Saturday, April 26, 2008

Robert Shiller: Current housing crisis is worse than 1929

Robert Shiller is the famous economist that formed the Case/Shiller index. All potential homebuyers need to listen to this IMO.


If you enjoy the video post's let me know. Feedback either way is appreciated.

I hope you like Dr. Shiller.

Major Landowner Default's in California

I hope everyone is enjoying the weekend. Its 75 degrees and sunny here in Maryland.

Well it looks like the housing boat has sprung a few more leaks. I wanted to talk about a big one that hit the news today in the Wall St. Journal. It appears major a landowner of over 15,000 acres of land in Southern California has received a default notice from its lenders. OOPS!

Here is some pieces of the article from the WSJ:

"A large California land partnership involving one of the largest U.S. pension funds has received a notice of default on a $1 billion loan after failing to meet certain terms of its lenders.

LandSource Communities Development LLC, a partnership that involves the California Public Employees' Retirement System, received the default notice Tuesday, amid talks to restructure $1.24 billion of debt. The partnership, which owns 15,000 acres in Southern California, had received an extension to meet its current loan terms, including a required payment, but the deadline expired on April 16. The default notice applies to about $1 billlion of the total debt.

Hundreds of lenders, including banks and institutional investors, hold the syndicated debt. Barclays Capital arranged the financing in early 2007. At the time, LandSource's assets were appraised at $2.6 billion.

Partnerships such as LandSource were a common way to own and develop land during the housing boom. They provided high returns to investors and lenders and a way for builders to keep highly leveraged land off their books. But the ventures have run into trouble as the value of undeveloped land has plummeted and as demand for new homes has eroded.

One problem with ventures such as LandSource is that they typically require builder partners to acquire land on a schedule, even if they don't need the lots. They also can require partners to contribute more equity if the land's value falls below a threshold."

My Take:

Expect these payment extensions from the banks to stop as they realize the housing game has come to a complete standstill. You will see string of bankruptcies among the builders and landowners as the banks get tired of giving these crippled companies extensions.

The reason the banks will start to pressure the builders for payment is because they need the cash! The insolvency risk among banks is rising as these foreclosures mount, and they will need to start pressuring everyone that is behind on loan payments. Its just a vicious cycle that's only going to get worse as long as people continue to default on debt in rising numbers.

The Land Source default described above is a mess because it involves hundreds of banks. It will be interesting to see how these negotiations go with the lenders. I think you now know why Calpers had a big shakeup this week. They helped put this thing together.

Bottom Line:

Builders and landowners will be the next explosion in the housing market. Expect many to go bankrupt as the bursting of the housing bubble continues to accelerate. The banks are broke and they need their money back in order to survive themselves.

Any bottom feeders buying the home builders during this financial rally beware! You were warned.

Friday, April 25, 2008

Depression on the way? One economist's view

I thought this was a great interview with John Williams. As we watch inflation soar, I thought his inflationary thesis would be one that we all should consider.

John Williams is a Dartmouth educated economist who doesn't get a lot of air time on the networks because his views on the economy are grim. This piece is from CNN. Expect to hear more from him as the economy continues to deteriorate.

I think we will see a Japan style deflation after the recession hits. However, Mr. Williams thesis must be considered as oil and commodities keep rising. We could see deflation and inflation at the same time in different areas of the economy. The end result may be what John describes here.


Mortgage Rates will Rise if the Fed Holds

Happy Friday to everyone. Its amazing how the surge in oil and food prices can affect the Fed ability to cut rates. From Bloomberg:

"Futures contracts on the Chicago Board of Trade show there's a 32 percent chance the Fed will keep its target rate for overnight lending between banks at 2.25 percent on April 30, up from 2 percent odds a week ago. The balance of the bets is for a quarter-percentage point reduction."

So what has this done to Treasuries in the bond market? Same article:

"April 25 (Bloomberg) -- Treasuries fell, with two-year notes headed for the biggest two-week decline since November 2001, as traders increased bets the Federal Reserve will stop cutting interest rates at its policy meeting next week.

The two-year Treasury note yield rose 5 basis points, or 0.05 percentage point, to 2.45 percent as of 8:38 a.m. in New York.

Ten-year yields rose 3 basis points to 3.86 percent, climbing for a fifth week."

My Take:

Many mortgages are done based off the 10 year rate and its up for the fifth consecutive week. This will not be good for mortgage rates. Interest rate increases will not be good for stocks because it will put more pressure on the banks and kill lending. This will be another blow for the housing market.

There may be a short term disconnect between the market and housing. Stocks seem to want to push higher now that the financial world did not come to an end due to the Bear Stearns blowup. I expect this rally to be on its final legs simply because there is no catalyst to take stocks higher long term. This is a relief rally and nothing more as we head into a recession.

Recession anyone?

Merill Lynch's famed US economist David Rosenberg came out with a research report yesterday(same article)

"`Too Early'
The U.S. economy will shrink 2.3 percent in the second quarter, which means investors should stick with bonds, David Rosenberg, Merrill Lynch's North American economist in New York, wrote in a research report yesterday. It's ``still too early to move away from bonds and toward stocks,'' the report said."

Bottom Line:

Well I think David's comments says it all. A 2.3% drop tells you we are in recession. Anyone buying into this rally is going to get burnt. One of the best is telling you its too early to jump into stocks.

Stocks don't generally rise for good until you are about half way through a recession. Right now the end of this recession is nowhere in sight.

