We're Depressed

It's a little off-topic, but check out this interview with Robert Prechter -- the 2001 recession has not ended and we are in the early stages of a depression. This is not the first time I've heard this and makes me think that even if house prices tumble 50% or more in the near future, do I really want to hold any debt at all and buy a house on the cheap? Or do I "wait for the bread lines"?

Some choice quotes:

""But I think there is one big myth out there in terms of the 2001 recession, that is that it ended. If you look at the manufacturing jobs in this economy, they continue to collapse. There’s been no recovery to speak of. Three million jobs have been lost in the manufacturing area. We can’t survive as a producing country just doing each other’s laundry, providing services for each other. So I think this recession is worse. I think actually we started a depression in 2000 and 2001, but people don’t recognize that we’re in a depression because we’re not in the bottom. They say, “I don’t see any bread lines.” Well, as soon as you see the bread lines, it’s the low. That’s when you want to start buying stocks, commodities and precious metals and everything else because then the deflation will be over. But we are in the very early stages of a depression, and the country is basically falling apart. What hasn’t fallen apart yet is the optimism, the confidence and the dream world that people are in, but that is going to happen.""

"JIM: Let’s talk about the consequences of Conquer The Crash. The conclusion was that the U.S. would enter into a deflationary depression. That has not happened. Why?"

"BOB: Well, I think we are in it. We are in a depression. We haven’t begun deflation yet, that’s true, but you can also see a lot of signs that it is extremely difficult for manufacturers and other people selling their goods and services to do anything about it. Car prices keep going lower because of the competition from abroad. There’s a lot of what I call deflationary psychology because there are people who can barely make ends meet, and the reason they are surviving is something you alluded to earlier: So many foreigners are buying our bonds that people are borrowing their way into survival. Obviously that can’t go on forever."

RE Bulls' Argument Based on Increased Demand is Bull

This article posted on Financial Sense is worth reading; it shows that "there never was a Demand-driven need for the new Supply [in housing]". I've heavily edited out the tables and other data for brevity. I strongly encourage anyone who is interested in this article to check it out for themselves.

Some choice quotes:

"There is no claim that is made more often and with greater zeal in the US financial media than that the rapid rise in the housing prices is due to the basic Demand for housing (a place to live) exceeding the Supply in the recent years, especially, at the present."

"The most important thing to note... is that the Owner Occupied Housing has gone down substantially. Yes, many former owners are glad to sell at the recent high prices and rent from rapidly increasing purchases by “investors.” Also, the Demand seems to be shrinking due to extremely high prices, as one would rationally expect."

"...for the 30 months up to 2004Q4 the Owner Occupied Housing, or homeownership rate, was rising, not smoothly but steadily."

"...we can get a five year picture ending in 2007Q2 and what we see is a disastrous imbalance between the Supply and Demand."

"There never was a Demand-driven need for the new Supply. It was strictly a low-interest rate and loose lending standards driven rise in prices that drew in speculators beginning in 2003-4. For the past three years 1/3rd of the new units added are lying vacant and in the past six months 2/3rd of the new units added are lying vacant. At some point the reality of the Supply and the Demand for housing (as in living in a house and not speculating) will assert itself and all the speculative buyers will have hell to pay."

"As to Mr. Barsky’s claim of purchases of second homes, anyone who is borrowing 80-100% to buy a second home at the current prices is courting disaster. Mr. Barsky’s article is a perfect example of self-serving propaganda that is the norm in the US financial media including the WSJ."

"The data from the Census Bureau is a box of dynamite for the Housing Bubble -- the primary source for the worldwide liquidity -- and the last stand before the Global Depression. Chinese and Indians have a nasty surprise waiting for them as to what was the real source of their boom for the past 3.5 years. Those ignorant of history find all kinds of explanation for bubbles and booms. There is nothing secular about liquidity-driven, or Debt-driven, booms. They always go bust."

Freddie Mac President Admits to a RE Bubble

According to this article in the Contra Costa Times, Freddie Mac's president, Eugene McQuade, admits that there is a real estate bubble and that hot markets like the Bay Area are most susceptible to a correction.

Some choice quotes:

"Call it a bubble, froth or lather, the Bay Area housing market is a party that has to end, the top boss at mortgage giant Freddie Mac warned Friday."

"Mortgage borrowers and residential real estate speculators are particularly imperiled as the market peaks, said Eugene McQuade, president of Freddie Mac, officially the Federal Home Loan Mortgage Corp., the company established by Congress to keep mortgage money flowing and stable."

"People who have adjustable-rate or interest-only mortgages could see their budgets stretched as interest rates rise. And those who bought second homes in hopes of a quick profit could face bankruptcy as the equity in their investment properties evaporates in an atmosphere of flat prices, McQuade told a Rotary Club economics conference in Concord."

"Nationwide, the country is not perched on a bubble, McQuade said. But the landscape is more ominous in places with white-hot realty markets such as the Bay Area, added McQuade..."

""Let's face it, the big run-ups on both coasts and in places like Las Vegas are not sustainable," he said. "Nor should they be.""

"That sentiment was echoed by Steve Wood, a Danville-based economist who gave a far more blunt assessment of the housing market in the Bay Area and around the country, regardless of how the head of the Federal Reserve might portray matters."

""There is a housing bubble," Wood said. "Alan Greenspan can deny it all he wants, there is a housing bubble.""

""The housing bubble may apply to only about 60 percent of the country, but if that bubble bursts, it will affect 100 percent of the nation's population," Wood said."

The RE Bubble is a Crime Being Committed Against Our Kids

The real estate bubble is a crime being committed against our children and maybe even our grandchildren. The kids who grew up in Marin during the late 70's and 80's cannot afford to return home and live in a house that they can call their own and that they purchased with the money that they earned for themselves; they cannot afford to raise their children in a house in the town they themselves grew up in. For shame! This is not the normal way of things. We house owners here are all to blame for our greed. But Marin is not alone in this crime.

Personally, I think doing right by our kids is way more important than being able to finance trips to Bora Bora or where ever during our retirement, buying a flat-screen TV or a big luxury SUV or whatever it is that giving-the-appearance-of-wealth demands.

Some choice quotes:

"Remember how we used to laugh when our parents told us how much they paid for their first home? You know, $25,000 with a $2,000 down payment. That's us now. We purchased our first home in Victoria in 1986 for $90,000 and $10,000 down. One day, not that far away, our kids won't find our story very funny as they try to scrape together a down payment for their first -- a three-bedroom rancher for $600,000."

"We're already reading stories of parents refinancing their homes to help a child come up with a 25-per-cent down payment on a $250,000, 550-square-foot condo in downtown Vancouver. Or grandparents being tapped to help grandkids who want to get a place in Abbotsford, a suburb 60 minutes east of Vancouver (100 minutes-plus during rush hour), where the average price of a single-family home is more than $300,000."

"There is hope for B.C.'s house buyers of tomorrow -- a massive correction."

"Yale economist Robert Shiller, the man who predicted the dot.com bubble would burst, is saying the same thing is about to happen in real estate. He was quoted in a local paper as saying that so-called "glamour cities" like Vancouver -- where prices have accelerated most rapidly -- will be hardest hit when the day of reckoning arrives."

"The New York Times also recently waded into this subject, profiling the real-estate collapse in Denver. There have been stories, too, about the house price crash in Sydney, Australia. So, there is hope."

"Those of us who are 10, 15 years away from retirement are of mixed minds about a massive correction. Yes, it might be good for our kids, but many of us have been banking on that big real-estate cash-out at the end. Many people I know have factored it into their retirement plans -- you know, sell the house for $900,000, buy a smaller town home for $500,000, and then spend the rest on travel."

"If real-estate prices go down the toilet, so will a lot of cruises and dreamed-about ventures to Bora Bora."

""Look at this," I told my son the other day, cornering him in the den. "You can get a home just outside Saskatoon on 10 acres that also has a barn, a milk house and a storage shed for $159,000. How cool would that be?""

June Housing Inventory Way Up Across the Country

A fellow blogger over at The Housing Bubble 2 has a very nice entry making it plain that June housing inventory is way up across the country. Based on this article from the California Association of Realtors:

"“Inventory levels in recent months were nearly double that of a year ago,” said C.A.R. Vice President and Chief Economist Leslie Appleton-Young. “This has contributed to the increased pace of home sales in the presence of continued strong demand for housing in California.” C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in June 2005 was 2.7 months, compared with 1.7 months (revised) for the same period a year ago. The index indicates the number of months needed to deplete the supply of homes on the market at the current sales rate."

