Chuck Ponzi October 19th, 2007

For those readers just stumbling on this post, you should follow my previous posts that I have made regarding Gary Watts’ predictions about Southern California, and Orange County over the past 2 years… all of which have been stunningly wrong, that it’s hard to believe that he still gets paid to issue them. (and perhaps just as stunning that so many realtors - maybe as much as 90% of the locals - still hang on every word like it’s religion)

Gary Watts will Burn in Hell (October 2005)
Gary Watts will Still Burn in Hell (April 2006)
Gary Watts Pulls His Head Out Long Enough to Stick It Back In (July 2006)
Gary Watts And The Incredible Logic Shrinking Machine (August 2006)
Gary Watts… Ignorant Optimist or Deluded Sociopath? (October 2006)
Gary Watts… Where’s the Inversion? (October 2006)
Watts, Old Scoundrel, At it Again (February 2007)
Who’s The Fanatic Now? (June 2007)

Hank Paulson (US Treasury Secretary) recently stated:

“The problem today is not limited to subprime mortgages as the number of homeowners having trouble making payments on prime mortgages is also increasing,” he said.

The problem is not with the quality of the credit score, but with the ability to pay. For Southern California, incomes have not risen as fast as home prices, and therefore, home prices have no support at current levels. Just like a small-cap stock that can make fast and violent up-swings based on hype, they collapse when there is no buying support at the levels they had achieved and fall back into the stable pattern. The fact that this takes place over years rather than days shows just how “sticky” real estate prices can be, not how “strong” the real estate world is.

However, the discredited economist Gary Watts seems to delink the relationship of fundamentals against “values” This is what his most recent presentation underlines for us. His new Forecast for 2008 unfortunately excludes the type of prediction we have seen in the past, a percentage change in predicted median prices. Perhaps he has conceded that he can no longer accurately predict using his models (since it seems his models consist of nothing but charts that point up and to the right), or more cleverly, has decided that with the spankings he recieved over the past 2 years, he had best shut up and not say anything before the lawsuits start in earnest. (Coincidentally, I believe he should continue with the 15% to 17% “in the bag” predictions, as it would certainly bolster an insanity plea).

It would be good to review some of the “touched” participants of our current housing mania said about Gary Watts back when I first started covering his predictions:

“I would put a lot of weight in what he has to say,” added Sharon Boyd, owner of Rosegate Realty in Orange. “He looks at so many things, and he takes other economic factors into account, not just real estate.”

and

“He’s never been wrong,” said Cate Florey, an agent with RE/MAX Metro in Anaheim, who hands Watts’ reports out to clients.

They are not alone. Nearly every single realtory reads his reports cover to cover and photocopies them for their clients. I know, I have recieved too many hard copies to remember. Some agents even hand them out at open houses… part of the “buy now or priced out forever” tactic.

Unfortunately, his predicitons are often so full of disinformation that if you even turn a skeptical eye towards it, it crumbles like stale week-old bread. There is virtually nothing of value, and most of the “statistics” are nothing more than beliefs that seem to have popped into the author’s head as a good way to convince people… he either needs to hire a fact checker, or fire his current one. It’s a shame, really.

His most recent 2008 paper is mainly divided into several separate but disjointed parts. Part one being a schizophrenic view of history, while part 2 can only be classified as “Tin-foil Hattery”, and part 3 is some kind of solo circle-jerk. (God, look how rich we are!!!!!), and the remaining part 4, An economic outlook(?) titled “Why Our Economy Will Continue To Do Well!

Watts’ Schizophrenic View of History

In This section, 2 additional claims were made: 1. Had you bought in the beginning of the current “downturn”, prices have still gone up since then, so you would have made money.

While individual cases may be different… the reality is that the vast majority of homes bought after 2005 in Orange County would now sell for 10 to 15% less than their last purchase price. Some areas (like my community in Aliso Viejo) have seen price declines of approximately 20%.

2. Gary states: “Historically, housing downturns average 27 months so we may be near the end.”

Not a chance… later in his own document, he shows Orange County median home prices down from 1991 through 1996. That’s a 6 year stretch of consistently, every year, declining home prices. If we were to extrapolate that into the future, as if this were the same severity, we’re likely to see declining home prices until 2013. In fact, our housing bubble is much, much worse than the late 80’s in terms of affordability (incomes) and price-to-rent ratios (alternatives), so our fall could either be steeper, or longer to reestablish affordability. Never in history has a bubble been maintained, and this time is no different.

Tin Foil Hattery

Gary, once again, opens up his mind in terrifying fashion. I wonder… does he really believe that the media is a boogeyman out to get Orange County housing? Someone ought to check his meds.

