Recently in the Great Housing Bubble Category

As I have said before, I hate doing my yearly tax form because it is so complicated. Consequently I have been in favor of a much simpler tax system, ie one without all the loop holes and deductions and credits. I dont see why the federal tax is not as simple as sales tax.

Having said that, I never expected to see it change so I was surprised to see Obama even mentioning the largest tax deduction: home mortgage.

I think the mortgage tax deduction is a bad idea but I never expected anyone to be able to touch it. By saying we need the money and the rich can afford it anyway, he is able to touch it. Nice.

Think about it. Who does the mortgage deduction really help? It helps banks. It tricks you into thinking you can afford a bigger house while at the same time raising house prices. Do you really need an incentive to buy a house? This interest deduction has gotten twisted up in our debt-society brains.

Reading the comments about the article though, I am reminded of my fellow Americans and their confused thinking. People that think it is communist to cut a tax deduction and fail to recognize that they are asking the government to help them buy a house. And all the people that worry about millionaires and who clearly arent.

Ironically, if this crisis is bad enough, it could allow us to restructure the government significantly. Simplify tax laws, remove sacred cows like the farm subsidies and actually get the "small government" Republicans are so fond of saying they want. We could even revitalize American business by removing the burden of health care from companies.

There is so much potential here and common ground yet you would never know that based on the public rhetoric. As a country, we have decided we are two teams in a football game and we have to fight any change on principle, often without even thinking about it. It is silly.

It has been weeks since I watched the Sunday morning news shows.

As I listened to the crew complain about Obama, the economy and Nancy Pelosi, it just struck me. What a bunch of wealthy, Baby Boomer dreamers. George Will and Sam Donaldson? What planet do they live on?

I am sorry but the problem with the economy is not that Obama needs to be more positive and give us all hope and confidence.

The problem with the economy is that for the past 8 years, the President and the Republicans dug a titanic financial hole in the ground. As they were living it up and reveling in their own short-sighted greed, they either sat idly by or actively contributed to creating the largest financial mess in history. Before we can move forward, someone is going to have to fill that hole back up again.

Instead we are borrowing more and more. $2T for 2009 alone. We are going to be setting debt to GDP records as we match the bad 1980's and then WW2 levels.

And here we are with the professional news media on TV telling Americans that all we need is a little confidence and to start spending again. It is so shallow and brazen you almost have to laugh. There is a lot of good information out there on what has been happening but you have to seek it out because the main streamers dont seem to know much of it.

People cant start spending again because they have been spending money they dont have for the last 15 years. Before we can really start spending again, we have get past the big debts we have already accumulated.

And its not just us. We exported our debt binge to every country around the planet. The stock market and the talk show hosts dont seem to read the paper. All I see is bad news, everywhere. Russia, China, Venezuela, Mexico, Brazil, Hungary, Iceland, Cambodia, Australia...

Life goes on but there is no guarantee it will be the life we knew or the life we want. (If I was a betting man, I would say it wont be either.)

I don't know what the future will bring but it is deeply disconcerting. When lots of people are unemployed and worried, it makes people stressed, angry and ultimately irrational and violent. When countries struggle with mass unemployment and fear, extremist politicians tend to get elected and they tend to start wars.

And the worst part of all this is that we did it to ourselves. Happy Sunday to you.

I have been marveling at how resilient housing prices have been here in Seattle.

Looking at incomes, housing prices are way outside of their historical averages due to the bubble-economics so I expect them to fall. But all I see are empty properties -- a LOT of empty properties -- for sale at bubble prices.

I know this is human nature. People wont drop the price unless they are forced to. So what will force people to take a loss and when will it happen?

Although we have been looking at single-family homes, I have noticed the huge supply of condos, specifically new, luxury condos. No one is going to purchase those condos and they are too expensive to rent. Why are they still being built? What will happen to them?

Here is the first article I have seen that provides some explanation - interest reserve provisions.

Back in February of 2008, we tried to purchase a house in Bellevue. We called it the "blue house". It was an older dare I say run-down house in an older neighborhood. The seller thought it was worth a lot more than I did so we didnt get the house.

The thing that stuck with me though was the neighbors. We met a few of the neighbors and I think about one of the couples from time to time. They thought the asking price was a fair one because they had just paid the same amount for a smaller house a few blocks away as an investment property.

The husband was an engineer. They were well educated and had steady jobs and were raising kids. These were people who were fully capable of doing math and showing some common sense. I get very nervous when I meet people like this who just bought "investment" properties.

I tried to delicately ask: Is the rent on that house enough to cover the mortgage?

They were happy to talk about it. The rent was not covering the mortgage but that was ok with them. "It would pay off in the long term."

I think about them from time to time.

I wonder if they have figured out by now that a short-term loss is never a long-term gain in real estate.

If you are starting a business, you invest money up front and expect a loss until your revenue grows enough to make your money back. But that model only works win a business where you get revenue growth which is not how real estate works.

With real estate, you pretty much know from the start what your revenue will be and if it is less than your expenses there will never be a long-term gain. You are basically buying a bankruptcy which is why its so important to stick with properties that are priced to cash flow.

Yes, from time to time I think about that family and the thousands like them.

How long can they keep it going?
How long before they want to get out and cant?
How long before they are forced to get out or go bankrupt?

And it wasnt just individuals. Lots of "professionals" got caught up in the same problems with their own investments.

what do you do when income is less than expenses?

First you try to raise your income but that is hard to do in rental property.

Generally there is a lot of supply out there. If you jack up prices on your tenants, you a) piss them off and b) push them into moving. (That's what happened to us.)

If there are a lot of rental choices out there, the tenants leave and it will be hard for you to replace them. So you drop your prices or offer intro rates to fill your unit. That is the time when you decide ANY money is better than no money.

If you cannot solve the problem by raising income, you cut expenses. You take your rent checks and you spend as little as humanly possible. The first thing you cut is the stuff people wont notice immediately - maintenance and repairs. Then you cut management and staff.

The result for renters is more problems and less service.

A friend of mine is renting the bottom unit in a "luxury" building. Her unit has been flooded twice. First time a toilette backed up in the unit above her. The second time the unit two levels above had a pipe freeze and burst. Instead of wrapping the pipes, management had to deal with damage to two apartments and storage units.

I would expect to see a lot of problems like this at larger apartment complexes as well as a lot of desperation to fill units because there are a lot of new units coming on the market.

If things are REALLY bad, you cut your biggest expense: your creditors. You take the rent checks and you stop paying your mortgage.

Its been a few months now and there is a steady stream of stories about renters who paid their rent and end up getting evicted because their landlord didnt. It is sad but I would expect to see even more of it in 2009.

And I expect to see problems in commercial property too. Just this last week the WSJ warned of a huge wave of commercial property defaults on the horizon. I would expect to see problems with any property that changed hands in the past 2 to 5 years.

Its funny to think back 6 to 9 months ago and look at what people were saying about investing in real estate and economy in general. What a different world it will be in 2009.

One of the most frustrating things about this financial "crisis" is that there appears to be no one responsible. It seemed like a day after 9/11 we were invading someone's country and smoking them out of caves.

But now we are in the throes of the worst global financial meltdown in history and no one saw it coming or could have prevented it?

Well plenty of people saw this coming and there are plenty of people to blame, some of them very public. This NYT article is a start although the comments on Big Picture may be more informative.

Taking Hard New Look at a Greenspan Legacy

By PETER S. GOODMAN

October 8, 2008

New York Times

“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.” — Alan Greenspan in 2004

George Soros, the prominent financier, avoids using the financial contracts known as derivatives “because we don’t really understand how they work.” Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential “hydrogen bombs.”

And Warren E. Buffett presciently observed five years ago that derivatives were “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

For many years the auto industry has had more manufacturing capacity than it needs to meet demand and that situation has only increased as other countries (Germany, Japan, Korea, India, China) create their own domestic industries. With overcapacity, the industry has pushed sales through advertising, fashion and creative financing. That “must have” SUV for safety kind of thing.

With this financial crisis, things are changed.

Car manufacturers can no longer afford to finance the system we were used to, in particular car leases. The end of car leases is huge. It’s a bombshell. Car financing was just about the only thing in the industry that was profitable and now its gone too.

Demand for cars is going to plumet. If American’s are forced to actually purchase cars, there will be fewer new car sales and more used car sales. There will also be fewer sales overall as people realize that the car they already have is good enough.

Car dealers are already going poof so when will we see the first American car manufacturer declare bankruptcy and which one will it be? Chrysler? Ford? GM?

Frankly, the world can live without any of them. Our lives would be fine if all cars came from Toyota, Honda, VW or BMW. All those companies can make small cars profitably and most of them have hybrid technologies. Moreover there just isn’t enough food to go around; we are all better off with fewer healthy companies than more sickly ones.

But this is an election year and Democrats are about to control the White House and the Congress. The only things Democrats like more than Fannie Mae is the UAW and labor unions.

The Big Three are begging for money. First they needed billions to invest in cleaner car technology. Now they need billions to stay alive.

We threw hundreds of billions of tax dollars at the banking industry. Will we throw another hundred or two at the auto industry? To save American jobs? To save our pride?

Will we throw a Socialist lifeline to our once proud symbol of American Industry or will we ask what they did with 50 years of huge profits and why they didn’t prepare for this obvious outcome? My guess is they will get the lifeline.

For a long time now we have known that American citizens have been living beyond their means, living on debt.

The signs of shrinking household wealth are easy to see. People have been using credit cards and home equity to buy toys and pay their bills. Our savings rate has been zero for a while and household debt has been rising while home equity has been falling. People that dont like to hear we aren't savers anymore (unlike Japan) always point out the value of our investments - homes and stocks. Not sure what their argument will be after this month.

The changes are even more apparent when you look at the WW2 generation's cash society and compare it with our current "ownership" society. A majority of people lease cars instead of buying them. Recent home mortgages have gone from 15 year to 30 year to 40 year and we have had interest-only loans. Ownership has become a euphemism as people dont "own" things anymore so much as they rent items in their possession.

Again, none of that is a surprise. The data has been public for some time.

What did catch me by surprise was finding out that businesses are in the same boat.

While the media and the experts focused on the "housing crisis", the stories about the corporate paper market were both sudden and surprising. Like finding out someone has been living in your basement keeping the water running and the heat working. All of a sudden corporate paper not housing was the real crisis. We are told that if corporate credit dries up, companies wont be able to make payroll. Wow.

I didn't know much about the corporate paper market before this meltdown and I find myself wondering how long it has existed and when it became the "lifeblood of our economy".

I can understand selling bonds to fund an expansion but I don't understand borrowing money to make this month's payroll. To me that indicates an irresponsible level of cash reserves. It also suggests that there are a lot of companies out there that are barely alive and will not survive without easy credit. Both bad things.

Now Paulson has his bailout bill but the cycle of fear as spread around the world and things have gotten worse not better. The billion dollar question is whether this will be a short but acute problem or whether we are seeing the collapse of a system and the creation of a new one.

Will there simply be less credit next year than there was last year? Will banks shrink the number of home loans? Will car leases disappear? Will credit card limits drop? Will company revenues (and jobs) drop as people have less to spend?

How will people and businesses adjust to a world with less credit? And will it last?

For many years I have argued that American's are living beyond their means and that that situation could not go on forever. But it kept going on and on and on.

Until this week when the Dow finally fell below 10,000... Is it actually unravelling now? Is this it? The big correction?

The past month, especially the past week, have been pretty unreal and I find myself feeling unprepared.

Our investments were well diversified and in good companies and funds. We did the "right" things and yet I saw our saving plunge day after day after day. I tried to be patient and not try to time the market but I just couldn't take it anymore. I cried "Uncle!"

One of the rules of investing is that if you cannot sleep at night, you make a change. I wasnt sleeping so yesterday we cashed out and sold almost all of our investments to keep cash. I didnt' want to do it, I really didnt, but after I put in the orders, I felt a wave of relief.

If this is like my previous attempts to time the market (like buying gold at $1,000), my sales will mark the recovery in the market so start buying! :)

But even brokers are talking about Dow 9,000, Dow 8,000 or a return to the long-term number, Dow 4,000. Folks are talking about the end of an era. And those are the GOOD scenarios.

There are a few folks quietly saying that our entire financial system is now bankrupt due to unregulated (and unmeasured) debt instruments like credit-default swaps. Trillions of Dollars worth of paper that could swamp the assets of all normal financial companies...

What a month.

The past few weeks I've been thinking about China and forest fires.

