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Pathfinder Partners' e-Newsletter
March
2008
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Charting Your
Course
On Extraordinary Popular Delusions and
on Denial and the Other Four Stages of Grieving
By Mitch Siegler, Managing Director
Newton's Third Law of Motion: For every action there is an equal and opposite
reaction. Economic corollary: The force of a correction is equal and
opposite to the deception preceding it.
When we formulated our business plan in early 2006, we observed plenty
of froth in the real estate market. Since we knew trees don't grow to
the sky, we realized the much ballyhooed equal and opposite reaction
wasn't far off. We saw a credit bubble, where risk was massively
under-priced and ridiculous amounts of leverage were piled on shaky
projects and unreliable cash flows.
Back then, apartments were being acquired for condo conversion at peak
prices with leverage ratios not seen in ages. Even the dowdiest
properties were belles of the ball, with traditional and mezzanine
lenders lining up with highly leveraged financing: the condo converter's
equivalent of the farmer putting lipstick on a pig. And, Sam Zell's
sale of Equity Office Properties in fall, 2006 was the proverbial
"ringing of the bell", with Zell, aka "The Grave
Dancer" calling a peak in commercial real estate.
Of course, you never find just one cockroach. The news in 2006 abounded
with stories of surprising leveraged buyouts - like highly cyclical
semiconductor manufacturers and second-tier retailers, who heretofore
wouldn't have received a passing glance from KKR and its contemporaries
- now being completed at astounding valuations. And, signs of froth in
the general economy abounded, too, as consumers continued to tap their
home equity as though they were visiting an ATM.
In 2006, we began tracking hundreds of recent condo conversions - from
2004-2005 purchases, to the underlying debt, to individual condo sales.
What we saw was not pretty.
Loans underwritten on cash flows from a property or company ebb and
flow with business conditions but are generally as healthy as the underlying
cash flows. Loans underwritten on the basis of asset sales - as in
condo projects - are far more tenuous. When a project's planned asset
sales don't materialize, there's no amount of cost control, asking
price reduction, improved management or other such techniques that will
save it.
That's why we were astounded during 2006-2007 when the lenders we
contacted about these floundering projects told us, essentially,
"We're very happy with our portfolio - we have no problem
loans." Of course, everything is always just fine until - well -
it isn't. But, we were beginning to understand how the Maytag
repairman felt.
Fast forward two years on Main Street and we watch the drama in the
housing sector unfold before our very eyes. The vaunted American dream of
owning a home - replete with sunken tub, great room and three-car
garage - has turned into something of a nightmare for millions of
recent homeowners.
Back on Wall Street last fall, major money center banks and national /
international financial institutions - like Citicorp, Wells Fargo,
Merrill Lynch, Wachovia and UBS - began coming to grips with problem
loans in their portfolios. Collectively, these institutions wrote down
more than $100 billion of mortgage-related loans in late 2007. However,
the middle market, regional and community banks, which made similar
loans, had very few write-offs. Many continue to exhibit denial about
the health of their real estate loan portfolio.
We continue to follow scores of publicly-traded banks and observe many
reporting dramatic increases in non-performing loans without increasing
loan loss reserves nearly proportionately. Of course, it is possible
that all of these banks have exhibited tremendous discipline in loan
underwriting and have credits which will ultimately prove safe and
secure - despite the large increases in non-performing loans. In our
view, that's not the way to bet.
During the past 24 months, we have maintained ongoing dialogue with
more than 100 money center, regional and community banks. During 2006-2007,
we would have characterized many financial institutions as
"complacent". In the past few months, we have observed a
steady mood shift in many institutions from denial to anger (think
Citigroup, Merrill Lynch, Bear Stearns and Countrywide, all of whose
former CEOs are now "pursuing other interests") and, in a few
cases, to acceptance.
Some forward-thinking banks have retained outside experts to value
their portfolios. This "reality check" provides substantial
benefits to bank executives. One quick-thinking former loan originator
- now tasked with heading his bank's Special Assets Group - shared an
enlightening story with us. His bank's Board was so swayed by the
valuation decline demonstrated by a recent third party review - and so
amazed by the lack of action being taken by competitors - that they
became convinced that when competitors finally respond to the declining
market later this year, the supply of defaulted loans and REO property
would overwhelm the market, exacerbating the declines in property
values.
