August 31, 2007

Real Homes of Genius: Today we Salute you Cerritos. All 88 Los Angeles County Cities Overpriced.

What an interesting week. As Rome burns and the political syndicates offer every possible option of bailing out the rouge gamblers and maverick flippers, they fail once again to highlight the nucleus of this bubble. Forget that the Bush Administration is offering a bailout plan even after he said they would do nothing last week. Pay no attention to the Fed with their implied wink-wink posturing that they will lower rates. So what. Homes are so overpriced in nearly every metro area in the country that they can drop rates to 0 and it still won’t make sense to buy because prices are out of line with local household incomes. Would you like to buy a beat up Ford Pinto for $30,000 simply because the interest rate is 0 percent? Apparently this is happening with all these Real Homes of Genius we are seeing. You may think that we are grabbing at low hanging fruit. But these homes are priced from $300,000 to $500,000+ in lower to middle income areas. Last time I checked, $500,000 was no low hanging fruit. So as the media is doing a Pavlovian response to an implied bailout, the fact is nothing can bail out an overpriced home by someone that simply cannot afford the payments. And to show you this, we are going to include higher priced homes in Los Angeles County to drive home the point that in EACH of the 88 cities in our county, prices do not make any economic sense. Today we will shine our flashlight on Cerritos. A middle to upper-middle class area in Los Angeles County. It is with great honor that we salute you Cerritos, with today’s Real Home of Genius.

Today’s home is what one would expect as a starter home for a professional family in Los Angeles County. A safe area, good schools, and a place one would probably like to raise a family. This home is over 2,000+ square feet, has 4 bedrooms and 3 bathrooms. Nothing spectacular. So what was this home initially listed for? Well someone actually thought that we were still in 2006 and listed this place for $778,000. Apparently there are no takers at this price. Let us take a look at the pricing action on this home:

Price Reduced: 08/02/07 -- $778,000 to $759,000
Price Reduced: 08/17/07 -- $759,000 to $739,900

Clearly not many people were biting at $778,000, or looking at it from another perspective, $200,000 away from $1 freaking million dollars! This is a four bedroom home in a middle to upper-middle class neighborhood. This isn’t Atherton or Beverly Hills. Before you shed a tear for this seller and bring out the violin, let us take a look at the previous sales history on this home:

Sale History

10/04/2002: $430,000

12/24/1998: $275,000

So even at the current sales price, these sellers are looking to come away with a $300,000 profit in 5 years. Since real estate over the long-term has followed in line with inflation, how would the price for this home look like if we followed a 5 percent annual increase starting in 1998?

5 Percent Increase

Current Sales





base year























So already with the sale in 2002, using 1998 as our base year the home at a 5 percent inflation rate is over the baseline by $95,736. Keep in mind the government data police are constantly telling us inflation is at 3 or 4 percent so we are being overly generous with 5 percent. If we continue with the trend, once we reach our current date of TODAY, we are now off by $312,385. Almost double what the inflation adjusted price should be. So this is back of the napkin math Dr. Housing Bubble; I’m sure people in Cerritos make $300,000 per year to justify these prices. Well let us take a look at the current average annual household income:

Average household income: $89,391

Not bad. A lot better then the $50,000 average we find for other Real Homes of Genius areas. But let us run a hypothetical scenario of a current family making the average income buying this home:

Monthly Net Income After Taxes: $5,603 (Filing as married with 2 exemptions)

PITI: $5,193 (10 percent down and current jumbo rates)

So this family is left with $410 disposable income each month. Bwahaha! Absurd. It is such a joke that these financial institutions, politicians, and other renegade zealots of housing are trying to keep this game going. Tax breaks for short-sales. Subprime support. GSEs being able to refinance mortgages into current FHA products. Are you kidding me? This may help people with subprime loans in areas where home prices are $250,000 or less. People can’t afford homes at current prices in Los Angeles without voodoo mortgages. The only way this game will keep going is if the subprime market opens up again. Now who is going to finance these high-wire mortgages? Doesn’t seem like Wall Street wants anymore. The government can only do so much with FHA loans and besides; the Fed has already stated they won’t lift caps. So that pretty much puts a plug on California since the entire region is jumbo-exotic-mortgage territory. Notice how politicians aren’t talking about bailing out people in Florida or California specifically? They are casting a wide enough net and when you dig into the details, the train is still coming. All these bandaids are simply that, a patch on a bigger problem.

They can jawbone all they want with Pollyanna projections and we’ll keep on showing how overpriced and absurd this market is and why foreclosures are exponentially growing. I’m keeping my eye on short-sales and foreclosures and each week, the numbers are consistently going up. The party is over and as much as they want this game to go on, nothing short of sucking the last drop of energy out of the dollar (which they may do since they don't care about fiscal responsibility obviously) will rescue this defunct mission. Housing is going to stay in a bear market for years in California. Why? Because like Bob Barker would say, the price isn’t right.

Today we salute you Cerritos with our Real Home of Genius Award.

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August 30, 2007

Pride and Prejudice: Examining the Psychology of Those in the Housing Industry.

“It is difficult to get a man to understand something when his job depends on not understanding it.”

