Chuck Ponzi October 28th, 2009

Much of the last 4-5 months has seen a veritable frenzy of activity in the housing market throughout Southern California and throughout the rest of the US.  What does this mean?  Have we hit a bottom?  Is it a dead cat bounce?  Or, was the last year a bump across the bottom before an explosion upwards?

Well, if you’re looking for easy answers, I don’t have a crystal ball, any better than anyone else, so it’s nearly impossible to tell you where its going.  But, I can tell you the basics of the Long, Medium, and Short term.  Much of this is common sense, but must be repeated constantly to remain tethered.

Long Term Prediction

Eventually, though, it’s an argument about inflation or deflation.  Housing prices relative to incomes, rents, and inflation have moderated, but at a much higher level than historically, as pointed out by Dr. Shiller above.  If this is indeed a bottom, the ramifications of higher home prices are profound.  Consider for a moment, the beginning of this thought expounded in the WAPO yesterday regarding the housing stimulus:

Putting cash in pockets does have a stimulative effect because some of that cash will turn into consumption. But as far as stimulus measures go, it has a low multiplier (the ratio of new economic activity to stimulus spending). By contrast, we could take the same cash and hire more teachers, police officers or soldiers to fight in Afghanistan. We would get more economic activity, and the government would get something for its money.

But the tax credit stabilizes the housing market, people say. What does this mean? It means that the credit keeps housing prices artificially high. But housing is something that all people need. Why do we want it to be expensive? Would we want government policies that artificially push up the price of food?

To take it a step further, is there anything in this world that we consume that we would cheer when it goes up in price?  Nevertheless, even knowing how wasteful, inefficient, and stupid the measure is, our congress seems intent on passing an extension of the home buyer credit.  Even worse, it appears to be expanding to existing homeowners, completely negating the originally intended purpose of clearing inventory.  Of course that could be in large part because inventory in many areas has dramatically decreased, and it’s simply a matter of pork and pork products for the housing industry.

Currently, housing prices receive the largest subsidy of any asset class, and for what?  To make our neighborhoods better in some way?

But isn’t it just better for more people to own their homes? The conventional wisdom is that homeownership has positive externalities: Homeowners are more likely to invest in their communities, and it is the best way to build household wealth. But the evidence for this is mixed. In “Our Lot,” Alyssa Katz cites three academic studies and concludes: “Scholars found that once they set aside the various traits that tend to determine whether someone chooses to own or rent one’s home, homeowners and tenants really aren’t that different. . . . Often the new homebuyers were purchasing the worst housing in the worst neighborhoods with the worst schools — hardly a solid investment.”

So, to recap, we’re giving money to people to do what they were going to do anyway, and thereby increasing our own costs and driving malinvestment into residential housing instead of manufacturing capacity or research and development reducing our country’s competitiveness.  We’re taking money away from firefighters, teachers, and policemen so that your neighbor can afford a larger SUV or better furniture, and this entire premise is built on the disproved theory that won’t improve our neighborhoods in any way?

As I mentioned earlier, the real fight is about inflation or deflation.  There is no doubt that inflation is a monetary phenomenon.  At the present time, the deflationary forces of deleveraging are stronger than the inflationary forces of the stimulus packages and absurd monetary policy.

Make no mistake about it, in the long run, our currency will be devalued through inflation to nothing.  This is the fate of every fiat currency, and given the political stupidity that occurs when large numbers of people vote conmen and shamsters into political office.  This is the state of the US, and there is no indication that this will ever change.  Just look at the last 30 years.  In this environment, you will want to hold assets, not cash in the long run.

Medium Term Prediction

However, in the long run, we’re all dead, so we need to know what’s going to happen in the next 3-5 years.  What we can expect are the following in the medium term.

1.  Higher taxes.  This is true of both state and federal taxes.  We are on an unsustainable path.  While most Americans would rather make do with smaller government, the fox guarding the henhouses will never allow themselves to be kicked out.  This means less money to be spent on food, housing, healthcare, education, etc.

2.  Low interest rates.  Financing will stay very loose as long as interest rates are held down.  This is the latest salvo on the war against savers.  Banks, governments, and every company is doing everything it can to separate you from your money.  Most Americans will simply give up because they know nothing else.  Saving will come from outside the US, and not inside.  American’s balance sheets are beyond repair.  Nothing can save the average consumer now.

