Ponzi Schemes Collapsing Under Their Own Weight

Some portions of the Great American Ponzi Scheme appear to have begun collapsing on themsleves.

The cash-out refinancing cycle kept many borrowers temporarily solvent. Rising home prices enabled overextended homeowners to continue piling on debt. They also brought in an increasing number of home buyers, helping to drive up prices further. Eventually, the supply of new buyers started declining and prices stalled. Defaults are up dramatically bringing an end to the ponzi scheme of lending homeowners far more than they can afford to pay back.

The corporate bond and commercial lending markets have provided homebuilders with all the capital they wanted over the past several years. As a result, they kept buying up land and building homes faster than they could sell them. Suddenly cash is becoming a pressing need for homebuilders. Credit is drying up, which will have far reaching effects throughout the economy. (My comments posted elsewhere are italicized below.)

These are likely just the first two schemes to start coming undone. Loose lending practices in the consumer credit arena will likely lead to a massive unwinding. Lending to Hedge Funds and Private Equity firms is a big potential crisis, and the insolvency of private and public pension plans will likely soon be exposed as a termendous accounting fraud and Ponzi operation. And the biggest of them all is the insolvency of the US government, based on tens of trillions of dollars worth of promises that can't be kept.




WCI wants to generate $1 billion in cash flow from operations this year. Last year they burned $490 million, and they burned smaller amounts in 2004 and 2005, so that would be quite a turn around. Indeed, for many years builders were content to pile up inventory of land and homes for sale, along with mountatins of debt. They didn't care about cash from operations when there was plenty of cash from financing to be had.

Why the sudden need to generate cash?

My take is that the financing is drying up. If builders can't raise cash from operations while the losses are mounting, then they'll have an especially hard time getting lenders to extend their credit agreements. With today's write-offs, WCI is already in violation of their credit covenants. DHOM violated theirs last year and had to renegotiate at significantly higher interest rates. OHB is also on a mission to generate cash from operations.

The sharp decline in housing starts in January was probably a first sign that builders are under pressure to raise their own cash. Residential construction spending will continue to dive as many builders seek to sell off inventory faster than they create it. Because builders capitalized interest and property taxes, along with construction costs on homes under construction, building spec homes didn't hurt earnings in the slightest. Now that the bubble has obviously burst, keeping lenders confident in their solvency will be important in order to maintain that solvency. WCI and OHB won't be the only ones stressing cash flow from operations going forward.