Is China Sick of Holding U.S. IOUs?

According to this article at Forbes, China is basically sick of its ever growing pile of U.S. IOUs and is putting its money into more tangible things like gold bullion and other hard assets. Kiss the currently low long-term interest rates goodbye.

Some choice quotes:

"Put yourself in China’s shoes. Your economy is heavily dependent for its economic growth and well being on exports to the United States, long its least-favorite country. It has to accept payment for its exports in U.S. dollars,a currency over which it has no control other than to cause it to depreciate by trading out of the dollars it holds and into another currency. (Note: This is something the U.S. is trying to get China to do to itself by revaluing the yuan.) To add insult to injury, it has accumulated a staggering $700 billion of such dollar reserves and sees no other investment option besides the U.S. Treasury market."

"Hence, they not only supply cheap goods to this least-favored country, they then lend it back the proceeds of their labor—lending which makes them vulnerable to a freezing of these reserves by the U.S. should serious enough policy differences arise, à la Iran. Welcome, China, to the World Trade Organization, or should I say, "Welcome to the Hotel California.""

"Fairly recent history offers... examples of countries who have dealt with this problem with mixed success. In the 1970s, when OPEC managed to take control of the oil market and more than double prices, their foreign reserves quickly built up as they had not yet figured out how to spend these vast sums. Their solution was to invest in CDs with large international banks, thereby providing the funds necessary for oil-importing countries to fund their higher oil import bills. This dubious arrangement lead to an international banking crisis, as the debtor nations defaulted nearly causing some major international banks to fail."

"The recent purchase attempt of Unocal (nyse: UCL - news - people) by CNOOC (nyse: CEO - news - people ), the state-controlled China oil company, exemplifies an attempt to pursue yet a different route for diversifying out of dollars. China appears to be trying to spend its foreign reserves to buy entire U.S. companies. From a Chinese strategic point of view, this is definitely the right policy: Buy the means of producing the raw materials you need or alternatively, buy the companies that have the technology and distribution channels for the products you produce or want to produce."

"For the United States, however, this strategy is a serious threat that goes beyond trade rivalry. Let no one kid himself. International trade and capitalism is a form of warfare where domination is the objective."

"Such dominance by a country that is fundamentally hostile to U.S. interests will not be tolerated by the U.S. government."

"How then can China reduce its subordination to U.S. interests and use its dollar reserves to strengthen its role in world affairs?"

"I believe China will eventually find gold as a partial solution to its foreign-exchange problem."

"Dominating the gold market would offer a number of benefits to China. It offers a viable alternative to buying more U.S. Treasury debt."

"The ultimate attraction of such a policy for China is that it allows them to reduce their vulnerability to the United States. Even more so, it allows them to play a dominant role in international affairs, clearly a high priority with current Chinese leadership."

Real Estate is a House of Cards

I lived in Orange County, CA for some time. It is near and dear to my heart. I know its housing market well. The Orange County Register has an article that makes the case that the housing markets in California's various "hot spots" are bubbles about to burst and predicts that a "hard landing" is the most likely result. I personally know people in Orange County who are in the real estate development business and who have sold all of their holdings except for raw, undeveloped land.

Some choice quotes:

"Are you familiar with the game Jenga, where players successively remove small wooden blocks from the bottom of a tower and place them on top, creating a progressively more unstable situation until one player causes the whole structure to tumble?"

"That's basically what's about to happen very soon in parts of California and several other "hot" housing markets around the country. Merrill Lynch recently issued a "bubble" warning for six California housing markets - San Diego, the Inland Empire, Los Angeles, San Francisco, San Jose and Sacramento, where "affordability" indexes are at historic lows. In other words, household incomes are way out-of-sync with home prices."

"Yet California housing prices adjusted for inflation have climbed 80.7 percent since 1997, the largest increase in the country, and well beyond the 45.7 percent run-up in housing prices we experienced in the period 1983-89."

"Low mortgage rates, a loosening of qualification standards and a surge in interest-only financing have certainly played a part. So has a housing demand-supply imbalance."

"But it won't take a big uptick in mortgage interest rates to trigger a slow-down or retrenchment in prices, and the argument that such high prices are justified by insufficient supply coupled with strong demand just doesn't hold water now that we have gone beyond all rationality with respect to affordability across the board."

"We're in the midst of a classic speculative bubble, and even the venerable Alan Greenspan referred to a bit of "froth" in certain housing markets in a recent speech. The UCLA Anderson Forecast, which has been warning of a break in the bubble for the past couple of years, echoed that warning again in its latest quarterly update and predicted a recession to follow even if it's a "soft landing.""

"A hard landing is more likely (where nominal prices actually fall) because houses are more overvalued than in past booms, inflation is lower and many people have been buying houses as investments."

"But the most compelling evidence of a bursting bubble to come is the divergence of home prices and rents. In the United States over the past decade the ratio of home prices to rents has increased by almost 40 percent."

"To re-calibrate to more reasonable historical levels will require rents to rise sharply, which is constrained by household income growth, or home prices will have to fall, the only other possibility."

"Japan presents the scariest boom-to-bust scenario, where home prices have declined 14 years running, representing a loss so far of 40 percent from their peak in 1991. Americans, who live on the edge of credit catastrophe anyway and who have cashed in on rising home equity to bolster their disposable incomes, are especially vulnerable to the negative consequences of flattening or declining home prices."

"Over the past four years, 90 percent of the growth in U.S. GDP was accounted for by consumer spending and residential construction. Declines in the nation's biggest housing markets are likely to trigger a major economic slowdown."

And finally, their dire prediction:

"It is not a question of whether this will happen but when, how dire will be the consequences on economic growth, and how long it will take to restack the blocks and begin again."

Is the "American Dream" a Joke Thanks to the Bubble?

Has the "American Dream" become an American joke thanks to the real estate bubble? It sure seems like it according to this New York Times article. More evidence that the "move up" chain is breaking.

Some choice quotes:

"In the hottest markets, owners whose homes have skyrocketed in value find themselves in a frustrating paradox. They were supposed to be the lucky ones: they bought in frenzied real estate markets like New York and Los Angeles three or more years ago and have amassed hundreds of thousands of dollars on paper."

"But as they try to roll that considerable equity into a bigger home, many are unpleasantly surprised to find that the cost of real estate at the higher end has outpaced their ability to buy. For homeowners who have watched the torrid housing market create wealth as if by magic, scanning the classified ads or visiting a few open houses serves as a harsh reality check."

"Trading up "is becoming harder and harder, even for people who are technically wealthy," Mr. Boals said last week as he took a break from his duties as a stay-at-home father for his daughter, 3, and son, 16 months."

"Families have always dreamed of the extra bedroom or the larger yard. But now that their current homes have shot up in value, their expectations for a lifestyle upgrade are even higher. The problem now is that in cities like Boston, New York and San Francisco the number of people vying to move up exceeds the number of larger places for sale."

""You often think, 'Geez, I have this huge windfall,' but your neighbors and the people in the building next door have the same windfall," said Christopher J. Mayer, a professor of real estate at the Columbia Business School in New York. "There are a lot of people who want to trade up, so that's really the problem they are facing.""

"In some places prices of bigger homes are hitting records, putting them out of the reach of even those who, on paper at least, have accumulated considerable wealth."

"Incomes have not kept pace."

"One result is that homeowners who might have followed the traditional path from starter home to dream house in a few years are now deferring the dream."

"Many families are shocked at how little their newfound wealth will buy."

"Some buyers forge ahead, but end up taking out riskier mortgages simply to afford the monthly payments."

California Foreclosures Soar in June

According to this Los Angeles Business Journal article, California's rate of foreclosures soared 19% in June. Is this increase due to the impending new bankruptcy laws (a perverse rationale along the lines of "maybe I should go into bankruptcy now while I still can; while the consequences are still relatively tame") or is it a dark omen of things to come?

"The number of new foreclosures in California soared 19 percent last month, renewing worries that the state is sitting atop a real estate bubble that is about to burst."

"Nationwide, the number of properties entering foreclosure last month rose to 67,024 from 62,432 in May. Texas, Florida, California, Ohio and Illinois had the most new foreclosures and accounted for more than half the nation’s total with 37,249."