3.  Commodities Bubble.  Expect the next bubble to be in hard assets.  Perhaps this is oil, gold, natural gas, copper, lumber, corn, porkbellies, wheat, etc, etc, etc.  The government DOES want prices to go up, and will do anything to make it.  It would rather destroy Americans in its quest to save them than to admit that they don’t know and just let the world sort it out.  Most commonly, those who think they understand economics are far more dangerous than those who study it.

To be sure, there are no easy answers, even in the medium term.  And, beware that many of the above issues work against each other, so it will all be relative.  For example, low interest rates will drive a weaker dollar, rising prices on products which will improve export industries that may end up increasing jobs and demand and moderate the decline of the dollar.  Such paradoxes routinely exist, and help prevent the currency of a diversified economy such as the USD from declining too quickly too fast.  But make no mistake, the endgame of the fiat currency is to fall to zero value.  Eventually, houses will hold their value, even if prices are still too high.  This just means that they will endure long periods of poor returns relative to other assets.

If housing prices stabilize here, there will be no free lunch that returns us to high returns. That can only come if they fall below intrinsic value, something I feel supremely assured in saying has not happened in Coastal California (not true of deep inland Cali such as the Victor Valley or Palm Springs).  Orange County, San Diego Coastal, Los Angeles Coastal, and Ventura and Santa Barbara Counties are still painfully overvalued in relation to their alternatives.

The medium term case to own a home in Coastal California is uncertain.  I predict that we will have a clearer picture in the short-term predictions, but there are no certainties with this much malinvestment.

Short Term Prediction

There has been a significant shift from foreclosures.  Various reasons abound as to the cause, but there is no clear reason that the Notice of Defaults has continued to rise to record astronomical levels while foreclosures have remained relatively low.

The Big Picture takes up part of that story with “Strategic Non-Foreclosure” and the Piggington site details some of the statistics in the recent past for SoCal.

Do not be misled, there is a serious imbalance that has grown between defaults and foreclosures.  Foreclosures are dramatically lower than they should be given the incidence of defaults.  There are 2 possible reasons for this imbalance:

1.  Banks are having difficulty foreclosing.  Numerous possiblities exist for this reason such as poorly equipped staff, moratoriums, trepidation of foreclosure while on government dole, stated contradictory policies, and many more.  The general perception is that this will eventually result in higher foreclosures once the problems are dealt with.  Noone knows when that historical balance will return.

2.  Banks are actually working out modifications and they are sticking.  This could mean that a dramatically higher number of modifications are being approved and they are having the intended effect of reducing the market’s fall.  This would be difficult to explain.  Never in history has this happened, but never in history have we been this indebted before either.

While it’s entirely possible that #2 is happening, the risk is much higher that #1 is the actual case.  The table is clearly tilted on a risk/reward basis that #1 is happening. Smart money should hold out at this time until the trend is clear.  While the past 4 months is the first indication of stabilization, an unbroken 1 year trend will be the clear signal.  The soonest that could happen is next spring.  That is the earliest BUY signal that the housing bubble could  give us since Summer 2005.  We will simply have to see if that buy signal is confirmed for early entrants.  Purchasing now is highly speculative and likely to result in knife-catching.

According to Occam’s Razor, it is beter to attribute the latest moves to #1.  I cannot stress this enough that the risk/reward ratio still favors waiting for much of Southern California.  The exceptions to this are areas where buying is at a significant discount to renting (some exist).  It doesn’t preclude the possibility of failure, but it does give options for medium term and longer term trends to mitigate the risks of buying a home now.  For coastal california, any purchase now can only be seen as speculative and imprudent.

The Final Wrap

The basis of any bubble is a speculative frenzy.  Recognizing the attributes of a speculative frenzy and the stages bubbles go through is critical to timing any asset purchase.

Remember, there is nothing more fundamental to investing than timing.  Anyone who tells you otherwise is a fool.  Timing your purchases of stocks, bonds, commodities, housing, or any other asset is critical to success.

My hope was that this country and its leaders could see the value of letting housing prices fall to their intrinsic demand value, but leadership is nearly absent in US politics today.  There does not appear to be an opportunity for this to happen any time soon.

