Thursday, September 28, 2006

The death of Demand

So I've been having discusions w/ co-workers and they are more in the "soft-landing" camp than am I. Actually, it took quite a bit of convincing to get them that far and honestly I don't think it was me that swayed them. I've been going on about the bubble ending for 6 months and they've only come around in the last month since all the MSM coverage finally began.

Their idea behind a "no-bust" or "soft-landing" scenario is basically that sales are down now but there are a lot of buyers on the sidelines and once prices go down a bit, say 10%, demand will jump back up.

I think that's an intuitive response, given your basic econ 101 supply and demand, but dead wrong in this case. Here's why: consider demand. The demand we've seen over the past few years was vastly inflated. And it's been inflated in almost every conceivable way:

1. Speculative demand accounted for 38% of sales in 2004 and 2005. This is, of course, due to the incredible rate of appreciation, and the massive amount of money that could be made in a short time through leveraging (borrowing more to make more). Of course there was high demand for a 20% appreciating asset! That's why there were bidding wars and "please pick me" letters and why houses would sell in one weekend above the asking price. In fact to say speculation was only 38% would be foolish because even people buying as a "primary residence" knew that the market was so hot, they would be making more money (in their sleep) off of their house (read: investment) than with their 9-5! "You couldn't lose"! This level of speculation, where the appreciation itself is fueling the appreciation, was seen last during the .com boom/bust. We won't see it again in housing for a long, long time. And worthwhile to note that all of this speculative demand has now shifted to the supply side.

2. Cheap money. All-time low interest rates made monthly payments low enough that buying a house came into reach for a lot of people even as home prices shot up, while a more historically "normal" interest rate wouldn't have allowed that. A good portion of these buyers would have represented "future demand" had they not been used up. After 17 sucessive interest rate hikes, do you think the FED is going to slash rates to 1% again?

3. Toxic loans - ARM's / interest-only / neg-am loans raised the "ceiling of affordability" for buyers. These loans can work to a buyers advantage in an appreciating market, but in a depreciating market things get ugly quickly. As stated earlier, a lot of people speculated that prices would continue to rise, accepting the risk of these loans. Other "less sophisticated" buyers were tricked into thinking they could afford these loans by predatory lenders and realtors. This is scraping Demand's "bottom of the barrel". In either case, the ceiling of affordability simply can't be raised any higher without loosening lending standards, coming up with new "creative loans", or lowering interest rates. And that's not too likely at this point is it?

4. Lenders allowed lending standards to become so lax that anyone with a pulse could get a half million dollar loan - whether they could afford it or not. Stated-income / "no-doc" loans, or "liar-loans" allowed people who could not afford homes to buy them anyway. How does a 21 yr old kid get $2.2 million in loans? By EVERYONE looking the other way. The amount of fraud and collusion is unbelievable. The Senate had inquiries last week over this and in the VERY FIRST bit of good news, "State targeting abusive lenders", Massachusetts is going after predatory lenders.

5. Homeownership is now at an all-time high already thanks to #2-4 above - 3% above the historical average - at least for now until the foreclosures really begin to kick in, at which point lives (and credit) will be ruined, life savings lost, comps forced down, and foreclosed properties added to Supply. BTW, foreclosures are already up 250% in San Diego and the ARM reset's have hardly started! And guess who pays for the bad paper when the loan goes into default? All of us! If you have investments there's a very good chance you have MSB's (mortgage backed securities) and that your MBS's will de-value when the loans start defaulting en masse.

6. Affordability. Last time I heard, in San Diego, affordability was at 2%. This means only 2% of the population can afford to buy a median priced home. Housing is like a pyramid in that it starts w/ first time buyers. If someone wants to move up to a larger home (family is growing), they need to sell their 1st home. People will typically go from "starter homes" to bigger & more expensive homes throughout their lives, as opposed to downsizing. So if first-time buyers are "locked out" because of affordability, we're now in a gridlock situation. In essence, it's impossible to be "priced out forever" because the market NEEDS first-time buyers to sustain itself, and will adjust accordingly. "Priced out forever" is a realtor scare tactic.

7. Psychology - Just as appreciation fuels appreciation, the same is true for depreciation. "Buy before you're priced out forever" - that was the psychology (and Realtor cliche). That's now changed to "buy a depreciating home now and be screwed good when the price drops another 10%."

