Housing Cheerleaders: Housing Evidence

Mike Shedlock discusses the views of the Housing Cheerleaders and the “permanently high plateau” theory, and why he disagrees with them. 

“THE EVIDENCE SUGGESTS that people will borrow to buy this housing bubble until lending literally seizes up,” writes Russ Winter on Silicon Investor.

Indeed. Let’s take a look at some of that evidence:

Mortgage Applications Rise on a Seasonally-Adjusted Basis

“The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending Oct. 14. The Market Composite Index — a measure of mortgage loan application volume — was 737.5, an increase of 6.1% on a seasonally adjusted basis from 694.8, one week earlier. This measure includes an adjustment to offset the effects of Columbus Day on application activity. On an unadjusted basis, the Index decreased 4.4% compared with the previous week but was up 3.7% compared with the same week one year earlier.

“The seasonally-adjusted Purchase Index increased by 7.3% to 503.9 from 469.5 the previous week whereas the Refinance Index increased by 4.5% to 2095.7 from 2004.9 one week earlier. Other seasonally-adjusted index activity includes the Conventional Index, which increased 6% to 1103.8 from 1040.9 the previous week, and the Government Index, which increased 7.8% to 126.3 from 117.2 the previous week.

“The refinance share of mortgage activity decreased to 42.8% of total applications from 43.5% the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 29.3% of total applications from 29.5% the previous week.”

Especially interesting to me is the strength of refinancing. Long-term interest rates have pretty much been rising for several months, but refinancing still continues strong. There are several possible explanations that I can think of.

1. People are so desperate for cash to support ongoing consumption that they are simply forced to pay higher rates to get it

2. People have once again racked up huge credit card purchases and are going through yet another round of paying off high-interest debt for lower-interest debt

3. People are scared to death of all these rate hikes and are rushing to lock in fixed rates and get out of their ARMs.

It is probably some combination of those factors, but the rate of new ARMs is still holding at 30% or so, higher in bubble areas from numbers that I have seen.

Meanwhile, housing construction increases in September to the highest level in seven months, according to the Commerce Department.

“September surge defies expectations of a slowdown in the housing market.

“Housing construction unexpectedly rose in September to the highest level in seven months, defying expectations of a slowdown in the booming housing market.

“The Commerce Department reported Wednesday that construction of new homes and apartments rose by 3.4% last month to a seasonally adjusted annual rate of 2.11 million units, the fastest pace since last February.

“Analysts had been forecasting that housing construction would decline by 1.7% in September, believing that increases in mortgage rates would finally start to cool the red-hot housing market.”


No one seems to be as optimistic as the Toll Brothers, according to the New York Times article, Chasing Ground.

“At the moment, Toll controls enough land for nearly 80,000 houses. Its competitors, which tend to build lower-priced houses on smaller lots, have even larger accumulations. K. Hovnanian has land for more than 100,000 houses. Pulte Homes holds 350,000 sites. Still others — Lennar, Centex Homes, D. R. Horton, KB Home — control hundreds of thousands as well. And all of them are in ferocious pursuit of more.

“The company expects to grow by 20% for the next two years and then will strive for 15% annually after that. Those estimates suggest that the company’s expected production of around 8,600 houses this year will expand to at least 15,000 houses by 2010. Individual Toll developments now range in size from a few dozen to 3,000 houses.

“‘Why can’t real estate just have a boom like every other industry? Why do we have to have a bubble and then a pop?’ asked Toll.”

At the top of the list in believing the “permanently high plateau” theory is David Seiders, the chief economist for the National Association of Home Builders. According to Seiders, single-family starts numbered about 1.6 million, in 2004. He expects another record this year, even as the industry begins to hit “the plateau we’ve been watching and waiting for.” Next year, Seiders said, he projects 1.58 million single-family-home starts.

Also chiming in on the permanently high plateau theory is Erik Bruvold of the San Diego Regional Economic Development Corp. in the San Diego News article, Housing economists raise yellow flag over San Diego.

“Mr. Bruvold predicted a flattening in prices rather than a dramatic falloff. Already, the inventory of homes on the market is growing and sales prices are lower than asking prices. ‘I think we’ve hit a plateau,’ Bruvold said. ‘I would not refer to it as a turning point.’

“David Berson, chief economist of Fannie Mae and David Seiders, chief economist for the National Association of Home Builders also seem to be giving some credence to the ‘plateau theory.’ ‘Prices are so high that at some point there is the possibility people may simply decide it’s too expensive to move there,’ Berson said. ‘Alternatively, prices may simply slow for a period of slow or no price gains.’

