December 27, 2008

The S&P500 slipped almost 2%, on light volume, for the holiday week.  Volatility dropped again, but it didn’t help create the much hoped for Santa Claus rally.   And the flow of bad data continued.  Jobless claims spiked to 586,000, a multi-decade high.  Consumer spending dropped, and durable goods orders slipped.  Notably, new and existing home sales plunged and the median sales price of existing homes fell (year on year) by over13%–the largest decline since the Great Depression according to the National Association of Realtors.

Why is this notable?  Aside from the fact that the usually optimistically biased NAR has started to acknowledge the magnitude of the housing bubble debacle, the housing data is clearly pointing to more pain in the housing market.  Before this data was released, some bottom-callers had started to suggest that they could see the light at the end of the tunnel in housing.  After a peak to trough price drop of 20+%, they were desperately looking for signs that the rate of price declines was deccelerating.  This data proved them wrong.  Housing is still falling and arguably falling off a cliff.

Why does this matter?  One of the root causes of our global economic crisis was the bursting of the U.S. housing bubble, a bubble fueled (in part) by the Fed’s easy money policies after the dot-com bubble burst and by the accompanying spread of easy credit products and their securitization all over the world.  The S&P500 is down about 40% in 2008 as a direct result of the negative feedback loops created by this imploding housing market.

So, if the housing market is nowhere near finding a bottom, then it creates additional–and substantial–downward pressure on the U.S. (and global) equity markets.  Unless the Fed, or the Treasury, or Congress, or the tooth fairy, can come up with some miracle cure to stop the free fall in housing, then the odds of further drops in equity prices go up. 

And keep in mind that the U.S. housing market has approximately $20 trillion in total value–even after its drop from peak value in 2005-2006.  Using the Case-Shiller 100 year trend line as a rough estimate of fair value (long term price to income and price to rent ratios are equally suitable substitutes), then the U.S. housing market could easily fall another 20% just to revert back to this level (and this assumes that prices would not fall below long term fair value, as they typically do in major corrections).  This means that another $4 trillion in housing value could vanish.  If about 50% of house values are encumbered with mortages and related liens, that means that $2 trillion in credit values would need to be marked down, say by 50%. 

This may mean another $1 trillion in mortgage related losses have yet to be booked.  If all of the disastrous economic and financial events of 2008 resulted from $1 trillion in credit losses, then imagine what havoc a second trillion dollar loss would wreak. 

2009 promises to be challenging.  Buckle up.

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