Gasoline prices are down say 20% in 30 days – can housing values be far behind and how far will prices retreat?

Implications: The gas pump is easier to contemplate now that every twenty gallon tank-full is twelve dollars cheaper. Demand slipped and the big refiners and marketers chose the only way out by reducing the sticker at the corner. Oil is going to be beaten up when corn ethanol is substituted in whole or in part. We don’t know now whether this is going to result in additional costs or a savings, but even if we just swap dollars between the two energy sources, oil is going to be a big loser and the corn ethanol industry players are going to rake it in. The principle of substitution is at work as one industry declines when the other provides a bigger benefit. The choice is would you rather battle Archer-Midland or OPEC.

Analysis: Housing has been and will be hit the same way. The cost of buying the median house on the market is no longer affordable for the consumer in the United States. Not only that, but now that the youngest baby boomer is by definition over 40, the number of buyers will decline. There is less liquidity and credit is not available on permissive terms like in the recent past. There are fewer lenders in business now and the secondary markets have been routed. The next generation of buyers is going to elect to substitute other benefits in lieu of the purchase of the average urban dwelling. Unless the prices come down to an affordability ratio of 33% of gross wages or less, demand will be below production capacity. Since we’re at a usual low 40’s to mid 50’s in a number of growth markets, prices may be off one third to 50 % depending on where you are. Sounds like a real jolt, but it’s just a return in some areas to 2000 prices. Does anyone see a parallel to earlier investment hysterias like tulip bulbs?

So what do you do with the huge home-building machines Wall Street put together in the last 10 years or so? The answer is you let them settle in to reduced volumes in fewer markets. The mission of management in home building these days is to maintain an adequate cash position until stabilization. I’m sure all of the majors and the lesser companies are struggling to emulate say Beazer in this regard. For a management explanation, listen to Beazer’s most recent quarterly conference call. That group doesn’t make any bones about not being able to predict margins and the necessity of an adequate cash account.

The major home builders are then going to run out of cash and expire at the auctioneer’s gavel or by default to their creditors, or maintain a cash position allowing them to stabilize at some significantly lower level of volume. Given a look back at trailing earnings, the capital markets will then begin to fund new growth more cautiously, thereby starting the whole cycle all over again. It’ll be the same strokes, just different folks.