Press Zero for Reset: Are we out of the Subprime Mess?

Before the subprime issues, there were many articles and research papers highlighting the impending challenge the mortgage market would face once rates started their inevitable reset descent. Two camps emerged; one believed that the subprime market would be contained while the other camp saw it as the tip of something much larger. There is no point in rehashing which side won this debate since it is already clear. The next step is to focus on a market analysis and assess the current situation. Recently, we haven’t seen much analysis in this area because it is a foregone conclusion that many subprime loans are resetting and this is causing a profound market impact beyond the subprime sector. But what does the future potentially hold? There is a great article that was published in the O.C. Register talking to a BofA analyst, Robert Lacoursiere discussing the future of the mortgage correction. The chart provided on the site provides a disturbing picture:

*Soucre: O.C. Register

From past articles and projections, we already knew that September through December of 2007 would see the largest number of subprime resets. We've seen a couple of reports putting monthly rate resets in the range of $50 billion to over $100 billion. This is important because it will be a litmus test on the resiliency of the housing market. It is clear that many lenders and financial institutions are buckling even with the current environment. A few other things will place additional strain on the market including third quarter results that unfortunately, will reflect a slow and underwhelming summer housing market. This coupled with growing inventory, stalling appreciation, and the massive wave of resets will make it very difficult for housing prices not to depreciate.

Option One – Refinance

According to DataQuick, during the first half of the year over 43.4 percent of loans in Southern California were jumbo loans. Jumbo loans are home mortgages that go above $417,000. The typical monthly payment buyers committed to was $2,421. Sellers facing reset issues have the option of refinancing into a fixed rate mortgage. Thanks to a low interest rate environment, rates are still hovering at all time lows. Unfortunately, many home owners are unable to refinance even into reasonable conventional loans because they stretched into their current home. If we take a look at notice of defaults (NODs) in Southern California, we are seeing an exponential jump:

The illuminating thing of this data is that many of these NODs are turning into foreclosures. This is a phenomenon absent in the previous decade of the housing boom. Sellers facing trouble were bailed out by a rising market and rapid appreciation. There was no need to refinance aside from taking out money or lowering a higher previous rate. Those sellers that desperately wanted to stay in their home, used creative methods such as tapping into a home equity line of credit and bought extra time for paying off their current mortgage. The burden has now shifted since the mortgage markets are tightening their belts and appreciation is stagnant. In fact, this is the first year of serious market issues in Southern California in over 10 years. The refinance option may not be a viable choice for many home owners that have a subprime loan and are facing a reset in the next few months. That is why many housing bears cautioned that these loans had a biased toward continued appreciation and no insurance in case the housing market started losing any steam.

Option Two – Sell

Last month sales volume fell over 50 percent in Los Angeles on a year-over-year basis. The last option of hope for many home owners in trouble was selling. In fact, many sellers were able to unload their homes before their rate reset and profited nicely. This went on for multiple years. In a bubble, rational behavior and fundamentals seem to take a backseat. Even staunch opponents of housing started singing a different tune. It is almost a historical prerequisite that once a bubble forms and is in full stride, rhetoric regarding a “new era” creep into the mainstream lexicon. Selling is becoming a challenge in the current market because of market depreciation, increased inventory, and buyer psychology. Another characteristic of any bubble is irrational logic guiding fundamental economic decisions. There was really no reason for housing prices to run up the way they did with no income support, population growth numbers that didn’t instigate amazing jumps, and renovations that didn’t reflect hundreds of thousands of dollars in price premiums. In addition, buyers are no longer fighting for the one home on the block. Any person living in Southern California need only get in their car for a weekend drive and cruise the local streets. Without fail you will find one or two homes for sale within your field of vision. The growing number of foreclosures doesn't help:

Sellers are also competing with short-sales and foreclosures. The worst time to negotiate is when you are hostage to spiraling debt. Many of these sellers have no choice but to sell. Life goes on and things such as divorce, employment disruptions, or crushing debt payments are enough reason to move out. At a recent presentation by Countrywide, they announced that the number one reason for people facing foreclosure was “curtailment of income” at 58.3 percent of all causes. The second leading cause? Medical or illness coming in at 13.2 percent. This paints a contrasting view to the current reports that employment and income is strong and healthy. We need to start examining leading indicators such as building permits, insurance claims, and the money supply because this will tell us where we are heading. Looking at lagging indicators such as the unemployment rate only tell us where we have been. They are both important but clearly we are at a tipping point of market data not reflecting market reality.

Option Three – Foreclosure

It goes without saying that most people do not want to lose their home through foreclosure. It is a financially and emotionally stressful life event. 100 percent of people do not want to lose money. Yet looking at the exploding number of foreclosures, it is becoming more apparent that the country debt load is becoming too much to handle. Keep in mind that we have never witnessed a time in history of such extraordinary national real estate appreciation. We had previous regional housing bubbles such as the Florida housing boom during the 1920s. In addition, our unemployment rate is relatively low and inflation according to government statistics is still under control. We examined this in a previous article and highlighted that in modern day society, avoiding debt is nearly impossible for most working class Americans. The cost of education, healthcare, housing, food, and energy have all gone up dramatically in the last decade. Let us take a look at the national mortgage debt load for the entire country:

As you can see from the above chart mortgage debt has tripled from 1992. It went from approximately $4 trillion to about $12 trillion in the current market. You can also see the inflexion point at roughly 1999. It is hard to imagine that such a booming economy with relatively low unemployment is facing the debt struggles that we are facing. One of the main reasons is that employment in the housing sector has boomed in the last decade. It goes without saying that a slower housing market will equal unemployment for those in the housing industry.

Solutions

Policy makers are providing their solutions to this mortgage crises. Initially what started as a subprime problem is now spilling over into multiple sectors. This has the potential of pushing the economy into recession and more and more economist are chiming in with future odds. What are some of the current solutions on the plate?

