Ranieri: Housing Market is ‘Still Very Fragile’

The “father” of the securitized mortgage market, Lewis Ranieri, has drawn some attention for his views on the current real estate market. Formerly of Salomon Brothers, Ranieri pioneered the practice of bundling government-backed mortgage bonds to create new debt securities, which was a highly profitable business. As we all know now, the market for mortgage backed and other collateralized debt obligations collapsed in the face of declining asset values last year, leading to the greatest financial crisis in decades. Of course, Ranieri now of Hyperion Partners, cannot be blamed for the perfect storm of circumstances that lead to the credit crunch, and we think his assessment of the real estate market is very credible.

In short, Ranieri says that expectations of an “instant gratification”, V-shaped recovery is unrealistic. Far more likely he says, would be a slow two-plus year recovery. Residential real estate has started to show signs of stabilization as the home sales data has improved and the S&P/Case-Shiller home price index has increased for the first time since the peak in 2006. Ranieri says that most of the credit for that goes to the government’s extraordinary efforts; providing tax credits to new buyers, buying more than one trillion dollars worth of mortgage bonds to lower rates and increase affordability. However, the recovery thus far has been seen in the lower priced homes and at current sales rates there is more than 4x more supply for properties worth more than $750,000.

His fear is that rising mortgage rates and still prevalent foreclosures make the improvements seen thus far “still very fragile.” The expiration of tax incentives, and the Fed’s program to buy mortgage bonds by the end of this year could drag on this market. Even though the subprime crisis has largely been dealt with, Alt-A mortgages will continue to put pressure on the housing market going forward into next year.

Ranieri also thinks that commercial real estate will continue to be a thorn in the side of economic growth. Persistently high unemployment rates could add to the strain in some already overbuilt areas, and banks with heavy exposure to CRE loans could be at risk. Many experts believe that commercial real estate follows residential real estate in the real estate market cycle. From Bloomberg.com,

‘Major Risk’

Commercial real estate is the “major risk” to the economy, Ranieri said, adding that he agrees “with a number of the Fed governors that it may very well be a very deep problem.”

Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said in Sept. 10 speech that “one risk I’m watching is the interplay of commercial real-estate and the financial sector.”

Since peaking in 2007, commercial-property values in the U.S. have plummeted 36 percent as banks restricted lending after mortgage losses and the collapse of the commercial-mortgage bond market, according to Moody’s Investors Service. The property market is unlikely to recover before 2012 and office rents in New York and San Francisco may drop 20 percent through next year, according to the quarterly PricewaterhouseCoopers Korpacz Real Estate Investor Survey released today.

At Ockham, we share Ranieri’s view that the recovery is going to be a slow one and the economy is still at risk for further trouble. There are of course signs of stabilization all around us, but as we learned a year ago that could change very rapidly. The stock market has priced in quite a bit of economic improvement and may be out ahead of itself right now. Even with continued improvement and a return to economic growth, a small pull back would not be a surprise at this point. However, any further major issues in the real estate sector could bring financial stocks down along with it. According to Ranieri, we are still on shaky ground and caution is certainly warranted.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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