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.

While he’s not a policy maker, having more media outlets understanding why high housing prices are putting a brake on our economy is critical to getting past the downturn.

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?

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.

from Interest Only – Creative Financing or Harbinger of Deflation?

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

The economists over at Elliott Wave have a great write up about deflation and what causes deflation in a piece titled “What is Deflation and What Causes it to Occur?”

All deflationary periods were marked with the following conditions:
(a) All were set off by a deflation of excess credit. This was the one factor in common.
(b) Sometimes the excess-of-credit situation seemed to last years before the bubble broke.
(c) Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases years, in advance.
(d) None was ever quite like the last, so that the public was always fooled thereby.
(e) Some panics occurred under great government surpluses of revenue (1837, for instance) and some under great government deficits.
(f) Credit is credit, whether non-self-liquidating or self-liquidating.
(g) Deflation of non-self-liquidating credit usually produces the greater slumps.

From the article: “Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time from production. Production facilitated by the loan – for business start-up or expansion, for example – generates the financial return that makes repayment possible. The full transaction adds value to the economy.”

Credit lent against homes are most definitely non-self-liquidating credit. Unless, you count the opportunity cost of renting as a form of liquidation – however this requires there to be some relationship of rents to monthly payments; something that can’t be said of current market. The relationship of these nonproductive asset backed loans to productive asset backed loans, it would seem is at its peak historically.

Reading this type of semi doom-and-gloom scholarly article makes me think about the many types of financing recently available to the public masses and what impact they might have.

It takes a bit of economic sense to understand a risk premium. A risk premium is an additional amount that a lender expects to compensate them for additional risk. If risk is considered great either a high risk premium is attached or sometimes a transaction cannot take place. We currently have some of the lowest risk premiums in history; interest rates on non-productive assets are at historical lows.

Typically, a lender requires that at some point, principal on the note must be paid back. Interest only loans are an exception to this. Why? And, why have they become popular now?

It’s easy to see why a borrower would want to take on one of these loans; why pay for something now if I can pay later. But, what’s more interesting is why are they so popular for lenders?

Human beings are a fickle bunch. Each one wanting to do something different than the other. Like watching an ant, it runs to and fro, sometimes lost, sometimes productive, but always unpredictable. But, take a step back, and the anthill is an extremely efficient, coordinated jumble of activity. A very predictable bunch. Human financial systems are similar. Each borrower is very unpredictable, but bundle a few thousand together and they suddenly become more predictable; hence the popularity of Mortgage Backed Security Bonds (MBS’s).

BUT… and you knew this was coming… you need to take even a step back to see what is going on in the macro environment. Who has all of this money, and why are they lending it at such low rates. A flat yield curve would signal that lenders see little reason require a larger risk premium for longer-term loans because they expect long-term rates to be about where they are far into the future. How often is the bond market right? Well, that’s for you to decide. Greenspan has even named it a conundrum.

So, this brings me to the title of my post. How could interest only loans signal possible deflation in the future? We already know that low-interest rates can be a signal, but what about creative financing?

Interest only loans cannot be self-liquidating in the short run. When they switch to a liquidating (fully amortized) loan, the payments jump substantially because they do 2 things at once: 1, they begin fully amortizing 2, they adjust to prevailing interest rates. One would expect that people faced with these issues would simply replace the shorter amortizing period with a longer amortizing period at the same rate. Or, they would attempt to liquidate the loan by selling. Since interest-only loans are not self-liquidating in the short run, the bond market is signalling that for the medium-term, interest rates and returns will be low, or that investors are extremely risk-averse to the stock market. The investors feel justified that any possible deflation is offset by the Fed’s moderate inflationary policy, or at least an attempt to prevent deflation. So, MBS investors have signalled that for the medium term (3 to 10 years), that they would rather take their chances with low interest rates AND non-liquidating debt.

Will this truly end as Greenspan has put it? I will leave you with one of his most famous statements on the subject:
“But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.“

And, a flashback is always great. Someday, we will see this as an example of how wrong people too close to it can call it:

So Subprime Blows Up; So What, Says Cramer

1. The bubble will or will not burst depending on your definition:

Predictions:

Sales Price: Down 5-7% correction

Sales Volume: Down 10 to 20%

Actuals:

Sales price: Down 13.3%

Sales Volume: Down 45.3%

Comments:

I whiffed this one. I believed strongly that we could encounter a credit event at some point in 2007, but as all events are, they are hard to anticipate exactly how swift they will start or end especially a year in advance. I was way too optimistic in 2007, though not nearly as optimistic as Gary Watts who predicted a 7% increase in prices.

