Many of you had the chance to catch a glimpse of the 60 Minutes episode this past weekend called, House of Cards. In a nutshell, what has occurred with the housing market is a glorified Ponzi Scheme. The housing market was fueled and pumped by perpetual housing speculation motion. That is, the idea that the home you buy today will be worth a lot more when you sell it in the future. The majority of those complicit in the charade never stopped and asked the inevitable question of how they would react should prices go down.We’ve all had those moments where we let our mind wander and think, where does money come from? Yet the answer is so obvious and disturbing that we erase the thought. The housing market was built on the margin of real asset wealth and speculative hedging. No one is going to dispute that housing has an inherent value to it. Unlike over-the-counter (OTC) stocks that can quickly vanish into thin air overnight, home values will not decline to zero. There is a fundamental and intrinsic value to real estate. And in most places this is determined by local area economics and the ability of people to afford a monthly payment.

With all the talk of blaming lenders, agents, brokers, Wall Street, buyers, and everyone else for the collapse in the housing market, there does seem to be one true culprit in all this mess. Debt. We constantly hear the term “credit crisis” but what we really are facing is a “debt crisis.” I’m not sure when credit became debt but the fact of the matter is American households would have kept the Ponzi Scheme going longer if it wasn’t for the fact that the monthly servicing of their debt crushed them like a ton of bricks. Let us take a look at household debt service as a payment of disposable income:

What you’ll notice is that in the previous 2 recessions debt actually declined during and shortly before the recession officially hit. What happened in 2001 with our brief recession was that former Fed Chairman Alan Greenspan decided to drop rates to an incredible 1 percent creating a negative rate and thus fueling the current debt bubble we are living through. Ben Bernanke risks doing the same. The next chart shows us the exponential growth of debt in this decade:

You’ll notice how the graph takes off in parabolic fashion starting in 2000. We went from the technology bubble of the 1990s to the housing and debt bubble of the 2000s. And unless central banks can find another bubble to inflate, this may be the endgame and decline of the housing market. The following chart shows that the housing market peaked for new homes in 2006:

With this week’s declining housing report, we are trending lower and 2008 will turn out to be the worst housing market since the Great Depression. The blame can be passed around but the reality of all this is the American consumer is maxed out. Incredibly people would buy homes for $1 million so long as someone was willing to give them the debt to do so. Now that the collateral is coming home to roost, investors are asking where did all this credit come from? In a few short words, foreign investors:

As you can see from the above chart, shortly after the 2001 recession foreign investments into the U.S. exploded. Yet these were investments into debt markets. The perception from many foreign investors was many of these obligations were safe like government bonds because the blessing of our largest credit agencies said so. As has already been noted, these ratings were inflated like the properties held in these mortgage backed portfolios. If you are planning on buying, you can expect more inventory to hit the market this year since fundamentals are weak. Rates are also good for prime borrowers. So if your credit is shored up and you live in a non-bubble area, this may be a great time to buy. Unfortunately many people do live in these overinflated metro areas. I wish there was one over arching answer but buying depends on where you live. Should you buy in Los Angeles? No. Should you buy in Dallas. Yes.

As the Fed wrestles with this market, their rate cutting apparatus is no longer as effectives as it once was because this is no longer a liquidity issue but a solvency problem. American consumers are saturated with debt and no longer can service the current debt available to them. You can offer banks billions of dollars but without credit worthy and willing consumers, this housing market is crushed.

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With the emergency rate cut by the Federal Reserve, it is not a question about going into a recession but how deep of a recession it will be. The markets have not bounced aside from a few sectors including those bottom fishing in the financial sectors thinking a bail out is in the works or that the Fed will simply not let them fail. The technology sector is having a hard time digesting information from Apple and Intel showing weaker than expected quarters. Other tech giants have also announced that they will be cutting their workforce back. The Federal Reserve does not have much power besides a direct influence on monetary policy and at this point, that weapon is being ineffective. Now that they have exhausted that measure, they will attempt to use fiscal stimulus to jump start the economy. There is talk about rebate checks that will go straight into the hands of consumers but this would still take one or two months at the earliest. Also, we are entering a year where the IRS is working to revamp the tax systems to accommodate the large increase of those filing with the AMT tax.

There are many factors at work here. Yet as much as the government wants to avoid a recession these are simply normal healthy signs of a system trying to revert to sustainable growth measures. Like a wildfire in the forest, this is intended to wipe out all the excess money. Each time the Fed tries to insert liquidity into the market it is only propping up and giving more ammunition to the purveyors of the current credit excess. The recession will be led by housing and all indicators are still pointing to this. Let us look at four factors that show us that housing is no longer sustaining the economy.

#1 Housing Permits

*source: Census.gov

As you can see from the above chart, housing permits have been steadily decreasing since April of 2006. These are great leading indicators letting us know where housing is heading. We are still at a very high rate of housing starts so we are simply returning to more stable numbers. You need to remember that behind these numbers, there is an entire industry catering to housing and housing related services so what this means is large contractions in the industry.

What this means to you? Expect to see declines in builders as current market excess is washed out.

#2 Homeownership Rates

*source: Census.gov

Home ownership rates have also started to decline with the rise in foreclosures. Historically homeownership rates have oscillated between 62 and 65 percent nationwide. We peaked in 2005 reaching a 70 percent homeownership rate. Of course much of this large jump was on the backs of people being put into dangerous mortgage products that they had no way of paying off. We are now back down to 68 percent and the trend is lowering.

What this means to you? Look for the trend to revert to historical means and expect a 66 to 67 percent homeownership rate in the future. This could even drop lower in the short term since many foreclosures are currently hitting the market with projects coming online.

#3 New Home Sales

*source: Census.gov

What you see is a clear signal of the peak. 2005 is the clear peak for new home sales while 2006 was the peak for housing permits. This demonstrates the art of picking peaks. Why is there a year discrepancy? First, the peak in 2005 new home sales gave the impression that we still had room to run so builders sought to meet this demand by building more homes. They were behind the curve by one year trying to meet the demands of peak 2005 which of course overstated their estimates now creating a glut of new homes competing with an already saturated market. New home sales have almost dropped in half since their peak in 2005.

What this means to you? Look for inventory to increase as sales decline and new homes keep hitting the market through projects being completed. This will compete also with rising foreclosures so ultimately this means a continuation in prices dropping. Supply is outstripping demand at the moment and until this trend reverses, you can expect much of the same.

#4 Construction Spending

A couple of charts above. First we have construction spending tapering off hitting a peak in 2006. With over $1.2 trillion in construction spending, even a small decrease means a reduction of $55 billion in one year. Keep in mind that the peak as we mentioned in our previous chart of housing starts showed the peak in the middle of 2006 so we are only starting to see the trend starting to emerge. The next chart, shows the amount of construction jobs. This is a large number and big segment of the economy. We had a peak in September of 2006 with 7,725,000 jobs in the sector and now currently we are at 7,489,000, a decline of 236,000 jobs.

What this means to you? Look for more declines in construction jobs as permits drop and the current housing inventory is washed out. This will take a few years since we had an unprecedented boom. Invest wisely and keep these things in mind if you are planning in going into REITs or have a heavy portfolio allocation to housing related fields.

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