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Fear, greed and loathing in Las Vegas - The US economy; then and now.

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February 21, 2008 – Comments (12)

I have always been very interested in economics. The interpretation of the behavior of millions of individuals all making decisions simultaneously is fascinating. Macroeconomics is incredibly complex, but if we can see some trends, above average returns are possible. First I will present my interpretation of how we have arrived at today's economy.

Las Vegas - circa 2004

I visit LV many time every year. I only live a few hours away, so the drive is quite pleasant. You would not believe my reasons for visiting sin city, but let us not digress. Sometime in 2004, I was having dinner at a PF Changs. I always go right to the bar since I hate waiting to eat, and I meet some real characters while dinning. On this particular evening, there were 3 young kids(anyone below 30 get my KID moniker) eating and drinking next me. They were all boasting of there latest real estate deals and profits. As a former slum lord, Having bought and sold over 30 properties, I was keenly interested in there discussions.

Not to my surprise, they were very willing to tell me about there recent killings in the LV real estate market. These young Turks were buying several new homes at the same time, then flipping within a few months for 50-75K profits per home. These guy were fun, and I enjoyed our conversations. I have found that ground level info on the economy is very valuable - our government should try this approach. On my drive into the desert, I dismissed there claims as just some lying, and one upping each other.

Las Vegas - circa 2005 - 2006

I'm back in Vegas baby! At PF Changs, at the same bar. The bar is packed - in fact LV is packed and vibrant. I can't believe the amount of desert being scrapped for more ugly boxes - this can not continue I scream! I am wrong - at the PF's bar I meet more 20 somethings and everyone is talking real estate. Everyone is a flipper and dealer - Can everyone be lying? I start to investigate. I am not surprised to find people buying more than one property at the same time - I have done this in the past with rental houses/condo's back in the 1980's. The banks still don't know real time that people are lying on there mortgage applications? HM I guess not. But I was buying property that ware cash flow positive - I had  tenants paying my multiple mortgages. In LV there were no renters, these were new homes that could not be cash flow positive. These new buyers had no cash, and there jobs were fairly low paying - they could not even qualify for one of these ugly boxes - but they were buying 3 or 4 at a time?

The reason, ALT A loans and basically ZERO due diligence from lenders. You can say anything - I make 15K per month - RIGHT.....This was when I started buying puts on some of the HB's. I picked KBH as my target for a hedge against my long fund.

How could this happen? a Macro interpretation.

I started to analyze this crazy home financing system. My theory is fairly simple. To much liquidity chasing an ever shrinking yield. After the US depression in 2001-2002 the federal bank lower the funds rate to 1% and kept it there. Wealthy investors were stumped; With short and long term risk free yields a pathetic low level - cash was getting very hard to invest. Investors were still hurt from the stock market crash, so these investor would not put there cash in equity markets. Then the US gave a large tax break to these investors, giving them even more cash per year to handle - what to do with all this money?????

The combination of historic low yields, fear of equities, and a poorly targeted tax cut; created a HUGE increase in  demand for stable return or yield on all this cash. Can you say SIV? Where you have demand - supply will not be far behind. The larger banks and investment house increased the creations of CMO, CDO's that satisfy the large increase in demand for yield. 5-6% yield will do just fine in this now low yield environment. To satisfy this large uptick in demand, lending standard had to fall - there is no other way to meet this new demand. No doc, negative amort., sub-prime, teaser rates loans all became common place - and much to the glee of my box flipping buddies back at the PF Chang bar in Vegas.....

Year of reckoning - 2008

Where is the US economy today? We are in a recession, and it may be a longer than average one. Housing is no loner the issue - it is the credit collapsing due to the lending ponzi scheme finally falling apart.   In conclusion, IMHO the US government has helped create the current housing bubble, and the current credit meltdown.

As far as housing, my calculations show that home prices have already fallen back to base affordability levels. The measure to use is simple - the monthly $ amount per sq. footage of new home price. Rates are close to historic lows, and the sq footage of new homes are at historic highs. Do not look at simplistic home price charts - stupidity or fear mongering - take your pick.

Will home prices continue to fall? IMHO, yes. Lenders are still trying to raise capital, not lend, and US consumers do not wish to buy an asset that is still falling.

Future US economy 2008 - 2009; what's next?

