KPBS San Diego did an interesting piece on raising taxes in California and Prop 13′s effect on this.

Thirty-two years ago, Californians en masse went to the polls and approved the largest tax-limiting legislation in recent history.  Basically, it limited the property taxes that could be assigned to a property.

In response, many municipalities responded by building more hotels, retail, and more while limiting the amount of houses (municipalities earn more money from sales and occupancy taxes than on property tax).  This leaves the state perpetually building too few houses, and worse, restricting adaptive reuse of residential real estate into higher density because of the reassesment rules.

Personally, there are 3 major qualms I have with Prop 13.

1.  This is not a homestead exemption, so it does nothing to favor homeowners over landlords (who already have strong incentives through.  This is landlord welfare.

2.  Commercial properties are not exempted (they have a fixed base as well).  This is fundamentally flawed, since it favors property-owning companies who lease as their primary business.  This is corporate welfare.

3.  There is no means test.  Millionaires have the same exemptions as indigent elderly.  This is welfare for the rich.

Unfortunately, taxpayers were sold that little old ladies were getting kicked out of their homes.  While this is true, we could avoid the landlord, corporate, and rich welfare by instituting some changes to the original proposition.

Instead, we have serious imbalances because cities favor not building homes unless they have significant Mello-Roos attached to them, allow corporate transfer of assets to perpetually avoid reassesment, and allows non-citizens and non-tax payers of California to receive the benefits of everyone else’s pain.  How do you feel about prop 13?

The money shot for me?

RAND (Caller, La Jolla): Thank you for taking my call and thanks for this discussion. I would just like to put two issues on the table. The main one is something that really shocks me, never comes up in these types of discussions, which is the distinction between commercial properties and homes. Of course, nobody wants homeowners to be taxed out of their homes but Prop 13 also holds down the property taxes paid by shopping malls, office buildings, all kinds of commercial properties. And they have a loophole that homeowners don’t have, which is that they can sell the holding company that owns the property and then someone else can take ownership of that property but, theoretically, it hasn’t changed hands, just the company has changed hands. And so there’s many commercial properties in the state that have not been reassessed for many years and they’re not paying the cost of the essential services that they need to stay in business. And I think that that aspect of Proposition 13 is very unfair and needs to be changed.

Some time ago, he wrote Chinese asset markets have become a giant Ponzi scheme that perked up my ears and got me to thinking.

But, his more recent piece in Caing has me thinking he’s talking about Southern California:

The overwhelming desire for getting rich quick dominates every nook, fissure and strata of Chinese society.

Ok, replace “Chinese” with California, and you’ve got a definite match.

Bubbles exaggerate reality but are not formed out of thin air. Cheap money and strong growth are the usual ingredients for bubble-making.

This is almost exactly what I wrote with “What is a bubble?” several years ago.  However, most interestingly is what is happening in China, and happened in California:

China’s property market is creating winners and losers based on timing. All other factors – including education and experience — have been marginalized as the economy rewards speculators. And as more play the game, the speculator ranks rise and fewer people work, perhaps contributing to a labor shortage.

This is exactly what happened during Southern California’s property bubble.  Many people got rich simply by being in the right place at the right time.  Many of them were incapable of understanding the circumstances of the rise, and so therefore simply did more of the same (buy real estate) without understanding the underlying problem that widespread repetition of that practice would cause a housing shortage (too many people “storing” housing instead of allowing it to be bought).  Rents reflected the “real demand”, and appreciated strongly.  Meanwhile, properties exploded with enough appreciation in 2 years to account for 30 years of inflation to support the prices.

The most poignant in my mind was a short-sale that Brad (my co-blogger and realtor) and I visited.  The original owner was trying to sell from a purchase made in 1996 at more than 300K lower than the short-sale.  The “owner” was so destitute that when the pool pump broke and they were unable to replace the $800 unit, the resulting ground shift due to hydrostatic pressure when quickly emptying the pool caused many more thousands in damage to the surrounding concrete.  They had been trying to support a 600K+ mortgage with a single income from working at Macy’s.  When regular equity withdrawals worked, the Ponzi scheme continued.

In normal times, the ponzi would have never worked, but because of the bubble, it allowed the “owner” to continue to persist in a property many times more expensive than they could support.  At the peak of the market, this would have sold for more than $1M, requiring the income of several well-paid professionals, not a single retail salesperson’s income.  The world did not make sense in 2006.

This separation of is true of a speculation/investment-centric economy.  This is part of the reason why most people make terrible investors; the concept of time is nebulous and fraught with uncertainty.  Indeed, I wrote (and bolded) in What is a Bubble? the following:

The most fundamental concept of investing is the concept of timing. The most fundamental flaw in most participants logic is that the asset provides more than just money… everything that costs money is an investment and can be traded again for money, nothing more.

This Southern California phenomenon of irrational belief has been covered extensively in another blogger’s repertoire, Irvine Renter’s Southern California’s Cultural Pathology.

We are quickly approaching the Day of Reckoning in our housing market. In my view this will be Armageddon for California debtors: the spending will stop, they will lose their homes and with it their illusion of wealth, and they most definitely will not be enjoying life. The cause of all the weeping and gnashing of teeth will not be some exogenous event, but rather a direct result of the circumstances they themselves created.

