This post first appeared on Minyanville.

It appears even the embattled homebuilding industry is getting rosy-eyed, finding enough “green shoots” of economic recovery to stick their shovels back into the ground.

In May, US builders broke ground on 17.2% more projects than in April, far exceeding analysts’ expectations. Work on new apartment buildings leaped, while single-family starts continued what’s now become a 3-month rally.

Although the aggregate figure is still well off last year’s rate, economists are breathing a sigh of relief that the worst of the housing market swoon could be behind us. Skeptics, however, are quick to point out that any recovery could be muted, as high levels of inventory, a weak labor market, and mortgage rates that just won’t seem to stay down, could forestall any recovery.

As Kenneth Simonson, chief economist for the Associated General Contractors of America, told the New York Times, “There’s a real possibility [housing starts] will just stall at a low level. If the recent jump in interest rates is sustained, that could choke off buyer enthusiasm for new homes.”

For nearly 4 years, the business of building and selling homes has been, in a word, lousy. As home prices tumbled, the likes of KB Home (KBH), Toll Brothers (TOL) and Lennar (LEN) slashed prices, offered generous incentives, and otherwise bent over backwards to unload inventory. Building all but stalled, jacking up unemployment — particularly in exurbs and sprawling communities whose economies were largely based on the construction trade. An industry that grew fat during the boom was forced to slim down, lay off workers, and hibernate, while the market’s violent correction ran its course.

And although a host of small builders have closed up shop, to date, no major US homebuilder has gone under. Consolidation, too, has been scant. The only merger of note was Pulte Home’s (PHM) purchase of Centex (CTX), a marriage that, once consummated, will create the country’s largest builder.

The outlook for those builders that remain — builders that are bleeding cash while pleading with creditors to extend loan terms and waive busted covenants — is bleak. Last week, the National Association of Homebuilders/Wells Fargo Builder Sentiment Survey ticked down after rising far more than expected the month before. Higher interest rates are mostly to blame, as the specter of bigger monthly payments is quelling optimism that the housing market is on the mend.

The reality — an unfortunate one for builders and their employees — is that for the foreseeable future, their services aren’t needed in this country; we have too many homes as it is. Demand for new ones remains weak as communities just a decade old slip into disrepair, and shoddy craftsmanship and half-finished developments scare off prospective buyers.

Builders are also fouling up the nascent housing “recovery” by turning recently completed condominium units into rentals. Even as demand wanes thanks to job losses and tighter budgets, rental inventory is rising. Rents, as a result, are falling. This is great news for tenants, eager to jump on affordable apartments, but bad news for landlords and even homeowners.

One of the most popular arguments posited by housing-market-bottom callers is that in some of the hardest hit areas, prices have gotten so low that investors can scoop up cheap homes and rent them for an attractive return. What they neglect to mention, however, is that this sort of market-clearing activity also increases the supply of rental units, further pressuring home prices. Even in the worst, most washed-out areas, a bottom remains elusive.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Washington just doesn’t get it: We don’t want more debt.

While congressmen berating bank CEOs for their unwillingness to lend out their bailout money makes for a nice media clip, it reflects the growing disconnect between our elected officials and any semblance of reality. Not that the relationship was ever particularly close – but lawmakers are floundering for good press while the nation’s economic future slips further and further from their tenuous grasp.

Bloomberg reports American consumers are wary of taking on more debt, as expectations about eroding economic conditions are forcing people, to *gasp* make responsible decisions about their personal finances.

Bloomberg cites Midsouth Bancorp (MSL) president C.R “Rusty” Cloutier, who says that, despite aggressive marketing, town hall meetings, and $20 million in TARP money, Midsouth’s customers just aren’t taking out new loans.

This is the rejection of debt Professor Depew speaks of when discussing the structural deflation we’re currently experiencing.

Credit is based on trust. And while conventionally we view this relationship as one in which the lender must trust the borrower to repay his debt — at least to an extent that’s commensurate with the interest rate — it does go both ways.

As lenders like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are increasingly being painted as corporate marauders out to rape and pillage the American public, would-be borrowers are wary of putting their financial future in the hands of these men of questionable repute. And with credit-card companies rushing to alter terms, it’s no surprise consumers are reluctant to extend themselves further.

