Housing Speculation Hangover

The Daily Reckoning PRESENTS: Everyone has their own opinion on what is happening in the housing market – some say we’ve reached the bottom…others say we still have a ways to fall. One thing is certain, however, the situation is going to worsen for real estate speculators. Dan Amoss explores…


According to the chief economist of the National Association of Realtors (NAR), the housing market is now transitioning from and “unsustainable boom” to a “permanently high plateau.” According to an October 25 NAR press release:

“David Lereah, NAR’s chief economist, said stabilizing sales should build confidence in the housing market. ‘Considering that existing-home sales are based on closed transactions, this is a lagging indicator and the worst is behind us as far as a market correction – this is likely the trough for sales,’ he said. ‘When consumers recognize that home sales are stabilizing, we’ll see the buyers who’ve been on the sidelines get back into the market, and sales will be at more normal levels in the wake of the unsustainable boom that we saw last year.’ He noted sales already are improving in some areas.

“Total housing inventory levels fell 2.4 percent at the end of September to 3.75 million existing homes available for sale, which represents a 7.3-month supply at the current sales pace.”

Housing inventory levels can certainly continue falling, but don’t make the mistake of concluding that this will automatically lead to the return of a “tight” market. Over the past year, inventories were given an extra kick as many existing homeowners merely tested the waters of the market; these homeowners hoped to extract big equity gains in 2006 via the analytically complex process of slapping an “ask” price closely resembling their neighbor’s sale price from last year. From there, they expected to sit back and wait for multiple “bids” above their ask price, ultimately selling to the highest bidder.

Trouble is, buyers have finally wised up to the realization that housing runs in cycles – and the top of this cycle has been the most overextended in history. Irrationally exuberant psychology extended the topping process, as buyers clearly feared being left behind by the home equity gravy train. This was very reminiscent of the tech bubble psychology that caused an already-overvalued NASDAQ to double yet again from spring 1999 to spring 2000 before crashing.

The hangover in the housing market will clearly not be as severe as it was in the case of the NASDAQ’s 78% peak to trough decline, because houses (generally) have more durable, tangible value than stock certificates. But by no means is housing about to turn around and rocket upward once again. Buyers’ lowball bids are reflecting this, and sellers can either withdraw their listing or hit lower bids if they must move out of necessity.

As I wrote in the August issue of Strategic Investment, too many pundits (who in fact must remain cheerleaders as part of their job description) are treating the housing market as if it were similar to the stock market:

“…about 9-10% of the housing market turns over every year. Compare this low turnover with volume in the stock market. The typical S&P 500 stock has about 150% turnover per year, so you can be reasonably sure that the stock sitting in your portfolio is worth within a fraction of a percent of the last tick. The low housing transaction volume makes aggregate national housing value statistics misleading. The near-term value of your house is completely dependent on what current shoppers are willing and able to pay for your house. The ‘willing’ part is psychological, and psychology has morphed from ‘my house will appreciate 15-20% per year’ to ‘my house will appreciate 8% per year.’ The ‘able’ part is dependent on global liquidity and mortgage financing aggressiveness.”

The data coming out over the past few months indicate that while homeowner psychology may have worsened to “my house will appreciate 2% per year,” the mortgage liquidity spigots remains on full blast. Those desperate to sell should be able to sell by hitting lower bids in this low-rate, high-liquidity environment, while those buying are doing so because they want to raise a family in a home – not because they are deluded into thinking they will become millionaires without lifting a finger.

But the bond market merits our attention, particularly after what we saw there last Friday.

If yields spike back above the June highs, the buying support under the housing market could quickly falter, making the “landing” far more perilous than it currently appears.

It’s a big analytical mistake to extrapolate the prices of a 9-10% turnover market onto the entire housing stock. But this mistake has convinced many millions that housing inflation equals “wealth creation.” Thus far, this mistake has not proven to be very costly, since credit availability appears to have no rational limit.

But those who have been planning under the assumption that last year’s housing market was the status quo are waking up to an ugly reality. An article in the November 3 Wall Street Journal entitled “The New Word in Home Sales: ‘Canceled,'” provides an anecdote:

“Cancellations by buyers of existing homes are up as well. Although no formal measures exist, historically they have been in the 2% range, according to the National Association of Realtors. In September, however, nearly half of the 454 agents responding to an online NAR survey said they had recently experienced cancellation rates higher than that.

