Wednesday, January 02, 2008

Constructing Capitulation: A Look Back at 2007

At the start of 2007, it was pretty clear that something had seriously gone wrong with residential housing markets in the United States.

After nearly a full year of declining home sales, widespread homebuilder and home “investor” trauma and some precursors of the mortgage-credit implosion, the backdrop was clearly set for a larger and more pervasive unveiling of one of history’s greatest economic debacles.

The Fed and chairman Ben Bernanke, though publicly reassuring and confident, promoting themes such as “containment” of the housing “slowdown” and the absence of “spillover” effects on the wider economy, were belatedly introducing new lending regulations sending some troubled lenders, such as New Century Financial and Countrywide Financial, scrambling to either adopt the changes or to sidestep them.

Realtors, on the other hand, presented a decidedly optimistic outlook both pushing a new ad campaign that promoted the false notion that “It’s a Great Time to Buy or Sell a Home” as well as having their then chief economist David Lereah report, through the traditional “dimwitted” and “bought and paid for” “make believe” news media, that the housing market was in the early stages of recovery.

Even some beleaguered yet not altogether beaten homebuilders such as “dancing” Bob Toll seemed to portray a sense of optimism, suggesting that the new home market was seeing some positive signs such as stronger than expected “commitments” in Maryland, Greater Washington DC and even portions of California, cancelations abating and evidence suggesting that consumers were simply sitting on the sidelines ready to buy at the first sign of price stability.

Unfortunately for scores of unlucky home buyers who were influenced by the National Association of Realtors and the other industry insiders onslaught of media propaganda, home purchases made at the start of 2007 had come nearly at the absolute zenith of home values… prices that, after having been artificially inflated by years of an unrestrained speculative frenzy and unchecked lending, will not be seen for many years to come.

Try as they might though, the false euphoria created by the real estate industry would last only moments as the housing collapse proved yet again that it was not going to go away silently.

To start the unwinding anew and with a decidedly ironic twist, New Century Financial, one of the nation’s largest subprime loan originator REITs announced that they needed to restate earnings for the majority of 2006 in order to “correct” improper accounting of an underestimated volume of “repurchase claims”, claims made by investors when loans purchased from the originator default unusually early.

Now, it appeared that all at once, and with the help of a handy dandy daily chronicle, lenders were dropping like flies as a flow of disclosures showed losses mounting quicker than any lending institution had anticipated and, for many, could reasonably manage.

The thick greenish gooey smog of the subprime slime was quickly descending, enveloping not just the nation but the worlds lending, housing and financial markets in a taint so pervasive and infectious that the losses would eventually be tallied in the tens of billions with conservative projections of many hundreds of billions.

Not all real estate industry insiders were so aware of the magnitude or consequence of the subprime debacle turning instead to other factors for explanation of the continued decline in buyer enthusiasm such as David Lereah’s suggestion that “El Nino” was the culprit of lagging sales.

Others though saw the writing on the wall quite clearly and accurately though and were not shy about admitting the extent to which the environment was going to “suck” for the remainder of 2007.

With scores of smaller, more risky, lenders and originators on the ropes and the lending-credit debacle escalating, the initial signs of a clever bluff could be interpreted from the statements of one of the nation’s largest lenders, the yet again even more ironically named Countrywide Financial (NYSE:CFC).

As the unfolding crisis had begun to cast a shadow of doubt over the whole of the real estate industry, many market participants found themselves fielding questions about the extent of its impact on their operations and even Congress began ratcheting up their investigations into the causes and possible outcome as well as debating possible plans for a public “bail out”.

The “second shoe” had dropped.

The budding false optimism from earlier in the year had correctly shriveled as the real estate industry resumed its downward spiral and now the mortgage lending industry, having come apart at the seams, degenerated into an ugly case of blame and finger pointing.

Heading into the summer of 2007 it was clear that there was a “perfect storm” on the horizon.

Try as they might, central bankers could no longer continue to ignore or downplay the significance of the lending meltdown that had now escalated into a wider credit crunch.

The economy that had just appeared “likely to continue expanding at a moderate pace supported by solid growth in employment and incomes” the day before was now experiencing “appreciable downside risks to growth” and requiring “facilitate the orderly functioning of financial markets”.

The cat was out of the bag, the subprime mortgage turmoil had now shown itself to be the tip of a far larger and more cataclysmic iceberg that would have credit markets reeling around the globe as the house of cards had begun to fold bit by bit.

Not even the superb bluffing on the part of “top conditioned athlete” such as Countrywide Financial’s Angelo Mozilo could prevent the outgoing tide of investor sentiment.

A single simple and now likely accurate forecast for possible bankruptcy amid a rising tide of delinquencies and foreclosure sent the nation’s largest lender down for the count as its stock dropped over 80% in value.

Along with it went all hopes that anything other than a complete washout was in store for the nation’s housing markets as the commercial lending markets collapsed and Jumbo loans, one of the major sources of fuel that served to inflate the massive housing bubble, all but disappeared.

Coming into the Fall Ben Bernanke and the Fed, although likely still not fully accepting the depth and enormity of the unwinding, were clearly in crisis mode.

Putting aside any caution of creating “moral hazard”, the Fed slashed the Fed funds rate and continued its other operations in an effort to stave-off widespread panic but at this point it seemed plainly clear that they were behind the curve essentially plugging holes that had sprung far in advance of their attention.

All home sales indicators now began to register resounding confirmation that the massive structural changes that took place during the summer would lead to a new leg down in the housing decline.

The new and existing and more leading pending existing home sales data all showed quite clearly that a significant percentage of buyers had been simply removed from the equation resulting in another 15%-20% falloff in demand for residential real estate.

Home prices too have suffered, showing the most negative and most widely felt declines to home prices ever recorded by the S&P/Case-Shiller home price indices.

As for the consumer, the initial signs now clearly show that the housing collapse has begun to spillover with confidence plunging to recessionary levels, weakening employment situation, real retail sales of discretionary items continuing to remain negative, and a significant pullback in the production of some consumer durables and even a possible collapse of commercial real estate as well.

2007 ended, in a sense, in a similar but altogether more severe state than it had begun.

A famous former president of the National Association of Realtor’s can still not sell his own home even with all the propaganda NAR money can afford, NAR’s predictions are no more accurate, and homebuilder sentiment is borders on depression.


The primary difference is that the ruse is over.

The housing bubble is in obvious collapse in America and elsewhere around the world and the mortgage meltdown is now fully recognized as a serious global credit crunch and with that nearer is drawn the specter of a calamitous downturn.

Will bankruptcy for Fannie and Freddie or bond insurers push things over the edge?

Or perhaps prime borrowers will fail in record numbers as recession sinks in and job losses mount?

No one truly knows for sure but what does seem certain is that 2008 will bring some monumental changes.