Part of that is because my professional life has come to the forefront since it is firing on all cylinders; advancements in that area come with a price tag, and the other part is because I have been diligently seeking a home for my family.  With a third addition to our family, we have decided that while there is still a great deal of danger in the housing market, we have decided to purchase a home.  Make no mistake, I am not advocating buying a house at the present time for financial reasons, I think we have a lot of malaise at the present time, but after all is told, it is about the same price as renting, since interest rates are very low.  I intend to occupy the house for a long period of time, making my entry point less important to my longer-term emotional and psychological well being of my family.

If anyone wondered, yes the house is a foreclosure, and yes it requires a lot of work.  I highly recommend having a good agent in your corner, since negotiating without one doesn’t strengthen your position, and my agent, Brad Davidson offers a rebate of a portion of his commission to offset your efforts in finding the house.  If you’re in the market, I recommend contacting him at WeHelpUBuy Realty.  He’s a good friend and excellent agent.

In the end, we waited over 6 years before becoming homeowners again, we found that the emotional decision to buy a home is quite powerful for people that have already owned; it was for us.

Feel free to ask any questions that you might have in the comments; I will be as honest as I can, keeping my identity private.

Any thoughts?

Source: here

Misallocation of Resources.

Schiff is right AGAIN

Our next bubble is still building. This blog could go on forever!

Ladera was carved out of some leftover parts of Mission Viejo abutted to San Juan Capistrano, and for the most part is searing hot in the summer with no views to speak of, has insane choked off traffic to get to the 5, or you endure ever-increasing tolls from “The Toll Road Company” whose stated objective is to siphon off as much of the local wealth as possible while crying foul and getting “Community Reinvestment” money from the Federal Government.  Good to see that even if the rich won’t support the toll roads, everyone else gets to with their taxes (without the benefit of actually using the roads.

Our subject today is 40 Lewiston Court, Ladera Ranch, now for sale for $1.1M.  At the peak it sold for 2.2M, and is having a hard time finding a bottom.

Here’s the beauty.  And, by the way, this is what 3% of 1.1M will get you in OC today:

I guess Realtors here haven’t yet gotten the memo: the internet sells properties.

But, between you and me, the most interesting part is not the cesspool that your neighborhood is, but rather the cesspool that is in the back yard, lovely.  Mosquito abatement anyone?

Please, for the love of god, will some knifecatcher step up to the plate?

Edit: South OC tracker already featured this one.  She gets around.

If HOPE for Homeowners, the foreclosure-prevention plan passed last summer, was a soft drink, it would be New Coke. If it was an automobile, it would be an Edsel. A movie? Howard the Duck.

In the five months since it has been in effect, HOPE has helped exactly one homeowner to avoid foreclosure. This despite Congress having made $300 billion available to back these loans and estimating that the program would benefit as many as 400,000 families.

This is no surprise to me or most readers.  We cannot fix the fundamental problem of too much household debt when the reason for foreclosure is simply an upside-down house.

I predict that even if we took the ludicrous action of simply depositing money into the bank accounts of those in foreclosure, they would rather spend that money on consumer products or pay off non-house debt because the asset the loan is secured against is worth less to than what they owe on it for the forseeable future; in SoCal possibly decades absent significant price, income, and asset inflation; something that seems unlikely for a while in the midst of a generational deleveraging and rising taxes at the present time.

I’ll start at the beginning. Adam Smith wrote a book called “Wealth of Nations”. At the heart of this book was the concept that individuals attempt to maximize their own personal profit. A lengthy discussion of capital, labor, and revenue conceded that individuals seek to minimize the cost of production and maximize their own personal intakes. This is the reason that we stand today at the brink of quick and painful deflation. (Unless our leaders force us to long, deep, and painful deflation.) However, it is important to remember that Smith was not concerned with money or the use of money. His analysis was only ex post facto considered the defining text for a field of study, economics. Up until that point, trade was only infrequently international and the costs of trade were quite excessive and time-consuming. Modern economists have become so entrenched in the day-to-day predictions of economic output that they often forget to look at the big picture of economics and what it means. Even the most popular “economist” bloggers of today largely ignore basic economic theory and tend to focus more on policy and politics (Paul Krugman comes to mind as a perfect example of this dichotomy as an “economist” but opining almost singularly on political rants and ignoring the motivations of individuals and how the present environment changes them). The only blogger or writer I have found that engages in a realistic discussion of economics is Mish (Mike Shedlock) of Global Economic Analysis. His insights have largely influenced my ideas of the last few years and its application in investing. I applaud his most recent discussion of how Peter Schiff got his hyperinflation call all wrong.

Adam Smith wrote:

What is the species of domestic industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him. The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.

This predisposition leads us down the road of what competitive advantage each country has at its disposal.  In the natural progression of industries, whatever component of production is in greatest shortage will grow in cost.  This is considered a shortage.  Everything has a point at which it becomes the bottleneck of production and therefore to employ more of it in production, the price of it will rise to bring additional resources that were engaged in lower-value activities.  In the most recent past, labor within established economies was the choking point and wages increased strongly for many years.  It seemed that these gains were not only here to stay, but would increase in infinity.  Under normal circumstances, these pressures are offset by automation.  By investing capital into additional production machinery, the cost of production can held in check.  In Adam Smith’s world, the “invisible hand” of profit maximization motivation means that this transition is seamless.  In periods of major labor dislocations, investment is “lumpy” meaning that spurts and stops of investment cause labor to be temporarily in shortage or in tight supply.

