First, the political left and National Association of Realtors are in the process of extending the now famous “first time homebuyer tax credit.” The initial plan, which was passed around this time last year and allows first-time homebuyers an $8,000 tax credit, is on track to cost about $15 billion — double the projected budget.

Heh, and just like “cash for clunkers” going massively over budget must be a sign of scorching legislative success. Thus, the new plan is to extend the tax credit into the summer of 2010, boost the credit to $15,000 and make all potential homebuyers eligible. Those who are content with their current home and/or unwilling to invest in a new one… well, they get the prideful assurance of knowing they played it safe — and their kids get the bill.

Also, the IRS has changed some rules to help keep commercial real estate afloat. It’s a technical matter (aren’t all American tax laws hard to understand?), but basically, the IRS fudged their rules on tax penalties for real estate investment pools. Under the new laws, certain commercial real estate loans could be modified or refinanced without hitting investors with a tax penalty.

We’ll save the details for more seasoned analysts, like our resident CFA, Dan Amoss. But you get the gist… the government is going out of its way to keep commercial real estate from going down.

“The fundamental outlook for REITs and commercial real estate remains bleak,” says Mr. Amoss, “and the market will soon wake up to this fact.

“The core of the bear case for REITs rests on falling comparative property values, falling rents, falling occupancy rates and tight to nonexistent refinancing conditions. Refinancing conditions are important because if lending remains tight, this will push up the amount of property foreclosures and liquidations. And conditions will remain tight because the regional and community banks that typically lend against commercial real estate collateral are not answering phone calls from desperate borrowers. They’re nursing hangovers from their existing commercial real estate loans, and have regulators watching their every move…

“Richard Parkus, head of mortgage-backed security research at Deutsche Bank, estimates that cumulative commercial real estate charge-offs will be in the range of 10% of the banking system’s $1 trillion in core commercial real estate loans. That’s a $100 billion hole in the banking system’s capital that many banks will not be able to ‘earn their way out of.’ I think 10% cumulative charge-offs could be conservative.

“Thus far, according to SNL Financial data, commercial banks have charged off just 1-2%. So in baseball parlance, ‘We’re only in the first inning’ of the process of recognizing and writing off whole commercial real estate loans sitting on bank balance sheets.

“As this occurs, this will lead to a flood of foreclosures and liquidations, which will push down market prices for commercial properties — the same types of properties owned by REITs.”

Source: The Coming Commercial Real Estate Crisis

New home sales jumped almost 10% in July, while the Case-Shiller home price index rose for the second successive month. Yet luxury homebuilder Toll Brothers lost $493 million in the quarter ending July 31, considerably worse than analysts had expected.

Housing stocks are certainly acting as if a recovery must be on the way. Pulte Homes Inc. (NYSE: PHM) has more than doubled from its low. Toll Brothers Inc. (NYSE: TOL) is up around 70% from its bottom. D.R. Horton Enterprises (NYSE: DHI) is up almost four times from its bottom. Lennar Corp. (NYSE: LEN) is up about 4½ times from its low. Finally, Hovnanian Enterprises Inc. (NYSE: HOV) is up almost tenfold from its low after a flirtation with bankruptcy. Yet all of these companies are still racking up quarterly losses, according to their most recently released earnings reports.

In terms of house prices, it would seem unlikely that a bear market bottom has been reached. Yes, the average house price is now back down around its long-term average of about 3.2 times average earnings, or only a little above it. But history suggests that markets don’t bottom at their average valuation: In fact, after such a huge excess to the upside, they overshoot on the downside.

The Case-Shiller 20-cities index is still 42% above its January 2000 level, having outpaced inflation during the last 9½ years. Yet January 2000 was not the bottom of a housing depression – far from it, in fact. That was actually close to the top of the dot-com bubble, when valuations of all assets were at all-time highs. So an average price over the whole country that – even now – remains 42% above the average price recorded at the very top of a huge economic boom does not seem like a market bottom to me.

You also have to remember that the U.S. federal government is hugely subsidizing the market. Interest rates are artificially low, and the U.S. Federal Reserve has bought more than $1 trillion worth of housing debt. Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) have been rescued by the government, and provided with more than $100 billion of taxpayer capital. And Ginnie Mae (the Government National Mortgage Association), directly a government agency, has provided almost $1 trillion of mortgages that require a 3% down payment.

