The History of the Los Angeles County Housing Bubble (2000 – 2007). Proudly a County of a Renting Majority.

Take a long and hard look at the chart above. Sometimes a picture is worth a thousand words or in this case, worth half a million. Many would be housing buyers have felt the angst of never being able to afford a home in Southern California. Anyone sitting on the sidelines for the past seven years has seen the largest historical run-up in housing and probably felt helpless at each consecutive jump in prices. “Housing has gone up 20 percent year over year,” became a monthly media sound bite embedded into the psyche of any California resident. We start out with a median price of $200,000 seven years ago and currently see median home prices of $520,000 in Los Angeles County. This double-digit year over year appreciation started in February of 2001 and didn’t end until April of 2006. That means housing never dropped below 10 percent yearly gains, (sometimes reaching gains of 26.6 percent) for 5 years and 2 months.

Even as we are facing massive meltdowns in the subprime and now prime mortgage arenas, why in the 30 mile zone world is LA housing still going up? Welcome to the world of shady statistics, exotic mortgages, and good old fashion greed.

Lies, Damned Lies, and Statistics

Los Angeles housing has always been relatively expensive in comparison to the rest of the nation. Let me define the word always. When I say always, I mean from 1970 and beyond. Similar to real estate agents saying real estate always goes up. Yet something happened in the last decade that sent housing prices in the Southland into the Al Gore stratosphere. I remember reading a book by Robert Allen called Nothing Down and thought to myself as I read it many years ago, “this sounds fantastic but this is relegated to the late night infomercial circuit with tanned gurus in Hawaiian shirts pimping real estate seminars at 2AM.” Go figure that a few years later, nothing down went mainstream. Not only was nothing down mainstream it became a staple of the housing bubble.

Lending standards took a major dose of laxatives and let out a major wave of dirty mortgages. Hence, the name “toxic” loans we now hear. At least that makes sense because these mortgage products were full of you know what. In addition, all the stats used by mortgage lenders incorporated skewed statistics and made up incomes. If you think stated income is ridiculous then you have not lived in Los Angeles. Stated income was the future baby! Why does the bank need to know how much I make? Why are they nosy and trying to dig into my business? When I say I make $500,000 I really mean it even though I have no idea where my W2s are. I’m not even sure if I work but we’ll let Wall Street worry about that. It was an implicit agreement of you sign here, and we’ll put you into this over inflated home. If people on the streets were conjuring up their incomes, what about the companies providing these people the mortgages? Well now, we are taking a deeper look at what really went on and opening the Christmas gift from hell. It turns out that Nothing Down doesn’t bode well in the mortgage game. Why is that? People will generally fight like riled up hyenas if they have skin in the game. If you had to put 20 percent down on a piece of real estate you will do all you can before having the house foreclosed. However, with zero down most folks are more than happy to walk away from their massive mortgage obligations. Heck, the lending institutions are doing this right now in their 11^th hour. We all know that every large metro area is declining and facing massive jumps in foreclosures.

Wacky Median is Still Going Up

No negative housing information seems to make a dent on the resilient LA median price index. The prices keep going up. Again, the devil is in the details. Sales volume has dropped off a cliff and has been in free fall mode for over a year. Yet a home that doesn’t sell cannot be factored into the overall sales data. Therefore, what we see is homes in prime areas such as Beverly Hills, Brentwood, Santa Monica, and Palos Verdes skew prices even higher because these places are still selling. Lower priced homes aren’t selling therefore they are not included in the overall sample size. And the sales sample size is shrinking as we speak.

Then we have homeowners addicted to five years of double-digit gains unable to reconcile that they can no longer sell their home for peak prices. They feel entitled to peak prices because they say so. Can it be that housing prices were inflated by exotic mortgages and general greed? Why else would people be so eager to jump into a home that they could rent for half the price? The new paradigm of housing included double-digit appreciation until the end of time. Well the end of the time arrived in summer 2007.

Why Did Los Angeles Go Up and Other Areas Did not?

This may come as a shock to you but we have sun here in Southern California. Actually, we own the exclusive rights to it. Therefore, prospective buyers had to pay a sunshine tax to live here. Florida has sun too hence their run-up in real estate. This may seem simplistic but most metro areas in the US are now overpriced. Some are overpriced by 10 percent and some are overpriced by 50 percent. LA wasn’t the only place with a mad run-up in prices.

We also have a very mobile population. The majority of folks spend a good portion of their day on the 5, 10, 210, 405, or any other freeway you can think of. A very small portion of people see housing as a long-term investment here. The general culture does not think of buying a home, raising a family, and retiring all in one place. In fact, we have a culture where you play the Russian matryoshka doll game; you know where each little doll is nestled in a larger doll? Well people purchase homes here to trade up. Each consecutive purchase brings you a larger home with an equally larger mortgage. Each added member to the family is reason to purchase a larger car on a new lease. This is how many families operate in the Southland.

Yet the squeeze is being put on the middle-class of the state. Rising gas prices, car costs, healthcare, food, utilities, and housing all cut into the operating budget of the family. Like the couple earning $130,000 and lost their home to foreclosure, many families are realizing they are suffocating on servicing their debt. The grim fact may hit many families like a ton of bricks that they were using credit to stay afloat. Now that credit is becoming more expensive to obtain, they are realizing the true nature of their spending habits. Many families are also feeling the pinch of a declining dollar. I’m not sure if John and Susie Public are too concerned about a falling dollar or inflation. You just hear them ramble about, “damn, prices are always going up!” I’m hoping that people start asking the next question and look into the reason prices are going up. And many folks are realizing that their paycheck isn’t keeping up with the cost of living. Slowly the public is being taxed via inflation and a falling dollar. The only person running for president that I’ve heard mention anything about these economic issues is Ron Paul.

Los Angeles is a different beast. We have 88 cities in the county. We have 10,000,000+ people living in a relatively small area. There are 3,339,763 housing units. The median income for a household in the county is $42,189, and the median income for a family is $46,452. In addition, the homeownership rate is 47.9 percent. So in fact, Los Angeles County has a renting majority population. But if you want to own, we have some wonderful Real Homes of Genius eager for a new owner.

Did You Enjoy the Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information.

American Home Mortgage Halts Trading Pending News: Market Cap Down $221+ Million Over the Weekend. SoCal Still in Wonderland.

According to CNN, American Home Mortgage (AHM) is another company facing issues regarding the subprime fall out:

“NEW YORK (Reuters) -- American Home Mortgage Investment Corp. shares sank on Monday after the home loan provider announced "major" writedowns, delayed a dividend and said lenders were demanding it put up more cash.

Shares of American Home were down 39 percent, falling in pre-market trading to $6.39 from Friday's close of $10.47. On Friday the shares hit their lowest level since April 2003. Trading on Monday was halted for news pending.”

The beating AHM is taking is predominantly on their announcement to delay dividends on their stock. Guess when they announced this. Late Friday! Since AHM knew that if the announcement came any earlier, it would take a beat down like any of the housing related stocks last week. So they let it fester over the weekend and as of this posting, trading has halted on further “news.” But how much market cap was lost over the weekend? We always hear that massive corrections cannot occur over night but really in terms of money, how much was lost? Well let us take a look at some details regarding the company:

American Home Mortgage

Shares Outstanding: 54.28M

Price Per Share on Friday: $10.47

Current Pre-Market Share Price: $6.39

Friday Market Cap: $568,290,000

Pre-Market Cap: $346,849,000

Down in Two Days: $221,441,000

Here’s the thing. All things real estate can go down fast and dirty. Keep in mind this is only one example of many companies. The fact of the matter here is that this company has a market cap of half a billion dollars and is rather large. The disturbing part, as highlighted by the CNN article is you have a company as of the end of March, that had $4.01 billion in “warehouse” credit lines. It is becoming apparent that the subprime contagion is spreading all across the housing sectors.

In reality companies are valued on multiple fronts including their potential earnings or cash flow. For example, say you and I own a company with $40,000 in assets. We decide that we will only have two owners (shareholders) and have two shares outstanding. Therefore each of us would have a “stock” of $20,000 in the company assuming we have $0 in liabilities. Say we expect to earn $100,000 next year in revenue. Obviously the share price of $20,000 will jump up because of the projected earning potential. But what happens should we have negative cash flow? That is what is occurring with these companies but on a larger scale. Of course this is a rudimentary explanation but many of these companies are in similar situations like home owners facing massive resets yet have negative cash flow that they didn’t expect. In addition, your underlying asset gets impacted by negative growth potential. The market is calling it liquidity issues but ultimately it boils down to being unable to pay your bills.

Issues on the Home Front

And then we have stories like this one submitted by a reader of a Ventura Country couple trying to sell their home at bubblicious prices. From the Ventura County Star:

“The Conroys might have aimed high at a time when the market is soft. The most comparable home with similar square footage in the Golf Course Villas had an asking price of $759,000 and sold for $773,500 in October, said Joe Virnig, president of Ventura County Coastal Association of Realtors. He said he believes the same pricing strategy would have been successful for the Conroys.

Doughtery thinks the weekend's event will likely expedite the sale, but not without a cost.

"I think if you want to unload a property for less than the actual value, then this is the way to go," he said.

Still, Virnig warns there must be a catch to this type of marketing tactic, and calls it a "gimmick" to get people to see the house. It's the first time he's seen such a strategy in Ventura County.

"I have trouble believing they'd honor the $594,000 price if that's all they get," he said. "I see all kinds of problems with real estate agents adopting these tactics. I'm not about to adopt it — it's fraught with risk. Until the inspection period is up, it would be difficult to be sure that you didn't end up buying a problem."

You should really examine the entire article but the fact of the matter is we have people stuck on housing bubble yesteryear prices. They are asking $849,000 when a comparable home sold last October for $773,500. Even the fact that they are "entertaining" offers above $594,000, they are still in the belief that they can yield top prices from their rhetoric. In addition, I’m not sure if they are aware, we are in full out suprime and Alt-A meltdown mode therefore limiting access to whacky LaLa land credit. So the pool of buyers is limited in comparison to October of last year. In fact, standards didn’t get tighter until Q1 of this year. So they may look at the $773,500 price and laugh at it, but they’d be lucky to even get that. And the scary part of the article is that there are many folks still looking to jump into the game. Thankfully, I’m sure many of these would be buyers are having issues getting mortgages since they probably don’t have a sufficient down payment and Wall Street is done with the creative financing game. Even in today’s absurd market, all you need is 5 to 10 percent to get top notch mortgage products and rates. Yet with our negative savings rate, this is obviously too much to ask.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Second Quarter Housing All-Stars Recap: Subprime closes shop, Prime Loans Gone Wild, and the Future of Housing.

When Darth Vadar lured unsuspecting folks to the dark side, he was actually referring to the sinister and destructive nature of lax credit. For some reason, the business world and the mainstream media believed that this economy built on recycling credit was going to last forever. Even listening to the numerous housing shows, you would think that housing would always be the number one greatest investment on the face of the planet. Even today, as I was heading over to an appointment, I was listening to a prominent radio show on FM regarding real estate and the host is still in wonderland. One of the female co-host actually told a caller this:

“Right now is the perfect time to buy. Because even if real estate goes down, in 3 to 5 years you will have massive equity.”

