Housing downturns: “longer and deeper than we’ve imagined”

Barron’s Alan Abelson discusses one of our favorite subjects:  the Housing slowdown. In particular, note the commentary from towards the end of the excerpt of Don Tomnitz, CEO of the No. 1 home builder, D.R. Horton:

"In Bernanke’s testimony last week, he cited housing’s diminished exuberance as rather a good thing, if only because it presumably will help restrain any untoward tendencies in the economy as a whole. Reasonable assumption, we’d grant. After all, the massive bubble in housing, which drew great drafts of sustenance from the absurdly cheap money and easy credit favored by the agency Mr. Bernanke now heads, was manna from heaven, or at least Washington. For it took up the menacing slack created by the stock-market crash in the opening years of this century and, more than anything else, kept the economy from going over the edge.

Understandably reluctant to make the natives too uneasy — not only have their houses served as their castles but also as a ready source of cash and no-sweat borrowing, all the while providing the incalculable comfort of an astronomically appreciating asset — he was careful to observe that "the downturn in the housing market so far appears to be orderly."

Which may have come as something of a surprise to any number of folks who earn their daily bread putting up houses. The latest survey by the National Association of Home Builders showed that activity had dropped for the sixth month in a row: The NAHB index, which measures the pulse of the industry, hit a low for nearly 15 years in July and is down by nearly 50% from its peak reached a scant 13 months ago.

Mr. Bernanke’s muted optimism to the effect that the decline in housing will be graced by a soft landing doesn’t quite square with the view of Don Tomnitz, CEO of the No. 1 home builder, D.R. Horton (that D. in the corporate title is a nomenclatural tribute to the founder, who bears the same first name as the current CEO; obviously, if you have your eye on the top slot of the company, better change your name to Don). In the course of a long conference call with analysts that followed the release of disappointing earnings, Mr. Tomnitz, to his credit, made no bones about the despairing state of his industry.

More specifically, he termed the housing market weak and opined it could get weaker. Nor was he overwhelmingly sanguine about the outlook for next year. (We’re grateful to our bearish buddy, Doug Kass, of Seabreeze Partners, for inspiring us to peruse the transcript of the call.) As Mr. Tomnitz ruefully reflected, "every time we’ve gone into a downturn in the home-building industry, they’ve always been longer and deeper than we’ve imagined, so we’re preparing for the worst…."

We must say, incidentally, that Mr.Tomnitz has provided us with a truly rare experience: a conference call that wasn’t all blah-blah bullish, but actually was straightforward and — dare we say it? — informative. (The analysts, in case you were wondering, pretty much asked the same aimless questions they always do.)

If by characterizing the retreat in housing as "orderly," Mr. Bernanke means that the downturn hasn’t yet reached the point of homeowners taking to the streets to vent their anger at plummeting home prices and inexorably mounting costs of owning a house, we won’t quarrel. But with the interest on trillions of dollars worth of adjustable rate mortgages vulnerable to "reset," as the euphemism for sharp hikes goes, and affordability of buying a house becoming ever more vexing, all we can say to him is… "Wait."  (emphasis added)

There’s more on this coming later today, and over the next few days — but suffice it to say the Housing slow down is a key element of both our slow motion slow down thesis and our very bearish market expectations.


Eyes Wide Shut
Barron’s MONDAY, JULY 24, 2006   

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  1. Chief Tomahawk commented on Jul 22

    Can’t wait to hear Larry Kudlow’s defense in the coming months as the U.S. economy heads towards recession. “The greatest story never told” may well be his failure to recognize the stimulous providing by housing has dwarfed the tax cuts he’s so triumphed. Maybe Larry will just take retirement…

  2. MikeF commented on Jul 22

    In a post from last week on “The Impact of Variable Rate Mortgages”, Barry mentioned that southern Florida was one of the regions in which there was a concentration of interest-only and variable rate mortgages. In speaking with friends and family down there, they anecdotally acknowledged this. However, to many I spoke with, a more immediate threat to household cash flow was the cost of homeowners insurance. For example, the owner of a relatively modest home in Boca Raton I spoke with saw her homeowner’s premium go from $2,200 in 2005 to $5,700 in 2006! God only knows how the condominium boards are passing these costs on to their poor residents. So, couple the astronomical increase in insurance costs with the mortgage rate reset exposure and there is some real potential for disaster down there.