You know those stories about China? Something bad happens in a factory and eventually the Chinese government decides to punish someone. They round of the factory managers - and they shoot them.

I dont know if it prevents future problems but it is a simple and has high political entertainment value.

When President Bush took office, budgets were close to balanced and we had more tax income than government expense - for practically the first time in my 40 year lifetime. Seven years later, our country is broke and doing a Thema & Louise off a cliff in a $450 GM gas-guzzler.

A few shootings would feel pretty good about now. Even a few prison suicides would be nice. Maybe Karl Rove could be a new cellmate on Oz...

And then there is fire.

A few weeks ago there were some news stories about how the Forest Service misunderstood fire. In the 1970's we decided fire was a bad thing and we set about preventing it. Brush built up over the years and eventually we had HUGE fires. Moreover, the areas of previous fires recovered and we learned that nature uses fire to rebirth and rejuvenate forests.

Morale of the story? 1) Nature is much bigger than we are and laughs at our attempts to control it; 2) Cycles are natural and unavoidable.

Cancer is uncontrollable growth. Imagine what you would look like if you never stopped growing after high school? Or if no one ever died?

We need ups and downs. Cycles are natural.

So why do we expect the economy to always go up with never a drop? We talk about "business cycles" but we do anything we can to avoid them.

This past week I heard a senator say that we need to support the bailout because if we don't the "stock market could drop". That was it. Suddenly the government's most important sacred duty is keep stock prices high? When did that happen? Crazy stuff.

Paulson's first bailout plan failed to pass in the House today even though more Democrats than Republicans voted for it. Confusing times these are. I dont know what will happen next but Im glad the plan failed.

Most people seemed to oppose the plan but there doesn't seem to be any real consensus on the reason why nor any real clarity on what the plan did or what it "fixed". Reading blog comments, I see all kinds of twisted thinking.

I've been writing about the housing bubble for over 2 years now but it seemed like the government woke up from a long nap and had an epiphany: the fundamentals are not sound - we are in a crisis!! Although the reasons for not voting for the plan are legion, most economists I have heard of did not support the plan so maybe we will get a better one soon - one written by economists not by CEO's or politicians.

The main reason I opposed the plan is that I didnt hear anything in it that would have prevented the current crisis from repeating once investors had digested the $700B.

My analogy is that our leaders suddenly realized that our house of debt was made of cards. The Paulson plan was to pay $700B for a sturdier table underneath our house of cards. The next time there is a strong wind, our house of cards will be right back here in crisis again. What we need is a house of straw or sticks or maybe a plan to get a house of brick. What we need is regulation and reform.

But I havent seen anyone in Washington talking about that. What exactly IS the crisis? If we cannot agree on the problem, how can we agree on the solution?

Over and over I hear that home loan foreclosures are the problem. Home foreclosures are still under 5%. Foreclosures are not new. How could that bring down all the banks and collapse the economy?

Now I hear is that the corporate paper market is essential to our economy and it almost shut down last week. How could home loan foreclosures stop all corporate lending?

What they arent telling us is that the home mortgage market has been changed forever and those changes (the creation of the CDO and CDS) quietly but fundamentally changed our economy. In a bad way.

What they arent telling us is that this change has been going on for years and it has been plain as day. These changes created a lot of wealth in the bubble but they also set us up for this crash and they complicate any plans to fix things.

How do you re-negotiate a mortgage for a troubled home buyer if you dont even know who owns the mortgage?

Turning a home mortgage into a security may have sounded good but it changed the idea of risk so completely that it landed us here. Any "solution" needs to specifically address these new financial vehicles.

As far as I could tell, the Paulson plan was to pump so much more debt into the system, housing prices started to go up again. If home prices went up again, we wouldn't need to resolve the CDO/CDS mess and everyone would start making money again.

But home prices aren't going to go up again because people don't have the income to pay for them. (Remember income? Its what you are supposed to use to buy things not "available credit".) The bubble created unsustainable prices and $700B wont change that.

Other people are floating similar plans that will "save our economy" by spending tax dollars to pay the mortgages of people that cannot afford their homes. These plans are equally suspect because they try to avoid the laws of economics. Houses cannot stay as expensive as they have been and the mortgage-backed securities that were sold for those mortgages are not worth their face value.

I dont know what will happen next but I think a bad year or two would be healthy for us. We have become so wealthy and people have such a sense of entitlement that a little humble-pie would do us good. It wont feel good but maybe it will cause folks to be a little more careful and thoughtful. Maybe a leader or two will emerge from the flock of sheep we have now.

Or maybe that is just as wishful thinking as Paulson's plan.

I've been working on some longer posts about the financial "crisis" but the events keep unfolding.

For now let me just ask how stupid, colossally stupid, fool me once; fool me over and over stupid are the Democrats?

After 9/11 Bush called them cowards and we wrote him a blank check. End result? Iraq.

A month ago, "the fundamentals are sound". This week "crisis!!!!". And here were are again, with Democrats writing another blank check.

Banks are failing but how many Americans can explain why in any detail? This is happening so fast, people haven't had a chance to breath. Democrats arent explaining the problem or looking for root causes or helping everyone see who should be held accountable. Bush says "Boo!" and Congress pees its pants.

Let me reassure you, Hank "Mr Wall Street" Paulson is not doing this for you; he is bailing out his buddies but the real problem is that this plan of "unprecedented power" will not stave off the crisis. This crisis is the result of actions over many years and spending a $1T may delay the day of reckoning but it is not going to fix anything.

The crisis is an alcoholic experiencing painful delerium tremens. The bailout plan is a beer. Its going to feel good but we will be back in the same place soon.

Taking Stock: U.S. Should Trade for Aid

By MARK GONGLOFF

Wall Street Journal

Warren Buffett is getting something tangible for his investment in the financial sector. Why shouldn't taxpayers?

Federal Reserve Chairman Ben Bernanke told Congress this week that, to bail out banks, it might buy hard-to-sell mortgage-backed securities not at current market prices but somewhere closer to "hold to maturity" prices. That means, roughly, what banks think the assets will be worth when the principal is recovered on the underlying mortgages. This price is much higher than the market price.

But many of the underlying mortgages have already defaulted or are in foreclosure, and many more are headed that way. Unless housing prices return to bubble highs and erase the risk of foreclosure, the day of "maturity" for many of these assets will be more painful than puberty.

"In structured securities, there is no coming back," says Joshua Rosner, managing director of Graham Fisher Co., an independent financial-services research firm. "Once the underlying collateral defaults, you'll never have recovery."

The market realizes that, which is why it's not interested in anything close to "hold to maturity" prices. While suggesting the government shouldn't overpay, Mr. Bernanke also suggests higher-than-market prices are necessary to get credit moving again. Otherwise banks' books will remain burdened. But this will also artificially reflate these assets, making the future day of reckoning uglier.

A better way is to get real prices for these assets now and use government money to cover the balance-sheet damage -- in exchange for an equity stake. That's the model Sweden used successfully during its crisis in the 1990s.

There are ways to do this that limit the risk of dilution to existing shareholders. Len Blum, managing director at investment bank Westwood Capital, suggests the government could take preferred shares and warrants to recapitalize banks that aggressively write down toxic assets. The Senate Banking Committee has proposed the government buy the assets and take an equity or debt stake in banks only if the assets fall in value.

Some suggest equity stakes would punish banks and keep them from participating in the bailout. But it's hardly punishment to give banks the capital they desperately need.

Buffett is one of the few people I still trust but he is wrong with this Pearl Harbor metaphor -- we didn't bomb ourselves in Pearl Harbor...

Monday: "Crisis on Wall Street...."
Thursday: "Mounting fears shake world markets...."
Friday: "U.S. drafts sweeping plan to fight crisis..."

I wish I had kept all the Wall Street Journals this week. In economic terms, this week was mind blowing. September 2008 is going to become known as a seminal month in the history of our country.

This month will mark the turning point in the largest financial bubble in world history. We haven't seen the consequences yet but they are likely to be as significant as the banking reform after the great depression of the 1920's and 30's.

Despite the significance of anything involving trillions of dollars, people seem to be going about their business as usual. Where is the fear? Where is the outrage and demand for accountability?

Sunday I watched the ABC morning news show (the one with Stephanopolous) which featured an interview with Senator Chris Dodd (R), co-chairman of the congressional committee on banking, followed by a round-table of news journalists. It was the first time I have ever watched one of these shows and felt that these people, these Washington insiders, the folks in charge, have no idea what is going on.

When McCain said that the head of the SEC should show some accountability and resign, the pundits called him "an angry old man" who went "too far". I remember when the stock market crashed in the 1980's (a MUCH smaller problem) and brokers committed suicide rather than face the loses and shame. When the idea of firing someone is going too far, you know we have problems.

Sunday night I watched the 60 Minutes interviews with our two presidential candidates: McCain and Obama. Much like the morning experience, I was not impressed or reassured. The best I can say is that Obama seems to be talking to a good group of economists and he seems able to have a conversation with them; McCain seems too old to deal with this crisis.

McCain is a soldier and best suited to the challenges of the 20th Century. We live in the Information Age now and this financial crisis is one that was created by the tools of the Information Age: spreadsheets and complex financial models run by hedge funds and others. The houses that we can see being foreclosed on are just the tip of the iceberg, the smaller 1/3 of the of the problem. The real damage is in the paper intangibles: options, derivatives, insurance.

Warren Buffett warned about these problems maybe 6 months ago but the only person I have heard speak intelligently about the mess is historian Kevin Phillips.

"Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism"

Last week, I caught part of a lecture he gave and Im thinking about buying it. Phillips' books are a pain in the ass to read but he is clear as a bell when talking. I dont know how one person can know so much, but Phillips does a financial rewind of the last century and brings together all the threads to today. The results are not pretty.

Besides explaining the factors in the current financial mess, Phillips' argues that an American today would have felt very much at home in England, Holland or Spain -- just before those empires collapsed. Yikes. A sobering thought even without the numbers, which he provides.

Hold on to your hats and pray for leadership. The news reports I keep hearing continue miss the story and simplify the issues to the point of nonsense.

Falling home prices, foreclosures, financial company failures, 9-11. Current events have me thinking about the idea of punishment.

In our culture we tend to go for the fire and brimstone stuff. That guy who stole VCR tapes from a 7-11 and got life in prison for it because of the 3 strikes law. Or the many people that smoke pot and end up doing serious prison time because of our drug laws.

When it comes to punishment, we often think more of vengeance. It is a simple reaction and it goes along with a lot of assumptions that maintain a black & white view. We tend to assume only the guilty get arrested (or put in Guantanamo). We tend to assume the worst of people of color.

This line of thought is pretty shallow and inconsistent. We focus on the vengeance aspect but ignore the total costs to us and the system as a whole. We forget about the tax dollars we spend on prison. We dont ask what we should do with people when they get out of prison or what they should be doing while they are there.

Like many of our problems we just want them to go away. Throw them in jail and we are done. Case closed.

But what about the guys who run their company into bankruptcy and ruin the retirement saving of thousands of employees? How do we punish those guys? The ones that are on the cover of business week one month as heroes and on the cover the next month as their company implodes due to fraud and corruption? What about the people we idolize until we find out what slime bags they really were?

Beyond the people that commit fraud, how do we punish the people that are just doing risky things? Driving a car without a seatbelt, taking drugs, or making purchases they cannot afford? There are a handful of Enron's but there are millions of people making risky decisions every day.

The idea of punishment is closely tied to the idea of responsibility. How should we punish adults who are irresponsible? How do we teach children to be responsible? If people are all telling us to do something that turns out to be risky, how do we treat those that go with the flow and those that choose a different path?

I wish I had an answer but I only have questions. It is not an easy thing although it is a very topical one. The problems that face us (financial and environmental) are problems of our own making. We have only each other to blame but I have yet to see any wisdom of crowds or any leadership with a significant following. Instead we tend to ignore the problem until there is a panic and then the mob rules.

Global warming is the biggest issue but the housing bubble and its painful deflation is the immediate one. There were so many people that helped create that problem that there is no single party to scapegoat. Instead it is going to divide us as different groups try to blame each other and protect themselves.

At the end of the day I am left wondering what happened to the ideas of personal responsibility and I wonder who if anyone will get punished and how.

When we moved here five years ago, the average home price in our county was roughly $300k. In 2007, the price peaked above $450k.

For a long time now, I have been saying the housing bubble would pop and prices would fall back to more affordable levels. August 2008 shows the first milestone in data that supports my theory.

