“Subprime Implosion” the word of the Decade
Chuck Ponzi August 21st, 2007
Housing bubble apologists often dismissed bubble believers’ concerns out of hand with the following party line: Southern California’s prices only fell last time due to substantial job losses due to the dislocation of the defense industry. (no matter that the Eastern Seaboard had a similarly-timed slide and did not attribute it to the same) Such job losses cannot happen again; the job market is too strong, diversified, and recession proof.
In a number of past posts, I have connected the dots related to current job strength, even while realizing that it was not just the number of jobs, but in particular, the type of jobs that matters when it comes to affordability. Indeed, it is important that the prices of houses are not supported by those that already live in an area, but rather by those who are coming to an area. On the flipside, as an area becomes too expensive, those unable, unwilling to remain, or tempted by their good fortune will sell to realize their gain and move elsewhere. We have already seen San Diego County’s negative growth rate (in spite of a substantially increased housing stock). These moves happen slowly, and reacclimating boiled frogs to lukewarm pots makes them believe they are actually in frigid arctic waters.
What the mainstream media failed terribly to see was that it is exactly the excesses created during the bubble that must be punished in a downturn. First, it was the mantra that Real estate never goes down. Then, it was a “soft patch”. Later, a “Soft Landing”. Then “A souffle’”. All of those jobs due to lending and construction that have paved the way to even higher housing prices have now turned into a vicious downcycle. Remember that the “Zombie Financial Media Awareness Week” is just a few weeks away. Why is it that the media has no memory that bubble blogs were appearing in early to mid 2005, warning of excesses in lending and finance?
Perhaps just as appropriately, one would ask, why are their virtual undead still haunting the pages of major news outlets. Featured writers, no less, that give denial a new face. It might be valuable to read what Wikipedia has to say about denial before visting one of our local train wrecks.
from Wikipedia:
Denial is a defense mechanism in which a person is faced with a fact that is too painful to accept and rejects it instead, insisting that it is not true despite what may be overwhelming evidence. The subject may deny the reality of the unpleasant fact altogether (simple denial), admit the fact but deny its seriousness (minimisation) or admit both the fact and seriousness but deny responsibility (transference). The concept of denial is particularly important to the study of addiction.
After reading that, you might be able to find perhaps even a bit of humor in a piece written by our own lovable village dolt based out of San Diego, George Chamberlain just last week:
Let me begin by passing along my congratulations to the many people who are celebrating the current situation in the housing market. In concert with much of the national and local media, they have been able to artificially construct something that has never —- I repeat, never —- been done before: drive down housing prices at a time when unemployment is low, the economy is booming and consumer confidence is approaching record highs.
A column I wrote about a year ago on the housing market triggered more hate mail than any other topic that I have discussed. I needed to check underneath my car and use a food taster for a couple of weeks after I suggested that the situation was dramatically overstated.
That this level of denial exists, is not prima facie a surprise. That a person so disconnected from reality, even after it is made known to the world can get published can only mean 2 things. Either the editor couldn’t care less about what is being written, or is in similar denial. Not once does the discussion turn to the primary driver of housing prices; job creation. Stagnation can already force prices down with an increasing housing stock; much more with out-migration.
If you read the entire piece, you’ll see that his article exhibits a number of different defense mechanisms. From minimisation to transference to outright denial. One might wonder if he is addicted to house price appreciation. We sure know many San Diegans are addicted… and their only fix is through another equity extraction. Wall Street just shut off the spigot, and it’s very interesting the stages of grief that participants go through as an outsider.
It wasn’t hard to spot where our problems lied, even a year or 2 ago. Jonathan Lansner was able to identify some time ago that housing related to 17% of Orange County’s entire job base. Many observers have noted that a healthy balance is between 6% and 12%. Just to bring us to parity with a healthy balance, we would have to increase our unemployment figures by 5% to 11% of the total workforce. Those are depression-level statistics.
As scary and frightening as they may seem, there are some actions that they everyday person should have done in the past 2 years: (and might still be able to pull off before the slide gains even more steam)
1. Eliminate any speculation that is lending or real estate related: sell any properties, refinance historic-low fixed rates, sell homebuilder or financial stocks, mutual funds, and even banks.
2. Housing-recession proof your career. Find a new one, or develop your business plan to excel when downturns happen.
3. Reduce debt, and raise cash or liquid investments. This one will allow you to ride out any temporary storms as well as purchase property in 3 to 5 years from now when they once again return to appropriate levels.
4. Pay off any adjustable debt, hoard cash. Many people are carrying unhealthy levels of debt. While comical, the man riding the lawnmower in debt up to his eyeballs is all too real in America. Don’t be the person who loses their home to out of control personal expenses.