"The overall increase resulted in the highest number of new foreclosures reported in any one month this year and resulted in a 7.4 percent increase in the nation’s default rate. Nationally, one new foreclosure was filed for every 1,726 households."

Doomsday: The Final Months

This statement says it all. Reprinted with permission:

“The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops.”

-- The Economist

I sold my home three weeks ago anticipating what I believe will be “Economic Armageddon” in the United States. It wasn’t an easy thing to do. My wife and I have lived in the same home for 25 years, raised both of our children there, and owned the property outright without any loans or mortgage. The house was paid for in “sweat-equity”, that is, by wielding a shovel day-in and day-out in my one-man landscape business. I don’t say that for sympathy, but to illustrate that we played by the rules, worked hard, paid our taxes, and took advantage of the American dream of home-ownership.

All that has changed.

I sold my home for one reason: George W. Bush. He and his protégé at the Federal Reserve have submerged the country into a morass of “unsustainable” debt, disrupted the nation’s economic equilibrium and thrust us towards fiscal disaster. They’ve also generated a humongous housing bubble through their irresponsible and self-serving manipulation of interest rates.

The facts are astonishing.

The current housing bubble is “larger than the global stock market bubble in the late 1990s (an increase over five years of 80% of GDP) or America's stock market bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.” (The Economist, June 16, 2005)

The banks have lowered the standards for home loans to such an extent that the traditional loan of 20% down and a fixed interest rate is virtually a thing of the past. Instead, those conservative practices have been replaced with “creative financing” schemes that put the entire housing market at risk.

Consider this: In 2004 “one-fourth of all home-buyers -- including 42% of first-time buyers -- made no down payment.” (New York Times, July 7, 2005)

No down payment?!

Sorry, but if a buyer can’t come up with at least $5,000 dollars for a down payment, he shouldn’t qualify for a home loan.

Equally troubling is the fact that “nearly one third of all new mortgages this year call for interest-only payments (in California, its almost half)” (NY Times) This tells us that a large number of new buyers can barely make their payments, but are gambling that their property value will go up enough to justify their investment. This is “equity roulette.” a shell game that anticipates that salaries will go up while interest rates stay low.

Is that a reasonable judgment?

No, Greenspan has said that he will continue to ratchet up interest rates to head off inflation. This means that an economic slowdown is a near certainty. Remember, “class-warrior” Alan Greenspan lowered the prime rate to a ridiculously low 1% in 2002 to keep the economy humming along while $300 billion was sluiced into Bush’s “preemptive” war in Iraq and while the tax cuts were siphoning the last borrowed farthing out of the public coffers. The Bush tax cuts transferred an average of $400 billion dollars per year into the pockets of America’s plutocrats. Now, the country is flat broke and Greenspan will have to “incrementally” raise rates to stabilize the sagging dollar. This means a sluggish economy for most of us and doomsday for over-extended homeowners.

Greenspan assumed he could carry out his plan without too much unnecessary carnage. Unfortunately, gluttonous mortgage lenders have lowered long-term loans while the prime rate continues to go up. The banks, it seems, are addicted to the “cash cow” of shaky lending and are providing even riskier loans to new applicants. This has upset the Fed master’s strategy for a “soft landing” and Greenspan has begun feverishly issuing warnings about an inevitable “adjustment” when the market bogs down. The bottom line is that the housing bubble is getting bigger by the day and increasing the potential for catastrophe.

The current problem is compounded by the dramatic surge of speculation in the housing market. As The Economist says, “A study by the National Association of Realtors (NAR) found that 23% of all American houses bought in 2004 were for investment, not owner-occupation. Another 13% were bought as second homes. Investors are prepared to buy houses they will rent out at a loss; just because they think prices will keep rising—the very definition of a financial bubble.”

What will happen to these “speculative” buyers when the market “flattens out” or the economy takes a sudden dip?

And, what will happen to the US economy when the jobs that depend on new home sales vanish overnight?

“Over the past four years, consumer spending and residential construction have together accounted for 90% of the total growth in GDP. And over two-fifths of all private-sector jobs created since 2001 have been in housing-related sectors, such as construction, real estate and mortgage broking.” (The Economist)

“Two out of every five” private sector jobs are now entirely dependent on an industry that is built on pure quicksand.

So, why would banks foolishly loan money to people who can’t even scrap together a few thousand dollars for a down payment or who can scarcely meet their “interest-only” obligations?

The reason is simple: because they are not the one’s taking the risk. Mortgage loans are acquired by investment banks and chopped up into various securities where they are sold in mutual funds, hedge funds and pension funds etc. To some extent, this takes the lenders off the hook, but it also means that the shock to the system will be much more widespread when the day of reckoning finally arrives. If we encounter a major glitch in the economy the shock waves will be felt throughout the world. “Investors now hold $4.6 trillion in mortgage backed securities. That’s more than the outstanding value of the US Treasuries.” (NY Times) Think about it.

Shaky lending, interest-only loans, no down payments, a US government that is $8 trillion in debt due to Washington’s profligate spending, and a “ticking-time bomb” of adjustable-rate mortgages that will reset within three years; the table is set for a disaster of Biblical proportions. If we hit a bump in the economic road ahead (rising gas prices? recession?) the “Land of the free” will be knee deep in bankruptcies and foreclosures. We’ll all be fighting for a soft spot under the freeway onramp.

The fatuous Greenspan believes that all this can be avoided by regulating the money supply.

He’s dead wrong, and I bet my house on it.

Note, the current dilemma could have been avoided if Greenspan had incrementally raised rates as the bubble began to appear. Instead he lowered rates to facilitate Bush’s war in Iraq. It was purely a political decision that “postponed” the economic pain of the conflict and allowed the Bush administration to shift the cost of the war onto future generations.

Consider, also, how Greenspan paved the way for the budget-busting tax cuts (which he enthusiastically approved) and how they have increased America’s debt by $3 trillion. This is real money that American workers will eventually have to pay back in the form of taxes and a higher cost of living. This “class loyalty” is strikingly at odds with his philosophy as a young man when he said, “Deficit spending is simply a scheme for the confiscation of wealth.”

So it is. And the $3 trillion dollars that evaporated on Greenspan’s watch was in fact stolen from the American people while the Fed chief concealed the crime behind the smokescreen of low-interest rates. In the final analysis, Greenspan will be seen as a greater traitor than Bush.

Mike Whitney lives in Washington state...

The Kubler-Ross Sequence

Since this housing bubble seems to be in the early stages of popping, it is prudent to remind folks of the Kubler-Ross Sequence of Emotions (originally, "The 5 Stages of Receiving Catastrophic News") so that we can more easily identify which stage of the bubble's popping we are in.

The sequence:

1. Denial ("I am not going to sell this house for less than I paid for it.")
2. Anger ("Damn if I’m going to believe that lousy report that says I am going to sell this house for less than I paid for it!")
3. Bargaining ("God, if you let me sell this house for a profit, I promise to be a better person.")
4. Depression ("I’m so sad that I’m going to sell this house for less than I paid for it.")
5. Acceptance ("I’m going to sell this house for a loss, but, you know what? I’m all right with it!").

Tech Bubble and Housing Bubble Side-By-Side

This is from a posting in The Daily Reckoning forum:

Jim Stack provides this remarkable chart of how similar the two back to back mania's have been. If you look at these two charts, one is the housing mania from 2000 - 2005 (represented by housing stocks) and the other is the internet tech bubble from 1995 - 2000.

They both lasted for 5 years and had parabolic blowoffs of 1323% and 1395% respectfully. Manias most always retrace to below the starting point of the mania. The Interactive week internet stock index is currently around 150! (not shown)

Kirby

Monthly Year-Over-Year % Sales for Marin County

The following graph shows the monthly year-over-year percent sales for Marin updated with the June data. Notice the overall down trend. Prices always lag behind sales volume. Percent sales are down even though the number of houses placed on the market is up sharply for this time of year (I'm still working on that data).


The following chart shows total sales in Marin from January, 2001 to June, 2005. The black, vertical lines mark June's data for each year. The red lines connect the points where the black line intersects the total sales data (blue line). Notice that for the first time in five years the line trends downward by a significant amount.