-Upton Sinclair

It is hard to be objective when your job depends on seeing things a certain way. Many people have a hard time accepting mistakes and would rather lament and lash out at others that contradict their view of the world. I remember posting in a housing forum 2 years ago the same analysis I’ve presented many times here on the blog. Those in the housing industry would dismiss the bubble argument as holding no merit and would simply pull out a nice upward trending chart, and point to the current median price. They were right. All the numbers pointed to incredible appreciation, quick sales, and no signs of stopping. My view was income in many areas simply did not support the current growth of the market. The only way the market was being supported was via exotic financing and bubble psychology. In a bubble market, psychology and perception is just as important as economic fundamentals. So people in the housing industry didn’t have to say much. Here are a few quotes from the former head of the National Association of Realtors during this time:

March 2005: " I believe that in years to come historians will see the beginning of the twenty-first century as the "golden age" of real estate. And I want to persuade you to take advantage of this historic opportunity. "

Source: Are You Missing the Real Estate Boom? Why Home Values and Other Real Estate Investments will Climb Through the End of the Decade-And How To Profit From Them" March 2005, p4. Author David Lereah

September 2006: "With a general background of growing population and favorable affordability conditions, home sales are staying at very healthy levels," said Lereah. "As a result, we'll continue to see above-normal home price appreciation for the foreseeable future."

Source: Chicken Little's revenge, Salon

I talked about the psychology of a housing bull in a previous article. The above quotes demonstrate a common view of many in the industry. One of these beliefs is housing will always go up. This is not true as we are seeing year over year drops in many locations. In some cases, these drops are large bringing down the price of a home by tens of thousands of dollars [see Real Homes of Genius]. In addition, as I pointed out in the Los Angeles County demographics article, population hasn’t exploded to the extent to justify 20+ percent gains for three consecutive years. Again, the chart is still used by many in the industry and they are right since last month Los Angeles hit another record median price in housing prices here in Los Angeles. But they are driving forward looking in their rearview mirror.

Now that the market is demanding economic fundamentals, the man behind the curtain isn’t so strong as we once thought. The unstoppable real estate juggernaut turns out to have an Achilles heel. Those subprime loans were actually a lot more shaky and weak than many had predicted. And this bubble bursting isn’t contained to only the lower nether realm of mortgages, it is also impacting the untouchable prime loans. Since late 2006 over 142 mortgage operations have closed shop. The year over year price appreciation predictions by housing bulls in late 2006 is no longer used as an argument. And this time when they hold up the chart you can see uncertainty in their eyes. After all, what does a mortgage broker care if the median is high if he is no longer in business? Or why would an agent be happy with a $700,000 home if he doesn’t have any clients to drive around?

The argument has psychologically shifted. There is no need to talk in obscure forums regarding the housing bubble. The mainstream media is now carrying the baton. Now the argument of many in the industry is one in which they are blaming all the negative press for popping the bubble. “Income is rising, population growth is occurring, and housing is still strong.” Or so they would like you to believe. Tell that to the tens of thousands of former mortgage workers. And this argument seems more of a self pacifying defense mechanism of convincing themselves that somehow the market will be back to its old tricks again. Deep down they pine for yesteryear when you could get Funky your mangy dog a $450,000 mortgage and move him into a 500 square foot home with no co-signer.

Common sense isn’t so common as the adage goes. Why is this? We all know exercising and eating healthy is paramount in your long-term well-being but why do so few Americans do it? In fact, according to the American Obesity Association 127 million adults in the US are overweight with 60 million categorized as obese. Maybe it isn’t so easy. After all, exercising and eating healthy requires commitment, a desire to better your body, and a belief that keeping yourself in peak shape will benefit you throughout your life. Yet we live in an instant gratification world. Depending on your current condition, it may take you six months to get into good shape but only after working out multiple times a week and eating a healthy diet. When we see infomercials we always here “lose weight NOW!” or “lose 30 pounds in 3 weeks!” The psychology here is that people want solutions quick and fast for something that needs to be looked at as a long-term lifestyle commitment.

Okay Dr. Housing Bubble, what does being overweight have to do with housing? Aside from believing that staying in physical shape should be a top priority for everyone, the psychology behind the numbers speaks to the get rich quick mentality of the last seven years in real estate. Real estate is a great long-term investment. In fact, owning rental properties is part of my balanced portfolio. But you buy it at prices that make sense. Otherwise, it is like the expensive treadmill that so many people buy and later becomes a towel hanger with cobwebs. If you are smart, you’d just pick up the weekly classifieds and buy one at a deep discount from someone who overpaid from the start. There are a few ways to get rich quick: Hit the Lottery, inherit some money from a rich family member, invent something unique and sell it, or steal it. Other forms of getting rich take time like slowly building your business, going into a profession that’ll pay off long-term, and investing wisely. Even though some of the data is old, I recommend people read the Millionaire Next Door. It’ll give you a good idea of the difference between being wealthy and making a lot of money. Unfortunately, I know some brokers who made money hand over fist during the good times and now, are struggling to pay their lease on their brand new Mercedes. I detailed how a high earning couple with no financial plan can go from rich to struggling in one year.