My thoughts exactly.

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.

estimating that without cash-out refinancings and other withdrawals of homeowner equity, only 3 percent of outstanding mortgages would have been underwater at the end of last year

Basically, mortgage borrowers bought the rope to hang themselves.

I would recommend reading the entire article, but here’s an excerpt:

The study didn’t take into account the behavior of lenders or the supply of money available to refinance, instead assuming that borrowers could refinance as often as they wished at prevailing interest rates. That may have been pretty much the case in the decade leading up to the market’s June 2006 peak, the study said, with homeowners eager to take on debt and lenders only too willing to accommodate them.

But the study illustrates a more subtle problem than the “dysfunctional individual and institutional behavior” exhibited during the boom, said authors Amir E. Khandani, Andrew W. Lo, and Robert C. Merton.

“While excessive risk-taking, overly aggressive lending practices, pro-cyclical regulations, and political pressures surely contributed to the recent problems in the U.S. housing market, our simulations show that even if all homeowners, lenders, investors, insurers, rating agencies, regulators, and policymakers behaved rationally, ethically, and with the purest of motives, financial crises can still occur,” the study said.

“Near frictionless” refinancing opportunities, when they occur simultaneously with declining interest rates and rising home prices, create a “ratchet” effect in which homeowners exchange the equity they’ve built in their homes for debt they can’t easily “unwind,” the study said.

The situation poses a risk for lenders, too. A formerly diverse pool of borrowers — some who’d had comfortable levels of equity in their homes, and loans that were well on their way to being paid off — becomes synchronized, as if each had bought their homes at the height of the market with the highest allowable loan-to-value ratios.

When home prices decline, lenders have no way to compel homeowners to add more equity, like the margin calls employed by stock brokers when investors buy shares with borrowed money. Unlike equities investors who can sell off part of their portfolio to meet a margin call, homeowners can’t sell part of their home to reduce their debt ratio.

There’s no easy way to address the “refinancing ratchet effect,” the study said, because the three factors that can lead to trouble — declining interest rates, rising home prices, and easy access to mortgage loans — are “benign market conditions” often seen as indicators of economic growth.

“No easy legislative or regulatory solutions exist, such as prohibiting the Fed from cutting interest rates below a certain threshold, or placing a ceiling on housing prices, or putting ‘sand in the gears’ of the refinancing system and limiting consumer credit,” the study said.

In the end, were using the money from refinancing to supplement declining income, as was the case of a short sale I recently went to see with Brad Davidson (co-blogger and Broker at We-Help-U-Buy).  The homeowner had purchased some 20+ years earlier, but had withdrawn over $500K in the last decade.  Meanwhile, not a cent was put into home maintenance as the entire place was original.  In fact, she had cost the home probably $10K in damage to the in-ground pool draining too quickly because the pool pump broke and she didn’t have $800 to replace it.  (Hydrostatic pressure will do some interesting things to concrete when the opposing force is removed.

The most amazing thing to me during the housing downturn is the number and amount of refis that I have seen.  It seems MOST of Southern California took out several hundred thousand dollars each from their houses; enough to buy entire houses outright in most other places in the country.  Some of the most amazing and bizarre examples have been in the wealthiest enclaves, likely in an attempt to keep up with the Jones’.  This kind of insanity is well-documented in IrvineRenter’s Southern California’s Cultural Pathology.

The road ahead is still going to be fraught with disaster, as it will take us decades to rebuild our consumer balance sheets after having pulled so much of our income forward through equity withdrawals.  Let’s hope that we can do it sooner than later.

It’s no surprise to most readers, but banks are finally figuring out that which was already extensively investigated and reported on by SoCal bubble bloggers; that the primary determinant of foreclosure is not the point at which the buyer purchased the home, but rather all of the “wealth harvesting” that was done via refinancings and second mortgages.  Nowhere is this more prevalent than in Orange County, it seems.  Most of the area’s extravagent showings of wealth were actually extracted from home equity.

A recent study by CSU Fullerton with assistance from Fannie Mae has linked the correlation of cash-out refinancings with foreclosure.  The main takeaway:  Homedebtors who are now in foreclosure are not victims of circumstance (the prevalent thinking in Washington), but rather victims of their own selfish and greedy tastes.

The Wall Street Journal has some a great summary up by Nick Timiraos.

Michael LaCour-Little, a finance professor at California State University at Fullerton, looked at 4,000 foreclosures in Southern California from 2006-08. He found that, at least in Southern California, borrowers who defaulted on their mortgages didn’t purchase their homes at the top of the market. Instead, the average acquisition was made in 2002 and many homes lost to foreclosure were bought in the 1990s. More than half of all borrowers who lost their homes had already refinanced at least once, and four out of five had a second mortgage.

The original loan-to-value ratio for these borrowers stood at a reasonable 84%, but second and third liens left homeowners with a combined loan-to-value ratio of about 150% by the time of the foreclosure sale date.