Blast From The Past

Since people are fond of arguing that real estate never goes down in value, especially here in the Bay Area, try this blast from the past on for size.

Some choice quotes (sound familiar?):

"One reason housing prices fell so much in the Bay Area after 1989 was precisely because speculative excesses drove them to fanciful and unaffordable levels."

""The inflation of housing prices was just something we couldn't economically sustain,'' said Jim Hines, manager of Gibson Properties in San Jose. "Prices were going up 10 to 15 percent a year. When you have three or four years of that, somewhere it's got to stop.''"

"And it stopped for lots of other Santa Clara County residents after jobs began drying up in 1990 when the recession clobbered California. Homes in one part of San Jose, just south of Milpitas (zip code 95133), plunged nearly 17 percent over the past five years, including a 3 percent slide last year. Even affluent Los Altos and Los Altos Hills (zip code 94022) saw home prices fall 11 percent over five years, despite rebounding nearly 4 percent last year."

""In the 1970s and 1980s, people were looking at housing as an investment, a place to make money. Now they look at it as a place to live and raise a family, not as part of their portfolio.''"

And it is only worse this time around.

Not For Sale

I love the brash Australian news writers. Take this article from The Australian:

"Bookies take bets from fools backing horses that can't win, but at least they look you straight in the eye when they do it. And it's satisfying to know that occasionally - just occasionally - the bastards lose too."

"Real estate agents, on the other hand, move between buyer and seller, telling both sides what a great deal is being done for them. In the end, they never lose. It's probably why they smile so much."

"They don't have bookies in the US, but they do have a particularly obnoxious property market culture where your average garden variety real estate agent thinks nothing of knocking on a door and trying to persuade the occupant to sell."

"One result of this [real estate] boom is that anyone with five minutes sales experience thinks selling property is a passport to early retirement. As the number of real estate agents has swelled, so too have sales tactics become more aggressive."

"So, home owners across the country have taken to erecting "Not For Sale" signs in their front yards in a bid to keep the real estate pests away from their front doors and junk mail out of their letter boxes."

"But they may not need those signs for too much longer. There is mounting evidence that the US housing boom, which has run since 1996, and been a wonderful money spinner for Australian-listed building materials companies such as Rinker, James Hardie and Boral, is coming to an end. According to a Merrill Lynch report last week, US house prices have risen an average of 45 per cent in real terms since 1996. But there is now clear evidence of an oversupply that will demand a market correction."

"The danger, though, according to Merrill Lynch economist David Rosenberg, is that average-Joe Americans - many of them perhaps influenced by those smiling real estate agents - are not seeing it that way."

"Rosenberg cites a recent Michigan University consumer confidence survey showing that the number of Americans who believe now is a good time to buy property because prices will continue to appreciate is at a 25-year high."

Self-Help RE Guru Says There is a Bubble About to Bust

There's defection among the ranks of the real estate bulls. According to this San Francisco Chronicle article, a former publisher of pop RE investing advice books, RE bull lecturer, RE infomercial speaker, teacher in RE investment classes, someone with the exuberance to claim "One Weekend Can Make You a Millionaire", and all around cheerleader for the RE market now claims that RE is no longer a wise investment. How could it be? The horror of it!

Some choice quotes:

"You read the real estate-to-riches books and finally took the plunge. You pulled the equity out of your home and bought another and then another. Despite your income of $45,000 a year, now you're leveraged to the tune of $1. 7 million and loving every minute. Because when the properties appreciate you'll have made the nest egg of your dreams."

"Then you log on to your investment guru's Web site and discover this stunning news: Your real estate dreams are soon to be dust in the wind."

"But now, in the past couple of months, the man -- whose engaging financial parables have coaxed millions of ordinary under-earning boobs (including yours truly) into the real estate market -- has become a major bubble-blower."

"He cites the Economist at length, including the assertion that "the global housing boom is the biggest financial bubble in history." He confesses that he's currently dumping real estate that produces no cash flow (from rental income) and going "long on gold and oil.""

"He knows that many others have not been so prudent. "I'm worried about people using their houses as ATM machines," he says, referring to those homeowners who have refinanced their homes to buy cars, pay for remodels or to buy more real estate."

""And I'm worried about all the people who are flipping properties (those who buy in order to immediately resell for a profit) -- that's really stupid right now.""

"But didn't his books, despite all their sound financial advice about reducing liabilities and increasing assets, probably help fuel this real estate craze?"

""I think it's so," he concedes."

"One of the key tenets he hammers away at is that a home is not an asset but a liability."

"The real culprit behind the real estate bubble, he contends, is the federal government. "They're printing too much money," he says. "It's Gresham's law: When bad money enters the system, good money goes into hiding.""

""There's been enormous inflation," he explains. "(Federal Reserve Chairman Alan) Greenspan walks around saying there's no inflation, but that is based on the Consumer Price Index. They've taken all the assets out -- housing has gone through the roof, my steak has gone through the roof, oil has gone through the roof. In 1997, the price of oil was $10 per barrel -- now it's $57. If that's not inflation, I don't know what is.""

"Kiyosaki's solution is to invest in oil, gas, gold, silver -- whatever might be a hedge against the coming financial crisis."

"Like most influential self-help gurus, Kiyosaki's power lies in his charm, which is at once self-effacing, brash and disarmingly straightforward. This has allowed him to walk both sides of the street -- as an altruistic educator who shares his knowledge with the average wage earners whose pain he feels, and as the calculating, unabashed Machiavellian player who lives to win. In this sense, his sounding the alarm bells about the real estate market may be anything but altruistic. It may be, simply put, good business."

""Please crash, so I can buy some more," he says with a hardy laugh. "I want it to bust anyway. There's more opportunities in a down market.""

Jobs, or the Lack Thereof

According to this blog (mirroring an article at the Daily Reckoning) and this article, the official US unemployment figures are a gross distortion of the true state of affairs. What happens when this real estate bubble pops as it seems to be doing now? Where are all these people going to work next? I wonder how many of them are drawing income from property appreciation or who became RE agents. (When they lose that source of income, that will only put more downward pressure on housing sale prices.) I'm talking about the folks who majored in Art History in college because that was the easiest major, went into web design because that was what was hot then or quit their day jobs to become day traders during the dot com boom because that's where money seemed the easiest to make, and have now become real estate agents during the housing bubble because that's where the easy money is now. Where are they going to work? I guess if we want to know what the next bubble is going to be we just have to find out what their "plan B" is.

Some choice quotes:

"Every day, we get new headlines, statistics...new prices...new information. But prices are short-term. They will change tomorrow. Values, on the other hand, change very, very slowly - if at all. Financial theorists say that prices are "perfect" - but they are, in fact, perfectly worthless, for they tell us nothing about what things are really worth. We have to figure that out for ourselves. Besides, prices are subject to change without notice."

"And statistics? Almost all the statistics used in economic discussion are misapprehensions, scams or lies. The GDP "growth" numbers tell us how fast the U.S. economy is growing poorer. The inflation numbers tell us only how fast prices are rising for people who don't exist - those who buy a 1990s computer today! Guess what...it's cheaper. And the employment numbers are a swindle too, says Paul Krugman in today's International Herald Tribune. He quotes J. Bradford DeLong of UC Berkeley: "We have four of five indicators telling us that the state of the job market is not that good and only one - the unemployment rate - reading green." It reads green, rather than black, because it fails to count people who are not "actively" looking for a job. "The addition of these hypothetical participants," writes Katharine Bradbury, an economist at the Boston Fed, "would raise the unemployment rate by one to three-plus percentage points.""

"Why have so many given up looking for a job? We don't know, but we can guess: because the jobs they had hoped to find no longer exist."

""The United States is being virtually de-industrialized," writes our favorite economist, Dr. Kurt Richebächer. "The sector has lost 3 million jobs since 2000 and keep losing them month after month." America used to be a country that made things for export. It employed millions of well-paid people in factories where they made things to be sold overseas. The bars in "industrial" cities, such as Milwaukee and Baltimore, were full of working stiffs with money in their pockets. In the Highlandtown section of Baltimore, for example, near the Bethlehem Steel plant, there was a bar on practically every corner. Now, the old bars in the old working class neighborhoods are closed. The new bars, downtown, have a different clientele - office workers, real estate hustlers, and young professionals. Wine has replace beer at many of these places. Bragging about house price gains has taken over from bar fights. Wage earnings have given way to credit card and mortgage debt."

