Excellent analysis, IR. 

I would suggest a second potential variable to the median houshold income; that there may be a difference between the rate of wage inflation and the rate of base inflation in the cost of housing.  The issue I am trying to get at is that the overall inflation rate is made up of many components which inflate at different rates, for example, the cost of food has historicly generally fallen relative to the cost of other goods; whereas the cost of housing would probably trend to track overall inflation or possibly increase past it.  I would not carry this argument too far (since it allows one to simple-mindedly fall into the “they aren’t building any more land and real estate can only ever go up” argument)—but I think that there is an effect there that could proabably be quantified.  Perhaps my comment is premised in the illogical hope that things aren’t quite as basd as they seem to be. 

That said, your basic analysis is unimpeachable as a general ‘reality check’ tool—either wages have to rise (which they aren’t going) or real estate prices are gonna keep falling.

You may have noted in the WSJ and other publications today that rental rates are now falling sharply in OC—over 3% year on year—which puts more pressure on the rental market and a lower price level for “rental parity”.

I was frustrated when I tried to calculate the present value of trashed credit.  It was expensive for people with good credit, but a lot of it outstanding.  It almost didn’t matter to people who already had bad credit to go into foreclosure.

For people who did care about their credit and could pay their bills aside from their mortgage, good planning could wipe out their other debts simply by renting or moving in with their parents for a year or two. 

I was also concerned that the credit rating formulas, tax effects, and effects on future earnings would change if tons of people were foreclosed upon.  I’m just waiting for congress to introduce legislation to reduce the effect of foreclosures on credit ratings.  Someone will think it’s a good idea, regardless of the moral hazard.

What’s the price of a foreclosure on credit?  It depends on your situation, your actions just before and after.  It also depends on a number of things outside of your control.

The standard hit is about 200 points or so.

“I was also concerned that the credit rating formulas, tax effects, and effects on future earnings would change if tons of people were foreclosed upon.”

It is my understanding that FICO scores are graded on a curve. If millions of people default, their credit scores are not hit as bad as single individual would get hit. Also, those that do not default would get a boost to their FICO scores as the million defaulters fell below them.

I would not be surprised to see someone introduce legislation to manipulate FICO scores. It would be great political pandering, and lenders would quickly find a way around the problem if it were passed.

From my slightly similar own experience, I could imagine that a nearly fresh EE graduate working for 5-year old Broadcom would have bought that first place in ‘97.  I could not imagine them staying in it the whole time, considering the meteoric rise in BRCM over the next 3 years.  A similar new-hire (though I imagine their college recruiting is very slow today) to brcm today could probably afford the 1st, but it would be closer to the same affordability level as in ‘97 20% lower, or around $200k.  That would still make a nice profit.

The huge difference between 1997 and 2009 is that Broadcom and other companies were on a hiring and takeover binge.  Where there was a huge number of new graduates looking for starter homes in 97, if they don’t have a job yet, they’ll either stay at home or keep renting.

Is it possible for median incomes to rise, yet median home prices fall?  If there is a supply/demand imbalance - more supply of housing, less demand.  The biggest bubble areas saw huge building surges, and nationwide we have a decrease in jobs.  Even without a bubble, that supply/demand change should have been easy enough for economists to deduce falling home prices.

I’d rather be the non-heloc.  She’ll probably move up, take her 75-100k as a DP on a 400-500k property.

Irvine leads the county in layoffs. Is it a numbers game?

This is a poorly written article, but it does underscore the problems here in Irvine.

“So far in 2009, Irvine has lost 3,931 jobs. The number of layoffs for the next highest O.C. cities, Santa Ana and Newport Beach, are 1,288 and 715, respectively.”

To the extent that homes carry a lot of commodity goods - lumber, drywall, copper - they may follow a different trend than general inflation. 

