News - Rancho Murieta residents left on shaky ground - sacbee.com: "Dozens of Rancho Murieta homeowners have been left with cracked walls and listing foundations after local builder Reynen & Bardis said it can no longer afford to fix their defective houses."
More victims of the housing slowdown. Their homes were built on expansive clay soil, which undermines the foundation. The builder is trying to sell other homes in the neighborhood, for less than the previous buyers owe, so affected owners can't sell. Potential buyers may not be able to get a mortgage for a home with foundation problems. And this is a case where the builder seems to have some good intentions - they tried to fix many of the homes, and bought many of the homes back. But they ran out of money before they fixed them all.
There are pictures, too.
It's gettin' downright dangerous to buy a Sacramento home these days.
Friday, February 22, 2008
Thursday, February 21, 2008
Government to citizens: Ef you
Foreclosure prevention plan under attack - Feb. 21, 2008: "Both the Emergency Home Ownership and Mortgage Equity Protection Act of 2007 and the Foreclosure Prevention Act of 2008 aim to provide relief for some home owners in bankruptcy. Only borrowers who live in their homes and hold subprime or non-traditional mortgages, like interest-only loans, would be eligible."
The proposal is to allow Bankruptcy judges to "cram-down" the balance on a mortgage, reducing the amount the borrower has to pay. It only applies to risky loans.
The moral of the story, kiddies, is don't bother doing the responsible thing. Responsible folk don't get any help, government only helps people who intentionally accepted a greater degree of risk than was prudent. Put 20% down, take out a loan you can afford, take good care of the house, lose your job when the housing market tanks - too bad, so sad. Put nothing down, take out a loan you can only have afforded if the stars aligned perfectly in your favor - house appreciates, you get 5 promotions in 2 years, you manage not to have another kid you can't afford, you manage to refi to a lower rate than the already ridiculously low teaser rate - the government will pull out all the stops to make your house magically affordable.
(C) 2008 All rights reserved
The proposal is to allow Bankruptcy judges to "cram-down" the balance on a mortgage, reducing the amount the borrower has to pay. It only applies to risky loans.
The moral of the story, kiddies, is don't bother doing the responsible thing. Responsible folk don't get any help, government only helps people who intentionally accepted a greater degree of risk than was prudent. Put 20% down, take out a loan you can afford, take good care of the house, lose your job when the housing market tanks - too bad, so sad. Put nothing down, take out a loan you can only have afforded if the stars aligned perfectly in your favor - house appreciates, you get 5 promotions in 2 years, you manage not to have another kid you can't afford, you manage to refi to a lower rate than the already ridiculously low teaser rate - the government will pull out all the stops to make your house magically affordable.
(C) 2008 All rights reserved
Wednesday, February 20, 2008
To Buy, or Not to Buy? Moral hazard, or prudent risk management?
Janie and Bob, a fictional California family, own a home. Well, they own 2/3rds of a home, and a bank owns the other third. They have a 15-year mortgage, and they've made home improvements using a combination of cash and a HELOC. Janie and Bob paid off the HELOC. They have a good bit of equity. They have virtually no tax break, because their mortgage is very low and they can't deduct state taxes under the Alternative Minimum Tax.
They want another house - a little larger, but, most importantly, closer to school and work. They can afford a larger payment, but they're not willing to pay a great deal more - their current house is affordable and puts a roof over their heads. Anything more is nice-to-have, but not a true necessity.
If Janie and Bob sold their house and bought another, they could "liberate" equity from the current house, making the minimum down payment on a larger house. If the new house drops in value, they could ask the bank to renegotiate the mortgage balance to the lower value. The bank might not do it, but I used to think they would never, ever do a thing like that, and now banks are renegotiating mortgages in all sorts of "creative" ways. With the cash from their current house, and California's non-recourse mortgage loans, buying a new house would protect Janie and Bob's equity by cashing it out, while shifting the risk of further price declines to the bank. Heck, they could buy a house in another state for cash, and walk away from the new house if they wanted.
This is the "moral hazard" of low-down, non-recourse, renegotiable mortgages. It's like buying an option on a house for 3% down - Janie and Bob get all the upside profit, the bank gets all the downside risk and the only thing Janie and Bob stand to lose is their downpayment and their credit rating. With $100k in the bank from selling the old house, a bad credit rating wouldn't hurt that much.
Even contemplating such a move feels wrong, but then I think. People like Janie and Bob - who save, invest, watch their expenses, drive sensible cars instead of fun cars, and basically try to be financially responsible - pay the taxes to cover the costs of bailing out homeowners who weren't as responsible and thoughtful? Shouldn't Janie and Bob ensure their own family has at least as much protection and benefits as the people their taxes support? Shouldn't responsible citizens receive equal or greater protection under the law?
The homeowner with little or nothing down receives the benefits of homeownership in return for their interest payments, but the also receive a sort of pricing insurance. If the home devalues, the homeowner with no skin in the game doesn't have to keep making high payments, they don't have to pay off the loan deficiency to sell, they don't have to stay tied to a house that no longer works for them, waiting for the loan to stop being "underwater". Janie and Bob pay market rate on interest, but they don't get that free price-level insurance because they have too much equity invested. They are self-insuring the part that's paid off.
Should Janie and Bob buy a house, knowing they might default, but knowing they'll have a lot more cash as a result? Or should Janie and Bob stay in a house they don't love, in a location they don't love, because honoring a contract is the right thing to do? Forget for a moment the debate about whether the government should intervene in the housing market - accept the fact that government is intervening - what should a responsible family do? Suck up the higher taxes that will result, or grab their own brass ring while the grabbing's good?
Would it change your opinion if Janie and Bob were going to use the cash from the old house to finance their retirement? What if they used it to send their kids to school? What if they used it to pay for live-saving medical care for a child? What if they used it to buy a Hummer and go on that honeymoon they always dreamed of? What if they used it to pay the new mortgage for several years? Does it matter? Are they dumb for leaving their equity at risk, or immoral for shifting the risk to a lender?
They want another house - a little larger, but, most importantly, closer to school and work. They can afford a larger payment, but they're not willing to pay a great deal more - their current house is affordable and puts a roof over their heads. Anything more is nice-to-have, but not a true necessity.
If Janie and Bob sold their house and bought another, they could "liberate" equity from the current house, making the minimum down payment on a larger house. If the new house drops in value, they could ask the bank to renegotiate the mortgage balance to the lower value. The bank might not do it, but I used to think they would never, ever do a thing like that, and now banks are renegotiating mortgages in all sorts of "creative" ways. With the cash from their current house, and California's non-recourse mortgage loans, buying a new house would protect Janie and Bob's equity by cashing it out, while shifting the risk of further price declines to the bank. Heck, they could buy a house in another state for cash, and walk away from the new house if they wanted.
This is the "moral hazard" of low-down, non-recourse, renegotiable mortgages. It's like buying an option on a house for 3% down - Janie and Bob get all the upside profit, the bank gets all the downside risk and the only thing Janie and Bob stand to lose is their downpayment and their credit rating. With $100k in the bank from selling the old house, a bad credit rating wouldn't hurt that much.
Even contemplating such a move feels wrong, but then I think. People like Janie and Bob - who save, invest, watch their expenses, drive sensible cars instead of fun cars, and basically try to be financially responsible - pay the taxes to cover the costs of bailing out homeowners who weren't as responsible and thoughtful? Shouldn't Janie and Bob ensure their own family has at least as much protection and benefits as the people their taxes support? Shouldn't responsible citizens receive equal or greater protection under the law?
The homeowner with little or nothing down receives the benefits of homeownership in return for their interest payments, but the also receive a sort of pricing insurance. If the home devalues, the homeowner with no skin in the game doesn't have to keep making high payments, they don't have to pay off the loan deficiency to sell, they don't have to stay tied to a house that no longer works for them, waiting for the loan to stop being "underwater". Janie and Bob pay market rate on interest, but they don't get that free price-level insurance because they have too much equity invested. They are self-insuring the part that's paid off.
Should Janie and Bob buy a house, knowing they might default, but knowing they'll have a lot more cash as a result? Or should Janie and Bob stay in a house they don't love, in a location they don't love, because honoring a contract is the right thing to do? Forget for a moment the debate about whether the government should intervene in the housing market - accept the fact that government is intervening - what should a responsible family do? Suck up the higher taxes that will result, or grab their own brass ring while the grabbing's good?
Would it change your opinion if Janie and Bob were going to use the cash from the old house to finance their retirement? What if they used it to send their kids to school? What if they used it to pay for live-saving medical care for a child? What if they used it to buy a Hummer and go on that honeymoon they always dreamed of? What if they used it to pay the new mortgage for several years? Does it matter? Are they dumb for leaving their equity at risk, or immoral for shifting the risk to a lender?
Tuesday, February 19, 2008
Bank owned, falling apart, and stripped
I am pretty handy with a hammer, and, if it weren't for time constraints, we'd probably build a custom house. So "bank-owned" and fixer didn't scare us off. Besides, I love the charm of old houses and despise cookie-cutter "semi-custom" tract home neighborhoods, but find truly custom home neighborhoods pretentious.