I almost punched my stereo by this financially retarded advice. For one, the caller had no down payment. And another point, if real estate is going down and he comes in with little money, how is he going to have “massive equity” in the home? This was a case and point of so called real estate experts purporting short-term thinking and failing to look at the macro scope of this credit bubble. And then, I was watching a local television station this week discuss the record foreclosures here in California and they told the audience this nugget of wisdom:

“If you are having a hard time making your payment and have equity, refinance your house and get some money out. This will keep you afloat for a while longer. If this doesn’t do it, go ahead and cash advance on your credit cards to keep your mortgage payments.”

Am I really hearing and seeing this? Did I eat some kind of imported food tainted with hallucinogenic mushrooms? This “advice” is wrong on so many levels. For one, tapping out equity to keep a payment you clearly cannot afford is financial suicide. What you need to do is evaluate whether you need to sell your home or not. And tapping into credit cards as a short-term carryover loan to pay your mortgage is flat out stupid. You think these folks are going to pay the bank before they purchase food and keep their utilities on? The inflated sense of self for some of these experts makes you think that we are seeing miniature Napoleons running around.

In this article we will examine three major converging factors that bursted the housing bubble. First, we will examine the end of subprime lending. Second, we will look at the cancerous spread of horrible loans into the prime sector. Finally, as noted by last week's tremendous drop in the stock market we will examine what will happen now that the bubble has fully burst and is spilling green toxic sewage credit all over the country.

Subprime Is Out to Lunch. Forever.

We witnessed weakness in the markets with many subprime lenders closing shop. We are now out over 100+ major players in the subprime market due to horrible loans and collapsing on their own weight. As the subprime market collapsed earlier this year, the market kept on chugging along because of the belief that this damage was contained to one sector. Clearly as the quarter progressed this was not the case. And how could it be any different? The housing market stalled and folks couldn’t play the musical chair game of refinancing. This was noted in the massive drop in mortgage equity withdrawals. Like a WWE wrestler, the market needed to tap out.

In addition, we realized that Wall Street had enough of subprime loans. Principally because hedge funds realized that the underlying assets may be a tiny bit overpriced. Oh really? I’m reminded of the story of some of the large hedge funds homes being inhabited by raccoons and roaming free range hogs. I wonder if the hogs went 2/28 on the property? The problem stemmed from long distant investors buying up properties sight unseen on inflated appraisals. Now that the market is scrutinizing what the collateral was, it does not like what it sees.

Later in the quarter, we have the end of the 2/28 teaser mortgages. A mainstay of the industry during boom times. No longer are folks able to squeeze into over priced places on these ridiculous loans. In Southern California we had a peak originating month in August of 2005. Perfect timing for next month where many loans will reset and folks are no longer able to refinance into additional loans. The problem is also happening where appraisers are now seeing homes drop in price. No longer will most banks give you a HELOC simply because you have a pulse and a home in an over inflated metro area. As in the last article, foreclosures are booming to the next level. Not only that, as highlighted in detail, people making $130,000 a year are also having problems covering their monthly nut.

It is clear that subprime is now down and out. But prime was protected right? Well this leads us into the end of Q2 and the infection of the prime sector.

Prime USDA Mortgages

Countrywide announced that it has faced one of its worst quarters. Not only that, the CEO Mozilo stated that he didn’t see housing coming back until 2009. Talk about a vote of confidence. We also saw the problems at Bear Sterns with prime loans going bad in the so-called Alt-A tranches. That is, financially risky loans given out to credit worthy customers. But again, simply because you have a 750 FICO doesn’t mean you can make the payments on a $600,000 mortgage unless you have income to back up your score. The issue with the last few years is income didn’t even matter. As I discussed many months ago, a study conducted by the LA Times found that stated income borrowers over stated their income 60 percent of the time. Out of these, 50 percent overstated their income by 50 percent. This in conjunction with mortgage resets is showing who has been swimming in Huntington Beach without any trousers now that the tide is going out.

So the market got extremely spooked. That is why last week we saw almost a 5% retrenchment of the overall stock market. And not only here in the US did markets suffer, but markets in Europe as well since they decided to jump into the worldwide credit orgy. Alt-A is going to face some serious pain. At the peak in California, 73 percent of all originated loans were adjustable. Now that rates are resetting in the face of housing depreciation home owners are facing something they didn’t expect. Being stuck. Stuck like a stick in the mud. Yet you hear housing pundits sound off asinine quotes like the two mainstream folks above, and you wonder why this bubble is bursting? Somehow they feel that everyone is living in their world of perpetual credit expansion. Many of the prime banks, hedge funds, and Wall Street drank this Kool Aid for many years. But the party is now finished. Eventually the music stops and the piper needs to be paid. Last week the overall stock market, which keep in mind supposedly tracks the health of the overall US market, went down with a three hit combination. And this is in the face of good GDP numbers! But the numbers are a farce because many are realizing that the sustained growth was predicated on us buying consumption goods on credit therefore inflating the health of the economy. Doubt me? Go to Target, Wal-Mart, Trader Joes, Ralphs, or the mall and count how many folks actually pay in cash or check.

So Now what that Housing is Done?

If you don’t want to take my word for it, you can listen to Mozilo who is head honcho of the mortgage giant Countrywide. He doesn’t see this “ship” turning around until 2009. I get a kick out of housing pundits stating things like this from the same housing radio show:

“Okay. Enough of the housing bubble. The correction is over. This is a perfect time to find a good deal. You will have equity in your home. Housing always goes up. We may see a small correction but once it goes up, it will go up fast like the last few years!”

Correction? We’ve been in a decade long boom and they think two quarters is a correction? We are in for multiple years of housing being a horrible overall investment. This assumption that housing goes up massively in good times and only retracts baby steps in bad times is fundamentally wrong and is clouded by their own judgment. To quote Upton Sinclair, “It is difficult to get a man to understand something when his job depends on not understanding it.” Clearly they are seeing what they want to see because the implication would imply challenging times for them should the market go down. You can’t blame them for this faulty analysis. However, they are fundamentally wrong and demonstrate their lack of macroeconomic policy each time they open their mouths.

On Friday we were left with a taste of things to come. An announcement that Fannie Mae and Freddie Mac may face losses of $4.7 billion in the subprime market. These government sponsored entities are the white elephants in the room in our over mortgaged 3/2 stucco home. As we were too busy looking at subprime imploding and Alt-A tranches getting hammered, most mainstream folks failed to examine the cancerous growth of this credit bubble. Now it is reaching the absolute nucleus of the US housing market. These two behemoths should they face a problem have the potential of bringing down the entire market significantly. Last week we dropped almost 5 percent across all major markets because of Countrywide and a fear of credit being shut off. Just wait if issues at the two GSEs are as bad as many think.

The housing and credit bubble lasted too long. There is tremendous excess that needs to be washed out. The market is in for a long and prolonged downturn. What you need to look out for is snake oil salesmen trying to tell you that we’ve already had our correction and it is time to buy. It is comical to think that many months ago the former NAR chief David Lereah had called the bottom, multiple times. Maybe we have a differing view on what constitutes a bottom.

Do you think Fannie Mae and Freddie Mac are the next to show cracks due to this housing market?

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Housing Minsky Moment: 3 Factors. Prime Contagion, Record Foreclosures, and Publicity.

This week witnessed the final nail in the housing bubble coffin. We have reached what seems to be the Minsky moment for the housing market. Named after the US economist Hyman Minsky, the idea holds that over long periods of economic stability leverage tends to grow in predictable stages. This economic stability leads to a fertile environment sprouting trunks of easy credit access with little perceived risk. However, as the growth continues there seems to be a movement from moderate lending, risky lending, and finally outright irresponsible Ponzi like lending. With 100+ subprime lenders imploding on their own convoluted mortgages, the housing market is like a fish out of water gasping for life and clearly in the last stage of the lending cycle. The first event occurred on Tuesday when the gargantuan mortgage lender, Countrywide Financial announced dismal second quarter results. They announced that second quarter profits shrank by a third due to growing delinquencies and get this, creditworthy borrowers defaulting. The talk early in the year about subprime being contained turns out to be an absolute ruse. Now we have prime mortgage borrowers swept up in the housing slump. Yet the bigger news came from Countrywide’s CEO Mozilo, saying that he does not see housing recovering until 2009. Imagine that.

Then we have the inability of the mainstream news media to inform us regarding critical issues. Instead, we have the morning news plastered with Lohan up to her usual debauchery and athletes gone wild. As a matter of fact, while California set a new record in the foreclosure department, the mainstream media felt this only warranted a footnote at the end of the newscast. We don’t hear much about Iraq anymore. And what of the collapsing dollar? I think I hear Nero Fiddling while something burns.

In this article we’ll examine three critical factors that propelled housing into its public Minsky moment; prime contagion, record number of foreclosures, and negative publicity.

Prime Contagion

Mozilo likened the housing market to a gigantic ship needing to turn in the ocean. It will take time was his underlying point. I like to think of the housing market more like a NASA mortgage rocket with no turning back. Have you ever tried turning back a rocket-propelled vessel? His statement seems to offer some hope that housing will return even though he unloaded millions in his company stock. Maybe he forgot to mention that the ship he was referencing was the Titanic. Either way, housing is passed the shaky ground stage. I’ve shown countless examples in our Real Homes of Genius series that clearly highlights an outrageous bubble housing psychology. We also discussed a few months back the subprime implosion as credit suddenly tightened and subprime lenders started dropping like moths heading toward the light. In fact, I felt this was the watershed event and would set the tone for the summer.

Yet glorious housing bull pundits at this time championed the amazing summer rebound and the silo mentality of containing the subprime debacle. Ignoring rising inventory, $1 trillion in mortgage resets, and a stagnant market they decided to jump on the housing Pollyanna bandwagon. After all, this summer was housing's last shot to demonstrate continued bubble resilience. Unfortunately, this summer is only the beginning of a very difficult downturn in the housing market and most likely the overall economy. The market has ballooned beyond any economic model of sustainability. I discussed the pseudo $5 trillion in wealth created by this housing bubble and all credit linked to it. How much of this wealth will disappear is yet to be seen.

Yet now we are realizing that prime loans are also taking a hit. No longer is this implosion contained to one segment of the housing market. For a large part, we have this entitlement mentality of folks thinking their homes are worth more than what they truly are. Say you bought in 1997 for $200,000. Now your home is worth $600,000. This is a very typical scenario in California. You’d feel $400,000 richer simply by living in your home. And many folks had this wealth effect. In fact, they converted their homes into ATM machines and used mortgage equity withdrawals to prop the economy. Unfortunately, many folks are now realizing that some appraisals may be bubblicious in their estimates. Say this given home drops to $400,000 in a few years. Nothing is lost, in fact they are “up” $200,000 but the psychology and perceived loss does make people feel poorer. When people feel poorer, they spend less. In our economy based on 70 percent consumption, that equals a recession. Clearly, this is where we are heading. We have scheduled mortgage adjustments set for 2008 and 2009 to the tune of approximately $2 trillion:

This housing market followed no economic rules and like the Minsky moments of past, greed and irresponsible credit will once again collapse another bubble. Chalk it up to history repeating itself. Which leads us to the historical moment set in California.

Record Foreclosures

Southern California has reached a record number of foreclosures. That is correct, we are swimming in uncharted territory. Notice of defaults are quickly approaching record territory as well. To be exact we are off by 102 homes, which by the time this article is posted, we will surpass. So we can say that we have record numbers of Notice of Defaults and foreclosures. Take a look at the chart below and see if you can spot the trend in California:

The interesting tidbit of this information is NODs are turning over and going into foreclosure. If anything, you can consider the NODs as a canary in the mine; and if we are to read the data correctly we are in for some massive foreclosures. As stated by DataQuick:

“Most of the loans that went into default last quarter were originated between July 2005 and August 2006. The median age was 16 months. Loan originations peaked in August 2005. The use of adjustable-rate mortgages for primary purchase home loans peaked at 77.8% in May 2005 and has since fallen.”