• Bottom Callers , Dead Cat Bounce , Deflation , Housing Crash
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Chuck Ponzi June 8th, 2009

I’ll start off by saying that I don’t know exactly when the bottom for Southern California is, but that I’m confident 2009 is not it, not by a long shot.  So, with that in mind, I am beginning a series of systematic exploration of previous bubbles and how we might relate this time around to give us a reference to what me might expect this time.

There seem to be some myths circulating both in the Financial Media as well as the blogosphere about exactly how long housing busts tend to last.  To clarify some of these myths, I’ll borrow heavily from 2 of the best know (and contemporary) housing busts, the Southern California 1990’s housing bubble and bust and some from the Japanese housing bubble and bust.

These myths are some that have cropped up at reputable financial media sites and on television often (I believe) because the human attention span is very short.  We find it difficult to believe that bad times can persist for a long period of time.  We have a coping method that tends to follow a predefined path, often known as the Kübler-Ross Model or Stages of Grief.  Over a period of time, we pass through Denial, Anger, Bargaining, Depression, and finally Acceptance.  However, keep in mind that just because humans have gotten over the financial tragedy of the 2000’s (which we haven’t), there is no specific reason why that should translate into a financial or economic end to the problems.  The real world operates outside of our internalized emotions.

Still, these myths are strong emotional pulls that if believed, will lead you astray.  Over the coming week or 2 I will be taking a guided tour through some of the strongest myths that have gripped the housing market.  Let’s start with the most pressing one right away:

Myth #1.  As soon as the recession ends, housing will jump right back up.

This myth plays on the fear that was found to be prevalent during the housing bubble.  It plays on the “buy now or be priced out forever” fear of being left behind.  Indeed, one could argue that immediately after the 2000 recession, housing prices quickly vaulted to the stratosphere and left many high and dry.  If this were to happen again, all those currently sitting on the sidelines would once again be left in the dust as many others partake in the new propserity of housing wealth.

However, keep in mind that the 2001 recession was not housing led like the July 1990 recession.  While both were quite short, they were very different.  In Southern California, the effects of the 1990 recession were felt long after it ended in March 1991.  Indeed, housing prices had been inflated to bubblicious prices as early as 1989.  As the economy strained under high housing prices, both consumption fell as well as pulled a number of financial institutions with it.  Albeit much smaller than the present crisis, the Savings & Loan crisis still strikes fear into the hearts of many bankers.  That was supposed to be “the big one”, and yet, it appears nothing was learned by that experience about residential prices risk taking.  This crisis played out much like the previous crisis, where defaults led to restricted credit which in turn hurt businesses.  Households strained under the increased debt load that had been created during the housing bubble in the previous 5 years, and that final crack shattered the weakest financial institutions.  The effect snowballed into a full blown crisis, requiring the formation of the Resolution Trust Corporation, or RTC.  The RTC did what the banks could not, liquidate assets in a timely manner.  This quick liquidation set the stage for a much stronger rally later in the decade and avoided a Japan-style housing bust where banks hold bad assets for fear of becoming insolvent and being remanded into recievership unwillingly.

First off, let’s clearly define how long housing prices fell during the 1990’s following the late 80’s bubble.  The following graph is inflation adjusted to 2008 prices, but the amount is not as important as the trip that was taken:

Source: Dataquick and BLS

As the readers can easily see, the 1990’s bubble was retraced in nearly every single major SoCal county.  Orange County, for example did not complete a full retrace as it developed from a sleepy surfing and vacation town into a pricey suburb of the LA area.  However, for most counties, there was a full retracement to the pre-bubble inflation-indexed prices.

There are some notable trends that one can see in the numbers.  First, that falls were fairly mild, so there was a transitory period for homeowners who had accumulated significant wealth through paying down mortgages and through inflation could still “get out” before the door closed.  This is important to the swiftness and the after-effects of the housing bust because it differs significantly with the existing housing bust.  Indeed, so slight was this housing bust, that many believed we would fare the same this time around (allowing inflation to eat away at the home prices makes them an economically bad decision, but not necessarily a bad financial decision if the price is right and the tax benefits are right as well).  With prices clearly more than 20% off in all counties this time around, a recession that it likely to be almost 3X as long as the 1990’s and with reckless speculation not seen since the 1920’s, a “soft landing” was never in the cards.  This the hardest landing we will have in our lifetimes.  Make no mistake about it, this will not be easily forgotten like the last bubble.