We have all faced circumstances in life where our pride is at hand. It is hard to let go of something you fully believe in, even if you may be wrong. You may be wondering where any economic analysis or data is in this article. There isn’t any. Bubbles don’t follow economical rules. They rely just as strongly on market perception and psychology. By the time people get out of the euphoria and start examining the market with a critical eye economic fundamentals are no where to be found. You may want to read the article on Manias, Panics, and Crashes. Bubbles expand because of greed and pop because of fear. Too much greed and fear is never good in a society. Even after the Crash in October 1929, people in early 1930 still thought the market would rebound. But the market slowly went downward hitting a bottom on July 8, 1932. A plunge of 90 percent from its peak high in September 1929. It took the market 25 years before the Dow Jones ever saw the peak of September 1929. I’m not sure we’ve even seen the major capitulation point yet. Was it the subprime collapse? The hedge fund issues? Liquidity problems? We won’t be able to have an exact apex until 2 or 3 years out as to the exact moment the market gave way. And bottoms take a few years to play out after a bubble collapses. If you don’t think we are in a bubble you can read the article over at TIME Magazine with the title, Your House is Worth Less? Good . They are finally acknowledging that what we’ve lived through is a bubble.

Many in the industry that still do not get it, are wanting the Fed or some other form of government intervention. During the boom times, they wanted the government to be hands off and not enforce even the smallest regulations. Yet now with times shifting they want the Fed to jump in with an orange rescue jacket. This is what we call cognitive dissonance. According to Wikipedia:

“Cognitive dissonance is a psychological term describing the uncomfortable tension that may result from having two conflicting thoughts at the same time, or from engaging in behavior that conflicts with one's beliefs, or from experiencing apparently conflicting phenomena.”

I know how most of you feel about a bailout and I’m glad we share the same sentiments. If there isn’t a bailout for those losing their home there shouldn’t be one for lenders who irresponsibly gave money to everyone and anyone. Senator Dodd’s proposal is absurd regarding lifting caps on mortgages. The last thing we need to do is prolong the bursting of the bubble and waste more taxpayers money. Politicians seem to be throwing out ideas and seeing what sticks. Some city politician wanted to give $10,000 to each family facing foreclosure here in California. Which would only help for a few months and then what? I haven’t heard any idea that I liked until this morning when presidential candidate Barack Obama unveiled his bailout plan:

“Unscrupulous lenders who deceptively sold subprime mortgages to millions of Americans should be fined and the proceeds used to help bail out borrowers facing a wave of foreclosures, according to Barack Obama, the Democratic senator running to be his party’s presidential candidate.

The proposal is among the most radical yet from a leading Democrat and comes as Washington tries to respond to a growing wave of foreclosures and a crisis in credit markets.”

I’ve thrown around this idea in the comment section of this blog and other forums. I was wondering when someone in the public eye would have the guts to put something on the table like this. Whatever you may think, this is the way to approach this issue. Why should you, a financially prudent person that didn’t participate in this credit orgy be forced to subsidize someone’s speculation? And don’t feel sorry for those in the industry because the housing complex has sufficient money to throw at lobbyist in Washington to keep the party going. Instead of lobbying, they can start the foundation called Bail Out America (BOA), not to be confused with BofA, and open up their check books. If they really care about the family on the street, they will not feel so bad about bailing out the folks that got them rich in the first place. It’ll be an interesting 2008.

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August 28, 2007

Dissecting a County of 10,000,000 People: The Housing Demographics of Los Angeles.

As we reach a record 16 year high of inventory, the biggest supply since 1991 we are starting to realize that housing was fueled by easy credit. If housing wasn’t fueled by easy credit and went up because of rising incomes and demand as many in the housing industry proclaimed, then why in a few short months has stopping subprime lending and Alt-A loans brought the entire market to a screeching halt? It is becoming more apparent that lax lending standards and easy credit were the fuel that kept this fire burning even though the wood was turning into ash. We were running on fumes. The only thing that would keep this boom going is less restrictive standards and I’m not sure how much lower we can go without our money turning multiple colors and becoming a real game of Monopoly. Unbelievably those in the housing industry and politicians are calling for weaker standards. Here is a list of some of their ideas:

· Increase mortgage caps from $417,000. Since anything above this is considered jumbo many in the industry want these caps higher because areas such as California, have inflated houses way above $417,000.

· Dropping the Fed Funds rate. The Fed has already dropped the discount rate.

· Bail Out Funds. A local official is looking to create a multi-million dollar bail out fund for families in foreclosure. The preliminary information seeks to give struggling families $10,000 in assistance. $10,000 will buy a family maybe 4 months at current California prices.

· Bring the Government Into the Subprime Arena: This is one of the absurd propositions and a perfect example of corporate welfare. Wall Street is no longer buying these risky loans. Instead of learning the lesson that maybe there was some irrational exuberance in the credit markets many are now calling on the government to back these loans.

These “solutions” miss the boat completely because homes are simply not worth what people paid for them. Plain and simple. Incomes could not support market prices without the crutch of exotic banana republic loan products. The loans almost by default encouraged flipping and a nomad culture of moving up into larger homes. There is really no purpose for a 2/28 loan or many of the other mortgage products that flew into the market. Many will argue otherwise that this is for the sophisticated investor. Maybe. But it wasn’t used this way. See, the underlying message of a 30 year fixed conventional mortgage implies that you are looking to stay in your home for a few years. If the market goes up, then you sell and move on. You didn’t have a ticking time bomb forcing your next move with an invisible hand. If the market went down and wallowed in the dumps for a few years, at least you knew your payment was fixed. Now many are facing down the barrel of a locked and loaded mortgage ready to reset in the face of a depreciating market. Whether they knew it or not, they’ve suddenly become speculators and are witnessing a margin call. Either pay more cash to stay or sell. And many of these loans had 3 year prepayment penalties. Basically these products only made sense to those earning higher commissions and hungry investors chasing higher yields.

