Monday, March 24, 2008

It is over?

Hell no it isn't over. The Fed closes a brokerage company, FNMA and FHLMC get permission to go broke and the worst credit crunch since the Great Depression goes under the rug? Only a kid would think this thing is past.

What did the Fed do? I think they opened the door for the banks to get money to pay themselves because the banks they owed didn't trust them to loan it back to them. What this means is the potential insolvency hasn't left town and is still there. The Fed isn't lending on MBS's at par or any where near par and in fact are buying treasuries to swap for MBS's. Contrary to the view on CNBC, you can bet these are the good securities, not the CDO's these idiots got stuck with before they could peddle them off to the Chinese. We are a long way from the high powered credit market that has created this rosy picture the bulls still think is in play.

There is one thing I know for certain. We won't go forward as usual. Not only will we not go forward as usual, as the economy slows down, more cracks are going to show. Part of the story Monday, March 24 was that housing sales were up 3% for February. I think the news the problem was over was running all over the place in February so it isn't surprising the sales were up a little. What I saw was something I only piece together from time to time, that we are not in a housing slump. This might come as a shock to many people, but the truth of the matter is that sales for January on an annual pace would beat every year in history prior to 1998. In fact, every year since 1996 has beaten the prior record that stood from 1978 until 1996. 1995 narrowly missed the record.

I was involved in the real estate business in 1978. It was a crazy year with rampant speculation and we had broad based inflation and were in the midst of the baby boom generation reaching home buying and family starting age. The move to 2 income families was in full swing and anything looking like a real bust was several years in the future. The slowdown that followed was significant, dropping to 2 million units in 1982. Even if we could make a case there was more people in the US today and legitimately we should have a 40% greater top sales year, 5.6 million would be peak. But, 2.8 million would constitute a down year, not 5 million. The fact that sales stayed below 4 million all through the 1980's and well into the mid 1990's lends credence to the idea that we have yet to see the housing bust if the recent stats are any indication.

Why is this important? Because anyone that can trace the flow of funds will begin to see that the entire world financial structure is now resting on the state of US housing. Doug Noland of Prudent Bear fund
over the years has clearly made the link between the stock market bubble and the continued inflation of borrowing on homes through financing provided first by FNMA and FHLMC then by Wall Street itself. Being that this procedure hasn't slowed down to previous levels yet, despite much hardship in the financial end of housing, the worst is yet to come. It might appear to get better first, but the point here is the bubble has a hole in it and it can't help but get worse.

There is more to this story than housing, but the whole cake can be deduced from what has happened and what is happening in the housing market. What is happening is foreclosures and declining prices. The housing market didn't collapse because financing collapsed, but financing collapsed due to housing being saturated. We are seeing sales at an unsustainable level, even at the present. In fact, I sense the figures are being cooked if one is to be believed that the market is bad. If the market is falling apart with 5 million sales pace, what is going to happen when the sales pace reaches the normal bottom in the 3 million or less range?

This time isn't different. It is never different and the valley of sales, whenever they do come, is going to be much lower than were we are. This means that quite possibly 10 million people will desire to sell homes with no buyers. Those having hardships won't be able to get out from under homes and those that previously invested in homes will not be stepping forward attempting to get rich buying more of them. Instead, they will join the sellers in trying to get out of the absolute headache of being a landlord and quite possibly before the declining cashflow bankrupts them.

Why do I believe sales are still high? If you look at this chart compliments of Calculated Risk you will note that between 1969 and 1992, sales of homes significantly exceeded 3.5 million 1977, 1978 and 1979 and were roughly 3.5 million 1986, 1987 and 1988. Remember the post war babyboom started in 1946, so the later years were years the early boomers were 40 and over and the early years, they were 30. This wasn't a poor sales period, but historically high. So, in a period of 24 years, we saw sales significantly over 3.5 million only 3 years when demand was high and the need for inflation hedges and tax shelters were also high. All other years during that period, sales touched 3 million twice and marginally exceeded it 5 other times.

If you look at this bubble, you will see that it is quite comparable to the NASDAQ bubble in size. The United States isn't China and the idea that sales that were limited in boom years to 4 million for 4 really fast growing decades only to see them go to 4 million, then 5 million then 6 million then top at 7 million is evidence of nothing else. Looking at this chart, I see a 15 year uptrend in sales. There were a few years flat against the prior year, but nothing where sales backed off to any degree. We went right through what they called a recession with no pullback in housing. I think it only interrupted the upswing a little. In fact, sales in 2001 exceeded sales in 2000.

My point here is that money coming out of financed housing sales propels the US economy and the propeller is still spinning. What we are about to see is the propeller might be spinning, but it is out of the water. The equity is drying up rapidly and not too many experts seem to think we are near the end of this mess.

What is in part behind this rally is the delusion that the Fed is buying mortgages when they are only swapping them at a discount and that the banks are getting money to lend when in fact they are getting money to pay the other banks for what they have already loaned out. The balance sheets of these rambunctious operations are nowhere near repaired and I suspect that more than any of us care to think about are operating insolvent in fact, but covertly so. The idea that the value of all this crap they packaged is coming back is nonsense and the idea that they are going to turn sub prime borrowers into prime candidates is a bunch of nonsense even the bulls won't buy. But, to buy the bull market coming back, they have to buy the idea that the sub prime market is going to continue. Also, they are going to have to buy the idea that Wall Street alchemy financing is going to come back strong.

The other news out there is that FNM and FRE can go out and buy another $200 billion in mortgages. That is fine and dandy, but I would have a hard time believing there is enough mortgage insurance capital out there right now to get that kind of business going together with the fact that I find it doubtful that in this market FNM and FRE are going to find ready buyers for an unlimited amount of paper. I don't believe the banks are in the mood to finance hedges to carry this stuff.

The point about all of this discussion is that the market needs demand to prop up its earnings, its cash flow and all else that it so joyously is celebrating today. I doubt seriously they see 80% of the new credit going forward they saw in the past and that spells trouble for the economy, for debt service, for housing and for the international markets as well. There are going to be 2 types of sellers of homes, those with no mortgages or 15 year old mortgages in some cases and those that are hoping they get out with what they put down to start. The zero down game is done, which means the demand driver longer term is done. If anything, pre-owned home sales are being supported by the fact that there are fewer new homes being sold.

If I had to guess, my best guess is that we are in a month long or 2 month long period of everything is going to be okay. The world financial system is stacked on speculation and bad credit risks and the Fed and most likely the bank of England are taking enormous risks going forward. The fact that the Fed made the changes they made tells me where we are, one hell of a lot farther from the top than where the market stands. The delusion has set in that you make money out of holding stocks forever because they got even from the last dive in 2000-2002. They aren't going to get away with a 6 month flat in this mess. The next downturn is going to be historic and I hope it is historic to the point that we can live to write about it.