Borrowers, meanwhile, took out around $2 billion in equity from their homes, or nearly eight times the $262 million that they put into their homes. Lenders lost around four times as much as borrowers, seeing $1 billion in losses.

“[W]hile house price declines were important in explaining the incidence of negative equity, its magnitude was more strongly influenced by increased debt usage,” writes Mr. LaCour-Little. “Hence, borrower behavior, rather than housing market forces, is the predominant factor affecting outcomes.”

What happened in SoCal over the past few years has been tragic, not only because of what happened to families, but rather that it was a tragic waste of human abilities; a misallocation of our skills into a non-productive asset.  Rather than investing time and capital into a productive enterprise, it was wastefully fed into a giant Ponzi scheme.

Unfortunately, old speculative habits die hard, as is evidenced by the dearth of investment-worthy housing in the midst of a sea of WTF asking prices.

Now that the goose that laid the golden egg is killed, cooked, and finding its way through the proverbial lower intestine of our financial system, wealth will need to be made from something other than housing.  Here’s to hoping it’s something that actually produces value for our company.  However, considering the loose monetary and regulatory policies that are still written in stone, I wouldn’t hold my breath.

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.

The T2 Partners paper provided by More Mortgage Meltdown can be downloaded here:

I recommend looking over the entire presentation, as it provides a play by play of where we have come in the last 3 years, and what to expect for the coming 3 years.  I agree with the general assessment that we are in the middle innings of the overall price declines (perhaps in Inning 5 of 9), but the real movement is yet to come in the middle and high-end price tiers.  Of course, there is no way of accounting for significant outside involvement that might change that outcome, however any change must be structural and permanent (such as offering citizenship to anyone purchasing real estate, offering 20% of the purchase price, no questions asked by the government, or total global thermonuclear war.  I doubt many can understand what those outcomes would look like, so we’ll focus on the most likely scenarios.

The key is really what is happening and will continue to happen California. Their assesment, given by Mark Hanson, is in my opinion spot on to how I expect the next 2 years to play out:

California housing — at the low end — is ‘bottoming’ mostly because: a) median prices are down 55% from their peak over the past two years, thereby making the low end affordable; b) foreclosures have temporarily been cut by 66% through moratoriums reducing supply; and c) demand is picking up going into the busy season.
But the moratoriums are ending and the number of foreclosures in the pipeline is massive — they will start showing themselves as REO over the near to mid-term. The Obama plan held the foreclosure wave back, creating a huge backlog and now the servicers are testing hundreds of thousands of defaults against the new loss mitigation initiatives. We presently see the Notice of Defaults at record highs and Notice of Trustee Sales back up to 9 month highs — there is no reason for a loan to go to the Notice of Trustee Sale stage if indeed it wasn’t a foreclosure. However, the new ‘batch’ are not only from the low end but a wide mix all the way up to several million dollars in present value.
Because the majority of buyers are in ultra low and low-mid prices ranges, the supply-demand imbalance from foreclosures and organic supply will crush the mid-to-upper priced properties in 2009. We already have early seasonal hard data proving this. As the mid-to-upper end go through their respective implosions this year and the volume of sales in these bands increase as prices tumble, the mix shift will raise median and average house prices creating the ultimate in false bottoms. We also have data proving this phenomenon.

You can find this narrative (and much more) on slide 62.

Yes, the SCREBC-famous Pepto Bismol House in San Clemente.

My assertion at the time was that there were several problems in order of increasing stupidity:

1.  Terrible Marketing, pictures, etc.

2.  Terrible Pricing… one year on the market, chasing it down and never being close enough to reality

3.  Terrible Location.  I’ll let the picture speak for itself:

Well, if you wondered what happened… it’s back up for sale.

Yes, a scant nearly 2 1/2 years on the market hasn’t deterred this delusional seller from trying to sell for higher than market prices.  It’s listed today for 649K, probably a full 150K higher than what it would take to move the property.  At least they came down from 875K in December 2006.  If they had been aggressive then, I believe they could easily have gotten 750K to 775K at the time.  Unfortunately, greed got the better of the owner, the listing agent, or both.

The post is a “What Not to Wear” for home listings.  And, remember in September 2007 when the bubble was still a debateable topic?  Yeah, I warned the sellers then that the next year was going to be tough.  It was.

And, it doesn’t seem to be getting any easier.  Keep in mind that one of the properties that I compared it to last time seems to have been foreclosed on and appears to presently be in shadow inventory land.  It (a 2700sq ft sfr built in 2001 with much better curb appeal) appears to have gone back to the bank in January at $568.5K.  That doesn’t bode well for the area.

Besides, I think the realtor must not have changed or learned much in the intervening 2 years about property marketing:

I think she learned to turn the camera on its side this time… projects height.

Luckily, the buyer bought in 2000 for $402K.  They’re almost assured a gain on the house unless they already spent it.  Let’s hope they didn’t.  If this doesn’t sell, it’ll always be shadow inventory, waiting for prices to tick back up.  Unfortunately, there are many better prices in the area this time around.  Even though the listing is now 225K lighter, I’m afraid it’s still in fantasy land.

Thanks and come again to Fantasy Island.