*Tax forgiveness for those in foreclosure

*Lowering the Fed Funds Rate trying to make credit products more attractive

*Increasing loan caps through government sponsored entities (GSEs)

*Funding for credit counseling

These solutions may help but they only put a bandaid on the overall broken housing market. In a politically charged environment with so much at stake next year, both sides of the political spectrum are treading water carefully. No one wants to be seen as the party that didn’t help suffering home owners. Bernanke is a student of the Great Depression and realizes that history doesn’t bode well for a Fed and government that doesn’t act swiftly. Even though they publicly echo fears of inflation, policy moves and data point toward a more permeating fear of deflation. I truly believe Americans do not want to see their fellow citizens fail and suffer. In fact, I believe most Americans have a strong work ethic and hold that people that sacrifice and work diligently should be rewarded. What frustrates most Americans is a game where the uber-wealthy are given corporate welfare when times are tough but poorer Americans by these same groups are seen as not being able to pull themselves up from their own bootstraps. The solution to this, even though people do not want to hear this, is a market correction. This means that local income levels and the new tighter credit standards will dictate future housing prices. In some areas this means 10 percent drops while in others this can reach 50 percent or higher. Will this happen? The data is already pointing toward this. Even if property drops 30 percent over 5 years, combined with inflation adjustments this is close to a 50 percent drop. Some areas in Los Angeles are already seeing 20 percent adjustments year-over-year.

By looking at the reset charts, we realize that the housing correction still has a long way to go. What will happen in the next year through policy and market sentiment will set the tone for the next decade of housing in America.

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Operation Destroy the Dollar: H.R. 1852 Objective Number One – Bailout the Lenders.

You can tell it is an election year when political operatives try to pander to every single group with no long-term thought process of the implications of instant gratification. Maybe that is why the United States on a personal level, has a negative savings rate. How can the government encourage people to save and be prudent when they do the complete opposite? Let us take a look at the winners with this newfound ease in lending:

Home Loans: Winner because they become cheaper

Auto Loans: Winner because payments will be lower

Credit Cards: Winner since your APR just dropped from 18 percent to 16 percent
Lenders: Winner since they are given a lifeline to do more loans

Savings Account: Losers since your interest rate is lower than inflation

Dollar: Loser as you can clearly see by the drop below the 80 support level

Pretty basic right? But if you think about the deeper ramifications of the decision it shines the light on an eerie part of our economy. The only way we can keep this game going is by making savings unattractive to the masses and encourage spending at all cost. Many investors realize the game is up and are diversifying out into foreign currencies, stock, and everything else that will benefit from a falling dollar. Many are doing short-term call options and figure they can make a profit on these pseudo bull runs. This does not help the massive majority of Americans. How is this good for our country in the long run? Today we will take a look at an absurd piece of legislation that passed the house, H.R. 1852. I will translate the key points for you into blunt language and what it means to you and our country. Take a look at this press release issued a few days ago from the House Committee on Financial Services:

· Lower Down Payments. Authorizes zero and lower down payment loans for borrowers that can afford mortgage payments, but lack the cash for a required down payment.

Translation? We are going to institutionalize subprime lending! Forget about the tried and tested 10 and 20 percent down payments of yesteryear. We are overhauling the system to remove down payments. After all, we have a hard enough time saving anything month-over-month so how can we expect people to save a few thousand dollars? So instead of requiring this archaic “saving” that is so passé, we are going to allow people, assuming they can make the monthly payment, to purchase homes even if the prices go beyond financially prudent ratios. Down payments exist for a reason. They show that a prospective buyer has the ability to tighten their belt and manage their finances for a few years to purchase a home; normally this is achieved by foregoing spending on other discretionary items. But you can have your cake and eat it too in the mortgage world! Debt is saving in this apparently brave new world.

· Housing Counseling. Authorizes more than double the current funding level for housing counseling, to help subprime homebuyers and borrowers late on mortgage loan payments.

Do we really need housing counseling? I can imagine one of these sessions:

Counselor: “Can you tell me about your current situation?”
Supbrime Borrower: “Ok. Someone from one of those now bankrupt lenders gave me this great 1.25% teaser loan and told me it wouldn’t reset for a long time. I didn’t read the note because hey, I trusted him since he was in a nicely ironed suit. When he said long time I thought he meant 10 years, not 2 years. Now my payment went from $1,250 a month to $2,200. What can I do? I barely was able to afford it even with the crazy teaser rate?”

Counselor: “Damn. Looks like you need to increase your income by adding an all America 2^nd or 3^rd job. Another option is to go into foreclosure since the market price on your home is now less then the mortgage balance. Oh hold on a second…I’m getting a fax from our blessed government. [pause to get fax] Hey! Good news. We can refinance you into another loan with another teaser rate since the government is now subsidizing these loans.”

Subprime: “Great! Because I was looking at this other home that I would like to flip…”

The folks that need “counseling” are the lenders and the policy makers for thinking this is a good long-term strategy.

· Subprime borrowers. Directs FHA to provide mortgage loans to higher risk (but qualified) borrowers, without authorizing unnecessary fee hikes on such borrowers.
Reverse Mortgages. Enhances the FHA reverse mortgage loan program to help seniors pay for health and other expenses, by removing the loan cap to avoid program shutdowns, raising loan limits, and by reducing the maximum fee lenders can charge for these loans.

Higher risk but qualified borrowers? Bwahaha! You couldn’t write more Orwellian language. Could it be that they are high risk because maybe they can’t afford the home? This is like saying that a person is perfectly suitable for working at the drug enforcement agency so long as his cocaine and heroine addiction doesn’t rear its ugly head while raiding a drug house. As we are seeing, it is unethical to give someone that doesn’t have their financial house in a row $100s of thousands of dollars in the form of a mortgage only to have them lose their house later on. That is why we have [had] lending standards. When lenders had to hold the notes they actually vetted the loans with higher scrutiny because a foreclosure would hurt their books. Now we have this moral hazard where we are encouraging irresponsible lending. This doesn’t help the homeowner. This is horrible classical conditioning on a mass scale. What we are telling people is credit doesn’t matter, saving is irrelevant, and bad financial moves will have a bailout from the government. Does this make sense?

