The housing bubble has popped

Reports of falling sales and investors stuck with properties they can't sell are just the beginning. Property owners should worry; so should their lenders.

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A recent story in the Wall Street Journal, "Hot Homes Get Cold" (subscription required) offered lots of its useful vignettes that serve as a microcosm of manic markets -- starting with the bravado-cum-denial displayed by a medical-equipment salesman in Stuart, Fla.

Concerned about his real-estate investment apparently going sour, he can't afford to reduce the price to what homes now sell for in his neighborhood -- which is about $100,000 less than he's asking. Says the salesman: "If I got in a jam, I would have to drop the price, but I am not at that point." His game plan: Rent the house, so as not to "lose my shirt."

That's the mentality often seen in manic markets -- the belief that you can't possibly lose, and, when the price goes against you, you don't have to deal with it, because it will come back. This fellow (and millions more like him) is going to find out that his belief is a mistaken one, in the same way that folks did when the stock bubble burst.

Dwelling takes a little shelling
The story went on to note that many formerly hot markets in California, Arizona, Washington, D.C., and Florida are now "languishing without buyers or even prospects. Many once-booming markets are seeing double-digit declines in sales." The magnitude of the drop in Florida home prices (once the frothiest market in the country) is striking. Single-family home sales declined 20% in February, year-over-year. Similarly, California sales dropped 15%. Some of the hottest towns in those states were off twice as much.

I loved the point that what seems to be really alarming is how "real-estate agents in some of these formerly red-hot markets have been surprised at how suddenly (my emphasis) market conditions have deteriorated in the past few months." Of course, that's what happens when manic markets and bubbles turn. Prices change radically and, seemingly, for no reason.

Many people will say that the real-estate market has turned due to higher interest rates, and rising rates have hurt. But the real-estate market ignored rates going up for quite some time. Its topping was caused by exhaustion. Same with the stock bubble -- many folks think it was rising rates that caused the implosion. That isn't true. The stock bubble ran until it popped in March 2000, having ignored everything up to that point.

Symptoms of the doldrums
To me, it's not debatable that the real-estate bust is starting to gather steam. The top was approximately when Time Magazine published its June 12, 2005, cover story: "Home $weet Home: Why We're Going Gaga Over Real Estate". (For more, check out my June 13, 2005, column, "Straight talk on what the Fed has wrought," and my Aug. 29, 2005, column, "It's RIP for the housing boom.")

After having leveled off for a while, the real-estate market is now starting to slide. We're seeing signs of sales slowing and inventory accumulating, which are all quite classic, even though the timing of when this would begin was not possible to predict in advance.

Continuing on, the article noted that Florida is "ground zero for the housing market" and as good a laboratory as any to watch. The real power behind the housing bubble, i.e., irresponsible lending, was "exacerbated in Florida." Quoting from Mark Zandi, chief economist at Moody's Economy.com: "There were more lenders, more realtors, more foreign investors" than the rest of the country -- which is how a hot market gets really wild.

The story cited the plight of investors who'd purchased homes in formerly hot housing developments that now resemble "ghost towns." One such individual is Paul Zani (no pun intended, I'm sure), who'd bought a couple of condos, listed them for more than he paid and now can't sell them. However, he doesn't want to reduce the price (even though he'll probably have to). This mentality is an example that many real-estate "investors" seem to share -- heads we win, tails the bank loses. (Some people are sanguine these days because, as the article notes, "while sales are slackening, they aren't collapsing." To that, I would add: "Yet." They will.)

By and by, heartburn for the bankers
It is indeed the financial institutions that are most at risk in the real-estate market (which is not to say that consumers and speculators won't get hurt). The lenders will bear the brunt of the pain, because in many cases, they loaned the entire purchase prices of many homes. As I have said often, the housing bubble has been more a lending bubble. It will be the impairment of the financial institutions that will stop the flow of credit to the real-estate market. In turn, that will accelerate the collapse in house prices somewhere along the way.

The story closed with a description of how slow the market has recently become in Florida -- via the following comments in an e-mail by real-estate broker Mike Morgan: "We went three days this week with not a single showing. That's incredible. I have 35 listings. We usually get 2-6 showings a day. ... I received more desperate calls from sellers than ever. One lady broke down into tears. Her husband bought two investment properties, and they are now going to lose their 'life savings' if they sell the homes in today's market."

Ladies and gentlemen, unfortunately, a lot of people around the country are going to be badly hurt as this bubble unwinds. And, after they have taken their losses, the financial institutions that were the engine behind this folly will take their own hits. 'Easy Al' Greenspan at the Fed tried to bail out one bubble with another bubble. While it bought some time, it will end in far-worse pain.

A vision of mean reversion
Finally, a recent edition of The Liscio Report, the economic newsletter, put into perspective how wacko the current climate is. It said that the ratios of (a) stock value to GDP and (b) real-estate value to GDP are both nearly twice their averages from 1952 to 1970. As the report noted: "If mean reversion still has any role in market valuations, then both markets have plenty of room to fall."

