Testing the waters?

The Fed, as expected, bumped up short term rates by another 25bps. This was no surprise, however, the language in the statement was decidedly different in tone from previous statements. To me it's quite bizarre. For the previous few weeks, fed officials were out in the media demonizing the evils of inflation and trying to sell their inflation fighting credentials. However, the statement was, in my opinion, much more dovish on inflation than previous ones. Is the fed stuck in it's own connundrum? Obviously the markets have interpreted the statement as a signal from the fed that it is at or near the end of the tightening cycle. This has led to a dollar decline and a pop in gold prices. It seems to me as if the fed wants to stop raising rates so as not to push the economy into a housing led recession. However, the greater risk, probably, is of a dollar crisis. It seems rather obvious that the dollar is receiving support from interest rate differentials, and if the fed stops raising rates, this source of support will diminish. That could cause the dollar to plunge, which could really cause long term rate to rise from a U.S. Treasuries sell off. So it will be interesting to see how the talking heads at the fed disseminate information over the course of the next six weeks. We are told that they are "data driven". But it seems to me the only data that interets them is relative dollar strength. Good luck Ben!

Current Market Conditions 6/18/06

The summer market is here. Only one word can describe the r/e market - stagnation. Inventory is up, but stagnant, prices are down slightly, but stagnant. Even the air is stagnant today, the usual NJ high humidity summer day. I got a mailer from a local realtor, probably the busiest in my area. I though it would be one of the usual r/e letters I receive about houses listed and sold and what a great realtor that particular realtor is. However, this letter was different. The letter states "The real estate market has changed. In these new times you really need a good realtor", i.e. "him". To my knowledge, this is the first realtor in my area who has stated in his mailings the obvious fact that the market has changed. Alas, prices are still high, and there has been no mass capitulation. I continue to stand by my forecast that unless there is a "market event", the r/e market will deflate slowly over several years. Of course, there seems to be suficient risk out there for such an event to occur.

McMansion Glut from WSJ.

The McMansion Glut
America's love affair with sprawling homes is showing signs of waning as the real-estate market softens and aging boomers seek smaller houses. Our reporter on nervous sellers and the growing supply of 'faux chateaux.'
By JUNE FLETCHER
June 16, 2006; Page W1
Mickey and Jane Finn put their five-bedroom, 6,200-square-foot home in Leesburg, Va., on the market in April, but already they've cut the price to $899,900 from $1.1 million. Now, they've decided to put it up for auction.


What's the hurry? Down the street in their leafy subdivision, two similar-sized houses are also on the market, and around the corner, five more have for-sale signs. The Finns, who paid $692,000 for the new house in 2002, recently retired and, with their two children grown, they're eager to move to a place half the size. "We don't need this big a house anymore -- if we ever did," says Mr. Finn, age 63.

The golden age of McMansions may be coming to an end. These oversized homes -- characterized by sprawling layouts on small lots, and built in cookie-cutter style by big developers -- fueled much of the housing boom. But thanks to rising energy and mortgage costs, shrinking families and a growing number of retirement-age baby boomers set on downsizing, there are signs of an emerging glut.

Interviews with dozens of real-estate agents, sellers, developers and housing economists turn up signs across the country. In an affluent Dallas ZIP Code, where half the houses have four bedrooms or more, home sales fell 31% in the first quarter compared with the previous quarter. But sales rose 23% in a nearby ZIP Code where 7% of houses have that many bedrooms. In Santa Fe, N.M., homes in the 2,000-square-foot range sell within weeks, while larger ones languish for months, says broker Pat French. In the Boston metro area, sales of homes with four or more bedrooms were flat in the first quarter from a year earlier; sales of homes with three bedrooms or fewer rose 14%. New Jersey appraiser Jeffrey Otteau says the inventory level statewide for large, $1 million-plus houses stands at 13 months, more than twice the state's overall average of six months.

A TALE OF TWO ZIPS


Sales of larger homes are flagging in many markets. See a comparison of home sales in nearby ZIP codes.
There is no formal definition of what constitutes a McMansion. (Some would say it's any home bigger and showier than your own.) One broadly accepted definition, used for this article, is a house larger than 5,000 square feet -- about double the national average -- with four or more bedrooms that is built cheek by jowl with similar houses. Most have been erected since the mid-1980s, when major developers such as Toll Brothers and K. Hovnanian Homes began to chase couples who wanted more space -- and luxury -- than they had when they were kids. These houses often boast grand, two-story entryways, three-car garages, double-height family rooms and master-bedroom "suites" equipped with sitting areas and whirlpool tubs. Developers market the homes under names such as the Grand Michelangelo, Hemingway and Hibiscus -- while detractors have dubbed them "garage mahals," "faux chateaux" or "tract castles."