Despite the chorus of locals saying prices would never drop in the Seattle area, the average home price is now down 10% from the peak level. Moreover, the slope of that change does not indicate a bottom is near. National financial news suggests that the loan supply will continue to contract and who knows what will happen here if WAMU goes bankrupt.

We recently rented a house and resolved to wait at least another 9 months for a purchase. This month that decision is looking like a sound one.

NWMLS: Double-Digit Price Drops Arrive in King County

Posted by The Tim

September 9th, 2008

LINK

NWMLS statistics for August have finally been released.

The NWMLS press release will be posted at this link when it goes up.

Here is your summary along with the usual graphs and other updates.

Here’s your King County SFH summary:

August 2008
Active Listings: up 16% YOY
Pending Sales: down 16% YOY
Median Closed Price*: $423,950 - down 11.2% YOY

When I saw the run-up of housing prices in San Francisco back in the late 1990's, I thought it was crazy. I thought it was unsustainable because housing essentially became unaffordable.

Then I saw the same prices and mentality spread across the country and the world. It may have been crazy but money was being made and people felt crazy like a fox.

The more I learned, the more convinced I became that the forces at work were unsustainable and eventually the music would stop and the pieces would come crashing back to earth.

But I felt like a crank because the music never stopped. Year after year it went on. The hype became the common wisdom. I kept saying the end was near but my friends and family kept saying I was wrong.

Well this week, the end finally is near. I can comfortably say the music has stopped and we are on the road to recovery, a long, slow, painful recovery.

Fannie Mae and Freddie Mac have been taken over by the federal government because the government feared their collapse. (Unprecedentedly huge.)

Lehman Brothers is expected to fail soon. (Bear Stearns already failed.) Morgan Stanley doesnt look much better than Lehman.

WAMU is expected to fail soon. (Following IndyMac and CountryWide.)

Finally. For almost 10 years we have created a Great Housing Bubble. Now we are seeing the Great Unwind of that bubble.

What I expect to see next are hedge fund losses and more financial and bank failures. People that invested in these "safe" companies are going to lose everything and that includes the other banks and pension funds and international banks. The finances are all tied together and the losses will ripple through the economy like a glacier slowly sliding downward.

On the personal front, people will use credit cards to maintain the lifestyles for a while but in a year or two, personal bankruptcies and home loses will climb. Spending will drop on luxury cars and big TV's.

The banking problems will cause lines of credit will dry up. Demands for 15% to 20% down-payment on new mortgages will put a serious hurt on home sales and cause prices to drop. Someone is going to have to determine how to handle short sales and figure out who will take a loss when homes are worth less than their existing mortgage(s) or else housing sales will freeze up.

It wont be pretty but in the end, we will have a more affordable housing system and a more reasonable sense of what we can afford.

From time to time, I worry that my blog posts are over the top. That concern apparently doesn't trouble this economist.

Nouriel Roubini goes off!

Comrades Bush, Paulson and Bernanke Welcome You to the USSRA (United Socialist State Republic of America)

Nouriel Roubini

Sep 9, 2008

The now inevitable nationalization of Fannie and Freddie is the most radical regime change in global economic and financial affairs in decades. For the last twenty years after the collapse of the USSR, the fall of the Iron Curtain and the economic reforms in China and other emerging market economies the world economy has moved away from state ownership of the economy and towards privatization of previously stated owned enterprises. This trend was aggressively supported the United States that preached right and left the benefits of free markets and free private enterprise.

Today instead the US has performed the greatest nationalization in the history of humanity. By nationalizing Fannie and Freddie the US has increased its public assets by almost $6 trillion and has increased its public debt/liabilities by another $6 trillion. The US has also turned itself into the largest government-owned hedge fund in the world: by injecting a likely $200 billion of capital into Fannie and Freddie and taking on almost $6 trillion of liabilities of such GSEs the US has also undertaken the biggest and most levered LBO (“leveraged buy-out”) in human history that has a debt to equity ratio of 30 ($6,000 billion of debt against $200 billion of equity).

The way Roubini chose to discuss this topic is a bit strident but I agree with his analysis. The takeover of F&F is HUGE - and all but ignored by the people I know. Just another news blip.

I thought I understood the difference between prime, alt-A and sub-prime mortgages. Until I read this fascinating article.

Reflections on Alt-A

by Tanta

Monday, August 11 2008

read it on Calculated Risk

It never ceases to surprise me how a little bit of history changes one's whole understanding of things.

The three C's indeed. My takeaway from the article is an even stronger feeling that the people in the know did know and they let us down. It is frustrating how much damage greed can do.

So much for the ideas of "free market" or "meritocracy". So much for individual responsibility or personal accountability.

The multi-year housing debacle is headed for a federal bailout package endorsed by the President, the House and the Senate. The leaders that showed no leadership in preventing the housing bubble are now shocked and alarmed into action, falling all over themselves to "help Americans".

But will this bill do anything? Looking at the highlights, I am not seeing much other than the FHA agreeing to guarantee $300B in loans. Presumably banks will either ignore that offer or unload the worst of the worst loans in their portfolio, pretty much guaranteeing that tax payers will pay for the ignorant and the fraudulent.

What you wont see in this package is punishment or accountability for all the wrong-doings. The individuals who knowingly bought more than they could afford. The speculators who gambled on a never-ending gravy train. The investors who were too greedy to stick with traditional investments. The bankers and bond-agencies who were paid to know better and paid to manage risk.

The really tough part of this whole situation is separating the true victims from the folks who should be held accountable for one of the biggest financial crises in history. A crises that many say is still in the 2nd inning...

Housing Bill Will Extend Federal Role In Markets

By DAMIAN PALETTA and JAMES R. HAGERTY

July 24, 2008

Wall Street Journal

Key points of the housing bill, and their cost over 10 years (to be fully offset by tax code changes and fees):
• Fund to provide more low-income housing: $5.3 billion
• Tax credits for first-time home buyers: $4.6 billion
• Grants for state and local governments to buy foreclosed homes: $3.9 billion
• FHA insurance for up to $300 billion of home loans: $729 million
• Counseling for homeowners facing foreclosure: $210 million
• Loosens restrictions on how states issue tax-exempt housing bonds
• Keeps lenders from foreclosing or increasing mortgage interest on returning troops for a year. Creates financial-counseling program, increases home-loan limit for military veterans: $112 million
• Raises loan limit for lenders to 115% of the local area median home price, up to $625,000
• Raises limit on seniors' reverse-mortgage program to $625,000
• Raises limit on federal debt to $10.6 trillion, from $9.8 trillion
• New regulator for Fannie and Freddie, financed by the two lenders

The bill also authorizes the Treasury secretary to expand credit and buy equity shares in Fannie or Freddie if necessary. The Congressional Budget Office estimates this would cost an extra $25 billion if it happened.

...

The biggest boost for homeowners is a program that would allow the FHA to back the refinancing of as much as $300 billion in home loans for distressed borrowers. Under this plan, the lender or investor holding the mortgage would have to accept at least a 15% write-down in the value of the previous loan. The new mortgage would then receive federal backing.

But lenders wouldn't be required to participate, and many are likely to conclude that they are better off proceeding with a foreclosure or offering the borrower some other means of trying to catch up on payments. The Congressional Budget Office recently estimated that the program would lead to 500,000 borrowers refinancing loans totaling $85 billion.

Countrywide and Bear Stearn's were the first shoe to drop. The other shoe, the really big one, is Fannie Mae and Freddie Mac. In large part, our entire economic system is based on the foundation of home mortgages and over $5T of those mortgages depend on Fannie and Freddie.

For those who blame the Bush administration for all evils should know that Fannie and Freddie are largely examples of Democratic pork and corruption going back to the Clinton presidency. It is very hard to trust the Bush administration about anything but the Republican's have had some of the best leadership on reforming these two agencies and limiting the risks they pose to our financial system.

Keep your eye's peeled for stories on Fannie and Freddie. Just today there were two articles in the WSJ. It is looking more and more like these two companies will default before the end of the year if left to themselves. The question now is what the government should do and whether it will be willing to do it.

U.S. Mulls Future of Fannie, Freddie

Administration Ramps Up Contingency Planning as Mortgage Giants Struggle

By JAMES R. HAGERTY, DEBORAH SOLOMON and DAMIAN PALETTA

Wall Street Journal

July 10, 2008

The Bush administration has held talks about what to do in the event mortgage giants Fannie Mae and Freddie Mac falter, according to three people familiar with the matter, as the stock prices of both companies continue to fall sharply.

The shares of the two companies have plummeted for several reasons. Investors are worried they will suffer bigger losses as housing prices continue to fall and mortgage defaults rise. Stock-market investors are also worried they will need to raise significant amounts of capital to cover those losses. For stock investors, that means the value of their ownership stakes in the company will be cut. Bond investors continue to lend to both companies, though they are also demanding slightly higher interest rates.

Fannie and Freddie's health is of deep concern to policy makers because of the critical role they play in the housing market. The two companies own or guarantee about $5 trillion of mortgages or nearly half of all U.S. home-mortgage debt outstanding. The government has increasingly leaned on the companies to provide critical stability to a housing market crippled by falling home prices and banks too nervous to lend.

The current credit crisis has prompted some unprecedented thinking from national policy makers about how to maintain the integrity of the financial system. Since the near-collapse of investment bank Bear Stearns Cos. earlier this year, both the Treasury and the Fed have been pondering how to unwind a failed institution in an orderly way.

A WSJ op-ed. Add 1/3 to the national debt? Yikes.

The Price of Fannie Mae

July 10, 2008

Wall Street Journal

As opposed to GM or Ford, most Americans have never heard of Fannie Mae and Freddie Mac. Yet the insolvency of either mortgage giant would have far more profound consequences for every American taxpayer than the bankruptcy of those car companies. It's time Americans understood the price they could soon pay for the Beltway's confidence game with these high-risk "government-sponsored enterprises."

These columns have warned about Fannie and Freddie going back to 2002, and our fate has been to climb a wall of denial and hostility. This week reality began to set in. The duo's share prices tanked nearly 20% on Monday on fears that their capital levels may not be adequate. They rallied on Tuesday as their regulator played cheerleader, but they sank again yesterday to prices in the teens, compared to more than $60 a share last October. Investors are saying that a Bear Stearns-like run on the companies is a real possibility, and they're right.

What Americans need to know is how damaging such a failure would be. This wouldn't merely be a matter of the Federal Reserve guaranteeing $29 billion in dodgy mortgage paper, a la Bear Stearns. Fannie and Freddie are among the largest financial companies in the world. Their liabilities – mortgage-backed securities (MBSs) and other debt – add up to some $5 trillion.

...

To put that in perspective, consider that total U.S. federal debt is about $9.5 trillion, compared to a total U.S. GDP of $14 trillion. About $5.3 trillion of that debt is held by the public (in the form of Treasury bonds and the like), while $4.2 trillion is intragovernment debt such as Social Security IOUs. This is the liability side of America's federal balance sheet, and its condition influences how much the government can borrow and at what rates.

The liabilities of Fan and Fred are currently not on this U.S. balance sheet. But one danger is a run on the debt of either company, putting pressure on the Treasury and Federal Reserve to publicly guarantee that debt to prevent a systemic financial collapse. In an instant, what has long been an implicit taxpayer guarantee for both companies would be made explicit – committing American taxpayers to honoring as much as $5 trillion in new liabilities. U.S. debt held by the public would more than double, and the national balance sheet would look very ugly.

...

Our own proposal, made months ago, is to require a more honest form of socialism by injecting taxpayer money now into both companies (say, in the form of subordinated debt or preferred stock) to recapitalize them enough to weather the current storm. This would help prevent a U.S. balance sheet debacle, and it would force the politicians to acknowledge the mess they have created. Then as the crisis passed, the taxpayers would at least get something for their money, while regulators could work to unwind Fan and Fred's liabilities and shrink these monsters to a less dangerous size.

This would be real "change" in Washington. Instead, the political class continues to promote the status quo illusion that Fannie and Freddie are risk-free purveyors of the American housing dream. It is one of the great political scandals of our age, and it has unfolded in broad daylight. As usual, the American taxpayer will get stuck with the bill.

I have been talking and writing about the housing bubble for several years. Turns out I was an unwitting investor.

A while back I pulled some money out of securities and put it into ultra-short-term bonds, which I expected to be ultra safe.

SWYPX

Category: Ultrashort Bond YieldPlus seeks to maintain an average portfolio duration of 1 year or less.

You may want to consider this fund if...

You are seeking higher yield than a money fund can offer for your longer-term cash (cash you intend to hold for one year or more) yet can accommodate share price fluctuation.