“David Seiders said constraints on supply will tend to keep prices from falling. ‘That makes me think prices are going to stick,’ he said.”

I wonder: Does Toll have any idea of the likelihood of growing at a 15-20% rate for perpetuity with a plateauing market? What if it doesn’t plateau, but sinks? Even IF the market expands, is 15-20% a year doable? Does he really believe this or is this just yapping for shareholders? From where I sit, it’s a pipe dream to think that this expansion can continue with housing affordability at all-time lows, and real wages falling. I think what Toll is suggesting is financially impossible.

Housing Cheerleaders: “A Permanently High Plateau”

All of these housing cheerleaders sound just like Yale professor Irving Fisher, who just before the stock market crash in 1929, declared that stocks had reached “a permanently high plateau.”

Mish’s view of the “permanently high plateau” theory is right here:

Note: I made that chart in spring of 2005. Please mentally shift the arrow one notch to the right. Perhaps we stay up here a bit longer forming a broader top, perhaps not, but mark my words, there will be nothing remotely permanent about this plateau.

When Toll asks: “Why can’t real estate just have a boom like every other industry? Why do we have to have a bubble and then a pop?” I wonder: has Toll ever studied economic cycles? Is his memory so poor that he has already forgotten what happened four years ago in a stock market bust led by telecoms and dot-coms? Exactly what boom is he referring to that, “like every other industry,” can go on forever?

Susan Wachter, a housing economist at the Wharton School of the University of Pennsylvania, remarks: “The fact of the matter is that housing prices are increasing in the U.S., faster than inflation, in ways we haven’t seen before. Ten years running. It’s the first time in keeping these numbers that we’ve ever had a run like that.” Mish asks: Does that sound remotely sustainable?

Doug Noland sure nailed it in his latest Credit Bubble Bulletin

“Analyzing today’s Mortgage Finance Bubble does bring to mind speculative dynamics at play during the late-80s commercial real estate bubble. Despite increasing signs of late-cycle stress and fundamental deterioration (rising vacancy rates, over-supply, and sagging rents), it took quite some time to pacify (and then quickly crush) the speculative spirits that had blossomed during the boom. The boom-time financial infrastructure and the resulting Wall of Liquidity continued to finance additional building, with both the quantity and quality of the projects guaranteeing a devastating downside of the credit cycle. We saw similar dynamics at work throughout the tech and telecom industry during that fateful period, 1999/2000.

“Today, the system is basically preordained to finance and construct at least 2 million new residences a year, notwithstanding fundamental developments (rising inventory of unsold units!). Too many of these homes will be oversized, upscale, and constructed in the hot/susceptible markets (California, greater Washington, D.C., Miami, Las Vegas, etc.). The vulnerable condo, investment property, and vacation home sectors will see more than their share of construction activity. And the reality of the situation is that this housing juggernaut is destined to pressure exiting home prices and exacerbate post-Bubble system impairment. You can throw any notion of a self-adjusting and correcting system out the window.”

It is actually “build or die” for all of the homebuilders. Private companies could simply pull their chips off the table, finish selling what inventory they have, scale down and slowly go toward extremely high cash ratios. If Toll Brothers did that, its stock would crash. Thus, Toll Brothers and all of the other public homebuilders will buy land and build and attempt to expand no matter what the market climate is, no matter what the cost of materials is, and no matter what national housing inventories levels are. As public companies, being bearish is simply not an option, no matter how bleak things might look. This is exactly why homebuilders go bankrupt at the bottom of every cycle. It happens every time. Builders will keep building as long as banks will lend them money. They will not stop because they fear they will lose their crews, their market share, or their stock options. Homebuilders will run under the model of “build or die” until margins are squeezed so hard they sustain heavy losses. At some point “build or die” will morph into “stop building or die.” At that point, concerns about market share and promises of 20% growth will both go out the window. By then it will be too late.

This cycle will not be any different. No, I am not calling for Toll Brothers to go bankrupt, but the possibility is actually there. I do expect some bankruptcies out of this mess, but it is not easy to predict which ones.

Let’s return one final time to what “The Housing Evidence” suggests:

1. Homebuilders haven’t a clue about business cycles, affordability issues, tightening credit, or liquidity. Money has been too easy for too long for anyone to understand what might happen in a liquidity crunch. No one sees even the slightest possibility of a credit crunch.

2. Homebuilders will keep buying more and more land and adding more and more to housing inventory in a foolish attempt to grow 20% every year fighting for “market share” right at the peak of the boom.

