LOOK OUT BELOW / BARRON´S MAGAZINE ( VERY HIGHLY RECOMMENDED READING )

Up and Down Wall Street

 

SATURDAY, APRIL 23, 2011

Look Out Below

By ALAN ABELSON 

There's still plenty of room on the downside for home prices. Sizing up Donald Trump.

Since we go to press Friday night, we can't obviously describe this year's annual stroll down Fifth Avenue known far and wide as the Easter Parade, where the swells and the not-so-posh proudly display their finery, crowned more often than not by some outrageously flamboyant headwear. Rumor has it, though, that the latest aspirant for the presidency of this fair land, Donald Trump, plans to join the preening multitudes, carefully ruffled locks and all, disguised as an industrial-strength mop, to publicize his hopes of making a clean sweep of the nominating field come 2012.

Mr. Trump has chosen an auspicious moment for his political debut, what with concerns growing about the nation's dangerous accretion of debt. For he's the only candidate able to boast more than passing experience with bankruptcy: As we recall, one of the hotel and casino entities bearing his name has been forced to seek that ignominious refuge not once but three times when the wolves (politely known as creditors) began howling at its door.

Moreover, if we understand him rightly (no easy chore in itself, given the din and roar of bombast that accompany virtually his every utterance), he has devised the ideal solution to one of those sticky conundrums confronting Washington that combines foreign and domestic problems. We're referring to the civil war in Libya, which has prompted NATO to try to quash the odious Gadhafi, and the shocking surge in gasoline prices that the shutdown of crude supplies from that benighted country has helped fuel here at home.

What Mr. Trump seemingly recommends (we're cribbing from a Fox News interview) is since we're spending $1 billion in the effort to dislodge Gadhafi (he doesn't bother to identify the source of that figure, but, hey, why be picayune about hundreds of millions of dollars more or less), we pressure the Saudis or maybe the Chinese to cough up the dough to cover the cost of our involvement. He's not clear on just what form such pressure or involvement would take, but alludes to our military as the only one that can do the job (whatever the job might be).

We can only assume that in one of those magical transmutations, Mr. Trump's suggestions would somehow result in the new American dream: lower gas prices. Come to think of it -- and admittedly we haven't run this one up the flagpole to see if Donald salutes -- we might make profitable use of the Trump Doctrine to place the oil fields of the United Arab Emirates and Kuwait in a kind of protective custody as well.

Why, before you know it, the world would be swimming in oil and prices at the pump would tank. Oddly enough, quite independent of Mr. Trump's urging, the Saudi oil minister, Ali al Naimi, complacently assured one and all last week that the world's loaded to the gills with oil. "Oversupplied" with oil is the way he put it, an interesting locution in light of the fact that crude has run up from less than $70 a barrel a year ago to over $112 today, and naifs like us always assumed that higher prices typically were caused by an excess of demand over supply. Our thanks to Mr. Naimi for setting us straight.

Not the least of the obstacles that Mr. Trump may encounter on his boisterous ride to the White House is paradoxically the runaway bull market and the generous fruits it has showered on investors. For in contrast to Mr. Trump, who trumpets the claim whenever the occasion arises (and frequently when it doesn't) that he's a billionaire several times over, not everyone who has invested with him has enjoyed a profusion of happy returns. Quite the opposite.

Just ask a bondholder in some of those casinos that went bankrupt. Or a stockholder in Trump Entertainment Resorts, whose shares in December 2008 skidded from $4 to 23 cents as the company missed a $53.1 million interest payment and also wound up in bankruptcy.

And no matter the old and rusted boilerplate warning that accompanies every recommendation a securities firm issues that prior performance is no guarantee of future gains, investors remain convinced it is. But if not a guarantee, it might still be a feasible guide. Regrettably, especially for someone running for high office, investors do tend to be sore losers and have been known to bear loud witness against anyone they perceive as responsible for their losses.

So word tends to get around, even to the multitudes at some considerable remove from Wall Street and to whom Donald Trump is just another familiar face (and sound) on TV.

AFTER A BAD OPENING-SESSION SHUDDER, the stock market shook off Standard & Poor's warning of a possible credit-rating downgrade if Washington fails to mend its feckless finances and spent the rest of the holiday-truncated week sailing merrily on to new highs in the averages. The swiftness with which S&P's stricture was dismissed and its impact evaporated was a clear register of the upbeat mood in the Street. It didn't hurt, either, that the agency's caution was carefully couched to convey it posed no immediate menace and, in any case, the worries it articulated, however valid, were hardly brand new.

Besides, as they have been for the better part of the past couple of years, investors remain living proof of the pithy axiom that nothing succeeds like excess, and they've been more than amply rewarded for that steadfast conviction. Until the market turns tail big-time, they're not apt to take up extended residence in the storm shelters.

There's this, too: As a shrewd investor observed to us, with inflation beginning to bite whatever the official protestations to the contrary, and Bernanke & Co. striving to keep a tight lid on yields, equities seem all the more attractive, if only because the alternatives are so darn uninviting.

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Moreover, for the moment, at least, the economy, however gradually and spottily, is getting better. Corporate earnings in particular have been flourishing, although with the upswing in commodities and consumer income lagging, margin erosion can't be far behind. And despite the improved tone, as the accompanying chart offers graphic testimony, there's still one huge gapping hole in the economy: housing.

The chart is the handwork of Yale economist Robert Shiller, and it plots an index (fittingly called the Case-Shiller Index) that depicts the trends of house values over the past 120 years. It has been updated for Barry Ritholtz's Big Picture blog by Steve Barry. So much for its provenance. More to the point, it provides a beautiful snapshot of the biggest housing bubble in history, which peaked in July 2008 and has been deflating at a murderous rate ever since.

And despite the occasional glint of better tidings, the outlook remains unwholesomely grim and prices continue their mournful descent. Not the least of the reasons for housing's dour prospects is that so many home owners are underwater. Just in case you're lucky enough not to have shared that sorry condition, "underwater" in this context simply means the value of their homes is less than they paid for them, and not infrequently these days a whole lot less.

The estimate by CoreLogic is that 11.1 million people with mortgages, or 23% of the total, are in that decidedly uncomfortable position. Zillow, a Seattle-based service, reckons that 27% may be closer to the mark.

Nor do such numbers, disquieting as they are, tell the whole sad story. For as Mark Hanson, a savvy professional observer of the real-estate scene points out, they fail to include what he calls effective negative equity.

Effective negative equity, he explains, begins at the point at which the homeowner can't sell his house and buy another because he has to pay a real-estate broker 6% of the sale proceeds and then plunk down 10%-20%, depending on the type of loan needed.

There are in the neighborhood of 3.5 million previously owned homes on the market. And there are something approaching two million homes that are in foreclosure or whose owners have fallen behind in mortgage payments. The bad news is that the banks are back in the foreclosure mode after a relatively immobile interlude, and that means, by one knowledgeable estimate, that the shadow inventory of homes destined to hit the market may be as high as eight million.

The pause in bank and servicer foreclosures was inspired by a regulatory crackdown and lawsuits that followed revelations of sloppy bookkeeping, robot-signing of foreclosure notices and errant, inadequately trained personnel, those collective serious flaws that came to be known as Foreclosuregate.

As Mark Hanson points out, banks and servicers are back with a vengeance and cutting asking prices sharply "to blow out distressed inventory." Other price depressants he cites include unfavorable demographics, soaring energy costs and a broken mortgage market.

How low can home prices fall? The consensus is somewhere between 5% and 10%. But as the chart suggests, that may prove conservative given all that room on the downside before the bubble has completely burst. 

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