“The bottles stand as empty
as they were filled before
Time there was and plenty
but from that cup no more.
Though I could not caution all I yet may warn a few:
Don’t lend your hand to raise no flag
atop no ship of fools.”

Ship of Fools - Hunter/Garcia

I’m taking a break from following the imminent demise of the US real estate boom to post some musings on the situation and some unique takes on the housing crisis and its solutions.

In case you haven’t been following the news, a long-brewing credit crisis is currently coming to fruition. Its causes are numerous and complicated, for some background take a look at the excellent report State of the Nation’s Housing 2007 from the Joint Center for Housing Studies at Harvard University, then study this excellent NY Times graphic about sub-prime loan packaging and sale as securities from last week’s paper and peruse this Center for Economic Policy and Research report on the likely fallout.

The basic gist of the situation is that a Fed policy of low interest rates during the first half of this decade, a la Alan Greenspan, led to the proliferation of low-interest variable-rate loans to less than qualified buyers. The worst of these loans featured high loan-to-value mortgages with low interest ‘teaser’ rates that would then reset to some prime rate (usually LIBOR) plus a margin after a specified period of time, and were made to borrowers with little paper documentation of said borrower’s income or ability to pay back the loan.

These types of loans were too risky for lenders to sell to the Government Sponsored Entities (GSEs) Fannie Mae and Freddie Mac, so the loans were sold to Wall Street Investment Banks who in turn decided that these loans could be ‘packaged’ as Mortgage Backed Securities (MBSs), and that the securities could further be sub-divided into higher-risk packages known as Collateralized Debt Obligations (CDOs). Stakes in the MBSs and CDOs were then sold to investors, often Hedge Funds, who in turn used them as collateral to leverage huge sums of money to finance things like private takeover bids.

Fast forward to the beginning of this year, when large numbers of people began defaulting on their loan payments as their interest rates reset, forcing investors to recognize the risk associated with MBS and CDO investments. The problem has now ballooned to the point where no one will any longer buy these loan packages and Hedge Fund Investors are demanding their investment funds back, forcing the Funds to sell off their still-valuable investment holdings and leaving them with a bunch of worthless MBSs and CDOs.

Now for the double whammy. Rising defaults and foreclosures (together with un-affordable asking prices) have caused a tremendous rise in home inventories across all markets, precisely at the time when lenders have vastly restricted the types of risky loans that buyers had been relying on to enter the overpriced market for the last few years. In other words, it is now very difficult to borrow money, and even if you have the credit and finances to do so, it is considerably more expensive.

Consider, for example, the Phoenix market, where inventory this week stands at 47,310 Condos and Single-Family Homes for sale. That is a Year-Over-Year (YOY) increase of 20%, with no end in sight. Portland, Oregon? 40% YOY increase in inventory. Basic Econ 101 here; lots of supply, very little demand. Housing is going to crash, and it is going to cause a lot of collateral damage along the way.

This is another situation where the industry folks (bankers, lenders, brokers etc.,) are way ahead of the knowledge (panic) curve, so beware! For the most part, home owners, Real Estate Agents (though this is changing) and certainly Sellers and some Buyers are still in the dark, or in denial, about the magnitude of this correction and where it will eventually take the market. The media and the National Association of Realtors (NAR) are spinning like crazy (its a great opportunity to buy! Hint - it isn’t). Even Wall Street has just seemingly awoken to the danger that MBS and CDO defaults pose to investors (yes, the market is tanking, but this inevitable correction is long overdue).

If you own a home, or rent, or if you earn money from a housing related industry, you should definitely read up on the entire boondoggle, because it is going to affect you one way or another. Don’t forget that if you own Mutual Funds or other real-asset backed investments you could own MBS or derivatives and not even know it.

Thanks to the The Theroxylandr in Flames, a site I found by accident at the end of the last year, I’ve been aware of the brewing credit crisis since the sub-prime story first broke back in February. I can also recommend the insightful economic prose at Calculated Risk and Housing Doom.

So where is the novel solution to all this mess? Well, the obvious end result is a return to sane and affordable housing prices, which will be painful for the get-rich-quick speculators who still want triple digit returns on their ‘investments’. In the mean time, we can look forward to lots of lender bankruptcies and Hedge Fund collapses, foreclosures, short sales, depreciated appraisals and lawsuits galore.

How will it impact the overall economy? It is clear that the housing boom has provided the bit ‘o boost for G.W. and company to clang the prosperity bell for the last four years or so, now that the easy money is gone, who can say? From the perspective of environmental health, the sooner the whole globalization house of cards tumbles, the better. The situation is amusing in a dark comedy sorta way, and it illustrates well how our global economy is so much smoke and mirrors. You have to believe, Peter Pan!

Check out this link via Minyanville, where some inventive and recycling conscious designers have put together some very cool homes built from modular shipping containers.

 

Tags: Credit+Crunch, Housing, Real+Estate, JP+Oliva

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