Are things really as bad as the pundits would make them out to be? You be the judge…

To look at the causes of our current market mayhem, we’ve got to go back to 2006. That’s the year the housing market peaked. For five years, real estate prices had been going on a tear of double-digit increases in home value as more and more people entered the world of home ownership. By 2004, the home ownership rate had reached 69.2% — an all time high.

Demand for homes was also booming; realtors couldn’t seem to keep up with the barrage of business coming to their doorsteps, but that was about to change…

As abruptly as it had come, the housing bubble burst in August 2005 sinking housing prices and delivering a 40% blow to stocks of U.S. homebuilders.

The Aftermath of the Housing Bubble

By 2007, the housing crisis was becoming the biggest problem on the horizon — Treasury Secretary Henry Paulson entered the scene just a year after taking office, calling the housing market “the most significant risk to the economy.” And indeed it turned out to be. Despite the Dow’s ascent past 14,000 for the first time ever in July, tides were turning on Wall Street.

In September, major lenders like Countrywide, Ameriquest, and American Home Mortgage were facing serious financial troubles as credit became harder to come by. By October, housing prices had fallen for 10 consecutive months in what the National Association of Realtors noted was “the first price decline in many, many years and possibly going back to the Great Depression.”

By March 2008 the Dow Jones Industrial Average had fallen 20% in just five months, and Bear Stearns sold itself to JPMorgan for 1.1% of its $170 high the year before. Fast forward today to the first week in October, when the Dow plummeted further than ever in what’s now being referred to as Black Monday 2008.

What Caused the Subprime Run-up?

One of the biggest causes of our current financial crisis was the popularity of subprime mortgages among financial institutions. Subprime loans are loans made to people who are high-risk. Subprime loans carry higher interest rates — meaning higher profits for the lender. But things suddenly changed when the credit market locked up and many consumers were unable to pay their mortgages. Lenders like Ameriquest soon found that the loans they’d made couldn’t be paid off and were next to worthless.

Unfortunately, the fallout wasn’t limited to banks…mutual and pension funds bought subprime debt too, because they had such high rates of return. When those mortgages became worthless, millions of Americans with nothing to do with the problem lost money overnight.

Many people believe that predatory lending was largely to blame for the collapse of the subprime lending market — lenders convinced consumers to sign off on loans that had complicated payment schedules (often increasing over time) and very long payment horizons.

And despite the windfall they found themselves in for a short time, banks soon got caught holding the bag on the subprime fiasco.

The Road Ahead

Just a few days after Wall Street’s worst week, things aren’t looking as bleak as they once were. Uncle Sam’s been intervening, ensuring that the economy doesn’t deteriorate any further. Recently, Secretary Paulson announced that the government would be buying stakes in U.S. banks to the tune of $250 billion.

The news sent stocks on their biggest-ever gain on Monday October 13, the Dow ending 936 points higher than Friday’s close.

Just where our economic crisis will end isn’t sure, but as liquidity slowly comes back to the credit market, chances of a stronger 2009 look better.

Cheers,
Jonas Elmerraji

October 20, 2008

P.S.: There’s a lot of volatility in this market that you can take advantage of. Until midnight tonight, we have the best way to exploit it.

A Breakdown on the Stock Market Crash was originally featured in the Penny Sleuth.

The debt-dealers are getting desperate. And you could cash in while the housing market starts to cash out. More on that in a minute…

Their message is smeared on billboards, TV and Internet banner ads — the lenders want you to cave in and cash out that home equity. One advertisement in particular is sure to catch your eye: A house made of money, with the spigot turned on and money pouring right out into your hands.

Cash out that equity! Debt doesn’t matter; money is FREE! These are the messages they pound into your skull. After all, this is the only way you’re getting a raise. Real salaries are stagnant or dropping… So people have cashed out and put the money into cars, clothes and maybe even another garage out back for that new car.

Then along came a new career: house flipping. Last year, you could have made a lot of money simply by buying a house, holding it for a few months, then selling it for a handsome profit.

Only the more intellectual news outlets mentioned the idea that the housing market was in bubble mode last summer, but now you’d be hard pressed to find someone who hasn’t heard the phrase “housing bubble.” After all, what goes up must come down.

And down they go. Homebuilders are warning investors that this year might not be as great as 2005. From the Associated Press:

“Shares of homebuilders took a hit [Feb. 7] after Toll Brothers Inc. said new orders fell in the first quarter and home deliveries this year would be weaker than expected.

“The Philadelphia Housing Sector Index, a national index based on share prices for 21 companies, fell by more than 1% as investors worried about signs the housing market has cooled. Shares of Toll Brothers sank $1.73, or 5.5%, to close at $29.47 in trading on the New York Stock Exchange.”

Downturn in Real Estate: Look to Lending Instead of Housing

So what should investors do as the bubble continues to lose air? Well, you should anticipate the housing market to struggle this year because the Fed will continue raising rates. And when the Fed raises rates, payday lenders make a lot of money, as do loan collectors — the folks who collect the bad loans when people default due to high interest rates. And many of these are small-cap companies.

Here are some companies you might want to research:

– Portfolio Recovery Associates (PRAA: NASDAQ); market cap: $733 million; price: $46
– Advance America (AEA: NYSE); market cap: $1.1 billion; price: $13
– QC Holdings (QCCO: NASDAQ); market cap: $266 million; price: $13
– First Cash Financial Services (FCFS: NASDAQ); market cap: $535 million; price: $34

And for those who deny the potential after-effects of the housing bubble, take a look at some other economies that have been affected.

You only need to turn to other markets around the world to see the end result of the housing bust. Just look at this excerpt from Bill Fleckenstein’s MSN Money column that ran today:

“And last week brought evidence of how the problem has affected Australia. This, from ‘Slump hits home,’ a story in the Sydney Morning Herald. As writer Matt Wade chronicles, the slow unwinding of that country’s housing bubble is starting to hurt a bit, after having been somewhat benign last year:

“‘The casualty list from Sydney’s property boom is growing. First, a generation of first-home seekers found itself priced out of the market. Then, as house prices finally sagged, thousands of overstretched investors and owner-occupiers fell into trouble.’

“He goes on to point out the insidious nature of bubbles… which is why I detest the Fed so much, because of its role in aiding and abetting idiotic activities that ultimately harm society…

“‘Now, even vulnerable people who had nothing to do with the fluctuations of property prices could be hurt. As the State Government struggles to repair the holes in the budget caused by stagnant property revenue, the aftermath of the boom could be painful for bystanders like the old, the sick, the disabled and the poor. The suffering would occur if the Government were forced to cut services and lift charges for these groups as it covers the shortfall in property taxes.’”

Until next week,

Gunner
february 13, 2006

P.S. Small-cap gold stocks are another key investment to keep in mind as the housing bubble fizzles out. In fact, Sala Kannan offers some important advice in her Friday Sleuth column about why you should buy small-cap gold.

Downturn in Real Estate: Protect Yourself from the Real Estate Recession was originally featured in the Penny Sleuth.