We saw an interesting houses for sale, with a price beginning to resemble rational, and we scheduled a viewing. We drove by the house the day before our visit, and watched two separate couples emerge; in both cases, the wives came out with arms crossed, faces pinched, leaning away from their husbands. The husbands' body language and mannerisms didn't suggest that they were any happier with the house. It seemed comical at the time, the similarity of both couples' reactions.
The house is on Winding Way in Fair Oaks, California. Bought in '05 for over $700k, "sold" (probably the foreclosure action) for just shy of $500k last year, and on the market today for $430k. Oh, sure, a kitchen remodel costs $50k so it would still be a half-million-dollar home, but it also had hand-coved ceilings and straight, quality wood. Well, it also had termites and dry-rot nibbling away at the wood - to the point that one window sill had a gaping hole to the outside. The bedrooms were all painted garish theme colors, and the bathroom had been painted bright yellow, right down to the vanity top, bathtub, and tub enclosure. I think that the carpet in one bedroom was actually painted - but it did match the hot-pink walls nicely, if you like that kind of thing. Half of the square footage was a badly-done addition - poor craftsmanship and the terrible "flow" of a poorly conceived floorplan. Shapes and finishes didn't match the main house, and the master shower was located in the laundry room. The pool house smelled of mold, the workshop was converted to an illegal apartment, and the garage had drainage holes so the entire backyard could drain through the garage. Wear your waders to get in the car in the morning - that sounds fun.
Still, no big deal. Put in proper drainage, gut the workshop back to a workshop, tear down the pool house, rebuild the addition. Oh, but there's more. The house had two air conditioners; now it has the exterior shell of two air conditioners, with a bunch of cut wiring poking out. One air conditioner looked brand new, but with every removable part stripped, it is probably a complete loss. Every light fixture I saw was missing parts, and the ceiling fans dangled oddly, with a blade or two removed, the wiring stripped for a few cents copper value. The lawn sprinkler controls were gone, and the entire pool pump/filter mechanism was missing. The attic access panel was askew, and I shudder to imagine what was removed up there. The little 1-foot long copper pipes from the water heater to the wall had also been cut, worth very little in the scrap market, but a nice $50 repair for the next owner. Given enough time, so much will be stripped that it will not be economically feasible to repair - the once-proud $700+k home will be just another tear down.
It might already be. The house had a 14-page Section 1 pest report (items deemed major and in need of immediate repair). Termite damage, fungus damage, broken windows, water infiltration. It seemed that every water fixture had a leak - I wonder if the pipes froze and burst? I don't know if it was an optic illusion or a major structural defect, but one of the rooms seemed to slant away from the rest of the house. The pool was green, the tennis courts cracked and being overtaken by weeds. The yard was uneven and had trenches in the front yard, an earth berm in the side yard, and a rather frightening wood retaining wall in the back. The grass, such as it was, was a motley mixture of grasses and weeds, with lovely large shade trees in the front yard, and broken branches abandoned beneath.
This, my friends, is the asset that backed a mortgage security for over half a million dollars.
We saw an interesting houses for sale, with a price beginning to resemble rational, and we scheduled a viewing. We drove by the house the day before our visit, and watched two separate couples emerge; in both cases, the wives came out with arms crossed, faces pinched, leaning away from their husbands. The husbands' body language and mannerisms didn't suggest that they were any happier with the house. It seemed comical at the time, the similarity of both couples' reactions.
The house is on Winding Way in Fair Oaks, California. Bought in '05 for over $700k, "sold" (probably the foreclosure action) for just shy of $500k last year, and on the market today for $430k. Oh, sure, a kitchen remodel costs $50k so it would still be a half-million-dollar home, but it also had hand-coved ceilings and straight, quality wood. Well, it also had termites and dry-rot nibbling away at the wood - to the point that one window sill had a gaping hole to the outside. The bedrooms were all painted garish theme colors, and the bathroom had been painted bright yellow, right down to the vanity top, bathtub, and tub enclosure. I think that the carpet in one bedroom was actually painted - but it did match the hot-pink walls nicely, if you like that kind of thing. Half of the square footage was a badly-done addition - poor craftsmanship and the terrible "flow" of a poorly conceived floorplan. Shapes and finishes didn't match the main house, and the master shower was located in the laundry room. The pool house smelled of mold, the workshop was converted to an illegal apartment, and the garage had drainage holes so the entire backyard could drain through the garage. Wear your waders to get in the car in the morning - that sounds fun.
Still, no big deal. Put in proper drainage, gut the workshop back to a workshop, tear down the pool house, rebuild the addition. Oh, but there's more. The house had two air conditioners; now it has the exterior shell of two air conditioners, with a bunch of cut wiring poking out. One air conditioner looked brand new, but with every removable part stripped, it is probably a complete loss. Every light fixture I saw was missing parts, and the ceiling fans dangled oddly, with a blade or two removed, the wiring stripped for a few cents copper value. The lawn sprinkler controls were gone, and the entire pool pump/filter mechanism was missing. The attic access panel was askew, and I shudder to imagine what was removed up there. The little 1-foot long copper pipes from the water heater to the wall had also been cut, worth very little in the scrap market, but a nice $50 repair for the next owner. Given enough time, so much will be stripped that it will not be economically feasible to repair - the once-proud $700+k home will be just another tear down.
It might already be. The house had a 14-page Section 1 pest report (items deemed major and in need of immediate repair). Termite damage, fungus damage, broken windows, water infiltration. It seemed that every water fixture had a leak - I wonder if the pipes froze and burst? I don't know if it was an optic illusion or a major structural defect, but one of the rooms seemed to slant away from the rest of the house. The pool was green, the tennis courts cracked and being overtaken by weeds. The yard was uneven and had trenches in the front yard, an earth berm in the side yard, and a rather frightening wood retaining wall in the back. The grass, such as it was, was a motley mixture of grasses and weeds, with lovely large shade trees in the front yard, and broken branches abandoned beneath.
This, my friends, is the asset that backed a mortgage security for over half a million dollars.
Thursday, February 07, 2008
IRS Mortgage Interest Deductions Limited to 100% of Fair Market Value - but market value when?
The interest on home equity loans is tax deductible (subject to income limitations and maximum loan limits), as long as the debt is equal to or less than the Fair Market Value (FMV) of the home. See IRS Pub 936. What does this mean?
Suppose you have a Home Equity Line of Credit (HELOC). There is a line of credit available to you on any given day, but you don't owe any money on the HELOC. Then the value of the house declines. The house was worth $450k; with a $350k mortgage, the bank gave you another $100k line of credit to tap 100% of your "trapped" equity. Then, the housing market tanks, your house is worth $400k, and you decide to access the line of credit to give your kid a down payment for her own home. The debt is now more than the house is worth. Is the interest deductible?
According to the IRS, the test for deductibility is based on the date you open the HELOC (when the bank gives you a contract and a book of checks), not today's FMV or the FMV on the day you actually wrote one of those HELOC checks to borrow money. You take the Fair Market Value of the home, subtract other qualified debt (like purchase money mortgage), and basically determine your equity. If the HELOC line is equal to or less than your equity, on the day you open the HELOC, it's deductible.
(Note: other tax rules may restrict or eliminate deductibility of mortgage interest; I'm only looking at this one aspect). It might be worthwhile to retain documentation of the home's value on that date, although it seems unlikely for the IRS to start auditing people for taking an interest deduction on HELOCs.
3110618
When dealing with an obscure IRS rule, I would not take a stranger's word for what's deductible and what isn't - I'd check with my CPA or with the IRS directly. So don't take this article as tax or financial advice - just an interesting footnote in the weird world of real estate tax rules (like how a loss isn't deductible, but a gain is taxable, and a HELOC'ed car or vacation is deductible, but not if you make more than some arbitrary income limit).
Suppose you have a Home Equity Line of Credit (HELOC). There is a line of credit available to you on any given day, but you don't owe any money on the HELOC. Then the value of the house declines. The house was worth $450k; with a $350k mortgage, the bank gave you another $100k line of credit to tap 100% of your "trapped" equity. Then, the housing market tanks, your house is worth $400k, and you decide to access the line of credit to give your kid a down payment for her own home. The debt is now more than the house is worth. Is the interest deductible?
According to the IRS, the test for deductibility is based on the date you open the HELOC (when the bank gives you a contract and a book of checks), not today's FMV or the FMV on the day you actually wrote one of those HELOC checks to borrow money. You take the Fair Market Value of the home, subtract other qualified debt (like purchase money mortgage), and basically determine your equity. If the HELOC line is equal to or less than your equity, on the day you open the HELOC, it's deductible.
(Note: other tax rules may restrict or eliminate deductibility of mortgage interest; I'm only looking at this one aspect). It might be worthwhile to retain documentation of the home's value on that date, although it seems unlikely for the IRS to start auditing people for taking an interest deduction on HELOCs.
3110618
When dealing with an obscure IRS rule, I would not take a stranger's word for what's deductible and what isn't - I'd check with my CPA or with the IRS directly. So don't take this article as tax or financial advice - just an interesting footnote in the weird world of real estate tax rules (like how a loss isn't deductible, but a gain is taxable, and a HELOC'ed car or vacation is deductible, but not if you make more than some arbitrary income limit).