Still, lawmakers are pushing through an economic stimulus package that depends, in part, on a willingness on the part of consumers to keep spending. Their delusion is only outmatched by their hubris – the belief that a bunch of self-interested politicos can coerce the average American into making ruinous financial decisions for the betterment of the country.

Floundering industries — notably automakers and homebuilders — are counting on government subsidies to encourage Americans to keep borrowing to buy their products. But what General Motors (GM), Ford (F), Centex (CTX) and KB Homes (KBH) don’t understand is this: We just don’t want what they’re peddling. And we certainly don’t want to borrow against it.

The transition from a debt-dependent, credit-drunk consumerist society won’t be immediate: It’s taken 18 months of financial panic for evidence of the shifting social mood to make its way into the mainstream.

But as the economic outlook continues to darken, the country becomes more disenfranchised, and the government grows ever-more addicted to sound bites and empty promises, reality will set in.

For the past 20 years, we’ve been blithely driving along an economic road that ends in a cliff. And that cliff is now in our rear-view mirror. We’re tumbling, groping for any branch that can save us from the fall. But each one of these new government programs, bailouts and rescues simply tries to set us gently back on the road from which we only just plummeted.

We already know where that path ends, and it ain’t pretty. What say we try another road?

By ANDREW JEFFERY

This post first appeared on Minyanville.

Is it a buyer’s market?

Ask most real-estate professionals the above question, and the response will almost certainly be an emphatic “Yes!”

After all, they quickly explain, inventory levels are at all-time highs, sellers are desperate to get out from under their rapidly depreciating homes, and mortgage rates are at historic lows. What more could buyers ask for?

How about not losing their shirts, for starters.

The traditional definition of a buyer’s market is one where supply outstrips demand, pushing down prices: Buyers have the upper hand. As the bull market begins to wane, however, buyers lose their enthusiasm and become concerned about price. The market cools down and buyers shy away, forcing sellers to make concessions and lower prices. This, in turn, creates an environment where buyers can shop around, be picky, and patiently waiting for their dream house to come on the market.

As demand returns, sellers start upping their list prices, refusing to pay for closing costs and holding out for a better offer. Buyers, fearful they might miss out on the next boom, bid up asking prices and ask for fewer concessions. Now that sellers have the upper hand, the market favors sellers as prices move upward. Such is the cyclical nature of real estate.

This story has played out for decades as real estate plodded along, homebuilders like DR Horton (DHI), KB Homes (KBH) and Toll Brothers (TOL) supplied the market with new construction and home prices marched steadily upward, outpacing inflation by the narrowest of margins. A little more than 10 years ago, however, that relationship started to come unglued.

The recent housing bubble turned the prevailing view of real estate on its head. Homes, long viewed as the most stable of all assets, became a speculative tool for even the most unsophisticated investor. The mania, fueled by lax monetary policy and Wall Street alchemy, helped contributed to the financial crisis currently gripping our country. As property values have careened back to earth, real estate assets of all kinds have become toxic.

Nevertheless, the National Association of Realtors (or NAR) and its dedicated minions have tirelessly peddled their lies that ours is a buyer’s market. Let’s take a quick jaunt back in time to some recent headlines and where that traditional assessment of a buyer’s market got us:

Las Vegas: It’s Definitely a Buyer’s Market
USA Today: July 5, 2006
“Real estate looks like one of the biggest gambles in Las Vegas.”

How true. Property values in Vegas have fallen 33% since summer 2006. Not to be outdone by their peers at USA Today, ABC ran this piece just weeks later:

Take Advantage of Real Estate’s Buyer’s Market
ABC News: July 31, 2006

“The National Association of Realtors said that the number of homes for sale has reached new heights, which is good news for buyers. After years of a seller’s market, it’s finally a buyer’s paradise in Phoenix, AZ.”

Anyone who bought in that “buyer’s paradise” in Phoenix has seen their home’s value fall by more than 30%.

The point isn’t to criticize realtors for arguing it’s a buyer’s market: After all, one should expect nothing less from a group whose entire existence is based on convincing buyers it’s a great time to buy – irrespective of the truth. Just ask Gary Keller, whose new book, Shift: How Top Real Estate Agents Tackle Tough Times, advises agents to “find every way possible to overcome the media-driven real-estate malaise.”