You are looking for relatively stable monthly income but are unwilling to take on the risks associated with a longer-term security.

Recently I noticed that the value of these ultra-safe bonds had dropped. A LOT. What?!

Look at this graph... 2004. 2005. 2006. 2007........!

Turns out my "ultra-safe" investment was actually investing in CDO's and other housing-related kruft. Despite my own warnings about the housing mess, I am now a victim too. If I had known what they were buying, I would never have bought this fund. And if I had listened to Schwab, I would never have known what happened -- it took this lawsuit and article.

More specifically, the Complaint alleges that, in connection with the Funds' Registration Statement, defendants failed to disclose or indicate the following:

(1) that the Funds' assets were or would be overly-concentrated in the highly risky mortgage industry and that such securities were or would be highly vulnerable to illiquidity;

(2) that there existed no primary market for the majority of the bonds;

(3) that the duration for a majority of the Funds is over two years;

(4) that the values of the Funds' shares were inflated and highly speculative given their composition;

(5) that there were not adequate internal controls; and

(6) that, as a result of the foregoing, the Funds' Registration Statements were false and misleading at all relevant times.

Well isn't that just great. Joke's on me.

March 2008. What a month! If you had written a movie about the Bush White House -- no one would have believed it yet here we are.

strike one

After years of obvious and unsustainable behavior, we finally witnessing a complete meltdown of our financial system and housing. The canary in the coal mine is Bear Stearns. Teh poison gas is cheap money and the morgage-backed security.

At the end of last year, we had a "credit crunch" because of the process of turning mortgages into bonds. Bear was a leader in this financial wizardry and they profited handsomely from it. Then in Q4 2007, the world woke up and admitted it wasnt such a good investment after all.

The shares of Bear fell and the experts assured us the worst was over. I even considered buying shares of Bear in Dec/Jan. (How dumb was that.) Fast forward to March and from Friday to Monday, Bear shares fell from $150 to $2 and a buyout was announced by JP Morgan. What?? Out of the blue, a total meltdown.

How could this happen so quickly? So suddenly? Most of all, how could this happen with the FED orchestrating it? Why on earth would the federal government reward unscrupulous speculators?

Suddenly the small-government-dont-tax-me-free-market evangelists like Bear are getting a bailout from the federal government. It appears to be the ultimate fast one, the ultimate financial joke on Americans.

Tax payers pay for all the risk when things go bad and the bankers get all the profit. Even the purchase of Bear's assets by JP Morgan while the Fed assumes all of Bear's liabilities stinks to high heaven. That is 100% NOT how the free market is supposed to work. In fact, things are so upside down and confused its like an alternate reality sci-fi mini series...

And the revelations keep coming. The truth is we still dont know much about the details nor is it clear why the middle class should foot the bill for the wealthiest 1% when they screw up. Every day, I find myself aghast. Again.

strike two

If financial market debacles arent enough for you, we also have the Iraq occupation. Go on YouTube and watch interviews of Donald Rumsfeld telling us that the "war" would cost $50B. A few government analysts predicted $300B -- and got fired for the trouble. Oh it seems so quaint and jocular now.

A few years later, economists say well actually, it will be more like $1,000B or $1T. A year after that and we have more estimates - $2T to $3T!!! $3,000B of your tax dollars. An inconceivable amount of money and it went to pay for... what exactly?

"The Three Trillion Dollar War: The True Cost of the Iraq Conflict" by Joseph E. Stiglitz, Linda J. Bilmes

We didnt get any free oil. We didnt create freedom or democracy. We didnt make friends or even keep our old friends... We also didnt rebuilt New Orleans, repair our own crumbling public schools or worn our bridges or put fiber optic networks into every home for the "information economy"...

strike three

A third major Bush Administration contribution to the world is also shaping up in March -- global warming. A giant ice sheet in Antarctica has now crumbled away. Glaciers are melting everywhere and our government still has a policy that says global warming is not real enough to actually do something about... gosh no, that might be expensive. Better wait until someone else is president.

you're out!!

Wow.

Bush wanted to go down in history. It seems pretty clear that he will.

And yet there are no riots in the street. No calls for impeachment. No nothing. We as a country are lining up and happily bending over. It is just bizarre. Think about the protests in the 1970's and compare that with the business as usual experience today. The people who do complain are "left-wing nuts". There isn't even a national consensus on whether or not we have problems let alone any unified moral outrage. (It's not just tax dollars after all. We have killed hundreds of thousands of people in Iraq - an we NEVER talk about it.)

vote with your wallet

Who do you think is going to pay for all these things?

Do you think cutting taxes is going to pay for the $1T in losses when the housing bubble finally resolves itself? Or Iraq?

We seem so removed from our own condition these days. Oh sure, you are broke, you borrowed all the home equity you could and spent it on a vacation, a new TV and a BMW... but dont worry, you will get our economy going again with more shopping...

And dont get me started on "accountability" or "individual responsibility". Republicans have preached for years about "responsibility". We shouldn't have welfare!! People should be responsible...

Well I dont see anyone lining up to pay the check for any of these crisis. I dont see anyone lining up to pay MORE taxes so we dont have to borrow so much. I dont even see any Republicans talking about how to fix these things with the next president. Apparently when it comes to your mistakes, accountability is synonymous with total denial.

Perhaps our voting system would garner a lot more attention and responsibility if we paid for our choices. After years of Bush Tax Cuts, I would like to see Congress enact the Bush Tax. If you voted for the president in 2004, you should be personally responsible for any debts he acquired since then. Just send the money in with your tax bill. If you didnt vote for him, why should you have to pay for him?

Maybe we can apply market forces to our political process and attempt to get the people who spend the money to pay the money. Then again, we would probably put Bear Stearn's in charge of the plan and screw it up.

For the past few months, I have really enjoyed reading the posts, charts and comments at Seattle Bubble.

Their new layout is terrible but this is a great blog. It provides a much better analysis of the local housing market than the news papers or realtors (who have a disincentive to be honest). Because of the hard data and analysis of the local conditions, this blog has become my main source of information on the Seattle area.

In business school, they tried to impress a few rules on me:

1. Supply and demand are not always at equilibrium but forces eventually try to push them there.
2. People want to be paid a premium for taking risk.
3. Real estate is local.

One of the reasons I have not been posting recently is that we have been trying to purchase a house. Even when I knew what to expect, I was surprised by how emotional the experience was for me. I was also surprised by how irrational people are when it comes to real estate. The rules of business are clearly not understood by many Americans.

all real estate is local

The classes I took on real estate really impressed the rule of locality on us, even if it included a few twists.

The basic idea is sound. Real estate prices are set by supply and demand.

Historically, the main drivers of demand for homes are population and the ability to pay. The ability to pay is another phrase for "jobs". If people make more money, they can pay more; if people make less they can pay less. If the area is losing jobs, like Detroit, home prices fall.

If there is unmet demand, builders increase the supply by creating new housing. Competition for homes due to high demand causes prices to rise.

Since building a home takes a long time, there is always lag in the process. This lag in turn leads to the boom/bust cycles that all local real estate markets have seen because builders are still building after equilbrium is met; they overshoot the true demand. This is where the twist comes in, usually in commercial properties.

In commercial real estate, the locals know what things are worth. But when rents rise during a boom, someone with money from another city (as in "not local") has a spreadsheet that tells them to "buy buy buy!". They invariably overpay for the building, own it for a few years, lose money each year, and then sell the building back to a local -- and take a huge loss in the process.

The lesson here is that prices, that elusive equilibrium, doesnt necessarily move in smooth steps. More often, it moves in big jumps up and big losses down.

the driving force

The problem we face today is that the rules of business were thrown out of the window over the past 8-10 years.

RE may be local but for the first time in history, prices were rising in EVERY city, in EVERY country, all at the SAME time. Moreover prices were rising much faster than historical rates (5%) or incomes (3%).

How do our rules explain what was happening? They dont. Clearly something else, something new, was going on.

What was going on was a revolution in the way RE was financed. What was going on was Wall Street.

Someone invented the idea of re-selling mortgages as bonds. Someone concluded that these mortgage-backed securities were safe (after all, houses are safe, right?). Then a lot of people found out that these MBS were VERY profitable.

Risk? What risk!! Risk and reward went out the window as every party in the real estate process found out that they could make money. LOTS of money. It was a miracle.

In the past, banks had to be careful about who they lent to. They were taking a risk with a lot of money and their caution kept the brakes on home prices. The key to the MBS revolution is that banks no longer kept the mortgages. Instead they sold them off as soon as they could get them. They made money on the loan transaction and did not have to worry about the risks of the borrower anymore.

Moreover, everyone involved in the process was financially incented by the same thing: sell houses and sell them for as much money as you can.

When I say everyone, I mean everyone. The real estate agents, the real estate brokers, the mortgage borkers, the mortgage banks, the mortgage insurers, the bond rating agencies, the home owners. Everyone.

No downpayment? No problem.
No job? No problem.

Prices went up. Everyone could buy a house. Everyone made money. Everyone you might ask for advice was advising you to buy in now. "You cant lose!" Money from around the globe poured into flipping houses, building houses, and buying mortgage-backed securities. No one much talked about the "real estate is local" rule while they were busy creating the first global real estate bubble.

The only problem is that this situation was clearly unsustainable. People were getting into homes they could never pay for. Everyone who cared to look and think knew what was happening but no one wanted things to stop. Carpe diem! Live for today!

And then it stopped. As it always does.

What happens now?

About 2 years ago, the music stopped and people are still trying to find a seat. My recent home-buying experience has shown me that there are still a lot of people who fervently want to believe that the music is still going. They still hear it; why cant you?

Who is to blame? Personally, I blame the professionals: banks, brokers, realtors. They knew what was happening.

On the other hand, the whole experience has shown me that most families have no idea how to understand the housing market or how to run their personal finances. They dont understand why prices went up or why they will now go down. The insiders are going to keep their millions but this whole experience is going to be a painful financial disaster for a lot of Americans.

After some temporary insanity, the rules of business will return. All roads lead down at this point. The bubble is over. The major force driving prices up has vanished and people are still trying to figure out how much money has been lost and who will pay for it. A trillion dollars? More? Entire cities appear to be toxic forclosure wastelands.

The main question for each of us is how this change will affect our local market. How fast will prices drop, how far will they drop, and how long will they drop. Suddenly the old rules are back and real estate is local once again.

whither Seattle

In Seattle, the phrase we hear over and over and over from the music lovers: "Microsoft is still hiring x-thousand people every year!!" That may be the case (but this whole thing should have taught not not to extrapolate trends forever) but is Microsoft really enough of a factor to replace the main driving force behind higher prices to begin with? In my mind, they are comparing a mountain and a mole-hill but it illustrates that emotion is one of the main factors behind individual housing decisions.

Home prices are not completely elastic. Prices move up with less resistance than they move down. People are eager to see prices rise but they have to be forced to move down. That takes more time and bigger disparities between supply and demand.

What we are seeing right now in Seattle is huge supply and small demand. Will population and jobs cause demand to rise enough to keep prices where they are or will supply (ie prices) have to drop?

To answer that question, one needs to do some grade-school math. If you spent 25% of your gross income on mortage, mortage insurance, taxes and maintenance and the median income level for a household is $55,000, what size of mortgage is "affordable"? (answer: less than $1150/mo or $175k at 7%)

Everyone thinks their house is priceless and everyone else's is overpriced. They say this neighborhood is worth it and that one is not. Houses are emotional and people get anchored on imaginary ideas of "value" and "what its worth". But money is money. If you dont make enough, you cannot pay the bills. If incomes can afford $175k and prices are $450k... well something has to give eventually.

Other cities have seen falling prices for a while now. In the Seattle, I think we are finally at a turning point and the next three months will show which way things are going to go. Can Microsoft can keep the game afloat or is supply>demand going to drive prices down.

I dont expect a lot of forecolusures in this area but I could be wrong. How many people bought those $500, $600 and $700k homes with ARMs knowing they could only afford the teasers rates? How many people put no money down and can walk away if home values drop below their mortgage? How many families spend more than they earn, every month?

One critical factor in all this is that it takes a long time to see the effects. The teaser rate on ARM's typically last 2 to 3 years and people can live a long time in denial, ie on credit cards. Households can run deficits for a long time on credit cards until eventually, they cant.

And I think the biggest casualty of this irrational exhuberance is going to be even longer in the telling. I expect to see that millions of Americans have blown their retirement savings trying to maintain their lifestyle. But that's an article for another day.