Then the reverse mortgage portion is just classic. You can see the light bulb over these congressmen go off. “Next year is so important. Older voters are an important constituency group.” Since Social Security is peanuts and the cost of living adjustments are based on ministry of truth data, they only see marginal increases. The majority don’t have adequate savings but what do they have? Over inflated home equity! How about we slap on another virtual ATM and drain all their savings so instead of the equity going on to their children or grandchildren, it will go to the good old government. Amazing planning here. Let us keep reading.

· Multifamily Loans. Raises FHA multifamily loan limits, so these loans can fully fund construction costs in high cost areas, and enhances sale of foreclosed FHA rental housing loans to localities, so that affordable housing can be maintained in local communities.

You really need to put on your doublespeak reading glasses for this one. So they want to raise FHA multifamily loan limits to encourage affordable housing? They are basically forcing prices to go up. If the market played itself out, construction companies that are able to acquire cheaper resources and labor would be forced to pass on the savings to consumers via more affordable housing. But this legislation assumes that current housing bubble prices are justified and are trying to institutionalize them under the guise of good public policy. What we need is less legislation and more open market competition. Think about it. If you have two companies and materials are being driven down because of competition and efficiencies, then the company that can provide lower priced goods to the market will win. That means lower priced homes and more sales. Did you notice how Hovnanian had no problem attracting buyers when it slashed prices by $100,000? But here, we have this big government mentality and you’ve seen the ridiculous budgets where toilets cost $2,000 and pens go for $30 each. Do you really think these companies compete when they know they have a locked in price? Why do you think communism failed so miserably? And the language is scary. What do they mean “fully fund construction costs” in bubble areas? They call them more expensive areas instead of overpriced bubble metro areas fueled by rancid loans but I think the PR folks removed that language. This is a blank check. Make sure you contact your representatives in both houses and contact the White House to veto this. Maybe Bush will dust off the pen and use it for once.

· Affordable Housing Fund. Authorizes up to $300 million a year from the bill’s excess profits for affordable housing, instead of returning such funds to the General Treasury.

You don’t need the affordable housing fund if you relax zoning rules, stop bailing out lenders, and make these folks accountable for their actions. They are trying to seal high prices into the system as a paradigm shift. These folks want you to believe that higher prices are just a thing of the modern day as opposed to being fueled by exotic funky lending and mass greed.

· Higher Loan Limits. Adopts the Frank/Miller/Cardoza amendment that would raise FHA single family loan limits, which now bar loans above 95% of the median home price in each local area and shut FHA out of higher cost home markets. The amendment raises the FHA loan limit in each area to the lower of (a) 125% of the local area median home price or (b) 175% of the national GSE conforming loan limit. The amendment also also retains the bill’s provision for a nationwide FHA loan floor of 65% of the GSE conforming loan limit, and gives HUD authority to raise these loan limit amounts by up to $100,000 “if market conditions warrant.”retains the bill’s provision for a nationwide FHA loan floor of 65% of the GSE conforming loan limit, and gives HUD authority to raise these loan limit amounts by up to $100,000 “if market conditions warrant.”

This is the one that is getting everyone worked up. How is raising loan caps going to help the family on main street USA by pushing limits over $500,000? I thought the median price was somewhere around $225,000 for most Americans? Oh! I forgot. Lenders make their most profits from overpriced bubble metro areas therefore we should ask our brothers and sisters in Wyoming, Montana, Arkansas, and every other non-bubble state to contribute to their mass greed. Make no mistake. This bill is 95 percent for the housing industry. It will not help you or your family if you are facing foreclosure. They will use the 1 or 2 examples to get media heart bleeding and lenders going into crying moments (did you see that Youtube video of the guy pleading for Brittany?); it’ll be something to that effect but everything is garbled up in this translation. Pandering at its finest. How is someone in a high priced area with a $400,000 or $500,000 mortgage with a family income of $50,000 going to get help if the main problem is a pricing and income issues? Unless they want to give everyone a 50 percent mandatory raise, I’m not sure how this helps anyone except lenders on the large part by washing their hands clean ala Pontius Pilate of unethical and corrupt mortgage products?

Doublespeak: Helping Minorities Pad our Bottom-line

Someone once told me that getting married is easy, staying married is the hard part. During a presentation, one of the nation’s mortgage lending leader reiterated their goal of helping minorities to own homes. The government always throws this PC statement out. The last few years these lenders have done the most damage to minorities. Guess who are the folks who are losing their homes because of subprime lending in the largest numbers? These greedy lenders didn’t care about folks’ long-term well being, they only cared about putting people into homes and getting their nice commission cuts. So what if 1, 2, or 3 years down the road the family drowns in their own debt service? Setting people up for failure is not the American way.

The fact that many are subprime meant they couldn’t afford homes to begin with. Simple way to avoid this mess from the start. If people want to buy homes why is it so bad to ask that they save a minimal down payment? You know why? Because this slows the real estate complex down. During this time people aren’t buying, selling, refinancing, busting out home equity lines of credit and all things where the housing Ponzi Scheme gets their money from. To use this “we are helping minorities” line is arrogant and absurd. Why don’t they address the real reason that of massive inequities in pay for minority groups? Oh! We can’t talk about income because that is taboo. Yet they are okay with putting people into ticking time bombs. A good senator and representative, for example, in voting for a war should always ask themselves if they would send their own child to a conflict. In the case of lending, a good lender should be required to ask, “would I loan this person money if it came out of my own bank account?” Guess what your answer would be?

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When the Housing Clock Stops Ticking: Why the Median Price is Going up While Sales are Going down.

If you haven’t noticed, Los Angeles returned to its previous median record price of $550,000 last month. Before you scratch your head in dismay, let us take a look at what is really happening. As you know, higher priced homes are still moving while lower priced homes are stagnant thus skewing the numbers. If a home doesn’t sell, it doesn’t show up in the data. Similar to taking an immensely hard mathematics course where half the class drops out, but those that remain push grades higher. When calculating the final overall class performance the statistics show the best of the best and those that stuck the course out, but what of the students that dropped out? Well as you can see from the Real Homes of Genius examples, prices are coming down. So what do we make of this seemingly contradictory information?