The traditional definition of a buyer’s market needs a bit of a makeover. A more sensible definition is a market where buyers have ample opportunity to make good investments. To be sure, a home is more than just an investment; it’s a place to raise one’s family, to grow old, to spend time with loved ones. However, as far too many American families have learned in the past three years, homes can become a debilitating burden if bought at the wrong price.

In today’s market, there certainly exist attractive investment opportunities. But to label the market as a whole as one where buyers should be rushing out in search of the American Dream is borderline lunacy. Throughout much of the country, home prices are still too high: Real incomes don’t support prevailing property values, even after the historic declines we’ve already seen. Supply, despite remaining at record levels, is likely to remain so for the foreseeable future. Home prices are undergoing a much-needed correction, and will continue to do so until fundamental demand catches up with supply.

This isn’t to say every home on the market is overpriced, or that every buyer in the past 36 months has gotten a raw deal. There are deals to be had if one knows where and how to look – and, most importantly if the purchase makes good financial sense. To borrow a theme from Toddo, “financial staying power” should be at the forefront of any prospective buyer’s mind.

So ignore the hype, both good and bad. As often is the case, not until the most ardent bulls turn in their horns will the bears return to hibernation. So, as soon as realtors concede it may not be a buyer’s market after all, voila! A bottom we will have.

By ANDREW JEFFERY

For as bad as things are in the housing market, it’s remarkable that none of the country’s big homebuilders have gone bust. The industry’s resilience is a testament to how much money the firms raked in during the boom.

Just ask guys in charge.

The Wall Street Journal reports many homebuilder CEOs socked away such obscene amounts of cash over the past 5 years that they out-earned their Wall Street counterparts. As profits soared, Toll Brothers (TOL) CEO Robert Toll and his brother Bruce together took home $773 million, while Dwight Schar, chairman of Virginia-based NVR (NVR) earned more than $625 million from stock sales.

By contrast, vilified Countrywide CEO Angelo Mozilo earned a mere $471 million during the same period.

Sitting on huge — but dwindling — stockpiles of cash, big builders like DR Horton (DHI), Lennar (LEN) and Ryland Homes (RYL) have thus far ridden out the bloodletting. According to JPMorgan analyst Michael Rehaut, these 3 may yet see positive cash flow in 2009.

Their smaller rivals, however, may not be so lucky.

Rehaut predicts that Pulte Home (PHM) and KB Home (KBH) could see negative cash flow next year – and some analysts believe 2009 could finally be the year that weaker hands start to fold. Credit protection for Hovnanian (HOV), Standard Pacific (SPF) and Beazer Home (BZH) is trading like the companies’ failure is a foregone conclusion.

Meanwhile, one key characteristic of market bottoms is notably absent: Consolidation.

Just as strong American banks have swallowed up the weak, no meaningful housing market bottom will be found until homebuilders begin to feast on one another.

Let’s face it: We don’t need 10 different multi-billion dollar companies churning out indistinguishable cookie-cutter ”mansions” on tiny lots in cramped subdivisions miles from the nearest grocery store. We’ve got our hands full already, thank you very much.

Yesterday, the Commerce Department said October housing starts registered the lowest reading since 1959. Since just 4 of the 10 builders mentioned in this article existed 50 years ago, it looks like 6 are pretty much dispensable.

By ANDREW JEFFERY

This post first appeared on Minyanville.

The private sector is actively engaging the mortgage crisis with the first broad-based, systemic attempt to prevent foreclosure. Both Bank of America (BAC) and JPMorgan (JPM) are attempting to help hundreds of thousands of troubled homeowners with massive loan modification efforts.

Regulators and bank executives are operating under the assumption that reducing foreclosures will slow record drops in home prices. In turn, this will help stabilize the financial system - and, by extension, the economy as a whole.

This logic isn’t necessarily flawed - but it’s reactive, rather than proactive, which is what’s most needed now.

Most foreclosures are concentrated in regions where homebuilders like Centex (CTX), KB Homes (KBH) and Lennar (LEN) built huge developments, using cheap financing to help fuel speculation and massive over-valuation. These areas, especially those where homes were purchased by lower income buyers, are being decimated by delinquencies and repossessions.

This, however, is widely known. What’s less well-understood is the storm that’s brewing on the horizon: Trouble in the prime mortgage market – where borrowers with good credit are starting to miss payments with alarming frequency — is looming on the horizon.

