Chuck Ponzi November 30th, 2005

dis·in·for·ma·tion (ds-nfr-mshn)n.
1. Deliberately misleading information announced publicly or leaked by a government or especially by an intelligence agency in order to influence public opinion or the government in another nation: “He would be the unconscious channel for a piece of disinformation aimed at another country’s intelligence service” (Ken Follett).
2. Dissemination of such misleading information.

The feeding frenzy of the housing bubble has its share of pundits. As no surprise, when the stakes get higher, so does the rhetoric. During the unwinding of the last speculative phase in the stock market, many learned the hard way that giving false or misleading information can get you into trouble. The saving grace of many of those analysts was their ignorance… they actually believed that the stocks would go higher.

In the US justice system, incompetence is not a crime. However, losses from malpractice can be had when a responsibility of some magnitude is placed in the expectation of the minds of those involved. Doctors and Lawyers can be sued for incompetence when the reciever of the service has been led to believe that the person is qualified. Stockbrokers can be sued for giving misleading information in the light of contradictory evidence.

So, this leaves us with the question of what responsibility Real Estate Pundits and Agents have when making statements of the future performance of an asset such as a home in the future of price declines. Anyone care to wager how sue-happy Southern Californians will handle a 35 or 45% drop in their home prices?

Here are some of the implicit parties

Name: Gary Watts
Qualifications: Was right the last time around in 89
Stance: Prices will increase into the forseeable future at double-digit rates

Name: David Berson
Qualifications: Chief Economist for Fannie Mae
Stance: “Since they started keeping track in the early 1950s, there has never been a nationwide decline”

Name: John Karevoll
Qualifications: DataQuick Information Systems Economist
Stance: “(Affordability Index) is an interesting number but for the past two years or so, it hasn’t really meant anything to tell anybody anything”

Name David Lereah
Qualifications: Chief Economist for National Association of Realtors
Stance: “There is no national price bubble. Never has been; never will be”

Name: Gary Painter
Qualifications: Director of Research for the University of Southern California’s Lusk Center for Real Estate (Wow, that’s a mouthful)
Stance: (Hot housing markets aren’t bubbles) “because valuations have been pretty much in line with what economists call the fundamentals of demand — low interest rates, very little supply”

Will these gentlemen become targets of personal damages in the future? Will they be required to submit the standard “Not for use as investment advice” as other professionals need to?

Anyway you look at it, residential real estate has changed in the minds of the people of America. It is no longer a place to live, many consider it their most important “investment”, and for many, their only.

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Chuck Ponzi November 28th, 2005

The economists over at Elliott Wave have a great write up about deflation and what causes deflation in a piece titled “What is Deflation and What Causes it to Occur?”

All deflationary periods were marked with the following conditions:
(a) All were set off by a deflation of excess credit. This was the one factor in common.
(b) Sometimes the excess-of-credit situation seemed to last years before the bubble broke.
(c) Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases years, in advance.
(d) None was ever quite like the last, so that the public was always fooled thereby.
(e) Some panics occurred under great government surpluses of revenue (1837, for instance) and some under great government deficits.
(f) Credit is credit, whether non-self-liquidating or self-liquidating.
(g) Deflation of non-self-liquidating credit usually produces the greater slumps.

From the article: “Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time from production. Production facilitated by the loan - for business start-up or expansion, for example - generates the financial return that makes repayment possible. The full transaction adds value to the economy.”

Credit lent against homes are most definitely non-self-liquidating credit. Unless, you count the opportunity cost of renting as a form of liquidation - however this requires there to be some relationship of rents to monthly payments; something that can’t be said of current market. The relationship of these nonproductive asset backed loans to productive asset backed loans, it would seem is at its peak historically.

Reading this type of semi doom-and-gloom scholarly article makes me think about the many types of financing recently available to the public masses and what impact they might have.

It takes a bit of economic sense to understand a risk premium. A risk premium is an additional amount that a lender expects to compensate them for additional risk. If risk is considered great either a high risk premium is attached or sometimes a transaction cannot take place. We currently have some of the lowest risk premiums in history; interest rates on non-productive assets are at historical lows.

