Before a few weeks ago, if you heard the word "subprime," you might have thought someone was talking about a bad steak. But by now, everyone knows that subprime has another meaning — and if you listen to some of these guys, you'll hear that it's going to subsume the entire economy of the United States.
Listen, I started in the financial business in mortgage debt securitization, and I've forgotten more than most of these guys ever knew about this field — if I do humbly say so. So let me cut through some of the malarkey here so we can get a handle on what is — and what is not — happening with the subprime issue.
I am not in any way saying that there aren't people who took out mortgages — maybe as many as a million people — who weren't prepared to pay that mortgage off. That is a fact. But we've got to put this in the larger context of the 110 million homeowners in the United States.
About 40% of these folks owned their homes outright by the end of 2006 — so we have to take those off the table. Now, let's go to the 65 million or so homes that have a mortgage. These are homes and condos out of which about 3.5 million to 5 million have mortgages under this subprime adjustable-rate/toxic mortgage deal.
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When I'm checking the numbers, I look at the data from First American Financial, a big title company in Orange County, California. They are the ones who absolutely have their finger on the pulse of what's going on here, and their affiliate First American CoreLogic put out a mortgage payment study just the other day. Click here if you'd like to read more about it.
The finding that paints the most realistic picture — assuming homes and condominiums don't go up in value for the next six years — is that, based on an analysis of almost 9 million of these mortgages, First American projects that about 1 million households would ultimately not be able to make payments or would give the keys back because the house has fallen below the value of what the mortgage owner paid for it.
All right, a million homes sounds shocking, like the world is coming to an end — but remember, we have about 65 million households with mortgages, and we have another 40 million to 45 million homes fully owned free-and-clear.
So let's put this in perspective. If those 1 million homes are foreclosed on — or sold if they're not foreclosed — and you subtract the proceeds from the original mortgages, you're talking about losing around $115 billion. That's about 1% of the total mortgage market in the United States. Now, is this 1% going to flip the U.S. economy upside down? Absolutely not!
Bursting Bubbles, Leaking Hedge Funds
Beyond that, you have to take into account who owns these mortgages. Who ultimately owns this stuff after it's all chopped up and diced up and sold in all sorts of packages?
Hedge funds represented by $2 trillion of equity, that's who — by the way, they're also trillions of dollars of hedges out there against these loans coming apart.
So, come on — 1% is going to sink the economy? It's not going to happen.
Now let's look at the prospect of five or six years of the real estate market going nowhere. All you have to do is look at the other housing markets that have had bubbles that already burst — Australia, New Zealand and all of the U.K. — they've all had huge bubbles. In Ireland, houses are now up 400% or more during the last six years.
Here's my point: We've had housing bubbles in other large, developed countries, and they have burst. And what happened? After about two-and-a-half, maybe three years, they got back to equilibrium and started to grow again. If you look at 2006, U.K. home prices were up about 8%, and in Australia they were up about 9%.
So it's very difficult to make a strong case for the notion that we're going to be in this dark, cold freeze for the next few years.
But let's say home prices go nowhere for six years. Many people (and I will not name names — Stephen Roach of Morgan Stanley) are making the case that the subprime housing bubble bursting is the equivalent of the Nasdaq 2000 Internet bubble fiasco.
I mean, come on people! Let's just look at the facts again. We've talked about the total number of households with mortgages. We've talked about the fact that $110 billion to $115 billion in subprime-based losses is not going to take down a market that's around $10 trillion to $11 trillion.
It just ain't gonna happen: Number one, it's going to be absorbed, and number two, we have demographics on our side here.
The demographics of the 25- to 35-year-old household are growing right now. These are the prime home buyers today. (I guess Steve Roach forgot to mention that part.) Now there is no question that the people who were unqualified are not going to make it, but guess what? We'll barely notice.
Remember, we're not taking 2005 as an example of what a healthy housing market is, because it was not. When we talked about the housing bubble bursting in March 2005, any newspaper you opened had full-page ads about how you're going to make $90,000 every quarter on real estate. Come on, that's not what you'd call healthy — something had to give, folks. A healthy housing market is really more like the one in 2002 and 2003.
This year, we're going to build more than a million homes. And we're going to sell homes at a normal pace — not an abnormal pace, just at a normal pace. But guess what? The number of 25- to 35-year-olds is growing, and they've got to buy someplace to live. In the meantime, the 44- to 55-year-old boomers own 85% of their homes already, and some of them are buying second homes. Where? In places that are warm. I mean this is not changing — these demographics just don't change.
Back to Normal
Now let's look at just the tax aspect for a minute. Unless the government goes insane, the home is still the greatest asset ever invented on the planet from a tax standpoint. You can deduct your interest. You can get a $500,000 exemption on capital gains, and only pay capital gains on top of that.
So is anyone suggesting people are walking away from homes? No. But I do not belittle the ones who will have to -- it could be 400,000; it could even be a million. By the way, the same study mentioned above found that if housing prices were to appreciate just 10% in the next six years, the foreclosure rate would indeed be down to 400,000.
Now let's take a breath. Understand that there are at least hundreds of thousands of Americans who are facing an ugly six- to 12-month future because they got into these toxic mortgages. But, let's not try to connect the dots that aren't there. Let's not assume that this somehow infects the rest of the mortgage business, that it infects the economy, or employment.
We're currently at a 4.5% unemployment rate. Maybe we're going up to a 5% unemployment rate — but that's tops.
The late 1980s and early 1990s is the last time we truly had a real estate recession — right now, we have a real estate building recession. But, you know what? That means going down from 1.5 million homes to about 1.2 million. That is not a depression, that's a recession. We have pulled back about 15%-20% — so we're back to normal.
If the medical care industry were to go down, then we'd be talking. If the technology industry were to go like it did in 2000, that would be enough to bring down the economy. This subprime business is clearly not going to do that.
So, let's not make hasty decisions, and let's not go crazy by selling all our stocks, going to cash and getting into a bunker because subprime mortgages are going to take the economy down. The math just doesn't add up.
I know I've talked to you about it before, but I think you needed to hear it again, because you're going to keep hearing nothing but bad news and more bad news. Hang in there guys, and don't let it get to you.
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