I think that no matter whose definition you are using, the bubble burst in 2007. Only Gary Watts can’t see it, and he’s got to be the only person in the entire world who cannot see it.

2. The Subprime Mortgage market will shrink considerably.

Volume Prediction: Down 40%

Volume Actual: It has been difficult to find a reliable source that can be quoted, as even the MBIA doesn’t have a grasp on what happened in 2007 yet, it is safe to say that subprime was likely much more than 40% off from 2006. Many of the major subprime companies went Tango Uniform this year, while those that (somewhat) survived have been castrated (Countrywide total volume was halved, subprime near nonexistence)

Comments:

This again was unpredictable due to the sheer volume and speed of failures of subprime lenders. It is very likely that subprime will contract back to its 2001 or 2000 originations volume, which is about a 95% retracement. Reversion to the mean.

3. Gary Watts will not realize how bad he is at predicting things, and he will still make a lot of money this year.

Comments:

This is a no brainer. Gary Watts is quite possibly the worst predictor of housing in Southern California. Even the most hardened and staunch supporters were asking questions at the beginning of 2007. If you were completely surprised by last year, I suggest you stop covering your ears and eyes.

Still, I’d like an opportunity to offer as many workshops as he does. He knows no more about the local real estate economy than my 4 year old, and yet he’s highly paid for his “work”. So much for reporting integrity if he’s just doing it for the money. If he really believes it, I have to wonder how he’s able to dress himself in the morning. Normally that kind of mental retardation imposes some pretty stiff limitations on your ability to care for yourself.

4. We will have asset deflation with stable (high) CPI inflation.

Lead story on Yahoo finance today was titled: “Inflation Rate is Worst in 17 Years“. Housing prices are plummetting in almost every locale.  Nuff said.

5. I will be spending more time on posts

I did… I really did. Sometimes it seems like I take long breaks between, but it’s because I hold down a regular job, run an internet business on the side, am involved in community and church affairs, and I have a wife and 2 young children.

I will be following up shortly with the belated 2008 predictions. Suffice to say, it’s not going to be positive. We won’t be seeing a bottom in 2008, much less a rebound.

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.

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.

New Century is now Old Century and some such garbage.

New Century announced that 2000. Yes, 2000 employees will be severed tomorrow (no, not their limbs, just their jobs).

From Forbes:

Financially strapped subprime mortgage lender New Century Financial Corp., failed to receive any bids for its mortgage loan origination business, forcing it to shut down the unit and lay off around 2,000 employees, the company told employees Thursday.

The Irvine-based company, which has been preparing to sell off its assets under Chapter 11 bankruptcy protection since last month, notified employees during a conference call that they would be laid off effective Friday.

Speaking on the call, New Century President and Chief Executive Brad A. Morrice said despite a number of potential buyers for its wholesale and consumer-direct operations, “none of those potential deals have come to pass.”

Just who those original “suitors” were remains a mystery to the outsiders. I remember clearly the day that it was announced that 6 companies had thrown their hats into the ring. I guess there was a realization that little to no value remained in that portion of the business. Of course, not all is lost, the servicing arm has already lined up buyers.

It’s good to take a look back at how hopeful that really was. Irrational Exuberance?

Interestingly, last night, my wife made me watch American Idol. One of the departing contestants (I don’t know or remember who) sang the Bon Jovi hit “Blaze of Glory”.

Therefore, I dedicate this video to New Century:

No I aint looking for forgiveness
But before I’m six foot deep
Lord, I got to ask a favor
And I’ll hope you’ll understand
cause Ive lived life to the fullest
Let the boy die like a man
Staring down the bullet
Let me make my final stand

Here comes the best quote, related to DR Horton’s cancellation policy:

Unlike other home builders, Horton said it has no plans to weed out potential buyers who may not be able to qualify for a loan in order to bring down the cancellation rate.

“As I’ve said to all our salespeople, if a buyer is warm and has a pulse, we want to put them on paper,” he said.

You could tell the whole story in that single phrase.