This Newport Beach residence sold for 2.5M in August 2006.  It’s now for sale for $781,000.

One might consider buying this just to rent it out and sell it later on to a developer.

Contrary to my first thought, it’s not trashed inside:

Better like some traffic noise, though.  It backs to Newport @ Via Lido.  Nice weather, too bad you won’t want to open your windows.

So, it seems kind of strange that 4 years later, I am posting about prices that have fallen from the peak more than 70%.  Yes 70% of peak value, 30% of original value or less.  No matter how bad your stock portfolio is, I would find it hard to believe that you could have lost more than buying a home in some places in SoCal.

I have family who live in the Victor Valley area, so from time to time I chatted with them about what was happening in housing there.  I learned long ago to shut up about where I thought things would go… nobody wanted to hear it, so I wouldn’t say it.  Needless to say, I took my examples from that area, in fact, all from Hesperia which is a kind of commuter haven for Inland Empire jobs; many moved out of the smog-choked IE to live a more rural lifestyle and have a house that could be afforded.  When demand temporarily outstripped supply (for about 2 or 3 years), prices skyrocketed.  The Victor Valley had been depressed since the 1990s, so any sign of life was welcome in the locals’ eyes.  Too bad that this has not only petered out, but left the area saddled with several years’ supply of homes.

I’ll have to tear through these pretty quickly otherwise this post would quickly turn into several pages of information:

70% Loss

The first one comes to us from 16570 Chestnut Street in Hesperia.  Sold on December 19, 2005 for 270,000, it is now for sale for $81,900.

71% Loss

The next ones come from 18375 Carob St.  Sold on July 3rd 2006 (Just in time for Independence Day) for $299,000, it is now for sale for $86,900.

also, 16349 Mission St is 1600 sq ft of homey goodness sold on September 13, 2006 for $330,000 and is now for sale for the low price of $94,900.

You can’t forget 17575 Redding St which was sold on May 13th, 2005 for $277,000 and you can snap it right up for $79,000.

72% Loss

The next one is a doozy:  10401 Victor Ave was sold on October 19th, 2006 for $318,500 and is now for sale for $90,000.  An interesting tidbit is that it sold for 119K in 1990 and is now 24% below the sales price 19 years ago.

73% Loss

This is getting crazy!  What about 7871 Maple Ave?  It is now for sale for $89,900 and sold on October 3 2006 for $330,000.

74% Loss

The next 3 all had 74% losses so far: 13351 Sunny Ridge St for $90,000 down from $344,000 in 2006; 8466 Buckthorn Ave for $89,800 down from $347,000 in 2006 and 8288 Madera Ave for $79,000 down from $300,000.

76% Loss

With this next one, I thought I was pushing it (but no, see below for more):  8311 5th Avenue sold at the peak for $334,000 and the bank is now trying to get $93,900, or a 76% loss.

Winner!

Here’s a doozy:  81% off peak pricing!  It’s crazy at this point.

8862 Glendale Ave which sold at the peak in June 2007 for $390,000 and is now for sale for $69,900… I don’t know if fraud was involved with this one or any of the above.

Notable mentions:

In addition, there are some additional honorable mentions that are currently on the market:

Lower than 92 pricing:

and a gimme:  almost back to 88 pricing!  I’m sure the bank will take it if you ask!

Can’t forget! Below 1988 pricing:  The lost double decade.  7484 Glider Ave was sold for 91,500 in 1988 and is now for sale for $70,900.  That’s 21 years with negative 1.2% return compounding!

Also, one could have lost more with 10370 Redwood Ave which sold for 250,500 on June 28, 2005 and is for sale for a paltry $70,000.  and is unbelievably 44% below the 1990 sales price of $126,000!  That’s gotta be one of the worst.  It’s a compounding 3% negative return for 19 years.

Still think California real estate is a good long-term investment?

Ladies and gentlemen,

Unfortunately, we have so far failed to comprehend the true scale of the ongoing crisis. But one thing is obvious: the extent of the recession and its scale will largely depend on specific high-precision measures, due to be charted by governments and business communities and on our coordinated and professional efforts. In our opinion, we must first atone for the past and open our cards, so to speak. This means we must assess the real situation and write off all hopeless debts and “bad” assets. True, this will be an extremely painful and unpleasant process. Far from everyone can accept such measures, fearing for their capitalisation, bonuses or reputation. However, we would “conserve” and prolong the crisis, unless we clean up our balance sheets. I believe financial authorities must work out the required mechanism for writing off debts that corresponds to today’s needs. Second. Apart from cleaning up our balance sheets, it is high time we got rid of virtual money, exaggerated reports and dubious ratings. We must not harbour any illusions while assessing the state of the global economy and the real corporate standing, even if such assessments are made by major auditors and analysts.

In effect, our proposal implies that the audit, accounting and ratings system reform must be based on a reversion to the fundamental asset value concept. In other words, assessments of each individual business must be based on its ability to generate added value, rather than on subjective concepts. In our opinion, the economy of the future must become an economy of real values. How to achieve this is not so clear-cut. Let us think about it together.

