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.

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

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

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

70% Loss

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

71% Loss

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

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

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

72% Loss

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

73% Loss

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

74% Loss

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

76% Loss

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

Winner!

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

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

Notable mentions:

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

Lower than 92 pricing:

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

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

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

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

Keep in mind that this advice is free, and you get what you pay for. If I were in the same situation, my actions might be different from what I am currently doing simply because each person and situation (as well as timing) is different.

When we left our friend Boomer yesterday, I had advised him to sell his home in Arizona even though that wasn’t the question. There was no question that the house was overvalued based on normal valuation methods. In addition, rates have remained stubbornly high despite a strong easing campaign by the Federal Reserve Bank. To that point, just over 2 years ago, I wrote about interest rates and what that portended:

1. Why are rates going down over time?
2. Is there a savings glut?
3. Why are risk premiums (spread) so small?
4. Are we about the enter a recession like the other small spreads indicated?

To the last point, if we enter a recession, is there any chance that housing can be saved through inflation? Does this mean 70’s style stagflation, or even worse, Japanese style deflation with ZIRP?

If anyone can provide a coherent way that housing can survive in the next 2 years, please tell us now!

At this point, I think we are out of options from a monetary perspective.

1. We already have inflation. Dropping rates will make it much, much worse.
2. Economic growth is slowing despite the mad dash of construction.
3. The credit market is precariously spread and rates could make a mad dash upward if international investors get spooked and run for the exits. The only way to keep the Dollar from meltdown at this point will be to raise rates even more.
4. Housing speculators will be crushed by negative amortization and high interest rates in this event(which arguably should have already happened by now).
5. The sitting inventory will cause personal financial distress and combined with the mad dash of rates could generate a general credit system event.

Either way, we will be seeing a much more favorable buying environment for housing in 3 or more years due to the general stress and turning of investor sentiment.

The backdrop of investor sentiment is the worst that I can remember, insomuch that you have everyone talking about a financial armageddon:

Buffet Struggles

Todd Harrison is 100% Cash

and, don’t forget the fear du jour:

Oil climbs peak, economies plumb depressions and the future will not imitate the past

While I agree that the next 10 years will not look like the last, I do think that there are plenty of opportunities that can be entered into in the next 6 months.

First, I have a couple of predictions:

1. The DOW should hold somewhere between 10,000 and 10,500. If it breaks that support level, even I’ll admit I haven’t a clue where we’re headed there.

2. I do think we are headed for a U-shaped recession, but that we have entered that recession 6 months ago and that we should emerge sometime in the next 18 months.

3. Oil is a bubble, but like the housing bubble, it is unpredictable. But, whatever you do, do not listen to the experts. They are called the experts because it’s up. If it were down, they’d be called idiots like bubble bloggers were circa 2005.

So, what should Boomer do with his new tax-free windfall?

I am also not quite 50% cash now with some recent purchases, but I do have a major cash position. I won’t recommend specific stocks, but there are some areas that I will generally avoid:

1. Oil-centric energy stocks. This is really dangerous because we learned from previous energy shocks, the seeds of conservation are being planted now and will grow into the future. Oil could very easily crash.

2. Look for investments that provide a cheaper way of performing necessities, or some game-changing technology that reinvents its space in a necessity. (wouldn’t we all like to find them) while avoiding consumer-centric stocks (many of which have already been trounced)

3. Small caps that rely heavily on borrowing for operating expenses. Many of these are already having difficulty obtaining financing, or even maintaining revolving lines.

Personally, I have invested most heavily in individual biotechnology stocks that have previously crashed by have a strong pipeline. Pharmas and biotech are littered with the remains and half-eaten carcasses from failed drugs, but entering after a crash for a company with strong fundamentals can provide some cover for potential falls. Personally, I stay away from pharmas with “lifestyle” drugs such as ED treatments in favor of those with candidates for life extending treatments for cancer, heart disease, and alzheimer’s. With an aging boomer population, I believe that we can still see strong growth in these areas in an attempt to “fix” the medicare problem. The companies I look for are those that don’t just extend life, but prevent deterioration of mental and physical faculties as these will be.

Any way you look at it, even investing in CDs is going to provide a better return for the next 5 years than real estate.

Boomer, sell and find a good place to park that money. Find a few funds that you believe in, or do the research yourself. All of the easy money was made and now it’s down to the nitty gritty of investing… yield, growth, and preservation. Good luck

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.