Now if you examine the rate reset chart in conjunction with the foreclosure data, there really isn’t anything stopping this train. Over 75 percent of loans originated in August 2005 were adjustable-rate mortgages. Given the hot product was 2/28 teaser suicide loans, what special date are we approaching? That is right, August 2007 where a massive batch of these loans will be resetting in a declining market with higher rates. So even if these folks want to refinance, they will be hit by higher rates and a larger payment.

Amazingly, these loans are also fairly new. With a median age of 16 months. Clearly the problem here is people jumping into homes they cannot afford by horrible mortgage products. In addition, the rate of default on second mortgages is also skyrocketing. This would seem obvious since missing the payment on the primary loan implies you are not paying your second. But guess what? In the midst of all this there is good news. The median price for a home keeps on going up! We won’t go into exposing the inaccuracy of using a tiny sample size of higher priced homes skewing overall market stats. We want to leave you with one piece of good housing news for the day.

Negative Publicity

This may turn out to be the only good news left for housing. The media is fickle and suffers from long-term memory loss. Even a year ago, we were reading about stories of people making thousands in real estate transactions. People were racing over like NASCAR drivers ready to become brokers and agents as reflected by the number of licenses issued by the Department of Real Estate here in California. Now, you are more likely to find negative housing information permeating the media machine. And don’t you find this odd in a state where housing is still flirting with a median price of $600,000? If the media dug deeper into this implication and did constructive journalism, it would be clear that we are in a full fledged housing bubble bursting. Why are they afraid to come out and simply admit what the data is suggesting? That housing is in for a major correction and housing prices grew on the back of irresponsible lending and greed. The key ingredients from any historical bubble are present again.

The issue is the real estate industry employs countless people, pays high amounts of money for advertising, and has many politicians bought. So of course they carry clout. But this will only get you so far. You can only fool the market for so long. It is becoming apparent that this system will collapse on its own weight. In a way we haven’t felt the ramifications of what is to come. We are only getting a sneak peak of the real housing bear market. I was looking at old LA Times articles and the positive rhetoric from housing peak to negative bubble chicken little print took about 3 to 4 years. So given this past reference, you can expect a bottom somewhere in 2009 or 2010. Employment numbers still do not accurately reflect the coming job losses we will face. Our economy was based on this bubble via credit, mortgage equity withdrawals, trading houses up like baseball cards, and a cultural neurosis on all things housing.

When do you think we will reach a housing bottom?

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Real Homes of Genius: Today we Salute you Lakewood. A Short Sale with a $100,000+ Loss.

I realize that most Real Homes of Genius are featured in lower income areas, yet sellers still command $400,000+ for a run down home in a questionable neighborhood. Call it a symptom of bubbleland hallucinations in the mental asylum of the housing bubble. The purpose of these posts is to highlight the magnitude of the housing bubble when people still doubt we even had a bubble to begin with. Moreover, these calculations should give you an idea of how to run your own analysis and figure out the value of a home with financial facts (as opposed to bubble fiction). The housing bubble is a piece of the larger global credit bubble. Homes are overpriced in practically all of Southern California; from high crime areas to posh and prime neighborhoods. Like the couple that earned $130,000 a year, drove two Mercedes, and still lost their home I want to break the stereotype that only poor people lose their homes to foreclosure. Today we’ll feature a home in a middle-income suburb of Southern California. Today we salute you Lakewood with our Real Homes of Genius Award.

This enormous 816 square foot home has 2 bedrooms and 1 large bath to entertain guest. The agent tells us that the kitchen is completely remodeled with granite countertops. Granite countertops of course, are the ultimate status symbol of home prowess. Consider it the virility of a strong homeowner. Otherwise, you are ten steps down on the housing evolution ladder. This place also has “custom paint colors” like the low riders you see jumping on hydraulics on Figueroa Avenue. Absolutely riveting. This place is so hot, it has been on the market for 6 months. Too hot to touch. But let us dig into the history of what happened here.

This home is so great, that it sold twice in one year:

Sale History

08/31/2006: $500,000

03/17/2006: $489,000

The last buyer enjoyed the place so much they decided to hand it right back to the bank in 6 months. The bank, looking at sophisticated market analysis of the area decided to put the home back on the market for $500,000. This price was arrived at by the “latest greater fool theory” of appraisal or LGFT for short. Looking at the LGFT, the bank figured they would easily recoup their money. Forget about the subprime implosion or mounting inventory, they put on their rosy colored glasses and saw the market according to them. Here is the pricing action on this great home:

Price Reduced: 04/24/07 -- $499,900 to $485,000
Price Reduced: 05/27/07 -- $485,000 to $470,000
Price Reduced: 07/11/07 -- $470,000 to $450,000
Price Reduced: 07/18/07 -- $450,000 to $400,000

After a month on the market, the bank decided to reduce the price by $14,900. This certainly would generate some interest. May goes by and still no buyers. So the bank decides to lower the price by another $15,000. What is going on the bank wonders? This isn’t the housing market of 2001-2006. The bank decides that it will wait for the fabled summer housing Easter bunny before reducing prices again. Early July and no buyers are found for this place. The bank decides to get more aggressive and drops the price by $20,000. Nothing. Now something happens at this point. Either the bank is getting nervous about “bubble bursting” talk or is desperately ready to unload the home. Only a week after the $20,000 drop the bank goes down another $50,000! Holy crap! In one week this home went from $470,000 to $400,000. Now that is what I call pricing a home to sell.

As you’ll notice from the short sale count on this site, the number is growing daily. All of a sudden, risky interest-only-no-money-down-exotic loans are unavailable to customers. Someone will have to come in with 3 to 5 percent at a minimum to buy this place. Believe it or not, this minor adjustment to the mortgage market is enough to collapse the bubble. I’m not sure what constitutes a crash but losing a $100,000+ in 6 months is pretty significant. A 20 percent drop in 6 months is definitely a bubble bursting. This is a preview of things to come since we are only in the first stages of rate resets, growing inventory, declining prices, and tighter credit. Take a look at the market demographics for Lakewood:

Average Annual Household Income: $69,279

Median Mortgage Debt: $43,631

Median Net Worth: $47,348

What does the data above tell us? For one, the median mortgage debt is low meaning a bulk of the people that currently own homes in the city bought prior to this decade long bubblemania. Somehow I doubt the previous two buyers on this place came in with 10 or 20 percent down. Next, you’ll notice household income isn’t anywhere near the amount to support $500,000 homes. Since doing a monthly balance sheet is so useful (too bad many folks didn’t spend 10 minutes doing this before signing a mortgage) we’ll run the numbers here if we were to buy this Real Homes of Genius at the current $400,000 and earned the current median income of the area. Time to bust out the financial calculator and do some housing magic!

Monthly Gross Income: $5,773

Monthly Net Income: $4,526 (filing as married couple with 2 allowances)

Monthly Home Payment (PITI) = $2,817 (5% down and market rate of 6.5% on 30 year fixed)

Monthly Auto Fuel Cost: $350 (average for 2 vehicle households)

Monthly Auto Insurance: $120

Monthly Auto Payment: $500 (assuming modest car loans)

Monthly Food Budget: $400 (moderate shopping budget)

Monthly Disposable income: $339

Keep in mind we are not factoring in cell phone costs, utilities, cable, healthcare, and pretty much anything else you pay on a monthly basis. As you can see, even with the $100,000 reduction this home will still consume 62 percent of the family’s net income. Let us do a bit more research on the rental market for this area. After looking at rental data, the median rental rate for a 2 bedroom place in the 800 to 900 square foot range in Lakewood is $1,400; or 50 percent below the full mortgage, taxes, and insurance payment on this home should we purchase it. If this home is overpriced at $400,000 what in the world were people thinking buying it at $489,000 and $500,000?

When you run the numbers, you realize we are in some other twilight dimension of housing here in California. Keep in mind this home is massively “under priced” for this area which has a median home value of $505,000 according to the latest housing reports.

Today we salute you Lakewood with our Real Homes of Genius Award.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

The Foreclosure Story: What does the Process Look Like?

We all know that foreclosures are on the rise throughout the nation. Most people realize that a foreclosure means that you will lose your home. But how does this process look like? In reality, the foreclosure process is a drawn out and lengthy ordeal. It is a gut wrenching and personal nightmare for most folks. So this article is a story about a couple. A couple who is the poster representation of the housing boom and now bust. In this article, we will examine their profession, income, and monthly budget. Amazingly, folks are very upfront when they are making lots of money but go into clandestine mode when they are having financial difficulties. Below is the couple’s profile:

Joe and Mary

Ages: 29 and 28

Professions: Joe - Senior Account Executive (lender), Mary - Real Estate Agent

Location: Orange County

Yearly Income Combined: $130,000 Gross

Net Monthly Income (After Taxes): $8,200

Automobiles: Mercedes E350 Sedan ($599/33 month Lease), GL 450 Suv Purchase ($56,000)

Monthly Auto Fuel Cost (Filling up Once Per Week): $350

Home Purchase: Costa Mesa 4/2 Home, Bought Late 2004 for $675,000

Credit Card Debt: $25,000

Monthly Food Budget (Including Dining Out): $700

So this should give you a nice snapshot of the couple. Since they were sophisticated investors in the know, they decided to jump into the home with a 2/28 loan, interest only with no money down. After all, someone making $130,000 a year can clearly sustain pretty much anything right? And as we all know, no money down was no longer simply a thing of late night infomercials but a mainstream way of buying a home. Here is the monthly budget below with the teaser rate loan (they had it for 2.75%):

2004 Budget

House Payment (PITI – at 2.75% interest only/2 years): $2,249

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment: $500

Total: $5,198

Monthly Net: $8,200

Disposable income: $3,002

Keep in mind we are not factoring in medical insurance, cell phone cost, utility bills, retirement accounts, and many other items. These are things that I am aware regarding their budget since I was privy to the information. Well, more like them showing off to me, but I made mental notes on these items as I would with a past client showing me their monthly budget. So even with that said, $3,002 a month in disposable income is a pretty nice chunk of change to pay the remaining monthly items. But again, this was a teaser 2/28 loan. Unfortunately, they didn’t factor in one of them losing their job, a rate reset, and a slumping housing market. Let us take a look at the late 2006 monthly budget:

2006 Budget

House Payment (PITI – amortized fully over 28 years/full rate of 6.25%): $4,962

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment: $500

Total: $7,911

Monthly Net: $8,200

Disposable income: $289

Suddenly the jump in the rate creates a crunch on the household income. Keep in mind the above still doesn’t factor in other monthly cost. In addition, this was in late 2006 before, Joe lost his Senior Account job because the company went under. They were already feeling the pinch since the housing industry was already showing signs of weakness and their income being variable with commissions, was also taking a hit. Joe jumped to another mortgage outfit but they were only able to give him $30,000 a year base plus any commissions. Of course with the tightening of the housing market business is not going so well since both of their careers are tied directly to the housing industry. Their combined income is no longer $130,000 a year but approximately $80,000 a year. So let us run the numbers again with the new household income:

2007 Budget

House Payment (PITI – amortized fully over 28 years/full rate of 6.25%): $4,962

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment: $500

Total: $7,911

Monthly Net: $5,804

Disposable income: $-2,107

Now we are running massive monthly budget deficits. It may come to a shock to many people that a household earning $130,000 a year actually may have financial difficulties. But looking above, you can see how easy and quickly someone can go into financial ruin. Statistically, this couple was in the top 10 percent of household incomes in the country. Yet they spent way beyond their means. California living is very expensive. You’ll also notice that being in the industry they are in, they felt that they needed symbols of affluence to keep up with the Joneses. So now that you can see that not only folks that make $14,000 a year purchasing $720,000 go into mortgage trouble, even those that are considered the most affluent also have financial problems. The next phase of this case study is the foreclosure process.