I was thinking about rent-vs-own on vacation at the beach, in an area with a roughly equal mix of owner-vacation-homes vs. primarily-rentals.  If the ‘commodity’ underlying vacation home values is hotel rental rates, the sharply reduced demand will push rental rates, and then vacation home values down.  One property claimed 16 weeks rented at $1500/wk and was listed at $1.4M - that’s < 2% yield!  Minus appreciation or using it the other 36 weeks I couldn’t figure out how it was anywhere near a good investment.

The other problem that we have is that I’d say ‘97 was about the dawning of the age of the McMansion and the Pimp My House social movement.

We went and prematurely razed a whole bunch of 1200 to 1500 sq foot practical housing and erected behemoth starter castles in their places at double the price since these new bigger and “better” houses “cost” a whole lot more than the smaller and practical ones that were trucked off, piece by piece, to the landfill.

I see this as a problem for those McMansion owners as those oversized houses are eventually going to have to become affordable which means that the prices are going to have to fall to a level relative to the smaller houses that they replaced - even if they are twice the size and stuffed to the rafters with pergraniteel; you cannot squeeze blood out of the turnip.

I received an email from a reader with these two great links:

More trouble ahead for housing

Overview of the Housing Crisis

I think your comment would apply to an input cost driven inflation trend, which I am not sure housing is, especially in the existing home market.  I suppose that could apply to the housing market, if you include land in the mix (and since land is the plug in the equation, I guess that works in a sense).  But I was thinking more of the substitution effect that occurs as income goes up over time—certain commodities, e.g., food, decrease in relative value, while other more scarce resources, e.g., housing, increases.  This is an effect of increasing incomes that will actually happen to the extent that the growth in incomes outstrips the growth in the cost of the “essential” commodities. 

I agree with you on the rental parity computation—single family homes are almost never a good investment if rental income is your goal.  Even in rental markets, you see weird investments in housing—about 10 months ago I signed my lease on a place in Hong Kong.  I offered a very hefty rent for a four bedroom apartment, and the agent’s first response was “they will never accept that—they paid $4 million for the place, and that is a return of only 2%!”  This was in November at the height of the financial crisis.  My response was, in effect, that the price the owner had paid for the place was no concern of mine and not relevant to the discussion.  They accepted the offer.

Oh…You just had to bring up 1997. 1997 is the year of probably the biggest financial blunders of my life. I was living in LA and renting a house. My mother is savvy and realized buying made sense. She proposed that she help me buy a fourplex in Burbank close to Disney studios. She had found one for in the low $200,000. The property was cash flow positive. Today that place is generating like $8000-10,000 a month in rent. But no, I was young stupid and back out the escrow. This time around I’ll jump on my mom’s bottom call.

When you step back and look at how effective the various governmental measures have been for the common man, little to nothing has been accomplished. (True, interest rates are low but the result has generally been refinancing of homes not under water. That was not the objective). A lot of activity; virtually no accomplishment - and no reason to think the near future will be any different. I think turmoil will continue for at least 3 or 4 years. The proven DTI ratios of 28-36 will ultimately prevail, probably in spite of, not because of, all the “activity”.

I like having Robert Shiller on my side:

Shiller on Housing

“[Shiller] says the housing market could “languish for many years,” due to the “huge inventory” of unsold holds, “shadow inventory” of homes kept off the market by banks and other potential sellers, and “a lot of financial problems.””

This is also part of the problem…  The pent-up speculation and wannabees sitting on the fence thinking that they are going to game the system when everything hits bottom. 

The average Joe thinking that he is going to position himself to catch the next housing bubble.  Unfortunately, he does not realize that everyone else has the exact same idea and his delusions of grandeur are nothing but that - delusions.

“I see this as a problem for those McMansion owners as those oversized houses are eventually going to have to become affordable…”

I thought of this while walking through a ‘90s - not those ‘90s, but the 1890s - section of Denver yesterday afternoon. On most blocks, few of the mansions are still single units, and those which remain whole are law offices. The rest have been cut up into 3 or more apartments, usually more.

I figure that the typical McMansion will either be shared by multiple families, cut up into multiple apartments, or held by someone willing to pay huge heating and A/C bills for a status symbol until maintenance costs force a tear down or apartment conversion.