“Sean Shallis, senior real-estate strategist for the Shallis Team of Re/Max Villa Realtors in Jersey City, N.J., says that roughly 22% of his sales have fallen apart before closing this year because the buyers backed out, up from 10% last year. With the market cooling, buyers have decided they can buy a similar property for less. For others, adjustable-rate mortgages have gotten more expensive, making a home purchase too costly, Mr. Shallis says. To reduce the chances of cancellation, he is advising his clients to close their deals as quickly as possible after the offer is accepted, and to put fewer contingencies in the contract. ‘The longer your property is under contract, the longer the buyer has to talk and think about it and watch the market change.’

“Mr. Shallis himself is among the would-be buyers with cold feet. Late last year, he agreed to pay $595,000 for a new two-bedroom condominium in Jersey City for his in-laws. He pulled the plug on the deal this summer after his father-in-law’s illness scotched the planned move. ‘My exit strategy was if they didn’t move into it, we could sell it or rent it,’ Mr. Shallis says. But that plan made less sense after the price of similar properties dropped to as low as $529,000. At the same time, higher short-term interest rates made it unlikely that he would be able to cover his mortgage payments and other costs if he found a renter. Instead, Mr. Shallis walked away from the contract and lost his $30,000 deposit.”

The huge number of people who bought investment properties in recent years cannot all rent them out. For those who can, their after-tax, after-expense yield is practically negative. Without the fundamental support provided by yield, the “second house” market rests on the speculation that prices can continue to irrationally inflate. As the WSJ story shows, even “senior real estate strategists” are beginning to grasp this concept.

Best Regards,

Dan Amoss, CFA
for The Daily Reckoning

P.S. The hangover for real estate speculators is likely to continue worsening. Upon the first hint of “deflationary” fears, global central banks tasked with destroying paper money at a “measurable” pace will unleash their next campaign of rate cuts and liquidity injections. At that point, the “good” inflation in the stock and real estate markets can quickly morph into the “bad” inflation of rising CPI levels, gold, and commodities.

“The people have spoken…the bastards.”

-Dick Tuck, after losing a race in California to Richard Nixon

The big news this morning is that the Democrats have retaken the House.

After 12 years of going straight, the Dems in the House are about to take up their sordid old trade of cracking safes and cracking heads.

The business of Congress was always simple enough – breaking budgets and breaching the dignity of civilized society. Now, at least in the House – the outcome in the Senate is still in doubt at 4AM EST this morning – the Democrats get to lead the way.

Here at the Daily Reckoning, we exercised our constitutional right not to get involved. So our hands are clean.

“But wait,” protests a friend. “Not voting is a political act too. You’re just affirming the status quo.”

“Not at all,” we reply. “It’s just that voting is a wussy way to change politicians. If a leader gets his people into something as ruinous and preposterous as the war in Iraq, he ought to face something more terrifying than an election.”

“The vote was a vote against the war,” say this morning’s reports. The war has cost as many as a million dead, and as much as $2 trillion in expense – to say nothing of the damage to America’s military power and her diplomatic position in the world.

We recall when the news of 9/11 spread around the globe. In our office in Paris, French friends and employees came up and told us how sorry they were…and how they supported us. “We all feel like Americans now,” they said.

In Britain, the Queen ordered the band to play the Star Spangled Banner. Guardsmen at Buckingham Palace wept upon hearing it.

Even Yasser Arafat rolled up his sleeve and gave blood.

The whole world stood with us then.

And now?

“In my lifetime, I have never experienced around the world and in Britain such loathing and contempt for America,” writes Gavin Esler in the Daily Mail. “It’s as if the only acceptable racism in 2006 is to be anti-American.

“At a local school in London, I gave a talk recently on world affairs to a group of clever kids ranging in age from 14 to 18.

“When I mentioned that I was concerned about a possible war with Iran over the Iranian nuclear program, more than half the pupils said they were more likely to believe the Iranians than the Americans. Can you believe it has really come to this?

