Tuesday, April 29, 2008

Still no Light at End of Housing Tunnel

This morning's release of the Standard & Poor's Case/Shiller Indices proves extremely disappointing for those who are looking for evidence that home prices are nearing a bottom. Unfortunately, prices are still falling at an accelerating rate.

S&P tracks 20 major markets. The most recent data, which are for February, show that nineteen of those markets experienced year-over-year declines that were bigger than the declines seen in January. Prices fell more than 20% in Las Vegas, Phoenix, and Miami. In Las Vegas, prices are down 25% from their all-time high set in August 2006, yet because they remain 77% higher than they were in January 2000, they could go quite a ways lower. Charlotte was the only market to see a year-over-year gain in February. Prices in Charlotte inched up 1.48%, but even this was smaller than the increases in previous months.

Home prices will likely fall throughout 2008. Before they can stop falling entirely, their declines have to slow down. Because the S&P data are almost two months old, there is hope this may already be happening. Evidence of a slowdown in price decreases is the light at the end of the tunnel that will ultimately bring confidence back into the housing market.

Thursday, April 24, 2008

Housing Stocks Surge Despite Plunging Sales

New home sales continue to plummet. According to the joint release issued this morning from the Census Bureau and the Dept. of Housing and Urban Development, only 51,000 new single-family homes were sold in March in the entire country. Seasonally-adjusted and annualized, that comes out to about 526,000 new home sales, down 8.5% from February and down 36.6% from March 2007. Because the 90% confidence level is ±11.1%, it is possible that the decline was much worse. We'll find out for sure over the next two months as this figure is revised.

If that's not bad enough, it turns out that inventory is still growing. If sales stopped falling and homebuilders stopped working, there would still be enough new homes available for sale to satisfy demand for 11 months. Furthermore, the median price of a new home is down 6.8% over the past month and down 13.3% over the past year.

Despite this seemingly dismal news, almost all homebuilding stocks are up today. Although most homebuilding stocks are down by huge amounts over the past year, they are also some of the best-performing stocks year to date. At least three of them, Hovnanian Enterprises, Standard Pacific, and M/I Homes, are up more than 50% so far this year.

Many investors are obviously betting that the worst is over for the homebuilders. I doubt this is the case. Most of these companies will report huge operating losses this year. Indeed, they may report losses next year as well, assuming they survive that long. While some may consolidate, others will go out of business. At current prices, it's still too early to buy the homebuilders.

Wednesday, April 16, 2008

More Questions About JPMorgan/Bear Stearns Deal

A recent SEC filing from JPMorgan Chase raises more questions about the government's role in JPMorgan's pending acquisition of Bear Stearns. Steven Davidoff does an excellent job of pointing all this out in a New York Times DealBook piece. For example, he asks why the New York Fed agreed to give Bear Stearns a secured lending facility on Friday, March 14, then suddenly changed it's mind and backed out of the agreement by the end of the day. The SEC filing also notes that JPMorgan indicated a willingness to pay $8-$12 per share for Bear Stearns, but eventually offered only $2 per share following discussions with government officials. Take a look at Anatomy of a Merger for more questions prompted by the SEC filing. I thank Gary Lutin for bringing Davidoff's piece to my attention.

Monday, April 14, 2008

Buffett Loses Another General Re CEO

After a week of rumors, Joseph Brandon finally stepped down as CEO of General Re, a Berkshire Hathaway subsidiary and one of the country's largest reinsurance companies.

Brandon's resignation is big news because he was frequently praised in Buffett's annual letters to shareholders. Berkshire followers considered Brandon a leading candidate to replace the great man when he eventually retires. But Brandon is now the second General Re CEO to step down under a cloud. Ron Ferguson was the first.

Warren Buffett does not like to use stock to consummate acquisitions. He made an exception, however, when he bought General Re on Berkshire's behalf in 1998 for $22 billion using a combination of cash and stock. Things soured almost from the start.

When writing about General Re in his 1999 letter to shareholders, Buffett said, "we had a huge--and, I believe aberrational--underwriting loss." He said General Re was underpricing policies, yet he also praised CEO Ferguson. However, just a couple of years later, Ferguson was out and Brandon was in.

It turns out General Re was also plagued with other problems. It had accounting irregularities that resulted in $800 million of costs being charged against 2001 earnings. It had derivatives-related losses that amounted to about $400 million. In fact, these losses prompted Buffett to make his now famous statement calling derivatives "financial weapons of mass destruction."

Just two months ago, Ferguson and three other General Re executives were convicted of helping American International Group, formerly run by Maurice Greenberg, deceive investors by manipulating earnings with fraudulent reinsurance contracts. Although Brandon was not convicted of any crime, prosecutors considered him a co-conspirator and Buffett came under intense pressure to let him go. Today, he relented to that pressure.

