Southern California Real Estate Bubble Crash Blog

If you haven’t gotten the notice, L.A. housing is the least affordable housing market for the 6th consecutive quarter, the Daily News Reports.

The reason for the affordability issue?

Rising interest rates, while still low by historical standards, also helped drive down affordability, the association said.

I think we all got the memo on that one. Although, there are some who are doubting whether interest rates will ever rise again. They have been so low for so long; maybe this is just the way the 21st century works?

I wouldn’t bet on it.

A good bet would be in with the term “Debt Monetization“. Readers would do good by reading up on this oft misunderstood Federal Government/ Federal Reserve relationship.

Essentially, the government buys its own bonds by printing money. Under normal circumstances, this causes inflation. Does anyone question why the M3 is being discontinued?

Bill Fleckstein stomps all over this topic in a write up about inflation. His question is valid: If there’s no inflation, why do we fight it?

This brings us full circle back to housing. Interest rates (which are very low anyay) are helping to keep the credit and housing bubbles intact. If Bernanke wishes to give a soft-landing, he can only through inflation. If our assets are inflated, the only thing left is our income. This would have a double benefit of additional income tax for the federal government on top of easing us into pricier housing; helping to restore a more balanced budget. However, because much of the entitlements are based on inflation indexed amounts, we are really going to burn out our printing presses trying to get out of this one.

What’s interesting is in fact, the denial of inflation as a problem. January’s CPI was +.7% (annualized to about 9%), and the bond market rallied. Are people really willing to lend money at 4.5% just to lose another 4.5% per year? Bill has a theory:

Folks have done so well with their homes’ appreciation and all the money-printing that, while prices are up, they’ve chosen to ignore inflation, as it’s been “good” to them. Thus, rising prices do not bother them.

My opinion? I think this has more to do with debt monetization and foreign funds holding down the cost of borrowing US dollars; creating a kind of rickety scaffolding upon which to build housing wealth. One trip-up and it all comes tumbling down on interest rates. I also believe that interest rates (especially to consumers) can move much faster than is generally believed by the masses. Could we have a 2% increase in prime in a matter of a week? You bet. Any loss of confidence (especially with respect to inflation) could cause mass exodous from US dollar denominated bonds. The problem with this scenario is that the rest of the world is more or less built on the US economy. We are the buyer of last resort. When we don’t buy… noone else will have the money to do much else.

This leads us to Southern California affordability. Only 2.3% of the homes are affordable to the median income household. Our writer at the daily news has a grasp on this when the story closes with the line from Leslie Appleton-Young:

“Most homeowners could not afford to buy their homes today if they had to,” she
said.

So it is. Welcome to the American Dream.

Have you ever met someone so out of touch that they didn’t get the joke staring them in the face? Ever told someone to do something sarcastically only to have them actually go and do it?

Well, the World’s Most Gullible Award of 2006 definitely goes to the OC register Blog.

A recent article proves just how out of touch their writers can be. For fear that they might discover their stupidity, I just absolutely have to copy the portion where they mistakely understand the purpose of the site http://thereisnohousingbubble.blogspot.com/ below:

Filling that void is a new over-the-edge blog, There Is No Housing Bubble, which addresses some people’s fear that they will feel enslaved by their home if they buy one. Under the heading “Slavery Is Freedom,” the blog sings the praises of rising home equity:”If you need $100K to give your child an Ivy League education you can use the wealth created by your home to fund it. Try doing that with your canceled rent checks and see how far that gets you. If you need Bruno Magli shoes and an Armani suit for a social function you can tap your home equity line of credit and the best part is you get to deduct it all from your taxes. Thank you Uncle Sam! This so-called slavery leads to the greatest freedom a human can possess: the freedom to do anything.”
Other headings include “Debt Is Wealth” and “Fear Is Happiness.” Under that final topic, the blog states, “For most of us, it strengthens our resolve to do whatever it takes to become one of these rich, happy landowners. For the frightened renter/bubble advocate, it causes fear and resentment to want to ruin other people’s lives. Don’t become one of these pathetic wretches. “That is why I’m writing this blog, to educate the few redeemable renters out there. To let them know that if they take a chance and let debt, slavery, and fear into their lives they’ll find wealth, freedom, and happiness.”

If you don’t get the joke, perhaps you should go buy a sense of humor on Ebay. It will probably be a better “investment” than a home right now.

The rest of the story is pretty blah, blah, is there a bubble? No one knows for sure, they say; well, they may not, but many already do and are doing something about it by selling their own “investment” digs.

As soon as John gets some time away from his indentured servitude, he will post some analysis of San Diego’s transaction volumes! (This will be more fun than reading OC Register blogs)

Now that John is back from his travels to Asia, there is quite a lot to catch up on this President’s Day.

