Housing prices may fall, but slowly – Thornberg

[LA_Renter]

http://www.dailynews.com/business/ci_4209057

“Is this going to be an economic train wreck like the one that happened in the early 1990s?

No, concludes economist Christopher Thornberg in a somewhat surprising assessment since he’s been one of the biggest bears about the California real estate market.

He recently left the UCLA Anderson Forecast to start his own consulting firm, Beacon Economics, and was one of the first to conclude a bubble had formed in the residential real estate market.”

I think Powayseller pointed out that Thornberg skirts this issue of exotic loans. IMO the coming resets are the biggest risk to RE right now. I would like to hear him elaborate his views on this topic.

[powayseller]

He went from “prices will NOT decline, but will stay flat until fundamentals catch up”, to “prices will drop 10%”. He is a lagging economist. He waits until stuff has happened, then tells us about it. How did he ever get so popular???????

I can give better forecasts than he can. I say prices will drop 35%, and we are heading into a recession.

I wonder, seriously, why he has so many followers. He had one good forecast, and people still remember that. Ever since, he’s been lousy.

[LA_Renter]

This is a Barron’s article by LON WITTER. This is a subscription so I will list the entire article here. I wanted to put it on this thread due to Thornberg’s (whom I respect) reluctance to approach this subject.

The No-Money-Down Disaster

By LON WITTER

A HOUSING CRISIS APPROACHES: According to the Commerce Department’s estimates, the national median price of new homes has dropped almost 3% since January. New-home inventories hit a record in April and are only slightly off those all-time highs. Existing-home inventories are 39% higher than they were just one year ago. Meanwhile, sales are down more than 10%.

Although the stocks of new-home builders are down substantially, the stock market and many analysts are ignoring other implications of the housing news. In the latest Barron’s Big Money Poll of institutional investors, not a single money manager ranked problems in the housing market among the factors likely to lead to a sharp selloff in stocks in the next 12 months (see “Headed for Dow 12,000,” May 1, 2006). Most experts still predict a 2%-6% rise in housing prices for the year.

These experts and analysts are basing their predictions on a possible increase in wages, inflation and GDP growth. They are overlooking the fact that by any rational valuation there has been no support for the run-up in housing prices since 2001, when the wealth of the middle class was battered by a bear market. Since then, inflation has been low, and wages practically stagnant. Housing prices, on the other hand, are through the roof.

Extrapolating housing prices from their current level based on wages and inflation is like saying a $100 Internet stock with no cash flow and negative earnings will rise as long as it is able to narrow the loss. The analysis ignores the fact that the stock never should have been trading at $100 in the first place.

By any traditional valuation, housing prices at the end of 2005 were 30% to 50% too high. Others have pointed this out, but few have had the nerve to state the obvious: Even if wages and GDP grow, the national median price of housing will probably fall by close to 30% in the next three years. That’s simple reversion to the mean.

A careful look at the reasons for the rise in housing will give a good indication of the impact this drop will have on the stock market. They include, in chronological order: The collapse of the Internet bubble, which chased hot money out of the stock market; rock-bottom interest rates; 50 years of economic history that suggested housing never goes down, and creative financing.

The first three factors might not be enough to cause a crash, except that together they led to the fourth factor. Irresponsible financing causes bubbles. It causes individuals to buy houses they can’t afford. It causes speculation to run wild by lowering the bar to entry. Finally, it leads individuals who bought houses years ago at reasonable prices into the speculative borrowing trap. The home-equity credit line has supported American consumer spending, but at a steep price: Families that tapped into their home equity with creative loans are now in the same trap as those who bought homes they couldn’t afford at the top of the market.

The cost and risk of adjustable-rate financing can be devastating. Consider a typical $250,000 three-year adjustable-rate mortgage with a 2% rate-hike cap. If the monthly payment now is $1,123, after the first adjustment, the monthly payment is $1,419. After the second adjustment, the monthly payment is $1,748, a $625-per-month increase. That’s $7,500 more per year just to maintain the same mortgage. If you think high gas prices are biting the consumer, consider the cost of mortgage adjustments.