So, the Board decided to beat its competitors to the punch, by selling
before supply overwhelmed the market, even if it meant cutting prices
to find a buyer quickly. It recalls the famous maxim of Sol Price,
founder of Price Club (now Costco): "Your first markdown is your
best markdown."
Meanwhile, other banks have foreclosed on defaulting borrowers and have
experienced, first-hand, the operational challenges and expenses
associated with completing project construction, paying for property management,
security, property taxes and insurance.
One bank we know has non-performing loans underlying several partially
completed condo conversion projects. Rather than selling the loans or
properties, this bank has determined that the optimal "business
plan" is for the bank to complete project construction (at a cost
of several million dollars) and then sell condos over several years.
While we believe this is a highly questionable strategy and an
inappropriate use of resources for a commercial bank for numerous
reasons, such an approach is illustrative of the massive level of
denial in certain financial institutions.
During the past 90 days, though, we have observed a marked increase in
the number of lenders taking steps to sell their defaulted mortgages
and REO properties. But, most of the lenders we follow have been
relatively slow to take meaningful action.
In searching for parallels, we have examined previous economic cycles
and thumbed a few of our favorite history books. Charles Mackay's
"Extraordinary Popular Delusions and the Madness of Crowds,"
first published in 1841, chronicles bubbles and financial manias,
including the tulip mania of the 17th century and the South Sea Company
and Mississippi Company bubbles of the 18th century. Financier Bernard
Baruch credited his sale of all of his stock ahead of the 1929 crash
with the lessons he learned from this classic tome. In
"Delusions," Mackay demonstrates that a key element of all
bubbles and financial manias is denial. History doesn't repeat, but it
does rhyme.
Another parallel is the work of Dr. Elisabeth Kübler-Ross, famous for
her research into the grieving process. Dr. Kübler-Ross identified five
sequential stages - denial, anger, bargaining, depression and
acceptance. There it is again - most of us don't get to
"acceptance" without first going through denial, anger and
several other steps.
For many, it is not a straight path to "acceptance". The
credit crunch which began last summer means business is anything but
usual - and financing contingencies are anything but routine. But, hope
springs eternal and we observe banks going under contract to sell
non-performing loans and REO property at prices that seemed too good to
be true. We were not surprised that, after several months in escrow, these
transactions stalled and the properties returned to market. The few of
us making realistic offers on an all cash basis should ultimately win
the day over the hope and prayer buyers whose mantra remains "sign
and re-trade."
We welcome readers to our inaugural, quarterly newsletter. We commit to
calling it as we see it and providing more than the usual babble found
in traditional news sources.
Mitch Siegler is a co-founder and Managing Director of Pathfinder
Partners, LLC. Prior to founding the company in 2006, Mitch was a
partner with the management consulting firm Lenser & Associates and
founded and served as Chief Executive Officer of several businesses.
Previously, Mitch was a partner with Sorrento Associates, a boutique
investment banking and venture capital firm. Mitch received an MBA
degree from Pepperdine University in 1986 and a B.A. in finance from
University of Missouri, Columbia in 1982.
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Finding Your
Path
Making Lemonade out of Lemons
By Lorne Polger, Managing Director
I've been intimately involved with real estate since 1988, but, in many
respects, the business is in my blood. My father was a real estate
lawyer for twenty years in Montreal, before moving the family to Denver
in the late 1970's, in the face of uncertain politics in Quebec. In
Denver, Dad started a hard money loan and real estate development
business. I've been a real estate lawyer myself for 20 years, a real
estate investor for almost as long and started Pathfinder, an
opportunistic real estate investment firm, in 2006. I've witnessed four
complete cycles in various real estate worlds by the ripe old age of
45. Each cycle was a little bit the same and a little bit
different, but the lessons learned affect a lifetime of investments.
Montreal was an established, culturally and economically diverse city
by the 1970's. It had hosted a World's Fair (1967), the Olympic Summer
Games (1976) and was, then, the largest city in Canada, with a
population of over 2.5 million. The area had enjoyed a healthy,
growing real estate business for years. In the fall of 1976, Rene
Levesque was elected "Premier", akin to a U.S. governor.
Levesque ran on a separatist platform whereby Quebec would become a
separate country to preserve its French cultural heritage.
