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Friday, September 15, 2006

Just Trying To Figure It Out

I wandered over to this WSJ Fiscally Fit article about a couple looking for a house in northern NJ, and it contained a link to the Fiscally Fit forum and the discussion on the article. H/T The Housing Bubble Blog?

The forum is particularly good because it contains a lot of advice and anecdotes from people who have made money on real estate, such as this one:
We have a house in El Dorado County and Zillow says it's worth $534,000.

I'm a broker (not for El Dorado County) so I watch the market like a hawk and I can tell you that El Dorado County is a buyer's market.

I don't mean a neutral or what realtors like to euphemistically like to call a "balanced" market.

It's an all out buyer's market, without a lot of active buyers, with the streets littered with for sale signs and I get Realtytrac foreclosure bulletings weekly for that area.

So Seller and Buyer beware of Zillow.com. If we had to sell our house today, I would not list it for more than $434,000, i.e. $100,000 LESS than what Zillow claims.
(I second that. Zillow seems way off in some cases.) And this comment:
I'm a broker in both CA and AZ. Most of my life was spent in southern CA and I, like another person who replied have always made money in buying and selling SoCal real estate (LA and San Diego). However, I came into the market back in 1981 with 17% interest rates and really couldn't afford to buy my first condo in San Diego until 1987 when rates were around 9-10% and the late 80s real estate boom got wind in its sails. I vididly remember lines of people camping out for 2-3 nights in front of new development sales offices hoping to get into a lottery to buy a house. I quickly bought and sold two homes almost doubling my money on each. By the luck of the draw I was transferred in late 1989 to the east coast and my employer bought my last San Deigo home under a relo contract for 50% more then I paid for it 8 months earlier. In January of 1990 (2 months after we closed escrow) the bottom fell out of the market and prices in SoCal dropped 40% almost over night. Sidenote: most younger real estate agents and mortgage brokers don't remember and don't believe that such a precipitous drop could happen. One of the reasons for the crash in SoCal was the fall of Soviet empire and resultant collapse of the aerospace/defense business which was a mainstay of SoCal employment since the 1950s. The market stayed depressed for about 6 years before the market started to turn up again. I actually transferred back to San Diego in 1994 and bought my same house back for 1/3 the price I sold it to the relo company 4 years earlier. I then bought a condo 1 block from the beach in 1995 for $300K after it had been on the market for over a year. I sold it in early '98 for $475K. The person I sold it to sold it in 2000 for $700K, that buyer sold it in 2002 for $985K. Last summer (2005) that same 1,400 sq. ft. condo sold for $1.595M!!!. There's no way on earth that a condo could or should ever go from $214/ sq ft to over $1,100 per sq. ft. in a 7 year period. Maybe over 40 years, but not seven! I could cashflow the beach cono as a rental at $300K, there is no way one could do so at $1.6M. Bush/Greenspan propped up the economy with low interested rates. Lenders and appriasers once again got greedy and sloppy in their practices. My prediction is that barring no external inputs (earthquake, terrorist attack, etc.), prices will continue to slide month-over-month and by this time next year we'll see a repeat of the S&L crisis and the forclosure will be rampant in markets like SoCal, Boston, etc. The absolute numbers are so much bigger this time around. The use of securitiziation in the mortgage market may cushion the impact on the financial markets persay, however the individual homeowners are going to ake the full brunt of the falling prices. Long story short for SoCal; start looking for your dream home today, be patient, and over the next 12-24 month you'll be able to buy it for 40-50% less! That $1.595M condo isn't worth more then $750K and the bank will sell it to you at that price as an REO.
I hope this poster is wrong, but I think the downdraft on pricing is building. There's other knowledgeable advice in the thread. I know a lot of people are trying to figure out what to do. If that's your situation, maybe this will be helpful. I think the big losses will be concentrated in areas with particular negatives, such as high investor participation, higher costs (taxes & property insurance) and/or bad demographics/job market. So don't get too scared. I have been looking at Sacramento, and it seems to me to have lost at least 10 percent.

A lot is being written about foreclosures, but they are still low (except in a very few areas), historically speaking. I do think there will be quite a few of them, but we haven't seen it yet. Good perspective at Inman.

The story of this year has been continuous cuts in oil demand forecasts. Crude went below $63 today after OPEC cut its forecast. Then they rose again, but the trend is still lower. FRB said US industrial production declined in August. Industry capacity utilization fell, but it is still above historical highs. See the Chron.com article on oil here. If gas prices continue to fall, we may be looking at a large overall stimulus to consumer spending for basics, and a potential backstop to the effects of the housing problem. We'll see. These oil prices were always speculative (compare April to September), and in some luxury sectors on the coasts it seems as if a recession has already begun.

But isn't the real story the auto industry wreck? It's hard for me to believe the optimistic forecasts that predict a slowing of growth rather than a recession, because if both housing and autos are in trouble, what is left? How does an economy overcome that? The only way is by accelerating other types of production, and there is nothing pending now that could possibly pick up the slack. I still think asset deflation is the economic theme for the next two years.

What might be the effect of non-US buyers on the RE market? Particularly in desirable areas like the Florida coast or the Utah ski areas, I'd think European buyers (for example) would be snatching up bargains and thus helping to set a floor under prices.
Hi Mama; Here's the ABS CDX run from this morning.

