[Editor's Note: This is the sixth installment of a new series that looks at the global investing outlook for 2009.]
By Don Miller
Contributing Writer
Money Morning
The U.S. housing market is already being pounded by the “perfect storm.” And the outlook for the New Year is for the stormy weather to continue – and probably to get worse.
As if a locked-up credit market and tidal waves of foreclosures weren’t already enough, we’re now watching unemployment climb and consumer confidence plunge.
But even when the housing market is taking on water, there are ways to stay afloat. Indeed, investors nimble enough to maneuver can even make money.
The watchword on this market, though, is caution. If an investor decides to test the waters, beware of the extraordinary financial undertow.
Here’s a look at what’s happening now, and what the implications there are for investors in the New Year.
Rising Unemployment Feeds into Sinking Demand
The grim reality is that skyrocketing unemployment is a major threat to the recovery of the U.S. housing market. And consumers shackled with record levels of debt are unlikely to ride to the rescue this time.
Since this recession is expected to be long and deep, economists are projecting high rates of unemployment. And the latest statistics released by the U.S. Labor Department show the crucial jobs market deteriorating at an alarmingly rapid pace.
The U.S. unemployment rate jumped to a 14-year high of 6.5% in October as another 240,000 jobs were cut – an uptick from 6.1% in September and the 10th month in a row the jobless rate has risen. Most forecasts are calling for unemployment to spike as high as 8.5%, which would be the worst showing since 1980.
So far this year, a staggering 1.2 million jobs have disappeared. More than half the decrease occurred in the past three months alone, Money Morning reported in its “Outlook 2009” series economic forecast story. Even worse: A year ago, job cuts were concentrated in the financial-services and homebuilding sectors. Now they’re rising across the board; virtually every part of the economy is feeling the squeeze.
For instance:
- U.S. automaker Chrysler Corp., one of Detroit’s wheezing “Big Three,” is laying off 25% of its white-collar work force of 18,500.
- Appliance maker Whirlpool Corp. (WHR) recently announced it would cut 5,000 jobs to cope with declining sales.
- Worldwide shipping giant DHL, a subsidiary of Deutsche Post AG, is laying off 9,500 people, and threatening to close its U.S. distribution center.
- Onetime Internet search giant Yahoo! Inc. (YHOO) plans to let 1,100 workers go – on top of the 1,000 already jettisoned in January – the result of several botched merger attempts.
- Ailing banking giant Citigroup Inc. (C) heaped more bad news on the financial sector, announcing whopping 50,000 layoffs in the next 12 months.
Layoffs of this magnitude are more than a mere shot across the bow of the housing market – they’re actually a direct hit amid ship. People who are unemployed cannot buy homes. Period. But even consumers who are afraid that they might be joining the jobless ranks are loath to take on the added risk – making them unlikely candidates to buy a new home.
Foreclosures Still Rising
As unemployment climbs, foreclosures will continue to multiply. That only exacerbates an already unappealing combination – more houses being dumped onto the market even as the pool of potential buyers grows increasingly smaller.
RealtyTrac Inc. reported that more than 81,000 homes were foreclosed on in September – 71% increase from the same period just a year ago. For 2008, foreclosures rose to a record 765,558.
“I wouldn’t be surprised to see foreclosures increase as the economy slows down,” said Rick Sharga, RealtyTrac’s vice president of marketing. “The people living paycheck to paycheck are at risk if they lose their jobs. It will cause more people to lose their homes.”
And while foreclosure volumes are outpacing projections, the cumulative losses by banks on bad mortgages may have yet to hit their books. Since loan losses don’t get recorded until the property is sold, it’s likely there’s a lot of bank-owned inventory that hasn’t been unloaded – meaning there may be more foreclosures out there investors don’t yet know about.
“We are in uncharted waters,” said Brian Bethune, an economist at research firm Global Insight (IHS).