“One opinion poll published yesterday found that Britons now believe George Bush poses a greater danger to world peace than either the Iranian fundamentalist leader Mahmoud Ahmadinejad or Kim Jong-il…”

Esler goes on to reflect on what a great job the Bush administration has done of greasing the “Axis of Evil” so it can roll on to wherever it is going. North Korea has managed to get a nuclear bomb, under the watchful gaze of the United States, while the American military has actually helped Iran achieve all of its most important foreign policy objectives. It removed Iran’s biggest rival in the region – Saddam Hussein – and neutralized its biggest enemy – Iraq. In destabilizing Iraq, the United States also helped to extend the Shia revolution and expand Islamic fundamentalism.

Mission Accomplished! The mullahs must be high-fiving each other.

But now the voters are fidgeting. Fifty-five percent of them tell pollsters their wages aren’t keeping up with inflation. And fifty-three percent say the war in Iraq isn’t worth fighting.

Meanwhile, this from the art market: David Geffen, of Hollywood fame and fortune, bought a Jackson Pollock painting for $140 million. This follows the near-purchase of a Picasso for – what was it? – $139 million…and the purchase of a Klimt for $135 million.

Everyone falls for something. While the cheap suits go for ARMs, Neg Ams, and I.O.s, the expensive suits plump for Picassos and Pollocks.

But the difference is, the rich are putting down real money.

“Big Bonuses Seen Again for Wall Street,” says the New York Times.

“Never in the history of Wall Street have so many earned so much in so little time,” adds a Bloomberg report.

“Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos. are about to reward their 173,000 employees with $36 billion of bonuses. That’s a 30% increase from last year’s record, and it doesn’t include the billions more that will be paid by Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co., the three largest U.S. banks, as well as the hundreds of hedge funds and private-equity firms that constitute the financial industry.

“Enriched by the unprecedented value of takeovers, equity trading and credit derivatives, this year will be the best ever for the major brokerage firms,” said Brad Hintz, an analyst at New York-based Sanford C. Bernstein & Co.

“The average windfall for each individual at the five largest U.S. securities firms will be enough to buy a $165,000 Bentley Continental GT, the two-door coupe favored by Paris Hilton and Cher. They’ll have plenty of change for a box of Romeo y Julieta cigars and a case of Pol Roger champagne – the stuff enjoyed by Winston Churchill, Britain’s prime minister in the 1940s and 1950s.”

And lest you think this phenomenon is limited to Wall Street, from the city of London comes similar news:

“Expectations have been bolstered by a study predicting that the average bonus would rise 18.2% this year,” writes The Business. “And that 4,200 City employees – working across London in banking, hedge funds, law firms, private equity and other up-market financial services – would receive a bonus worth at least $1.9 million…

“They also believe that a handful of City traders will earn more than $50 million and possibly as much as $100 million.”

So London property is soaring. The art auction houses are making a fortune. The best restaurants are full. And the rich are congratulating each other on what geniuses they are.

But elections are not decided by rich geniuses. They’re decided by the plebes…the lumps…the hoi polloi…the masses. It’s the average man who decides who misgoverns a democracy. And the average American is by definition dumber, poorer and more ignorant than 150 million others.

His mortgage is being reset just as his house has stopped rising in price. He owes more than ever, and he has less disposable income than he had thirty years ago. And if he doesn’t catch a break pretty soon, he’s going to go sour.

And now come the election results. The Republicans are being punished. But getting voted out of office – with a million dollar pension – doesn’t seem like the just reward for the damage done. A firing squad would be more like it.

More news:


Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“Last night, the Reserve Bank of Australia (RBA) came through as I expected and raised their key interest rate 25 BPS to 6.25 percent.”

For the rest of the story, see today’s issue of The Daily Pfennig


And more views:

*** Not much on the housing bubble lately. But here’s an interesting comment from Toll Brothers founder and CEO:

“It is worth noting that, atypically, this housing market is weak in an environment of low interest rates and low unemployment,” says Robert Toll. “We believe weak buyer confidence is keeping many customers on the sidelines.”

The CNN report continues:

“Toll Brothers (Charts) is just the latest builder to warn of reduced earnings amid weaker demand. [The] No. 1 builder Pulte Home (Charts), the No. 1 builder in terms of revenue, last month reported third quarter income that missed forecasts as it trimmed guidance for the current period well below the consensus estimate. [The] No. 2 homebuilder Centex (Charts) also cut its guidance last month.

“Other leading builders – D.R. Horton (Charts), Lennar (Charts) and K.B. Home (Charts), also are forecast to see earnings and sales fall.”

