Chuck Ponzi January 22nd, 2007

We learned today that OPEC countries are unloading their US denominated treasuries at their fastest rate in at least 3 years.

Bloomberg gives us the insides scoop:

Exporters including Indonesia, Saudi Arabia and Venezuela, sold 9.4 percent, or $10.1 billion, of their U.S. government debt securities in the three months ended in November, according to Treasury Department data. Members of the Organization of Petroleum Exporting Countries last sold Treasuries for three straight months in June 2003.
Oil producers have surpassed Asian central banks as the largest pool of global savings, accumulating an estimated $500 billion in 2006 alone, according to research by Pacific Investment Management Co. The sales during those three months mark a reversal because OPEC countries have boosted their holdings of U.S. government bonds by 70 percent to $97 billion in the past 17 months, Treasury data show.
“There will be a significant sell-off,” Joseph Stiglitz, a Nobel laureate and economics professor at Columbia University in New York, said in an interview. “Medium-term and long-term yields will go up.”

What does this mean for us in SoCal? Most likely interest rates are going to be rising. I have been expecting for at least 8 months now, the beginning of a substantial credit crunch. A credit crunch will come from 1 or 2 sources. The first being the tightening of credit availability (banks taking write-downs and are forced to restrict lending to riskier customers) which we have yet to see in a meaningful way despite the rumblings and bumblings to that effect, and the second being a rise to the cost of extending credit.

The past few years has seen credit extended in some of the poorest of circumstances. And, at the lowest rates to boot. Worst of all, spreads between high-quality credit (such as treasuries) and low-quality credit (junk bonds) are some of the lowest in a very, very long time. The world, it seems is awash in a sea of liquidity. I first remember hearing this term from Gordon Gekko in the movie “Wall Street” which was incidentally shot in 1987. (figure out the reason that is interesting, and you win a self-pat on the back)

I described the potential “snap-back” that could trigger an unwinding credit event in a post last year titled “Interest Rates Gettin’ you Down?”

This type of sell-off can trigger substantial inflation and require the FED to raise rates in the face of an economic slowdown.

While I suppose that the greatest losers to the current economic slowdown is likely the same ones who benefitted most from it (undocumented workers), we will see a trickle-up effect. Jobless claims have been surprisingly tame despite the substantial removal of building from the economy, and this is likely missed in the official statistics the government collects and records.

We will likely see the next few months how this effect changes the current lending rates in the Southland.

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Chuck Ponzi January 19th, 2007

Some time ago, we debunked the myth of rising rents in Southern California due to the housing Bubble. The title of our post was Rents to Follow For Sale Housing Trends?

We hypothesized that this was merely a scare tactic by RE professionals to buy now or be priced out forever. I said:

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.
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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.
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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.
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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.

Indeed, we learned recently that Landlords Lowering Apartment Rates, Offering Incentives as if this was news and none of us saw it coming. The article quotes John Husing (we all know who he is)…

But “there’s a point at which you push beyond where people can afford the price and you run into resistance,” John Husing of the consulting firm Economics & Politics Inc. in Riverside told The Times. “In supply and demand terms, the sign that the price has gotten too high is when you start seeing vacancies go up in the rental market, and inventories go up in the housing market.”

Back in our original discussion, Robert Cote’ and I got into a discussion of the debate between supply & demand of housing stock (my thesis) and basis costs (Robert’s thesis at least at the time) Robert, have you changed your mind yet on this?

It all goes back to the concept of supply/demand lags. For those of us who in college played “the Beer Game”. (Note I didn’t play this until my MBA days since I went to a religious university for my BS where drinking was prohibited). It pits suppliers with lag times from a manufacturer to deal with demand changes and an unclear order/order cancellation process. Kinda sounds like our homebuilder scenarios.

Essentially, what happens is that people on the retail side signal an slight increase in demand which gets amplified throughout the supply chain. Since the short-term shortage signals a much larger demand (if you can’t get Budweiser at your local 7-11, you go to Ralphs, and both 7-11 and Ralphs place an order) and the lag time between increasing supply in the supply chain and delivering it to the market can be as much as years, you can very easily oversupply a market. This is what happened in the early 1990’s in California, and it’s happening again. The only difference now is the bagholder. In the past cycle, there were a very large number of spec homes held by builders. This time around, the speculation was democratized through rampant and pervasive poor lending practices. Either way, we will revert to the mean.

In another article, we learn from the Pasadena Star that overbuilding was indeed the mantra since the turn of the century (at least and probably well into the future as well). There Ismael Abidi from the A. Gary Center for Economic Research at Chapman University tells us:

California gained 723,000 jobs and built 851,000 homes from 2000 to 2005, a ratio of 0.8 jobs created for each homebuilding permit issued, he said.
The long-term ratio of jobs to homes from 1980 to 2000 is 1.7, he said.
“We built too much for the job growth,” he said.