For the decade of the 90′s, despite a recession, labor demand grew quite steadily.  At the same time, an entirely new labor force for America was being trained on the other side of the world.  Several types of labor were created in India and China; production and information workers.  With India’s long history of British influence and control, they were largely positioned as an alternative to information workers in the United States.  Until the infrastructure was created in the 1990′s to provide real-time support and analysis, the use of place-shifted information workers was largely unheard of.  After the late 90′s, it was a matter of general business in the US.  While the Tech bubble drove up IT costs to insane levels, most companies were planning to offshore as much of the information workers world as they could.  India had done an incredible job of attacking this part of Corporate America, both here (through H1B lobbying) and abroad(through direct outsourcing).  Meanwhile, China was feeding off of the wealth of the West by siphoning off manufacturing jobs.  First, it was manual menial labor, and later, skilled labor of all kinds from jewelry manufacturing to circuit boards.  American’s often now lament that nearly nothing is produced in America.  We, it seems, have priced ourselves out of the labor market.

Which leads us to the outcome.   America has lost the orignal source of its wealth: innovation and manufacturing.  Luckily for us, we own some quite valuable assets; Intellectual Property and real estate. (okay, we’ve got more, but that’s not really what this is about)

While the cost of labor was rapidly declining, and in an environment of tight labor supply (much of the 90′s and this decade), most Americans found high paying jobs such as consulting, sales, and management.  While these are often high paying jobs, they can be quite transitory. Meanwhile, the cost of everything was getting relatively cheaper compared to incomes; food, housing, computers, cars, etc.  Indeed, the loose monetary policies were in a sense combatting this dramatically increased productivity and lower cost labor.  We were digesting it quite well; however right around the corner was indigestion.  This indigestion was where monetary policy was letting us go.  We overheated and the engine of growth stalled.  There was nothing more to milk out when our housing bubble hit.  When  prices of the #1 asset owned by most Americans began to defy logic, reason, and prudence, most took it in stride.  To make up for diminishing household income in real terms, most just extracted the equity of their homes.  Because lending on real assets had proven so effective in the past, investors, cheered on by a FED determined to keep money flowing freely accepted lower and lower restriction on limit, chasing yield.  This chase of yield ended in multiples of leverage beyond human comprehension.  Meanwhile, average Americans could get a piece of their own leverage with low-down or even zero down (and frighteningly negative down 120% loans in some cases).  When prices were normal, this worked as there was little stress on incomes and savings could account for some losses.  Once prices began rising, consumers found little need for savings when their homes were provding them for us.

Which is what led us to the housing bubble popping when noone could afford their own home and noone could continue to pay their mortgage (more or less nearly everyone who “owned a home fit into one of these, if not both in Southern California in 2006-2007).

While we are deleveraging, deflation is setting in.  There is no way to combat this without creating massive amounts of money.  Where that money ends up is no matter when you’re in the storm of deflation.  Right now, 0 interest rates are all that are keeping us from a deflationary depression.  We’ll see what wins out.  Adam Smith’s invisible hand dragged jobs out of America.  Perhaps one of our own “economists” can provide us a way to bring them back.

Which brings me back to a statement I made back in November of 2006:

Historically, strongly inverted yield curves have historically preceded economic depressions… and normal inversions have preceded recessions.

I also agree that we have a “normal inversion” signalling a potential economic recession.

One of the questions that is somewhat debateable is still what makes this time different:
1. There is a lot of liquidity still in the system. China, for instance, has waaaaay too much currency reserves, and heavily weighted towards USD… depressing our rates in treasuries, likely setting off our really low mortgage rates as well. Mortgage rates could snap back due to a variety of situations, not the least of which would be higher defaults. Of course, the cows have already left the barn, the question only remains how fast will lenders close the gates?
2. Lending standards in the mortgage area are likely the lowest they have been in history. Lenders are offering neg-am option-arm, no-doc, teaser rate loans to people one day out of bankruptcy. Best Funding here in L.A. even advertises to this kind of people. I don’t know how you can get any lower than that.
3. Bank reserves are frighteningly low. Why the FED has not yet stepped in to raise reserve rq’s is beyond me. It’s like a drunk asleep at the wheel. I just don’t know when it crashes, but it’s going to. I wonder how much the FDIC designation is going to mean then… I wouldn’t recommend to anyone to exceed those amounts… open more accounts at more banks if you have to, but you dont’ want to take a haircut on cash.
4. The stock market is surprisingly bullish (might be a sucker rally, but I can’t say for sure). Either way, I can sense the tenseness on Wall Street. I am tempted to liquidate everything and hold cash for a while, just because spooked investors can pack the exits at any time.

Some time ago, someone was mentioning stagflation… something which is absolutely garbage. There is no comparison of now to the late 70’s. Still, i might be led to see the uncanny similarities to the ‘72-’73 market.

By your statement, you and I are both asset deflationists, however, the FED can (under pressure) jam the ZIRP pedal and go to infinity with debt monetization to stimulate the economy. It would tank the dollar, but we might actually start producing stuff again. If that doesn’t save us from price deflation, then there is no hope for Keynsian monetary policy in the future.

We’ll see if Keynsian Monetary policy can rescue us here.

Is now a good time to buy a new home? i would be a first time home buyer and i have heard the market is bad.?

