 percent of all single-family debt outstanding in the country now, he said.

Many of these mortgages carry negative amortization features that permit borrowers to pile on additional debt beyond their original balance, and make minimal payments for the first several years. Once the initial period is over, however, payments could shoot up by 100 percent or more as the loan resets.

To head off potential problems, Countrywide Loans, the largest mortgage originator in the U.S., has started sending out letters to thousands of its borrowers who have been making only the minimum payments on the company's pay-option ARMs

The letters contain hypothetical examples of what lay ahead. One is a California homeowner making only minimum payments on a $402,000 loan. The current full interest rate on the loan is 7.6 percent, but the borrower has been paying just $1,348.47, far less than what's needed to fully amortize the mortgage over its 30-year term. If the loan reset at today's rates, the full payment required would be $2,887.50more than double what the homeowner is currently paying.

O’Dette could afford a 30-year fixed mortgage on a home in the upscale Lake Tahoe area she lives in but instead chose a negative amortization loan with fixed monthly payments but an adjustable rate, currently at 7 percent. “So far, I’ve added $12,000 to my $900,000 loan, but the value on my home has gone up $300,000 since I took on the loan. If someone offered me $1.5 million on my house, that $12,000 extra is not much of an issue.” (bubblementalität)


analyse gdp zahlen usa / roubini

immer gut wenn man das ganze nochmal aus ner anderen perspektive zu sehen bekommt.
die headlines von gestern und heute in der finanzpresse hörten sich ja alle ganz wunderbar an.

kotrastprogramm gibt es von nouriel roubini
dank geht auch an mish und sein markettraderforum

Revised Q2 GDP Figures: Much Worse Than the Headline…Beware of the Spin Doctors


Beware of these spin doctors. Behind the headline figure, the numbers in the revised Q2 figures are much worse than the initial estimate. Essentially, almost all of the upward revision to the figures comes from a much larger increase in inventories of unsold goods, an ominous signal for future growth as firms saddled with unsold goods will soon start cutting production (as it is happening, for example in the auto sector). Indeed, if you exclude inventories and look at final sales, the figures are much worse: in Q2 final sales of domestic product grew only 2.3%.

The GDP growth improvement is also due in part to slightly better net exports but beware of this. The fact that now net exports are not anymore a drag on growth is also bad news, not good news: as the economy sharply slows down imports of consumption and investment goods are slowing down. Thus, the news from net exports is also lousy as it signals the coming recession: net exports improve when an economy slows down and worsen when the economy grows fast. Indeed, the figures about a fall in imports - a -0.1% in Q2 – are a clear indication that, as the economy is sharply slowing imports are falling.

The sharp increase in inventories is particularly worrisome since, as in any inventory cycle, an increase in such supply of unsold goods, is a leading indicators that firms will tend to reduce production when faced with slowing demand and rising inventories. So, higher GDP figures for Q2 via higher inventories means that – all equal – Q3 and Q4 figures for GDP growth will be worse than otherwise as a sharp inventory adjustment will occur; indeed, the Ford decision to cut production by over 20% in Q4 is a typical – if extreme - canary in the mine in terms of signaling how corporates will react to a sharp unexpected increase in inventories.

The new data also confirm that the bust in the housing market is even greater than initially estimated: real residential investment fell in Q2 at an annualized rate of -9.8%, much worse than the initial estimate of -6.3%. Given these revised figures I now expect that real residential investment will fall closer to a 20% annualized rate for the next few quarters.

The revised data also confirmed that corporate investment - in software and equipment was falling already in Q2 at annualized rate of 1.6%, even worse than the 1.0% reported in the first estimate of Q2 GDP; so much for the view that corporates will invest more as housing and consumption falter. Indeed, corporates may be full of profits and cash now but they do not see any good real investment opportunity as other components of demand are slowing sharply and inventories of unsold goods surging; thus, there is an unprecedented share buybacks bonanza, the largest in U.S. history, a signal of no god real investment options out there for corporate America.

And beware also of the rhetoric on profits and earnings. Based on the revised data, corporate profits in Q3 increase a mediocre 3.2%, down from 12.6% in Q1. Indeed the Q2 figures now show a sharp and worrisome increase in unit labor costs as Q1 employee compensation growth was revised much higher and Q2 was also revised higher. So, you can expect profit growth to become sharply negative once the economy slows down even more in H2 and enters into a recession in 2007. I will separately blog soon on the relation between recessions and the stock market and on what is happening to earnings; the perma-bull spin that earnings growth is still rapid is non-sense once you carefully dissect the data; the reality is that earnings growth is sharply decelerating now with ominous implications for the coming bear market in equities.

So, in summary the details of the new Q2 GDP figures are simply ugly and uglier than the initial estimate: much bigger inventories of unsold goods implying slower production and GDP growth in the second half of 2006; very slow growth of final sales that is down to 2.3%; actual falling investment in software and equipment; a modest trade improvement that is reflecting an economic slowdown; profit growth sharply down, sharp productivity growth slowdown and unit labor costs sharply up; anemic consumption growth and flat consumption of durables (and a worsening of consumer confidence based on current July-August data); negative growth of Federal consumption spending.

das ganze liest sich doch schon wieder ganz anders als die nackte headline. schon klar das nach diesen tollen daten die märkte weiter steigen.....


fallout / pier 1+ ethan allen+j.c. penney

der slowdown im immobiliensektor schlägt nicht überraschend voll auf die immobiliennahen bereiche durch. in diesem fall auf 2 einrichtungshäuser. die eigentliche news hier ist aber das der august wohl noch schwächer wie der juli war. das gleiche muster hat sich im vergleich juni auf juli wiedergespiegelt. der trend hat sich alo verstetigt und verstärkt.

Pier 1 Imports August same-store sales drop 9.1%

Pier 1 Imports, Inc. reported a 9.1% decline in August same-store sales, saying traffic trends remained below last year. But it added consumer traffic and sales improved during the last two weeks of August, which it attributed to marketing initiatives including new TV commercials. Analysts polled by Thomson First Call, on average, forecasted an 8.1% decline in same-store sales

ethan allen
"As indicated in our July 27th earnings press release, sales did start slowing in July and have slowed further in August. This quarter we are being impacted by both lower consumer confidence and our initiative, started last July, to reduce the lead time in filling customer orders. As we previously indicated, the faster backlog turnover reduces the forward visibility of delivered sales, and we are subject to more volatility as demand levels fluctuate.

J.C. Penney Co., Inc. said Thursday that sales at stores open for at least a year declined 0.5% in August, hampered by weaker furniture sales

J.C. Penney pointed out that sales of furniture were very strong in August 2005, creating a sales comparison that was difficult to overcome in the current year (bubbletop)

leider wird der rückgang in der erklärung nicht in prozenten ausgerückt. dürfte sich aber in ähnlichen größenordnungen wie oben bewegen.


england / uk

denke das sich hier die letzt zienserhöhung der bank of england noch nicht niedergeschlagen hat.
wenn man sieht mit welchen mitteln gearbeitet wird um die preiese weiter auf diesem niveau zu halten kann man an einer hand abzählen das es hier bald zu ersten rückgängen kommen muß.

Nationwide survey shows U.K. house prices rose 0.8% in Aug

LONDON (MarketWatch) -- British building society Nationwide said Thursday that U.K. house prices rose 0.8% in August, bringing the annual growth rate to 6.6%. The pace of growth was unchanged from July, when annual house price inflation stood at 5.9%. The average price of a U.K. home now stands at 167,721 pounds (249.000€, 320.000$), the Society said, compared to 167,733 a month ago


Wednesday, August 30, 2006

Commercial Construction is Booming

meine meinung ist eher das sich hier der nächste bubble aubaut

Commercial Construction is Booming
By Tony Contributor8/30/2006 9:14 AM EDT

Commercial construction activity is currently very strong. This is evident in the revision to the "structures" component of the gross domestic product, which was revised this morning to show an annualized gain of 22.2% in the second quarter instead of the 12.7% gain that was previously reported. The gain was the largest since 1994 and the second-largest of the past 25 years.

The data underscore the notion that gains in commercial construction activity will help to mitigate weakness in residential construction. The dollar gain in commercial construction was $13.3 billion, which helped to largely offset a $15.8 billion decline in residential construction.

The commercial construction sector has lagged significantly during the current economic expansion, with activity still well below the peak set in 2000. The current rebound in commercial construction activity is hence in its early stages and will probably continue for many more quarters, given the recent uptick in rental demand.


china erhöht foreign-currancy ration

ein weiterer versuch der lage herr zu werden

China Raises Foreign-Currency Ratio to Ease Pressure
By Christina Soon
Aug. 30 (Bloomberg)


China ordered lenders to increase the amount of foreign-currency they hold at the central bank for the first time since 2004, limiting cash available for investment and easing pressure on the yuan to strengthen.

Banks must keep 4 percent of their non-yuan deposits as reserves, compared with 3 percent currently, according to a People's Bank of China circular to the country's banks, obtained by Bloomberg. The reserve ratio takes effect from Sept. 15, according to the notice.

The requirement will reduce the supply of dollars circulating in a nation with $941 billion of currency reserves, the world's largest, slowing gains in the yuan. The government wants to avoid inflation and control the country's investment boom, which spurred the economy's 11.3 percent growth in the second quarter and caused commodity prices to soar.

The move ``is to contain domestic borrowing and upward pressure on the yuan,'' James Malcolm, a currency strategist at Deutsche Bank AG in Singapore, said today. ``It's another step in a series of recent tightening measures that we've seen.''

The foreign-currency reserve ratio was set at 3 percent in November 2004. Foreign banks previously had to set aside 5 percent of foreign-currency deposits with a term of less than three months, and 3 percent of those with longer maturities.

By increasing the reserves, the central bank will be able to reduce about $1.6 billion of funds from the financial system, the newspaper said. Financial institutions had an excess in liquidity of about $161 billion of foreign deposits at the end of June, it reported.

Growth in China's foreign-currency reserves will still help strengthen the yuan, said Liang Hong, senior economist at Goldman Sachs Group Inc. in Hong Kong.

``The decision will indirectly help to lower yuan appreciation pressure,'' Guo said. ``China doesn't want the currency to rise in one step. Yuan gains will continue, but they will be gradual.''


preise fallen in 82% aller märkte

es scehitn so als wenn sich der abschwung im august ungebremst fortgesetzt hat.

dank geht an ben und calculated risk

Aug Home Data Weak; Market Wonders If Stocks Reflect Downturn

08-29-06 01:30 PM EST
NEW YORK -(Dow Jones)- Sales and home prices fell at a faster clip than expected and inventories climbed further in August as the housing market continued to deteriorate, according to a Banc of America Real Estate Agent survey.

And market experts believe the housing downturn will likely last longer than homebuilding stocks currently reflect.

The study, released Tuesday, shows consumer sentiment toward buying a home soured in August.

"Consumers are shifting from a mindset of waiting for a better price to one where they do not want to buy at this time, no matter what the price is," the study said.

"We think this shift in sentiment is particularly worrisome, as it could take time before the mindset shifts back and could lead the downturn to last longer," Banc of America analyst Daniel Oppenheim said.

