Monday, June 26, 2006

 

Alan Rips Alan


UP AND DOWN WALL STREET
By ALAN ABELSON
June 26, 2006

Call to ARMs

ANYONE KNOW A GOOD LAWYER?

Before you accuse us of cavalierly perpetrating an odious oxymoron, rest assured we're using "good" in the sense of professional superiority, certainly not moral rectitude. And what inspires our request is we're trying to prepare for a flood of requests from angry readers hot to sue Alan Greenspan.

Be assured as well that we would earnestly seek to discourage such action. For one thing, Mr. Greenspan is a well-meaning and gentle soul, known far and wide for his generosity (they don't call him Accommodating Al for nothing). For another, as the New York Times reported last week, chasing ambulances is already a lavishly rewarding occupation. More so, for sure, than tending to the unfortunates being hauled to hospitals in those ambulances, as evidenced by a study that found lawyers' incomes between 1995 and 2003 rose 7%, while your average sawbones over that same stretch suffered a 7% decline in his take-home pay.

But the incontrovertible if sad truth is that Mr. Greenspan did offer financial advice using, what's more, the bully platform of a congressional hearing to make his pitch.

And the even sadder truth is that any innocent who chose to follow his advice is now the poorer for having done so. That Mr. Greenspan has recently received a huge advance for a book on his life and happy times as a famous economist and revered civil servant is, alas, a cinch to only whet already ravenous litigious appetites.

More specifically, Mr. G stands guilty of committing a capital crime several years back by regaling the peasants, who considered his every word a divine utterance, on the joys of adjustable-rate mortgages (as opposed to the old stodgy fixed-rate variety).

As it happened, he couldn't have picked a worse moment to make what Stephanie Pomboy of MacroMavens nicely dubs his "call to ARMs." Yields were their lowest in 40 years, but poised to begin a remorseless climb up the slippery slope.

The masses who rushed to follow the master's advice are only now starting to feel the pain of their folly. Stephanie reckons that some $1 trillion of adjustable-rate mortgages are due to be reset this year and another $1.7 trillion next. In the event, legions of homeowners will have to cough up 25% more every month and, for some, the bite will be as much as 60% greater.

Our melancholy prediction is that, what with killer prices at the pump and inflation extending its merry spiral, come winter a goodly number of said homeowners will find themselves too strapped to pay their fearsome oil or natural-gas bills. Having long since picked the neighborhood clean of sticks and twigs to kindle in their fireplaces, they'll have no recourse but to strive to stave off the chilblains by burning effigies of the beloved Mr. Greenspan.

Much as we sympathize with their plight, the hapless borrowers have only themselves to blame for failing to perform sufficient due diligence before acting on Mr. G's urgings. Had they made even a cursory effort to take his measure, they would have known better. For though not always wrong on his projections or wildly off on his timing (he isn't, after all, a financial journalist), he invariably has been wrong on the big ones. The only thing worse than his misdiagnoses have been his proposed remedies, which consisted mostly of the same old snake oil of easy money and easier credit. He was always ready with a fix, never with a cure.

Most notably, he lost his nerve when confronted by a runaway stock market and what to do about it. His politically correct but economically inane answer was essentially...nothing. When equities inevitably came back to earth with a horrible thud, he sought to distract us simple folk from the smoking ruins by creating the greatest housing bubble since shelter-seeking man first crawled out of his dank cave.

Now, that bubble's losing air rapidly and bad stuff is beginning to happen. Mr. Greenspan has fortuitously or craftily -- or both -- slipped out of the line of fire and, presumably, is busily scribbling away, offering, as the key player, his priceless perspective on the great bull markets in stocks and houses. (The perspective may be priceless but, the book will probably, depending on length, go for close to 30 bucks a copy, with the usual discount at Barnes & Noble.) We can hardly wait to read his account. But, then, we're a real sucker for anything with a financial theme, especially fiction.

THAT HOUSING IS ON THE SKIDS IS NOT EXACTLY new news, of course. We know that because we ventured some notions along those lines for a good stretch of last year and the early months of this year and have a treasure- trove of angry letters those items provoked to prove it. The nub of the irate communications was that they don't make real estate anymore, so housing can never go down, at least for any appreciable length of time. (We said those letters were angry; we didn't say the points they raised were original or, for matter, logical.)

One could argue that they do make real estate every day: It just goes vertical instead of horizontal. And as for housing never declining (which really translates into housing prices never declining and housing shares ditto) the telltale signs, alas, are everywhere, particularly among the stocks of home builders, and they all read "for sale."

