Sunday, October 22, 2006

Schadenfreude - It's the Word du Jour or What's For Dinner

With the dramatic decreases in the year-over-year percentage number of sales, all time lows in market activity, realtors (like Lereah) essentially begging sellers to lower prices so as to get transactions moving again, a proliferation of 'for sale' signs in this normally slow part of the season, one must wonder if we are starting to see a classic "seizing up" in real estate markets:
Unlike stock market bubbles, real estate bubbles don't pop. Collapsing stock market bubbles are characterized by a sudden collapse in prices because stock markets are highly liquid. You see huge volumes of transactions at ever lower prices during a stock market collapse. Collapsing housing bubbles, on the other hand, are characterized by illiquidity, a sudden collapse in transactions. Buyers and sellers seem to disappear. The reason is a reversal in the psychology of buyers that developed at the top of a speculative housing market. Buyers had been buying at prices they knew were too high but on the assumption that they'd be able to sell if they needed to. The thought was: "Ok, maybe it's overpriced, but at least I'll be able to sell it later for at least what I paid for it, but likely more." What happens on the way down is that houses go on the market and just about NO ONE shows up to look. That's because buyers weren't buying earlier primarily because they needed a place to live, but because they thought the price would likely rise and that, in any case, they'd be able to get out when they wanted with all of their money or more. On the way down, neither condition is true. So buyers stay home, so to speak.

But can't buyers be enticed by declining prices, by bargain hunting, you ask? No. Once housing sale transactions suddenly fall from, say, several hundred a month in a large community to, say, one or two a month, this creates fear and loathing about prices. Long periods of time pass when there are no transactions at all. Think of it this way. What's the comparable on your 3000 square foot home in San Mateo when the last sale was, say, seven months ago? Is it 10% less than the last sale of a similar home on the area? 30% less? This happened in Japan, and prices nationally are still more than 60% below peak prices in 1992, where real estate prices continued to climb for several years after their stock market bubble popped. Sound familiar?
Q: What happens when you can no longer reduce your asking price without going "under water"?

A: You just decide to sit on it for an unknowable length of time and hope for a better market in the future all the while hoping that during the meantime you won't be forced to sell due to illness, job relocation, divorce, a huge law suit, a disabling accident, kiddies go to college or some other large expense, etc.

And this never ceases to be fresh:
Justifications for abnormal price increases are themselves a symptom of an asset bubble. Ones I’ve been hearing to justify housing prices in recent years are similar to those I heard here at iTulip.com in the late 1990s about the stock market. The more a person had invested in the stock market, the more strongly he pushed the justifications for absurd prices, and the closer we came to the end the more rabid the defense.

There are nine key plausible but wrong "it's different this time" arguments most commonly used to justify housing prices during the bubble:
  1. low inventories;
  2. modest mortgage rates that will not rise high enough or fast enough to end the price expansion,
  3. favorable long term demographics of boomers and retirees,
  4. growing demand from immigrants,
  5. the Internet has eased the cost and time needed to buy or sell properties,
  6. banks and mortgage companies have automated mortgage underwriting, making financing a shorter and simpler process,
  7. financial innovations have created new mortgage products to make homes more affordable to more buyers,
  8. low-income assistance programs will continue to boost the level of U.S. home ownership, and
  9. the 2000 stock market downturn and 9/11 attacks motivateed investors to avoid the risky stock market and put their money “safely” into real estate.
Taking on the nine key justifications one at a time:
  1. inventories are rising just about everywhere and rapidly in some areas such as Denver, Colorado;
  2. interest rates are now rising fast making not only monthly payments too expensive for homeowners with barely affordable ARMs but also making a switch to a fixed rate mortgage unaffordable for many;
  3. baby boomers and retirees made up 40% of all home purchases in 2005 so they’re probably full up;
  4. immigrants can only afford homes if monthly payments are kept inexpensive via low interest rates and Suicide Loans, but these are going away;
  5. the Internet will be just as efficient as a mechanism for transmitting price deflation in a declining housing market as it was at transmitting price inflation when the market was rising;
  6. banks are tightening lending standards as foreclosure rates rise, making loans less available;
  7. Suicide Loans are behind the first wave of foreclosures in places like Denver, so banks and mortgage companies are taking them off the market and there is proposed legislation by banking regulators to place severe restrictions on them,
  8. new legislation to control predatory lending will decrease sales in low-income areas, and
  9. investors bought stocks in 1999 because they thought that stock prices only go up. The same psychology was allowed to develop in the housing market. The same reversal in psychology will occur in the housing market as home prices start to fall, fueling further declines and eventually a loss of interest in the housing for investment purposes.

12 Comments:

Anonymous meltormay said...

Excellent information!

Marinite, you rock!

