The homebuilders are all lobbying Congress for tax credits and other incentives. Today Pulte Homes said “The Problem Is Demand”. Professor Kevin Depew in point #1 of “Five Things” says No, the Problem is Pulte Homes.

This morning both Toll Brothers (TOL) and Pulte Homes (PHM) are presenting at the JP Morgan (JPM) Basics and Industrials Conference.

We heard from Toll’s Bob Toll yesterday on bended knee looking for Congress to stimulate housing demand, and this morning Pulte Homes joined in. Nothing really new there – the homebuilders are asking Congress for a $15,000 tax credit similar to the $2,000 tax credit offered to kickstart housing 35 years ago during the Ford Administration (they’ll likely get half of that amount) – however, there were some interesting comments related to pricing that are worth sharing.

Richard Dugas, PHM CEO, said he believes it is a mistake to believe the new housing market can correct without the resale market also correcting. This is an important point of distinction. New homes are now selling at a 10% to 15% discount to resale in most areas of the country. Historically, that ratio has been reversed.

“We clearly need resale pricing to correct, and correct dramatically,’ Dugas said. He cited the most recent data from the S&P;/Case-Shiller index showing a 14% decline in prices year-over-year, by far the largest on record, but noted that even that kind of decline is not enough.

“We view that [price decline] as a good thing,” Dugas said, “and frankly we think resale pricing needs to continue to move down, because existing buyers are telling us they would like to buy our homes, but need to sell their existing homes, but they’ve obviously got to get realistic about price before they have a chance to sell those homes.”

This view – that prices still need to come down significantly – makes some sense, especially if your business is selling new homes, but there are other issues at work. Foremost is the problem facing both Fannie Mae (FNM) and Freddie Mac (FRE) if Dugas gets his wish for dramatically lower home prices. We believe both companies are underestimating coming price declines.

Fannie recently relaxed downpayment rules so borrowers approved by Fannie Mae’s automated underwriting program will now be able to borrow up to 97% of the value of their homes. At the current pace of decline using the Case-Shiller composite, it would take just four months to be underwater on your mortgage with a 3% down payment.

Meanwhile, the real issue facing homebuilders is the psychological impact of housing price deflation. “Of [the issues facing housing], I think by far the biggest issue is buyer confidence and the lack of the ability for the buyer to make a decision to get in housing, because they are fearful of price declines,” Dugas said. That’s why he’s looking to Congress to help. “The whole idea here folks would be to put a floor under pricing and get people back in the market,” Dugas said.

If Dugas and Toll get their way, we taxpayers will essentially become home price guarantors as existing homeowners are forced to reprice their homes downward while only they (the homebuilders) get to share in the profits. The rationalization for this disjointed and incongruous view of risk and reward is that housing is a “key linchpin” of the U.S. economy. Well, so was the cotton industry in 1790. Some things need to change.

Problems Deep And Many

The problem is not just the homebuilders, but Congress, the Fed, the GSEs, and the administration. Ironically, Dugas admits that home prices are too high.

Dugas is correct but what was he saying three years ago? How much land were the homebuilders buying at absurd prices? And if home prices are indeed still too high, then why do we need a $15,000 tax credit to stimulate prices?

Dugass is being an disingenuious ass when he says “by far the biggest issue is buyer confidence and the lack of the ability for the buyer to make a decision to get in housing, because they are fearful of price declines” while at the same time begging for handouts and saying price declines are “a good thing”.

Mike “Mish” Shedlock
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