The "ceiling of affordabilty" has been pushed up and up through a credit expansion driven by incredibly low interest rates, "creative lending", collusion and fraud. This, coupled with speculation created a huge amount of demand - artificial, inflated demand. This demand help to sustain the bubble, fueling it to unprecendented levels. But there's nowhere left to go. While median home values jumped 32 percent from 2000 to 2005 nationwide (and more like 200-300% in bubble areas), incomes dropped 2.8 percent during the same period.

If the hangover from credit expansion and debt bomb result in reduced consumer spending and layoffs, a recession would further reduce demand.

Affordability is now at an all-time low. Even if prices come down a bit, affordabilty may not improve if rates go higher. Who else is left to buy that hasn't? Recent graduates and illegal immigrants? Not at these prices. There are some bubble-watchers, myself included, and a certain amount of people who may be at a point in their lives when they're just ready to buy. Let's acknowlege that there will always be some demand but not overestimate overall Demand without scrutiny. My two co-workers think of Demand as a single-sized, consistent force that's either up or down. I think that's a very naive viewpoint. It's anything but. And there's just not that much real Demand left.

Wednesday, September 27, 2006

Writing on the wall: this is just the beginning

Here's some (abridged) news from the first chapter of the housing bust. There will be many to follow.

P.S. Los Angeles is down 6% (YOY).

From USA Today - Home prices likely to fall more
- Supply of homes for sale at a 13-year high - nation-wide
- The median-priced U.S. single-family detached home fell 1.7% year-over-year (YOY). - Prices haven't fell nationally since April 1995.
- The price drop was also sharp, the second-steepest in 38 years.
- Sales of existing homes fell for the fifth month in a row.
- The confidence level of builders, who are slashing profit forecasts and seeing their stocks pounded on Wall Street, plunged this month to the lowest in 15 years, the National Association of Home Builders says.
- "We have a serious correction taking place in the housing sector," Richard Fisher, the Federal Reserve president in Dallas, said in a speech Monday.
- "The speed of the collapse has been astonishing," (economist) Shepherdson says. "This time last year, single-family home prices were up 16.4%. With inventory still rising, there is no chance of any short-term relief. Prices and volumes have a long way to fall."
- "If we have prices drop for the rest of the year and sales also continue to drop, then we will have a bad situation in housing of balloons popping rather than air coming out," David Lereah of the NAR (Nat'l Assoc. of Realtors) said.
From the Boston Globe - Mass. home prices fall 6.1% as downturn gathers speed
- The downturn in the Massachusetts housing market gained momentum in August, with the median price of a single-family home falling 6.1 percent the Massachusetts Association of Realtors said yesterday.
- The median condo price fell 3.3 percent in August, to $278,000, and sales fell 18.5 percent.
- While sales volume has been in a freefall for months, price declines began showing greater momentum during the summer and are expected to continue into the fall.
- "Things are not over in terms of the price declines," said David Iaia, a senior principal for Global Insight, a Lexington economics consulting firm.
- "Now you're at the end of the major selling season, and people who've had their house on the market all summer and haven't sold it are getting concerned, so there are probably more price declines coming this fall," he said.
- The real estate market is slowing across the country, although not as dramatically as in Massachusetts.
-Massachusetts experienced the most price appreciation of any state between 2000 and 2003, and the appreciation continued over the next two years and pushed sales and prices to record levels. The downturn is now in full swing, analysts and agents said.
- The August price slide was confirmed in a second report yesterday by the Warren Group, a Boston real estate and publishing firm that compiles market data. Warren Group said the median single-family price declined 8 percent, condo prices fell 5 percent.
- Both the Warren Group and the realtors base their monthly report on actual sales closings in August, but their data sources are different. The realtor association sales and price data are based on house-listings posted in the multiple listing service, an agents' database, while Warren's data is culled from court records on home-sale closings statewide.
- David Wluka, president of the Massachusetts Association of Realtors, blamed soaring appreciation during the boom for making it difficult or impossible for many first-time buyers to afford a single-family house. Without them, homeowners are unable to sell when they want to trade up. (suprise, suprise)
- High prices are "creating a clog in the system," he said. "People trying to buy houses can't buy until they sell houses they own, and unless they price houses they own correctly they're not going to sell." (that's the way a pryamid-scheme works)
And then there's the news from California
‘We’re In The Initial Stages Of Adjustment’: CAR