Typically, a lender requires that at some point, principal on the note must be paid back. Interest only loans are an exception to this. Why? And, why have they become popular now?

It’s easy to see why a borrower would want to take on one of these loans; why pay for something now if I can pay later. But, what’s more interesting is why are they so popular for lenders?

Human beings are a fickle bunch. Each one wanting to do something different than the other. Like watching an ant, it runs to and fro, sometimes lost, sometimes productive, but always unpredictable. But, take a step back, and the anthill is an extremely efficient, coordinated jumble of activity. A very predictable bunch. Human financial systems are similar. Each borrower is very unpredictable, but bundle a few thousand together and they suddenly become more predictable; hence the popularity of Mortgage Backed Security Bonds (MBS’s).

BUT… and you knew this was coming… you need to take even a step back to see what is going on in the macro environment. Who has all of this money, and why are they lending it at such low rates. A flat yield curve would signal that lenders see little reason require a larger risk premium for longer-term loans because they expect long-term rates to be about where they are far into the future. How often is the bond market right? Well, that’s for you to decide. Greenspan has even named it a conundrum.

So, this brings me to the title of my post. How could interest only loans signal possible deflation in the future? We already know that low-interest rates can be a signal, but what about creative financing?

Interest only loans cannot be self-liquidating in the short run. When they switch to a liquidating (fully amortized) loan, the payments jump substantially because they do 2 things at once: 1, they begin fully amortizing 2, they adjust to prevailing interest rates. One would expect that people faced with these issues would simply replace the shorter amortizing period with a longer amortizing period at the same rate. Or, they would attempt to liquidate the loan by selling. Since interest-only loans are not self-liquidating in the short run, the bond market is signalling that for the medium-term, interest rates and returns will be low, or that investors are extremely risk-averse to the stock market. The investors feel justified that any possible deflation is offset by the Fed’s moderate inflationary policy, or at least an attempt to prevent deflation. So, MBS investors have signalled that for the medium term (3 to 10 years), that they would rather take their chances with low interest rates AND non-liquidating debt.

Will this truly end as Greenspan has put it? I will leave you with one of his most famous statements on the subject:
“But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.“

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Chuck Ponzi November 22nd, 2005

Can home prices continue to grow faster than income?

I’ve had a grand ‘ol time reading the great Realtor’s Anti-Bubble reports for San Diego. A particular line of this publication made me delve a bit deeper into the thinking. The line was:

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Housing equity will most likely continue to accumulate to local homeowners. The equity gains under three price growth scenarios are presented below. One scenario assumes a historical conservative price appreciation of 1.5% above consumer price index inflation. With most credible inflation forecasts pegged at 2.5%, home prices can expect to rise by 4% per year under normal circumstances. The two other scenarios assume slightly below (1.5%) and slightly above (6.5%) the normal rate of appreciation.
—————————————————-

I always appreciate a good meaty discussion about cost of living. One of the assumptions that gets thrown around quite a bit lately is exactly the kind of nonsense that is put out by the good folks over at the NAR. Essentially, it goes like this…

Housing prices outpace inflation, and therefore is a good long-term investment.

This old-wives tale really has to parts, one independent, and on dependant. Therefore, if you can prove that the independent one is not true, it makes the entire statement untrue.

Therefore, if you can prove that house prices do not outpace inflation in the long-term, you can prove that housing is not a good long-term investment; or at least in the way they mean.

This one is so easy, I won’t even have to factor in some of the more difficult issues such as maintenance costs, just the known and easily calculable. Here are our assumptions:

1. Current Median Household Income is $104,414
2. Current Median Home Price is $605,600
3. Wages match inflation at 2.5% increases per annum
4. Per the NAR, home prices inflate at 4.5% per year (seems kinda paltry, huh?)
5. Interest Rates average 8% over the long-run (we need this for first time buyers)
6. Insurance rates are .15% of insurable property
7. Tax rates are 1.5% of property (assuming Prop 13 stays, but this is a low amount and does not include typical mello-roos for many SoCal neighborhoods, but oh well, we’re being conservative, right?)
8. First-time buyers will be able to put down 20% of the purchase price and finance the remainder

This is a sample of the next 30 years.

