Builders Facing Inflation, Ponder Bankruptcy

PRESS RELEASE Citizens for Corporate Accountability

(SEATTLE) 04/05/04 - It’s happening all across the country. Builders for all kinds of projects, from bridges to homes, are faced with skyrocketing prices for everything from plywood to steel. Now, according to industry insiders, builders and contractors may be facing bankruptcy.

Almost overnight, prices have skyrocketed, as American homebuilding jumps at record rates, and as Chinese factories--acting as factory floors for both US and Chinese production--consume at record rates.

The problem comes as various builders, anxious to meet demand, drew up contracts well in advance of procurement and actual construction. Especially hard hit are builders of steel-intensive structures such as bridges. But the impact goes far beyond just bridges. “Even steel rebar prices have gone way up,” says one insider--and rebar is used in most concrete casting.

US homebuilders may be especially hard hit, having planned backlogs of many months. But in some cases, costs may be passed along--according to an insider at a major construction bonding firm, state legislatures are being asked to fund the gap on public projects. Yet, higher funding might be difficult, with tight state budgets. Ultimately, some costs have to be absorbed by builders due to uncertain prices at subcontractors. If buyers end up paying, they face surcharges financed into mortgages, jacking up already high prices-charges that they might never recover. So much for “cheaper” low-interest mortgages.

The truth is, nobody knows what will happen over the next few months. “They’re talking about bankruptcies, ” says the bond industry insider.

[Frodo]

1. There you go with "inflation" again Dan.

Which homebuilders are we talking about? Centex? Ryan? DR Horton? Pulte? Lennar? Toll Bros? Beazer?

I'm not sure you can find a home builder who isn't making record profits and has a record stock price. None of them look like they are close to bankruptcy.

Supply and demand are not the same thing as inflation. "Artificial" price changes (specifically steel prices changing when Shrub created/ended the import restrictions) don't count as "inflation" or "deflation" either.

2. Do I bother responding to you?

This problem is pervasive, had you read the article.

Any builder is at risk because they depend on cost models and contracts.Further, contractors depend on subcontractors, and vice versa.

Bonds are involved on public projects--there are fewer protections available for homebuilders. I do not think most bond individual houses.

I know you don't wish to define anything as inflation!

I will accomodate you...

How about instead "unwelcome price rises leading to bankruptcies and more offshoring"

[Frodo]

6. Certainly not among homebuilders.

You overreached on what the article said and the article overreached on who it impacts (not that a press release from a non-economic political group counts as an "artice" - ).

The real problem here is Steel. Part of the result of Bush's policies. This can certainly have a substantial impact on some commercial construction companies, but not all construction.

Once again. Inflation is not simply "prices increase" it's a rise in the supply of money NOT in correspondence with the production of goods and services. This CAUSES price increases not the other way around. If production of goods and services goes way up and the money supply is NOT expanded in reasonable step you get deflation which can be worse.

OPEC has a stranglehold on the price of oil... Noting (as many have here) that gasoline prices have skyrocketed is not proof of "inflation" (as many have claimed). And steel prices are not either. Inflation is evidenced by a general and pervasive increase in the prices consumers pay for goods. If lots of them are going up and quite a few are going down "inflation" isn't a problem.


Not that any of that matters. The article claims that "builders are facing bankruptcy" and "US homebuilders may be especially hard hit". Where is the evidence for that in the face of the best financial performance the sector has seen in decades? NONE of them appear "on the brink" of "sell" signals... let alone bankruptcy.

8. Supply of money (or credit)

Yes.

The supply of credit to the housing industry has led to so much inflation that segments of it are now in trouble due to the price pressures related to this. Moreover, these price pressures are actually displacing a potential manufacturing recovery.

I was shocked the other day to find out the construction industry has overtaken the (former) US manufacturing industry as the top consumer of materials.

There are reports of domestic manufacturers going bankrupt due to price pressure related to materials they share with the construction industry!

With all the easy money (credit) for housing, there is significant domestic competition for potential domestic manufacturing.

So housing is hogging the economy, as long as interest rates are low.

How to break this cycle?

[Frodo]

10. "money supply" and "credit" are not the same thing.

I have no idea where you are getting the "supply of credit to the housing industry" from. Depending on which segment of the industry they are in there may not need to be much credit. But whatever.

"I was shocked the other day to find out the construction industry has overtaken the (former) US manufacturing industry as the top consumer of materials."