Wednesday, February 06, 2008
Foreclosures leave renters in the lurch
Foreclosures leave renters in the lurch: "At first, Adriana Diharce ignored the envelope taped to her front door because it wasn't addressed to her. Then she saw the words 'trustee sale,' so she opened it. The letter said the modest, ranch-style Hayward house rented by Diharce and her husband would be sold at a foreclosure auction.
When Diharce called the phone number on the letter last month, a representative told her the house was slated for auction on Feb. 8 - tomorrow - and said the couple and their two young children would have to vacate almost immediately after that. Diharce called her landlady, but her phone had been disconnected.
'The landlady owes us our deposit, and we cannot locate her,' said Diharce, 29, who is expecting a third child in March. 'I am so upset. As a tenant, we have no rights, no deposit and nowhere to go.'"
Renters and landlords can both probably find some value in the tips (and traps) outlined in the article. If you've ever bought a house thinking "if I get transferred and can't sell it, I'll just rent it out," this article might just change your mind. Of note: Both California and the Federal legislatures have considered passing laws to protect tenants in foreclosure situations. Yes, tenants should have some warning, and yet, on the other hand, the harder we make it for banks to get their money out of a foreclosure, the harder banks will make it for people to buy homes. There's gotta be some balance.
When Diharce called the phone number on the letter last month, a representative told her the house was slated for auction on Feb. 8 - tomorrow - and said the couple and their two young children would have to vacate almost immediately after that. Diharce called her landlady, but her phone had been disconnected.
'The landlady owes us our deposit, and we cannot locate her,' said Diharce, 29, who is expecting a third child in March. 'I am so upset. As a tenant, we have no rights, no deposit and nowhere to go.'"
Renters and landlords can both probably find some value in the tips (and traps) outlined in the article. If you've ever bought a house thinking "if I get transferred and can't sell it, I'll just rent it out," this article might just change your mind. Of note: Both California and the Federal legislatures have considered passing laws to protect tenants in foreclosure situations. Yes, tenants should have some warning, and yet, on the other hand, the harder we make it for banks to get their money out of a foreclosure, the harder banks will make it for people to buy homes. There's gotta be some balance.
Tuesday, February 05, 2008
The National Association of Realtors has mobilized - are they lobbying for YOUR best interests?
Paper Economy - A US Real Estate Bubble Blog: Capitol Appeal!: "The National Association of Realtors (NAR) recently produced an email campaign that seeks to harness its legions of member Realtors specifically to urge congress to include the conforming loan limit provision of the economic stimulus package.
Not only has the “temporary” increase to the conforming loan limit been approved by the house, influential representatives are now calling for the conforming loan limit increase to become permanent."
Please click the link, read the argument, and take a moment to let your legislators know how you feel. If we want to live in a representative democracy, we have to hold our elected officials accountable to the electorate (I guarantee the lobbyists are holding them accountable). Voters have more power than lobbyists, if we choose to exercise it.
Not only has the “temporary” increase to the conforming loan limit been approved by the house, influential representatives are now calling for the conforming loan limit increase to become permanent."
Please click the link, read the argument, and take a moment to let your legislators know how you feel. If we want to live in a representative democracy, we have to hold our elected officials accountable to the electorate (I guarantee the lobbyists are holding them accountable). Voters have more power than lobbyists, if we choose to exercise it.
Goldman Sachs: California home prices to drop 35%; $2 Trillion in losses
STIMULUS PLAN A SCAM TO BENEFIT THE RICH / Higher loan limits will lead to Fannie Mae, Freddie Mac bailout: "Now, thanks to Congress, junk bond investors will be able to pawn off their bad debt to Fannie and Freddie, instead of suing the big investment houses for ripping them off. This shift will certainly doom Fannie Mae and Freddie Mac, so don't be surprised if we, the taxpayers, have to bail out poor Fannie and Freddie - to the tune of more than $1 trillion.
Why more than $1 trillion? If Goldman Sachs is correct in its recent projections that home prices in California are going to drop 35 to 40 percent, the state's losses alone would top $2 trillion, because California has a disproportionate number of jumbo loans. The irony here is that the collapse in housing prices could make Fannie insolvent even without raising the loan limit. Increasing Fannie's limit is like going on a spending spree with your credit cards because you know you are going to file for bankruptcy in a few months. Only here the taxpayer is left holding the bag. Our children will pay interest on this debt in perpetuity. It is our debt. It is inescapable."
As an investor, I am trying to understand the scope of likely housing losses. If it is a drop in the bucket, I need to be buying back into the market on dips (like today's 3% loss). If it is enormous, I need to pull more cash out of the market. The signs point in a million directions. Now Ben Stein - he of the claims that the housing collapse was a nit - is now using the word "terrifying" to describe the last few months in the markets. One day, I am reading a Fed report on equity extraction - wow, people were pulling billions out of their homes to buy stock - another day, I'm reading in Greenspan's book that our economy is tremendously resilient. Indeed, our recessions have been historically short and infrequent in the few decades I've been alive. The Fed is doing everything they can to put some air back in our sales. On the other hand, who is left to buy houses at prices that are 60% higher than they were just 5 years ago?
I am already seeing sales in the Sacramento market that are more than 30% off peak. A house in a 1970's tract sold for $350k in the bubble, it recently sold as a REO for $235k (33% loss, and I should point out that $350k was the going price for that model - this was not a statistical outlier). Another house, on an odd >1 acre lot was bought for $624k by an "investor" who planned to split the lot; today it's a REO languishing on the market at $399k (36% loss). I've reported on Centex Black Oak, with asking prices 36% lower than last year.
San Diego and L.A. ranked in the top 10 declining markets. San Diego recorded 13% declines. These sorts of price cuts are happening all over the less-desirable inland portions of the state. As commute-distance areas become cheaper than more desirable coastal areas, they will siphon off buyers from those expensive markets. California will probably wag the national market, simply because the abundance of high-dollar home loans gives us a disproportionate share of the total national loan pool.
To put this theoretical $2 Trillion loss into perspective, here are some other things that are valued in the Trillions of dollars:
__________________________________
Sources:
NYSE, New York Stock Exchange > Listed Securities > Listed Company Directory: "The New York Stock Exchange (NYSE) is the largest equities marketplace in the world. Our listed companies represented a total global market value of approximately $27.1 trillion, as of December 31, 2007. These companies include a cross-section of large, midsize and small capitalization companies. Non-U.S. issuers play an increasingly important role on the Exchange. Our approximately 421 non-U.S. companies are valued at $11.4 trillion."
THE MARKETS: Market Place; Blazing Hot and Highly Volatile - New York Times: "Today, the total value of stocks traded on Nasdaq amounts to $3.7 trillion. The Nasdaq composite index is weighted by market capitalization, and a third of it now is accounted for by just five of the 4,842 companies in the index: Microsoft, Intel, Cisco Systems, MCI-Worldcom and Qualcomm."
CIA World Factbook: United States
CIA World Factbook
Default rate on U.S. subprime mortgages continues to rise - International Herald Tribune: "'There are $10.6 trillion of mortgage loans outstanding in the U.S., and even if the brakes had been slammed, it was going to take a long time to slow this locomotive down,' said Youngblood, who has researched home lending for more than 20 years."
* Other data sources put Fannie Mae/Freddie Mac market share at 25%, with ~$4.9 Trillion dollars in debt. That would suggest that outstanding mortgage loans are closer to $20 Trillion. Another source says that ~$2 Trillion dollars in mortgages, roughly 1/4th of all outstanding mortgages, will reset in 2006-2007, making the mortgage market $8 Trillion at time of publication, prior to 2006.
A region's gross domestic product, or GDP, is one of the ways of measuring the size of its economy. The GDP of a country is defined as the total market value of all final goods and services produced within a country in a given period of time (usually a calendar year). It is also considered the sum of value added at every stage of production (the intermediate stages) of all final goods and services produced within a country in a given period of time.
U.S. 10-city home price drop a record in Nov: S&P Reuters: "Home prices in 10 major metropolitan areas fell a record 8.4 percent in the year through November, suggesting the housing slump is worsening, according to a Standard & Poor index released on Tuesday.
A broader but newer index of 20 cities recorded an annual decline of 7.7 percent in November, S&P said. Miami and San Diego led with annual declines of 15.1 percent and 13.4 percent, respectively. Other double-digit year-over-year declines were in Las Vegas, Detroit, Phoenix, Tampa and Los Angeles.Total declines in U.S. home prices will be at least 15 percent from the peak to the trough, Meyer said."
My usual disclaimer applies: I am not giving investment advice. I can't even decide how to invest my portfolio! LOL
Why more than $1 trillion? If Goldman Sachs is correct in its recent projections that home prices in California are going to drop 35 to 40 percent, the state's losses alone would top $2 trillion, because California has a disproportionate number of jumbo loans. The irony here is that the collapse in housing prices could make Fannie insolvent even without raising the loan limit. Increasing Fannie's limit is like going on a spending spree with your credit cards because you know you are going to file for bankruptcy in a few months. Only here the taxpayer is left holding the bag. Our children will pay interest on this debt in perpetuity. It is our debt. It is inescapable."
