April 24, 2007
For people considering how to minimize development, keep forestland in sustainable production, and maintain respect for conservation values in the forest landscape, the current housing market crisis is a wake-up call. There is also a great deal of discussion aboout Pacific Lumber (PL) Company's bankruptcy proceedings, yet there is little mention of the economic context in which the bankruptcy is taking place. We
are accustomed to viewing PL as our local 800-lb. gorilla. Looked at from the perspective of the industry as a whole, PL's over-leveraged financial position has it looking more like an 800-lb. canary--a warning to others that all is not right in the timber mining business.
March 13's 242-point market slide in the Dow Jones index encouraged many people to revisit the issue of overly lax lending practices in the subprime mortgage market. While the Dow has recovered for now, the debate continues about how far the housing market will slide before it bottoms out. The impact on the timber industry is already significant--whether or not epidemic defaults on subprime mortgages create a credit crunch in the financial sector that impacts the economy as a whole. Construction-grade framing lumber prices have fallen by a third or more. Mills are cutting shifts, curtailing production, and even shutting down all over the Pacific Northwest and beyond. For those who want to see our working forests maintained intact, it's important to understand the impact that this down cycle in the housing industry will have on the economic viability of sustainable forest management.
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Owners of working forests with a high proportion of Douglas fir and other non-redwood conifers will be hit hard by the current down cycle. Forestland owners and mills with a significant component of redwood have so far been somewhat insulated from the direct effect of this market decline, but the full impact of this cycle may be yet to come.
The current housing market correction has been significantly exacerbated by mortgage broker lending practices in the subprime market. "Innovative" packages offered to high-risk borrowers have been a driving force inflating the housing industry bubble since at least 2005. Home loans with features such as the interest-only "balloon mortgage" and the undocumented "stated income" or "liar loan" tempted many low-income buyers to make commitments beyond their means. One broker flippantly referred to their loan package as a NINJA loan: No Income, No Job, and No Assets.
Last month the "carnage" in the subprime mortgage market became front-page news. According to one website tracking subprime lenders, more than 40 lending companies have "imploded" since late 2006. The Mortgage Bankers Association reports that foreclosures are at the highest level since the group started keeping data 37 years ago. The CEO of DR Horton, a major national developer, declared, "The housing market sucks, and will continue to suck through all of 2007." Very few analysts continue to predict a "soft landing" for the housing market.
There is a growing awareness that the high level of defaults is due to mortgage industry "innovations." Whether or not calls for more stringent loan standards are acted on at the federal level, market discipline will likely remove a large number of buyers from the pool of potential homeowners.
In their March 12 report "Mortgage Liquidity du Jour: Underestimated No More," Credit Suisse estimates that 50% of the subprime market is at risk, and that tighter lending restrictions will also reduce the volume of more credit-worthy Alt-A and prime loans by 25% and 10%, respectively. They estimate aggregate fallout of 21% of originations over the next one to two years and an additional 11% decline in housing demand as speculators withdraw from the market.
Credit Suisse Summarizes:
"Aggregating the various impacts would result in a 35-45% drop-off in new starts from the peak of 2.1 million homes to roughly 1.2-1.4 million, as compared to the 16% decrease thus far on a trailing twelve-month basis. For comparison, starts during the last three downturns ending in 1991 (down 34%), 1982 (down 32%), and 1980 (down 37%) fell by an average of 34%.
Expressed differently, if we assume that the full impact of mortgage lending tightening will be felt in 2007, all else equal, we would expect new home sales to fall roughly 20% from December's seasonally adjusted rate of 1.123 million to an annual rate of 887,000 homes (236,000 reduction from tightening lending standards).
The slump in new home demand looks like it is far from bottoming out. As the contagion spreads to higher-rated loans, the potential for a broader credit crunch is beginning to be acknowledged. Even Alan Greenspan has mentioned the possibility of an overall economic recession. The Federal Reserve Board's recent decision to keep interest rates stable at 5.25%, despite concerns about inflation, gives evidence of increasing concerns that the subprime meltdown will spread beyond the housing recession to impact the financial sector and the economy as a whole."
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Despite, and in some cases because of, the current economic uncertainties many investors see timberlands as a relatively secure long-term investment. A key element in that long-term value is the development value of subdivided forests. An article promoting investments in Timberwest of Vancouver notes: "The land is located on highly desirable Vancouver Island, and significant tracts of it are near areas of rapid urban and suburban expansion. This provides the potential for large windfall profits on real estate sales, in addition to Timberwest's solid production revenue."
As "solid" production revenues in working Douglas fir forests decline, we can expect to see timberland investments focus more tightly on productive redwood forests and an increase in sales of Douglas fir forests for development.
While Pacific Lumber is focused on redwood production, it holds a third of its inventory in other conifer species, primarily Douglas fir. Reductions in framing lumber prices alone reduce the cash flow from PL's projected harvests by approximately 10%. If declining housing markets and tightening credit requirements impact consumer access to capital, even the buffer that redwood's niche market offers may be affected as reductions in overall consumer spending slow the economy as a whole.
For those who want to see our working forests maintained intact, the current housing market correction is indeed a wake-up call. ISF's valuation of Scopac properties emphasized the need to develop effective financial strategies if the goals of community-based forestry are to be met.
But we need to go beyond that: The protection and recovery of conservation values in working forests is linked to our ability to understand, anticipate, and prepare for the local impacts of economic forces from well beyond our area. We need ownerships that can weather periodic cycles, even severe cycles, in the industry and the economy. We need a strategic plan that enables community-based ownerships in Humboldt County to develop the financial resources and make the commitments necessary to maintain working forests, rebuild standing inventories, increase productivity, and manage our forests for conservation values.
For more information visit
www.newforestry.org
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Institute for Sustainable Forestry
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- by John Rogers, Institute for Sustainable Forestry
- about Timber Industry
- by Institute for Sustainable Forestry
TOC for Forest & River News, Spring 2007