The study also found that prices fell sequentially for the 11th consecutive month. Prices tumbled in 82% of the markets surveyed. In July, only 79% of the surveyed markets fell.

The use of incentives continued to rise, hitting record levels. The study found that incentives were used in lieu of price decreases whenever possible in weak markets, but that incentives were also used in healthy markets to allow builders to increase volume and market share.

The amount of inventory rose in all markets, except Austin, in August. The inventory of existing homes for sale reached 3.86 million in August, up from 2.15 million in January 2005.

The latest inventory level would take 7.3 months to sell at the current pace, and Banc of America analyst Dan Oppenheim expects this inventory supply could reach nine months before next spring.

Oppenheim said the survey shows prices, incentives, selling times and traffic were all worse than real estate agents had expected. "We expect that conditions are likely to worsen further through the fall/winter and into next spring," he said.

"We think this excess inventory makes it unlikely that the market will rebound in the near term," he added.

Raymond James analyst Rick Murray said the study backs up his finding that consumer sentiment has definitely shifted.

"Consumers are just of the mindset at this point that it is not the time to be buying a home and this becomes increasingly problematic for housing," Murray said.

"Inventory levels right now would suggest that this downturn is probably going to last a period of years as opposed to quarters," the analyst said.

He doesn't believe the stock prices reflect this longer-term downturn.

"We would argue that the stocks are not pricing in the prospect that this could be a very prolonged downturn similar to some that we've seen in past cycles," Murray said.

He said homebuilding stocks are currently trading at about 1.2 times book value, which is "far above where valuations have troughed in past cycles." During the housing crash of the late 1980s and early 1990s, valuations fell to 0.6 times book value. (harmoniert irgendwie nicht mit dem barrons artiekel vom wochenende, oder?

Mike Eckerman, founder of Residential Asset Management, a real estate investment company, said the "unrealistic appreciation" in home prices in certain major markets over the past few years was unsustainable. So he isn't surprised by the pullback.

He said it's investors with a day-trading mentality, who want to flip properties for big profits after a few months, who are being hit hardest. He said housing still remains a good long-term investment........






WASHINGTON (MarketWatch) -- The number of applications for mortgages dropped 0.9% last week as interest rates bounced off a five-month low, the Mortgage Bankers Association reported Wednesday.

The number of applications for home purchases fell 1.6% to the lowest number since November 2003.

Applications for refinancing an existing loan inched higher to a five-month high.

Applications are down 22.4% from a year earlier -- a reflection of the weaker real-estate market.

Loans to refinance existing mortgages accounted for 41.5% of total applications last week, up from 40.6% the week earlier. It's the highest share for refinancings since February.

Adjustable-rate mortgage applications increased to 26.8% of total loans, up slightly from 26.4% the previous week

von calculatet risk

Purchase activity continues to fall and is at 2003 levels. August 2006 purchase activity is off 21.7% compared to August 2005. Year-to-date purchase activity is off 12.9% compared to 2005 and appears to be getting worse.

man kann gespannt sein wie sich ggf. die verschärfung der richlinien auf die hypothekenanträge auswirken wird.


regulierung subprime

nachdem das kind in den brunnen gefallen ist .......

man kennt das ja. jetzt endlich und viel zu spät soll der amok gelaufene kreditmarkt zur ordnung gerufen werden. dürfte den verfall der immobilienmärkte wohl weiter beschleunigen. letztendlich muß man zudem abwarten was nachher tatsächlich in die tat umgesetzt wird. bisher hat sich die lobby noch (fast) immer durchgesetzt.

Dodging A Bullet

A band of five government regulating agencies led by the Comptroller of the Currency, appear likely in the next 60 days or so to pour cold water on the hot--and lucrative--nontraditional mortgage loan market adored by banks and mortgage brokers. These include the popular, but deadly interest only and pay-option adjustable rate, in which borrowers decide each month how much to repay.

The proposed guidelines--meant to be used by bank examiners--will address high loan-to-value, low documentation and other underwriting criteria perceived as too risky by regulators and even some industry participants. That means lenders would need to explain the loan more carefully, require higher down payments and better scrutinize borrowers’ income.

Mortgage insurers are egging on regulators to finalize language "in part because the most recent market trends show alarming signs of ongoing undue risk-taking that puts both lenders and consumers at risk," Suzanne C. Hutchinson, executive vice president of the Mortgage Insurance Companies of America, wrote in a July letter to regulators. Hutchinson cited first quarter data that indicate interest-only and pay-option mortgage products now account for 26% of loan originations, "a sharp increase from last year," she noted.

Non-traditional mortgage products are most popular in states with the strongest home price growth, according to data collected by the FDIC. Little surprise then that investors (speculators, really) comprise 15% of the borrowers in this niche market. While some on this playing field may be financially savvy borrowers with low credit risk, regulators have concluded "lenders have targeted a wider spectrum of consumers, who may not fully understand the embedded risks but use the loans to close the affordability gap."

ISI Group's Laperriere cautions that the government's new rules will reduce demand for mortgage credit--hurting bank profits.

"Tightening underwriting guidelines and requiring delivery of excessive disclosures to consumers may stifle innovative product development before we have evidence that these products are actually detrimental to either consumers or the financial institutions that offer them," Cindy Manzetti, chief credit officer of Fifth Third Bancorp (nasdaq: FITB - news - people ), wrote recently to regulators. Manzetti's letter did point out that her bank does not offer pay-option mortgage products.

Richard Kenny, president and chief executive of Charles Schwab (nasdaq: SCHW - news - people ), urged regulators not to paint all nontraditional mortgages with the same broad brush.

A letter from Countrywide Financial Corp (nyse: CFC - news - people ). disputed regulators' assessment of risks, saying payment-option adjustable mortgages have been tested in previous economic cycles and are fundamentally sound loan products.(war ja auch nicht anders zu erwarten )

According to his letter to regulators, Lehman Brothers' (nyse: LEH - news - people ) general counsel Joseph Polizzotto thinks the proposed guidance is too prescriptive and does not fully consider all factors relating to payment shock.

Sure, industry rarely welcomes enhanced regulation. But bankers' resistance ignores another political risk of a damaging drop in housing. In addition to high-risk mortgages creating potential credit losses, Laperriere foresees a "significant political backlash as consumers blame the lenders for deceiving them about the risk of those loans."

Don't expect politicians on Capitol Hill to react in a more forgiving way.


Tuesday, August 29, 2006

trouble in bankland

dank geht an fred hopper und ben sowie bloomberg

Citigroup, Bank of America, JPMorgan Squeezed by Bond Market


Aug. 29 (Bloomberg) -- Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. are among the biggest losers in the bond market, where the largest U.S. banks' relative borrowing costs are the highest in three years

A slowing economy has prompted investors to demand an additional 11 basis points of interest, or $1.1 million for each $1 billion face amount, on bank bonds since February, according to data compiled by Merrill Lynch & Co. The widening yield premium amounts to a loss of $7.3 billion on bondholders' principal the past six months and a profit squeeze for banks, which make money on the difference between their borrowing and lending charges.

Bank bonds, which account for almost one fifth of the $5.2 trillion U.S. corporate bond market, are heading for their worst year since 1999

Slower growth may cause bond defaults to quadruple by 2008, adding to bank losses, Standard & Poor's says.

The total return on the bank index, including both capital appreciation and reinvested interest, is 1.64 percent this year, the worst since it declined 1.73 percent in 1999.

A slowing economy also may cause a growing number of borrowers to default, requiring banks to set aside more money for losses and leaving less for debt payments. Defaults will rise to 4 percent from their current record low of 1.03 percent by the first quarter of 2008, according to S&P. should also read this / solltet das ebenfall lesen,

``We're probably at the top of the mountain for loan quality, and it's going to start falling pretty soon

Investors now demand 23 more basis points in yield over government debt, or 1.36 percentage points, to hold Countrywide's $1 billion of 6.25 percent notes than when they were sold in May (no wonder / kein wunder )

Higher borrowing rates have contributed to shrinking lending margins, a measure of profitability. S&P said earlier this month that those margins are at their lowest since 1991.

Citigroup's net interest margin, the difference between the average rate the bank pays to borrow and what it charges in interest, fell to 2.8 percent in the second quarter, the lowest since at least December 2000.

``We view a future deterioration in credit quality as pretty much inevitable,'

``Banks will tighten their lending standards by increasing loan spreads and by simply refusing to lend to some at any spread,'' said Paul Kasriel, director of economic research at Northern Trust Securities, in an e-mail on Aug. 18. ``This, in turn, will create even more drag on economic growth

Debt deemed uncollectible by U.S. banks fell to 0.4 percent of all loans and leases in March, the least since before 1985, according to the Fed. Borrowers defaulted on high-yield, high- risk, or leveraged, loans at a 3.2 percent rate in the first quarter, down from 10 percent in 2002, according to S&P.

Atlanta-based SunTrust Banks Inc. was stuck with a non- performing $200 million loan because the borrower's business deteriorated before the bank had a chance to sell the loan to investors, said Richard Bove, who follows the bank for Punk Ziegel & Co. in Pinellas Park, Florida

``SunTrust is definitely a bellwether,'' said Tanya Azarchs, managing director and coordinator of global research at S&P in New York. ``We're going to see a lot more of this.''


consumer und die "reale" nicht "core" welt





WASHINGTON (MarketWatch) -- U.S. consumer confidence weakened sharply in August, the Conference Board said Tuesday. The consumer confidence index fell to 99.6 in August from a revised 107.0 in July. This is the lowest level of confidence since last November, when hurricanes battered the southern United States. The fall was sharper than expected. Economists expected the index to drop to 102.7 from the initial estimate of 106.5 in July. Expectations for inflation in the next year rose to 5.5% from 5.1% in July. This is the highest level since last OCtober


first horizon / fhn regional bank

fakten zu first fhn:
Mortgage banking, one of the nation's top 25 mortgage
originators and top 15 servicers,

First Horizon's profit to drop on mortgage slowdown

First Horizon National Corp. said trends in its mortgage business "foreshadow approximately a $1 billion reduction in originations and deliveries" during the third quarter. The Memphis-based banking institution also said "further deterioration" is in the mortgage environment, thereby reducing pre-tax operating earnings by about $35 million compared to the second quarter. The drop reflects in part a pinch on First Horizon's gain-on-sale margins as well as higher net hedging costs. In addition, settlement of a class-action lawsuit is anticipated to create a third-quarter pre-tax accrual estimated at $21 million, the company said. "Although we currently expect some modest improvement in mortgage banking in the fourth quarter, the current operating environment suggests that mortgage banking operations will only be in the range of breakeven," the company added.

to be continued.......


top of the flagpole stuck into an iceberg

mal ne andere sichtweise die sich in erster linie mit dem innenleben und der organisation eines homebuilders auseinandersetzt. wie vorher schon bemerkt kennt das management/divisionsleiter bisher oft nur einen bullamarkt und ist in der jetzigen phase vollkommen orientierungslos. das mag evtl. auch eine erklärung für die im monatstakt getutzten prognosen und warnungen sein.

dank geht an txchick57 und ben sowie

Housing Industry’s Hidden Cracks
By Dan Contributor

Last week I wrote about the homebuilding sector, an industry that has been getting a lot of attention lately. But after spending much of the weekend looking at what various homebuilding analysts have been saying, I am convinced that some critical issues are being overlooked. The homebuilding industry is unique in many ways, with essential intricacies that matter only during significant downturns in real estate — like the one we’re in now.