"The good-paying factory jobs are disappearing. A man can still find work - but not necessarily at the same price."

"We note in passing that the Dow has gone nowhere for a very long time. From the late '90s to today, an investor would have made nothing. But in India, stocks have more than doubled in the last three years. These are just prices, of course, not values. But people are beginning to ask questions. Not only are stocks soaring in India, wages throughout most of Asia are rising. How come people are earning more and more in Third World "basketcase" countries...while their hourly wages in America go nowhere?"

Commercial Real Estate Bubble

There have been a lot of articles recently about the commercial real estate bubble. I guess using the logic of residential RE bulls, "supply is tight and there is huge demand, everyone wants to work here, they're not making this anymore", etc. Well, at least when jobs do in fact increase the workers will have a place ready made for them to work in.

[Personally, I think we in the US would be much better off if we were less well-off.]

Some quotes:

"In recent weeks, the feverish residential market has spurred incessant talk about the prospect of a housing bubble. But prices for commercial real estate have also been going through the roof, despite high office-vacancy rates and lackluster job growth."

"Some investors think that commercial real estate is enveloped in a bubble of its own."

"Others wonder if there could be a return to the early 1990s, when huge fortunes were lost as many landlords were forced to turn over the keys to their buildings to their lenders."

"For several years, prices for office buildings have continued to rise steadily, even though vacancies in many cities have remained high."

"From January through May, more than $32.4 billion worth of office properties valued at $5 million or more changed hands, up 41 percent from 2004, according to Real Capital Analytics, a New York research company. The average deal size increased 22 percent, to $37 million, the company said."

"Some sophisticated investors are sending strong signals that prices cannot rise much higher."

"Calpers, the nation's largest pension fund; Equity Office Properties, the giant real estate investment trust; and private landlords such as the Shorenstein family of San Francisco are among big sellers that have been shedding billions of dollars worth of office and retail property in recent months."

"Jim Titus, managing director of Realpoint, the research arm of GMAC Institutional Advisors, observes that today's prices are reminiscent of the late 1980s, when Japanese investors overpaid for trophy buildings and went on to suffer huge losses. "I sort of see a similar situation potentially brewing," Titus said."

"Commercial real estate is awash with capital, and many buyers are accepting initial returns of 5 percent or even less because they have few investment alternatives."

"Once interest rates rise and investors can buy 10-year Treasury bills with a 5 percent yield, real estate will seem less attractive, Titus said. "That can have a real impact on valuations in the marketplace.""

"Nationally, the average office vacancy rate dropped half a percentage point from the first quarter this year to the end of June, from 15.9 percent to 15.4 percent, but in many cases, Lynford said, "the cash flow has been deteriorating," because rents are not improving"

"The volume of outstanding commercial mortgages has been growing and the total is now equivalent to 14.4 percent of gross domestic product, a level not seen since the days before the real estate crash of the early 1990s, according to Moody's Investors Service. As with residential real estate, the proportion of interest-only loans has risen sharply."

"Green Street calculates that the value of property owned by real estate investment trusts has risen 27 percent since 2000, while home prices have shot up 51 percent. This suggests, the company said in a recent report, that "homes have a much worse case of bubblitis than commercial real estate."

More On Revaluation of Yuan

The Contra Costa Times has an article explaining why China's decision to let the yuan float against a basket of currencies spells trouble for the Bay Area's bubbly real estate market. Some choice quotes:

"China's decision to revalue its currency caused interest rates to jump Thursday and cast a shadow over a super-heated housing market that has been bolstered by relatively affordable loans."

"Talk of currency fluctuations and the value of the dollar vs. the yuan might cause a person's eyes to glaze over. Yet the move by the emerging Asian economic power, a response to pressure from the White House and Congress, could have a significant impact on personal pocketbooks and property portfolios."

"Why? To keep the yuan's exchange rate against the dollar fixed, China has had to scoop up huge amounts of dollars. And China has invested much of that money in U.S. treasury bonds. That, in turn, has helped keep U.S. interest rates quite low."

"The market's reaction to Thursday's decision was immediate. The yield on the 10-year Treasury note, a benchmark for mortgages, jumped from 4.16 percent to 4.28 percent. That's the highest interest rate for that note since early May."

""This is another nail in the coffin of the housing bubble," said Christopher Thornberg, an economist with the UCLA Anderson Forecast. "Inflated prices are the biggest factor in the housing market. But this is going to hit mortgage rates, which are also a factor.""

"The outlook for the housing market -- a major engine for the Bay Area economy and especially important in the fast-growing East Bay and Solano County -- is ominous, according to John Rutledge, chairman of Rutledge Capital, a Connecticut-based investment firm. Recent buyers could be especially vulnerable, he warned."

""Because China has been forced to revalue, that has shut off the U.S. housing boom," Rutledge said. "I would not want to be the last person to buy a house when this happens. This is very bad for the U.S. housing market.""

"Now, a lot of products imported from China could become more expensive. And that again would hit consumers in the wallet."

Forbes - The Housing Bubble is a Bubble

According to Forbes, the housing bubble is in fact a national bubble. Some choice quotes:

"The housing bubble is not local, but national—not surprising since it's driven by economy-wide forces: investor zeal for high returns but skepticism over stocks, ample cheap mortgage money and lax lending standards. Indeed, these forces and the housing boom are global."

"The most likely bubble-pricking pin is massive speculation itself, and as prospective buyers stand aside, mounting inventories will precipitate a downward price spiral."

"In any event, investors remain complacent, apparently convinced that there is no bubble or, if there is one, that it will continue to expand for some time—and even then not burst but rather slowly deflate. Witness the persistent upward trend in conventional home builder stocks (see chart below). Sure, these stocks sell at low price-to-earnings ratios and may appear cheap, but if home building slows substantially, their earnings will evaporate."

"The housing bubble could end if the low-end first-time home buyers who made down payments of 3% or less under government-sponsored programs engineered by Fannie Mae and Freddie Mac lost their jobs and consequently were frozen out of the market. Then their plight would ripple up the move-up market, as those planning to buy more expensive houses wouldn't be able to sell their existing abodes at their hoped-for prices. Already, the delinquency rates of these low-income, minority and young folks, most of whose mortgages are insured by the Federal Housing Authority, have jumped. It probably would take a recession, spawned elsewhere, however, to create the unemployment needed to activate this housing bubble pricking pin."

"Finally, extreme speculation and excessive investment may finally sink the housing ship. During speculations, the participants see nothing but shortages and insufficient inventories. Housing today is no exception. Publicly-owned home builders assure stockholders that they build only to firm orders, with virtually no inventories. Note, however, that home builder Toll Brothers’ CEO recently bragged about the firm’s high level of non-binding deposits — essentially reservations for new houses that prospective buyers can cancel and reclaim their money."

"Speculators assure themselves and all who will listen that they are long-term real estate investors, but many of those houses are rented at less than profitable returns, and only make economic sense if prices continue to rise rapidly. An National Association of Realtors economist said that “house price appreciation over the last three years has been nearly 20% nationwide in each of the years, and that implies there is a housing shortage.” Well, sure, a shortage relative to insatiable and self-feeding speculative demand."

"But in past bubbles, even the starry-eyed speculators finally realized that huge excesses had been built, and shortages became surpluses overnight as they dumped their holdings on the market, depressing prices in a self-feeding cycle. In addition, when buyers disappear, the supply chain can never be shut off fast enough to avoid huge inventories."

"And remember that inventory problems are never fully understood by buyers and sellers until they’re huge. What’s different about housing? And even if major builders have avoided excess inventories, how about all those small builders with their pickups who each build only a few houses a year but constitute the bulk of that fragmented industry? Has human nature so changed that they’re resisting the urge to build extra houses amidst the multiyear surge in prices?"

"Inventories of new homes for sale—or existing homes for sale, either—have yet to move up to alarming rates. But what will happen when housing buying dries up while supply increases continue to roll and inventories come out of the woodwork? Many of the houses bought in recent years as investments and now rented at unprofitable rates will be dumped on the market. Look for mounting inventories to precipitate a downward price spiral."

"During a full-blown housing retreat, the bulls’ argument about strong demographic underpinnings will also be seen as hype, not reality. Indeed, demographics will be rough on housing in the years ahead, at least on primary residences. A large percentage of the population, the postwar babies, now in their 40s and 50s, are all housed. Meanwhile, people in their 20s and 30s, the prime first home buyers, are fewer in number."