Some more numbers:

• 32.6% of new mortgages and home-equity loans in 2005 were interest only, up from 0.6% in 2000

• 43% of first-time home buyers in 2005 put no money down

• 15.2% of 2005 buyers owe at least 10% more than their home is worth

• 10% of all home owners with mortgages have no equity in their homes

• $2.7 trillion dollars in loans will adjust to higher rates in 2006 and 2007.

These numbers sound preposterous, but the reasoning behind them is worse. Lenders have encouraged people to use the appreciation in value of their houses as collateral for an unaffordable loan, an idea similar to the junk bonds being pushed in the late 1980s. The concept was to use the company you were taking over as collateral for the loan you needed to take over the company in the first place. The implosion of that idea caused the 1989 mini-crash.

Now the house is the bank’s collateral for the questionable loan. But what happens if the value of the house starts to drop?

The answer, at least from banks, is already clear: Float the loans. The following figures are from Washington Mutual’s annual report: At the end of 2003, 1% of WaMu’s option ARMS were in negative amortization (payments were not covering interest charges, so the shortfall was added to principal). At the end of 2004, the percentage jumped to 21%. At the end of 2005, the percentage jumped again to 47%. By value of the loans, the percentage was 55%.

Every month, these borrowers’ debt increases; most of them probably don’t know it. There is no strict disclosure requirement for negative amortization.

This financial system cannot work; houses are not credit cards. But WaMu’s situation is the norm, not the exception. The financial rules encourage lenders to play this aggressive game by allowing them to book negative amortization as earnings. In January-March 2005, WaMu booked $25 million of negative amortization as earnings; in the same period for 2006 the number was $203 million.

Negative amortization and other short-term loans on long-term assets don’t work because eventually too many borrowers are unable to pay the loans down — or unwilling to keep paying for an asset that has declined in value relative to their outstanding balance. Even a relatively brief period of rising mortgage payments, rising debt and falling home values will collapse the system. And when the housing-finance system goes, the rest of the economy will go with it.

By the release of the August housing numbers, it should become clear that the housing market is beginning a significant decline. When this realization hits home, investors will finally have to confront the fact that they are gambling on people who took out no-money-down, interest-only, adjustable-rate mortgages at the top of the market and the financial institutions that made those loans. The stock market should then begin a 25%-30% decline. If the market ignores the warning signs until fall, the decline could occur in a single week.

There are other possibilities: The housing market could strengthen; consumers could shrug off higher loan payments and declining housing values; the financial system may have anticipated a collateral disaster (though with banks holding a record 43% of total assets in direct mortgage loans that seems unlikely); the rest of the world could carry the United States for a change. But these are difficult bets to place. Anyone holding stocks, futures or stock-index funds in this environment is taking a tremendous risk.

What happens after the decline depends on our financial policies. When Japan went through a similar situation in the early 1990s, the right advice was clear: Bite the bullet and get the bad loans off the books. Eventually the Japanese acted, but it took them 15 years of trying everything else first.

If we have the courage to take the right medicine right away, the effect of a market collapse could be very sharp and painful, but relatively short-lived. If, like Japan, we fail to act, the coming decade could be very bleak indeed.

[PD]

Wow, this guy thinks the bad times could last a decade. I was thinking that RE would be turning up again in five. Could we be in for a meltdown like Japan? If that is the case, my son will be buying his first property at the bottom and he is only 10!

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

OK, I cannot resist anymore. Here is a wall street joke about economists. A group of interns were doing their daily rounds with the head resident. They stopped at each patients bed, and had the interns review the charts. He then asked each one for a diagnosis of the current condition of each patient.

At the end of the rounds, the head resident turned to the group and picked out one individual. He said, “In all of my years of doing this with all of the groups I have taken through the hospital, we have a record.” As the group fell silent, he continued turning to the young man on his immediate right. This is the first time ever that an intern has mis-diagnosed every single patient in the hospital, have you ever thought of becoming an economist?