Darren gave a long-winded answer:

Congratulations of thinking of buying a new home.

Is there a “bubble”? The simple answer is “no”. Even if interest rates move a bit higher, it won’t be enough to cause a nationwide slide in home prices. The key to a healthy housing market is the job market. If the payment on a new home might be slightly higher due to increased interest rates, it generally won’t stop someone from purchasing the home of their dreams…but if they feel their job is in jeopardy, it might be enough to stop them from making a move. So with the currently low levels of unemployment and the beefy gains in job creations, it looks like the housing market will remain vibrant. Although it will be difficult to sustain the double-digit gains that much of the country has seen, price declines are highly unlikely. Expect a more moderate rate of appreciation, perhaps closer to the historical 6-7% range, which is still very good.

The post goes on for nearly 2 more pages of bubblespeak.  It’s an interesting read on what was going on at the time.   The most choice example:

Don’t be victimized by the bubble hype. Buying a home is a big step, but it is almost always one in the right direction.

Darren was also quoted on housing doom and felt required to issue a long-winded discussion of the merits of buying a house, leveraging it to the hilt and other such nonsense.  I also at the time replied (when I was writing under the pseudonym John Doe) to his crazy thoughts:

I kinda wish we had a behind the music rendition of where is he now?

Anything worth saying to Darren after the bubble popped?

My basic premise was that housing created a lot of imbalances, most notably in job creation.  This included both traditional construction jobs as well as well paid professional jobs in lending and real estate sales.  At the time, the ranks of California realtors had swelled to nearly one in every 50 adults in California, and loan brokers were probably not far behind.  This not only supported high prices, but also ensured that even a slight downturn in one would result in a crash for the other.  Indeed, when sales volumes hit their lows last year, it was hard for many real estate agents, or even loan brokers to continue to exist which is evidenced by the Lender Implode-o-Meter.

Today’s news comes from the Inland Empire (and Coachella Valley), which is now sporting some impressive (if downright incredible statistics):

This corner of Southern California had the highest unemployment rate of any area with 1million or more people in the United States — including metropolitan Detroit.

“We are the epicenter of the economic crisis in this country,” said John Husing of Economics and Politics Inc., a leading regional economist.

Federal labor statistics showed the two-county Riverside-San Bernardino area that includes the Coachella Valley with 9.5 percent unemployment in October, compared to 8.8 percent in metropolitan Detroit.

What’s interesting is how much previous forecasts from so many economic think tanks based in SoCal were based on strong employment numbers.  While this has steadily worsened, it has not been completely unseeable; I saw it developing more than 3 years ago when I first began the blog as an outsider to the housing market.  Shouldn’t more have seen it coming?  I would argue no, due primarily to groupthink, and that we are generally programmed in larger groups to not question authority unless that kind of activity is rewarded; something that cannot be said about the last 30 years.  Most Americans have been told to shut up, sit down, and take what we give to you.  However, this blog is not about social commentary; greed is more of an objective observation to me since it motivates people.  Understanding others’ motivations will ensure you can achieve what you want.

Which after all, leads us to the basic questions posed by Southern Californicators:

1.  If we came to SoCal for the jobs, and they’re no longer here, why are we still here?

2.  If there are no jobs (or the ones available are transitory) why does it cost so much more to live here than anywhere else?

3.  Can weather pay the bills; house payment, electric, water, gas, and taxes?

4.  If weather can pay the bills, what about places with crappy weather like the IE?

5.  Also, if weather can pay the bills, what about cheap places with good weather like Florida?

6.  Oh, yeah, can’t forget the once-in-a-lifetime opportunity to have your life destroyed by a massive earthquake.

All of these questions have in the past kept SoCal home prices pretty well tethered to similary type-housing prices in other states.  And why did they go so out of whack this time?

Was it Subprime?  No, that wasn’t widespread enough, since only a small percentage of the people were getting subprime loans.

Was it Option ARM?  Maybe, but that’s a Ponzi scheme that requires a lot of confidence that others have more than you.

Was it Loosening Standards?  Maybe, but then you gotta be able to pay off that note.

I believe, in the end, the only conclusion that one can come to after so many other possibilities is that people were irrationally optimistic about housing.  Just like internet stocks in 1999.  Just like Tulips in the 1600′s.  We really have learned nothing, and many will lose their entire lives’ savings from it.  Hopefully, most of the innocent can keep their jobs, but I’m not optimistic.  I believe unemployment will get worse before it gets better.

Our friend, let’s call him Boomer for short, had this to ask of me:

Moved my family to La Costa area (renting) and own a house in AZ which I owe $159k at 6.5% (it adjusted and will again in 8 months) The home was at peak worth $750k now $550k I had it rented last yr for $2200 and just signed a 3 yr lease w/ new tennant for $2,400 . I have $600k in cash..Should I pay this house off?? or should I just refi it and hold on to my cash to buy here in S cal in a yr or two?

First off, I have a couple of thoughts:

1. Whoever Boomer is, he’s in a pretty good position, relatively speaking

2. Without knowing his age, I’d say Boomer is likely Early Xer or Late Boomer.

3. The most important point of all (where he wants or needs to live) is missing from the question. Don’t feel bad, many people forget this little factoid. We’ll assume that he wants to stay in SoCal.

I’ll deal with some important points:

1. What is that house in Arizona really worth long-term?

2. What should Boomer do with the cash?

3. What kind of financing makes the most sense?

What is that house in AZ really worth?