E.g., Marin:

"Trying to predict the timing of any bubble’s end is normally a waste of time, but for the demise of housing mania there are some straws in the wind. In some of the nation’s more tony suburbs, high-priced houses aren’t moving. Also, house prices have gotten so high and rents are so cheap that a number of people are renting apartments."

China Floats the Yuan

Today China allowed the yuan to float. Granted, for now it is small, only a 2% revaluation. But it is sure to increase in the near future. What does this mean for the housing market? Well, as the yuan becomes more valuable relative to the US dollar, Chinese exports become more expensive. This will result in an increase in the CPI "core" rate of inflation in the US which will further inspire Greenspan to increase short term rates. Furthermore, as Americans purchase fewer Chinese-made goods (assuming the yuan becomes more valuable relative to the dollar with time) Chinese profits will be down and will have less money to spend. All in all there is less incentive for China to buy US Treasuries. After all, China "pegged" their currency to the US dollar by buying huge amounts of US dollars. Other Asian countries will almost certainly follow China's lead. This will result in an increase in long-term interest rates which will negatively effect the housing bubble:

"Right now China is one of the biggest buyers of U.S. government bonds, helping keep U.S. interest rates low. But if the yuan rose, the Chinese would probably cut back on their purchases, driving yields on Treasuries and mortgage-backed securities higher."

"Ashraf Laidi, chief currency analyst at MG Financial Group, cited estimates that yields on the benchmark 10-year Treasury note are up to 70 basis points below where they would be without purchases by China and other Asian buyers. There are 100 basis points in 1 percent."

"If China were to suddenly to drop its yuan-dollar peg, that means long-term bond rates could rise as much as a full percentage point, Laidi estimated."

"Just the possibility of a free-floating yuan could drive up long-term rates, said Sung Won Sohn, CEO of Los Angeles-based Korean bank Hanmi Financial. "They don't have to do anything," he said. "If they just say they are going to buy fewer U.S. Treasuries, they can hurt us badly.""

"Even advocates of a free-floating yuan agree it will mean higher rates in the United States."

""Mortgage rates are going to go up, the long bond rate is going to go up," said Maryland's Morici, who has long been calling for China to let the yuan rise. "The only question is what is the precipitating event.""

We'll see.

People don't always get what they want, but they get what they deserve.

Real Estate Agents Now Preparing for Downturn

This just in from Inman Real Estate News. Interesting how real estate agents are suddenly changing their stories. I guess we will be seeing a lot of RE agents out of work. And every RE agent that I know owns more than one house on speculation. That should put more pressure on the housing market:

"As the high-flying housing boom loses feathers in some formerly hot markets, real estate consultants say it is time for brokers to focus on those survival skills that will carry them through a market shift."

"Many agents, brokers and companies have joined the real estate bandwagon at a time of record home sales and home-price appreciation, and historically low mortgage interest rates. The housing boom has prospered for more than a decade in some markets, and many real estate professionals have never known a "normal" market or a cyclical downturn."

""Companies are tightening the reigns. I think people realize this is a cyclical market. It may be a longer cycle than normal. Nobody is that intoxicated to (think) that this party is going on forever. They do not want to make these changes when it happens because it's almost too late," he said."

"Jon Cheplak, a former real estate executive for Better Homes and Gardens of Las Vegas who now serves as a real estate consultant for The Real Estate Recruiters, said he expects that some agents will leave the real estate industry and some companies won't survive the transition as the market turns. "Some of the people that are making it today won't make it in the market-shift. You will see many agents getting out of the business," he said."

"Cheplak said brokers are definitely aware that some markets are turning. A couple of months ago a real estate professional told him that the Orlando, Fla., market is showing some signs of slowing, he said, though by outward appearances that market is still hot. "Don't spend so much time focused on everything that's wonderful. A broker looks for what's not right (too)," he said. "Some people say that numbers don't lie -- they do if you look at them the wrong way.""

SFO Housing Has Slowed

According to this article from the San Francisco Chronicle, Bay Area housing is slowing in part because it is so much more affordable to rent. Some choice quotes:

"Karen Mak, a real estate agent at Coldwell Banker in Burlingame, said three properties in her territory priced at more than $1 million received no offers by the stipulated offer date."

"'That's not what we're used to,' Mak said. 'We're not seeing 20 offers anymore,' said Julie Rogers. 'We're seeing five or six. I think some buyers have stepped out. They just don't want to do this anymore" particularly because rents are so affordable relative to mortgage payments.'"

Greenspan's Testimony

Here is the text of Greenspan's latest testimony to the House Financial Services panel. Some choice quotes:

"Nevertheless, they [the fall in bond premiums] suggest that risk takers have been encouraged by a perceived increase in economic stability to reach out to more distant time horizons... History cautions that long periods of relative stability often engender unrealistic expectations of its permanence and, at times, may lead to financial excess and economic stress."

"Such perceptions, many observers believe, are contributing to the boom in home prices and creating some associated risks. And, certainly, the exceptionally low interest rates on ten-year Treasury notes, and hence on home mortgages, have been a major factor in the recent surge of homebuilding, home turnover, and particularly in the steep climb in home prices. Whether home prices on average for the nation as a whole are overvalued relative to underlying determinants is difficult to ascertain, but there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels. Among other indicators, the significant rise in purchases of homes for investment since 2001 seems to have charged some regional markets with speculative fervor."

"The apparent froth in housing markets appears to have interacted with evolving practices in mortgage markets. The increase in the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages are developments of particular concern. To be sure, these financing vehicles have their appropriate uses. But some households may be employing these instruments to purchase homes that would otherwise be unaffordable, and consequently their use could be adding to pressures in the housing market. Moreover, these contracts may leave some mortgagors vulnerable to adverse events. It is important that lenders fully appreciate the risk that some households may have trouble meeting monthly payments as interest rates and the macroeconomic climate change."

"The U.S. economy has weathered such episodes before without experiencing significant declines in the national average level of home prices. Nevertheless, we certainly cannot rule out declines in home prices, especially in some local markets. If declines were to occur, they likely would be accompanied by some economic stress, though the macroeconomic implications need not be substantial."

Fact or Fiction?

A fictional, "what if" article set exactly two years in the future:

Real estate foreclosure crisis inspires desperate measures

Home Owners Loan Corp. II: A fable

Monday, July 18, 2005

Author's note: Home Owners Loan Corporation II was established by Congress on Aug. 7, 2007. The following is a transcript of the chairman's introductory comments at the first board meeting, held Sept. 12, 2007.

"Before we begin our deliberations on how to cope with the wave of foreclosures sweeping the country, a word about our predecessor institution.

The first Home Owners Loan Corporation (HOLC I) was established by Congress in 1933 to help families avoid having their homes foreclosed in the worst depression this country had ever seen. HOLC I refinanced loans of borrowers with mortgages in default, or held by distressed institutions.

HOLC I largely succeeded in its mission, refinancing about 20 percent of all qualifying home mortgages in the country, liquidating itself in 1951 at a slight profit to the government. This history no doubt was instrumental in the government reviving the model this year to deal with the current crisis in home finance.

This crisis is quite different from the one faced by HOLC I. Instead of a depression, we have had an eruption of inflation, comparable in magnitude to the one we experienced in the late 1970s and early '80s. As then, the inflation has caused a sharp spike in interest rates, but the consequences of the recent rate spike have been much worse. It punctured the housing bubble, with house-price declines especially large in areas where appreciation had been strongest. New construction in such areas has been cut in half, and construction of condominiums has ceased almost entirely.

Another major difference between this rate spike and the previous one is that this time we had many more mortgages with little or no equity before prices started to drop. This reflects both the widespread use of 80/20 first- and second-mortgage combinations in the financing of home purchases, and extensive cash-out refinancing for purposes other than building equity. In addition, a substantial proportion of outstanding mortgages are adjustable-rate (ARMs), many with the option to pay interest only, and in the case of option ARMs, even less.

It is estimated that 9 million mortgages are now underwater – the loan balance exceeds the value of the property. A large proportion of those are interest-only and option ARMs, on which the interest rate and mortgage payment are rising as we speak.

