Let us warm up our brains and do a visualization activity shall we? Imagine you are in a forest being chased by wild boars. You run through the green and brown shrubbery and hear the grunts of the boars as they follow your scent. Your breathing is intense and you run at full pace toward a light that you see creeping through the forest foliage. As you approach the light, you realize it is heading toward a steep and rocky cliff. The boars are gaining ground. What are you to do? You only have a few minutes and things are getting worse by the second. But then you realize you are a card holding Realtor! And you remember the speech given to you last month about real estate always appreciating and growing branches into the sky! Heck, the speech even went so far to discuss that everything in life given the right mentality goes up like a hydrogen powered German Hindenburg. As you remember this the boars surface, hungry for your flesh. You smile and hold your mantra to your heart and jump with pure glee.
So what is the point of this story? Besides the fact that the boars were only chasing you because you had unopened beef jerky in your left pant pocket the story serves as an example of faulty logic even in the face of imminent danger. Yahoo Finance had a top story today discussing the massive drop in new home prices. The headline reads “Home Prices Plunge by Most in 35 Years” and the article contains this as the opening paragraph:
“The median price of a new home plunged in September by the largest amount in more than 35 years, even as the pace of sales rebounded for a second month.
The Commerce Department reported that the median price for a new home sold in September was $217,100, a drop of 9.7 percent from September 2005. It was the lowest median price for a new home since September 2004 and the sharpest year-over-year decline since December 1970. The weakness in new home prices was even sharper than a 2.5 percent fall in the price of existing homes last month, which had been the biggest drop on record.”
Even in the face of this we get talking heads such as David Lereah, King of all things delusional discussing that the worst is already past for housing. Even Greenspan jumps in by saying real estate has seen the worst, but not yet. Huh? Are we taking notes out of the Karl Rove handbook or are we testing our ability to use Orwellian double-speak? So let us dissect the article. Last month we had a record drop of 2.5 percent reported by the Commerce Department for August housing data. This month, we get a drop of 9.7 percent for September which is four times the amount of the past month. These are year over year figures so this is a trend. By my account, when you break a record two months in a row you have not seen the worst. Anyone who has taken a basic economics class realizes that macro trends take time to filter through the economy. Reversion to the mean at times is slow but at other times can happen very quickly. But listening to these folks is like having a four year old translate a Chinese television program to you in Oxford English and expecting it to be 100 percent accurate.
You are starting to see a paradigm shift. Those associated with housing have had centralized meetings regarding their message.
“How should we address inventory rising?”
“What about year on year price drops?”
“What can we say when home builders are losing 50 percent of their market cap in one year?”
And these brilliant minds of America came up with a slogan that would even baffle Einstein for years. The bust and slow down is already over! Wow! Simple yet so profound. These real men and women of genius decided that their campaign message would be to preempt any bust or down turn talk by already saying that it occurred. Forget the fact that the last six years of real estate appreciation would look like a rocket ship flying off of your Excel spreadsheet. Forget the fact that we are in unprecedented territory and have never witnessed such massive credit expansiveness linked to one industry. Even Bloomberg magazine links 40 percent of recent jobs are somehow related to the current housing boom.
Bloomberg 40 Percent Linked to Housing
But again, why let facts get in the way! These are things of the brain and who wants to waste their time using a worthless organ when you can go with Jim and the Twins and speculate, flip, and use massive credit to become the next Donald Trump. You need to give it to the housing industry for this tactic. They are simply protecting their interest (and livelihood for that matter).
So why is the party only beginning? Let me list a few major reasons:
1. Sky rocketing inventories
2. Massive number of loan resets
3. Buyer and seller psychology
Regarding point one, sky rocketing inventories by simple microeconomic theory will force prices down. Homebuilders have created a massive glut of homes on the market that will continue to saturate 2007. For you mathematicians you can figure out inventories by this very complex Calculus equation:
Homes For Sale – Homes Sold = Remaining Inventory
More homes for sale plus less homes sold equals more inventory! Damn, my head hurts when I do math so let us move on to point two.
This year it was estimated that 500 million in loans reset. Next year it is estimated that 1 trillion (yes, that is a Mr. T) will reset as in 2008. So if so much has gone into reset this year why haven’t we felt the boars teeth in our leg? Because this year, many folks were still able to refinance and unload homes to greater fools. Yet 2007 will prove to be the year were the buck stops for housing. I discuss this in detail in another one of my post so I won’t go into that further. Point three regards market psychology.
Remember the current Yahoo headline? They use the word “plunge” as in “yo, he took a massive plunge on that motocross jump dude.” Or the word conjures up memories of you standing over the porcelain throne plunging away to fix the toilet. Either way, pain or crap, we are in for it and this is only the beginning. Yet listening to real estate agents you would think that today is the absolute greatest day to buy because as the fool you are, you missed out on the equity run. This Johnny come lately mentality worked when year on year gains were in the double-digits. But how do you sell a 9.7 percent drop? Easy! Just say this:
“Hey when I told you the 2.5 percent drop was the lowest ever and prices would go up I was off one month. This 9.7 percent drop IS the real lowest and now we are set to soar to the moon.”
You can modify this script to fit your needs and modify it to incoming figures but you get the point. Market psychology is shifting quick and the mainstream media is now using stronger words in headline stories. There was a story on ABC this week about a couple that didn’t realize there payment had adjusted from $1,700 to $3,800 a month. There explanation? They didn’t read the fine print. The lender didn’t mention a reset happening so soon. Oh, and the lender said boars don’t bite and you can fly as if you were tripping on LSD. Well, they didn’t say that last sentence but at least that would have more semblance of reality than the drivel that they are currently spewing.