On the other hand, there are agents who will actually flourish in the coming real estate bubble pop. These hardened souls know the importance of negotiation, and have experience to back it up. Agents like these are well worth their six percent. I came across just one of these recently. I have only had brief contact with his business partner Lina, but after reading his website, I am convinced he’s at least going to maintain his business while many others like our aforementioned Mr. Pannatoni are going to scramble. Embracing change is key to managing it.

Turning to his site, we read:

The Return Of The Short Sale

If you lived in the Shadowridge area or anywhere else in California about fifteen years ago and owned a home, you probably remember short sales – they are back.

A recent report from Sacramento sounds eerily similar to the 1990-1996 California real estate bust, except this time, home prices are multiples of what they were back then, therefore….so will be the drop!

I have been talking about inflated home values and financing foolishness for several years now. In 2000 or so, there were the 125% loans, scary, but home values began marching upwards as real estate looked attractive to the folks who had chased the .coms.
Folks wanted to grow what they had made or rebuild what they had bled in the stock markets.

Greenspan had raised interest rates decimating investments that were already overvalued causing a mass exodus from the equity markets into real estate. Then rates dropped again and property values begin to rise further. Builders who were behind on keeping up with housing demand began to build like mad. In addition, the folks to begin to, once again, speculate in real estate just as they did in the stock market. It was easy because of technology and the web.

Day trade this stock….flip this house!

Now, the folks who can really afford to own a home, are seemingly leaving California in droves. We have lots of people coming but not the type who can afford to buy these homes. These new citizens are more likely to use our social services and put a burden on our resources.

I don’t know if the statistics show it (I haven’t bothered to check), I just know the termite inspector we use told me 18 months ago that 3 out of 5 of the homeowners who he is doing inspections for, are leaving the state. And this continues.

With so many homes at such high prices and so few buyers, what happens?

The 35% property value drop that we saw between 1991 and 1994, that’s what happens.

Thirty Five Percent. That was pretty much the price drop we saw across southern California during that period. There were pockets that did better, there always are. But, pretty much across the board in southern California, the home prices dropped by 35% or more.

I remember, I was selling foreclosures and doing short sales for homeowners in the Shadowridge area during that time. By the way, what was your real estate agent doing back then? This would be a good question to ask them, before you list your home for sale of course!

The possibility of a short sale arises when you need to sell your house, but you owe more than it’s worth – like a fully-financed new car being driven off the dealer’s lot, you are “upside-down” on your loan as soon as your tail lights have crossed the curb.

That is exactly what has happened to thousands of homeowners who, for a variety of reasons, should never have bought homes but did. Most of them putting no money down. Many of these homeowners are also investors who own more than one home. Speculating on real estate just like they did in stocks.

Here’s the rub. If, for one reason or another, these homeowners must sell, then they are faced with a few choices, none of which are very appealing:

-Sell the house, and pay the difference to the lender…right

-Walk away, and give the house back to the lender…the lender doesn’t want it but will foreclose if they must or,

-Make a deal with the lender so they don’t wind up with another foreclosure.

I specialized in this sort of thing in the 1990s; luckily for many, I have dusted off my short sale notebook and am now helping people hand their homes back to their lender with the least amount of hassle.

I am becoming a very busy guy.

I have no doubt he is going to be a very busy guy. San Diego County is encountering its share of short sales now.

Thirty Five Percent was a lot back then, and it’s even more now. He could be spot on with his predictions, even if it is just a “back of the napkin” calculation.

Luckily, the guys over at Wharton (which, surprisingly have more credibility than some anonymous guy with a blog) have given the media world some soundbites to play over and over again.

We began speaking of Moral Hazard once the downturn started.  When you fix someone else’s problem, you create an incentive for that person to do the thing that caused the problem… they’ll just get bailed out again.

From Wharton’s school of Business:

“I think that for the moment, they should probably leave it alone,” says Joseph Gyourko, professor of real estate and finance at Wharton, warning that bailouts can make people more reckless in the future. “We don’t want to introduce moral hazard …. We don’t understand this very well right now, so any regulation is probably going to be wrong or imprecise.”

In fact, he says, the market is already correcting the problem. Lenders have dramatically cut their offerings of the most hazardous products –such as loans that require no down payment or proof of the borrower’s income, or those which allow borrowers to decide for themselves how much to pay each month.