Oct 23, 2006, 2:31:00 AM  
Anonymous tom stone said...

as a loan broker,i would estimate that no more than 10% of those who used exotic mortgages to buy in the last 3 years will be able to refinance into fixed rate products,if they have not yet done so.these loans were 70% of the market last year,and the average downpayment was 2%.

Oct 23, 2006, 10:21:00 AM  
Blogger Dr Housing Bubble said...

Schadenfreude! You know what happens when you can’t make your payments? Foreclosure time! In California, for the third quarter of 2006 foreclosures are up 118% from last year. In addition, 50 percent of these loans that are entering foreclosure originate on or post 2005 with a median of 14 months. These loans are infants so in your post when you discuss what happens when you reduce and reduce and no one bites unfortunately the next step is selling the house at whatever asking price even going into a short-sale.

In regards to Schadenfreude, the housing bubble has done a great job in bringing this out in people. Bubble heads vs. housing heads. Keeping up with the Joneses. Or at least hoping that the Joneses get their car repossessed. This unprecedented boom has created a split between those that own and those that do not. What we may be seeing in the next few years is those with pent up renting anger unleashing on many poor recent homeowners who are unable to make their payments. It’ll be an interesting study in mass human psychology and behavioral economics.

Oct 23, 2006, 11:32:00 AM  
Anonymous Anonymous said...

The rising 10-year rate is not helping the situation either. Inflation is picking up and at one point, even government data could not hide the fact. Owning gold would be a great investment.

Oct 23, 2006, 11:38:00 AM  
Blogger sf jack said...

About that inflation business...

*******

"By one measure, inflation's higher than we think

By Scott Burns - The Boston Globe

October 22, 2006

An unassuming research economist at the Dallas Federal Reserve Bank may influence decisions that will affect all of us in the next few months. A better measure of inflation that he has created indicates inflation is closer to 3 percent than the 2 percent rate sought by our central bank."

See "The Boston Globe":

http://tinyurl.com/ygqs7z

Or:

http://www.boston.com/business/personalfinance/articles/2006/10/22/by_one_measure_inflations_higher_than_we_think/

Oct 23, 2006, 12:26:00 PM  
Anonymous Anonymous said...

You forgot reason #10 (the most important one):

It's SPECIAL here.

Oct 23, 2006, 1:33:00 PM  
Anonymous Anonymous said...

These loans are infants so in your post when you discuss what happens when you reduce and reduce and no one bites unfortunately the next step is selling the house at whatever asking price even going into a short-sale.

At which point, you're either still stuck owing the difference to your lender or it becomes "forgiveness of debt", i.e. Taxable Income. (Say hello to Mr. IRS.)

Owning gold would be a great investment.

I hear this every time there's a downturn. "GOLD! GOLD! GOLD! AK-47S! FREEZE-DRIED FOOD! GOLD! GOLD! GOLD! WORTHLESS GOVERNMENT FIAT CURRENCY! CANNIBALISM IN THE STREETS! GOLD! GOLD! GOLD! GOLD! GOLD! GOLD!" It's like Left Behind for the rest of us.

Oct 23, 2006, 2:19:00 PM  
Anonymous Anonymous said...

...there's a little issue about the buying, holding, and selling of gold. When you talk of financial disastor, this becomes even more of an issue. Usually when you bring this up to the gold buying buzzer, the conversation gets vague. Heck - if someone could clarify it I would be more interested.

Oct 23, 2006, 11:35:00 PM  
Anonymous Anonymous said...

It's like Left Behind for the rest of us.

Actually, fiat currencies have crashed many times throughout history, however, I'm still waiting for one rapture a la 'Left Behind'.

anon 10/23/2006 11:35:22 PM :

I'm no expert, but have been holding gold for some time after doing research on my own so I could get specific it there's something specific you're curious about.

Oct 24, 2006, 9:25:00 AM  
Anonymous Anonymous said...

"I'm no expert, but have been holding gold for some time after doing research on my own so I could get specific it there's something specific you're curious about."

My question is whether there was anytime in history owning gold was prohibited. According to my distant memory, during depression period, circulation of gold was not allowed.

Oct 24, 2006, 9:51:00 AM  
Anonymous Anonymous said...

My question is whether there was anytime in history owning gold was prohibited. According to my distant memory, during depression period, circulation of gold was not allowed

Yes gold was confiscated under the Rosevelt administration, and had to be exchanged for paper dollars. The dollar was than devalued about 50% against gold. This was a campaign to boost money supply (by allowing treasury to double notes in circulation) and force teh country onto the debt based money system we have today.

In actuality, many people did not turn gold coins in. Those coins are St. Guardians and carry a small to large collector premium today.

Marinite, sorry if I'm digressing from the housing topic. I'll stop if you want.

