Tuesday, May 12, 2009

Seeing what we want to see

it's a problem for all of us. As a current bear, I tend to see the glass half empty. Alan Greenspan right now sees the glass as half full when it comes to the real estate market, at least that's what he told a conference of the National Association of Realtors (NAR) according to Bloomberg. Of course, telling a group of perma-bulls on real estate that the bull market in real estate is coming back is sort of like telling a Gold bug that hyperinflation is just around the corner. It's like shooting fish in a barrel, really.

I wouldn't be surprised if Mr. Greenspan got a standing ovation for speaking bullishly about real estate to a group of realtors - truth be damned. Of course, the data don't support a bottom and the NAR has called a bottom in real estate every month since before the top was even in, so the credibility issues here are huge. Even though Greenspan and the NAR have been completely wrong in all their real estate predictions so far, they continue to get mainstream media attention because they tell it like the corporate sponsors want Americans to hear it.

How about Deutsche Bank's assessment on commercial real estate, which uses actual data and those pesky little things called "facts"? Not only are delinquency rates soaring at an accelerating pace, but the value of commercial real estate is dropping rapidly even though many loans in the 2009-2011 time frame will need to be refinanced. Of course, these properties can't be refinanced because credit is drying up and these loans will be underwater just like in the residential sector when it comes time to refinance. Only a lender-of-last-resort pledging other people's money like the federal reserve would even consider offering such high risk, underwater loans.

And how about the large number of residential homes banks are keeping on their books after foreclosure and not listing for sale? No sale means banks can continue to mark these properties to their fantasy value and avoid collapsing for a few more months. Think this might weigh on the real estate sector for at least another year or two?

We should also consider the Alt-A and Option ARM mortgages that were so heavily used in bubble markets like California, Nevada, Arizona and Florida. These loans affect higher end homes, which means there will be a greater loss per home foreclosed upon than with subprime, which was of course only the first wave of the foreclosure tsunami. By the way, that first wave of subprime foreclosures bankrupted half of Wall Street (the other half was kept solvent by the generous taxpayers of the United States), Fannie Mae and Freddie Mac, AIG and many banks and mortgage lenders. So this second larger wave of foreclosures on residential properties worth even more per house I'm sure will be tolerated well by our strong banking system - especially since they just passed the rigorous stress tests of widdle Timmy Geithner.

The rapidly changing public psychology of preferring to rent for a while rather than rushing to own a home at all costs I'm sure won't be an issue for Alan and the NAR's predictions of a stabilizing real estate market, since fewer eager buyers and speculators shouldn't dampen prices at all. Also, since lending requirements are now becoming rational again, I'm sure a large decrease in the number of qualified buyers won't matter to price stability in the real estate market.

Since unemployment is still rising, many people are now so underwater in their mortgages that it makes sense to walk away rather than honor the mortgage contract if they have no "skin" in the game (i.e. no equity), and baby boomers are looking to downsize and sell real estate to raise cash, I'm sure those seeds of a real estate market bottom are just around the corner (the next few years aside).

Real estate is one of the keys to understanding this mess. The banks and Wall Street are overleveraged in many credit-related vehicles (e.g., credit card loans, auto loans, student loans, recreational vehicle loans, gambling on the outcomes of all these loans, etc.), but real estate is the big Kahuna. Real estate and the leverage associated with it will drag our banking system further into insolvency and the country deeper into a deflationary depression as credit dries up and banks start failing left and right.

The federal reserve and U.S. Treasury will end up "pushing on a string" as their "stimulus" measures do nothing but add to an overwhelming debt burden and push us closer to a currency crisis, which seems the only viable option for ending the deflation that needs to occur. It is my hope that market forces continue to overwhelm bureaucratic efforts to stop the primary trend, which is deflation.

So I'll take the other side of Sir Alan's prediction, thank you very much. I won't be investing in real estate, copper, lumber or Home Depot unless I see a shorting opportunity I like. In 2-3 years, I may change my tune, but trust me, there's no rush. Once real estate bottoms, it will still drag along the bottom for a few years. Once a bubble in real estate pops, it ain't coming back until decades later when there is a new generation that needs to learn the same lessons all over again.

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