How Does Foreclosure Really Look Like?

Foreclosure has been a somewhat unheard of novel thing in California for the past decade. Any homeowner in trouble was able to put their home up for sale and it would sell quickly before the entire process ran its course. The market was so hot that it covered financial irresponsibility by letting folks off the hook. This all ended last year. Suddenly, the market is declining yet rates are still resetting. Folks are realizing that they are unable to make the payments, sell for their asking price, and losing their homes. So how did Joe and Mary lose their home? This is the next stage of the foreclosure story and a sad one.

The psychology of running massive monthly deficits is a hard one. For one, you are probably wondering about the incredibly high car cost. This is Southern California and having a new model is somewhat common practice. The worst depreciating item you can own is a vehicle. Regardless, they purchased one of the two Mercedes and after a year or so, if they decided to sell they would be selling at a loss. So after Joe lost his job, they decided to put their home up for sale knowing they would be unable to make the payments. At first, they thought that they would be able to make a nice profit on the home. This was not the case. This is how the following months looked like:

Month 1-6 – (Pre-Foreclosure)

Joe and Mary miss one payment. They have their home listed at $790,000 on the MLS. No bites. The bank sends a late notice to their home. Since they’ve been in the industry, they have seen homes sell even before landing on the MLS. They are certain that they will sell the home.

Total Monthly Payment Behind: $4,962

Late Payment: $40

Total to Cure Account: $5,002

Another month goes by and no offers. They lower the price to $775,000 to generate some interest. Nothing. They start getting a bit anxious. They get another payment from the bank but this time, they will need to make two payments. At this point, they make a conscious decision not to pay the mortgage and put in a clause for a future buyer to cure the account when they buy:

Total Monthly Payment behind: $9924

Late Payment: $40 x 2

Total to Cure Account: $10,004

At this point the bank tries to make contact with Joe and Mary. If they couldn’t pay $5,002 how are they going to pay double that? A third month comes along and they lower the home price to $750,000. Still the market is dry and silent. At this point the couple receives letters from the bank and attorney. They now start receiving formal letters:

Total Monthly Payment behind: $14,886

Late Payment: $40 x 3

Legal Fees: $75

Total to Cure Account: $15,081

Forth month comes along:

Total Monthly Payment behind: $19,848

Late Payment: $40 x 4

Legal Fees: $75 x 2

Total to Cure Account: $20,158

Fifth Month:

Total Monthly Payment behind: $24,810

Late Payment: $40 x 5

Legal Fees: $75 x 3

Total to Cure Account: $25,160

The bank issues a demand for full payment including full balance, back interest, plus late charges, and legal fees all at once. The legal notices start. Joe and Mary now have their home listed at $715,000. Still no bites. They did have some people come by but the deals didn’t materialize. Now they need $25,160 to cure the account but the bank has legally informed them that they will accept no payments except a full balance payment on their original $675,000 note. Keep in mind the bank is no place for negotiations. Can you imagine calling up your local Mercedes dealer and saying, “Hello Mercedes? Yeah, I’m not going to be able to afford the $600 this month but would you be willing to take $300 plus a free Dodger ticket?” The bank now sends a certified letter of notice of intent to foreclose. Joe and Mary realize they will not sell their home. The notice and waiting period begins. They stay in the place two more months. Now it will cost $35,000+ to bring the account current plus a full payment on the balance. Of course this will never happen given the circumstances of their finances. No payments are arranged and the house is sold at auction and of course, the bank reclaims the home as REO since they are on the sheets for $675,000.

The home is now officially REO and get this, they have it listed for $750,000! The bank is delusional. Joe and Mary now have a foreclosure on their credit record and rent a much smaller home. They managed to break the lease on the Mercedes but are on the hook for the purchased SUV. You’ll notice how things spiral out of control when you spend more than you earn. I can only imagine households with $60,000 getting into this mess. If anything, it will accelerate ten times faster. They are considering bankruptcy but the new laws are now more stringent in terms of letting people completely off the hook, especially a couple that makes nearly twice the median US income.

Hopefully this article gives you an inside look at the story of foreclosure and how it can happen to anyone. I've seen many blogs talk about foreclosures and the numbers but haven't seen a post detailing the entire process and how it impacts a home owner's bottom line. Not only that, but you should get an understanding that we are in a bubble so large, that missing one payment puts you in arrears for $10,000, or the down payment of a modest home in many states of the US. If this is what happening at stage one of the bubble, what do you see happening in the latter stages?

Did You Enjoy the Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information.

Big Ben and the Ministry of the Fed: Housing Doublespeak. NovaStar Shining.

One important rule for investors is don’t chase bad money with good. NovaStar Financial is having a challenging time getting out of the doldrums even after a $150 million booster shot it received from private equity funds. Not only are analyst predicting a future price target of $4.50, much less than the current $5.96 price but the company is also planning on slashing the dividend for many investors. Keep in mind this is a company that once was trading as high as $64 a share. But home equity lines of credit and loans are much more expensive now that rates have shifted. 30 year fixed rates are still doing fine at historical lows, but financially, this was a small sliver of the pie for these subprime players. According to Reuters:

“NovaStar shares were down $1.15 to $5.96 in late-morning trade on the New York Stock Exchange after falling to as low as $5.91 earlier in the session.

As a result of the deal, FBR's Valentin said NovaStar common shareholders will see their dividend slashed to $2.67 a share from $4.21 a share. Valentin also said the $150 million injection is not enough to sustain NovaStar, a REIT, unless mortgage markets suddenly rebound."

Like other subprime lenders, which make home loans to people with weak credit, NovaStar has suffered rising defaults and has struggled to sell the loans it makes to investors. Quarterly results have suffered this year, while rivals were prompted to exit the business or forced into bankruptcy.”

This isn’t something new. I warned about the subprime implosion a few months ago including the challenges NovaStar would face. Although many pundits were echoing that $150 million dollars would keep the company solvent for a while longer, there is no way any amount of bad money would keep over inflated assets high forever. And the caveat in the above quote is “unless mortgage markets suddenly rebound.” Now do we really see that happening?

Big Ben Chimes in Again

Then we move on to Big Ben using his glorious Orwellian Doublespeak. First, Mr. Ben is frustrated that the Yuan is rising at a slow pace:

“"I share your frustration about the slow pace" of China's currency revaluation, Bernanke said in response to a question from the Senate Banking Committee following his twice-yearly Congressional testimony.”

Glad he shares the frustration of the American public. Well that can easily be remedied by raising the Fed interest rate. Of course this will pop the bubble. But why should housing pundits worry? They’ve mentioned that housing rose on its own merits without the crutch of easy credit. When asked if housing could face a hard fall, this is his response:

“"We think it remains a risk, we have an inventory problem,"

An inventory problem? Well isn’t that something! And here I was thinking that it was a pricing problem. The doublespeak gets better in this testimony. When asked about the overall state of the economy, Ben responded:

"The ongoing housing correction could prove larger than anticipated, and energy and commodity prices could continue to rise sharply" and that could "spread to other parts of the economy," said Bernanke. Therefore the "upside risks to inflation is [the Fed's] primary policy concern."

You’ll understand that political operatives love using the word “could.” Well I could make a million dollars tomorrow, or not. Well housing could correct, or not. And they keep calling it a “housing correction.” This is a bursting credit bubble! Call it what it is. All these convenient euphemisms make it seem like we are in a high school band class. So the primary concern is inflation. Excellent, at least we agree on one thing. Then what about the resounding housing inflation we have seen in the last few years? The Fed actually created this monster by lowering rates and creating excessive easy credit. This played perfectly into a society that has a very hard time saving for retirement or anything else. Not only that, it made everything you buy with credit cards easier. Even last year, it was incredibly easy to find 0 percent offers on credit card purchases. Try finding these deals now. Now they include a 3 percent transaction fee. Suddenly people can’t play the mortgage refinancing musical chairs game.

“"The most pressing issue facing the U.S. economy today is excessive and growing inequality,"

Bernanke responded by pointing to other studies that show middle class Americans are generally much better off now than they were two decades ago.

But he also said better education training programs, as well as cheaper access to health care, are some things that could be done to lessen the income gap.”

Basically you are doing better if you aren’t buying your first home, eating food, don’t get sick, and avoid going to college. Aside, from that you are doing fantastic! Amazing double speak in face of the largest housing inventory in multiple decades.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Sales Drop Their Pants in Southern California. In More News, Median Prices Still Strong Like Arnold Schwarzenegger.

What a shock that housing median prices are still holding strong. In the land of Oz otherwise known as Southern California, June data released today shows housing prices resiliently strong with one caveat; sales are falling off a cliff! So even though Los Angeles County has a median home price of $545,000, a 4.8 percent yearly gain and Orange Country has a median home price of $645,000, a 0.4 percent yearly gain the devil is in the sales declines.

Los Angeles is down 32.5 percent in sales numbers. Orange County is down 31.6 percent. Riverside is down 47.2 percent. San Bernardino is down 50.1 percent. San Diego is down 22.6 percent. Ventura is down 27.8 percent. After each sentence I expect you to say Hoorah! Here is an excellent test of housing sentiment. In July of 2006, only one year ago we were having double digit sales drops but pundits kept hyping the yearly gains in the median income. “Sales drops mean nothing. Look at the tasty yearly median gains! Housing is hotter than a burnt tamale.”

Of course any person who studies housing markets realizes that drops in sales volume are indicators of where prices are heading. Housing is sticky on the way down. But the ironic thing is you don’t hear the housing syndicate jumping up and down for the positive median home prices just released. Why? Because business is horrible and the public is tired of being bamboozled. Just listen to the sentiment of the home builders. The summer bounce isn’t here and we are quickly approaching August. Suddenly visions of infinite double digit gains start to seem more distant. Summer 2007 is a vastly different housing market. For one, the subprime market is imploding. Imploding? Seems abstract to say it that way. How about “no more mortgages for LaLa land investments.” Aside from irresponsible lending and delusional sellers, housing is coming back to Earth from a long vacation to Uranus.

The housing syndicate wants to blame the Fed and anyone championing tighter credit. If it were up to them, we’d be purchasing $2 million dollar homes while inflation goes along at 25 percent and every new buyer ended up in a 70 year multi-generational loan. They wouldn’t care. Sustainability is a word outlawed in the subprime industry. These companies have such little reserves, that a simple credit tightening brought many companies to their knees in a few months. And this on the back of the largest housing bubble in history. They could have easily built up their cash account to weather a storm over the healthy years; but why save when you can make money hand over fist loaning out ridiculous suicide loans? Wall Street ate them up.

Well now, thanks to the transparency of information most people look at the median price and just laugh because they know it is simply absurd and a horrible indicator of the current market. Sellers are still doing baby steps trying to lower prices by $10,000 or $15,000 on a home overpriced by $200,000. So it is in today's market. The great summer standoff. I predicted this many months ago. Call it the summer housing Easter bunny and he ain’t hopping in Southern California and time is running out.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Viva La Housing Society: Social Security, Savings and Debt, and Retirement.