With this as our back drop, I wanted to dig into the demographic facts of Los Angeles. I’ve already discussed that Los Angeles is a county with a renting majority. But I wanted to find out how much change has occurred over the last few years. I’ve reviewed four years of data from the Census data sets regarding housing and economic data pertaining to Los Angeles County. Has population boomed? What is the overall cost between renting and owning? Did people really go haywire with mortgage equity withdrawals? These are a few of the questions we will seek to answer.

Los Angeles County Population and Income

Argument #1 – Housing has boomed because of population growth.

First, as you can see from the above chart the population of Los Angeles County hasn’t exploded into another dimension. In fact, it dropped in 2005. The data set doesn't include 2006 and 2007 numbers but we can estimate numbers have stayed relatively the same. Even if they have gone up, there are studies showing a net migration out of middle-class families from the state. The numbers balance out because lower-waged workers filled the gap. But are these the people pushing up the market prices? Let us take a look at the median family income for the same data set:

Argument #2 – Income growth is in direct proportion to housing appreciation.

Clearly income growth is not the reason for housing growth. Even with the big jump in 2005, the median family income only increased by 5.5 percent. The previous three years saw stagnant wage growth. However, during this same time period we find the following data for housing prices in Southern California:

Median LA County Home Price:

2002: $266,000 (July 2002) YoY Increase: 15.1 percent

2003: $328,000 (July 2003) YoY Increase: 23.3 percent

2004: $406,000 (July 2004) YoY Increase: 23.8 percent

2005: $488,000 (July 2005) YoY Increase: 20.2 percent

2006: $520,000 (July 2006) YoY Increase: 6.6 percent

2007: $547,500 (July 2007) YoY Increase: 5.3 percent

Doesn’t exactly coincide with the data we are finding does it? In fact, we had three years of consecutive 20+ percent annual price gains! The annual housing price gains amounted to more than the annual family median income in the county for 3 years. Why work when you can live in your home and make more money than your job?

Looking at Owners vs. Renters

Argument #3 – 70 percent of people own their homes in the United States.

The caveat to the above argument is that this statistic doesn’t apply to Los Angeles County. 10,000,000 people live in a micro world that bucks the trend of the nation. As you can see from the above data, not once in the four years from 2002-2005 did owner occupied units ever take over renter occupied units. Even at the peak of buying in 2004 with every imaginable toxic loan flying around like the monkeys in the Wizard of Oz, renters still held a majority over owners. People also argued that a large number of those that owned had absolutely no mortgage. Let us take a look at the data:

Argument #4 – Many people own their home with no mortgage.

Clearly those without a mortgage are a very small subset of the market. In fact 4 out 5 owner occupied homes do carry a mortgage in Los Angeles County. And the interesting thing to note above is the nice jump of non-mortgaged homes to mortgaged homes from 2003 to 2004. Clearly this had something to do with the mortgage equity withdrawal mania. So the housing industry would like you to believe that many people own their home outright here in Southern California. They are wrong on two fronts. First, as we clearly see from the data the majority of the 10,000,000 residents live in renting households. Second, approximately 80 percent of people that own their home carry one or more mortgages. What is the difference between owning and renting?

Argument #5 – It is only slightly more expensive to own as opposed to renting.

Again, for 2005 the monthly cost for a home owner was $1,919 while the median renter carried a monthly housing cost of $918. Owning a home, as opposed to renting is 109 percent more expensive in Los Angeles County. Of course owning a home is always going to be more expensive given maintenance cost, tax benefits, and the desire to own your proper place. But something has seriously gotten out of whack here. Keep in mind some in the housing industry would like to pinpoint data for Beverly Hills, Santa Monica, or other cities that clearly do not house the majority of the 10,000,000 residents of Los Angeles County. Yet we have an overall median for the county of $547,500. Los Angeles County has 88 cities, all which are overpriced by any fundamental economic measures. Not overpriced by 10 or 15 percent but we are looking at a bubble that has inflated prices by 50+ percent in many cities. Let us revisit those home owners that own their home outright shall we?

Argument #6 – When you own your home outright, you no longer have to worry about any further payments.

As you can see from above even the untouchables, those who have paid off their mortgages completely still have to pay something. In fact, in 2005 with approximately a $400 median monthly payment, they are carrying half the amount of a median renter. Given that this is a very tiny sliver of the market it is interesting to break some of the myths flying around Los Angeles.


We’ve seen countless articles hitting the mainstream media regarding the mortgage debacle. Yet the mainstream media paints in large strokes. That is, it is hard for them to devote a 5 page in depth analysis on one specific market. That is the implication behind broadcasting – you try to reach a broad audience. However, when we examine the demographics under a magnifying class for Los Angeles County, we realize that there is only one reason behind the current market prices and that is massive speculation in the form of a housing bubble. Population, income, growth, and every other major fundamental factor does not offer an explanation for the current prices. Take a minute and look at the below chart:

Do not make the mistake of seeing this as only an economic chart. Behind this data, 7 years of dreams and hopes built on the back of real estate play out like a novel. In this chart we see the birth of shows such as Flip this House, Property Ladder, Flipping Out, Real Estate Pros, and of course the Apprentice where 20 to 50 percent of the contestants made their small fortune in real estate depending on the season. In the chart is also the story of new industries and high paying professions. The number of California Real Estate Agents jumped in tandem with the above chart. Mortgage brokers, construction, hedge funds, and all things real estate seemed invulnerable to any market woes. This was an unstoppable train with an endless supply of steam. As we sit at the apex, wondering how this decade long housing bull market will end, many have been conditioned to know only one thing about housing. And that is real estate never goes down. As this speculative game winds down, there is an eerie calm engulfing the market.