And that’s not all.

The government is spending additional billions helping homeowners avoid foreclosure. First-time buyers are given a tax credit of $8,000 towards the down payment on their house – this credit currently runs out on December 1. So the current overall market bottom is propped up artificially. Even if the proposed tax-credit extension is approved, at some point, those props will be removed.

In individual cities, the picture is somewhat brighter. Phoenix and Las Vegas prices are less than 10% above their 2000 levels, having been halved from their respective peaks. In those markets, house prices may truly be reaching a bottom, although the overhang of foreclosures after such a huge drop may make recovery slow. At the other extreme, Detroit housing is 30% cheaper than in 2000, a testimony to the awful economic environment there, with the bankruptcies of General Motors Corp. (NYSE:GRM) and Chrysler Group LLC.

Again, with the government bailouts of both companies, there may be something of a recovery in the local housing market.

Probably the best prospects, however, are in Denver and Dallas, where prices are about 20% above their 2000 level, roughly in line with the increase in consumer prices during that same period. However, the local economies are strongly based on natural resources, particularly oil, whose price is triple its 2000 level. With prices in Dallas and Denver down only about 10% from their 2000 peaks, a true recovery in those cities may be near.

At the opposite extreme are the metropolitan “Big Three” of Los Angeles, New York and Washington, where prices are 61%, 71% and 74% above their 2000 levels, respectively.

Washington will be fine, of course: The Obama administration’s spending-and-legislation plans have attracted yet another huge influx of bureaucrats, lobbyists and lawyers, all of which will boost the housing market to new highs. With New York you have to worry about all the financial-services jobs being lost as a result of the worst financial crisis since the Great Depression.

From a nationwide standpoint, the most likely path for the housing market is for a modest recovery, with some later slippage as subsidies are removed. Housing is likely destined to once again become a highly regional market, as it always was prior to the 2001-2006 market boom, with the cycles in each market being very different.

As for homebuilding stocks, they appear to already be discounting a recovery in their businesses that may well be years away. Selling at well above net asset value (NAV), with Price/Earnings (P/E) ratios that are infinite because the companies continue to lose money, shares of homebuilders represent a very poor value, indeed.

Source: The U.S. Housing Market’s False Dawn

Consider this likely scenario: The heavy retail investor inflows into corporate bond funds last spring (far in advance of the peak in defaults, by the way) undoubtedly helped push corporate bond spreads down. The quant funds’ models detected this movement, concluded that the recession might be over, and proceeded to buy stocks that are highly sensitive to future U.S. consumer spending — including banks and REITs. This scenario likely explains some of the rally in bank and REIT shares, which occurred far in advance of the peak in credit losses.

This type of scenario could easily reverse this fall as experienced stock and bond fund managers start to question why they own barely solvent financial companies at valuations that imply 4-5% real GDP growth over the next two years. Huge swathes of the financial sector are insolvent (the mark-to-market value of assets is less than liabilities), and the debate over mark-to-market accounting boils down to whether losses should be recognized up front or over long periods of time. The losses are not going away, and were baked in the cake as soon as the bubble-era loans were made.

Last fall’s panic was not really a “black swan” event; it was the realization that much of the banking system was insolvent and at the mercy of electronic bank runs. Last fall, I thought that at the very least, the authorities had a plan to wind down Lehman in a controlled manner. Instead, Lehman went into forced liquidation and took the “shadow” banking system down with it. Our Lehman puts were huge winners, but even I was surprised at how quickly Lehman stock went to zero.

The issue facing REITs parallels that of the banks: an industry-wide solvency crisis. Only REITs lack access to enormous subsidies from the Federal Reserve, which include the manipulation of borrowing rates down to the range of 1%, resulting in a profitable spread on new lending.