The bulls will try to spin the possible end of the Fed rate cutting as a positive because it will strengthen the dollar. The reality is its going to raise rates which will put more pressure on housing due to higher costs of borrowing.

The fact that the Fed is tapping on the brakes is going to hurt and have negative repercussions. Like Mr. Rosenberg said "its still too early".

Thursday, April 24, 2008

Its Official: The Market has lost its Mind/Inflation

What a wacky world we all live in. It seems the worse the news gets the higher stocks move because everyone keeps saying to themselves "ok NOW we have seen the bottom".

This mindset is also being heavily sold by the snake oil salesmen on Wall St. Hour after hour on CNBC you keep hearing that stocks have already priced in all of the bad news. So as a result, any bad news is good news and stocks move higher.

Another theory you hear from these talking heads is that the Bear Stearns sticksave by the Fed was the peak of the crisis, and we are now past it and the Fed will be there to fix any other bumps in the road.

The pigmen also love to compare this to the Long Term Capital Management crisis where Wall St. bailed out one fund which resulted in a quick market rebound. None of these are compelling reasons to buy IMO. It sounds more to me like gambling than investing.

Buying on a 10% correction and "hoping" its a bottom is a very dangerous investment strategy when you see all of the risks that are out there. Investing should be based on fundamentals not "hope".

If you think the end result of what some are calling the biggest financial crisis since the Great Depression is a 10% correction then you need to have your head examined. Stocks drop an average of 28% during an average recession, and this is going to be a nasty one.

Consumer led recessions are different then business led recessions. They tend to last longer, and when you throw inflation into the mix, they tend to be even worse. The main reason they are long is because it takes time for people to pay off debt and find new jobs and recover. We also now have the inflation that will eventually have to be killed via interest rates and this is going to take time.

I read a great piece in the Financial Times today on:


Killing inflation is going to be as important as recovering from the housing mess when it comes to saving the economy long term. What I am becoming concerned about is the Fed is looking at the wrong indicators when it comes to gauging inflation. I picked this up from The Financial Times.

This is a brilliant commentary. Here are some pieces:

The Thesis:

"Today, what happened in the developed world in the 1970s is happening in the emerging markets, which are now a much weightier chunk of the global economy.

Developing countries' central bankers have been slow to respond to the rise in food and other commodity prices.

After a long period in which emerging market economies were operating with much excess capacity, the gap between actual and potential output has dwindled. Headline inflation rates are rising.

Energy and food take much more of workers' incomes in emerging markets than in the developed world. So the message in the food price riots is that these workers will soon be fighting for much higher wages.

In behavioural terms the inflation of the 1970s was about rival claimants defending their income shares. One section of the community tried to increase its share of gross domestic product at the expense of another, causing upward pressure on costs and prices.

This process has now gone global. Emerging market workers are battling for their income share. So the developed world will have to pay more for its imports."

My Take:

Alright, so the food riots are something we need to seriously focus on because FOOD is a huge cost in developing countries like India and China. Right now Food is thrown out the window when the Fed looks at inflation.

This is not an American 1970's version of inflation which the author claims was mainly fueled by unions forcing higher labor costs. Remember those steelworkers making 80k a year in 1975?

This new version of inflation will be workers in Asia demanding wage increases so they can EAT. This will then rapidly increase the costs of all the products we buy from China which seems to be everything you see in a Walmart these days.

The FT's conclusion:

"This is, then, a new, global version of the 1970s inflationary problem, in which the developed world acquires wage inflation by the back door. True, there is a strong cyclical component in the commodity boom, especially in hard commodities. This will weaken as global growth slows.

Yet something structural is clearly going on in both food and energy markets which means, as I have argued here before, that the central bankers' focus on core inflation rates that strip out energy and food prices is potentially dangerous.

For the developed countries there are also two sinister factors that are much more important than in the 1970s.

The first is the huge accumulation of private sector debt in the Anglophone economies and of public sector debt in Japan and Italy. Inflation is the easy way to reduce this debt burden provided that the inflation is unanticipated, ensuring that nominal interest rates stay below the inflation rate. Creditors are the losers from the process.

The second factor is the problem of ageing, and unfunded pensions. The cost-inflationary pressure arising from existing pension commitments and demands for increased healthcare will be on a scale that dwarfs the public spending problems of the 1970s. It will not be confined to the developed world.

So the question is, will the central bankers be able to stem this inflationary tide? As the banking bail-outs continue, I have my doubts."

My Take:

This Fed has it all wrong when looking at inflation. Food and energy have to be thrown back into the inflation numbers like the CPI. As the FT explains, we will get back doored by this if we don't pay attention to food and energy when making monetary policy decisions like rate cuts or increases.

These food riots could be that curve ball the Fed misses and gets socked with when import prices go through the roof. Bailing out Wall St. and flooding them with liquidity and cheap interest rates is becoming a very dangerous proposition.

When you play with fire you get burnt.

New Home Sales Plummet to 17 Year Lows

The new home sales report came out today and it was much worse then expected as new home sales hit 17 year lows. What a surprise. The market did not react well. The most eye opening statistic in the report was the median price for new homes fell 13.3% versus 2007 which was the largest year on year drop in almost four decades!!!

Here is the news from Bloomberg:

"April 24 (Bloomberg) -- Purchases of new homes in the U.S. plunged more than forecast in March to the lowest level in almost 17 years as stricter loan rules and falling prices caused buyers to hold off.
Sales dropped 8.5 percent to an annual pace of 526,000, the fewest since October 1991, from a 575,000 rate the prior month, the Commerce Department said today in Washington. The median sales price slumped 13.3 percent from the same time last year, the most in almost four decades."

