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Monday, October 23, 2006

Bubbles, Fixing To Pop

Casey's on the ball and Dean is going mean for green. Ya wanna know who makes money in down RE markets? Sharks & swindlers. My guess is that Rich Dad is a shark, which means Casey is chum. Or you can go into the auction business. SDCIA's troll thread is getting action from regulars posting comments like:
I spoke at the Inland Empire Investment Club on Sept 26, 2006.
A couple of investors told me that housing prices for Temecula had dropped by 10-12% in the past 3 months.
I have already seen a 15% decrease in entry level condos in Palm Springs. This is a very different number that what the NAR seems to think it is, but what do I know.
I would like to continue investing in real estate but I don't believe anyone can make money in the real estate market right now. I can't wait till prices come down to the point that purchasing property is an investment.
About 18 percent of all mortgages issued in the first half of the year were to borrowers considered most likely to default, such as those with high credit-card balances, up from 2.4 percent in 1998, based on data from the Mortgage Bankers Association.
Be careful if you have a low mortgage balance; I have been hearing things about servicers trying to make their accounts more profitable. Check your statements and make sure your payments are being applied correctly. Also, don't believe anything you get from a lender on your housing value. Some of these "automated valuation systems" are producing stratospheric estimates - which does explain a lot. When I say "stratospheric", I mean 30-45% overvaluations.

The Housing Bubble Blog continues to have a good roundup of RE stories. You have to read about 16 or 17 of them to get the full impact of having very negative facts explained in a very positive way. It's a brave new world of American real estate, exemplified by predictions of future price drops less than the price drops that have already been reported. For example, from the Bloomberg cited article above:
Even with the gains, the National Association of Realtors this month predicted prices of new homes may fall for the first time in 15 years. The trade group on Oct. 11 estimates that the median price of a new U.S. home probably will drop 0.2 percent to $240,500.
The New Homes report released in September by the US Census had the median new home price at $237,000:
The median sales price of new houses sold in August 2006 was $237,000; the average sales price was $304,400. The seasonally adjusted estimate of new houses for sale at the end of August was 568,000. This represents a supply of 6.6 months at the current sales rate.
From my point of view, all of this has taken on a fascinating surreality. The fact remains that prices are falling over most of the country, and that with this many months of supply on the market, prices can't rise. There is a huge amount of statistical uncertainty in those Census figures, but the Purchase Money Index from MBA is a strong statistic. The best place to track it is on Hanley Wood because they give a year over year comparison and their latest is:
...the MBA’s seasonally-adjusted Purchase Index increased slightly to 384.7 from 383.3 the previous week. The latest number is up just 0.37 percent from last week but down 23.66 percent from the same period a year ago. This is the second straight week the purchase index has remained below the 400 level mark.
And the four week moving average declined. There was a brief uptick in September, but now it's gone.

About the signficance of that 18% statistic cited by Bloomberg? It indicates that 2007 should be a very, very interesting year indeed, because these loans are already showing high delinquency rates compared to historical averages. MBA's delinquency measures summary from September shows just how segmented the risks are in this market:
Compared with the second quarter of 2005, the delinquency rate increased 51 basis points for prime ARM loans and 220 basis points for subprime ARM loans. The delinquency rate decreased 2 basis points for prime fixed loans, while the delinquency rate for subprime fixed loans increased 17 basis points.
220 basis points equals 2.2%. However, the second quarter was too soon to see the full impact of a tightening market. We will see the full effects early next summer in these figures. Three months (one quarter) in a down housing market is a very, very long time indeed. Second quarter delinquency rates hadn't increased significantly, although the higher subprime origination rates mean that next year we are doomed to see a rise in delinquencies. Delinquencies are concentrated in subprime and adjustable rate loans:
All adjustable rate (ARM) loans had higher SA delinquency rates compared to the first quarter of 2006. Fixed rate mortgage loans (FRM) were either unchanged or saw a decline in delinquencies. The SA delinquency rate for prime ARMs increased 40 basis points (from 2.30 percent to 2.70 percent) and the rate for prime FRM loans was unchanged (at 2.00 percent). The rate for the subprime FRM loans decreased 38 basis points (9.61 percent to 9.23 percent), whereas the rate for subprime ARMs increased 22 basis points (12.02 percent to 12.24 percent).
The comparisons above are to the first quarter, not 2005. The problem is that the quality of the loans originated has been plummeting, and now the borrowers will usually be unable to sell out of delinquency (because they can't clear enough to pay their debt), so the underlying delinquency rate will now stay in the portfolio and escalate, whereas in prior years it didn't. Anyone who can is refinancing into fixed or better loans, so the quality of the remaining ARMs is getting worse.