Ken Thomas, a lecturer on finance at Wharton, argues that people and institutions that make risky choices are usually best left to suffer the consequences. “When we had the last big financial meltdown with stocks in 2001, did we consider bailing out those who lost money in the dot-com crash?” he asks. “We try to have markets regulate, not the government. Markets do a much better job.”

What we are seeing right now is that the markets are reacting to better information than they previously had.  Like Newton’s 3rd law of motion:  For every action there is an equal and opposite reaction.  In Economics, we say “There’s No Such Thing As A Free Lunch”

Besides, who would a bailout help?  Certainly not homeowners.  How could you weed out who where truly in trouble, and who were opportunists?  Wouldn’t that saving create a need that you would later need to feed?  What about my free lunch too?  Would I (as a taxpayer) need to pay for someone else’s indiscretion?  What about the money I lost in the stock market in 2001, can I get a refund there too?   For those subprime homeowners… many of them came to the table with bad credit and no cash.  So, they’re leaving with bad credit and no cash, is their life that much worse off, and is that our collective problem that they cannot manage money?

On the other hand, lenders wouldn’t lose a penny.  They were the ones who recklessly took risks and offered the loans to the higher credit risk for a higher return.  A bailout would only serve to line their pockets for taking outsized risks.  There’s a reason that it’s called risk in the first place.

Dodd, chairman of the Senate Banking Committee, plans to introduce legislation to protect homeowners from foreclosure and to crack down on predatory lenders who pushed high-risk loans on unsuspecting borrowers. Clinton is pushing for a federally mandated “foreclosure timeout” that would give homeowners more time to catch up on their payments, and she wants to curtail the prepayment penalties that make it hard for troubled borrowers to refinance. The National Community Reinvestment Coalition wants the Federal Housing Administration to be given new power to refinance subprime borrowers’ loans, and it wants the federal government to set up a fund for rescuing low-income homeowners.

Senator Dodd, you are treading on thin ice.  Be careful where you step.  The next one could be the wrong one.  Nothing like a good scandal to end one’s political career.  We all know you’re in bed with the financing organizations… all it takes is one false step.

I enjoy a good thriller as much as anyone else. Oftentimes, the truth is stranger than fiction. This myth, however seems to be created by CNN.com and perpetuated (or at least commented on) by one of the most interesting bloggers that I know of. Interesting not because he brings any specific knowledge to the table, but rather that his biting remarks, poor temper, and lack of in-depth research leaves him to be the butt of numerous internet jokes. Yes, we are talking about Larry Nussbaum. His internet presence has been immortalized by other bloggers declaring “You’ve been Nussbaumed” whenever his presence is made known by his constant truthiness comments repeated over and over enough times at least someone must actually believe them now. His most recent article that I have seen floating around is not actually a new one. It originated a number of months earlier, but the basic jist of the article is that there appears to be some uncanny similarity between the NAHB Index and the S&P 500 Index. The following even appears a number of times in different places on the internet accompanied with the following story:

Tucked away in the briefcase of Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., is a chart so scary she’s hesitant to show it to investors. It plots the National Association of Home Builders’ Housing Market index – a monthly measure of builder confidence – against the Standard & Poor’s 500 stock market index, with a one-year lag.

It turns out that the mood of builders is a terrific stock market bellwether: The correlation between current builder confidence and future stock market returns over the past ten years is downright unnerving.

Not only did the NAHB index presage the start of the post-1994 bull market in stocks, but its decline starting in 1999 foreshadowed the equity market collapse that came the following year. Builder confidence rebounded in November 2001 – a year ahead of the stock market upswing that began in October 2002.

This is concerning from a number of aspects. If it were true, this would represent a significant predictor of future stock market direction.

However, the BigNose.com takes on the trouble and determines that there is perhaps only a cursory and temporary relationship.

If only there were a Sesame Street song “Correlation Is Not Causation”. I bet I’d sing it all the time.

“One of These Things Is Not Like the Others” will just have to do.

Drawing them up myself (now with even more recent data, here is how it looks (previous decade and updated to include current times). There is often too much of a bias to simply reflect our own beliefs (be it bullish or bearish) into the information we read. Minds seeking the truth will be more interested in facts that have been very different from the “expected outcome”

The First one is recreating their baseline to ensure that we have a clear picture of what is going on:

Yep, correlation exists with the base data.  Then, I tried once again the previous 10 years to see if there was a correlation:

None that I can see.