This is the question that wasn’t really asked, but needs to be answered, what is the house in Arizona worth, so we can understand what to do with the money.

Well, Arizona is a big place. It has a varied geography with beautiful vistas, scorching deserts, and some bone chilling mountains. You may not like what I have to say, but I’ll say it anyway. Your perception of the world and finances is the boiled frog syndrome. Not that I blame you. You’ve been raised in a world of ever decreasing interest rates and increasing asset values. The world has been kind to you.

You see, the success of many of the past 30 years (primarily the boomer cohort) is a demographic abnormality. Asset values have increased simply because of the organic demand of the Baby Boomer generation and ever increasing ability to finance that demand. In addition to this, an extremely relaxed monetary policy has increased the value of assets consistently since inflation was trounced back in the late 70s.

Unfortunately for many, that time is over.

In the short run, houses are worth what someone else is willing to pay for it, but in the long run, they are subject to the value of the next best alternative, or substitute pricing. The best substitute for owning a house is renting one. In some cases (such as short-term living), renting is almost always the clear alternative.

There are many formulas for determining the value, but one of the simplest mechanisms is the GRM (Gross Rental Multiplier). Basically, this number is used to multiply the monthly rent to arrive at a fair estimate of rental value. However, this is only a rule of thumb and is not to be taken as gospel; lower interest rates (like I expect we will see for the forseeable future) will increase the GRM, while substitutes (buildable land, locus to employment centers) will decrease it. In certain premium places like Orange County, the upper stretch might be 220 or so, while in places like Las Vegas or Arizona, a more reasonable 120 to 160 is more in line with reality. If we err on the side of optimism (150 GRM), this places the current value based on long-term fundamentals at about $360,000, leaving Boomer with a $190,000 premium over its fair value. If I were evaluating a stock, I’d say SELL! SELL! SELL! Doubly more so if Boomer had lived in the house for more than 2 of the last 5 years since he can walk away with pretty much all of the money tax free. It doesn’t matter what the market is selling at, if there is really that much of a disparity, sell that house and get your money! (of course, it doesn’t help that it was just rented, but there are always ways to let a renter go, if the price is right). At a 229 GRM, his house is badly overpriced. When it was $750K, I haven’t a clue how someone could justify that, since it would have been a GRM of 340. Holy smokes!

The future good in some ways, but bleak in other. The Southwest is largely overbuilt in nearly every city with a real dearth of extensive employment opportunities (unless WalMart is your target), and if energy prices remain elevated (not a given in my mind), the ability to pay will deteriorate along with the economy. Boomer may end up with late (or no) payments from his rental. Rentals are generally difficult to manage from a long distance and I would only advise it if you were planning on returning back to the home at some date. However, that would be hard after living in LaCosta for a few years.

In addition, a house can be valued at the cost of money to purchase it. This is a bit more detailed, but an easy rule of thumb is to take the rental equivalent, figure in future increases in rent, and discount the cash flows based on current borrowing rates. It accomplishes about the same thing as GRM, but removes the variability of borrowing rates (especially if it is held as a long-term investment). Using the inverse calculation, you could figure what the “money rent” on the current place would be given a few variables such as the “current value” and current interest rates. Given a current value of $550,000, the money rent valuation using 7% says that Boomer should be collecting about $3,700 in rent on that money. This leaves out taxes, repairs, rental expenses, vacancy, and many other options, so it is by far the most optimistic. By this reckoning, the house would have an imputed value of $357K, pretty darn close to our above $360K value. Sounds like time to sell this puppy no matter how you look at it.

As another way of thinking of it, as interest rates go down, this increases the ability to pay, but that can only increase so much since the risk of buying on low interest rates and being unable to sell into a similar situation will weigh heavily on others’ minds and prices will need to adjust to handle this uncertainty. Since demand for housing is waning as the boomer generation ages in place or downsizes (or simply dies), it is unlikely that houses will be able to continue their rich valuation long into the future without a substantial demographic to replace them with the ability to purchase.

Any way you look at it, the house is currently valued at more than it is “worth”. I can show houses in Orange County that currently have better GRMs than what this house is showing, and Orange County is one of the most overpriced locales in the US.

Tomorrow, I’ll deal with the question of what Boomer should do with his cash. Any thoughts before then?

Ralph Cioffi

Matthew Tannin:

The NYT has a great piece on the indictments of former Bear Stearns Fund managers.

In an April 22 e-mail from Mr. Tannin — which the indictment said was sent not from Mr. Tannin’s account at Bear Stearns, but from his personal account to the personal e-mail account of Mr. Cioffi’s wife — Mr. Tannin wrote:

the subprime market looks pretty damn ugly… If we believe the [CDOs report is] ANYWHERE CLOSE to accurate I think we should close the funds now. The reason for this is that if [the CDO report] is correct then the entire supbrime market is toast… If AAA bonds are systematically downgraded then there is simply now way for us to make money — ever.

Three days later, Mr. Cioffi and Mr. Tannin hosted a conference call for investors in the funds. This time, his tone was very different.

Lying openly like that to garner more money needs to be treated pretty harshly.  Maybe some in the securitization business can get some religion.  If not, they can always find Jesus in the clink.

No mortgage bailout! None at all! Not to striving homeowners, not to the insanely-paid CEOs. Risk has penalties too.