  3. Michael C. commented on Jul 22

    I track inventory weekly here in Orange County CA, and inventory has just been relentlessly increasing since the beginning of 2005.

    Prices are simply STILL not adjusting to account for this inventory imbalance. The way I see it, the more inventory increases, the lower the prices will eventually have to give way to equilibriate with demand. It is only a matter of time before the pressure of supply eases the price.

    The mood here from sellers is simply – fine, our home may not be selling, but it is still worth a lot, and I don’t want to sell it for less than its “worth.” A few price reductions have occured from sellers who realize how to move their homes, but they are so few and far between that they haven’t yet even come close to affecting the overall real estate market.

    And they’ve just released 2 new master communities in Irvine this month. It’s a gala affair there as they give you unlimited free balloons, ice cream, and slushies to sweeten you up for a sell.

  4. Leisa commented on Jul 22

    Also in Barron’s is an interview with Dean LeBaron. He discusses debt–in a business sense, but I think that it applies to consumer debt as well.

    “The original notion of debt way back was that it would always be repaid out of the fundamentals of a business. Currently, that’s an archaic view.. . .Now debt is repaid out of refinancing, and the notion is that somebody will always come along to buy the asset. But the markets do not always accommodate and help take you out of the investments you have, and that kind of repayment risk is not factored into bond pricing.” I just couldn’t help but note that this seemed to be the judgment of some with respect to homeowners.

    I’ve seen the opinion expressed within blog comments that homeowners will be able to refinance their way out of the morass of debt. Interest rates rising and home values falling is a paradox that I’ve not seen in my adulthood (but I’m not as observant then as I am now). As Mike F notes in his comments insurance premiums are rising (if one can even get coverage!). LEt’s not forget that city/county governments ever starved for cash have reassessed taking advantage of the rise in home/land pricess. As reassessment occurs every 3-5 years or so in my area, what a clever lock they have.

    I was looking back through some of my notes. I’ve taken to having pen/paper in hand when I read stuff to jot notes down as I read things that bear remembering. I recalled Barron’s June 5 interview with Steve Romick (link noted below): He stated that there was much riskin the system; preparing for greatest consumer led slow down since the Great Depression; 50% of mortgage withdrawals end up in the economy (faucet turned off now).

    I’m still amazed at the lack of real discussion on current market risk in venues other than this. There seems to be this eternal hope by the pundits that the economy is strong and the consumer will prevail. I just don’t see it; I do not believe it.


  5. PeterB commented on Jul 22

    Good points, Michael. A key factor to the lag in price reductions is that home builders are offering every possible incentive they can imagine — free upgrades, giveaways like plasma T.V.’s and cars, discounting mortgages and closing costs, etc. — anything and everything they can think of to keep from reducing prices. Sure, their margins are getting squeezed in the process, but at least they can still point to those juicy revenue numbers.

    But that can only work for so long. New orders have dropped off a cliff and backlogs are shrinking as cancellation rates are going up inverse proporation to new orders.

    Actually, prices have been coming down since the late summer of ’05. It’s only now that they’re starting to show up in the YoY comparisons.

    Home builders have tried to hide this using “Weekend sales events” or “We’re selling 72 home in 72 hours!”. To no avail. Buyers are not biting.

    The HBs tried to rally this week on the likelihood that the Fed will pause Aug 8th. As if this is somehow going to inspire buyers to re-enter a market that is over saturated with inventory and still way over-priced by every historical measure.

    This is going to be a terrible time for anyone needing to sell their own home as it will eventually become a race to the bottom. Will ARM resets add fuel to that fire? A lot of people think so. No matter where you’re positioned in the stock market, there’s no way anyone can be happy about this gathering storm.

  6. CDizzle commented on Jul 22

    The weakest opinion I’ve heard on the housing outlook was from Bernanke. I don’t have the testimony in front of me, but what I heard was:

    1) We’re only worried about the subprime market. (DUH!)