The “lead down, lag up” nature of housing is just one factor that pundits and the public alike are ignoring. I’m also concerned about the lack of downturn experience among the bull-market babies who currently make up the executive ranks among homebuilders. And because they haven’t seen these issues before, they’re creating housing-price problems that will have nasty fallout. Worst of all, most Wall Street analysts just aren’t picking up on any of these issues.

First Down, Last Up

I’ve seen this before. I began my career in the homebuilding business back in 1984. By 1989, I was managing the Las Vegas division of a private homebuilder. One summer day, people just stopped buying houses. While the economy was just starting to weaken, somebody turned off the spigot on real estate. During the worst of it, many owners were simply giving their homes back to the bank because the house was worth less than the principal balance of the loan.

People didn’t start buying homes again for another few years, not until the economy had already turned around. This is an important point for anyone looking at this sector to understand: The homebuilding industry has always been the first sector to crack in an economic downturn, and the last to repair itself. This should be intuitive. People make big purchases — and a home is the biggest — when they feel secure, not when they’re nervous. As a result, the homebuilding industry leads on the way down and lags on the way up. It’s a fact of the business.

Since the early 1990s, we haven’t seen a deep pullback in real estate. Yes, we experienced some stagnant real estate values from 1998 to 2000, but the FOMC quickly came to the rescue with cheap money. The 9/11 attacks also put homebuyers on the sidelines and converted many homeowners into sellers. Over the next 16 months, the Fed again dropped rates to historic lows, and the homebuilding bull market continued — until about a year ago.

Staffing Issues

Now that the industry is struggling, a lot of deficiencies inherent in the business are once again relevant. Over the past several months I have outlined my current take on the industry, noting the high cancellation rates, the rising cost of raw materials and the futility of valuing these companies using current projections. I believe that the analyst community is overlooking some critical problems that will become more apparent over the next couple of years.

Homebuilding is the only business I know that relies heavily on information from its divisions with respect to product selection. While the corporate executives must approve all land purchases, product design and pricing, they rely on recommendations from their division officers. But few division executives have meaningful experience in dealing with a real slowdown in the industry.

I recently finished some consulting work for a public homebuilder at which the executives were all quite bright and strong in their divisional roles. But they weren’t at all aware of the macro picture because they lacked a frame of reference. Many had advanced degrees, but most were only in their 30s. Only a couple had been in the industry during the bear market of the early 1990s, and in relatively low-level positions. Those who were around during 1998-2000 or the post-9/11 slowdown considered themselves battle-hardened veterans. A few acknowledged that all of their experience had been gained during strong markets.

These bull-market babies were providing the corporate office with market studies, pro formas and product recommendations. Why? Because experienced executives long ago discovered that cheap money and ample demand for homes made it easy for them to start their own homebuilding companies. Their departures cleared the way for the newer staffers to move up the chain of command and shine during a spectacular bull market. But the bulls have stopped running, and the folks now at the helm are about to learn what happens when they do.

The older execs I know unanimously believe that 2007 will be much worse than 2006, and that 2008 will not be any better than 2007. As for the newer staffers and younger whiz kids with diplomas on their walls? The overwhelming assumption from that group is that 2006 is a really rough patch, but that the ship will be righted in 2007 and the next up cycle will begin. Consider this anecdotal evidence of the unwarranted confidence of today’s decision-makers: One vice-president recently told me, “Oh, this slowdown won’t be nearly as bad as it was back in 1990.” This “old warhorse” was in high school back then.

How Prices Really Get Set

The less experienced staffers on the front lines don’t understand the dangerous battle they are in, yet they’re the ones making key decisions. They continue to set high sales prices, but the bid-ask spread remains obscenely wide.

I recently heard an analyst touting the idea that sales prices have stabilized, meaning absorption rates were really the critical component. That’s just wrong. Sales prices have stabilized only because divisions are refusing to drop them. They want their 2006 bonuses, and that certainly will not happen if they start selling houses for a loss. So they hold back cancellations to give the impression that the price floor is firming up. It’s not.

In today’s market, most division officers are on edge. They fear division consolidation, or outright termination, due to poor performance. Their livelihood depends on capital allocation for new subdivisions. No money, no new subdivisions. No new subdivisions, no job. So they shade the numbers they submit to corporate headquarters. Here’s how they do it.

The division hires an outside consultant to provide an independent market study to present to corporate headquarters along with each new land-acquisition application. The recommended prices support the division’s profit projections for the project.

But these “independent” consultants are often pressured by the division officers to inflate their pricing recommendations, thereby making the project more attractive. A $20,000 per-unit adjustment can be the difference between approval and rejection.

Because of the belief that we are simply experiencing a brief slowdown, this dangerous tactic is used with alarming frequency. Remember, most of these optimistic real estate execs have no firsthand experience in a severe cyclical downturn, so their naïveté is leading them down a very slippery slope.

Another tactic for making new projects more attractive is to build inordinately large homes to justify the high sales prices. Theoretically, larger homes command higher sales prices. But homebuilders in Orange County, Calif., are finding out that few folks are interested in homes that are bigger than 3,000 square feet. That’s a problem when the only way to make your profit projections work is to build 4,200-square-foot homes. But a favorable market study goes a long way toward convincing the corporate land committee to approve the acquisition.

What’s Next

I believe that over the next several months we’ll start hearing about builders slashing sales prices by more than $100,000. This is already occurring Orange County; we’re just not hearing about it yet.

All builders subscribe to a local marketing report that provides monthly updates on pertinent data for all subdivisions in the region, including concessions offered. These data are obtained by calling the sales office and simply asking the sales agent for this information. But the sales agent would shoot himself in the foot by being honest; why tip off the competition that you are slashing your prices? The numbers in the local marketing report are rarely accurate.

But these price reductions are occurring, and they are bound to produce negative consequences far beyond a hit to the bottom line. First, appraised values will be impacted. This will anger recent homeowners. Over the next six months or so, I suspect that we’ll begin to see many homeowner lawsuits against the builders over those reductions. They’ll allege bad faith, fraud, misrepresentation and any other cause of action that the plaintiffs bar can think up to coerce the homebuilder into refunding the equity that just got vaporized by the latest round of price cuts. In essence, they’ll want a retroactive price adjustment. These high-profile lawsuits are likely to create even more hesitancy and suspicion among potential homebuyers. It’s a vicious cycle that is just in its infancy.

Builders also are simply walking away from land deals — forfeiting millions of dollars in nonrefundable deposits. These deals often are included in a division’s unit projections for the next several years. When these deals go away, anticipated sales revenue goes with them. Unless a division is able to replace a canceled acquisition with a new deal, earning projections must be revised downward. Most Wall Street analysts seem to limit their analysis to the multimillion-dollar deposits being forfeited and believe the worst of these forfeits is behind us. I’m more focused on the void left in a division’s business plan when it cannot find a viable deal.

Analysts and commentators have repeatedly mentioned that share prices of most homebuilders have dropped around 40% over the last several months. For example, since July 2005, Pulte (PHM) is down 40%, Toll Brothers (TOL) is down 55%, Centex (CTX) is down 38% and Ryland (RYL) and Beazer (BZH) both are down 50%. In my analysis, this is not even relevant. The market is a future-discounting mechanism, not a rearview mirror. The bull market in real estate values hid a lot of sins at the divisional level, but I think that dynamic has faded. That said, I am cautious about being too bearish in an already bearish environment.

But I think we are barely seeing the top of the flagpole stuck into an iceberg. In trading terms, this has been a blow-off top in housing, and all those who bought over the last couple of years are now sellers. Simply put, no one is left to prop up the bid.


in australien haben 66% der vermieter haben neg. cashflow

für uns hier in deutschland unvorstellbar. in den ländern die bereits länger im bubblefieber sind aber der regelfall. mietrobjekte die mit negativen cashflow/gearing erworben werden. ziel einzig und allein die wertsteigerung. klassisches spekulationsverhalten und sicheres anzeichen einer blase. mir hift dabei immer unheimlich der blick auf deutschland das zum glück nicht im "bubblmode" ist.

ich kenne keinen investor (die letzten private equity transaktionen mal ausgenommen) der auf die idee kommen würde mietobjekte zu erwerben ohne das ne entsprechende (positive) rendite dabei herausspringt.

oder stellt euch mal vor ein geschlossener immobilienfonds probiert ne platzierung mit nem negativen cashflow. irrwitzig.

in den bubbleländern bei fast allen objekten die in den letzten jahren erworben worden sind der regelfall.

in australien ist es zudem so das genau dieser umsatnd durch steuergesetze noch gefördert wird.
zudem werden wertsteigerungen niedriger beseteuert.all das bedeuerte den boom immer weiter. nun endlich sollen diese vergünstigungen eingedampft werden.


Safe as houses no more

Renting out housing has become Australia's most unsuccessful business

the long surge in investor housing in Australia has been driven essentially by a cocktail of tax breaks. The negative gearing rules allow investors in effect to push part of their losses onto other taxpayers. And the tax break on capital gains means that when they sell, they pay only half the tax on profits that they would face on wages.

After all, negative gearing has a lot wrong with it as an investment strategy. For a start, it involves losing money. Even in 2003-04, preliminary tax figures show, 938,000 rental owners declared losses of $6.1 billion.

Given rising interest rates and house prices since, by now they are probably losing $10 billion a year. That's a lot of money to throw away

Renting out housing has become Australia's most unsuccessful business, and by a long way. Two-thirds of landlords now tell the taxman they are losing money, and while some may be lying, most probably aren't.

A lot of today's housing investors could face years of operating losses without ending up with much in capital gains

Reserve Bank governor Ian Macfarlane told The Age last week that property prices in parts of outer Sydney had fallen by 20 to 30 per cent since 2003. "A lot of small-time investors who came in in 2002 and 2003 are probably way under water," he said.


mehr zu australien:

bank of england zur "core" inflation

wie wahr! ziemlich entlarvend, oder?

BoE hits at US inflation measure

The US Federal Reserve is wrong to focus on core measures of inflation that exclude energy prices, Charles Bean, chief economist at the Bank of England, has suggested.

It should focus instead on headline inflation, which is much higher, he argued. Including energy and food costs, US consumer price inflation is running at an annual rate of 4.1 per cent, against 2.7 per cent for core inflation.

Mr Bean told the Fed’s annual Jackson Hole symposium at the weekend that energy prices were rising for the same reason the price of many manufactured goods were falling: the rise of China and other emerging market economies. Since both price trends had a common cause, he said it makes little sense to focus “on measures of core inflation that strip out energy prices while not stripping out falling goods prices as well.”

Mr Bean did not mention the Fed by name but his implication was clear. Fed officials, including chairman Ben Bernanke, typically talk about measures of core inflation excluding volatile food and energy prices, which they say better predict future headline inflation.