If George Chamberlain wants positive to come out of this, Southern Californians need to break their cultural pathology and begin to save, invest, and build, rather than consume. Otherwise, there is nothing for us to look forward to. Last time, the scapegoat was the defense industry. This time, it will be the “Subprime Implosion”. Years from now, people will attribute the downturn, not with the excesses that led to it (that would mean assigning the blame to ourselves and our human nature), but with the trigger that collapsed the house of cards we had built.
We have met the enemy and he is us.
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Hi,
I have been reading your blog for a long time. I was wondering what makes you think the market will take 3-5 years to correct itself. So far I have agreed with many of your thoughts, but is this based upon you studying the last housing bubble or is it more conjecture.
I agree that prices are going to come down somewhere between now and seven years but what makes 3-5 your guess?
In total, I think we’ll take 7 years to correct at a minimum, with the beginning of the correction in 2005. In OC, that beginning might be 2006.
With that said, I think we’re 2 years into the correction already and believe we’ll see some reasonable deals in 2009 extending into 2015 or so. Could be longer, not likely to be shorter. So, you number might be smack in the middle of it.
I think most readers need to keep in mind that you needn’t worry about missing “the bottom” it’ll be there for a number of years. I don’t suspect we’ll have our next housing mania until about 2020 or so. Time comes and goes… humans change very little.
It’s a mixture of fundamental and technical analysis. Much like stock picking, you need to understand the fundamentals to know what to buy and sell, and technical analysis to know when to buy and sell. Housing in SoCal is not a good buy, and won’t be until a major correction, regardless of what our local dopeheads might say.
But, remember, you don’t need to be exact to make a lot of money, just spot the turning points. 2005 was a turning point. It was hard to see in 2002 or 2003 when the turning point was going to be made, because the bubble was just starting. Similarly, it’s difficult to see the next turning point until it is almost upon us.
Chuck Ponzi
I can’t stress enough how much timing is necessary to investing. Perhaps not EXACT timing, but timing nonetheless.
I sold my LEH earlier this year at $81.
I sold my GS earlier this year at $225 (avg).
Were they the absolute tops? No, those were $86 and $232. Are they a lot closer to the top than where they are now? You betcha!
I’ve been thinking about starting my own investment trust… minimum buy-in of $200K. Any takers?
Chuck,
I agree with your 7 year cycle assessment. I live about 25 miles outside of Boston, and it looks like we’re about one year into this down cycle.
The last housing bust lasted from 1988 to 1995 and was devastating. The Sunday papers continually contained 20 or more pages of foreclosures. Condo’s that were bought at $150K in 1988 were lucky to sell for $70K in 1992. My home, in Hopkinton Ma, fell in value from $155K in 1988 to $90K in 1992 (and I still couldn’t sell it). I know of cases where Condo’s were sitting empty with asking prices of $20K (they had sold years before for over $100K).
The Wang Tower, in Lowell Ma, which is a 14 story highrise with more than 1.2M square feet sold for $525K at the peak of the down cycle. It sold a few years ago for more than $100M.
How bad will this downturn be? It depends on what happens to the economy and jobs. If we have a recession like we had in 1980, I think we can expect real estate values to return to a level below the mean value of affordability. In my area, this could mean a reduction in value of 30 to 40% over the cycle. In Southern Ca, that reduction might be higher (more than 50%). People really need to picture this. If you paid $800K for a home in 2005, you might be able to buy that home again in 2012 for $400K (and lets not worry about inflation adjustments here).
As a further note, I’m a bit concerned about the stock market also. Even though the market is at a very low historical PE ratio of 14.8, compared to 45 in the year 2000, and 21 in 1988, stagflation could push us to the range of 7 to 9 (the historical rates from 1977 to 1979). If this occurs, we could expect a 40 to 50% reduction in the values of our stock portfolios. This could also mean 8% plus unemployment. Think about what this will do to real estate.
Should we be worried? I think so. We are no longer a nation of thrifty people, but instead a nation of debtors. Our political leadership has created massive budget deficits, trade deficits, current account deficits, and is spending 100’s of billions of dollars in Iraq. It’s time to pay the piper.
Another interesting act in this long play - At what point does this job loss in subprime change the prices in OC?
Lehman Brothers Shuts Down Subprime Unit, Fires 1,200 Employees
2007-08-22 14:35 (New York)
By Yalman Onaran
Aug. 22 (Bloomberg) — Lehman Brothers Holdings Inc., the biggest underwriter of U.S. bonds backed by mortgages, became the first firm on Wall Street to close its subprime-lending unit and said 1,200 employees will lose their jobs.
