Vigilant Investor

Don’t read too much into the reports that housing is on the mend based on yesterday’s numbers showing new home sales have picked up. As we’ve reported before, new home sales number never include the cancellation numbers that have been running at a very brisk pace according to homebuilders’ disclosures. Bary Ritholz has some good commentary on that, as well as statistical significance.

What’s in store for housing? Well, it would appear the consensus is catching up to your editor here at Vigilant Investor. Reports CNNMoney:

The battered markets for real estate and home building still have farther to fall, according to a range of economists who spoke Wednesday at a forecast conference sponsored by the National Association of Home Builders. The economists agreed that the problems with home finance markets will continue to hit housing into next year, and that even when there is a recovery, it will be a slow process that will see weakness continue into 2009.

Gee… don’t go out on a limb, now, Ok?

While most said they believed the overall U.S. economy can weather the housing downturn, several saw significant risk of a recession. Mark Zandi, chief economist of Moody’s Economy.com, said that large areas of the country will fall into recession, if they haven’t done so already.

Ok.. the mainstream catching on… What else?

The economists also admitted to being surprised by how bad the housing downturn has become, and all said that making forecasts of a recovery is difficult due to the problems in the credit markets.

Once again, evidence that far too many mainstream economists need to be hit over the head with the consequences. This is on par with the police showing up to draw chalk lines around corpses, and providing the stunning prognosis that the victim is dead. How about a little advance warning next time? (I say that fully knowing that their inability to comprehend the very predictable lead up to this housing recession is why Vigilant Investor exists!)

“This time, we just don’t know how it’s going to pan out because the securities markets have become so much more important,” said David Seiders, chief economist with the builder’s trade group.

We’ll, since Mr. Seiders is now caught up and is otherwise at a loss, we’ll take over: The credit markets remain a mess and that threatens asset values that have grown heavily dependent on constant, ongoing expansion of credit and money supply. With so much money flowing so easily for so long earlier this decade, people grew to believe happy days were here forever, and many forgetting much about the basics of risk related to time value of money. They borrowed more and more and invested it to bid up asset prices, changing the economy from one based on production and value exchange to one based heavily on Ponzi Finance, which works only as long as asset values increase fast enough to out-pace borrowing burdens.

Now there’s a huge insolvency issue in housing, a sector that was permitted to defy economic gravity thanks to the promiscuous credit environment provided by the Fed, where lenders lost all connection to reality, and borrowers gladly followed. With the credit markets still paranoid about defaults, asset prices supported by easy credit are now teetering, threatening to cascade into otherwise economically solvent industries — never mind the SIV shell game the Treasury has been organizing in a desperate attempt to ward off the day when overpriced assets must be finally judged by the to market vs. the fictional models created by the now embarrassed financial wizards who cooked them up. The big investment bank players who enabled this and partied along with it are threatened with both losing hundreds of $ billions and a credit market that could lock up and send the debt dependent economy into a well deserved tailspin in payment for the bubble’s free lunch. Many homeowners are threatened with losing their residences and politicians are quick to populist solutions with elections nearing. Add both issues together and it spells even more easy credit and liquidity in an attempt to paper over this serious problem. That will equal more inflationary pressures on the U.S. consumers whose chief export currently is debt.

The United States will in the not so distant future be facing higher borrowing costs to service that massive debt-load as foreign nations grow exhausted from inflating their own money supply so that their national currencies don’t get stronger vs. the dollar. That’s been a subsidy to the debt-addicted U.S consumer and government, a sacrifice nations like China grant their export sectors given their economies are export driven to preposterously distorted levels. By printing their own currency, they create inflation problems for their own citizens — which is beginning to raise political problems in China, the Mid-East, and elsewhere. With many U.S. consumers teetering towards insolvency and the economy nearing a credit crisis-led recession, expect such nations to finally capitulate. They’ll demand a higher risk premium when lending to the U.S., which for the last four years has developed a dangerous sense of entitlement to this foreign subsidized, 50-year-low interest rate environment.

All is further complicated by U.S. populist sentiment in an election year, with some politicians and constituencies demanding tariffs on China (and others) in response to their support of the dollar — a case of biting the hand that feeds. Such “hat-in-hand” arrogance is all the less welcome in lieu of broadly declining international approval of U.S. foreign policy, which many now define as an imperial geopolitical threat to their own security and economic interests. (Consider Russia, China, and Iran recently meeting to discuss the oil-rich Caspian Sea region north of Iraq and Iran.) Lender nations are questioning the wisdom of subsidizing the Federal deficits behind U.S. military presence in the Mid East and 100 nations worldwide, and the wisdom of dollar dominance, meaning the dollar is more vulnerable to ever, as is the extended low U.S. interest rate environment.

While such rate hikes may be a little while off, they are in our opinion inevitable and will arrive much sooner than many expect. Higher borrowing costs will lead an already badly limping U.S. economy further into recession, while the policy reactions in support of both housing and big bank’s and their major client’s asset values will create higher inflationary expectations among both domestic global dollar holders.  Can you say “stagflationary recession?”

The good thing is you don’t have to sit there and take lumps.  Armed with the correct fundamental economic outlook should help you plan accordingly.   As the saying goes, change and turmoil also brings opportunity.

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