Some will survive - likely the ones nearest the jobs.

What credit does he deserve?  He was only spot-on for both the dot-com and housing bubbles.  Let’s see if he can go 3-for-3.

You ask how can homes go up more than incomes, but you left out the 2nd of the two things people buy homes with:  assets.  It’s possible that assets accumulate over time and that would tend to support higher prices.  Newport Beach is a perfect example of this.

I think his most valuable insight there is “One thing is true about housing, it is a very inefficient market - and it shows momentum.”  Time lags in markets contribute to boom/bust cycles.  It happens with oil prices/investment and semiconductor sales/fab building.

The dogma of efficient markets should be dead.

I’m not doubting that you’re generally right; but sometimes it does seem that assets are simply revalued, and start to command higher prices in general.  I’m wondering whether you’ve compared SoCal prices with real estate prices in Europe… I know that London might have been hit by the same bubble as here, but in Germany, France, Italy…?  If real estate prices there are subtantially higher over the long term, that suggests that real estate prices reflect both cultural assumptions and desires.  And that they might be sustainably higher; that having gone up, they simply won’t come down to where they once were. 

Put another way, the Kool Aid we talk about might be more stable than you are assuming.

Pick-a-Pay Loans: Worse Than Subprime

WSJ reporting
As of April, 36.9% of Pick-A-Pay loans were at least 60 days past due, while 19% were in foreclosure, according to data from First American CoreLogic, a unit of Santa Ana, Calif.-based First American Corp.

Here is the link to the story

http://online.wsj.com/article/SB124744382165530247-email.html

They are just doing what they can to maintain the status quo and keep life good for themselves and their business partners.

I am seeing no evidence that the leadership is steering us into prosperity via production of any kind.  The plan, as I see it, is that we are going to continue to buy all our widgets from China, software from India, cars from Japan, etc.

All I see going on here is a bunch of road construction, bridges to nowhere, and the remaining masses rushing the entrances to every nursing school from one coast to another.

What is the end game here?  How can we keep buying all this stuff from other countries and pay for the stuff with construction of our own roads, bridges, and nurses to sponge-bath baby boomers?  How is all this stuff that we are doing beneficial to the rest of the world?

Fast forward 50 years and we are going to be a nation of fast food workers and government stooges.  We’ll just be be selling each other cheeseburgers, writing parking tickets to one another, and stroking each other other with sponges.  Living on minimum wage while the majority of wealth is held by the old money corporation owners that continuously pass the wealth down to their heirs.

It could also be that prices in Newport Beach have been bid up to a ridiculous and unsustainable level because people who bought there believe that prices there cannot go down.

The Immunity Syndrome.

Go look through Redfin and find properties purchased in Newport Beach from 1995-1998. You will see the same relationship between local incomes and house prices exhibited here in Irvine. The higher prices in Newport Beach are mostly because high wage earners choose to live there, not because it is a reservoir of value.

Similar buildings on the south hill in Spokane, WA.  Totally forgot about those places until your post.  Certainly a possibility. Why try to rent out a McMansion for $3500 to one family when you can refab a kitchen into the second floor and rent it out to two families for about the same.

“Put another way, the Kool Aid we talk about might be more stable than you are assuming.”

That is possible, but the kool aid was pretty strong in 1990, and it did not stop a 7-year price decline down to affordable levels, and so far nothing about this price crash has suggested it will be any different—other than it may be worse.

As your new Lennar home depreciates the Chinese Gypsum also makes you sick:

from today’s wsj: Lennar Corp. has identified 400 homes in Florida that have confirmed problems with defective Chinese drywall, and it has set aside $39.8 million to repair the homes, the Miami-based home builder said in a securities filing Friday.

The figures are as of May 31, Lennar said.

Complaints about odors and corrosion linked to defective drywall have been increasing for months.

The U.S. Consumer Product Safety Commission said in a letter to four U.S. Senators last week that it has received more than 600 complaints related to the drywall issue from 21 states and the District of Columbia. Most of the reports are from Florida, Louisiana and Virginia.

