The equity bears will argue that we’re seeing a classic bear market rally, but the bulls might soon have some new ammunition to push stocks higher. I must admit that I’m part of the bearish camp, but the following piece of news has forced me to reconsider my position:
Photo: TheTruthAboutMortgage.com, Creative Commons, Flickr
The New York Post reported yesterday that Sovereign Wealth Funds (SWFs) are targeting thousands of discounted foreclosed homes across the United States. One fund has put aside $29 billion for the purchases, the paper said. It added:
The Abu Dhabi Investment Authority is expected to announce next month what type of U.S. distressed assets they will be investing in and real estate is at the top of the list, according to a report in Financial Times last week.
Why would SWFs want to buy U.S. residential properties? My first guess is that these funds want to use property investments as a way to jump on the resurgent greenback strength. Population dynamics might also be a factor they are considering. The U.S. stands out as the only leading industrial power with a surging population. Because of immigration and higher birth rates, the U.S. population is now growing 2 to 3 times faster than any other major country. As the U.S. population increases, demands for U.S. homes will increase. SWFs are in a unique position to exploit these long-term trends, since they tend to have a long time horizon. In addition, academic research has shown that real estate offers inflation protection.
Some would argue this news is a credible signal for a bottom because Alan Greenspan, the former Chairman of the Federal Reserve, recently stated that the:
current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities.
The key problem for equities, if Greenspan is correct, remains the number of unsold homes in the United States. About 2.1 million homes were vacant and on the sales block at the end of the second quarter, according to Census Bureau data. In normal times, there would be only 1.3 million homes for sale. In other words, we are 800,000 homes away from a bottom for the slumping U.S. housing market, and perhaps a bottom for the stock market. According to the National Association of Realtors, the median national home price in June declined 6.1% from a year ago to $215,100.
A few calculations: 800,000 homes at an average price of $215,000 means that about $172 billion is needed to bring us to the bottom for the U.S. housing market. According to the New York Post, the unnamed SWF aims to invest $29 billion. We’re still short $143 billion.
But what if other SWFs join the party? The top 5 SWFs have total assets of about $2 trillion, and $171 billion represents about 8.6% of those assets. It seems highly unlikely that any SWF will allocate almost 10% to a single sector.
I agree that SWFs buying empty U.S. homes will help restore balance in the U.S. housing market, but these simple calculations demonstrate the severity of the problem. At first glance, it doesn’t look like SWFs can bail out the U.S. housing market.
Disclaimer: I own FXP