Shuttering BNC Mortgage LLC will cut earnings by $52 million, Lehman said in a statement today. Lehman acquired Irvine, California-based BNC in 2004 and used it to expand in lending to homeowners with poor credit or heavy debt loads. The job cuts are equivalent to about 4.2 percent of Lehman’s workforce of more than 28,000.
“Market conditions have necessitated a substantial reduction in resources and capacity in the subprime space,” the New York-based firm said.
Subprime mortgages, shunned for years because of the default risk, helped fuel the U.S. housing boom this decade as securities firms led by Lehman and Bear Stearns Cos. packaged them into AAA- rated bonds. A surge in late payments on the loans has since eroded confidence in credit products and roiled global debt and stock markets as investors fled to safer assets.
Accredited Home Lenders Holding Co., a subprime specialist, announced 1,600 job cuts earlier today in an effort to outlast the credit crunch that has forced dozens of rivals out of business. HSBC Holdings Plc is eliminating 600 positions in its U.S. operations and closing a mortgage office in Indiana, and Capital One Financial Corp. is closing GreenPoint Mortgage because it can’t make money anymore lending to homeowners and then selling those mortgages to investors.
3 Percent
Lehman said as recently as June that subprime mortgages and related securities provide less than 3 percent of its revenue, which was $17.6 billion last year. The firm said it will continue making home loans to borrowers with better credit through its Aurora Loan Services LLC unit.
Shares of Lehman have fallen almost 27 percent this year, the third-worst performance in the 12-member Amex Securities Broker/Dealer Index, on concern that contagion from the subprime crisis will hurt earnings. The stock fell 41 cents to $57.13 in
2:21 p.m. New York Stock Exchange composite trading today.
BNC made about $2 billion of loans in the first quarter, down 40 percent from a year earlier, according to industry newsletter National Mortgage News. The unit’s 23 offices in eight states will be closed.
Lehman said in June that it would merge BNC and Aurora in within three months, eliminating 400 jobs. Aurora originated $7 billion of Alt-A loans to better-rated borrowers in the first quarter, down from $10 billion, National Mortgage News reported.
Lehman said in a regulatory filing last month that it had “unrealized” losses of $459 million in the quarter ended May 31 from mortgages and mortgage-backed assets. Gains in corporate bond and equity holdings, as well as derivative contracts, offset those losses, according to the filing.
Where did the punch bowl go?
http://thegreatloanblog.blogspot.com
Hello Chuck….
FED waiving rules to big banks sbout brokerage affilates.
I dunno what to say. Lord help us.
In the spirirt of democracy and a good saturday round table discussion, what is your view on the proposed bailout plans that the presidential candidates have been discussing?
http://thegreatloanblog.blogspot.com/
I had been saving to buy an upscale house for about 3 years. I was going to pay about 80% in cash and finance the rest. We live in Syracuse NY. We are comming across a lot of good houses that are still priced at 150K to 200K above assesed values. How long should we wait.How do we determine the true value of the property? We dont want to over pay. There are not a lot of buyers for these properties. Any help with this analysis would be greatly appreciated.
Thank You in advance.
Kevin
Kevin,
A couple of things to remember:
1. Assessed values mean nothing: especially in New York State. My personal opinion is that while Syracuse might be slighly overvalued, I do not consider it a bubble.
2. When you’re dealing with “upscale” homes (I’m assuming 800K+) just go ahead and make the offer for what you think it’s worth. Don’t get emotional about it… if you don’t think it’s worth it, don’t pay above that. You’d be surprised how much negotiating room sellers have in this price range. A good friend of mine bought a Georgetown mansion in 1992 that was listed at 1.2M for only 800K. Having cash was a major negotiating point.
3. You’re right that there are not a lot of buyers for those properties. You have major negotiating power. Remember, it is not typical in upper-end real estate to pay sticker… unless you’re an instant millionaire. In that case, if you are, just blow your money on a house; it won’t last long otherwise.
Chuck Ponzi
Why is the MSM ignoring the affordability issue in SoCal and many of the other super-bubble areas. They spend all there time talking about the foreclosure tsunami, subprime implosions and other related BS. But I’ve seen little if anything on the fact that the average home is 10x the median incomes in these areas. They talk about 2%~5% declines in values. Nationwide those might be right but in the bubble markets the declines should be far greater. My current home went up over 300% in 4 years (2001-2005). So even a 50% decline still gives me decent appreciation for a home.
Is a 50% drop in local values a bad thing? Well if you bought after 2003 or are planning on selling and moving to Kansas it probably is. But for the rest of us who actually live in our homes it’s not a big deal. Moving up would be less expensive and more people would actually be able to afford a home. Yup, a small precentage of recent buyers, investors and dum$hits that HELOC’d themselves into oblivion are gonna take it in the arse. But overall I think it will better for the vast majority. I know all the Real Estate experts and so called Economists would never predict a 50% decline in prices but it can and probably will happen. The only variable I can’t clearly see is how fast it’s likely to happen. I feel a fast decline would be better for the overall economy. A long slow decline is likely to pull other areas down too.