The California realtors report on August home sales. “Home sales decreased 30.1 percent in August in California compared with the same period a year ago. ‘We experienced the greatest year-to-year sales decline last month since August 1982, when sales fell 30.4 percent,’ said C.A.R. President Vince Malta. ‘This is another indication that we’re in the initial stages of a long-anticipated adjustment in the market. Some sellers are still clinging to price expectations that are no longer valid in today’s market,’ he said.” (this is amazing, usually you only hear the normal cheerleading and 'positive-spin' from these guys)

“‘Although the median price in the state and in several regions hit an all-time record in August, we expect softer prices toward the end of the year,’ said C.A.R. Chief Economist Leslie Appleton-Young. ‘The median price typically peaks somewhere between June and August before declining toward the end of the year.
There you have it — any price declines we see from now until the end of the year are due to normal seasonal fluctuations. Please ignore those declining YOY price changes, as they are irrelevant.
Some areas of the state already have experienced year-to-year declines for more than two months.’”

The Orange County Register. “House prices in Orange County showed a (2.5 percent) annual decrease for the first time in a decade, the CAR reported today."

“The last annual price drop reported by the state association was in July 1996, at the height of the housing bust that gripped the region in the early 1990s.”

From KGO-TV. “Bay Area homes sales are slowing down. The latest real estate trends show sales down by nearly 25 percent from August of last year. About 9,000 homes and condominiums sold in the Bay Area last month, that’s the lowest number since 1997. It is also a significant drop off from peak sales of 12,500 in 2003.”

“In eight of the nine Bay Area counties, prices haven’t fluctuated more than a point or two in the last year. San Mateo home prices really took a hit last month, dropping nearly seven percent. Dan Newland, Alameda Home Seller: ‘Well it certainly is a different market than it was even three months ago.’”

“The slowdown comes as the inventory is piling up. Of the 1,231 apartments that have been converted in El Cajon, about 500 are on the market, twice as many as a year ago, said Ron Pennock, chairman of the East County Construction Council.”

“Notices of default in the (San Diego) county, notices sent to property owners who’ve missed at least one mortgage payment, have increased 250 percent since last August, according to the County Records Service."

speaking of which - more info
‘As of Sept. 11, there were 44,683 properties in some stage of foreclosure in California, and again, these exotic mortgages are a major factor,’ she says. ‘In San Diego, more than 50 percent of purchase money mortgages issued in recent years were these so-called creative loans.

The more precariously positioned ARM borrowers are very much on the minds of economists, some of whom fear that masses of consumers will not be able to afford the new higher payments, setting off a recession. According to Christopher Cagan, an analyst with First American Real Estate Solutions, a housing consultancy in Santa Ana, Calif., about 19 percent of the 7.7 million ARM’s taken out in 2004 and 2005 are at risk of defaulting.

(comments from people who remember the last housing bust in CA - found on Pigginton's)
- Now add to the people that purchased last year all the equity junkies that refi-ed every last bit of their appreciation. It’s not just those who purchased last year that are now under water.

- Even the early 1990’s bust saw some properties drop up to 40% (I was there and one of those was mine) and that bust was a mouse fart compared to what is in store this time around.

- Actually, Santa Monica 90405 declined 50% between 1989 and 1995 and all of California declined an average of 21% during the same period. It was terribly painful but not the end of the world. The current bubble makes the 1989 bubble look like a hiccup, both in terms of magnitude and scale. Now, instead of a few cities and regions, it has spread to about 20 states including both coasts and some popular western cities.

- My mom bought her condo in OC in 1990, saw its price plunge 33% and didn’t get back to its purchase price until approximately 1998.

- In the last cycle in soCalif, prices dropped 35% from 1990 to 1996. A nice $325,000 house dropped to aobut 200,000. I saw condos drop 50%. It took 11 years to break even, 1990 to 2001.

- If you adjust for inflation over that period, housing dropped more that 50% in real terms. Even more for some high end areas in OC.