    2) Sure, mortgage payments will adjust upward, but a) homes have gone up in value so people have more equity and b) only about 10% of all mortgages have adjustments/balloons this year.

    Thanks Ben, good to know that a) you have no idea what a mortgage extraction chart looks like (hint: it’s NEGATIVE because the consumer is already tapped out) and b) well, if it’s only 10% of ALL home mortgages…why worry?!?!?

  7. Bob A commented on Jul 22

    People who are underwater on their LTV CAN NOT GET NEW LOANS. How is it that the Chairman of the Federal Reserve does not get this????? What happens when people can rent for half of what their monthly interest payment is? They walk. What happens next. The bank gets the house. What happens next. The Bank sells the house at a discount. And the whole house of cards starts to tumble. The governments plan to deal with all of this is as watertight as the levees in New Orleans, so we need not worry.

  8. HF commented on Jul 22

    Bob A
    that’s why we should be short homebuilders DHI ,LEN ,PHM , etc. , and FNM , FRE , and HD and LOW , and all S&L’s …. we can make $$$$ off the suckers who bought this garbage at these prices

  9. dave commented on Jul 22

    It was idiotic for people to take out an ARM when rates were at historic lows (or sleazy for banks to push them to make more money on future resets). ARMs have been around for awhile, but only used when interest rates were high. In 1983, I bought 2 quadplexes using an ARM–the interest rate was 12% then!! (Why did I buy? before Reagan, I was in the 44% tax bracket for only two years and needed a write-off). The ARM has worked out very well for me, down to 6% two years ago before I paid it off. Why would you get an ARM when interest rates were 5%? What are you going to do when it goes to 10%? Has anybody who bought lately been told that interest rates could go to 10 or 12%? What is their plan when that happens? (It will happen again some-day)

  10. Brian commented on Jul 22

    HF, I wish I would have shorted housing stocks last fall. Back then, the “housing bubble” was still mostly considered an idea of the insane (“houses always go up in value!”). Now a lot more people have woken up and the housing stocks have already taken a huge dive.

  11. edhopper commented on Jul 22

    Mr. Tomnitz also said sales had;
    “fallen off the Richter Scale”.

    Soft landing…yeah, sure.

  12. albiegf13 commented on Jul 22

    Michael C:

    Well said… We also need to remember that residential housing represents a substantial percentage of employment in the economy. We are in for a very difficult period and I do believe that we could see a serious banking crisis. Remember the RTC… Seidman Says? I’m very concerned as this relates to equities as well and I’m not just talking about the home builders… Things are going to get very nasty and I can’t see light at the end of the tunnel.

  13. HF commented on Jul 22

    you can still short

    these companies are making $$$ now even with the steep slide , they’re still a short until book value

  14. diva commented on Jul 22

    Yer all gonna be wrong.
    (where else ya gonna make $500k tax free, ifn yer married)

    I look forward to the last laugh (the one who laught’s best)

    hee hee hee

  15. Mozo Maz commented on Jul 22

    Tax laws can change. They have before, and the tax-free gains for owning a principal residence just two years have been around since… 1997? If Congress faces a recession in after the next election, this may get some careful scrutiny.

  16. Leisa commented on Jul 22

    “I look forward to the last laugh (the one who laught’s best)”

    Well, the housing market might just step in and through devaluation of home values the exemption may not prove to be all that helpful to those who have bought within the last 2-3 years.

    I think that folks used the ARMS thinking that interest rates would stay forever low. They must be young, for I still remember my 14% mortgage rate in 1985. And for some, the ARM seemed smart–they’d get a low rate, flip the house when values increased dramatically and upgrade.

    Personally, I don’t wish to be right nor do I wish to be laughing. I think that there will be quite a bit of misery and it will extend to us all in one form or another.

  17. KB commented on Jul 22

    I’m certainly not an expert on this, but I’m still trying to figure out how raising the interest rates is going to moderate commodity prices/inflation (without killing the economy, that is)…what ever happened to buying/selling of treasuries to managing liquidity? And when will Helicopter Ben’s true colors be seen?

  18. Bob A commented on Jul 22

    I’ve heard from some that they aren’t getting that 250/500k capital gains deduction because of the AMT…

  19. Bob A commented on Jul 22

    In the end the taxpayers pick up the bill for the government bailout of the banks as in the early 90’s.

