Sonoma Housing Bubble

Pulling the cork out of Sonoma's bubbly housing foolishness

Monday, June 05, 2006

Speculative Craze is Crashing

Commentary from Gary Shilling

A. Gary Shilling is president of A. Gary Shilling & Co., economic consultants and investment advisers. Visit his homepage at

"The speculative housing craze is crashing from its own excesses, not Federal Reserve action."

"This is the first nationwide housing bubble since the 1920s, and it's driven by three nationwide forces: low interest rates, loose lending practices and the desperate search for a stock substitute after the 2000--02 debacle."

"Previous real estate bubbles were regional, spurred by economic cycles like the rise and fall of the oil patch in the 1970s and 1980s, and southern California's aerospace leap in the late 1980s during the Reagan defense buildup, ending with the Cold War's demise."

"If you still don't believe there's a massive housing bubble that is beginning to deflate, look no further than Toll Brothers. Toll orders fell 32% from a year earlier. The company blames the fall on cancelations by speculators."

"With dreams of huge appreciation dancing in their heads, speculators indeed drove the housing frenzy in the high end. Now that prices are flagging, they are fleeing. These investors and vacation-home buyers accounted for 40% of house sales last year, up from 36% in 2004."

"A lot of these investors rent out the properties. Despite low-payment interest-only mortgages, they cannot cover their cash outlays with rents, which are depressed by the proliferation of spec houses."

"To reduce monthly payments lenders have extended mortgages to 45 years. In 2005's second half 25% of new fixed-rate mortgages were interest-only (meaning the payback of principal is delayed) versus 5% a year earlier."

"And to buoy the subprime market, the U.S. Housing & Urban Development Department has proposed that Federal Housing Authority-insured mortgages eliminate the current 3% minimum down payment. The scheme is supposed to keep housing affordable in the face of leaping prices. But they're not leaping anymore."

"None of this will be sufficient to offset the mass exit by speculators and the hesitation of builders to slash production in the face of falling sales."

"Toll Brothers (nyse: TOL - news - people ) shows, cancelations are starting to be a problem for them. Moreover, this is an industry where small contractors dominate. These guys, who are often one pickup truck away from insolvency, will get slammed when spec houses don't sell or buyers cancel."

"The ten biggest home builders account for 25% of output, up from 10% five years ago, yet that leaves a whole bunch of small fry. Further sales drops are anticipated by the index of home builder sentiment--now at 45, down from the 72 peak last June."

"With inventories high and sales falling, the ratio of inventory to sales flow is rising. Nationwide median prices will probably fall at least 20% before the break is over. It will take a 35% fall to return prices to their long-run link to the Consumer Price Index; markets overshoot on the downside as well as the up."

"Even a 20% price decline will be devastating for many homeowners. On average, those with mortgages have 37% equity in their abodes. Of those who borrowed or refinanced in 2005, 29% have zero or negative equity, calculates First American Real Estate Solutions."

"A house-price collapse will be far worse than the 2000--02 bear market on Wall Street and will bring a serious global recession. Half of households own stocks or mutual funds, but 69% own homes. The resulting unemployment will kill many subprime borrowers' ability to make payments. Both Toll Brothers at the high end and dr Horton in the starter market will suffer."

"You can short-sell the bunch through the SPDR Homebuilders Index Fund (XHB ). Building suppliers and mortgage lenders are suspect. Golden West, the king of option mortgages that permit negative amortization (that is, your principal grows), timed its recent sale to Wachovia (nyse: WB - news - people ) brilliantly. Home appliance makers and do-it-yourself retailers are also vulnerable. Wait to remodel until contractors are hungry."


At 6/05/2006 01:55:00 PM , Anonymous tom stone said...

i sent this article to a few friends friday,i think that 35% figure is nationwide,when i look at properties in my part of sonoma county they are overpriced by 40-60% or in some cases more.i see no way this will be anything but a hard crash and a 50% decline statewide is easily believable when i see 15 year old tract hhomes selling for more than 500 times monthly rent in our economy...a 75% decline seems more apt there based on historical valuations...that is unless microsoft relocates its headquarters to the ssu campus.

At 6/05/2006 02:26:00 PM , Blogger Marinite said...

"The speculative housing craze is crashing from its own excesses, not Federal Reserve action."

Oh good because Bernanke made it pretty damn clear today that there are more rate increases coming.

At 6/05/2006 08:24:00 PM , Anonymous Anonymous said...

Sorry for being OT, but Tom Leykis saved his drive time slot to educate the unwashed masses about the housing bubble. Several industry goofballs called in with the familiar schticks and were mercilessly put down.

I know he's a guy most people love to hate, but I swear Leykis was using language often found on the bubble blogs. His personal angle is buying a second home in Napa after the "calamitous crash." I'll be anything he's lurked here at some point.

(I hope this doesn't slow Athena down.)

At 6/06/2006 09:28:00 AM , Blogger marin_explorer said...

Just look at builder stocks today. Anyone see a similarity to the tech sector in early '00? Some of us thought that could never happen again.

At 6/06/2006 10:20:00 AM , Blogger Marinite said...

Hey, today is 06/06/06 and the 30-year is around 6.66% If there was ever a Faustian moment then this would be a good time for it.

At 6/06/2006 01:13:00 PM , Anonymous tom stone said...

spent a little time today looking at subprime rates.they are beginning to reflect a risk premium,however the lending standards would have to improve a lot to become awful.still 100% financing on no doc loans,rates of 13.25%.this whole segment of the market will be gone soon,next year at this time we'll be seeing 20% down and 15% rates at least for 660 scores on arms.and bye bye to no present i would not buy subprime firsts at less than a 70% discount.this is as risky as any paper i have ever seen,who on earth is going to buy this stuff?i expect a lot of lenders will suddenly find themselves with stacks of loans that smell worse than cat pee and no one to buy it,at any price.someone smart will at 10-15 cents on the dollar...but good god,how can you consider this secured debt?

At 6/06/2006 01:17:00 PM , Blogger Athena said...

speaking of Faustian moments. Did y'all hear that NAR is begging the Fed to stop raising rates because of housing market vulnerability?

bwahaahhahahaha!!! But I thought there WAS no bubble? how can there be vulnerability? Rates are still at an all time low! Rates haven't been this low since Kennedy was in the White House according to that Coldwell Banker Asshat!

Why would they want to hit the interest rate panic button?

I mean back in the day... in the 80's people had 12 & 15% & 18% interest rates. Sheesh... we aren't even anywhere near those numbers. What's the big deal?

oh... whoops... have prices risen to unsustainable levels? Are they in danger of plummeting because there is no sustainable market that can keep them propped up? Oh whoops... are realtwhores in danger of being out of work if they can't keep selling overpriced chitboxes to the terminally indebted who no longer even want to own a house or ever pay off a mortgage, but just want the pleasure of renting from the bank indefinitely?

Criminy.... this is going to be a post of its own.

At 6/06/2006 01:21:00 PM , Anonymous tom stone said...

now athena,i'm sure ms juras can find appropriate work for the more attractive and ethical members of the matter their gender

At 6/06/2006 01:45:00 PM , Blogger Athena said...

bwahahahahaha! I got your open house right here! baahahaha!



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