Chuck Ponzi December 15th, 2005

A great little piece came out in the San Diego Union Tribune today with a few notable quotes that are a bit amusing. Here are a few of notable quotes:

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Despite rising interest rates, a growing for-sale inventory and a slowing sales pace, the county’s shortage of housing will prevent prices from dropping steeply, speakers asserted.

“It’s Economics 101,” said Leslie Appleton-Young, chief economist for the California Association of Realtors. “It’s demand and supply.”
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and …
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The fundamentals of the housing economy remain sound, said Louis A. Galuppo, director of USD’s Burnham-Moores Center for Real Estate. “We may see a decline in sales but not prices.”

Despite “air leaking out of the tire,” there are no major economic triggers, such as massive job losses, to cause the housing market to crash, said Joe Anfuso, chief financial officer of Shea Homes San Diego.
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I agree, it most definitely is Economics 101.

Anyone who has ever taken an economics course should be familiar with this picture:

It’s the demand curve and the supply curve. Basics: People buy more of something when it is cheaper (downward sloping demand curve) and suppliers supply more of something when it is more expensive (upward sloping supply curve). The market price is where the demand curve intersects with the supply curve. We won’t talk about elasticity of pricing or supply lags or anything, just the basics.

We all know that long transaction settlement times will make it an illiquid market and imperfect information make the market inefficient, so for the moment we will assume that we are currently at the perfect market price.

So, if quantity goes down, what could that mean? Well, back to Econ 101, it must be 1 of 2 things:
1. Shift in the Supply Curve
2. Shift in the Demand Curve

Without an exogenous shock, economists normally dismiss #1 and go right to #2. However, for the sake of fairness, we’ll consider it.

Shifts in the supply curve to supply a lower quantity would generally mean a higher price. Suppliers would do this if prices of raw materials increased, restrictions were placed on output, or some other event would cause them to be unable to provide more quantity. However, all other news articles recently have pointed to a consumer-led slowdown, and no immediate event has happened to suppliers to slow production in recent months. (Please, any reader correct me if I am wrong)

So… what does a shift in the demand curve mean? Well, that would mean that consumers are unable or unwilling to pay the prices, and have scaled back on purchases. (Once again, intentionally simplified) This would result in a left-shift of the demand curve.

Now, illiquid markets with imperfect information tend to overreact to information and overshoot the fair price of the goods.

So, how is that supported by Mr. Galuppo’s assertion that we can decrease transactions without decreasing prices? Well, anyway, it’s not Econ 101.

Which leads us to his second assertion; there are no major economic triggers such as massive job losses… Well if that isn’t just a jinx on the whole thing.

Besides, with the economy so dependent on Real Estate transactions and values, well, shoot, we’ll dang near just squeak by without all of that additional transaction volume, right?

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Chuck Ponzi December 12th, 2005

Time and again, in Southern California, we have heard the mantra that strong housing fundamentals are supported by demographic shifts related to Baby Boomers retiring and purchase of second homes, etc. etc. etc.

Although this is old news, Merrill Lynch’s North American Economist, David Rosenberg recently stated that “The demographic story behind the housing market boom, as we always thought, was a giant hoax.”

Lehman Brothers has weighed in with “(A) turn in the housing market is central to our economic forecast.”

Goldman Sachs has even said that a downturn in housing could shed 1.3 Million Jobs, increasing the unemployment rate by 1 percent in the US, and by 2 percent in California. These numbers do not include cuts in housing dependant businesses.

This sounds eerily familiar to the post I made back on April 7th, 2005 in my Jobs, Jobs, Jobs, Recovery to Crash Post where I predicted a 1% increase in unemployment and a 2.5Times multiplier (Not sure if my multiplier will hold up under intense scrutiny, there is a difficult link there to be made) Perhaps the guys over at Goldman are secretly reading my blog? OK, that would be a bit much… I think my head has swelled a bit much.

A great little story came our way from the good folks over at NPR in Boston. I like to listen to NPR every once in a while. Not really an unbiased news source, but they try their best. In their recent “Report from the Homefront” which you can listen to here, the discussion turned to how Boomers will be Decreasing, not increasing their purchases of homes, and living in smaller, not larger homes.

Most housing advocates have been spouting the party line that housing will only get more and more expensive as boomers hoard more and more housing unto themselves. I know firsthand through my parents (who are early boomers) that their taste for housing has changed over the years. In my lifetime, my parents have owned essentially 4 homes. Their first was a starter home that was about 1700 sq ft that housed them and 5 children. It was purchased in about 1974. Their second home was 5000 sq ft to house them and 7 children which was built in 1980. Their third home was 3500 sq ft to house them and 3 children purchased in 1991, and finally their final home was 2900 sq ft to house them and 1 child (my little brother moved out a few months ago, long overdue) purchased in 2002.

