Today's Real Estate Bubble: Let the Great "Homeowner Bailout" Begin

by Karim Rahemtulla
Today's Real Estate Bubble: Let the Great "Homeowner Bailout" Begin

By Karim Rahemtulla, Advisory Panelist Thursday, October 19, 2006: Issue #595

Alan Greenspan recently declared that the housing market has most likely seen its darkest days. I did a double take. Has the maestro fallen prey to the same ill-conceived thinking that is so pervasive on Wall Street?

Two weeks ago, a number of major investment banks upgraded home-building stocks. Last week, some of those very same companies reported that they saw nothing less than disaster ahead. One of the healthiest builders, DR Horton (NYSE: DHI), a very well-managed company with a pristine balance sheet and a portfolio that encompasses all economic strata, had this to say on the situation at hand:

"The company's cancellation rate [homes cancelled divided by gross homes sold] for the 4th quarter of 2006 was 40%."

Almost one out of every two potential buyers backed out. Heck, I don't need to see DR Horton's numbers I can just look down the street to see a for-sale sign on every other house.

And it's about to get worse. Consider the following regarding today's real estate bubble

Mortgage Payments Are Set To Double

I have always wondered who owned the houses up for sale everywhere. No one I knew had more than one house, unless it was their business to buy and sell homes as investments. Yet there were an inexplicable number of homes being built, apartments being converted and real estate wealth seminars being held. Who are these people? Could they be the Nasdaq 2000 investors resurrected? Nobody needs to learn that lesson twice.

During the Nasdaq bubble, the regular guy got sucked into a market that was manipulated from start to finish by low-float Nasdaq small caps. The manipulation was concocted and implemented by irresponsible investment banks that sold their reputations for quick hits from IPOs.

For the most part, they got away with it. But Joe Sixpack got killed. And now, he's back at it again, sucked in by the lure of quick profits in the real estate market. And, unfortunately, he is once again being helped along by the irresponsible comments from people like Greenspan, the commerce secretaries, the housing lobby and high-dollar realty companies.

What did you expect them to say when rates were at 3%? Lock in a fixed rate mortgage and don't speculate? Instead, Greenspan said, at the time, adjustable-rate mortgages make a lot of sense.

Here's One of the Early Results of Today's Real Estate Bubble

This result is largely due to massive adjustable-rate-mortgage debt that many people took on during the real estate boom: Homeowners, especially those who have interest-only or so-called "teaser-rate" mortgages, could see their monthly payments more than double.

"Some just won't be able to make the new monthly payments," said Jules Cohen, a bankruptcy lawyer and partner in Akerman Senterfitt, an Orlando law firm. "They'll get two or three months behind, and then you'll see a lot of them file Chapter 13 bankruptcy in hopes they can set up a debt-payment plan and prevent foreclosure."

Interest rates will rise on about $300 billion in adjustable-rate mortgages this year alone, according to First American Real Estate Solutions, a research group. That figure is projected to skyrocket to more than $1 trillion in each of the next two years.

So while the brokers are upgrading homebuilding stocks, and trying to make it seem that the worst is over for housing, I have some news for you: The real estate bubble is not today's news. It is going to be tomorrow's...

By this time next year, home prices in places like Nevada, California, Florida and Arizona will not be down 5%, as the experts predict, but could fall two or three times that number.

Home Sellers Refuse To Give In

Right now sellers aren't selling. They are in denial - still waiting for Santa to deliver the asking price on their homes, or close to it. My advice is to take the first reasonable offer your real estate agent gets for you and count yourself lucky.

A contractor who does some work for me is selling his house. He told me six months ago that it was on the market. I asked him if he had any bites. He said he had one, but was offered $5,000 less than his asking price. He said he'd wait it out.

I mentioned politely that he should call the potential buyer back and offer to sell it to him at the lower price. He declined. The house is still on the market today, and will likely be on the market this time next year as well. In the meantime, the owner will have spent at least $20,000 in mortgage interest, maintenance, insurance and property taxes.

Multiply that by several thousand and you can see what the future of real estate in the U.S. looks like a few months down the line. And for readers in Canada - take note: you are next to feel the bubble's impact.

Greenspan has an impeccable history of being right. But even more impressive is his ability of being right too early. Remember "irrational exuberance"? If you had listened to him then, you would have missed out on huge gains in the market. He was right; two years later the market did crash. What can we learn from his latest statement on the real estate market?

Jonathan Alper, a bankruptcy lawyer in Heathrow, said a couple that recently visited his office faced insolvency after buying two $400,000 homes as investment properties. With annual household income of only $75,000, the couple quickly defaulted on the loans. They blamed the ill-advised venture on tips from a "wealth-in-real-estate" seminar.

Based on the GIRLI Indicator (Greenspan Internal Real Estate Loss Indicator), we are about two years away from seeing the bottom in the real estate market... and the bubble fully burst.

Good investing,


P.S. Lee Lowell, a friend and colleague of mine, has recently launched a successful commodity trading service. For seven years, Lee was a market maker in the New York Mercantile Exchange, and he's a world-class energy trader. You can make serious money trading commodities - in a very short amount of time. And Lee walks you through every step of every trade. Here's how he's playing the oil market right now.

Today's Investment U Cribsheet

  • Shock Stocks... Shares of CBOT Holdings, Inc. (NYSE: BOT) jumped as high as 19% yesterday on news that Chicago Mercantile Exchange Holdings, Inc. (NYSE: CME) will acquire the company for $8 billion. CME is the world's biggest financial exchange and, until now, was in direct competition with the CBOT. The merger will allow the new group to significantly cut costs and increase its customer base. Volume on BOT spiked more than 1,200% Tuesday.
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