Another House Price Crash Coming

Bill Bonner - Tue 10 Nov, 2009

The signs of a second wave of property repossessions

Montevideo , Uruguay

The Dow rose 200 points yesterday, bringing it only about 75 points below the 10,300 level.

Why is the 10,300 mark important?

It’s not really... it’s just the point where this bounce will equal the bounce following the crash of ’29.

No reason in particular that this bounce should be the same as the one 80 years ago. But no reason it shouldn’t either.

Gold rises with the stock market. The yellow metal hit a new record over $1,100 yesterday.

Why is that important?

Well, it’s not important either. But gold still has another $1,000 or so to go before it equals the last bubble peak in gold, set in 1980 – on an inflation-adjusted basis.

The point is, there’s plenty of room on the upside for gold... and not much room left on the upside for stocks...

Stocks are going to be hit hard when people realise that the recovery is a fraud. When will that happen? We don’t know. But another big wave of repossessions may be the thing that sets it off.

“The Second Wave Begins...”

This was the title of a report over the weekend from John Hussman. The gist of it is that the long-awaited “second wave” of repossessions has, perhaps, finally begun.

First, many of the top 50 metro areas in the US are reporting “sharp increases in foreclosure activity”.

James J Saccacio, chief executive officer of RealtyTrac, said:

“Rising unemployment and a new variety of mortgage resets continued to gradually shift the nation’s foreclosure epicenters in the third quarter away from the hot spots of the last two years and toward some metro areas that had avoided the brunt of the first foreclosure wave.”

“While toxic sub-prime mortgages drove much of that first wave of foreclosures, high unemployment and exotic Alt-A and Option ARMs are spreading the foreclosure flood to more metro areas in 2009.”

Hussman:

“While the news itself is no surprise in the sense that we have expected and written about this situation repeatedly in recent months, the phrase ‘sharp increases in foreclosure activity’ is notable in the context of widespread views that credit difficulties are abating.

“Below is a reminder of where we stand in relation to the reset curve. This news of a shift in the character of foreclosure activity comes precisely in tandem with the beginning of the predictable second wave.

“The pleasant lull in the reset schedule is decidedly behind us.



“The mortgages certainly do not reset at Treasury bill yields or even at standard spreads over LIBOR. Instead, they reset to a ‘premium’ spread above those rates.

“That ‘yield spread premium’ is precisely what the homeowners agreed to in return for the undocumented loan, and is particularly obnoxious at the point of reset if the mortgage itself is under water (loan amount in excess of home value).

“Given that these mortgages were written during the last stages of the housing boom, at the highest prices, it is reasonable to assume they now sport very high loan-to-value ratios.”

So, there you go.

If Hussman is right, we’ll soon see real estate prices take another tumble.
 
(Editor's note: If this second house price crash hits the US, the odds are on it will hit us here in the UK too. Are you protected from the fallout that will affect all asset classes? Click here to see how you can take urgent steps now.)

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Well, Bill paints a pretty bleak ‘big picture’, it has to be said. And you can’t argue with his logic.

But let’s not allow that to stop us from seeking out profits from our individual stock picking ideas.

I am consistently in awe of the ability of our team of experts in finding great companies.

If you are lucky enough to subscribe to Dr Mike Tubbs’ excellent Research Investments, you’ll know exactly what I mean.

Mike doesn’t try to predict the direction of the markets… or when the recession will end… he just says what he sees… and picks what he thinks can make money…

From Mike’s recent note to readers of Research Investments…

“The recent rise in world equity markets is reflecting the belief that the recovery is likely to be V-shaped. Reasons include positive earnings for the second quarter and now some early reporting companies for the third quarter.

“It is also clear that low interest rates and government support measures are likely to be maintained until recovery is well under way. “Let’s face it, the alarming UK budget deficit is likely to mean low UK GDP growth for some time. This lower growth and low interest rates here and also in the US and Europe are likely to lead investors to look for higher returns from riskier assets like equities.

“Legendary UK fund manager, Anthony Bolton takes the view that, in this lower-growth environment, investors will seek out companies, sectors and countries that can grow faster than average.”

That’s exactly the way Mike sees things. In fact, Bolton’s comments chime with the Research Investments strategy of selecting companies with substantial overseas sales that also reinvest ‘invisible dividends’.

In case you haven’t come across ‘invisible dividends’, let me explain what these are. These are the investment certain good quality companies make in the research & development that generates new products and services.

In short, ‘invisible dividends’ can give a company the competitive edge needed to sustain profitable growth.

Mike is one of the few analysts we know who has been consistently bullish through the hard times of the past 18 months. Not bullish on the economy or the markets as a whole. But very bullish on what he sees as the “right stocks” – the ones that use ‘invisible dividends’.

Right now, he’s got a portfolio of 17 ‘invisible dividend’ companies and they have been outperforming the market by a substantial margin.

