Even a Dead Cat Bounces!

The latest Case Schiller Index published yesterday shows signs of a bottom in the US Housing market - this is great news. I am more than happy to put my fingers in my ears and cover my eyes so I can't see seasonally adjusted numbers, growing numbers of homes entering foreclosure after the early Obama moratorium expired in May or the still rising unemployment rate, as after over 2 years of falling prices in most U.S. markets, any news is good news.

However the really interesting thing is what happens now?

The numbers will probably be marginally positive for some time thanks to that dead cat. This financial market truism is that when something falls from a great height, once it bottoms it will bounce at least for a while, predominantly because of two reasons. The first is the comparative nature of statistics and our own innate ability to have them say whatever we want, so 27% lower than last year magically transforms into 1.5% higher than last month! In addition, and more importantly, it is a sign of a hangover of outdated rationality. By this I mean that there will always be some people in the world who believe that the economic crisis of the last couple of years is like a black cloud and that once it has passed over the normally sunny skies will resume and everything will go back to where it was before - i.e. nothing has really changed. These people are easy to spot, they are the ones with something to sell that they have been hanging on to for the last few years!

But something big did change this time. The drastic price rises in real estate over the 2002-2007 period have been pretty conclusively been proven to have been caused by radical changes in the availability and cost of credit. Banks were able to make as many loans as they liked, package them up and sell them off to some unwitting investor somewhere else. 50% of U.S. mortgage backed CDO's were sold to overseas investors! Not just sub-prime, but every other category of loan too, including prime loans, which have the fastest growth in the rate of default in the nation right now.

Now along the way we heard a thousand reasons why prices were going up, pretty much all of them now debunked. After all, there are just as many baby boomers today as there were in 2006, but why are all those resort homes in Palm Springs and Naples only worth 40cents on the dollar today?

The thing to understand about the financing market is that it has changed for a long long time to come. We may have been able to sell the treasurers of multiple small towns in Norway and Argentina a package of loans wrapped with a AAA rating and a guarantee from AIG once, but I highly doubt they are going to line up to buy them again. As a result banks are going to be a lot more choosy about who they lend to and how much, as they are going to have to keep a lot more of those loans on the balance sheet themselves. It is now 2001 all over again, why should prices not reflect this.

The biggest engine of real estate price growth this century has gone and until we go through at least another couple of generations of business school grads who decide to ignore history and that this time they really have come up with the ability to eliminate risk through mathematical confusion, this isn't going to come back.

So does this mean its all doom and gloom. That my friend depends on who you are,where you live and what type of property you own. Real estate isn't going away, but the concept of "the market" will have to be re-imagined. People still prefer to own their own place for lots of reasons, but we will see a massive division between Winners and Losers, driven primarily upon the type of real estate and who it appeals to.

More tomorrow.

NEOblogger