Luckily, the LA Daily News gives us the requisite Heebie-Jeebies that gets our engine started. It’s pretty much the same old stuff that the press has been jockeying to tell us… it’s different this time with a title of Could history repeat itself in Valley’s ’06 housing market?

The 851 single-family home sales in January 2005 ranks as the fourth-highest number since 1,057 transactions in 1989. Last month’s sales total, an anemic 582 transactions, ranks 13th. To find any deja vu in this, we’ve got to go way back to 1990, which had the seventh-highest sales total. But that January’s count fell 27.2 percent from the prior year.This year started with a hefty 31.6 percent decline to the lowest level in nine years. There are some striking similarities, and differences, between then and now. Both years started the same way the prior one ended. In May 1989, sales began falling under the prior year levels; that malaise lasted 22 months. Looking back, it’s the point when that real estate bubble began to burst.

Before you start to think that the LA Daily has taken the side of bubble sitters, consider that they quote Jack Kyser…

“Speculators were really in the market more heavily invested than now, new-home builders raced into the market … and were left with huge inventory overhangs and the most important thing is your (the Valley’s) economy was going through a major restructuring,” he said. Kyser also notes that the economy is much more diverse now than in 1990, which was the beginning of a prolonged slump that saw Los Angeles and Orange counties losing 700,000 jobs. Sales and prices didn’t fall in response to each other so much as they reacted to jobs leaving the area.

If you don’t have a healthy level of skepticism, let me help you with the following:

Inventory overhang exists, but in the hands of individual speculators, not speculative builders. The economy is decidedly housing-centric, not more diverse as Mr. Kyser purports, and likely to go through a major restructuring with companies leaving for lower-cost locales and off-shoring.

And, of course, we need to consistent level of optimism injected into the conversation:

Jim Link, executive vice president of the Southland Regional Association of Realtors, does not see a price decline accompanying this fall-off in sales, just a moderation in the rate of appreciation. “A year from now, I think it will be a single-digit increase but it will be higher than it is now,” he said of the median.

The most telling line of the whole story is next:

He was just as optimistic in January 1990, anticipating that full-year sales would match 1987 or 1989. Single-family sales ended up plunging 31.6 percent that year, a suddenly familiar number. Analysts and industry executives don’t expect that kind of a train wreck this time around, though. Of course, no one saw the last one until it flattened the market.

Local economists and think tanks such as the UCLA Anderson School know that the outlook is not so optimistic. Truly, the local Realtors(tm) and builders have just one leg left to stand on — the bad news hasn’t come in yet. But, we need not even wait… the momentum has changed and there is a change afoot. The LA market is not “moderating” at all. The rush for the exits has already begun.

True to the Yahoo Effect I documented some time ago, it is a dumbed down version of the truth for something about the housing bubble to appear on Yahoo.com. Their recent story of stupidity is a little title of Why Homeowners Get Rich and Renters Stay Poor.

Its main premises are fivefold.

1. Owning is cheaper than renting

The argument compares 30 years of renting with 30 years of paying a fully-amortized mortgage, assuming you bought 30 years ago and the home is fully paid off now. His premise is the worst kind of monday-morning quarterbacking. If you could see 30 years into the future, I doubt that the best decision of that time would be the purchase of a home. In addition, he fails to mention the cost of maintenance, updating, taxes, and other expenses incurred when owning a home. The hard truth of homeownership is that it is far from cheaper than renting for at least several years. And, timing is everything; people rarely keep jobs more than a few years; and moving every several years has become a consistent reality over the past 15 years. Conventional wisdom used to be that you must own a home for at least 5 years to break even after selling; anything less than that would most assuredly be cheaper to rent.

Just as importantly, the fully-amortized loan is almost unheard of. In stretched affordability, any submission must be of the negative or zero-amortization art. As a famous proponent of the bubble once said; paying off a mortgage is unsophisticated.

2. Homeowners get Leverage

The point here is that you are using other people’s money to make your own; leverage gives you greater gains on the upside.

The unfortunate problem is that leverage also gives you greater losses on the downside. The stock market crash was largely precipitated by leverage of lower multiples than the current housing bubble. Good luck on the way down.

3. Homeowner’s get tax breaks, renters don’t

The article states the obvious:

The best way to stay poor is to pay more than you have to in taxes.

Well, if that’s not a truly strange argument. An absolute statement would be assured in the opposite; the best way to get rich is to less than you have to in taxes. (or paying what you have to in taxes). However, the problem with this statement is that hundreds of millions of people have paid what they owe in taxes and not gotten rich; and some have even gone to jail for paying less than you have to in taxes. Taxes have little to do with being rich; regardless of what Robert “Tax Evasion” Kiyosaki might tell you. I can bet you that the richest people pay far more taxes than the normal person does.