The economic effect was a dramatic tail spin for the province. A
massive population and corporate exodus led to falling real estate
values beginning in 1977, with the trough of the market occurring four
years later - in 1981, the year after a provincial referendum on separation
was defeated on the ballot, kicking off a nine-year real estate
boom. So, there was a five-year down cycle, and a nine-year up
cycle. Where was the money made? Bread and butter
commercial real estate assets bought late in the down cycle (1980 to
1982) and early in the up cycle (1983), generally in urban locations,
without significant leverage.
Denver was booming when we moved there in the late '70s. The oil
business was going gangbusters and had reached Denver, now a city of
1.5 million people. Real estate speculation abounded. High rise,
downtown office buildings were popping up overnight, suburban markets
were expanding like there was no end. Although money was not
cheap (remember the inflationary Carter years, and the 14% prime rate?),
it was abundant. There was no such thing as "pre-leasing
requirements" for out of the ground projects, there was no problem
with giving a developer an acquisition fee before construction started
or healthy management draws along the way, because, everything was
going so well, how could it go wrong?
In 1986, the national energy market took a deep dive and Denver's one
dimensional economy was destroyed. Office vacancies rose to over 25%,
"see through" buildings abounded, foreclosures skyrocketed,
and shopping centers emptied. Unbelievably, not a single new high rise
office building has been built in downtown Denver since 1984. The
two-bedroom condominium that my wife bought for $57,000 was sold at
foreclosure for $10,000. The six-year downturn (1986 to 1992) was
followed by an unprecedented ten- year upswing. Where was the
real money made in real estate? Again, bread and butter
commercial real estate assets bought along the low apex of the curve in
1991 to 1994, generally in urban locations, without significant
leverage.
Flash forward to San Diego, home for the past 20 years. It's
1989, the height of a six-year boom. Unprecedented growth, huge
population increases, new suburban office markets, rapidly growing
retail and hotel sectors - as the saying goes, "it's all
good." Well, almost all. Kind of forgot that when you add
one part undiversified economy (i.e., military/defense and
hospitality), to two parts little war (Gulf I), and three parts
national bank failures, you end up with a deadlier cocktail than my grandfather's
Ukrainian brandy. A seven-year down cycle (1990 to 1996) left
developers and investors singing the blues and filing the bankruptcies.
In my law practice from 1992 to 1994, I did not work on a single
"normal" real estate transaction - with a traditional buyer
and seller. I did work on plenty of bank sales of REO properties,
single asset real estate bankruptcies and loan workouts. Little
by little, things changed. Economic diversity occurred, banks became
healthier, new developers replaced the old and we all got back to work
for a ten year up cycle (1996 to 2005). Which investments did
best? Bread and butter commercial real estate assets bought along the
low curve in 1994 to 1996, generally in urban locations, without
significant leverage. Are you sensing a theme?
Flash forward to today. With only a few exceptions (like Seattle,
Portland and Houston), virtually the rest of the U.S. real estate
market is in melt down mode. Deals are not getting done because lenders
are not lending. Nobody believes things will soon get better, only a
little worse (or a lot worse, depending on who you talk to and where
they live).
How did we get here? Well, my partner's article summed it up well.
Irrational exuberance, a belief that trees would grow to the sky, betting
the farm on over-leverage and financial forecasts not grounded in
reality. Do things really get worse before they get better? Take a
simple test next weekend. Spend a few minutes at your local Best Buy
and Home Depot. What would you estimate the traffic count to be as
compared with two or three years ago? Based on my visits and news
reports I read, it seems like traffic in many locations is down 10% to
20%. Think real estate won't have an enormous ripple through on all
facets of the economy?
So, how and when do you make the lemonade out of this cycle's
lemons? Patient money wins out. At Pathfinder, we've looked at
over 100 defaulted bank loans and REO properties in the past 90
days. The vast majority have not met our criteria. Why? Three
reasons: pricing, asset class and location. In a rapidly
declining market, you need to be extraordinarily careful about not
overpaying, especially given the uncertain holding periods. To date,
banks have been grossly unrealistic about pricing their defaulted portfolios
- which is why virtually none of them are selling anything.
Will they get "reality" eventually? Of course, and increasing
regulatory involvement, shattered stock prices and increasing
shareholder derivative lawsuits should add some momentum. I'm also a
firm believer that the tried and true real estate mantra of location,
location, location, applies to an even greater degree in a down cycle.
And, I think the urban core wins out over suburban sprawl in nine out
of ten markets.