``This blows away any hope that things are stabilizing in housing,'' said Michael Feroli, an economist at JPMorgan Chase & Co. in New York. ``It's a negative for growth and for the economy, and it's going to persist into the second half of the year.''

My take:

Housing continues to free fall. CNBC reported that new home inventories rose to 11 months which is the highest level seen during this current housing downturn.

So here we are in the spring selling season and prices are dropping faster then at any time in almost 40 years and inventories are at all time highs. There are no signs as the economist described above that we are near the end of this.

As I have said before, bubbles can be very psychological and after seeing these numbers, who in their right mind would try to buy a house right now? Why wouldn't you wait to buy if prices are dropping 13.3% year on year?

Expect this bad new to continue to put more buyers on the sideline which will exacerbate the problem.

Robert Shiller

How bad are things in housing? Look at what Yale economist Robert Shiller from the famed Case/Shiller index had to say:

"NEW HAVEN, Conn. – An influential economist who long predicted the housing market bubble cautioned Tuesday that the slump in the U.S. housing market could cause prices to fall more than they did in the Great Depression, and bailouts will be needed so millions don't lose their homes.

Yale University economist Robert Shiller, pioneer of the widely watched Standard & Poor's/Case-Shiller home price index, said there's a good chance housing prices will fall further than the 30 percent drop in the historic depression of the 1930s. Home prices nationwide already have dropped 15 percent since their peak in 2006, he said.

Home prices rose about 85 percent from 1997 to 2006 adjusted for inflation, the biggest national housing boom in U.S. history, Shiller said.

Basically we're in uncharted territory,” Shiller said. “It seems we have developed a speculative culture about housing that never existed on a national basis before.”

Many people became convinced that housing prices would increase 10 percent annually, a notion Shiller called crazy."

Bottom line:

You are now witnessing a bubble that is in the middle of a total collapse. The good news is at some point the renters of the world are going to be able to get one hell of a deal on a nice house that's affordable. The bad news is it will probably destroy the economy.

For the time being just sit back grab some popcorn and watch the fireworks. We are witnessing an historic economic event.

Wednesday, April 23, 2008

Homebuilders feel the Heat!

A quick "Moody's" warning. I discussed this a couple days ago. Buying homebuilders right now is suicidal! This is just my opinion but please read:

Moody's via AP:

"NEW YORK (AP) -- Banks are likely to make it more expensive and difficult for struggling homebuilders to get credit in 2008, Moody's Investors Service said Wednesday.
The ratings agency said homebuilders will also have trouble getting banks to amend existing lending agreements if the companies violate terms -- something likely to increase as the housing sector continues to contract.

Banks have become much less likely to automatically waive compliance with covenants," said Joseph Snider, vice president of senior credit at Moody's. That "could lead to forced acceleration of debt repayments and consequent bankruptcy filings."

Moody's said homebuilders that have lower ratings will be "particularly vulnerable" to tougher stances by banks. Ratings indicate a company's ability to repay debt. They are also used to set the terms of borrowing

"It is likely that banks will finally begin to hold homebuilders accountable for their failure to generate cash, maintain adequate liquidity, and reduce outstanding debt," Snider said."

My take:

If you bought these builders at the so called "bottom" and made a few bucks then now might be the time to lighten your positions. The bottom is falling out folks and I will repeat my advice about homebuilders: Do your homework and look at their balance sheets!!!

I personally would not touch any of these stocks but thats just my opinion. Expect the builders to take a hit tomorrow. Many of them will declare BK down the road as the banks start to step on their throat.

Be careful out there in the investment world!! There are many desperate people on Wall St. looking for a sucker. Buyer beware!

Stocks are Priced for Perfection

I wanted to jump on and discuss the big earnings reports that came out after hours tonight on Starbucks, Apple, and Amazon. Apple and Amazon beat earnings estimates while Starbucks had a big miss. Whats interesting to me is the market reaction to the news after hours. Now obviously after hours trading volume is light but its a good indicator of what we will see tomorrow.

All three stocks were down on the news in after hours trading and all three warned of lower guidance going forward. This could become a recurring theme because stock expectations for the second half of the year are way too high. Here are the earnings reports for each:




Starbucks missed big time and made this startling statement:

``The current economic environment is the weakest in our company's history,'' Howard Schultz, who returned as chief executive officer in January, said in the statement.
Second-quarter earnings were 15 cents a share, Starbucks said. Analysts in a Bloomberg survey estimated average profit of 21 cents."

One of the problems that stocks now face going forward in 2008 is the estimates set by analysts are pricing in a second half recovery. Everyone is now waking up to the fact that with rapidly rising inflation and $120 oil, it simply isn't going to happen.

You have a better shot at seeing Santa Clause in the second half of the year versus an economic recovery.

Equities have not yet priced in the fact that things might get WORSE in the second half of the year versus the first half. I listen to the talking heads on CNBC who see a big recovery in the second half of the year and we are now in the middle of the market bottoming process. Yeah right. Here is what I see:

I see a deteriorating economy with rising inflation that now faces the risk of rising interest rates and a consumer that is on its knees. These higher rates are inevitable because if the Fed doesn't raise rates then the banks will because they are insolvent and are in no condition to lend right now.