No kidding, Sherlock.

So, what does the future bring?

Personally, I believe we have already reached a cap on rents that cannot increase much (rents must be paid from cash unlike housing prices that can be financed on exotic terms), and that we are at best likely to see rents at the inflation rate (1 to 3% for much of the Southland). That’s if we don’t see a major recession in the next year which according to several leading indicators is not only possible, but likely as well.

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Chuck Ponzi January 17th, 2007

Every once in a while, I stumble across some good analysis of the current housing bubble that seems to go unnoticed. I uncovered just such a tidbit the other day that would make for a good read.

Some of the points I agree with, some I find hard to digest… the logic seems a little light, or perhaps there are other answers to the question posed. Just such an article appeared on Prudent Bear the other day.

The Author, Dan Forshee, takes us on a great historical ride regarding the last 90 years or so of housing prices in the US. It even includes the very impressive chart:

I am confident that it took quite some time to compile the data, normalize it, and show it in a meaningful way. As they say, a picture is worth a thousand words.

It made me reconsider the concept of cycles and supercycles that housing is falling into or may be falling into. Regardless of whether there is a supercycle at play here (I’m not sure myself), it’s a great way to consider the past as a possible predictor of future events.

Dan also includes a great discussion of land-use restrictions by measuring the number of years it takes for the tallest building early in the century to be superceded by an even taller structure. His estimation (and anecdotally if you look at the data he presents), is that it took quite some time after the roaring Teens, 20’s and early 30’s for land to once again be valuable enough to build taller skyscrapers on.

However, like any critical reader, I must view any assertions in some suspect light, even if I agree with the potential outcome.

For example, there was a very large drop after the 1930’s in land prices and corresponding building of supertall structures. Does this mean that suddenly land could become even less valuable than before? Possibly, but he offers very few clues as to the triggers.

Personally, I believe that there was a substantial shift that occured within cities as we knew them in the early part of the century with the widespread availability of automobiles and interstate highways. This made it possible for families to reside outside of urban centers and economically commute to places of work. This reduced the pressure on builders to build vertically. The technological changes of the automobile are fundamental when viewing the Southern California region’s building habits.

Much has been said about the condo-izing of Los Angeles, Orange County, and San Diego. However, the impetus for this kind of building up is also related to the relative prices/scarcity of cheap fuel for autos. The unseen hand both squishes up and smooshes down.

Peak Oil advocates (in my mind) would find it hard to be pro-housing bubble due to the obvious effects pricier energy would have on outer exurbs and commuting costs. However, it’s interesting to note that there are a number of die-hard bubble believers who are also peak oil believers as well. How they resolve that cognitive dissonance is as as difficult for me to understand as how Gary Watts is still able to sell his predictions after his embarassing smack-down on his 2006 forecast. Guess the impossible does happen.

On the other hand, if there were to be another fundamental technological shift, some disruptive technology that makes energy substantially cheaper than oil, or just as likely to negate the need for oil, we might see land prices once again fall. I have mentioned 2 such shifts… cheap nanotube based Solarpower and advanced telecommuting (for non service-based jobs). I know that many of the people I work with would gladly trade the great weather but terrible schools and oppressive taxes of California for other locales that have much cheaper housing and better schools (the bad weather notwithstanding). Anecdotal as it may be, employers have much to gain by reducing the costs of living for their employers since they then will be able to negotiate lower salaries. In the past, bandwidth was the primary hindrance to this dream. I believe we have already overcome it, and many new communities are recieving fiber to the home (fiber-optic internet) which can have much higher bandwidth than many can currently imagine. At this point, the hardware switches become the bottleneck, not the wire.

In addition, cheap nanotube solar power makes it possible for households to be self-supporting. Roofs as solar collectors are quite efficient and that’s a lower input per person in a high-rise. Stick-built houses are relatively inexpensive, and can collect greater amounts of solar power. This kind of disruptive technology will be available to homes much quicker than some know. As we speak, Nanosolar Inc. is developing a large production plant in Northern California to produce flexible solar panels on orders of magnitude cheaper than current silicon-based methods.

While my intention was not to discredit any particular concept outlined in Mr. Forshee’s analysis, it is rather to invite those reading to consider that even when a person comes to the same conclusion, thier reasoning might not be bullet proof. Bubble bloggers, after all, were the ones who railed against groupthink. We cannot allow ourselves to become victim to it.

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Chuck Ponzi January 12th, 2007

Local economists agree that SoCal Real Estate is a great investment. It *Always* increases in value.

We took at look at this some time ago with the article “Trees Cannot Grow to the Sky” Now might be a good time to review some of our assumptions now that we have hit 0% growth in housing prices.

