Is the Bottom Near for Housing?

There's a lot of money to be made in picking the tops and bottoms of cycles. But it's an extremely difficult exercise, and even a minor error in timing can lead to severe losses.

With that said, I'd like to examine some possible events that could signal that the bottom of the housing and credit cycle is near.

Off with their heads!
During a crisis, the public needs someone to blame. Ivan Boesky, Ken Lay, and Bernie Ebbers are some of the toppled titans who have been the focus of public ire. It's part of the cathartic experience to dispatch those deemed responsible and to start fresh with a new era.

At many major banks, we can see that the catharsis has begun. The CEOs of Citigroup, Bear Stearns, and Merrill Lynch have fired underlings they deemed accountable for the crises. And in the case of Merrill Lynch, CEO Stan O'Neal politely retired today, leaving a big void.

However, analysts, shareholders, and the general public don't seem satisfied. They seem to want to fry bigger fish in an attempt to close the books on the current era of the housing bubble.

Berkshire Hathaway enters the fray
In an interview with Fox Business News, Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) Chairman Warren Buffett said he hasn't bought any homebuilder shares yet because he doesn't think they're underpriced. No doubt Buffett is paying very close attention to the industry and may be simply waiting for his price.

In fact, the four largest homebuilders -- D.R. Horton (NYSE: DHI  ) , Pulte (NYSE: PHM  ) , Centex (NYSE: CTX  ) , and Lennar (NYSE: LEN  ) -- sport a combined $15 billion market cap. If you assume the shares of those homebuilders will slide another 20%, then the price tag would fall to $12 billion, plus a takeout premium. That's very doable for Berkshire and its $40 billion cash hoard.

In addition, if Berkshire were to buy several major homebuilders, it could be taken as a self-fulfilling prophecy that the end of the housing slump is near. Although the top 10 homebuilders have only a combined 23% market share, according to an article by the Dallas Morning News, markets are extremely local.

If Berkshire bought homebuilders with similar geographic exposures, it could help alleviate the stifling imbalance between housing supply and demand in certain markets by playing the waiting game. Many homebuilders have interest payments to make on their heavy debt loads. Thus, they have no choice but to fire-sale their homes and take part in a scramble for cash flow.

Berkshire, on the other hand, has pockets deeper than the Mariana Trench, so it could effectively take inventory off the market -- perhaps rent it out instead -- and wait for prices to recover before it sold any land holdings.

Vultures extract their pound of flesh
The unaccommodating credit markets mean that the mortgage lenders still standing -- such as Countrywide (NYSE: CFC  ) -- are trying to originate primarily conforming agency loans. That makes it harder for a large portion of the nonconforming American public to get a mortgage and buy a home.

Why are the credit markets effectively closed? If a portfolio manager buys some hard-to-price mortgage-backed securities at 50 cents on the dollar, and someone else comes along and buys them for 40 cents on the dollar, the first manager just took a 20% mark-to-market loss.

As a result, only the vultures have the stomach to eat the leftover carcasses. In fact, superstar fixed-income firm PIMCO recently raised a $2 billion distressed-debt fund, and TCW star manager Jeffrey Gundlach reportedly has started buying assets in its $1.6 billion "vulture fund." Once those funds start posting healthy returns, then caution will turn to envy, and imitators will rush in.

Foolish final thoughts
I can't predict when or if these events in housing will happen. But if they do, it could be a strong signal that the end of the cycle is near. And if so, it might then be a good time to start sifting through the wreckage.

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