The first raging housing bubble of this millennium has clearly deflated and the debate has now shifted to whether housing is nearing a bottom. A couple of months ago I got a chance to talk to an industry expert who held a senior management position at one of the largest US banks before starting his own mortgage company and has experienced multiple real estate cycles. I was trying to determine if the home builders I mentioned in the blog entry titled Housing Sector in Pain could go lower or had reached a bottom.
This expert told me that in the few decades he had spent in this industry, he had rarely seen the kind of euphoria that accompanied this housing bubble and his outlook was still bleak. He told me that mortgage lenders who had a large portfolio of sub-prime and exotic loans such as interest only loans or ARMs could be in a lot of trouble in this downturn and specifically asked me to look for signs of “regulators” stepping in to review their portfolios and restrict their lending activity. As you can see from this Wall Street Journal article, “federal bank regulators have been stepping up their scrutiny of residential mortgage lending by large banks”. Based on this conversation, I decided to also look into mortgage lenders in addition to the home builders as potential candidates for put options.