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Update On the Real Estate Debacle
First I wanted to share a significant personal announcement. I took the California Bar Exam last week after a couple months of preparing and doing practice exams. I will find out my results this November, so there will be quite a wait. I found the exam very difficult, especially the multiple choice component. We will see - as they say.
Second, I hope that everyone has been watching the imploding of real estate markets and most of the credit markets associated with different types of securitized home loans / mortgage backed securities. We are seeing a huge flight to quality with credit spreads between treasuries and these riskier assets widening substantially.
Third, the real estate spreadsheet strategy is finally beginning to pay dividends. I wish that I had not blown my portfolio up last fall so that I could actually being speculating with my own money on this down market. That said I have helped some people set up portfolios of longer dated put options on real estate related stocks in order to hedge their actual real estate holdings. The results so far have been very encouraging. The biggest surprises for me at least as far as the violence of their downside action is concerned are the Mortgage Insurers. Several of them are down 40-50% over the PAST 2 WEEKS!
The fallout from the recent Bear Stearns hedge fund meltdown and the dissemination of the information that the mortgage backed securities or CDOs were not worth anywhere near what they were marked at has had a significant impact on market action.
I am not convinced that we have commenced a new bear market yet. I think that dollar weakness overseas can continue to boost overseas operations of the major Dow companies and at least create the illusion of market strength in the Dow for the rest of the year. That said - there is a bear market underway in the homebuilders and mortgage lenders, and it is quickly spreading to many of the other financials that seemed immune even three months ago.
Let's keep our eyes open and fingers on the sell triggers. There are some fantastic implications for the precious metals markets out two to three years once the Government bailout of the banks and real estate sector begins, just don't jump too soon. The short to intermediate term action could actually drive gold prices down as investors flee to "risk-free" treasuries increasing the demand for dollars in the short term.
-BG
posted by Ben Green @ 1:34 PM
2 Comments:
I wonder if there is historical precidence for a homelender real estate collapse as you are predicting here. I know of several banking collapses in US history, but were they necesserily tied to real estate as you are predicting here?
What about prior to US history, where surprisingly, lending/real estate laws and structure are not too dissimilar to how they are today.
It would make a good term paper at least;)
It is a fascinating concept. There are several issues unique to this cycle. The crucial difference this time around is the market for securitized loan. There has been a huge demand for real estate backed mortgage securities over differing credit qualities by foreign central banks, institutional investors, and mutual funds for the past ten to fifteen years.
These markets have become enormous and they have perhaps falsely inflated the value of the collateral backing them (re: the underlying real estate.) I think what we have seen over the past two weeks, is a questioning of the value of that underlying collateral as well a greater focus on credit quality - prime v. non-prime.
As traditional lending standards return to the real estate market I think we should continue to see home prices decline. What are the effects in the stock market? Just that I would expect the stock market to act as a mechanism for price discovery that operates much faster than the actual real estate market. As we saw with American Home Mortgage this week and New Century Financial earlier this year, perception is key, and margin calls along with stock price declines can quickly force an otherwise healthy company into bankruptcy when they are dependent on others to provide them with credit.
I don't pretend to understand all the interrelationships. I am also not trying to "predict" anything. That said we are seeing actual spillover damage in many real estate related sectors which I have correctly anticipated for many months / years. I was incorrect in the timing as well as the magnitude (the bust has exceeded my expectations).
That said I feel we are just getting started. The down cycle will have to work itself out over several years. In the short term the key indicators to be watching are credit spreads - the difference in yield between US treasuries (riskless) and then Corporate Bonds or Mortgage Backed Securities of similar maturities as the difference in yield reflects the risk premium.
This has little predictive value but it is a great tool to gauge investor sentiment and risk preference and may be a coincident indicator with actual credit tightening. These events DO have important implication for equities.
-BG
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