Housing's Roof Collapsing

Bad news from Freddie Mac and D.R. Horton gives fresh signals that the market is nearing disaster.
Author:
Publish date:

There are fresh signs the housing market could be headed for total disaster.

Look at the huge quarterly losses reported Tuesday by

D.R. Horton

(DHI) - Get Report

, the country's largest homebuilder, and

Freddie Mac

(FRE)

, one of the largest purchasers of U.S. home mortgage loans .

Or check out

Standard Pacific

(SPF)

, a builder heavily leveraged to the California housing market, whose stock

has dropped about 40% in five days on no new company news but a plethora of liquidity worries.

Falling housing prices, coupled with high consumer mortgage debt payments, are causing homeowner defaults and delinquencies to increase. This is leading to larger loan losses, which has hit homebuilders, mortgage lenders and large financial institutions like

Citigroup

(C) - Get Report

and

Merrill Lynch

(MER)

.

The drop in housing prices is causing most of the pain. A report from real estate information firm Zillow.com released Tuesday shows that U.S. home values fell 6% in the third quarter, the largest decline in the last 10 years (since the firm began tracking the data).

On top of that, nearly 16% of homeowners who bought houses in the past year now have negative equity in their homes, meaning they owe more than what their homes are currently worth, the report says.

On Tuesday, Freddie Mac, the second-largest purchaser of U.S. mortgages, reported a

$2 billion loss due to increased reserves for loan losses and impairments of existing loans. Freddie Mac is now facing a problem where it has to put aside money to protect against past loans, rather than put that money to use in new loan purchases.

Freddie Mac and

Fannie Mae

(FNM)

, which are both government-sponsored entities, have been some of the only reliable buyers of mortgage loans after the summer's credit crisis.

"The Freddie Mac news is almost like a nuclear bomb has been dropped," says Alex Barron, a housing analyst with Agency Trading Group. "I think it is pretty serious. They are a lender of last resort to a certain extent."

D.R. Horton CEO Donald Tomnitz told investors on the homebuilder's earnings call that the Freddie Mac issues "could very well" lead to another round of tightened mortgage lending.

While some of Freddie Mac's losses relate to subprime, some relate to conforming mortgages as well.

The Freddie Mac news is another feather in the uber-bearish theory about the financial sector stocks.

One portfolio manager at a large hedge fund involved in the financial sector says he has been eying beaten-up names like Merrill Lynch and Citigroup. He said the stocks may be reaching sensible valuations.

His worry, though, is that conforming mortgage losses pick up dramatically, which is what Freddie Mac may be signaling to the market. The other worry for financials is that credit card defaults may rise sharply, the manager says.

Freddie Mac, the financials and homebuilders all share the same problem of massive impairment charges, as accountants force them to write down investments to fair value.

D.R. Horton's

$50 million loss in the quarter, near expectations, was caused by $367 million of impairment charges. The uglier news came on the company's earnings call, where management focused on how 2008 will only get worse than 2007 as the competition heats up and builders slash prices.

Builders are cutting prices because they cannot simply sit on their inventories. Large debt loads from the inventories require monthly interest payments.

At this point, buying a home is like buying a homebuilder or mortgage lender stock. Why buy today, if prices will drop in the future?

Freddie Mac shares were plunging 30% to $26.45 in Tuesday afternoon trading, while Horton shares fell 5% to $10.65.

Other homebuilders taking a beating included Standard Pacific, which fell 16.7% to $2.40;

Pulte Homes

(PHM) - Get Report

, which plunged 12% to $10.38; and

Lennar

(LEN) - Get Report

, which slid 11% to $15.63.