Market Report: February 2009

Housing in the Age of Empiricism

The political center of gravity has shifted from Wall Street to Main Street. The citizenry did not benefit from the first 350 billion dollars hurriedly tossed out by the last administration on their way out of town. Mr. Paulson, the ex-Secretary of the Treasury, failed to remember that in our free enterprise system you take no prisoners. The group of geniuses who run the nation’s largest financial institutions used Bailout I to preserve stockholder value and their jobs, but I am not sure of in what order.

This initial payment was hamstrung by haste and ideology. What appeared to be a good concept, a variant of the trickle down theory, was clearly unworkable during times of fear and panic. Considering the perilous state of the banks, Mr. Paulson should have foreseen the outcome. As I have argued in this column, the root problem lies at the bottom of the economic food chain but helping troubled homeowners, so it was argued, was seen as too complicated a task.

To make matters worse, absent massive government intervention, there will be a second tsunami of foreclosures over the next three years involving mortgages of better quality than those of the sub-prime variety. There are legions of these Alt-A and Option ARMs loans whose payments will substantially increase this year. Some economists have predicted that 70% of these mortgages will end up in default and if so, the effects on housing prices and on the economy would be catastrophic.

Predicting anything is problematic in these turbulent and unprecedented times. Even if Treasury and that FDIC halt foreclosures, by any number of tactics, their efforts could be subsumed by a contracting economy. Banks are the key players and their collective reluctance to loan money reflects the fact they are in survival mode. Taxpayers are left with two poor choices; either buy at face value all of the ‘toxic assets’ that are crippling the banks or fully nationalize them.

There is ample precedent for the latter in times of national peril. For example, in 1944 the government seized Montgomery Wards, then a huge player in the mid-western and wartime economies. Sewell Avery, the chairman of the Ward’s board, refused to settle a labor dispute that crippled both the mid-western economy and the flow of supplies to the military. One of the most striking photographs from World War II shows two soldiers carrying an unrepentant and resistant Mr. Avery from his office after the Feds seized his company. And of course you know the Freddie and Fannie story from last year. The stock market is also betting on nationalization judging from the sell-off of bank stocks last month.

I think we will be spared the sight of an overpaid CEO being dragged from his office in the event nationalization comes to pass. (He would have already taken his leave via a private helicopter) An accommodation, lubricated with huge amounts of Federal money, will be arrived at by this summer. There will be new government-bank partnerships created to free up credit and avoid seizures. The flow of credit will resume and, among other efforts, do more to stabilize housing prices than any other course of action.

The housing market reflects this disarray on a local scale. Buyers are paralyzed because of two fears, job security and possible deflation. Normal and ordinary consumer patterns may re-emerge after two or three years although there is a question, which is very important for real estate, if some new spending behaviors come to pass. Consumers represent seventy percent of the America economy and we have made a national decision to save more and spend less. This behavior, while laudable, is as dangerous to the economy as the credit freeze. Unless banks and consumers start moving money around, healthy cities will start to resemble Detroit.

The first step to stabilizing home prices begins by normalizing the retail and wholesale credit markets. Unfortunately Wall Street remains tone-deaf to political reality that arose from the ashes of their feckless policies. The new President, the ultimate empiricist, understands this and has the political capital to enact Draconian banking reforms. He has little to fear from his political opponents as corporate America has ceded the high ground by their reckless bonuses and horrid job performance. The Federal Government has, to a degree, already semi-nationalized parts of the financial system and will continue to do so until this economy stabilizes.

As of this writing, it is not clear exactly how Mr. Obama will find a good solution for housing prices. There are early signs that lenders are throttling back their foreclosure machine clearly anticipating some additional Fed assistance. I agree with the administration that the problem needs to be attacked at all levels, in particular a short term and deferred interest rate reduction I differ in that I think most stimulus funds should go only one place only, jobs. Forget tax cuts, they will just end up in the bank.

If the leaders of the financial community fail to act somewhat in the national interest, they too will be carted out of their executive suites. Daily the Feds are increasing their ownership stakes in the banks and the drama is far from settled. Without a free flow of credit, there will be more unemployment. It will come down to lend or be seized; the rest of the recovery is up to us.

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