The Sales Cycle

This chart shows sales for Los Angeles County over the past 7 years. As I point out in the above chart, each January and February we hit a trough because of the slower selling brought on by fall and winter. This has been the case for each consecutive year since 2000 and is actually part of the normal housing cycle. But what do we have here appearing in summer of 2007? It appears that we have hit a trough 5 months early. In fact, summer sales numbers are looking more like seasonal sales numbers of winter. This chart is also telling because it shows a consistent pattern over time. Those that don’t believe in housing cycles are spinning in their chair wondering what happened this summer. Normally a strong spring and summer selling season allows for the lower numbers in the fall and winter. This will not happen this year. Unless of course we see a radical jump in sales in the next few months. This data is also a good indicator of where we are heading. Keep in mind the data reported is from sales that close after escrow. This data can lag 1 to 2 months. So what we are currently seeing in the actual finalized recorded sales is probably from July to early August. Well of course the mortgage blow out just occurred and credit standards are much tighter since then. So guess what this will do for sales at the slowest time of the year? Either way, this is a much necessary correction and that is why any housing pundits thinking we are going to have some bounce back in the next few months is simply hallucinating and not following the trend.

I’ve been getting some e-mails about timing the market. There are many ways to valuate housing prices. As we previously discussed with 3 housing valuation methods, every city in Southern California is overpriced. If you haven’t noticed the media is now using the terms “housing slump” and “credit crunch” as if they’ve been talking about it for years. Too bad even as late as January and February of this year, they were still carrying the housing banner. Using rhetoric such as “booming” and “amazing” when talking about housing. I’ve seen a few articles pointing out that housing bears have unfairly criticized the media as this New Yorker online piece. Since they link up to a few places including our site, I feel it is important to state why I have been critical of the mainstream media in the past. Clearly, they are now carrying the housing bear flag and there is no problem finding populist information outlets dissecting the housing market. My main issue was during the boom, they kept giving air time to raging housing bulls that have led us into this current market. Dean Baker’s recent study does a great job researching the entire housing bubble and also pointing out that media airtime in the past few years has not been fair and balanced. I recommend you read the entire paper as a primer to this housing bubble. But here is some of the data found regarding media citations:

Media Citations (New York Times and Washington Post) on the Housing Market, 2005-2006

Bulls	Citations
David Lereah, NAR	1796
Doug Duncan, Mortgage Bankers Association	397
David Seiders, National Association of Homebuilders	652
Total	2845

Bears	Total
Robert Schiller, Yale University	516
Edward Leamer, UCLA	88
Dean Baker, Center for Economic Policy Research	248
Total	852

*source: Dean Baker, Midsummer Meltdown August 2007

And regarding the New Yorker, I do agree with the author that many journalists are now scrambling to be first in line to disseminate housing information to the public. In fairness, the media reports what is happening yesterday, today, and tomorrow. Historian and prognosticators they are not.

Case and Point: High Priced Area and Low Priced Area

Back to the median housing price analysis, clearly housing sales have fallen off a cliff. In fact, Los Angeles County saw a 50 percent year-over-year drop in sales last month. Not exactly stellar numbers. Multiple converging factors combined to create a perfect stew of housing stagnation. For one, the credit markets are now tighter and sub-prime is now a thing of the past. Also, appreciation is now gone. So folks are deciding on holding off on buying homes especially with a sudden onslaught of negative media coverage. And something specific to California, August of 2005 saw the largest origination of adjustable rate mortgages at a whopping 70+ percent of all mortgages originated. Guess what was hot? 2/28 mortgages. And what was last month? That’s right, 2 years and now these people are facing larger payments with mortgages amortizing on different schedules. In addition, they no longer have the option of refinancing because this will push payments higher and the reason they took out these exotic loans is to squeeze into an overpriced home. Now why would they go for a higher payment even if they could? As I discussed back in July housing has hit its Minsky Moment.

Let us take at a few case examples for last month to show how higher priced areas are moving up while lower priced areas are getting hit.

Higher Priced Areas Moving Up:

Agoura Hills with a median of $975,000 is up 18.9 percent year-over-year.

Arcadia with a median of $752,000 is up 19.3 percent year-over-year.

Hermosa Beach with a median of $1,255,000 is up 15.6 percent year-over-year.

La Canada Flintridge with a median of $1,455,000 is up 7.4 percent year-over-year

Wow! The housing party is still going strong. Why look at data when all 10,000,000 folks in Los Angeles live in these areas. Let us take a look at some lower to middle priced areas:

Artesia with a median of $370,000 is down 26 percent year-over-year.

Baldwin Park with a median of $400,000 is down 11.1 percent year-over-year.

El Monte (South) - with a median of $381,00 is down 20.3 percent year-over-year.

Montebello – with a median of $535,000 is down 10,8 percent year-over-year

You clearly see the pattern and why the median price is skewed higher. For one, more sales are happening in the higher priced areas so they have a larger subset. Sales in lower areas are facing intense drops in sales and downward pricing action. Could this be because many of the past buyers bought with sub-prime loans that are no longer available? I doubt anyone in Palos Verdes would avoid buying their dream home because of a lack of sub-prime loans. An interesting thing to note is middle class neighborhoods are facing a stagnant market with prices trending down slowly but sales having a sudden stop. I expect that we will see the lower end get hammered first as it currently is and then have the middle areas tip over as well. The higher priced areas will be the last to adjust.

How low will we go?

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Florida Housing 1920s Redux: History repeating in Florida and Lessons from the Roaring 20s.

History has a mysterious way of creeping up on those that fail to study it. Somehow, with all the talking heads going crazy, you would think this housing market has no parallel in history. When you hear that the national median home price has never gone down there is always the caveat of “since the Great Depression.” I’ve written 3 articles about the Great Depression (letter from a lawyer, letter from a president of a bank, and 3 main reasons why this bubble is worse) highlighting eerie similarities of this credit bubble to the Roaring 20s. Keep in mind during the 1920s the nation was engulfed with Coolidge prosperity and all things business were here to stay. In fact, today we are going to examine a few paragraphs from an amazing book by Frederick Lewis Allen called Only Yesterday written in 1931 which examines the decade of the 1920s in great detail. A reader of this blog recommended this book sometime ago and I'm glad I had the chance to read this in depth analysis of the 1920s from an author with an uncanny ability to retell history. Dispute it all you want but there is a chapter in the book called Home, Sweet Florida that if one didn’t see the date, could be published in the Miami Herald dated 2007.