Is there a limit to the growth over time?

We have heard local economists such as Gary Watts say time and time again that the “average” return we should expect over the long term is 8% per year because it corresponds with typical gains for an international supercity.

I say Baloney.

To test this theory, let’s consider one of the better documented sales of real estate in the US from a long time ago, the sale of Manhattan Island.

According to the story, Peter Minuit purchased the Island of Manhattan for approximately $24 worth of Wampum in 1626 from local Native Americans. Was this a good trade? Many consider it so, however we need to look at the facts before we just come to that conclusion.

Today, Manhattan is one of the most wealthy parts of the world. It is home to investment banks, trading houses, and some of the priciest real estate in the world. Much of the world’s assets are either traded here or tracked here.

Let’s consider our Local Real Estate Economists’ assumptions. If we were to take that $24 and reinvest it in 1626 at a return of 8.065% per year compounded (We’ll see later why we chose that number, but it’s close enough to 8% for our purposes), we would end up with $140,232,329,364,918.00 in 2005. That’s a lot of semolians. Over 140T to be general. (Yes, Trillion, not billion or million). All from $24 and 8% compounding return. The stock market has done better over the past 100 years.

How much money is $140T anyway?

It’s a lot. Trust me. Not even adding together all of the assets of Orange County would come close. Neither would adding together all of the assets of California, or even the entire United States would even come close. Still don’t believe me?

Thanks to Barry Ritholtz at The Big Picture, via the Wall Street Journal, the worlds ENTIRE Financial Assets equalled $140T in 2005.

Let that sink in for a moment.

$140T represents more than 3 times the worlds entire production for a year. Do you still think that Manhattan has seen an 8% return over time? Can Orange County or anywhere in the Southland achieve that over long periods of time? And if not, what would have to be the down years after returns of 30% or more per year for several years some areas? 0% for 10 years? -5% for 5 years? -10% for 3 years?

The reality

Over long periods of time, real estate approximately matches inflation with a huge jump in the past 10 years. Real estate is normally a great inflation hedge. There are periods of time when returns will defy logic, and then snap back into line with fundamentals. However, the current period is marked by an out of control psychological mania.

To get an idea of how strong these types of manias can be, I recommend reading “Extraordinary Popular Delusions and the Madness of Crowds” also available at Amazon or B&N. They can go on for years and decades. Their ends, however, are as mysterious as their beginnings. One day, the euphoria just wears off and people go back to being normal.

Are we there yet?

Not quite yet.

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Chuck Ponzi January 11th, 2007

Hi all. After this last pause, I have had a chance to regroup. I took some time off, got sick, took care of year-end in my real job, and planned out the coming year.

During that time, I had a chance to put together a roadmap for what we all can expect for the year 2007 in Southland Housing. Some good, some bad. Here are my ‘07 predictions.

1. The Bubble Will or Will Not Burst
Ok, that’s flaky, but it’s all in your definition. If you see a 5-7% decrease of the median price in most counties as the bubble bursting, we will be having a bubble burst. If you’re expecting even lower sales numbers (-10% to -20% from 2006) while the standoff between sellers and buyers continues until nearly the end of the year, then yes, you will also be satisfied in saying that it burst.

There will be many who will disagree that this is a bursting bubble. However, many others will be threatened by losing their home due to resetting mortgages, and that is the essense of a bubble by our definition.

The saying goes, “If your neighbor loses his job, it’s a downturn. If you lose your job, it’s a recession.”

2. The Subprime Mortgage market will shrink considerably.
Like try 40% or more. Nonperforming loans are all the speak now. Right out of the gates, default rates on 2006 vintage loans are seeing first payment defaults of heretofore unseen rates. And the risk spread between subprime and prime is dangerously thin. So are commissions. This means that many brokers will be throwing in the town this year.

However, it’s the back end that will create the credit event. The brokers are just the salesmen, but when the wholesale trading business dries up, then the real pain begins. This should be happening sometime later this year (and it has already begun with Secured Funding’s wholesale in Costa Mesa)

3. Gary Watts will not realize how bad he is at predicting things, and he will still make a lot of money this year.

What can we say? Some people are just gluttons for punishment; and I’m not talking about Gary. I’m talking about the people forking over hard-earned money to hear him talk about how bazillionaires are all moving to Orange County. Too bad we haven’t seen too many of them around here lately, we need some more since the current smug people aren’t quite rich enough without their housing gains.

4. We will have asset deflation with stable (high) CPI inflation.
This one’s a tough one, and nearly impossible to predict, so I’m just throwing it out there. We’ll see how it really turns out.

5. I will be spending more time on posts… no really, this is just and excuse to get going again. More commentary in the coming days promised.

Thanks for bearing with me while I took a vacation from the bubble.

John Doe

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