If you want to read a cracking analysis of the sub-prime mortgage fiasco, then get hold of The Big Short by United States financial journalist Michael Lewis.
OPINION: In an exhilarating, almost novelistic fashion, he tells the story of those who saw the crisis coming and profited hugely from their foresight. It is an intricate tale in which the protagonists make fortunes by effectively betting against what they saw as sub-prime garbage.
Lewis focuses on some eccentric characters who predicted the US housing market, and its sub-prime mortgage appendage, would plummet in value. The man who made the biggest fortune of all was hedge fund manager John Paulson.
Depending on your source, he is estimated to have made anywhere between US$5 billion ($6.4b) and US$15b by betting against sub-prime mortgage securities tied to a rising housing market. In the hedge fund world, it's regarded as the greatest trade ever. So what is Paulson up to now?
It seems so implausible but he is now doing the virtual opposite of what he did in 2006-07. He is making large bets on the US housing market entering a period of sustained rises. He is investing in mortgage insurers on the assumption house prices will increase for some years, meaning there will be few mortgage defaulters. He's also investing in land.
A recent CNBC story described it this way.
"If you have any doubts as to Paulson's conviction behind a strong housing market, look no further than his creation this year of a second real estate fund which will buy mostly raw land. This real estate will only see very big gains when the housing inventory is reduced to a point where house builders came scrambling back to Paulson to buy their land back."
A land banker! He'd get lynched in Auckland wouldn't he?
Which inevitably brings us back to the topic du jour, and every day after - Auckland's never-ending housing nightmare. For it is fascinating what a little research about the US housing scene reveals and the light it might shed on our woes. Read this next quote and try to work out which market is being discussed.
"The only way to moderate price increases is through more home building. This will determine how strongly prices will rise next year. New home construction must rise by 50 per cent or 500,000 units per year to ease the lack of housing inventory."
It sounds like a description of Auckland's "uniquely" horrendous housing market, doesn't it? Although the figure of an extra 500,000 houses might be a little high. So would you be shocked to know the quote is from Lawrence Yun of the American National Association of Realtors as reported by the Washington Post on June 21. We are not alone in having this problem. Even the US has a housing shortage.
If Yun is correct then Paulson is certainly on the right track to another fortune. And, despite the big falls we've seen on world sharemarkets since US Federal Reserve chairman Ben Bernanke's tapering statement, Paulson's gamble suggests a vigorous US economy is the most likely outcome.
US house prices have risen around 12 per cent over the past year, but they are still as much as 20 per cent below their peak in 2006. If they do continue to rise then Americans generally will start to feel the wealth effect again and they will spend and invest more.
That should help underpin the US economy, which is pretty much what Bernanke is forecasting, hence his wish to reduce financial stimulus. As the US economy is still the world's largest, a revitalised housing market becomes a plus for the global economy. For a change, it may be the US that takes up the slack from China.
Now there is one proviso. Paulson is not faultless. He has recently lost a fortune on gold. He has been a great advocate of the precious metal and, with the gold price having sunk this year, he is wearing some big losses.
However, when queried about this, he says in fact it's a relatively minor fortune he has lost . . . just 2 per cent of his fund's value. He is still a believer in gold, expecting it to bounce back when inflation starts to rise.
If Paulson is correct on his housing punt, there is a small New Zealand listed company, Tenon, which could benefit. Formerly part of the Fletcher group, Tenon exports wooden building products predominantly to the US. The past four years have been dismal and its last half year result was a loss of $US2 million. Recently it issued a more promising profit outlook reflecting the improved US housing market and a lower NZ dollar.
It's small beer though when compared with Paulson's wager. The signs do look good for him to make another fortune. Rather than shorting the US housing market he is going long. Could Michael Lewis's next book be called The Big Long?
- Fairfax Media