John McCain has just given the US public a crash course on why debt is not a good thing. McCain raised $11.2 million this past quarter but spent most of it and has very little cash on hand. Seems rather commonplace for many Americans to spend more than they earn. Not only that, the major issues that we should be discussing such as the credit bubble, declining dollar, Social Security, and international conflicts are nowhere to be found in the mainstream political debate. Why isn’t any politician tackling any of these problems head on and discussing them? The only person I’ve heard mention “inflation” is Ron Paul, who by the way is financially better off than Mccain. Maybe basic finance does help those in politics. Either way, I think most Americans are realizing that being able to purchase something on cheap credit does not equal financial independence. On the contrary, many are realizing crippling debt is like jumping into the ocean with an albatross around your neck.

So we close off the first two quarters of the year with the fuse inching along to the dynamite box full of funky credit and Wall Street collateralized debt obligations that are so complicated, even the people that created them have no idea how to untangle them. The big bang is here and the world is realizing and watching morbidly, that we spent way beyond our means. In this article I will discuss three main issues that will impact the entire country. From young professionals starting their career to those in retirement. This credit bubble discriminated against no one. If you wanted a home equity line of credit, you were welcomed. If you wanted a no money down interest only loan, come on in. This bubble is one for the ages and we are starting to see that the public is starting to get the memo that massive credit is not a solid solution for sustainable growth.

Social Security – Shhh! Please be Quite

It has been argued that Social Security is the third rail of politics. We remember Al Gore and his lock box talk. Or Bush and his goal of privatizing Social Security. Both went down in mad Ghostrider flames. Yet the issue still looms. Even Clinton recognized the issue with Social Security but no political will was willing to attack the problem. The buck has now passed from three presidents onto another one that will inherit the problem in 2008. Every expert acknowledges that we have a looming problem with Social Security. But anytime a politician brings up the issue, it gets shot down. Typical of the housing bubble, Social Security is a ponzi scheme heading down a slow but sure road of insolvency.

For one, 44 million Americans depend on Social Security (so guess how they'll vote). Two thirds of senior citizens depend on Social Security as their main source of income. 18 percent of senior citizens rely on Social Security as their only source of income. Income that pays for food and housing cost. Keep in mind, even if you have your home paid off you will still get yearly tax bills. You will also need housing insurance and maintenance costs factored in. Why do you think many senior citizens are victims to reverse mortgage loans that are so financially egregious, you would think that you were dealing with a local bookie or turf accountant.

In 1960, there were 5.1 workers putting in money to the system for each person drawing on benefits. In 2005, the number dwindled to 3.3 workers. The projected number for 2031 is 2.1 workers for each person drawing on Social Security benefits. Why the sudden shift? Well we can thank a population boom phenomenon otherwise known as the baby boomers.

Baby boomers are considered to be folks born from 1945 – 1964. The total number of births during this time is somewhere in the ballpark of 76 million. Currently they are 20 percent of the adult population. An incredibly large number. The term is normally given to those in the age bracket of 44 to 62. The major shift will start occurring in 2008 when we start seeing baby boomers go into full retirement. The system is solvent until 2018, which at the time more will be paid out than paid into the system. By 2042 the system will be dry. So anyone in the 20 to 39 age range needs to start planning for another venue of retirement benefits since the last three presidents didn’t do squat regarding the issue.

With a high cost of living, mounting credit card debt, ridiculous college costs, and entry level salaries how is it possible for young professionals to realize the dream of their parents? Hard work and savings are paramount. But the way mom and dad did it is not going to apply to this generation since the Social Security safety net won’t be there for many and housing costs are much larger in proportion to those a generation ago.

Savings and Debt – How does it Break Down?

I’ve been clipping a few charts from the previous LA Times with fascinating data. After reading how Kobe is still up to his antics with the LA Lakers and David Beckham’s Galaxy salary is larger than many third world country’s gross domestic product, I enjoy heading over to the business section. The numbers are startling and the picture that is painted is that young folks of today consume at a high pace and save very little for retirement. It could be a generational thing where many of us are more comfortable paying with a credit card rather than cold hard cash. This debt mentality is also a contributing factor for the housing bubble. After all, a generation raised at the teat of debt is easily coerced into further spending. Large mortgages didn’t phase many young professionals. I’ve had a close friend purchase a Real Home of Genius condo with his wife for half a million dollars in a regular suburb of Orange County. The condo is slightly over 1,000 square feet and as cookie cutter as they come. Their combined income barely allows them to cover the mortgage, taxes, and association fees but they are following the lead of mom and dad. The only caveat is, mom and dad bought with 10, 15, or 20 percent down and went 30 year fixed. But the need to own a home is so psychologically ingrained that folks are willing to live on Cup-o-Noodles to pay the mortgage.

Let us take a look below at some raw numbers:

Average amount in bank accounts per household
20-29	$15,724
30-39	$22,561
40-49	$29,048
50-59	$43,194
60-69	$63,008
70-79	$70,031
80+	$93,641
Overall	$37,675

This first table looks at average amounts in bank accounts per household. Keep in mind that with averages, a person with $200,000 in the bank will skew the chart higher. But even with that considered, the amount of money in accounts isn’t that high. You may say, “well of course not, these people have them in 401(k)s and retirement accounts.” I’ll get to that in the next section but suffice it to say that folks aren’t really saving elsewhere.

The next chart looks at household debt from the same sample in the survey of 158,000 US households:

Average debt per household, including mortgagages
20-29	$62,786
30-39	$107,525
40-49	$106,027
50-59	$94,224
60-69	$79,493
70-79	$59,358
80+	$47,168
Overall	$90,222

This chart should put a major hole in many housing pundit theories of Americans being okay with large mortgage debt. The above chart includes revolving debt and mortgage debt. The highest average is in the 30 to 39 category and it tops out at $107,525. Now think about a young professional couple buying a starter home of $500,000 with 20 percent down. They’ve taken on $400,000 in debt. Or 4 times the average overall debt of those in the 30 to 39 and 40 to 49 group range.

Another scary factor is many of those hitting retirement are still in debt. As we’ve mentioned, if you are relying solely on Social Security as your main retirement income or a large part of it, $50,000 in debt is a large chunk of change.

Retirement

It is pretty clear that anyone in the 20 to 39 age bracket will need to fund their own retirement and not depend on Social Security. So how are folks doing?

Percentage of households with 401(k) plans
20-29	39.1%
30-39	52.3%
40-49	50.5%
50-59	47.7%
60-69	32.9%
70-79	20.3%
80+	18.6%
Overall	43.80%

Well there goes the argument that the majority of people are funding their 401(k). The 20 to 29 year olds are the one’s who need to fund their 401(k) accounts most aggressively. Those in the 30 to 39 age range seem to be getting the message that Social Security will not be there for them. Is fear of no Social Security the only reason for this shift? We have another reason:

Percentage of households with pension plans
20-29	8.1%
30-39	14.1%
40-49	19.1%
50-59	26.5%
60-69	33.7%
70-79	35.2%
80+	34.9%
Overall	21.50%

Pension plans are going the way of the Dodo bird. Anyone under the age of 40 is most likely to be at the tail end of a generational ending of pension plans. You can see from the numbers above that only 8 percent of household in the 20 to 29 range have pension plans and 14 percent of those in the 30 to 39 age range. If anything, these charts should show you that we are not in the world of our parents.

Let us not even dive into the declining dollar, massive deficits, and the ridiculous shadow government tactics used to calculate inflation. This all ties into the housing bubble because with such a high cost of living and lack of future planning, many young professionals seem to indicate by their buying habits a “screw the future” and live a carpe diem type lifestyle. To keep up with the dream of being equally as successful as their parents, they are mortgaging their present lifestyle to meet a dream that is no longer available. They chase this dream by diving into credit and hyping the monthly payments. Yet this is unsustainable. At which point will folks in the 20 to 39 age range become furious about paying into a system that they will not benefit from? At what point will they realize that inflation numbers are cooked and demand better accounting practices?

Sometimes it seems that the media is trying to create a generation of zombies that will stay away from picking up a book and educating themselves about the true state of affairs. According to A.C. Nielsen Co., Americans watch an average of 4 hours of television a day! Mortgage ads spouting crack pot numbers. Flip this House. Extreme Home Makeover. And all the other housing related shows seem to be the number one source for where people get their housing information. In addition we get this mantra of easy monthly payments and the advent of gorilla marketing making it seem like using cash is for old folks. The credit card commercials tell you two things; the faster you spend the better and don’t be uncool and use cash. God help us if people are using the television to educate themselves regarding the credit bubble, savings, debt, and retirement.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Mortgage Equity Withdrawal Syndrome. The 3rd Rail of the Housing Led Boom.

Unless you’ve been living under a rock, it is apparent that there will be no summer bounce in housing. This comes as a grave shock to those that are entwined like a ball of yarn with the housing industry. We’ve created an entirely new generation of folks that think housing equity equals housing wealth. All of us have anecdotal stories of friends, family members, or ourselves tapping into home equity for vacations, consumption purchases, or using the HELOC to pay off other credit cards. The simplicity of getting money out of your home is so easy it is frightening.

Step one, you call the bank.

Step two, you decide between a home loan or home equity line of credit.

Step three, you get a 2^nd on the home after an inflated bubble market appraisal.

Step four, your off to the spending races.

Sounds rather poetic doesn’t it? But aside from the personal stories, how much money was taken out of homes at inflated prices and pumped back into this economy? The answer may surprise you.

Making Your Home a Bank

During the 1990s, in terms of tapping out equity, mortgage equity withdrawals (MEW for short) were roughly flat for a decade. It was flat for a couple of reasons. The collateralized debt obligations market wasn’t as streamlined as it currently is. This made it more difficult and a longer drawn out process to extract money from your home. The next major point is home prices were stagnant throughout this decade. How are you going to extract money out of a dry well? And finally we have declining returns and world wide investors chasing stronger yields. Keep in mind it was very normal to see 35% year-over-year gains in the technology sectors. Why in the world would you want to invest in housing where over a century of gains have trended with inflation? This all changed after 9/11.

After 9/11, we suddenly saw a progressive campaign of rate slashing to keep the economy afloat. Of course, when you decrease the fed funds rate, you increase the money flowing through the economy. Take a look at the below chart:

As you notice, through the 90s MEW stayed flat. Then we see a sudden quarterly jump in 2001. The tipping point started in the late 90s and early part of the decade because many people started jumping ship from technology investments when most seasoned investors realized that annualized gains of 35 to 40 percent were not going to last. They did what any smart gambler would do, they took their winnings off the table. But here come the stragglers, Joe and Susie public, and go tech crazy. No need to dive into that $7 trillion debacle, but suffice it to say that bubbles do pop. As you will notice from the chart, MEW jumped at a whopping 2 to 1 ratio over the following years. Keep in mind that the bull argument was that money that was extracted from the home was being used to pay off debt and not splurge on consumption. Let take a look at some data from the Fed:

As you will notice, we have a normal progressive growth of public debt from the 1970s to about 2000. Then we see something odd happening. We see the angle trajectory of the chart suddenly shift. Somehow I doubt the majority of folks were paying off debt. If anything, they were consolidating credit card debt, only to reuse the damn things again! Kind of defeats the purpose of debt reduction if you are moving your money from different pockets in your pants and thinking you are richer.