Big Fuel Bills

The 2003 American Housing Survey, the latest available, found nearly 3.2 million homes in this country with 4,000 square feet of space or more -- the largest category the group tracks -- up 11% since the previous survey in 2001. Part of the big-house mania was fueled by speculation as home prices surged, says housing economist and consultant Thomas Lawler in Vienna, Va. "Folks bought megasized houses well beyond their needs to increase their investment in real estate," he says.

Now, some boomers in their late 50s are counting on selling their huge houses to help fund retirement. Yet a number of factors are weighing down demand. With the rise in home heating and cooling costs, McMansions are increasingly expensive to maintain. Nationwide, electricity rates have risen 12% over the past three years, while the price of natural gas for heating has risen 43% in the same period, according to the U.S. Energy Information Administration. That means it can cost $5,000 a year or more to heat and cool a 5,000-square-foot house in a city such as Farmington, Conn., according to Connecticut Light & Power Co.

The overall slump in the housing market also is crimping big-home sales. The volume of newly built homes sold fell 11.2% in the first four months of the year from a year ago, while sales of existing houses fell 5.7%, says the National Association of Home Builders and the National Association of Realtors. Yesterday, one of the biggest home builders, KB Home, cut its earnings outlook for the year, citing declining demand. Bruce Karatz, chairman and chief executive, said demand has fallen "largely due to a sharp reduction of speculative purchases and an oversupply in new and resale inventory."


Tom Green threw in a high-definition TV to sell his house in Loudoun County, Va.
Meantime, the jump in interest rates has put the cost of a big house out of more people's reach. With 30-year mortgages at 6.2% yesterday, a $700,000 loan costs about $4,300 a month, up from $3,900 when rates were 5.28% in June 2003, according to Bankrate.com. "The young people coming up don't have the means to absorb these big houses," says Mr. Otteau, the New Jersey appraiser.

Since February, Kris and Ray Victory have been trying to sell their five-bedroom house in Brookville, N.Y., built in 1987 with a sunken living room and a fireplace in the master-suite wing. The couple raised three children in the 8,000-square-foot home, but they say younger families seem turned off by its $1,000-a-month utility bills and $25,000 annual taxes. "Buyers tell us it's too big," says Mrs. Victory, a 45-year-old electrical engineer. The couple recently shaved $200,000 off the $2.35 million price.

This dynamic could become more acute in coming years. As the nation's 78 million baby boomers, born from 1946 through 1964, become empty-nesters and hit retirement age, many are already selling their trophy homes and trading down to smaller models. There are roughly the same number of people in the next pool of potential buyers, but they're marrying later and often have smaller families: U.S. Census statistics show that the average household size in 2005 was 2.57 people -- down from 3.14 in 1970.

Already, the McMansion oversupply is acute in places like Loudoun County, Va. In the fast-growing area northwest of Washington, D.C., thousands of hulking, red-brick colonials sprouted over the past 10 years on quarter-acre lots that had been carved from farmland and woods. In May, 4,719 houses were for sale, more than three times the year-earlier level. The number of sales dropped 39% to 484 in the month, and the number of days a home remained on the market lengthened to 70 from 14. "Sellers are dying out there," says local real-estate broker Michele Stash.

In one Loudoun subdivision, Tom Green, a 47-year-old airline pilot, put his five-bedroom house on the market six months ago for $1 million so he and his wife could downsize to a $592,000 townhouse nearby. But his home had to compete with 38 others for sale in the neighborhood with four or more bedrooms. His 5,600-square-foot, five-bedroom house, which he bought new for $515,000 in 2000, didn't get a nibble for months. Finally, a relocating California family agreed to buy it if the Greens would leave behind their high-definition TV and a lifesize Spiderman statue that had been a gift from Mr. Green's sister -- plus slash the price to $820,000. (They also had to throw in a cookie jar with "Biscuit" -- coincidentally, the name of the buyers' dog -- written on the side).