You shock easily. And usually assume it means something is drastically wrong. I thought about the total weight of everything I own or have purchased and thrown out and compared it to my house and the materials that went in to it's construction.... I'm not sure manufacturing has EVER consumed more materials than construction. What are you basing this on? And why would I care? Is the construction of a home of less value than the construction of a car or stereo?


"There are reports of domestic manufacturers going bankrupt due to price pressure related to materials they share with the construction industry!"

Did I miss where I questioned that? Or did I miss some evidence in your post that construction companies (specifically homebuilders) were going bankrupt? There is no parallel there.

You can't sell a car for 25% more than you could three years ago... you CAN sell a house for that much. If you've ever done any of your own home improvements you know that raw materials are a much smaller portion of the cost of the job than people may think. Labor costs are EVERYTHING here and I KNOW you aren't going to tell me that THOSE are going way up?


"So housing is hogging the economy, as long as interest rates are low.

How to break this cycle?"

You've got to clue me in on your rationale here. Again... why is building a home of less value than TVs?

19. You miss the point

I don't expect you to understand the big picture, I guess. Sorry if I did expect that. I don't even expect that of the folks in charge...

You say "why is building a home of less value than tvs"

The economy is supposed to be broad-based, and weaned from dependency on residential investment (and massive credit drawn against said). Get one of your friends who is an economist to explain to you why that is. Also, get them to explain to you how a market has to have entry level buyers in order to be sustained.

[Frodo]

23. That post makes less sense than your usual.

"The economy is supposed to be broad-based" (true, so?)
"and weaned from dependency on residential investment" (excuse me? Why do we put such strong incentives/tax deductions on home ownership? We abosultely do not want to reduce the importance of "residential investment")

"Get one of your friends who is an economist to explain to you why that is."

Unlike your background of "taking a econ course once" I actually do this for a living. I can just ask the guy in the office across the hall. He doesn't think you know what you're talking about either.

"Also, get them to explain to you how a market has to have entry level buyers in order to be sustained."

"Entry level" has NOTHING to do with houses vs. TVs. NOTHING. Just because one costs a LOT more than the other does not make a TV an "entry level purchase" and a home something else. BOTH product categories span the entire spectrum. Ever hear of a "starter home"? And since virtually everyone lives somewhere and has to pay either a mortgage or rent (which usually at least covers the net mortgage cost) buying a home does not take you out of the "entry level buyer" part of the market.

As homework. Take a look at other economic recoveries. Rates certainly went up making homes more expensive to own. What usually happens to the housing market?

26. Where do you guys work?

Send me private e-mail. I'm curious.

The Federal Reserve and Pentagon read my website, by the way.

You do know that I was in the news last year related to exposing a major, complicated scandal, no???

[kalian]

3. And your sources are...?

Granted, Dn hasn't provided any links but there IS asset inflation...
In some areas in upwards of 125%. Steel, as posted by another poster,
is actually up 30% across the board. So...there's definitely
something to be said about homebuilders facing inflation...

[Frodo]

4. Pick your favorite financial website.

Look up any or all of the big homebuilders (I think I got most of the big ones, but I'm really only familiar with the east coast). Every one of them is looking at record profits and record stock prices.

There's bound to be one that is just doing "great" instead of "record", but the point stands... NONE of them look to be facing bankruptcy.

Sure there's "asset inflation", but they don't care if plywood has gone up 25% (a few dollars a sheet) when the DIRT the house they are building sits on has "asset inflated" $15,000 in the same period of time.

7. "Record stock prices" are backward looking

You really have to look at the root of what got any stock prices to a high level, and how underlying predictions are going--forward.

Enrons balance sheet looked good, for some time.

I assure you, my source says parts of the building industry are facing bankruptcy. Consider that homebuilders rely on subcontractors. When subcontractors go belly up--which is happening--builders lose out one hundred percent of their investment in said, plus they have to cover replacement costs. Subcontractors are not bonded in the residential building market. And even if they were, the price of bonding would go up, due to the current fiasco.

As for the inflation("indicators"--smirk), it isn't simply "plywood up 25 percent". Plywood has almost doubled in price, depending on the period you look at. Also copper, aluminum, steel--everything.

That's why some segments are facing bankruptcy. It is CERTAIN to affect the builders, even with strong balance sheets (in the past). At least, delays and major cost overruns, which means smaller margins.

The Federal Reserve is way, way, way off base when they cite "low inflation." So much so, I wonder if disaster is unavoidable at this point.