Is now the time to buy? Are we at that "low point of the
apex" that I referred to in the Montreal, Denver and San Diego
examples? Hard to tell - it's always very tricky to try to call
"the bottom". But if you invest in quality assets, use real
numbers, apply low leverage and have patient money, it's hard to see
how you can get too hurt.
Lorne Polger is a co-founder and Managing Director of Pathfinder
Partners, LLC. Prior to founding the company in 2006, Lorne was a
partner with the law firm of Procopio, Cory, Hargreaves & Savitch
in San Diego, where he headed the Real Estate, Land Use and
Environmental Law group. He received his law degree from UCLA in 1988.
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Snippets:
Truth is Stranger Than Fiction
A Collection of Comical, Outlandish and Bizarre True Stories
The pause that refreshes?
Treasury Secretary Hank Paulson calls it "Project Lifeline",
a plan unveiled in mid-February whereby six major banks would
"pause" the foreclosure process for 30 days to allow selected
homeowners to negotiate new terms with their lenders. While not limited
to subprime loans, the government's Lifeline would help only a small
fraction of those facing foreclosure. "Project Band-Aid",
anyone?
The Oracle of Omaha to the rescue
Warren Buffett's Berkshire Hathaway tossed a lifeline to the monoclines
insurance companies (Ambac, MBIA and FGIC) offering to reinsure $800
billion of municipal bonds so they could maintain their AAA ratings.
Analysts doubt the monolines will bite, since that would leave them
with only the toxic subprime mortgages on their books.
$200 billion here, $200 billion there...pretty soon you're talking
real money
UBS estimates that investment banks may need to write off another $203
billion in debt if the monolines fail. That's in addition to the $152
billion they've written off to date. And, according to Alvin Katz,
partner in the Real Estate group at Chicago's Mayer Brown, LLP, there
is $200 billion of "unaccounted for" subprime debt; the
people who packaged it up just can't seem to figure out who owns it. Go
figure.
From A-paper to default, in the blink of an eye
Wall Street Journal reporters Carrick Mollenkamp and Serena Ng detailed
the rise and fall of a $1.5 billion collateralized debt obligation
("CDO") called Norma, mid-wifed by Merrill Lynch last March
with 90%+ of its paper rating A or better. Amazingly, nearly $1.25
billion of Norma's paper was rated AAA. By November, the entire Norma
CDO had been downgraded to junk status.
News flash from Merrill
A recession in the U.S. "has arrived," reports Merrill Lynch
in January. "This isn't even a forecast any more, but a
present-day reality. To say that the backdrop is 'recession
like,'" Merrill asserts, "is akin to an obstetrician telling
a woman that she is 'sort of pregnant.'" (Our wives are pleased we
didn't take them to obstetricians on Wall Street.)
Whither goes housing so goes the economy
We're convinced the problems in housing have to have an impact on the
broader economy. The obvious: Fewer new home sales mean layoffs at
homebuilders and mortgage originators, fewer big screen TV purchases at
Best Buy and lower demand for home improvement products at Home Depot
and Lowe's. The less obvious: Folks are buying fewer $4.00 double
lattes at Starbucks and $14.95 Cobb salads at Cheesecake Factory. And,
luxury goods? Coach is selling fewer handbags and Tiffany fewer
baubles. Haven't we seen this film before?
The mood of bankers
In its first "Senior Loan Officer Opinion Survey on Bank Lending
Practices" in 2008, the Fed said that 80% of U.S. banks reported
tightening lending standards on commercial real estate loans in the
past three months, a notable increase and the highest since this
question was asked in the 1990 survey.
The government as an enabler of speculation
Some banks attract deposits by offering superior rates on CDs and
savings accounts. With six-month treasuries yielding 2.25%,
FDIC-guaranteed rates of 5.0% on CDs and savings accounts have been
attracting significant capital. But which lenders are paying these
kinds of "loss leader" rates? Those with troubled loan
portfolios - like Washington Mutual, Countrywide, Bank United, and
Corus Bank. They make up this higher cost of capital with higher loan
returns, which have added risk. Gee, we wonder if these banks would
attract as much capital without FDIC insurance.
In case you were hoping for the Fed to save the economy
In a recent "Macro Mavens" dispatch, reported in Barron's,
analyst Stephanie Pomboy writes that the Fed's latest moves merely
confirm it is off on a "mission impossible, namely to pump up the
fast-deflating housing bubble." She advises Bernanke & Co. to
forget it, reminding them that "never in history has a bubble been
reflated." While there's always a first time, she makes clear,
this isn't likely to be it.