Mickey and Jane Finn have decided to auction their Leesburg, Va., house (left); the pool and waterfall at the Mumme house in Phoenix (right).
The Greens complied. The buyers, John Zuccaro and Cindy Fonseca, say they were emboldened to make their demands when they saw how much the market had cooled since April 2005, when they sold their three-bedroom house in Torrance, Calif., for its full asking price of $759,000 in only five days.

Though huge houses continue to be built across the country, many architects and builders appear to be responding to shrinking demand for McMansions. In the latest quarterly survey by the American Institute of Architects, 68% of the 500 residential architects polled said home sizes are stable or declining, compared with 58% a year ago.

Focus on Smaller Homes

For anti-McMansion activists, who hate to see big homes supplant smaller "teardowns" in established neighborhoods, a decline in demand may be good news. Homeowners in some areas have successfully lobbied for laws designed to rein in the light-and-view-blocking monsters: Last year, Arlington County, Va., limited home footprints to no more than 30% of a lot, while Wood-Ridge, N.J., recently said homes could take up no more than 55% of a lot.

Faced with dwindling demand and a fall in their stock prices, many national builders are starting to focus more on smaller houses, which often feature separate dining and family rooms but just two bedrooms. K. Hovnanian Homes, long known for McMansions, is building such houses under its "Four Seasons" label in nine states. Toll Brothers is creating communities like Cranbury Brook Villas in Plainsboro, N.J., which has two-bedroom homes ranging from 1,656 to 1,958 square feet that can be equipped with lofts, sunrooms and dining-room accent columns (the "Bayberry" model starts at $389,975).

Yet some families have found it hard to downsize. In Phoenix, David and Mary Mumme, both 49, are selling their 4,938-square-foot house, partly because their oldest son is heading to college and partly because maintaining the house and yard -- with pool and waterfall -- takes about eight hours a week. They're asking $1.8 million, about three times what they paid for it six years ago, because they saw nearby houses sell quickly for about $2 million last year. But even though the house has 12-foot ceilings, marble countertops and skylights in the closets, no one has made an offer during the month it's been on the market.

John and Barbara Fiore, both 54, had to slice $50,000 off their $900,000 price to move their 5,500-square-foot house in Warwick, N.Y. Ms. Fiore, who has five grown children, says she worried that no one would want her six-bedroom home while it sat on the market all last year, because today's families are smaller. (The eventual buyer was a married doctor with three young children.) The delay in selling "was scary," says Mrs. Fiore. The Fiores, who built the house 14 years ago, now live in a three-bedroom house nearby that's less than half the size. Meanwhile, Mrs. Fiore's parents recently sold their Warwick house in a month -- but it's only 2,500 square feet.

And even some young couples who have tried the big-house life are getting out of it, trading space for higher-quality construction. Last October, Andrew and Sheri Leppert of Alpharetta, Ga., both 32, exchanged their four-bedroom, 2½-bath home for a smaller one that has only three bedrooms and two baths -- yet, at $450,000, cost 50% more. Ms. Leppert, a homemaker who now has a young child, says she was attracted by the new house's details -- including beaded-glass windows, wide-plank flooring and 9-foot-tall doors made of solid wood -- which elevated it in her mind above the "Georgia sprawl" house she was leaving. She and her husband never used the fourth bedroom of their old house, she says, and she doesn't miss cleaning the extra space. "Taking care of it became a burden," she says.

Write to June Fletcher at june.fletcher@wsj.com

A Tale of Two ZIPs

In many markets, sales of bigger homes are flagging while smaller ones are doing better. Here's a comparison of nearby ZIP Codes for the first quarter of 2006:

CITY ZIP CODE % OF 4+ BDRM HOMES NO. OF SALES MEDIAN HOME PRICE COMMENTS
Dallas 75205 49% -31% $365,000* There are many new homes in both ZIPs, but in 75206 they're selling better because they're typically half as big, and cheaper. For sale in 75205: a 6,390-square-foot home for $3.5 million with wine room and library; in 75206, a 3,300-square-foot Tudor, $599,000.
75206 7% +23% $125,000*
Miami 33133 19% -8.1% $538,500 Miami's market has cooled, agents say. In 33133, which includes trendy Coconut Grove and Coral Gables, a 6,900-square-foot, three-year-old house has dropped $1.25 million, to $3.5 million.
33132 0% +32.7% $340,000
Seattle 98119 21% -9.8% $499,500 Anti-McMansion sentiment runs high in Seattle. In 98121, most homes are tiny and relatively new. Newer homes in the older neighborhoods of 98119 are pricey: a six-year-old, 5,200-square-foot house with Puget Sound views asks $3.3 million.
98121 10% +5.4% $395,000
Tucson 85718 39% -9.7% $401,500 Tucson's had a big growth spurt since 1990. In a gated community in 85718, a 6,100-square foot home, built in 2003, has fallen $200,000 in asking price, to $3.3 million. In 85704, $600,000 buys a new, 2,400-square-foot pueblo-style custom house.
85704 28% +3.9% $279,500
*Census 2000