Higher rates will then destroy housing. These economic pressures combined with helpless financials and a crippled consumer will then push the economy into a deep recession. Rates cannot stay low because of the rising risk of massive inflation or worse: hyperinflation. I don't think anyone wants to see the starvation/class warfare that hyperinflation can cause.

If it comes down to the Fed making a choice on rates then they MUST pick the lesser of two evils and raise rates to prevent out of control inflation. The ECB realizes this and has already warned they will raise rates to control inflation even if they are heading into a weaker economic environment.

Bloomberg today:

"April 23 (Bloomberg) -- European Central Bank officials are raising the prospect of interest-rate increases for the first time since the global credit squeeze began last August, stepping up their battle to keep inflation in check.
Comments by policy makers including Axel Weber and Christian Noyer are forcing investors and economists into an about-face after they previously bet the bank would follow the U.S. Federal Reserve in cutting rates to shore up growth. "

Europe realizes the risks of inflation. We cannot continue to cut if they decide to raise rates because inflation would then spiral out of control. Expect the Fed to slow way down on the rate cutting if the inflationary pressures continue. The Fed will raise rates if they are forced too because in the end, destroying parts of the financial system sure beats having your people starving to death due to hyperinflation.

Expect the analysts to start cutting estimates as these companies report earnings and lower guidance for 2008. This will not be good for the Wall St. boys and their stocks.

Mortgage Applications Plummet/Ambac's Stunning Losses

Well spring is in the air as the weather starts to warm bringing everyone outside to watch outdoor events like the Kentucky Derby. Others are preparing to celebrate Mothers Day with their loved ones.

The one thing missing from this spring is the millions of families moving into their new homes as the spring selling season is supposed to be peaking. We all know this has been a bust. Mortgage applications confirmed this today. In fact, the mortgage applications index for the week fell to their lowest level in four months dropping 14% from the previous week. From Bloomberg:

"April 23 (Bloomberg) -- Mortgage applications in the U.S. last week dropped to the lowest level in almost four months, hurt by fewer purchases and less refinancing.
The Mortgage Bankers Association's index of applications to buy a home or refinance a loan declined 14.2 percent to 637.6, the lowest since the week ended Dec. 28, from 743.4 the prior week. The group's purchase index fell 6.4 percent last week and its refinancing gauge decreased 20.2 percent.

Home buyers are waiting for prices to drop further and banks have made it harder to qualify for financing after a surge in subprime mortgage defaults and foreclosures. Bloated inventories signal a housing slump in its third year will remain a drag on the economy, reinforcing concern about a recession.

Today's report showed the average rate on a 30-year fixed loan jumped to 6.04 percent last week, the highest in six weeks, from 5.74 percent the previous week."

My take:

Think about this for a second. There were more weekly mortgage applications on average during the dead of winter then there were last week. This is at a time when housing activity is supposed to be peaking as the weather warms up.

One thing you might start to conclude from this is many people may have given up trying to get a mortgage because they can't afford housing at these prices and cannot qualify for a loan. Ummm....Maybe this is because housing has doubled in some markets instead of going up the historical average of 3% a year? Just a guess.

The other thing to take notice of here was the quarter point increase in interest rates from 5.74% up to over 6%. This is killing the refinancing business which reported a 20% drop in applications. IMO this is due to the fallout from the Libor scandal last week where banks were lying about interest rates that they paid to lend between each other.

If the Fed only cuts .25 next week and interest rates continue to rise due to fear and lack of trust then its going to accelerate the housing crash which is already falling apart at an alarming rate.

Ambac showed you how fast the housing market is deteriorating this morning when it reported earnings.

Ambac is one of the famous monolines that insured a good chunk of the mortgage AAA CDO's that are now worthless. The company reported stunning losses and a huge drop in new business.


The world's second-largest bond insurer tumbled as much as 31 percent in New York Stock Exchange trading after reporting a first-quarter net loss of $1.66 billion, or $11.69 a share. The company's operating loss of $6.93 a share was more than three times the $1.82 estimated by six analysts surveyed by Bloomberg.

Ambac, larger competitor MBIA Inc. and the rest of the industry have posted record losses after expanding from their business of guaranteeing municipal bonds that rarely default to securities linked to mortgages that are going delinquent at the highest rate since 1985. Ambac's new business slumped 87 percent last quarter, and the company increased its estimate of the claims it will need to pay on home-loan debt by $2 billion.

This ``could send a negative ripple effect through the market,'' said Wayne Schmidt, senior portfolio manager at AXA Investment Management in Minneapolis, which has about $14 billion in assets under management. ``It sends a message that we're not out of the woods yet.''

My Take:

I don't see how this company makes it going forward. Losses were three times worse than expected and expectations already called for a disastrous quarter. Companies don't last long when they lose $11 dollars a share.

If I owned Ambac I would be more concerned about the 87% drop in revenues. How does a company survive when your sales are down almost 90%? This tells you that the whole housing ponzi scheme is over. This housing game has virtually vanished in the span of a year. Its quite remarkable when you think about it.

If these bond insurers go under its been said that this could cause an additional $70 billion in writedowns for the banks because their CDO's will no longer be insured by Ambac and they will be forced to lower the value of these CDO's.

Bottom line is the news in housing continues to be bad and expect housing prices to continue to deteriorate. The housing game has ended. It will be a long time before we recover.

Tuesday, April 22, 2008

Its Time to Ignore the Stock Analysts

I hope everyone had a better day then the market did today. Things are really getting messy folks. We have $120 oil, soaring inflation, and houses that can't sell. I think the market is finally starting to realize what a disaster this is.

