Economic Despair

Existing home sales declined by 8.4%, the biggest drop in 17 years.

New homes sales fell by a whopping 17.3%, the largest in 16 years.

Around 35 percent of mortgages were "non-traditional" - i.e.mortgages that allow borrowers to pay only the loan interest or just a part of the interest each month without paying anything on the principal.

.....just putting the numbers in perspective. So, no more happy talk about the US housing market recovering please.

The truth is slowly coming out. When the bubble was raging across the land, everyone thought that it was speculators and flippers who were driving prices up. Now, we are learning that it was something else. True, the flippers and speculators were there, but they could only continue because there were mortgage lenders out there, ready to push the loand that financed the madness. These jokers were pushing mortgages on ill-prepared and naive borrowers like doomsday was almost upon us.

And just how mad did it get? Well, lending standards were so lax that people could get mortgages with monthly payments higher than their monthly income. Presumably, the idea was that the unfortunate borrower could eat into their savings to finance the monthly payments, then sell up and pocket the equity. There was only thing that this scheme required - eternally rising prices. In turn, that required continued lax lending standards.

The Washington Post has an interesting example how the scheme worked:

"Nahid Azimi, who immigrated to the United States from Afghanistan 22 years ago, recently stood in the upstairs hallway of her home in Loudoun County, silently sobbing as she removed the last of her personal items from the $410,000 townhouse in South Riding she bought with pride last summer. She said she was persuaded to buy the house by an Afghan real estate agent she considered a friend and by an Afghan mortgage broker who promised to get her a good loan.

Instead, Azimi, a cashier at Giant who makes $2,400 a month, found herself strapped into a no-down-payment loan with payments of $3,800 a month. She knew it would be impossible to make the payments, but the mortgage broker promised to refinance her loan to make it more affordable. Azimi couldn't qualify for the refinance, however, so she got a second job to try to cover the costs, borrowed money from her friends and tried unsuccessfully to sell the house. Then one day in November, she collapsed at work, in part because of the stress.

"I can't do it anymore," said Azimi, 44, a U.S. citizen. "I cannot afford it, and I don't want them to come one day and put my stuff on the street."

Currently, around 13 percent of sub prime mortgages are experiencing some kind of payments delay. Within a few months, those delinquencies will turn into foreclosures, which will quickly add to housing supply. Not that teh market is short of unsold houses. In most cities, housing inventory is at record highs.

This crash is slow; it is taking its time; but it is getting there. Two things will get us there. Foreclosures, and tighter lending standards.


National mortgage news are keeping a scorecard of lenders going under. So far, about 14 percent of the market has disappeared (measured as the last time each lender filed non-prime or prime origination figures with National Mortgage News). Most of the decline is due to New Century, who pulled down around 8 percent of the market.

Meanwhile, the mortgage implode-o-meter keeps rising remorselessly. Today, the reading is 45 lenders down, out and heading for bankruptcy.

Deflation is not yet beaten in Japan. After ten months of mild inflation, consumer prices fell 0.2 percent in February. The data was particularly bad news for the Japanese central bank, who had been trying to raise interest rates and after several years of free credit, restore monetary policy to something closer to normality. Unfortunately, February’s data suggests that the recent interest rates hike was premature.

Japan continues to act as a warning to others about the dangers of speculative bubbles. The long cold winter of deflation followed on from an extraordinary asset bubble from the late 1980s. Speculation was quickly followed by a recession, a banking crisis and higher unemployment. The government’s repeated attempts to kick start the economy with higher fiscal expenditure have largely failed and led to rising public sector indebtedness.


The housing market data just gets worse. According to a housing index released by Standard & Poor's, prices of single-family homes across the nation depreciated in January compared to a year ago. Furthermore, the decline was the worst in more than 13 years.

The S&P/Case-Shiller composite index showed a drop of 0.7 percent from a year ago in the price of a single-family home based on existing homes tracked over time in 10 metropolitan markets.


The Washington Post has a long and dishonorable record of talking up the metro-DC housing market. It is old habit, mostly driven by the desire to sustain real estate ad revenue.

Today, readers were confronted with the Post's "Housing outlook: 2007". The newspaper is still at it, spinning out feel-good stories for realtors, despite the fact that the market is crashing in flames.

Take for example the article A Buyer's Market? Lenders Permitting. It is highly representative of the kind of rubbish for which the Post is famous. Rather can speak the truth and say that the market is collapsing, and that it is unlikely to recover for years, this is what the newspaper passes off as analysis:

"Once upon a time, would-be home buyers had to outbid each other and forgo inspections to get the place of their dreams. Now, sellers are the ones making concessions. "The buyers are in the driver's seat," said John Eric, a real estate agent with Long & Foster in Arlington.

But not completely. The real estate boom that ended in 2005 was driven partly by lenders' willingness to give money to people with blemished credit or with no money for down payments. Nontraditional loans, such as adjustable-rate mortgages with low introductory interest rates that increased dramatically after two or three years, became popular. With foreclosures now at a record high, banks are once again getting picky. "It's not just a buyer's market," said Leon Bailey, a real estate agent at Exit Powerhouse in Prince George's County. "It's a buyers-with-great-credit market."

Think for a moment about supply and demand. On the supply side, Washington is flooded with overpriced and largely unsellable housing inventory. Moreover, there is a glut of half constructed condos, waiting to pour onto the market. More supply means inevitably lower prices. It may take some time for sellers to understand this reality. There may be a lot of denial out there. But, more supply means lower prices.