- Condos and some extremely bubbly zip codes dropped 50% after the 1989 bubble collapsed. Someone on these blogs posted a whole bunch of headlines from this implosion and the current headlines look very much like the fall of 1989. The 1990 headlines included bank failures. It unwound very quickly then with most of the deprectiation happening in the first 2.5 years of the implosion.

- Japan RE prices dropped 80% over 10 years.

- Why, after watching prices rise 300% over the last 7 yrs with no fundemental means of support, does it seem impossible that they’ll return to fundemental support levels -ie 50% off?


“Home sales decreased 30.1 percent in August in California compared with the same period a year ago. ‘We experienced the greatest year-to-year sales decline last month since August 1982, when sales fell 30.4 percent,’ said C.A.R. President Vince Malta.”

1982 was the year of the second dip in Reagan’s “double-dip” recession. How did it get so bad so fast, especially given the underlying strength of the overall economy?

- Because it really is different this time? (LOL!! Now THAT was funny!)

Saturday, September 23, 2006

Stalling economy?

Factory activity in mid-Atlantic region fell for first time in more than three years.

The Philadelphia Federal Reserve Bank said Thursday its business activity index tumbled to negative 0.4 this month from 18.5 in August, far beneath forecasts of about 14.8. It was the first reading below zero since April 2003, indicating a decline in regional manufacturing.

"We're seeing signs in the Philadelphia survey that the economy is cooling off," said Gary Thayer, chief economist at AG Edwards & Sons.

The entire survey was troubling, with new orders also slipping into negative territory. The six-month business outlook turned gloomy as well, showing its first negative reading since just before the last recession, which ended in 2001.

"The region's manufacturing executives were significantly less optimistic about future activity, with most indicators dipping to their lowest readings in six years," the survey said.

The survey added to evidence that the economy is entering a rough patch led by a sharp slowdown in the housing sector, which is expected to take a toll on consumer spending.

"These are very weak numbers," said Chris Low, chief economist at FTN Financial.

Many economists had been counting on business investment to pick up where consumers left off. The Philadelphia Fed data suggested, however, this handoff has so far failed to take place.

Excerpts above from

I believe that the job losses and reduction in consumer spending (which results in more job losses) from the combined impending housing bust and debt bomb will add a great deal of recessionary pressure to our economy. 70% of the GDP is consumer spending, so as ARMs & HELOC's reset and people realize that their house is not an ATM - the loans actually have to be repaid - the amount of escalades and frappacino's sold will expectedly decrease.

I'm not an economist but I'm firmly in the recession camp. How many red flags do you need? Look up "Inverted yield curve" and see what that gets you.

We have a National sickness with credit (read: debt) individually and as a nation. There should be no argument about that. We lead lives of shallow consumerism because ... I guess ... image is more important than substance and maintaining a hip lifestyle is more important than financial security. I like "things" as much as the next guy, but I don't buy things I can't afford and certainly not to keep up with the Jones'.

Keeping up with the Jones': Buying stuff you don't need with money you don't have to impress people you don't know.

Who will the housing crash effect? Everyone. Real estate agents will be first.

From Mish's great blog, Mish's Global Economic Trend Analysis

No Hard Landing
I have it on great authority that there will not be a hard landing in real estate.
Who told me that? It was none other than Mike Morgan at MorganFlorida. Please listen in to what Morgan has to say.

Mike Morgan:

Will there be a hard landing? No!
Will there be a crash landing? Absolutely!
Who will the housing crash effect? Everyone. Real estate agents will be first.

full article

How many jobs did the housing boom create and sustain. And what happens when the boom cycle turns into a bust cycle?

How low can we go?

I'm not saying this bubble will end the same way it did in Japan, where housing slid for 14 straight years, but rather point out that it is possible for real estate to go down over a significant period of time. BTW, might be a good time to buy in Japan - it's starting go up in Tokyo.

How fast and how far this housing market (bubble) will correct is anybody's guess, but every asset bubble since WWII has eventually returned to the mean.

Friday, September 22, 2006

Ever get the feeling you're being lied to?

Bernanke: "There's No Housing Bubble to Go Bust"

In the spirit of the great Johnny Rotten ("Ever get the feeling you've been cheated?"), I give you our new FED chairman, Ben Bernanke.