Bad news has been bringing buyers to the market recently because the analysts were predicting a short recession, and as a result, investors figured they were able to buy stocks cheap as the DOW crept below 12000.

Many are starting to second guess these bets as the news flow and earnings have been horrible. I say this because recently people have been selling on bad news versus buying on bad news. Today was a good example of this. Investors are starting to realize how bad things are out there.

I think I am starting to realize personally that things are worse then I thought they were. Sometimes when I get on here I don't even know what to discuss because there are so many negatives related to housing and the economy right now.

For example, I came across this when I got onto the computer today:

"The number of California homes lost to foreclosure in the first quarter surged 327% from year-ago levels -- reaching an average of more than 500 foreclosures per day -- DataQuick said in a report, warning that the widening foreclosure problem could "spread beyond the current categories of dicey mortgages, and into mainstream home loans."

I can't even put into words how bad this is. This was the worse foreclosure data on record which dates back to 1992.

I read this type of news all day and sometimes I want to be like CNBC and try to find a silver lining amongst all of the bad news. I want to be bullish on America and its future.

The problem is I don't see that we are even near the end of this crisis. In fact, things seem to be deteriorating at a faster pace then I could have ever imagined. 300% increase on foreclosures? I wish this was a misprint.

I say this because I see the banks scrambling to find capital by diluting their shares to stay solvent. Then I see the rapidly rising default rates on housing, credit cards and home equity debt. I flip to another article and I read about the dollar hitting all time lows forcing gas and food prices through the roof.

I can only come to one conclusion. We are going to see the worst economic downturns since the 1970's. What really scares me about this is Americans have ZERO savings to combat it as we head into this mess. This is going to put people in the bread lines much faster if this turns to be worse then the '70's.

Now a little advice:

Ignore the talking heads on CNBC!!!

You hear me say this all the time and I found a great article today explaining why. This is how clueless most of our "analysts" are. Bloomberg looked at some research looking at the accuracy of analysts calls on earnings estimates:

"In the fourth quarter, the almost 1,800 equity analysts overestimated final results by 33.5 percentage points, the biggest miss ever, based on data compiled by Bloomberg. Yet 62 percent of companies in the Standard & Poor's 500 Index beat average estimates -- because analysts lowered their forecasts as the quarter progressed. First-quarter numbers show a similar trend, with 55 percent of the 111 companies reporting so far exceeding the average estimate."

Take a look at their ratings on GE heading into their nightmare quarter:

"Most analysts missed the earnings shortfall for Fairfield, Connecticut-based GE, the world's biggest supplier of power- plant turbines, locomotives and medical imaging machines.
Sixteen of nineteen had ``buy'' ratings on the shares before the company said April 11 that profit from continuing operations fell 12 percent to $4.36 billion, or 44 cents a share, 7 cents less than the average Wall Street estimate"

My take:

Look at how ridiculously bullish the analysts were in the fourth quarter. 62% of companies beat earnings during the quarter and analysts on average were 33% too high on their estimates. If that's not market pumping then I don't know what is. 16 of 19 had "buys" on GE, and they were then made to look like fools when GE announced their worst quarter since 2000.

These are the same clowns that are predicting a mild recession followed by a bounce back in earnings during the second half of the year!!! The idea that this will be over in June is a pipe dream!!

Bottom line:

Next time you hear that slick analyst scream BUYBUYBUY on CNBC simply ignore them. When you look at the fundamentals now is not the time to buy stocks.

Financial News/Housing Data/Home Builder Buying Warning

Well stocks have gotten off to a very shaky start today as more bad news in the financials was reported today. I think the banks earnings reports have been more grim then many expected this week, and I suspect many on Wall St. are starting to second guess their bottom fishing and have decided to lighten their positions in the financials. Many of them are down today.

One of the reasons for this was there were more disappointing results from the financials today. I will report some of these results before I talk about the home builders.

Sun Trust missed earnings estimates as profits dropped 45%. Here is the scoop from Bloomberg:

"SunTrust Banks Inc., the largest bank based in Georgia, said first-quarter profit fell 45 percent after the company set aside more money to cover bad loans to homeowners and builders.
Net income declined to $283.6 million, or 81 cents a share, from $513.9 million, or $1.44, in the same period a year earlier, the Atlanta-based company said today in a statement. The figures include expenses from preferred dividends. That's lower than the average estimate of $1.03 a share from 21 analysts surveyed by Bloomberg."


RBS also announced today that they are taking $11.7 billion in writedowns due to bad loans and announced they are raising $24 billion dollars in new capital by selling additional shares of stock. More dilution!!! From Bloomberg:

"Royal Bank of Scotland Group Plc, the U.K.'s second-biggest lender, will sell 12 billion pounds ($23.7 billion) of new shares to investors in Europe's largest rights offer to boost capital depleted by writedowns.
RBS fell as much as 5.7 percent in London trading after saying it marked down assets by 5.9 billion pounds and will cut the 2008 dividend.
Chairman Tom McKillop defended Chief Executive Officer Fred Goodwin, saying ``our executive team has all the ability to steer the bank through this tricky period in financial markets.''

My Take:

Expect this to be a continuing theme quarter after quarter as home prices continue to fall. These announcements of losses quarter after quarter are going to get old real quick with investors. You will start to see more selling on the bad news versus buying on the bad news as investors will start to lose confidence that they are buying at the bottom.

There is no sign of the housing crisis being anywhere near over, and banks will continue to take hits as prices drop.