Third. Excessive dependence on a single reserve currency is dangerous for the global economy. Consequently, it would be sensible to encourage the objective process of creating several strong reserve currencies in the future. It is high time we launched a detailed discussion of methods to facilitate a smooth and irreversible switchover to the new model.

Fourth. Most nations convert their international reserves into foreign currencies and must therefore be convinced that they are reliable. Those issuing reserve and accounting currencies are objectively interested in their use by other states. This highlights mutual interests and interdependence. Consequently, it is important that reserve currency issuers must implement more open monetary policies. Moreover, these nations must pledge to abide by internationally recognised rules of macroeconomic and financial discipline. In our opinion, this demand is not excessive. At the same time, the global financial system is not the only element in need of reforms. We are facing a much broader range of problems. This means that a system based on cooperation between several major centres must replace the obsolete unipolar world concept. We must strengthen the system of global regulators based on international law and a system of multilateral agreements in order to prevent chaos and unpredictability in such a multipolar world. Consequently, it is very important that we reassess the role of leading international organisations and institutions.

If only we could have this kind of leadership in this country.  I was convinced that Obama would not simply revert to politics as usual, and my hopes have been severly dashed.  We are screwed up more than I thought.  You cannot fix free markets with state intervention; our speaker will attest to that.

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.

Meanwhile, the world financial system is in meltdown.  The worldwide housing bubble and deflation is finally being priced into the stock market.  It is complete and utter housing panic.  There is no safe haven at this time.

Personally, I cannot believe some of the deals out there in the stock market!  Armageddon is priced in.  Many stocks yielding more than 5%.  If yields stay at this level, sheer and utter panic is the only reason.  I’ll be getting some sun and water for all of you there.  Good luck to everyone.

I have a lot of money invested in the stock market, but I have a lot more invested in mine and my children’s future.

See how the 228 voted against the bailout from the New York Times.

We’ve got a full-blown taxpayer revolt on Congress’ hands.  There has been enormous amounts of scaremongering going on today with everything from ranting congresspersons to talking head reporters, and man-on-the-street info from traders on the NYSE floor.

The stock market took one on the chin, and could erode further if bailout proposals are blocked.  My hope is that until some seriously different legislation gets proposed, I will personally oppose this on the SCREBC blog.

And, for today’s reflection, we’ve got to give kudos to Dr. Ron Paul for opposing the bailout:

Now that the meltdown is in full force, are there still many reasons for leaving?

Here are a couple I can come up with:

1. Even with prices falling +30%, Southern California is still one of the more expensive places to live in the US.

2. The terrible economy means fewer jobs, the reason most of us came here in the first place.

3. Freeways are still clogged

4. Taxes are still high.

5. The state is undergoing a fiscal crisis, almost assured to mean even higher taxes

6. Maybe it’s my perception, but violent crime seems to be on the uptick

7. We still have the worst school system in the country.

8. Prop 13 ensures the rich a great tax subsidy.

On the flipside, I can think of some reasons to stay:

1. Cali is probably going to come back and have more jobs…

2. You can get a double double protien style with no onion pretty much any time, any where.

3. Housing prices are falling faster than the OC register and Lansner can report that we’ve hit a bottom.

4. The weather, you know. It’s not that bad.

5. Where else can you work for the state and get paid minimum wage?

What do you think?

Foreclosures across the state surged to a 20-year high during the last three months, as tens of thousands of additional Californians lost their homes and more than 100,000 neared the brink.

Notices of default, the first step in foreclosure proceedings, rose nearly 125 percent from a year ago during the second quarter and trustee deeds recorded, which reflect the actual homes taken back, soared more than 260 percent, according to research firm DataQuick Information Systems.

But, this doesn’t even come close to telling the full story. Fact is, it isn’t the highest foreclosures in the last 20 years, which would imply that it was higher 21 years ago. Not so. In fact, these are the highest foreclosure statistics EVER.

Noone demonstrates that better than BubbleTracking in the update to the LA Times graph of foreclosures. Thanks OCRenter!

What’s noteworthy is the backstory to the image. The original LA Times article was somehow attempting to soothe buyers that the real estate market was healthy, in part because foreclosures were at historic lows.

Even more onerous than the picture above is another factoid of the story.

The number of defaults and foreclosures were the highest in DataQuick’s statistics, which go back to 1992 and 1988, respectively. Among homeowners who fall into default, an estimated 22 percent now emerge from the foreclosure process by catching up on their payments, refinancing or selling. That’s down from 52 percent a year ago.

That’s an incredible fact. In other words, 78 Percent of those entering the foreclosure process end up going through foreclosure. Considering that there is a record number of notice of defaults, we are ensuring years worth of upcoming foreclosures to push down prices. Recent report have showed that banks are swamped simply with the volume current in process and unable to expand to the need. Early in the bubble blogging world, more than 90% of those who received a notice of default were able to cure their delinquency due to quckly rising prices. Now, with prices falling 30% or more per year, one misstep is a lucky break for a would-be homeowner to simply walk away.