So you may say, what does the Fed have to do with this? They don’t lend the money to the consumers. Au contraire my friend. Just because something isn’t directly related doesn’t mean no change is occurring. If anything, you need to ask yourself where do banks bank? They have standards set by the Federal Reserve and the key interest rate is vital for so many reasons. If they lower rates as they did to the 1 percent range, it makes no sense to purchase US Treasuries long-term since inflation will kill your investment. In addition, since the rate was lowered to a historical low, it actually encouraged people to spend. Many reports have been issued showing that Americans actually have less equity as a percentage in their home than in the past. Begs the question of all this $5 trillion housing wealth we’ve been wallowing in. Well somehow it became our patriotic duty to spend (remember the Bush speech) and folks true to form, went out and spent like a drunken hyena. We save so little, we are actually in a negative savings rate. Think about that for a second. We spend more than we earn! You can only do this if excess credit is in the market. With the advent of MEW and inflated housing prices, folks decided to appoint themselves CEO of the Bank of Home.

What Will Happen when Home Bank Forecloses?

Since the dollar is worth a lot less because of inflation and irresponsible monetary policy, you are now able to purchase less with your current income. Think about the nature of inflation. When you print too much money, you devalue the worth of the current money supply. This is basic economics. What makes something valuable? The amount and scarcity of an item in relation to the demand. Money for a few years was so cheap, it made no sense to save and the public followed. The leaders of this consumption used every advertising medium available. If you drive a two year old car you simply were an old school idiot with no taste for the finer things in life. Have you noticed those credit card commercials where the person paying with a check or cash is seen as a leper? Everyone is having a merry time paying with their Visa and Mastercard but god forbid you show cash you dirty rotten animal. How dare you stop the flow of credit to the rightful owners of consumption!

But you can only spend so much and grow an economy on pseudo-wealth. Eventually someone will have to pay for it. And at a certain point, there will be no more money left. Take a look at the below chart:

Source: http://calculatedrisk.blogspot.com/

You’ll notice that suddenly as we hit the housing peak in 2005/2006, MEW dropped off the map. Why did this happen? For one, housing is correcting and coming back down to Earth. Another reason is the Fed was forced to tighten credit standards, otherwise we were on our way toward paying for orange juice with wheel barrows of dollars at Ralphs.

So the perma bull arguments are absolutely false. Housing was artificially inflated by investors looking for higher returns, a Fed that dropped rates faster than muscle growth in the MLB, and finally a society that is based on 70 percent consumption. If you read your history books, you’ll find many great empires collapsing because of massive deficits. However, this is a worldwide glut in credit so this will impact the entire planet. Have any doubt about the bubble? Take a look at these 10 homes and then come back and let us know your thoughts.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Housing Voyeurism: What Kind of Housing Personality are You?

Housing has become a national obsession. As a kid you were told not to talk politics at the dinner table or ask a person how much money they make. Yet you still had that curiosity. Today there is no need to ask because you can go to Zillow and find out how much they paid for their 2,000 square foot 4 bedroom home. So they say they have a pool eh? We can go on Google Maps and zoom into their backyard via satellite imagery to verify this claim. “So it was an above ground pool Bob was talking about!” And if you turn on the tube, you find the following television shows:

Extreme Home Make Over

Flip That House

Property Ladder

Sell That House

National Open House

Secrets that Sell

Designed to Sell

Bought and Sold

Million Dollar Listing

These shows appear on Bravo, A&E, HGTV, and your regular network stations. The point is, we are incredibly saturated with media marketing real estate. And do you notice a key phrase and underlying message in many of the shows above? Sell your house! Buy a home! If we are to combine a hybrid of the messages above we get something like “extreme flipping that will design to sell your house for a million dollar listing!” I think I’m on to something here. No longer is housing a place to live and raise a family in modesty, but housing is now an investment to propel you into the next dimension of uber-wealth. In reality, the amount of traffic online regarding real estate is unbelievable therefore indicating a wide demand for housing information. Not only that, here in California we have, according to the Department of Real Estate, 534,266 licensed brokers and salespeople. With 12,200,082 housing units in California that gives us one agent or broker for each 22 homes. Maybe we have an agent and broker bubble?

Either way, housing is becoming a massively important part of our culture and economy. Looking at recent employment data, for the past seven years real estate related employment has been attributed to impact 29% of all added jobs. And consumption is so important, accounting for 70 percent of our GDP, without housing we might as well forget the $5 trillion in pseudo bubble housing wealth and we’d be in a recession as we speak. But looking at the psychology of housing, we begin to see in the theatre of life many characters emerge. Since we have the tools to literally piece together every facet of a neighborhood and play amateur James Bond, we can find tons of information regarding our environment. So let us look at the housing personalities emerging in this housing bubble masterpiece performance.

The Five Housing Personalities

1. The Perma Bull Housing Sales Person

This person has never seen a house he wouldn’t sell (or buy). It all depends on the weather and the global positioning of the Earth. These folks have tattooed on their right bicep, “10% appreciation 4 life!” and show it off with glee. Folks that fall into this category are people like David Lereah, former chief economist of the NAR. His ability to spin would put the Harlem Globe Trotters to shame. He reminds us of Iraqi Information Minister Muhammed Saeed al-Sahaf. "We have them surrounded in their tanks" as US tanks rolled into Baghdad. You got to hand it to these folks, they have the ability to say absurd things in the light of mounting disaster. Either way, this personality will always see real estate as the absolute best investment ever. Even if the land is over Chernobyl they’ll tell you that spent uranium is good for brain development or that soon, you’ll be able to flip the property as a national treasure.

God forbid you give these people any facts or historical background. If you do, be prepared for a cadre of verbal assaults. They’ll call you a tinfoil hat wearing bitter renter. Or they will claim that the statistics you pulled out are fraudulent like the Nigerian documents CBS received. They’ll claim that the only truth is that of their all mighty association. Anything diverging from these talking points is tantamount to treason. They offer you a guarantee of appreciation. They’ll use the typical 7 to 10 percent annual appreciate rate; it all depends on what the central pundit hub is dishing out. A formidable foe no doubt.

2. The Perma Bear Housing Naysayer

The antithesis to the housing perma bull sales person. These folks are masters of dark and dreary statistics. For every argument a perma bull has, they have an equally convincing argument that claims otherwise. They are ready to do battle from experience either from losing money in certain deals (normally initiated by perma bull rhetoric) and suddenly are sworn warriors to the cause of outing the perma bulls. “Housing appreciation is 10 percent year over year” the housing bulls will say. Oh really? “What about the fact that 100 years of data show housing trending at a slow pace only keeping up with inflation?” Touché.

Their argument is valid and has merit in economic reality. However, in a bubble world they are throwing pebbles into the ocean. They will argue that inflation is cooked by government agencies trying to hide the real cost of living and seeing it as an invisible tax on the people. They will also claim that incomes do not support current market housing rates. Since 70 percent of the US population owns a home, there are less housing perma bears out there simply because of the law of self preservation and self interest. Either way, an equal challenger to the perma bull.

3. Apocalypse Now

A fiery asteroid will hit Earth and burn us to a crisp and then we will see 110 percent price decreases. After the 10 million people that survive the impact, you’ll see amazing deals hitting the market. These folks have a strong case of schadenfreude, that is taking pleasure in others misfortune. Normally many are angry and will throw it in your face that your 10 percent appreciation won’t matter after we collide with intergalactic space rocks. It’s an interesting personality to observe. They usually want to see housing explode and wouldn’t mind seeing a 2^nd depression shake up the world. The psychology behind this is rather fascinating. Whether they have the “moth going to light” syndrome I do not know, but one fact is certain and they want destruction and they are geared up for it.

These folks see housing overpriced by 90 percent. Forget using any income to rent to price ratios, housing will go down to Chinatown no matter what. 10 percent annual appreciation? Not in this world. Some of these folks have all their cash buried in the back yard. Great source for screenwriting a Hollywood script.

4. The Housing is in a Bubble? Person

These folks are your paycheck to paycheck people. They are the folks that signed for a $400,000 loan and forgot to ask if they just got a 30 year fixed or interest only adjustable mortgage. Oh well, unfortunately they’ll get the wake up call on a future mortgage payment in 1 to 2 years. These people really don’t care about a housing bubble. They were at home, watching one of the above mentioned housing shows and somehow subliminally, they learned that 10 percent appreciation always happens. So when Joe the agent showed them how to get into a 3/2 home for $500,000 on an exotic loan, they figured “what the heck!” This personality is a mixture of not really having time or initiative to care about the basic economics of the housing market. They are like a reed in the wind. They are more concerned about making the car, gas, electric, health, food, and other basic bills of life to dig into economic theory.

These folks are usually people who will have $3,000 in a savings account earning 2 percent while carrying a balance of $3,000 on a credit card at 29 percent simultaneously. Many of these folks will be burned once rates resets or they need to sell their home for various reasons.

5. The Hybrid Housing/Bubble Head

This is where the large majority of the population is. They see the value of owning a home. They realize that rent is really not a viable option for the entirety of life but they also understand that a home can be overpriced. It is a challenge for these folks because to a certain extent, they believe in the perma bull argument that housing is a great investment. Yet they also have the gut feeling of many perma bears that housing, after crunching the numbers, is overpriced. They normally don’t think that the world will end but realize prices will come down and in certain areas, significantly. These people normally understand some basics of finance; the major point they get is spend less than you earn. They also try to live within their means, have an emergency savings account, and want to have a safe neighborhood with good schools for their family. Many times, they fight the urge to move to a questionable neighborhood because family safety is more important than homeownership.

Conclusion

Most people interested in housing fall within a few of these personality categories. Imagine that all these personalities have gradients attached to them; some people are on the extreme ends of the gradients but the majority falls within the middle. They exhibit hybrid views on the housing market. What is your housing personality?

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Real Homes of Genius: Today we Salute you Compton with a Short Sale at $375,999. New! Short Sale Search Option.

We are having so much good housing news hit the media that you would think the White House press secretary is suddenly working for the housing industry. Next thing we will find out is the President issuing pardons to anyone who bought a home on negative-interest-option-only-adjustable-rate-suicide mortgages. After all, with the amazing tax cuts the government feels you deserve a get out of jail pass too. Today we salute another Compton property with our Real Homes of Genius award. ZipRealty has a wonderful feature that allows you to search for short sales. This was added in addition to other features, that of “fixer uppers” and “interest level.” I’m thinking that any home hitting as a short sale is probably a fixer upper with low interest level – maybe they should have defaulted the search item and save the buyer a minute. ZipRealty is ahead of the curve on this one since this is a booming market:



On with the home. This 1,089 square foot home includes four bedrooms and two “full” baths. Nestled in the majestic resort town of Compton, you will entertain your friends and family behind U.S. Steel reinforced gates, such as those guarding the Rockefeller Estate. This home uses transcendent features of the 1950s including a patented aqua green color to ward off nuclear attacks from Soviet warships. This moderately priced dream crib is all yours for the rock bottom price of $375,999. This is actually less than the sale price of 2006:

Sale History
06/23/2006: $412,000
10/01/1981: $58,500

So already in less than one year, we are giving you the dear buyer, a $36,001 discount. Or to look at it from another perspective, the median per capita income of someone living in the area. The absurd notion here is that someone paid $412,000 for a home that will rent from $900 to $950 a month. Now the bank is taking it in the shorts, hence the name short sale, and looking at yesteryear appraisals for a market value. Keep in mind this home initially was listed for approximately $400,000 but no bites. I’m not sure how anyone can justify prices like this. It’s almost like sellers went into asylums, removed the straightjacket from patients, showed them pictures of homes, and asked them how much would you pay for this? “$500,000!” Okay. And this home? “$500,000!” When people say we have crazy housing prices they mean it in more than a figurative sense.