Keep in mind the data we are digesting regarding sales and prices is still 1 to 2 months delayed since escrow filings and closing data lag the current market information we are seeing. Which means data we are digesting today was immune to the recent ugly stick beating the mortgage market underwent. Logically it follows that any future data will be worse because of the now dwindling credit markets. If we are to revert to market fundamentals, housing in Los Angeles County has a long way to go down. I believe that running the numbers for Las Vegas, Phoenix, Miami, Boston, or Denver would yield the same fundamental analysis, and that is housing is overpriced no matter how you dissect the data.

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August 26, 2007

Real Homes of Genius: Today we Salute you Buena Park. 717 Square Feet for $465,000.

I know many of you must be feeling overwhelmed with all the hard-hitting housing data from recent weeks. The sky isn’t falling, but home prices are. Foreclosures and short-sales are hitting the market daily and adding up like an abacus. I’ve decided that it was time to get our feet placed solidly back into reality with another fantastic and spectacular deal here in sunny Southern California. Today we salute Buena Park with our Real Homes of Genius Award.

If you are not familiar with short-sales don’t worry, soon you’ll be reading and hearing many mainstream articles discussing this growing phenomenon. A short-sale, for the sake of simplicity, is selling a home at a loss. Typically, this happens when a seller needs to unload the home but finds that their mortgage(s) has put them underwater. Unlike the Fed, the IRS isn’t one to give bailouts so sellers still need to pony up even after a short-sale is executed. You may be wondering why you haven’t heard much about short-sales in the last few years. For one, a rapidly appreciating market as we have here in Southern California masked a lot of financial irresponsibility. For example, someone bought a home for $350,000 but after 2 years, was unable to pay the mortgage; the mortgage may have adjusted or simply the carrying cost started weighing on the owner. Either way the owner is feeling the pressure to sell. They appraise the home and find out it is now worth $510,000. Instead of dealing with a bad purchase, they are given a nice cashier check for all their woes. With such rapid housing price growth, the market hid the fact that many people were unable to afford the home that they bought. But what happens when appreciation disappears? This is were we discuss the Buena Park home.

This majestic 717 square foot home includes 2 bedrooms and 1 full bath. The fresco color gives you the feeling that you are in a Monet painting. Supreme Scream isn’t only a ride at Knott’s Berry Farm, but also your reaction when you realize you bought at the top. Let us take a look at the sales history of the home:

Sale History

03/08/2007: $510,000

05/05/1995: $110,000

What are we to make of this? Well for one, the purchase of the home was only five months ago. At the sale price in March, this gorgeous home fetched a whopping $711 per square foot! No bubble here. The current price is $465,000. So already in five short months, we have a reduction of $45,000. Not bad for waiting a few months to purchase a home.

But the magnitude of the bubble is highlighted even further when we look at the neighborhood data. Let us dig deeper in the anatomy of this microcosm of the housing market:

Average Household Income: $57,022

Monthly Net Pay: $3,811 (filing as a married couple with 2 federal exemptions)

Monthly PITI: $3,066 (Assuming 10 percent down and 30 year fixed at a generous 6.27 percent)

So what does this added information tell us? A family buying this home putting down $46,500 (what it dropped in 5 months) is looking at spending a whopping 80 percent of their net pay on housing. Talk about crazy ratios. If it is overpriced at $465,000 what were people thinking at $510,000? The only logical explanation is we are in a bouncing bubble. What does a comparable rental go for in the area? The median 2 bedroom 1 bath rental goes for $1,425. Owning this home will cost you twice as much as renting a similar home. In economics, we call this the substitution effect; if something is too expensive and there is a respectable alternative, many people will flock to the lower priced item. With tighter credit standards, the substitution is already happening by force since people in the local area cannot qualify to purchase a home. In addition, no investor would buy this place. Think about it. Your carrying cost is $3,066 and your monthly rental income is $1,425. You are in the red for $1,641. You don’t need to be Rene Descartes to figure out that the math doesn’t work on this one.

With all the chatter regarding the subprime debacle, Fed intervention, and collapsing mortgage operations why isn’t the mainstream media stating the obvious? Incomes in many metro areas do not justify the current prices and hence the market is viciously correcting. In other words, massive credit speculation allowed people to buy more than they could afford.

