"Study the past, if you would divine the future." ~ Confucius. Chinese, Philosopher Quotes
Source: irrational exuberance 2nd edition by Robert Schiller
This chart illustrates what we have been saying all along for a very long time. The housing market exploded to such heights that it must literally be destroyed before it finds a bottom; this is exactly the same thing that occurred during the internet mania which lasted from 1996-2000. As most individuals were able to buy houses with little to no money down the biggest losers in this game are the banks and the many institutions that purchased these sub prime mortgages from them. Notice the Steep second up trend line because this chart has no individuals price points we are only able to put in two up trend lines but if it was plotted as a regular chart we are almost positive we would be able to draw at least 4 if not 5 up trend lines. The main up trend line falls in the 110 ranges and we feel that at the very least this index will have to pull back to that level if not lower. This index has already started to pull back and this pull back is not reflected in the above chart but it still has a pretty long way to go before it approaches the oversold range.
Most of these individuals were buying houses instead of renting so when they walk away from their homes they are only risking their credit but essentially nothing else. You then have the next category who thought they could make a fortune by buying 2-3 or even more houses; again for the most part they were able to buy these houses with little or no money down or to use the leverage of the previous house purchased as collateral for the next house. A lot of individuals in the housing valuation sector were being pushed by banks to over evaluate houses. Now in the aftermath this situation which borders on fraud is being investigated when it should have been investigated and brought under control before the housing market went out of control. In the end it comes to the same old story greed seems to blind even the most savviest of investors; bankers are known for being cautious but during the housing mania it appeared that they threw caution to the wind and just focussed on today's bottom line instead of looking out into the near future.
For the most part the majority of the individuals who purchased homes with little to nothing down are not truly losing that much in terms of money. Look at it this way they would still have to pay rent and so the monthly mortgage payments could be viewed as monthly rental payments; in most cases one could argue that if a small down payment was made most of it was recovered when these individuals ceased to pay their mortgages; for
These individuals are not losing that much money; what they are really giving up is the profit they could have once locked in had they sold their houses at the right time. Yes ones credit rating is important and valuable but stupidity extracts a high price and those that did not think or let greed rule will now need to have long intimate talks with the grim reaper. To an outsider it might look as if we are taking a light view on the situation but we assure you we are not. We know of individuals who did not even ask the mortgage brokers what their rates would be once the deceivingly low adjustable rates came to an end. There were numerous stories of individuals bidding up prices in the tens of thousands just because they thought they could more than make up this money in 1-2 years. At one point Apartments in Vegas with a view to the strip were commanding premiums of 50k plus; imagine this insanity paying 50k more just to be able to look down at a stupid over lit strip. These individuals did not take the time to evaluate what they were getting into or what they stood to lose if the housing market crumbled; they had only one thought in mind and that was to make as much money as they could possibly make.
For illustrative purposes we are going to provide very simple examples of how in most cases individuals did not really loose much except to sacrifice and in most cases destroy their credit ratings.
let's say the rent for their home was 1800 dollars a month and they buy a home in 2005 with a very low adjustable mortgage of 2%; based on this their monthly payments come in at say 1478 a month. At one point they were even offering rates of between 0%-1percent for the first 2-3 years of the mortgage. They jump because it now looks like they could own a home for less than what they were paying for in rent; stupid reasoning for you never own the home till it's paid of in full. Also the Adjustable rate was not taken into consideration; euphoria has a way of blinding everyone. When the low adjustable rates ended mortgage payments in many case doubled. Let's assume that their credit was average; at one point even individuals who had bankruptcies on their records could get a mortgage. So the house value falls, payments double; the math is simple they walk away. What have they really lost? Other than their average credit nothing much. Once again we are not saying a person's credit rating is not important but we are looking at the situation from what one lost financially and not from the emotional stress and trauma that comes about from destroying one's credit.
Good credit and so called smart individuals
Purchased several homes and rented them out to use the rent to pay for the mortgage but kept on doing this until the end instead of bailing out when they were sitting on lovely gains. Some smart astute individuals did bail out but the majority held thinking that the party would never end. Look at some of the big housing names such BZH, LEN, etc many of them bought huge tracts of land for insanely inflated prices, and some even bought massive patches in the desert.
The picture is the same. Prices have fallen, rates have doubled and they can't make their payments. So what do they lose? A huge amount of potential profit and their very good credit status, but in terms of real money lost they have not really lost that much.
There are other variations of this but the picture is the same; in the end it's the institutions that gave these mortgage and the ones that re purchased them that have lost the most.