He’s not overly worried about the stock market as Bill is. But he’s been in the game long enough to know that we’re likely to get weakness at some stage. As you’ll see, he considers that an opportunity…

“…despite encouraging pointers to growth next year,” Mike explains, “there is likely to be at least one pullback in share prices and perhaps more than one. Companies of real quality that invest in their futures are those where you should consider increasing your holding during such pullbacks.”

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And back to Bill with more thoughts...

*** What’s Bill doing in Uruguay? We were wondering the same thing... More to come later in the week...

*** “There are a lot of houses for rent... you can get a very good deal,” reports our oldest son. Will is relocating, from Argentina back to the US. He’s moving back to Florida.

“Why don’t you move back into your own house,” his father wanted to know.

“Dad, I’ve got a good tenant in there. Besides, it’s not in very good shape. I’d rather sell it than invest more money in it.

“And there are so many places on the market, I can rent something better.

“Even after a big drop in prices it is still cheaper to rent than it is to buy something.”

There are probably millions of homeowners who would like to sell – if they could. This hidden inventory of unsold houses will depress housing prices for a long time.

*** But there’s a crisis coming in commercial real estate too.

“An extreme amount of commercial debt is to mature over the coming years,” writes real estate investor George Karahalios in Marc Faber’s ‘Gloom, Doom and Boom Report’.

“And unlike the residential market, there is no safety net (Fannie Mae) for commercial loans.

“Instead investors must rely on financing through commercial banks, a few insurance companies and other private lenders who now demand much higher interest rates and more equity for the risk associated with these investment.

“Thus, not even the Fed’s printing presses can save commercial property prices, and I am expecting certain locations to crash, perhaps falling as much as 50-80% from the peak.”

So, you see, dear reader, there is bad news ahead – a lot of it.

Stocks will go down. Gold will go down too, most likely, when people realise that the economy faces a long, deflationary depression... not a period of inflationary growth.

But while stocks are fair weather friends, gold sticks by you in foul weather too. Right now, gold is rising on good news. Eventually, it will soar when the news turns bad (though not necessarily right away...).

*** Financiers have the world’s financial system in a ‘doom loop’, says the Bank of England.

We’ve thought so ourselves.

The bankers take money from the government and use it to speculate, not to lend. ‘Excess’ reserves are at a record high as consumer credit continues to decline.

Most people find it both galling and absurd to see the bankers getting $10 million bonuses while there is 10% unemployment. Here at The Daily Reckoning, it’s just a matter of curiosity.

You’d think there would be more wage competition to drive down bankers’ compensation.

Why doesn’t Goldman go to an unemployment line and make an offer...

“Any of you guys want to earn a $9 million bonus?”

Surely there would be a few takers. And Goldman would save $1 million.

Of course, we’re joking. Banking is not a trade you can pick up just like that. Borrowing from the Fed at 1%... lending back to the Treasury at 4%... hey, it must take a few days of training to be able to turn around money like that.

On the other hand, there are periods when speculating for a big bank is a breeze.

Over the last seven months, for example, there was almost no way fed-financed traders could lose money.

They borrowed dollars – the new carry-trade funding currency – at next to zero interest. It didn’t matter what they did with it... they could trade it for Brazilian reals... or buy stocks in Singapore... or buy gold. Almost everything went up against the dollar.

Institutional investors – such as those managing money for banks – are judged on how well they do against the benchmarks, the averages, not on how much money they make or how many losses they avoid.

If their colleagues are making money, they have no choice. They have to get in the game too.

So, they’re in a ‘doom loop’, where they continue to bid up asset prices – even at the beginning of a depression.

*** Meanwhile, over in the real economy... the deflation continues.

David Rosenberg:

“It is like a magic show – the US economy is somehow out of recession with both employment and consumer credit outstanding still in full-fledged contraction mode.

“In September, total consumer credit fell $14.8bn, making it the eighth month in a row of debt repayment – an unprecedented string of declines.

“Over this period, the amount of consumer credit (not including mortgages) that has come out of the system has totalled $163bn at an annual rate (or
-6.3% at an annual rate).

“Looking at the fact that total household debt still exceeds long-turn norms of 60% by a factor of more than two, we are still in the early stages of a secular credit contraction that could well end up seeing another $5 trillion of debt collapse.

“This is a highly deflationary process. It will take time. And while we are bullish on gold and commodities strictly on global supply-demand imbalances, bonds remain a very good place because deflationary episodes provide solid real yields to investors.

Let’s see…

We’ve tried several ways to gauge how long it will take to deleverage the private sector (which is another way of figuring how long this depression will last).

At 6% a year – assuming private sector has about twice as much debt as it should have – it will take about seven years to get down to a more comfortable level…

Did we do the maths right? Well, who knows? But every time we do it, we come up with about the same answer – seven to ten years, more or less.

But it’s not that simple.

Because as the private sector deleverages, the feds try to prevent it from doing so... while they leverage up the public sector.

This is bound to stretch the whole thing out... and bound to lead to some serious bust-ups.

Until tomorrow,

Bill Bonner
The Daily Reckoning

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Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600.