CNBC Alert:

CNBC just announced some new March housing data. Existing home sales dropped another 2% in March and inventories rose to 9.9 months. Prices also dropped 7.7% from March of last year. Isn't this supposed to be the big spring buying season where everyone buys? What a joke.

Here was the most startling statistic from CNBC's report: 18% of homes that are now on the market are listed at prices below what the seller paid for them. This means that almost 1 out of 5 homes on the housing market are going to be short sales when they sell.

So much for housing as an investment. This number is incredible. If you think banks are recovering anytime soon you can forget it.

This number would probably be higher if unrealistic sellers trying to get 2005 prices decided to price their homes correctly.

A quick warning on the home builders:

Anyone buying builders thinking they have bottomed really needs to do their homework. I recently discussed building cycles with some contacts on Wall St. involved in this area.

Banks always allow builders some time to sell units before they start pressuring them on getting paid back. They realize it takes time for properties to sell and usually they are given about 2-3 years to move the units before they really get pressured to pay back their loans.

What is unknown right now is how much slack the builders are getting from banks as we struggle through a brutal housing market. Usually during downturns the banks will force them into bankruptcy if they can't get paid.

Whats funny is they almost always give them their credit back once the cycle turns back up because its such a profitable business when the housing market is booming.

If you are buying builders right now realize that most of the banks have not turned up the heat as they allow them to try to dump inventory in a tough environment. As these banks continue to struggle with their capital ratios expect them to start asking for their money back.

There will be many bankruptcies down the road as this housing bubble bursts. I would avoid buying any of the builders right now even though they look cheap. There are some that will end up being great buys. There are many however that will go under.

If you want to take a shot at these make sure any builder that you buy has a solid balance sheet with lots of cash.

Monday, April 21, 2008

Meredith Whitney Strikes Again!

Meredith Whitney pulled out her sword again today and decided to slay a few more financials. Today her targets were Wells Fargo and Citibank(her favorite punching bag).

The Wells Fargo call was surprising to me because she hasn't talked about them very much. I love her analysis because she is honest and she calls them like she sees them.

Most analysts won't make tough calls like this because they play the game with Wall St. realizing that some may be future clients. Its also in everyone's best interest on the street to keep the music playing and push stocks higher. This results in more money for the pigmen!

Anyway, back to her call on Wells Fargo call. From Bloomberg:

"Wells Fargo

Wells Fargo retreated 65 cents to $29.75. Whitney cut her recommendation on the shares to ``underperform,'' saying the stock has ``significant room for multiple contraction in the event of anything unexpected, and in this case an unexpected reserve build.'' In a note to clients, the analyst reduced her 2008 per-share earnings estimate for Wells Fargo to $1.20 from $2.15. Whitney previously rated Wells Fargo ``market perform.''

My Take:

Thats about a 40% haircut on earnings estimates for 2008. Thats a big number. Most analysts have praised Wells Fargo for being more conservative with their lending during the housing bubble and avoiding subprime.

I think what is starting to catch up with Wells is the fact that they did many loans in California where prices are imploding. Many of the jumbo/alt-A loans that they did out there are doomed and this is where Wells Fargo is going to feel a lot of damage down the road IMO.

One thing to take notice of here. If a smart bank like Wells Fargo's earnings are being cut by 40% in 2008 then where does this leave the reckless lenders for the balance of the year?

I thought this recession was only going to be in the first half of the year? Yeah OK.


Meredith's favorite target. Here is her call on Citi:

"Citigroup Inc., the biggest U.S. bank by assets, may cut its dividend for a second time this year as losses escalate, Oppenheimer & Co.'s Meredith Whitney said.

Whitney tripled her 2008 loss estimate to 45 cents a share and reduced her 2009 profit estimate to 90 cents a share from $2.50. The New York-based analyst was one of the first to gauge the depth of the global credit crisis, predicting in October Citigroup would slash its dividend to preserve capital. The bank cut its dividend by 41 percent in January, the first reduction since the early 1990s.
``The company has seriously constrained earnings power,'' Whitney wrote in a report today. Citigroup also may have to ``seek additional capital from outside investors.'' Citigroup spokeswoman Christina Pretto declined to comment."

My take:

It looks like the dividend is toast according to Meredith. In addition, the losses in 2008 will be triple her previous estimate! This is how fast this debt bubble disaster is flying out of control. Meredith Whitney has previously stated that she needs to keep revising her targets because she can't keep up with the stunning rate of losses. Now her 2009 estimates on Citi have been cut by over 50%.

Home loans are defaulting much more rapidly then anyone could have ever imagined. S&P reported today that the default rate on HELOCS from 2006 went from 6.51% in Februaary to over 11.45% in March. In thirty days the default rate almost doubled!! This is how fast things are deteriorating.

Its amazing that the market only dropped about 25 points today considering the amount of horrifying data that came out. Equities have priced in a second half recovery. Meanwhile, Meredith Whitney is busy cutting 2009 Citi estimates by over half.

I will bet with Whitney on this one. She has continued to be accurate with her calls while Wall St. continues to underestimate the scope of what is happening. Debt defaults are happening all over the place: Housing, credit cards, HELOCS, auto loans. We partied like rock stars for 20 years and now its time to pay the piper.

Dilution: An Investor's Nightmare and the new Risk to Wall St.

I hope everyone had a great weekend. I wanted to talk about dilution of shareholder stock today after National City Corp's capital raising announcement.