If you carefully consider the combined statistics on commercial mortgage debt, equity, and future rental cash flows, you come to the conclusion that the value of many REITs is permanently impaired. Even if a core group of higher-quality REITs escapes bankruptcy, their equity will still be impaired because lenders will only refinance properties on very tight terms: strict covenants, high interest rates, and requirements of hefty equity infusions into upside-down properties. This is a transfer of wealth from REIT shareholders to creditors. This wealth transfer is occurring through many channels, but the most important one relates to claims on future rental cash flow, which will be bleak regardless of who owns it:

1. Creditors will take a higher share of those rental cash flows via higher interest rates
2. Of the cash flows that trickle down to shareholders, they will be divided up among more and more REIT shares as we see more and more dilutive secondary offerings

This unprecedented collapse in commercial real estate fundamentals means that for the next few years, you can throw out the analyses that rely on “cap rates” to value REITs. Distressed sellers and vulture buyers will make up the bulk of commercial real estate transactions for at least the next few years. Equity looking to invest will be scarce, so it will demand very low prices and high potential returns to invest.

Between now and 2013, $1.6 trillion in commercial real estate debt will mature. Bankers know this, so they’re going to keep conditions very tight for any refinancing that they grant. Plus, a hefty chunk of this debt is held by commercial mortgage-backed securities (CMBS), in which the lenders cannot sit across the table and renegotiate with stressed borrowers; owners of senior CMBS tranches will want to liquidate the collateral to get paid back, while owners of the junior tranches will want to refinance and pray for a recovery in value. I expect the motives of the senior lenders to win out, resulting in lots of property liquidations.

REITs Selling Must Compete to Dump Properties

Lots of REITs have plans to sell properties to pay down debts but… Sell to whom? And at what sort of price? Yet REIT investors seem unaware the hundreds of billions in new equity that creditors will require to refinance mortgages that were made during the 2006-2007 peak in values — and what that catalyst will do to the value of their equity.

On Wednesday, The Wall Street Journal ran a story that relates to this theme: “Tishman Faces Office Downturn.” Link in Web Version Only. The article describes the tough choices facing privately owned real estate investment partnership Tishman Speyer, which owns Manhattan landmarks like the Chrysler Building and Rockefeller Center.

Tishman also owns a levered portfolio of Washington, D.C., properties named CarrAmerica. You’d think that with all the crony capitalists flocking to Washington the lobbying business is booming. But apparently, even lobbying is not a strong enough business to justify CarrAmerica charging the pricey rents it needs to pay its mortgages. The WSJ describes the financing problem:

The Tishman partnership that bought the CarrAmerica portfolio has been in talks with its lenders, led by Lehman Brothers Holdings Inc., since late 2008 about modifying the credit agreement, according to S&P. But so far, nothing has happened and, until now, the talks have been kept quiet. “We have confidence in the long-term value of the properties,” Rob Speyer said.

S&P warned even if Tishman wins new covenants, its ability to refinance the loans in 2011 “will likely require additional capital investment or a recapitalization.” [emphasis added]

The Tishman mortgages were one of many credits that Lehman was marking at fantasy levels. As it turns out, the bears on Lehman were right: The loans that Lehman provided to Tishman to finance its acquisition of Archstone-Smith were impaired soon after they were underwritten.

What will the Tishman family do about its privately held portfolio? How much debt is carried against Tishman Speyer’s properties? I get the impression that it’s a lot, considering Tishman’s aggressive behavior at the market peak (as opposed to, say, Sam Zell, who unloaded a ton of properties onto Blackstone (NYSE:BX) and Maguire (NYSE:MPG), which will both wind up losing most or all of their equity). Tishman Speyer will probably hit a lot of low bids on its second-rate properties to raise the cash that banks will require as new injections in order to refinance — and keep to deeds to — its trophy properties.

The smart money in commercial real estate — including Sam Zell — certainly sees the mountain of debt maturities coming down the pike. Investors will certainly be looking for bargains in commercial real estate, and they will find the best deals in either foreclosure auctions or purchasing commercial mortgages from stressed banks at a discount.

Regards,
Dan Amoss

Source: REITs Racing to Bankruptcy

Existing home sales rose 7.2% to a 5.24 million annual rate in July, the most since August 2007 and the fourth straight month the figure increased, the National Association of Realtors (NAR) said Friday. Year-over-year sales grew 5%, the increase since September 2007, just before the markets came crashing down the following month.

“The housing market has decisively turned for the better,” said NAR chief economist Lawrence Yun. “A combination of first-time buyers taking advantage of the housing stimulus tax credit and greatly improved affordability conditions are contributing to higher sales.”