  20. ed commented on Jul 22

    Worth mentioning that those who re-financed or over bought had appraisals that in many cases were over stated to meet the needs of buyers/sellers. This along with no interest and arm’s compound the issue of declining prices. No one will laugh last in the end.

  21. GRL commented on Jul 22

    And let’s not forget about the remainder of the Abelson article, which is not quoted in the main comment:

    “The folks at ISI say that, despite its tardiness, the new, more stringent rules [on I/O and Option ARMs], chances are, will be issued by the end of the summer. And when they finally see the light of day, contrary to the conventional wisdom on the Street, they’ll have an impact, and a substantial one. And that impact will consist of cutting already shaky demand for housing and putting further pressure on home prices.

    That prediction, the authors of the report assert, is based not on idle speculation, but rather on conversations with the regulators. The latter believe that ‘many financial institutions will have to change their underwriting standards significantly to comply with the new rules.’ . . .

    What the regulators are aiming at, pure and simple, says ISI, is to discourage banks from layering risks by writing option ARMs and IO loans to borrowers with high loan-to-value, high debt-to-income and low credit scores. In other words, from piling dubious debt on impecunious or unreliable borrowers.

    “On that score, the regulations would also require banks when peddling ‘nontraditional mortgage products’ to make some reasonable effort to determine whether the wannabe borrower will ever be able to repay the loan. . . .

    “It also strikes us that the regulatory timing is truly exquisite. For had the rules been issued on schedule, as last year was calling it quits, when housing was still aboil and home builders were reporting strong earnings, they might not have been all that much of a big deal as an investment depressant. Come the end of the summer, though, with housing likely awash in bad news and the economy listing, it could be another, much uglier story.”

  22. whipsaw commented on Jul 22

    I don’t think shorting the builders is the way to play this- they’ve already been hammered pretty good (XHB has lost about 1/3 of its value) and don’t have enough scope left. My choice would be lenders with the most housing exposure as defaults and foreclosures will be picking up. I think that regional banks are going to take most of the hit and I’ve been watching the RKH etf which seems to be reasonably liquid and offers puts, altho the longer term ones look awfully expensive. It spiked up last week and has plenty of room to fall a very long way, so I’m going to keep an eye on it for the post-November festivities.

  23. Francois commented on Jul 22

    I am one of those first-time can-be home buyer. In my area (Philadelphia and suburbs) sellers are still hooked on last 12 months value, and quite a few still think that prices will go up.

    I’ve already looked seriously at 3 homes and in all cases, sellers just wouldn’t budge from their ask prices, despite having the home on the market for more than 4 months. They really have this attitude of “can’t you see how much this home is really worth?”

    Alas for them, I just can’t see it. With interest rates rising, banks getting dour on borrowers, local taxes on a northward path, (remember all those unfunded mandates from the assclowns in DC, in turn dumped to the locals by the States?) and home insurance getting truly insane, I’ll stick around my rented appartment despite being able of laying down 50% of the home price right now.

    And this is precisely what several real estate agents have been telling me recently. Sellers still look at prices from 2003-2005 and buyers look forwrd to lower prices. So, nobody’s moving unless forced to do so.

    I ain’t one of them.

  24. Cherry commented on Jul 23

    Yep, the ponzi credit bubble created by the monetary masters is becoming unglued in 2006, right beyond their denial little eyes. Now we wait for the event which will cause the hulk to keel over.

    By 2008, the hightimes of 2005 will seem so long ago.

  25. GRL commented on Jul 23

    I don’t think shorting the builders is the way to play this- they’ve already been hammered pretty good

    I don’t do shorts, but might I suggest Ethan Allen (ETH) as a possible candidate?

    My wife, who is an Ethan Allen fanatic since back in the ’80’s, says the stores, at least in California, are going down hill. The furniture, which used to be made in America, is now outsourced to China. The collections are being downgraded in terms of style and quality in order to deal with rising costs and still have a price point that appeals to the “middle class” (a shift that acually started shortly after it went public). Stores (Northridge) are being closed. Showroom displays (Pasadena) are not as good as they used to be. She couldn’t even get a catalog during her most recent visit because they can only give out so many, and she was too late.

