The re-buy period is now OVER.


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The re-buy period is now OVER.

By EdmondDantes on 08/18/2007

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Tilt or just bad play?

I’m not sure how many readers follow macroeconomic events, but the recent market developments are worth observing, even if you’re not invested. A number of market participants—hedge funds, complacent investors, CNBC, et al.—would argue that the stock market’s on tilt, and all that’s necessary to settle the market back into its A game is a rate cute and calm nerves. I’d argue that the market’s recent swings are more the result of poor discipline by investors and consumers—overvaluing marginal hands out of position—and that the bankroll impact of that lack of discipline is just starting.

Earlier this year, the credit markets began to unravel (that is, borrowers had trouble funding loans) when several sub-prime lenders (lenders to homeowners with less than stellar credit) began to wobble and, in some cases, liquidate. Then in July, a couple of large hedge funds (investment funds for institutions and wealthy individuals) showed heavy losses from these investments causing many to reassess their investment criteria.

Within a matter of days, a few large bond financings (deals to finance corporate buyouts) stalled in the market, causing investors to then rethink other bonds they held in their portfolios. Investors began pulling money out of funds and many banks began liquidating large portfolios of loans. The end result has been a rapid deterioration of companies’ and individuals’ ability to borrow as easily as they could even 2-3 months ago.

”Just open-shove! It’s a re-buy!”

In the old days, when you wanted to buy a house, you had to pony up a 20-30% down payment and, if your credit was good, you would then borrow the balance in a 15 or 30-year mortgage. When the housing market took off over the last few years, competition for new loans was so fierce lenders began offering “creative” mortgages—interest-only loans, adjustable rate loans, no income verification loans, etc. In addition, they offered many loans to borrowers who were poor credit risks (aka sub-prime borrowers). The end result was that home ownership, a tenet of the American dream, was available to pretty much anyone who breathed.

When anyone could qualify for a loan, predictably many did. Home prices appreciated monthly, and the pressure to get in the game was great—“It’s the best investment you can make!” “God’s not making any more of it!” “You’re throwing away money by renting!” While there’s an element of truth to those arguments, there’s another truism. When capital can move freely and stupidly, it will. And when it’s an emotional investment (as most housing is), look out. Americans bought homes in record numbers, flipped them, bought second homes, re-financed money out. It was a wonderful cash machine. Now, though, that game’s over.

”Next hand, blinds and antes are up!”

If you’re a marginal homeowner with a creative loan, and you were looking to refinance or flip when the “creative” part ran out, you’re now officially out of luck. Countrywide, the nation’s largest mortgage broker, is reeling under rumors of liquidity problems and possible bankruptcy. They’ve announced that henceforth they’ll only issue “conforming” loans, i.e. the good, old-fashioned boring ones. The problem is, that some 30-40% of mortgages in speculative markets (Las Vegas, Florida, California, etc.) were “creative.” There are over $800 BILLION of reset mortgages coming due next year. Imagine if you have an adjustable rate mortgage, interest only, at 2-3%, not an uncommon situation. Now when your mortgage resets, your rate will approach 7% increasing your monthly payment dramatically. That’s not a problem, though because you can flip your house if you get tight for cash. Well, at least you USED to be able to.

I’m convinced that over the next few years, the real estate market (including markets like California, Manhattan, etc.) is going to shake out hard. It won’t happen overnight since home sales are illiquid generally and even more so now with limited credit availability. However, people who over-reached and over-levered will eventually lose money and, in some cases, their homes. Of course, many will howl that they were, in fact, victims of greedy mortgage sellers, but the reality is they got ahead of themselves in a levered asset. It’s a hard lesson to learn.

This housing market, like the internet bubble and other brilliant ideas, will run through its five phases, namely

Enthusiasm.
Disillusionment.
Panic.
Punishment of the innocent.
Praise & honor for non-participants.

We’re about halfway through stage 2, and nowhere near the bottom.

"Floor!"