Recent delinquency data indicates that while defaults on subprime loans are occurring at a less frenetic pace than in recent months, prime borrowers are starting to feel the pinch. In early September – before the financial crisis accelerated in October — the Mortgage Bankers Association released its quarterly delinquency data, concluding,

“The increase in prime ARMs foreclosure starts was greater than the combined increase in fixed-rate and ARM subprime loans. Thus the foreclosure start numbers will likely be increasingly dominated by prime ARM loans.”

There is still a vast misconception that only “subprime” people maxed out credit cards, took out loans they couldn’t afford, and were generally reckless with their personal finances.

This couldn’t be further from the truth.

As the economic slowdown swirls outward into the broader economy, cracks are starting to form in established neighborhoods that have thus far experienced minimal home price depreciation. Many of these areas experienced stratospheric appreciation – just as their subprime neighbors did – but the strong job and stock markets insulated middle- and upper-middle income homeowners from rising interest payments and the slowing economy.

As mortgage underwriting requirements have tightened in recent months, home buying has slowed in these more well-to-do areas. This trend is being masked by spikes in the distressed sales driving broad housing market indicators.

As layoffs continue, homeowners in these areas will be forced to sell for the first time in years. The illiquidity in these markets means it will take just a few such sales to readjust prices dramatically downward. Homeowners that don’t sell by choice, particularly if they’ve accumulated equity in their homes, are apt to be less picky about their price.

Furthermore, it’s likely the recent onslaught of modification programs, tomorrow’s election, and pundits’ continued obsession to call a bottom in housing will encourage buyers to step back into the market. Increased sales transactions – even if they continue to be concentrated in distressed areas – will fuel the perception that the housing market is stabilizing.

This is likely to encourage a fresh round of selling, as anxious homeowners leap to take advantage of “improving” market conditions. This new supply won’t necessarily offset inventory that’s kept off the market by preventing foreclosures on a unit-to-unit basis; instead, the supply will simply crop up in different neighborhoods.

The subprime mortgage crisis may indeed be waning; its final battles are now being aggressively fought in Washington and bank boardrooms across the country. The prime wave, however, is just beginning to crest.

This post first appeared on Minyanville.

Some say the definition of insanity is trying the same thing over and over again, expecting a different result. By that measure, voters should load up on straitjackets this November and drag everyone in Washington off to the nuthouse.

Despite overwhelming evidence that we’re in the middle of a debt crisis, regulators insist they’re wrestling a liquidity crunch. And all the while, a cancer continues to eat away at the guts of the economy: The housing market. Only when it stabilizes will the financial system and, by extension, the economy – recover.

And yet, despite this widely recognized fact, the recent $700 bailout package contains little support for struggling homeowners. Even the $250 billion being dumped into banks will have only a minor effect on property values.

Smothered under the weight of falling home prices and tight credit conditions, consumers are reining in spending, as evidenced by yesterday’s bleak retail sales data. The economy is following the housing market into the abyss.

Since last summer, Washington’s tactic has been to encourage loan modifications through HOPE NOW and Project Lifeline and to widen the scope of government-backed loan programs via the Federal Housing Administration, Fannie Mae (FNM) and Freddie Mac (FRE).

As noted in the Wall Street Journal and discussed ad nauseum here at Cirios, these measures are woefully inadequate to stem the continued decline in housing prices.

As property values fall, over-leveraged borrowers find themselves underwater, or owing more on a house than it’s worth. In order to sell, the homeowner must come up with the difference between the sales price and the balance of their mortgage. For most, this is cash that simply doesn’t exist.

As a result, homes sit on the market for months, further pressuring home values. Despite the insistence by some real-estate agents that this is a buyer’s market, it most certainly is not. Until bloated inventories fall, home prices will continue to slide, making buying a home a dangerous proposition in the vast majority of the country.

Meanwhile, politicians continue to bang their heads against the proverbial wall, backing programs simply that do not work with the scope and efficiency that’s needed. Loan modifications, opening up mortgage guidelines and providing tax breaks so homebuilders like Centex (CTX), Pulte Homes (PHM) and KB Homes (KBH) can sell more overpriced houses may help a select few, but they do little to address the root of the problem.

Until taxpayer funds are appropriated to absorb negative equity, price discovery in the housing market will be a long, agonizing process.