Chuck Ponzi Law of Unintended Consequences II

On October 8, 2007, In Credit Bubble, Debt, Housing Crash, Inflation, Mean Reversion, By Chuck Ponzi

Some longer time readers will remember a post that I made back in April of this year titled “Chuck Ponzi’s Law of Unintended Consequences“.  That post detailed the bail-out idea du jour… foreclosure moratoriums.

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.

 
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“Now is the Time to Hunt for Housing Bargains”

On August 9, 2007, In Bubble, Contrary Indicators, Housing Costs, Housing Crash, Inventory, Mean Reversion, By Chuck Ponzi

This was the headline of some financial reasearch issued by Joseph Hargett of Schaeffer Research on March 27th, 2007.

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.

Homebuilders Stocks

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: View sentiment for LENsentiment, chart, options) and Hovnanian (HOV: View sentiment for HOVsentiment, 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.

 
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Not So Many Courters After All

On May 3, 2007, In Credit Bubble, Debt, Mean Reversion, SubPrime, By Chuck Ponzi

OK, the jokes can now officially begin.

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

 
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“Warm and Has Pulse”

On April 20, 2007, In Housing Costs, Inventory, Mean Reversion, By Chuck Ponzi

DR Horton is doing what I have predicted builders would do:  offset falling housing prices by building more, not less (as housing bulls suggested).  Their reported earnings fell 85%.  Not much of a surprise.

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.

 
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Getting It, Some Agents Do

On April 17, 2007, In Mean Reversion, Psychology, San Diego, Short Sale, Speculation, By Chuck Ponzi

After my last post, one might believe that real estate agents have no other opinion than the mantra of “housing prices only go up”. For those ill-informed and those lacking true experience in a down market (or at least studied one out more than attending a Gary Watts cheerleading session), there is little to convince them outside of the crushing pressure of the future markets.

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.

 
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“Bailouts can make people more reckless in the future”

On March 28, 2007, In Credit Bubble, Debt, Lending Standards, Mean Reversion, By Chuck Ponzi

With recent talk from Senator Dodd about a bailout for the “little man”,  we’re left to ponder who a bailout would really help or hurt, who pays, and who benefits from it.

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.

 
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Don’t Blink or You’ll Miss the Truth

On March 19, 2007, In Mean Reversion, Psychology, By Chuck Ponzi

There is an old saying that if a lie is told enough times, it becomes truth. For the lack of a better term, there is a definite misconception I have seen floating about the internet that has begged for a response from someone – if not in the mainstream media, at least a blogger to attack it. Since noone has bothered to rid themselves of the problem, I guess I’ll do my best at continuing to dispell myths. (Calculated Risk already did some here)

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.

SP500 to NAHB Index

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:

NAHB SP500 Mine 1

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

NAHB SP500 Mine 2

None that I can see.

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

nahbspx3.PNG

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.

Grilled Cheese

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)

 
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Slow RE News Day in SoCal

On February 26, 2007, In Bubble, Contrary Indicators, Mean Reversion, SoCal, By Chuck Ponzi

Slow News DayThe slow news days the past few days in SoCal has given me an opportunity to take a trip around the area. This last weekend I failed to post because I was visiting locations in Orange County, Riverside, San Bernardino, and Victor Valley. Needless to say, for me it was busy.

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?).

(more…)

 
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Chuck on Dead Cat Bounces

On February 20, 2007, In Bubble, Dead Cat Bounce, Mean Reversion, Psychology, By Chuck Ponzi

With the mainstream media in a tizzy about whether housing has bottomed or not, the professional wishers and hopers are all too quick to tell us that everything will be fine, everything is ok.

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.

(more…)

 
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Rents Not Measuring Up?

On January 19, 2007, In Mean Reversion, Rents, By Chuck Ponzi

Some time ago, we debunked the myth of rising rents in Southern California due to the housing Bubble. The title of our post was Rents to Follow For Sale Housing Trends?

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.
…
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.
…
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.

 
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