Friday, October 12, 2012

US Housing: How Long Can Shadow Inventory Stay Hidden?

I have written many times over the course of this year (into rising prices over the last six months) that the US housing market had one more leg down before we reached the ultimate long term bottom in prices. The reason for this boils down to essentially these five main bullet points:

1. The shadow inventory would eventually enter the market creating the final flush of supply (like the RTC program of the early 1990's)

2. Interest rates artificially being held down by the government and the Federal Reserve would eventually rise (meaning less buyers could afford the monthly payments at current prices)

3. The US government could not afford to fund 100% of the homes across the country forever. This means lending restrictions would eventually tighten (meaning fewer qualified buyers could obtain a mortgage at current prices)

4. The general economy and employment would slow down as the artificial stimulus provided by the government and the Federal Reserve wore off

5. Demographics and psychology toward housing would impact buyers. Baby boomers are looking to downsize and the younger generation has only known falling prices and falling interest rates. Homes and monthly mortgage payments are "always lower tomorrow" to this younger group. The was the exact opposite of the psychology on the way up.

Argument number 5 is already in effect as the government and Fed have the least ability to temporarily and artificially change major demographic changes.

Numbers 1 through 4 have so far been postponed due to a staggering amount of continued and increased artificial government intervention in the market.

Up to this point the US has incurred no speed bumps toward larger and more reckless government spending. The bond market has done the opposite and rewarded this behavior in the short term, like betting on a NASCAR driver who continues to drink beer after beer before a major NASCAR race. The bond market today assumes that things can only get better with more debt and less income.

If the bond market does not punish the reckless spenders then no changes will be implemented. As I have stated here over and over again and what is probably the most important idea you can take away from this website: change will only come with crisis.

This means that until the crisis arrives, the government will continue to fund 100% of the new subprime loans being created. Many of these loans are funded with 3% (or less) down with an interest rate somewhere around 3% (and falling). I could write a book alone on how large of a disaster this will be, but this is only one fraction of the problem.

What is keeping rates this low (and most likely will soon be sending them lower) is the Federal Reserve's new QE-to-Infinity program directed exclusively at mortgage bond purchases.

Lenders have no risk in making loans because they can immediately get them insured or sell them directly to the government. The government has no risk in insuring or purchasing loans because they can now offload them onto the Federal Reserve's balance sheet. What is the difference between loans made today through the government and loans made during the previous subprime bubble?

Interest rates are now lower and in many cases 50% less than during the 2006 - 2007 years. In other words, the federal government and the Federal Reserve are buying mortgage loans at a price 100% higher than those bought during the peak of the subprime crisis.

I have discussed this portion of the argument against housing in length. It can go on for much longer creating more damage for the government's balance sheet and hurting buyers even more as they get closer and closer to being the final home purchasers at the end of this ponzi scheme.

What I want to talk about briefly is bullet point number one because this one has truly fascinated me. When the robosigning scandal hit in October 2010 the number of properties entering foreclosure fell off a cliff as investors did not know who actually owned the mortgages (meaning they could not foreclose).

The scandal took about 15 months to resolve and the big banks wrote a check for a settlement at the beginning of 2012. It was widely assumed that not only would the foreclosures pick up significantly as banks were once again able to move forward, but there would be a surge above and beyond the normal level to make up for the lack of foreclosures over the previous 15 months.

The exact opposite happened which can be seen in the amazing chart below provided by Zero Hedge. You can see the drop off in October 2010, but the rate of new foreclosures never rose back to previous levels and is still falling today.

Many have argued that this has been due to a sharp increase in short sales. This is when a bank allows a buyer to sell their home below the mortgage level in order to avoid the costs of foreclosures. It essentially skips the foreclosure process meaning it would not be detected in these readings.

This is true, many homes have begun to move through this process. The exact number is unknown. If a home is sold through a short sale it is sold at a significant discount. It only seems logical that if this number of homes were being sold through this massive discount program (enough to make up for the huge drop off in the foreclosure pipeline) it would have a tremendously negative impact on home prices nation wide.

But we have seen the exact opposite in home prices. They have actually begun to rise in many areas over the last six months. It has not felt like a short sale environment, it has felt like a bidding war environment due to the limited supply of inventory available on the market.

The second argument for this drop off in the number of foreclosures is the number of successful modifications that banks have worked through with borrowers on loans. This notion is laughable. Every statistic shows that only a small fraction of those that receive a modification do not end up back in default.

This leaves me to wonder.

After pulling homes off the market for sale during the robosigning scandal, banks have seen the limited supply of available homes create an artificially small amount of homes available to purchase. This, alongside unlimited government loans and free falling mortgage rates, has created a new utopia in the housing market.

Is it possible the banks wanted to stand back and let this momentum and euphoria build?

While we cannot see how many homes continue to be held off the market in the shadows we can see that the number of days it takes a home to enter foreclosure continues to rise year after year and hit a record once again this past month. This shows that if the banks ever do decide to put a home into foreclosure they are waiting longer and longer before they do it.

Next month I'll be moving into a beautiful home in a nice neighborhood in Charlotte. I will be renting. As the market continues to become more positive around housing I will soon once again become one of "those people." The renter class of society.

