Supply and Demand. Repeat. Supply and Demand.

Basic economics. Common Sense.

Oil prices have risen dramatically this year. Why? Supply and Demand. Corn prices have risen dramatically this year. Why? Supply and Demand. Publix (my local grocery store) just put some items on sale. Why? Supply and Demand. Summer clothes/bathing suits are being marked down drastically Halloween is almost here. Why? Supply and Demand. Wait until November 1, and you'll see Halloween supplies marked down drastically. Why? Supply and Demand. You know where I'm going.....

Back in the 1600s, tulips became quite popular in Holland (do a Google search on "Dutch Tulip Craze" and you'll get plenty of info). Buyers became crazed, wanting tulips at any cost. The fever spread to the general populace and tulip prices shot north at an amazing rate. Why? Supply and Demand. Seems foolish to think back and wonder "What on Earth were those nuts thinking?".

Fast-forward to the late-1990s and early-2000s here in the U.S., substitute "homes" for "tulips". Same scenario. Numbers of houses are falling off of a cliff, prices soon to follow. Supply and Demand. But....will it be a catastrophe/recession/devastation/depression? No. Not by a long shot. After all, Holland has done quite well.....

I'm going to paste a bit from this week's Forbes interview of Susan Byrne; she hits the nail on the head.

Will the subprime mess lead to a recession?

Right now, we think no, because it appears the policymakers are going to provide for a workout. It could take two years to work out, and the economy could stay slow during that time. But unemployment isn't a particular problem, and for that reason we probably will escape a recession.

What kind of a shape do you see the consumer in?

I don't think they are in such bad shape. Everybody has credit-card bills, but people are working and they are getting raises and they are cautious. There are going to be people who, say, speculated on condos, who will get hurt on an individual basis. But by and large people are working. This is not an environment where the consumer just falls over dead. Taking money out of houses for little extras is over, but that's not a recession, that's a recession in the housing market.

I like Barrons (most of the time) and one of my favorite sections is the interview, as it gives insight into investors thoughts. Susan hit the proverbial "nail on the head" above. I'll expand.

For centuries, people built their own homes. Then, architects came along and helped with that process for decades (still do!). This most recent U.S. housing boom gave birth to the 'Home Builder', such as Toll Brothers, Lennar, Centex, etc. Why? Because there was demand! Tax breaks are great, but then the capial gains tax law changed in the mid-1990s to allow the first$250k/$500k of a sold home be tax-free. Great! Major demand, followed by homeownership craze, followed by building boom, more craze, condo craze, investor craze, craze, craze, craze. Supply and demand. Builders had to keep up with the demand. But now? Demand has fallen off of a cliff.

In the summer of 2005, existing home sales were on pace for ~7.2 million sales annualized. The September, 2007 report came out with 5.04 million sales annualized. That's about a 33% drop, with more to come. New home sales have seen even a bigger % fall! Why the drop? Why did tulip sales and prices fall in Holland? Supply and Demand.

But won't it lead to a recession? Read the Susan's comments again, as I agree with her. No, it won't. At least, not by itself. It will cause homebuyers to become more cautious with their decisions and monetary committments. It will cause banks and mortgage companies to be more cautious when committing to a loan. It will cause home appraisers to be more cautious when doing comparisons. Unfortunately, it won't cause lame-brained realtors to stop being "ultra-positive about this great buyers market! Hurry up, it won't last long!". (apologies to the few smart realtors I know). It will cause many investors to lose money on houses and mortgages, but that is risk.

The American homeowners will continue to survive, even thrive. Homeowners who overpaid for thier house in the past few years will mostly keep the house, pay the mortgage and look to stay long-term instead of flipping the house sooner. Homeowners who bought their house anytime before 2002 should still get out at a profit if they decide to sell (though, not as nice a profit as they could have reaped in 2005!). Anybody else is in the minority, and has already been priced into the stock market.

Here's a crazy thought. Are falling home prices good? Let's rephrase....who would benefit from falling home prices? How about renters who were priced out of the homeownership market in recent years? Remember, people still want to buy a home, it's just my opinion that the market is in a correction because consumers wised up! Let the market correct naturally (aka, prices fall) and homes will be sold in a true buyers market.

I could go on and on, but it's time to conclude, with one final note. There were actually two 'crazes' recently: the housing "craze" and the credit "craze". If you had a pulse, you could get 100+% financing on a house until this past summer. Now, good luck to any homebuyer looking for anything more than ~90% financing. Also, credit score limits have been raised for 'subprime' borrowers (and many other borrowers) across the board. Mortgage rates are higher today then they were in 2002, 2003, 2004. With the collapse of both the housing bubble and "consumer-mortgage" credit, U.S. home sales are going to continue to decline for months to come. There will be a bottom sometime, but it will be a long, drawn-out bottom with no rocket-ship ride back to the glory days.

That being said, if you are a homeowner looking to sell your house now or in the next few years (say, before 2011), I'd swallow your pride, take your lumps, and just get out at whatever price. Don't listen to a lame-brained realtor too long. Learn your lessons and move on in life. Foreclosures will continue to accelerate, even in neighborhoods where you think "surely that can't happen here!". They will. Prices will continue to fall, steeping in nature, through most of 2008, if not longer. Sell now or hold long-term. Even though you're not getting the exhorbitant sales price you could have received back in 2005, you're contributing to the economy and helping somebody else become homeowners. Good for you.

PS - AAPL, PRE and GR reported last week. Solid buys all three. Buy them if you're looking for solid growth for the next 6-12 months minimum. RL and LF report in the next 1 1/2 weeks. Still like both. Glenmorangie.