Greater Expectations: Quotes and Psychology of a Modern Day Housing Bull.

John is a hard working middle-class man in a mixed blue collar and upcoming white collar neighborhood. A vestige of old times when working class groups of families purchased homes before the mention of any housing bubble or subprime mortgage ever hit the CNBC newswires. Now this neighborhood is experiencing a Renaissance that doesn’t include blue collar working class families. “I wouldn’t be able to purchase my own home if I were to buy it right now,” echoes John as many families in this neighborhood feel the same sentiment. The idea of using interest only mortgages or refinancing to tap into mortgage equity seem like a foreign language to his frugal and debt free way of life. The only debt that he has, he proudly tells me, is the mortgage debt which he only has a few years left to pay off. Welcome to a bygone era and the rhetoric of a past decade. We are living in a time where the definition of “home” is radically shifting. Take a look at some quotes from the ex-head honcho of the National Association of Realtors had to say over the past few years:

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

What made real estate so special in March of 2005? Did it all of sudden become supernatural and have uncanny healing powers? Nothing really changed except the fuel of a massive credit bubble and rhetoric like this was swallowed by buyers and sellers believing that they somehow found El Dorado and an endless money pit in their home. This language started many years ago but you can see even as of March of 2005, the psychology of many in the housing syndicate was such that housing was entering some kind of new era. Remember the book DOW 30,000? Maybe someone should write 500 Square Foot Box, $500,000. Even the last sentence about “I want to persuade you…” echoes of a sales pitch for a speculative product. There was no frame of economic reference aside from a tiny window of 2001 to 2005 that of course, made it seem that real estate was the hottest investment on the planet. And it was. But not anymore. Like any speculative bubble, those that get in early and are able to time the peak make out like bandits. Yet those that come late to the party have a hard time figuring out what happened. Even as the market was clearly showing signs of bubblicious behavior, we get more absurd housing teeth gnashing.

August 2005: "If you paid your mortgage off, it means you probably did not manage your funds efficiently over the years. It's as if you had 500,000 dollar bills stuffed in your mattress."

Source: David Lereah quote, August 2005 LA Times quote

Say what? So let me get this straight, if you paid off your mortgage you somehow have a problem managing your funds? Of course, the assumption here is that you should use the money to buy more homes and flip them like the Ukrainian gymnastic team. Maybe you should slap the virtual ATM of home equity lines and loans to the side of your house and turn on the shiny chrome spigot and let the equity ooze out. And guess what? People believed this and actually followed the lead of the housing syndicate. Mortgage equity withdrawals became a new industry unto itself. The problem with the statement above is that it isn’t completely financially prudent. In fact, the better advice would be to sell a home in an overpriced area, rent, and ride the bubble down. But no one in the housing industry would say this because if you would sell and wait for a few years that would mean that the following isn’t going on during your sabbatical from housing: Sales go down, refinances drop, construction falls, home upgrades no longer happen, and anything else that lives on the butter churning housing industry. Sell, upgrade, refinance, rinse and repeat seems to have stopped and as you may have currently noticed, the way housing goes so goes the world economy.

April 2006: David Lereah, the Realtors' chief economist, said he was still looking for a gradual slowdown in housing that would result in a drop of around 6 percent in home sales this year and a slowing in price gains to around 6 percent, compared with the double-digit gains in prices in recent years.

Source: St. Petersburg Times, April 26, 2006

This statement above highlights another fallacy in the housing syndicate logic. Yes, real estate can appreciate by double-digit returns with no economic fundamentally sound reason however, the downside has a safety net of only single digit drops. Think about the implication here for the consumer. “Well, if I buy I have the potential of 20 percent returns but if the market goes down, I will only lose 5 percent for one year and then we’ll be back at double-digit returns.” Hedge funds live off these analysis. Risk assessment and running market assumptions on potential future scenarios. Most consumers didn’t do either but bought with the unconscious belief that housing will go up drastically but the downside was very minimal. Clearly, we are now seeing with some Real Homes of Genius that homes can drop $100,000 in one year. So if they are wrong about the downside what else were they wrong about?

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

Strike three amigo. We are now facing housing depreciation on a national level, the first time since the Great Depression. He gave this opinion in the same month that Bloomberg mentioned this fact! And it doesn’t seem like we are on track for a bounce back this summer with the mortgage market debacle. So we’ve given them long enough with one year. Clearly the Chief Economist is the figurehead for his industry, and as such he speaks for many in the industry. I was listening to a local housing show on the weekends that discusses the real estate market and the host did an absolute 180. All of sudden, he turned into a Democrat and started blaming mortgage brokers directly for the housing debacle. “I can’t believe these brokers with subprime lending…” as he went off on his opportunistic CYA moment. Keep in mind, a year ago this same person was echoing the benefits of adjustable rate mortgages and pumping housing like the next great invention. Unbelievable. But that is the psychology of a good sales person; once one market is dry make sure you are prepared to jump into the next market. And this host was since he touted his incredible ability of refinancing and saving folks from foreclosure. Still trying to churn the butter. And he had a broker call in and gave him a piece of his leveraged mind, "what you are doing is wrong. What we need is the Fed to drop rates. We didn't force people to sign."