It is true that lenders are now scared witless by sub prime defaults. It is also true that mortgage lenders will be much more reluctant to extend loans to people who don't have the capacity to repay them. However, that is a demand side issue. Less financing means less demand, which means lower prices.

So lets summarize for the benefit of all economically illiterate real estate journalists out there. Greater supply means lower prices; less financing means less demand, which in turn means lower prices.

So, if you are a buyer, in the sense that you have the financial capacity to buy a home, the collapse of the sub prime market means that it really is a buyers market. In contrast, if you are a recidivistic credit-crippled debt defaulter, yes, it will be much harder for you to buy that overpriced POS in Manassas, or the converted crack house in SE DC.

If the Post wants to regain its credibility, it has to stop quoting self-interested realtors. It needs to start telling the truth. The truth is simple enough to understand, just think about supply and demand, and it will follow like water flowing from a tap.

Today's housing market problems gave plenty of warning. Since the summer of 2005, real estate indicators everywhere had been flashing red. Inventory, sales, new home incentives were all telling the same story. The market had peaked and it was going to crash.

For example, take a look at just one indicator - KB homes, and in particular, its share price. In early summer 2005, the stock was trading at around $84; three months later it was down at $66. Although there was a temporary rebound during the winter of 2005, thereafter it has traded at around half of what it was during those heady days of summer.

Back then, smart investors knew that the housing bubble was over. Prices were just too far out of whack with reality. The KB homes share price reflected that unsustainability. Since everyone with an Internet connection had access to KBH data, it should not have been too difficult to see where things were going.

Of course, it did not quite happen that way. People looked at the rising housing inventory, declining sales and rising interest rates and somehow could not bring themselves to admit that the market had topped out. Denial and delusion are essential ingredients to any financial catastrophe, and America had both in abundance.

Up until a few weeks ago, many people still believed that the housing slowdown was only temporary. It has taken a 5 percent mortgage delinquency rate and the disappearance of 40 or so sub prime lenders before America as a whole woke up and understand that there was a crisis.

What about KB homes today? What is it telling us about the future for US housing? Well, the recent numbers are grim. The company just reported numbers for the first quarter. Compared to the same period last year, revenues are down 20 percent; net income fell from $173 million to $27.5 million; while orders fell by 12 percent. The only ray of sunshine comes from their cancellation rate, which improved slightly compared to the fourth quarter of last year.

Chief Executive Jeffrey Mezger suggested that "it is hard to predict when the housing markets will stabilize". Perhaps Mezger should try thinking about it a little harder. If he did bother to think, two somewhat related problems would give Mezger sleepless nights. Thinking on a little further, he would understand that the market will not stabilise any time soon.

First, the recent rise in mortgage delinquency and foreclosure rates, will mean distressed sales at knock down prices. In turn, this will undermine KB homes revenue growth potential. Second, the sub prime fiasco will lead to tighter lending standards, drying up housing demand.

KB homes are looking at nasty double-dip; increased supply of unwanted houses, lower demand due to fearful mortgage lenders, this means only one thing, lower sales volumes at lower prices. Since 2005, the share price has implicitly priced in these problems. The share price was flashing red, telling us that the housing bubble is over. Take heed, it is still flashing red today, and it is telling us that the collapse has only just begun.

"The US central bank has yet to develop an exit strategy from the multi-bubble syndrome that the Fed, in its zeal for inflation targeting, has spawned.

Moreover, as one bubble begets another, excess asset appreciation has become a substitute for income-based saving — forcing the US to import surplus saving from abroad in order to sustain economic growth.

And, of course, the only way America can attract that capital is by running a massive current-account deficit. In other words, not only has the Fed’s approach given rise to a seemingly endless string of asset bubbles, but it has also played a major role in fostering global imbalances."

From Stephen Roach, Economist at Morgan Stanley, May 23, 2006



A brilliant youtube movie. It says it all.

What have we done to ourselves? What have we done to our country?

According to government statistics, Japanese land prices rose for the first time in 16 years last year. Average residential land prices rose 0.1 per cent nationwide in 2006, while commercial land prices rose 2.3 per cent. The increases were anemic but given almost two decades of real estate losses, the Japanese were happy to see the change in direction.

The Japanese property bubble is now just a horrible memory, softened by the passing of time. At the height of the bubble, the land beneath the Imperial Palace in Tokyo was supposedly worth more than the entire state of California. In 1989, prices were highest in Tokyo's Ginza district, where land was changing hands for over US$1.5 million per square meter ($139,000 per square foot). However, by 2004, prime "A" property in Tokyo's financial districts were less than 1/100th of their peak. Things were a little better for Tokyo's residential homes, they were worth 1/10th of their peak valuations.

There is one much less commented upon aspect of the Japanese real estate crash - its speed, or lack of it. It was slow, real slow, like watching paint dry. It took years of painful gradual downward price adjustment. Disbelief was the real driver of the crash. No one in Japan wanted to believe that land had become so overvalued.

There was no comfort in this lack of energy. The subsequent damage to the Japanese economy was enormous. The ten years after the real estate peak are now known in Japan as the lost decade. Furthermore, the economy over there still has a long way to go before recovery is assured. Government indebtedness increased dramatically during the last decade, and it is a problem that will come back to haunt the Japanese for decades to come.

Will it also take 16 years before the US real estate market recovers from the excesses of the last five years? Probably.