Oct 24, 2006, 1:28:00 PM  
Anonymous Anonymous said...

Thank you for your information regarding gold. Today I just received the following article via my email:

STAGE THREE GOLD RALLY
By James Boric

The most profitable stage of the gold rally - stage three - has not yet begun.

The first stage of the recent metals rally began in 2002. That's when the world lost faith in the U.S. dollar - the dominant currency of the world. Of course, it didn't happen all of the sudden. Leading up to 2002, the stock market crashed, U.S. debt piled up to all time highs and the trade deficit swelled to epic proportions.

All of these factors, coupled with the geopolitical concerns around the globe, led foreign central banks and a handful of shrewd investors to question whether holding U.S. dollars was really a safe thing to do. A few brave souls decided it was not. So they smartly sold their paper assets
(dollars) and bought gold - a true store of value in uncertain times.

For the first time since the 1970s, both demand and the price of gold increased significantly as the value of U.S. dollars fell in half. This marked the first phase of the metals rally.

Of course, not many people bought gold (or any precious metal) in 2001. The mainstream never catches an idea in its earliest stages. People are too afraid of being wrong and going against the herd. So they wait for confirmation from mainstream before they buy. That is exactly why noticeable buying didn't occur in the gold markets until late 2004 and early 2005 - when the second stage of the gold rally began.

By 2005, global demand for gold was large enough that spot prices actually rose no matter what the dollar did. For instance, in 2005, the U.S. dollar gained about 9% versus a basket of other world currencies as it bounced off its 10-year low and as the U.S. stock market rose. Meanwhile, the shiny metal rose in tandem with the dollar - from $420 an ounce to $520.

This divergence from the U.S. dollar coupled with the first signs of retail interest in gold and silver as a legitimate investment opportunity marked the second phase of the metals boom. During the time, Barclays unveiled its iShares COMEX Gold Trust ETF (IAU:AMEX) and the first-ever silver ETF. Since that time, money flow and volume for the gold ETF proves that there is interest in gold as an investment vehicle.

Average daily volume for IAU has more than doubled in the last year and total assets have gone from nothing to $1.2 billion. But this interest in gold is still very tiny. Wal-Mart alone is a $200 billion company! In other words, despite the interest that has been drummed up in the gold world to date, it is hardly indicative of a mainstream rally.

The third stage (the "mainstream stage") of this metals rally has yet to begin. But when it does, it will be quick, explosive and very lucrative. To understand what this mania phase will look like, we turn back to the 1970s. During the last metals boom, stocks rose fast and furiously in the final stages of the metals rally.

* Bankeno rose from $1.25 to $430 a share
* Resources rose from $0.40 to $560 a share
* Steep Rock rose from $0.93 to $440 a share
* Mineral Resources rose from $0.60 to $415 a share
* Azure Resources rose from $0.05 to $109 a share
* And Leon Mines rose from $0.05 to $385 a share.

Although many small-cap gold stocks have already risen hundreds of percent since 2001, we have not yet seen mania-buying like in the late 1970s. In fact, since May of this year, gold stocks have sold off to several year lows, despite better underlying fundamentals.

Last year at this time, an ounce of gold traded in the $470 range. As I write this essay, the shiny metal is at $601 - 28% higher. Yet many gold companies are selling for less than they were 12 to 24 months ago. For instance...

IAMGOLD is a junior mining company (market cap of $1.5 billion) with 4.6 million ounces of proven and probable gold reserves. At $8.50 a share, it is trading for the same price it traded for back in December 2004. Yet its reserves are worth $430 million more today.

Bema Gold is a mid-tier producer with 11.4 million proven and probable ounces of gold in the ground. Based on FY 2005 numbers, those reserves are worth an estimated $4.9 billion. Yet, Bema stock is trading for the same price as back in Dec. 2003 - when its reserves were worth about $1.1 billion.

And Newmont, a major gold producer with a market cap of $20.1 billion and 93.2 million ounces of proven and probable reserves, trades for the same price as it did in Sept. 2003.
Yet its reserves are worth about $4.1 billion today, versus $2.9 billion in 2004.

This price action is not, in any way, indicative of a fierce, mainstream metals rally. While the price of gold has significantly increased in the last year, mining stocks have not followed suit.

As investors, you have a choice to make.

You can invest in gold stocks now - before the third stage of the rally begins (and while prices are trailing the overriding fundamentals). Or you can wait for confirmation from the herd.

Those who buy now must have a stomach made of steel, patience and a thick skin. While it may be a rollercoaster in the short term, it will be these people that walk away with the largest profits in the end.

Of course, those who buy now will only have one group of people to thank for their riches - those that wait for confirmation from the rest of the market before they get in.

Regards,

James Boric
for The Daily Reckoning

Oct 31, 2006, 10:33:00 AM  

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