Tuesday, October 30, 2007

Kass: They're Still Not Getting It on Housing

We need more of these reality checks (see article below). Too many folks are trying to broad brush the housing decline as a short-term, economically contained event. I don't buy it. This will be a steep and long decline, and there is and will be spillover impact into the broader economy. I always appreciate candor from smart investment types, and i don't think it gets better than this: (Vito Boscaino)


By Doug Kass
RealMoney Silver Contributor
10/25/2007 3:14 PM EDT
URL: http://www.thestreet.com/newsanalysis/newsonthego/10386473.html

This blog post originally appeared on RealMoney Silver on Oct. 25 at 7:26 a.m. EST

Last night I appeared on CNBC's "Kudlow & Company" with my favorite host, Larry Kudlow, and I went face to face with Dr. Wayne Angell, Jim Lacamp, Dennis Kneale and Dr. Robert Shiller.

I want to give you a rundown of the show because it offers pretty clear evidence that many of the same misconceptions that surrounded the inflating of the housing bubble are still around -- and as such are still dangerous to your financial well being.

So read on.

Most of last night's discussion involved the subject of housing and the meaning of yesterday's turnabout in equities.

Angell encouraged the Fed to move aggressively in order to revive the housing markets. Later on, I questioned him on this, asking why another rate cut would help when the September cut didn't -- indeed industry statistics have worsened. He just said I was wrong, but I didn't really get an explanation.

Shiller put the magnitude of the housing situation in perspective. The two-year housing drop has continued, and the future outlook is not optimistic for the sector as the correction will continue for some time.

The optimism from the panelists was summarized by my pal Dennis, who started by denying that there was a housing problem, and stating that the housing bogeyman is not that important, that most homeowners have benefited from the rise in home prices during this decade -- and even if they sold, they would end up well. He went on to say that the recovery in stocks yesterday was testimony to the bull market.

What?

I accused Dennis as being too linear in his comments, especially on the market. By that, I meant that diagnosing the recovery in equities (in any one day) and making a grand statement about its import was a one-dimensional (or linear) way of looking at things.

The investment mosaic is multidimensional and incorporates a lot more than just recent market behavior. From my perch, his view of the meaning of the market recovery on Wednesday could prove as wrong as when many made the incorrect observation when homebuilder stocks rallied impressively in May 2007 that this was an indication of a likely recovery in the housing markets.

I asked, what would he have said after Friday's schmeissing? "Buy," he said. Point made: Buy when they drop; buy when they pop.

On housing, I expressed the view to the panelists that leaning on the Fed with shock and awe (again) next week would have little positive effect on the housing markets, just as the last 50 basis point had no impact (as housing statistics continue to move lower). The affordability issue remains unresolved, and the inventory of unsold homes remains at record levels -- and, according to traffic readings, looks to worsen in the months ahead.

As to Dennis' remarks that most consumers are well off after the long rise in home prices, I expressed the view that the problem was the mortgage loans that were made at the margin over the last three years; they are coming back to bite the homeowner in mortgage rate resets in lower home prices and in a difficulty getting a loan as the originating business evaporates.

Jim Lacamp expressed the bullish view that the housing market will be "ring-fenced" and will not spill over into the economy or capital markets and that the fact that the markets are where they are is proof positive of the market's strength. He used the metaphor of "rope a dope" as an expression of the market's continued vigor. That reminds me of something that Jeremy Grantham recently wrote in this month's GMO Quarterly Letter:

Of course, I am fed up. We had Risk on the ropes. His followers were panicking. They were calling for the ref to stop the fight: "He has absolutely no idea how badly our boy is hurting ... He has no idea!" And what does the ref do? Ends the round early, extends the break, and allows a dangerous injection of adrenaline. Risk then leaps out of his corner, apparently rejuvenated, and wins the next couple of rounds. And here we are, wondering whether Risk has taken enough punishment to make him vulnerable to a knockout blow in a later round. Or has he completely recovered?
-- Jeremy Grantham, GMO Quarterly Letter, October 2007

From my perch, the bulls continue to ignore the ramifications of the housing market's depression not only on the economy but the spillover and contagion in the credit markets.

For example, ignored in last night's conversation was how the subprime fiasco has devastated the credit markets, as evidenced by the continued structured investment vehicle problems and the huge writeoffs of permanent capital at the leading money-center banks and investment bankers.

It is astonishing to me that the subprime-/housing-induced inflection point in credit, from credit expansion to credit contraction, continues to be ignored by market and economic bulls.

The ironic thing of course was that after several of the guests denied the very existence of the housing problem (what...? again), the next two segments were dedicated to Countrywide Financial's (CFC) deal to renegotiate some of its adjustable-rate mortgages and the implications of Chapter 13 bankruptcy filings on homeowners whose mortgage problems have accumulated.

I have mentioned in the past that a 20% drop in home prices, as currently predicted in the Case Shiller Futures Index by 2011, means that about $4 trillion of consumer wealth will be wiped out. Another $500 billion to $1 trillion of losses looks to be taken by the financial institutions and hedge funds from the collateralized debt obligation mess.

That's close to the amount lost after the tech bubble -- and very large in the context of a $13 trillion U.S economy (the number Larry used last night). Moreover, the financial industry's reluctance to provide credit to homeowners provides another important economic headwind.

The housing problem ring-fenced? Not likely.

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