No one forced anyone to sign but only a few years ago, anyone calling a housing bubble was labeled as a Chicken Little. Take a look at this PowerPoint from a big housing presentation calling any bubble believers Chicken Little back in October 2005:

Chicken Little Slide from Presentation

Many other quotes, information, and articles can be found at the once great site, David Lereah Watch that is no longer positing since the NAR has replaced Lereah with a new housing bull, Lawrence Yun. These people are important because they are the Chief Economist to one of the, if not, most powerful housing associations in the nation. The NAR has membership of over 1.2 million folks and the majority believe the party line. They have large advertising and marketing campaigns that fund their industry. In addition, these industries are some of largest contributors to both political parties. Do you think they are looking out for you or Mr. John worrying about the risky new buyers coming into his neighborhood?

There is a great article in the Orange County Register that came out August 12 called One street’s subprime struggle. It talks about a block in Santa Ana that is the epitome of the subprime risky mortgage collapse. There is one fantastic quote from one of the older owners who is almost done paying off his mortgage:

“"I never sell. I never refinance," Zambrano said. "I don't take money out of my house to buy a car or take a vacation. I'm not stupid."

Don’t tell that to some folks in the housing syndicate. They may think you have bad money management skills and will try to get you to slap a virtual American Express to the side of your home. Maybe John has a point about being frugal and trying to manage his debt wisely. Should we try to convince Mr. Zambrano about his poor money management ability and tell him about a wonderful HELOC that’ll fund a nice trip to Europe?

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Nostradamus in the House. Looking at 4 Potential Scenarios for Southern California Housing.

I couldn’t resist the “in the House” pun but it is becoming apparent that people are placing their bets on what is going to happen now that the housing bubble is bursting. It doesn’t seem like there is any debate regarding that we are in fact, living in a bubble. Subprime lenders are realizing once rates went up, people just said screw it and let the mortgage notes role on in without payments. No complicated economic theory behind it, just common sense which seems less common as each day progresses. With the foreclosure process taking anywhere from 3 to 6 months, folks don’t seem too concerned about getting their credit ravaged like Barry Bonds at a Dodger game. I mean why would someone fight vigorously to defend a home that in all likelihood, isn’t worth what they paid for it. For honor? The person that gave the mortgage is likely no longer employed and the note is chopped up like sushi in the mortgage backed securities markets. It isn’t like your local WaMu personal banker is going to give you a call and say, “Hey Mike, is everything okay? What is going on?” The personal touch is gone. The more likely scenario is your going to get a legal letter from the lender in your mailbox saying pay up or else. Most people in subprime loans feel screwed so they are simply returning the favor to lenders. I mean what are they losing? Their credit? They are freaking subprime to begin with! Its not like they are feeling an emotional ache in their heart that their 580 credit score will drop to 400. And you wonder why the market is tanking? With $1 trillion in loans resetting this year, 2008 and 2009 we can expect much of the same.

So it is established that the housing market is no longer a viable rock solid investment. So what can we expect to face here in Southern California or any other large overpriced metro area in the country? In this article, we will use the clairvoyant power of Excel and run four likely scenarios that will occur here in Southern California. We will use the current median price, current income, and try to predict future scenarios. Consider it a housing premonition.

These are the key reference points we will use:

• Current Southern California Median Single Family Home Price: $502,000
• Current Southern California Media Income: $60,000*
• Los Angeles County Family Median Income: $43,518
• Orange County Family Median Income: $58,605
• San Diego County Median Family Income: $51,939
• Ventura County Median Family Income: $59,379
• San Bernardino Median Family Income: $43,179
• Riverside County Median Family Income: $46,885

(Source: Census.gov)

• Income growth of 5 percent annually.

*We’ll be generous and use an upper-limit since we are looking at the ENTIRE region.

Scenario #1 – Housing Goes up 10% Each Year for 5 Years

You may be thinking to yourself, there is no way this can ever happen. Well keep in mind that we did have 5 years and 2 months of 10+ percent year over year gains in Los Angeles County so not only can this happen, it did. In addition, before 2007 hit full stride, we had many housing pundits predicting double-digit growth! Each month after more and more negative housing news, they slowly scurried away and now they are silent in the dark green jungles of mortgage implosions. Irresponsible public policy and financial negligence led to this mess. But let us humor these heroes and take a look at how these scenarios would look if we let them run their course for another 5 years:

Median Home Price: 2012

year	income
2007	$60,000
2008	$63,000.00
2009	$66,150.00
2010	$69,457.50
2011	$72,930.38
2012	$76,576.89

While the current annual income to home price ratio is hovering around 8.3, by the time 2012 hits it will be approximately 10.6! Keep in mind we are also using a higher reported family income. If we were to use current Census data the housing to income ratio would be much higher. What will the mortgage cost look like?