This is the graph:
Next, the trick was to calculate the percentage of income that a median household would need to spend towards PITI assuming the NAR was right.

This is the graph:
This means, if the NAR were right, we would be spending 88% of our GROSS INCOME BEFORE TAXES on housing by the year 2034 in San Diego. Glad to see we’re keeping it real.

This is what stops the trees from growing to the sky. If people can barely cover the 50% of monthly GROSS, what makes people think they can do it at 88%?

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Chuck Ponzi November 18th, 2005

Some avid bubble readers may have stumbled across what might be one of the most honest pieces I have have ever read by a realtor. And… it is hosted on realtytimes.com. The piece is titled San Diego Real Estate — A Trend to Go National?

I think most of us are quite hard on real estate agents, even though there are many that are quite competent and skilled at their art. Our frustration is correctly aimed at those poorly organized, poorly informed, or downright dishonest about the market. Bob says it like this, “So, sure it’s great to be optimistic about your real estate market place, but ignoring the obvious trends will cost you in both money and reputation.”

His call to action? “What I’m saying is be up-front and truthful with your clients, especially sellers. In just one hot area here the last few sales showed huge drops in the actual sales price vs. the original listed price. In one case this difference was $100,000 or just about 20 percent of the listed price. The other differences were about 9 percent of the listed price. Personally, I attribute these huge reductions mainly to the agent’s inability to see that our market has turned. When you tell your seller that the real market is fantastic, it’s a little tough to get multiple price reductions.”

What’s surprising is how realistic he is in his assessment. “Yes, we have started on the down leg of the typical ‘Bell Curve’ and the probability of surpassing our approximate 20 percent drop in San Diego home values experienced from 1990 through 1996, seems assured. Plus, as real estate trends seem to start in the West and then move east, any U.S. real estate market that experienced huge price appreciation the past five years, will experience the same depreciation in real estate residential values.”

He even uses the reasoning of the last bubble “It was about five years ago that the mantra was that this was a new paradigm and the stock market no longer followed the old rules of valuation. We were soon to reach Dow 20,000! Hopefully, you missed that costly over-enthusiasm. The result was such a drop that five years later we finally may be building a base.”

One assessment from him? “According to the California Association of Realtors, only about one in 10 households in San Diego can afford to buy a median-priced, single-family resale home with a 30-year, fixed rate loan. Combine the above, with the multiple Fed interest rate increases and the proliferation of EZ qualification, 100 percent interest only financing, and the stage has been set for not just a ‘return to normal,’ but a major change.”

AND…

“However, due to the huge home appreciation all San Diego real estate has seen, with the average home up 100 percent in the past 5 years, combined with the boom in 100 percent adjustable/interest only loans, the stage is set for what is sure to be mind-numbing depreciation.”

I have to applaud Mr. Schwartz. I’m sure it must be difficult to voice his opinion or even hold these kinds of ideas in his profession, but I am sure he will weather this one quite well and his clients will be pleased with his work.

I, myself, am quite happy with the broker who sold my house. He was professional, knew how to market my home, and was able to get me far more for my home that I had imagined. The result of this… he was well worth the 4.5% I paid. He helped me negotiate broker fees, asking prices, and even a rent-back. An agent like this is worth his weight in gold.

And, honesty cannot be faked. Thank you Mr. Schwartz. If I ever buy a home in SD in the future, I will be sure to look you up.

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Chuck Ponzi November 15th, 2005

I thought for a while that we would be done making fun of people for a while. Then someone has to go and say something so ludicrous, so insane, so stupid, it has to be posted.

