To say that it’s been a crazy week is a gross understatement. Let’s recap some items:
- U.S. takes over AIG with a $85 billion bailout. This agreement states that the government is providing AIG with a loan $85 billion over a two year period, offered at 11.5%. The government also gets 79.9% equity ownership in the company. It appears at the moment that AIG’s ability to pay claims is intact.
- Lehman Bros. goes into bankruptcy and the credit markets froze, basically on concerns that other companies were going to fail.
- RTC2? Government has announced a plan to take failed assets off the books of companies, essentially by establishing a fund, similar to the Resolution Trust Corporation (RTC) that was formed during the savings and loan scandal in the late 1980’s. The cost is expected around $500 billion. The two part plan covers the private label mortgage securities underwritten by Wall Street and the already approved purchases of government backed mortgage securities, ie Fannie and Freddie. In theory it looks like the government would purchase the securities at deep discounts and maybe hire a manager to oversee the portfolio and their hope is that the enterprise eventually makes money. This plan requires Congressional approval and the details are not there yet. In case you are wondering….the net result of the RTC was a loss of about $125 billion to taxpayers.
- Last night the SEC announced it’s stopping short selling on 799 financial companies until October 2. This is a controversial decision so I’m sure there will be more to come on this one.
- Credit markets still under siege, despite the $180 billion infusion from the world’s major banks. The 3 month Treasury bill actually traded at 4 basis points, .4% a few days ago. You have to look back to the 1930’s to find T-bills under 10 basis points.
- Two money market funds traded under $1 earlier this week and it led to $89.2 billion being pulled out of money market funds on Wednesday…..I’m sure that was a record.
- Secretary Paulson announced that the government would offer to temporarily insure money market funds.
- European stocks liked the news, especially when the UK issued a ban on short selling of financials through January 2009.
- Dow is up, but keep in mind there’s lots of short covering going on today in light of the ban.
On the housing front…….Has the housing market hit bottom?
While some are comparing this real estate cycle downturn to the real estate downturn in the 1990’s, they are vastly different. The down turn in the 1990’s was driven by very high unemployment and regional factors.
In terms of past history there have been a couple of factors that should be taken into consideration. First, the relationship between incomes and home prices—home prices can only rise so far above income-based affordability before an adjustment period kicks in. Over the long haul, homes must be priced at levels buyers can afford. July’s median house price was $204,000. Assuming a 6.4% mortgage rate, that works out to an initial after-tax monthly payment of $795, or 20.7% of after-tax income, which historically is a relatively low share of median family income. Second, we can look at the number of new-home sales per 1,000 of population, which hit a high of 5.7 at the peak in 2005 and has since plunged to 2.2, just above the all-time low of 2.1 in 1982, after which we saw a rebound.
Existing home sales rose 3.1% in July—the largest increase in 17 months and well above expectations. On the surface this looks great, unfortunately the large number of foreclosed properties being sold at distressed prices is drawing significant buyers into some markets, lifting sales.
In some areas, foreclosures are increasing, housing inventories are higher than normal, and even well-qualified borrowers cannot receive mortgage loans. It’s become clear that credit availability will be a significant factor in a housing rebound as well as regional factors.
Another concern is that homeowners with good credit are beginning to fall behind on their mortgage payments. The percentage of Alt-a mortgages(one step above subprime) behind on payments has quadrupled since last year, while delinquencies among prime loans have doubled over the same period.
There are about $1 trillion in Alt-A mortgages outstanding (compared to $855 billion of subprime loans), with over 16% currently at least 60 days in arrears. Many of these loans were interest-only with the rate resets at three- to five-year intervals (“option ARMs”). Beginning next year, we will see a wave of resets with jumps as high as 4% to 8% from their initial rates. Many monthly payments are set to double!
Given all of this information......no we have not hit bottom.
While what we are going through is different in some ways from past scenarios our take away should be that our financial markets have always pulled through. In light of that information if you are a home buyer be advised that there are deals out there and I think there will continue to be deals for some time.
At the end of the day, your decision to purchase a home should be based on your specific situation. If it makes sense financially(consult with your CPA) and you find a well priced home, you should buy. Waiting for the bottom of the housing market is not all that different from waiting for the bottom of stock market.
