Bad Day for the Housing Market

Good day… Friday’s rally of the U.S. dollar – which was due to a turn around by the housing market – was short lived, as new home sales, as reported Monday morning, fell dramatically in February. Sales of new homes dropped to the lowest level seen in nearly seven years, while inventories of unsold homes rose to a 16-year high.

These numbers bear repeating: Sales of new homes are the lowest in seven years, and inventories of unsold homes are at a 16-year high! Some economists blamed bad weather for the drop in home sales, but how can you blame weather for a surplus in unsold new homes that represents an 8-month supply?

I have a somewhat unique perspective on this problem, as I ran a family business selling manufactured housing. After leaving the remnants of Mark Twain Bank and while waiting for Frank and Chuck to get EverBank WorldMarkets started again, I ran Coachman Homes – a manufactured housing business started by my father in 1968.

The manufactured housing business peaked in 1998 and 1999 when lenders were flush with ‘Wall Street’ cash and were willing to put just about anybody into a manufactured home. The party came crashing down in late 1999 and 2000 as a couple of the major lenders started to have problems with foreclosures (Greentree Financial, Security Pacific) and therefore began to tighten lending standards. The manufacturers were slow to realize this was not just a temporary slowdown and kept building homes as quickly as they could get them produced.

We soon had a glut of home inventories, and the lenders wouldn’t approve as many buyers; so naturally the prices of homes started to come down. This caused several new homeowners to suddenly become upside down in their home loans (they actually owed more than the home was worth) and so they just decided to ‘walk away’ from the homes and ‘give them back to the lenders’. Suddenly, the new home retailers were competing with bank foreclosures chasing after a decreasing number of approved buyers.

Needless to say, the industry has taken several years to work out of this down turn and is still struggling to turn a corner even after some help from mother nature. (Hurricane Katrina was a godsend to the manufactured housing industry.)

I use this as an example of why I don’t believe we will see the full effect of the housing down turn for some time. Yes, builders are now scrambling to offer incentives to buyers of their ‘spec’ homes. But what about all of the homes which are going to start hitting the market due to foreclosures?

U.S. foreclosure filings last month jumped 12% compared with a year ago. More than 130,000 homes entered foreclosure last month according to RealtyTrac, which is the second highest reading since they started keeping records in January 2005.

Adding to the mortgage problems, there will be a massive amount of adjustable rate mortgage resets coming in the next few years. More than $2.28 trillion worth of ARMs were originated in 2004, 2005, and 2006, at the peak of the housing boom. Many of these ARMs enticed buyers with very low ‘teaser rates’ which will significantly change the amount of the monthly mortgage payment when they reset. Now that these homes are no longer increasing in value and lenders are tightening credit standards, look for foreclosures to skyrocket.

So what will this mean for the U.S. dollar? Well we will definitely be seeing a dramatic slowdown in the economy and possibly a reduction in interest rates by year-end. Not good news for the dollar, which has been seeing some strength from thoughts that the FOMC would actually have to raise rates sometime in 2007 to combat inflation, since lower rates and a slower economy would help to force a sell off in U.S. treasuries by foreign investors.

Fed Chairman Bernanke addressed this topic in a March 16 letter. According to Bernanke, “the U.S. credit markets should be able to absorb without great difficulty any shift in foreign allocations; since foreign holdings represent only a small part of total allocations”. What is he smoking? Sure it is a ‘small part’ as long as you classify over 50% only a ‘small part’. International investors, including central banks, own over half of the $4.3 trillion of marketable treasuries outstanding, according to Treasury figures.

Bernanke continues to assure us that the “substantial accumulation” of reserves by China isn’t a problem for the United States or its monetary policy. Maybe he knows something we don’t. (Maybe a back room deal that says they won’t sell as long as we don’t force them to raise the renminbi!?!) But looking at the massive amount of treasuries owned by the foreign central banks, I have got to believe this is a problem that will have seriously negative implications for the value of the U.S. dollar.

The euro continued to rally overnight, as German business confidence unexpectedly rose in March, signaling that Europe’s largest economy will be able to withstand a U.S. slowdown. The Ifo institute said its sentiment index rose to 107.7 from 107 in February, despite the fact that economists had predicted a drop to 106.5, due to a sales tax increase and slowdown in the United States.

Ifo said today that the “economic upswing is strong and robust.” The euro also benefited from statements by Nicholas Garganas, another ECB council member who stated interest rates have not peaked yet. As I said yesterday, any move down by the euro should be seen as a buying opportunity, as interest rate differentials and economic fundamentals are all pointing toward a move up for the euro.

Asian economies are expected to grow 7.6% in 2007 according to a report released by the Asian Development Bank. This is slightly slower than last year’s 8.3%, but is still good news for the Asian region. Per the report, rising incomes in China, India and other Asian economies are boosting consumer spending and encouraging companies to lift investment. The Asian region will continue to be the economic engine of the world in 2007. Investors would do well to have some exposure to these currencies. (Our Pan Asian Index CD is an excellent way to get this exposure!)

The Australian and New Zealand dollars will both benefit from the expected growth in the Asian region. Both currencies have been performing very well as of late, with the Aussie dollars jumping over 0.81 and the kiwi nearing 0.72.

New Zealand’s current account gap has been problematic and is a cause for concern. A report scheduled to be released on Thursday is expected to show that the current account deficit probably narrowed in the year to December as exports outpaced imports. New Zealand’s current account deficit more than tripled in the three years to June 2006 amid surging demand for imports while a stronger currency crimped exports. While the expected narrowing is a good start, we are still wary of this currency and believe the Aussie dollar is a better alternative at this time.

Currencies today: A$.8091, kiwi .7175, C$ .8636, euro 1.3343, sterling 1.9649, Swiss .8236, ISK 66.10, rand 7.2585, krone 6.0909, SEK 6.9817, forint 186.04, zloty 2.9025, koruna 20.97, yen 118.38, baht 32.49, sing 1.5168, HKD 7.8135, INR 43.29, China 7.7334, pesos 11.0343, Silver $13.34, and Gold $664.90

That’s it for today… A little long winded this morning, but the housing market really got me going today. We will get consumer confidence numbers today, which won’t be good for the dollar. Look for more of what we saw yesterday in the currency markets. Hope everyone has a great day!

Chuck Butler — March 27, 2007

The Daily Reckoning