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Posted 10/3/2005
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Empty houses, falling prices: A boom dies
You can see how the housing bubble is bursting in places like Columbus, Ohio, where builders and lenders threw common sense away and enticed people to buy homes they couldn't afford.
By Bill Fleckenstein
Regular readers know that since early 2004, I have described the housing ATM as what's allowed the economy to move forward. In June, I suggested that Time magazine's cover story, "Home Sweet Home: Why We're Going Gaga Over Real Estate," might be signaling the peak. It's looking more and more like June was the peak (witness last week's disappointing new-home sales, pre-Katrina), as various problems begin to surface around the country.
To some degree, the housing market is a compendium of local markets, unlike the "centrally located" though all-encompassing stock market bubble. There is no Nasdaq or Dow Jones housing index. For that reason, as the housing bubble unwinds, it won't be quite so obvious to folks around the country unless it's happening in their community.
Home-style seduction
Turning to one such place, I am indebted to a reader of my daily column, who forwarded a copy of the Sept. 19 Columbus Dispatch. It ran a thorough article on the plight of a couple in the Galloway Ridge subdivision in suburban Columbus and also shed light on some financing techniques that get folks into trouble. The article, "Suburban Blight," singled out Dominion Homes (DHOM, news, msgs) for enticing people to reach too far. Allow me to share a few quotes:
"Big dreams filled Rick and Christy Alonso when they bought their new house from Dominion Homes. Start a family. Build equity. Move to a larger house. But six months later, their suburban neighborhood on the Far West Side began to deteriorate. New houses suddenly emptied. Thistles and dandelions overran lawns. Neon orange labels appeared in windows, signaling foreclosures."
Buy now, foreclose later
It's worth making a point here: On average, people across the country have a good deal of equity in their houses. But I think that average is misleading. There are people with huge amounts of equity, and there are people with virtually no equity. It's the people with no equity (otherwise known as "marginal buyers") who find themselves in trouble, wind up "upside-down," and are forced to sell. It's those marginal sellers who start the price dislocation (after the supply of marginal buyers has been exhausted). The story Ohio describes this process: "Foreclosures damage entire neighborhoods. They affect families such as the Alonsos, homeowners who pay their mortgages on time, yet find themselves stuck with houses losing value."
Related news and commentary on MSN Money
The story noted the specific attitude that's helped lead to this problem: "The recent spate of suburban foreclosures includes buyers whose appetite to have it all -- now -- leads to financial overreaching."
Dominion is lambasted as an accessory to the process: "Nearly a third of the Franklin County houses and condominiums built since 1998 that have been listed for sheriff's sales involved Dominion buyers." Further, the company is cited for its loan violations: "In 2002 and 2004, HUD randomly selected 42 Dominion loans and found violations in 22 cases, some of which had more than one problem."
Al, the debtor's pal
Against this backdrop of abuse, the story quotes one brave Columbus appraiser named Lori Austin: "Nobody's looking out for the buyer." Well, that, in fact, is true. No one is looking out for the buyer. The process was created by Easy Al trying to bail out the stock bubble by taking rates to 1%. Folks got caught up in taking the equity out of their homes, as if they were on-site ATMs. Rising house prices attracted speculation. Lenders abdicated all responsibility -- dropping standards so low that folks could buy a house and even walk away with cash, much less put zero down -- thereby creating the credit bubble that has precipitated the problem we now have.
This story illuminated the plight of the Alonsos, who don't appear to have been greedy. Sometimes folks who are on the innocent side wind up getting hammered. (It's not always greed that leads to destruction. Often, just being naive will do it.) Though the Alonsos hadn't planned on spending more than $140,000, a Dominion salesman showed them how they could buy a house for $189,900, of which they financed $187,500. The family was able to shoe-horn into the loan with a creative financial package.
Meanwhile, the Alonsos were given a low estimate for property taxes, and when they got their first payment notice, the tax increase really stung: "'I about croaked,' said Mrs. Alonso." Of course, increasing property taxes hurt their neighbors, too. As of a month ago, 10% of the houses in the Galloway Ridge development, were either in foreclosure or had gone through foreclosure.
The Alonsos now find themselves with a house that cost $189,900 in 2001 and now can't be sold for that price. The real-estate agent has told them that if they really wanted to sell it, they'd have to knock off about $30,000 from the asking price.
Nehemiah: Rebuilding Jerusalem's walls . . . and yours
Alongside that front-page story, the Columbus Dispatch ran "Loophole Fuels Zero-Down Mortgages," which illuminated a wrinkle I was unaware of:
"Homebuilders across the country, including Dominion Homes, have found a way around a Federal law barring sellers from giving money directly to buyers for a down payment. They route the money through charities such as the Nehemiah Corp. of America, a faith-based group in California. Nehemiah provides down payments for both existing and new homes, and its relationship with Dominion is the largest of its kind in central Ohio between a builder and charity.
"Nehemiah uses a loophole in federal regulations that allows charities to provide the 3% down payment required to qualify for Federal Housing Administration mortgages. An uncounted number of copycats have followed, leading to an explosion of 'zero-down' loans. Federal authorities do not regulate or track such organizations."
The Alonsos' story is about just one family in one property development, singling out one homebuilder and one abusive financial scheme. There are undoubtedly many, many variations on this theme, and the full story won't be written until the housing bubble really unwinds -- much as we didn't find out about Enron, WorldCom, and those assorted problems until the tide went out on the stock mania.
Financial flotsam and jetsam
When the tide goes out on the housing mania, it will reveal lots of bad debt, both for folks like the Alonsos to choke on and for financial institutions to have to eat. In writing those bad loans, financial institutions will become progressively less interested in lending. That will further cut off credit to the housing market, thereby exacerbating the problems as they unfold.
That house prices have gone up a lot is not in itself the problem. If they'd risen in an environment where folks were behaving prudently with their financing arrangements (i.e., putting 5%, 10%, 15% or 20% down and taking out 10-, 15- or 30-year mortgages), we might be set up for a dip in prices, as has occurred from time to time. But that's not what we'll witness, thanks to the complete abdication of responsibility on the part of financial institutions, where seemingly no loan was turned down. Thus, those of us who talk about a housing bubble are really referring to a credit bubble.
Anyone home?
That leads me to Alan Greenspan -- the very man who created the conditions for the stock bubble and the housing bubble -- who (1) claimed that real estate couldn't experience a bubble, (2) actually suggested that folks obtain adjustable-rate mortgages as short-term rates were making their lows, and (3) has been unable to realize that the Fed should have been warning banks about their imprudent lending standards.
But if you can't see a problem, you can't try to head it off at the pass -- just as he was oblivious to the bad real-estate loans and junk-bond "investments" that helped precipitate the 1990-91 S&L collapse.
Ironically, in 1985, as a paid consultant to Charles Keating's Lincoln Savings & Loan, Greenspan proclaimed that its management was "seasoned and expert" -- with a "record of outstanding success in making sound and profitable direct investments." He later wrote a letter to Edwin Gray, then-chairman of the Federal Home Loan Bank Board, telling Gray to "stop worrying so much," and "that deregulation was working as planned." Greenspan noted 17 S&Ls that had just reported record profits. Within four years, 15 of those 17 institutions were out of business, costing the Federal Savings & Loan Insurance Corp. $3 billion.
Just as the masthead of my daily column says "All roads lead to inflation," by my reckoning all financial problems lead back to Greenspan. I have not penned a Greenspan rant in some time. Given all the focus on his speech last week -- and the fact that he's getting ready to ride off into the sunset -- I will have a special follow-up column tomorrow to reprise his comments. Stay tuned.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC or MSN Money.
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