    Layer on top of that the coming housing bust/recession, and I think they have some real problems brewing.

    All of this is antectodal, and please do your own DD to make sure the actual hard numbers match up with what I am saying.

  26. Laura B. commented on Jul 23

    What goes up must come down and vice-versa. There is always an appropriate action to take in any given market. We must roll with the changes and have a strategy that coincides with the happenings of today. There is a way to make money in ANY market. If things are tough for someone, they must hang tight and ride out any storms if their strategy stays the same, or, change their strategy.

  27. fred hooper commented on Jul 23

    Laura, I’ll get in touch when I see a 60-80% reduction in the central Phoenix market. As a former ‘expert’ in valley real estate for over 20 years, I’ve said many times that the coming crash will be like nothing we’ve seen before. Unfortunately, I fear it will coincide with a collapse of the dollar. My strategy, long physical gold and silver.

  28. whipsaw commented on Jul 23

    per GRL:
    “I don’t do shorts, but might I suggest Ethan Allen (ETH) as a possible candidate?”

    Not a bad idea, but I personally have quit chasing individual companies up or down. Between corrupt management and buyouts/buybacks there is no telling where something will land, so I like sector or index ETFs that don’t have so much sensitivity from one day to the next because of the fortunes of a single company.

    There are some pretty good books on intermarket analysis by John Murphy and Martin Pring that lay out the sector cycles and the way that currencies, bonds, commodities, and equities interact (altho Pring ignores currencies which is a big mistake). It isn’t too hard to figure out where we are and where we are probably going if you understand that stuff.

    This isn’t mystical, this is just how it is and nobody can say how long a given phase will last or whether it will do something strange, but the basic framework is valid and provides a pretty good pointer to things on a monthly basis. What it tells me now is that you would be nuts to be long.

    I can’t quote Richard Russell without violating my subscription agreement I suppose, but I can paraphrase him wondering why nobody seems to have mentioned that Dow Transports crashed last week? In Dow Theory, that’s a big deal, and in Simple Country Boy Theory, that means that the haulers are running out of things to haul. That’s a pretty good tell on the economy as a whole and it really doesn’t matter what Bernanke does next month or the month after, the market is going down, down, down.

  29. Bob A commented on Jul 23

    As for short candidates, if you look at the three year run in the small and mid caps, the biggest opportunity for shorting indexes would be in IWM, IJR, IWR all of which are breaking the long term trendline.. The biggest, or at least a large part of the homebuilders fall may have already come and gone, not that they couldn’t keep going down for another year or more. But IWM, IJR, IWR are in a bubble that looks like NASDAQ in 1999. If you look at a longer term chart.
    REIT ETF’s are in a similar bubble but have not yet seemed to break, though Suttmeier on Real Money talks about them today. The ETF’s SRQ JRS SRO NRO etc are for the most part made up of the REIT’s he talks about. You have a three year peak in price trend similar to IWM, a lot of new office space coming on line in the next year or so, and if the economy slows, the spectre of declining demand. Air is air, water is water and a bubble is a bubble… from my viewpoint.

  30. Bob A commented on Jul 23

    … but those REIT ETF’s are thinly traded and much harder to whip in and out of compared to IJR IWR IWM. Also pay a big dividend monthly. perhaps a little too tricky to short for me.

  31. Laura B. commented on Aug 24


    If you kept up with what’s going on in historic Phoenix, as well as surrounding central Phoenix and the central corridor, you would know that homes are not only holding their values but still having gains, despite what’s happening perhaps in different locations.

    Overall, and you should know this being a “former expert”, RE is always in cycles. Central Phoenix and historic Phoenix are still rocking. I’ve always been a fan of Gold and Silver too, and it fluctuates as well.

    Too many people are being influenced by the negative media instead of looking at trends and the positive data. Central Phoenix & Historic Phoenix is still doing remarkably well! Look at Willo Historic, Roosevelt Historic , Encanto-Palmcroft Historic and so many more surrounding areas in central Phoenix. We all have to buy smart!

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