What surprised me the most was how much bad luck they had had in the last few purchases/sales of homes. They had always seemed to buy at the peak. At each step, they were making life changes with their peers. Is it possible that the past 3 or so housing booms have coincided with Boomers’ life shifts? If my parents are any indication, they have inhabited smaller (yet nicer) homes as time has gone by over the past 20 years. Will the boomers move to super low maintenance luxury condos? Maybe next time if my parents are any indication of what is to come. Perhaps when my father can or will no longer do yard work and the such.

So, the central argument is that boomers will be buying more and more homes to do less and less with them. The people over at NPR seem to be thinking so.

But, Rosenberg’s comment about a “giant hoax” was based on household formation. Household formation has decreased over time (and yes, households are a direct correlation with how many housing units are needed). So, who is buying all of the inventory? If my parents are any indication, it is indeed Baby Boomers. Not for living in, of course, but because my parents needed 25-35% returns yearly to be able to retire. So, if there is massive building without household formation, what would this be called? You got it, a great big speculative bubble. What will happen when investment money needs to be returned? That’s another simple one. Excessive supply will flood the market, and only when holding costs exceed ability to pay, will prices begin to come down. My parents have considerable reserves to handle holding costs, but a low tolerance for losses; as they require the capital and return for living expenses. In addition, since they are already retired, there is no additional income to repay losses from investments.

Will baby boomers be buying your home from you? Not likely. Their tastes, needs, and wants are all different from other age groups. If heating/cooling costs rise substantially, they will not want enormous entries, 12 ft ceilings, or backyard pools. After all, energy costs are not built into CPI which drive Social Security and Pension benefits. Perhaps a smaller place with lower upkeep but nicer amenities might be in the cards; but only if they can sell their spec home to you.

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Chuck Ponzi December 9th, 2005

——————————————————–
in·fla·tion ( P ) (n-flshn) n.
1. The act of inflating or the state of being inflated.
2. A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.
——————————————————–

A great little piece about the Inland Empire Real Estate environment has come out recently. Apparently, the real estate business is still gangbusters out there. Of course, I could have just asked my dad who has gone from being an accountant by trade to being a real estate speculator and flipper.

Stranger than that, the story yesterday was located at this link. However, it has more recently been moved. While ensuring that my mind wasn’t playing tricks on me, I checked back to Ben Jones’ blog where I had come upon the link once, and sure enough, he commented on it, but did not copy the full text of the article. Anyway, his take on the article is here.

It’s pretty much the same sentiment that all locales are sweating these days. It basically says, yes we’re in a speculative era, but we’re different because….

Well, my memory does recall enough to know that it piqued my interest, and there were 3 ideas expressed that I wanted to comment on.

First, the premise was brought forth that prices were so much higher on the coasts than in the Inland Empire and that’s why prices were going to keep going up.
Well… let’s think about that. If we were to extend that further and further, well prices should still be going up in Las Vegas too right? They’re farther inland and well, we all know that money is simply found floating in the ocean and that’s why we all want to live near it.

Second, they mentioned the fast growth of the area in terms of people. Conveniently, they didn’t mention job growth, because frankly, there isn’t enough to support the kind of migration they are having. No, the migration was out of the LA and OC area to escape the high prices of housing. If the Inland Empire is no longer a bargain, what will people do? I guess by their reckoning, they’ll just pay more. Move out of town? Pish-posh, won’t ever happen, California is the Golden State.

Third, and I really wish I had the article because I didn’t copy the quote, but one gentleman quoted said something like “There’s a lot of money out there floating around, and it’s gotta go somewhere.” Well, this one takes the cake. He is right, there is a lot of money floating around out there. And then there is pseudo money, aka Value. The first causes inflation, the second causes optimism.

Let’s define them. Money is the hard stuff that you put in your wallet. It’s also in your bank account, brokerage account, and many other accounts. Value is something money buys. Value is only worth what someone will give in exchange for it (some will argue this about our fiat currency, but we won’t discuss that at this point). Value is a gift card from Home Depot or stocks. Value is your car, your boat, or your house. Any number of events can affect what someone will pay you for items of value. A bankruptcy of a company, car accident, boat sinks, or hurricaine can all change the value of certain items. Money is just there. It floats around in the economy being spent and respent. The speed at which it changes hands is velocity, and the measure of virtual money (not actual currency) is how the Fed determines inflation through M1, M2, and M3 money supply figures.