Here’s our typical homeowners:

Here’s the problem with CEOs:

I have to write this entry because of the amount of absolute rubbish that I see printed throughout the media and repeated ad nauseum in the blogosphere regarding the money supply and how the recent fed actions are inflationary.

Even with the dramatic action today in the stock market (the last time we saw a 400 point day in the dow was mid 2002, near the depth of the last bear market), the general trend is that the market is quickly siphoning off the dollars put out via the central bank the past 8 years.

Noone now doubts that Greenspan made 2 fatal mistakes that caused the largest bubble in history. First, he brought interest rates too low and held them too long, and secondly and more importantly oversaw the most complete and utter breakdown of lending standards in history. Put together, it pumped too much debt into the system.

This debt became non-servicable from income during a time when debt should have been waning, not peaking since the largest demographic baby boomer bulge is passing into its retirement age. The sad state of affairs of most baby boomers is only a testament to the incredibly poor management of their finances until this point. Several decades of declining interest rates and ever-increasing credit has created a new age of debt serfdom where most can only hope to ever service the debt and hope it never gets called, the serf ever sickens, or misfortune visits a single household.

Put succinctly, increasing the money supply is inflation, deflation is decreasing the money supply. The accomplished blogger Mike Shedlock has made this case quite well, and the facts speak for themselves.

In the deluded minds of those pumping housing, they are hoping that actions by the FED will rescue housing. It won’t. Housing was in a bubble that was reinforced by the increase in money supply, and as long as the money supply is contracting and remaining contracted, we not see a return to the insane days of lending we have seen the past 7 years. This is deflation. Assets going down in value. Housing, stocks… even commodities should be declining. Which brings us to the next bubble… commodities. It was only a matter of time; and frankly I haven’t a clue as to how long it will last. But it’s not ready to pop yet. We are just now getting the first whiff of a bubble; and there will be plenty of time for commodities apologists to scoff it off and disprove recent price action, but let’s not forget the fundamentals… commodities are priced between the cost of production plus normal profits and the cost of alternatives. Gold, corn, rice, sugar, even oil has alternatives, and let’s be honest… we have departed from these fundamentals. It costs approximately $400 to produce an ounce of gold. It costs approximately $4 to produce an ounce of silver. We have all gone mad in the search for the next place to put our dollars. We are living in an inflated world where stocks and housing are no longer considered safe havens after the last 2 bubbles have popped, yet commodities are just warming up.

But, let’s not forget that even with the bubble forming in commodities, it does not yet have a complicit Federal Reserve bank… borrowing for precious metals is much more difficult than leveraging equity in a house or margining stocks; and there are few takers to lend the money in that kind of speculation.

I predict this next commodities bubble will be much shorter than the last 2 and more violent to the participants.

Disagree below.

I’ll let you decide how prudent that advice was by viewing the top homebuilders’ stocks from that date until today measured against the S&P 500.

I’m predicting that even with all of the price declines, I believe there’s still a lot more.

Here is what Joseph had to say:

It seems you can’t talk about the housing sector these days without mentioning the “S” word. Subprime, yes I said it, has even wormed its way into the vernacular of many Fed watchers and Fed members – not to mention the warning shots fired from the sidelines by former Federal Reserve chief Alan Greenspan every other week or so. This morning, the Fed sounded yet another gloom and doom note for the housing sector, as Sandra Braunstein, the director of the Fed’s division of consumer and community affairs, stated that borrowers could see “more difficulty” in the next one to two years. In particular, those borrowers with recently originated adjustable-rate mortgages are likely to experience more delinquencies and foreclosures, Braunstein said.

and

Admittedly, the situation is not very flattering for the U.S. housing market. However, I think that the hype over the popping of the so called “housing bubble” is being overplayed just a bit too much. Just take this quote from a March 18 New York Times article titled “On the Homefront”: “In many quarters, Greenspan was essentially accused of cheating the country out of the depression we deserved: instead of allowing the swooning Nasdaq to bring down the United States economy and punish us for our sins, he had rolled the tech bubble into a housing bubble and allowed the party to go on.”

Blaming Greenspan seems convenient at this point, especially with Bernanke’s Fed in a holding pattern. And comparing the “Dot-com” bust to the current situation in housing seems rather irresponsible. After all, betting on virtual real estate seems a far cry from betting on housing prices and “real” real estate. I mean, can you really compare the long defunct Pets.com and WebVan to Lennar ( LEN: sentiment, chart, options) and Hovnanian (HOV: sentiment, chart, options) ?

I have sat on this article for 5 months to see if my research was right on where they were headed… in an effort to dispel any myths. He was dead wrong, and worse than that, revealed poor research on the underlying fundamentals of the housing problem. It is and still is an affordability crisis. The decline in sales will not abate until that affordability standard is reachieved. At current course and speed, that won’t be for another 2 years at the minimum.

I believe that we will still see some of these builders declare bankruptcy (ch 11) before this bust is through.

Remember the good ‘ol days when Subprime was “contained” and we were all just lauging at all of those people with bad credit who were going to lose their homes while we with good credit were sipping Mint Juleps and smoking cigars? Those were the days, right?

How fast a month passes. Impac just created a massive earnings crater.

Impac Mortgage is an Alt-A lender.