The next notable trend that one finds is that even after the recession ends in March 1991, housing prices continue to fall for 5 additional years until 1996.  This was primarily because several of the savings and loans tried to time the market, waiting for a rebound.  Only to find that their hesitation caused them to miss higher prices, eventually dumping them later as regulators forced them to liquidate into a softer market.  In a housing bust, there is no orderly decline, if we have learned one thing from prior busts, it is this: the longer you wait to foreclose and liquidate the property, the greater the economic loss and the more significant the effect to the financial institution.  In fact, so ingrained in the minds of market participants that housing was a risky investment that the greater masses shunned it for some time afterwards, only beginning to buy again when the argument was much more compelling than renting.  When buying was cheaper than renting, even accounting for potential losses.  We have not yet reached that point, as any further declines wipes out significant equity since in most places in Southern California, renting is still a significantly cheaper option after factoring tax consequences for most locals.

To give you a breath of where we have come so far, the following is the Southern California Housing Prices inflation adjusted for 2008:

Source: Dataquick and BLS

You can see that there has been no transition time for owners to jettison out the escape hatch.  While this is primarily a problem to do with mix (very low priced properties selling vs a normal mix), I will explore this more in detail in a future myth review.  Please note that even with the dramatic drop in prices, we have not seen a full retracement.  With the magnitude of the present bubble in perspective, I find it unlikely that at present course and speed we will simply give up at a retracement to prior fundamentals.  I fully expect an overshoot of epic proportions as the bubble that preceeded it was of epic proportions.  Here’s a chart showing the 2 bubbles side by side, adjusted for inflation:

Source: Dataquick and BLS

Finally, it is important to remember that when housing does bottom, it does not turn on a dime.  It is much like a vast oil tanker that requires significant time and distance to change course.  Ingrained social opinions are slow to change, but once they do, they don’t flip flop back.  We saw this in the Wile E. Coyote moments of 2007-2008 in our present bubble.  This recession is going to be significantly longer, and the recovery substantially slower than previous ones.  Indeed, the “truth about jobs” is that there may be many fewer than before because we are no longer driven by a significant bubble in Southern California (at least in the forseeable future) while the late 1990’s recieved a shot in the arm.

Some thoughts about the current unemployment rate (which is over 10% in California at the present time) and future projections over the next 2 years.

Indeed, remember that in past recessions, unemployment peaked some time after the recession ended, hence the effects of the recession being felt much longer than the recession lasting.  It is important to remember that the end of a recession only signals that the economy has stopped contracting.  It does not mean that there will be a quick return to the heady days of the prosperous times that preceded it.  This time might be much worse, as household balance sheets are still carrying considerable debt with litle savings.  Until those are rectified, it is hard to see any meaningful reignition of economic activity that is not inflation-linked.  And, with joblessness at record levels, any inflation we do see will not be the kind of inflation we saw in the 1970’s, constituting a wage-price spiral.

We’ll touch on that next time when we discuss Myth #2, Housing Prices will jump as soon as unemployment begins to come down.

• Bottom Callers , Denial , Housing Crash , Mean Reversion , Real Estate Myths , SoCal , predictions
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Chuck Ponzi December 16th, 2008

BMIT put up an interesting post the other day that I think needs to be read and reconsidered.  Basically, there are still people flipping properties; it is unlikely that after the biggest bubble in the history of the world, that the crisis is over and properties can once again be resold for several hundred thousand dollars more by simply trimming some bushes, putting down sod and painting the picket fence.  There are still too many people chasing limited opportunities and therefore overpaying for something that makes little economic sense.  In a recession, economic sense should prevail.

Therefore, I ask the most difficult question regarding the property that OCR dragged up in San Diego:

San Diego Shack

In this corner, we have the lightweight contender.  Weighing in at just 570 square feet, and surrounded by squalor, you can bask in the beauty of your red front door that leaves nothing to the imagination and your K-mart clearance special patio set.  Luckily for you, you can now dry your clothes directly outside your front door with the convenient ledger board that is stapled to the outside of your quaint demi-cottage.  Only you and your neighbor will know when you pass gas in this  beautiful little near-beach house.  IT HAS PRACTIALLY EVERYTHING YOU NEED TO SURVIVE.