Happy renting.

Seattlites like to say that our housing prices will stay high because demand is so high. People keep moving here because the jobs are good and they dont't have to see the sun for 9 months.

A nice thought but census data does not support the idea that people are flocking here and scooping up housing.

Every day bring more articles explaining both the housing boom and the finance boom that enabled it. Irrational exuberance indeed.

Expect next year to be one of "corrections" - when debt catches up with borrowers and the price of assets, especially housing, drops. The party is over. Get ready for the hangover.

January 2006 peak? 2006?

In absolute terms, foreclosures are a small number of total households but we are still seeing record levels. And because of the way leverage works (and how banks have levered themselves), $1 of foreclosure loss means the bank has to restore much more than $1 in capital reserves. "Un-winding" is a painful process.

Moreover this graph shows that the only borrowers who are not trending negative are fixed-rate prime. Everyone else is failing to meet their debt obligations. We are also seeing articles that point out this problem is not limited to houses - credit cards and car loans are also increasingly delinquent and consumer loans for things like elective surgery are way down.

This is just the beginning. Expect another 6 months of blue news.

Home Foreclosures Surge to a New High

By SUDEEP REDDY

December 7, 2007

Wall Street Journal

The number of homes starting foreclosure jumped in the third quarter to the highest level since the Mortgage Bankers Association began keeping track in 1972, while the fraction of homeowners behind in their payments rose to the highest level in 21 years.

Both reflect the continuing credit-market turmoil, a slowing economy and falling house prices.

Foreclosures rose for all types of mortgage loans, according to the association's quarterly survey. But the upturn was sharpest for adjustable-rate mortgages, including homeowners with better records who are considered to be in the "prime" loan category.

In a way, I am surprised that this is considered news. It seems totally obvious to me but then again there were a lot of people who tried to argue that the "subprime" problem was teeny tiny, only affecting a few sorry poor people.

Well, it turns out that was not the case. No money down, teaser interest rates and huge interest hikes "someday" proved too hard to pass up for a big cross section of borrowers.

You cannot see it in the stock market at the moment but I am expecting a whole lot of American households who have been living beyond their means to run out of rope in 2008. The poorest folks are an obvious target but I expect to see a lot of families with their kids in private schools who have been living on credit cards and home equity.

Short-term thinking seems to know no bounds in our culture today.

Subprime Debacle Traps Even Very Credit-Worthy

As Housing Boomed, Industry Pushed Loans To a Broader Market

By RICK BROOKS and RUTH SIMON

December 3, 2007

Wall Street Journal

One common assumption about the subprime mortgage crisis is that it revolves around borrowers with sketchy credit who couldn't have bought a home without paying punitively high interest rates. But it turns out that plenty of people with seemingly good credit are also caught in the subprime trap.

An analysis for The Wall Street Journal of more than $2.5 trillion in subprime loans made since 2000 shows that as the number of subprime loans mushroomed, an increasing proportion of them went to people with credit scores high enough to often qualify for conventional loans with far better terms.

In 2005, the peak year of the subprime boom, the study says that borrowers with such credit scores got more than half -- 55% -- of all subprime mortgages that were ultimately packaged into securities for sale to investors, as most subprime loans are. The study by First American LoanPerformance, a San Francisco research firm, says the proportion rose even higher by the end of 2006, to 61%. The figure was just 41% in 2000, according to the study. Even a significant number of borrowers with top-notch credit signed up for expensive subprime loans, the firm's analysis found.

The numbers could have dramatic implications for how banks and U.S. regulators address the meltdown in subprime loans. Major banks, mortgage companies and investment firms have been rocked by billions of dollars in losses as shaky subprime loans -- which typically carry much higher, or rising, rates and other potentially onerous costs -- have increasingly gone into default. Many analysts expect hundreds of thousands more loans could go bad over the next several years. The Bush administration and major financial institutions are working on a plan to freeze interest rates of certain subprime loans in hopes of avoiding an even bigger meltdown.

The surprisingly high number of subprime loans among more credit-worthy borrowers shows how far such mortgages have spread into the economy -- including middle-class and wealthy communities where they once were scarce. They also affirm that thousands of borrowers took out loans -- perhaps foolishly -- with little or no documentation, or no down payment, or without the income to qualify for a conventional loan of the size they wanted.

One key factor in determining what kind of loan a borrower gets is his credit score. Credit scores can run from 300 to 850, and many involved in the business view a credit score of 620 as a historic rough dividing line between borrowers who are unlikely to qualify for a conventional, or prime loan, and those who may be able to. Above that score, borrowers may qualify for a conventional loan if other considerations are in their favor. Above 720, most borrowers would expect to usually qualify for conventional loans, unless they are seeking to spend more than they can afford, or don't want to have to document their income or assets -- or are steered to a subprime product.

But rising home prices, and the growth of an industry of lenders specializing in subprime loans, led to an increase in all kinds of reasons for borrowers with good credit scores to sign up for subprime loans.

"Every single day ... I saw prime borrowers coming through my desk with 660, 680 [and] 720 credit scores," says Thomas Rudden, a former senior account executive at Mercantile Mortgage Co., a now-defunct subprime lender. Some were taking out loans as speculators, he believes, while in other cases he thinks brokers put borrowers into these loans because they thought it was easier.

Many borrowers figured they would refinance in a few years before the rate on their loan moved higher -- but falling home prices and tighter credit standards in the past year have suddenly made that unrealistic in many cases. "Brokers and agents were telling" borrowers with high credit scores for the past several years "that it was OK" to get subprime loans, "and borrowers were wanting to take on more debt," says Mark Carrington, director, analytical sales and support at First American LoanPerformance.

I have been reading a really interesting book this past week, "The Chastening: Inside the Crisis That Rocked the Global Financial System and Humbled the Imf". (Thanks Ben :) One of the fascinating things about history is that the more history you know, the more you see how it repeats.

"The Chastening

The book is about the Asian financial crisis that hit in the 1990's. The "crisis" was the result of years of lax lending practices which created an unstable Jenga tower of finances in many Asian countries. This tower of sticks was upended by the combined actions of governments, central banks, the IMF, World Bank, and currency traders - many of whom were trying desperately to keep the tower standing.

The really fascinating part of the story is how many parallels there are to the US economy today.

Although our banking system is much more mature than the Asian economies, we have a huge bubble of housing and corporate loans that has been created by years of lax lending practices. We also have a huge current account deficit and a gigantic federal debt ($9T) due to excessing government spending since Bush took office. Add in the actions of hedge funds and currency traders and we have a steadily declining national currency (the US$). And of course we also have plenty of greedy insiders, people in denial and a totally clueless population who will probably suffer.

The book is a bit repetitive but the story is compelling. Even when people know the apple is rotten, it still takes a lot to topple the tower until eventually it finally does fall -- hard. Runs on banks, fear and doubt by everyone about the stability of the system and the value of assets. Although things were great here in USA, life was hard for hundreds of millions of people for years after that crash.

For the IMF and World Bank there was a huge debate about the "moral hazard" of bailing out people that made bad decisions or who should have known better. How do you help the truly needy without helping the deadbeats, who are often the countries most wealthy, most educated, and most elite individuals?

Why that is the same question people are asking now about the sub-prime loan mess with the same results: inaction while people disagree about who to help.

Rising Rates to Worsen Subprime Mess

Interest Payments Set To Grow on $362 Billion In Mortgages in 2008

By RUTH SIMON

November 24, 2007

Wall Street Journal

Next year, interest rates are set to rise -- or "reset" -- on $362 billion worth of adjustable-rate subprime mortgages, according to data calculated by Bank of America Corp.

While many accounts portray resetting rates as the big factor behind the surge in home-loan defaults and foreclosures this year, that isn't quite the case. Many of the subprime mortgages that have driven up the default rate went bad in their first year or so, well before their interest rate had a chance to go higher. Some of these mortgages went to speculators who planned to flip their houses, others to borrowers who had stretched too far to make their payments, and still others had some element of fraud.

Now the real crest of the reset wave is coming, and that promises more pain for borrowers, lenders and Wall Street. Already, many subprime lenders, who focused on people with poor credit, have gone bust. Big banks and investors who made subprime loans or bought securities backed by them are reporting billions of dollars in losses.

Besides the $362 billion of subprime ARMs that are scheduled to reset during 2008, $152 billion of other loans with adjustable rates are set to reset, according to Banc of America Securities. The other resetting loans include "jumbo" mortgages of more than $417,000 and Alt-A loans, a category between prime and subprime. The latter category is the riskier, in part because it includes borrowers who provided little or no documentation of their income or assets.

Ms. Bair has proposed that mortgage companies freeze the interest rates on some two million mortgages at the rate before the reset to help borrowers avoid trouble. "Keep it at the starter rate," Ms. Bair said at conference last month. "Convert it into a fixed rate. Make it permanent. And get on with it."

The mortgage industry opposes a blanket move to modify loans that are resetting, says Doug Duncan, chief economist of the Mortgage Bankers Association. While modification may make sense in some cases, he says, it may also simply postpone the inevitable or reward borrowers who didn't manage their finances wisely. Mr. Duncan says the industry is working with government officials and consumer groups to develop principles that could be used to determine quickly who qualifies for a modified loan.

The political efforts are aimed at keeping the U.S. economy out of a housing-triggered recession. The Mortgage Bankers Association estimates that 1.35 million homes will enter the foreclosure process this year and another 1.44 million in 2008, up from 705,000 in 2005.

The projected supply of foreclosed homes is equal to about 45% of existing home sales and could add four months to the supply of existing homes, says Dale Westhoff, a senior managing director at Bear Stearns. This is a "fundamental shift" in the housing supply, says Mr. Westhoff, who believes that home prices will drop further as lenders "mark to market" repossessed homes.

Another fascinating aspect of the current situation is what will happen to the dollar.

We Americans enjoy amazing benefits from the fact that the US$ is the main currency of international trade. If we were anybody else, we would probably be in a massive recession/bailout situation already.

Just like in the Asian crisis, we have a massive current account deficit and have been devaluing the US$. Just as the IMF demaded Asian countries back then, lowering the value of the dollar lowers the costs of our exports while raising the costs of imports. This is designed to lower the amount of money we have to borrow each month because our imports are bigger than our exports.

While the mighty dollar keeps us afloat, there are increasing signs that other countries want to float their currencies because the US$ is dragging them down too. 12% inflation? Will the dollar lose its luster in our lifetime?

Wealthy Nations In Gulf Rethink Peg to Dollar

By JOANNA SLATER and CHIP CUMMINS

November 20, 2007

Wall Street Journal

For many years, oil-rich Persian Gulf states have pegged their currencies to the dollar. Now that link is stoking a bad bout of inflation in their red-hot economies and putting policy makers in a dilemma: Break the dollar peg and risk undermining the U.S. currency, or keep it and face growing local discontent.

The dollar peg has "served the economy...very well in the past," said Sultan Nasser al-Suweidi, the governor of the United Arab Emirates' central bank, last week. "However, we have reached a crossroads."

Because countries such as the UAE, Saudi Arabia and Qatar sit on large reserves of U.S. dollars, their decisions will have repercussions beyond their borders. If they move away from their strict dollar pegs -- perhaps following Kuwait, which earlier this year switched to a basket of currencies -- it could undermine demand for dollars and encourage others to diversify their holdings. Many nations have already created sovereign wealth funds to invest their holdings in a broader array of assets.

The UAE and Qatar have suffered some of the worst inflation, as the oil gusher has triggered a building boom. In Qatar, inflation hit 11.8% last year, and the International Monetary Fund estimates it will average 12% this year. This week, officials in Doha, the capital, raised taxi fares by a third.

Here come the 3Q losses. As expected, the music stopped and there werent enough chairs to go around.

Now we are seeing losses, huge losses. A billion there. $6 Billion here. $11 Billion there. Bear Stearns, CountryWide, Morgan Stanley, Citibank, Wamu...

And most of these loses only go up through September. Expect more for October, November, and December as one of the largest financial bubbles in history slowly recedes.

Heads are rolling as CEO's and others either resign or get fired. But there were so many moving parts in the mortgage-CDO-housing system, it is hard to see all the connections or predict how far the problems go or how big the problem really is.

Some companies are trying their best to hide any losses by postponing their day of reckoning. If they have more time, maybe the market will come back and their assets will regain their value? Please?!

Expect to hear about a lot of schemes to buy time and postpone losses which almost guarantees the problem will drag on and on. At least one company made deals with hedge funds to get their now diminished assets off their books temporarily - if the fund buys their paper now, the company will buy it back in a year at a guaranteed price and return.

