Housing Bubble Horror: Market Has Makings for a Gory Story

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The New York Sun

Investment crazes come and go, invariably bloodying the eager buyers who are 100% convinced they’ve latched on to a sure-fire winner.

The Dutch tulip bulb mania in the 1630s, Britain’s South Seas bubble in the early 1700s, the Florida land boom in the 1920s, the stock market frenzy that led to the 1929 crash and the Internet craze of the late 1990s are just several that come to mind.

The latest is the housing boom, which some Wall Street professionals insist has already evolved into a housing bust, as evidenced by shrinking sales, falling home prices, burgeoning inventories and tumbling stock prices for housing-related companies.

Addressing himself to the latest delirium — the biggest real estate bubble in history — the chief investment strategist of Raymond James Financial, Jeffrey Saut, is warning clients that the ongoing collapse of residential real estate has far-reaching implications for both the economy and the stock market.

As evident, though, by last week’s rosy showing in which some stock indices rose 3% to 6% and turned more positive on the year, the market is essentially saying it doesn’t give a hoot.

But Mr. Saut certainly does, noting that real estate has been chiefly responsible for much of the nation’s economic and job growth. Taking note of significant year-over-year price breaks in his home base of Florida, which has been slammed with doubledigit declines in 12 of its 20 metropolitan areas, in one instance (Punta Gorda), as high as 97%, he thinks what’s happening there is a pretty good prism of what’s occurring on the “coasts,” as well as in some previous hot real estate markets like Las Vegas, Phoenix and Washington, D.C.

Regrettably, our housing worry-wart says, he expects the “homesick” environment to get worse, amplified by the $2.7 trillion worth of adjustable rate mortgages that will reset at a higher interest rate in 2006 and 2007. These higher rates, he notes, come on top of the fact that 10% of all home owners with mortgages have no equity in their houses, while 15% of the 2005 home buyers owe at least 10% more than their home is worth.

The associate editor of Safe Money Report, a monthly investment letter in Jupiter, Fla., Michael Larson, tells me the market is on the verge of realizing the third phase of the housing bust, which he believes has very negative implications for stock prices.The first two were the stiff declines in homebuilders and suppliers of home products. Next on the list, Mr. Larson says, are the financial institutions, notably those banks and sub-prime lenders that provided the financing for super high loans on inflated properties.

Such lending practices, he believes, will invariably lead to a rash of failures among these companies and the stock market will soon begin reflecting this risk. “We could be in for a rough few months ahead,” he says.

Some stock market bulls argue that all the negative factors about the housing industry are already known. Mr. Larson doesn’t think so because of his belief that “the housing market is in really bad shape and the pain is going to be awful.” In support of this, he points to some of the latest numbers, namely a 13.3% yearover-year drop in July housing starts, a 21% decline for the month in building permits, a 4.1% drop in existing home prices and a 4.3% skid in new home sales. “These are huge declines, which tell you the housing market stinks,” he says.

The problem, he says, is that the risks of the housing bust are under-appreciated, pointing to (among other things) such follow-up effects as the likelihood of serious loan losses, surging mortgage defaults and a worsening job market.

Mr. Larson notes that a lot of people on Wall Street seem to think the likely end of higher interest rates in the current credit-tightening cycle is a significant plus for the economy as a whole since it should ensure a soft landing. Our housing bear disagrees. On what basis, he asks, is it rational to expect a soft landing in a period that has produced the biggest real estate bubble in history?

Given his negative view of the economy and his belief that termites will continue to gnaw away at the housing market, Mr. Larson expects it will be thumbs down for the stock market in 2006. Not a crash, he says, but about a 5% decline in the S&P 500. Likewise, he thinks stocks with exposure to the housing market—despite some hefty declines this year—remain anything but risk free.

Among those housing-related names he regards as most vulnerable are Lennar Corp., Home Depot, New Century Financial, Black & Decker, Countrywide Financial and Washington Mutual.

The bottom line from our two housing bears is unmistakable.The housing horror show, as it relates to the economy and the stock market, has a long way to go before it runs its course.

That’s also the view of former money manager, now private investor, Neil Weisman, who thinks it will take the housing industry at least 5 to 7 years to work off its excess inventories, rather than the 1 to 2 years many Wall Streeters are projecting.


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