Apply "COMMON SENSE" when evaluating the home builders!

I hear pundits (on CNBC again) give all types of ridiculous theories on why home builders are rising in price, how the bottom may or may not be near, and trying to call a reversal now or some time in the future. Now, I can be fairly analytical, but sometimes you simply have to sit back and use what your momma gave 'ya. We had a great global macro experiment in an attempt to reflate the economy in the face of recession. This experiment has caused risky assets to fly and put significant downward pressure on risk pricing. Basically, it caused people and institutions to gamble with cheap money and credit. This resulted in a bubble of risky assets, which then popped, like all bubbles, like the bubble that led to the experiment in the first place, that just happened to cause another bubble (stick with my train of thought, I'm know I rambling here:-).

Now, as this bubble pops (primarily real estate, mortgages, and asset backed securities), the scientists in the lab (the Fed) have opened the monetary spigots which have caused even more speculation. The difference this time is that the first experiment has pushed more speculation and money into the world, not just the US, markets than any other time in history. Thus, we are just beginning to deflate the last bubble (real assets, asset backed securities), after just coming off of the one before that (tech stocks, private and public equity), while scientists (central bankers) around the world are injecting even more juice for speculation in an attempt soften the pop of this most recent bubble, which has just caused stocks aroung the world to bubble up, commodities did the bubble gum, and emerging markets are flying.

Sound confusing to be simple, ain't it. Well, a picture is worth a thousand words. Take a look at this graph of the builders (click the picture to enlarge it), that's right, nearly all of the builders.

Now, the housing boom started somewhere in the last 6 months of 2000, at least in the NYC area. I know this for a fact, for I participated in it. That is where lax underwriting really started in earnest. The interest rate cuts, simply threw fuel onto the fire. Reference that year in the chart, and look at the equity prices of the builders. They arch straight up from the last half of '00 and peak at the last half of '05, where the bubble was at its peak (and where the CEO of HOV bought a house with a no money down ALT-A loan, shortly before he called several bottoms in the housing bubble - go figure how good some of these home builder CEOs are, some are obviously better than others). For all of those technical analysis guys who bitch and moan about the builders coming XX% off of their 52 week highs, who gives a damn? Without the housing bubble, you can see where they belong, sans the inflation rate increase for the years in question.

What we haven't included in this little analysis here is the fact that these builders (yes, all of them) have gorged on massive amounts of debt to buy overpriced property during the bubble, most of which at the bubble peak (just look at that big hump in the chart), and are now stuck with it since there are no more suicide mortgages that allow people to overpay for it. They are not just stuck with it, but when adding in all of their other problems, they are laden with significantly depreciating property which they have to pay debt service on derived from more debt than negative cash flow companies can prudently handle, combined with the fact that no one needs their services any more since their job is to build houses and the last thing anyone in the US needs right now is more houses. Thus, economically, they are actually worth less now, than they were before the boom due to mismanagement (or to be fair, excessive aggressiveness in expansion during boom times). Nearly all are, or will be soon, running an operating loss. In addition, massive book value write downs burn more value, contributing to this operating loss. Then, there is the cut throat competition to beat foreclosures, banks, and other builders to catch those last dozen or so home buyers that cause them to discount already under water assets by up to, and over 50% in order to sell at an extreme loss, increasing the loss. All of this adds to the threat of defaulting on debt that ill lead to bankruptcy. Most builders will have to tread water for 8 quarters at consistent half billion dollar losses to weather this. Do they really have that much cash???

I digress... Back to the point, just taking the bubble from under the homebuilders drops their price by about half from their prices today. Add in all of the depreciating assets, overly expensive, and debt laden fat, and their prices need to be discounted even further from that. With all of this, pundits (and Citibank analysts) have the nerve to try an call a bottom..!!!???

The Case Shiller index has the major building centers for these companies dropping in price around 8% year over year (and you know how I fell about this index which makes things look rosier than they really are), and the futures on this index indicate those who should know think that prices are going to accelerate a lot faster and a lot farther for several years. Even the CEOs of the these companies have nothing but negative things to say (except for Ara Hovnanian, of course). So, those who are buying the builders up of over 10 percent on the Citibank bottom call (I think this is his third call that was wrong on this industry) are either very fast and deft traders, or probably just bought a long bridge in Brooklyn, on margin with a 110 LTV sub-prime, no doc loan.

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[Reggie]

In case you missed it, all of the home builders shot up over 400% during the boom, and some of them shot up over 1,400%.