Sources: DataQuick.com, City-Data.com and local multiple listing services

Prediction for next fed meeting!

I predict a 25 bp rise with more hawkish talk on inflation. I am curious what others think.

"Tough Love" by Stephen Roach!

After years of excess accommodation, the US central bank may be trying to reclaim the "tough-guy" image that a credible monetary authority needs.

It’s been a long time since I said something positive about the Fed. That saddens me. The Board -- as insiders call the Washington-based Board of Governors of the Federal Reserve System -- was my first place of gainful employment after grad school. I spent seven wonderful years there in the 1970s, and there will always be a soft spot in my heart for this great institution. It has pained me no end to write of a Fed that lost its way in the bubble-infested waters of the past seven years. But now, for the first time in a long time, America seems about to get a meaningful dose of monetary discipline. Ironically, it could be tougher on the markets than on the economy. For investors, that’s a painful wake-up call, to be sure. But in the end, it’s absolutely essential in order to put an unbalanced, asset-dependent US economy on a sounder and more sustainable course. Three cheers for Ben Bernanke!

Of course, he hasn’t really done anything just yet. The Fed could disappoint -- and end up being all bluster and no action. Or there is always a chance it’s too late -- that America’s imbalances are so advanced, the only way out is the dreaded hard landing. But in my new role as the optimistic pessimist, I am willing to give Bernanke & Co. the benefit of the doubt. By talking tough in the context of only a fractional overshoot of inflation -- an overshoot that may be more statistical than real -- the Fed is sending an unmistakably clear message of a move to policy restraint. And by delivering that message in the context of down markets, the rhetoric of monetary discipline has an even stronger ring. If there’s ever been a time for America’s central bank to take on the markets, this must surely be it. Former Fed Chairman William McChesney Martin put it best in his legendary quip: "The job of the Federal Reserve is to take away the punchbowl just when the party is getting good." For years, the Fed has provided more than its share of refreshments at the biggest party of them all. Those days could now be drawing to an end.

A few weeks ago, I wrote of a crisis of confidence in central banking -- arguing that a profusion of asset bubbles was an increasingly perilous consequence of a successful journey on the road to price stability (see my 22 May dispatch, "Wake-Up Call for Central Banking"). My point was that at low levels of inflation, the policy rule of the inflation-targeting central bank results in exceedingly lower nominal interest rates -- the sustenance of an ever-expanding liquidity cycle. I argued that the monetary authority actually needs to broaden out its targets as it approaches price stability -- paying special attention to excesses building in asset markets. In effect, monetary policy needs to be conducted with an asymmetrical bias in those circumstances -- predisposed more toward tightening than accommodation. This has important tactical implications for the Fed: A tight-money bias at low inflation rates may well be essential if the US central bank is to succeed in satisfying its "dual mandate" of price stability and sustainable economic growth.

My reading of Ben Bernanke’s now-infamous 5 June statement is that he gets it. His hand-wringing over inflation actually seems exaggerated in the context of the downshift he is now expecting for US economic growth. In fact, his statement goes out of its way to speak of a transition to slower growth arising from the combination of higher energy prices and a cooling of the housing market. At the same time, his concern over inflation also seems at odds with some obvious statistical quirks in the aggregate price data. Yes, the core CPI is running at a 2.3% y-o-y rate through May -- in Bernanke’s telling words, "…at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth." The overshoot, however, is due entirely to the notorious "owner’s equivalent rent" of primary residences; excluding this key item -- fully 30% of the core CPI -- the core would have been 2.0% y-o-y in April ( and actually 1.9% excluding the entire shelter category). It is arguable whether the inflation alarm would even have been rung were it not for that statistical acceleration in one of the CPI’s most controversial components. And then, of course, there’s the financial market climate to consider -- an already-meaningful correction in global equity markets and a particularly sharp downdraft in risky assets such as emerging markets and commodities. In a still low-inflation climate, a risk-averse Fed might have been tempted to wait until the dust settles in the markets before flexing its policy muscle.