~06-2 Spreads ~ 06-1 Spreads
AAA 9 / 7 11 / 9
AA 15 / 13 15 / 11
A 50 / 46 49 / 44
BBB 140 / 134 125 / 118
BBB- 250 / 242 235 / 227

How do you think these spreads look relative to your forecast of house prices?
David - last year there was already huge foreign speculation buying in many FL areas. Miami, in particular. Since Miami seems to be leading the way down, I'd say not much more effect on foreign buyers. The foreign news has been far franker than US news for months on the risks, and I notice that a lot of Europeans with an interest seem to be hanging at some of these bubble blogs.
Churchill Fan,
I do have confidence that economies are somewhat predictable if you know the interactors influencing them. But I don't think we know the fundamentals on even the next set of interactors this time, so bonds and derivatives may offer relatively little reliable information. Also, when derivatives and credit swaps so dominate a market, risk information can easily be lost.

However, when I see 9/14's TCM yields:
3-month 4.95
6-month 5.12
5-year 4.74
7-year 4.75
20-year 4.99
30-year 4.92,

I say to myself "No one knows what's happening." To me this is the sign of turbulence and unpredictability indicating that we do not know and cannot properly assess risk. Then I look at CD rates, with the six month and 5 year showing small increases from last week, and I say to myself that the flux points are six-nine months and five-seven years. This also tells me that no one knows what's going to happen, and that the basic uncertainty is near-term recession and mid-term depression/deflation.

The depositories are all scrambling for deposits, and I don't think that's a healthy sign.

I'm beginning to wonder if the high-risk tranches (whether officially designated as such or not) aren't sequestered in held portfolios in various firms which have accepted holding the risk because of the very high immediate and intermediate profits on selling the profitable segments and the ability to report phantom income in the near-term. If so, the market has relatively little information with which to work.

The massive shift in mortgage financing over the last five years has left us with little historical correlation to various technical indicators, so I am concentrating on whatever actual market information I can glean.

As for setting floors, if NJ goes much lower I will say that there is no long-term floor that can be set higher than a 35% drop, because the combination of the highest income state having relatively severe housing deflation is an indicator that public debt has overtaken that economy, and NJ is not that different quantatively than CA or areas around DC. Of course, that would mean something like a depression is possible.

We have clearly reached a ceiling. (Is Golden West going to go to .05% interest on their option ARMS? I heard they're back down to 1.5% already.)

The interactors dictating a floor are unknown. One of them definitely is how many people are (like me) financial conservatives who will buy in when they see real value. I have asked several people in this blog and others whom I know in real life, and they all seem to be looking below 30%. This is not a good sign.

And one further note: last year I was trying to get some of my banks in FL to at least consider modifying their HELOC terms and lending limits based on the property insurance problem ALONE, and I did not succeed. I was deeply disturbed by the combination of high LTV's and high property insurance deductibles.

This means to me that the entire market had reached a point of cohesive irrationality that wiped all information out of the financial system. It is the areas that are seeing the high property insurance combined with massive tax hikes, combined with overbuilding and speculation that are producing the 40% drops out there. This was entirely predictable last year.

One of my private indicators is early retirements by bank execs, and that index is off the scale.
Hi Mama, thanks for sharing your thoughts. I think Wall Street is to blame- now hear me out on this. Remember back pre 2000 NASDAQ crash, there were 1500 stocks covered by the street, 1490 buy rec's and 10 neutrals? Well the new gig in town is Hedge Funds. Something like 1/3 of the street's revenues are from the HF's. Goldman Sachs has a staff of 5 just to find new HF's office space. The funds, eager to put a return on capital, in a low return environment, have taken to selling volatility. There are various ways they're doing this. But as it relates to the mortgage market, it's buying the junk pieces as you suggest, and hoping the high yields will help them "Beat the clock" before something goes wrong. I'm sure the flat curve is hurting that approach. The CDX run I sent you yesterday is another way they can get short vol and earn the carry without getting they're hands dirty clearing the actual mortgages- and not even put up any margin in the process. If real estate prices drop by more than the 35% your suggesting, than the problems in the street will make LTCM look like a graden party.
Churchill Fan, the research that I've been doing all tends to support your conclusion. Junk RE bonds can be made profitable to financiers in the short term, but the mortgages destroy wealth of the homeowners and the idiots who eventually end up with them.

I'm starting to suspect that this is Enron on a larger scale.
Morning Mama. Perhaps you can give me some suggestions how to profit from the coming debacle. I've tried being long the curve when 2/10's got close to flat, but with the negative carry it's tough to hang on to. Same problem being long Credit Default swaps. Those to me are the most obvious ways to profit from a real estate led slowdown. It's unusual to see the curve flat when the front end has eases priced in the red euros.
I think the uncertainties are such that it would be hard indeed to know how to profit from this, other than by making sure your own cashflow is sound. If the worst happens, there will be plenty of investment ops out there. If it doesn't, sitting on the sidelines for a while will not kill you.

I also have a rule that I will not seek a profit directly from disaster. I think this is the error that the street has made in this instance. It believed it could control the risks by credit swaps, etc, instead of by avoiding unsound investments. Well, I think the brilliant ones stand a good chance of getting bitten in the butt by reality, because one simply cannot profit overall from any investment practice which strips money away from the rank and file to a large extent. These mortgages that were made knowing that the borrowers couldn't keep up with them without pulling $ out of equity were always going to end up by pulling money out of the economy.

I sure hope that this lesson is relearned quickly and well.
Thank you Mama; To be flat is a position, too. Don't get your hope up about the street learning any lessons. The medium changes, but the outcome is always the same. Keep up the good work. I might change my screen name to "Mama Fan"!
CF, thanks for your kind words, and don't change your screen name! I like to think of Churchill's superior ability to confront reality, especially at this time.

I don't feel very good about my failures in this area, and I think it says a lot about how we got here.
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