As an investor, I am trying to understand the scope of likely housing losses. If it is a drop in the bucket, I need to be buying back into the market on dips (like today's 3% loss). If it is enormous, I need to pull more cash out of the market. The signs point in a million directions. Now Ben Stein - he of the claims that the housing collapse was a nit - is now using the word "terrifying" to describe the last few months in the markets. One day, I am reading a Fed report on equity extraction - wow, people were pulling billions out of their homes to buy stock - another day, I'm reading in Greenspan's book that our economy is tremendously resilient. Indeed, our recessions have been historically short and infrequent in the few decades I've been alive. The Fed is doing everything they can to put some air back in our sales. On the other hand, who is left to buy houses at prices that are 60% higher than they were just 5 years ago?
I am already seeing sales in the Sacramento market that are more than 30% off peak. A house in a 1970's tract sold for $350k in the bubble, it recently sold as a REO for $235k (33% loss, and I should point out that $350k was the going price for that model - this was not a statistical outlier). Another house, on an odd >1 acre lot was bought for $624k by an "investor" who planned to split the lot; today it's a REO languishing on the market at $399k (36% loss). I've reported on Centex Black Oak, with asking prices 36% lower than last year.
San Diego and L.A. ranked in the top 10 declining markets. San Diego recorded 13% declines. These sorts of price cuts are happening all over the less-desirable inland portions of the state. As commute-distance areas become cheaper than more desirable coastal areas, they will siphon off buyers from those expensive markets. California will probably wag the national market, simply because the abundance of high-dollar home loans gives us a disproportionate share of the total national loan pool.
To put this theoretical $2 Trillion loss into perspective, here are some other things that are valued in the Trillions of dollars:
- Federal government budget: $2.7 Trillion this year; Bush is proposing $3.1 Trillion for next year
- Federal government debt: $9.2 Trillion
- The combined value of all domestic NYSE stocks: $16.3 Trillion
- The Gross Domestic Product of the United States: $13.86 trillion (Purchasing Power Parity)
- The Gross Domestic Product of China: $7.043 trillion (Purchasing Power Parity)
- The Gross Domestic Product of Saudi Arabia: Half a trillion / $572.2 billion (Purchasing Power Parity)
- The Gross Domestic Product of the United Kingdom: $2.472 trillion(official exchange rate)
- Total outstanding mortgage debt in the United States: $10.6 Trillion*
__________________________________
Sources:
NYSE, New York Stock Exchange > Listed Securities > Listed Company Directory: "The New York Stock Exchange (NYSE) is the largest equities marketplace in the world. Our listed companies represented a total global market value of approximately $27.1 trillion, as of December 31, 2007. These companies include a cross-section of large, midsize and small capitalization companies. Non-U.S. issuers play an increasingly important role on the Exchange. Our approximately 421 non-U.S. companies are valued at $11.4 trillion."
THE MARKETS: Market Place; Blazing Hot and Highly Volatile - New York Times: "Today, the total value of stocks traded on Nasdaq amounts to $3.7 trillion. The Nasdaq composite index is weighted by market capitalization, and a third of it now is accounted for by just five of the 4,842 companies in the index: Microsoft, Intel, Cisco Systems, MCI-Worldcom and Qualcomm."
CIA World Factbook: United States
CIA World Factbook
Default rate on U.S. subprime mortgages continues to rise - International Herald Tribune: "'There are $10.6 trillion of mortgage loans outstanding in the U.S., and even if the brakes had been slammed, it was going to take a long time to slow this locomotive down,' said Youngblood, who has researched home lending for more than 20 years."
* Other data sources put Fannie Mae/Freddie Mac market share at 25%, with ~$4.9 Trillion dollars in debt. That would suggest that outstanding mortgage loans are closer to $20 Trillion. Another source says that ~$2 Trillion dollars in mortgages, roughly 1/4th of all outstanding mortgages, will reset in 2006-2007, making the mortgage market $8 Trillion at time of publication, prior to 2006.
A region's gross domestic product, or GDP, is one of the ways of measuring the size of its economy. The GDP of a country is defined as the total market value of all final goods and services produced within a country in a given period of time (usually a calendar year). It is also considered the sum of value added at every stage of production (the intermediate stages) of all final goods and services produced within a country in a given period of time.
U.S. 10-city home price drop a record in Nov: S&P Reuters: "Home prices in 10 major metropolitan areas fell a record 8.4 percent in the year through November, suggesting the housing slump is worsening, according to a Standard & Poor index released on Tuesday.
A broader but newer index of 20 cities recorded an annual decline of 7.7 percent in November, S&P said. Miami and San Diego led with annual declines of 15.1 percent and 13.4 percent, respectively. Other double-digit year-over-year declines were in Las Vegas, Detroit, Phoenix, Tampa and Los Angeles.Total declines in U.S. home prices will be at least 15 percent from the peak to the trough, Meyer said."
My usual disclaimer applies: I am not giving investment advice. I can't even decide how to invest my portfolio! LOL
California Mechanic's Liens: Homebuyers asked to pay Subcontractors and Suppliers stiffed by the builder
News - Lien times hit Elk Grove - sacbee.com (registration required, or visit bugmenot.com for user ID): "Sukhwinder 'Suki' Kaur bought the wrong house at the wrong time. Within months of her July closing on the two-story home in Elk Grove, work in the new subdivision stopped and the builder's parent company, Dunmore Homes, filed for bankruptcy protection. Kaur, who is paying on a $430,000 mortgage, has become the target of two lawsuits and 28 liens from unpaid subcontractors and suppliers. More than a dozen other individuals in the Monterey Village development are in similar predicaments."
SacBee has some really bad writing, and it's a bit difficult to figure out from the story exactly what's happening. But I've done some renovations on my house, so I'm somewhat familiar with the Mechanic's Lien laws here. The story sounds implausible - buyers paying for their homes, and then having to pay the subcontractors, too - but it is a reality under California's mechanic's lien laws.
I used to have a client who made and delivered concrete. Every time I was in their office, I heard one side of the non-stop phone calls to the woman who processed Mechanic's Liens. It seems there was a small army of unlicensed, often illegal, contractors who poured cement patios, driveways, and foundations. They charged the homeowner for materials and labor, but never paid the suppliers. What I gathered from the conversations I overheard at the concrete plant, was that the homeowner was responsible for the suppliers being paid, even if a subcontractor had already been paid for the materials.
Soon after, I had my roof replaced. I was served with a Mechanic's Lien, and I finally learned what law allowed concrete companies to sue homeowners when a contractor 1) contracted for the supplies, 2) received payment for the supplies, and 3) didn't pay the supplier for the supplies. Contractors and subcontractors do work that increases the value of the home. The person who owns the home thus benefits from the contractors'/suppliers' work, even if the owner didn't contract for the work (like if a tenant made unauthorized improvements) or if the homeowner didn't contract with the supplier(s) or make any payment promise to the supplier(s). California law provides a way for subcontractors to be paid for their work, even if a client stiffs them. The contractor files a Mechanic's Lien with the county, does the work, receives payment, and then provides the homeowner with a final release of the lien. If the contractor doesn't get paid, the lien remains against the property and the contractor can even foreclose on the property to get their payment.
That's right - the homeowner can be forced to double-pay for materials and/or subcontractors if the homeowner hires a sleazeball who doesn't pay subs and/or suppliers. The homeowner is responsible for hiring honest, licensed contractors and for understanding the law. Because of this, when I hired contractors, I made final payment with a cashier's check and demanded a lien release at the time of final payment (we put it in the contract). When a subcontractor was involved, we required the contractor to provide a payment bond, or else we paid the materials/subcontractor portion of the bill w/ a joint check (payable to the contractor and the sub/supplier jointly). Go to the Contractors State License Board to read up on the law. For a new home purchase, I would consult a lawyer and ask the title company about mechanics' liens.
These poor buyers in Elk Grove seem to be in a pickle. They didn't hire the contractors - they just bought a house. They paid in full for the house, they shouldn't have to pay any more. I would bet none of them ever, ever imagined this could happen - neither would I. This is what title insurance is for, right? The title company searches public records for any liens outstanding, and then promises to pay off any liens they missed. If the liens were filed after the title insurance policy was issued, the title company won't cover them.
According to the CSLB, suppliers and subcontractors have to provide a Preliminary 20-Day Lien Notice within 20 days of beginning work/delivering materials, and then they must record the Mechanic's Lien within 90 days of completion, acceptance, or "When owner began using the improvement." It seems that California law puts buyers of new-construction homes into a 90-day gray zone, where the title policy has been issued at close of escrow, preliminary lien notices (which are not recorded, and thus won't appear in a title search) were probably delivered to the builder before close of sale, but subcontractors and suppliers can file liens up to 90 days later. Since the lien attaches to the property, the homeowner is on the hook - failure to pay can result in a cloud on the title or even foreclosure. The buyer's recourse is to sue the builder - but if the builder is bankrupt (or simply skipped town), the buyer may never recover a penny.
It's a jungle out there in real estate land. Be careful.
This is not intended to be legal advice, just practical advice to be aware of the existence of mechanic's liens and what they can mean for you. Please consult the CSLB and/or a competent attorney for your specific situation.
Note about SacBee: It appears they move stories to their archives within a few days, and then require payment for access to them. The link above will probably only be good for a few days.