Lennar has found defective Chinese drywall in some of its homes in Florida.
Lennar and some other builders have been forced to gut homes, mostly built in 2006 and 2007, to replace drywall, wiring and other fixtures.

Lennar said that it hasn’t yet found defective Chinese drywall in homes it built outside of Florida and that it isn’t yet able to “reasonably estimate its future exposure” to the problem, which has led to a spate of lawsuits against drywall suppliers and builders.

The builder said it has a $20.7 million receivable for covered damages under its insurance policies.

Lennar said it is seeking reimbursement from subcontractors, insurers and others for costs the company expects to face in investigating the problems and repairing damaged homes.

Drywall, also known as wallboard, is made from gypsum coated with paper and is used in walls and ceilings.

The CPSC said recently that staff members who have visited some of the homes noted odors and metal corrosion inside the homes.

“While in the homes, they also consistently experienced some throat irritation, scratchy eyes, headache and other symptoms that tended to clear up or dissipate after some time outside the homes,” the agency said.

The CPSC and state agencies are investigating potential health and safety risks related to the Chinese drywall.

Evaluating things at the median has some inherent problems. People in the lower income levels move inland, rent, or double up. You have another group of people who are the savers, who either own their homes outright by now, or are well into paying off loans that were taken out when prices were much lower.

The clearing price will be set by the median income of families who are actually in the market, which I suspect is measurably higher than the median income. It’s also not unusual to get multi-generational families where an aging parent or two will bring additional assets to the down payment and income.

We still have a long way descent until we reach an equilibrium, especially since there’s every indication that the median income is dropping. (California’s income tax collections are down 20% year-over-year).

What are these assets that people have that are driving up prices?  Please, educate me.

” How is all this stuff that we are doing beneficial to the rest of the world?”

We’re still the reserve currency, if for no other reason than the mountains of dollars everyone still holds. I don’t see how China can cease to buy treasuries in the near-to-medium term. Furthermore, we run 97% of the military bases throughout the world, making us the inefficient-but-resource-consuming policeman of the world. For industrial oligarchs in China, Russia, and Europe, this not a bad situation.

I’m beginning to buy the arguments of the deflationist camp.

Sure, the long-term result will be disaster, but there will at least be 15-25 years of slow, excruciating pain, just bad enough to destroy the psyche, but not bad enough to bring sweet death or unconsciousness.

Furthermore, baby-boomer sponge baths look like a growth industry for sure. Stroking one another with sponges is at least a stable service-sector activity which creates two jobs simultaneously.

Yes, the geniuses running this shell-game apparantly didn’t think about when their mark turns the tables and picks the “no payment” payment. 

What a hustle - Every time I hear that stupid phrase “Pick A Pay”, I instantly think of a Casino game.

Do you mean appreciate or accumulate?  Accumulate is buying 100 shares of BRCM every month, and how much that would be worth.

People also sell assets, and nearly every asset class is far less valuable today than it was 1-3 years ago.

There are people who believe in an incomprehensible ‘magic’ of markets that sets prices accurately, and there are those who believe in market fundamentals - earnings, income, history of growth, rents, cash-flow - and that markets can be inefficient.  I don’t know what evidence moves people from one group to another.

IR could you do a post comparing what you get for the dollars in 1997 vs. 2009 vs. the bottom? It could either be $/sq. ft or $/lot area. I know it is a subjective thing as to what is really valuable in a home purchase. My impression over the years has been that housing dollars actually buy less but it is hard to figure inflation and interest rates on the fly.

Reservoir of value or irrational exuberance?

415 Marigold Ave Corona Del Mar, CA 92625, Sold: $284,000, Price: $1,169,000

708 Avocado Avenue B Corona Del Mar, CA 92625, Sold: $310,000, Price: $1,049,000

313 Carnation Ave #2 Corona Del Mar, CA 92625, Sold: $800,000, Price: $2,450,000

4 Drakes Bay Dr Corona Del Mar, CA 92625, Sold: $865,000, Price: $2,050,000

514 Poinsettia Ave Corona Del Mar, CA 92625, Sold: $353,500, Price: $1,685,000

If Newport Beach supports higher prices due to the assets of its owners, why were prices so low in the mid 90s? Were the owners here poor back in the mid 90s?