Let us compare and contrast the past with our current housing debacle:

“There was nothing languorous about the atmosphere of tropical Miami during that memorable summer and autumn of 1925. The whole city had become one frenzied real-estate exchange. There were said to be 2,000 real-estate offices and 25,000 agents marketing house-lots or acreage. The shirt-sleeved crowds hurrying to and fro under the widely advertised Florida sun talked of binders and options and water-frontages and hundred thousand-dollar profits; the city fathers had been forced to pass an ordinance forbidding the sale of property in the street, or even the showing of a map, to prevent inordinate traffic congestion. The warm air vibrated with the clatter of riveters, for the steel skeletons of skyscrapers were rising to give Miami a skyline appropriate to its metropolitan destiny. Motor-busses roared down Flagler Street, carrying "prospects" on free trips to watch dredges and steam-shovels converting the outlying mangrove swamps and the sandbars of the Bay of Biscayne into gorgeous Venetian cities for the American homemakers and pleasure-seekers of the future. The Dixie Highway was clogged with automobiles from every part of the country; a traveler caught in a traffic jam counted the license-plates of eighteen state among the sedans and flivvers waiting in line. Hotels were overcrowded. People were sleeping wherever they could lay their heads, in station waiting- rooms or in automobiles. The railroads had been forced to place an embargo on imperishable freight in order to avert the danger of famine; building materials were now being imported by water and the harbor bristled with shipping. Fresh vegetables were a rarity, the public utilities of the city were trying desperately to meet the suddenly multiplied demand for electricity and gas and telephone service, and there were recurrent shortages of ice.”

So first we must realize that real estate frenzies have occurred in the past. In addition, the idea of people waiting to bid on property not currently built occurred during the 1920s in Florida. And all those high-rise condos waiting to come online in 2008 or 2009? Florida again seems to be ground zero of the real estate frenzy. Even the out of town investors going zero down on a mortgage for a property that isn’t even built is something that happened long ago. Reminds many people of the multiple license plates in Arizona a few years ago of people extending their credit to buy a pre-fab construction only to flip it a few months down the road. Like any boom, this didn’t happen overnight back then either. What events led to Florida being the prime location? Let us take a look:

“For this amazing boom, which had gradually been gathering headway for several years but had not become sensational until 1924, there were a number of causes. Let us list them categorically.

1. First of all, of course, the climate-Florida's unanswerable argument.

2. The accessibility of the state to the populous cities of the Northeast-an advantage which Southern California could not well deny.

3. The automobile, which was rapidly making America into a nation of nomads; teaching all manner of men and women to explore their country, and enabling even the small farmer, the summer-boarding-house keeper, and the garage man to pack their families into flivvers and tour southward from auto-camp to auto-camp for a winter of sunny leisure.

4. The abounding confidence engendered by Coolidge Prosperity, which persuaded the four-thousand-dollar-a-year salesman that in some magical way he too might tomorrow be able to buy a fine house and all the good things of earth.

5. A paradoxical, widespread, but only half-acknowledged revolt against the very urbanization and industrialization of the country, the very concentration upon work, the very routine and smoke and congestion and twentieth- century standardization of living upon which Coolidge Prosperity was based. These things might bring the American businessman money, but to spend it he longed to escape from them-into the free sunshine of the remembered countryside, into the easy-going life and beauty of the European past, into some never-never land which combined American sport and comfort with Latin glamour-a Venice equipped with bathtubs and electric iceboxes, a Seville provided with three eighteen-hole golf courses.

6. The example of Southern California, which had advertised its climate at the top of its lungs and had prospered by so doing: why, argued the Floridians, couldn't Florida do likewise?

7. And finally, another result of Coolidge Prosperity: not only did John Jones expect that presently he might be able to afford a house at Boca Raton and a vacation-time of tarpon-fishing or polo, but he also was fed on stories of bold business enterprise and sudden wealth until he was ready to believe that the craziest real-estate development might be the gold-mine which would work this miracle for him.

Crazy real-estate developments? But were they crazy? By 1925 few of them looked so any longer. The men whose fantastic projects had seemed in 1923 to be evidences of megalomania were now coining millions: by the pragmatic test they were not madmen but-as the advertisements put it- inspired dreamers. Coral Gables, Hollywood-by-the-Sea, Miami Beach, Davis Islands-there they stood: mere patterns on a blue-print no longer, but actual cities of brick and concrete and stucco; unfinished, to be sure, but growing with amazing speed, while prospects stood in line to buy and every square foot within their limits leaped in price.”

Did someone write this yesterday? The book title is still accurate even though 1931 is a distant memory. The same arguments used in 1925 are being used in the current marketplace regarding housing. First, the main argument for Florida and Southern California is the weather. We’ve dubbed it the sunshine tax. So this argument for pumping ludicrous mortgages isn’t something new. Next, we have the argument of proximity to locations and centers of employment. Another argument used by many housing pundits pushing these overpriced units. None of these things changed (after all we still have the sun) and this is nearly 100 years ago. Subdivide and conquer seems to be the mantra in real estate booms. The author makes a unique point about the primal desire for families to reunite with a more tranquil life at the cost of working like a maniac to afford the mortgage on a home in an urban area. A Catch-22 that many families in 2007 are facing. And the marketing and advertising tactics haven’t changed. Have you seen the current ads for Florida housing? “Your home with the tranquility of Venice” or “Come escape to your own private Paris.” What they are implying is that your subdivided cookie cutter home is somehow similar to condensed apartment style living from Europe. Last time I checked not many Parisians or Italians had 2 car garages to support monster Hummers and Expeditions. So this yearning for European style tranquility is highly misplaced because even Europeans do not live this way. But the underlying implication is “you too can get away from the stressful congested freeways and 12 hour work days in the city” at least for a few hours in your private palace even though you have to work like a maniac to afford your exotic-high-flying-zero-down mortgage. But did people get caught up in the frenzy like this current boom?

