Hank Paulson, who art in Washington, hallowed by thy name. Thy fiefdom come, thy will be done, transfering wealth from Main St. to Wall St. Give us this day all your bread. And forgive us our debts, as we foreclose on those indebted to us. And lead us not into solvency, but deliver us from bankruptcy. For thine is the fiefdom, the power and the glory. For ever and ever. Amen.
How many bankers are uttering those words right now? How many are soiling themselves praying for the government to pass this bailout?
Personally, I have my doubts that any government intervention will help the situation. It certainly won't make a difference for house prices. If it is passed, it may keep a number of insolvent banks on life support for a brief period of time, but their demise is inevitable. Perhaps this whole bailout is just a way for Bernanke and Paulson to control the implosion of the banking industry. I believe it would be far preferred to make the banks bring all these hidden assets back on to their balance sheets and value them at market. (Barry Ritholtz at the Big Picture wrote a very good post on Understanding the Significance of Mark-to-Market Accounting. I highly recommend it.) We would know immediately who is solvent and who is not. The insolvent banks will quickly go under, and the survivors will pick over the bones of the dead. That would be the natural recessionary purging that would occur absent a useless government intervention. Once this purging has taken place, then we can talk about infusing capital back into the banking system. It would be a far more efficient use of government money. What we are proposing to do now is very similar to what Japan did when their stock and real estate bubbles collapsed. The result of propping up all their banks was a decade of lost economic growth. This whole process is like removing a band aid. Remove it quickly and it is more painful, but then it is over. Take it off slowly, and it is arguably less painful, but the pain goes on for much longer. There is no way to avoid the pain.
Today's featured property is yet another example of why the securities the government wants to buy are worthless. Bad loans like this one were packed up into asset-backed securities and sold to collateralized debt obligation structures. There they are loaded with more debt and sold to banks and investors who thought that they would be getting their money back with interest. The money is not coming back, and the various tranches of CDO's have little or no value as a result.
Yesterday was quite a day. It witnessed the defeat of the housing bailout bill (unless it is resurrected which is probable) and it saw some of the largest one-day declines in stock market history. The credit markets are still frozen, and we appear to be on the brink of a complete meltdown of our financial system. It must be a good time to buy a house... You do have to wonder what buyers are thinking right now.
It is hard to say why some neighborhoods get hit harder than others. Often times it is a combination of factors like age, desirability, amount of toxic financing, etc. The Lakes condo development has been getting hammered by foreclosures because it is old, undesirable, and full of toxic financing. The neighborhood containing today's featured property is new -- which of course means it is full of toxic financing -- and it is in an undesirable location. The peak prices paid here were also WTF high. I have profiled 8 Orangetip and 10 Orangetip before. Both properties are remarkable for the extreme discount from peak pricing. Today's featured property is no exception.
Today's featured property is being offered for 38% off its peak purchase price.
This property is being offered for similar pricing to the two comps I profiled earlier. This one is not likely to get bids over asking.
If I were the king of the world; Tell you what I'd do... I'd throw away the loans and the moans and the unknowns; Make home sweet home for you...
When I started writing for this blog, part of my drive was emptying my Reservoir of Schadenfruede. It has grown beyond that, and I appreciate all the people who thank me for convincing them to wait and saving them a great deal of money. I am not a pessimistic or bearish person by nature, and I would rather everyone experience the joy of living rather than the pain and stress of the collapse of an epic financial bubble. However, I am a realist who is willing to face the truth come what may. The truth is prices have fallen, and they will continue to do so. The government may be able to ease the transition to lower prices and borrower solvency by keeping interest rates low for a time. However, sub-6% mortgage interest rates will not be available forever, and after a big push to restructure and refinance existing borrowers out of their bad loans (that may be mandated,) market pressures will cause a gradual rise in long-term rates.
Mortgage interest rates are a combination of the risk-free rate, the inflation premium, and the risk premium. Risk premiums during the bubble were artificially low. If they weren't, our banking system would not be in trouble, and the bailout of the GSEs would not have been necessary. When the government took over the GSEs, they knowingly took on the investment risk in order to control the risk premium in the open market. This allows them to keep rates artificially low during the upcoming restructure period (I am of the opinion that the government took control of the GSEs to rid the market of toxic paper through a combination of low interest rate refinancing and foreclosure). Government ownership of the GSEs is not going to be a permanent condition, unless of course the government wants to be the defacto subsidized mortgage insurer of the country forever. At some point, the government will want to get out of the mortgage insurance business, particularly since it will not be profitable. Risk premiums will rise to market when the government moves to get out of the business. Three to five years from now, I would look for the government to spin off the GSEs once again (they did this first in the early 70s). I doubt it will take that long for mortgage interest rates to rise again, so if you ever thought about refinancing, now is the time.