SacBee has some really bad writing, and it's a bit difficult to figure out from the story exactly what's happening. But I've done some renovations on my house, so I'm somewhat familiar with the Mechanic's Lien laws here. The story sounds implausible - buyers paying for their homes, and then having to pay the subcontractors, too - but it is a reality under California's mechanic's lien laws.
I used to have a client who made and delivered concrete. Every time I was in their office, I heard one side of the non-stop phone calls to the woman who processed Mechanic's Liens. It seems there was a small army of unlicensed, often illegal, contractors who poured cement patios, driveways, and foundations. They charged the homeowner for materials and labor, but never paid the suppliers. What I gathered from the conversations I overheard at the concrete plant, was that the homeowner was responsible for the suppliers being paid, even if a subcontractor had already been paid for the materials.
Soon after, I had my roof replaced. I was served with a Mechanic's Lien, and I finally learned what law allowed concrete companies to sue homeowners when a contractor 1) contracted for the supplies, 2) received payment for the supplies, and 3) didn't pay the supplier for the supplies. Contractors and subcontractors do work that increases the value of the home. The person who owns the home thus benefits from the contractors'/suppliers' work, even if the owner didn't contract for the work (like if a tenant made unauthorized improvements) or if the homeowner didn't contract with the supplier(s) or make any payment promise to the supplier(s). California law provides a way for subcontractors to be paid for their work, even if a client stiffs them. The contractor files a Mechanic's Lien with the county, does the work, receives payment, and then provides the homeowner with a final release of the lien. If the contractor doesn't get paid, the lien remains against the property and the contractor can even foreclose on the property to get their payment.
That's right - the homeowner can be forced to double-pay for materials and/or subcontractors if the homeowner hires a sleazeball who doesn't pay subs and/or suppliers. The homeowner is responsible for hiring honest, licensed contractors and for understanding the law. Because of this, when I hired contractors, I made final payment with a cashier's check and demanded a lien release at the time of final payment (we put it in the contract). When a subcontractor was involved, we required the contractor to provide a payment bond, or else we paid the materials/subcontractor portion of the bill w/ a joint check (payable to the contractor and the sub/supplier jointly). Go to the Contractors State License Board to read up on the law. For a new home purchase, I would consult a lawyer and ask the title company about mechanics' liens.
These poor buyers in Elk Grove seem to be in a pickle. They didn't hire the contractors - they just bought a house. They paid in full for the house, they shouldn't have to pay any more. I would bet none of them ever, ever imagined this could happen - neither would I. This is what title insurance is for, right? The title company searches public records for any liens outstanding, and then promises to pay off any liens they missed. If the liens were filed after the title insurance policy was issued, the title company won't cover them.
According to the CSLB, suppliers and subcontractors have to provide a Preliminary 20-Day Lien Notice within 20 days of beginning work/delivering materials, and then they must record the Mechanic's Lien within 90 days of completion, acceptance, or "When owner began using the improvement." It seems that California law puts buyers of new-construction homes into a 90-day gray zone, where the title policy has been issued at close of escrow, preliminary lien notices (which are not recorded, and thus won't appear in a title search) were probably delivered to the builder before close of sale, but subcontractors and suppliers can file liens up to 90 days later. Since the lien attaches to the property, the homeowner is on the hook - failure to pay can result in a cloud on the title or even foreclosure. The buyer's recourse is to sue the builder - but if the builder is bankrupt (or simply skipped town), the buyer may never recover a penny.
It's a jungle out there in real estate land. Be careful.
This is not intended to be legal advice, just practical advice to be aware of the existence of mechanic's liens and what they can mean for you. Please consult the CSLB and/or a competent attorney for your specific situation.
Note about SacBee: It appears they move stories to their archives within a few days, and then require payment for access to them. The link above will probably only be good for a few days.
Friday, February 01, 2008
Update on Centex's Black Oak: 36% price drop
On January 17th, I posted A little window on the Sac metro housing market, about a gated Centex community outside Sacramento that has dropped prices from over $800k to the $500s (the highest "sold" price I've seen was $961k). Now, less than 2 weeks later, prices have dropped again to $490s-$607s.
The entry-level model, the 3555, has dropped from $771k to $491k, a $280k reduction, more than 4x the median household income of $65k/year. That is a 36% decline in asking prices. Zillow has only a little info on the community, but they do show a sale in December for $500k, well off the then-listed price of $671k.
Now, with a mere 15% down (or 20% down and some upgrades) entry-level buyers in Black Oak can qualify for a conforming loan (under $417k). It's almost plebian. I hope the early million-dollar-home (give or take) buyers can stand rubbing elbows with the half-million-dollar home commoners and their government loans.
The entry-level model, the 3555, has dropped from $771k to $491k, a $280k reduction, more than 4x the median household income of $65k/year. That is a 36% decline in asking prices. Zillow has only a little info on the community, but they do show a sale in December for $500k, well off the then-listed price of $671k.
Now, with a mere 15% down (or 20% down and some upgrades) entry-level buyers in Black Oak can qualify for a conforming loan (under $417k). It's almost plebian. I hope the early million-dollar-home (give or take) buyers can stand rubbing elbows with the half-million-dollar home commoners and their government loans.
Wednesday, January 30, 2008
Lies, Damn Lies, and the National Association of Realtors (R)
The National Association of Realtors (R) wants you to know that home values usually double every 10 years. They also want you to know that Real Estate is a great way to build wealth. They want you to know that the only people who can possibly do a good job of helping you sell or buy a home, are Realtors(R). They have launched an advertising campaign using TV ads, print ads, billboards, radio commercials, bus shelter signs, and posters, all to tell us, the ignorant public, that 1) we really, really need a Realtor(R); 2) Realtors(R) are terrific, honest human beings; and 3) Now is a Great Time to Buy a House! They don't qualify that statement, so don't try to sue them if you buy a house and lose your shirt - now is a great time to buy - a great time for Realtors(R).
One ad says: "You might be wondering if buying a home right now is a smart financial decision. The fact is, homeownership is key to building long-term wealth, no matter when someone buys." They cite a N.A.R. study as evidence of their claims that real estate is a better investment than stocks. "Thanks to the power of leverage, a homeowner’s return on investment is even more impressive over time. For example, over 10 years, a $10,000 investment in the stock market at a normal 10 percent market rate of return would yield $23,600. The same investment as a down payment on a $200,000 home at a normal appreciation rate of 5 percent would return nearly 5 times the stock market return, at $110,300."
Begin rant:
End rant
What's wrong with the N.A.R. logic? Carrying costs, transaction costs, liquidity and leverage.
That theoretical $200k house -let's put it in California to make things simple - has monthly carrying costs. Property tax ($167), insurance ($120), maintenance ($85), and the mortgage payment ($1,022 P&I) add up to a monthly carrying cost of $1,392. Assume a 23% combined federal/state tax rate; the homeowner might save $215 a month in taxes, for a net housing payment of $1,178.
Homes are complex because they combine the saving/equity building function with the gives-us-someplace-to-live function. As an investment, any savings below comparable rent is analogous to cash-flow income from an investment (think dividends or interest payments) and any excess cost over comparable rent is a loss. So we have to look at rents. First, let's notice that the homeowner will pay his/her own water, Mello Roos, trash, etc. A renter usually gets basic services included for free with their rent. Let's put the theoretical buyer into the Sacramento housing market because you can find $200k fixers in bad neighborhoods around Sacramento. (We won't burden the house payment with the Kevlar vest, alarm system, Glock, and carry permit you'd need in the neighborhoods with homes priced under $200k.) Okay, so trash and water service will run about $100 a month. Add that to the $1,178 net housing cost and you get a rent-comparable monthly cost of $1,278. $200k buys a crummy house in a crummy neighborhood; Sacramento area rents start at $650 for a house, $1000 will get a 2-bedroom.
So the carrying cost in excess of rent has to be charged against the "investment" value. $1,278 minus $1,000 equals $278 a month. If you didn't buy a house, we assume you would have left the $10k down payment in the stock market, paid $1,000 a month rent, and invested the $278 extra dollars per month. At 10% compounded annually, your $10k investment plus $278 monthly deposit will grow to $73,410, roughly three times more than the Realtors(R) acknowledge in their comparison, but still less than the $110k the Realtors(R) claim you will make on a house.
Oh, but you don't get to keep all of that $110k appreciation. Transaction costs are relatively low in the stock market and more than a little higher on houses. First, you buy the house, and pay closing costs which vary dramatically from one community to another, but 2% is not unusual. That's $4k rolled into the loan on our theoretical house (remember, you only have $10k to "invest"). Then, when you sell you have transaction costs - typically, about 8% (6% to your Realtors(R) and 2% to all the other miscellaneous parasites). So subtract the $4k closing costs you paid at time of purchase, and the roughly $24,800 closing costs you'll pay to sell, and that $110k appreciation you earned on your "investment" is only $81,178 net. But you've also paid down the loan by a little more than $52k; so you walk away from closing with $133k.