As per its instructions from Congress, HOLC II will follow its predecessor in refinancing mortgages in some stage of default but not yet in foreclosure. However, where Congress set eligibility requirements for HOLC I, it has delegated this responsibility to the board of HOLC II. The only guidance we have is that eligible borrowers should be those in distress 'through no fault of their own,' and that we cover our costs over the life of the agency, as HOLC I did.

Our staff recommendations for defining eligibility are considered to be consistent with the Congressional guidelines.

1. We will only refinance mortgages on which the balance does not exceed our estimate of "long-run sustainable value" (LRSV). The LRSV will be above current market prices but below the prices reached before the crash. HOLC I followed a very similar rule.

2. Only mortgages secured by the borrower's primary residence will be considered. Mortgages on second homes and rental properties are not eligible.

3. Mortgages larger than $1 million will not be eligible.

Unfortunately, less than one in 10 of the mortgages now underwater meet these conditions. A large proportion are in what had been the hottest markets, where current prices are well below LRSVs, and balances had not been paid down because of the popularity of interest-only and option ARMs. Many of the underwater mortgages are on second homes and rental units, which had been purchased on speculation. And a surprising number is larger than $1 million, with a concentration in California.

Unlike HOLC I, HOLC II has no authority to refinance loans held by distressed institutions if those loans are not otherwise eligible. The earlier Congress was concerned about bank failures, which could cause loss to depositors – deposit insurance did not arise until several years later. The Congress establishing HOLC II had no such concerns. It took the position that lenders who loaded up on inherently risky ARMs in go-go markets should bear the full consequences of their folly."

Debtor Nation at Red Alert

Ours is a nation addicted to debt as people have decided that it is the only palatable means available to them to live the high life without actually having to work for it and earning it for themselves; an accomplishment that they could call their own. It used to be that personal debt was shameful. Maybe the new bankruptcy laws will force personal financial ethics back on our culture.

Some choice qoutes:

Debt has become part of our culture, a product of a society bent on self-gratification now and future generations be damned. Like any cultural trend, we are constantly enticed to take part. From the endless pre-approved credit card offers that fill up our mailboxes to the home shopping shows' 'painless' lay-away plans, debt is easier and easier to incur. Wells Fargo advertised a credit card with an "easy-access" line of home equity credit as a way to help pay "for everyday expenses, like gas, groceries, clothes, etc," prompting a CNN reporter to observe that today, it is possible for Americans to "eat their homes."

According to PBS' "Now," personal bankruptcy filings increased 320 percent between 1980 and 2004. As I'm writing this, a baby born in America owes $26,000 dollars worth of national debt. Students graduate today with an average of over $20,000 in student loans and credit card debt, and those who borrowed to pay for a graduate degree come out of school with a median debt of almost $46,000 dollars--up 72 percent since 1997 according to Brendan Koerner, a fellow at the New America Foundation.

Part of the explosion of personal debt was fueled by mortgage refinancing as people cashed in on low interest rates. But as much as we hear about the real estate boom (President Bush often notes that more Americans own their homes than ever before), the percentage of equity we have in our homes is the lowest it's ever been.

Add to that a consensus that federal spending and perennial tax-cutting are keys to economic growth, with little regard to what kind of spending or which taxes are cut, and you get a perfect, self-reinforcing circle of bad fiscal policy.

Budget deficits combined with a growing trade deficit and sky-high energy prices create a very real danger of an economic disaster looming on the horizon. Paul Krugman's been warning of this potential "perfect storm" for some time, but he's dismissed by conservative apologists as an "alarmist" and his calls for reform have gotten little traction. In the past year, though, he's been joined by such fringe leftists as the IMF--which warned in a recent report that America's fiscal situation could lead to a global economic meltdown. It's time someone talked about it.

People understand their own personal debts. They have wants and needs that exceed their paychecks, so they take mortgages on homes, accept a monthly car payment and run up their credit cards. But they believe that public debt is an abstraction for bureaucrats in Washington to worry about, if they're aware of it at all.

The relationship between the two begins with the fact that Americans make up one twenty-fifth of the world's population, but our consumer spending accounts for a fifth of the global economy. We purchase many more goods and services from abroad than we sell. That private consumption has remained high even as most of our wages have stagnated--meaning that it is increasingly financed with debt.

According to Business Week, overseas central banks now hold about a third of Fannie Mae's and Freddie Mac's debt. Those are government-sponsored agencies that give many Americans the chance to become homeowners, so it counts as public debt. But it's also entirely possible that China owns your living room.

It's all related. High budget deficits put pressure on interest rates. Millions of working families took second and third mortgages in recent years --we essentially spent and refinanced our way out of the last recession, and now those rates are slowly creeping higher, in part due to the budget deficit. That means that Americans will feel more of a pinch in their pocketbooks as the cost of servicing their debts increases.

Our debtor culture is an issue that doesn't fit on a bumper sticker or make for a pithy 30-second sound byte. What's more, on the consumer side you're talking about a tough, structural problem, with no easy fixes. Seventy percent of our economy is consumer-driven, and if folks started borrowing less and saving more, it would push us right into a recession.

Industry Describes it as a 'Megabubble'

It looks like most folks in the industry think there is a global real estate "megabubble".

Some choice quotes:

I gave you a 20-question quiz on June 26, focused on 20 smaller bubbles, asking you to score each from 1 to 5 in terms of risk. A score over 50 put you in the megabubble camp. See previous Paul B. Farrell.

It turns out this is a real hot-button issue. I received 1,249 e-mails, three times more than on any column I've written in eight years. I read every response.

Eighty-six percent of you scored the bubble risks at 50 or more. And 39% of you scored between 75 and 100. Only 14% scored under 50.

Many of those who e-mailed identified themselves as officers in banks, securities and brokerage firms, professional financial advisers, corporate executives, federal and state government professionals, mortgage bankers, building contractors and real estate professionals. They scored the bubble risks as high.

Comments by real estate pros stood out because the housing bubble is likely to be the lead domino triggering a global economic meltdown. Real estate respondents expressed virtually unanimous concerns about this bubble.

"This bubble is no myth," wrote one California builder who said he had "been around for decades." "Real estate will go back to the Agricultural Age. Get ready for deflation."

"Warning signs [are] everywhere," said a New York mortgage banker. "Rates went through the floor, prices to the moon. I sold everything a year ago, paid off debt. The Great Depression will look like a cakewalk."

If you believe a global megabubble is near, what's your best strategy? Cash out now, at the top? Sell real estate, stocks too, rent, pay off debt? Then patiently wait until prices drop and buy bargains? Yes, that may be the best strategy for some.

But timing is critical. So is courage!

Speculators are Doomed to Forever Blow Bubbles

This Washington Post article makes some good points:

...the theoretical argument over what constitutes a bubble doesn't help ordinary investors much. No matter how many I-told-you-so stories we hear now, a clear consensus identifying the recent tech-stock experience as a bubble didn't emerge until after its collapse -- satisfying a famous rule of thumb that bubbles are known only by their bursting.

In the making of investment decisions such as whether to buy a house in Malibu or a technology mutual fund, after-the-fact information comes too late. That's a problem, because nobody who makes those decisions can afford to ignore the issue.

In the absence of better answers, investors can at least imprint on their minds the idea that bubbles represent a separation of the market price from the basic purpose of the asset in question.

So investors can begin an informal test for bubble conditions by examining their own motives for buying a stock. If we are working from some reasoned appraisal of what the company might earn in five or 10 years, based on a study of its business model, we can hope we are on solid ground. If it's because "they're talking about a price target of $500," probably not.

So, too, with houses, which in their essence are places for people to live, not price-appreciation vehicles. It's a reasonable certainty that people will always need a roof over their heads; price appreciation is a wish, not a need.

There was a time, just a couple of generations ago, when the standard advice given to new homeowners was to depreciate one's investment by, oh, 3 to 5 percent a year in doing one's family accounts. Like cars and many other consumer durable goods, houses lost value as they aged.

How quaint, I thought even then. Time had already given the younger generation a different set of expectations about the economics of houses.

Then again, we also say "how quaint" today when looking back on assertions, widely advanced less than a decade ago, that stocks in the New Economy were going to behave differently from the way they did in the Old.