I see this as being a huge new risk to investors as the pressures of maintaining the debt bubble combined with tighter credit markets is making it increasingly more difficult to raise capital.

National City Corp. is a regional Cleveland based bank that got into trouble because of the housing slump in Ohio that was caused by massive losses in manufacturing which is a large part of the Ohio economy. We all know what this has done to Detroit. The bank also did a lot of bad subprime lending.

So how bad is the situation at National City? Well the stock is down 82% in the past year and they just announced their third quarterly loss in a row. This is a bank that was obviously on the verge of a collapse and needed a massive capital infusion in order to survive. We almost had our first major bank failure folks.

Well Bloomberg reported today that National City was able to secure $7 billion dollars in new capital today. Great news for the company and shareholders right? Wrong.

The terms for the deal are terrible and the stock is down 27% on the news because shareholders were crushed as the company was forced to massively dilute their shares in order to raise the capital. From Bloomberg:

"National City will raise $6.37 billion selling convertible securities, the Cleveland-based company said today in a statement. The bank is also offering shares of common stock for $5 apiece, about 40 percent less than National City's closing price on April 18. The dividend was slashed to 1 cent a share from 21 cents.
``Shareholders continue to get penalized,'' said Gerard Cassidy, a Portland, Maine-based analyst at RBC Capital Markets, in an interview yesterday. ``It's another major company going to the capital markets to enable them to survive in this incredibly deflationary environment.''

Corsair and another private equity investor are contributing $985 million. Some of National City's largest current institutional shareholders are also providing funds, the bank said.

The company ranked among the 10 biggest originators of loans to people with poor credit histories in 2006."

My take:

Well my first question is where are all of the Sovereign Wealth Funds that were going come in with billions of dollars and save Wall St.? I guess after taking massive losses like the 30% hit that they took on buying Citi shares has made them realize that maybe catching falling knives is not such a good idea.

Without the easy SWF's cash flowing like it used to, companies like NAtional City are now forced to go to the credit markets and hedge funds with hat in hand and take whatever terms they have to in order to raise capital so they can stay alive.

Listen to the terms of this deal. National City agreed to sell an additional 1.4 billion in shares of the company at $5 a share which is a 40% discount of where the stock closed on Friday. They only had 600 million shares of stock before the capital raising. Talk about dilution!! They more then tripled the amount of shares outstanding in one day!!!

So if you bought National City on Friday you have lost 27% on your investment due to dilution. You are down 82% if you bought this stock a year ago. They also lowered their dividend to a whopping one penny a share.

Bank of America Earnings:

A quick blurb on these. Earnings were down 77%. Ooops. From Bloomberg:

"First-quarter net income declined 77 percent to $1.21 billion from $5.26 billion a year earlier, the Charlotte, North Carolina-based bank said today in a statement. Results included $1.31 billion in trading losses and $2.72 billion in costs for uncollectible loans. Earnings per share shrank to 23 cents from $1.16, falling short of analysts' estimates and sending the bank's stock down as much as 2.6 percent in New York trading.
The slide casts doubt on Chief Executive Officer Kenneth Lewis's goal to increase profit by at least 20 percent this year."

Wow this is ugly. Well Kenny I am sorry but my guess is that 20% growth in earnings this years isn't going to happen.


Real quick. Meredith Whitney is announcing that Citit may eliminate their dividend and she slashed her earnings outlook. More on this later.

Bottom Line:

If you have a moment of insanity and decide to buy a financial stock or any company with a weak cash position you need to consider the risk of dilution when you are making your investment.

The reason the risk of dilution is so high right now is because the housing downturn has frozen the credit markets and as a result of this, they will only lend money at ridiculous terms like buying shares of your stock at a 40% discount. I wouldn't touch any stock that has a weak cash position right now which in my book includes just about every financial.

I wonder how those bottom callers are feeling right now? Something tells me they may be sweating a little bit. As long as housing continues to deteriorate expect these financials to be in a tailspin. They will continue to need capital infusions and dilution will be one of the easiest ways to find capital.

Expect the market to start reacting negatively to any dilution news as they did with National City today instead of buying on the dilution news like they did last week with Washington Mutual thinking financials are at a bottom.

Each dilution will damage confidence in the market and you will start seeing stocks selling on dilution news instead of being bought by bottom callers.

Sunday, April 20, 2008

Thinking of Buying a Condo? Think again

There was an excellent piece in the Baltimore Sun today that discusses some new mortgage regulations that are going to result in a drastic tightening of lending standards in the condo market.

Condominiums tend to get hit the hardest when a housing bubble bursts. They tend to lose more value and start falling in price earlier then houses. IMO because they get hit first, you can use the condo market as a great early indicator as to what will eventually happen in housing as a whole later in the cycle.

I wanted to share a few pieces from the Sun on how the standards are changing:

"If you own or plan to buy a condominium, an ominous new phase of the mortgage credit squeeze could be looming on your horizon.

Fannie Mae, a dominant financing source for condominium projects, has rolled out new procedures that some lenders and mortgage brokers say could tighten up the availability of loans to condo purchasers in the coming months. Freddie Mac has issued similar new guidelines.

Under Fannie Mae's changes, most of the due-diligence research on condominium projects' key characteristics -- their legal documentation, the adequacy of condo association operating budgets, percentage of unit owners who are late on association-fee payments, percentage of space allocated to commercial use, and percentage of units owned by investors -- must now be performed up front by loan officers.