Since the name of my investment partnership is the RTM Fund (which stands for "reversion to the mean"), I obviously believe that plenty of mean reversion lies ahead.

Russia’s planned oil pipeline to Asia will help cut deliveries to Europe, which is currently being oversupplied with Russian crude, the head of Russia’s pipeline monopoly Transneft told a newspaper, the Reuters news agency reported.

“We have overfed Europe with crude. And every single economic manual says that excessive supplies depress prices,” Semyon Vainshtok told the daily Nezavisimaya Gazeta in an interview published on Monday.

“As yet we cannot reduce supplies, as all our exports are going to Europe. But as soon as we divert (flows) to China, South Korea, Australia and Japan, that will immediately take away crude from our European colleagues,” he added.

Vainshtok has repeatedly said that building a pipeline to Asia would help diversify Russian oil flows and cut discounts on the country’s mainstay Urals crude blend in European markets.

His new comments are likely to come under much closer scrutiny after another Russian monopoly, state gas behemoth Gazprom, shocked Europe last week by saying it would supply gas elsewhere if its expansion in Europe was blocked.

The European Union said Gazprom’s threats only confirmed Europe’s views that it needed to diversify its energy imports.

Russian critics say Gazprom’s comments mean the Kremlin is increasingly active in using energy as a weapon in a situation when Europe relies on Moscow for a quarter of its gas needs and Russia produces every ninth oil barrel in the world.

Vainshtok said Transneft planned to use a shipping fee of $38 per ton of crude oil on the Asian-Pacific pipeline route to make it competitive with current fees paid on the route to the Black Sea port of Novorossiisk.

The $11.5-billion pipeline will ship 600,000 barrels per day at the first stage, mainly to China, with supplies rising to 1.6 million bpd at the second stage, when a big terminal is build on the Russian Pacific coast.

Vainshtok said his firm would borrow 13.4 billion roubles ($487.1 million) from state bank Sberbank and another $2 billion via a five-year loan from Western banks. The firm had previously planned to borrow up to $6 billion from Western banks, led by Barclays.

Beijing's desire for a Saudi-fed strategic oil reserve in China underlines the Asian nation's drive to secure crude supplies amid rocketing energy prices, analysts here said.

However, they added that any deal between the two nations was unlikely to put pressure on global crude inventories.

Chinese President Hu Jintao discussed a proposal to set up an oil stockpile in China during a weekend visit to Saudi Arabia, a Chinese official said Sunday.

China plans to fill the first of its strategic oil reserve facilities by the year end, a senior planning official said in March, adding that three other reserves would be ready in 2007-2008.

China had planned to begin accumulating oil reserves, which are to be used in the event of an emergency, last year.

However with oil prices soaring to record high points -- New York crude matched its record high of 75.35 dollars per barrel on Monday -- China has been forced to delay its plan by almost two years.

China knows it cannot delay for ever with its energy demand accelerating owing to the country's economic boom. Consumption of oil in China is forecast to jump 6.0 percent this year after consumption of 6.4 million barrels per day in 2005.

"The Chinese authorities are quite familiar with how their domestic production is being outstripped by demand, and that there's always going to be a measure of vulnerability and reliance on foreign production," Global Insight analyst Steven Knell said.

"Having strategic reserves creates a buffer that will allow them to mitigate some of the sharper consequences of that reliance should there be any disruption of supply," he added.

The China-Saudi plan was raised during Hu's talks with King Abdullah on Saturday and both sides want to see it through, the Chinese official told AFP, requesting anonymity.

The reserve would be on top of the oil supplies Saudi Arabia exports to China for its daily needs.

Saudi Arabia is the world's biggest exporter of crude oil and the biggest supplier to China, which imports about 15 percent of its oil from the Arab nation.

Knell said he believed such a tie-up between the two countries would unlikely hurt major oil consumers such as the United States and Europe.

"Given the volume of this facility, I don't think it's going to make such a difference. It will come as a separate delivery, on top of the current demand, but the scale will not result in major shortages elsewhere or compromise other deliveries," he said.

"The most profound impact will be on the Chinese domestic market. This is another contribution to the reserve capacity that they've thought for some time and they've actually been vulnerable for so long that this makes a very positive step for the stability of their energy balance."

According to the Chinese spokesman, the reserve would be set up in a coastal city in southeast China.

The official did not say how much oil would eventually be stockpiled. But he said Riyadh and Beijing were discussing the feasibility of the plan and ways of cooperating to carry it out.

Calyon analyst Mike Wittner doubted also that there would be any major impact on global supplies, and therefore prices.

"I don't think it has any significance for the short-term market, and perhaps not even for the longer term," he said.

"Saudi Arabia is already a large and growing supplier of Chinese crude oil imports, and this is a logical development and a logical extension of that trend," he said.