2007 is going to make 2006 look like a fond memory; 2006 was largely the product of the speculators stopping their wave of purchases. That produced a pretty consistent 20% year over year decline in purchase money apps during the last six months and the beginning of price declines. It will also produce an economy running near stall speed by the beginning of 2007 with pockets of definite recession. Moving into 2007, we will see the beginning of widespread credit tightening, a slower job market, localized high unemployment rates, a demographic panic as the 60 and over crowd try to figure out how to escape high property tax rates in the wealthier sections of the country, and a slowly increasing recession. We will end 2007 with higher unemployment I am guessing will be reported as somewhere near 5.3% (our unemployment rate is beginning to be masked by the demographics, workers 60 and over simply retire), and a set of unattractive options, especially at the blue state and local level.

Of course, all of this carries with it an increased risk of attacks by splodey dopes of the Islamic variety who will hope to exploit our problems. Whether the recession will be easing or deepening in 2009 will depend on our public policy. If we cannot develop healthy investment in the US, things are going to get ugly. This moving from one bubble to the next cannot continue, but there is underlying strength in the US economy that is not being exploited. The real cause of all these bubbles is a lack of profitable longterm investment options, causing money managers to stampede from one crest of the wave onto the next rise. Being better at knowing when to get off the risk boat than the average guy does not lead to the types of investments that build an economy.

If we could unload the worst excesses of our environmental public policy, we could begin to redress our trade imbalance very quickly by building power plants of all varieties and drilling for oil. This recession will be a consumer-led recession combined with a great capital reserve in the portfolios of the boomers. If their assets could be invested in new construction, we could emerge from the other side of this in much better fundamental economic shape. If we don't change our policies, things will become grim indeed by 2012.

I feel no sympathy at all for people who lose money in RE. Suddenly, what? Speculators shouldn't lose? You buy a house to live in, not make a killing on some time in the future, at least this is the way it was til about twenty years ago. Any time speculators dominate a market that market will rise dramatically, be it stocks, commodites or real estate. RE bubbles bursting brings down prices so people can afford real estate products. Stop whining about falling values like the government should underwrite your "speculations." The one thing I've noted over the years about civilian investor-speculators is that all of them want to buy something and then stand aside and watch it grow; then they can sell and make a profit. Put all your eggs in one basket and then watch that basket.
Since I'm not a specuvestor I'm not whining. I'm sorry for the poor idiots who got caught in the mess. There are a lot of first-time homebuyers who are going to take a bath.

It's unavoidable, and the government can't fix it. But you know how you keep writing about wrath? This are times that will try our domestic tranquillity.
Afternoon, Mama. Just back from my afternoon ride ( 2hrs, 175 watts, 128 HR). We had our weekly risk meeting. The Mortgage guys were saying they can't get enough product. The demand for loans of all quality is overwhelming. If that remains the case, I think the housing selloff will be muted. now that's a big if. It's interesting to note, that this is the first significant tightening cycle in the past 40 years that has not resulted in a financial crisis. That is, not yet.
CF - but in all economic equations, there are two sides to the equation. Right now your mortgage guys are faltering on supply, which explains why 18% of the mortgages written in the first half of 2006 were classed in the "most likely to default" category. Basically, the pipeline is drying up.