Way to go Ben. What's next? "These aren't the droids you're looking for." ??!!??

Don't buy stuff you can't afford

Here's a classic! Great for the negative savings/new Escalade crowd.

Debt Bomb

I love graphs. They really put things into perspective.
Note that they are adjusted for inflation.

So what does all this mean? Well, a hangover for sure but more importantly, the consumer spending that has gone on as homeowners used their "best investment" as an ATM and truly made the transformation into homedebtors simply can not be maintained. Like home prices, there is a ceiling where no more refinancing can occur and the piper demands payment.

Thursday, September 21, 2006

Rich Dad, Poor Dad - Robert Kiyosaki says:

The Catastrophe Ahead

... we recommend that you change yourself and prepare for the economic turbulence that lies ahead. If you think political action can save this country from itself, I'm afraid you're dreaming -- or perhaps daydreaming as you waddle through that figurative crosswalk.

In the next five years, the United States and the world will go through some of the most financially disturbing times in the history of the world. Once again, the rich will become very, very, rich, and the unsuspecting will be left like the passengers on the S.S. Titanic, heading straight for an economic iceberg.

...Which reality you choose -- deciding on how much you can earn and how fast you can earn it -- will determine your station in life five years from now, when things start to get really sticky.

Full article here

He's a real ass to suggest that we should all be out making $70K/day and that we're suckers to work for $70K/yr, but I give his prediction of a dire economic situation about 50/50.

When you do the math and hear the stories of people who bought homes ten years ago for $80K and now owe $300K, it makes you think we might be in for a bit of a hangover. Credit is what got us into this mess. And because of that, cash will be king ...again.

This is gonna hurt

Ouch! - OK, that's adjustable rate mortagages (ARM's) , but what about all the HELOC loans that have to be repaid? Add this to the equation. Looks like a lot of Ramen noodle dinners in California's future.

I've shown this to people who ask "What dies this mean?" and immediately (before I even respond) try to explain that there's no crash going on, or why the housing market won't crash. Here's my take: This chart isn't trying to convince you of what is going to happen, it's purpose is to simply illustrate how large this last housing boom is in relation to historical booms/busts. It's a big'n.

Tuesday, September 19, 2006

The Hard Landing For Housing is Already Here

from Comstock Partners, Inc.

The market is suddenly assuming that since energy prices are declining and mortgage rates are drifting down, consumer spending will pick up and the housing industry decline will end. In our view this outcome is highly unlikely. Our negative outlook for consumer spending is based far more on the end of the housing boom than it is on high oil prices. In turn, it is now evident that housing is already undergoing a hard landing that can’t be cured by a downturn in mortgage rates, and that the situation is likely to worsen. Here are some facts to consider.

• 32.6% of new mortgages and home equity loans in 2005 were interest only, up from 0.6% in 2000

• 43% of first-time home buyers in 2005 put no money down.

• 15.2% of 2005 home buyers owe at least 10% more than their home is worth.

• 10% of all home owners have no equity in their homes

• $2.7 trillion in loans will adjust to higher rates in 2006 and 2007.

• 70% of borrowers who took out pay-option ARMS in the past year have loan balances larger than their initial loan.

• Homeowners face higher payments as mortgages are reset. Generally, monthly payments rise between $200 and $500 depending on the size of the mortgage.

• According to Reality Trac, August foreclosures were up 23% over July and 53% over a year ago.

• The number of homes for sale is at record highs, and inventories are 59% higher than a year earlier.

• New home sales are down 22% and existing home sales down 11%.

• The NASB housing market index has recorded an all-time decline.

• The housing affordability index is at a 15-year low.

• The house price-to-income (rents) ratio is off the charts. According to HSBC, in 18 states accounting for over 40% of national home values, the price-to-income ratio is 3.6 standard deviations above the mean.

• The OFHEO index of house prices deflated by the consumption price deflator has soared to a record high of 350 from 250 in 2001. From 1976 to 1996 it never was above 220.

• According to the NAR the year-to year prices of existing homes are now flat. A short time ago they were rising at a yearly rate of 16%.

• Nationally, home prices have not declined on a year-to-year basis since 1933. Recently, however, prices have been dropping in the North East, West and Mid-West.

• Sales incentives are now estimated at 3% to 7% of selling prices.