In the mean time, expect to see continued price pressure on real estate as foreclosures and bankruptcies continue to climb into next year.

Structured Investment Vehicle. SIV rhymes with HIV except this virus is financial not biological.

You have probably never heard about SIV's before this year but you can expect to hear a lot more about them since they are now at the heart of the question: who will get stuck paying for all the bad mortgages that were collateralized into CDO's.

The first time I had ever heard about off balance sheet investments was when experts tried to explain why Enron imploded. Now we have our largest banks using SIV's and the Department of the Treasury is trying to help them with a super-SIV fund.

Call me old fashion but if my bank has invested millions if not billions of dollars in something in order to make a profit, that thing ought to be on their accounting books. There ought to be a formal record of that investment. The concept of an "off balance sheet" investment should be anathema to a bank.

Then you have the whole mortgage-to-security process that involved SIV's and enabled the cheap money for the housing boom. Seeing the bond rating agencies now restate "AAA" CDO's as, oops!, junk bonds only re-enforces the obvious - the whole process involved a lot of risk. The kind of risk banks should not have been party to.

With all the fuss about sub-prime mortgages and foreclosures, few people take the trouble to mention that these problems are occurring BEFORE the loans reset to higher prices.

This awesome graph shows that the reset of low ARM rates to higher rates is going to be with us for a LONG time, especially over the next two years.

With banks suddenly skittish and tightening their lending standards (you know, asking for silly things like proof of income), one has to wonder how many of these folks will be able to a) pay their ARM or b) find a new mortgage.

Adjustable Rate Mortgage Reset Schedule

With all the chatter about sub-prime borrowers in over their heads, I have been arguing that the problem is far from limited to the poor and uneducated. I see a lot of brand new luxury cars and people buying homes from $700K to $1M and I just cannot believe the income levels are there to sustain all that. But the social pressure is there and when your neighbor gets one, you need one too (and feel like you deserve one). Emotions drive bad decisions and the lending markets have been there to feed the addiction.

This is the very first article I have seen that supports my theory. It is easy to get into a debt problems, it is easy to spend at an unsustainable rate, and people will do anything to keep the music going. Like drug addicts, I expect people to drain their savings, spend their retirement money and sell their assets, do anything they can, to keep up appearances.

The problem will be hard to see but like any unsustainable system, it will come to a halt eventually. And that time is most likely to be a very unhappy retirement when millions of Americans find themselves facing poverty at the age of 70.

And yes, this is all tied to housing and the exploding prices of SFH this past 5 years.

Even the Seemingly Well-Off Caught Easy-Borrowing Virus

By HERB GREENBERG

April 14, 2007

Wall Street Journal

You may have seen that LendingTree commercial with a happy-go-lucky guy named Stanley Johnson, who brags about his big house, his new car and how "I even belong to the local golf club. How do I do it?" he continues with a big, dumb smile, "I'm in debt up to my eyeballs." Lowering his voice, but still smiling, he adds, "I can barely pay my finance charges." The smile doesn't leave his face as he drives a riding lawn mower, saying, "Somebody help me."

Thanks to easy credit, many Americans have been living well beyond their means. But that credit picture is beginning to change. And when you think about where the U.S. economy might be a quarter or two from now, you have to wonder how many Stanley Johnsons are out there. This isn't the stereotypical subprime borrower, with a spotty credit history and low credit score, but instead people perceived by friends and neighbors to be living the good life, some even sporting good credit scores.

For a preview, all you really need to do is check with someone like R. Douglas Ley, a certified public accountant and certified financial planner in Macungie, Pa. Many of his clients live in a wealthy part of New Jersey. Few get a closer peek into what is really going on than people like Mr. Ley, who do taxes. As I recently quoted him in a MarketWatch column as saying, "I am shocked by the bad and deteriorating financial condition of many of my clients."

He wasn't referring simply to the "careless tapping" of home-equity loans as though they were ATMs with a bottomless pit or the extensive use of credit cards while paying only the minimum payment. More disturbing, he says, is how some clients have perilously little in taxes withheld by their employers but then wind up with a sharply higher tax hit at year-end because they have resorted to tapping their 401(k)s or individual retirement accounts for living expenses. Such moves trigger a 10% tax penalty for early withdrawal. "Two of my clients had to sell their homes last spring to cover their 2005 liabilities, some big numbers. These clients had adjusted gross incomes in excess of $200,000. At least they were lucky because the housing market was firmer a year ago," he says.

I have a huge pile of housing articles from the past three months. Instead of blogging all of them, I thought I would write a summary of the picture I am seeing. A picture that is becoming more and more clear each day as major lenders like New Century Financial file for bankruptcy and details about the "rise" become more clear.

The housing market is unravelling because the two reasons the market boomed in the first place are unravelling: unwise consumer spending and a bottomless supply of cheap loans. Both of these factors were unsound, and most importantly unsustainable, reasons for a housing boom.

Consumers

How much home can you afford?

How much is that home worth?

In order to make sound decisions, consumers need to have some basic financial training and they need to be willing to say no when they reach their limits. Unfortunately, public schools do not teach any financial training so most people make housing (and other investment decisions) based on emotion. Two particularly strong emotions today: "I deserve it", "Real estate is always a safe investment!", are particularly troublesome. These two emotions are hard to resist and they lead to very bad decisions.

What most people dont know is that the best way to value a house is to look at rent. What would someone pay to rent this condo or house? If comparable properties are renting for $1,700/mo and the mortgage alone is $2,000/mo, the home is overpriced. You need to say no.

But saying no is hard to do. Especially when lenders are waving money in your face and realtors are telling you that you deserve it and that you can find a loan to get it.

For many consumers, the answer to how much a home is worth is how much they can possibly borrow. And the answer to how much they can afford is whether they can make those interest-only ARM payments or whether they can cash out more home equity.

With the boom, there was a huge rush into real estate jobs. With a slowdown, there is now a movement out of real estate jobs. The notable thing here is that even realtors themselves are admitting there are too many people in the field and it would be better for everyone if say 1 out of 5 of them quit. Dont hear comments like that everyday, do you Detroit?

Amid Slump, Real-Estate Agents Hang Up Their Blazers

Housing Downturn Leads To an Industry Shakeout; Seeking Alternative Careers

By JAMES R. HAGERTY and ANJALI ATHAVALEY

February 7, 2007

Wall Street Journal

When David Lereah, chief economist of the National Association of Realtors, addressed the group's convention in New Orleans in November, he got one of the biggest bursts of applause by predicting there would be fewer Realtors around in a year. Mr. Lereah said in an interview that he expects membership in the trade group to decrease by about 6% to 8% from the record of nearly 1.4 million reached in 2006.

The culling of agent ranks is a reaction to the downturn in housing that started around mid-2005. Sales of previously occupied homes last year declined 8% to 5.7 million, even as the number of agents continued to increase for the year as a whole.

Even before sales slowed, people in the industry said far too many agents were chasing too few deals. If hordes of inexperienced agents are scrapping for business, says Christopher Galler, a senior vice president of the Minnesota Association of Realtors, that can only lead to "a race to the bottom in fees."

More competition on commissions could strike many consumers as a good idea. Mr. Galler argues the result would be poor service. He says more productive agents, who complete 20 or more transactions per year, are better at solving problems than those who do only a few deals annually.

One of the fundamental flaws in the current real estate process is the way financial incentives are structured.

In a typical home sale, they buyer and the seller each retain a real estate agent r represent them and their interests. The buyer pays the seller a sale price. The seller then pays 6% of that price to the realtors. The buyer's realtor gets 3% and the seller's realtor gets the other 3%. That 3% is then split between the realtor and the broker that employes them.

Brokers are very vocal about protecting that magic 6% commission but they rarely point out that both realtors are financially incented to agree on a higher sales price. The higher the sale price, the more they get paid.

On one hand this makes some sense since the seller is paying all of the realtor fees. The realtors essentially reward the seller with a higher price and they get a better fee in the process.

Forgetting for a moment about how much or how little realtors do to make the sale and their oath to fairly represent their client, the deck is stacked for higher prices. There is little incentive for a buyer's agent to fight hard for a lower price and that is the rub.

In 2006, there was growing concern about both the fixed 6% commission and the anti-competitive behavior used against discount brokers (ones who charge less than 6%). But there is a lot of money on the table and some real estate transactions really are simple which means there are sharks in the water looking for change.

Redfin is one of those sharks who is pushing a business model redeux. Can Internet companies change the housing business the way Amazon changed the retail business?

Remember when real estate fans assuaged your fears about escalating home prices? Dont worry, they said. Real estate is local; there has never been a national housing slump.

Well we arent quite there yet but we are back in record-setting territory again. This time a record drop. For the first time ever, more than half of the 150 cities measured reported a price drop and we arent just talking about California or Florida either.

Never say never. And keep watching sub-prime mortgage defaults.

If mortgage insurance is designed to protect lenders from borrowers who have no equity at risk in the property, doesn't this piggy-back loan defeat the purpose of mortgage insurance in the first place? Why do lenders allow it?

It still seems to me that a lot of people are taking on an unbearable amount of risk - and banks are helping them do it. I wonder who will pick up the tab if (when?) things go south...

Uhh, these are THE rules not new ones. When you invest in a property, it must make a monthly profit - every one. That is called "cash flow positive" and the fact that people have totally lost site of this basic principle is why housing is so overpriced today and why the future looks bleak for a lot of investors.

The end of 2006 brings a few articles that reflect the changing view of housing investments

Real estate is already a poorly regulated industry with very low requirements for becoming a real estate agent. As a result, the quality of realtors varies considerably.

As housing boomed, thousands of people rushed out to become realtors. As housing now slows, the financial incentives and lack of regulation promise to create some very severe conflicts of interests, which may ultimately hurt the credibility of all realtors.

As ever, caveat emptor. The safest course when buying is to find the property yourself and hire an attorney to complete the transaction.

Keeping up with the Jones' is never easy but consumer spending (fueled by home equity debt) has been on a tear for several years. History tells us there are natural market cycles but most people would prefer the booms over the busts.

How long can the spending spree continue though?

If housing sales slow, so does the revenue banks get from loans. The slumping housing market is gonna hurt a lot of banks (ie bank stocks) and they are reacting.

A year ago, all the housing articles were about rising home prices and how the boom could not be stopped. The dotcom mantra "Better get in now before its too late!" was recycled and used everywhere.

Today the articles are about slowing sales and the lengths lenders and builders are going to to keep people buying. Think Carl Rove, insisting that Republicans would maintain their control of the House and Senate. There are natural cycles to things and its hard to hold them back.

Still just a trickle but get ready for "unusual".

The biggest housing boom in history has a number of enabling factors affecting lenders and borrowers. Low interest rates, fewer credit checks for lending, and lots of media reports on the housing gold rush are only a few.

One of the many signs that things are out of whack is the pressure on appraisers to keep raising appraisals - whether they are warranted or not. Expect more stories of how inflated appraisals allowed people to get credit that they could not afford and dont have the collateral to pay off, even in bankruptcy.

A month ago "economists" were predicting housing prices would flatten. Here comes a report from Moody's that predicts 10% drops over the next few years, and back-to-back reports that people are spending an increasing amount of their household budget on housing at a time when household incomes are not rising.

People are focused too much on their house and too little on their retirement savings. Eventually the cost of housing is going to catch up them. My guess is that the drops will be even larger because the numbers dont reflect the drops that have already occurred due to "incentives". Especially if the cost of borrowing increases.

Three articles on the banking side of the housing market.

In short, sub-prime lenders are starting to see problems at a time when real estate holdings represent their highest percentage of bank holdings in 30 years, and the Fed Chairman is unsure how the market will correct itself.

This is a great article with more evidence that our economy IS real estate.

But dont worry. It's never been a problem before...

When things are looking grim, people always bring up the argument that it "never happened before." What they fail to say is that the world isnt like it was "before" and that the system involved today is very different than it was in the past. This is as true for global warming as it is for housing prices.

When in doubt, follow the money. The lending industry has changed dramatically in the past decade so there is some real question about the rewards, risks, and motivations of the current system. Does our current system really protect itself from bad loans? If not, who is going to pay for those loans when people cant pay them anymore?

This is the first article I have seen that asked this critical question. Although the numbers are small now, this is a big issue and it may take years to find the answer.

Here are a few housing articles from back in September. At the time, analysts were predicting flat to slight declines....

