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Lifting the Roof on Housing


Todd's query about whether or not the homebuilders will be impacted by any trouble at Fannie Mae (FNM:NYSE) or Freddie Mac (FRE:NYSE) is a good one. In fact, digging deeper anywhere into the homebuilding/mortgage arena is important work. After all, it is not too much of an exaggeration to posit that the entire U.S. economy rests precariously on low mortgage rates (for reasons I outlined in my Get Shorty piece).

The homebuilders do not have substantial direct exposure to Freddie or Fannie; their exposure is more of the indirect (but no less important) kind. The most obvious is that cheap mortgages (facilitated by the twin hands of Greenspan's liquidity boom and the GSE's incredible leverage) reduce the "cost" of owning a home. So cheap capital for and massive leverage by Freddie and Fannie lower the cost of the homebuilders' products. Second, many of the homebuilders have mortgage operations (refis and originations) of their own, so they make money in the lending business as well (points, spreads, etc.). So there's another indirect relationship: By providing stability and liquidity to the mortgage market, Freddie and Fannie create an environment where the homebuilders can extend their business vertically by serving the mortgage needs of their customers. Voila: the homebuilders are sleeping in the same bed as Freddie and Fannie.

Of course, any trouble at Freddie or Fannie means trouble for the mortgage market writ large: they are, in fact, the market. So any distress to their balance sheets (or their counterparties' balance sheets) means a potential negative change in the liquidity and risk characteristics for the mortgage market. Mortgage rates could go up, homes could become less affordable, interest costs could rise (for those on adjustables), and the supply/demand environment for housing -- so weighted toward the demand side right now -- changes.

What keeps me awake at night is the terrible déjà vu I get when I look at the housing market: it reminds me a lot of the technology/Internet era in the late 1990s. Today's Fed-engineered cheap money has drawn an enormous number of marginal buyers into home ownership; folks who, if the 10-year wasn't at a 45-year low, wouldn't have the credit quality and income profile to be able to take down so much debt. After all, jobs are being lost, not gained, and consumer income growth statistics are anything but healthy. Yes homes are affordable because of low rates. But consumers' ability to pay the debt service and their prospects for paying off that debt, are decreasing.

Let's see: cheap capital chasing diminishing returns business and creating asset valuation extremes. There is no question that sums up the tech bubble in 2000. My fear is that is sums up the housing market in 2003.

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