As evidence of just how quixotic this quest is, she cites the massive
supply of unsold houses and the little matter of the "banks having
to write off the $300-$500 billion (already realized if not recognized)
in mortgage-related losses before they can begin to think about
extending new credit."
The next shoe - commercial real estate
Goldman Sachs said on February 5, 2008 that U.S. real estate lenders
have only just begun to write off the troubled mortgage loans they have
on their books. Goldman says credit deterioration is spreading into the
commercial real estate (CRE) sector, which will contribute to a 20%
fall in commercial property values over the next few years.
Goldman analyst James Fotheringham said "we see CRE losses as the
most significant 'problem area' after subprime." He forecasts
"CRE prices will fall 21% to 26% from current levels, leading to
total related loan losses of $180 billion. Total credit losses from
CRE, residential mortgage excluding subprime, consumer and corporate
loans will likely exceed $330 billion. By comparison, Goldman expects
total subprime-related losses to top $210 billion over the next few
years. Goldman forecasts house prices will fall 18% to 20% from the
peak in [the first quarter] 2007, vs. the 8% experienced so far,"
Fotheringham added.
Another shoe - California real estate
Californian homes are overvalued by as much as 40% and stricter lending
standards will probably contribute to "material" price
declines, according to analysts at Goldman Sachs. Prices in California
"have proven surprisingly resilient, given the severe curtailment
of credit availability and rising unemployment, however, we believe
that a downturn is imminent."
Last August, the median California home price was $589,000, though
incomes only supported prices of $350,000 to $380,000, according to the
analysts. The average U.S. home was about 13% overvalued, the report
estimated. The California Association of Realtors estimated in October
that the median California home/condo price would drop 4% to $553,000
in 2008, the biggest decline in 15 years.
And, this just in from the Sunshine state
In Miami, the temperature is heating up in more ways than one.
MarketWatch's Alan Farago writes that police arrested a couple having
sex on a construction crane. "For the foreseeable future, renting
out crane cabs for sex would generate a higher percentage profit than
selling condominiums in unfinished buildings," writes Farago.
It's raining shoes - credit card defaults
"Unpaid Credit Cards Bedevil Americans," is the headline of a
recent Associated Press story. "Americans are falling behind on
their credit card payments at an alarming rate, sending delinquencies
and defaults surging by double-digit percentages in the last year and
prompting warnings of worse to come." AP's analysis of financial
data from the country's largest card issuers also found that "The
greatest rise was among accounts 90+ days in arrears."
"Credit card accounts 30+ days late jumped 26%, to $17.3 billion,
in October from a year earlier" at 17 large credit card trusts
examined by AP. That represented more than 4% of the total outstanding
principal balances owed to the trusts on credit cards that were issued
by banks such as Bank of America and Capital One and for retailers like
Home Depot and Wal-Mart.
"At the same time, defaults - when lenders give up hope of ever
being repaid and write off the debt - rose 18%, to $961 million, in
October, according to filings made with the SEC. "Serious
delinquencies also are up sharply: Some of the nation's biggest lenders
- including Advanta, GE Money Bank and HSBC - reported increases of
50%+ in the value of accounts 90+ days delinquent when compared with
the same period a year ago. "Capital One reported that
delinquencies and defaults are highest in regions with troubled
mortgages, including - where else? - California and Florida.
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Special
Article
The Mother of All Accounting Pronouncements
By Mitch Siegler, Managing Director
Special thanks to the folks at Agora Financial, whose insightful
analysis provided the framework for this article.
For the non-accountants out there, Federal Accounting Standards (FAS)
concern "the framework for fair valuation of balance sheet
items." The latest buzz at all the best accounting parties
surrounds FAS 157/159, likely to determine which banks have to write
down how many billions for bad loans. These accounting pronouncements
may even determine which banks are still solvent. While some banks had
already begun moving to the FAS 157 level of disclosure last fall, such
disclosure becomes compulsory for all banks this spring.
In a recent Financial Times article, Jennifer Hughes explains this for
laymen. Basically, these standards divide tradable assets into three
"levels." A Level 1 asset has quoted prices in active markets
- they have a high degree of liquidity and can be valued by an objective
standard. Examples are a U.S. Treasury Bill and gold bullion. A Level 2
asset has an intermediate character, falling short of Level 1. The
problem is with Level 3, illiquid assets which can not realistically be
marked to market - because the market is limited or nonexistent. They
confer particular rights in specific circumstances, but there is no
certainty as to their value or even that they can be traded.