Rising sales numbers in the past few months may have triggered previously discouraged sellers to re-list their homes, according to Yun.

Total housing inventory at the end of July grew 7.3% to 4.09 million existing homes available for sale, representing a 9.4-month supply at the current sales pace. However, the raw inventory totals are 10.6% lower than they were last year.

Sellers are responding to rising inventories accordingly: The national median existing home price was $178,400 in July, 15.1% lower than a year ago. But the fact that buyers are dipping their toes back into the murky depths of the housing market doesn’t necessarily mean the sector is trending toward a full-blown recovery.

Turn of the Year Makes for Uncertain Future

One in three homes sales last month came from first-time buyers who benefited from the Obama administration’s $8,000 tax credit, which ends after November. First-timers accounted for almost the same amount in June with 29%. That means there could be a significant drop in purchases when that program expires.

The real estate industry is lobbying Congress to extend the first-time buyer tax credit, and Nevada Democratic Senate Majority Leader Harry Reid told reporters earlier this month an extension is “something we can get done.”

With or without a tax break, consumers in this economy are looking for a bargain much like they are with retail sales and auto sales. The bulk of the first-time tax credit sales have come from lower-priced homes, and NAR data supports that. Sales of homes that cost less than $250,000 were up almost 17.8% year-over-year through June. Meanwhile, sales decreased 13.3% in the $250,000-$500,000 bracket, 18.6% in the $500,000-$1 million range, and 32.7% in the $1 million – $4 million range.

Lost pricing power in the more expensive homes wasn’t lost on Pulte Homes Inc. (NYSE: PHM), which last Tuesday finished its acquisition of value-priced homebuilder Centex Corp.(NYSE: CTX), making Pulte the largest homebuilder in the United States.

“I’m not seeing a tremendous amount of good news on the job or economic front, so I do think it’s important that the [tax] credit get extended,” Pulte Chief Executive Officer Richard Dugas told The Associated Press.

The turn of the year isn’t likely to yield much good news on the job front. Most economists are expecting the unemployment rate to top out around 10%, and although July’s rate dipped one-tenth of a percentage point, the latest weekly initial unemployment insurance claims were discouraging, rising 15,000 to 576,000 for the week ended August 15.

“The improvement in the labor market has stalled,” Scotia Capital Inc. economist Derek Holt told Bloomberg News following the latest jobless claim figures. “Consumer spending will be pushed back on its heels for a longer time than markets are expecting.”

When the bleeding of jobs does peak, an upturn in employment could take some time as the United States experiences a jobless recovery. With an unemployment rate at or around 10%, home inventory levels could creep back in to 2008 territory.

“[The unemployment rate projection] indicates that the level of labor market slack would be higher by the end of 2009 than experienced at any other time in the post-World War II period, implying a longer and slower recovery path for the unemployment rate,” Fed economists wrote.  “This suggests that, more than in previous recessions, when the economy rebounds, employers will tap into their existing work forces rather than hire new workers. This could substantially slow the recovery of the outflow rate and put upward pressure on future unemployment rates.”

Source: Home Sales Will Struggle to Rebound Without Tax Credit Extension

The 1990s were an ideal period to have timber as an investment:

• Housing was doing well, and growth was beginning to take off in major cities.
• The world was still pre-digital, and business still relied heavily on shuffling paper.
• Electronic news was still a novelty; magazines and newspapers were still going strong.

What a difference a decade makes…

• Housing is in the dumper, with no clear sign of a resurgence on the horizon.
• Business has embraced the smartphone and has gone digital, shunning paper.
• The world is increasingly getting its news in electronic form, as evidenced by the number of newspapers that are no more.

This shift away from stuff that comes from trees has resulted in an almost complete lack of demand for wood or wood pulp. As a result, prices for paper and lumber have hit multi-year lows. Lacking any catalyst for change, it’s the perfect setup for an extremely overvalued scenario in the timber industry.

Timber REITs… Look Out Below

Whereas timberland prices hovered in the $1,500 to $2,000 per acre range in the mid 1990s, a more realistic valuation today is less than half that. And therein lies the problem: Many of the timber REITs haven’t devalued their land.

If it sounds a little like the looming overvalued commercial real estate mess we’re in right now (a story we broke long before anyone else did), it’s no accident. The biggest problem? REITs are managed by human beings.