A great cheerleader piece came out describing the North County San Diego slowdown and what it could mean. There are a couple of noteworthy comments:
————————————————————
In October, there were 853 detached home sales in North County down from 960 in October of last year and 926 in September of this year, Brown said.
…
“I am seeing a little bit more inventory,” Smith said.
…
In North County, 1,511 detached homes were listed on the service a year ago, said Irv Erdos, a Realtor with ERA Property Movers in Escondido. As of Monday, that number had zoomed to 5,624.”
————————————————————
That’s just classic. No need to even comment on that one except to say that that registers right at about 6 months of inventory… a nice number to be at for a market turn. Of course, these aren’t high times of the year, so a final assesment should happen in the spring.

The next one is great:
————————————————————–
In condo purchases in particular, Feldman said, some speculators look at a purchase as an “option”: they are willing to default on the purchase if the value drops; if the value rises, they’ll “flip” it to another buyer for a quick profit.

However, Feldman said mortgage lenders are being “fairly conservative,” so the likelihood of a crash, which he defined as a drop in value of at least 15 percent, is unlikely.
————————————————————–
You gotta wonder if he has seen the 100% LTV Interest Only ARMs at 1% teaser rates that people are getting qualified for in these purchases. The idea that lenders are being “fairly conservative” is pretty laughable. The “fog a mirror” test is perhaps what he considers rigorous screening. Has he been living in a cave?

Besides, won’t the defaults drive down prices? Maybe not in his psuedo world where supply and demand don’t have to intersect for a transaction to take place.

And then Lew Feldman hits us with the MOTHERLODE of all stupid remarks:

Brace yourself for it:

It’s coming:

—————————————————————
The housing market slowdown is taking place throughout Southern California, said Lew Feldman, a real estate and public finance partner at the law firm of Pillsbury Winthrop Shaw Pittman LLP in Los Angeles. Feldman said the slowdown won’t become a collapse, because new buyers from overseas are poised to enter markets such as San Diego’s.

“We haven’t seen the full onslaught of what’s going to happen,” Feldman said. “The Chinese have $700 billion of our paper right now. When they cash it in, they’re going to buy real estate and they want to buy coastal communities.”
—————————————————————-
Now, I have to admit. I sat and read that bit about 5 times before I dared to laugh. If this man really believes this, he has got to be one of the most disconnected individuals from International Finance.

First off, the Chinese GOVERNMENT have bought our paper, not individual owners. Does he really think that the government will trade Mortgage Backed Securities for our North County inventory?

China is playing an international game of hide the trade surplus in US backed securities, not individual mortgages. If they failed to do so, they would have a stronger Yuan by raising demand for their own currency, effectively making DVD players 50% more expensive due to the exchange difference. They keep us buying their cheap stuff so some day they can grow a middle class that will buy their own stuff and they can wean themselves off of us. Our trade deficit is the reason Chinese own any paper in the US; and it’s what has kept our interest rates abysmally low and created Greenspan’s conundrum and Bernanke’s savings glut.

To think that the chinese government would want to trade in liquid government backed and GSE-backed securities for residential real estate is truly one of the stupidest things I have heard since the bubble began. It’s a leap that no rational or logical thinking person could do. If we had a Comment of the Bubble Award it would have to go to Mr. Feldman. Thank you for making our day.

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Chuck Ponzi November 14th, 2005

The media has given California business a pounding lately. Between Countrywide’s Mozilo’s statement of “California Sucks”, tales of families escaping to Missouri, and a recent announcement that Nissan will move it’s North American Headquarters to Nashville, one would think that California will be a great target for derision for just about anyone.

What’s sad is that California used to be a great place for families and working people. What caused the shift? Was it solely the cost of living?

What’s perhaps even more sad are those Californians who lay claim to nothing more than being “Californians” as if it were somehow a blessing bestowed from on high. They claim the weather is unbelievable, diversity tops, and great jobs…

Opinions about the real estate bubble aside, California is a good place to live for most families. We don’t have anything against California per se, but the cost of living is definitely something to consider if you are not a multi-billionaire. Yes, even millionaires have to take out suicide mortgages in California.