While tax breaks can be an important reason to buy a home, it makes little sense to pay $10 to save $9 in taxes. More importantly, in today’s housing insanity, you’d be paying $10 to save $3 in taxes.

4. Homeowners can Earn Tax-free profits

While this statement has many qualifications, it is nonetheless true. However, there is no deduction for losses on the way down. Sorry; if you lost, no tax savings for you.

And, just as importantly, which is it? Are you going to hold your house or take the tax free profits. While this diametrically opposes point #1, I doubt that anyone in the housing industry would tell you to sell your home; you’re sitting on a gold mine, after all. The truth is, tax free profits are just rolled into another house in most cases; defeating the purpose of all of those tax-free semolians.

5. Homeowners become savers

This is the dumbest of the five:

Each time you make a mortgage payment, you’re saving money. That’s because with each payment you’re reducing your loan balance a little — and that, in turn, is building your equity. (This assumes you don’t have an interest-only loan.) The longer you’re in your home, the more equity you build, the more you save — and the richer you get.

The problem with this one is that you’re not really saving. You can’t just take the money out of a house (yes, there are HELOC’s, but that’s a loan, not a withdrawal) Besides, noone gets a normal-amortizing loan anymore; they’re so 1960.

No, the sad reality is that homeownership might just do the opposite of making you rich; it’s common enough for it to have its own term; House Poor.

The difference between house rich and house poor is similar to becoming rich from investing; it is largely an issue of timing.

I recommend anyone read a recent interview with David Barry, an antitrust attorney that could forever change the face of selling real estate in California. His proposal? A statewide MLS system that would be free to viewers and only $20/month to list a home.

What would this do to real estate professionals? Sorry, guys, but this is a wooden stake to the heart. You will not survive this one any better than travel agents survived Orbitz or Travelocity. If this trend goes national, there will be nowhere to hide.

I recommend thinking about another profession and considering how that fits into your current plans. If David Barry’s vision comes true, you will have to serve a very different, diminished role in the process.

On the other hand, consumers would be the real winner on this one. Having access to real information becomes a valuable tool in negotiation for buyers. For sellers, it ensures that you get visibility and a reasonable price to sell your home. You’re going to need it with the upcoming crush of inventory. You can still utilize an agent, and it will likely lower the cost of selling dramatically.

The problems?

Honestly, I think that $20/month is a bit low still. I know it’s not about making money, but you want to ensure it doesn’t turn into a craigslist for real estate where anyone with twenties stuffed in their pocket can make a political statement. There needs to be active policing and a review of postings before they are published (this takes money and California workers aint cheap).

Also, with all of the information that would be available through a MLS, (address, phone, names, etc.) you have to be concerned with identity theft, privacy, and the like. This means that you need fraud controls for the control of information and tracking of users(Still possible, but $20 seems a little light). You might want to designate different classes of users that have different sets of information available to them (some for a fee, some not) and, for heaven’s sake, please build some anonymity into the information sharing (like craigslist does with anonymous emails)

The Big Picture

All in all, this would reinvent the world of California real estate and is great for the consumer. Mr. Barry should be applauded for his quest. But… and you knew this was coming… the real estate industrial complex will do everything in its power to crush it (and people’s will to revolt). Your gain is their loss, and diametrically opposed interests will oppose this.

Much like the discussion of taxing gains on homes or the mortgage interest tax deduction, I don’t think this one will survive without a true anti-trust champion (where is Elliot Spitzer when you need him?). Good luck Mr. Barry, we’re all rooting for you and for the little man.

Now, if we could only bust the public education teacher’s union trust…

You all might be interested to hear what some of the new ideas coming out of the housing bubble are. We are all treated to an eyebrow raising when we read that If Home Prices Fall, Rents May Fuel Inflation.

The gist of it

What this theory portends is that rents will drive inflation through the stratosphere because housing prices which have doubled in the last few years need to catch up to resolve the imbalance between rent/buy.

They say that single-family rents drive a whopping 23% of the CPI, rents have been stagnant… until now. The massive tsunami of foreclosures will force overextended home buyers out of their homes and into rentals. And, as we all know, they would naturally gravitate towards SFH’s.

Fear, can you smell it?
This is a decidedly different tactic at fear mongering than we have seen in the past with “better get in now, before it gets even more expensive.” Trying to coax out the last few bubble sitters, it was but only inevetable that it finally came to this; all financial manias try to eke out the last of the last even when alarm bells and whistles are going off. This tactic essentially is the “there’s nowhere else to hide, you will only make it worse for yourself to stay put” induction.

However this tactic is long on fear, it is decidedly short on logic; at least the old one had “demographic statistics” and some historical context to try to back it up. No, this one makes no sense if you think about it more than the writer wants you to.

With housing prices peaked and set to fall, these falling prices will trigger a housing debacle according to the writer. They even have the requisite quote from an “Economist”.

