Housing Problem: What Inning is It?

Are we the only ones getting tired of the "What inning?" question?  When we think baseball, it is better to enjoy the early success of Chicago's two teams, especially the suddenly slick-fielding White Sox.

For several months financial television asked everyone about recession chances.  Prior training or experience not required -- all opinions welcome.

The question du jour is now, "Which inning of the mortgage crisis are we in?"

John Hussman's Answer

The widely-read and respected John Hussman complains as follows:

One of the fascinating aspects of Wall Street is the ability of analysts to provide opinions without the faintest backing from evidence. Among the latest topics of opinion is how far the mortgage crisis has to go. Evidently, the idea is that the recession that these analysts didn't forecast is already over, so it is time to “look across the valley” on the belief that most of the writedowns are behind us.

Hussman's own approach is to take a schedule of resets and integrate the curve to show a cumulative effect.  From this, he concludes that we are still in the early innings, with each inning lasting three months.  The worst is yet to come, etc.  Check out the entire article.

Two Errors

The Hussman analysis makes two serious errors.  First, he uses data from nearly a year ago.  This is assuming that ARM resets are a stationary target.  In fact, many mortgage holders have already refinanced.

This was reflected in a recent AP-AOL survey, the subject of an article we wrote for Real Money (subscription required).  Two survey results were especially relevant to this question:

1. Only 11% of those with mortgages have adjustable rates; 18 months ago, the figure was 22%. This suggests that there has already been a lot of refinancing.
2. Among homeowners with adjustable-rate mortgages, those who are worried about making their payments after an increase is 36%, exactly what it was in the prior survey.

We are hesitant to mix two different methods of measurement and two different time periods, but surely there has been some change since the stale chart cited in the Hussman article.  If he is going to use some fancy analysis to impress and frighten the average reader, at least he could update the data.

The second Hussman error is quite common.  He is focused on the problem while completely ignoring any solutions.  The loosening of restrictions on Fannie and Freddie (including the conforming loan cap and the overall portfolio cap) will help to encourage refinancing that was difficult a few months ago.

Jordan Kahn at In the Money, one of our featured sites, writes as follows:

I think the news from Freddie Mac (FRE) today was pretty significant, although it received little attention.

In the press release, Freddie said it will buy jumbo mortgages in high-cost regions from Wells Fargo (WFC), JPMorgan Chase (JPM), Citigroup (C) and Washington Mutual (WM). The government-sponsored enterprise expects to finance between $10 billion and $15 billion in new jumbo mortgages in 2008.

He points out that the old caps were ridiculous in some areas, a theme we have also argued.  Jordan calls it "big news" which will help us get closer to a bottom in housing.

[Jordan sat in the hot seat today, covering for Doug Kass on his daily investing blog, The Edge.  Doug is doing a lecture at the Harvard Business School!  We hope that the Wharton man gets the appropriate respect from the Harvard crew.  Meanwhile, Jordan did his usual great job as a substitute.]

Conclusion

Ironically, John Hussman did exactly what he accused others of doing.  The evidence he adduces for his answer to the "innings question" is no more plausible than anyone else's.

Our own answer?  We do not know.  Neither does anyone else.  It is going to depend upon the ability of people to refinance, where fixed rates go, how quickly Fannie and Freddie and the FHA provide help, and whether a foreclosure assistance bill passes Congress and gets signed by the President.

We do not know the answers to those questions, but at least we know what to look for.

TCA-ETF Update

As we regularly do on Thursday, we are showing an update on our TCA-ETF sector model rankings.  The overall result for the third cycle, begun on January 25th, is about even, roughly the same as the S&P 500 and a bit ahead of the NASDAQ.  There are two interesting things to observe.

First, the strongest sectors remain the "weak dollar" plays.  Second, the overwhelming majority of sectors are in the "buy" range.

Interested readers can get a report via email on participating in our weekly trading program for individual investors.

Comments

[Bill aka NO DooDahs!]

Hussman says "Evidently, the idea is that the recession that these analysts didn't forecast is already over"

Rempel says "Evidently, Johnny boy wants the recession that he predicted for three years to last as long as Hussman had to wait to finally see it - assuming it ever eventually 'officially' gets here."

[Tim Plaehn]

Since we have been reading and hearing about the recession longer than the average one lasts I hearby declare it over and may we all profit!

[gaius marius]

fine contra opinion, mr miller, but i would take issue on a couple of points.

first, surveys are probably a bad way to estimate who has what for a mortgage. as the psychology of events has progressed, terms such as "adjustable-rate" are developing a stigma that will encourage underreporting. it's not to deny your point that the composition of mortgage debt is a moving target, but i think we'd be better off examining at the loan books of major mortage players.

second, i think the fannie/freddie news is, in some ways, being made too much of at this juncture -- particularly as relates to future house prices and mortgages yet to be made.

let's look beyond the fact that these are capital-constrained entities which are, after all, run for profit, highly geared and probably more risk averse than they once were (along with most everyone else) -- and then also look beyond the fact that even they are simply not big enough to replace the entire private mortgage securitization industry which truly fueled the boom and has wilted on the vine in the last year.

the GSEs are talking about buying existing mortgages from capital-constrained banks, not making new mortgages. the odds that these banks then take that precious cash and dive right back into california mortgages on the old terms are, i think, nearly nil. fannie/freddie might be to some extent the policy instruments which relieve immediate balance sheet pressure from the banks involved, but i do not think they can rightly be viewed as supporting housing prices going forward in this environment by doing so. chastised banks are likely to be very much more frugal in home lending for the foreseeable future -- and THAT more than anything is what likely ordains lower prices in housing, as the prices of 2007 were the product of the near-evaporation of credit underwriting standards.

so perhaps it depends on what we mean by "the housing problem". if we mean banks in trouble, then yes -- i think this move will at least incrementally help the banks to recapitalize. if, however, we mean the direction of house prices, then i think almost certainly not. house prices are reverting to their historical mean vis-a-vis household income as credit underwriting standards also revert, and even recapitalized and healthy banks will not be making loans on the terms that supported prices in 2007 again in the foreseeable future.

thanks as always for a provocative discussion!

[gaius marius]

i should add, too, as i did not single this out in the above:

The government-sponsored enterprise expects to finance between $10 billion and $15 billion in new jumbo mortgages in 2008.

what is $15bn in this market? even if we presume a minimal average jumbo loan size ($500k), this is 30,000 mortgages in a national home sales market that will, even in the worst slump in memory, probably top 5 million transactions. this is not assistance so much as public relations, i fear.

[muckdog]

From my hood in Sacramento... Bidding war on the house next door, sells for $30K above asking. Inventory drops from 50 homes for sale to 14 for sale. The real estate agent across the street told me he's sold more homes the past month then he did all of last year. He says multiple bidding wars on houses.

Just one neighborhood in the contiguous 48.

[VennData]

Called on account of rain? Or extra innings? Slumps eventually end.

"Win, or Die Trying" is the baseball equivalent of making ten figures or having a 100% draw down.