Here's a quick update on housing, I've been asked a bunch lately, so thought I'd send it widely:

In 2005 Enron and Tyco and corporate bad guys made the federal regulators crazy, so they decided to pick on every public company. This included Fannie Mae and Freddie Mac, two mortgage loan underwriters and bond packagers. This began the market slow-down and also the tightening of standards. In essence Enron made it hard for Fannie Mae to do what they do so well, to create liquidity in the housing money markets.

Early 2006 saw the local near fall down of Harvest Homes, and nationally big builders taking big write-offs. This hurt our local subs and got them thinking about things like margins and service work. Prices continued upward even though the market was stalling. This is called inflation at the macro level and isn't at all good for anyone. Less people could afford to buy a home and therefore specs increased in time to sell and the existing market began to stall.

In late 2006 the housing market went to fully down cycle. But, sadly many builders tried to build specs to keep themselves and the subs afloat. Well when there are too many specs, the title companies get worried. They know that builders have to pay themselves and their staff out of these spec loans, and so they started tightening their rules to make sure that the subs were getting paid first. They also started worrying about loans being given to borrowers that seemed a little less than grade A. Title companies were asked to become the mortgage police, taking a service industry and making it less than helpful.

In early 2007 some regulators and investors began worrying about what is called sub-prime mortgages. These are loans where less than 10% is put down and the buyers may have credit issues. Typically these loans cost a little more, but frankly they were still pretty cheap for the risk. Well as the housing market began to get soft, more foreclosures happened and these sub-prime loans looked like a bigger issue. Maybe the risk in these loans wasn't truly understood? Maybe these loans should have had higher interest rates?

Interest rates continued to rise as the Federal Reserve attempted to further slow inflation in a pretty decent economy except for housing. The housing market even picked up a little in the spring. And then ... sub-prime woes kicked back in 6 weeks ago. Someone found bad news in a bunch of these loans, it spread like wildfire. Investors began selling their mutual funds that included sub-prime loan investments. Well one interesting side note is that sub-prime loans are never packaged all by themselves in a mortgage bond, they are packaged with good loans for good mortgages and good commercial paper. Guess what? The commercial paper and good mortgage market got hurt too. Even though good mortgages have not had major problems, the lenders started feeling pressure across the board from bond holders like hedge funds.

Last week several major mortgage players got phone calls from their investment bankers, guys that had been loaning them billions short term to warehouse their loans while they package them to sell into the bond market, and these bankers said "no more money". Immediately Charter Funding (part of First Magnus) and seven other companies like them had to shut their doors. We had a buyer sitting at the closing table when Charter Funding shut down! Our friend Jim Snyder, mayoral candidate in Portage, told me that he is having to send loan applications to multiple lenders just in case they are gone when he tries to close. But the good news is that lenders still want these higher rate loans, they will just have to price them higher yet for the risk. Jim also said he's getting more lenders wanting loans again already!

All the national news focused on Countrywide, the largest lender in the country, but they got the good fortune of dropping $20 in stock price which kinda attracted some investors. So while 7-10 major players went belly up, Countrywide got about $2 billion in investments and $11 billion in loans to put them back in good standing with shareholders. Hopefully the bond market will be happy as well. The Federal Reserve cut the rate that banks could borrow money at for one night, in an attempt to calm everyone down. They will probably cut interest rates too in September, which means that mortgage rates have come back down closer to 6%. They've shoved about $20 billion in cash into the banking system to keep everyone liquid. In normal times this would be a bad omen, and portend inflation. Right now it did seem to help to calm the banks nerves. I heard that the Chinese hold trillions in mortgage bonds that have sub-prime inside them, the Fed needs to keep the Chinese happy too so they don't dump their investments.

Let's be honest the market will be slow the rest of the year. Floods in the Midwest and drought in the South aren't helping either. Inventory is bad, costing interest and having very little ability to liquidate. Presales with good solid customers will still happen but at a much lower rate, since many of them will have existing homes to sell and of course that market is quite soft. Smart builders will leverage the market slow-down to get better prices from subs and to build pre-sales at solid margins.

Housing will rebound locally, I would guess in late 2008 or early 2009. Vacation markets have been decimated and will probably rebound a bit sooner since the stock market is solid and people will feel like they are making money and buying ahead of the next wave, probably early 2008 the vacation markets will start their climb. I would expect hundreds of subs will fall out of the market this fall, as many of them overcharged and underserviced, and then 30 day pays stretches out to 120 day pay. Job losses in residential construction will be in the thousands this fall.

Opportunities?

Legitimate home buyers who are scared that the sky is falling, and need professional calming to see that this is still a great time to buy a home. 6% is low, you can still get zero down payment loans, you can still qualify with less than perfect credit. Homes are still a great investment.

Cost of construction should continue downward all year, giving capitalized builders a chance to lock in better prices for the next 12 months. Land prices will have stopped rising and may go down a bit. $80,000 for a ¼ acre in Valpo was getting a little crazy.

Commercial construction is still strong, and these lower prices for land and materials may make this a strong niche for the next couple years. Job creation may be more commercial for the next 18 months as residential completes it's down portion of the cycle.

In-fill and Green building will have an even greater appeal to those buying homes. Buyers with money are going to be able to buy "ethical" homes at a decent price.

Politicians will be able to "feel the pain" and get mileage from special bond deals and affordable housing initiatives that no one cared about two years ago.

UPDATE:  Sorry for the original lack of formatting, I posted from my blackberry.