“Yes, the public bought. By 1925 they were buying anything, anywhere, so long as it was in Florida. One had only to announce a new development, be it honest or fraudulent, be it on the Atlantic Ocean or deep in the wasteland of the interior, to set people scrambling for house lots. "Manhattan Estates" was advertised as being "not more than three fourths of a mile from the prosperous and fast-growing city of Nettie"; there was no such city as Nettie, the name being that of an abandoned turpentine camp, yet people bought. Investigators of the claims made for "Melbourne Gardens" tried to find the place, found themselves driving along a trail "through prairie muck land, with a few trees and small clumps of palmetto," and were hopelessly mired in the mud three miles short of their destination. But still the public bought, here and elsewhere, blindly, trustingly-natives of Florida, visitors to Florida, and good citizens of Ohio and Massachusetts and Wisconsin who had never been near Florida but made out their checks for lots in what they were told was to be "another Coral Gables" or was "next to the right of way of the new railroad" or was to be a "twenty-million-dollar city." The stories of prodigious profits made in Florida land were sufficient bait. A lot in the business center of Miami Beach had sold for $800 in the early days of the development and had resold for $150,000 in 1924. For a strip of land in Palm Beach a New York lawyer had been offered $240,000 some eight or ten years before the boom; in 1923 he finally accepted $800,000 for it; the next year the strip of land was broken up into building lots and disposed of at an aggregate price of $1,500,000; and in 1925 there were those who claimed that its value had risen to $4,000,000. A poor woman who had bought a piece of land near Miami in 1896 for $25 was able to sell it in 1925 for $150,000. Such tales were legion; every visitor to the Gold Coast could pick them up by the dozen; and many if not most of them were quite true-though the profits were largely on paper. No wonder the rush for Florida land justified the current anecdote of a native saying to a visitor, "Want to buy a lot?" and the visitor at once replying, "Sold."

Greed has an interesting way of coming back into the mainstream. As the author points out, even places that were 15, 20, or 30 miles away from the prime locations were selling like crazy simply because the real estate tornado frenzy brought these places into the fold. Think of the Real Homes of Genius, the Inland Empire, Arizona, Nevada, and Florida. One need only look at the current headlines of current Florida housing to find similar parallels from the above. Why are housing pundits so quick to dismiss history without taking a critical eye of what happened in the past? Do they somehow think they are above the narrative of history? Is this time really different? They want you to believe that they have found the new calculus of housing success. Well as you are seeing, this bust is playing out exactly like it did almost 100 years ago. To continue with the chapter, it appears that speculation was rampant just like it was during our boom:

“Speculation was easy-and quick. No long delays while titles were being investigated and deeds recorded; such tiresome formalities were postponed. The prevalent method of sale was thus described by Walter C. Hill of the Retail Credit Company of Atlanta in the Inspection Report issued by his concern: "Lots are bought from blueprints. They look better that way .... Around Miami, subdivisions, except the very large ones, are often sold out the first day of sale. Advertisements appear describing the location, extent, special features, and approximate price of the lots. Reservations are accepted. This requires a check for 10 per cent of the price of the lot the buyer expects to select. On the first day of sale, at the promoter's office in town, the reservations are called out in order, and the buyer steps up and, from a beautifully drawn blueprint, with lots and dimensions and prices clearly shown, selects a lot or lots, gets a receipt in the form of a `binder' describing it, and has the thrill of seeing `Sold' stamped in the blue-lined square which represents his lot, a space usually fifty by a hundred feet of Florida soil or swamp. There are instances where these first-day sales have gone into several millions of dollars. And the prices! ... Inside lots from $8,000 to $20,000. Water-front lots from $15,000 to $25,000. Seashore lots from $20,000 to $75,000. And these are not in Miami. They are miles out-ten miles out, fifteen miles out, and thirty miles out."

Wait. Did they say people needed 10 percent down? We out did the speculative bubble of the 1920s since we cut out that measly 10 percent down and went zero down and sometimes people got cash-back at closing! This reminds one of sales even in Orange County California where new subdivisions sold out the first day. People waited in line for days to get on a list for the chance to purchase a home at a hyper inflated price. Looking back people must feel that they were waiting in line to be punched in the face by Mike Tyson. And what about the metal cranes covering the Florida skyline? Many of these units won’t hit the market until 2008 and 2009 at the peak of the bubble decline. Fascinating how greed can overtake an entire population. And lets be honest, how many of these people actually had visions of buying a Miami condo to live and raise a family for an entire generation? I would venture that the percent can be counted on one hand. What kind of rhetoric was used to pump these new paradise resorts? Let us take a look:

“Steadily, during that feverish summer and autumn of 1925, the hatching of new plans for vast developments continued. A great many of them, apparently, were intended to be occupied by what the advertisers of Miami Beach called "America's wealthiest sportsmen, devotees of yachting and the other expensive sports," and the advertisers of Boca Raton called "the world of international wealth that dominates finance and industry . . . that sets fashions . . . the world of large affairs, smart society and leisured ease." Few of those in the land-rush seemed to question whether there would be enough devotees of yachting and men and women of leisured ease to go round.

Everywhere vast new hotels, apartment houses, casinos were being projected. At the height of the fury of building a visitor to West Palm Beach noticed a large vacant lot almost completely covered with bath- tubs. The tubs had apparently been there some time; the crates which surrounded them were well weathered. The lot, he was informed, was to be the site of "One of the most magnificent apartment buildings in the South"-but the freight embargo had held up the contractor's building material and only the bathtubs had arrived! Throughout Florida re- sounded the slogans and hyperboles of boundless confidence. The advertising columns shrieked with them, those swollen advertising columns which enabled the Miami Daily News, one day in the summer of 1925, to print an issue of 504 pages, the largest in newspaper history, and enabled the Miami Herald to carry a larger volume of advertising in 1925 than any paper anywhere had ever before carried in a year. Miami was not only "The Wonder City," it was also "The Fair White Goddess of Cities," "The World's Playground," and "The City Invincible." Fort Lauderdale became "The Tropical Wonderland," Orlando "The City Beautiful," and Sanford "The City Substantial."