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

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August 23, 2007

3 Reasons Why This Credit Bubble is worse than 1929. Precursors to a Recession: Complicit Fed, Population Involved, and Greater Dependence on Credit

The market seems to have taken well to the liquidity injection by the Federal Reserve. Since the past two weeks of subprime debacles and stock market woes, the market is slowly gaining a foothold. Investors don’t seem to care that each day a few lending companies are collapsing and firing thousands of people. Growing foreclosure numbers, housing prices depreciating, and consumer spending cut backs don’t seem to matter. The sentiment is we will be back to good times in a matter of weeks. Just to give you some idea of how quickly the market is turning take a look at the number of foreclosure filings in California:


This is no small increase. We are up nearly 300 percent in one year. And since the data available does not have the current month of resets (which for California will be the largest) you can easily predict where the next data point will land. So why is the market rallying? There are multiple parallels to the false jump in stock market prices that occurred during March of 1929. At this time, we actually had a Fed that was concerned regarding the booming market. In fact, let us take a look at sentiment at the time:

“The tug-of-war between Washington and Wall Street reached its peak in late March of 1929. The Federal Reserve took steps to limit how much banks could lend for buying stocks. Interest rates doubled, which should have discouraged borrowing, “But people who dreamed of 100 percent profit in a week were not deterred by an interest rate of 20 percent a year,” President Hoover recalled. “When the public becomes mad with greed and is rubbing the Aladdin’s lamp of sudden fortune, no little matter of interest rates is effective.” Borrowing continued. “

This quote from a very brief booked called Six Days in October by Karen Blumenthal, which ironically is for “children over the age of 12” seems like it may provide some insight into the current credit crunch. Many books cover the Great Depression with opposing views and reasons for the decline. But this event happened sufficiently long ago that we can look at it and take lessons from it from an objective stand point. During the last few days in office, Calvin Coolidge was quoted as saying stocks were “cheap at current prices.” Keep in mind that all this speculation ramped up in the last three years of the decade specifically 1927, 1928, and 1929. Sort of like 2004, 2005, and 2006 with the subprime fiasco. Again, the rhetoric during these times was of continued prosperity with little consideration of the massive debt being used to support the current market.

As we hear about certain companies stepping in and the Fed offering support, we are reminded of the big players during the Great Depression that stepped in such as National City offering $25 million to brokers in March preventing a decline at the time. So the market had 7 more months of breathing room. The underlying fact still existed at the time as it does in 2007 that the underlying assets such as U.S. Steel, RCA, Westinghouse, and other companies were incredibly overpriced for what they were selling for. Fundamentals were living in Wonderland. Instead of stocks being over valued we now face massively overpriced houses in 2007. Before I punch my fist through the monitor, yes I do realize that stocks and housing are very different pieces of investments. How many times have we heard, “you can’t live in a stock” as if we were going to run off to the San Gabriel River and fabricate a makeshift home out of Google stock under the freeway overpass. Yet there is comparisons that we can make. Many people speculate through their homes. Need we point out the cadre of players: Flippers, Mortgage Brokers, Agents, Hedge Funds, Banks, Builders, Stock Investors, and pretty much everyone in this country. A stark contrast from 1929; it is estimated that out of 121 million people, just 1.5 million to 3 million of them owned stock during the latter years of the 1920s. How many Americans own their home in 2007? How about 70 percent. How many are living in an overpriced and inflated asset? Probably everyone in most metropolitan areas.

The issue occurs with the credit leverage of what has been going on. Let us highlight a brief example. Say Bill and Susie public decided to buy a starter home in Southern California for $400,000 in 2004. Bill and Susie figured that they would flip this house in 1 or 2 years so it didn’t make sense to take on a 30 year mortgage. They talk with their mortgage broker Jane, and she offers them a 2/28 mortgage with zero down. Bill and Susie seemed shocked that they can control a $400,000 piece of real estate for nothing. They purchase their home, live a comfortable life, and after 2 fantastic seasons of American Idol decide to sell their property. Amazingly, Joe and Cindy public want to buy this same home for $600,000 in 2006. After speaking with Jane the broker, Joe and Cindy plan on flipping the home in 1 or 2 years so they decide on going with a 2/28 mortgage as well. Bill and Susie leave with a nice chunk of change after selling fees and since this is sunny California, they will not pay any capital gains taxes because they lived in the home for two years. Sweet deal. Now Joe and Cindy are licking their chops and “know” they’ll be able to sell the home in 2 years for $1 million at the current rate of appreciation. However, they start hearing rumblings of a crashing market. They get an appraiser to their home in summer of 2007 and find out their home is only worth $550,000. They realize that they will not be able to make the payment once it resets since it will amortize over 28 years with a higher rate and will jump a whopping 75 percent. So who made money here?

Bill and Susie: Approximately $200,000 profit. Return on Investment? Over 100 percent since they didn’t put down one penny.

Joe and Cindy: They are down over $50,000. Return on Investment? Nothing and in fact, they will owe a lot more money than if they had rented.

Broker Jane: Nice kick backs on each loan.

Agents: Nice cuts from each sale (and purchase) of the home.

Wall Street: Amazing returns in Real Estate and Mortgage Backed Securities.

Government: Great returns on higher assessed property taxes and sales receipts.

Consumer Outlets: Amazing sales with mortgage equity withdrawals and the wealth effect making every American spending happy.

So it seems we only have one loser when the game of musical chairs is over. And that is the current owner of the property. However, if what we are hearing from Fed and other central banks is true, this market has a little bit more steam in it because so many players are involved in making money from continually perpetuating this bubble. Forget fundamentals and true asset values. Who cares when everyone is making money. This is why from a policy perspective, this credit bubble is much more widespread than the time just before October of 1929.