If you’re not sure what that means… it’s basically people with good credit, but can’t qualify for traditional loans due to “unreported income” (aka wink, wink, nod, nod)

While the reality could conceivably not be as bad as it now seems, their book losses this quarter were $112M. Which, by most peoples’ standards, is a lot of money (except rich people who own homes in SoCal) However, much of that loss is a book write-downs. The big question is, does it get better from here on out for them, or worse? Does the future hold more, or less write downs?

It is important to remember that in the heyday (just months ago), bubble bloggers everywhere stated that loan loss reserves were incredibly low. Making up for the difference is going to be painful for current shareholders.

H&R Block Inc. will sell its troubled Option One Mortgage Corp. subsidiary to an affiliate of Cerberus Capital Management LP, the finance management company said Friday, in a continued shakeout of the subprime lending market.

OOMB Acquisition Corp., a newly formed company, will pay $300 million less than the value of Option One’s tangible net assets, which were valued at $1.27 billion on Jan. 31.

H&R Block will also receive an “earnout” representing half of Option One’s loan origination sales for 18 months after the deal closes, which is expected in the company’s second quarter, ending Oct. 31. The earnout is capped at $300 million.

That seems like a very expensive price for one of the worst underwriters of Neg-am products. Someone at Cerberus must think that the subprime mess is nearly blown over. I don’t think so, and I think there are significant liabilities that go along with the entire business model.

With Bear Stearn’s announcement yesterday effectively capping Neg-Am products at 110% of original value, that may prompt others to follow suit (hat-tip to Calculated Risk). I believe the cap at OO is 120%. Can someone clarify if that is wrong? **Updated**

Any way you look at it, Alt-A is beginning to show cracks. Yahoo tells us more:

Don’t expect a quick recovery from the subprime mortgage debacle.

That’s the view of well-known value investor Robert Rodriguez. A rare switch-hitter in the fund industry, he runs both a stock and bond fund: FPA New Income, a $1.8 billion fixed-income fund (one of Money’s 70 recommended funds) and $2.2 billion FPA Capital, a small value fund (currently closed to new investors), which both have solid long-term records.

Rodriguez is a contrarian who buys issues that are out of favor on Wall Street, and he keeps a sharp eye on risk. When he cannot find compelling bargain, or when he sees economic problems mounting, he lets cash build up in his portfolios. Recently, cash made up a hefty 40 percent of assets in both FPA Capital (FPPTX and FPA New Income (FPNIX.

“We see significant risks, so I’m in preservation mode,” said Rodriguez.

Topping Rodriguez’s list of worries is the collapse of the subprime mortgage market, where he first saw problems emerging two years ago. “Starting in 2004, it’s has been one of the worst mortgage underwriting cycles that I’ve seen in my career,” says Rodriguez. “Lending standards deteriorated as more and more groups got access to credit even though they didn’t qualify.”

Right now, the economic consensus is that the subprime fallout will cause only a temporary economic downturn. It’s a view that Rodriguez does not share.

“It’s still early in the cycle to know how things will turn out. But I think the notion that we won’t have a major economic readjustment is really optimistic.”

I think we all envy optimists, but optimism can be fatal if you ignore the risks and warning signs. We hope that Option One’s new owner can bring their company into some semblance of an organized entity. Good luck to them.

As always, I am interested in the impact on the local economy… as it is central to my forecast for Orange County’s housing debacle.

Subprime mortgage lender New Century Financial Corp. filed Monday for Chapter 11 bankruptcy protection, and said it would fire 3,200 workers, or 54 percent of its work force, to better position the company for a possible sale.

And, cutting off the arm to escape:

New Century said it has agreed to sell its loan servicing business to Carrington Capital Management LLC and its affiliate for about $139 million, subject to the approval of the bankruptcy court.

There’s not much left of this company to reorganize. Might as well make it a Chapter 7 and be done with it. I guess all we need now is to sell the new office chairs and give up the commercial office space in Irvine…

I recently heard some rumblings of how commercial RE was going to save our sorry butts in OC… not here, not now.

************************Update 04-02-2007 5:45PM**************************************

Just found out that Matthew Padilla has the inside scoop on Layoffs for New Century:

500 from Today.

I suppose many more to come.

Best quote:

Jack Kyser, chief economist with the Los Angeles County Economic Development Corp., which also covers Orange County, said buyers are interested in parts of New Century, but no one is likely interested in the brand or company as a whole.

“What do people think of when you say New Century?,” Kyser said. “There’s no value in the company name anymore.”

You can say that again. New Century has turned into a certain liability for other companies similarly named.

Here’s a breakdown of the differing theories:

1.1 Million

Americans borrowed $2.2 trillion from 2004 through 2006 in the form of adjustable loans, which start with low monthly payments that reset to higher rates. As those loans reset, 1.11 million people will lose their homes, according the study by First American CoreLogic, a firm that tracks mortgage risk for the financial services industry.

The figure is significantly less than a widely published number from the Center for Responsible Lending.

1.5 Million

As many as 1.5 million more Americans may lose their homes, another 100,000 people in housing-related industries could be fired, and an estimated 100 additional subprime mortgage companies that lend money to people with bad or limited credit may go under, according to realtors, economists, analysts and a Federal Reserve governor. Financial stocks also could extend their declines over mortgage default worries.

2.2 Million

A new Center for Responsible Lending (CRL) study reveals that 2.2 million American households are likely to lose their homes and as much as $164 billion due to foreclosures in the subprime mortgage market.

The CRL study is the first comprehensive, nationwide review of millions of subprime mortgages originated from 1998 through the third quarter of 2006.