Location, location, location. Speculation, speculation, speculation. I was going through this weekend’s LA Times and an inordinate amount of space is given to real estate advertisements. In fact, most of the ads are housing related. For example, you have your multiple electronic stores telling you how to fill up every nook in cranny of your place with 60 inch plasma TVs and state of the art refrigerators that make ice out of thin air. All for 0 percent financing over 24 months. And then we have all the ads about majestic beds and sofas that are fit for King Tut himself. Even the King didn’t have access to American Express! And then we have the housing ads. I was looking at some condo ads in Florida and you would think that you are buying the most fantastic, stupendous, amazing, fabulous, and gorgeous 1,200 square foot piece of land in the entire universe. You may want to buy stock in Thesaurus publishers with the amount of adjectives these advertising and marketing agency use for housing. With the benefit of foresight, we know how the bubble of the 1920s ended but we are still uncertain how this current market will unfold. As humans, we like hearing things in a narrative form. If A happens then B happens which obviously leads to C happening. We are terrible at constructing real-time narratives because we are living the moment and have a hard time stepping back and examining the landscape from a bird’s eye view. Call it existential living. For the sake of forecasting, how did the 1920s Florida housing market end and can we learn anything from it?

“Perhaps the boom was due for a "healthy breathing-time…

As a matter of fact, it was due for a good deal more than that. It began obviously to collapse in the spring and summer of 1926. People who held binders and had failed to get rid of them were defaulting right and left on their payments. One man who had sold acreage early in 1925 for twelve dollars an acre, and had cursed himself for his stupidity when it was resold later in the year for seventeen dollars, and then thirty dollars, and finally sixty dollars an acre, was surprised a year or two afterward to find that the entire series of subsequent purchases was in default, that he could not recover the money still due him, and that his only redress was to take his land back again. There were cases in which the land not only came back to the original owner, but came back burdened with taxes and assessments which amounted to more than the cash he had received for it; and furthermore he found his land blighted with a half-completed development.

Just as it began to be clear that a wholesale deflation was inevitable, two hurricanes showed what a Soothing Tropic Wind could do when it got a running start from the West Indies.

No malevolent Providence bent upon the teaching of humility could have struck with a more precise aim than the second and worst of these Florida hurricanes. It concentrated upon the exact region where the boom had been noisiest and most hysterical-the region about Miami. Hitting the Gold Coast early in the morning of September 18, 1926, it piled the waters of Biscayne Bay into the lovely Venetian developments, deposited a five-masted steel schooner high in the street at Coral Gables, tossed big steam yachts upon the avenues of Miami, picked up trees, lumber, pipes, tiles, debris, and even small automobiles and sent them crashing into the houses, ripped the roofs off thousands of jerry-built cottages and villas, almost wiped out the town of Moore Haven on Lake Okeechobee, and left behind it some four hundred dead, sixty-three hundred injured, and fifty thousand homeless. Valiantly the Floridians insisted that the damage was not irreparable; so valiantly, in fact, that the head of the American Red Cross, John Barton Payne, was quoted as charging that the officials of the state had "practically destroyed" the national Red Cross campaign for relief of the homeless. Mayor Romfh of Miami declared that he saw no reason "why this city should not entertain her winter visitors the coming season as comfortably as in past seasons." But the Soothing Tropic Wind had had its revenge; it had destroyed the remnants of the Florida boom.

By 1927, according to Homer B. Vanderblue, most of the elaborate real-estate offices on Flagler Street in Miami were either closed or practically empty; the Davis Islands project, "bankrupt and unfinished," had been taken over by a syndicate organized by Stone & Webster; and many Florida cities, including Miami, were having difficulty collecting their taxes. By 1928 Henry S. Villard, writing in The Nation, thus described the approach to Miami by road: "Dead subdivisions line the highway, their pompous names half-obliterated on crumbling stucco gates. Lonely white-way lights stand guard over miles of cement side- walks, where grass and palmetto take the place of homes that were to be .... Whole sections of outlying subdivisions are composed of unoccupied houses, past which one speeds on broad thoroughfares as if traversing a city in the grip of death." In 1928 there were thirty-one bank failures in Florida; in 1929 there were fifty-seven; in both of these years the liabilities of the failed banks reached greater totals than were recorded for any other state in the Union. The Mediterranean fruitfly added to the gravity of the local economic situation in 1929 by ravaging the citrus crop. Bank clearings for Miami, which had climbed sensationally to over a billion dollars in 1925, marched sadly downhill again:

1925.............................$1,066,528,000

1926................................632,867,000

1927................................260,039,000

1928................................143,364,000

1929................................142,316,000

And those were the very years when elsewhere in the country prosperity was triumphant! By the middle of 1930, after the general business depression had set in, no less than twenty-six Florida cities had gone into default of principal or interest on their bonds, the heaviest defaults being those of West Palm Beach, Miami, Sanford, and Lake Worth; and even Miami, which had a minor issue of bonds maturing in August, 1930, confessed its inability to redeem them and asked the bondholders for an extension.

The cheerful custom of incorporating real-estate developments as "cities" and financing the construction of all manner of improvements with "tax-free municipal bonds," as well as the custom on the part of development corporations of issuing real-estate bonds secured by new structures located in the boom territory, were showing weaknesses unimagined by the inspired dreamers of 1925. Most of the millions piled up in paper profits had melted away, many of the millions sunk in developments had been sunk for good and all, the vast inverted pyramid of credit had toppled to earth, and the lesson of the economic falsity of a scheme of land values based upon grandiose plans, preposterous expectations, and hot air had been taught in a long agony of deflation.

For comfort there were only a few saving facts to cling to. Florida still had her climate, her natural resources. The people of Florida still had energy and determination, and having recovered from their debauch of hope, were learning from the relentless discipline of events. Not all Northerners who had moved to Florida in the days of plenty had departed in the days of adversity. Far from it: the census of 1930, in fact, gave Florida an increase in population of over 50 per cent since 1920-a larger increase than that of any other state except California-and showed that in the same interval Miami had grown by nearly 400 per cent. Florida still had a future; there was no doubt of that, sharp as the pains of enforced postponement were. Nor, for that matter, were the people of Florida alone blameworthy for the insanity of 1925. They, perhaps, had done most of the shouting, but the hysteria which had centered in their state had been a national hysteria, enormously increased by the influx of outlanders intent upon making easy money”.