Just in case you needed a reminder of what caused this problem, today's featured property was purchased with an Option ARM with a 1.5% teaser rate. Restructuring this borrower into a mortgage they could afford would require a very low interest rate and likely some significant principal reduction. Since this is well outside of the parameters for a reasonable restructuring, and since this wasn't a GSE insured loan, it is another foreclosure-in-waiting.
Many people during the bubble took out HELOCs and extensively renovated their properties. Historically, interior property renovations add $0.70 for every dollar spent. Exterior renovations add $0.50 per dollar. It was not uncommon to see property listings touting $200,000 in renovations to justify a $500,000 price increase. It isn't the renovations that were adding value to property; it was the financing that was inflating it. There were several properties in Irvine that were torn down to a single wall and rebuilt from the ground up. Those that attempted this kind of extreme home makeover in 2007 did not fair to well.
We first profiled 2 Angell, Irvine, CA 92612 in February of 2008 when it first came on the market. The flippers who were trying to sell this property took a $600,000 house, rebuilt it, and asked $1,469,000 for it. I was thinking they might get lucky to get $1,000,000. Now the property is back on the market for $1,199,000.
Today's featured property is another total redo. It is an interesting story of renovation gone awry.
Are we selling out tomorrow for today? The takeover of Freddie Mac and Fannie Mae has opened the door for a massive government bailout. Since we are already running a large budget deficit, any bailout would be debt financed. As such, we are borrowing from future tax receipts to pay today for the sins of lenders, speculators and others who foolishly bought more house than they could afford.
The whole mortgage market bailout is yet another false hope for troubled homeowners. The bulls are somehow convinced that the problem of insolvency can be rectified through even more borrowing. People have too much debt already. That is the problem. Giving them more is not the answer. I believe you are going to see two things happen with the government in control: 1. There will be more workouts and refinancing of existing debt. 2. Credit standards will continue to tighten and interest rates and fees will continue to rise for new mortgages. There is not much the government can do with the existing toxic loans it must now make good on. It will do what workouts it can, and it will foreclose on the rest. It has a great deal of control over the new mortgages it writes going forward. It seems unlikely to me that the government would suddenly embrace all the practices that proved so disastrous during the bubble in order to prop up prices. It is one thing to minimize the losses you have, it is quite another to create new losses through foolish lending practices.
The cynics (and the bulls) believe the government will lower credit standards and write a plethora of new bad loans simply to support current price levels. This would amount to a huge, direct government subsidy to homeowners. The Government is stupid, and they do have political pressures to deal with, but they are not that stupid. Right now the focus is on limiting the damage and letting the bubble unwind without losing the secondary mortgage market causing a complete seizure of our credit markets. The government is not concerned with resale house values in Irvine, California. Everyone knows prices must come down, the only issue is how can this occur with the least amount of disruption to our financial system. Prices will stabilize, they will just do so at a much lower price level -- A price level supportable by incomes where the borrowers are solvent and not prone to default on their loans.
Today's featured property is a short sale that has been garnering a lot of attention in Northwood. Apparently there are multiple offers. After 47 days on the market, I guess everyone just discovered it... Or perhaps the realtors are lying...
You have the power. It is A Buyer's Market. Did you ever think you would see properties under $200/SF again? How about $162/SF? Today's featured property caused one commenter yesterday to opine, "This must be bottom." Is it? The price drops have been so dramatic and come so fast on many properties that people can't get their mind around the valuations. A property selling for 26% off its peak purchase price of just two years ago seems cheap. When viewed through the lens of 2006 prices, it is. However, when viewed through from the perspective of fundamental valuations, a property like today's featured property is still overpriced. People did not put much effort into understanding prices when they were rising, after all, prices always go up -- not. People assume that market prices are fair value and any discount from that price a bargain. When viewed from a broader perspective of valuations based on rents and incomes, the degree of price inflation becomes clear, and the amount prices have yet to fall also becomes apparent. Today's featured property is probably closer to the bottom than to the top, but at $559,900, it still requires a rental rate of $3,500 a month to reach a breakeven threshold for an owner-occupant. Does this look like a $3,500 a month property to you?