CRL’s research suggests that risky lending practices have triggered the worst foreclosure crisis in the modern mortgage market, projecting that one out of five (19.4%) subprime loans issued during 2005-2006 will fail.

5 Million

But Ackelsberg listed that as one of the myths about subprime borrowing.

Actually only 11 percent of subprimes are made to first time buyers, he says. The majority are homeowners convinced to refinance into inappropriate loans.

The second myth is that subprimes are good credit repair products. The pitch here is that by paying a subprime for a while, borrowers will increase their credit scores and soon transfer into a prime loan. Ackelsberg says there is scant evidence that this happens very often.

According to him, the entire subprime meltdown should come as no surprise to anyone. Subprime mortgage lending was the modern equivalent of a gold rush with home equity the gold. Furthermore, even though foreclosure stats are spiking, they represent subprime loans that have mostly not yet reset.

He guesses that as many as five million foreclosures may occur over the next several years, basically saying, if you think it’s bad now, wait until all those ARMs reset.

How many will there really be? While it’s easy to say that it’s probably somewhere in the middle, that middle area is awfully large between 1.1M and 5M.

Change is afoot that has the potential to drown out any discussions of rate cuts in the future.  I’m talking about China’s currency reserves.

China will stop stockpiling its massive foreign exchange reserves, China’s central bank governor Zhou Xiaochuan said in an interview published Tuesday.

“Many people say that foreign exchange reserves in China are [already] large enough,” Zhou told the Emerging Markets magazine, whose latest issue was released at a meeting of the Inter-American Development Bank in Guatemala.

“We do not intend to go further and accumulate reserves,” Zhou said, adding the government will “cut a small piece of reserves” for a new agency to be set up for the management of its massive foreign reserves, which have swollen because of the trade surplus.

He did not say how much money would be passed to the agency.

China’s premier, Wen Jiabao, said last week that plans to form a new agency to invest part of the country’s swollen foreign exchange reserves, the world’s biggest at more than $1 trillion, would not have an adverse impact on the U.S. dollar.

Right,  I guess it all depends on what you consider “adverse impact”.  With the USD just recently testing the 80 mark and accumulation stopping, we may have a hard time selling too many treasuries the the remaining buyers.

Time to monetize that debt, baby!

Would you just love to stick something in their face that breaks it down scientifically and proves them all wrong?  Something that shows exactly how much these variables changed the cost of living here?  Wouldn’t you love to get your hands on exactly that piece of information?  Wouldn’t you love to prove in graphs and numbers that the variables they just mentioned had little to no effect on prices, while it was exactly the proliferation of ARMs that did it?

Wouldn’t you love that piece of work to include formulas such as this:

And written by a professor of finance at a California university? 

What if I told you that exactly such a paper exists that delves into California’s history of home prices discussion that includes a detailed explanation of what caused the home price explosion?  It does exist.

Here’s a rundown of the conclusions:

Well, have I whetted your appetite enough to sit through 30 minutes of mind-tearing edumuhcashun to get to the data behind the pretty little graph I pounded out?

Here it is.

Can you say Ruh roh Shaggy?

Regulators are concerned lenders are issuing mortgages to borrowers with little proof that they can repay their loan and do not fully understand the risk of increasing payments, the document states.

Subprime borrowers could find themselves unable to afford monthly payments after the initial “teaser” rate expires and make payments for taxes and other expenses if lenders do not hold such costs in escrow, the document states.

Subprime borrowers also face the risk of “losing their home,” the document states.

That pretty much describes most of Southern California.  When our affordability dipped below 6%, and much of the wealthy already live here (we’re not attracting a higher percent of millionaires than are already here), the area’s housing will stop in its tracks if documented income were required on a fully amortizing basis.

Dead Cold.

More than 80% of the loans made recently in SoCal were of the adjustable rate ilk, and I’d venture a guess than more than just a smidgen of those are due to affordability of the monthly payment.  Fully amortizing loans are currently touted as stone age devices not worthy of a modern world.  All part of the “it’s different this time” argument that is so quickly spouted by the clueless.  Just look at history if you want to know what affordability is going to look like.  Because, frankly, if the loans of yesteryear are reintroduced, so are the prices.  Incomes have not kept up with basic inflation, much less the out-of-control prices of Southern California.

The positive to all of this speculation squashing is that it will flush homes back to banks and back on the market at reduced prices.  Individuals will lose out, but the overall will be better.  Risk will once again be priced in.

For real estate in SoCal? Not so much, especially when sewage backups in Tijuana are basically front page news. Isn’t there constantly sewage coming across the border from TJ? Sorry, no references to immigrants please. The place is just dirty, and is constantly polluting San Diego beaches because the Mexican government fails to do just about anything about environmental protection besides limiting ownership of land by non citizens. Pretty much sums up the problem with the Mexican government (er, politics)anyway… does nothing.

Which, sometimes isn’t all that bad.

For example the former Fed chairman Alan Greenspan (a politician, but alas not currently with the US government) declared today that we might slip into a recession later this year. This was as much of a contrary indicator that fellow blogger Barry Ritholtz of the Big Picture could take. It might make him change his economic forecast since Al has been wrong on so many occasions. Of course, the change in opinion was made in jest (I think), so there’s little chance of a major rally (or is there?).