And what is the agent thinking? Taking pictures behind bars isn’t exactly making this a hot item. Didn’t they see how unappealing the Paris Hilton mug shots appeared? They need to add some pizzazz or hire some unemployed paparazzi; there is plenty in the LA metro area for a good price. Or maybe you can ask Alan Greenspan to give you a stump speech on how adjustable rate mortgages are good for America. After his speech, he should be dragged to this home, and forced to purchase it via a New Century Financial no money down interest only mortgage. As he stated so eloquently that ARMs are good for the economy. Good job easy credit. Thanks for flooding the world with such lax standards that housing prices are beyond unreliable, we might as well purchase a pregnancy test from the 99 Cent Store to determine whether housing will appreciate in the next year. Let us see…two lines. I guess that means it’ll be 20 percent appreciation again in 2008.

Today we Salute you Compton with our Real Homes of Genius Award.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

Housing and the age of Affluence: Transforming the Definition of Income and Wealth

Most people consider families with 6-figure incomes to be financially secure. Some would even venture to say that this is the upper-middle class. Yet very few housing articles look at income in relation to housing prices if you have noticed. It is almost a foregone conclusion that people earn enough to support Wonderland prices. So how does income distribution really look like in the United States? Looking over data from the Census Bureau, you will be surprised to see how various quintiles breakdown. Considering that a median home in Southern California is over $500,000+, a family earning $100,000 a year is still paying 5 times their annual gross income for a home. Keep in mind a half-million dollar home in California is not what you would see displayed on Lifestyles of the Rich and Famous. You are more likely to find a Real Home of Genius in this price range. I’ve observed housing bulls arguing that housing is being supported by radically high incomes and unbelievable job growth. Do we really have that many people making $100,000 a year to support $500,000 homes? Let us take a look.

The Number Breakdown

F. Scott Fitzgerald once said that the rich are different from us. To which Hemingway responded, “Yes. They have more money.” There is a fascination in this culture with the uber-wealthy. Take a look at shows like Cribs where opulent wealth is showcased. Tabloid magazines make their money from this cultural fascination. What do the rich eat? Do they shop where I shop? What do they do for fun? Where do they live? If you really examine what it means to be rich, you will find some surprising answers. But first, how many rich people are in this country?:

Household income (overall percent of US households over):

Income Percent of Households over:

$65,000 34.72%

$80,000 25.6%

$91,705 20.0%

$100,000 17.8%

$118,200 10%

$166,200 5%

$200,000 2.67%

$250,000 1.5%

$1,600,000 0.12%

Some of you may be surprised to see this data. If anything, it should point out to you that there is not nearly enough of an income base to support the $500,000 median home prices in Southern California or any overpriced metro area in the country. Even a household with dual income earners making $100,000 a year, after taxes they are pulling in a monthly nut of approximately $5,900 without contributing to a 401(k). And what is the monthly mortgage payment on a $500,000 home with 5% down ($25,000) at 6.5% over 30 years? The principle, interest, and taxes will cost you approximately $3,600. After taxes you are paying 61% of your income toward your home. Moreover, this is for families that fall in the top 17% of income earners. Last time I checked, we have a national homeownership rate of 70% and in California, a homeownership rate of approximately 57%. Since we realize that income isn’t the main protagonist of amazingly high home prices, then what is it? Surely there must be an explanation for the radical jump in home prices over the past decade.

Risky Loans and Easy Credit

How can a family earning $65,000 a year, jump into a $500,000 home? Easy. We can lock them into the world of subprime loans. Only a few years ago, it was incredibly easy for a family to go stated income and jump into a 2-year teaser rate mortgage with a 1.25% rate. The rate would adjust but by that time, you could flip your home and make a nice little return. Don’t know how? Just watch the show Flip this House. I remember a mortgage broker telling me, “it is easy to get anyone into any home. All they need is the willingness to find a place and sign.” He even told me about his ability to squeeze in families with $50,000 incomes into $500,000 homes and got joy how he was churning $10,000 a month in commissions. That was 2005. Fast forward to 2007. He is no longer working at the company since it imploded early this year. When I last talked with him, I asked him what his plans are now that he is unemployed. “I’ll go work for another lender but one that focuses on foreclosures. That’s the next big market.” Didn’t want to burst his bubble but in a bear housing market, sales drop massively therefore cutting into the churning of transactions. Therefore, his $10,000 a month will only be seen again if he has some advanced college degree or sells crack on the streets. Ironically, this person has nothing saved up after 3 years of being in the business and making $100,000+ each year. The product of conspicuous consumption and financial irresponsibility – easy come easy go.

This is only one case of many. The person above is young. But so many people got caught up in this housing frenzy and believed it was a ticket for easy street. They under funded their retirement accounts in belief that Social Security will be there for them. But think about the culture of credit that they blossomed in to. They entered the workforce with a national negative savings rate, credit cards being given out like candy at colleges, and cash becoming almost a thing of the past. People even pay for $1 cheeseburgers at McDonalds with a credit card! So is it any wonder that they have no fear issuing out or taking on absurd mortgages? Credit will always be there for them. It was there in the past, why not in the future?

Age and Culture Conflict

I have a colleague telling me how buying a home is always expensive. He tells me about earning only $30,000 a year and buying a home that cost $110,000 back in 1988. He is also proud that he would not be able to afford his current home if he bought it at today’s market value. It is a sense of pride that he can’t afford his own home, “if I were in the market today, I wouldn’t be able to afford my own home!” This from a baby boomer nearing retirement with a locked in pension. Looking deeper into the income stats, we realize that the top earning households are those headed by working baby boomers. The exact range of top earners is 45 – 54. The conflicts of managing a high cost of living seems to be disconnected from those from the 25 – 39 age group. For one, we do not have the luxury of having a Social Security safety net, therefore many of us actually have to over fund our 401(K) if we do not want to live off government cheese. Yet we pay 15% of our income into a fund we will not see. Not only that, but many companies are now eliminating defined pensions and passing on the cost of health insurance to the young working class. The cost of living is much higher even though incomes on the surface may seem high for young working professionals.

In addition, housing has never been this expensive in relation to income. Even though buying a home may stretch a family’s budget, anyone buying a home in today’s market would need the flexibility of Gumby to purchase a starter home. There is a generational divide in our culture. Many young folks feel they are getting advice from a person that has a locked in retirement, years of Social Security, and locked into affordable housing – things that are not in our lexicon. These items are remote to any young professional. So the “live and spend” culture of today has some direct correlation to the psychology of both generations. Even though I disagree with this mentality, I can understand where it comes from.

Yet this housing market also affects baby boomers. Many are counting on their equity in their home for retirement. I’ve talked with many people telling me that in 5 years when they retire, their home will be worth $1 million and they’ll use the equity to downsize. When I ask them how they know 10% annual appreciation will occur from 2007 to 2012, they reply, “real estate always goes up.” So not only does this housing market hurt families looking for a starter home, it also hurts those nearing retirement with an inflated few of their home and a perceived idea that a built in safety net will always be there for them. In general, the young overestimate the difficulty in paying back large amounts of credit (i.e., buying a $50,000 car) and the older generation underestimate the need for a larger retirement nest egg (i.e., American’s nearing retirement have an average nest egg of $50,000).

In the end, looking at income numbers, home prices do not justify their current market rates. These rates are inflated on bubble psychology and easy credit that is slowly evaporating. The market will contract and a major shift in cultural psychology will occur.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

$5 Trillion in Housing Wealth Gone: The Impact of the Housing Bubble Bursting

A sane person surrounded by insanity will at some point, question his or her own mental health. Examining the past decade of housing especially from Southern California, the epicenter of the housing bubble, you begin to question economic fundamentals and simple rules of finance. At this point, we are reaching the overdue housing correction. Housing has created immense wealth in the economy and has propelled us out of a brief recession earlier in the decade. Yet this wealth was created on an illusion of easy credit. It is estimated that the housing bubble has created 5 trillion additional dollars of wealth as compared to a scenario where housing kept pace with inflation. This is important to note because historically, housing has only kept pace with inflation as an investment. When you have certain areas up 80 percent in real terms as the Center for Economic Policy Research has showed, we have speculation and not normal growth.

We will look at the past decade of housing and address the following issues: income, inflation, rental rates, bubble specific regions, and the public policy issue of bursting the bubble.

Income Has Gone Up

In real terms, per capita income has grown 2 percent annually since 1997. This is something positive for our economy. It does show that as a nation, we are growing and thriving. Yet certain industries are now facing the pull back associated with the housing downturn. Consumption and automobile sales are taking massive hits in the last few months. Construction is falling in large numbers. We have only started to see any of this impact in our economy. The $5 trillion in bubble wealth has created an extra $250 billion in consumption that would not be present if it were not for the housing bubble. This works out to be 2 percent of our GDP; in other words, without that wealth we would already be in a recession.

Even though income is up, it does not justify housing prices being up in real terms of 80+ percent. And with income being up, we also have higher cost associated with health care, energy, and household items so the 2 percent increase is really negligible.

Real Estate Has Normally Treaded with Inflation

Decades of data show that real estate normally grows at the rate of inflation. That said, why do we have real increases of 80 percent in certain areas? You may say, 80 percent is large and I doubt this is true. In California, countless homes that cost $175,000 in 1997 are now on the market for $500,000. Pick any of the 88 cities in Los Angeles County and you’ll see that this 80 percent number actually understates the growth. So is it possible for housing to fall 50 percent in a few years? If housing can go up 200 percent in certain areas over 10 years, then yes, a 50 percent drop is plausible. As a caveat, when you are arguing market fundamentals for a bubble, any number is possible but the eventuality is that the bubble will burst and market fundamentals do rear their head again. For example, the long tested rule of housing keeping pace with inflation.

Rents have not Increased Significantly

During the initial stages of the bubble, rental rates did go up in decent numbers. However, in the past few years, real estate has outpaced rental market rates by an unbelievable number. Most investors and economist associate a rental value on the property in terms of deriving the actual value of the home. For example, many investors will divide annual rents - expenses by the price of the home to arrive at a return on the investment. In most cases, it will always be slightly more expensive to purchase a place than renting even after factoring in tax benefits. The premium will always exist because you are purchasing an appreciating asset that is building up equity (normally at the pace of inflation) and will create a real store of value for you.

After a few years of bubble psychology and straightjacket number crunching, many people modified their equations to factor in 20 to 25 percent annual appreciation rates and thus justified the price of homes even though rental rates were significantly lower and in no way supported the market value of the home. The premium of the home was based on the false assumption of abnormal market returns. In simple terms, pure speculation. Now that more inventory is hitting the market and sales are dropping, we will see certain areas declining in rental rates. In certain prime areas, we will see an inverse reaction with rental rates going up while housing prices go down. It will all be specific to each certain market. In the end real home prices will decline.

Only Certain Areas Have Bubbles

Certain areas such as the South and Midwest actually saw no true real increase in prices over the past decade. Then we have areas such as the Southwest, DC, Northeast, and Florida seeing real price increases of 80 percent in certain regions. The bubble is national in the respect that overall statistics are heavily tilted by regional bubbles. Meaning, the numbers are skewed by certain metro regions being overvalued. Population trends do not justify the upward jump in prices because overall, we are seeing many baby boomers retire. If anything, they are getting ready to downsize their home as opposed to expanding for a growing family.

