Improvement in Home Inventory Levels Marks a Bottom?

"Sales increased 0.3 percent to an annual pace of 352,000, lower than forecast, after a 351,000 rate in March, the Commerce Department said today in Washington. The median sales price

decreased 15 percent from April 2008, while the number of homes on the market fell to the lowest level in almost eight years.

Near record-low mortgage rates, bargain pricing and tax credits for first-time buyers are helping to put a floor under purchases after almost four years of declines. Still, rising unemployment and tight credit indicate sales will not rebound much in coming months, even as the worst recession in half a century begins to ease.

“The good news is probably the continued improvement in inventory levels,” said Adam York, an economist at Wachovia Corp. in Charlotte, North Carolina. “We’ll take the improvement in the new-home market as a sign we’re getting closer to the bottom and we might see some stability in the housing market by the summer.”"

I see stories like this printed constantly in the financial media, constantly touting improved inventory levels marking the bottom and the worst being behind us in terms of the housing market. Sorry, that is absolutely the wrong conclusion. What is happening is that subprime mortgage resets have worked their way through the system and the subprime mortgage borrowers have long-since defaulted, with the houses at the low end of the market having worked their way through the system. What will happen now, and what we are starting to see is a huge uptick in Alt-A and Prime mortgage defaults.

Now, while the default rate is lower % wise for these two segments, the total size of these types of mortgage outstanding is much much greater than subprime, and hence the wave of defaults, in dollar amount, will be as large if not larger than the subprime wave we just endured. Since these buyers tend to buy higher priced homes, the median sale price will undoubtedly increase as the distressed sale cancer moves upmarket, however the price Y-o-Y on the properties for sale will tank. It will take 2-3 years for this wave to work through the system.

NY Times has the data which is depicting this: http://www.nytimes.com/imagepages/2009/05/25/business/economy/25foreclose.grfx.ready.htm

Subprime defaults rose rapidly in 2006-2007, plateauing in 2008 while ALT-A defaults began to rise rapidly in 2007 continuing through today, and prime mortgages defaults began rising in earnest in 2008. Already the total dollar amount of ALT-A and Prime mortgages defaults individually exceed the total amount of defaulted subprime mortgages ($250B), and we are only partially through the ALT-A default wave and just beginning the prime default wave. This default wave is being caused less by fraud (though still a significant part of the ALT-A default wave) and more by macroeconomic factors (job losses mostly).

Mortgage issuance:


2003:
$2,445B in Conforming (62% of 2003 issuance)
$ 631B in Jumbo's (16% of 2003 issuance)
$ 315B in HEL's ( 8% of 2003 issuance)
$ 79B in Alt-A ( 2% of 2003 issuance)
$ 237B in Subprime ( 6% of 2003 issuance)
$ 237 B in FHA/VA ( 6% of 2003 issuance)

2004:
$1,198B in Conforming (41% of 2004 issuance)
$ 526B in Jumbo's (18% of 2004 issuance)
$ 526B in HEL's (18% of 2004 issuance)
$ 204B in Alt-A ( 7% of 2004 issuance)
$ 321B in Subprime (11% of 2004 issuance)
$ 146B in FHA/VA ( 5% of 2004 issuance)

2005:
$1,092B in Conforming (35% of 2005 issuance)
$ 560B in Jumbo's (18% of 2005 issuance)
$ 374B in HEL's (12% of 2005 issuance)
$ 374B in Alt-A (12 of 2005 issuance)
$ 624B in Subprime (20% of 2005 issuance)
$ 94B in FHA/VA ( 3% of 2005 issuance)

2006 (Start of subprime default wave):
$983B in Conforming (33% of 2006 issuance)
$477B in Jumbo's (16% of 2006 issuance)
$417B in HEL's (14% of 2006 issuance)
$387B in Alt-A (13% of 2006 issuance)
$596B in Subprime (20% of 2006 issuance)
$ 90B in FHA/VA ( 3% of 2006 issuance)

2007 (Start of Alt-A default wave):
$1166B in Conforming (48% of 2007 issuance)
$340B in Jumbo's (14% of 2007 issuance)
$364B in HEL's (15% of 2007 issuance)
$267B in Alt-A (11% of 2007 issuance)
$194B in Subprime ( 8% of 2007 issuance)
$ 98B in FHA/VA ( 4% of 2007 issuance)

