Big Bang Theory: Housing Bubble meets pin

By Paul Mampilly

You didn’t hear it? You weren’t the only one. Wall Street missed it, too. And who can blame them? After all, they are engrossed in important issues like if they should be buying Google shares after its recent decline or perhaps adding to their gold collection. After two years of being on bubble watch, the media save for the Wall Street Journal has lost interest in the housing bubble. They too are distracted with Iran, Iraq and Washington shenanigans occupying their thoughts.

This week we received notification that the great, mega, massive Greenspan housing bubble has finally arrived at its graveyard. However, there’s still time for a eulogy and a last viewing and the chance to listen out for the chant of last rites.

It’s fitting that the end of the housing bubble is aligned symmetrically to Greenspan’s retirement from his position chairman of the Federal Reserve. Greenspan’s eighteen year tenure as chairman was marked by the astonishing increase of debt in American society and an addiction to speculative gains in asset prices, catalyzed by declining interest rates.

Leading the housing bubble busting “pin-prick parade” this week was Toll Brothers. Toll is the nation’s largest builder of luxury homes and just reported a 29% decline in new orders. Standard Pacific, another homebuilder operating in the prime bubble territories of California, Arizona and Florida also recently reported a 20% decline in new orders. Ryland, a California builder reporting on its 2005 year-end results reported a drop of almost 5% in January. Please see our Risk & Return Grid for our ratings on these stocks.

But wait, if the Wall Street Journal’s “Finding A House gets easier” article is correct, this string of recent disappointments is the good news. The really bad news is inventories. In one bubble territory after another, homes are piling up as speculators cut their losses and run. According to the Wall Street Journal, Washington D.C. leads the pile up with inventories increasing by 149.2% compared to last year. Los Angeles County, CA and Manhattan, NY saw increases of 88.0% and 86.9% respectively (see full table inside). Living in Brooklyn, NY, we can’t imagine a space, any space going unsold in New York city. Every friend, cousin and acquaintance has either already bought, or is buying or plans to buy a home or apartment. Nationwide inventories too have increased by 25% over last year. Evidence that listings are increasing while sales are declining is illustrated by the 5.1 months supply of existing homes on the market. This is a 34% increase over 3.8 months supply that was observed in January 2005. As the recent decline in home builder’s orders are computed into these statistics, that number is headed straight up in 2006.

The Wall Street Journal has more worrisome news for recent homebuyers. Toll Brothers CEO, Robert Toll, says that speculators are canceling their contracts and exiting the market while prospective buyers sensing a slowdown are no longer eager to commit to homes with a long delivery lag. Further, the article says that “as orders slow, builders are engaged in heavy discounting and promotional activity, particularly among homes for the second-time, move-up and luxury buyer. A survey conducted last month by the National Association of Home Builders (NAHB) found that 64% of builders are now using incentives such as offers to pay closing costs and free upgrades; 19% are cutting prices.” These observations are signals that the boom is done. It’s only a matter of time before the long-predicted panic ensues.

But there’s no fear, yet. Some like John Weicher, Director of The Hudson Institute’s Center for Housing and Financial Markets believe that concerns over the recent slowdown are overdone and alarmist. Weicher, in a Financial Times column entitled “Rumors of America’s housing bubble are hot air” writes, “a longer view suggests that the US is seeing a blip in a long-term bull housing market, not a bubble about to be pricked.” His analysis attributes recent weakness to a innocent misunderstanding by sellers i.e. they think their homes are worth more than the market is willing to pay for them. Or, as Weicher puts it, “what seems to be happening is that home sellers are overshooting the market, incorporating a further expected increase in their asking price.” For historical verification of his claims, he cites the 30-year history of the OFHEO price index. Weicher says “In those 120 quarters house prices have dropped only eight times and never for more than one quarter.”