Central bankers in Europe take a sharply different approach. Both the Bank of England and the European Central Bank put greater emphasis on talk of headline inflation, which includes the immediate “first round” effect of rising energy prices.

The Fed has tended to treat the rise in oil prices as a step change to a new equilibrium price level, which in itself does not generate ongoing inflationary pressure. It focuses on trying to prevent the “pass through” of higher energy costs to consumers in the form of higher prices for other goods and services.

But the Bank of England and the ECB increasingly take the view that energy prices may be on a long-term upward trend, driven by industrialisation and urbanisation in China and India.

denke das ohne die "core" interpretation und ner fast nicht vorhandenen realverzinsung die usa schon lange in ne handfeste krise gerutscht wäre. frage ist nur ob die langfristigen auswirkungen dieser "core" weltansicht die die fed exclusiv hat nicht schädliche sind. wenn man den us konsumenten fragt der ständig reale lohnverluste einzustecken hat dürfte die antwort eindeutig ausfallen.


Monday, August 28, 2006

japan / usa

die zahl des tages kommt aus japan. dort sind die grundstückspreise um 0,9% gestiegen. das ist der erste anstieg seit dem platzen der japanischen immobilienbranche im jahre 1991.

aus dem economist:

Japan provides a nasty warning of what can happen when boom turns to bust. Japanese property prices have dropped for 14 years in a row, by 40% from their peak in 1991. Yet the rise in prices in Japan during the decade before 1991 was less than the increase over the past ten years in most of the countries that have experienced housing booms (see chart). And it is surely no coincidence that Japan and Germany, the two countries where house prices have fallen for most of the past decade, have had the weakest growth in consumer spending of all developed economies over that period. Americans who believe that house prices can only go up and pose no risk to their economy would be well advised to look overseas.

denke das zeigt ziemlich eindrucksvoll wie lange ne erholung dauern kann. im prinzip braucht man sich da auch nur den chart des nasdag anzusehen........

wenn man davon ausgeht das die ganze geschichte in den usa ähnlich ablaufen wird erscheint vor allem das ganze gerede in sachen soft landing, colling down usw. als totaler unsinn.

besonders der hinweis gestern in barrons bezug auf die homebuilder das diese aufgrund ihrer bewertung zum buchwert für valueinvestoren interessant sein wird mit dem beispiel japan widerlegt. da der hauptwert der builder in den rieseigen landpositionen liegt und es in japan 14 jahren einen verfall und erst im 15. jahr einen neuen anstieg gegeben hat macht doch weitere massive abschreibungen sehr wahrscheinlich.


quote of the day / zitat des tages

dank ghet an kim und ben

Comment by Kim
2006-08-28 06:42:15

......This is just what some friends of ours did. They have a house in San Diego that they bought many years ago. (They moved to the Seattle area several years ago) Last year they put it on the market and when it did not sell they refinanced and took out as much equity as they could, which I believe was 300-400k, and used the equity to pay the bills they had run up while the husband was establishing a business and this past April the wife told me they were planning to invest in RE here with the remaining money. I told here about the RE bubble, but she said that her husband was also a RE agent (in addition to his Tax accounting business) and he knew all about the RE market. Now they have bought a run down 6 unit building at what we will probably later know as the top of the market here, plus they have their house in San Diego so they are poised to lose everything they gained and then some. Just last week the husband commented to us that they had paid 100K for college for their son and that was why they were invested in RE; because it is the only asset that appreciates enough to pay for the high college costs. I wanted to mention that in that case it was strange that no one used to think of doing that, all my life (I’m 48) until now I have never heard anyone say

I need to buy some RE so that we will have money to pay for our kid’s college expenses,”

but I knew it would’t do any good now since they have already bought so my husband and I just didn’t say a word in reply and the conversation moved on to other subjects.

so weit ist der ständig steigende immibilienpreis schon in gedanken und im handeln verankert gewesen.


fundstück des tages

dank an barry ritholtz marketbeat.


with more than 3,700 companies reporting, net income growth on a year-over-year basis was up 12%

However, the growth in the first quarter was much broader than in the second, when energy and financials ruled the roost. Energy companies have recorded 50% growth in net income, while financials grew by 19%. Exclude those two groups, and net income is down 1.1%, in part due to significant dropoffs in basic materials (down 12%), consumer goods (off 11%), health care (37% lower) and technology ( down 4%), and a 13% decline in telecommunications.


creative (enron) acounting medicare

aus der wochenendausgabe von barrons. schon dreist wie hier teilweise auf plumpe art versucht wird das defizit optisch aufzuhübschen. besonders gefällt mir der hinweis das ceo´s für solche vergehen lt. sarbanes-oxley dafür hinter gittern kommen würden.

dank geht an barry ritholtz

dazu auch/more on enronacounting in the

...... Let's get to the heart of the matter. Our advice is simple: Don't get sick in the last nine of the days of Uncle Sam's fiscal year; and if you're already sick, for gosh sakes, don't get sicker. Especially if you happen to be a geezer, or have the bad luck to be disabled.
This exhortation is not based on any new medical research or even quack notion, and it has absolutely nothing to do with any seasonal blips in the incidence of disease. Instead -- and here's the beauty of it -- it springs from cold, hard logic, derived from last week's disclosure of some smarmy accounting sleight of hand that the Bush administration plans to indulge in so as to make Medicare's deficit look better this waning fiscal year. Just the kind of manipulation, incidentally, that under Sarbanes-Oxley can land a slippery CEO or chief financial officer in the pokey.

The bureaucratic brainstorm was straightforward -- simple-minded is, perhaps, a more appropriate description -- don't pay doctors, hospitals and their army of auxiliaries tending to indisposed old folks and the afflicted disabled for their labors in the last nine days of the current fiscal year. Instead, send them a check for what you owe them, sometime after the first of October, the start of the government's fiscal '07. In essence, those doctors, hospitals et al. are making an involuntary loan of nine days' pay without interest.

That way, point out the gleeful budgeteers and Medicare pooh-bahs, all of whom presumably are glowing with health, Uncle Sam's Medicare tab this fading fiscal year will be $5.2 billion less than it otherwise would have been. Or at least would seem to be $5.2 billion less -- in Washington, as we all know, appearance and reality are not invariably the same phenomena.
Of course, this oh-so-clever stratagem would mean that next fiscal year's Medicare bill will be $5.2 billion more than it would have been. But, not to worry, those indefatigable financial watchdogs in the Office of Management and Budget and their henchmen in the uppermost reaches of Medicare are on the case. And we have every confidence that next year they'll make up for any untoward increases in costs by ceasing to send checks to doctors, hospitals et al. in August or even July, if necessary.

It's never too early for the prudent sickie to begin to prepare for the worst and do everything in his or her power not to allow his or her condition to grow worse toward the end of the fiscal year. Get used to waiting until the start of the new fiscal year before letting it all hang out.
For it ineluctably follows that the doctors and their cohorts might feel some inhibiting hesitation about putting in an often onerous day's work for the promise of payment later. In the circumstances, who can blame them if they decide en masse to shut down their offices for the summer? And wasn't it the president, himself, after all, on an earlier occasion, who pointed out that government IOUs are just pieces of paper?..........


eight market spins by perma bulls plus reality check

in der tat tauchen genau diese 8 punkte in fast jeder argumentationskette der "bullen" auf.
hier werden sie wenn auch sehr ausführlich und nicht für alle leser neu in die einzelteile zerlegt.
Eight Market Spins About Housing by Perma-Bull Spin-Doctors...And the Reality of the Coming Ugliest Housing Bust Ever….

Nouriel Roubini Aug 26, 2006
recent detailed analysis of the high risks of a housing-led recession in 2007 has stirred some serious discussions and debates in the blogosphere and the press. Now that the onslaught of bad news about housing (see the table below) has taken the force of a tsunami that will soon trigger an ugly recession, Goldilocks spin-masters and perma-bulls are on the defensive. Since the housing slump is now undeniable – and rather than a slump it looks like a really ugly bust - the new line of defense of perma-bulls is to argue that the problems of the housing market are only a healthy correction from bubbly excesses, that housing is only in a modest slump that will soon bottom out and recover, and that housing problems will not lead to wider macroeconomic troubles such a broad recession. What a set of Delightfully Delusional Dreams that smash against the ugly reality of recent free falling housing data shown in the table below.

This free falling bust in the housing sector – that I warned about in my last paper - was indeed colorfully depicted today by David Rosenberg and by Steve Roach, as cited in the FT: "New home sales are now down 22 per cent year-on-year, which is a swing of gargantuan proportion from the plus 26 per cent trend exactly a year ago - this is the weakest trend in a decade," said David Rosenberg, North American economist at Merrill Lynch. "The only thing 'orderly' out there right now is the guy carrying the stretcher." Stephen Roach, chief economist at Morgan Stanley, added: "America's housing bubble finally appears to be bursting." He said a post-housing bubble shakeout could take at least two percentage points off the overall US gross domestic product growth rate.

Indeed, in a matter of months, the gravity-defying housing boom and bubble turned into an alleged “orderly slowdown”; then, the orderly slowdown turned into a euphemistic “soft landing”; and next, the soft landing slipped into a “slump”; most recently, the slump worsened into a hard landing; while the latest data suggest that the hard landing recently turned into a bust. And soon enough this housing bust will turn into a rout and an unprecedented meltdown. To paraphrase the witty Rosenberg, soon enough the only thing “soft” and “orderly” about the collapse of a comatose housing market will be the undertaker carrying the coffin.

As the onslaught of data about the disorderly housing meltdown is piling up, even evergreen perma-bulls such as the WSJ op-ed page are now in defensive and semi-panic mode and are attacking “not-so-cool economists” (what does that is supposed to mean? that you need to be “cool” or hip to be right? what a stupid remark from a WSJ op-ed page that is starting to nervously sweat about the coming recession and is losing its own well-groomed “cool”) that worry about a housing-related bust; but then, the same WSJ op-ed page goes on to warn about the housing slump and blaming only the Fed's past loose monetary policies for the ugly hangover from the housing bubble (more on this below).

I have analyzed in detail in my last blog why we will soon have a housing related recession; these views have been widely picked in the press, most prominently by Paul Krugman in his Friday column in the NYT. While, as Krugman correctly points out, I may be the only “well-known” economist who is arguing that we will have a housing-led recession, many other very prominent economists – including Krugman himself as well as Ed Leamer (who calls a soft landing scenario a “fantasy”), Jim Hamilton (see also here) and Bob Shiller (who predicted the tech bust stock of 2000 and is now predicting a housing bust) – are now of the view that there are serious risk of a housing market bust that could then have macro consequences.

Then, whether this housing bust will lead to a recession or not is the only remaining uncertainty: Krugman himself does not yet share my “certainty” - as he puts it – about a recession but, short of that certainty, he is fully of the view that the housing bust will be “ugly” and has some risks of triggering a broader economy-wide recession. So, the “Shrill Order of the Reality-Based Reputable Eeyores” is growing by the day and I am proud to be in company of such distinguished academic and non-academic colleagues.