Losing Brandon can not be easy for Buffett. Each year, Buffett heaps praise on several of his managers in his annual letter to shareholders. Brandon's name frequently showed up in these letters. Now that Brandon is gone, Ajit Jain is the leading candidate to become Berkshire's next CEO. If interested, you can read more about Berkshire's investment in General Re in my forthcoming book, Even Buffett Isn't Perfect.

Friday, April 11, 2008

Shiller at the BSAS

I want to thank one of my former students from Boston College, Harry Markopolos, for sending me his notes from a talk delivered last month by Robert Shiller to members of the Boston Security Analyts Society. Shiller, who is a member of the faculty at Yale University, is also the man who closely tracks housing prices. He was instrumental in developing the now famous S&P/Case-Shiller Home Price Index. I had the pleasure of interviewing him a couple of years ago shortly after he released the second edition of his prescient book, "Irrational Exuberance." I call the book prescient because the first edition correctly called the top of the stock market in 2000; and the second edition correctly called the top in housing.

As everyone knows, housing prices are still falling. Shiller expects them to keep falling for quite some time since the monthly year-over-year declines are still accelerating. Actions taken by government officials may slow these price declines, but eventually the market will have to find its equilibrium. In fact, it would probably be better for our economy if the government did not intervene and allowed this process to proceed as quickly as possible.

Shiller pointed out that the price gains seen in recent years were historically unusual. From 1890 to 1990, housing prices appreciated at about the same rate as inflation. Starting in 1990, however, prices took off as home buyers began to view a house more as an investment rather than just a place to live.

Shiller pointed out that for many home owners, their house is their most valuable asset. Unlike other assets, however, it was nearly impossible to hedge against a drop in value. But he has helped develop financial derivatives linked to the Case-Shiller indexes that allow home owners to do just that. Shiller believes the existence of such instruments make it much less likely that a housing bubble will develop again in the future.

Interestingly, Shiller said that in every market he examined, lower-priced homes exhibited the greatest price increases during the recent housing bubble. He attributes this to the widespread availability of sub-prime mortgages, which sometimes did not even require a down payment or the verification of income. This made it possible for individuals, who would not have otherwise qualified for mortgages, to buy homes. As a result, lower-priced homes saw the biggest increase in demand, and therefore, the biggest percentage increase in price. But now, this is also where most of the pain is being felt. Unfortunately, other segments of the housing market and the wider economy are not entirely immune. They, too, are feeling some pain.

Wednesday, April 09, 2008

Forbes Roundtable Discussion

About once every quarter, the Forbes Investors Advisory Institute hosts a roundtable discussion with some leading investment strategists and portfolio managers. Wally Forbes moderated one such discussion last night at Forbes headquarters. Panelists included Barbara Marcin of GAMCO, Mike Holland of Holland & Company, Joe Battipaglia of Stifel Nicolaus, Rich Peterson of Thomson Financial, and me. Most participants were bearish about the economy. Views on the stock market, however, were more varied with some being bullish and others expecting only mediocre returns at best for quite some time. The Forbes video department filmed the discussion and expects to post highlights on Forbes.com within a few days. We also expect to prepare a transcript for subscribers to the Forbes Growth Investor and Special Situation Survey investment newsletters. They will be notified when it is ready.

Monday, April 07, 2008

Olympic Boycotts

As a former track and field athlete, I can't help but comment on the commotion surrounding the upcoming Olympic Games in Beijing. China is coming under severe criticism for its crackdown in Tibet, as well as its cooperation with the government of Sudan, which is accused of perpetrating genocide in Darfur. The most recent developments involve protesters in France accosting a wheelchair bound athlete who was carrying the torch.

Like it or not, the Olympic Games have long been politicized. President Jimmy Carter made the Olympics a political issue for Americans when he kept our team out of the Moscow Olympics in 1980. Carter's boycott was meant to protest the Soviet Union's invasion of Afghanistan. The Russians eventually vacated Afghanistan, but not because of the boycott. Ironically, the U.S. military now finds itself mired in that very country.

As you might imagine, the Russians were not pleased with the U.S. led boycott. They felt America was trying to embarrass them. Therefore, it came as no surprise when they retaliated by boycotting the very next Olympic games, which conveniently were held in Los Angeles.

I was never an Olympic caliber runner, yet I had the opportunity to train with runners who were. In fact, one of my former track coaches was a member of the 1980 team. As you can imagine, he was not happy to see all his training go for naught. After making the Olympic team, all he got was a trip to the White House and a handshake from the man who kept him from competing in Moscow.

I am not saying that China's policies should not be protested. Indeed, they should be vigorously protested. However, an Olympic boycott is not going to do much good. It certainly is not going to convince China's leaders to change their ways. On the contrary, a boycott will probably make them close ranks and become even more belligerent than they already are. Those who are really serious about delivering a strong message to China should seek other ways. Boycotting Chinese made goods, for example, would be more effective than boycotting the Olympics. But are consumers willing to pay higher prices for goods manufactured elsewhere?