Friday, August 22, 2008

Housing situation

I am kind of amazed at some of the things that no one seems to care about. When the FDIC seized IndyMac, it was a godsend -- get that crummy lender out of the picture. Then the FDIC announces a radical plan to allow homeowners who borrowed from them to get off the toxic 2-and-28s and teasers and go into fixed-rate loans with some forbearance. We got that this week. No one cared! No one!

How can that be? The FDIC is offering us a plan that would make it so we can root against Washington Mutual (WM) and know if that scourge of all lenders went under, we would have far fewer foreclosures because of the FDIC takeover. Also, once the loans are all under fixed rates or sent to the FHA for rehab -- as the housing legislation makes clear will happen -- we are going to see a dramatic decline in the rate of foreclosures.

Now, right now, when we see this, we are skeptical. When Wells Fargo (WFC) decided to give its borrowers more grace -- the same grace that other banks give -- we immediately figured it was a canard to mask things. But John Stumpf, the CEO, said it seemed like the right thing to do, and the bank would do better trying to work things out with lenders than throw them out on their butts. Instead, of course, the rate of foreclosures went down, and I bet ultimately the number of foreclosures will go lower.

We need time. We need time to solve the housing depression. The elements of time play out positively, because we are a growth nation that cannot have as few homes built and as few homes bought as in 1991, when we had 248 million people in this country. We now have about 310 million people. We have more than 60 million more people in this country, and we are buying as many homes as we did back then? How long can that last?

The answer, of course, is that given the dramatic overbuilding and the foreclosed homes, the oversupply will take months to burn off. But not years. The trick is to restrict supply, which wasn't being done by the homebuilders until last year, when they finally cut back the numbers -- they are now building about half the homes they did in 2006. Then we need to make it easier for people who bought homes to stay in them, so far the hardest part of the equation. Given that 14 million people bought homes between 2005 and 2007, and half took exotic mortgages to pay them, I figured there was no way that more than 3.5 million people could lose their homes (half of the half that took the 2-and-28s and the pick-a-pays and all the other nonsense). That was wrong. I am now thinking that all -- that's right, 100% -- of the people who bought homes between 2005 and 2007 are going to default. All of them! It makes too much sense not to given the home price declines.

That's why we need the FDIC to own more banks and more banks like Wells to work it through and more money from the FHA. You can see how the system is being overwhelmed by the simple equation of demand vs. supply. In 2006, for example, 7 million homes changed hands. Slightly more than 2 million were new homes. In 2008, we get half the number of new homes being built, but we are going to regurgitate 3.5 million homes that foreclosed. That gives us 3.5 million more homes on the market than we need

Historically, we get about 800,000 new homebuyers naturally in this country because of household formation demographics -- marriages, divorces, kids and the like. If you believe they all bought new homes we would still have 3.7 million more homes than we need. That's the real issue.

So, if you attack the problem that way, you can see that anything that keeps people from getting foreclosed will cut back that 3.7 million, and anything that gets people to want to buy -- tax credits for buys, lower prices for homes and perhaps a nationalization of Fannie (FNM) and Freddie (FRE) , which would reduce the price of money to buy homes -- will work off the problem over time.

If you really wanted to get granular, you can chart out what happens rather easily. The default rate on homes spikes in the first two years, particularly these years, because of all of the fraud and recklessness. Two years ago was the height of the fraud, and it continued unabated for seven more months. Right now I would venture -- we don't have hard figures -- that maybe a quarter of the defaults that will be part of the 7 million have already occurred. We're going to get the rest of the three-quarters in the next seven months. The maximum pain is in these next seven months. Once the two years that began tolling at the end March of 2007 -- the last of the really bad lending practices period -- occurs, you simply cannot have more increases in homes being foreclosed on, because you didn't have nearly as many purchases, and many of the corrupt lenders were flushed out.

Or in English, the problem peaks over the next seven months even without any intervention or stimulus or plans.

Of course, I am saying that with the FDIC's plan, WFC's changes, the FHA getting involved and the continued decline in the rate of builds and the tax credit, all of these positives are going to cause that foreclosure rate to decline slightly faster than otherwise.

Here's the bottom line. The market is factoring in three wrong things:

1. that the problem will get worse forever, rather than recognizing the peak that has to occur;

2. that nothing is being done about the demand side -- not so, because prices are coming down fast, mortgage money will get cheaper after FNM and FRE go away and there is a tax credit of size that matters; and

3. that nothing is being done to keep people in their homes -- also really wrong, because of the FDIC's plan and the FHA money meant to stem these declines.

Right now, if you think housing is going down for the next year, you are making what I think is a sucker's bet. Six months? Yes. One year? No. We will have gone through too much of the bad lending.

Oh, and remember, I am predicting 100% defaults on all non-fixed-rate loans from 2005 to 2007. No one in America is using that negative a forecast. Do you ever hear anyone say 100% of those loans from that era are going to default?

I am.

And I still think housing will bottom at the beginning of the second half of 2009. Less than one year from now.

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