Housing mess too big for a quick fix

By Bill Fleckenstein

Recently a friend, noting my firm belief that the credit side of our real-estate problem won't be solved anytime soon, asked me why I feel so certain about that.

In this week's column, I'll explain exactly why, bolstering my position by giving equal time to the bull side of this debate.

Simply put, too much debt

Sometimes, in order to figure out what's likely to happen, you need to boil the problem down to its simplest state.

The problem in this country is that too many people have houses they can't afford and debts they can't service. Many financial institutions are owed those debts, which are impaired.

If we had just one financial institution and one consumer and we put them in a room together, we could probably get the financial institution to write off the value of the mortgage to where the debt could be serviced and the housing market could clear its inventory. That might be 25% or 30% lower.

We could cobble together a deal whereby that consumer could afford to live in his house, be able to make the monthly payments and, in effect, do a short sale to himself. (A short sale, in real-estate terms, is when a house is sold for less than what the owner still owes on the mortgage.)

The financial institution could then write down the loss over the life of the mortgage, or, if the house were to rise in value, it could capture the gain.

That would probably allow the consumer to move forward with less angst, assuming the economy managed to stay OK in the absence of the housing ATM -- something that might not be possible. Nevertheless, in this manner, the problem could be worked out in a couple of years.

The financial institution would have time and be given an accounting mechanism by which to write off the problem slowly. During that period, the economy would be only sort of crummy.

However, in the case before us, mortgages have been sliced and diced. Hardly a mortgage is left in the place it was originated. Conceivably, any given mortgage could be held by 50 or 100 financial institutions rather than just one. And every community has unique problems to deal with.

When 0% is onerous

As for those folks who think still-lower interest rates would reinvigorate demand, Bob Campbell of the San Diego Real Estate Timing newsletter counters with this undeniable fact: "When an asset like real estate becomes overvalued, even if you drop interest rates to zero, you can't force consumers to borrow more, because they've already borrowed too much. Nor can you force lenders to lend, because they're already puking on 'bad paper.' It's called a liquidity trap."

I don't believe there's any way to get the genie back into the bottle or to solve not just the size but the complexity of the fundamental mortgage problem: Too many people are involved with too many different agendas to make these credit problems go away quickly and easily.

A procession of recession soft-pedalers

Even so, many Wall Street participants envision a quick ending to the unwind of the credit/housing mess. It's their belief the economy will skirt a recession or experience one that's minor and painless.

For instance, Richard Russell recently wrote in his Dow Theory Letters: "As for the recession, the stock market's not worried about one, so why should you??"

(Of course, the market didn't worry about the tech bubble, credit bubble or real-estate bubble, either.)

"I have to think that the Dow Jones Transportation Average ($DJT) is telling the story," Russell wrote. "From the Transport low of 4140.29 recorded on January 17, the Transports rallied to (a recent) closing high of 4807. . . . It follows that if the Transports have recorded their lows, then no matter what the Dow does, the correction or decline or bear market -- or whatever you want to call it -- has ended."

Artificially colored Greenspan

This sanguine view is echoed by others, including certain corporate insiders, a handful of whom have made chunky purchases, according to data compiled by investment research firm Washington Service. In fact, January saw insiders buy more shares than they sold for the first time since the 1990s, with purchases registering 1.44 times sales. But recognize that the firm's data go back only 20 years. That is not a very long stretch and essentially encompassed the years when the "Greenspan put" was in existence -- or believed to be in existence.

Furthermore, insiders are not infallible. For instance, from everything I've read about the 1929-30 period, many "insiders" (the term was used differently then) correctly anticipated the problems of late 1929, both in terms of stock speculation and potential economic trouble. But after the crash, they believed the worst had passed and bought stocks through the spring of 1930, a move that was a disaster.

That is not to imply the situation is exactly the same but to illuminate the fact that insiders don't always get it right.

Arguably, our country has experienced the biggest bubble ever: the real-estate bubble induced by easy credit. I cannot believe that Wall Street will escape with only the recent damage in stocks or that the economy will suffer no more than a modest downturn.

Folks would be wise to hope for the best but to plan for the worst.

Published Feb. 11, 2008