Now, factor in rising interest rates, and the possibility that mortgage liquidity could vanish overnight if Fannie Mae goes out, or is reduced in capacity, which is likely.

Not to mention, the Asians are cutting back on Treasury purchases, which have depressed interest rates for some time.

Finally, the whole growth model for housing was drawn up considering a pre-outsourcing immigration and white-collar salary model--which has evaporated.

I did not mean to do a stock analysis, but since you asked...

[Frodo]

11. Ok... where to begin?

"I assure you, my source says parts of the building industry are facing bankruptcy."

"Your sources"?? So you are the source of the article that you are quoting as a reference and linking on your website? Is that intellectually honest?

And a couple links might be helpful. Name a homebuilding company that is under stress and document it.



"Consider that homebuilders rely on subcontractors." Duh (though not all of them)

"When subcontractors go belly up--which is happening" No. It really isn't. The homebuilding business is booming so strongly that we can't get subcontractors for individual work - they're all booked up solid. Are some going under? Sure, just like any year, but in general it's the healthiest they have ever been.

"--builders lose out one hundred percent of their investment in said, plus they have to cover replacement costs." No - they really don't. You think subs get paid in advance by builders? You and I might have to pay half up front (though I would never deal with that kind of sub) but Ryan sure isn't.


The rest of this still makes you look like you live in a fantasy world. Your predictions are all based on nightmare possibilities that you assume are "likely".
"Disaster is unavoidable at this point"? "the Asians are cutting back on Treasury purchases"? (you read today's market news?) "Fannie mae" is "go(ing) out"? "The Fed" doesn't know anything about inflation (there you go using your assumptions as proof for your assumptions again. The screaming inflation that nobody knows is there is evidence of inflation that nobody knows is there).


"I did not mean to do a stock analysis, but since you asked..."

Yeah... I was going to just go with Business Week ranking so many of them in the "top 50 best performing companies", but now that your "analysis" says they're going bankrupt... gee I'll have to think long and hard about it.

Or I could go with A.G Edwards -

"It's not only the change in interest rate expectations. It's that the biggest home builders have strong balance sheets, and have kept costs under control, putting them in a position to buy growth through acquisitions if the market slows."
"

9. Sources

At the largest construction bonding company in the US, and a business associate, who is a large builder.

If you search on the web, you can find similar stories.

[Frodo]

12. "If you search on the web, you can find similar stories."

Please link one or two for us.

That you didn't write preferably.

14. As long as you asked, smartie

Steel price hike nails builders

One company falls, while others teeter

James Temple

Skyrocketing steel prices have the local real estate industry bracing for project delays, product shortages and possible bankruptcies among subcontractors.

http://www.bizjournals.com/sanfrancisco/stories/2004/03/29/story3.html

(My source was independent and a living person--within the largest US construction bonding company.)

But I love your ranting about how great everything is. I'll bet you were doing that when the Nasdaq was at 5000 too.

[Frodo]

15. Cute attempt, but non-responsive.

I made real clear that I recognized steel was a problem. But we were talking about how "US homebuilders may be especially hard hit", remember?

Got anything on point? You know... something that refutes something we've been disagreeing about?

But I love your ranting about how great everything is. I'll bet you were doing that when the Nasdaq was at 5000 too.

No, but I don't expect you to recognize the difference since you compare any company that's doing well to Enron.

The NASDAQ was dramtically overinflated by ANY measure. Large percentages of these companies were not making a profit and never had made a profit (some didn't even have a product). It was all pure speculation. P/E ratios were so massively out of proportion that it could not possibly be sustained.

Homebuilders, on the other hand - even after nearly doubling in price last year - still have remarkably low P/E ratios ( a trailing "9" for Centex even after a stock price doublign in the last 12 months).

Stock pickers like to compare earnings growth rate (in percent) to P/E multiples to determine rational pricing. By that measure, Centex could double again and still not be "overbought" like the NASDAQ was. Not by a long shot. I'm not saying it's going to double - just that it doesn't look at all like a "bubble".

In short the difference is that they are actually making money.

18. It's not too far a logical leap

If someone brags about how they made all kinds of bucks, and are building months worth of homes because of backlog-- and the next day you read about subcontractors going bankrupt because of inflation of materials--your mind should go "click"

But apparently not in your mind. Instead, you talk about P/Es.

Not really a problem--just a different level of looking at things.

