Praying We Don’t Get Fooled Again

This article was written with Oliver Pursche, of Gary Goldberg financial network. It was part of a series of articles developed under an agreement with to work with a variety of contributors and assist them in delivering actionable investment ideas each week.

I’m a fan of The Who. The in-your-face lyrics and rebellious guitar riffs still speak to me. (Although the breaking of the guitars – Fender Stratocasters on most occasions – still makes me queasy)

Who would have guessed that old Pete Townshend would have been prophetic, though? This morning when I heard, “Just like yesterday, I’ll get on my knees and pray, we don’t get fooled again,” it reminded me to send out a warning about the real estate market and homebuilder equities.

Yes, there’s been some good signals lately — homebuilder sentiment, existing home sales, and other housing data have been encouraging – but let’s not get fooled again.

New bank capital rules will cause a flood of foreclosures. As a result, foreclosed properties will come onto the market in areas like Miami, Phoenix, and other badly hit real estate markets. In October of this year, large US banks like JPMorgan (JPM), Citigroup (C), and Bank of America (BAC) will adopt new bank capital rules as established by the Basel III accord.

The rules require banks to maintain a minimum ratio of 4.5% for common equity tier one capital to risk-weighted assets; in addition, banks face top capital surcharges of up to 2.5 percentage points. In short, they have to pay for the privilege of being a bigger bank. JPMorgan CEO Jamie Dimon has called the rules “anti-American.”

One outcome of these new capital requirements is that single family homes will move down a notch in the amount of capital they contribute to a bank’s balance sheet. Moreover, “upside down” real estate will have an even bigger drag on the net capital of banks. I recently spoke to a retired Miami city official who believes – based on his knowledge of the situation – that banks will move much more aggressively to “dump” bad real estate, even at steeply discounted prices.

In addition, the regulatory and economic environment is still too uncertain to deliver consistent growth. The slow growth economy, continued high unemployment, and persistent worries about “the future” are making demand from would-be home buyers tepid at best. This tepid demand will combine with new capital rules to keep lending levels low, slow, and bureaucratic.

And let’s not forget that when Wall Street sneezes, a lot of other people catch colds. Lower bonuses for the 1% on Wall Street will impact home prices in Connecticut, New York, and New Jersey.

According to the most recent data from RealtyTrac, home prices in Westchester County, New York; Bergen County, New Jersey; and Fairfield County, Connecticut are experiencing some of the biggest declines seen since the beginning of the Great Recession.

Take, for instance, Fairfield County, where I live. Year over year, through July 2012, home prices in some of Wall Street’s favorite enclaves, like Greenwich and New Canaan, tumbled 12.9% in the second quarter from a year earlier, which was the biggest decline of the 147 US metropolitan areas measured by the National Association of Realtors.

And sorry, but this doesn’t seem to be the bottom. “Things are getting worse in Connecticut,” said Daren Blomquist, vice president at RealtyTrac. “As additional foreclosures come online, it could have chilling influence on home prices in Connecticut. If there’s not a lot of demand for houses falling into foreclosure, that’s going to hamper any housing recovery.”

Prices for many homebuilders’ stocks have appreciated. My advice: If you think now is the time to buy them, you are setting up yourself to get fooled again. If you buy them anyway, I’ll just get on my knees and pray.

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