SPM Chief Don Brownstein Talks History, Future Of Housing Market

Jun 3 2010 | 9:55am ET

By Mary Campbell, Senior Reporter

The single family housing and subprime mortgage crises, which hit the U.S. beginning in 2006/2007 and sent home equity, housing prices, stock markets and retirement assets plummeting could have been prevented, says Don Brownstein, if Americans had paid more for their plasma TVs.

You’re scratching your head, but bear with us, all will be explained.

Brownstein is the CEO of Structured Portfolio Management (SPM), a hedge fund that actually got the subprime bet right.  According to the Absolute Return hedge-fund database, one of its funds posted returns of about 185% in 2007 (after fees). Brownstein believes those who do not know their history are doomed to repeat it, so to come to grips with what happened in the U.S. housing market in 2006/2007, we have to look at what happened in the past.

“I think you have to look back to the Great Depression and World War II as crucial moments for what we have experienced up through 2006,” Brownstein told FINalternatives during a phone interview.

In the 1930s, in the aftermath of the 1929 stock market crash, many Americans lost their homes. At that time, mortgage structures were very different – they weren’t securitized, they were held by local banks; 30-year mortgages were a rarity; and many were balloon payment mortgages, so called because they don’t amortize over the term of the note, but leave a balance due at the end.

“People were thrown out of their houses, if they weren’t thrown out of their houses, they were thrown off their farms – The Grapes of Wrath is about that. But there were many, many other families dispossessed not only from homes that they owned but from homes that they rented. And in a sense what happened during that period, I think, is that we had a national experience of dispossession.”

The result, says Brownstein, was that a home of one’s own became something to strive for. Homes were seen as shelters not just from the elements, but from economic turmoil.

After the Depression came World War II and although the United States was not subject to the destruction inflicted on much of Europe over the course of the conflict, it did have 15 million Americans in uniform and when they began returning home in ’45 and ’46, they faced an acute shortage of housing, as housing construction had dropped to almost nothing during the war.

“People who had just been mustered out of the armed services were living in what amounted to army barracks,” says Brownstein. “My first wife lived in a Quonset house with her parents in Brooklyn, New York...basically it was temporary housing for people who could not find housing.”

Quonset huts – lightweight, corrugated steel structures built for the US Navy in a plant near Quonset, Rhode Island – were pressed into service all over the country after the war to help ease the housing shortage. But this answer was temporary, the real answer was to take the form of a building spree.

Enter the tract house which, combined with an expanded highway system, inaugurated the age of the suburb: the Depression-era dream of home ownership became a reality for more and more Americans.

Home sales began rising and continued to rise as mortgages became more widely available. People moved into bigger and bigger houses. “They built more houses and more houses and more houses,” says Brownstein, “Until eventually – we ran out of people.”

But the building continued.

“Then what did they do?” asks Brownstein. “They found ways to put people into those houses who couldn’t possibly afford to live there. And that was the subprime revolution. And if you want to know what, in my opinion, helped push the applecart over the cliff, it’s what both Ben Bernanke and Alan Greenspan talked about – it was a global savings glut.”

Brownstein doesn’t necessarily subscribe to the “global” description. He thinks the phenomenon was more prevalent in China and other parts of the developing world.

The China Factor

The U.S.’s trade imbalance with China became its largest “practically overnight,” says Brownstein, surpassing even that with Japan.

“What was going on was [the Chinese] were selling us stuff and their currency, by all accounts, was being held at a level which made their goods cheap here.” As much as 30% cheaper than what they should have been on a trade-weighted basis, he says.

“Well, if they were selling us plasma TVs and bobble-head dolls for 30% less than, on a trade-weighted basis, they should have been charging...then we were giving them dollars that were only really worth 70 cents. So for every $1 we gave them, we should have given them $1.39. Put another way, we were selling them $1 bills for $1.39 in plasma TVs.”

With their American dollars, the Chinese bought U.S. debt, says Brownstein, allowing “new mortgages to be created cheaply, at floating rates, at teaser rates for two or three years – the infamous 2/28 and 3/27 mortgages.” (Thirty-year mortgages with fixed interest rates for two years and three years, respectively, which then became floating rates for 28 and 27 years.)

So the American dream of home ownership met cheap money and the two conspired, says Brownstein, to drive housing prices – which had already been rising for decades – up even faster. Another American dream – that of getting rich quick – also had a role to play in this situation, as investment firms found increasingly exotic ways to package and repackage these easily available mortgages (good, bad and ugly) for sale.

