Wednesday, August 17, 2005

Real Estate Prices Will Not crash!!!

Wall Street Journal and a guest on CNBC today both acknowledged that there is a bubble (or overvalued as they put it) in the real estate market but opined that if the bubble does burst, the decline in price will not be great and one of the major assumptions that the guest on CNBC is because:, "...especially if you're bullish on the economy and job creation in 2006 that should keep prices buoyant!". In addition, he mentioned that creative financing such as interest only loans (traditional mortgage payments consist of interest and principal payments while interest only loans is such that principals are rolled into your balance, in effect you have lower monthly payments but your loan amount increases every month, compounding) are adding to the aggregate demand.

Let me explain why this logic is flawed. First, basing your opinion on assumption (such as job creation) is dangerous to say the least. Job lay-off annoucements have spike to the highest level (this is fact according Challenger Gray Consultion firm) and the lamest excuse the general media can base their opinion good job growth to recommend that the housing price will not collapse?

Second, creating financing is equivalent to vendor financing done by the telecom debacles in the late 90s. Vendor financing is financing handed by suppliers to keep sales going (think GMAC, the finance arm of GM that finances all those 0% sales). Eventually everything will stop. This phenomenon is not just limited to the housing sector nowadays. Look at Dell's earnings (which was good by the way albeit short of expectations) for instance, Q2 sales were growing at 15% yoy but RECEIVABLES GROWTH were a whopping 23%. This is a major RED FLAG if you are financial analyst (In fact I will do another post on this).

The other more dangerous sign I have read today is the key word "few economist" think there will be a melt down in real estate prices. The contratrian in me rang a bell so loud that I have to cover my ears. In 1931, before the bottom of the stock market market and deepening of the Great Depression, majority of CEOs and Fed officials were bullish on the economy just as we are today.

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