And so the boom ended in a spectacular fashion. The peak hit in 1925 and steadily declined through the Great Depression. And as the author points out, this was during a time when the country was supposedly prospering. Doesn’t this remind you of the current administration touting our record low unemployment rate and record high home ownership rate? You would think we are in the apex of financial success with a minor bump in housing. But markets in Florida and California are hitting massive defaults. Keep in mind we are only in stage one of this housing bear market. Looking at the past as a reference, we know that there will be pain in the next few years. Even if Bush and others are pushing for income relief on debt forgiveness, this means society will carry the burden. After all, if someone bought a $500,000 home and it was foreclosed and sold for $450,000 – shouldn’t the lender and buyer shoulder some responsibility? We will be heading down this moral hazard road for months.

Even looking at current default rates in Southern California, many people in default have loans that are 2 years or younger. Now either the lender did a horrible job looking at the buyer's financial situation in which they should be liable, or a buyer speculated either knowingly or unknowingly. I have empathy for a family that was conned from an FHA fixed mortgage into a $200,000 subprime mortgage at 10 percent with prepayment penalties. No reason for this except higher commissions. But a person buying a $500,000 home trying to flip it for $600,000? See why I have an issue raising the caps? Most people think the money will evaporate like some sort of Vegas magic act. Yet the public as a whole, even those who didn’t participate in this speculating frenzy, will be on the hook if no one directly involved is willing to shoulder the responsibility of gambling [speculating] in a housing bubble. How about the lender, home owner, and the Wall Street players shoulder some of the debt forgiveness instead of asking for a government handout? Why isn't anyone going after the MBS market or the hedge funds? After all, some one did buy these exotic mortgages. So what are some other viable solutions? Lenders can modify terms on 30 year mortgages and extend the duration or drop rates; yet this would suppose that buyers actually bought homes to live in for the longterm. Speculate together, pay together. If you can cut through the green tangled vines of bail out rhetoric, the bottom line is someone isn't happy because the music stopped and they are left standing with no chair.

Back to the Florida boom and bust, it would be wrong to think that the real estate fever in the 1920s was only specific to Florida. Other cities had similar booms as well:

“The final phase of the real-estate boom of the nineteen-twenties centered in the cities themselves. To picture what happened to the American skyline during those years, compare a 1920 airplane view of almost any large city with one taken in 1930. There is scarcely a city which does not show a bright new cluster of skyscrapers at its center. The tower building mania reached its climax in New York-since towers in the metropolis are a potent advertisement-and particularly in the Grand Central district of New York. Here the building boom attained immense proportions, coming to its peak of intensity in 1928. New pinnacles shot into the air forty stories, fifty stories, and more; between 1918 and 1930 the amount of space available for office use in large modern buildings in that district was multiplied approximately by ten. In a photograph of uptown New York taken from the neighborhood of the East River early in 1931, the twenty most conspicuous structures were all products of the Post-war Decade. The tallest two of all, to be sure, were not completed until after the panic of 1929; by the time the splendid shining tower of the Empire State Building stood clear of scaffolding there were apple salesmen shivering on the curbstone below. Yet it was none the less a monument to the abounding confidence of the days in which it was conceived.

The confidence had been excessive. Skyscrapers had been overproduced. In the spring of 1931 it was reliably stated that some 17 per cent of the space in the big office buildings of the Grand Central district, and some 40 per cent of that in the big office buildings of the Plaza district farther uptown, were not bringing in a return; owners of new skyscrapers were inveigling business concerns into occupying vacant floors by offering them space rent-free for a period or by assuming their leases in other buildings; and financiers were shaking their heads over the precarious condition of many realty investments in New York. The metropolis, too, had a future, but speculative enthusiasm had carried it upward a little too fast.”

Compare this to the current metal cranes that stand up like a Brontosaur head in the middle of many metro cities. You see them in San Diego, Miami, and Orange County. Take a plane over Arizona and Nevada and you’ll see a jigsaw of subdivided land and spectacular urban sprawl. Are we growing this fast? Looking at population statistics it doesn’t seem that the building is in proportion to our growing demand for housing; we may have overbuilt a tad bit. Considering that many baby-boomers are looking to downsize, many homes should be coming online in the next 5 to 10 years simply because of the natural occurrence in the shift of demographics. Many will downsize and retire to less urban areas, thus creating more inventory.

A question many are wondering is "will there be another bubble after this one?" Considering we went from a technology bubble to a housing bubble, I think we’ve had enough for two decades. The cost of owning a home in certain areas, as many families are realizing, comes at too high of a cost. A society can only prosper so long via debt spending. So what happened after the boom in Florida?

“After the Florida hurricane, real-estate speculation lost most of its interest for the ordinary man and woman. Few of them were much concerned, except as householders or as spectators, with the building of suburban developments or of forty-story experiments in modernist architecture. Yet the national speculative fever which had turned their eyes and their cash to the Florida Gold Coast in 1925 was not chilled; it was merely checked. Florida house-lots were a bad bet? Very well, then, said a public still enthralled by the radiant possibilities of Coolidge Prosperity: what else was there to bet on? Before long a new wave of popular speculation was accumulating momentum. Not in real-estate this time; in something quite different. The focus of speculative infection shifted from Flagler Street, Miami, to Broad and Wall Streets, New York. The Big Bull Market was getting under way.”

Maybe we will finally see the decade long obsession with real estate go away. However after the boom in the 1920s, people decided to go back and gamble on US Steel, General Electric, General Motors, Woolworth, and Radio. Keep in mind that the economy didn’t shift gears over night. From the peak in September of 1929 it took approximately 3 years to hit bottom in 1932. Will we have another Great Depression? Probably not since there are many other factors in our current economy that are vastly different. However, a recession and a deep one at that, is almost a foregone conclusion.

I highly recommend that you read Only Yesterday by Frederick Lewis Allen because it’ll give you a fascinating and enlightening view of the 1920s and how an important defining time for America still impacts us today. We will always have booms and busts, otherwise known by a nicer name, the business cycle.

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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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