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Monday, March 26, 2007

GUH Part 1

I'm done crunching numbers, and I had written this monstrous summary. I think instead I'd better post it in smaller, more digestible hunks. GUH stands for Grand Unified Housing theory. Make all the comments on hubris you want.

First, let's consider the background. Beginning in December of last year, loan defaults had reached a point requiring that those who were buying the loans from the originators or packagers draw back and require a higher quality of loan or a much higher return. From a market point of view, it makes little difference as to whether people refuse to lend money at all to some would-be borrowers, or will agree to lend money to those would-be borrowers only at very expensive terms. Both produce rationing of effective demand in the housing marketplace.

Terms have been tightening since December, with the bulk of the effective tightening happening in late January and February. Terms have not stabilized yet; in the last two weeks much of the effective tightening has occurred in the Alt-A market rather than the subprime market.

The major economic debate in the last few weeks has centered on how much of an effect the tightening will have on the housing market and on the general economy. In terms of immediate effect, a cut in building has a broader effect on the economy than a drop-off in existing home sales, and many optimists argued that the credit tightening would have little effect on the new home market, because that was a "richer" target market and it would not be affected by troubles with subprime.

That, of course, is BS. I wrote about Centex and Beazer loans last year. It is not that these two homebuilders were unique, either - they weren't. KB Homes, for example, partnered with Countrywide for a great deal of its home loans. My belief is that the tightening in lending standards will have a greater effect on the new home market than on the existing home market because a great deal of the lending supporting new home sales was highly speculative and a great deal of speculation was occurring in new homes.

Just to make myself perfectly clear - my projection is that tightening lending standards will cut out 18-23% of the new home demand and only 9-12% of the existing home demand. I haven't read any forecast that remotely agrees with mine, so keep that in mind when you read any of my posts. If I am wrong and everyone else is right, the overall economic picture should be better than I am forecasting. Another aspect of my divergent forecast is that I expect ultimate overall losses in the Alt-A sector to be greater than in subprime.

Existing home sales will be supported by the financial conservatives who actually saved for downpayments and/or sold at the height and buy back in when they see good deals in stable-looking neighborhoods. However, by definition, a great number of the new developments are highly unstable. Some will become almost instant ghettos in the next two years. If one-third of the buyers got in with extremely variable loans, the foreclosures and the resulting price decreases will far outweigh those for existing, stable neighborhoods.

Today Census released the New Home Sales report for February. IMO it clearly shows the disproportionate impact of tightening lending standards on new home sales. This report had downward revisions for the end of 2006 and January, giving the following seasonally adjusted national totals (all data in thousands):
Oct 2006..: 967
Nov 2006.: 988
Dec 2006.: 1,047
Jan 2007..: 882
Feb 2007.: 848
This represents an 18% drop in sales from February of last year. Year to date non-seasonally adjusted sales are down 17.9% compared to 2006 year-to-date sales, so I place some confidence in that number. For additional perspective, in 2005 total new home sold were 1,283, and for 2006 total new homes sold were 1,053. It is certain now that there will be no recovery for new home sales in comparison to 2006. Seasonally adjusted sales (which are annualized) did not drop below the 1,XXX level until July of last year, and after July exceeded the 1,XXX figure in three months - Aug, Sept & Dec.

What does this mean? It means that overall building, which has just begun to slow, will continue to slow, and that residential and total construction will have a significant net negative effect on the 2007 economy. Regardless of all the talk, net construction was very strong last year. Total construction, and therefore total construction employment and general economic stimulus, has just begun to fall off.

These are Census figures for construction put in place during a particular month. It is tracked under four different categories.
Total All Categories
Jan 2006..: 1,194,547
Nov 2006: 1,181,274
Dec 2006: 1,189,308
Jan 2007..: 1,180,212
Jan 2006.: 19,441
Nov 2006: 20,885
Dec 2006.: 20,452
Jan 2007..: 22,440

State & Local

Jan 2006.: 235,790
Nov 2006: 256,727
Dec 2006: 263,766
Jan 2007.: 263,520

Jan 2006..: 277,893
Nov 2006: 311,586
Dec 2006.: 319,002
Jan 2007..: 318,865

Jan 2006..: 661,423
Nov 2006: 592,076
Dec 2006: 586,088
Jan 2007..: 575,387
So consider the ugly reality that the fourth quarter's anemic 2.2% GDP gain will be further undercut by housing, and you can understand how overwhelmingly optimistic predictions of 2.5% GDP growth for 2007 must be. This is beginning to seep through the dikes of economic denial, btw. Bloomberg:
Private economists may not be so sanguine. They have cut their forecasts of business spending three times since December, and now expect it will grow this year at the slowest pace since 2003, according to surveys by Blue Chip Economic Indicators. That's after expenditures on equipment and software fell last quarter by the most in four years.
This year, profit growth is slowing as margins shrink. Analysts surveyed by Bloomberg News see per-share earnings growth among S&P 500 companies slowing to 6.8 percent this year from 16.6 percent in 2006.
In short, we are seeing a correspondence in economic wave troughs, with construction reinforcing other economic problems. It's not a matter of the economy "shaking off" housing - it's a matter of housing no longer compensating for a fundamental slackness in the economy.

Next up - commercial.

Pretty scary, Mama;

Remember, the MRE's taste better when you're hungry.
You know how they elect popes? They get all the cardinals together, and feed them bread and water until they make a decision.

I'd like to do the same with Fed meetings and MREs- I think it would produce much acuter forecasts.

There is a point at which optimism is both warranted and realistic, and a point after which it becomes pure BS. We seem to have crossed over that latter point on consumer spending alone. The employment effect of slower business investment and slower construction is going to reinforce weaker consumer spending.
I think the only thing I could add would be to say that the overriding strategy of the Bush administration is to lie and stall their way into 2009.

The dishonesty quotient is already skyrocketing.

A friend of ours sold their house and was qualified a month ago, but the lender is "reconsidering" their loan for their new house due to tightened loan standards. This bodes ill for a lot of Americans.

A weird, unintended consequence of all the housing news here: people aren't selling their homes, there is hardly enough available homes in our area, so the values are sky-rocketing and are still less than new home sales (where there is a glut of available homes). So, builders are trying to give away their homes and used home sales are going nuts. We've had three or four homes sell in two to three days on our street in the last month.

It's crazy.
Dr M - Yes, the credit tightening is real and will have very discernible consequences.

Existing home sales will continue to do better than new homes, IMO. But they too will be impacted by increased caution in lending.
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