Just like they’ve been doing in the commercial real estate market, timber REIT managers have adopted a “wait it out” strategy, in the hope that timber values – and by extension the land it’s growing on – will suddenly reverse. Don’t bet on it.

Unfortunately for the REITs and their shareholders, hoping and praying for a resurgence in the housing market isn’t going to work.

It’s going to get even worse: Timber prices could drop another 50% in the next few years, as an anemic housing market – the only possible timber demand catalyst – isn’t looking at a recovery for as long as five years.

Most timber REITS, however, haven’t taken a big hit to their balance sheets. Not yet anyway. But that’s all about to change.

As a result of the aforementioned head-in-the-sand mentality, Plum Creek Timber (NYSE: PCL), Potlatch (NYSE: PCH) and Weyerhaeuser (NYSE: WY) are all on the verge of imploding. Weyerhaeuser isn’t a REIT, but it suffers from the same issues.

At a minimum, all are going to have to significantly cut their dividends, which aren’t based on anything remotely resembling ongoing operations. Nearly all of their 2009 income – and I use that term loosely – will come from land sales.

That’s a problem, too, and not just because of depressed prices for timber. Much of the hopes of the REIT management are that they will be able to sell land to real estate developers to generate cash. Huh?

You’ve got to be kidding: With the current depressed state of the housing market, developers aren’t exactly chomping at the bit to buy more land. After all, many of them are still writing down the value of land they already own.

Timber REITs Taking A Big Hit Before The Dust Settles

While it’s clear that timber REITs are going to take a big hit to their balance sheets before all the dust settles, there are others that will likely be the biggest losers of all.

You see, over the past few decades, university endowments, pension funds and Timber Investment Management Organizations (TIMOs as they’re referred to) plowed an estimated $40 billion into timberland.

TIMOs are privately run organizations that hold and manage timber on behalf of institutional investors. Here’s the big problem: The funds that the TIMOs manage have predetermined liquidation dates, and many are coming due in the next several years.

When that happens, timber industry land prices could fall even further.

One notable exception to the REITs woes is Rayonier (NYSE: RYN). It has a much more diversified stable of holdings; namely its performance fibers division, which are used by customers around the world to make certain kinds of plastics, LCD screens, pharmaceuticals, food products and more.

The bottom line is that investors who own any of the timber REITs – with the exception of Rayonier – may want to consider lightening their position or eliminating it all together. Investors could also consider establishing a short position in Plum Creek, Potlatch, or Weyerhaeuser, the three stocks most likely to fall the hardest over the next 12 to 18 months.

Good investing,

David Fessler

Source: Overvalued Timber REITs: Why Timber Investing Isn’t What It Used To Be

As Money Morning warned in an investigative report that ran in early April, the stumbling U.S. commercial real estate sector was developing into a financial black hole that was threatening to blot out the resurgence of the U.S. economy. Commercial real estate prices have been in sharp decline for the past two years, making it tough for owners to refinance and pressuring companies to sell buildings at steep discounts.

The plummeting prices not only jeopardize a possible recovery, but they put pricing pressure on commercial mortgage-backed securities (CMBS) that are held by institutional investors.

Commercial property is “certainly going to be a significant drag” on growth, Dean Maki, a former Fed researcher who is now chief U.S. economist at Barclays Capital Inc. (NYSE ADR: BCS), told Bloomberg. “The bigger risk from it would be if it causes unexpected losses to financial firms that lead to another financial crisis.”

Property values for commercial real estate such as hotels, apartments, shopping malls, and office buildings fell by more than 18% on a year-over-year basis during the second quarter, according to an index published by the Massachusetts Institute of Technology’s Center for Real Estate. That’s the biggest decline in the 25 years since the index was first published. It’s also the fifth consecutive quarterly drop and the seventh quarterly decline in the past eight quarters.

The index is down 39% from its mid-2007 peak, surpassing even the 30% decline in housing prices.

That means companies that earlier in the decade borrowed heavily and expanded as property values soared have been left with buildings that are worth far less than their mortgages and aren’t generating enough cash from rental fees to pay off financing expenses.

Maguire Properties Inc. (NYSE: MPG), one of the largest office-building owners in Southern California – including in the downtown Los Angeles market, for instance – is making preparations to turn seven properties with about $1.06 million in debt over to creditors.