Obviously, a high proportion of mortgage-backed assets will have to be
declared Level 3. Goldman Sachs decided to disclose all its Level 3
assets last fall, though it was not required to do so until this
spring. Its total, as reported by analyst Martin Hutchinson, is $72
billion, no chump change even for Goldman but still just 8% of the
firm's assets. More disturbing is that Goldman has just $36 billion of
capital. Obviously, Goldman depends on the financial market having
confidence in the real value of its Level 3 assets.
This is true for other investment banks and commercial banks, which
likely would have a lower proportion of Level 3 assets. Per Martin
Hutchinson, Lehman has $22 billion in Level 3 assets, or 100% of
capital. Bear Stearns has $20 billion, or 155% of capital. And J.P.
Morgan Chase has about $60 billion, or 50% of capital.
The implications are obvious. Auditors will have to satisfy themselves
that Level 3 assets have real value, and that Level 2 assets are really
Level 2. The test is basically one of liquidity - if an asset can not
be sold, it belongs in Level 3.
Now, every bank will be seeking to raise its mix of Level 1 assets and
lower its mix of Level 3 assets, with two implications. First, it will
become very difficult or impossible for banks to lend against Level 3
securities. This means less lending, as banks get their own balance
sheets in order. Second, it reduces the value of all Level 3 assets,
which affects the availability of credit.
The great inflation of credit of the last decade was based on upgrading
illiquid securities by packaging them and selling them, or moving them
off balance sheet. If Level 3 assets become unacceptable, the process
will reverse.
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Notables and Quotables
"Prices in housing markets are very sticky on the way down. I
know people who have lost 20% to 30% on their home but it happens over
a four- to seven-year period."
- Real estate consultant John Burns in Wall Street
Journal's SmartMoney.com, April, 2003
"In the next six months, one year, two years, the
problems in the mortgage market can cause a lot of problems with
consumers and hurt buying power in the U.S. The crisis will have more
of an impact than investors have already endured."
- Warren Buffett, October, 2007
"The recession in housing is more severe than the
1990-1991 downturn. It could have a much broader impact on the economy
than people realize and will be longer in duration. I don't think
[proposals to bail out struggling homeowners] will do enough to
forestall the inevitable - the consumer is going to roll over."
- Ivy Zelman, former housing analyst at Credit Suisse who
warned of the housing bubble
"Boston is still in the pits...in Florida, it's like
death takes a holiday...Las Vegas is now terrible...Michigan may be a
situation where it doesn't come back."
- Robert Toll, CEO of Toll Brothers, one of the nation's
largest home builders, May, 2007
"This
is just a giant insurance industry that is under-regulated and not very
well reserved for and does not have very good standards as a result. I
think unregulated markets that overshadow, in terms of size, the
regulated ones are a real question mark."
- Michael Farrell, CEO of Annaly Capital Management, on
the $45 trillion credit default swap industry
"I would say we have reverted to a 'normal' financing market in
something like six months: pricing, equity, LTV and guarantees are at
historic norms but it seems like a credit crunch to some since we had
drifted so far from the norms and stayed there for a long time. The
reversion is significant and more than a few people have been caught
midstream in the process."
- John McCullough, Senior Vice President, HSBC Bank
"Homeowners have lost about $1 trillion and could
lose three times that much over the next few years. And, there's more
to go. It would take a 24% decline in prices to re-establish the normal
relationship with building costs. A 27% fall is required to bring house
prices back in line with rents. And, a 50% drop is needed to return to
norm when house prices are adjusted for overall inflation and their
growing size."
- Professor Robert Shiller of Yale, who created the
S&P Case/Shiller index, which tracks housing prices
"Household net worth is not growing by leaps and
bounds - if anything it's going down - which means people actually have
to start saving out of current income, which has negative effects on
spending growth. In many ways, I think the next five years could look
like Japan after 1990. The big growth you got in variety of asset
classes - financed by borrowing because of extraordinarily low rates -
will come out. When you look at the economic landscape, stock prices
are too high, house prices are too high, and you put all the pieces
together and the size of the adjustment needed seems reasonably large.
How many years does it take? Who knows? It doesn't necessarily mean we
have five years of recession - maybe just three to four quarters of
recession."