I think we need to get helicopter Ben, and Hank Paulson to frequent  a PF Changs bar once a month. It is still unbelievable to me that our GVMT did not see this recession coming.......I know many CAPS bloggers love to hate the HB stocks. Many have made the top 1-2% on CAPS by shorting this group. Your days are numbered IMHO. We will get a US housing bailout package before the end of the year.

Even without a bailout, making additional money on shorting the HB's  will be increasingly difficult. It will be like trying to kick a dead whale down the beach - good luck! Am I going long the HB's? No, I have many other stocks and industries(like my NG Blog) for my cash. I will be publishing my top 20 DCF stocks this weeks. Many of these are already in my CAPS picks, and real fund.

The US housing bailout needs to work as follows. 300-500B of lower level tranches of CMO debt needs to be purchased and held by the US government. Also the GSE's/FHA need to loan cheap money 5.5% 30 yr, to refi the weak/poor loans with 2006-2007 vintages. and slow down the foreclosure process. The third leg of the bailout would be the GVMT helping states and cities raise bond funds to purchase distressed homes in hard hit communities and take them off the market - maybe affordable rentals, for lower level workers, etc....

This is an election year, and the politicians will be tripping over each other to show how much they care about us. If the US economy is a weak as I suspect - and as weak as all the bears on CAPS think, then this above housing/economic bailout will happen. And if the economy is really not as bad as we think - no bailout, but no more profits for shorts either way.

What about moral hazard? This is not an issue for me. As my blog suggests, I hold our government responsible for the current credit meltdown, so a bailout is not unreasonable. Don't even get me started about the questions about government oversight and regulating the fraudulent lending practices, and ratings agencies during the past 5 years.

Baseline economic projection is a recession for most of 2008, followed by slow but steady recovery in 2009. I think the recession started in Dec. 2007. The midpoint of a recession is typically the best time to buy equities IMHO. So April/May will be the best time to increase exposure to equities. The HB's tanked first, so they may bounce back up first and hard. So if you have cash on the sidelines I would average down slowly to a fully invested position by May. I still like my high yielding cash flow stocks, energy(natural gas) stocks, and international infrastructure plays like MTW, or TEX.

Good luck to my fellow investors during this challenging period - and if you get a chance - visit a PF Changs in Las Vegas for more real time economic data!

12 Comments – Post Your Own

#1) On February 21, 2008 at 2:14 PM, SemperGumby77 (60.68) wrote:

This is a very good post, Bellard. I'm not crazy about seeing the gov't bailout the irresponsible or the "socialization of losses" that such an action represents, but I understand that it may be necessary here, and is increasing likely in an election year.

I am interested in your take in how this affects the homebuilders. You cite April/May as your time to go long, but really, hasn't that time already passed? I have several homebuilders on my screen (HOV, OHB,TOL, MHO) that are (unfortunately for me) up 20-70% since the beginning of the year. Do you expect these to come down to more reasonable levels, or would you still feel comfortable buying in April at these present price levels?

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#2) On February 21, 2008 at 2:35 PM, CycleFreak7 (< 20) wrote:

SemperGumby, check out blog posts from floridabuilder.  IMO, another drop is coming and will present a good buying opportunity for the various builders that will survive.

Bellard, thank you for the good blog post. In any bubble, it inflates the fastest just before it pops because that's when all the speculators (or, vultures) start circling. Vegas, parts of California and Florida suffered terribly from house-flippers. They bid up the prices so high that people who actually needed a house could not afford them.

Or, bought anyway and are now sitting on huge negative equity.

It's sad.

 

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#3) On February 21, 2008 at 2:59 PM, floridabuilder2 (99.24) wrote:

you are correct, there is not a lot of blood left on the short side of builders...  builders are going to drop, but a lot of stocks are going to drop going into late spring.... so you can short a lot of things and make money..  since early dec 2007 i think all builder stocks have outperformed the SPY....

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#4) On February 21, 2008 at 3:29 PM, bellard (99.32) wrote:

Semper;

My April/May time frame is a guesstimate. I can not time the bottom. You are correct, many HB's have already had huge gains in the last 2 months. I think KBH, LEN, CTX, DHI will all trend lower into the spring. I would wait to buy the HB's until after they report the next Q. Sales and EPS will look terrible, even without the impairments. I personally do not like buying HB's stocks, or buying puts right now.

So in April/May, I think you may get better pricing on HB stocks, but more importantly maybe some clarity on new orders, cash flow, and US policies regarding the HB environment.