The funny thing is, I remember less than a year ago, discussions about how Freddie Mac and Fannie Mae were well capitalized, preeminently prepared for any disaster, and frankly, as unsinkable as the Titanic.  Little good that has done.  We may be witnessing a historic crash of epic proportions, greater by far than the crash we have seen to date.  To put it in perspective, FRE and FNM have pretty much been the only thing that have kept the real estate market together in the US over the past year.

Consider for a moment this statement regarding the mortgage insurance statistics from the GSEs.

There are more hard numbers available to support MI’s recent surge. MICA, the trade association representing the private mortgage insurance industry, began reporting rising volume monthly after February 2007. For example, mortgage insurers wrote 190 percent more business this year, through April, than in the comparable period of 2006, when subprime/Alt-A were in their heyday.

To put that sort of gain into proper context, consider that even GSE production is only up 160 percent — and they are doing an estimated 80 percent of all new mortgage lending. By inference, MI providers have made huge gains in market share.

Let that sink in for a moment:  GSEs are doing an estimated EIGHTY PERCENT of all mortgage lending, up 160 percent.  IN AN ACTIVELY FALLING MARKET.  Any implied “worst case scenario” imagined last year of the US government bailing out the grossly irresponsible GSE lending facilities is quickly not only becoming a reality, but would represent a necessity unless the entire lending business  in the US becomes STATE OWNED.

State owned lending?

Is that such a bad idea?  I mean, we pretty much have so many controls that we expend an enormous amount of government money in oversight, what’s so wrong with giving the federal government the right to nationalize the largest lenders as they fail?

I’ll write the next part only partially tongue in cheek.

Lending is perhaps one of the great debatable rights of Americans in the 21st century.  We have become so conditioned by its availability to believe that it is owed to us.  We need it, we want it, we should have it.  If we want to create our own financial ruin, and by extension the country’s entire financial ruin, we should be able to do so.  It is our right as Americans.  By this rationale, we should allow all Americans the right to open access to low-cost lending much like clean air, clean water, food and drugs free of harmful contaminants, and an interstate transportation system.

For example, if free enterprise were required to finance our transportation systems, we would be required to pay for every trip we consume on local and long-distance roads.  This is where economics has a hard time playing the role of moral coach, because, frankly, Economics is concerned with the free market and the most efficient method of delivering the utility people desire.  Governments have typically only concerned themselves with PUBLIC NEEDS.  Therefore, the big question is, is real estate lending a PUBLIC NEED?

I am certain that many could make the argument for and against, but perhaps the question needs to be viewed in a longer timeframe.  Is lending STABILITY more important as an ongoing public need to ensure the ability to liquidate lending and homes in an orderly manner?  What controls and insurances should the government provide?  How should the government handle lending standards and manipulation?  Could there be a cross-control against lying using collaboration with the IRS?  What kinds of manipulations would this open up the home lending business to?  Would the government “crowd out” any potential competitors and therefore stifle competition?  Has the current role of home lending harmed the public more than it has helped?

In any case, the general public perception is that home lenders have harmed America, and therefore must be harshly dealt with.  I don’t agree with that.  I personally believe that the problems is on its way to being fixed by the free market, and frankly I’m not happy with the directors of the GSEs getting away with fat pensions, stock options, and the like while the public swallows the bad debt.  On the other hand, it would end, once and for all, the deceptive practices and level the playing field by nationalizing lending.  Frankly put, the government could recapitalize easier than a private entity or a stock-owned entity.

I have to say that I oscillate between incensed outrage and cold acceptance of the reality.  There is no simple answer to that.  Lending has changed forever (hopefully).

If I had followed conventional wisdom and sold in may, I’d be a bit behind where I am now.  It’s not bad that I’m outpacing the S&P500 by 30% this year.  I’m happy with the results so far.

Investing takes a lot of time to get it right, and frankly, I’m just now reaping the rewards of investments made more than 1 year ago.

Thanks for all of you sticking around, and most of all listening to my jack-assed comments about how great I am at market timing.

There’s still room for a fund in the future!

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’m sure some can appreciate how this is actually greater than the 17% “in the bag” that Gary Watts promised us in 2006 in reverse. After an already negative appreciation in 07 and depreciation on the way down is the inverse (more $ on the downside than on the upside per percent), prices are easily back to 2005 prices in the median, and 2004 and 2003 pricing for what is actually selling. The crash is continuing.

Remember the original rule:

If there is any chance that someone can get bailed out by someone else, they will, and you will have to pay for it from your own pocket.

I had to later add:

while you may need to pay for it, anything other than letting the market deal with it efficiently will likely crash it anyway

This time, I’ll have to add the following:

And messing with it will make it crash harder than if you had just kept your stupid nosy butt out of it.

and that’s how I can frame the message to those reading the MSNBC article about “saving” people from their underwater houses.

The current plan to “save” homedebtors is to “forgive” the amount that borrowers are underwater. Meanwhile, the Jeffrey Birnbaum seems to take the tack that we should be poopooing on the stupid lenders for lending that amount in the first place. Naturally, banks are fighting it. In the short run, this “solution” becomes their problem. Unfortunately, in the long run, it becomes everyone’s problem.