Statistics are meaningless without context. During the 30-year period cited, as Weicher himself admits was a period of “erratically accelerating inflation that…drove everyone into tangible assets in self protection.” In other words, another boom that ended badly. Further, as our chart (from April 1971 to January 2006) reveals, mortgage rates hit an all time low during the current cycle, reaching a nadir of 5.23% in June 2003. Low rates have been the transformational factor for home prices over this period. It’s delusional to believe that these values will be sustained as interest rates rise. Weicher’s contention of a bullet proof housing market are exactly what he claims it is not i.e. hot air. He ends his commentary with a variation of the bubble salute, writing that “this time, it is real.” We know how to translate this to standard bubble talk: This time, it’s different.

But that’s the way it is with bubbles. Investors and speculators spurn the opportunities to get out while the getting is still good. Don’t forget too that Uncle Al (Greenspan) is no longer around to provide liquidity to save the bubbleheads. Greenspan is busy “getting some” for himself, before the hyper-liquid environment he created ends. At $250,000 a session in his new role as celebrity ex-banker, Greenspan will earn more in the next 18 months than he did in 18 years at the Fed.

For the rest of us, left holding the bag from Greenspan’s halcyon days of being savior to the markets, its dark days ahead. The Greenspan housing bubble will be different than the aftermath of the Greenspan stock bubble. Back then, he had the luxury to reduce rates to 1% and consider rates of less than zero to stave off an asset bust and accompanying deflation. Then, he could encourage us to use our homes as ATMs, as lower rates provided a double pump of higher housing prices and lower monthly installment payments to finance our hyper-consumption of cars, vacations, electronics, etc., Then, we did not answer to capricious central bankers in China, Japan, Taiwan, South Korea, Russia and India, that now hold 50% of our treasury debt. Then, we were sitting pretty with a surplus, to address the massive adjustments needed to finance baby boomer’s Social Security and Medicare expenditures. Now, with $11 trillion in personal debt and $8.2 trillion in national government debt, we can thank Greenspan’s liquidity manipulations for leaving us at the precipice of a financial disaster.

For the rest of us, left holding the bag from Greenspan’s halcyon days of being savior to the markets, its dark days ahead. The Greenspan housing bubble will be different than the aftermath of the Greenspan stock bubble. Back then, he had the luxury to reduce rates to 1% and consider rates of less than zero to stave off an asset bust and accompanying deflation. Then, he could encourage us to use our homes as ATMs, as lower rates provided a double pump of higher housing prices and lower monthly installment payments to finance our hyper-consumption of cars, vacations, electronics, etc., Then, we did not answer to capricious central bankers in China, Japan, Taiwan, South Korea, Russia and India, that now hold 50% of our treasury debt. Then, we were sitting pretty with a surplus, to address the massive adjustments needed to finance baby boomer’s Social Security and Medicare expenditures. Now, with $11 trillion in personal debt and $8.2 trillion in national government debt, we can thank Greenspan’s liquidity manipulations for leaving us at the precipice of a financial disaster.

Today, Ben “printing press” Bernanke is at the helm of the Federal Reserve. Bernanke is a student of the Great Depression. He believes the Federal Reserve did not inject enough liquidity into the economy during that period and caused the deflation that nearly destroyed the political and social fabric of the country. He is determined to ensure that this mistake will not be repeated. Destiny though has dealt Bernanke a cruel hand. His quota to be the liquidity-supplying hero to the markets was avariciously consumed by Greenspan. Instead, he’ll preside over the biggest housing and asset bust in recent history.

In our Risk & Return Grid are stocks/ETFs that we have rated negatively and that reflect our bearish views on the housing bubble and consumption trends related to it. The Risk and Return Grid is a regular weekly section that lists stocks and ETFs by themes and by positive/negative rating. You can view this section and our regular weekly sections that review stocks, bonds, energy and gold/dollar/yen by purchasing a 3-month or annual subscription to our newsletter or through the purchase of this individual issue using the button listed above. Our next edition will be published on February 26, 2006, as we take a week off for the President’s day holiday.

Paul Mampilly, CFA
Editor & Publisher

Editor’s Note: Paul Mampilly CFA is the editor of Capuchinomics and a leader in the use of Behavioral Finance decision making with respect to stock, bond and commodity markets. This article was originally published on Capuchinomics:

Big Bang Theory