Then again, is seems like analysts always have a positive bias. I guess no one wants to predict bad news even though we acknowledge that there are regular business cycles. I guess we only see them in hindsight.

So you dont think there will be many mortage defaults in the next few years? People need a home, right?

This another of those "ten kinds of wrong" articles and it raises several questions for me.

One thing to keep in mind regarding housing prices is that there is a LOT of pressure to keep prices from dropping. While that pressure cannot stop price changes, it can distort price statistics. And it does.

In the past three weeks, there has been a raft of articles on changes in the housing market. There doesnt seem to be any question now of whether there will be a correction. The questions now are about what shape it will take. Will it be a soft landing? Will it be a hard landing? Will it happen here? Or there?

For a long time it was unfashionable, possibly even rude, to suggest hat housing prices were rising too quickly and would have to come back down to match fundamentals like population and personal income. Counter-arguments often took the tact of quoting history. "Prices in Seattle have never dropped before", therefore, they wont drop now.

What I have noticed however is that these "historians" never quote the past when prices are going up. They don't say, "prices have never risen 10%, 15%, 20% year after year, therefore they wont rise that much this year." Historical price changes are cherry-picked and only brought out to argue that prices wont drop back down. There is an emotional appeal to this strategy but it certainly isnt logical.

If historical prices didnt predict the meteoric rise, what makes them evidence that there wont be an equally historic fall?

History is a guide but it is not a rule. The only rule of history is that things change and all investments move in cycles. Investments involve math, and complex legal systems, and money but most of all they involve humans and human emotion. And humans are fickle creatures indeed.

Several articles on the housing market came out in the last week of August.

Articles at the end of July indicate that the long-awaited reversal to the housing market has begun.

Well now this is an interesting graph that came from my most recent Market Outlook email from Charles Schwab.

The article is a good read albeit not terribly uplifting. They are referring to stocks but I think one line sums it up best:

Our advice to clients can be summed up in a single word: caution.

Strike a blow for the consumer and free the real estate data from its MLS monopoly!

This FTC action is a positive sign for consumers who want to see some competition in the real estate industry and hopefully some lower costs. The MLS exercises a monopoly on property listings which prevents competition and helps maintain high commissions. It is high time we see some data-competition and good to see that the government is taking some action.

A few articles on bank loans for housing and businesses. Are banks wisely handling their funds or is there a lot of risk out there?

Speaking of risky collateralized-loans, I just refinanced my student loan debt... Watch out!

A few articles on bank loans for housing and businesses. Are banks wisely handling their funds or is there a lot of risk out there?

Speaking of risky collateralized-loans, I just refinanced my student loan debt... Watch out!

There are so many websites out there, I sometimes wonder how any of them can make money. But in this case, I hope they are successful at pushing some cost cuts through the real estate industry. That industry is long overdue for some consumer-friendly changes, especially in fees and the structure of the MLS system.

Angela and I spent the weekend looking at housing options here in Seattle. Sadly there is little sign of a slowdown here yet and renting is still considerably cheaper than buying. We also found a TON of new homes and condos for sale, and some of the new luxury condo buildings had converted to apartments.

This article caught my eye because we left California due to the cost of real estate. And half the people we have met in Seattle are from California. We've even met people up here who were neighbors of ours down there in 2001.

Personal anecdotes aside, Im curious when/if the high cost of housing will have a negative impact on the economy. Zooming house prices are great if you already own one but how long will you put up with them if you dont?

Off-shoring hasnt slowed at all and I have noticed that Google and Yahoo are building their fancy new operation centers in the middle of nowhere, ie eastern Oregon and Washington, because it's cheap.

Given supply and demand, if people are leaving then the prices ought to start dropping...

The articles in the paper used to be all about how prices kept going up up up.

Now they are about the cooling off.

This is a good article with a terrific graphic. I love graphics :)

I suppose it shouldn't be a surprise but it appears that a lot of home owners do not understand the terms of their mortgages or what could happen to them. It is sad but I think this means that there are a number of people who are going to get into trouble when rates go up again.

It is also understandable since there isnt anyone out there to educate consumers; everyone you are likely to interact with when buying a house makes money from your purchase. There is not much money to be made in restraint.

This data is from 2001 and the number of people with ARMs is almost 3x higher than it was then.

I have a few friends who have struck out on careers in real estate. I wish them the best but I fear they picked a tough time to enter the industry.

The fixed-commission system is archaic and going to come under increasing pressure from substitutes and regulators. Then there is the supply and demand of the number of realtors. When the housing market cools, times will get very tough for the newbies. And what isn't mentioned in this article is that many realtors work part-time for extra income. They can outlast a market decline in ways that people who depend on the income cannot.

If you are considering a career in real estate, you should give this article a read.

March brings two articles on problems in the housing market. Sales are dropping, inventories are rising but prices are more sticky.

Two articles from February presage a peak in the single family housing market. For a while now, talk has shifted from whether there will be a "slowdown" to what shape it will take, gradual or sudden.

It's no secret that I think the cost of housing has risen too high and will have to come back down.

One of the biggest factors that I look at is the number of people who have purchased property they cannot afford, either as their own home or as an investment property. Borrowing has been so cheap and lending practices have been so lax, it seems like a given that there are a lot of bad loans out there. As the cost of borrowing rises, I expect to see a lot of people who cannot make their payments and who will need to make changes.

I could be wrong and the process has been much slower than I expected. But we are starting to see the signs... One household in eight? *ouch* This is a scary article.

Net worth is rising (due to housing not savings). Long-term bonds are rising (which raises the cost of borrowing). Job growth is strong (although no numbers here on salaries which I think are still flat).

Money is still cheap but the number that I would look at is the rise of consumer debt.

We all know that home prices have been rising but is that price rise causing any changes to the underlying housing market?

When you look at family housing, we see a cycle. Entry level couples and individuals buy 'starter homes'. After they're income rises and they build equity, they are able to sell their existing home and buy a larger home. Home owners thus need new buyers so that they can sell their own homes and move up. If something stops this cycle, everyone suffers.

As home prices have risen, the first question to ask is whether first time buyers are still able to afford those starter homes and begin the process? The second question is where these $200k homes are? :)

Previously I wrote about my theory that there is a big pile of cash flowing around the world looking for investments and pushing up prices to levels seen in California or New York.

Based on this article from February, others see the same thing.

I continue to find people who believe their house is their "best investment". If you are one of those people, this post is for you.

Assets, Liabilities and Ownership

This post is about investments but the definition of an investment is closely tied to the idea of an asset.

Im sure you have heard these terms before. An asset is something you own that is worth money. A liability is money you owe to someone else. The difference between the two (assets - liabilities) is what you actually "own". (It is also called net worth.)

I haven't been writing (or thinking) much about real estate lately. This weekend I had some friends over to share my favorite past-time (watching MSU win games) and we got into a discussion about real estate and whether my wife and I will move soon.

The answer is yes: We will move but into a rental not a purchase.

I think the big gains in real estate are over. If you didn't get in already, it is too late. Buying a property now is akin to buying Microsoft stock during the dot-com boom in 2000. Instead of buying property, it makes more sense to rent and invest your housing money in the stock market. It make take 5 more years but the housing market will run out of steam and a few years after that, it will be time to buy property again.

At least that is my take on things. Buy low, sell high and all that stuff.

An article in the local paper today suggests that home prices in Seattle (although they define "Seattle" as the area from Tacoma to Everett which is huge) could increase up to 40% over the next two years. The numbers come from a PhD (wahhahaooo!) and confirm what my friends seem to think: real estate never goes down.

Are area housing prices getting ready to pop?

By Elizabeth Rhodes Seattle Times staff reporter

Feb 18, 2006

While recent real-estate buzz has centered on a slowing home-sales market — with some doomsayers even questioning whether greater Seattle's high prices are ripe for a fall — Lawrence Yun has crunched several economic numbers and come to a startlingly different conclusion:

Median home prices could shoot up 30 to 40 percent over the next two years.

I dont have a PhD, but I have been accused of having common sense so here is my argument against these rosy predictions:

The process for purchasing/selling property in this country is ripe for advancement. A lot of people are making a lot of money for doing very little, thanks to "tradition," proprietary data, and vested interests. Here is an interesting website that attempts some minor change.

Getting Wise to Mortgages

New Tools Help Decode Jargon, Sniff Out Deals;

Avoiding the Camel Market

By JAMES R. HAGERTY and RUTH SIMON Staff Reporters of THE WALL STREET JOURNAL

February 4, 2006

A few entrepreneurs are developing new tools to help home buyers tackle one of the most confusing projects they face: figuring out whether a mortgage is a fair deal.

The problem for borrowers is that lenders have a vested interest in making it tough to compare rival offerings.

"The general public, they think they know how to shop for mortgages," says Mike Stoffer, who owns a mortgage brokerage in North Canton, Ohio. "They have no clue."

Some entrepreneurs are stepping in to give consumers some added muscle. One of the quirkiest tools available is a Web site, www.mtgprofessor.com1, by a maverick retired finance professor who has made a hobby of skewering mortgage lenders. The site is a compilation of tutorials, calculators and a glossary defining everything from "balloon mortgage" (one that is payable in full at an early date) to "right of recission" (your right to back out of a refinancing within three days of closing).

It also has some tart words for rogue lenders from Jack M. Guttentag, the Wharton professor emeritus behind the site. Example: In one passage, he compares parts of the mortgage market with a camel bazaar -- except that the chances of being fleeced by a camel dealer are smaller.

...

In many cases, lending officers or mortgage brokers get more compensation if they persuade you to take a loan with a higher rate or fees. Like any savvy salesperson, they can spot customers who are naive or disinclined to shop around and jack up their profit margins accordingly. James Nabors II, president of the National Association of Mortgage Brokers, says that mortgage brokers have "an ethical responsibility" to treat all customers equally and fairly and make sure they understand the loan they are getting into. Mr. Guttentag examined 774 loans a few years ago and found that two-thirds involved overcharges, rates above the best rate available on the lender's internal daily pricing sheet.

...

For individuals willing to do more research and punch their personal data into a computer, it often makes sense to deal directly with online lenders rather than brokers or bank branches, particularly if you aren't looking for something exotic, Mr. Guttentag says. That is partly because online lenders can eliminate certain costs, such as commissions, by reaching customers through the Internet, and then pass some of those savings on to borrowers.

Many people will never have the time to even begin figuring out all the tricks of the mortgage trade. That is why Mr. Lazerson, who owns a mortgage brokerage in Laguna Niguel, Calif., says he plans to introduce later this year software designed to enable some consumers to type in their financial details and then get firm offers from several lenders, without revealing their name, address or Social Security number. One advantage is that consumers aren't then flooded with unwanted marketing material.

First it was an issue of whether the yield-curves would invert. Now its a question of how much they invert. Is this the end of the era of cheap money?

Regardless, here is a good article that explains the issues involved with bonds in plain english. Worth a read.

Yields on Bonds Invert, Reflecting
Unease About Economy's Future

By MARK WHITEHOUSE Staff Reporter of THE WALL STREET JOURNAL

December 28, 2005

The nation's bond market interrupted the holiday season with a downbeat message yesterday: Many investors expect the economy to hit tougher times within the next year or so.

That pronouncement came in the form of long-term interest rates dropping below short-term rates, a trend that often -- but not always -- precedes an economic downturn. The development is known as an inversion, because it flips the traditionally upward-sloping shape of bond yields plotted on a graph. The yield curve typically rises because longer-term debt usually pays higher interest rates to compensate investors for the greater risk they incur waiting for repayment.

Inversions can squeeze or even eliminate profit margins for banks, hedge funds and any other financial business that borrows money at short-term rates and lends it at long-term rates. "This is a warning signal...that we are on recession watch now," says Paul Kasriel, chief economist at Northern Trust Co. in Chicago. The inversion, however, so far is minor, he says. And some economists believe an inversion isn't as reliable a predictor as it once was.

Bonds make fixed interest and principal payments to investors, but their yield depends on what the market is willing to pay for the bonds on any given day. In deciding what yield -- or return -- to demand on bonds, investors consider various factors, including their expectations for future short-term interest rates and the bond's duration.

Investors, for example, usually demand more yield from governments and companies to tie up their money in longer-term bonds. When they are willing to accept a lower yield, that means they are persuaded that the Fed, which most expect to raise short-term rates to 4.5% or higher early next year, will soon have to bring those rates back down to mitigate, or ward off, a recession. Yield-curve inversions have preceded all of the last six recessions, but have also sounded two false alarms, the most recent in 1998.