3. No one seems to see or believe the devastating consumer-led recession that is staring them in the face. It’s simply “build or die.”

4. People will indeed borrow to buy this housing bubble until lending literally seizes up.

I believe we can now answer Toll’s question: “Why can’t real estate just have a boom like every other industry?” My answer is, “Patience Mr. Toll, you will, and it will end up looking a lot like the telecom bust of 2000, too.”

Mike Shedlock ~ “Mish”
October 28, 2005

Playing Hardball With Softwood

The New York Times Op-Ed contribution Lost in the Woods summarizes nicely the dispute between Canada and the United States over lumber.
Following are the key points:

“American and Canadian lawyers, lobbyists, and negotiators have been fighting on and off over Canadian lumber exports to the United States since the 1980s. In 1982, a coalition of 250 American lumber mills claimed that Canadian provinces were subsidizing lumber exports by charging set “stumpage fees” — the price forest companies paid when harvesting standing timber — while American mills were paying open market prices. While the fight over things like stumpage fees is complex enough, it got a sharp twist in 2000 when Congress passed an amendment giving American companies injured by foreign trade the punitive duties imposed by the United States, which in the case of Canadian lumber exports now amount to about $5 billion.

“Never mind that the right of the United States to impose such duties is in dispute, or that the W.T.O. declared the Byrd amendment (named after its creator, Senator Robert C. Byrd) illegal. American and Canadian officials now face two lumber disputes: the old one about timber management practices; and the new one about who owns the money held by the Treasury. Making things uglier are conflicting decisions by a panel convened under the North American Free Trade Agreement and by the W.T.O., with the United States claiming that favorable rulings by the latter trump adverse rulings by the former.

“Canadians, including the normally friendly Canadian business community, are particularly outraged that Washington has rejected the NAFTA panel decision. In Canadian eyes, this refusal by the United States betrays the central deal that underpinned NAFTA in the first place: Canada allowed unfettered access to its energy resources and an end to restrictions on American investment in return for a binding method of settling disputes. As Prime Minister Paul Martin made clear recently, the dispute is coloring everything from the oil and gas trade (Canada is the largest foreign supplier of energy to the United States) to cooperation in the World Trade Organization, the International Monetary Fund and World Bank.”

If a supposedly big advocate for “free trade” cannot even resolve a relatively minor dispute with its biggest trading partner when it is clearly wrong, what hope do any free trade talks have down the road? One has to wonder just how much the lumber lobby contributed to the presidential and congressional campaigns.

Lawrence Herman and Gary Hufbauer, the authors of “Lost in the Woods,” proposed appointing “a special envoy with the authority to negotiate a final and durable compromise by a date certain, say June 2006.”

No! As far as I am concerned there is simply nothing to negotiate. The Byrd amendment is illegal, the United States has illegally confiscated $5 billion from Canada, and worst of all, the United States betrayed the deal that underpinned NAFTA in the first place: Canada allowed unfettered access to its energy resources and an end to restrictions on American investment in return for a binding method of settling disputes. Not only does the United States refuse to honor NAFTA agreements with Canada, it will not even honor agreements as to resolving disputes.

What’s stupid about all of this is cheaper lumber is desperately needed in the United States. With the cost of lumber high and lumber demands up in the wake of several hurricanes, not to mention the stupid waste of paying more than necessary to build houses just to make a few lumber barons rich, one would think that it would be to our advantage to increase the supply at a cheaper cost. But no. We do not honor our own agreements with our biggest trading partner, even when it is obviously to our own advantage to do so.

That is a pretty pathetic record on “free trade” in general and NAFTA specifically. It is certainly not a record one would expect unless from “free trade” advocates unless there was a lot of money sloshing around somewhere to keep the status quo of illegal tariffs. I suggest it is high time for Canada to demand the United States honor its agreements.

If the only way to get trade agreements honored is to make it extremely painful to those not honoring them, then so be it. Canada can end this mess in about two days flat if it wants to. As a free trade advocate, I recommend that Canada threaten to shut off all oil and Natural Gas deliveries to the United States on one week’s notice if the United States will not abide by its trade agreements.

Playing hardball over softwood would not only end this nonsense in a hurry, it would also send a strong message to every country about the consequences of ignoring trade agreements for political convenience. Just to make sure people do not mistake this for USA bashing, the E.U. is equally guilty with its protectionist farm subsidies. The difference being (for now), no one has either the political will or a bat big enough to force changes in the E.U. Canada does, and it should use it.

Mike Shedlock ~ “Mish”


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