The air is clean in some places (Orange County, LA Westside, and San Francisco to name a few), but deathly choking in some others (Bakersfield, San Bernardino, and Antelope Valley to name a few). There are cities with neighborhood after neighborhood of neatly manicured lawns and homes like Aliso Viejo and Rancho Bernardo, and there are nightmare areas like Watts and Compton, and soon to be nightmare areas like Panorama City, Van Nuys, and El Cajon. But no matter how much you try to escape the bad areas, they are still only a few miles away. Nowhere is this more pronounced than the LA area with BelAir/Beverly Hills in close proximity to Westside gangs and the homeless in Santa Monica.

The freeways are congested with no end in sight… When did the 405 start being gridlocked at 5:30AM on a Saturday?

Whatever the cause, it is clear to most that the businesses are the reason that the area holds its appeal. Sure, the weather is great, but most places have some great weather at some point of the year, and most of Southern California is a burning pit of fire for 6 months of the year. Besides, the weather has been great for all known history; nothing changed in the last 5 years. Diversity is nice, but most cities in the US are now fairly diverse, and besides, most SoCal residents try to keep the diversity to a minimum with economic barriers. No, the things that made Southern California great were the companies and the jobs they provide. During the mild 2001-2002 recession, SoCal created a large number of jobs in various sectors; most notably in banking and finance.

But, like any misguided and fiscally liberal state legislature, they found that the .com implosion left them little choice but to tax its residents and businesses into submission. The credit bubble took care of any possible problems related to declining state revenues. The wealthy weathered it well; their businesses did well enough. But, companies that had been attracted to the area are finding a sort of “double taxation”. On the one hand, they must pay their normal taxes, endure earthquakes, regulatory issues, rolling blackouts, and a gridlocked transportation infrastructure, but on top of all of these expected costs; wage inflation has been stronger in the past 2 years. Quite surprisingly, actually, wages have had to keep pace with local housing prices or lose some of their best employees to out of state opportunities to afford housing.

It’s no secret that employees with families tend to be stable, responsible, and reliable. However, families have the choice of staying in California and enduring micro-housing, 3-hour commutes, and broiling climates just to have a job, or leaving the state to deal with cold weather and lower pay, but a secure job and a well-appointed home in an area close to work. It’s a no-brainer for most families.

Some companies will make the jump and leave California, as Nissan did with their announcement that they will move their North American Headquarters from Southern California to Nashville. (Nashville has wonderful weather AND traffic, if you ask me). I believe we will see a lot more of this going on in the coming years.

A great piece was written by the Motley Fool jokers, in which they succinctly explained a fundamental rule that has been ignored by RE cheerleaders: “As for what to make of the exodus — if indeed it exists — it’s just more proof that although it might be painful in the short run, the system works. When stuff gets too expensive, we look for alternatives.” There are definitely alternatives to living and working in Southern California.

Their parting comment is exactly what has been discussed in numerous boardrooms across the region. “Around here, Juniper runs some pretty amusing newspaper ads — featuring commuters portrayed as trapped rats during rush hour — about cost and frustration savings achievable by using its products for telecommuting. How about all those companies selling us the Internet Utopia make better use of it to put more money in shareholders’ pockets? Maybe it’s time the owners of all these firms — that’s you and I, Fool, with our little stubs of paper — demand that they say farewell to the California dream and its nightmarish costs.”

Housing, after all, is about utility. Manias temporarily skew people’s perceptions, but over time the market always returns to equilibrium.

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Chuck Ponzi November 11th, 2005

Recently, Cole Kenny over at The Boy in the Big Housing Bubble posted a great little vignette about the times we are in. He’s calling it the “No Duh!” days of the Housing Bubble.

Avid readers remember my post about “Illiquidity and Disinformation” back in April 2005. This seems like such a long time ago, but we all know that Mr. Kenny has nailed it with this one. We have definitely moved into a new period in the Housing Bubble. Anyone who follows the housing bubble knows this:

1. Pretty much everything that can be said about the Housing Bubble has already been said. People are left to just stating the obvious, and besides housing moves glacially slow; this will take a long time to ride down, and due to the “Yahoo Effect“, we won’t pay attention for long. Besides, noone likes to think or talk about the negative for very long; it’s fairly depressing.