The housing market is the most likely trigger for an economic slowdown and Fed reversal. As the Fed raises rates, monthly payments on adjustable-rate home loans go up, cooling demand for houses and leaving homeowners with less money to spend on all the other things companies want to sell them. Second, as house prices stall, homeowners aren't able to borrow as much against the value of their homes -- a source of cash that has added hundreds of billions of dollars to consumers' spending power in recent years.

"What the Fed is going to do is shut down the ATM machine known as the housing market," says Tad Rivelle, chief investment officer at Metropolitan West Asset Management in Los Angeles.

Same old housing news at years end. Whether we are in a bubble or not seems to depend on how much you have invested in the bubble. :) The final quote about saving money by renting says a lot to me about prices today.

Affordability is important for everyone because housing is a cycle dependent on buying-in and upgrading. If people cannot buy in, that virtuous cycle stops.

Stay tuned for next year when we get to see the start of Greenspan's asset-spending legacy.

Housing Affordability
Hits 14-Year Low

Higher Prices, Rising Rates Hurt Buyers as Creative Loans Lose Some of Their Punch

By RUTH SIMON Staff Reporter of THE WALL STREET JOURNAL

December 22, 2005

Soaring house prices and higher mortgage rates have put homeownership out of reach for more people than at any time in more than a decade.

Housing affordability in October sank to its lowest levels since 1991, according to the National Association of Realtors' Affordability Index, a widely followed measure of the average household's ability to buy a home at current interest rates. In some areas, including New York City, Los Angeles, San Diego, San Francisco and Miami, housing affordability has dropped to levels not seen since the early to mid-1980s, according to mortgage giant Fannie Mae.

Affordability has long been a problem for low-income home buyers. But as home prices have marched steadily higher in recent years, many buyers with healthier incomes also are being squeezed. Declining affordability mainly affects whether first-time home buyers will enter the market, but in some markets people who already own a home are finding it tough to trade up.

Despite the drop in affordability, the percentage of households that live in a home they own is at near-record levels. Mortgage rates, though edging higher, are still relatively low by historical standards. And lenders have helped to offset declines in home affordability with creative mortgage products, such as interest-only loans, that allow borrowers to stretch into a more expensive home, while keeping their monthly payments down. But rising short-term interest rates are eroding the effectiveness of many such mortgages.

In 57 of 379 metro areas nationwide, homes were so expensive in the third quarter that a family earning the median income couldn't afford the median-priced home based on traditional lending standards, according to Moody's Economy.com. Sixteen markets have joined the ranks of unaffordable areas over the past year, according to the analysis.

...

And renting remains a bargain in many parts of the country. Stephan Vrudny, an engineer who lives in San Diego, sold his three-bedroom condo to an investor in June for $405,000, then rented it back for $1,500 a month. Mr. Vrudny figures the arrangement is saving him $430 a month, even after taking into account the lost mortgage-interest deduction. "We'll be homeowners again when it makes sense again as an investment," says Mr. Vrudny, who had purchased the unit for $345,000 last year.

Selling their own company stock? For shame.

A Housing Slowdown? 
Not if You Ask Builders

Sales Soften as Inventories Rise, And Critics See Stock Prices Behind Added New Construction

By KEMBA J. DUNHAM Staff Reporter of THE WALL STREET JOURNAL

December 22, 2005

Everyone has heard the housing market is showing signs of slowing. But the companies that build homes aren't going to let popular wisdom gum up their works -- or their stocks -- if they can help it.

New-home construction rose 5.3% in November from the previous month, the largest monthly increase in housing starts since April and far above the level economists and analysts were expecting. The pace of applications filed by builders for future construction also picked up last month.

Traffic is down at new-home communities around the country. Real-estate agents are taking longer to sell homes, and homeowners in some areas have had to cut prices to trade out of their patch of the American Dream. Meanwhile, the number of unsold new homes under construction is at an all-time high.

Executives at some of the biggest publicly traded home-building companies say they're on top of their game and are managing their projects and landholdings in a way that won't leave them or shareholders exposed. Yet some of these same executives, including those at Toll Brothers Inc., have been net sellers of their companies' stocks this year, even as they cite the health of their industry. The Dow Jones U.S. Home Construction stock index is up nearly 17% on the year, although many builders' stocks are well off levels seen this summer.

Investors start to move. Will it be an organized retreat or will it become a stampede?

Investors Retreat
From Housing Market

Inventories Rise as Speculative Buying Slows In Once-Hot Markets Like Phoenix and San Diego

By RUTH SIMON Staff Reporter of THE WALL STREET JOURNAL

December 7, 2005

Individuals are pulling back from buying homes and condos as an investment, in a move that could accelerate the cooling of the housing market.

In markets such as Las Vegas, Miami, Phoenix, San Diego and Washington, D.C., where investor activity had been heated, fewer people are competing to buy properties as an investment, real-estate brokers and housing analysts say. Some investor-owned properties are returning to the market for sale. With the pace of price appreciation slowing, some investors who were betting on quick profits are instead being squeezed.

 

The apparent pullback by investors is recent and is just beginning to show up in national data. Evidence of the development can also be seen in a number of markets that had until recently been a hotbed of investor activity. As speculators withdraw from the market in San Diego, for instance, the number of investors buying property has fallen by nearly half, estimates Russ Valone, president of MarketPointe Realty Advisors, which tracks the San Diego housing market.

It's too early to tell just how a pullback by investors will affect the broader housing market, but their impact on the housing boom has been considerable. Investors accounted for 9.6% of mortgages used to purchase homes in the first nine months of this year, the most recent data available, up from 6.7% in 2002, according to LoanPerformance, a unit of First American Corp. But the investor share began to drop in the third quarter, the firm says. The figures don't include second homes that may also provide rental income and serve as an investment.

A softening in investor demand is likely to accentuate any slowdown in home sales, says David Berson, chief economist at mortgage giant Fannie Mae. He estimates that home sales will fall 10.4% over the next two years, largely because of a decline in investor and second-home purchases. Mr. Berson also figures that without the recent surge in these purchases, home sales would have been 7.3% lower in each of the past two years. That estimate assumes that investment properties and second homes account for 10% of total sales.

This article is an interesting read because it describes the market structure for the big home builders.

How Big U.S. Home Builders
Plan to Ride Out a Downturn

D.R. Horton Keeps Costs Low As It Takes On Small Rivals In 'Pickup-Truck' Markets

Skepticism on Wall Street

By JAMES R. HAGERTY and KEMBA J. DUNHAM Staff Reporters of THE WALL STREET JOURNAL

November 30, 2005

"We can earn our way through any economic cycle, except one like the Great Depression," says Mr. Tomnitz, a former banker and Army captain who has served as D.R. Horton's CEO since 1998, six years after the company went public.

Apartments and single family homes are counter-cyclical: When people buy a house, they leave their apartment; When people lose or sell their house, they move back to an apartment.

Looking at apartment rents and vacancies is another housing indicator to watch.

Rents Rise, Vacancies Drop
As Apartments Join the Boom

By MICHAEL CORKERY Staff Reporter of THE WALL STREET JOURNAL

November 30, 2005

The real estate boom has been very good to property owners of all types. But apartment landlords have largely missed the party as low interest rates and the prospect of rising home prices turned thousands of would-be renters into buyers.

Vacant apartments often stayed empty until the landlord lowered the rent. "In some cases we were giving away $50 to $100 in [monthly] rent to keep people coming in the door," says Warren Rose, whose family business owns 52,000 apartments in mostly small cities around the country.

Mr. Toomey expects even more prospective renters because of higher interest rates and rising home prices. He says that last year, 25% to 30% of the people who moved out of his apartments bought homes. In the third quarter this year, that number has decreased to 15%.

Not housing directly but it does show the link between our current prosperity and home prices. Greenspan has talked a little about this issue. If spending money comes from assets/loans and not from salaries/cash, it's a big deal if those assets take a hit. It's a big deal...

Real-Estate Boom Soon May Sputter
As an Engine of Retail Sales

By RAFAEL GERENA-MORALES Staff Reporter of THE WALL STREET JOURNAL

November 28, 2005

Leading the worrywarts are economists at Goldman Sachs Group Inc. For several years, they have been closely watching what the firm dubs MEW, which stands for mortgage-equity withdrawal. It is the cash people extract from their homes by drawing on home-equity loans, "cash out" mortgage refinancing, or capital-gains earnings from real-estate sales.

Federal Reserve Chairman Alan Greenspan co-wrote a study in September that estimated Americans withdrew $600 billion in equity from their homes in 2004, or 7% of their disposable income. While economists at Goldman and the Fed came to similar conclusions in their studies, there were a few differences. Goldman estimates that consumers spend about 68% of the cash they extract through home-equity loans and refinancing and use most of the rest to pay down credit-card debt or invest. The Fed's 2003 report estimated that consumers spend about 51% of the cash they extract.

In other words, Goldman believes that consumer spending is even more closely tied to home equity than does the Fed. If Goldman is correct, that means the housing slowdown will have a bigger negative impact on spending and the economy than commonly thought.

Jan Hatzius, a Goldman Sachs economist, estimates Americans will withdraw $834 billion from residential real estate this year. That will fall next year, he says, to $758 billion and to $645 billion in 2007. "As households' cash flow goes down," Mr. Hatzius says, "spending weakens." That, in turn, will reduce economic growth.

Cracks in the Foundation




By JUSTIN LAHART

November 29, 2005

The question is no longer whether housing is slowing, but how severe the slowdown is going to be.

Virtually every major report on the U.S. housing market that has come out in the past month, including yesterday's tally of October existing-home sales from the National Association of Realtors, has come in below economists' expectations.

Even if the dismal scientists get today's report on new-home sales from the Commerce Department right, it will hardly be cheering. Economists polled by Dow Jones Newswires and CNBC reckon that sales came in at an annual rate of 1,218,000 last month, down from 1,222,000 in September and a far cry from July's 1,354,000.

The details of the report will be most revealing. In September, the number of new homes on the market was 20% higher than the year before. If the supply of new homes continues to climb, and sales continue to cool, what had been a sellers' market could turn into a buyers' one.

One mark of a buyers' market is price reductions. In September, the median price of a new home came to $215,700 -- just $4,100 higher than the year-earlier figure. New-home prices last month may come in below the October 2004 mark.

Still, a steep price decline is unlikely. Home builders, like sellers in general, will be slow to lower prices, opting instead to hold on to inventory in hopes of an eventual buyer. Lehman Brothers economists point out that, even when overheated regional real-estate markets run cold, like Los Angeles did in the early 1990s, the price declines play out over years rather than months.

Given that dynamic, 2006 is likely to be a year full of tedious debate over whether housing will have a soft landing or a hard one. Consider yourself warned.

The other subject of (tedious) debate will center on how dependent U.S. consumers are on the housing market. Homeowners have extracted a massive amount of equity from their homes in recent years, and the usual rule of thumb is that half this money eventually will get spent on consumer goods and residential investment.

The key word is "eventually." Even as housing prices decline, homeowners will still have cash left over from refinancings and such to spend. It will be a long time before we know whether consumer spending has dodged the real-estate bullet.

Three articles on changes for lenders and loans.

Three articles this week on the housing bubble. The first article talks about one of the contributing factors to the bubble; the other two articles talk about changes stemming from higher interest rates.

With retirement on the horizon, it appears that Alan Greenspan has found time to put down the Aynn Rand and pick up the newspaper. "Eureka! Consumers are going into greater debt by borrowing against their homes to make disposable purchases. Not only that but the rise of housing prices which is enabling this spending spree is creating unsustainably high housing prices."

Anyone who has been reading the newspapers and looking at houses could have told him that. Interestingly Allan has been studying this issue since 1999 and only now, with retirement in sight, is he bothering to talk about it like its a problem. A huge problem, largely enabled by loose money in the banking system that the Fed (and Alan) is supposed to monitor and control...

Better late than never, i guess.

Very good article summarizing the pro/con arguments about housing.

One very important issue raised is the validity of the numbers in the first place. What we measure isn't always what people think we measure or what we imply we measure.

When trying to understand any system, one must ask what the motivation is for each of the parties. Parties generally do not do things hurt themselves, unless the immediate pressures are greater than the fear long term consequences.

Here is an article that illustrates why banks would contribute to a housing bubble. What a surprise, the answer is money.

Tulips aren't the only previous example of irrational exuberance.

Gosh, Greenspan warned about the irrational exuberance of the tech bubble 4 YEARS before it burst. This year he is talking about a housing bubble, dare i say, froth...