Similarly, I’ll compare it to this:

Laguna Niguel Shack

This quaint beach cottage has a measly 10,000 square feet, but who can be sure?  It features subterranean parking, wine cellars, an opulent entry, is centrally located in Laguna Niguel near Monarch Beach and boasts a true 180 degree view of the ocean.  Luckily, you won’t need to hang your clothes out to dry, you actually have a laundry room and servants quarters to ensure your underwear is neatly pressed day or night.

However, there’s something this house lacks that the San Diego house has.  It’s a critical component in today’s current economy.

No, it’s not irrational exuberance… but you’re getting close.

Figured it out yet?

OK

Here

it

is.

The shack in San Diego boasts a higher price tag per square foot, exceeding $1000/ square foot while the opulent mansion with views to the ends of the earth weighs in at a measly $975/ sqft.

Now that’s amore.

• Bottom Callers , Contrary Indicators , Denial , Flipping , Lizard Brain
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Chuck Ponzi November 19th, 2008

Housing? Maybe 2011.

Stocks? I’m buying at these levels.

Looking back? Peter Schiff got most things right. I don’t think we’ll see inflation for a little while more, that might come when people actually have money, but we’re in a deflationary recession right now. Everything is hit. Everything.

I think we’ve got more pain to come, but after a nearly 45% hit to the broad indexes, my opinion is that it’s got to get better sometime. This could be a replay of the late 1974 double-bottom. JMHO, this is not investment advice. If you get gains, take ‘em, you may not know when they’ll come again.

Don’t buy SoCal housing yet, you’ll be handsomely rewarded in the future for patience. There’s a lot of knife catching out there that might tempt some people, but the trend is in, and it’s down.

• Bottom Callers , Dead Cat Bounce
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Chuck Ponzi September 24th, 2008

A few days ago (before the super bailout was mentioned), I made an uncharacteristic comment about the future of the stock market.  I stated that we were not at, but close to, a bottom.

While the fundamentals may still erode, I will give you 2 indicators that are surprising:

The first is the Yield Curve for the last 50 days.  I’ll let it speak for itself:

That is a normally sloping yield curve.  That is not at this time portending a recession like it was when I wrote this back in November 2006:

Imagine if investors caught a whiff of Lacker’s higher inflation, increased risk aversion, and China begins a rebalancing or reduction of US reserves? The result could be catastrophic to our debt-based economy. No longer would borrowing be cheap. No longer would funding be plentiful. No longer would assets be liquid.

This is precisely what happened.  The “snap-back” I told about happened over the ensuing 18 months.  I believe that pressure is abating.

I also wrote the following:

Our current housing prices are fueled entirely by easy, cheap credit, as is evidenced by our high ARM content, and astronomical house-price to income ratios. If a credit event does occur, we have the most to lose. However, all other unwinding scenarios depends on many other moving parts of our global economy to work in clockwork like precision. While the current slowdown is a manifestation of the bubble stretching under its own weight, it is likely that the added pressure of a credit event (and likely even the perfect unwinding as described) would pancake the entire housing and local retail economies that are so dependent on lending. While I would admit I still don’t believe the residential real estate bubble has yet popped, the true test of future direction will be in the credit markets over the next year, not in the for-sale housing market.

I feel a strong desire to state that once again, we are not too far away from the stock market being an attractive place to invest in.  Not yet, but soon.

Housing?  At least still 1 or 2 years out to being close to attractive.  Almost everything is still overpriced.

The second interesting piece I bring today is news about the Treasury Prices auctions announcing that T-bill rates fell below Zero.  Yes, you heard me right, Zero.

Here are some notable quotes:

Elsehwere, Treasury bill rates fell with one-month rates slipping below zero, prompted by an unrelenting migration into cash and low-risk assets amid turbulence in money markets.

Worries about the passage through Congress of the government’s proposed $700 billion bank bailout intensified safety bids for bills as well as longer-dated bonds, traders and analysts said.