For now, since a lot of spin is being furiously spinned around – often from folks close to real estate interests - to minimize the importance of this housing bust, it is worth to point out a number of flawed arguments and misperception that are being peddled around. You will hear many of these arguments over and over again in the financial pages of the media, in sell-side research reports and in innumerous TV programs. So, be prepared to understand this misinformation, myths and spins.

in the rest of this blog below I will thus deconstruct and unspin eight commonly heard spin arguments on why we should not worry about the coming housing bust.

Continue reading this blog right below...

Spin #1: Housing prices are not falling, have never fallen and will not fall

Some folks are still deluding themselves that home prices have not fallen yet and that they will not fall in the future. Indeed, since the Great Depression of the 1930 we have not had a year-on-year fall in median home prices, as opposed to some quarters in which home prices were falling. But now median existing home prices are only 0.9% up relative to a year ago and new home prices are only up 0.3% relative to a year ago. Worse, actual median home prices are falling – on a y-o-y basis - in every US region with the exception of the South. They are even falling in the Mid-West where, allegedly, there was not housing bubble to begin with.

Worse, as the NYT was reporting today, home sellers are now providing a variety of financial benefits (seller paid closing costs, buyer-side realtor bonuses, and seller subsidized mortgages, even $30K swimming pools free) that effectively reduce the price of a sold home, even if the headline price is officially not reduced: “The typical incentive package from a home builder consists of upgrades to the house — granite countertops instead of humdrum tiles, stainless-steel refrigerators and stoves instead of plain white models and wood blinds instead of plastic. At the extremes, some have thrown in $30,000 swimming pools.” Estimates of this effective price cut – via side benefits to buyers – are in the 3% to 8% range. So, while officially median home prices are “only flat” relative to a year ago, the effective median price has already sharply fallen. And if you were to control for CPI price inflation – now running above 4% - home prices are even lower in real terms relative to their nominal value. More ominously, futures contracts for home prices predict a 5% fall in home prices in 2007, and even a larger percentage fall in a number of key cities. It is now clear that, for the first time since the Great Depression, even official - i.e. not fudged by side incentives and subsidies - median home prices will be falling on a year on year basis; the typical lag in the adjustment in home prices to a gap between supply and demand and an increase in inventories of unsold homes will be trigger for this home price bust. On a year on year basis, real home price may fall as much as 10% or even more.

Why would prices fall so much if we have never had – since the 1930s – a year on year fall in median home prices? The reason is clear: part of the increase in prices in the last few years was not due to fundamentals but, rather, to a pure speculative bubble. Thus, once this bubble bursts the reduction in speculative demand that had lead to a sharp increase in the supply of new homes well above any fundamental demand, must need to an actual sharp fall in the prices of the previously bubbly asset. If there had not been any new supply response above fundamental demand, the bursting of the bubble would have led to a smaller price response. But since the initial bubble led to a glut of new housing whose support was only the speculative demand, the final bust requires a sharp fall in price and this fall in price is greater than otherwise: once fundamental demand falls, the real price of homes must be lower than before the bubble started as the increase in supply during the bubble was much greater than the increase in fundamental demand. So, over time the cumulative fall in home prices over the next two years may actually be very large. And, indeed, in the most bubbly regions of the US, home prices are already starting to fall – in real terms – at double digit levels.

Spin #2: We have never had in US history a recession that was initially triggered by a housing bust. So, it cannot happen this time around

This spin goes in a number of varieties. One version of the argument is that housing busts are usually the consequence of a recession triggered by other factors; i.e. it is claimed that an exogenous shock in housing has never been the initial cause of a recession. Others argue that the housing slump can lead to a recession only if there are other major shocks in the economy, such as a war or oil supply shock like in 1974 or 1990. But my argument about a housing-led recession has always been based on the fact that multiple bearish shocks – high oil prices, the delayed effects of the increase in short and long term interest rates, in addition to housing – have been buffeting a US consumer with falling real wages, negative savings, falling confidence and rising debt and debt servicing ratios. So, while the housing bust is necessary to tip over the US consumer, it is not the only factor that will trigger the coming recession. Also, while it is true that housing may not have been the initial trigger of a downturn in past recessions, it is also true that past recessions – namely the one in 2001 – have been triggered by an asset bubble that went bust.

In the 1990s, the tech stock bubble – in part fed by a Greenspan complaining about “irrational exuberance” but then wimping out and doing anything about such a bubble – led to a massive over-investment of new capital spending in tech goods (computers, IT networks, style internet companies, internet-related capital goods, etc.). This super-glut of capital goods first led to the tech stock bust in the Nasdaq in 2000 when it became obvious that these investments had low returns; then it lead to a bust of real investment in software, equipment and machinery as the massive glut of capital goods and excess capacity led to sharply falling investment rates for four years (from 2000 until 2004) to run down such excess capacity in the economy.

In the last six years a similar bubble – an even more massive one – has taken place in the housing market and has led to a boom and bust cycle that is qualitative identical to the tech boom and bust of the 1990s. Initially, higher and higher home prices – fed by easy Fed policy, speculative demand and a most favorable tax treatment of housing – first led to a price bubble, then to a sharp increase in the supply of new housing, and finally to a glut of new homes. At the beginning of this cycle, expectations of rising prices made speculative demand for homes even higher, in a typical bubble fashion. But eventually you had a fall in housing demand as speculative high prices and rising interest rates (that came too slow and too late) made the purchases of housing less affordable to many. More recently, the growing gap between rising supply and falling demand led to an inventory adjustment – an increase in unsold homes. Next, you had a sharp fall in the stock prices of homebuilders – by almost 50% by now - as the demand for their new homes started to fall and their profits started to shrink. Then, most recently the reduction in the production of new homes – as signaled by sharply lower housing starts and building permits – ensued as homebuilders with falling revenues and profits and lower expected demand finally reacted to the growing glut of unsold inventories. Finally, we are observing now the unavoidable price adjustment with an actual fall in actual housing prices as the glut of unsold homes is now putting sharp downward pressure on actual prices.

So, and this is a crucial point, most US recessions have been triggered by a turnaround in real investment. In most cases this fall in investment started in non-housing sectors – and was triggered by a variety of economic shocks - but then spread to the housing market once the economic slowdown got underway. But in the 2000-2001 episode, the actual initial trigger for the slowdown was not a severe monetary tightening (even if the Fed did hike interest rates by 175bps between 1999 and 2000) or a severe oil shock (even if oil prices rose from low teens to high teens in 2000): it was rather the bursting of the bubble and the bust of the tech sector – first the stocks, then the real investment – that led to the recession. So, bubble cycles can and do lead to booms and busts that then cause recessions – in the US and abroad. The reaction of the Fed to the tech bust of 2000-2001 then generated the housing bubble of the last five years in a new cycle of boom and bust. So, the crucial point is not whether exogenous shocks to housing have ever led to a recession: the crucial point is that recessions triggered by bursting assets bubbles have occurred – most recently in 2000-2001 and will occur again this year as the housing bubble is imploding.

In a previous longish paper (“Why Central Banks Should Burst Bubbles”) and other writings, I have analyzed and criticized in detail the asymmetric Fed approach to asset bubbles that is the source of these booms and busts. In the view of Greenspan, Bernanke and Kohn the Fed should never target asset prices and should not try to prick an asset bubble for two reasons: you are not sure there is a bubble in the first place; and trying to prick an asset bubble is like attempting to perform “neurosurgery with a sledgehammer”, i.e. the treatment will always be too harsh and kill the patient, i.e. economy. Thus, the Greenspan-Bernanke view is that you do nothing when bubbles fester on the way up and then you aggressively ease monetary policy when bubbles burst, since such falling bubbles risk to cause severe real, not just financial, damage to the economy. This asymmetry is the source of the Greenspan-Bernanke “put” and the moral hazard that this asymmetric insurance has created in financial markets: let bubbles fester on the way up, do nothing about them and then pick up the debris and shelter investors from the free fall when the bubbles burst. Speak about moral hazard. This is what happened in the tech cycle of the 1990s and the same bubble cycle was created in the last few years in the housing market. We will now see whether Bernanke will try to rescue the housing market with aggressive Fed easing. Certainly, the next Fed move will be a cut when – in the fall or winter - the signals of a US recession become even stronger than they are now. Unfortunately, the Fed is running out of bubbles to be created and allowed to fester.

Thus, the “not-so-cool” but “perma-bull” WSJ op-ed page has it partly right and mostly wrong: right in pointing out that the housing bubble was in part triggered by the Fed easing too much and for too long and starting to tighten too little and too late. Mostly wrong because: a) it supports the now flawed view that the Fed should not target asset prices while sounding the usual and tired gold-bug style alarms about the risks of inflation that are allegedly priced into the high asset prices of a barbaric relic such as gold; b) it has been pushing the Fed to keep on tightening monetary policy now when the coming recession will already reduce inflation; c) deluding itself in believing that a recession is now avoidable, even more so if the Fed were to follow the senseless advice of the WSJ and keep on raising the Fed Funds rate when the economy is spinning into a recession. <>So, in summary, it is a spin to argue that housing alone cannot trigger a recession. The tech bubble and bust did trigger a recession in 2001; and the housing bubble and bust will trigger a deeper and nastier recession next year than the one in 2001: as I have analyzed in detail in previous writings the effects of the housing bust will be more severe and intense than those of the tech bust because the aggregate demand, wealth and employment effects of housing are much larger than those of the tech sector. So, this will indeed be the first housing-led recession and the second-in-a-row bubble-led recession in six years. Also, as in all the US recessions since 1973, this investment bust – in most cases first in non-residential investment and consumer durables – in this case first in residential investment and consumer durables – will be the combination of three similar factors: 1. shocks that hit investment, be it bubbles or other factors; 2. a monetary tightening; 3. an oil shock. This has been the pattern in every recession since the 1970s and it will be the same pattern in the recession of 2007.

Spin #3: In spite of the housing slump, the levels of activity in the housing market are still very high relative to a few years ago. So, there is now housing bust, only a healthy correction.

Whenever I present on TV my views on a housing-led recession there is a pundit or anchorman or guest expert that shows a few colorful charts of the housing markets and spins: “Yes the housing market is correcting and housing starts and sales and all other indicators are now falling BUT they are falling from very high levels; for example, housing starts are still in the millions! LOOK: all these indicators were sharply rising year after year and now they are only softening downwards; their absolute level is still high relative to three or four years ago! SO, this is only a healthy adjustment from some modest excesses!”

