Housing Correction Just Getting Started

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

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NEW YORK SUN CONTRIBUTOR

Don’t get relaxed about the housing industry, because it’s going to get much, much worse. That’s the message from Gary Gordon at Annaly Capital Management, a firm which invests in mortgage-backed securities. Mr. Gordon is looking for substantial further declines in housing starts and sales, which will result in a recession beginning in 2007.

He is on the pessimistic side of the Great Housing Debate, which will doubtless be reignited when the figure for September housing starts comes out tomorrow.

The optimists took the uptick in home sales in August as a sign of bottoming. They see homebuilders responding aggressively to rising inventories, and cutting prices to quicken the industry’s return to equilibrium.

The fact that the prior three months’ numbers were revised downward muted the celebration. However, bulls were again cheered by last week’s Federal Reserve comments on the economy, and drove the stock market beyond the 2000 highs. Lower gas prices, lower inflation, and a resilient consumer appear to be a heady cocktail for this market, and rightly so.The stalwart American consumer has been defying pessimists for years, not to mention Katrina, $3.00 gas, low wage expansion and rising interest rates.

The real issue is: How much consumer spending has been funded by rising home prices and how vulnerable is the economy to a fall-off in home values? Bears argue that the consumer has used his home ownership as a piggybank that is now ominously empty. They point out that mortgage equity withdrawals have climbed almost without pause since the early 1990s. Today, these borrowings are plummeting, a development that the folks at economics consultancy ISI call “unprecedented.”Equally without precedent is that existing home prices may actually decline this year.

Further gumming up the works is that confidence in rising home prices turned lenders into enthusiastic coconspirators. Mortgage lenders have required less information about borrowers and less regular payments on loans than ever before.

As an example, 62% of non-agency loans made last year had low or no income verification, up from 24% in 1998. Also,52% of such loans made in 2005 had zero or negative amortization requirements. In 1998 there were no such loans.

Standards have become so lax that the Comptroller of the Currency issued new lending guidelines last month, which require greater reserves against non-traditional loans and greater disclosure by borrowers. These new standards are slowly filtering through the system and will likely lead to a tightening of credit in the mortgage markets.

Indeed, ISI reports that last week New Century, a sub-prime lender in California, announced that it is tightening its requirements. Little wonder.Apparently 88% of its loans are sub prime; 17% of loans are interest only, and 42% are stated income, meaning there has been little background check done on the applicants.

The August bounce should not be mistaken for the bottoming of the cycle, says Mr. Gordon in a piece sent out to clients last week.Mr. Gordon expects existing single family home sales to bottom at 25–30% from the mid-2005 peak level of 7.2 million. Currently, sales are off 12% from that level. New single family home starts should bottom at 40% below the peak level of 2.2 million reached in late 2005; currently starts are 20% down. He thinks prices for new single family homes will likely end up 5% to 10% off the $275,000 peak rate; today they are off about 2%. As we said, there’s more to come.

Mr. Gordon says that affordability is key. Home prices have increased at the second fastest rate in over a century, only surpassed by the years following World War II. This rapid cost increase means that many people are simply priced out of the market.

Mr. Gordon predicts that a slowing in debt growth will lead to a faltering economy, and ultimately a falloff in job growth. He points out that of the record $2.3 trillion borrowed by Americans in 2005, fully $1.2 trillion was an unprecedented level of home mortgage debt. The growth in total borrowings last year was over 9%, way above a longterm trend, and way above GDP growth. The ISI analysts report that American mortgage payments have never been higher when compared with wages and salaries. That excess is not supportable.

Not everyone is as pessimistic as Mr. Gordon. Jim Glassman at JPMorgan Chase, says

“There’s more to life than housing,” he points out.”Consumer spending is driven by jobs and income growth, the stock market, and the housing market. Two of those are doing fine. And, consumers are getting a little break on energy.”

Mr. Gordon responds that “home ownership is much more broadly based than stock ownership. And, there’s a whole marketing system geared to getting you to borrow against your home. When was the last time you got a flyer in your mailbox encouraging you to borrow against your stock portfolio?”

Another industry observer, Bradley Gendell, from hedge fund Cumberland Associates, points out that the housing industry is regional. He says that the pricing bubble on the East and West Coasts has received undo attention and has distorted the picture.His firm thinks some homebuilders, such as Centex (CTX $52.55), are attractive at current deflated prices. Centex sells modestly priced homes in markets like Dallas, which are still growing and profitable.

Mr. Gendell is reassured by the disconnect between the equity markets’ treatment of housing-related issues and that of the fixed income markets.Prices of mortgage-backed securities have held up well and spreads have remained narrow, even as industry stocks have been trashed. He thinks the fixed-income fellows have a better handle on credit, while equities analysts have overreacted to negative press about the industry.As he says, it is the first time in history that housing has fallen off in the absence of an economic correction; some of the decline may be because of all the media alarmism.

Mr. Gordon agrees that mortgagebacked securities markets have been slow to respond. However, he thinks that spreads will widen. A huge inflow of funds from CDOs, and indirectly from hedge funds and private equity firms have compressed spreads, but that cannot last.

Mrs. Peek is an investor with Cumberland Associates and can be reached at peek10021@aol.com.

NY Sun
NEW YORK SUN CONTRIBUTOR

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.


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