And then it might not bother you that surcharges are getting factored into mortgages, but people are being told they are getting a "deal"--but it might bother others. Oh, and by the way, Fannie and Freddie, who buy almost all mortgages, aren't really backed like everyone thinks (oops).

Once again, a different way of looking at things. You look at a P/E (a simple math value), whereas I look at multiple trends and analyses at different levels.

And as for the aspect of sustainability, that relates to the ability for the market to sustain demand in this area. And you need look no further than prospective buyers, demographics, and the claims the companies themselves are making. And that is most interesting.

[Frodo]

22. Ahh. Now I see where you are disconnecting.

"building months worth of homes because of backlog-- and the next day you read about subcontractors going bankrupt"


You think "subcontractor" is a class of company that shares economic underpinnings.

Let's make it simple... a "subcontractor" who builds bridges (using tons of steel beams and steel-reinforced concrete) is not at all like the plumbing sub who works for Toll Brothers on a home. You can't demonstrate that homebuilders are having trouble with subs going bankrupt by quoting an article that shows a Navy subcontractor is going bankrupt over the cancellation of some helicopter. Yet you are now trying to talk about "the next day you read about subcontractors going bankrupt" as if it is somehow responsive on the homebuilders issue. You have demonstrated no such thing.

I think the missing "click" is on your side of the argument.

And I'm not sure the transition to Fannie/Freddie, but since I've worked with the for years I'm pretty sure I know how they operate. How exactly is that you assume everyone "thinks" they are really backed?

[amazona]

5. i wish some builders would go bankrupt

In my area they do not intend to stop while there is a tree left standing. There should be some law passed that no new construction can take place while old construction stands empty. It is sickening. As far as homebuilders, it's either McMansions or apartments being built -- no moderately priced new construction of single family homes. Don't know what it says about the builders but it suggests to me that these people, who are pretty canny about making money, no longer believe that the middle class exists in any great numbers.

[seasat]

13. Interesting Washington Monthly Article related to this

There Goes the Neighborhood Why home prices are about to plummet and take the recovery with them

One of these spells flared up during the last week in February, when Greenspan recommended that the home-owning public take a good hard look at switching from fixed-rate mortgages, under whose terms payments stay the same no matter what interest rates do, to adjustable rate mortgages (ARMs), where payments fluctuate along with interest rates--which, right now, makes close to zero sense. Interest rates are lower than they've been in 30 years, and, with all economists predicting a general economic upturn, and Bush's budget deficit and the weak dollar sucking up capital, little doubt exists that interest rates must rise, in which case, switching from a fixed-rate to adjustable-rate mortgage would be pretty costly for any family naïve enough to take Greenspan at his word. The episode did not pass completely without critical notice. It was "the strangest bit of advice ever to be proffered by an American central banker," Jim Grant, publisher of Grant's Interest Rate Observer, told the San Francisco Chronicle. Then the press moved on: "Oh, it's just Greenspan."

But sometimes wacko ideas can betray deeper truths. It is tempting to ask what stake the chairman might have in trying to convince millions of people to do something so contrary to their own interest. One theory floated by Fed-watchers is that the chairman is trying to help out his classic institutional constituency, the big banks, which hold trillions of dollars in fixed-rate mortgage paper. There may be something to that theory, but there is almost certainly a deeper and more important motive behind this curious advice. Quite simply, Greenspan is trying to keep a wobbly and fragile recovery alive--and using mortgage refinancing to do it.

There are many strange things about the choppy recovery we're in, but among the most curious is that it is being fueled largely by consumer spending. Why consumers should continue to spend, and why they've done it throughout the recession, is not immediately obvious. After all, average income growth has been puny in the last few years. There's been a big falloff in jobs. Health care and tuition costs have only been going up. And the stock market has spent the last three years unsuccessfully huffing and puffing to get back to the level where it was in early 2001. Why have consumers been spending so much?

Economists have advanced two main reasons. One is that Americans have so lost their moorings that they've had few qualms about going deep into debt. That's certainly true. The average person's debt as a percentage of his income is now higher than it's ever been. But there's another reason, too: Americans have been using their homes as ATM machines, refinancing their mortgages in order to fund their spending. This, of course, makes sense. The one sector of the economy that has consistently swelled has been housing prices. This has intrigued and surprised many economists, because housing is supposed to operate in sync with the economy, expanding during flush times and contracting when things go poorly. But even in a down economy, prices have soared.

