Martin Denholm of the Smart Profits Report shows us where to find the profits in the wreckage.

This from Martin:

Hey… wake up, Larry. The coffee is ready.

If you were as amazed as I was at the sight of President Obama’s chief economic advisor, Larry Summers, snoozing through Obama’s Fiscal Responsibility Summit on Monday (on the podium, no less), hopefully these numbers will shake him out of his slumber…

The latest S&P/Case-Shiller index shows that home prices in 20 U.S. cities plummeted by 18.5% in December, compared with December 2007. On the back of an 18.2% slide in November, it was the fastest decline on record and extends a decline that began in 2005. The 10-city index fared even worse, sinking by an annual 19.2%.

From its high in 2006, the 20-city index has tanked by 27%, with Phoenix, Las Vegas, and San Francisco leading the way down during December. On a national scale, the Case-Shiller index showed an 18.2% drop compared with Q4 2007.

Let’s take a look at the real estate market and see how investors could play this news…

Homebuyers Should Have Adopted The PAYGO Plan

The housing numbers came just a day after Obama proposed a PAYGO approach to government spending at the Fiscal Responsibility Summit. Simply put, it’s based on the “You don’t spend what you don’t have” concept, making cuts to fund spending plans.

Forcing the government to balance its books and pay more attention to the national debt sounds great in theory. It’s an approach that helped turn America’s federal deficit into a surplus over the 1990s and the early part of the 2000s.

But of course, the country wasn’t mired in two prolonged military conflicts, nor did it face the worst economic climate in a generation – issues that don’t discriminate when it comes to book-balancing efforts or debt levels.

And at the current rate the government is going, it’s going to have to find a lot of extra pennies buried in the couch – or make some significant cuts – because Obama is clearly determined to spend his way back into prosperity.

There’s No Place Like Home For $275 Billion

With housing however, this fiscally responsible PAYGO approach would have worked wonders for many homebuyers who now find themselves clutching for the last bit of rope. Record foreclosures (up 83% to 2.3 million in 2008, according to RealtyTrac) and slumping property prices (down a record 8.2% in 2008, according to the Federal Housing Finance Board) have eaten into Americans’ wealth and eroded consumer spending, which makes up about two-thirds of the economy.

To combat it, Obama wants to pump $275 billion into the real estate market in order to flatten out its freefall. And as I wrote last week, $75 billion of that housing aid package will go towards allowing homeowners to refinance and lower their monthly mortgage payments in a bid to slow the foreclosure rate.

Whether these efforts will work… time will tell. But check out this interesting nugget from Minyanville:

“While pundits and politicians debate the various aspects of President Obama’s $275 billion housing bailout, one piece of data proves just how misguided federal efforts to revitalize the housing market are: $275 billion could buy more than half of all American homes already in foreclosure.

“Such an undertaking would remove distressed homes from the market and spur community revitalization efforts throughout areas desperately in need of the hope they were promised in November.”

The housing recovery isn’t going to happen anytime soon. With the foreclosure rate still rising (up 18% in January), it’s still squashing prices. And with home demand very weak, there’s a big supply of excess homes on the market.

And that’s crippling this industry…

Trouble For Toll

“The past five months have been among the most difficult in U.S. economic history.”

And the award for “Most Obvious Statement” goes to…

Robert Toll, CEO of fallen homebuilder giant Toll Brothers (NYSE: TOL).

Toll was speaking on the back of a 51% plunge in his company’s first quarter revenues – a trend symptomatic among the nation’s homebuilders.

Prospective buyers aren’t buying, amid job security fears. And sellers can’t sell their homes, due to the depressed economy and market. And with the glut of unsold homes on the market and prices falling, homebuilders have no reason (and no money) to build any more. Toll says new home construction is at its lowest level in 50 years.

And profits are tanking. Analysts project a $0.30 per share first quarter loss for the company – but Toll is so concerned about the economy and uncertain about the market that it hasn’t even bothered to issue any guidance itself.

Others aren’t hanging around to participate in the carnage any more…

Insiders Are Bailing On This Builder

Recent SEC filings show that Dwight Schar, founder of NVR Inc. (NYSE: NVR) recently cashed in his housing chips, dumping 339,059 shares worth $139 million.