The legislation would allow bankruptcy judges for the first time to alter the terms of mortgages for primary residences. Under the proposal, borrowers could declare bankruptcy, and a judge would be able to reduce the amount they owe as part of resolving their debts.

There are at least 2 significant problems with this solution.

1. There is a moral component to paying back what you owe. It is supremely unfair to prudent citizens when gamblers and speculators are saved from their own poor decisions. But, it goes further than that; this bailout encourages more risk taking and gambling – a term referred to as moral hazard. The fear is that open risk taking can create systemic risk that at some later date cannot be bailed out; the captains must go down with the ship.

2. The other is the physics of a forgiveness. Like Newton’s third law of physics, for every action there is an equal and opposite reaction. If Banks believe that they can lose up to 20 or 30% of the value of a home, they will begin to require borrowers to “self insure” by raising collateral requirements to mitigate their new risk. They will also likely offset the risk through higher risk spreads translating to substantially higher rates with stricter requirements for credit worthiness.

Consider who this is attempting to help:

The Democrats and their allies see the plan as an antidote to the recent mortgage crisis, especially among low-income borrowers with subprime loans. The legislation would prevent as many as 600,000 homeowners from being thrown into foreclosure, its advocates say.

The poor? Who would least likely be able to handle an increase in the collateral requirements and interest rates set forth for the purchase of a home? My belief is that if this law is passed, it will severely deepen the housing crisis. Indeed, this will likely make the housing problems a super-crisis; akin to raising interest rates in a deflationary environment. This would mean not only that we would be erasing all of the gains of the bubble, but likely much, much more. If first-time buyers were required to save 20% collateral again, it would literally shut down the first-time homebuyers in Southern California. It would not return to the existing levels for perhaps another generation as the system cleanses itself. All of the increased savings would have a positive effect of actual savings, but it would create a severe recession since consumers would need to retrench and cut off discretionary spending. We could easily see homeownership rates erode by 10% or more over the coming decade of turmoil.

This “solution” is quite possibly the worst kind of consequence in itself. It will crash housing markets in high-priced locales and deepen the coming recession throughout the country. I’m a fan of just letting the markets right themselves and sort out the mess itself. Any kind of well intentioned tinkering will only make the problem worse. The time to act is past and cannot be recaptured. The right time to fix the problem was to prevent it in the first place.

Unless the US Government wants to become the lender of last resort (see the discussion of systemic risk) and to personally insure low collateralized mortgages in an inflated market, there is no way this legislation cannot wipe out innovative lending. All of the lending and borrowing participants will have been crowded out by risk aversion.

Let’s hope that our government is aware enough to see what this would do and kill this legislation before it becomes a reality.

Don’t get me wrong, I’m no banksters apologist. They are greedy, self-serving, and destructive. Their moral compass is broken and their money guides their actions. Congress, unfortunately are worse. They work with a corrupt moral compass and other people’s money.

Here’s hoping that if Congress can’t pull their heads out of their collective asses that President Bush has enough sense to wield the necessary veto rights. The very civil liberties of property rights must be protected; both for individual citizens and corporations. Once we take it from one class, we can take it from others; it’s only a matter of time before we find a reason to.

I believe a lot of that timing will come from Bernanke’s will to crush the housing bubble. If he doesn’t, it’ll be a long time before we can get well again. We need to take the tough medicine.

Early October home-selling stats from DataQuick show the credit crunch’s grip on the market. Difficulties getting mortgages meant sales activity was down 41% vs. a year ago for the 22 business days ended Oct. 12. If that holds, it’ll mean that O.C.’s losing streak will hit 25 straight months where the buying pace failed to meet last year’s activity levels.

Pricing was also weak. The overall median selling price, down 8.8% in a year, held at the 31-month low ($570,000) hit last month.

It appears that median prices are beginning to show the overall trend in pricing. This could mean one of 2 things:

1. Lower end is recovering

2. Higher End is also feeling pressure now.

Originally, I forecase a median price down year over year for 2007 to be in the 3 to 5% down range. That may prove to be too optimistic, and reality further from that.

Consider what is now typical pricing:

23 Nopalitos Way, Aliso Viejo

1923 Sq Ft 4-bd, 2.5bth. Gated Community. Recent foreclosure. Landscaping dead, dead, dead.

List Price: $604,900

Last Purchase Price: $740,000

Last Purchase Date: 9/13/2006.

Loss in Last 13 months if asking price is met: $135,100 (18.3%) (23% after commissions)

Zestimate: $756K (Can you say disconnected?)

These houses sold 5 years ago in the 300K range. I wouldn’t be surprised to see mid 400′s, if not low 400′s.

So, isn’t the 8.8% reduction in median price still skewed a bit high? Yes. On upswings, it understates the increase, and on downswings, it understates the decrease. It’s more of a lagging indicator.

Enjoy your weekend

I always enjoy a discussion of how the mortgage mess that we find ourselves in can be “fixed” by using nontraditional methods.  For each of the parties arguing the solution, it often involves directly benefitting them, while the cost is to be borne by another group… “the marks”.

