Is John Paulson's Super Bullish Call On Housing Insane?
The billionaires are feeling bullish.
Several billionaires among us have taken publicly announced aggressive bullish outlooks. There’s David Tepper, of course, who proposed that stocks are in for a “win-win” scenario: going up if the economy recovers or, if the recovery doesn’t come about, going up when the Fed intervenes with a second round of quantitative easing.
But perhaps no billionaire—or even many of us regular folks—has sounded as bullish a bellow as John Paulson.
Speaking to a standing room only crowd at the University Club in midtown Manhattan, Paulson reportedly said: “If you don't own a home, buy one. If you own one home, buy another one, and if you own two homes buy a third and lend your relatives the money to buy a home."
Paulson’s claim to fame is to have engaged in “the greatest trade ever”—massively shorting the housing market. (Incidentally, we think Tepper’s trade of going massively long the US bailout of financial institutions may have immediately supplanted Paulson’s trade for that particular superlative.) Thanks to that trade he’s now one of the E. F. Hutton’s of the market: when Paulson speaks, people listen.
We’re listening. So what is it that Paulson’s telling us?
As we recall the story from Greg Zuckerman’s terrific book, Paulson was mainly a merger arbitrageur—a guy who made speculative trades on the price of companies that were targets or acquirers in M&A deals—until he became skeptical of the housing boom. When an employee at his fund produced a chart that house prices had overshot their historical inflation adjusted rise so much that they would require a 40% fall to return to trend, Paulson’s skepticism became bearish conviction.
It’s important to realize that Paulson’s bearishness on housing was really nothing more than an ordinary arbitrage bet. He assumed that a price that had fallen out of its historical trend would return to that trend. All the things that the uber-bears tend to worry about—baby-boom retirement, own-to-rent ratios, massive consumer debt accumulation—seems not to have played a large role in Paulson’s thinking. It’s just that home prices were out of whack and would almost certainly have to fall.
So has Paulson concluded that prices have fallen by the full amount to return to trend? If so, he is certainly operating from a different data than we’ve seen. Michael David White at HousingStory.Net has posted some useful charts over at seeking Alpha. He looks at four sets of data on housing prices—which all show different levels of upward departures from trend, and therefore predict different overall declines from the peak. All of them, however, predict that house prices have further to fall. HousingStory.Net averages them and predicts a a 9% decline this year and an 18% decline before we hit the bottom. So if Paulson thinks we’ve hit bottom, he’s got different data from everyone else.
By the way, Paulson’s analyst is also said to have shown that housing declines tend to overshoot on the way downward, declining 10% below trend in a downturn. So does Paulson think we’ve not only returned to historical trend lines but passed them by 10%?
Over at Clusterstock, my old boss Henry Blodget—who watches home prices very closely—has expressed his surprise at Paulson’s reading of the housing market. He figures that Paulson is betting on housing as a hedge against inflation, the same way Paulson appears to be betting on gold. But he’s confused since there seem to be so many reasons to be skeptical that housing will work as a hedge—the debt overhang and unemployment, tighter credit standards, and rising interest rates that could make mortgages less affordable.
We could throw in there a half dozen other reasons to be wary of housing as a hedge against inflation: an economy that demands greater mobility making long-term ownership less feasible, aging boomers selling homes to pay rising health care costs, the amount of underwater mortgages that make houses act as capital traps, backlogged foreclosures, the fact that its still cheaper to rent than own, and the lack of a private secondary market for mortgage risk come to mind.
But Paulson’s view isn’t crazy. It’s just simple. From 1970-2000, home prices rose and fell somewhat in tandem with the CPI. This pattern broke in the latest housing bubble, with home prices rapidly rising even as the CPI fell. Perhaps Paulson is just betting that the pre-bubble correlation between home prices and inflation will return.
In other words, maybe he’s still just a simple arbitrage guy at heart, and he’s betting that price of gold and homes will appreciate when inflation kicks in. He’s betting that this time it’s not different.
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