I think its is pretty obvious that the values in Newport Beach have no justification at all, and it is very likely to see a catastrophic collapse in real estate values. I predict we will see 50%-65% declines in home prices there. It would take that to get back to reasonable levels based on Mid 90s pricing plus some income growth appreciation.

Zoning and building codes for two reasons.  Most are in SF and not duplexes.  Two kitchens = duplex and where the fire wall between the units?  It will depend on the city/county and who you know to get a variance.  Many places also have restrictions on the number of unrelated people in a house/apt.

Unless your MJ, there does seem to be an upper limit on rent for regular people that pay out of pocket.  If a public company pays, the sky is the limit. Was MJ paying out of pocket or from a public company?

While I agree with some of what you’re saying, you need to reconsider this statement:

“People in the lower income levels move inland, rent, or double up.”

If they move inland, that raises the median.
If they double up, that raises the median (assuming we’re talking about median household income).

“It’s also not unusual to get multi-generational families where an aging parent or two will bring additional assets to the down payment and income.”

Again, that raises the median household income.

Statistics can be misleading, but not for reasons you are citing.

My problem with all of this is that when you think back to how this country was founded by a bunch of immigrants who came over to farm the land, work in the factories, etc; this was a country that producted of food and widgets.  I build you a wheelbarrow and trade it to you for some of your food.  We adopted currency systems to make this barter system more efficient.

We used to land to build farms and factories which would be used to produce these goods.

What do we use our land for now?  We build houses, banks, resorts, golf courses.  Am I the only one that looks around and thinks “WTF?”

Nowadays what is the barter?  I’ll spongebath you and you fill out my mortgage application?

I’m not saying that we have to return to an Agrarian society, but shouldn’t we at least try to come up with something that can be sold to the rest of the world other than our brand currency?

Irvine mhi = $91k, but the survey was 2005-2007.

how many high salary jobs at New Century have evaporated since then?

Is it logical to think house prices can go up more than incomes?

Wouldn’t that be possible if the population was growing faster than new housing was being built?

producted?  Cool word.

“producted of” is AZSpeak for “produced its own”

Oh, David where is your sense of humor today? I was just trying to laugh at myself for turning down a great investment that was handed to me on a sliver plater.

No, other people think wtf too.

Can I fill out your mortgage app while you’re spongebathing me?

The real utility of the barter is the wheelbarrow allows the farmer to get 10% more yield for the same effort.  This is a difference between a productive and non-productive investment.  There’s a difference between building a factory and a home.

JMO ~ This is likely the best posting IR has done for this blog.

After reading this, you have to ask yourself this one simple question:

WHY IS THE PRIOR GENERATION OF HOME BUYERS ASKING THIS GENERATION OF BUYERS TO GIVE A MUCH HIGHER PERCENTAGE OF INCOME TO SERVICE HOUSING COST?

Would also be possible if people were buying up multiple houses, using lots of available credit, and holding them like speculative assets….

Anyone here know anybody who “owns” a secondary speculation “investment” house?  I do….

Only if the job market grew faster than the population and was competing for employees from a limited pool. The opposite is in effect at the moment and shows no sign of changing in the near future. That’s one of Obama’s big concerns.

Thank you.

I have been trying to make this argument for quite sometime now.

A few weeks ago when we had the owner of one of the houses show up at the blog and pump the “Hate The Game Not The Player” defense, I asked him if he would want his kids to take on that kind of debt to buy his house from him and he would not give a straight anwer; I wonder why.

Why do you think that the realtors go on to Zillow and hide the “Charts and Data” link on the homes that they are selling?  Because they don’t want you to figure out how badly you are getting screwed compared to what the previous guy paid.