2. The Housing Bubble no longer requires the use of quotation marks, and has even earned the status of proper noun in many writings. This is a surprising development, one that I wouldnt’ have expected 6 months ago… but there it is.

3. Seeing some people hold on to the mantra that there is Housing Bubble evokes feelings of pity and a bit of eye-rolling rather than holding credence. These guys are paid to say this, anyone with half a brain understands that the twin defecits, weakening dollar, Helicopter Ben, nonlinear psychologies, and stagflation will soon take their toll on the credit market which will choke off the housing bubble.

So, what’s one to do? Well, you might start by reading something like “Tired and bored of Real Estate” or just perusing the 65 Pages of links to Housing Bubble News over at HouseBubble.com

Or, just go vent your frustration at Ben Jones’ blog or patrick.net’s blog or just go to an open house and look around. Is that house really worth twice as much now than 3 years ago? If you truly like to wring your brain around some monetary policy head wringers, head on over to Macro Mouse.

Maybe even open a savings account?

Last but not least, you could always take some time just post to this site. Anyway you see it, we’re just stating the obvious.

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Chuck Ponzi November 9th, 2005

Although this is old news, in a bizarre, surprising twist (even for bubble sitters like myself), the president’ s council for tax reform has supported a dramatic reduction of the mortgage interest deduction.

Our favorite pundit, Mr. Lereah has weighed in that home prices could fall 15%.

I fail to see a problem with this post. If the government’s intention is to make home prices within reach, this will most assuredly allow MORE people, not less to afford a home. Reasoning, you might ask?
1. Lower downpayments
Need we say more? This goes without saying if housing prices are lower. However, some might argue that the upset in the credit markets would cause a reversion to the mean with respect to down payment requirements. However, this is already in process with the guidlines set forth by the fed recently, and lenders would stop acting so irrationally seeing that asset prices were artificially inflated. Long-term, however, downpayments will be lower considering the lower prices.
2. lower prices mean higher interest rates for lower-income, less-qualified buyers have less “bite”.
Ever seen what a 1% increase in rates does to a $200K loan, what about a $400K loan? What about as a percentage of after-tax income? Use of after-tax money represents a non-linear basis of income. However, one argument is that this would increase RE speculation, since interest for business purposes is deductible and therefore lowers the cost of borrowing for investors vs. homeowners. The danger is the same the other way. Why not make all interest deductible then? Why not make most every expense deductible for that matter like businesses and small business? This is just how our tax system is currently setup; any radical changes is just as likely to reward other undesirable activities. The graduated income tax system we have now is intended to better favor lower-income families, this would just be aligning some provisions in the overall system. Consumption taxes have their own problems.
3. Greater capital availability for “productive” assets increases american’s job base by supporting high-tech investment
This is a no-brainer. Instead of willy-nilly investing our capital into a nonproductive asset, we might actually invest in assets that add value in international competitiveness and create domestic jobs. A stronger trade balance would offer strength to the beleagured dollar and keep other products cheap for Americans. While we would all agree that real-estate in general adds productive value, what value does a 4000 sq ft house offer over a 2400 sq ft house? What value do sky-high realtor commissions have in the international competitive arena?

Who would lose with this legislation?
1. Homebuilders - don’t believe the hype, they are alredy on their way to being entrenched; this is a cyclical business and we’re on the downside. The stock market already knows what the average American doesn’t since the stock market is forward-looking, while real-estate measures are backwards looking. You can’t drive an economy looking out the rear-view mirror.
2. Retailers - the cash-out refi is already over, but this would drive a stake in the heart of the asset-backed debt monster. Is this a bad thing?
3. Overextended homebuyers - This is a tragedy, and to make the transition easier, the country should grandfather the breaks and transition them in for the next 5 years for current homeowners to gradually ease into the change and to get their finances in order.

Who wins?
1. The capital markets/American economy
2. Average americans
3. The middle class (gasp!, is there one left?)
4. Prudent home-buyers who never borrowed more than they could comfortably pay

In the end, 10% year-over-year appreciation in homes is not an American god-given right. It has been worse, and it could be much, much worse. This is just a single step in the right direction.

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