Bottom line the biggest losers were and still are the banks who issued these mortgages and the institutions that purchased these repackaged instruments. What the majority of the small investors lost was the possibility of owning a home and their credit rating as they had over leveraged themselves to the hilt. Now some would point to the tent cities cropping up for example in California as an illustration of the pain many of these individuals are feelings. Let's examine this a bit more deeply. In many cases these individuals were forced out of their homes and into the street because they lost their job, which means that even if they were renting they would have been thrown out of their homes for not being able to pay the rent. Indirectly their jobs were affected by the downturn in the industry but this would have happened regardless of whether they bought a house or not. If you lose your job no one is going to let you live rent free unless they have lost their minds. Had they instead of taking this risk decided to live one or two standards below their over inflated life styles and put this money into a savings account they would have had something to fall back on a rainy day.
What is causing their real pain? Well the slow down in the economy and the huge number of lay offs. Thus the pain caused is not directly related to the purchase of their homes but to the fact that many of them were indirectly employed by the housing sector. The real pain is once again being caused by over exuberance; everyone over invested in one sector (housing sector) and as prices rose they started to live like the rich and the famous. The pain that is being caused now is no different from the pain that was caused during the internet mania; in the end some great bargains will be found as was the case in the after math of the dot com era.
While it may look tempting to purchase housing stocks right now we would wait a bit longer for its far better to play safe then jump in too early as one could be flying from the frying pan and straight into a smouldering fire; markets have a tendency to overshoot these days and just as the housing sector overshot to the upside it will most likely do the same on the downside. As an example let's take a look at LEN.
From roughly Jan of 2000 LEN started to take off; the housing sector was in the first stages of a huge upward move while the financial markets were embarking on the first leg of a massive correction. LEN soared from roughly 7 dollars in Jan 2000 to a high of 68 dollars in July 05; it has since given up most of those gains and like the internet bust we feel that it together with DHI, PHM, etc are all probably going to at the very least test their pre break out prices. In Lennar's case this would equate to a price of roughly 7 dollars.
Today's article stating that a record 4 million (9% of total homeowners) homeowners were either behind on their payments or in foreclosure does not exactly bode well for this industry Full Story. It indicates that the worst is still not over or more importantly the market has probably not yet priced all the potentially negative news that still could emerge from this sector. Let's not forget that not all Adjustable rate mortgages have reset yet; census data indicates that roughly 2 million mortgages will reset from May 2008 to Sept 2008, almost double that of 2007.
New legislation which was passed to help owners will only help a small percentage of the total as the guidelines are rather strict. Most individuals are living from pay cheque to pay cheque but let's assume that they happen to have 1-3 months of reserve payments and for arguments sake let's choose 3 months. Foreclosure times vary considerably from state to state so let's assume that an average period would be 7 months. Thus roughly in July of 2009 a whole wave of new foreclosures will hit the markets and given the fact that it is taking roughly 11 months to sell a home now we are left with this sobering thought, who would have the guts to go out and buy in the midst of all this chaos? We think very few would be brave to venture out during such trying times. The real estate sector needs to go through a stage where the amount of bad news coming out starts to slow down and the number of foreclosures starts to drop before the brave would risk venturing out to buy; this means that at the very least the real estate market won't put in a bottom until early 2010.
It's for this reason we have stated that we have to reach the stage of helplessness before this market will put in a bottom. Look back at those that purchased shares in internet companies and if you paid attention you would have noticed that when CMGI dropped from 166 to 4 dollars and Yahoo from over 124 to 20 dollars, etc these people just lost it; they gave up and just buried their heads in the sand hoping against hope that some miraculous force would come and rescue them from their plight; their wait proved to be fruitless. For the record CMGI traded as low 1 dollar and Yahoo as low as 4 dollars before putting in a bottom. Something like this will hit the housing sector before it will start to put in a long term sustainable bottom. As example look at PCLN; even though its drop was just as steep (over 90% at one point); it managed to rally from a low of 6 to a recent high of roughly 126 dollars. It is still no where close to its old high but who cares if you bought anywhere from 6-20 dollars you are sitting on massive gains; the same will hold true for the housing sector.
"Men nearly always follow the tracks made by others and proceed in their affairs by imitation, even though they cannot entirely keep to the tracks of others or emulate the prowess of their models. So a prudent man should always follow in the footsteps of great men and imitate those who have been outstanding. If his own prowess fails to compare with theirs, at least it has an air of greatness about it. He should behave like those archers who, if they are skilful, when the target seems too distant, know the capabilities of their bow and aim a good deal higher than their objective, not in order to shoot so high but so that by aiming high they can reach the target." ~ Niccolo Machiavelli 1469-1527, Italian Author, Statesman