But even with those sales, Maguire still has $3.5 billion in debt and many analysts believe that exceeds the value of the properties in its portfolio.

“Almost everything in Maguire’s portfolio is underwater,” Michael Knott, an analyst with Green Street Advisors Inc., told The Wall Street Journal. “I don’t envy some of the choices that they are having to make.”

Maguire reported a second-quarter net loss of $380.5 million, more than triple the loss of $110 million reported a year earlier.

If the slump in commercial real estate continues to test these depths, the Federal Reserve may be forced to keep emergency-lending programs in place and leave its benchmark interest rate close to zero for longer than some investors expect.

The Fed expanded the Term Asset-Backed Securities Loan Facility (TALF) in June to cover as much as $100 billion in loans to support commercial mortgage-backed securities.

More than 40 members of Congress, led by Rep. Paul E. Kanjorski, D-PA, on July 31 sent a letter to Bernanke and U.S. Treasury Secretary Timothy Geithner, asking them to extend the program through 2010.

“The $6 trillion commercial real estate market has recently experienced a massive credit shortfall, which the TALF program has only just begun to help stabilize,” the petition read. ”While I would like to wind down the government’s emergency support for the private sector as quickly as possible, we need to provide more time for the TALF program to work in this industry, especially with $1 trillion in commercial real estate debt maturing in the near future.”

Fed Chairman Bernanke – in his testimony before the Senate Banking Committee on July 22 – assured lawmakers that he is ready to counter the threat posed by the ailing commercial real estate market, and said he would consider the policymakers’ petition for an extension of the Term Asset-Backed Securities Loan Facility.

“We will certainly be monitoring the situation, and if markets continue to need support, we will be extending the final date of that program,” Bernanke said. “We are somewhat concerned about that sector and are paying very close attention to it. We’re taking the steps that we can through the banking system and through the securitization markets to try to address it.”

Source: Will Commercial Real Estate Pose the Next Hurdle for the Federal Reserve?

Here was the question:

I would love to buy a piece of America now while prices are suppressed especially income producing real estate properties in the U.S. But, specifically, exactly how do you find and pick up some great deals on bank-owned and short-sale properties.

I would love to purchase a single family home in beautiful Palm Beach Gardens, Florida for only $65,000.  I just don’t think the vast majority of people — myself included — know how to find this type of property and then close the deal.

I guess I just don’t know the right people.

I’ll tell you how I got a great deal on a short-sale property.  My wife and I looked at many homes on realtor.com until we found a few properties that were good candidates for rental properties.  One of these was a nice property listed for $99,000.  This home was going for $250,000 a couple of years ago.

We called the listing agent directly and inspected the property thoroughly.  I suggest you work with the listing agent directly.  The listing agent will work extra hard for you because they will get the maximum commission by being the agent for both the buyer and the seller.

The owner of the single family home owed the banks $200,000 for his two mortgages.  We offered a low-ball offer of $55K and he accepted, because the bank was going to take the hit in the short-sale and he just wanted to get rid of the property.  The whole process took five months and the banks finally accepted $65,000 for the house.

An impatient person would have asked for their deposit back after a couple of months of waiting – and that’s why most short-sales don’t get completed.  The key to getting a fantastic deal on short-sale properties is to have plenty of patience.   Short-sales take time to close and can be frustrating at times, but you could truly get the deal of the century in today’s real estate market.

Best Wishes,

Ted Peroulakis

Source: How to Buy Short-Sale Properties

But that’s the word from Deutsche Bank (NYSE:DB) this week, which claims the number of U.S. mortgages worth more than the actual value of homes is going to double in the next couple of years. In line with our forecast yesterday, the bank is especially worried for prime and jumbo borrowers. 41% of prime borrowers will be underwater by 2011, says the DB forecast, up from 16% at the start of this year. Jumbos will be even worse, with a 46% underwater rate.

“The impact of this is significant given that these markets have the largest share of the total mortgage market outstanding,” said the bank’s report.

How significant? They’re expecting home prices to fall another 14% by 2011, for a total crash of 41%.

(By the way, we think this second wave of the housing tsunami is going to wash out one big bank that most people think is safe and sound. We’re brewing up a special report on the matter… stay tuned.)

