Wednesday, August 23, 2006


Bubbles last longer than you expect, and deflate faster than you expect. Has the US housing bubble finally popped? Will it be a hard, soft or hard-soft landing? The Fed is clearly convinced the housing slowdown is well underway, and that it will reduce inflation and economic growth.

The WSJ reports today on some of the associated mayhem. It's anecdotal journalism, but backed up by statistical data as well.

PIMCO's Bill Gross has been betting on a slowdown for some time -- and taking the pain while waiting. This article describes how hard trading can be, even for a superstar like Gross. Another interesting tidbit is that PIMCO actually sends out researchers posing as house buyers to test markets around the country.

Excerpts from both articles below.

"It would be difficult to characterize the position of home builders as other than in a hard landing," says Robert Toll, chief executive of luxury home builder Toll Brothers Inc., which reported yesterday that net income fell 19% in the third quarter ended July 31. (See related article.)

In his 40 years as a home builder, Mr. Toll says, he has never seen a slump unfold like the current one. "I've never seen a downturn in housing without a downturn in employment or... some macroeconomic nasty condition that took housing down along with other elements of the economy," he says. "This time, you've got low unemployment, you've got job creation, you've got a stable stock market and relatively low interest rates."

Joan Guth is one homeowner who was taken by surprise. Last September, she put her stately five-bedroom home in Herndon, Va., on the market for about $1.1 million. She was confident she would get something near that price, and planned to use the proceeds to buy a retirement home in Florida. But her home in the Washington suburbs attracted few serious lookers, and in March, she cut her asking price to $899,900. Still there were no takers. Finally, on the advice of her broker, she called in an auction firm, beginning a process that would eventually reveal to her just how weak the Northern Virginia market had become. [Eventually, she gets only $500k!]

...In a speech yesterday, Michael Moskow, president of the Federal Reserve Bank of Chicago, noted: "While we factor a housing slowdown into our outlook, there is some evidence -- such as higher rates of cancellation in home-building contracts -- that the slowdown could be more extensive."

With fewer consumers applying for home loans, some big mortgage lenders are already retrenching. Countrywide Financial Corp. last month announced plans to reduce costs by $500 million. Earlier this year, Washington Mutual Inc. eliminated 2,500 jobs at loan-processing centers.

Builders, who were optimistic about prospects until a few months ago, are cutting back too. KB Home, a big home builder based in Los Angeles, has eliminated 7% of its work force, or 440 jobs. In July, U.S. home builders started construction at an annual rate of 1.45 million single-family homes, down 20% from the January peak.

Last August, when Horsham, Pa.-based Toll Brothers reported that its quarterly profit had doubled, Mr. Toll boasted: "We've got the supply, and the market has got the demand. So it's a match made in heaven." Since then, Toll has cuts its guidance four times on the number of homes it expects to close on, and its share price has fallen by more than 45%. Yesterday, the company said orders for new homes in the third quarter were down 48% from a year earlier.

...At D.R. Horton Inc., the nation's largest home builder by units built per year, executives said late last year they were confident that quarterly earnings would continue to increase even during a housing-market slump. In July, Horton reported a 21% decline in net income for the third quarter ended June 30, the first quarter in 28 years in which it didn't report year-over-year profit growth. Horton's chief executive, Donald Tomnitz, said the surge in home prices had priced many people out of the market.

"Every time we've gone into a downturn in the home-building industry, they've always been longer and deeper than we've all imagined," Mr. Tomnitz told analysts in a July 20 conference call. "So we're preparing for the worst, and we think this one will be longer and deeper than just the last six months."

Bill Gross is Wall Street's long-reigning bond king, but he is struggling to adapt to a new world.

For more than three decades, Mr. Gross, the 62-year-old chief investment officer at Pacific Investment Management Co., which has $617 billion in assets, has run the world's largest bond mutual fund. In that time, the $95 billion Pimco Total Return Fund has handily outpaced both the bond market and almost all of its competitors. In 2000, when Germany's Allianz AG bought Pimco, based in Newport Beach, Calif., it was so eager to keep Mr. Gross at the helm that it agreed to a pay package valued at about $200 million to keep him around through next year.

As hedge funds and other investors have been scooping up riskier bonds with the highest yields, however, it has been harder for Mr. Gross to beat the market by buying this kind of debt.

...At the same time, Mr. Gross has taken a contrarian view for many months, predicting a slowdown for the economy and an end to the Federal Reserve's campaign to raise interest rates. For much of the year that stance didn't work. The losses, and the added volatility, took a toll on Mr. Gross, a soft-spoken manager who usually keeps an even keel by practicing yoga.

A month ago, with Pimco's bets misfiring, Mr. Gross was so stressed that he left the office, taking an unplanned vacation, sitting at his home with his wife, he says.

"I just had to leave for nine days, I couldn't turn on business television, I couldn't pick up the paper, it was just devastating," Mr. Gross says in an interview at Pimco's headquarters, near the Pacific Ocean. "We've increased the volatility [of the portfolio] but I'm not enjoying it. You can't sleep at night."

...Now, his predictions that the housing market would slump and the economy would suffer are starting to show signs of materializing, sending the bond market on an impressive rally that has sent the benchmark 10-year yield -- which moves in the opposite direction of its price -- down to 4.817% yesterday from 5.25%, since June 28.

...Mr. Gross remains bullish on bonds, which tend to do well in a slowing economy, in part because weakness in the housing market will discourage the Fed from raising short-term interest rates -- and could even get them to cut rates in the year ahead, he says. Mr. Gross collects reams of data on the housing market and reads it at home on the weekends, and Pimco even sends "shoppers" to key markets across the country to pose as home buyers and pick up intelligence on where housing is going.

Part of his concern stems from the aggressive adjustable-rate mortgages he has seen many consumers -- including two of his children -- take on. He isn't sure they will be able to handle the monthly payments when the interest rates on these mortgages adjust higher.

"We could really see a drop in home prices that hurts the economy," he says.


Anonymous said...

As I see it, there are four major reasons to buy: roof over your head, prefer to be in a place you own (you can paint your living room purple, or plant a tree and know you are there to watch it grow), place to store your money, and hope to make money. All four have been attractive until recently, though the second has always been sort of idiosyncratic (maybe you are perfectly happy with white living room, and you like having landlord come and fix your leaky toilet). Now #4 is not looking good at all. This drags #3 down with it - cheery how-to-sell-it articles suggest sellers offer a new Jeep to buyers and that it can take 6 months to sell, when was the last time you had to give your mutual fund manager a new Jeep and wait six months before you could withdraw money? And the aggregate cost of roof-over-your-head has to include, besides comparison to what you would pay in rent, any losses from decline in property value, or even if dollar price is stable, from paying 5% on a mortgage versus making 3% on mutual fund.
These things can turn on a dime, and I think they have.

Anonymous said...

Here in San Diego, I'm still getting solicitations from people who have recently left other careers to become... you guessed it.. real estate agents. There must be a great need for real estate agents, because about five of the homes on my block have for sale signs in front of them (and have for a while).

Anonymous said...

It seems suprising that at $200M/yr, Bill Gross can not serve as a loan source for his children. Of course, his children may be contrarians, using ARMs to "flip" houses.

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