Not bad. Except that the Realtors(R) are assuming 5% annual appreciation on a house, an assumption that is aggressive at best in the current housing market. If the home price depreciates 10% in the next two years and then grows at 5% annually, the $200k house will only be worth $253k 10 years after you buy it, slashing your appreciation in half. You pay the Realtors(R), title company, county recorder, etc. 8% of your selling price - about $20k in closing costs - and the loan is paid down by $52k (you took a fixed-rate mortgage, didn't you?). You walk away from closing with a check for $80 Grand. Oh, wait, did you remodel the kitchen or install landscaping? Subtract those costs from your theoretical gains.
Liquidity refers to how easy it is to get your cash out of an asset. Checking accounts are highly liquid, while rare antique sports cars are relatively illiquid - you have to find someone who wants to buy it and can afford your price. Housing is moderately liquid in a normal market. Realtors(R) might say it's always a good time to buy, but it's definitely not always a good time to sell. We are seeing homes in my area sitting on the market for well over 6 months - I've seen some sit vacant for over a year. If you have to move before the house sells, you'll be stuck with 2 home payments. You'll want to leave the utilities on so your Realtor(R) can show the house, and you'll probably hire a cleaning service and landscaper. Over 6 months, your carrying costs on the vacant home will be well over $7,000. If you need to pull your money out of the stock market, there are always buyers for decent stocks (no webvan.com, thank you very much). If you need your cash from stocks, sell today, pick up your check tomorrow. No muss, no fuss. Suppose you think the market is going to crash. With a liquid investment like stocks, you decide to sell one day, sell that afternoon. With a house, selling (or "liquidating" your equity) requires quite a bit of fuss - moving, cleaning the house up so it shows well, even finding a Realtor(R) and signing a contract.
Now back to that leverage that makes me so cranky. Realtors want you to compare a leveraged house purchase against an unleveraged stock purchase. That's not quite fair. If you don't mind the risk of leverage, borrow some money from your stock broker to "lever" your way to riches. If you leveraged your stock portfolio - using 50% margin - you can invest $20k. That $20k would grow to $47,158, leveraged. Add the $278/monthly premium you pay to be a homeowner instead of a renter, and your stock portfolio will grow to $96,990 in 10 years. On the other hand, when you leverage your way into a house with a low downpayment, it's easy to end up upside down in a market downturn, owing the mortgage company more than what your house is worth (before Realtor(R) fees, no less).
Apples to apples, the National Association of Realtors is misleading the public. Shame, shame. But don't just take my word for it - Forbes says the stock market has returned 4 times the returns that housing has from 1980 to 2004:
Real Estate Vs. Stocks - Forbes.com: "But if you take a longer view--say 25 years--you'll find that the S&P 500 has actually stomped the real estate market, from Boston to Detroit to Dallas. From the start of 1980 to the end of 2004, home sale prices increased 247%. A pretty sweet deal, it would seem. Over the same period, however, the S&P 500 shot up more than 1,000%."
If you're looking for an investment, talk to an investment professional. If you're looking for a house, that's when you talk to a real estate professional. And whichever you do, make sure you do due diligence - never take a salesperson's word at face value.
This article is not intended to be investment advice; it is merely intended to provoke greater transparency and discourse in the housing market. Please seek the advice of appropriate professional advisors to determine your personal investing and/or housing needs. Copyright 2008. All rights reserved.
One ad says: "You might be wondering if buying a home right now is a smart financial decision. The fact is, homeownership is key to building long-term wealth, no matter when someone buys." They cite a N.A.R. study as evidence of their claims that real estate is a better investment than stocks. "Thanks to the power of leverage, a homeowner’s return on investment is even more impressive over time. For example, over 10 years, a $10,000 investment in the stock market at a normal 10 percent market rate of return would yield $23,600. The same investment as a down payment on a $200,000 home at a normal appreciation rate of 5 percent would return nearly 5 times the stock market return, at $110,300."
Begin rant:
My stockbroker can't tell me that buying stocks on margin is a good idea,
but the N.A.R. somehow gets to tell us that housing is a good investment,
encouraging us to use margin (leverage, mortgage loans, debt) to increase our
payoff, without even a footnote about the risk of leverage. What's up with that? Are they trying to position themselves as investment advisors?
End rant
What's wrong with the N.A.R. logic? Carrying costs, transaction costs, liquidity and leverage.
That theoretical $200k house -let's put it in California to make things simple - has monthly carrying costs. Property tax ($167), insurance ($120), maintenance ($85), and the mortgage payment ($1,022 P&I) add up to a monthly carrying cost of $1,392. Assume a 23% combined federal/state tax rate; the homeowner might save $215 a month in taxes, for a net housing payment of $1,178.
Homes are complex because they combine the saving/equity building function with the gives-us-someplace-to-live function. As an investment, any savings below comparable rent is analogous to cash-flow income from an investment (think dividends or interest payments) and any excess cost over comparable rent is a loss. So we have to look at rents. First, let's notice that the homeowner will pay his/her own water, Mello Roos, trash, etc. A renter usually gets basic services included for free with their rent. Let's put the theoretical buyer into the Sacramento housing market because you can find $200k fixers in bad neighborhoods around Sacramento. (We won't burden the house payment with the Kevlar vest, alarm system, Glock, and carry permit you'd need in the neighborhoods with homes priced under $200k.) Okay, so trash and water service will run about $100 a month. Add that to the $1,178 net housing cost and you get a rent-comparable monthly cost of $1,278. $200k buys a crummy house in a crummy neighborhood; Sacramento area rents start at $650 for a house, $1000 will get a 2-bedroom.
So the carrying cost in excess of rent has to be charged against the "investment" value. $1,278 minus $1,000 equals $278 a month. If you didn't buy a house, we assume you would have left the $10k down payment in the stock market, paid $1,000 a month rent, and invested the $278 extra dollars per month. At 10% compounded annually, your $10k investment plus $278 monthly deposit will grow to $73,410, roughly three times more than the Realtors(R) acknowledge in their comparison, but still less than the $110k the Realtors(R) claim you will make on a house.
Oh, but you don't get to keep all of that $110k appreciation. Transaction costs are relatively low in the stock market and more than a little higher on houses. First, you buy the house, and pay closing costs which vary dramatically from one community to another, but 2% is not unusual. That's $4k rolled into the loan on our theoretical house (remember, you only have $10k to "invest"). Then, when you sell you have transaction costs - typically, about 8% (6% to your Realtors(R) and 2% to all the other miscellaneous parasites). So subtract the $4k closing costs you paid at time of purchase, and the roughly $24,800 closing costs you'll pay to sell, and that $110k appreciation you earned on your "investment" is only $81,178 net. But you've also paid down the loan by a little more than $52k; so you walk away from closing with $133k.
Not bad. Except that the Realtors(R) are assuming 5% annual appreciation on a house, an assumption that is aggressive at best in the current housing market. If the home price depreciates 10% in the next two years and then grows at 5% annually, the $200k house will only be worth $253k 10 years after you buy it, slashing your appreciation in half. You pay the Realtors(R), title company, county recorder, etc. 8% of your selling price - about $20k in closing costs - and the loan is paid down by $52k (you took a fixed-rate mortgage, didn't you?). You walk away from closing with a check for $80 Grand. Oh, wait, did you remodel the kitchen or install landscaping? Subtract those costs from your theoretical gains.
But I thought buying a house was going to make me a LOT more than the stock
market! I saw the other ad about how ethical Realtors(R) are - they
couldn't have lied!
Liquidity refers to how easy it is to get your cash out of an asset. Checking accounts are highly liquid, while rare antique sports cars are relatively illiquid - you have to find someone who wants to buy it and can afford your price. Housing is moderately liquid in a normal market. Realtors(R) might say it's always a good time to buy, but it's definitely not always a good time to sell. We are seeing homes in my area sitting on the market for well over 6 months - I've seen some sit vacant for over a year. If you have to move before the house sells, you'll be stuck with 2 home payments. You'll want to leave the utilities on so your Realtor(R) can show the house, and you'll probably hire a cleaning service and landscaper. Over 6 months, your carrying costs on the vacant home will be well over $7,000. If you need to pull your money out of the stock market, there are always buyers for decent stocks (no webvan.com, thank you very much). If you need your cash from stocks, sell today, pick up your check tomorrow. No muss, no fuss. Suppose you think the market is going to crash. With a liquid investment like stocks, you decide to sell one day, sell that afternoon. With a house, selling (or "liquidating" your equity) requires quite a bit of fuss - moving, cleaning the house up so it shows well, even finding a Realtor(R) and signing a contract.
Now back to that leverage that makes me so cranky. Realtors want you to compare a leveraged house purchase against an unleveraged stock purchase. That's not quite fair. If you don't mind the risk of leverage, borrow some money from your stock broker to "lever" your way to riches. If you leveraged your stock portfolio - using 50% margin - you can invest $20k. That $20k would grow to $47,158, leveraged. Add the $278/monthly premium you pay to be a homeowner instead of a renter, and your stock portfolio will grow to $96,990 in 10 years. On the other hand, when you leverage your way into a house with a low downpayment, it's easy to end up upside down in a market downturn, owing the mortgage company more than what your house is worth (before Realtor(R) fees, no less).
Apples to apples, the National Association of Realtors is misleading the public. Shame, shame. But don't just take my word for it - Forbes says the stock market has returned 4 times the returns that housing has from 1980 to 2004:
Real Estate Vs. Stocks - Forbes.com: "But if you take a longer view--say 25 years--you'll find that the S&P 500 has actually stomped the real estate market, from Boston to Detroit to Dallas. From the start of 1980 to the end of 2004, home sale prices increased 247%. A pretty sweet deal, it would seem. Over the same period, however, the S&P 500 shot up more than 1,000%."