Making the waters even rougher was the decision by Standard & Poor’s Inc. (MHP) to cut the ratings on $34.1 billion of “Alt-A” residential loan packages that had been issued in 2006 and 2007. Alt-A mortgages are those written with little or no documentation, i.e., without proof of income or assets. Even worse, S&P put an additional $351.7 billion of Alt-A securities up for possible review reflecting the rating company’s “belief that further declines in home sales will depress prices further and push loss severities higher than we had previously assumed.”
On top of all that, record numbers of borrowers are already “underwater,” or “upside down” on their mortgages, making it more attractive for them to default by simply walking away, than to hang around and drown.
About 18% of homes nationwide are now “upside down,” according to a report from First American CoreLogic. Almost two-thirds of those homes are in just seven states: Arizona, California, Florida, Georgia, Michigan, Nevada and Ohio. In Mountain House, Calif., an unincorporated planned housing community located in the foothills of the Diablo mountain range, the housing crisis right now has nearly 90% of the homeowners owing more on their houses than they are worth – the highest percentage in the country, The New York Times reported on Nov. 10. The average homeowner is underwater by $122,000, the newspaper said.
Other areas are suffering almost as much: In Nevada, alone, borrowers owed a whopping 89% of the value of their homes.
Despite such dramatic anecdotes, this housing slump is nationwide in nature. It’s more severe than any other such downturn since World War II, mostly because of the risky lending practices that inflated the real-estate bubble in the first place.
The Downdraft in Housing Prices
Meanwhile, while unemployment rises, the downward spiral in housing prices is gaining momentum.
“The No.1 thing that drives housing values is incomes,” said Todd Sinai, an associate professor of real estate at the Wharton School at the University of Pennsylvania. “When incomes fall, demand for housing falls.”
The S&P/Case-Shiller Index of home prices plunged 16.6% in August from the year before, following a 16.3% drop in July. The index has fallen every month since January 2007 (See accompanying chart, “Plummeting Prices.”).
Prices were lower in all 20 of the major cities the index covers, with Phoenix and Las Vegas down nearly 31% from last year.
Nationwide home prices have fallen 20.3% since peaking in June 2006.
And the skid isn’t over.
According to Fitch Ratings Inc., U.S. home prices will fall another 8% to 10% before they show signs of stabilizing. According to a Fitch forecast, the peak-to-trough price decline will be 30%.
And still one other reliable indicator of housing prices seems to confirm that, in many cities, home prices still have further to fall.
According to analysis by Moody's Investors Service (MCO), Miami houses are right now priced at about 22 times annual rental income – versus an average of just 15 over the past two decades. This suggests that a home currently priced at $350,000 is actually worth only $238,600 – meaning the price would have to drop 32% to reach the fair-value point.
Congressional Missteps
In an effort to help more than 400,000 homeowners avoid foreclosure, Congress came up with the “Hope for Homeowners” program. Unfortunately, in their infinite wisdom, federal lawmakers designed a program that is almost certain to fail.
The program supposedly makes as much as $300 billion available to at-risk borrowers, enabling them to refinance into a 30-year, fixed-rate loan insured by the Federal Housing Administration (FHA).
The biggest mistake Congress made was to make this program strictly voluntary for participating banks, experts say.
Just as bad: In an effort to make the program more affordable for beleaguered homeowners, it also requires the lenders to write the value of the home down to 90% of its current market value. So in a downtrodden market like Phoenix, if a lender holds a $400,000 mortgage on a home currently appraised at $300,000, the bank would have to settle for a new mortgage worth only $270,000.
Needless to say, the response has been underwhelming. After four weeks, a whopping 79 people had applied for the program.
Not to be deterred, the Federal Deposit Insurance Corp. (FDIC) is proposing another package, which would extend the terms of at-risk loans from 30 years to 40 years, with interest rates as low as 3.0%. Housing payments for delinquent borrowers could not exceed 38% of gross monthly income.