“If you’ve had very quick home-price appreciation, you don’t have to raise rents too much,” said Steven Wood, chief economist at Insight Economics. “But if home-price appreciation slows, landlords will have to raise rents to start to cover that negative cash flow.”

So, it all makes sense right? Peak Oil? Peak Housing?

The real Deal
The truth, unfortunately for these schadenfreude hopefuls, is much less stranger than fiction. Like many on the “rent” side who are not so quietly enjoying the demise of overextended homebuyers, there are a great number of homeowners who would love nothing more than to stick it to these snobby renters if their housing ATM goes in the toilet.

Sorry, no deal. The housing bubble was an appirition that will disappear as mysteriously as it arrived; it was psychology to begin with and that is how it will end.

If rents rise, it is due to rental stock vs. housing demand, not what the investor paid for it and needs to cover each month. Rents cannot be financed and must be paid monthly from cash and income, and therefore cannot be delayed for the future like many of the more recent purchasers have done with interest only or neg-am products. Honestly, investors have not been willingly depressing rents so that they can have the negative cash flow that they always dreamed of; the appreciation just made up for the losses. In recent years, rents have not only been stagant, real rents have been declining due to overemphasis in purchases and a far greater supply of available rentals.

So, what does this mean for our crush of errant homebuyers who will be foreclosed on and still need a place to live? Well, the bank might rent it back to them, another investor might pick it up pennies on the dollar and rent it back to them at positive cash flow, or they will downsize; none of which changes the housing stock. Without reducing the housing stock (say, if banks suddenly prefer holding onto properties just to let them sit vacant), rents cannot increase since any foreclosed properties are soon enough released back into stock. Yes, we all know it takes a while, but banks generally haven’t wanted to be property management companies and have tried to offload properties as soon as possible. Generally, recovering some of your losses is better than making nothing and most banks do not respond to short-term psychology.

Because the economic picture does not look to be all that bright for the mid-term one would expect some increasing unemployment and downward pressure on prices. For the most part, increased cash prices correspond with income changes. Not the same can be said with credit purchases.

It’s good to be back in the US from my stops in Europe last week; the next week leaves me going to Asia, which typically has better internet access, so I will continue to post.

I spent the time training others in new skills. Training others helps to see how many different people can come to many different explanations for the same phenomenon; and many of them wrong.

See, people see the world in a certain way and have perceptions, past experiences, and information from a variety of sources to draw conclusions from. Rarely, however, does a person understand the core of a subject without getting that ONE THING. You know what I’m talking about; it’s the essenct of the topic. For accounting, it’s double-entry. For systems, it’s the structure of the objects, and I’m sure for many other topics, there is a core set of ideas upon which the entire engine runs.

You might ask yourself, what is that one thing that the US Economy runs on? Well, much like those who stand at one end of the elephant and describe it’s trunk or tail, I would say that it runs on optimism.

When you’re happy and optimistic, you buy. This is what drives America’s consumers, and the businesses that provide for the consumers. Conversely, when you’re pessismistic about the future, you hoard. And, by the looks of it, we are just past the tipping point of optimism.

I don’t believe that this is a simple answer; see there are always optimists and pessimists; but there are a great number of fence-sitters who are swayed by public opinion, personal experiences, and groupthink. For the past 3 years, these middle-of the roaders have been wildly optimistic. They were buying and going into more debt than you can shake a stick at. (and we can shake a stick) You might want to check out the paper Living with Debt from Lending Tree for the gory details of how we have overconsumed our way into a scary finance-everything society.

As with any large swing in a direction, the travel back tends to be painful; the farther it swings one way, the harder and faster it swings the other direction. Just a year ago, things seemed rosy; the war in Iraq was just needing a good mop-up; the deficits were big but manageable; and there were new cars and houses on every block. In the last few months, the sense of danger and financial fear has crept in so quickly that it seems almost palpable.

On that line, you might compare the articles about San Diego aptly named Canary In Coal Mine for National Housing Woes and Tumble with Mike Shedlock’s description of Shanghai’s bubble popping (The prices are down already 50% in some hotspots, and consumers are taking to the legal avenues because they were duped into buying) and with the description of the UK’s bubble popping as well with news that the number of bankrupt UK families hits an all-time record.

Any way you look at it, San Diego is on it’s way to a very painful real estate correction and is being preceded by some pretty hot global regions as well.

Thanks for your patience with John for his absense. John is currently in Germany working and will not be back for a couple days. Internet access has been limited (Europe needs better traveling hotels) and information limited:

One thing is clear; the credit/housing bubble is almost EVERYWHERE. British buying condos in France, French buying in Spain. Spaniards buying Germany, all feverishly trying to buy and sell homes as fast as possible.

Look forward to being back in the Southland and seeing how things are there; most think it’s not healthy.