Then, I extended it out to the most recent data:

Sorry, not seeing it anymore.  We have clearly diverged in a statistically significant manner, and I’m just not clear what would cause that if there were some correlation.

Kinda reminds me of this picture at least in part.

I guess you can see what you want to see. To me it just looks like a piece of toast.

The worst part of the entire comparison is that you’re comparing apples and oranges. The NAHB is an absolute measure between 0 and 100. The S&P500 shares no such tether, and frankly with US monetary inflation the way it is, there is really no upper limit. Correlation is definitely NOT causation in this case, nor does it last very long.  Like the normal cheese sandwich that will crumble and get moldy, the CNN article just doesn’t stand the test of time (or history for that matter)

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

We hypothesized that this was merely a scare tactic by RE professionals to buy now or be priced out forever. I said:

What this theory portends is that rents will drive inflation through the stratosphere because housing prices which have doubled in the last few years need to catch up to resolve the imbalance between rent/buy.
…
However this tactic is long on fear, it is decidedly short on logic; at least the old one had “demographic statistics” and some historical context to try to back it up. No, this one makes no sense if you think about it more than the writer wants you to.
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The truth, unfortunately for these schadenfreude hopefuls, is much less stranger than fiction. Like many on the “rent” side who are not so quietly enjoying the demise of overextended homebuyers, there are a great number of homeowners who would love nothing more than to stick it to these snobby renters if their housing ATM goes in the toilet.
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Sorry, no deal. The housing bubble was an appirition that will disappear as mysteriously as it arrived; it was psychology to begin with and that is how it will end.
If rents rise, it is due to rental stock vs. housing demand, not what the investor paid for it and needs to cover each month. Rents cannot be financed and must be paid monthly from cash and income, and therefore cannot be delayed for the future like many of the more recent purchasers have done with interest only or neg-am products.

Indeed, we learned recently that Landlords Lowering Apartment Rates, Offering Incentives as if this was news and none of us saw it coming. The article quotes John Husing (we all know who he is)…

But “there’s a point at which you push beyond where people can afford the price and you run into resistance,” John Husing of the consulting firm Economics & Politics Inc. in Riverside told The Times. “In supply and demand terms, the sign that the price has gotten too high is when you start seeing vacancies go up in the rental market, and inventories go up in the housing market.”

Back in our original discussion, Robert Cote’ and I got into a discussion of the debate between supply & demand of housing stock (my thesis) and basis costs (Robert’s thesis at least at the time) Robert, have you changed your mind yet on this?

It all goes back to the concept of supply/demand lags. For those of us who in college played “the Beer Game”. (Note I didn’t play this until my MBA days since I went to a religious university for my BS where drinking was prohibited). It pits suppliers with lag times from a manufacturer to deal with demand changes and an unclear order/order cancellation process. Kinda sounds like our homebuilder scenarios.

Essentially, what happens is that people on the retail side signal an slight increase in demand which gets amplified throughout the supply chain. Since the short-term shortage signals a much larger demand (if you can’t get Budweiser at your local 7-11, you go to Ralphs, and both 7-11 and Ralphs place an order) and the lag time between increasing supply in the supply chain and delivering it to the market can be as much as years, you can very easily oversupply a market. This is what happened in the early 1990′s in California, and it’s happening again. The only difference now is the bagholder. In the past cycle, there were a very large number of spec homes held by builders. This time around, the speculation was democratized through rampant and pervasive poor lending practices. Either way, we will revert to the mean.

In another article, we learn from the Pasadena Star that overbuilding was indeed the mantra since the turn of the century (at least and probably well into the future as well). There Ismael Abidi from the A. Gary Center for Economic Research at Chapman University tells us:

California gained 723,000 jobs and built 851,000 homes from 2000 to 2005, a ratio of 0.8 jobs created for each homebuilding permit issued, he said.
The long-term ratio of jobs to homes from 1980 to 2000 is 1.7, he said.
“We built too much for the job growth,” he said.

No kidding, Sherlock.

So, what does the future bring?

Personally, I believe we have already reached a cap on rents that cannot increase much (rents must be paid from cash unlike housing prices that can be financed on exotic terms), and that we are at best likely to see rents at the inflation rate (1 to 3% for much of the Southland). That’s if we don’t see a major recession in the next year which according to several leading indicators is not only possible, but likely as well.