Smart move. He sold at an average price of $409.90 each. The stock’s current price is around $348.

He’s not the only one either. Four other company directors and the CEO have also been busily selling their holdings this month.

One razor sharp analyst called this spate of so-called “cluster selling” (which occurs during particularly weak periods) “a pretty bad signal” for investors (okay, so I’m giving that “Most Obvious Statement” award to him now).

Profit From The Housing Pain

With the National Association of Realtors announcing this morning that existing U.S. home sales defied projections for a rise and dropped by an annual 5.3% in January from December – the lowest since July 1997 – homebuilder stocks are getting knocked around again.

The median home price: Down 14.8% to $170,300 in January – the lowest price since March 2003. And 9.6 months worth of unsold housing inventory.

Whether this marks anything approaching a bottom or not remains to be seen. But in any event, homebuilders that have struggled to turn a profit over the past few years are now closer to going bust instead.

To combat the slide, homebuilders have dumped as much land as they can and trying to load up on cash instead. But in this market, that’s obviously coming at a loss. And when the assets run out… what then in a still-depressed market? Not to mention the debt that many companies have accumulated, due to excess leveraging during the boom times.

On a broad scale, you could take a look at playing the downside of sector ETFs like the SPDR S&P Homebuilders (NYSE: XHB) – already down 55% over the past year.

But if you want to look for downside in individual stocks, focus on ones whose debt-to-equity level is high and/or who are running low on cash. And when insiders are selling, that’s usually a good indication that you should do the same.

Source: How To Send Your Profits Up As America’s Homebuilders Go Down

According to the S&P/Case-Shiller index, home prices in Phoenix, Las Vegas and San Francisco sunk the most – giving back 32.7%, 31.7% and 31.0% of their value in a year’s span, respectively.

The ocean-side metros of Miami, Los Angeles and San Diego followed, with respective declines of 29.0%, 27.9% and 26.7%.

Atlanta, Seattle and Portland entered what Case-Shiller called “the double-digit club,” with annual rates of decline of 10.5%, 10.2% and 10.1%, respectively.

The three best performing housing markets – meaning the ones that lost the least value – are Dallas (-3.0%), Charlotte (-4.4%) and Denver (-5.2%).

On a monthly basis, Detroit was hit the hardest, with home prices falling 4.5% from September to October of this year. That’s a dramatic leap from the 2.5% decline from August to September.

“The bear market continues; home prices are back to their March, 2004 levels.” David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s, said in a news release.

Recent statistics from the National Association of Realtors suggest similar pain. Single-family home sales fell 8.0%, the slowest sales growth since July 1997, NAR reported last week.

And the national medium home price fell 13.2% from last year to $181,300, the largest drop since the NAR started tracking statistics, and likely the largest decline since the Great Depression, said Lawrence Yun, the trade group’s chief economist.

“Falling home prices would lead to faster contraction in consumer spending and further deterioration in bank balance sheets,” Yun said in a news release. “More importantly, falling home values would lead to higher loan defaults, including those recently modified distressed mortgages.”

Source: U.S. Home Prices Post Record 18% Annual Drop in October

“Month-to-month, it gets consistently worse,” said David Blitzer, chairman of the index committee at S&P, noting that February also marked the sixth straight month that all 20 cities experienced declines. “The slope is one direction. There is no sign of a bottom.”

“If you expect a ‘muddle through’ economic recovery to persist over the next 12 months – and I do – then the Fed will have to stay on guard as housing attempts to establish a bottom,” says Eric Roseman in The Offshore A-Letter.

“This doesn’t imply the dollar must fall further. But it does suggest commodities and gold will continue to rally because most central banks will continue to print credit while they try to look concerned about inflation.”

Bill Bonner in The Daily Reckoning says, “The last two big bubbles – in residential housing and the financial industry – are deflating. Prices are going down for both assets. But inflation-sensitive commodities, most notably oil and gold, have soared. And now prices seem be working their up all along the chain… from the oil wells, to the shipping containers, to the Chinese sweatshops, to the shelves of Wal-Mart.

“What this means to central bankers is that they have to watch it. They can’t cut rates so freely… not while consumer prices are rising. Instead, the pressure will be on the other side – to raise rates.

“To the man on the street it means that he has to prepare to pay higher prices for everything.”