Bernanke’s conclusion that there has been an "unwelcome" deterioration of inflation -- and inflationary expectations -- can also be challenged on other grounds. The fractional rise in the hourly wage rate in May (+0.1%) throws cold water on the notion that tight labor markets are bidding up the price of labor. At the same time, the sharp recent correction in commodity prices challenges the belief that surging global growth is leading to a coincident boom in input prices that could further exacerbate incipient inflationary pressures. And on a structural basis, the ongoing pressures of globalization continue to act as powerful headwinds restraining any cyclical pressures building on the inflation front. Finally, there’s a tactical policy issue to ponder: At low inflation rates, the strict inflation-targeting central bank has the leeway to make a minor policy mistake; it can, in effect, afford to be late and come in after the fact with a monetary tightening -- suffering the consequences of what should be only a brief detour on the road to price stability. In short, there are plenty of reasons why Bernanke might have elected to wait out this so-called inflation scare. But he didn’t. In fact, he struck early in the game, and this message has been reinforced by a coordinated rhetorical assault by other members of the Fed’s policy-making body.
Maybe I’m reading too much into this, but I think there is an important implication of the Fed’s hair-trigger response to an arguable inflation scare: After years of excess accommodation, the US central bank may be trying to reclaim the "tough-guy" image that a credible monetary authority needs. And there is good reason to believe this sentiment is global in scope. Recent monetary tightenings by the ECB and by central banks in India, Korea, Turkey, South Africa, and even Iceland all speak to a similar disciplined mindset. And these actions all have comparable implications for the global liquidity cycle and world financial markets -- reducing the flow of high-octane fuel that has fed the multiple asset bubble syndrome of the past seven years. I am not saying that central banks are united in their views in targeting asset markets. But I do believe that a strict adherence to inflation targeting may have become a foil that now enables the authorities to turn their attention to other important issues -- namely, the increasingly dangerous excesses of a very powerful liquidity cycle.

This sudden outbreak of monetary discipline around the world very much fits the script of my newfound optimism on global rebalancing. The world’s biggest imbalance -- America’s current account deficit -- is a direct outgrowth of a property-bubble-induced shortfall of income-based saving. Lacking in domestic saving, the US must import surplus saving from abroad in order to grow -- and run massive current account and trade deficits in order to attract foreign capital. To the extent central banks have promoted asset-bubble-related global imbalances by overly accommodative monetary policies, an emerging bias toward monetary discipline is a very encouraging development on the road to global rebalancing. While it’s "tough love" for bruised investors, this may well end up being the requisite correction that clears the decks for the next upleg in the markets. Thank you, again, Ben Bernanke.

Could there be a 50?

It's been interesting to watch the market lately. It seems like the thought of cheap money disappearing is putting a big hurt on share prices. What's interesting to me is all the "Fed Talk" by various officials about unacceptably high inflation. It is a little bit strange. Oil prices haven't changed for a while, gold has come down by more than $100/oz, housing prices have leveled off, so what gives? Is the fed trying to inflict pain on the market? Are they really trying to mop up the liquidity? When the minutes of the last fed meeting came out, I was astonished to hear that they were considering a 50 bp increase in rates. Well, back then, they were not talking about inflation with nearly the same intensity as they are now. So the question begs itself. If they considered 50 bps in May, why not consider a 50 now? The dollar is under a lot of pressure, so increasing the spread will certainly keep the dollar attractive relative to other currencies. Want to raise risk premia? Bring out the hammer and squeeze out the marginal speculators. Ultimately I don't believe it matters. We have such a highly leveraged, indebted society that over time, even a fed fund rates of 5.0% is too high. As the fed has been raising rates in baby steps, it gets closer and closer to producing a "market event". Something has got to give. Will a large hedge fund blow up a-la LTCM? Will it be a major bank incurring huge loses through it's derivatives trading? Will the stock market crash again? At some point, we have to stop being an asset economy and start being a real economy again. So I say just do it. Pop the bubbles, heal the wounds and lets move on.