Wait 5 months; TSHWTF. You are going to see a wave of very early defaults that's going to be a shock and awe type of deal for all those who can count.

People have basically been borrowing against equity in their homes in order to pay their mortgages, and in many cases it has been non-existent equity. I think the US economy is short the ability to pay about 1.5 trillion in new mortgage debt (half the increase between 2002 and 2005), and population that could pay the debt isn't willing to buy on the terms offered.

Jest you wait, 'enry 'iggins, jest you wait.
PS: I own an exercise bike too, and sometimes I amuse myself while pumping away by trying to calculate my contribution to global warming. After all, I breathe in O2 and exhale CO2. My sharply increased respiration rate is clearly a contributing factor to Gaia's coming demise. I bet she's mad.

I hope you feel guilty for melting the oceans now!
Evening Mama; OK, I'll spot you the 5 months. If you're correct about the 1.5 trillion number, that's going to turn a few heads. I wouldn't bet on it, but I seem to remember the S+L bail out was like a third of that. People buying the low credit quality loans is just another expression of a massive short volatility trade the street and hedge fund world has on. It's been my policy to never allow short vol trades. Perhaps (Besides my charming personality) that's why I'm still here. If liquidity ever dries up, the fireworks will make it into the next edition of Popular Delusions and Madness of Crowds. That being said, at the moment nothing feels stressed. The Amaranth thing came and went without a burp. Maybe I'll buy some 1 yr vol 6 months forward.....

About the bike.... I love it. I train 10-15 hours per week, and do 8-10 races a year. As far as the guilt goes, I've got a Jewish Mother...I'm immune!
Yes - the volatility kick is a sort of cheap way to make money. But it catches up with you. The Amaranth crash will have effects, but not the widespread groundlevel effects of the housing credit bust.

I've backed into this 1.5 trillion number three different ways, so now it's worrying me. I do hope I'm wrong.

Read the comments on this Calculated Risk posting. Note the descriptions of the people that various west coasters know. Casey's not that rare out there.

Also, see the comments on this Piggington thread.
But I am definitely beat on the Jewish mother/guilt issue.
I'm not too proud of the way I ran my loans... but I still think there is an honest way to make buck fixing-n-flipping real estate.

With the RE market going down, the speculator are going to leave the field and those who learn to be smart buyers (deep discount) of the right inventory (starter homes) and have a way to sell fast (creative marketing) will make a bunch of money.

I'm trying to learn from my mistakes and do it right.
Casey - in a market like this, you need capital to make money fixing and flipping. The people who do this for a living are getting out, and the sharks and swindlers are getting in. Casey, you are going to jail if you don't snap out of it, and you may even if you do. That USA Today article was suicide.

I would strongly recommend that you start birddogging for contractor firms in your area. Cruise neighborhoods and look for work that needs to be done. Go up and knock at the doors and introduce yourself. Talk to the homeowner. Start up relationships with contractors of various types who have no bad knocks on Better Business Bureau, have letters of recommendation, current business licenses, etc.

You can sell these leads to these firms. They will all be scratching for business shortly, and you could make a good living doing this if you work hard at it. It requires only hard work and almost no capital. You will need a cheap, fuel efficient car, shoe leather and a good work ethic. Perhaps the prospect of jail could inspire that last.

That's the best shot you have, kid. If you handle this properly, within six months you could be earning good money. If the contractor gets the job, follow up on it with the homeowner. Hand out cards. You will make most your contacts with older people, and they will pass your name along if it worked well and you check back up on them to make sure it did. Make sure you only sell leads to established contracting firms with a good record.

Casey, if you ever signed a HUD omitting cash back payments from the seller to you, you are going to jail unless you get out of the country. Or, alternatively, they may sentence you to jail and then deport you. I'm not asking you if you did, okay? But if you did, your best option is to leave the country now.

This is inspired purely out of middle-aged kindness. You have bilked a bunch of people Casey, and you do not need publicity.
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