*** “I don’t think the economy’s ‘landing.’ I think the economy’s doing great…It’s better than Goldilocks quite honestly. This is the greatest global boom of all time,” writes Ed Yardeni of Oak Investments

We are so pleased to read this comment from Yardeni. If he said it, it must be wrong. Yardeni will believe anything. In the late ’90s, he believed that the new era had created a ‘new man’ capable of understanding it…just as the Soviets once believed that the Bolshevik revolution had created a ‘new man’ who would be immune to the old bourgeois sentiments and urges. The idea was so crackers it took our breath away.

*** “I think you should go there soon, before you lose your house,” volunteered a dear friend. “At least then, you’ll have the memories.”

She was talking about our place in Nicaragua. There, the old Soviet man, Danny Ortega, has won the presidency. The papers say it will be a disaster for those of us who have invested money down there. But we’re not so sure. Will he be a cad? A scoundrel? Will he be good for Nicaragua…or bad for it? Who knows? Politics is as full of surprises as it is of swindles.

George W. Bush campaigned as a conservative. But once in office, he set in motion the most activist foreign policy since Wilson and the most reckless social spending since Lyndon Johnson. Maybe Ortega will prove to be as big a humbug as George W. Bush.

Being cold blooded about it, Ortega is bound to be a cross to bear – at least in the short run. He will say and do a lot of repulsive things. The press will pick them up…and amplify them. It will look bad for Nicaragua.

But a year from now the story may change. The specter of the Sandinistas has hung over Nicaragua for years. If Ortega turns out to be as moderate and reasonable as he now says he is, the ghost of the 1980s could finally be swept away…and Nicaragua could boom again.

*** From Investor’s Business Daily:

A Tyrant Returns to Managua

Posted 11/6/2006

“Latin America: Daniel Ortega’s near-certain return to power in Sunday’s election is a new Marxist disaster for Nicaragua. For the rest of us, Ortega should be kept at arm’s length as global forces send him their message.

“It’s a shame, because Nicaragua had a lot going for it…

“Foreign investment, worth $291 million, already is fleeing. Corruption is set to snowball, given Ortega’s rapacity and socialism’s inability to create wealth. The economy will tank as the government grows and the private sector is abused. And thousands of refugees will join millions of illegal immigrants already flooding the [United States]…

“Make no mistake: Daniel Ortega is a totalitarian. He insists he’s changed and even found Jesus, but he’s aligned with the region’s tyrants. He’s never apologized for the civil war he inflicted or his crimes as dictator from 1979 to 1990. He still faces charges in The Hague for crimes against humanity from Nicaragua’s indigenous Indians…

“Ortega’s changed all right, but only in his mastery of new tactics. When he was booted from office in the 1990s, he vowed to ‘govern from below,’ and piece-by-piece he has. Through various legal maneuvers, he controls the courts, the electoral authority and the legislature. That should effectively concentrate his power as president.

“He may say he’s a new Ortega, but it only calls to mind his false claims during his Marxist Sandinista regime from 1979 to 1990 that he wasn’t really Marxist, or that he would build a truly good communism, different from all the others. History shows he was lying.

“And so does the present. Ortega outspent his nearest rivals by 20% to 50% and shamelessly pandered for votes. He got energy handouts from Chavez and openly distributed them as bribes to voters. He doled out other goodies on his campaign tour, a man at his side ladling checks and medicines from a big black bag, playing candy man and claiming this was how poverty would end.

“That’s some sustainable economic solution.

“Like all Marxist regimes, Ortega’s will fail just as surely as his last. He may have Chavez to bail him out for a while, but the Venezuelan leader has spread his overseas pork too thinly, and faces a potential electoral defeat at home next month.

“As for the [United States], we’ll probably recognize Ortega as president for the time being. But we should be ready for his old tricks as he tries to create wealth through robbing Nicaragua’s middle class, shipping illegal immigrants our way, destabilizing neighbors and making himself dictator for life.

“It’s unlikely we can throw him out. But when the realities of globalization hit and the pork barrel from abroad runs dry, he’ll face the music on creating sustainable development through market forces. Let’s hope he doesn’t destroy Nicaragua first, taking it from the second-poorest country in the hemisphere to the first.”

The Daily Reckoning