Not only is this time-consuming and costly, but under the new procedures, Fannie Mae expects the lender to warrant the accuracy of its research. Some condo-project legal documents run into hundreds of pages, yet lenders are supposed to take legal and financial responsibility for their accuracy.

"It's ridiculous," said Phil Sutcliffe, principal of Project Support Services of Lansdale, Pa., who helps put together condominium project financing for developers. Not only does this shift huge paperwork and time burdens onto lenders and brokers, but it also forces them to make "absolute judgments on things that are not absolute."

For instance, said Sutcliffe, the new Fannie guidance requires loan officers to make certain that at least 10 percent of a condominium project's operating budget is reserved for "capital expenditures and deferred maintenance."

Sutcliffe, who has analyzed condo project budgets for two decades, says there are no wiggle-room provisions in the guidance for "compensating factors," such as when part of the line-item reserves are for important but nonphysical expenditures like insurance."

My Take:

The lenders are going to run away from condo lending as fast as they can. First of all, who wants to do a loan where you have to do hours of research and also forces you to make absolute judgements on things that are not absolute?

Very few lenders are going to want to stick their neck out and lend when they are forced to make calls on the financial viability of a condo project when prices are in an absolute free fall.

If they do lend the money expect its going to be at ridiculous interest rates and require large amounts of money down.

Here are the reactions of two mortgage presidents to the news from the Sun:

"Jeff Lipes, president of Connecticut-based Family Choice Mortgage Corp., said the Fannie Mae changes, combined with other retrenchments battering the condo market, mean that when potential applicants inquire about getting a loan on a condo unit, "we really can't give them a definite answer" because it takes research to determine whether their building qualifies.

"Even if you had an 800 FICO score and 50 percent equity," said Lipes, "you still might not be able to get a condo loan." It depends on whether the underlying project can pass the underwriting tests, is in a declining market, and has a lender "concentration" limit on it. Some lenders refuse to finance more than a set percentage of units in a single condo project to limit their risk.

Bruce A. Calabrese, president of Equitable Mortgage Corp. in Columbus, Ohio, said "Everybody is really backing off condos" because of all the restrictions and changes. He said he owns two condo units -- one in Florida, another in Myrtle Beach, S.C. -- and even though he is in the mortgage industry, "I don't think I could refinance either of them right now if I tried."

Bottom line:

This is going to put the condo market into a free fall IMO. You might not even be able to get a condo loan going forward. If you have a condo for sale thats not moving I would advise you to be realistic with your pricing and get out now before all of this starts to get implemented. Lending availability for condominiums is going to virtually disappear due to these changes.

Expect the reaction to this news to be even more violent if you live in a bubble area because these loans going forward are going to be an even riskier bet for the lender.

Stay away from condos!!!

Housing Piggyback Loans: The Next Banking Nightmare

Well I see nothing but more bad news for stocks after doing some research this morning. This probably means the DOW will rise another 1000 points the way this irrational market has been acting.

I actually think you are going to see a lot of selling over the next few days as the people take profits from the 5% rise we saw last week. During periods of stress in the markets, everyone tends to sell into rallies because the market is vulnerable to bad news.

Piggyback Loans/HELOCS:

Here is what I wanted to talk to about today. Everyone on Wall St. is trying to figure out if the writedowns are over for the financials. Many have placed bets that the worst is over as many financials were being bought last week even though they reported bad news.

I still think there are many shoes that will drop forcing more losses for the banks. The next big set of writedowns will be in the secondary mortgage market. These are the 20% part of the 80/20 piggyback loans that were common during the peak of the housing bubble.

Many people bought houses with these loans because it allowed them to avoid having to pay the PMI insurance that is required if you don't have at least 20% equity in the house. So by securing a secondary loan at 20% you were able to avoid having to pay for the PMI insurance every month.

Home equity loans or HELOCS are also considered to be secondary mortgage paper. The piggyback loans and the HELOCS are sold together in the credit markets as secondary mortgage paper. I have a source thats involved in this area of the credit market.

According to my Wall St. source, the bid for these securities in the credit markets is one penny on the dollar!!!

This tells you that Wall St. predicts that these loans are worthless and will never be paid back. According to my source the the reason the bids for this paper are so low is because the 20% piggback loans and HELOCS get paid back secondarily to the 80% part of the home loan.

So if a house that has a 80/20 piggyback loan is sold at less then 80% of the price of the full loan amount then the piggyback loan doesn't get paid back. The home equity loan doesn't get paid back either because the intitial 80% loan gets paid back first buy law.

So as foreclosures mount and housing prices continue to freefall these loans will essentially become worthless. This debt for the most part hasn't been written off yet. As prices continue to drop, banks will be forced to give up on these loans and write them off. This will mean billions of additional writedowns.

Buying financials right now is a lot like gambling at a casino. No one has any idea of how many losses they are hiding. Eventually they will be forced to take their medicine and mark their bad loans to market.

The ones that survive this disaster will end up being excellent bets that will pay off down the road. The problem is there will be many that don't survive which means their stock will go to zero. This risk/reward ratio simply isn't there when your downside risk is zero on some of these financials.

Investing on speculation versus fundamentals is a fools game. It reminds me a lot of buying tech stocks during the tech bubble at $400 a share that hadn't even made a profit yet. Many are still licking their wounds from their "speculative" bets in 1999. I imagine that many housing speculators are feeling the same way right now as their investments continue to plummet in value month after month.

If you want to speculate then head to Las Vegas and play some Roulette. More on the financials later tonight. There was a big profit warning from Bank of America over the weekend. Enjoy your Sunday!