Monday, January 28, 2008

You Know What Happens When You Assume Things

I am already tired of all the talk about the Superbowl. I just want to have the game played. I understand that the NFL likes to have a 2 week circus to showcase the game and build the hype, but I would really prefer a one week schedule. Oh well, only a few more days.

Rate Cut Rescue Dream Runs Hard and Runs Deep
The markets were moderately calm today after the wicked volatility of last week. No doubt most want to play the FED rate decision on Wednesday. While this blog and others have made the observation that rate cuts are not really going to help things much, the belief on Wall Street and amongst financial analysts/commentators that rate cuts rule is deeply ingrained. Perhaps it was because today is Monday, or perhaps using circular logic is a common practice today there was a piece on Yahoo Finance that caught my attention:
Stocks Rise on Rate Cut Hopes
Monday January 28, 5:46 pm ET By Madlen Read, AP Business Writer
Wall Street Advances After Big Drop in New Home Sales, Disappointing Earnings
NEW YORK (AP) -- A jittery Wall Street advanced Monday, reversing some of Friday's sharp losses as investors took a dismal new home sales report as a sign the Federal Reserve will lower rates this week. The Dow Jones industrial average rose more than 176 points in a session that was relatively calm when compared to the turbulence of last week.
On the surface, the advance appeared surprising after the Commerce Department reported sales of new homes in December fell by 4.7 percent and that 2007 new home sales plunged by a record 26.4 percent compared to 2006. But while the report at first exacerbated the market's concern that the housing and mortgage crises are causing a recession, it also raised hopes that the Fed might cut rates again by a wide margin to stoke the weakening U.S. economy.
"Anticipation of another Fed rate cut is the main magnet in the market today," said Alfred E. Goldman, chief market strategist at A.G. Edwards & Sons Inc.
He was skeptical the gains would stick -- anything the Fed decides after its two-day meeting lets out Wednesday could be met with disappointment. If the rate cut is small or nonexistent, the market will likely be unsatisfied; if the cut is wide, the market may worry the economy is worse than it thought.
"If we do rally into a Fed rate cut, we have a lose-lose situation," Goldman said.
And traders who bet on the Fed's next move were pricing in a more than 80 percent chance of a half-point cut. "Any less than that could be a problem," said Richard Sparks, senior equities analyst at Schaeffer's Investment Research.
So there you have it. A smaller than expected rate cut and the market will throw up and move down because the FED is not doing enough. A larger than expected cut and the market may worry that things are worse than they think! Too funny. Can the FED cut by say 62.5bps? That seems to fit the lunatic criteria the two sources for this article are using.

I seriously doubt that a larger than expected rate cut will be met with fear. Think like one of these guys for a second: If the FED cuts by say 100bps, things may be worse than currently thought, but that will open the door for even more rate cuts! Its pure beauty in its simplicity. I cannot wait for the time when rates are at 1% and things are still a mess. What will be the reasoning at that point? Perhaps a plan to have the FED actually pay interest to the banks to loan money out? Maybe I should not have printed that!

You Know What Happens When You Assume Things
There is a major buzz concerning the 60 Minutes piece last night called "House Of Cards". Particular attention is being paid to the following exchange:
Matt and Stephanie Valdez say they knew exactly what they were doing when they bought this small two bedroom house for $355,000, but now....
They cannot refinance because the value of the house fell below the existing mortgage. They say they can afford the higher payments but see no point in making them.
Matt: The value of the house keeps going down and the payments keep going up. Where's the logic in that?Stephanie: Why make a $3200 a month payment on a 1200 square foot home? It makes no sense.
Steve Kroft: But that's what you agreed to do when you bought the house.
Stephanie: Fine if the value was going up. The value is going down.
Steve Kroft: You are saying essentially you are going to stop making payments.
Stephanie: The only advice we've gotten so far is to walk away.
Very revealing indeed. One of the major points that was sadly missed by the usual suspects (FED, Wall Street, Homebuilders, etc) was the main reason for a home purchase during the mania that was the bubble. It was not for shelter. It was not for a long term investment. It was not for better school systems. The MAJOR reason for buying a home was PROFIT. That's it, that's all. Take away the potential for big buck profits, and you have folks like the Valdez' who correctly now see no reason at all to stay in their home.

One of the easiest mistakes to make is to assume that other people will behave like you would in a given situation. I remember a conversation I had around 2006 with a former boss about the housing bubble popping. I had remarked that people were buying with no money down, and had no income to support a home purchase. I added that they were simply using the rapid price increases to pay the mortgage and were hoping to cash out big time. If the prices ever started down, I offered that they would just walk away form the home. My former boss thought that was a crazy idea. He said he did not know anyone like that. For the record, neither do I, but the point is this: Just because You (or people you know well) would not do something does not mean nobody will. It is impossible to get an accurate number, but I would propose fully 50% of all home sales from 2003-2006 were sales to people just like the 60 Minutes couple. Common denominators for these types of buyers are:

  • Income that cannot support the home purchase price except at ultra low teaser rates

  • No savings

  • Already impaired credit

  • Pure speculative purchase; looking for a "payday"

  • No inhibitions about bailing on a losing proposition

Not a good list! It is the great pile of these buyers that resulted in purely fantasy home sales numbers and price increases. It is the same buyers that will delay any recovery in housing for a very long time.

The funny thing is that only NOW will the buyers show any financial savvy and smarts. There is no reason at all to stay in a home that is taking a 50% haircut in price. It is a waste of time and money to try and wait out a housing bubble for possibly 10 years. At the cost of having troubled credit form a foreclosure, and the soon to be proposed (my opinion only at this time) release form all tax penalties from said foreclosure it only makes sense to dump the asset. Herd mentality is a powerful thing and a flurry of foreclosures may just become all the rage. Imagine block parties where a whole group of foreclosure family's live rent free for up to 8 months and throw wild parties with the extra cash that they are saving. Think it cannot happen? We will see.

I am including the following picture for use by all the "housing bottom" callers that were out in full force today:

Have a good night.


Anonymous said...

I think this market rally needs to be put in that bag. I'll be adding to the short positions tomorrow. I think the market will throw up no matter what the FED does as they have started down the road in a car with no reverse.

Getting ready for some wild weather, it was 52 today and we are suppose to be 10 tomorrow with minus readings with the wind chill. This weather is starting to have a lot of volatility, I wonder if there is an index like the VIX that tracks that.

Russ DoGG said...

I was fascinated by seeing recent talk of the developing game contemplated by people walking away from mortgages. Musical houses may be next?

That's where you walk away from one overpriced houseat nearly the same time as you buy a foreclosed (or REO) property for a lot less. Then your neighbor can move into your house doing the same thing, and so on ...

When the music stops playing everyone who actualy wants to live there has moved a short distance into a probably comparable house at a fraction of their former house price / payment.

In the past apparently opportunities arose to do this in 'mill towns' or 'company towns' when a major negative employment event occurred causing housing prices & demand to drop. and occur they did! Within the span of a few years everyone shuffled into similar houses at a fraction of hte previous price.

If you have a job, plan on staying, and are not generally dependent on credit scores to finance cars, etc. then it may be worth the potentially enormous savings if you have a large non-recourse mortgage. I guess you have to purchase the second home (at like 50% off) with a good down payment (cash) prior to walking from the first. I don't know how this can be pulled off (the details) but it has happened so im told. Like a game of musical chairs.

Anybody know if there will be opportunity for homedebtors to do this again in steeply-depressed priced markets?