Double Bubble Trouble

This from the Orange County Register:

The convergence between long-term and short-term interest rates is one of the strongest developments in Wall Street history, says Investech Research Market Analyst newsletter (2472 Birch Glen, Whitefish, MT 35997). "Either the bond market's aberration [referring to the fact that long term rates have remained stubbornly low which Greenspan has called a 'conundrum'] will be reversed by a sharp upward spike in long-term rates by year-end, or astute bond vigilantes are anticipating the deflationary fallout of a bursting real-estate bubble or a more serious economic slowdown. Whichever takes place, the outcome may not be painless for investors."

Denver is on the Edge of the Cliff

Three months ago I had a very "heated" debate with someone from Boulder, CO about how real estate is such a great investment and how prices will never go down. There was no talking sense into her as her reasons included familiar themes such as "this is God's country" (I thought that one was reserved for Marin; I guess not), "everyone wants to live here", "the weather is really good", "it's pretty", and so on and so forth. Well, according to this article Denver's real estate market may very well be a model for California and all the other bubble areas.

Some choice quotes:

"Denver's homeowners are learning the hard way about living through the real estate doldrums. Five years ago, median house prices were rising at an annual clip of nearly 17 percent. By the first quarter of 2005 the increase had slipped to 3 percent, according to an analysis by Economy.com, a research firm."

"Although sellers continue to profit, houses are sitting on the market longer, buyers are negotiating harder, and some owners, particularly young buyers who may have been counting on rapid appreciation, are postponing dreams of renovations, moves to larger homes and big savings for their families."

"With economists warning that prices in hot markets cannot continue to rise as sharply as they have in the past few years, the experience of Denver's homeowners may foreshadow what could happen if those markets start to cool."

David Lereah is the eternal real estate cheerleader --

""I think it's a good example of when a market softens, what happens," said David Lereah, the chief economist of the National Association of Realtors, a trade association. "You see double-digit price appreciation go down to 4 percent or even 1 percent, and then it starts coming back to a historical norm of between 4 and 6 percent. That's very healthy. That's wonderful. It beats inflation.""

"But many analysts take a gloomier perspective, suggesting that the most heated markets could suffer more than Denver's so-called soft landing. "I think Denver is a best-case scenario," said John H. Vogel Jr., adjunct professor of real estate at the Tuck School of Business at Dartmouth College."

The "buying up" cycle is broken (when first-time house buyers are out of the market, the entire market collapses):

"But for other homeowners, the calculus of the 1990's that might have led them to trade up quickly no longer applies. "When the market was strong, somebody would move up to a nicer home in two years because they had so much equity," said Karen Snyder, an owner of Metro Brokers Right Realty in Centennial, a suburb southeast of Denver. Now, she said, "they're just staying put.""

People are clueless about what has been happening. I guess they should have been reading more RE related blogs:

"Mr. Salazar, 30, said he was shocked that the house had appreciated so little. "I was thinking the market was going up because this is such a nice area," he said."

"Local analysts say it was inevitable that surging prices would not last."

Since when was this "inevitable"?! Everyone's been saying RE always goes up, it's the best investment one can make, yadda yadda yadda.

"In fact, analysts say the Denver market has remained as healthy as it has because of low mortgage rates as well as creative financing, including no-money-down and interest-only loans. Interest-only loans have accounted for a high rate - 42 percent - of purchase loans over $360,000 in Denver this year, according to LoanPerformance, a mortgage data firm."

"That unnerves some economists, who say that even with appreciation of less than 5 percent, Denver's housing prices may be overvalued."

""I think it is a very frothy market," said Tucker Hart Adams, the chief economist of the Rocky Mountain region for U. S. Bank, adding that those who bought homes with interest-only or variable-rate mortgages could be vulnerable. "When rates start moving up, they're going to see their payments go up," she said. "When people start getting nervous and start to sell, it's a downward spiral."

So what will be the catalyst for the Bay Area in general and Marin in particular? Or are we going to be just like the folks in Denver and believe our own stories about why we are special?

House Poor

Here's a worthwhile article by Bill Bonner. Some choice quotes:

"In California, the typical person lives in a box with neither grace nor charm. But it is worth $522,000, according to the latest figures. The man figures he is half way to being a millionaire. He might as well spend a little of his fortune, he believes, before it gets away from him. And so he "takes out" what Benson calls the "phony equity" and uses it to improve his standard of living. Which is to say, he spends money. Whether the spending actually improves his quality of life or not is hard to say. Until now, he didn't have to worry about it. The money was almost free. It came without work or sacrifice. Getting rid of it as fast as possible only seemed appropriate.

But there's nothing quite as expensive as free money. Home ownership has reached a record 69% in the U.S. Trouble is, the homeowners don't own much. Most houses are heavily mortgaged. As many as one in ten "homeowners" have no financial stake in their houses. A typical mortgage payment for a typical California house is over $3,000 a month. You would need an income of $122,000 per year to get a conventional loan for that amount. Not many people earn that much; it's more than twice as much as the median family income. That's why many people are spending half their income on shelter. But as long as prices rise, they don't worry about it.

It's when prices stop rising that real values show up. Then, the homeowner has only the expenses...and the debt...to think about. Then he begins to wonder what it's really worth to him to live there.

How much? We don't know. But the value of the typical California house is probably much less than today's asking prices."

Here's a chart from the blog CalculatedRisk which shows just how little California houses are worth relative to their sales price ("real price" is the "nominal price" adjusted for inflation less Shelter):

North Bay Area Realtors Reluctantly Admit Slowing

It is rare for a real estate agent to actually admit that maybe things in the housing market won't be as rosy as they have recently been. And it's usually laced with understatement and wishful thinking. But here in la-la-land, aka Marin, it's notable:

"'There are three things we have been seeing which make us believe that the market is calming down a bit,' says Perotti from his office in Larkspur's restaurant district. 'The price per square foot for a home is beginning to drop in Marin. As in the rest of the state, we are also seeing an increase in the average number of days a house stays on the market, which indicates the overall market is slowing a bit. The other thing is more of an educated guess, but you have to know that these interest rates will rise in the next year, and that move will take some buyers out of the market.'"

"The only segment of the market that has slowed is over $2 million. If it is $550,000 or under, it flies." [Last year, if it was under $900K it flew. So now it's if it's under $550K?! I have personally seen $2 million houses drop 40-50% both this year and last.]

"We are doing a lot of training with our staff right now, getting them ready for 'The Talk."

La-la land for sure:

"We are seeing a different buyer in the market now. They want the low interest rate, the low payment, but they don't really think about what it is going to take to pay it off. They just want into the market and seem to think that it is all going to work out."

Wishful thinking and denial:

"Most everyone agrees that the Fed will not raise interest rates any higher than a point over the next year; they are being very careful," he says. "And even anticipating a raise, there are still plenty of buyers out there who want to get into the market. At this point, I don't think a bubble is a concern."

The first indicator of a local real estate market beginning to bust is a reduction in sales volume. Here's Marin County's for the last year (note: this is a real estate industry backed report, so take it for what it's worth):

Will Hedge Funds be Blamed?

Are hedge funds starting to get set up to be the target of the inevitable blame game? After all, we can't blame the Chinese because we depend on them to finance our debt-based life-styles. Can't blame the current Administration because that is not "politically correct" and besides, we're in a war. Can't blame Greenspan because he's been talking out both sides of his mouth about the bubble and is ready with the "well, I told you so". Hedge funds. Yeah, that's it. No one likes hedge funds; they short markets.

Bubble? What Bubble?

The lame, pseudo-contrarian argument that people like to pander about which claims that 'there cannot be a housing bubble if everyone knows there is a bubble' is bogus because so few people are aware that there is a bubble.

"... [a] National Association of Realtors... poll found that only 23% of respondents had heard of a housing bubble, and that lots of people didn't even understand the "bubble" part of the question."

People are just in a state of profound denial typical of the end of an asset bubble:

"It's obvious that no one likes to hear comparisons between home prices today and the stock market bubble that burst in 2000. The obvious differences between real estate and equity shares duly noted, there is one undeniable and disturbing similarity, to wit: During the stock market bubble, traditional valuations did not matter to shareholders. Valuation matters only if you believe that the stock's price should reflect the worth (or value) of the company. But stock investors could have cared less about value. They were willing to pay outrageous prices because they believed a greater fool would pay a more outrageous price later on."

The argument that we are experiencing a housing bubble is nicely made by the following two graphics (source of first graphic; I've lost track of the source of the second):