Although new housing starts directly account for only 5% of GDP, the indirect effects are far greater. Some studies show that the housing industry and all its related activities have accounted for 30% to 40% of the entire employment growth in the current cyclical expansion. In addition it has been well demonstrated that mortgage equity extractions have been a cash cow providing home owners with hundreds of billions of dollars that have gone into consumer spending. With housing already in a hard landing, it will be extremely difficult to avoid a hard landing in the economy as well. In our view the stock market is in the same kind of denial it was in 2000 when the vast majority of strategists and economists already knew the dot-com bubble had burst, but mistakenly thought it would have little impact on the rest of the economy or on stocks.

coming home to roost

posted in athread at HousingPanic
Stolen from the SDCIA website which is home to the San Diego Real Estate Investors Club. These are observations of a sub-prime loan office manager:

I think that the “experts” should just spend one week in my office observing the financial profiles of our refinance applicants. I believe their outlook would be much different.

Most people simply cannot believe the profiles that we see.
I am the sales manager of a branch office of a top-10 national lender.

My office of 7 loan officers takes +/- 100 loan applications per week, 90% of that coming from cold calls.
Of the last 100, I have taken some simple statistics and have found the following:

68/100 had LTV’s over 80% at time of application
16/100 had LTV’s over 100% at time of application
78/100 had back end DTI’s over 55%
31/100 had back end DTI’s over 70%
23/100 had FICO’s under 500
81/100 had credit card debt above $10,000
54/100 had credit card debt above $20,000
18/100 had credit card debt above $50,000
66/100 had Pay-option ARMs
27/100 had Pay-option ARMs and mortgage lates
22/100 were either in forbearance or had been in forbearance within the past 12 months
We took 14 applications today and we cannot qualify a single borrower for any type of loan. We are sub-prime, in fact, sometimes I say we are sub-sub-prime. We can qualify almost anyone for a loan. Not today.

Let me tell you about just one borrower from today:

Husband and wife
Husband on fixed income military retirement $1800/mo
Wife makes $9500/mo as a registered nurse
5 properties with $3,400,000 in mortgages
All mortgages currently have prepays
8 interest-only mortgages
1 option ARM deferring $3500/mo
3 in Chula Vista and 2 in Escondido
No more than $75,000 equity in any of the homes (verified by comp checks with 3 appraisers)
All properties with front end LTV over 90%
$65,000 credit card debt $672 Mercedes payment
One property had 3 mortgages, one of them hard money
621 mid FICO
2×30 in the past 12 months
Not a dime in the bank
They have been making mortgage payments with their credit cards and refinancing to pay off the credit cards. They are at the end of their rope, but refuse to throw in the towel.

This is not even an “extreme” example. I could show you dozens of these every single week.

I just wish the experts would see what I see. I think the statistics released would be different.

Granted, I only see applications from San Diego and Imperial Counties, but this is just getting out of hand.

“I have no idea what the general public is like. I only know that this is what I see each day. We certainly do see our share of 800 FICOs and 25% LTV’s, but it is the exception, and not the rule.

Most applicants are desperate to lower their payments, not realizing that they cannot lower a payment when they currently have the option arm.

Others are desperate for debt consolidation. When their mortgage payment went from $3000 to $1000 (fixed or ARM to option ARM) they found other things to do with the cash flow. Mostly toys.

We generally pitch up to 4 strategies:

Debt consolidation - most common
Max cash - a close 2nd to debt consolidation
Max cash same payment - almost never possible
Term reduction - hardly ever fits DTI
We do not sell Option ARMS. We hardly ever sell interest-only. The bread and butter of my office is selling people out of option arms and IO and back into a “real payment.”

The broker office next door simply can’t believe that we stay in business without an option arm to sell.

I will say this without any hesitation: 9/10 borrowers who currently have Option ARMs have no real understanding of what their loan is doing. I have had more than a few old ladies cry in my office when I show them the amount of deferred interest on their loan.

They were careless enough to sign a bad loan (ultimately the responsibility of the borrower to read the docs before signing), but it doesn’t help that every hack broker out there is pitching the option arm just because the rebate is so high.

Almost daily I see 70-year-old+ borrowers who used to owe $50k on their home now owing $600k on option arms.