In recent weeks, the Fed and other central banks have been providing massive amounts (billions) of liquidity into the monetary system to ease the crisis. Late last week, the Asian markets got pummeled and the only thing preventing the same thing in the U.S. was the Fed’s surprise decision to drop the discount rate (rate at which it loans money to banks) by ½%. The Fed had declined to reduce the more influential Fed funds rate (the rate banks charge each other) because it’s fearful of inflation pressure. But then when the Asian markets were down 5%, they stepped in with a little boost. That cut and the market’s reaction was the equivalent of telling you “She’s a big girl, but she’s got a great personality.” Do yourself a favor and ask for a recent photo.

Short-stacked?

Remember, the American consumer’s already under a tremendous amount of pressure. Government figures suggest that core inflation is under control, but “core” inflation excludes several important items, housing, energy costs and food costs, that have been increasing dramatically. I don’t know about you, but rent, gas and food comprise a big chunk of my budget. It’s an even bigger chunk of the average American family making $60,000 or so a year with kids and a couple of SUVs in the driveway.

In addition, the Bureau of Labor Statistics would have you believe that employment is going along at a good clip. Indeed, lots of small businesses have been hiring. But huge layoffs are announced daily in larger corporations (expect more in financial services) and the government figures include estimates for construction and housing employment that are based on recent years data. I’m pretty sure there hasn’t been a new construction or housing job created in MONTHS regardless of what the BLS forecasting model says.

In short, the American consumer is already under a tremendous amount of pressure even before this credit crunch. Just ask Wal-Mart, the nation’s largest retailer, which accounts for some 9% of all retail purchases—it’s a good proxy for the consumer, at large. They recently missed their revenue and profit forecasts and cut their expectation for the year.

Does this mean the market’s going to crash? I don’t think so. Markets are now global and European and Asian lenders are not as exposed to problem housing loans as US lenders. In addition, countries who’ve been the beneficiaries of our consumptive ways over the last couple of years (China, Japan, oil producers, etc.) have big surpluses that they can move into markets when financial assets get cheaper. Here at home, there are plenty of institutions out there with plenty of cash to invest (Berkshire Hathaway, for example) and a number of corporations are sitting on wads of cash with which they could repurchase their stock. In short, it could get ugly, but, I believe, the markets and US economy will sort itself out.

But Edmond, I play POKER not the MARKET

Yeah, but what’s this mean for poker players? Americans love to gamble; they spend more in casinos that on movie tickets, recorded music, theme parks, spectator sports and video games…COMBINED. That said, I think it’s naïve to think that any significant impact to the American consumer won’t show up in numbers of tournament entries from casual players. In almost every tournament I’ve played over the last year, there’s at least a couple of “developers” at the table. Many pro poker players I know tend to keep themselves either in cash or bust, so exposure to a portfolio of real estate or levered assets isn’t a risk for most. A soft housing market or overall economy, though, will mean the steady flow of shot-taking recreational players might suffer a bit over the next few years.

Imagine, if you can, heading out to Vegas for the WSOP main event with some of your own dough and some from a friend and backer. The field is huge and soft and it looks like everyone’s got dough. You’ve had a little success in your home game and you’re ready to make your name. You start off great—a couple of nice hands hold and then a marginal hand nets you a huge pot. You’re checking in with your wife and backer daily—everything’s great, you’ll money, for sure. You can’t help but think about what you’re going to do with your score and over the next few days run up a nice little Rio bill. And then BAM! Out of nowhere, you get worked for your stack, overplaying AJo or some piece of trash within sight of the money. The blinds burn off the rest of your stack and just like that you’re gone, out of the tournament with nothing but an unused food voucher. You head back to Tennessee or wherever with 6 days of room service bills, a hangover and a suitcase full of clothes that smell like smoke to show for the effort. That’s how the American consumer/homeowner feels right now.

In time, the market will get over this crunch, like we all got through those bubble bust-outs, but for now there’ll be plenty of players swearing off the game and walking around muttering “Never again.”

Still digging,

Edmond

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