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Profound John Hussman Column Today
Old 06-01-2010, 11:52 AM   #1
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Profound John Hussman Column Today

Hussman Funds - Weekly Market Comment: Oil and Red Ink - June 1, 2010

...before the housing crisis, it might have been tempting to shrug off mortgage defaults as relatively isolated events, since the price of housing had generally experienced a long upward trend over time. Indeed, historically, sustained declines in home prices could be shown to be very low probability events. But as the bubble continued, investors made little attempt to assess the probability of a debt crisis given that home prices had become detached from all reasonable metrics of income and ability to pay. Just as buy-and-hold investors assumed that the long-term return on stocks was constant at about 10%, despite the late 1990's valuation bubble, investors during the housing bubble kept looking at the "unconditional probability" P( credit crisis ) based on decades of normal housing valuations, when they should have recognized that the conditional probability P( credit crisis | extreme housing overvaluation and lax credit standards ) was probably higher. This turned out to be a profound oversight.
But that was evidently not a sufficient lesson. As soon as the surface appearance of the problem was covered up by an expensive and opaque band-aid of government bailouts and suspension of accounting transparency by the FASB, investors went right back to using those unconditional probability estimates. Indeed, until the spike in credit spreads that began a few weeks ago, the amount of additional yield investors demanded for taking credit risk had fallen back to the lows of 2007. We've had a major credit crisis, we have failed to restructure the debt underlying that crisis, and yet investors are approaching the market as if the debt has simply been made whole and we can continue along the former path.
Knowing that the cash flows from mortgage payments cannot possibly be adequate to service the original debt, that delinquencies continue to hit new records, and that there is an enormous overhang of nonperforming debt and unforeclosed homes - it seems utterly naive to assume that the problems we saw over a year ago have been adequately addressed.
What holds for oil also holds for red ink. Disasters contain information.

It is so tempting to assume that this big awful thing happened, and here we all are, not much the worse for the experience. It is tempting because this type of thinking is hardwired into humans. This exact sentiment has been expressed on this board and elsewhere over the past year.

But as Hussman's analysis demonstrates, this is likely not the correct way to assess the true probabilities of more trouble ahead.

Ha
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Old 06-01-2010, 12:18 PM   #2
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makes me feel better about making our own assessment of the value of places we buy or loan on based on our experience with rental rates rather than going with an appraiser's value. also makes me feel less like a Shylock about the rates we charge.
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Old 06-01-2010, 01:04 PM   #3
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hussman gets it. the shadow housing inventory will cap any rebound...and the suspension of mark to market...in favor or mark to fantasy -

these two items are very important (bold):

Still, mortgage losses are based on actual delinquencies and losses taken in foreclosure, not on seasonally adjusted data, however bad. For that reason, we will be most attentive to the actual delinquency and foreclosure data that will be reported in the coming months.

There is an enormous inventory of delinquent but unforeclosed homes in the system, as well as unsold foreclosure inventory (amounting to an overall total that is about twice the entire number of homes that that have completed foreclosure since 2007).

The underlying mortgages are not performing, and the inventory will ultimately come onto the market, which may put even more existing mortgages underwater.

Of course, investors hope to ignore the solvency problem to some extent, since the FASB has obscured accounting rules to allow Madoff-like disclosure. Even if the latest proposal by the FASB to restore mark-to-market survives the outcry of the banking industry, it would not be implemented until 2013.

Why should we care if banks actually are solvent as long as they tell us they are solvent? This is an open question, but only if one can be certain there is a greater fool available. We prefer not to make that assumption. For our part, the negative shift in market action suggests that we should be wary of complacency.
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Old 06-01-2010, 01:25 PM   #4
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Ha, my expectation is that housing values on average will flatline (more or less) for years to come, likely becoming cheaper in real terms. Hard to see appreciation is anything but isolated markets.
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Old 06-01-2010, 01:32 PM   #5
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We recently bought a house in a high foreclosure area. My immediate neighborhood was built out in 2001 and there are very few foreclosures...or homes for sale for that matter. We paid roughly 50% of the market high valuation and a little less than it originally sold for in 2001. It was a distressed sale, but not a foreclosure. We really like the area and plan to live here for at least the next 10 years. There are a lot of seniors in the area, but it's not located in a retirement community.

Here's what I can't wrap my head around...I keep reading about all of the foreclosures in the pipeline here, yet I'm seeing new SFR houses being built. I know all about "location", but what are they going to do with all of the SFR houses in the foreclosure pipeline. Doesn't look like anyone's thinking about a price "reset" except for the foreclosed properties. Now that you have to qualify for a loan, the pool of potential buyers is a lot smaller. I may be a simple person, but this doesn't look good to me.

