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The Housing Bubble Bottom

Sorry Charlie, but the Bottom is Not in Yet

Written by Brian Hicks
Posted May 25, 2010

Like the piss-ants in my kitchen, my pal Charlie is a nuisance that I just can't seem to shake.

A real estate agent by trade, he crawls into my life every time there is even the slightest whiff of good news in the housing market. Much like those bothersome ants, he latches on to any available grain of sugar, no matter how tiny.

The result has been a four-year running dialog in which I have squashed him every single time...

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But the truth is that I have to hand it to him... Despite all of these drubbings, Charlie is as persistent as the sunrise.

He's sort of like that ant trying to move the rubber tree plant; he's got high-apple-pie-in-the-sky hopes.

And he keeps calling me and calling me. He called me this morning delivering a rant that sounded like it came straight from spin zone at the National Association of Realtors.

"Steve," he said, "you're fighting a losing battle. I hate to break it to you, but the housing bottom has come and gone... "

On and on he went.

It was like having Lawrence Yun on line 1. Finally, I just couldn't take it anymore.

"Charlie," I said, "In case you haven't figured it out yet, housing is between a rock and a hard place right now."

Here's why...

The Elusive Housing Bubble Bottom

The dirty little secret among Realtors like Charlie and mortgage brokers right now is this: all of them lose sleep over the nightmare of higher rates.

The reason for this, of course, is pretty simple. In a higher rate environment — say, 6% — it's game over for housing and they know it.

After all, home prices are partly a function of interest rates...

This is the one lesson about the housing bubble that should be apparent to everyone by now. Falling rates lead to higher prices.

Conversely, the opposite is also true. As rates rise, prices fall. That's why continued historically low mortgage rates are the only thing keeping housing afloat right now.

That's the good news — especially since mortgage rates have fallen to 30-year lows today at an average of 4.87%. Numbers like these make folks like Charlie giddy with anticipation, which was part of the reason for his phone call this morning.

However, what Charles can't seem to understand is the we live in a financial system that is so interconnected that the flapping of a butterfly's wings in Athens can cause a tornado in the Plains.

Low rates, I explained, are no accident. All it took was the prospect of a Europe in monetary flames and renewed rumblings of another global economic leg down. As a result, nervous investors ran screaming into the U.S. Treasury, driving down home mortgage rates.

That leaves housing basically on a knife's edge where neither outcome is likely to be beneficial to the market.

On the one hand, though the European debt crisis has lowered rates, the net effect will likely be a double-dip recession, putting even more people out of work and killing the confidence in the nascent housing rebound. That's the rock.

The hard place, meanwhile, is the higher rates that will undoubtedly come when and if the recovery really does take hold. In that scenario, higher rates are a given.

That leaves housing with a Hobson's choice: low rates and no jobs or many more jobs and much higher rates.

Neither one of them is going to be enough to help home prices recover.

Of course, I would be remiss if I didn't at least mention a third stomach-churning scenario: no jobs, no recovery, and much higher rates — courtesy of the same bond vigilantes that just pushed Greece over the cliff.

But let's be honest, even without the bond vigilantes and a crumbling euro, the housing market has never made it off of life support...

The $1 Trillion Hole

Even still, Charlie keeps pounding away at me with stories about how hedge fund manager John Paulson believes that home prices could go up by 8%-12% next year, that the market is getting better everyday.

Yesterday's existing home sales numbers only encouraged him as the NAR reported sales jumped 7.6% in April from March. "Even better," he went on, "sales were up 22.8% from the same time last year."

But a few good months don't exactly make a trend — especially since the home buyer tax credit is now gone for good. And in the long run, all it likely accomplished was to pull demand forward from future sales.

Meanwhile, the delinquency rate for mortgage loans residential properties increased to a seasonally adjusted rate of 10.06% of all loans outstanding as of the end of the first quarter of 2010. That doesn't even included the homes already in foreclosure. Adding those homes pushes the rate to 14.01%, according to the Mortgage Bankers Association.

As bad as that may sound, the devil is buried a bit deeper in the details. The serious delinquency rate or the percentage of loans that are 90 days or more past due or in the process of foreclosure was 9.54%. The cure rate for these loans is less than one percent.

So out of a total U.S. mortgage debt of about $10 trillion, there is a contingent liability of nearly $1 trillion dollars hanging over the heads of the banks.

And you wonder why the banks aren't that eager to lend money...

In fact if it wasn't for the nationalization of the mortgage market, housing literally would have gone over the cliff by now.

Instead, the FHA, Fannie Mae, and Freddie Mac have been financing more than 90% of U.S. home mortgage after the collapse of the market for mortgage bonds without government-backed guarantees.

What's more, government-related entities backed 96.5% of all home loans during the first quarter — up from 90% in 2009, according to Inside Mortgage Finance. And for the first time ever, the FHA backed more loans that Freddie and Fannie combined.

That, my friends, is troublesome — the FHA backs loans with down payments as little as 3.5%.

Or as FHA Chief David Stevens told a conference at the Mortgage Bankers Association yesterday, "This is a market purely on life support, sustained by the federal government... Having FHA do this much volume is a sign of a very sick system."

So, Charlie, the bottom is not in yet...

Of course, one of these days Charles will get it right; when he does, I think I'll be happier than he is.

Today's just not that day.

Your bargain-hunting analyst,


steve sig

Steve Christ
Editor, Wealth Daily

P.S. According to the latest figures this morning from the Case-Shiller Index, home prices actually fell in March from the previous month — a sign of a more foreclosures to come. So, how do you profit from the potential for even more foreclosures?

You buy the very companies that help process them. To learn more about these companies, click here. 

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