- Ramachandra Bhagavatula, Managing Director at hedge fund
Combinatorics Capital
"The U.S. housing market will fall into deep
recession in 2008, with home prices dropping up to 35%. Home prices
will fall, on average, 13% from their 2006 peaks by early 2009. The
report also suggested that some markets in Florida and California will
fall as much as 35%. This is the most severe housing recession in the
post-World War II period."
- Mark Zandi, Chief Economist for Moody's Economy.com
"Now is the perfect time to buy a home."
- Headline of a $40 million national ad campaign,
featuring full page ads in Wall Street Journal, USA Today and other
leading papers in Jan-Feb, 2007
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From Bubble
Talk to Double Talk:
Would you buy a used car from the National Association of Realtors?
Below is a summary of forecasts issued by the National Association of
Realtors ("NAR"), a trade group for realtors. NAR
unsuccessfully predicted housing trends for nine straight months, from
April through December, 2007, according to UrbanDigs.com, which has
been tracking NAR's not surprisingly too bullish predictions. You may
recall that NAR is the same trade association once headed by David
Lereah, dubbed "Mr. Everything is O.K." as the national
housing market went into free fall in 2006. Mr. Lereah's famous quote:
"It's a great time to BUY and it's a great time to SELL!"
Well, isn't that a credible comment from the head of a group whose
members earn their salaries on transaction commissions?
December, 2005
NAR predicts that national median home prices will rise 6.1% in 2006.
Over a full year, prices "have never declined since good
record-keeping began in 1968." (Through October, 2006,
median residential property prices declined 3.5% from the prior year.)
September, 2006
Even NAR acknowledges that the housing market might be cooling,
predicting a 2.0% decline in residential real estate prices for
2007. NAR's relatively sanguine forecasts are based on lower
mortgage interest rates and continued economic expansion. NAR also said
that about one-third of our country - including Alaska, Vermont, New
Mexico and many southern states - are still experiencing economic
expansion and increasing home prices.
November, 2006
NAR released its "anti-bubble reports" In these propaganda
handouts, NAR basically said that it would be extremely unlikely for
prices to decline by 5% in all markets. The research was headed by the
now discredited, former chief economist for NAR, David Lereah.
In its Sarasota-Bradenton Report, NAR claimed "price declines in
the local market are unlikely according to our stress test." This
report also claimed that "the local housing market will experience
a price decline of 5% only under extreme unlikely scenarios. For
example, mortgage rates increasing to 9% combined with 33,000 job
losses could lead to such a price decline." (Well, mortgage rates
got nowhere near 9% and there have not been 33,000 job losses in the
Sarasota-Bradenton metro area. Yet, Sarasota-Bradenton prices have
plummeted, with year-to-date 2006 price declines of 18% in October, the
month NAR issued its report.)
January, 2007
The 2007 NAR forecast, calling for 3.0% increase in new home prices,
1.5% increase in existing home prices and 0.9% decrease in new home
sales, is released.
February, 2007
"Now is the perfect time to buy a home" - the headline of a
$40 million national advertising campaign, featuring full page ads in
Wall Street Journal, USA Today and other leading newspapers. NAR's
reasoning: record low interest rates, large inventory won't last (really?),
prices overall have stabilized (is that right?), positive economic
outlook and this oldie but goodie - home ownership is a great
investment.
May, 2007
Modified 2007 forecast released. Forecast calls for 1.0% decrease in
new home prices, flat existing home prices and a 2.9% decrease in
existing home sales.
December, 2007
Revised monthly forecast from NAR, which followed nine straight months
of downward revisions, calls for U.S. existing home sales to fall 12.5%
this year to 5.67 million - the lowest level since 2002. (Note: this
2007 "forecast" was issued on December 10, 2007 - isn't it a
little late for 2007 forecasts?)
January, 2008
2007 proved to be the worst year for housing in decades, perhaps since
the Great Depression, NAR finally admitted on January 24, 2008.
Existing home declined by a greater-than-expected 2.2% in December. For
2007, home sales dropped 13% - the largest annual decline since 1982.
And, the median price for a single family home fell 1.8% for 2007 - the
first annual decline since NAR began keeping records 40 years ago.
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Credits:
Associated Press, Bloomberg, Wall Street Journal, Financial Times, John
Mauldin's Investors Insight, Agora Financial, DataQuick Information
Systems, Global Insight and San Diego Union-Tribune.
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