OTOH, commercial construction is picking up, too. So...maybe I should get out my rose-colored glasses and tap my foot while I wait for my house value to go back up.
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Old 06-01-2010, 01:58 PM   #6
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Here's what I can't wrap my head around...I keep reading about all of the foreclosures in the pipeline here, yet I'm seeing new SFR houses being built. I know all about "location", but what are they going to do with all of the SFR houses in the foreclosure pipeline. Doesn't look like anyone's thinking about a price "reset" except for the foreclosed properties. Now that you have to qualify for a loan, the pool of potential buyers is a lot smaller. I may be a simple person, but this doesn't look good to me.
This would seem to be an anomaly, but I saw an interview with a large builder in Las Vegas. He says that buyers with down payments and financing prefer new to what is currently available used at the prices at which both are being offered. Since there is no housing czar, we get new subdivisions while only slightly older ones are being de-populated.

Ha
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Old 06-01-2010, 01:59 PM   #7
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So, other than not investing it real estate, what's a person to do? I bought my house to live in, not as an investment. I guess I'd be upset if the value plummeted so much that I could rent cheaper somewhere else. So far that hasn't happened.
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Old 06-01-2010, 03:04 PM   #8
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There is an enormous inventory of delinquent but unforeclosed homes in the system, as well as unsold foreclosure inventory (amounting to an overall total that is about twice the entire number of homes that that have completed foreclosure since 2007).

The underlying mortgages are not performing, and the inventory will ultimately come onto the market, which may put even more existing mortgages underwater.
And it may be spread out over a very long time:

For Some Homeowners in Foreclosure, a Rent-Free Approach - NYTimes.com

And, I suspect, it will come in waves.
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Old 06-01-2010, 03:29 PM   #9
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And it may be spread out over a very long time:

For Some Homeowners in Foreclosure, a Rent-Free Approach - NYTimes.com

And, I suspect, it will come in waves.
Quote:
The average borrower in foreclosure has been delinquent for 438 days before actually being evicted, up from 251 days in January 2008, according to LPS Applied Analytics.
More than 650,000 households had not paid in 18 months, LPS calculated earlier this year. With 19 percent of those homes, the lender had not even begun to take action to repossess the property — double the rate of a year earlier
I find Hussman very logical and so obviously true, I am always wondering how the markets continue to value assets as if all problems have been solved.

There is a common belief that since the Federal government is backing all the home mortgages in America now that they are no longer a problem. The fact that foreclosures have gotten to a backlog means when they begin to start up price declines in homes will accelerate as the realization hits that homes will not recover as the stock market did.
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Old 06-01-2010, 03:46 PM   #10
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Housing was going to tank in many states/regions even if we had not had the bubble. There are a lot of baby boomers retiring and downsizing, and much less people in the demographic needed to buy these houses.

The generations following the boomers are poorer as well. Even if the numbers were there to buy all the supply, the money needed to buy them wouldn't be.

If people think housing is bad now, just wait five or ten more years and it will be worse.
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Old 06-01-2010, 03:52 PM   #11
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All of which tells me that LBYM and being able to wait to pay cash or close to cash for all of a purchase will be good strategies for real estate in the near future. As a previous poster said, I buy a house to live in, not as an investment. YMMV.
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Old 06-01-2010, 03:54 PM   #12
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So, other than not investing it real estate, what's a person to do? I bought my house to live in, not as an investment. I guess I'd be upset if the value plummeted so much that I could rent cheaper somewhere else. So far that hasn't happened.
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Old 06-01-2010, 04:24 PM   #13
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This data may have changed but I remember reading that 25% of baby boomers own a second home. When baby boomers get ready to sell, they are going to find few buyers. Generation X is tiny and Generation Y is just entering the job market.

This is kind of off-topic but one data point that has stuck in my mind is that roughly 50% of STEM (science, technology, engineering, and math) workers are baby boomers. I look forward to jacking up my rates, way the hell up, 10+ years from now when employers get desperate.

There will be a lot of outsourcing, but that will only go so far. The entire developed world is facing a skilled labor shortage, and the developing world isn't going to have the skills/education to fill it, at least initially.

Besides there is only a small percentage of the human population that is smart enough to go to college and a far smaller number that can graduate in a STEM field. As the developing world becomes first world, the old first world countries will no longer be able to brain drain these countries. Those people will stay in their home countries and the US with it's 50% foreign science graduate students will be a thing of the past.

The wages for smart STEM people are going to rise all over the world.
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Old 06-01-2010, 04:35 PM   #14
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This data may have changed but I remember reading that 25% of baby boomers own a second home. When baby boomers get ready to sell, they are going to find few buyers. Generation X is tiny and Generation Y is just entering the job market.

This is kind of off-topic but one data point that has stuck in my mind is that roughly 50% of STEM (science, technology, engineering, and math) workers are baby boomers. I look forward to jacking up my rates, way the hell up, 10+ years from now when employers get desperate.

There will be a lot of outsourcing, but that will only go so far. The entire developed world is facing a skilled labor shortage, and the developing world isn't going to have the skills/education to fill it, at least initially.