10 percent down with 30 year fixed at 6.5 percent:

Budget 2012

Price	$808,476
Down Payment	$80,847
PITI:	$5,441
Net Income After Taxes:	$4,785

You think we have affordability issues now? Just wait if we hit this scenario. Let us take a look at a more conservative 5 percent annual increase.

Scenario #2 – Housing Goes up 5% Each Year for 5 Years

Now we are being more conservative. As a matter of fact, Southern California is currently up, 2.4 percent year over year. Housing bubble? Not here in the ever resilient SoCal market. Let us take a look at a 5 percent annual appreciation rate (which is more historically accurate):

Clearly this scenario seems more probable. Let us run the numbers once again with the 5 percent annual appreciation rate:

Budget 2012

Price	$640,693
Down Payment	$64,069
PITI:	$4,311
Net Income After Taxes:	$4,785

Okay, now at least we aren’t running into monthly household budget deficits. But the basic monthly nut will consume 90 percent of our net take home pay of the hypothetical median income family. Talk about taking it to the house. Let us now look at some more bearish predictions. First, let us examine a 5 percent annual decline.

Scenario #3 – Housing Goes down 5% Each Year for 5 Years

Even at a 5 percent decline annually over 5 years, we now see the median house price hit $388,438. Many in Southern California haven’t seen the fabled $300,000 mark in many years. Can it be possible that we have a blast from the past? Let us break down this scenario:

Budget 2012

Price	$388,438
Down Payment	$38,843
PITI:	$2,613
Net Income After Taxes:	$4,785

Now this is looking more reasonable. And all we saw was a 5 percent annual decline over 5 years. Not exactly a horrific crash or bubble bursting. In this scenario, the monthly housing nut will only take 54 percent of our net income. Seems like we are approaching a more realistic and reasonable environment. For the heck of it, let us do our maximum doom and gloom scenario of 10 percent annual declines for 5 years. After all, we did see 10+ percent increases for 5 years (sometimes even 20+ percent annual gains) so why not on the downside?

Scenario #4 – Housing Goes down 10% Each Year for 5 Years

Now most folks cannot imagine this scenario. Are you telling me we can actually be in the $200,000 range? If we follow the above scenario that is where we will eventually end up. $296,426 doesn’t even get you a studio apartment so how can it ever purchase a single family home? Let us see how the household budget works out:

Budget 2012

Price	$296,426
Down Payment	$29,642
PITI:	$1,994
Net Income After Taxes:	$4,785

We actually have a monthly payment of under $2,000. Now, the housing nut only takes up 41 percent of the median family’s net income. Keep in mind in more prudent times, most financial advisors recommend that housing not consume more than 1/3 of your household income (some go with net and some use gross). Either way, even with our massive decline of 10 percent year over year for 5 years, we are finally reaching parity with ancient financial standards.

I hope the above gives you an idea of how ludicrous it is to expect 10 or even 5 percent continued annual appreciation rates. Unless income starts going up by 10 or 15 percent a year, the positive scenarios will simply not happen. There are two questions that I’ll throw out:

1. Do you think housing will slowly decline or will it happen faster and more abrupt?

2. Do you think interest rates will go up? Because if rates do go up, the above scenarios will make it even more difficult for the average family to purchase a home and not stretch their budget like Gumby.

Related Articles:

The Housing Tipping Point

10 Real Homes of Genius in 5 Southern California Counties

The History of The Los Angeles Housing Bubble

The Foreclosure Story: $130,000 Income and Going Through Foreclosure

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

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

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

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

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

American Home Mortgage

Shares Outstanding: 54.28M

Price Per Share on Friday: $10.47

Current Pre-Market Share Price: $6.39

Friday Market Cap: $568,290,000

Pre-Market Cap: $346,849,000

Down in Two Days: $221,441,000

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

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

Issues on the Home Front

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

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

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

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

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

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

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

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

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

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

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

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

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

Big Ben Chimes in Again

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The housing syndicate wants to blame the Fed and anyone championing tighter credit. If it were up to them, we’d be purchasing $2 million dollar homes while inflation goes along at 25 percent and every new buyer ended up in a 70 year multi-generational loan. They wouldn’t care. Sustainability is a word outlawed in the subprime industry. These companies have such little reserves, that a simple credit tightening brought many companies to their knees in a few months. And this on the back of the largest housing bubble in history. They could have easily built up their cash a