In order to sweeten the pot for lenders, the government would share as much as 50% of the losses if a borrower ended up in default anyway. In addition, the FDIC would pay servicers who process these new mortgages a fee of $1,000 for each re-worked loan.
FDIC officials estimate that this anti-foreclosure program would cost $24.4 billion, and would prevent 1.5 million of the 2.2 million at-risk homes from falling into foreclosure.
But that also means the taxpayer will be on the hook for half the value of 700,000 mortgages that do fail.
Can you say “fuzzy math?”
Homebuilders on the Ropes
You can probably guess where this leaves the nation’s homebuilders – gasping for air.
D.R. Horton Inc. (DHI), one of the nation’s biggest homebuilders, just wrote down $1.1 billion in land, deposits and inventory in the third quarter, as sales fell by half. The Ft. Worth, Tex.-based company expects to post a fourth-quarter net loss of between $800 million and $900 million, 18 times more than it lost in the fourth quarter a year ago.
Other builders are in similar shape. Pulte Homes Inc. (PHM) and The Ryland Group Inc. (RYL) just reported quarterly losses of $280.4 million and $65.7 million, respectively.
Even Toll Bros. Inc. (TOL), which caters to the high-end buyer, said fourth-quarter revenue fell 41% from the same period last year.
The Forecast for 2009: More Pain Before Any Gain
No matter what happens in the U.S. housing market, until a large inventory reduction takes place, housing prices will not stabilize.
In a recent Forbes magazine column, A. Gary Shilling, president of an economic consulting firm of the same name, said the worst is yet to come. Says Schilling: “Excess inventory, the mortal enemy of prices, now amounts to 1.8 million homes, which is a huge number relative to the net demand (new families minus departures due to deaths and moves to nursing homes) which is only 1.5 million a year.”
And one of the architects of the U.S. housing debacle – former U.S. Federal Reserve Chairman Alan Greenspan – is also downbeat: “At a minimum, stabilization of home prices is still many months in the future,” Greenspan said in an October speech.
The question that needs to be answered, then, is this: In the current atmosphere, does anyone believe we actually need homebuilders to add even one new home to the market?
Some pundits claim this may be a golden opportunity to short U.S. homebuilders. Even though they’re already down 80% from their highs, the deadly combination of skyrocketing unemployment, deflating prices and tight credit continue to spell further pain for the industry.
Short sellers would obviously look at any of the companies mentioned above. They might also consider iShares US Home Construction (ITB), the prominent exchange traded fund (ETF) for the group. However, any such move would have to be made with extreme caution.
The reason: All bets are off if the new Barack Obama Administration implements a moratorium on mortgage foreclosures. There’s also the possibility that Obama will be able to shepherd through any one or more of the proposed mortgage guarantee programs now on the table.
Those kinds of moves could provide a boost to homebuilders and leave short sellers in the grips of an uncomfortable squeeze – just like the millions of homeowners saddled with mortgages they can no longer pay.
[Editor’s Note: With our ongoing “Outlook 2009” economic forecasting series, as well as our newly launched “Profiting From the Aftershocks” series, MoneyMorning continues its unrivaled coverage of the global financial crisis – chronicling the key news stories, while also uncovering cutting-edge profit plays. Our two newest special-investment research reports highlight these efforts. In the first, we detail the five financial-crisis aftershocks we believe will create the greatest profit opportunities of this generation. In the second report, we show you how to “crash-proof” your investments – and we detail a corporate gem that’s riding the profit wave of the most-powerful global trend we’re following right now. In the “Outlook 2009” series, we last wrote about the prospect for gold prices in the New Year. Next up in the “Outlook” series: Latin America and U.S. retail sales.]