Not only are sales slowing, but, meanwhile, inventories of unsold houses are going through the roof. Builders, as always, have a tendency to keep building so long as some lender out there is silly enough to give them money. Nor is it only new homes that aren't selling like hot cakes these days: according to the National Association of Realtors, existing-home inventories were up by more than 30% over a year ago, the biggest such rise since the NAR started to keep tabs back in 1983.

Another set of numbers, which comprise an index compiled by the National Association of Home Builders (affectionately known to the housing crowd as the NAHB), measures the buoyancy of the housing market. The latest reading was 42, down from 68 only eight months earlier; that's the worst eight-month slump ever.

House prices are giving ground, even if only grudgingly (it takes all of us a while after the music stops to realize that the party, even -- or especially -- a great one, is over) and affordability for wannabe homeowners grows ever more elusive. On that score, the rise in mortgage rates and unrelenting gasoline prices obviously are burdening the would-be house buyer's wherewithal and dampening his ardor for making maybe the biggest financial commitment of his life.

The stock market deserves a kind word here: It has been quite reserved in its view of the home builders, refusing for the most part to grant big P/Es during the recent glory days and marking down the stocks in advance of the industry's loss of momentum (we trust using that word doesn't make us terribly out of date). The Standard & Poor's 500 Homebuilders index, which topped out last July at over 1323 and was over 1200 at the start of this year (it was as low as 201.34 in September of '01), last week sagged to around 785.

That's the kind of drop that gets the speculative juices flowing and causes otherwise sensible people to hunt frantically for bargains.

Best in this case, we suspect, to resist temptation. And if you happen to be one of those investors, of whom there's no shortage, who can resist everything but temptation...well, lots of luck. We fear you'll need it.

NOT THE LEAST of reasons for taking a wary stance on housing is that there seems to be so much darn room on the downside. Boom doesn't really begin to describe the extraordinary upswing now ending. As a recent report by HSBC on the industry observes, increases of 100%-150% in sales, starts, building permits and home-builder optimism from the bottom of a housing cycle to its peak are pretty much the norm, and the advances have tended to last four or five years. This one, in striking contrast, has gone on for some 15 years, with gains in the aforementioned indicators ranging from 130% to 300%.

So if it hasn't been the mother of all building booms, it'll certainly do until the real thing comes along. Besides the Fed's extraordinary exertions, the bubble has been kept aloft and steadily inflated by a host of new mortgage gimmicks and financial engineering wonders, not a few of them dubious if not downright evil. As the mounting disenchantment with ARMs demonstrates, some of these cockamamie concoctions are coming back to bite the very souls they were designed to initiate into the pleasures of home ownership.

The flip and ugly side of the blazing boom in housing, the savvy chaps at HSBC point out, is that it's still early days in the current downswing, which could easily go on for perhaps five years. And before it's over, the decline could range to 40%-60%. Given those whopping gains that housing has racked up during its remarkable run, a 40%-60% give-back stacks up as serious pain.

Just how serious is the subject of another recent study, this one by the Levy Economics Institute of Bard College. By its reckoning, at the end of the third quarter of last year, U.S. household real-estate equity weighed in at slightly more than $19 trillion; subtracting total mortgage debt of $8.2 trillion leaves equity at slightly over $10.9 trillion. A 20% drop in housing prices would mean a loss in household equity of $3.8 trillion, a 25% drop a loss of $4.78 trillion. That's "t," remember, as in terrible.

Even these days, $3.8 trillion, much less $4.78 trillion, is not exactly chump change. That kind of hit would be more than sufficient to send the consumer reeling and the economy into recession.

And we're not talking one of those feathery recessions that barely leaves a mark.

STEPHANIE POMBOY IN A RECENT commentary cites the paradox of bank stocks outperforming at the top of a credit cycle, with real estate threatening to tank. The explanation, she posits, is the widespread belief that banks "shrewdly offloaded all their risk in the great securitization of the last few years." Which, Stephanie says, ain't necessarily so.

To the contrary, she exclaims, the U.S. banking system is more exposed to the real-estate sector than at any time since the end of World War II. Banks may have securitized a mess of mortgage debt, "but they still have $3 trillion in direct mortgage loans sitting on their books."

Which happens to be a record 43% of total bank assets.

And, as if that weren't exposure enough, the banks have been avid buyers of the stuff they securitized. Since the start of this year, they've increased their holdings of mortgage-backed securities at a sizzling 48% annual rate.

Bankers, we might interject, have long been famous for the conviction that you can never get enough of a bad thing.

In any case, Stephanie sighs, it will be an unhappy day when those investors now eagerly taking cover in financials discover theirs is but a levered bet on this waning housing market.


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