Complicit Fed

The Fed has already cut the discount rate and has done a few symbolic injections of liquidity into the market. Yet they are still cautious. As I was watching Senator Dodd talk about the bail out, he constantly mentioned that he was “pleased” that the Fed is willing to use any tools necessary to help this market. However, he wasn’t "pleased" that the Treasury wasn’t so Pollyanna and didn’t want to lift certain caps for government secured mortgages. As we’ve talked about, the Fed in the year leading up to the Great Depression radically increased rates to put a stop on the market. In this case, we actually have a Fed that is willing to continue this market speculation. We also have symbolic buys from certain large banks stepping in trying to assure the market that everything will be okay. Seems familiar. Yet looking at the raw numbers and looking at the fundamentals, no one is talking about a housing bubble. Am I the only one wanting to drop kick the morning newscaster like Chuck Norris when they say, “the problem with this market is the subprime debacle.” At this moment I pull out my megaphone, turn it on high and scream, “IT IS THE RIDICULOUS HOUSING PRICES YOU MORON” while dogs and birds scurry off my property. Everyone suddenly wants to blame the mortgage company and lenders as the soul reason for this entire mess. Since 2000, we’ve had countless players [see above] that made out like bandits in this market. Why would they want to see a different market?

The Fed is an independent agency. At least that is what they would like us to believe. Senator Dodd kept emphasizing this while giving the public an implicit wink that the Fed will do whatever the politicians tell it to do. Can it be that someone wants to buoy this market up at least until the election is over in November of 2008? Sadly, I’m not sure what could be done. Thankfully the Treasury at the moment seems to be standing its ground. I wouldn’t be surprised if in a month or so we turn on the television and see printing presses hand delivered to each lending institution. This may seem far fetched but just a few months ago, you literally had an ATM machine attached to your home (if you owned it) and could create money out of thin air simply by writing a check to yourself. $50,000 made out to me. Yes!

Population Involved

The parallels are very different this time as well. A large part of the country is involved in this bubble. Consumer sales will be hit when the market turns south. If your business depends on people buying discretionary products from you, the oncoming recession will hurt you. Anyone that worked for a subprime outfit is definitely at risk (if not gone already). Construction and building is on the decline. After all, why would you buy a depreciating asset at least in the short-term? Financial institutions are having trouble. Borrowing has gotten more expensive. 70 percent of the U.S. population owns their home. When I say own, I mean that that many are on the deed or title as owner. Some estimates point out that 30+ percent of Americans own their home straight out. But for those that don’t, equity as a percentage of the value of the home has been on the decline. This is a sobering fact considering that in no time in our country's recorded history have housing prices risen so drastically. Can it be that many folks turned on the spigots and let the equity drain out of their homes? Maybe.

Even those in the public sector will be hurt since local governments and municipalities depend largely on sales and property tax receipts. The State Controller of California in August reported a projected short-fall of $787 million in total tax receipts; a big adjustment considering the projections were only issued in May of this year. These are things that haven’t hit the mainstream media but will in the near future.

Great Dependence on Credit

Think this country doesn’t have much mortgage debt outstanding? Take a look at this chart I put together showing the increase of debt over the last 15 years:


We’ve nearly tripled the mortgage debt in 15 years. Again this is as much a credit bubble as it is a housing bubble. At the peak of this mayhem, in August of 2005 over 70+ percent of all loans in California were adjustable rate mortgages. Of course this includes negative amortization, option ARMs, 2/28, interest only, and every other exotic mortgage product floating out in the market. Our dependence on credit is amazing. This partially comes from the fact that we as a nation have a negative savings rate. I imagine it is hard to spend something you do not have but many credit card companies during this massive boom were more than willing to lend you the credit. Where does this end? I think we are already seeing the end. I know we are in a bubble like no other when I get credit offers and refinancing offers from companies that no longer are in operation! Maybe they should contact their direct mailers and let them know that they are no longer offering 0 percent for 12 months or 5 percent Home Equity lines.

The parallels to the Great Depression are many. I’ve highlighted two letters one from a lawyer dealing with the fallout and another from a banker giving his opinion on the market. Yet it doesn’t seem like we are willing to learn from the past. In fact, it appears that from every branch of government we are more than willing to keep this thing going. Don’t you find it ironic that big banks can go to Fed and get a discount while you can’t? How does this liquidity help Joe and Cindy who are upside down by tens of thousands of dollars? I guess in the end, someone needs to carry out the garbage.

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August 21, 2007

Triangulating Real Estate. 3 New Market Behaviors: Rewriting History, Falling Sales Receipts, and a Sort of Diverse Workforce.

As I was cruising on the 405 this weekend fighting off the 93 degree humid weather, something was stickier than the air and that was the new message being spouted off over the airwaves pertaining to the housing market. Like listening to a compulsive liar, at this point I am amused at what is being presented as investment advice. The stock market seems pacified with the Fed’s actions even though foreclosures are going up by the hundreds each week and folks are scaling back their spending. With this as our context, I was listening to so called “real estate experts” saying that now is the perfect time to buy. Why? Because the market is going down! Yes folks, you heard right. Since the market is tanking you should jump in. Consider it like getting a 25 percent discount on your Titanic ticket after the ship hit the iceberg. The logic (or lack thereof) goes as follows. Since the market is going down, buyers now have the leverage in negotiations. TRUE. Since there is more inventory, you have more choice. TRUE. Therefore, you should buy a house. Sounds good doesn’t it. But what happens after you sign the papers and close escrow? Does the market suddenly stop going down because you bought a home? Are inventories projected to start declining anytime soon? Do we really need to point out how intellectually sophisticated you need to be to buy a Real Home of Genius at this point?