It seems that too often, people espouse one idea, and desperately seek to find information to support their assertions. This is true of both housingheads and bubbleheads alike, but moreover, it’s human nature. If we constantly second-guessed our beliefs, we might just be chomped by a sabre-toothed tiger. So much for a rational anlysis of facts. Case in point is a book I recently read by Harry Dent. Yes, that Harry Dent. It was some book about how the housing bubble will roll back into the stock market and cause the mother of all bubbles from 2006 to 2010 or some such idea. The book’s title is The Next Great Bubble Boom: How to Profit from the Greatest Boom in History: 2006-2010. Which title kind of reminds me of DL’s book, Are You Missing the Real Estate Boom?: The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade – And How to Profit From Them.

Most people have staked their credibility on a specific claim. If outside circumstances change the outcome (but not the forces driving it), is the predictor all that wrong? For that matter, another blogger, Mike Shedlock, believes strongly in deflation based on research of Japan’s bubble economy of the 80′s and 90′s.

Many other bloggers believe strongly that we will see substantial inflation.

Bill Fleckstein (one of my favorite reads) was amazingly accurate about the subprime and lending implosion currently underway. However, even he isn’t sure about the economy’s larger fallout. Could it become a contagion throughout the entire economy?

What will really happen? Nobody knows, but with as much liquidity as is floating around in local, national, and global markets, it appears that where its final resting place is, noone is certain of or able to predict.

Which makes one wonder, what is different between our forecasts and those of Gary Watts? Well, for one, we use broad-based economic indictors that have proven robustness (such as affordability, local economic structure, and relative business attractiveness measures such as income) instead of slanted, irrelevant, and cherry-picked demographic moves? For example, what good does a retiring baby boomer generation do for housing in general? Absolutely none if household formation does not promote it, or savings provide for the ability to actualy buy a non primary residence home. (which Boomers are largely guilty of)

One thing is certain, though, housing prices in Southern California will be lower in the future. Until then, there will be quite a few slow news days.

Everything is not fine, everything will not be okay.

David Lereah, in fact was quoted:

Last year “was the year of contraction,” said David Lereah, the NAR’s chief economist. “When we get the figures for this spring, I expect to see a discernible improvement in both sales and prices.”

Uh… yeah. Call me in a few months and tell me how that’s working out for you.

The sad part (and the cause of so many dead cat bounces) is that the psychological environment changes enough for committed (and often overcommitted) interested parties to buy back in (Never Been A Better Time To Buy crowd). It is only when these parties become dissillusioned by repeated losses that the entire market capitulates and often sinks below fair value. In the heady times, leverage is power, in bad times, leverage is death.

Take for example, the latest “stock market crash” if you will. There were at least 4 distinct sucker rallys (aka Dead Cat Bounce) that occur from top to bottom.

Eerily similar, you will find that in a similar time frame (3 years), the Dow Jones had very similar action:

The year was 1929.

The fact that dead cat bounces occur is not in itself surprising. What is often surprising is how easily participants latch on to them. When so much has gone right for so many for so long, it is hard to imagine that it was all just hot air after all.

When Americans hear that their paper wealth is slipping away, the denial that grips otherwise educated, informed, and critical thinking homeowners is stunning.

Typical coping methods include:

“It’ll come back in the spring, I know it will” Even in the face of abysmal affordability, faltering economy, and a lending meltdown. Not surprisingly, many were in denial last year with the exact same phrases coming from many Real Estate Agents’ lips… and not surprisingly David Lereah’s as well.

“I’m not going to give it away!” Eliciting at least a few snickers from impartial observers. They may not be giving it away, but the bank may be forced to. This, of course, implies that there is some fundamental rationalization of the value of the home by the rents that it brings. When rents can barely cover 1/2 of the mortgage payment alone (not to even include taxes, insurance, or maintenance costs), while simultaneously having some of history’s lowest mortgage rates and in an environment of tightening lending standards, the future doesn’t look bright. You think affordability is bad now? Just wait a few more months and you’ll be surprised when statistics show that even fewer people in Southern California can afford a median priced home than the current 7% or less (depending on the county).

“It’s all the media’s fault.” Yes, it is. They bring you the truth. Good when it’s going up, bad when it’s going down. Still, think of all of the jobs we’ll create in the foreclosure reconveyance, reposession, and bank auditor areas. Bad for you, good for someone else. Maybe it’s just another form of creative destruction.

Will the housing market have a Dead Cat Bounce this spring?

The question is not so much, will it happen, but rather will it FEEL like it’s happening? Drawing inferences between very liquid markets such as the stock market are tepid at best. Because of the illiquidity of the housing market, any emotional lift caused by this psychological change is unlikely to bleed through to the price. Volume? Maybe. Price? Unlikely.

As we have seen, volume in Southern California is at its lowest since 1998. Which means we can still go even lower. And why couldn’t we? Have we resolved the underlying issue of affordability? Have we resolved the issue of the imbalance between rent and owning? Without these changes, the market is only being puffed up by more hot air. Reinflating the bubble with a small leak only serves to do one thing… place more pressure on the expanding hole… which causes even more deflation. The fact that housing markets are like the Titanic only means that it doesn’t immediately sink when it hits an iceberg, it just means there is time to get on a life raft. While 8 months ago was the best time to get on one, it’s still not too late. The last one took 7 years from top to bottom in Southern California, and another 3 years to return to previous price levels (13 in total adjusted for inflation). This is one DCB that sellers should not pass up.

Chuck Ponzi