Just imagine if I told the neighbors about the precious metals in the basement. We would certainly never be invited over for card games.

h/t Realty Trac, ZH

Wednesday, October 10, 2012

Looking Ahead To 2014: The Coming Obamacare Nightmare

There is concern today, mostly through the media who love the drama, that the US is approaching the coming......fiscal cliff. Both parties will stand firm on their commitment to making America great in the long run "no matter what," only to instantly cave following the election when they will avoid the immediate pain by keeping lower taxes and higher deficits. If anyone still does not understand how this process works or still sees a difference between a Democrat/Republican, or a Romney/Obama, please let me assure you that you are wasting important time in your life that could be directed somewhere else meaningful.

Here are the market implied odds of a fiscal compromise (higher deficits now in exchange for more pain later). The stock market has priced in a 98% chance of compromise. In other words, don't look for a huge bounce once this charade is resolved - it is already priced in.
There is something much more important coming down the pipeline the following year that will begin to have an impact on the economy soon; the massive economic weapon of mass destruction known as Obamacare. This time bomb has already been pushed through and unless something drastic happens it will be unleashed on the shores of America January 1, 2014.

What does this entail for the economy in simple terms? Companies who employ full time workers will be taxed severely in order to provide these workers with Obamacare. Estimates range from $3,000 to $11,000 per year based on the number of people in the worker's family. Sounds like a small amount right? Seems like something big corporate America should handle no problem?

That is true, big corporate America will have less of a problem with this. It will be the small businesses, that employ the vast majority of workers in the country, that will be devastated.

Hit the hardest will be low income workers. Do you think a small company still in the early stages of growth will see a difference between paying someone $29,000 per year vs. $40,000 per year? The business owner will not go through the process of hiring the worker only to have to declare bankruptcy as Obama hopes. One of two things will happen:

1. The small business will cut the hours under 32 to make the worker part time (excluding them from Obamacare) The worker's check will be reduced significantly.

2. The company will not hire the worker at all. The worker's check will disappear.

Perhaps to counter this Obama will demand that even part time workers be included under Obamacare. Then all employers will chose option 2. Please read the book Atlas Shrugged for a fictional (and soon to be real life) story of how this plays out.

Darden Restaurants, the owner of Olive Garden and Red Lobster, is already rolling out test programs in regions of the country to bring workers below 32 hours per week. 

There is no economic benefit to the program, other than the business some portions of the health care industry will receive. It will shrink the economy, shrinking the size of government tax receipts, and cause the deficit to mushroom further.

The positive benefit to the program is that there will be some workers who will not be brought down to part time or laid off completely that will receive health care when they otherwise would not have. 

I am of the ultimate belief that a few years down the road, when America reaches its debt crisis moment, the government sponsored health care program already in place will move toward rationing. That is not some immoral statement that "could never happen," it is just common sense for anyone with a calculator beyond the 5th grade math level.

But we look to the future here. In the mean time, enjoy those debates and promises of no pain today.

Remembering The Week Ending October 10, 2008

It's amazing to think back to where the world was only four short years ago on October 10, 2008. I'm guessing the financial markets were the first thing you thought of when you woke up that morning. What was happening?

The DOW plunged 697 points in the first five minutes of trading that morning. During the day it traded in a 1,000 point range. By the end of that Friday stocks had fallen 2,400 points in just 8 days - down 22%.

The markets were not correcting based on a news headline from that morning. They were correcting downward based on the artificial stimulus which was injected into the economy during the previous seven years. Think of it as a patient entering drug rehab and going through withdrawals. Stimulated markets have been known to ride the escalator on the way up and jump out the window on the way down.

Today that world seen in the October week of 2008 is long forgotten. The DOW is trading at 13473 as of this writing and a normal day now has less than a 100 point move. Complacency is higher today than it was during 2006 and 2007.

The following chart shows the movement in the S&P 500 during the entire secular bear market which began in March of 2000.

It originally fell 49% into 2002 then rose for five years into late 2007, up 101%, then fell 57% into 2009, and has now rebounded 113%.

We now know that the markets were juiced back in 2001 - 2007 by low interest rates from the Federal Reserve, tax cuts, and government spending. This created an enormous credit bubble concentrated at its epicenter in the housing market.

During the current recovery we have seen the same "plan" used only on steroids. After cutting interest rates to zero the Federal Reserve has gone above and beyond and provided additional quantitative easing programs. Keeping the tax cuts in place, the federal government has unleashed trillions in annual deficit spending.

During 2006 and early 2007 it was obvious to many observers that this solution only created a mirage of recovery, ultimately leading to a much bigger problem when the drugs could no longer stimulate. Today it feels like we are once again at that 2006 - 2007 moment; the mirage has returned.

What happens when the drugs wear off again? You will see a hangover far bigger than 1929 and 2008.

Tuesday, October 9, 2012

Bill O'Reilly Vs. Jon Stewart Rumble

A more humorous debate from two of the leading voices from the Republican and Democratic sides of support in the media.

Mitt Romney Debates Himself

Mitt Romney, who crushed Obama in the first debate, has finally found an opponent that he struggles with: himself.