These arguments are total nonsense for various reasons: 1. if an indicator that is at a high level is falling at an annualized rate of 10, 20 or 30% - as many housing indicators are now - there is still a housing bust regardless of the previous level: when first and second derivatives show an accelerating fall, this is a bust and levels may, in due time, go back to the previous lower level of a few years ago. 2. in a rising economy where economic growth is positive, every real economic indicators heads up over time given the trend growth of the economy: GDP, employment, consumption, real estate data, etc., they all do. So, every economic times series looks like a rising chart given the underlying trend in the economy: if you chart GDP over the last 60 years you see a straight line up where you can barely notice – only by using a magnifying lens – the dozen or so recessions that did occur during that period. Indeed, in a long term chart of the level of GDP these recessions look like barely noticeable ripples in a increasing line. Still, when you get a recession GDP falls and that fall – however short – is ugly and painful for jobs, incomes and the economy. <>So, saying that housing indicators – while now sharply falling - are still high or higher than previous levels is spin: of course they are still higher as long run economic growth, demographic change with population growth and migration and a big huge bubble for the last decade made them go higher and higher for years for fundamental and non-fundamental reasons. Leaving aside periods of housing busts (and we have had many of these busts in the last 60 years), the direction of all housing indicators – like any economic indicator - is an upward trend line. Thus, even after we had a nasty housing bust this year and next year, the level of housing indicators will be higher than they were in 2000 or 1990 or 1980 or 1970 as you got trend growth and trend population growth; this is basic Economics 101 that I teach daily to my students. And, as any student of Economics 101 well knows, what matters for busts and recessions – when you have trend growth - is not the level of a variable compared to past historical levels: what matters is the direction of change: a protracted fall in the level of a variable represents a bust in that sector and, if that bust is at the aggregate level, you call that a recession.

Jim Hamilton at Econobrowser takes on the same spin arguments about the level of activity in housing still being high in spite of the recent falls. He says: “Dave Altig at Macroblog [1], [2], another source that's always worth reading, thinks the gloom and doom has been overdone. Dave notes that even with a drop back to 2003 levels, home sales per person are still at historically high levels, a point also noted by Bizzyblog and some Econbrowser readers. I must say that I don't take much comfort in that. The bigger the preceding surge in construction, the bigger the overhang that might now have to be worked off. I certainly don't see much in the historical record to suggest that the more dramatic the prior boom, the more modest was the subsequent bust. Just the opposite-- 1929 (the year the Great Depression began) started out as a tremendous boom, as did 1973, which preceded the biggest U.S. recession since World War II.”

In summary, beware of misleading charts and arguments allegedly showing that housing indicators are still at high levels, even when the tail of these charts looks like a free falling death-defying sky slope with a slope close to 90 degrees.

Spin #4: If the housing bust gets ugly, the Fed will ease rates and rescue us from a recession.

This spin-masterful wishful dream pins its hope on the Fed coming and rescuing the economy from a recession if the housing bust were to affect the broader economy. Indeed, as I have been arguing from an out-of-consensus line, the next move by the Fed – this fall or winter – will certainly be a Fed Funds cut, certainly not an increase. This cut will be triggered by signals that the economy is experiencing a hard landing and risking a serious recession. Indeed, even before such a cut, the changed market mood about the Fed next actions – so far a change in expectations from a Fed “pause” to a full “stop” – has already led to a meaningful reduction in US long rates and in mortgage rates that could, in principle, dampen the recession risks.

However, as I have argued before, such Fed easing will not rescue the housing market and will not rescue the economy from a now unavoidable recession. The Fed easing will not prevent a recession for the same reasons why the Fed pause and easing in 2000-2001 did not rescue the collapse in investment in the tech sector. The reasons why the Fed cannot rescue housing and the economy are clear. First, Fed policy in 2001-2004 fed an unsustainable housing bubble in the same way in which the Fed policy in the 1990s fed the tech bubble. Now, like then, it payback time: with huge excess capacity in housing (then in tech capital capacity) even much lower short and long rates will not make much of a difference to housing demand. Real investment fell by 4% of GDP between 2000 and 2004 in spite of the Fed slashing the Fed Funds rate from 6.5% to 1.0%. Does anyone believe or can show that a 50bps or even 100bps easing by the Fed will undo the housing investment bust that is coming in the next two years? No realistic way: when there is a glut of excess supply of capital goods or housing stock or consumer durables, the demand for such durable consumption or investment becomes interest-rate insensitive. When there is a glut of capital goods or consumer durables or housing as there is one now, easing monetary policy becomes ineffective as it is like pushing on the proverbial string.

Second, a Fed easing in the fall may be too small - at most 50bps cut by Q1 of 2007 - and will have too little of an effect on long rates to be able to affect the debt servicing ratios of debt over-burdened households. Also, long rates will not be affected much by a Fed ease for the same reasons – the global conditions that determined the 2004-2005 “bond conundrum” – why a Fed tightening did not affect long rates in the recent experience. Some easing by the Fed will have a little downward effect on long rates; indeed, long rates have recently fallen as markets have started to price in the fact that the Fed is done with tightening. But, if inflation were to actually rise further because of oil and other stagflationary shocks, long rates may actually go up if an excessive Fed easing would likely cause increases in long term inflation expectations. Since we are still facing potentially stagflationary shocks, while the Fed will cut the Fed Funds rate during the coming hard landing, the Fed can ill afford to ease too much as too much easing will be counterproductive for bond rates and for housing. Thus either way households, burdened with ARMs and overburdened with increasing housing debt at the time when housing prices are slumping and now falling, can expect little relief from lower short rates or long rates. The Fed just cannot rescue housing; it can only very modestly dampen its protracted multi-year free fall.

Indeed, in 2000 the Fed stopped tightening in June 2000 (after a 175bps hike between June 1999 and June 2000). That early pause/stop did not prevent the economy from slowing down from 5% plus growth in Q2 2000 to close to 0% growth in Q4 2000. Also, the Fed started to aggressively ease rates – in between meetings in January 2001 – when it dawned on the FOMC that they had totally miscalculated the H2 2000 slowdown (they were worrying about rising inflation more than about slowing growth until November 2000 when it was too late). And this aggressive easing in 2001 did not prevent the economy from spinning into a recession by Q1 of 2001. This time around you will get into the same pattern: today’s 5.25% Fed Funds rate reflects the effects on the economy of a Fed Funds rate closer to 4% given the lags in monetary policy and the effects of past tightenings in the “pipeline” (as Bernanke and Yellen put it recently). So, pausing or stopping now will not help (like the June 2000 pause/stop did not help) and easing in the fall will be too late, in the same way in which the aggressive easing in early 2001 did not help.

Spin #5: Credit conditions in the housing market are not tight. Credit growth is still perky and there is no credit crunch. So, unlike the past, there will be no hard landing

A further spin is the argument that a housing bust and a wider economy-wide recession requires tight credit conditions, while current credit conditions, in the housing market and more generally in the economy, are not that tight. It is true that past recession have been usually caused – in part – by a sharp tightening in monetary policy and tighter credit conditions: the Fed tightened by 175bps between 1999 and 2000 for example; by that standard, the current 425bps tightening by the Fed in the last two years is larger even if, of course, what matters is the level of nominal – or even better – real interest rates.

Using a core measure of inflation, real rates are not so low for borrowers – even in comparison to conditions in 2000. And for homebuilders now facing falling prices of the goods they are selling – i.e. homes – the real borrowing rate is now extremely high as home prices are now falling. Thus, the reduction in the real price of housing is a severe credit crunch for homebuilders and contractors who are facing a fall in the relative price of what they are selling at a time when there is a glut of new homes: no wonder that building permits housing starts are in free fall (-21% and -13% respectively relative to a year ago).

More importantly, you do not need a credit crunch in order to get an investment bust; if an investment bubble has led to an excess supply of an real asset relative to its fundamental demand, eventually the bursting of such a bubble will lead to a fall in the speculative and fundamental demand for such an asset, regardless of a credit crunch: a modest monetary tightening is enough to burst such a late-stage bubble (a bubble at the late stage when overpricing is so excessive that small shocks are enough to prick the bubble) and trigger a sharp fall in the real investment in such a capital good. The perfect example was 2000-2001 when a 175bps tightening by the Fed between June 1999 and June 2000 was enough to first prick and then burst a tech stock price bubble – that had led to the overinvestment in tech capital goods - and lead to a sharp fall in real investment (by 4% of GDP between 2000 and 2004). The same is happening now with housing: the 425bps tightening by the Fed has finally burst an overinflated housing bubble that was getting out of control with ever rising rate of increase of housing prices.

The crucial conceptual point - that is essential to understand why the housing bust will lead to an economy-wide recession - is that it is not necessary to have a severe monetary tightening or a severe credit crunch in order to have the bus of an investment boom that was initially triggered by easy money and an unsustainable bubble. Once a modest monetary tightening - or any other shock that prick the bubble - does occurs, the investment bust can occur even without a credit crunch. That is what happened in 2000-2001 with the tech stocks and the tech goods real investment; and that is what is happening today with the bursting of the housing bubble.

In other terms, a housing-led recession can well occur even without a credit crunch. In the case of a bursting bubble, the demand for credit – rather than the supply of credit – is most important and a reduction in the demand for credit can be associated with a bust. Indeed, recent lending indicators - both for housing and consumer loans - are also headed south. While the supply of credit is not getting tighter based on recent surveys, the demand for credit by firms and households is sharply slowing. Of course, the slowdown in the demand for home mortgages is related to the housing slump. But now you are also seeing lower demand for C&I loans; this suggests that investment spending may be falling ahead, as already signaled by Q2 data on real investment in equipment and software. The fall in the demand – rather than the supply - of mortgage financing is also very clear in the data: while overall mortgage applications are still up in the latest figures published this past week, due to sustained refinancing applications, applications for purchase applications have fallen 1.0% during the last week, for the fifth time in the last six weeks. Moreover, there is a large amount of evidence that suggests increasing cancellations of initial mortgage applications, as the slump in the housing market and in the economy is now scaring households considering buying a home. Thus, the official data on purchase mortgage applications are very likely to exceed actual home sales as cancellations increase over time.

Also, note that the demand for home equity withdrawal (HEW) will be sharply down soon enough as the housing price flattening is turning into an outright fall in average housing prices (as such prices already falling in most of the U.S. regions). And with lessened HEW, the ability of households with negative savings to consume more than their incomes - as they have been doing for two years with negative savings - will be severely curtailed.

Finally note that, soon enough, credit conditions in the housing markets will become tighter as an increasing number of homeowners – pinched by falling home prices, rising mortgage servicing obligations and weak income growth - will be unable to service their mortgages and will end up defaulting on them. Indeed, H&R Block stock price plunged on Friday by 8.7% on news of large losses and loan liabilities related to rising mortgage delinquencies at its Option One Mortgage unit: the problems result from an increase in mortgage customers who have fallen behind on loan payments. Not surprisingly, other sub-prime mortgage lenders’ stock prices got a beating on Friday following the H&R Block news and the news that a California home lender reported higher default rates.

These news are ominous as the housing bust will very soon lead to a sharp increase in default rates on mortgages (see more on this below) and will, in short order, lead to a credit crunch in the housing market. Thus, while until now there has been no credit crunch and most of the action has come from a falling demand for housing credit, once default rates start to skyrocket - and they will soon – you can expect a widespread credit crunch in the housing sector that – like in the late 1980s – may eventually spread to the rest of the economy. Indeed, there is a meaningful risk that – like in the S&L crisis of the 1980s – the housing bust will lead to the collapse of a large number of mortgage finance institutions and a broad banking crisis (more on this risk below).