5 year totals:
$ 6,884B in Conforming (45% of 2003-2007 issuance)
$ 2,534B in Jumbo's (16% of 2003-2007 issuance)
$ 1,996B in HEL's (13% of 2003-2007 issuance)
$ 1,311B in Alt-A ( 9% of 2003-2007 issuance)
$ 1,972B in Subprime (13% of 2003-2007 issuance)
$ 665B in FHA/VA ( 4% of 2003-2007 issuance)
-------------------------------------------------------------
$15,362B total, $7T in Conforming, $3T in Jumbo's, $2T HEL, $1T Alt-A, $2T in Subprime

See http://www.growthology.org/photos/uncategorized/2008/07/11/litanhousing1.gif

There is a lot more pain to come in the housing market, except now it will be the better off and those with jumbo mortgages who are in trouble. Take an optimistic simple hypothetical.

What's just starting to hit the system:

Prime default rate (for ALL loans in this category):

(1.11% Q1 2008, 2.4% Q4 2008, 5% peak) vs. 2003-2007 issuance: $9,400B

What's just starting to hit the system:

HEL default rate (for ALL loans in this category):

(2.9% Q1 2008, 4.4% Q4 2008, 6% peak) vs. 2003-2007 issuance: $2,000B

What's partially worked through the system:

Alt-A default rate (for ALL loans in this category):

(5.2% Q1 2008, 9.1% Q4 2008, 12% peak) vs. 2003-2007 issuance: $1,300B

What's been worked through the system:

Subprime default rate (for ALL loans in this category):

(11% Q1 2008, 17% Q4 2008, 20% peak) vs. 2003-2007 issuance: $2,600B

Banks Aiming to Play Both Sides of the Coin

Banks Aiming to Play Both Sides of the Coin

I find it impossible to believe the Treasury didn't see this coming.
See the post from Tuesday, March 24, 2009 to get some idea of what the banks want to do.

Example: Bank A puts put up $3B of their capital (maybe some TARP funds? who knows, capital is fungible) into an off-balance vehicle (essentially a hedge fund) and receive $97B of government leverage to buy its OWN securities and loans from itself (i.e. overbid).

Their goal here is not to make a profit by purchasing the securities and loans at fair value, but rather, to DUMP the securities and loans into the off-balance sheet structure so they no longer have to take loss provisions. If the loan book turns out to be decent, they can re-absorb the off balance sheet vehicle.

$3 to DUMP $100 B of securities, what a swell deal!

BrIC, not BRIC

An acronym thrown around recently:

BRIC countries are supposedly fast growing emerging economies that are somewhat independent of US driven demand and supposedly are going to become the dominant four economies by 2050:

Brazil
Russia
India
China

Russia does not belong in this group.
Its economy is extraordinarily hydrocarbon and metals export dependent, in fact, such a huge proportion of the economy is natural resource driven that even the UAE has a more diverse economic base. Its GDP imploded in the recent economic malaise, contracting a staggering 9.5% in q1.

In fact, its economic performance has been so horrific that a recent strategic blueprint released by the Kremlin and signed by President Medvedev listed the current resource export economic structure as a major threat to Russia's future.

Furthermore, its life expectancy is abysmal, its population is on the decline, it has decreasing business transparency, and it has decreasing rule of law.

BrIC, not BRIC. Russia should be categorized with natural resource dependent nations, such as Saudi Arabia and Venezuela, not multi-faceted economies such as Brazil, India, and China.

Chavez Nationalizes Oil Services Companies Operating in Venezuela

Chávez, Extending Control, Seizes Assets of Oil Contractors

In 2002 PDVSA's engineers and oil workers went on strike along with other unions as well as businesses to protest Chavez placing his men on the board of directors of PDVSA. In 2003 the Venezuelan NOC fired all PDVSA's striking engineers and oil workers and replaced them with Chavez cronies. In the immediate aftermath, oil production never recovered to the pre-strike value of 3 MM bbl/day and has continued its steady decline to 2.4 MM bbl/day.

Most of the oil in place in Venezuela is extra-heavy, sour (high in sulfur), and requires significant upgrading. Most of these upgrading facilities were joint ventures with international oil companies and the oil services companies were providing secondary recovery techniques to help stem the drop in Venezuelan production (Venezuela's field output is steadily degrading and require more complex secondary and tertiary extraction techniques to maintain output).

Firing the PDVSA engineers was disastrous enough, but now nationalizing the oil services companies who have been the only thing keeping production from imploding, that is an incredibly dangerous move on Chavez's part. I would gamble that Venezuelan output is going to be hindered significantly by his actions.

Financial Tempest

Luckily, the upper right quadrant packs the largest punch.