“There’s a tremendous amount of anxiety whether this (bailout) bill will get passed,” said Thomas di Galoma, head of U.S. government bonds at Jefferies & Co. in New York.

I believe that at least portends a tradeable bounce coming up when the anxiety is resolved.  That will happen whether it passes or not (I hope it doesn’t).  However, there is a lot of cash in short-term treasuries now.  That’s a significant development.

“There’s still a lot of money trying to find a home on the front end,” di Galoma said.

The thrust into T-bills sent one-month rates a touch below zero percent overnight and three-month rates below 0.50 percent.

The intense T-bill demand could crimp demand for longer-term Treasury paper, so the market will closely watch the Treasury’s auction of a record $34 billion of two-year notes later Wednesday, analysts and traders said.

The only question now is, how long before we hit the bottom.  I know I won’t be able to call it when it happens, but things are much more attractively priced today than they were 6 months ago.  Much more.

For example, I recently purchased GE sporting a 6% yield (that is, if they can maintain it).

On the flipside, many are calling for a return to the commodities bubble.  I don’t see that happening.  It’s a gutsy call to make, and I may be wrong, but I think this 6-year long commodities bull has been ridden hard and put up wet.  If you want an alternate opinion, go visit Tim Iacono at The Mess That Greenspan Made blog.

And, as a parting gift, I have returned Housing Panic blog to my feed again after a respite.  I highly suggest visiting it.  Great outrage mixed with comedy.  It’s gold, pure gold.

• Bailout , Bottom Callers
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Chuck Ponzi September 17th, 2008

After being out all last week on a family trip, I felt like it was difficult to get back into the mindset of investing, especially considering the many events that have happened since I last posted. Fannie Mae, Freddie Mac, Lehman Brothers, Merril Lynch, and now AIG just to name a few of them.

In addition, I will be moving soon to Laguna Niguel. We still haven’t bought a house, in case you were wondering.

The biggest news of all of these is the nationalization of Fannie and Freddie. Numerous opinions abounded since the first whispers of the nationalization. I even did my own post back a while ago portending it.

Take a look at what it has produced:

It took me a while to believe my eyes, so I’ll sum it up as this:

Insured jumbo debt is loaned at 5.875%. Banks are demanding 8.0% for the same money. Without a rescue of FNM and FRE, the housing market would have effectively shut down… and that was before the AIG action today. I have never in my life seen a spread between jumbo loan money this high (over 2%). Considering the current crash and asset deflation, there is no way that I can call rising interest rates; I just don’t see it, and perhaps my blinders are on, but I can’t see bank credit going any further out of whack than it is right now.

In light of all of the Sunday action, I have dedicated this song to the post:

And, if this wasn’t enough, I am feeling like we are very close to capitulation, if not there. About 1.5 years ago, I predicted to a coworker that I thought the DOW would decline substantially and bottom around 10,000 to 10,500. He was incredulous, and up until this week, I was starting to wonder about my own analysis and work, and I think we are going to meet my expectations after all. In the meantime, all of the bulls have been silenced, and (except Barry Ritholtz), many are wondering if we arent actually at a bottom in the stock market. I’m not going out on a limb, but my general feeling is that we are getting close.

Housing bottoming? … not even close yet.

• Bottom Callers , Investing
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Chuck Ponzi August 21st, 2008

I’m going to start periodically looking back at the past 3 years since the blog was started at some of the predictions. Most will be Southern California related, but other outstanding areas will also be called out.

The first of such series comes to us from Naples, Fl. As expected, this one comes from the super-optimistic realtor via Naples News from November 19 2006.

Joe Ballarino, a Realtor with Amerivest, said except for specific instances, home prices are going “sideways” and he expects them to continue doing so.

Market generalizations are usually off base, he said.

“I am on a kick of discrediting market averages,” Ballarino said. “Pricing is so localized, each property has to be valued separately.”

His view of the market is that buyers already are beginning to come back.

“I think (studies) are off the mark,” he said. “At most I can see prices going down maybe 5 percent in some cases but I don’t see (a) 14 percent (decline) — not in the overall market.”

Surprise. Naples-Fort Myers has fallen 32% in just the last year alone. And the pain isn’t over.

• Bottom Callers
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