What’s frightening is that money supply is so out of control that not only can federal reserve bankers see it, little old guys in the Inland Empire can see it sloshing around in their own area.

Kinda like the “you know you’re a redneck if” jokes, there might be a saying like “you know you’re in for an inflationary period when rednecks in the Inland Empire use it to justify half-million dollar stucco boxes” except that it isn’t as funny.

If Bernanke sees what this gentleman has seen, he will most definitely continue to raise rates, and not at a measured pace. The bond market has already built in 2 more quarter point raises, could they be fooled and find themselves on the receiving end of a half-point?

And, if you read my piece on deflation, you might be asking yourself, well, which is it? Is it deflation or inflation? It all depends. Mr. Bernanke has inherited a pretty nasty tightrope walk.

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Chuck Ponzi December 6th, 2005

It would be difficult to spend any amount of time discussing housing prices without discussing the “house as an ATM” phenomenon. An interesting piece came out recently in the San Diego Union Tribune titled House can lose big if owner gambles with fickle markets.

I had expected by the title that it would be another ho-hum piece about how buying at the top of a market could be financial ruin, blah blah blah. I was completely surprised to find it was more about investment advice - for those using the House ATM.

Some of the findings of this journalist is that an expected 11% of cash-out refinancing dollars find their way to stock market investment. She derides these investors as “(hoping) to emulate Warren Buffett or perhaps Jim Cramer, the hyperkinetic host of a CNBC stock trading show.” Her decision? “It’s not hard to think of reasons why you should avoid exchanging your home equity for a pile of poker chips.”

She concludes that those “counting on the (investment) to generate enough money to meet their monthly mortgage obligation” could end up losing their home.

I have a problem with some of the issues she takes for the following reasons.

1. A house is not an “investment”. Never was, never will be. But, even if you see it as such, what’s wrong with a diversified investment portfolio? Isn’t that what most investors should be doing? Is she suggesting that keeping all of your assets (or a major chunk of them) in your house is the smarter move? Yes, investments go up and investments go down, but smart investing, like smart homebuying, is a long-term strategy.
2. OK, so 11% of refinance money goes to investments. So… 89% goes towards consumption? Alright, I know that’s a bit steep, but even if a full 50% goes to house remodels (most of which are excessive, but we’ll assume they increase the value of the home some), that means that the 39% remainder are going towards consumption of “other” goods & services. That’s 3 times the amount she is worried about going into the stock market. She seems like she’s swimming upstream with this one. It’s like the pot calling the kettle black.
3. Since when was the stock market equal to “a pile of poker chips”? To non-savvy investors, yes, it seems scary and daunting when the Nasdaq loses 80% of it’s value. But, if you believe that investments are akin to poker… you should probably be stuffing your mattress with gold and hoarding guns. Companies with cash flow do have intrinsic values.
4. How dare you mention Warren Buffett and Jim Cramer in the same sentence? Have you no sense? It like comparing a rock with an ostrich. Their investing styles are as different as sausage and Uzbekistan.
5. If you are counting on an investment to throw off enough cash flow to offset your expenses, you really need to go with a lower-risk investment than a stock fund, and you likely will not exceed the hurdle of the cost of your debt. I doubt that she is an investment advisor, though, and would understand the implications of risk/reward in the stock market, since everything is “a pile of poker chips” and you are “betting against the House”.
6. While I admit that I agree with her that borrowing to invest is the wrong way, she comes to this conclusion with fear mongering and disinformation. She is attempting to scare people away from investing at all because your risk losing money. Yes,… well,… that’ s the nature of investing. While there is no such thing as a “no risk” investment, you could always look into low risk investments like Government bonds.

Investing in companies via the stock market can be the smartest decision of a lifetime. Any research into the work of Warren Buffett would show you that risk can be moderated and returns can be quite good with smart value investing. Fear, however, is the enemy to value investing.

However, this wasn’t about investing was it? So, which is the worst decision?

1. Borrow against your home to spend on vacations, cars, or other consumer items?
(you will rarely get anything returned)
2. Borrow against your home to spend on home remodels
(Historically, this has not resulted in increased home values greater than the cost)
3. Borrow against your home to invest
(Historically, this returns 8 to 12% annually)

You decide.

Or, is there a fourth option?

4. Don’t spend more than you make? Is this possible
(Historically, you get all of your money back with this one)

When faced with these options, personally, I consider #4 best with #3 second best, then #2 , and would never consider #1.

Should we really be worried about investments when most of the time people are choosing returns below the 0% mark?

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