This from economist Nouriel Roubini quoted in Reuters on October 8, 2009 (emphasis mine):
“U.S. housing prices may still fall more than 10 percent, killing an incipient recovery, as demand from first-time home buyers fades, leading economist Nouriel Roubini said on Thursday.
Roubini, one of the few economists who accurately predicted the magnitude of the financial crisis, said massive losses in commercial real estate loans will add to the problem, forcing banks to raise more capital.
“The stress is moving from residential mortgages that are still in deep trouble, to commercial real estate, where they are just starting to recognize that they’re going to have massive, massive losses,” Roubini of RGE Global Monitor told reporters after a presentation for a World Economic Forum report on the global financial system.
U.S. home prices rose for the third straight month in July, raising hopes the market is stabilizing after a three-year plunge.
A first-time buyer credit of $8,000, which is set to end on November 30, has jump-started housing activity this year and has helped reduce a massive inventory of unsold homes.
While the number of unsold houses may have bottomed out, prices are poised to fall further, increasing pressure on the economy again, Roubini said.
One of the main risks next year may be from losses on some $2 trillion in outstanding commercial real estate loans, the economist predicted.
“Half of this is in medium-sized and smaller banks, and even in the larger ones. Most of these losses are not recognized because they’re keeping the loans at face value on their books,” he said, forecasting that U.S. and U.K. banks will need to raise more capital when those write downs are made.”
Roubini’s point is well made and from our standpoint ought to be heeded. Many banks holding commercial real estate loans are holding the loans at less than face value due to a suspension of the ‘mark to market’ rules last April. (Source: Bloomberg) Mark to market rules required banks to use current market value when recording the level of an asset on its balance sheet. When these rules were suspended, banks were allowed to use ‘significant judgment’.
What does this mean? Many banks are recording the value of assets held on their books at a value other than the market value. If one of these assets is sold, the asset’s value is ultimately adjusted to its’ true market value. When this occurs, the write downs that Roubini warns about will occur.
We couldn’t agree with Roubini more on this point anyway. While the banking sector led the last market decline, it’s possible the next market decline (which we believe is likely) will also involve financials to a fairly significant extent.
A recent study by real estate information service zillow.com estimates about 23% of all outstanding mortgages in the United States has the homeowner underwater, owing more on the home than it is actually worth. The same study estimated there are about 55 million outstanding mortgages in the United States, meaning there are over 12 million homeowners who may be underwater in their homes – owing more than the home is worth. If property values continue to fall as we expect, that number will increase placing even greater pressure on the housing market and even more stress on the banks.
Meanwhile foreclosures continue to escalate.
Note: This is an excerpt from my November ‘Moving Markets’ newsletter; if you’d like a free subscription to the monthly publication, click here: www.usawealthmanagement.com.
Securities offered through USA Advanced Planners (Member FINRA/SIPC). Advisory services offered through USA Wealth Management. USA Advanced Planners and USA Wealth Management are affiliated companies. The opinions expressed herein are those of the writer and not necessarily that of the above noted affiliated companies. This update may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. The information obtained from third party resources is believed to be reliable but the accuracy cannot be guaranteed.
This information is education in nature and, therefore, is not intended to constitute investment advice and should not be interpreted as a recommendation to purchase, sell or hold a particular security. Prior to making any investment decision, the services of an appropriate professional should be sought as investment related recommendations are dependent upon the personal situation of each individual investor. Investing in market related securities involves a risk of principal loss