If you're looking for an investment, talk to an investment professional. If you're looking for a house, that's when you talk to a real estate professional. And whichever you do, make sure you do due diligence - never take a salesperson's word at face value.
This article is not intended to be investment advice; it is merely intended to provoke greater transparency and discourse in the housing market. Please seek the advice of appropriate professional advisors to determine your personal investing and/or housing needs. Copyright 2008. All rights reserved.
Bubbles and pops
Quoted:
Comparing the early 2000s housing bubble to the 1990's pop:
"When this moral hazard is present, credit flows rapidly into inelastically supplied assets, such as real estate. Rapid appreciation is the result, until the inevitable albeit belated regulatory crackdown stops the flow of credit and leads to an asset-price crash."(then) FRB Gov. Bernanke Speech from 2002 on Deposit Insurance crises in 1990s
http://minneapolisfed.org/community/events/100407/strategies_brewster.pdf Page 11
Comparing the early 2000s housing bubble to the 1990's pop:
"When this moral hazard is present, credit flows rapidly into inelastically supplied assets, such as real estate. Rapid appreciation is the result, until the inevitable albeit belated regulatory crackdown stops the flow of credit and leads to an asset-price crash."(then) FRB Gov. Bernanke Speech from 2002 on Deposit Insurance crises in 1990s
http://minneapolisfed.org/community/events/100407/strategies_brewster.pdf Page 11
Investment opportunity?
The Minneapolis Fed has a map of nationwide Subprime mortgage concentration. Now, the obvious culprits are shown - Florida, Bakersfield California, Detroit. But another large area of concentration is Western Pennsylvania/Eastern Ohio - coal country. The coal is pretty much mined out. Well, the coal worth mining has been removed - some coal finds were just too small or too deep or too scattered to be cost-effective to mine. The same thing has happened to oil wells, and some closed oil wells AND coal mines are being reopened as rising prices make them economically feasible, after all. But that's not the investment opportunity.
Coal-bed methane is a naturally-occuring gas that can be liberated from coal seams and used just like natural gas. You can cook with it, heat with it, or even pump it into specially-outfitted natural gas cars (dual-fuel gasoline/natural gas vehicles are especially useful, and can be purchased used from fleets). I have seen properties in the region priced as low as $70k claiming "free gas" (though OGM - oil, gas, mineral rights - are not usually specified in the real estate listings). Parts of West Virginia and Kentucky also have some coal-seam methane wells.
http://minneapolisfed.org/community/events/100407/strategies_brewster.pdf Minneapolis Fed map of nationwide Subprime mortgage concentration, page 6
Coal-bed methane is a naturally-occuring gas that can be liberated from coal seams and used just like natural gas. You can cook with it, heat with it, or even pump it into specially-outfitted natural gas cars (dual-fuel gasoline/natural gas vehicles are especially useful, and can be purchased used from fleets). I have seen properties in the region priced as low as $70k claiming "free gas" (though OGM - oil, gas, mineral rights - are not usually specified in the real estate listings). Parts of West Virginia and Kentucky also have some coal-seam methane wells.
http://minneapolisfed.org/community/events/100407/strategies_brewster.pdf Minneapolis Fed map of nationwide Subprime mortgage concentration, page 6
Tuesday, January 29, 2008
Pick a problem: Inflation, deflation, or stagflation?
Challenges for Monetary Policy in a Globalized Economy - Richard Fisher Speeches - News & Events - FRB Dallas: "To be sure, movement in the fed funds rate, or even no movement at all, may have an immediate psychological effect and influence expectations for future monetary policy action. But the act of changing or not changing the fed funds target rate, in and of itself, has no immediate effect on the economy. Like a good single malt whiskey, the ameliorating or stimulating influence kicks in only with a lag.
The lag time necessary for inflation to respond to policy is especially long. As a policymaker discharging our dual mandate, I am always mindful that in providing the monetary conditions for employment growth, we must not also sow the seeds of inflation that will eventually choke off the very employment growth we seek to encourage. You do not have to be an inflation 'hawk' to recognize that would be a Faustian bargain."
The stock market isn't all greedy hedge fund managers. It's also municipal pension funds, little old ladies, and 401k/IRA accounts (mine AND yours). So while Fisher says that the Fed's mandate doesn't include making Wall Street happy, we have to recognize what a huge impact the stock market has on individuals, municipalities, and corporations.
At the same time, inflation is an enemy of the poor. The government consistently understates inflation (so-called "core" inflation excludes volatile categories like food and energy), so people relying on government benefits find that their inflation-adjusted benefits don't go as far anymore. Inflation gives rise to stories of pensioners eating cat food because they can't afford people food. Anyone can find their purchasing power eroded by inflation, but the poor are disproportionately harmed. Inflation punishes savers by eroding the value of their savings, and rewards borrowers by eroding the value of the principal they have to repay.
In the 70's, we tried to have it both ways - we wanted to avoid the pain of recession, but then complained about inflation. Ultimately, Volker had to tighten interest rates to bring inflation down from teens-percent; by some counts, the resulting recession cost Carter the election. The moral of that story, it seems, was "pay now, or pay later." I think of economic imbalances as being like an economic bought of influenza; you can suck it up and take bed rest today, or keep working 60-hour weeks and risk dying of walking pneumonia. The Fed seems to think popping rate-cut pills and taking a couple liquidity injections will cure this particular bug.
The lag time necessary for inflation to respond to policy is especially long. As a policymaker discharging our dual mandate, I am always mindful that in providing the monetary conditions for employment growth, we must not also sow the seeds of inflation that will eventually choke off the very employment growth we seek to encourage. You do not have to be an inflation 'hawk' to recognize that would be a Faustian bargain."
The stock market isn't all greedy hedge fund managers. It's also municipal pension funds, little old ladies, and 401k/IRA accounts (mine AND yours). So while Fisher says that the Fed's mandate doesn't include making Wall Street happy, we have to recognize what a huge impact the stock market has on individuals, municipalities, and corporations.
At the same time, inflation is an enemy of the poor. The government consistently understates inflation (so-called "core" inflation excludes volatile categories like food and energy), so people relying on government benefits find that their inflation-adjusted benefits don't go as far anymore. Inflation gives rise to stories of pensioners eating cat food because they can't afford people food. Anyone can find their purchasing power eroded by inflation, but the poor are disproportionately harmed. Inflation punishes savers by eroding the value of their savings, and rewards borrowers by eroding the value of the principal they have to repay.
In the 70's, we tried to have it both ways - we wanted to avoid the pain of recession, but then complained about inflation. Ultimately, Volker had to tighten interest rates to bring inflation down from teens-percent; by some counts, the resulting recession cost Carter the election. The moral of that story, it seems, was "pay now, or pay later." I think of economic imbalances as being like an economic bought of influenza; you can suck it up and take bed rest today, or keep working 60-hour weeks and risk dying of walking pneumonia. The Fed seems to think popping rate-cut pills and taking a couple liquidity injections will cure this particular bug.
FBI investigating 14 companies for mortgage fraud - CNN.com
FBI investigating 14 companies for mortgage fraud - CNN.com: "'On insider trading, we're looking in some cases at whether executives were aware that the value of their holdings would be going down and the executives traded on that information,' said Power.
'On accounting fraud, we're looking at housing developers who may have reported cash reserve accounts to reflect falsely inflated values,' he told CNN."
The article says the FBI only investigates cases involving a loss of $500k or more. And, no, the FBI won't say who they're investigating right now.
'On accounting fraud, we're looking at housing developers who may have reported cash reserve accounts to reflect falsely inflated values,' he told CNN."
The article says the FBI only investigates cases involving a loss of $500k or more. And, no, the FBI won't say who they're investigating right now.
Universal Healthcare - What does it cost?
California's penalty-for-being-uninsured universal healthcare proposal is dying in committee. Liberals argue that single-payer healthcare (socialized, or government-paid healthcare) is a better choice. Democratic presidential candidates say they want universal healthcare for the entire country. So what does that cost?
I have seen insurance advertised at $300 a month for a couple in their 30's. Since children need shots and get into accidents, and seniors need hip-replacements and heart surgery, $150 a person sounds like a nice, if especially low, average assumption. (Under the proposed healthcare reform bill, the State was estimating costs at $250 per person/month, which was considered an unrealistically low assumption.)
California's population is 36,457,549, according to wikipedia. At $150/person/month, that works out to $5,468,632,350 per month, or a mere $65,623,588,200 per year ($65.6 Billion), or more than half of the State's ~$103 Billion combined annual income/sales/property taxes.
The population of the United States is 301,139,947. At $150/person/month, that works out to $45,170,992,050 (thats Billions) per month, or $542,051,904,600 per year. Thats $542 Billion per year. To put that in perspective, our GDP is $13.86 trillion (CIA World Factbook); universal healthcare would consume 20% of the Federal government's $2.7 Trillion budget.