I do not know why anyone pays any attention to these guys. The UCLA people have been wrong for years about RE, why would anyone think they would magically now be correct. Maybe Thornberg was that intern? Economists are notorious for being incorrect about predictions, ignore them.

Most of the people in here have a better sense about what is going on than these guys do.

[powayseller]

Chris, I share your poor perception of economists. As Dean Baker, economist at CEPR said, in the fall of 2000, none of the Blue Chip 50 economic forecasters predicted the recession, which was only a few months away at that time!!!! Even though the stock market had fallen significantly…. I also have a poor perception of most mutual fund managers; they are con artists, spending too much money selling snake oil. In the end, they don’t beat even the S&P500.

You’ve got to know how to weed out the bad from the good. I made a post recently about good economists. While Thornberg has some interesting and astute comments, his forecasts are lousy.

I respect Dr. Nouriel Roubini and Dean Baker. A good economist can be judged by how well he thinks independently, digs into the numbers rather than falling for the government headline, and how contrarian he is. Mostly, what’s his track record?

There is a dire need for a good economist in San Diego. SANDAG is a government cheerleader, and Alan Gin will go down in history as having missed the biggest bubble in our history. We really need a decent forecaster. This is the challenge I am considering. For the national and international scene, we’ve got Dr. Roubini.

[bob007]

it looks like thornberg has become more bullish since leaving UCLA for his private firm.

Does his private firm have any business to do with real estate industry ? Just checking !!!

[Jim Brubaker]

I think that we ought to view economists more akin to a doctor doing an autopsy. Trying to look forward into the future with a live patient, is like reading tea leaves.

Consider for a moment, that everyone that has an economic opinion could be right; the point to realize, is that even if they are right, its only at a certain point and time. It’s just that they can’t all be right at the same moment.

Another thing to look at, as an economist, there needs to be some lying to the general public when things are bad, to keep them from hopefully getting worse.

Reality is that Frys Electronics just sold a gazillion wide screen TV’s at $3,000 a clip (no payment due for one year) and the supermarket is selling lots of premium beer for the Sunday game. If your reading this blog, you know the economy is going to hell–the arrival date is the only item in question.

[bob007]

the mention of bad news in the media can alter the time in which a recession starts etc.

[LA_Renter]

OK what is it that UCLA Anderson is trying to say? Talk about mixed messages. So they are saying there is no way this could be a soft landing but it won’t lead to a recession and home price won’t fall. But it will be bad.

Despite talk of a soft landing, a number of economists are warning that the economy could suffer a severe slowdown, if not a recession, or that inflation could reach higher levels.
Ed Leamer, director of the UCLA Anderson Forecast, doesn’t expect a recession to develop over the next year, but tells USA Today “this soft-landing scenario is a fantasy.”
He predicts that the housing slowdown will be much more severe than the Fed is saying. As a result, consumer spending, jobs, and overall growth could suffer, he says. “Anything housing-related is going to feel like a recession, almost like a depression,” says Leamer.

“Energy prices matter, but they don’t play the kind of role that housing is going to play,” says UCLA’s Leamer. “The Fed can do very little now. … It made a major error by letting this housing sector get out of control.”

[bob007]

my fear is that housing bubble will deflate slowly over a decade. we may avoid a severe recession. but the housing bubble will slow down the economy for the decade.

If commodity and energy prices shoot up any further we might slow growth + inflation = stagflation

[LA_Renter]

That is probably a concern for the FED long term. Japan is just now coming out of deflation as a result of their bubble in 80’s. Whats worse a severe recession thats over more quickly or a long drawn out downturn? As indicated in that Barron’s article it is probably best just to take all the pain now and get it over with. It wont be fun but we will probably b better off in the long term. i wouldn’t hold my breath though, this situation has some politics to it.

[bob007]

a sudden downturn would be so severe that vested interests in this country won’t survive. my bet is that we will settle for 10 years of slow growth with above average inflation.

[PerryChase]

I’ll watching with interest. We lectured the Japanese about bitting the bullet and writting off the bad loans. Will we be able to let the chips fall where they may?

[Author]

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