Source: The Second Leg of the Housing Crisis

The earnings figures released over the last month are absolutely hideous, scary really, yet Wall Street hails them as a sign of recovery and safety.

Revenues are at a fraction of where they were this time last year, yet they beat analyst expectations.

Earnings, if a company is lucky enough to find a profitable strategy, are down by figures like 80%, 90%, even 95%, yet shares are moving up. Investors figure even a couple of bucks in free cash flow is better than nothing.

But what so many investors and even analysts are overlooking is where the surprising figures are coming from. According to reports like today’s dismal same-store sales figures, the extra cash is not from spend-happy consumers.

Instead, companies are slashing headcounts, cutting services and doing absolutely anything they can to increase their margins. In other words, they are burning their house down to cut their electricity bill.

It is great in the short term, but what about the long-term effects?

Not going to be pretty

A perfect example of the recent phenomenon comes today from HSN, Inc. (NASDAQ:HSNI), a.k.a. the Home Shopping Network.

Shares of the couch-potato-friendly shopping channel are up by about 20% today on the news the company was able to cut costs and increase margins enough to squeak out a profit of $11 million even though revenues dropped by 8% during the quarter.

For some perspective, this time last year the company reported a loss of $249.8 million.

The comparison begs the question why didn’t the company cut costs last year when it was hemmoraghing cash?

Easy answer… it did not make strategic sense. It would have been detrimental to the company’s core business if it made a drastic cut to expenses.

So why did the company do it this time? It had no other choice. With credit tight and few signs of any worthwhile recovery, it was cut or be cut for HSN.

But that does not mean the reductions in spending are any better for the company now than they were this time last year. Chances are, we will see the detrimental effects well into the future, in the form of lost market share and slow growth.

For HSN and the plethora of other companies making the same margin-boosting reductions, the key variable will be if their cuts were less detrimental than their competitors’ cuts.

No time to think… just hope and  pray

When marketing, employee benefits and customer service expenses are reduced, there is no doubt it will have a negative impact on a company’s future growth. All there is do is hope its competitors cut just as much or more.

This is an ultra-important consideration for today’s investors. While the bulls may be rushing forward with no ultimate destination in mind, eventually the turnaround stories are going to come to an end and the markets will beg for organic growth.

The only companies adding to their shareholder wallets will be the firms actually able to increase top-line growth. These days, there are not too many of them out there.

Education companies like Apollo (NYSE:APOL) and Grand Canyon Education (NASDAQ:LOPE), which earlier this week announced a 72% top-line increase, are good candidates going forward.

So are companies like, I can’t believe I am going to write this, Sirius XM Radio (NASDAQ:SIRI).

If you can handle the throng of annoying, Howard Stern-obsessed shareholders and the risk associated with the penny stock, today’s report that the company managed to meet expectations and increase its top-line by 1% is some of the best news the company announced in a long time.

Basically it is like this: You can burn down your house to lower your monthly utility bills, but when it is time to crawl into bed, you may regret the move.

Just because a company manages to cut its costs further than expected does not mean its share price should rise. The bewildered market is making a lot of mistakes these days.

Source: Burning the House to Save Money

Jumbo mortgages — home loans exceeding $417,000 — now have the fastest rising default rates of any mortgage class. According to recent data from First American CoreLogic, 7.4% of these larger-than-life mortgages are currently in some form of default, nearly three times the rate at the start of 2008.

As you can see, when stocks tanked in late 2008, the market for super-sized mortgage loans followed suit:

(Heh, we love the “exclude option ARMs” note… no need to worry about them!)

Is there any reason for this trend to improve? The Obama administration has done plenty to help out their beloved middle-class homeowner… like the $8,000 first-time homebuyer credit, artificially low FHA mortgage rates and several mortgage modification programs. But those programs don’t apply to jumbo loans. Even Fannie and Freddie, masters of mortgage speculation, will no longer stand behind jumbo mortgages.

And the market is blowing jumbo loans a stiff head wind, too. Mortgage rates are roughly 100 points higher for jumbos and inventory — geesh — this is pretty remarkable:

So… an accelerating rate of default; a government cold shoulder; higher-than-typical lending rates; and a huge, growing glut of supply? Could get interesting.

Source: The New Credit Crunch Victims