Physicians for Guaranteed Physician Income - I mean "for a National Health Program" - says we spend $7,129 per capita, and that 31% of that money is spent on "private insurance bureaucracy and paperwork." So, if we are addle-headedly optimistic and assume that there will be NO paperwork or administrative overhead whatsoever, we can assume that the cost of providing healthcare is 69% of $7,129, or $4,919/year ($410/mo.) per capita (and, at this price, we have 47 million uninsured, according to PNHP). My $150/mo. figure is crazily low.
In fact, the Kaiser Family Foundation says that "The nations examined spend a median of $2,193 per capita on health care," or $183/person/month. But this is America, the land of ingenuity, so let's assume that we can get our health costs near the bottom of the world average (not because we can, but because I think it's meaningful to realize how much healthcare would cost in an unrealistically low cost environment, and then to consider that realistic costs would be much, much higher). American physicians earn roughly twice as much as doctors in socialized-medicine nations (even adjusted for relative wealth in nations being compared), and physician's salaries have risen "about twice as fast as the average increase for other full-time workers," due, at least in part, to doctor shortages. So you can realistically double my low-ball estimates of costs, possibly more if we don't ration care.
So let's try a new assumption. Using PNHP's $7,129/person/per year minus the claimed overhead of 31%, we get $410/person/month. Let's assume that we can develop greater efficiencies, and ration care, and basically stretch that $410 per person to cover the 47 million uninsured. How much would that cost?
At $410/person/month, California would spend $14,947,595,090 per month, or a $179,371,141,080 per year ($179.4 Billion), or more than the State's ~$103 Billion combined annual income/sales/property taxes. In fact, "California currently spends $36 billion per year on health care for low income Californians," according to California Senator Dave Cox's January newsletter.
At $410/person/month, the United States cost works out to $123,467,378,270 per month, or $1,481,608,539,240 per year. Thats $1.48 Trillion per year, more than half of the Federal government's $2.7 Trillion budget.
Maybe cost-containment would be a better starting point than providing free care to everyone.
I have seen insurance advertised at $300 a month for a couple in their 30's. Since children need shots and get into accidents, and seniors need hip-replacements and heart surgery, $150 a person sounds like a nice, if especially low, average assumption. (Under the proposed healthcare reform bill, the State was estimating costs at $250 per person/month, which was considered an unrealistically low assumption.)
California's population is 36,457,549, according to wikipedia. At $150/person/month, that works out to $5,468,632,350 per month, or a mere $65,623,588,200 per year ($65.6 Billion), or more than half of the State's ~$103 Billion combined annual income/sales/property taxes.
The population of the United States is 301,139,947. At $150/person/month, that works out to $45,170,992,050 (thats Billions) per month, or $542,051,904,600 per year. Thats $542 Billion per year. To put that in perspective, our GDP is $13.86 trillion (CIA World Factbook); universal healthcare would consume 20% of the Federal government's $2.7 Trillion budget.
Physicians for Guaranteed Physician Income - I mean "for a National Health Program" - says we spend $7,129 per capita, and that 31% of that money is spent on "private insurance bureaucracy and paperwork." So, if we are addle-headedly optimistic and assume that there will be NO paperwork or administrative overhead whatsoever, we can assume that the cost of providing healthcare is 69% of $7,129, or $4,919/year ($410/mo.) per capita (and, at this price, we have 47 million uninsured, according to PNHP). My $150/mo. figure is crazily low.
In fact, the Kaiser Family Foundation says that "The nations examined spend a median of $2,193 per capita on health care," or $183/person/month. But this is America, the land of ingenuity, so let's assume that we can get our health costs near the bottom of the world average (not because we can, but because I think it's meaningful to realize how much healthcare would cost in an unrealistically low cost environment, and then to consider that realistic costs would be much, much higher). American physicians earn roughly twice as much as doctors in socialized-medicine nations (even adjusted for relative wealth in nations being compared), and physician's salaries have risen "about twice as fast as the average increase for other full-time workers," due, at least in part, to doctor shortages. So you can realistically double my low-ball estimates of costs, possibly more if we don't ration care.
So let's try a new assumption. Using PNHP's $7,129/person/per year minus the claimed overhead of 31%, we get $410/person/month. Let's assume that we can develop greater efficiencies, and ration care, and basically stretch that $410 per person to cover the 47 million uninsured. How much would that cost?
At $410/person/month, California would spend $14,947,595,090 per month, or a $179,371,141,080 per year ($179.4 Billion), or more than the State's ~$103 Billion combined annual income/sales/property taxes. In fact, "California currently spends $36 billion per year on health care for low income Californians," according to California Senator Dave Cox's January newsletter.
At $410/person/month, the United States cost works out to $123,467,378,270 per month, or $1,481,608,539,240 per year. Thats $1.48 Trillion per year, more than half of the Federal government's $2.7 Trillion budget.
Maybe cost-containment would be a better starting point than providing free care to everyone.
Monday, January 28, 2008
Global downturn won't hit China badly
Global downturn won't hit China badly: "'We expect the Chinese economy to grow by 10 percent this year despite a US-led global economic slowdown,' said Liang Hong, an economist with Goldman Sachs in Hong Kong. 'Strong domestic demand, especially investment growth, is expected to sustain the overall GDP growth, though the export growth is set to slow down.'"
Mei Xinyu, a researcher in China's Ministry of Commerce thinks that the weakening dollar will make American technology cheaper for Chinese companies, while it won't reduce China's exports by much. The thinking seems to be: Americans will continue to shop at Walmart, while Saks 5th Avenue's suppliers may fare worse.
Given China's propensity for selling knock-off merchandise, I worry about increasing technology exports to China. Toxic dog food and lead-painted toys are the big headlines, but the economic damage comes from pricier products. From sneakers to golf clubs to re-branded computer processors and counterfeit cars, the Chinese imitations are the most expensive form of flattery. Billions - with a "B" - of dollars, as much as $50 Billion a year, worldwide. Software piracy is so rampant, Microsoft won't even take a piracy report unless the counterfeit is particularly good, with full edge-to-edge hologram.
It's hard to get a guage on the Chinese economy. "'China's policy in international affairs has been to 'hide its capacities and bide its time’,' Mei says, pointing to China’s growing assertiveness in the World Trade Organization and its push for more voting power in the International Monetary Fund. " Indeed, everything from GDP to per capita income is subject to revision for a host of reasons, from data becoming more refined over time, to changes in purchasing power parity formulas. Full and honest disclosure doesn't seem to be one of the Chinese government's virtues.
Mei Xinyu, a researcher in China's Ministry of Commerce thinks that the weakening dollar will make American technology cheaper for Chinese companies, while it won't reduce China's exports by much. The thinking seems to be: Americans will continue to shop at Walmart, while Saks 5th Avenue's suppliers may fare worse.
Given China's propensity for selling knock-off merchandise, I worry about increasing technology exports to China. Toxic dog food and lead-painted toys are the big headlines, but the economic damage comes from pricier products. From sneakers to golf clubs to re-branded computer processors and counterfeit cars, the Chinese imitations are the most expensive form of flattery. Billions - with a "B" - of dollars, as much as $50 Billion a year, worldwide. Software piracy is so rampant, Microsoft won't even take a piracy report unless the counterfeit is particularly good, with full edge-to-edge hologram.
It's hard to get a guage on the Chinese economy. "'China's policy in international affairs has been to 'hide its capacities and bide its time’,' Mei says, pointing to China’s growing assertiveness in the World Trade Organization and its push for more voting power in the International Monetary Fund. " Indeed, everything from GDP to per capita income is subject to revision for a host of reasons, from data becoming more refined over time, to changes in purchasing power parity formulas. Full and honest disclosure doesn't seem to be one of the Chinese government's virtues.
Friday, January 25, 2008
George Soros: Shoot the messenger
FT.com / Comment & analysis / Comment - The worst market crisis in 60 years: "Boom-bust processes usually revolve around credit and always involve a bias or misconception. This is usually a failure to recognise a reflexive, circular connection between the willingness to lend and the value of the collateral. Ease of credit generates demand that pushes up the value of property, which in turn increases the amount of credit available. A bubble starts when people buy houses in the expectation that they can refinance their mortgages at a profit. The recent US housing boom is a case in point. The 60-year super-boom is a more complicated case. ....
"With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.
"Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world. "
Soros is a loose cannon with little (if any) loyalty to America. However, he is also a savvy investor and a pretty clever guy (best known for "breaking the Bank of England" and destroying the Thai baht).
"With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.
"Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world. "
Soros is a loose cannon with little (if any) loyalty to America. However, he is also a savvy investor and a pretty clever guy (best known for "breaking the Bank of England" and destroying the Thai baht).
Tuesday, January 22, 2008
News - Couple faced money strains - sacbee.com
News - Couple faced money strains - sacbee.com: "As the woman suspected of inexplicably drowning her baby this weekend at her Granite Bay home was under close observation at the Placer County jail Monday, records show that she and her husband have been under significant financial strain."
Monday, January 21, 2008
St. Louis Fed: Economic Data - FRED®
St. Louis Fed: Economic Data - FRED®: "FRED® (Federal Reserve Economic Data) , a database of 18,725 U.S. economic time series. With FRED® you can download data in Microsoft Excel and text formats and view charts of data series."
Subscribe to:
Posts (Atom)