Spin #6: Given the increase in housing prices there is still so much net wealth (equity) in the housing sector that most households are richer, will keep on feeling richer and will keep on spending more.

The “there is still trillions of untapped equity in housing” spin goes along the following lines: “Doom & Gloom Eeyores worry about all the debt – now well above their incomes - that households have been piling up in the last few year with new mortgages, refinancing and consumer credit but, in spite of this larger debt, the increase in the value of their housing, has led to a sharp increase in households’ net wealth; so, there is still tons of untapped equity in housing and this untapped wealth will support home equity withdrawal and consumption; so there is little risk that the housing bust will lead to a consumption bust and a recession”

This spin can be deconstructed in many ways. First, is the increase in housing prices a true positive wealth effect? Or just a factor that leads to a loosening of the credit constraints that then allows households to use their homes as an ATM machine or as a credit card? The wealth effects of an increase in housing values are more ambiguous than the wealth effects of capital gains on financial assets, as households also consume the services of such housing.

An example may suffice to clarify the problem of treating housing price increases as a true wealth increase. I bought a loft in downtown NYC three years ago whose value has gone up by 125% (an exact figure – not a guess- as it is based on the recent purchase of an identical loft above me by a celebrity). Do I feel richer and should I consume more as I am wealthier by 125%? The simple answer in no: if I wanted to cash the capital gain I would have to sell the loft and buy another one with the same amenities and features; but I will be paying the same higher price for the new loft to get the same housing services; so no wealth effect. So, I am not wealthier in spite of a lofty 125% alleged “capital gain”: what has happened is that the price of my consumption of housing services has increased by 125% in the last three years; I am not richer: I am just paying more for the same housing services in my now overpriced loft.

There are two counter-arguments to my argument that rising home price are not a true positive wealth effect. First: “You could sell at the high current price, move to Idaho, buy a much cheaper home and enjoy the capital gain; so you are richer!” Of course, that counter-argument is nonsense: I want to live in NYC and enjoy the amenities of this city life; so I am paying more for my housing service when the value of my loft goes up; I am not richer. Indeed, the recent sharp increase in “owner equivalent rent” – after years in which this contribution to CPI inflation was biased downward – is a reflection of the fact that - as home prices have skyrocketed and made housing unaffordable to first time buyers and forced them to rent homes rather than buy them - now rents are rising and this implicit increase in the real prices of housing services is, finally, correctly reflected in our CPI measure of inflation.

Second counter-argument: “If home prices are so high relative to rents – and indeed the home price rental ratio was sharply up in the last few bubbly years – you should sell, rent a home with similar features and then enjoy the capital gain; so you are indeed riche!r” This argument is also flawed in many ways: a) it is true that many non-owners who could not afford the crazy and rising home prices of the last few years have decided to rent rather than buy and this is now pushing rental prices sharply higher; so the disequilibrium in the relative returns and costs between owning and renting is now shrinking as rents are adjusting upward; so this ownership-renting arbitrage is disapperaing; b) it is hard to find for rental a home with the same amenities and features of a home that you purchase; c) there are a lot of sunk costs involved in owning a home and thus selling and moving to rental does not make sense: home ownership has psychic benefits and it also has positive social externalities’ benefits that many studies suggest; also, buying a home includes investing a lot in home-specific durable good purchases (furniture, home appliances, décor and design of a home) that are not easily and costlessly transferable to a rented unit. So, in practice – given all these sunk costs and benefits of owning - almost all of the homeowners do not sell and move to rentals when the home-price to rental ratio is in disequilibrium and out of line. They rather pay a higher price for their consumption of housing services. So, they are not richer: in some sense, they are poorer as they are paying more for the consumption of the same housing services.

Of course, I do not want to argue that all increases in housing wealth coming from an increase in home prices are not a true wealth increase. Some of it may be truly perceived and be an increase in net worth; I am just saying that it is not conceptually so clear that most of it is a true positive wealth effect as housing is an asset whose return is represented by the consumption of its own services. Also, some older households eventually retire and go to cheaper housing location or sell and downsize the size of their home to a smaller one when their children have left home; so they can benefit of some of the capital gain. But for many households – including myself – the recent increase in housing prices is not a true increase in wealth.

So, the next question becomes: why would households borrow so much more – as they have done in recent years - against their increased housing wealth when home prices go up – and spend it on consumption - if most of this price increase is not a “true” wealth effect? The answer is twofold: first, there may be some degree of wealth illusion and some households that downsize are actually able to benefit from a “true” capital gain; second, even if a household is not truly wealthier, a paper increase in the value of the home allows a households to reduce its credit constraint in the capital market: i.e. a household is able to borrow more against this alleged increased “home equity”. So, what an increase in home prices does it to loosen the credit constraints of households, both how much they can borrow as well as the interest rate at which they can borrow as the collateral of housing wealth reduces the cost of such borrowing relative to the cost of uncollateralized borrowing (say credit card debt).

Thus, households that
are credit constrained and whose incomes are not rising fast enough to keep up with their increased consumption patterns re increasingly borrowing to be able to keep on spending above their incomes. Indeed, as households’ savings rates having been negative for the last two years the only way households could consume more than their incomes was to use their homes as their ATM machines, i.e. running their debts via refinancing and other increases in consumer debt. Note that running down assets rather than increasing debt – to finance an excess of consumption over income - does not work for most US households as their liquid assets are small and as most their assets are in highly illiquid forms (housing and investments in 401k plans and other retirement savings plans that – given their tax-deferral advantages – are effectively highly illiquid).

Indeed, in 2005 out of the $800 billion of Home Equity Withdrawal (HEW) at least $150 or possibly $200 billion was spent on consumption and another good $100 billion plus went into residential investment (i.e. house capital improvements/expansions). The rest of it was used – most likely – to manage household assets (increase buffers of liquidity) and liabilities, i.e. reduce the stock of uncollateralized high-interest debt in exchange of lower interest rate housing-collateralized home equity loans or refinancings. But this massive amount of recent refinancing and HEW means that it is enough for house price to flatten, as they already have done recently, let alone start falling as they are right now in major US housing markets, for the wealth effect to shrink and for the ability to borrow to be reduced; then, the HEW will dribble down to much lower levels than in the recent past and consumption growth will sharply fall and possibly stall.

Would the fact that households still have a large amount of untapped housing wealth untapped imply that they can and want to further withdraw such equity and sustain their previous consumption patterns? No for several reasons: First, note that this year there will be large increases in the borrowing costs for $1 trillion of ARMs that will be re-priced and this figure for 2007 will be $1.8 trillion. As short-term interest rates have sharply increased in the last two years, this repricing of low interest rate ARMs will imply sharply increasing payments on past mortgages and refinancing loans. Thus, debt servicing costs for millions of homeowners will sharply increase this year and next as $2.8 trillion of mortgages will be repriced.

Second, many households do not have much housing equity to begin with. In fact, as recently argued by Lon Witter in Barrons (hat tip to Ritholtz for this), 32.6% of new mortgages and home-equity loans in 2005 were interest rate only, up from a figure of 0.6% in 2000; 43% of all first-time home buyers in 2005 put no money down and thus had no initial equity in their homes; 15.2% of 2005 buyers owe at least 10% more than their home is worth (in other terms they have negative equity); and 10% of all home owners with mortgages have no equity in their homes (in other terms, they have zero equity).

Moreover, the expected fall in home prices that is currently occurring implies that the existing home equity is actually shrinking over time. Worse, a combination of increased debt, increased interest rates on these home mortgages, falling real wages – especially for poorer households – and shrinking home equity (that for many may actually mean negative equity) will imply that it will become increasingly hard for millions of households to service their mortgages. Many of these households will end up defaulting on such mortgages and thus be subject to foreclosure of their homes. Notice that for households with negative home equity that are unable to service their debt obligations it is a rational choice to default as the costs of default will become smaller than the benefits of continuing to service a liability on an asset for which they have negative equity. So, the likelihood of default by households with negative home equity will be large.

But even households with positive but low amounts of home equity may decide to default if they cannot service the increased payments on their mortgages: these households may become liquidity constrained when low income and increasing debt servicing on the principal and interest on the mortgage produces a binding credit constraint. Ability to refinance or extract equity at low interest rates will disappear and, only under conditions of financial distress and near default, some households may be able to restructure their mortgage liabilities and avoid outright default and foreclosure. Either way it will be very ugly for millions of households who will outright default or restructure their debt obligations. And the increases in delinquencies that H&R Block and other sub-prime mortgage lender are already observing now is only the tip of this delinquency iceberg that will become much worse when the economy slows down further and falls into an outright recession. Note that you do not need a fully fledged recession to have this severe pressure and rising delinquencies: a growth slowdown and rising debt obligations will be enough to tip over the cliff millions of weaker mortgage borrowers. Moreover, with the recent changes in personal bankruptcy laws, that make it more painful for individuals to default, the negative income and consumption effects of default will be more severe: the new law – by making the costs of default higher – will leave defaulting households poorer and with less resources for consumption. Thus, the consumption and demand hit from default will be more severe than in the past.

Note also that, even for households with meaningful amounts of untapped home equity, the slowdown and then outright fall in home prices together with higher debt servicing ratios and flat or falling real wages and negative savings, the ability and willingness to further extract home equity will sharply shrink. Indeed, for US households to continue to consume at a rate that is 2% higher than their incomes – as they have done on average since 2005 - implies a significant persistent reduction over time of their remaining home equity; obviously, this Ponzi game of running down one’s own assets to finance an excess of consumption over income cannot go on forever and is not even a optimal path that rational households will take. More rationally, with the housing bust and falling prices, households are been pinched by a negative wealth effect and are starting to cut back on consumption and reduce the rate at which they are dissaving. Indeed, based on the experience of countries such as the UK, Australia and New Zealand, it is enough for home prices inflation to slow down – let alone to outright fall as they are now in the US – for HEW to sharply fall. And since household savings in the US are negative – unlike the US, Australia and New Zealand – this sharp slowdown in HEW will have much more severe effects on consumption than in the other countries where the fall in HEW did indeed lead to a sharp slowdown – but not outright fall - in consumption.

Thus, the coming US housing bust and fall in home prices will have a significant and severe effect on consumption and will be a key transmission factor that will trigger a broader consumption retrenchment and a recession.

Spin #7: Banks and mortgage lender are still very sound and there is no risk of systemic banking crisis.

The other spin that one hears over and over again is that, unlike the 1980s when we had a systemic banking crisis (the famous Savings & Loans (S&L) crisis) today banks and mortgage finance institutions are very sound and with low delinquency rates: default rates on mortgages are still low if rising.

The reality is quite different and much uglier: the housing bubble of the last few years may have planted the seeds of another nasty systemic banking crisis that could be more severe and costly than the S&L crisis of the late 1980s. First, notice that the housing boom of the last few years has led to a credit boom that is quite unprecedented for the US in recent history. Credit boom and excessive overlending episodes – based on cross country experienceoften lead to credit busts that cause both banking and financial crises as well as economic recessions.