And so it continued, says Brownstein, until 2006 when suddenly, there were too many houses and not enough people who could afford to buy them.

“And then, guess what happened?” asks Brownstein, “Housing prices started to fall.”

People unable to refinance their mortgages because the value of their properties had dropped then defaulted on their loans. Lenders who still had an interest in those loans started suffering, the dealers who created all those deals “blew up,” says Brownstein, and when they blew up, the banks suddenly realized “they didn’t know who they were lending money to and they stopped.”

It was only intervention of the world’s central banks that guaranteed inter-bank lending and, he says, saved the day.

The Aftermath

So that’s the history.

As for the situation today, Brownstein believes the U.S. housing market has reached “something approximating a bottom.”

“Some of the indices, particularly if you adjust them for seasonality, are up from the lows, which I think were reached in March or April of 2009.”

The picture isn’t uniform across the country, of course. Real estate, you may have heard, is all about location: when you consider the national housing market, what makes the difference is not the actual house.

“If you look at a three-bedroom or four-bedroom split ranch house in this part of Michigan and you look at the same sort of house – and they’re practically always built to the same specs – in that part of Indiana, well, they’re in different locations but are they really all that different? The answer is probably not.”

The difference is the “audience” for those ranch houses, says Brownstein. And that audience can vary significantly in different parts of the country, depending on a number of factors – including how far housing prices fell in that area in the first place.

The Federal Housing Finance Agency (FHFA) says U.S. house prices fell slightly – 0.1% compared to Q3 2009 – in the fourth quarter of 2009, according to its seasonally adjusted purchase-only house price index (HPI). (This is calculated using home sales price information from Fannie Mae and Freddie Mac-acquired mortgages.)

Break that down and you discover that in the Miami-Miami Beach-Kendall Florida area, house prices fell 12.9% between the two quarters (the steepest decline in the country) while in the Washington-Arlington-Alexandria area, prices rose 10.6%.

“We’re seeing some crazy stuff going on in places like Las Vegas, but less crazy stuff in places like Los Angeles. And that’s, I think, going to continue for some time,” says Brownstein.

Mortage Market

As for the U.S. mortgage-backed securities market, it has seen better days in terms of originations, says Brownstein: Fannie Mae, Freddie Mac and Ginnie Mae accounted for 90+% of all the mortgage loans in the U.S. last year.

The non-agency market is at the “very earliest point of rebirth,” he says. (According to Barclays Plc, U.S. home-loan bonds without government-backed guarantees rallied for two straight weeks in April, with the most-senior securities rising 1 cent on the dollar to 56 cents early in the month.)

“One deal was just done a few weeks ago,” says Brownstein. “It was a very small deal by historical standards and...the loans themselves were not 30-year loans, they were very large-balance loans, super-high down payments, excellent credit – but it sold out, it did very well.”

Nevertheless, he remains “very dubious” about how long it will take to see real signs of life.

Where Do We Go From Here?

Brownstein says the question now is should we expect housing to return to its growth trajectory of the period from WWII to 2006?

And the answer? Well, he says, is not yet clear. But he does point out that decades of uninterrupted market growth is “a pretty strange thing.”

SPM has compared housing market returns from the late ‘80s to 2006 to total returns on the S&P 500 and the 10-year Treasury note over the same period. Brownstein says that while on an unlevered basis, housing underperformed the others, on a leveraged basis (“and almost nobody bought a house without leverage”), even subtracting the 30% of homes in the U.S. that don’t currently have mortgages, the housing market outperformed the S&P 500 and the 10-year note considerably.

“And if you look at the volatility on all three,” he says, “on a risk-adjusted basis, housing wildly outperformed all the others.”

But 2006 was a turning point, after which “nobody is going to be deluded into believing that housing always goes up – that’s like believing in Santa Claus,” he says. And very early indications are that the “echo boom” generation (the children of baby boomers) will not absorb housing at the same rate the boomers did.

Percentage-wise, home ownership could revert to the lows 60s, or even slip into the 50s. That, he says, would be closer to the average for developed countries.

“Maybe that makes some sense. It doesn’t mean people won’t own homes, they may own multi-family homes, as is common in New York and other large cities, instead of living out in the suburbs.”

Maybe, he says, the exodus to the suburbs will reverse to some degree, with people spending less time in their cars commuting between home and work each day.

“So it could be that the trend in housing ends up being a really big boom for the environment,” he says, then laughs, “Or maybe we’ll find another way to screw it up.”

History suggests he’s probably right.

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