We also have massive construction that really had no bases in population growth. If anything, as a society families are choosing to have fewer children. The need for larger and bigger homes is spurned on by nothing more than bubble speculation. The demand is simply not there. That is why we are seeing a record number of vacancies hitting the market in many regions of the country. Many people bought homes in other states thinking that they would be able to rent them out as investments but forgot to check local market conditions. The population in many of these areas simply did not meet up with the growth in housing. In fact, some areas didn't even have a population to begin with - these are the future ghost neighborhoods of America.

Public Policy: Bursting the Bubble Now is Good

When you watch shows like American Idol or America’s Got Talent, you can see that some contestants honestly believe they are the greatest thing to walk this Earth when in fact, the sound of mating cats is more enticing. Just like these delusional would be superstars, we have many folks accustomed to the decade long bubble in housing. They feel entitled to this $5 trillion of pseudo-wealth created by a bubble fueled by horrible public policy. Public policy by who? The Federal Reserve and the hunger for mortgage backed securities on Wall Street. The quicker the bubble bursts the better it will be for the overall long-term sustainability of the economy. The bubble has already been left unchecked for too long and the repercussions will be felt to the very core of our nation. You cannot use debt to finance your entire economy. Unfortunately, we have too much credit floating around and we are going to face a radical public policy debacle and potentially a government (read public) bailout.

Many baby boomers are counting on the wealth in their homes. In fact, savings rates and retirement nest eggs for many of these folks are massively under funded. And why should they save? If they have the perception that their home is going up $50,000 per year unabated for the next decade, why fund a 401(K) or IRA when you can make much more simply living in your house. This is reflected in the response many people have regarding their retirement. They assume the money will be there. Like a mirage in the desert, the closer they get to retirement the more they will realize much of what they saw was simply an illusion.

Then we have 8 million people a year buying homes at inflated prices. Like Alan Greenspan has mentioned, bubbles are only identifiable after the fact, it is hard to say the exact start date of the bubble. Was it 1997 or 2000? It also varies on which region. Back to the millions of recent buyers, they are purchasing homes at current bubble market rates. When the market corrects, the negative wealth effect will hit these folks very hard and direct. Even those who bought 10 years ago and never planned to sell, will take a psychological blow because their once valued $500,000 home is now only “worth” $375,000. This will have a major impact in our nation’s consumption.

Even with this tremendous housing wealth, owner’s equity isn’t that high. A startling fact if you think about it. The ability to take money out of your home has been a national phenomenon in the last 10 years. Once thought as an untouchable resource, folks have been more than willingly to extract perceived equity and fuel consumption. This only increased the magnitude of the bubble. For one, the money tapped out of the home creates a 2^nd lien on the property that needs to be paid back. It isn’t free money. Yet people treat it as a grant that doesn’t need to be paid back. In many cases, these loans are paid over 10 years. Now what do you think the impact on a person taking out $50,000 in their home only to realize their home was never worth that additional $50,000? My guess is they will feel slighted and think that they got suckered into signing up for $50,000 of relatively cheap debt.

This irresponsible lending has created an environment where the only recourse is a hard and steep correction in the housing market. The Fed, housing industry, buyers, and sellers were only all too happy to be accomplices in this bubble. Yet this doesn’t mean that what has occurred is based in any economic reality aside from the fundamentals of asset bubbles. It was all an illusion. Now that we are seeing subprime lenders imploding and mortgages resetting, the true cost of this economic expansion is coming to fruition. The more and more I look into this issue, the more it seems that we will not see a soft-landing in housing.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.

The Cost of Mortgaged Suburbia: 3 Modern Housing Psychological Shifts

As we firmly enter the summer selling season, we have a wonderful aroma of massive mortgage debt and overpriced homes filling the air. It is the smell of burning American Express plastic in the wallets of many itching to buy anything imported. Then we have home equity lines of credit and home loans fueling the real estate market to another dimension. Let’s face it, we are a debtor nation in every sense of the word. We are running massive trade deficits and are content turning on the printing press and letting inflation devour our green dollar. But there is a cost to this. This mixed panacea of suburbia creates mixed emotions in the hearts of many. Many families want a nice sized home and good schools for their children. But are you willing to sacrifice the quality of your own life by commuting one-hour each way simply to purchase a home? Are you willing to spend 50+ percent of your income servicing the debt on your home? The mental vision of a home with a stunning green lawn and a white picket fence are etched into the American psyche even if you grew up in a concrete jungle like Manhattan. And we also have urban sprawl dominating our nation’s landscape. With the housing boom that occurred during the watch of Sir Alan Greenspan, we’ve seen builders subdivide and conquer the landscape of our nation with 3/2s popping up everywhere. It almost came down to a science; subdivide here, put 100 homes here, put a shopping center there with a Starbucks and Wal-Mart, and voila, you have yourself a new town. But will the people come?

There are 3 quality of life points that many metropolitan areas are facing. One has to do with commuting. The second point discusses that extent to which sprawl can be supported. And finally we discuss our sudden nonchalant cultural acceptance of debt.

Commuting

Love it or hate it, most Americans in metro areas commute. According to an ABC poll, American’s spend an average of 1.5 hours a day commuting to and from work. Below are some interesting figures:

Commute Time:

Average 26 minutes

On a good day 19 minutes

On a bad day 46 minutes

The survey also found that those in congested cities found their commute “bad” as compared to those in rural areas. Aside, from that obvious tidbit, commuting does have a major impact on our society aside from the time lost on the highway. The average American family spends approximately $4,200 a year on fuel cost and another $2,000 in car insurance. According to Edmunds, the average MSRP of a new car is $30,000+. So total it all up and we are spending a large portion of our disposable income on automobile cost.

The highway system was constructed under the National Interstate and Defense Highways Act of 1956. The purpose was two-fold, to create standards of driving such as speed limits and for civil defense/emergency evacuation. Well of course we saw how well it handled an emergency evacuation with Katrina. The highway system was championed by the auto industry and has been a major reason for the economic growth of our nation for the past decades. However, the system itself is having challenges supporting urban sprawl and massive jumps in our population. 56% of the system is funded via taxes (largely the gasoline tax) and other federal and state taxes. Given the inordinate amount of money spent on fuel, do you wonder where this money is going? In large established areas such as Los Angeles County, there isn’t any land surrounding areas to add additional lanes or expand alternative routes. We’ve heard numerous times that they’ll double-deck certain congested areas but any work would take a decade at the very minimum. This talk occurs in the background while commute times increase every year.

So what does this have to do with housing? For many people, it has a lot to do with their quality of life and where they choose to live. It is becoming obvious that living near your work is a luxury in Southern California. Each day the 405, 5, 10, 210, and other highways become flooded with millions of drivers heading to work. Red lights fill the lanes like busy ants. How much are people willing to take of commuting to realize the American dream of that big house on a nice plot of land? Is this dream really a nightmare in disguise for many metro residents? This leads us into our next discussion, the urban sprawl caused by growing cities.

Salton City and Other Outskirt Boom Areas

You are left with a few options regarding commuting. You can either rent near your work thus improving your commute time. You can buy near your work and pay market rates for a home in that area. Or you can buy miles away and increase your commute. The latter option has emerged as a booming trend for many in Southern California pursuing the dream of homeownership. Examples include areas such as Temecula, Hesperia, Victorville, and Rancho Cucamonga. Once thought to be too far away from the hub of the city, are now home to hundreds of thousands of commuters that now own a home.

An interesting article appeared in the LA Times discussing the boom/bust of Salton City. This city is near Salton Sea over in the inland empire desert area of Southern California. Builders with the current run-up in real estate prices figured that those retiring will see this area as a Mecca of growth. Salton City decades ago was thought to become a large resort like area rivaling Palm Springs. Big names like Sinatra and the Rat Pack made the desert area famous and are booming to this day. But the sea did not boom. The salinity levels in the water are much too high for biodiversity and it turns out that you can in fact be too far from metro hubs. There is a limit to what people will drive. The California land mentality has taken hold many times and builders point to areas such as those in the inland empire that once were thought too far away, and now are thriving suburbs.

I’m not sure much thought was put into this land development. There is a point where working commuters will no longer travel. The breaking point seems to be about 2 hours each way. This part of the desert falls within that category. Homes are cheap in this area but you are in the desert where temperatures reach 120+ on hot summer days and you are far from any large metro area. If the argument is people will leave the area for more peaceful locations to retire, why won’t people simply move to Arizona or New Mexico where you get the same desert for hundreds of thousand less? After all, Social Security and other retirement funds are directly deposited into your account so you can retire anywhere. The money you save on your home, you can use at local airports to fly into the Southland should you need to (might even be faster than hitting the road). I’m not sure much thought was given to certain booming areas in California and other parts of the nation. They figured that if they built it, people would come. So much is based on the American dream of homeownership that builders believed folks would fork over 3 to 4 hours a day simply to make the mortgage payment. Many middle class Californians are voting with their feet and leaving the state to places such as Arkansas, Arizona, Oregon, and other diverse locations.

The argument has been made time and time again that we need more housing. This is correct. But the type of housing needed to support our population is high density affordable housing. Look at New York or London. The idea of a home on a large plot of land is nearly non-existent for the middle-class in these highly populated areas. Southern California will become that way or we will see a two-tier system solidly emerge; the lower and middle-classes paying rent or buying in the boondocks, and the upper-class staying put. Demand will be high in these prime areas because people are willing to pay to be near work. That is why I believe many of the 88 cities in Los Angeles County will decline in prices in the upcoming years while few select cities will stay put or even increase. Orange County will follow a similar path. When you factor in commuting cost and the median for LA County at $550,000 and Orange County at $635,000, you start to realize that most families simply work for their family and car with practically nothing left over at the end of the month.

Married to Debt

This seems gloomy but here is the good news. We love debt as a nation. Want to see the average and median on a few items? Take a look at this:

Average Wedding Cost: $27,000

Average New Car Cost: $30,000

Average New Home Cost: $236,100

Average American Credit Card Debt: $9,200

Average American Median Income: $46,300

The willingness to take on inordinate amounts of debt has also fueled the housing bubble. Given that our savings rate is negative, we are realizing that spending (via debt) is the way we keep the economy afloat. Whether people refinance their home or take money on through loans and credit card debt, consumer spending is by many estimates 70% of our economy. Now that credit is tightening up, we are seeing how quickly the economy is contracting. Many pundits are crying foul and blaming the Federal Reserve for spoiling the party. Yet we have set a standard that isn’t sustainable. I’m sure many of you saw the Saturday Night Live skit of debt reduction where they parody a commercial and a man comes out with a breakthrough idea, “spend less than you earn!” Somehow this idea hasn’t caught on. The fact that many Americans are locking themselves into 30 year mortgages in areas that will face market declines, will cause a negative wealth effect on the overall economy. Economics show that during recessions, people spend less especially if they perceive their employment being tenuous. This massive credit bubble will no doubt lead us to a recession because in reality, there is no other way out. We have few options. We can create more money by lowering credit rates thus fueling more spending via debt – with this the economy at least has the perception of staying afloat because spending is so vital to our growth. Or we increase rates, and flush out the excess credit. This will be a painful experience. The amount of credit through mortgage equity withdrawals, credit card debt, auto debt, student loan debt, is so incredibly high, any credit contraction will cause a major shift in the economy.

We are married to debt and seeing how expensive marriages are, we have put ourselves in debt for this matrimony. But one thing is more expensive than marriage and that is divorce. Soon we will face the divorcing of massive credit and it will be painful. It was fun while it lasted.

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.