A truly amazing opportunity lies before all investors. For those like myself who were on the wrong side of the first leg down in housing, we quite possibly have an opportunity to still enter the trade.
Possible and probable are words often used by attorneys. It’s possible you can burn yourself with a cup of McDonald’s coffee but not very probable you can sue for 2 million dollars (only 1 million). So as we venture in 2011, the question investors really need to ask is do you see home prices falling more or have they bottomed and begun to move back up. The highly probable answer is they have another leg down anywhere from 20% to even 40%.
“Some of the most cyclical parts of the economy like housing for example are already very weak and they can’t get much weaker.” – Ben Bernanke December 5, 2010 60 Minutes interview.
Truly astonishing that the above comment is from the Chairman of the Federal Reserve. Housing is really no different than the equity market and we all know that markets never get it right. They overcorrect either to the upside or the downside. To keep things extremely simple, one need only look at the chart below of historical home prices going back to 1890. Since 1997 homes prices have risen 83%. That’s mind boggling and no different than the tech bubble. There’s no reason Apple should have traded at 75 in March 2009 but markets over correct. Irrational prices happen and that is when bottoms are put in. Wealth is transferred.
Peter Schiff in a WSJ op ed was quoted “In January 1998 the 10-City Index (Case Shiller) was at 82.7. If home prices had followed the 3.35% annual 100 year trend line, then the index would have arrived at 126.7 in October 2010. This week, Case-Shiller announced that figure to be 159.0. This would suggest that the index would need to decline an additional 20.3% from current levels just to get back to the trend line.”
We have already seen the past few months, home prices accelerating to the downside faster than expected. If we truly believe that homes prices will over correct as do equity prices then you must seriously look at a long term short sided trade in the financials. Banks do not have the capital to sustain another leg down in housing. Currently banks are letting homeowners not make payments for over 12 months (much longer in many cases) and do not even send a delinquency notice. The simple truth is their earnings are diminishing yet their hits to their balance sheet are growing. Right now they are simply trying to reduce their balance sheet at the rate that income can offset. The entire US economy as a result is held hostage. The top four banks alone (JPM, WFC, C, BAC) hold over 400 billion in second lien credits (second mortgages). This is an entire other shoe to drop that in the first leg down in housing really did not affect the need for added bank capital.
We’ve been conditioned to think the Fed will simply bail out the banks but there comes a time where even the Fed must face reality. The Dallas Fed recently published a paper that accepts the harsh reality that the market, not the government, may in fact be the only solution to the housing crisis. In this article I don’t even touch on issues facing the banks from securitization fraud, put back risks, robo signing and the already massive level of shadow inventory yet to hit the market. I’ll leave you with two very scary statistics.
1 – Should home prices drop just 5% more then another 8 million homeowners will be underwater. The Dallas Fed study is quoted “36% of defaults are strategic.” The homeowner can make the payment but because they are underwater decides it’s not the best business decision.
2 – Mortgage rates have moved up in very short order recently. Should this continue rates alone will force home prices lower. In the past 6 weeks, rates have moved up enough that monthly payments on a $300,000 mortgage have gone from $1,462 to $1,585. In other words that buyer can now afford a $278,000 mortgage.
The probability for a major leg down in housing and the financial sector is highly probable (and always possible).
Submitted by Tony (Runedge). If you would like to follow me on my new blog, please visit – http://ultratrading.blogspot.com/