There are plenty of people just like me that are willing and able to buy a home once the prices come back in line.
Chuck,
In your opinion, is it a good idea to purchase a lot in Carlsbad and build a custom 4,000 sf home at thid time, if total cost including land is around $1 million if I was to keep it for 5-7 yrs. Area comps are $1 mil + but what does that mean these days.The good news might be that material and labor cost should come down.
The simple answer is No. (in my opinion)
You’ll have falling land prices (which are much more sensitive than overall prices) for the next several years.
The 3 things to remember about real estate is: timing, location, and value. (some people have reduced it to a mindless chant of location, location, location which wasn’t true until 1965 till now, and will likely not be true for at least 10 years)
San Diego County is in rough shape. It could pull out, but then again, it could not. Buying land there now is like buying a microcap stock through a full-service (commission based) broker. You can do it, but the risk and fees associated will likely eat up any financial stake you might have.
Like my dad once told me… “Go ahead and shoot off your finger for all I care. I’ve got more kids with 10 fingers”
Thanks Chuck! appreciate your opinion and I’m in thinking the same. But my house is rented in AZ. and just relocated here and are renting for 2k a month. If I just sit back and wait till things turn in 3-4 yrs, i’LL BE OUT 100K IN RENT. Any ideas of what to do if say a million cash is available. Perhaps a foreclosure or two?
On the flipside, you’ll be out 200K to 500K on capital losses. You decide which is a higher number to lose.
I have a number of ideas. None of them involve real estate. There are reasons they are called secular bear markets. And leverage is a bitch on the downside… no doubt why you do not want to leverage.
I have been thinking of starting my own investment trust like Warren Buffet’s when he started out. I’ve done well on my own, so I could do even more with other people’s money. Warren guaranteed 6%. With current reduced yields… I’d probably guarantee 50 basis points over the Fed Funds rate down to 4.5% plus 75% of excess returns… gotta give investors something if market sours bad. With 1M invested, you could churn out $56,250 minimum per year at current rates, reducing your “renting expense” to being paid to live in your rental $688 per month.
This year to date, my total portfolio has exceeded 17%, even with 30% in cash. That would have netted an investor with $1 Million in my portfolio using the “Buffet method” (if the year ended now) $141,562, or 14%. This would have paid for your rental and a new Porsche 911 C2S.
I heard someone a year ago say something about private placement banking, where funds get moved around other banks and countries in other currencies. The yield is suppose to be very high. Any truth there?
Not much on my mind right now, but it is not important. I have just been letting everything happen without me. I just do not have anything to say right now.
Your are Great. And so is your site! Awesome content. Good job guys!
Senators and Bankers Beg for Jumbo Loan Changes
http://thegreatloanblog.blogspot.com/
FHA Plan:Bring a water gun to fight a fire.
http://thegreatloanblog.blogspot.com
“When should I buy a home?” The quick answer.
http://thegreatloanblog.blogspot.com
Hello,
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Property Speculators first to default.
http://thegreatloanblog.blogspot.com
Is Jeff from “the great loan blog” just too cheap to buy a link from you or does he think repeatedly putting his link here is going to help his crappy little site?
I’ll gladly buy a link.
Thanks for this post!!
Excellent analysis of how many people live in denial when it comes to real estate. That theory of “real estate will always go up because there is too much demand and not much supply” implies that we have a free market where people buy real estate for the right reasons, because they need a place to live or want to rent it.
However, in the last few years with so many subprime and exotic mortgages being issued, the demand for houses was artificially distorted. Many people bought houses because they did not want to be left out of the market. Others lost money in the stock market during the dot com bust and they saw real estate as the new way to make easy money.
Now that the credit markets are back to reality and risk is being repriced, we see that there was not as much demand as realtors made us believe.
Hey Chuck
Wake up, time to post again and clean up some of the linker comments, they are using your site for google stats. Burn ‘em.
Take care Jim
Great blog.
I have been sitting on the sidelines for the dot-com bubble (was a student) and the housing bubble. I’ve just been working my 9-to-5 and saving as much as possible.
My question is:
Where is the next bubble going to be?
I’m not an expert, but I know enough to know there’s going to be one.
Hi
Very interesting information! Thanks!
Bye
The next bubble might be gold and silver. That’s the price we’ll pay for the inflation the Fed will set off by cutting the Fed Funds rate.
They’re trying to fix one set of problems (financial health, liquidity), by creating another (dollar devaluation and inflation). That’s why economics is called the dismal science. There is no free lunch, and you always pay the piper.