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#5) On February 21, 2008 at 5:09 PM, mickeyc21 (29.50) wrote:

Bellard - excellent post.

You are spot on regarding cause. Even Lawrence Yun (NAR) put up a post today citing a housing boom caused by (primarily) lax credit and overly low rates. I nearly fell off my chair.

Congrats on the realworld intelligence. It can be overused but it is a stunning resource.

It may surprise many on here given my bearish rants that I have seen summer 2008 as a good buy in for HB for a year now. At the moment I would push that back a little but I definitely agree with you and fb that shorts on HB are a relatively low percentage play right now. I still have some in my real world portfolio and am looking to exit within a month. One more rogue trader would make my day!

I very strongly agree with you that a bailout will occur. In fact we will see several if my take is correct. Our transition to a socialist state will be complete. I am in Europe at the moment and it amuses me talking to very different people - from bankers to businessman - that Europe sees the US as a bastion of free market capitalism. Dios Mio - try running a business here. We still have great capital access advantages but that hasn't existed since August last year. I am still in the fingers crossed "this can't be happening" capital access club right now but how long can a temporary abberation last?

I have some of those guys you met working for me in Vegas at ten dollars an hour. Their sunglasses are worth more than their current weekly paychecks.

Once again, great post.

 

 

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#6) On February 21, 2008 at 6:22 PM, cabuilderboy (88.80) wrote:

Good Post. Any sales uptick here at the start of the spring buying season will kill any short positions. You have to have some courage to bet on the builders right now, but all will benefit if there is an inkling of good news in the next couple of months.

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#7) On February 21, 2008 at 6:42 PM, alstry (35.42) wrote:

Great Post!!!!!!!!!!!!!!!!!!

I think your conclusion is dead wrong.

You say affordability should be measured on a price per square foot?  But you fail to address non housing related costs and the impact on the consumer.

For example, for an extreme example to say the least, let's say the average American income was $60K per year, and a months supply of potable water was $60K, how much could the average American spend on housing?  Whooops.

In your example, you fail to address how much the housing boom really impacted the economy and the effect if its contraction.  With the Dot.com Boom we know it added about $10 trillion to savings, very little to income, and when it imploded most of the savings was eliminated.

With the housing boom, it added not only trillions to savings, it added trillions to income.  With the additional income, additional leverage was taken out, stimulating the economy even further.

Now the incomes are evaporating but the TRILLIONS in debt remains.  My friend, your few hundred billion dollar bailout is seemingly a few standard deviations off from a black swan event.

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#8) On February 21, 2008 at 9:27 PM, abitare (35.58) wrote:

Recession, yes

The govenment bailing out some one? With what money? Gold is $900 for a reason and oil at $100 for a reason.  

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#9) On February 22, 2008 at 9:43 AM, bellard (99.32) wrote:

Mickey;

I agree with you on the bailout - there will be several since the US will refuse to really see what is happening.

 

Al;

I have analyzed the US economy since the housing boom started. The economy as a whole did well - but was not overheated - we did not have 6-7% GDP during the boom, also the equities market underperformed it long term average. A 300-500B US purchase of the worst toxic waste of mort's will help the housing market and economy - IMHO....We will have to just agree to disagree....will time tell?

Catania;

The US will have little trouble sell T-bills to the chinease and middle east. 500B in the world market is a drop in the bucket imho.... 

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#10) On February 22, 2008 at 10:49 AM, alstry (35.42) wrote:

In analyzing the US economy since the "housing boom" started, what percentage of the growth of the US economy do you attribute directly or indirectly to the housing boom(such as MEW, growth in financial profits, growth in commercial RE to support housing growth, growth in municipal revenues)?

If all of the above evaporates, what effect do you think it will have?

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#11) On February 22, 2008 at 11:44 AM, bellard (99.32) wrote:

Al;

We are starting to see the effects of the end of the housing boom. All the financials are down big, all the retailers are down big - check out BBY - they have further to fall imho. I own puts on EXP and VMC - due to municipal revenue and funding issues. We are currently seeing the effect - the HB boom ended a year ago. The market looks ahead 6 months, so it all about when you feel the recession will end. My guess is October/Dec of this year. 

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#12) On February 22, 2008 at 1:13 PM, alstry (35.42) wrote:

Nice Work.

 You are right, we will agree to disagree.

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