[On the Road]

16. Dan, You Have to Source These Things

for people to believe them.

You correctly wrote about rising inflation when it was on nobody's radar. That is to your credit. But just making assertions is not enough. It's very, very easy to dismiss if there's no support given.

Maybe you have conversations with people in the industry that give you insight. You could (1) ask people to give their names, (2) ask them to be quoted as "an unnamed purchasing manager for a builder in Kansas," (3) quote an industry association or stock analyst in the same way, or (4) write anecdotally, eg about a specific builder filing for Chapter 11.

I don't know if builders are taking losses or not. Home prices are so high I would assume material costs are more than made up for by higher sale prices. But who knows? You may be right -- you just need to show it more clearly.

17. Frodo just goes on and on

You are confusing Frodo's opinion with some kind of plurality. He's always just jabbering.

Many news stories quote sources without releasing names. I don't have to release my sources.

I would never quote an industry association or stock analyst--that would be idiotic. It surprises me to hear you say that after the deluge of daily corruption stories surrounding various businesses and stock analysts. If you want that, read the mainline news.

Also, the story I linked in (which I found after I wrote mine) corroborates. There was another one somewhere too which talked about the massive price rises in everything hitting builders at the same time.

And it isn't my place to report on the fact that some company reports chapter 11. What use would that be AFTER?

I >>>telegraph problems<<<. I don't report on them after they happen!

Also, in my first few stories I went to great lengths to link in all kinds of tables and web links, and I found people didn't use them, for the most part (i can track who clicks what).

[On the Road]

20. I Won't Keep Beating the Same Drum

and I promise to drop the issue.

I see some of your posts and and read them with interest. Many of your points may be correct -- I credit you with bringing up the rise in producer prices before I saw it anywhere else. There is just no corroboration in most of the stories I see on the site.

There are many ways to back up your assertions. You just need to pick some -- as many as possible. It doesn't matter if you link to a government number and nobody clicks -- your readers may simply be taking you at your word and not bothering to check. You are still backing up your claim and making a stronger story.

Your articles obviously have some basis. When I read them, I just don't know what it is. It's just like anything else I read on a private internet site -- I have to take it with a grain of salt until I see something to back it up.

Just like bankruptcy among builders. The rise in materials costs is documented, but bankruptcies are not. To me, it's counterintuitive. Maybe it's really happening, but you don't cite statistics or examples. If you did this routinely, I think your site would gain readership, trust, and support.

21. The question is not IF bankruptcies, but how many, and how far

This is from the story I linked in above, not written by me; you guys must not have read this...

"At least one local subcontractor has already filed for bankruptcy after increasing steel prices put its contracts under water, industry sources said. Other companies are said to be similarly teetering."

http://www.bizjournals.com/sanfrancisco/stories/2004/03/29/story3.html

So I don't see the fact that bankrupticies are occurring as being in question. The question is where else? And clearly, there is at least one other case per my discussion with the bond guy.

What's the impact? Delays...overruns, for sure. More bankruptcies are just speculation.

[On the Road]

24. Thank You -- That's a Good Story

It makes more sense that the financial strain would be felt by subcontractors, who have to shoulder material costs or renegotiate, rather than general builders, who are benefitting from higher home prices. I recently had a normally reliable handyman ask to renegotiate because the price of prehung windows had gone up so sharply.

It also sounds like some hoarding may be starting: Swinerton Builders...(is) urging clients to buy steel materials as soon as possible and store them, rather than waiting until construction begins and risking further price hikes."

25. I don't see price relief any time soon

A lot of people are thinking that the biggest risk right now to the industry is the fallout from massive material price rises, rather than from higher interest rates. Project delays are almost certain, and investors have priced perfection into many investments related to real estate.

And bankruptcies can cascade.

Incidentally, the most recent problems I heard about from my insider were with electricians, who are facing much higher steel and copper prices. Many homes have a large amount of wiring these days, being much larger than homes built years ago, (according to statistics on my website). So it isn't just steel contractors anymore.

The builders may benefit from higher prices only to the extent they completely offset any delays or cost overruns. But they are used to 100 percent utilization...so these changes can have impacts. Margins, which have been expanding, fall quickly.

I don't normally give advice, but there is more leverage than most people think (I am working on another story). If you own stock in these companies, or are paying for something new under mortgage, I would suggest you think twice. Although it wasn't publicized widely, one of the institutional investment firms went way negative on the housing sector the other day. I'll find that story again if I can.