Is the sky really falling? I guess it depends on whether or not you associate falling real estate prices with the end of the world. Real estate prices are falling, and they will continue to do so until prices are affordable again. With all of the talk about stabilizing the housing market, people overlook the benefits of affordable housing. If people can live in a property and only spend 28% of their income on it, they have money left over for other uses. The economy will benefit from lower prices as discretionary consumer spending will increase. Of course, if you believe in perpetual Ponzi Scheme financing, we can always fuel our economy on ever-increasing debt loads justified by inflated real estate values. However, we just tried that, and so far the results haven't been too encouraging. We grossly misappropriated resources to non-productive uses, we overbuilt home improvement shopping centers, and we employed too many people in real estate related professions. The inevitable collapse of the Ponzi Scheme has left us deeply in debt, with an insolvent banking system, and with an economic recession. It will take many years for the California economy to readjust from the housing bubble just as it did in the early and mid 90s. The allocation of resources must change, and it will not be a pleasant process. I hope the California economy that emerges is rooted in something productive rather than another unsustainable Ponzi Scheme.
Today's featured property is another loser in our real estate game of musical chairs. When the music stopped, today's owner had taken out all the equity and left the lender is without a chair.
There have been some rumblings about the declining inventory numbers and the slight uptick in sales in Irvine. Perhaps it is signaling a bottom in pricing? This doesn't seem likely, particularly with the Alt-A and Prime ARMs due to reset over the coming few years. The fact remains that REOs continue to enter the market, and they continue to drive prices lower to find buyers. Until that stops occurring, prices will not stabilize much less appreciate. Today's featured property is 35% off its 2005 purchase price, and the lender recently reduced the price drastically to find a buyer.
Isn't real estate supposed to be like vintage wines that get better with age? Rare vintage wines can get very expensive, and unless they turn to vinegar, their prices do always go up. Well it appears the 2006 vintage homes are all turning to vinegar now because they certainly are not appreciating in value.
Today I want to relay a story to you that was told to me by a real estate developer currently buying property in one of our most blighted California bubble markets. His company is purchasing this particular property from the bank for far less than the original loan amount. Do you remember the residual land value calculations from Land Value 101? This particular property was ready for the construction and sale of houses in 2003. The original prices were $400,000 in this particular market. By 2006, houses were selling for $700,000. When sales volumes plummeted, the builder gave up and let the property go back to the bank. The developer ran a proforma using a $275,000 house price. As you can imagine, this did not leave a large residual land value. The bank took the offer. This developer knows he can build and sell houses profitably for $275,000 in this particular market. If prices increase, he stands to reap a windfall. His only real concern is the competition from the REOs, particularly all the previously built homes in this subdivision he is undercutting by over 50%. He knows he is probably going to cause more walkaways, but prices are what they are, and as long as he can build and sell $275,000 houses, it isn't his problem.
Fortunately, for those living in Irvine, the developer is financially stable, and it is concerned about long-term house prices and probably will not cut prices over 50% to move homes. As we noted with the problems in Columbus Grove, those who are off the Ranch are not so lucky. Today's featured property is another of the bad 2006 vintage properties in Woodbury. This seller is really being hosed by his competition as he owes $184,000 more on his property than his comparable neighbor is asking for sale.
Speculation is a battle. The forces of greed and fear drive the financial markets, and the speculator attempts to profit from these moves. Speculation is not investment, although most do not understand the distinction. Speculation is the battle of the individual against the herd. For those who understand it and have learned to move against the emotional forces of fear and greed, there is opportunity to profit. For those who follow the herd, there are brief moments when profits are available, but few have the discipline to take them. Most speculators are slain by the market.
Like many others, I have a disdain for pure speculative flips.
People who buy properties, make no improvements, and attempt to resell
it for a profit simply inflate market prices. There is no value added.
People who rehab old or run down properties do a community service, and
they earn the money they make. However, flippers are merely financial
parasites profiting by constricting supply at reasonable price points.
Of course, flipping is a dying art, and those who are attempting it now
are losing money which makes for great schadenfreude.
Flipping is much more difficult now, not just because prices are
dropping, but because the constriction of credit and the tightening of
financing terms makes it much more costly and difficult to do. The
Option ARM with 100% financing was the ideal tool for the flipper. It
allowed him to enter the market with none of his own money, it
greatly reduced the carrying cost of the property, and it gave him downside protection in the event prices fell. With these conditions in
place, it is no wonder speculative flipping became the pastime of every
would-be Donald Trump in California.
Another behavior enabled by loose credit during the bubble was
cash-out serial refinancing. With the ability to get access to cash
from the property without selling it, there was no need to sell the
property, and many speculators held their properties and withdrew their
cash as needed. Houses were treated like savings accounts earning a
very high return. Of course, they were not withdrawing free money, they
were adding huge amounts of debt, but since the debt service costs were
low, and since nobody thought they would ever have to pay this money
back out of their income, cash-out refinancing became the rule rather
than the exception.
Today's featured property is an example of a speculative cash-out
serial refinancing flip-flop. The speculator bought the property with
100% financing using a 1-year ARM, took out some cash, refinanced with
an Option ARM, took out some more cash, and now they are walking away.
