Case-Shiller Home Price index declined, this should not be shocking to anyone. According to Case-Shiller data which shows home Price Indices, the leading measure of U.S. home prices, show that the U.S. National Home Price Index declined by 3.9% during the fourth quarter of 2010. The National Index is down 4.1% versus the fourth quarter of 2009. There is a direct coordination between household income/job market and housing value. I believe we did not only have housing bubble, actually we had job bubble too. As Mohamed El-Erian, CEO and co-chief investment officer of Pimco, says, "We need to accept the New Normal,". Many jobs were created due to spike in home prices and they are not coming back any time soon.
Allen Greenspan in an television interview admitted that he knew new a head of time that house prices is going to burst but he did not want to be the Fed chairman that things falling apart under his supervision. His economics policy to keep interest rate low fueled the housing market! And Ben Bernake followed his foot steps for a while. By the time Bernake started to raise rate it was too late.
The reality is that the home foreclosure rate did not improved and if we see some improvement in some states like Florida it is due to clogged up courts that are not able to address the flood of foreclosures on time. I wrote an article about Option ARM's tsunami last year. I'm looking for another leg down in the U.S. housing market by summer. Option ARMs (Adjustable-rate mortgage) is one of the most popular mortgages in the past decade, it enables the borrower to select from various loan payment options. The interest rate on the note is periodically adjusted based on a variety of indices. Among the most common indices are the London Interbank Offered Rate (LIBOR), the rates on 1-year constant-maturity Treasury (CMT) securities, and the Cost of Funds Index (COFI). These mortgages are typically structured with a low introductory interest rate or teaser rate of 1% which usually resets with in 5 years to a much higher rates. There are as many as four major types of payment options:
1)A fully amortizing 30-year payment.
2)A fully amortizing 15-year payment.
3)An interest-only payment.
4)A minimum payment option that adjusts after the first 12 months.
The option ARM loan program was one of the most popular mortgage choices for borrowers in the United States in the last few years due to its forgiving payment flexibility. This same loan originally was designed for high quality credit borrowers who invest in housing market and wanted to take advantage of payment flexibility, and low payments, but Wall Street abused this financial instrument and start to use it broadly for anyone who could find. Payment flexibility has also made it one of the most scrutinized loan programs in history because of its sometimes misleading ability to qualify borrowers for a home they truly can’t afford. Typical option arm programs do not have any caps aside from the lifetime cap of 9.95%, though the minimum payment generally increases 7.5% each year until it is no longer an available option. Problem started when mom and pop start to get in the housing business and financial industry start to promote Option ARM's as a common practice. The way mortgage brokers trap their preys was by telling them that they could flip the house before the teaser rate ended. Therefore many home buyers bought many homes that they could not afford. They could afford to pay the 1-2% teaser rate but when the promotional period ends they are going to face 300-600% increase in their mortgage, therefore they have to sell. Every body knows what happened to home prices. Thus they cannot refinance because the value of their house is significantly lower therefore they have to short sell or face foreclosures. The sad thing is that many home buyers who can afford to pay their mortgages use “strategic default” and walk away from their investments.
In summer of 2006 a friend of mine who is a successful mortgage broker gave me a heads up about the abuse in mortgage industry and lack of integrity between mortgage brokers. He complained that his boss put pressure on them to pitch Option ARM's to their clients. This was not an isolated incidence it was common practice nationwide.
You may want to know how big is the next wave of foreclosures? what you should recognize is that prime mortgages on average are significantly larger than sub-prime, and the larger the house and mortgage, means the bigger the loss. With over 50% of mortgages failing coming from prime loans, bigger loan losses lie ahead. The total losses to come is anyone’s guess, but the $11 trillion in outstanding home mortgages could easily produce over $2 trillion in defaulted mortgages!!
The light pink bars in the chart below shows when the tsunami is going to hit us. Please note the eye of the storm will be hit us by summer of 2011.
As you see in the chart above S&P500 has been moving in a narrow uptrend channel (see the chart in yellow). As long as S&P500 stays in this channel bulls should have the upper hand. I covered my shorts at 1305. I'm betting on market to bounce from 1300 support level.
As you know I'm a contrarian analyst therefore despite the moaning and crying of talking heads on CNBC I'm going against the crowd. I think market is not ready for 10% correction yet. We are in the process to form a topping formation, I'd like to see a lower high before we start the next leg down. Therefore there is no point to panic. I think the potential for a strong short-squeeze is too great therefore it's too risky to go short until S&P500 makes a lower high or violates one of the major support levels. If you don't feel comfortable to be in market you should go to side line for a while until the dust settles. Meanwhile pay attention to 1300 as important support level, if S&P500 breaks it, the next logical support would be 1286. Please note we could get a fake out for a day or two to trap the weak hands before we head the other direction. If bid institutions send the market higher and S&P500 closes above 1315 we are going to get a big short-squeeze. 
Posts
