by Calculated Risk on 7/05/2006 02:44:00 PM

Kenneth Heebner, manager of the CGM Realty Fund was interviewed in the WSJ today. A few excerpts:

WSJ: How is the housing market?

Mr. Heebner: A significant decline in prices is coming. A huge buildup of inventories is taking place, and then we're going to see a major [retrenchment] in hot markets in California, Arizona, Florida and up the East Coast. These markets could fall 50% from their peaks.

WSJ: What has you so concerned?

Mr. Heebner: I'm worried that more people will default on their mortgages. Risky mortgages such as interest-only and pay-option adjustable-rate mortgages require no principal amortization and in some cases payment of only a fraction of the interest due, have been widely used in the last two years. Some people got 100% financing for their homes. It made the tech bubble look like a picnic. When housing is going up rapidly and you can buy far more than your income can support, some people are eager to make big profits by extending themselves financially.

As housing prices fall more people will be under water, and these people are just going to walk away from their homes. They are going to say, 'I'm outta here.' You're going to see increasing foreclosures over the next several years. As [home] prices come down, it will create a difficult environment for home builders.

WSJ: What data have you most worried?

Mr. Heebner: We're seeing a huge increase in inventories of unsold homes. The role of incentives in selling a home is increasing so the weakness doesn't show up immediately in list prices. Large price declines will follow in inflated markets.
...
WSJ: Given the big size of some of the markets that you see as inflated, won't the regional 'pops' reverberate throughout the economy?

Mr. Heebner: The pops will reduce the growth rate of the economy, but they won't precipitate a downturn. ...

WSJ: Do you agree with economists who have described the individual consumer as a linchpin of the economy during the past few years, using refinancings to fuel the expansion?

Mr. Heebner: Borrowing against home equity has been overrated as a source of economic stimulus. While it has been a factor in the economic expansion, I don't think it's been the most important factor.

Mr. Heebner has an excellent track record. Read the interview for more of his comments.

I think Mr. Heebner is underestimating the role that mortgage equity extraction has played in stimulating the economy over the last few years. I also think the "burst" will be more widespread than Mr. Heebner believes - because homeowners used nontraditional mortgages just about everywhere. Prices might not fall very much in the less frothy areas, but I believe housing activity will slow significantly in almost all areas.