The Housing Crisis: Denial is the first stage

Fear and Loathing

Dewey Beach is a small town in southern Delaware, just south of Rehoboth. Depending on who you ask, it stretches somewhere between 8 and 12 blocks along Route 1, speckled with shops, bars, restaurants, and, during the summer months, hordes of people ages 25-55 looking for a good time.

The house across the street from my vacation rental is up for sale. It’s a beautiful, three-bedroom, two-and a half bath residence with a quarter-acre yard, and is well-maintained. More than two years after being placed in the front yard, the “Sotheby’s” sign sits helplessly on the lawn, the faded phone number barely legible from the wear and tear brought on by eight seasons of the elements.

On a recent walk to the beach (our house is four blocks away), I counted the houses and made note of those for sale. There were 38 houses. 17 were on the market.

More than 44% of the beach houses are for sale on a single street of a town that is so crowded, it is common practice for people to park on their own lawns and literally sell their driveway space to vacationers. Businesses are thriving, vacationers come in droves, and the bars are packed on a nightly basis to the point where arriving later than 10 pm often results in time spent waiting in line at the entrance.

Here’s the point: People can’t sell their houses.

Of course, this begs the question, “why would they want to?” In a town that is saturated to the point of discomfort each summer, there is no reason that people should want to part with their valuable, arm-and-a-leg rentable gold mines.

Unless they are afraid.

Afraid that if they don’t sell soon, the price will only continue to fall as the supply side continues to be flooded. Fear and speculation have and always will drive prices more than any balance sheet or common sense logic ever could, and that is what will, in part, fuel this housing crisis further.

Surreal Commercials

Imagine seeing fewer and fewer Michelin tire advertisements on television, and instead one day you see a commercial making a feeble attempt at convincing you that buying rubber is a great decision.

That is what is happening with the housing market. For the first time in my memory, amongst the diminishing “ReMaxx”, “Prudential”, and “Century 21” commercials, I saw a commercial for the National Association of Realtors. The most pervasive message in the commercial was the line “If you are thinking of purchasing a home, The National Association of Realtors wants you to know that you are making a good decision”.

Of course you are.
Otherwise, they’d be out of a job. What this commercial (which I have now seen three times in four days) is essentially saying translates to “Please, please, for the love of God, buy a home. We could care less what company you buy it from.”

Here’s an excerpt from their website, posted on December 9, 2007:

“Existing-home sales are projected to trend up in 2008, with pending home sales showing a slight near-term rise, according to the latest forecast by the National Association of Realtors®.”

Check out the whole article here: http://www.realtor.org/press_room/news_releases/2007/ehs_dec07_trend_up_2008

They projected existing home sales to total 5.7 million this year. This number has been gradually revised every couple of months, with the most recent projection falling to 5.31 million. In addition, now they say that median existing-home prices are expected to fall 6.2% this year. But fear not, their latest projection is that existing-home sales will rise in the second half of the year. Laughable.

A word of common sense advice: if you want to know about the financial strength of a company, don’t ask the CEO.

Delusions of Grandeur

What will perpetuate the housing crisis as well is the fact that homeowners are under the mistaken impression that their house and/or the market owes them something. We’ve been riding along a seemingly endless real-estate boom that has lasted over 20 years, and now homeowners believe that because we’ve had a decline in prices for about a year or two, then it should start to level off and go back up.

Be patient. Housing prices can trend for years, and the market could care less when you bought your house or how much you paid for it. Just ask the millions of investors who held on to their tech stocks in the late 90s when every source they could find, most notably their own psyche, told them that the prices just couldn’t go any lower.

What about mortgage rates?

Here’s something else hindering housing prices. Rates can’t go much lower. That’s not a prediction, it’s simply a matter of arithmetic. The federal funds rate, currently at 2%, is already negative if you adjust for inflation.

When people look to buy a home, they decide how much they can afford per month, and extrapolate this based on their available funds for a down payment and current mortgage rates in order to determine the price of the house they can afford.

To keep it simple:

 Higher rates = Higher interest = Higher monthly payment = Less house can be afforded.
     = House prices fall.

This is not good news for people already having difficulty selling their house for their target price, and even worse news for people who overextended themselves by purchasing the largest house they could afford, “taking advantage” of rates that have been bottoming out in the past few years. For most people, their home is their largest asset, and an upside-down mortgage can really put a damper on a home that was intended to be a great investment.

Yes, I realize that lower home prices could entice buyers to acquire properties simply because of the bargains. However, let me assure you that this will not fix the problem, at least not overnight. Here’s why:

If Apple, Inc. decides to cut the price of the iPod by 25%, many people can afford to head out to their local electronics superstore and take advantage of this offer. On the other hand, if housing prices suddenly drop by 25%, very few people can simply decide to go out and pick up a few houses on their way home from work.

And lest we forget, if someone purchases a home, that means that someone else must have sold it. Someone who may or may not have taken a loss on that home, may or may not have had to alter their investment portfolio (i.e. sell a few stocks) if the equity in their home did not put them in the position they thought they would be in, especially if they need the cash flow for retirement or other life needs.

Enough babble, what the heck are we supposed to do?

If it were feasible to somehow invest in “For Sale” signs across all realty companies, I would say throw all your money at them.

Instead, I will issue a blanket statement urging people not to look for bottoms in bank stocks, housing stocks, and yes, even Fannie Mae and Freddie Mac. These stocks have gotten crushed, but I’m not convinced that they can’t get stepped on further. We are in a downward trend that contains dangerous territory where any period of price increase, no matter how small, will lure people into thinking they see a turnaround. Until we get enough of an upward move to signal a trend change, I would ignore these stocks and let other people lose their money jumping in and out during this volatile time.

John K. Whitehall
Analyst, Bourbon & Bayonets