Second, not only we have had in the last few years a massive credit boom associated with the debt financing of the housing bubble; this lending boom has also been associated with an extreme loosening of credit standards that allowed the boom to continue and feed an ever more unsustainable housing bubble. Indeed, many mortgage lenders have gambled for redemption during the bubble years and engaged in extremely risky and reckless lending practices that may eventually lead to financial distress, or even their outright bankruptcy; we may be soon facing the same mess and systemic banking crisis that we had in the 1980s with the S&L crisis. The lending practices of mortgage lenders became increasingly reckless in the last few years: indeed, in 2005 a good third of all new mortgages and home equity loans became interest rate only; over 40% of all first-time home buyer were putting no money down; at least 15% of buyers had negative equity; and an increasing fraction of mortgage came with negative amortization (i.e. debt service payments were not covering interest charges, so the shortfall was added to principal in a Ponzi game of accumulating debt). Finally, at least 10% of all home owners with mortgages currently have zero equity.

This reckless lending scam was fed by ever loosening lending standards, the massive growth of sub-prime lending and over-inflated valuations of homes to justify new mortgages and refinancings (when significant equity extraction was occurring). It was a vast and growing lending scam where lenders’ behavior was distorted by serious moral hazard incentives driven by poorly priced deposit insurance, lax supervision of lending practices by regulatory and supervisory authorities, slipping capital adequacy ratios, too-big-to-fail distortions and the distortions created by the financing activities of the too-big-to-fail government sponsored enterprises (Fannie Mae and Freddie Mac). Indeed, you can expect the WSJ op-ed page soon to blame the entire coming housing and banking crisis on the activities of these GSE’s (on top of blaming on the Greenspan and Bernanke put).

Citing the recent article by Lon Witter in Barrons, Barry Ritholtz clearly describes the reckless lending practices of many lenders:

Traditionally, Mortgages have been low risk lending, as the loan is securitized by the underlying property. When banks were lending less than the value of the property (LTV), to people with good credit, who also were invested in the property (substantial down payments) you had the makings of a very good business: low risk, moderate, predictable returns, minimal defaults. That model seems to have been forgotten. THIS IS REMINSCENT OF THE S&L CRISIS -- where lenders did not have any repercussions for their bad loans!

As bad as the above numbers look, the thinking behind them is worse:

"Lenders have encouraged people to use the appreciation in value of their houses as collateral for an unaffordable loan, an idea similar to the junk bonds being pushed in the late 1980s. The concept was to use the company you were taking over as collateral for the loan you needed to take over the company in the first place. The implosion of that idea caused the 1989 mini-crash.
Now the house is the bank's collateral for the questionable loan. But what happens if the value of the house starts to drop?"

A good example of how this is unfolding at lending institutions comes from Washington Mutual: You may recall Washington Mutual
laid off 2500 employees in their mortgage broker department earlier this year. As LTV went above 100%, and then as property values decayed from recent peaks, the collateralized aspect of these mortgages suddenly is at risk.

Here's how this has played out over the past few years via WaMu's ARM loans (data via Washington Mutual's annual report):

- 2003 year end, 1% of WaMu's option ARMS were in negative amortization (payments were not covering interest charges, so the shortfall was added to principal).
- 2004, the percentage jumped to 21%.
- 2005, the percentage jumped again to 47%. By value of the loans, the percentage was 55%.

So each month, the borrowers' debt increases; Note there is no strict disclosure requirement for negative amortization -- Banks do not have an affirmative obligation to disclose this to mortgagees.

Thus, a large part of our housing system have become credit cards. And according to Witter, "WaMu's situation is the norm, not the exception."

Even worse, Witter notes that negative amortization is booked by the banks as earnings. "In Q1 2005, WaMu booked $25 million of negative amortization as earnings; in the same period for 2006 the number was $203 million."

This situation is unsustainable. Witter's housing and market forecast is rather bearish:

"Negative amortization and other short-term loans on long-term assets don't work because eventually too many borrowers are unable to pay the loans down -- or unwilling to keep paying for an asset that has declined in value relative to their outstanding balance. Even a relatively brief period of rising mortgage payments, rising debt and falling home values will collapse the system. And when the housing-finance system goes, the rest of the economy will go with it.

By the release of the August housing numbers, it should become clear that the housing market is beginning a significant decline. When this realization hits home, investors will finally have to confront the fact that they are gambling on people who took out no-money-down, interest-only, adjustable-rate mortgages at the top of the market and the financial institutions that made those loans. The stock market should then begin a 25%-30% decline. If the market ignores the warning signs until fall, the decline could occur in a single week."

As Witter puts it and Ritholtz concurs, the scariest thing is that the gambling-for-redemption behavior and problems of WaMu are not the exception in the mortgage industry; they are instead the norm. There are good reasons to believe that this is indeed the norm as lending practices have become increasingly reckless in the go-go years of the housing bubble and credit boom.

If this kind of behavior is – as likely – the norm, the coming housing bust may lead to a more severe financial and banking crisis than the S&L crisis of the 1980s. The recent increased financial problems of H&R Block and other sub-prime lending institutions may thus be the proverbial canary in the mine – or tip of the iceberg - and signal the more severe financial distress that many housing lenders will face when the current housing slump turns into a broader and uglier housing bust that will be associated with a broader economic recession. You can then have millions of households with falling wealth, reduced real incomes and lost jobs being unable to service their mortgages and defaulting on them; mortgage delinquencies and foreclosures sharply rising; the beginning of a credit crunch as lending standards are suddenly and sharply tightened with the increased probability of defaults; and finally mortgage lending institutions - with increased losses and saddled with foreclosed properties whose value is falling and that are worth much less than the initial mortgages – that increasingly experience financial distress and risk going bust.

One cannot even exclude systemic risk consequences if the housing bust combined with a recession leads to a bust of the mortgage backed securities (MBS) market and triggers severe losses for the two huge GSEs, Fannie Mae and Freddie Mac. Then, the ugly scenario that Greenspan worried about may come true: the implicit moral hazard coming from the activities of GSEs - that are formally private but that act as if they were large too-big-to-fail public institutions given the market perception that the US Treasury would bail them out in case of a systemic housing and financial distress – becomes explicit. Then, the implicit liabilities from implicit GSEs bailout-expectations lead to a financial and fiscal crisis. If this systemic risk scenario were to occur, the $200 billion fiscal cost to the US tax-payer of bailing-out and cleaning-up the S&Ls may look like spare change compared to the trillions of dollars of implicit liabilities that a more severe home lending industry financial crisis and a GSEs crisis would lead to.

Spin #8: Housing may be getting into a slump but such a limited sectoral slump cannot and will not cause a broad economy-wide recession.

The last and most delusional spin that one often hears is the view that the housing problems will not lead to a broader economy-wide recession
. There are two variants of this spin: the first is that housing slowdown will be, at worst, a modest slump or slowdown with no severe housing sector bust; thus, a limited housing slowdown cannot lead to a wider economic recession. The other variant of this spin is that housing may experience a more severe slump or even a sharp and painful hard landing but – for a variety of reasons – such sectoral hard landing will not lead to an economy-wide hard landing, i.e. it will not lead to a recession. Why could the overall US economy decouple from a housing hard landing? The arguments are the trite and concocted ones that one hears over and over again: real residential investment is only 6% of GDP and housing indicator levels are still high in spite of their recent fall; very few people are directly employed in housing; homeowners have still trillions of untapped equity; the US consumer has always been resilient; HEW will continue at sustained rates and consumers will keep on borrowing to finance consumption above their incomes; the labor market is doing well; corporations are flush with liquidity and profits; monetary conditions are still easy even after 17consecutive Fed Funds hikes; credit growth is still buoyant, there is no credit crunch and mortgage lenders are sound; the Fed will come to the rescue and cut sharply rates if the slowdown becomes excessive; we will have a soft landing like in 1994-95; there has never been and there cannot be a housing-triggered recession.

The long discussion above –
and my previous analysis of the housing bust - has already dissected and refuted one by one these arguments and shown why a housing hard landing will lead to a sharp and severe recession: the fall in real residential investment and its effects on aggregate demand will be larger than the 2000-2001 tech bust; the employment effects of the housing bust will be larger than the tech bust as – directly or indirectly – 30% of recent employment growth has been housing-related; the wealth effects of a bust in housing will be large and larger than those of the tech stock bust as homeownership is widespread and housing is a significant fraction of households’ wealth; a housing-related recession can occur if triggered by a housing bubble bursting in the same way in which the bursting of the tech bubble in 2000 led to a recession in 2001; households are now at a tipping point and in a foul mood (as evidenced by the sharply falling consumer confidence level) being buffeted by slumping housing, high and rising oil and energy prices and the delayed effects of rising policy rates while experiencing falling real wages, negative savings and high and rising debt and debt servicing ratios; and Fed attempts to prevent the recessions via a cut in interest rate in the fall or winter will fail to avoid the recession as an unprecedented glut of housing and of consumer durables – starting with cars, home appliances and furniture – will make the demand for housing and durables insensitive to changes in short term and long term interest rates; the housing bust may lead to a banking and financial crisis that may be more acute - and cause a more severe credit crunch – than the S&L crisis of the 1980s and early 1990s that led to the 1990-1991 recession.

These are the reasons why I have argued that the developing housing bust – together with the other shocks that are buffeting the US consumer and the US economy – will cause an ugly, sharp, painful and protracted economic recession in 2007 that will be deeper and nastier than the previous two recessions in 1990-1991 and 2001. The dynamics and triggers of this recession will share the features of the reckless real estate lending boom excesses that lead to the S&L crisis and ensuing credit crunch of the 1980s and eventually caused the1990-1991 recession together with the bubble excesses – then of the tech sector, now of the housing sector - of the late 1990s whose bursting starting in 2000 triggered the recession of 2001. In all three cases, you had the toxic combination of three factors that made – and will make in 2007 – a recession unavoidable.

First, investment excesses, loose monetary policies, reckless credit booms and financial bubbles that led to massive real overinvestment in capital goods: in real estate in the 80s; in tech goods in the 90s; in housing in the 00s.

Second, politically-triggered oil price shocks: the Iraqi invasion of Kuwait in 1990; the second intifada in 2000; the terrorist threats, geostrategic tensions and geopolitical constraints to increased oil supply in Iran, Iraq, Nigeria, Venezuela, Russia and the Middle East since 2003.

Third, a tightening of monetary policy resulting from rising inflation concerns – the Fed tightening and the S&L related credit crunch in the late 1980s; the 175bps Fed Funds hike between 1999 and 2000; and the 17 consecutive Fed Funds hikes leading to a cumulative increase of 425bps in the Fed Funds rate since 2004.

In those previous two episodes – and even in the recession of 1974-75 and 1980-82 – this triple whammy of shocks – an investment bust, an oil shocks and monetary tightening following inflation threats - led to a recession. It is up to the perma-bull supporters of the “soft landing” view to explain in some detail why the current cycle will be different and why the US economy – as they argue – will avoid a hard landing. All the relevant macro signals and indicators and an analysis of comparative factors suggest that this time around we will not have just a hard landing; we will have a painful, ugly and protracted recession in 2007 that will be deeper and more severe than the moderate recessions in 1990-91 and 2001.