News and Related Story Links:
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Yahoo! Finance/The Associated Press:
Jobless rate bolts to 14-year high of 6.5 percent. -
Money Morning Outlook 2009 Series (Part II):
For the U.S. Economy in the New Year, the Pain Will Precede the Promise. -
Wikipedia:
U.S. Housing Bubble. -
Money Morning News Analysis:
Yahoo! Searching for Answers After Google Walks Away from Ad Deal. -
Money Morning News:
Citigroup Whacks Another 50,000 Jobs; Cuts Expenses by 20%. -
Wikipedia:
Alt-A Loan Packages. -
The New York Times:
A Town Drowns in Debt as Home Values Plunge. -
WiseGeek.com:
What is an Underwater Mortgage? -
Money Morning News Analysis:
Government Rolls Out Long-Sought-After Anti-Foreclosure Program. -
PressRelease.com:
D.R. Horton, Inc., America's Builder, Reports Preliminary Fiscal 2008 Fourth Quarter Results. -
Forbes.com:
We Haven’t Seen the Worst, Yet. -
ContrarianProfits.com:
Now Is a Good Time to Short the Homebuilders ETF (XHB).
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I found your blog on MSN Search. Nice writing. I will check back to read more.
Eric Hundin
In your excellent Money Morning's Daily E mail…. which, at present, I share a colleague's copy you refer to the Jersey Pound as being backed by Gold. Since other sources report the official currrency of the CI jersey as the Pound Stirling I assume that the Island supports two currencies….would appreciate conformation or correction either as n personel email or in my Mony Mornings Daily Email Report which I now look forward to receiving. Many thanks
Eleonora
Your article is very well written. The unemployment rate is keep raising and the consumer confident is keep slumping….The house value may decline another 30%…. What does this mean to me while I just bought my first home this week? Is all of my 30% down payment will be gone by next year? hmm….
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This loan renuevals is used as a inceasing the banks mortgages income and not a form of resolve the monthly payment, to loan owners. As of sort fo this the problem will increase and not resolve anything. We need this to be work independly and ofering first the loan holder the opportunity of re-finance or else pass out to an financial istitution that really want to work with this program.
It's getting to be more and more difficult to find good news on TV. Reporters seem to be reveling in stirring up as much "doom and gloom" news as they can – after all it's been proven that bad news sells better than good. Our addiction to news tickers and 24 hour coverage was solidified during horrific news events of the last decade. But there IS positive news to be found if you dig hard enough.
28 Metropolitan areas showed increases in median existing single-family home prices from the same quarter in 2007. Areas such as Elmira NY, Tulsa OK, Wichita KS and Urbana IL. Yes, I know that many areas are still showing declines, but let's at least acknowledge the gains!
But even in areas where average home sales have dropped drastically, there is good news. Buyers who have been shut out of the home ownership market, are now finding that they can afford to buy. And they ARE buying. Three states where the ‘housing bubble' has burst are seeing some of the highest increases in sales. The largest sales gain during the third quarter was in Arizona, up 28.3 percent from the second quarter, followed by California which rose 28.1 percent and Nevada, up 26.2 percent. These areas have seen some of the strongest sales gains with some reports of multiple bidding.
And there's also good news for sellers. The typical seller purchased their home six years ago and is still experiencing net equity gains, even in today's depressed markets. The national increase in value since the third quarter of 2002 is 18.3 percent, which is a median gain of $31,000. Even with the current downward price distortion, 90 percent of metro areas are showing six-year price gains.
So while we are definitely in turbulent economic times, there is GOOD NEWS to be found if you look for it. Hopefully, some home buying incentives will be passed soon to stimulate even more home ownership. Lawrence Yun, the chief economist at the National Association of Realtors, said that, "A pattern of sharply higher sales in areas with large price declines is well established," Yun said. "Affordability conditions have consistently been a major factor in driving sales. Historically during recessions, buyers have responded to incentives and it's important for government to keep that in the forefront of stimulus decisions."
Whenever optimism is rampant, beware of impending investment downturns.
Whenever pessimism is rampant, be on the alert for investment upturns.
Pessimism is rampant. Media expressions such as investing these days is like having a mouth full of spiders. Or here is another gem ….. Dr. Frankenstein has departed the building and left behind a house full of crazed monsters running amuck.
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