Underestimating the fallout from the housing crisis?

A new update to a Deep Creek real estate blog notes that "Bad decisions and bad loans have cost banks millions of dollars in losses but life must go on." Well, this is not exactly the honest and forthright type of analysis I was looking for when I made my comments about how a specific listing seemed to be in conflict with what I was reading on some of the real estate blogs. But back to the point here, the point is they are dramatically underestimating the total losses suffered by banks and other institutions as a result of the housing bubble and subsequent credit crisis. Right now the losses are well into the BILLIONS (with a "B" not a "m" as they have indicated) and many, the IMF, Bill Gross of PIMCO and others, estimate that the final tally will be at or near $1TRILLION (10,000x greater than $100million, 100,000x greater than $10million, 1,000,000x greater than $1million).

Once people start telling the truth about the housing bubble and the credit crisis maybe people will change their behaviors and begin buying again. Until then we are faced with the CEO of Bear Stearns telling us they have ample liquidity, real estate agents telling us things are well and improving daily and others dramatically understating the fallout from the crisis. A few days ago when Merrill Lynch finally threw in the towel and started selling off mortgage-backed securities for 22cents on the dollar it gave the market significant hope that the bottom was near and firms were finally recognizing the drastic measures that were necessary to deal with the fallout from this crisis. Instead of downplaying the crisis they are facing up to their mistakes and instead of hoping and wishing that things will get better, they are taking actions to secure their own future and restore their own credibility.

And yes, banks are still lending, just not as much as they were previously, which a big part of the reason why home prices are falling across the country. Without cheap and easy credit, buyers can no longer drive prices higher and higher with absolutely no connection to underlying value. At some point, however, the market will correct itself and prices and incomes will once again realign and we will see a market functioning as it should. In many areas (particularly those that have not yet seen fire-sale foreclosure sales), home prices relative to personal income, however, are still historically high and some believe we would need to see an additional 10-20% decline in national home prices to bring things back in line with historical norms. It won't happen overnight (see 1979-1984 period in Figure 6 on page 6 linked here) or may not happen at all but over time these things do manage to work themselves out which in this case could even mean that meager income growth will exceed home price appreciation so that a balance can be reached again. Anyway you get there, such a balance is estimated by the Wachovia Economics Group to occur sometime between the middle of 2009 and middle of 2010 if you read the full report linked above in this paragraph. This report goes into great detail about not only the present market but also puts things in historical perspective and is much more thorough and informative than saying prices have fallen and interest rates are relatively low as some have done.

I feel like I should also address this whole interest rate fallacy too. Lower rates lead to higher prices and higher rates generally lead to lower prices. So as an educated buyer when you would rather buy? Assuming you were always in the market to buy a home, you'd be best suited to buy a home when interest rates were at their peak because you have fewer people competing with you to buy the same property, will likely pay less and therefore take on less debt. If you look back at the last 25 years the people who made the most from real estate investments bought when rates were relatively high and the people who bought when rates were low got in bidding wars with countless others, paid more and went into more debt. Something to think about and not what you hear from the people trying to sell you a house on cheap credit and put you deeper in debt. Then again, I am more likely to think like the cash buyer than the person with no savings and a low credit score.

I think Warren Buffett and Ben Graham would advise others to do the same, but then again they are/were just simple, conservative guys who never took risks that could ruin them financially. It certainly seems to have worked out much better from them than those who went out and speculated on overpriced homes paid for with no-money-down loans! In 2006, Buffett himself warned of "significant downward adjustments" in the real estate market and today I'm sure there are many who wish they would have taken his free advice! Read what he said about mortgage financing too and ask yourself who would you trust to give you financial advice, Mr. Buffett? A lender? A realtor? I'll take Mr. Buffett's free advice any day!

It's hard to deny that the people who benefited greatly from the housing bubble were the buyers who years earlier bought at higher rates while those who lost out in a big way overpaid because they thought they were getting such a low interest rate when in reality they were simply fooled into taking on more debt than they could handle. Buyer beware.

Don't forget to check back to Dan's Deep Creek Blog for future updates.