housing market masked a weak economy sdf

How housing masked a weak economy
Since 2001, the nation's economic growth has been powered by the real estate industry, particularly mortgage-equity withdrawals. Without housing to prop it up, the economy is in trouble.

"Housing mania will end in tears." That belief served as the headline of my column back on March 7, 2005. Now this scenario is slowly playing out as, directly or indirectly, the noose around the housing ATM continues to tighten.

Withdrawing equity from one's home was the economy, from essentially 2001 through sometime last year. A statistic from a recent report by John Mauldin says it all: Real GDP growth, excluding mortgage-equity withdrawals, averaged less than 1% over the past six years (it averaged a little more than 2.5% a year overall). During the thick of it, the real estate industry was responsible, directly or indirectly, for 40% of all jobs created.

That 40% contribution to job creation has, in the past 18 months or so, declined to about 13% of new jobs. It will soon be responsible for the bulk of job losses, in my opinion. In fact, my friend in the subprime business said that WMC Mortgage, a wholly owned subsidiary of General Electric (GE, news, msgs), is laying off 35% of its work force, taking a $100 million charge and cutting back on its writing of loans.

But what's even more important, he notes: "They (WMC folks) are going to get rid of all 100% financing on all borrowers below 700 FICO. Also, (there will be a) 95% cap on first-time homebuyers. All we talked about is coming to a head. Now watch the home builders suffer."

(Editor's note: A WMC spokeswoman declined to comment on what she called "speculation" about layoffs and said the company is currently adjusting the types of loans it makes and its guidelines for underwriting loans. As for the charge, she said there have been more requests than usual from WMC's investors asking that the company repurchase loans from those investors.)

This is a story with far greater ramifications than just for the subprime sector, and we need to keep that in mind, even as the lunatic fringe -- i.e., the banking industry -- once again lusts after last cycle's winners: the mortgage originators.

In 2000, banks were busy buying brokerage firms, particularly those of a tech bent, such as Montgomery Securities and Robertson Stephens. In past cycles, they wanted to lend to leveraged-buyout artists, and before that there were "oil patch" loans, etc. Banks have an uncanny ability to pour capital into the wrong place at the wrong time. Bottom line: Wherever they are busy making acquisitions will be the source of problems in the next two years.

Home lenders versus the House
I have repeatedly made the point that there are no adults at home in the home-lending business, which is why I found it interesting reading some comments by U.S. Rep. Barney Frank. Though I wouldn't necessarily have picked the Massachusetts Democrat as the voice of reason, in a recent edition of the San Jose Mercury News he shared this novel thought:

"You shouldn't lend (home buyers or re-financers) more than they can afford to pay back, and you don't lend them more than their house is worth. . . . You can't just make a loan and then sell it (to investors, forget about it and expect no legal liability for putting people into a mortgage that never made sense for their situation)."

(The parenthetical material is Frank being paraphrased by the writer.)

Though those comments make perfect sense, and one would think that any lender with a brain would refrain from that kind of risky behavior, we also know that it's exactly what lenders have done. As for the consequences on the other side, my guess is that we'll see an enormous amount of lawsuits brought by folks who say that they were unsuitable candidates for the loans in the first place. (To quote a Jan. 26 New York Times headline: "Tremors at the Door: More People with Weak Credit Are Defaulting on Mortgages.")

Given that Frank is the new chairman of the House Committee on Financial Services, it sounds to me like Congress will be receptive to their arguments -- though that doesn't mean the courts will be. In any case, it seems quite clear to me that new legislation will be enacted. Which, of course, is just another way to tighten lending standards that are already being tightened.

At some point, the amount of damage being done will rapidly accelerate. I am certain that one day, when we look back on this period -- which witnessed the incredible housing-stock rally that ran from summer 2006 through early 2007, before it collapsed -- and we describe it to folks who may not have seen it firsthand, they will shake their heads in disbelief, the same way that folks now look back at the Nifty 50, the stocks that propelled a doomed early-1970s bull market, and ask: How could anyone have been so naive to have believed that concept?