So today we will examine what occurs at the pinnacle of a panic. Amazing behavior occurs in times of distress. Like the powerful letter from the Depression, things can radically change when one lives in a helium-filled bubble. The three new items we will examine are the rewriting of history by housing pundits, falling sales receipts, and a diverse workforce.

Rewriting the Past for a Better Tomorrow

We all remember the massive 416 point drop of the DOW back in late February. Remember what caused it? Well at this point, the subprime implosion was in its infancy at least in the eyes of the mainstream media. The pundits jawboned and talked about the “silo effect” and how housing was much more diverse then a small insignificant subprime market. Oh really? Well the market bought this line of hog wash and went on back to its merry way of being in denial. While subprime outfits were struggling to stay afloat, we have this following astonishing vote of confidence from Countrywide on May 14:

“Reuters, reporting from a Wall Street conference, says Countrywide CEO Angelo Mozilo unveiled plans for new reverse mortgage products and 50-year-subprime loans, and also said Countrywide plans to add 2,000 sales jobs this year.”

So while the market was hitting a wall Countrywide decided to ramp up subprime loans. Not only were these subprime, but 50 year mortgages! Almost as an affront to the market, the implication seemed to be that the housing game will go on forever (at least for 50 years). It was as if Countrywide was going against the grain and staking their claim on the subprime market. Yet the problem with the current system is we’ve been living in a Ponzi Scheme. I talked about the Ponzi nature of the current housing market in October of 2006 even before any major subprime implosions hit the mainstream media. Now we are seeing the bold move by Countrywide come to roost:

LONDON ( -- Troubled mortgage lender Countrywide Financial Corp. has started laying off employees in an effort to cut costs as it faces a credit crunch, according to a report published Monday.

The Wall Street Journal, citing an internal e-mail sent Friday to employees of Countrywide's Full Spectrum Lending unit, said the company has laid off workers in that division, which handles home loans rated between prime and subprime. The e-mail didn't detail the number of employees laid off, the report said.”

Countrywide employs about 6,800 in this specific part of their business. The question must be asked, why were they pushing 50 year mortgages and hiring more staff as recently as May of this year in their subprime outfit? It definitely sounds like some folks are pining for the days of zero-down-no-interest-reverse-mortgage exotic loans.

Falling Sales Receipts

Americans love to spend. Personal consumption makes up about two-thirds of our gross domestic product. And with our negative savings rate, you can thank your Visa and Mastercard for your nice windfall. Or like many others, you can thank the shiny ATM on the side of your house otherwise known as mortgage equity withdrawals. Not much data has been shed on this pressing issue. However, the State Controller Office of California released figures that should indicate the future of the state. The release shows that total tax receipts are down $787 million below revised figures issued in May. I’m not sure why May was such a Pollyanna month? We have Countrywide hiring 2,000 people and ridiculous sales receipt projections by the state. Could it be that the industry was betting on the summer housing Easter bunny? It is absurd to think this game could go on forever. Leased $50,000 cars rolling off the lot. $5,000 plasma TVs sold on 0 percent interest for 12 months. Granite countertops. Even a boob job is available in 24 monthly payments. At a certain point the psychology of the market tips and people realize debt is not wealth. Even if they don’t realize this, unfortunately a foreclosure or an auto repossession will make this more realistic.

Keep in mind that the state receives tremendous amounts of money via sales receipts and property tax payments. Sales receipts you would think are easier to project. Property taxes however follow a different calendar and we are going to be in for a rude awakening in 2008. For one, folks are going to try to reassess their properties on a lower basis to lower their tax bill. Many will not because they still want to believe the housing market will once again bounce to the sky. Falling sales numbers will also hurt state projections. California is just one example but many other states including Florida, Arizona, and Nevada will have issues next year regarding dropping property tax receipts.

A Diverse Real Estate Workforce

If you haven’t noticed in the last two weeks, we are tremendously dependent on the housing complex. It is estimated that as of the start of the millennium, nearly 30 percent of all added employment is related to the housing industry. With the current housing market, how is this impacting the California workforce?

“The largest year-over job losses were in construction (12,000) and financial activities (7,000)--the sectors most directly influenced by conditions in the housing market. Construction's year-over loss was its largest since August 2002. In June 2007, year-over job losses in California's construction industry exceeded those of the entire U.S. construction sector, which showed a year-over loss of 10,000 jobs. The California financial activities sector's 7,000-job year-over loss was its largest since December 1995. In sharp contrast, the U.S. financial activities sector showed a year-over gain of 117,000 jobs (1.4 percent) in June 2007. Manufacturing (5,900), and natural resources and mining (100) were the other California industry sectors that lost jobs over the last year.”

*Source: California Employment Highlights for June 2007

When we have such a dependency on housing for work and wealth, problems will occur when housing trends downward. The last housing recession as most housing recessions, was inspired by drops in employment. Oddly we are facing a housing led recession here; that is housing going down will force people out of housing related jobs which are normally high paying and this will lead to even lower housing prices and a vicious feedback loop is activated. Will people cutback on their spending when times become tough? Don’t bet on it if the Duesenberry Effect has anything to say about this. Welcome to the new world order of housing. The rules will be updated as we go along and history will surely remember this epic bubble.

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