Besides there is only a small percentage of the human population that is smart enough to go to college and a far smaller number that can graduate in a STEM field. As the developing world becomes first world, the old first world countries will no longer be able to brain drain these countries. Those people will stay in their home countries and the US with it's 50% foreign science graduate students will be a thing of the past.

The wages for smart STEM people are going to rise all over the world.
Good analysis.

Ha
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Old 06-01-2010, 04:56 PM   #15
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Good analysis.

Ha
Thanks.

The changes that will happen 10+ years from now will be incredible and a lot of it is inevitable due to demographics.

The wage disparities in the future will be tremendous. The college educated and skilled labor are going to have their wages sky rocket, while the unskilled jobs will face competition from robots. Robots are going to be doing a lot of the manual labor jobs. As an example, below is a youtube video of a fast food restaurant in Japan that uses robots. This kind of thing will be common place.

I don't want to depress anyone but I believe the future of the US will look much like that of Brazil. Massive sprawling favelas surrounding modern day cities. The middle class living in gated communities, telecommuting to work.

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Old 06-01-2010, 04:59 PM   #16
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So, other than not investing it real estate, what's a person to do? I bought my house to live in, not as an investment. I guess I'd be upset if the value plummeted so much that I could rent cheaper somewhere else. So far that hasn't happened.
Avoid investing in risk assets that depend directly or indirectly on full repayment of outstanding mortgages.

His point is that the outstanding mortgages, mostly CDOs on bank balance sheets, are overvalued, banks are not financially sound, and we have not completed the transition from “return of capital” to “return on capital”.
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Old 06-01-2010, 05:13 PM   #17
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This data may have changed but I remember reading that 25% of baby boomers own a second home.
25% of 76 Million = 19 Million second homes. Wow, is that correct? That seems awfully high to me. Can you find the source that said this?
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Old 06-01-2010, 05:24 PM   #18
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What about the mortgage holders? When they have to start marking to market, impaired assests will reduce their balance sheets whether they are banks or pension plans. To my way of thinking, this will impact insurance companies and banks. I have no exposure to either sector in my portfolio. I have foregone all the gains since March 2009. But at least I can sleep at night.
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Old 06-01-2010, 05:28 PM   #19
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This data may have changed but I remember reading that 25% of baby boomers own a second home.
I found this from a December 2006 "Study on Housing Trends Among Baby Boomers" by the Research Institute for Housing America:

Quote:
In 2004, there were over 43 million American households comprised of individuals aged 50 and older who owned their main residence, of which 15 percent, or 6.6 million households, also owned a second home.
Quote:
Despite anecdotal evidence, the rate of second-home ownership among 50–60 year olds—the peak demanders for these properties among older households—has remained flat over the 12-year period from 1992-2004. The Early Baby Boomers were no more likely to own such homes than older cohorts of homeowners.
Obviously second home ownership by baby boomers could have increased since 2004 but to get to 19 million (25% of baby boomers) they would have tripled. I suppose it is possible but once again it seems to be more that I would have thought possible.
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Old 06-01-2010, 05:30 PM   #20
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Thanks.

The changes that will happen 10+ years from now will be incredible and a lot of it is inevitable due to demographics.

The wage disparities in the future will be tremendous. The college educated and skilled labor are going to have their wages sky rocket, while the unskilled jobs will face competition from robots. Robots are going to be doing a lot of the manual labor jobs. As an example, below is a youtube video of a fast food restaurant in Japan that uses robots. This kind of thing will be common place.

I don't want to depress anyone but I believe the future of the US will look much like that of Brazil. Massive sprawling favelas surrounding modern day cities. The middle class living in gated communities, telecommuting to work.
Interesting how different from ours(US) the Japanese response to demographic challenges is. They are dead set against immigration, no matter how much it is pushed on them by the rest of the world. So robots substitute for labor. I wonder how the demand side will be handled? I guess if Japan continues to do most of the things it does for export very well, and the US and European and Chinese economies do not go completely to hell it will do well enough. As far as manufacturing, Japan seems to me to be doing better at it with their robots and high quality if smaller work force than the is US with it's UAW. They at least have a plan rather than making a series of poorly coordinated ad hoc responses to crises and pressure which seems to be our typical way of going. And they are not throwing away their blood and money on hopeless and counterproductive wars. Everytime N Korea rattles a saber, the US defense budget goes up.

I also agree with your assessment of what the US urban future might look like. In my city there are very expensive neighborhoods cheek by jowl with supposedly gentrifying but actually very risky neighborhoods. Some of these homeowners spend more on alarm systems than most of us spend on food, phone and cable. And if they didn't they could kiss security goodbye. Once gas prices get going again the historic US response to urban hazard of moving farther out will become more or less unavailable.

One of my sons is a manager in a high tech firm and the other one is a developer. Neither of them has a native born American on his team. Once the Chinese and Indians and Russians start returning or staying home, what are we to do for a brainforce?

Ha
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