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Mad "Housing Bottom" Is A Jumbo Problem

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In late August of last year, Jim Cramer, a la CNBC Mad Money, predicted the housing market bottom would be reached by the third quarter of 2009. A week later, the prediction was fine-tuned in his widely read magazine article, selecting June 30, 2009 as the official day the housing market would find a bottom. The publication date of the article was September 7, 2008.

During the week this magazine article came out, someone told me they had attended an economic conference and there was no shortage of tongue-in-cheek debate on the Cramer's housing market prognostication. Would the housing market "bottom" on the morning of June 30th or the afternoon of June 30th? Inquiring economic minds wanted to know.

The publication date of the Cramer article, actually marked the beginning of a 10-day window of financial mayhem that became the tipping point for housing. Virtually overnight, the housing market froze and prices fell sharply as consumers and mortgage lenders pulled back.

The 3 key events that defined the 10-day tipping point:

  1. Fannie Mae/Freddie Mac fail - On September 7, the Bush Administration announced that the federal government would seize Fannie Mae and Freddie Mac, who are in charge of providing liquidity and stability to the housing and mortgage markets.
  2. Lehman Brothers Bankruptcy - A second major investment bank fails in a year (Bear Stearns did 6 months earlier) and files for bankruptcy on September 14, 2008.
  3. AIG bailout - The insurance giant is deemed too big to fail on September 16, 2008 and propped up with $85B.

Fast forward.

June 30, 2009 is fast approaching. However, Cramer has already made the call: Housing Has Officially Bottomed.

He seems to be relying on the Commerce Department's 17.2% housing starts, a highly seasonal and staggeringly flawed metric (ie. It's 17.2%, plus or minus 14.4%). Plus, housing starts are still 45.2% below the same period a year ago and foreclosures continue to rise and many of those purchasers are speculators.

Mortgage rates jumped in the past two weeks as the Fed lost some of its ability to keep rates a record lows while the US Treasury continues to print money to cover all the bailout and stimulus costs. Higher mortgage rates will likely trigger more foreclosure activity.

Housing market trends are usually a lagging indicator, reliant on key drivers such as employment and income, local economic conditions and credit. A byproduct of the recent credit boom, housing seemed to be driving the economy rather than following it, providing the largest portion of new jobs created during the prior administration.

What has changed since the beginning of the credit crunch?

Consumers now need to have a job and now need actual income to qualify for a mortgage, plus they now need cash in the bank to provide a significant down payment. The housing boom from 2003-2007 was actually a credit boom and all of the above weren't important to lenders. Now, thankfully, they are.

Although the recession may end later this year, unemployment is expected to rise for another year and may even exceed 10% before it levels off. Mortgage lenders aren't crazy about lending in a weak economic environment and are being more draconian than ever with much stricter mortgage underwriting requirements (standards more similar to those that existed before the credit boom).

As a result, most buyers have to put 20% down to qualify for a conforming mortgage, $417,000 or less, in a large portion of the country and $729,750 in "high-cost" housing markets like New York.

A mortgage higher than those limits is considered "jumbo." Because secondary market investors in jumbo products have largely disappeared, mortgage lenders for higher priced houses have to hold the mortgages in their own portfolios and can't offload the risk to secondary market investors.

As a result, banks often require 40% to 50% down payments for purchases using jumbo mortgages versus 20% for conforming mortgages. This situation is not improving. That knocks a lot of potential buyers out of the high end housing market, many who would have qualified before the September tipping point.

So it's hard to imagine anyone calling a bottom of the housing market with much conviction considering a significant portion of the mortgage market is not functioning very well, unemployment is expected to rise through the end of 2010 and mortgage rates are rising as the Fed seems to be losing its ability to reign in rates as the US Treasury continues to print money to cover record government spending to stimulate the economy.

While he has had a successful and diverse career, and I admire his candor, perhaps Cramer needs to think about calling the top of his television ratings.