Mike Shedlock’s analysis of the CRL (Center for Responsible Lending) and FDIC’s proposed solutions is particluarly interesting.  His post is properly titled “The Debt Slave Act of 2005 Revisted“, which makes perfect sense considering how consumers have effectively been cut off from the one chance to make a clean break after devastating financial problems.  Instead, the newer law attempts to weed out deadbeat habitual spendthrifts from performing frequent and repeated filings to wipe the board clean every few years.  Instead, it has made it difficult enough to file bankruptcy that there is little to no possible way out.  In addition, with pledges to repay, many become debt slaves to past problems, unable to leave them in the past.

Don’t get me wrong, I’m definitely for personal responsibility in life, perhaps even too much; but the law as it currently stands puts a burden on already destitute people.  It has served to benefit lenders most of all.  So, it is with some twisted satisfaction that I read what Mish has to say on the matter… all of with which I agree.

First, he quotes a CNN Money article (shortened excerpt)

One consumer group estimates that 600,000 foreclosures could be avoided over the next two years by making a simple change to the bankruptcy code.

The Center for Responsible Lending (CRL) calls it a tweak, but it could be a significant change for homeowners and the market for mortgage-backed securities.
CRL’s proposal – reflected in a House bill recently introduced – would make changes to the regulations for Chapter 13 bankruptcies, which don’t wipe out debts, but rather establish a repayment plan.

Under current law, when a person files for Ch. 13 bankruptcy, judges cannot reduce mortgage debt owed on a person’s primary residence, although they may modify mortgages on investment property or second homes.

Under the House bill, the bankruptcy judge would have the option of reducing what the homeowner owes the lender. Say a homeowner’s property is worth less than what he owes. The judge could reduce the principal to match the home’s current market value as well as reduce the loan’s interest rate.

Mish also quotes the FDIC’s proposal:

The heat on U.S. mortgage lenders and servicers was turned up a few degrees this week when the country’s chief bank regulator publicly proposed that they permanently freeze interest rates on subprime adjustable-rate mortgages (ARMs) for many homeowners.

“Keep it at the starter rate. Convert it into a fixed rate. Make it permanent. And get on with it,” Federal Deposit Insurance Corp. Chairman Sheila Bair said in prepared remarks at an investor’s conference.

That solution is nearly as bizarre.

Now, before too many of my readers go off on rants considering how this is supremely unfair… consider 2 things:  first, if balances on loans can be decided in a court and lowered as a judge feels inclined, how many banks will want to loan money, and secondly consider what Mish has to say regarding “fixing” the ARMs:

It should not take a genius to figure out that if ARMs rates are “frozen” at a point where the market does not think rates should be, there simply will be no more ARMs offered. Furthermore, to cover the cost of existing ARMS, prices would rise on new fixed rate mortgages. Oddly enough, price fixing ARMs would not even help the person most at risk because that person cannot afford the teaser rate, let alone the cost of a current ARMS rate. Thus price fixing ARMs is a sure fired guaranteed way to cause a continued weakness in home prices, if not an actual out and out crash.

Which reminds me of the original Chuck Ponzi Law of Unintended Consequences:

If there is any chance that someone can get bailed out by someone else, they will, and you will have to pay for it from your own pocket.

Now, I’m considering that I have to add that while you may need to pay for it, anything other than letting the market deal with it efficiently will likely crash it anyway.  In the end, it is the same thing that my first Econ professor in college always said was the #1 rule of economics:  TNSTAAFL “There’s No Such Thing As A Free Lunch”.  No such thing.

I am willing to bet that any artificial means of attempting to “solve” the problem will only make it worse, both for the person they are trying to help, and the overall group of people.  The only people helped by the above solutions are those who have ALL of the following:

1. Long histories of repayment
2. Excellent credit scores
3. Lots of cash for a down payment, maybe up to 30 or 40% to prevent bankruptcy write-downs
4. Enough income to support purchases on fixed rates with lengthy work history.

This way, only the most qualified can purchase.  At current prices, there are likely only 1 to 2% of the people in the entire Southern California region who could fit this bill for an average home.  And, frankly, there is no way these people will live in an “average” SoCal home.  Imposing the suggested “solutions” will only serve to do three things:

• Depeen the credit crunch
• Crash the housing market
• induce a consumer-led recession, if not depression

The deeper the credit crunch, the harder and farther housing prices will have to fall to meet demand.  The harder and further prices fall, the more likely that good paying homeowners will walk away from an underwater mortgage.  More foreclosures dropping prices and deeper credit crunch will turn off MEW (Mortgage Equity Withdrawals) which is what has been keeping the consumer (along with their credit cards) in clothes, vacations, and Plasma TV’s.  A crumbled consumer is a crumbled economy.

When the service on debt becomes more than the income, defaults are certain.  Since US wages have been in real decline (against inflation), and the US dollar in severe decline, the loss of purchasing power has become an unbelievable crush.  Anyone who has not felt and seen the substantial inflation over the past 2 years has either been asleep or dead.  Even high-end wage earners have felt the sting of higher prices.

All of this leaves me very pessimistic about the local economy that has been so built on the fortunes of real estate.  I fear we may have much, much worse things ahead of us compared with the past few months.