We would do well to view our previous reference to Hank Paulson’s comments in the context of the speech he made:

Of the approximately 50 million outstanding mortgages in the U.S. today, approximately 10 million are subprime loans. Many have cited the statistic that 2 million of those subprime mortgages will reset to higher rates in the next 18 months. That statistic is true, relevant, and troubling, but it is not the complete picture of the risk going forward. Many of those borrowers will be able to afford their new mortgage payment or they will be able to refinance into another more affordable mortgage. Yet, the problem today is not limited to subprime mortgages as the number of homeowners having trouble making payments on prime mortgages is also increasing. And finally, the wide geographic variation in home price trends adds to the complexity of sizing this problem with any certainty.

Meanwhile, in Gary’s LaLa land, he quotes the following statistics

It may surprise you to know that sub-prime loans make up 5% of the U.S. total loan market, while Alt –A loans (those with credit better than sub-prime but less than prime) total only 8% of all loans.

If you have to wonder who has better information about the subprime market (the US Secretary of the Treasury or a Mission Viejo broker who gives sales seminars), please just trust me that Hank Paulson does. Just trust me on this.

Gary, it would indeed surprise me to know that subprime only makes up 5% of the total loan market, when a well-funded oversight group says that it comprises 20%. Where he gets his numbers from would make me call into question his motives in quoting that specific group or person. (he provides no reference to cross-check, as usual)

In similar fashion, Gary gives us a camel to choke on, pretending it’s a gnat:

Sub-prime loans in California represent only 25.7% of the total residential loans in the state. From the summer of 2005 through all of 2006, 43% of all California loans funded were in both categories of these sub-prime loans. Today, most of the problems arise in just one type of these loans - the Adjustable Rate Mortgages (ARMs). How big is the problem? Not big at all! In the first quarter of 2007 in the U.S., 88.5% of borrowers with ARMs were not delinquent on their payments!

First, mixing US delinquencies with California subprime percentages is a problem. How do we know if it’s not substantially higher in California or Southern California? It could be higher, it could be lower, but there’s no context provided.
In fact, some areas are in much worse shape than others. Back in our review of the Santa Ana Subprime Squish Down, the OC register reported that more than 75% of the census tract that includes the portion of Santa Ana reported on used subprime loans. I can be confident in saying that that number will be lower in Newport Beach and nearby communities, but it’s possible that this wasn’t even considering “Alt-A” products as well. This is indeed the 10th circle of Real Estate Hell.

However, the biggest concern is not the delinquencies themselves, but the turmoil created by the failing of subprime lenders, the vast majority of which are (were) headquartered in Orange County, California.

The second problem is that 11.5% delinquency rate is actually a rare thing, not common. (it’s a common trick to fool common people by quoting the inverse relationship, such as 70% fat free!, or 97% rat hair free!) The fact that 11.5% of all ARMs would be delinquent in a single quarter implies that if every one of them cured that delinquency within a few months, we’d have churn of more than 50% of all ARMs within a year. That’s a crapload of people. A CRAPLOAD.

Gary tries to convince us that delinquencies are not that bad. Take a look at Rich Toscano’s historical tracking of NOD’s and NOT’s for San Diego (we’re not that far off in OC)

We are literally off the charts compared to the worst downturn we have seen in history.

Check out some recent stories:

Reuters: “Worst Housing Market Since WWII”
Coloradoan “Real estate experts: Worst still to come”
Chris Thornberg “The worst is in front of us, not behind us”
Housing Predictor “Worst Housing Crisis Since Great Depression”

The excesses of this latest binge have not yet been worked out. Because the clearing process for foreclosures takes so long (between 6 and 12 months), and the knock on effects have not yet been felt of the credit crunch, the worst is most assuredly about to come. With absolute confidence, I can say that 2008 will be much worse for housing than 2007. If it does not have as many headlines, prices will grind lower, and sales will slow considerably.

God, LOOK HOW RICH WE ARE!!!!!!!

The next portion of Gary’s work is a swimming in self satisfaction. The kind of gratuitous back-patting that will not only dislocate your shoulder, but likely break every bone in your arm, if not sever it completely.

In a fit of insanity, Gary has latched on that Boomers will save us.

They won’t. They are declaring bankruptcy in droves far outweighing their numbers, and bringing our social network down with them. Medicare and Social Security will need substantial additional taxes or benefit reductions. In fact, one third of boomers will have NO money for retirement… much less be able to trade up to a pricier locale. There’s a reason that low-cost locales have been havens for retirement. With most of the US substantially cheaper than Orange County housing, we’re likely to get a great outflux of boomers. Most can still cash out here with much more than it will cost to live somewhere else. Equilibrium in supply and demand will once again be reestablished.

Gary tries to convince people that billionaires will save us by moving to OC. Unfortunately, their wealth does not “trickle down” as Laffer might have though it would. Just as likely as an outcome is a “Banana Republic” of OC. If superwealthy want to live here, they’ll have to live with the trashy poor.

Gary wants us to believe:

We are the youngest of the home-building nations. History does repeat itself! Every country has gone through a cycle whereby it breaks into two parts: those who own a home and those who don’t.

Nonsense. Everybody builds homes, not select countries. There is no cycle that any economist has ever been able to identify. Our low population density lends us to build the kind of homes that we do. Until we reach the kind of density that other countries have, we cannot expect these changes to take place… and most importantly, these kinds of changes take place gradually over time, not all within 3 years like our bubble did. There are certainly some fundamentals that have increased demand, however these fundamentals (household formation, migration, housing stock) have moderated as expected due to the higher cost of housing. San Diego, in fact, has experienced net outmigration. With the lending industry taking a beating, OC is likely to have a severe outmigration in the coming years. There are no other industries poised to take its place.

When this happens, rental rates begin to soar. We are in the beginning cycle of this event, as evidenced by the fact that the national rental rate increased 5.3% in the last 12 months. OC rents have risen 6.1% in the past year and 6.5% for LA. Since 2001, the rise in rental rates has easily outpaced inflation.

More nonsense. Rental rates are based on a relationship of housing stock to population. With a net outmigration imminent, flat to declining wages, and a recession beginning there is a good likelihood that rents will stay stable. However, rental stock has been substantially upgraded in the past few years with low-cost money, so it stands to reason that rental rates would have moderate growth in the coming years.

All in all, if you don’t own in 2007, you’re not missing the boat. History does not repeat itself, but it sure rhymes. You’ll likely be able to pick up a house cheaper in 2009 than 2008, and 2008 than 2007.

Gary also picks some interesting stats:

Consumers have $5 trillion dollars in liquid cash sitting in banks and savings and loans!
In 2006, households’ net worth rose 7.4% and now exceeds $56.2 trillion dollars!
Homeowners’ real estate equity is $10.9 trillion dollars – representing a 59% equity position!
The value of individual stocks and mutual funds held by individuals grew to $10.4 trillion dollars!
Other assets held by individuals include:
$ 3.2 trillion in bonds and credit instruments - $1.1 trillion in insurance reserves
$ 6.7 trillion of equity in non-corporate businesses - $11.1 trillion in pension funds
$ 2.5 trillion in 401K’s – plus $10 billion in loose change in homes and cars!
The rich and super-rich saw their assets surge 11.2% last year, to $37.2 trillion dollars!
(Boeing’s “mobile mansions” are private wide-party jets being customized at $150 million each!)

The superrich notwithstanding, the average family has actually seen their liquid net worth shrink considerably. In contrast, only homes have increased in value (which makes it difficult to monetize since you can’t sell off portions of your house to pay your bills, while portions of a stock portfolio or savings can). Most of increases to net worth have been at the high-end of the net worth, increasing the income disparity in the US.

Gary wants us to believe that these wealthy are giving this money to their children and they are spending it on homes. While I’m skeptical (like all things Gary says that appears to be pulled out of his ass), it’s possible that this could have a small impact on superwealthy enclaves. Still, it’s not going to save Santa Ana, Anaheim, or Garden Grove, or Aliso Viejo for that matter.

Why our economy will continue to do well!

It won’t. Gary hasn’t done any real research, and I’ve exploded this myth in previous postings. Southern California’s economy is in for a rough ride for at least the next 18 months, and the best thing to do now is liquidate, hunker down and look for buying opportunities coming up.

The tables of data tha he includes are a laugh. Here are a couple of the problems
1. He contradicts himself from earlier data (prior year appreciation, and length of downturns)

He picks 1970 as a starting point. (it’s a market bottom, and to our current top, it should be 8.9% p.a)

The starting point is very important:

If we pick 1981 as a starting point, it’s 6.7% p.a.

If we pick 1990 as a starting point, it’s 5.5% p.a.

The easiest way to lie is through statistics. Typical peak to peak and trough to trough appreciation is about 5 to 6%. That’s pretty good, but in an era of moderate inflation, it’s not that great. Real estate can be a good investment, but not if you buy at the peak. That’s what Gary’s asking you to do.

2. The totals that should sum, don’t

He needs to get himself a fact checker, and someone who can write his stuff for him. It’s pretty bad. A basic excel class can help.

3. Average Appreciation rates are not properly compounding, so give off a false positive bias

See #1. He just takes some numbers and averages them… no compounding. Either he’s an amatuer or patently deceptive. You decide.

All in All

It’s terrible research. It shows no regard for actual facts, history, or an ability to critically analyze. Anybody who buys his analysis is not getting their value. it’s not worth the paper it’s printed on.

There will be a time to buy in the future here, but now is not that time. Now is the time to sell (still).

The fact that Gary whiffed in 2006 (forecast 15 to 18%, actual 3%), and is about to get trounced again in 2007 (forecast 7 to 8 percent, actual likely slightly negative), and with a deepening credit crisis, any forecast that includes a positive number is just plain laughable.

I’ll leave you with a quote from Etrade’s President, Jarrett Lilien :

Our issue is that the value of high-quality loans is underperforming.

That, my friends is the essence of the problem. Many cannot afford the houses they are in now. Those same people are not going to save the housing market… they are going to crash it. It’s not a subprime problem and it’s not going away.

• Gary Watts