Here is an interesting post on a RE bubble blog for Sonoma County (h/t Calculated Risk).  Indicates that in fact the payment recast issue may take somewhat longer than people anticipate to occur.

http://healdsburgbubble.blogspot.com/2009/05/reset-chart-from-credit-suisse-has.html

I think the implication is that the large level of recasts will still blow up but it may be more of a 2014 phenomena than a 2011 phenomena.

All week I read the IHB and read interesting things about the housing economy.  Then on the weekends I look at open houses, to see what’s actually available and end up with some realtor or mortgage broker yelling at me about how I’m wrong, or about how Ventura County is different than other markets.

I start second-guessing myself.  A mortgage guy on Saturday told me the market is bottoming right now (I assume housing markets rarely bottom in July).  He talked about how all these houses with prices under $400k end up getting 10+ offers and bid up from their asking prices.

And then I wonder who are all these people out here that can afford these houses?  My wife and I combine for about $110k/year income.  It really seems like we should be able to find an average, 30+ year old, 3 br, 2ba house with 1600sqft.  If people like us can’t afford something like that, it really seems like the local economy just won’t be able to be sustainable.  Who are all the business execs going to hire to do their accounting and teach their children when we have to move to Kansas to afford to live?

We were born in the wrong decade.

WHY IS THE PRIOR GENERATION OF HOME BUYERS ASKING THIS GENERATION OF BUYERS TO GIVE A MUCH HIGHER PERCENTAGE OF INCOME TO SERVICE HOUSING COST?

Because they think they can.

And because many others have been getting away with it.

“Wouldn’t that be possible if the population was growing faster than new housing was being built?”

Generally what you end up with in that circumstance is an increase in people stretching to buy which does cause some price increase, but mostly you get a diminished standard of living.

Think about it; if a $110,000 yearly household income only gets you a small, old 3/2 in Irvine and a McMansion anywhere else, hasn’t the standard of living already been significantly diminished here?

If you have to put a larger percentage of your income to obtain inferior housing stock, then your standard of living has fallen. That is what happens when population grown exceeds income growth.

There are a lot of people out there that are thinking this though.  That’s the problem.  You were just saying it in jest, but it’s a serious game plan to a lot of bubbleheads right now.

I agree ... BUT what has facilitated these irrational prices?

(hand goes up) ... I know, I know ... Ponzi scheme financing!

Now that Ponzi scheme financing is (mainly) gone, Orange County (Irvine being the epicenter), is NOT GONNA have a healthy real estate market until prices reach a level where organic sellers can pass their houses to the next generation of financially qualified buyers.

That is an interesting post and analysis. I will look into this more. So far Ivy Zellman and Credit Suisse have been very accurate in their analysis and methodology, so I am inclined to think the annual report of Wells Fargo may be suspect, but maybe not.

Peter Schiff would agree with you too.

My father-in-law is a big supporter of tariffs to prop up what’s left of our manufacturing.  I’m starting to agree with him.

But I think that an equivalent job in a place where $400k buys you a McMansion, probably won’t pay $110,000.

Do you have stats on new home sales/construction for 03-, and population growth?  In So FL, there was a huge building overshoot.  What happens when supply > demand even when the price is 0?  Sure you get investors who will try to rent condos & townhouses, but what if there aren’t enough renters?  ‘Vacation’ properties will take up some of that slack.

Wasn’t that new-home demolition video in SoCal?  Sure it was further inland, but there’s a quantum leap from price decline to bulldozing.

Should we begin to consider a “worst case” scenario in a deflationary environment where housing price will head for a decade-long decline and a bottom can not be formed?  What would be the best strategy for future buyers if the worst case does become reality? When I looked around I generally saw three possible scenarios related to housing market in SoCal:
1.  Scenario 1: market will recover in a year or two as the general economy stages a quick turnaround. Unemployment rate will drop, and wage and rent will rise again by next year. Lending standard will be loosened again as housing price resumes the pre-bubble style quick ascendance. Of course most folks with the ability to think and analyze would dismiss this in a heart beat. But it seems that a large portion of our population still believe this crap.
2.  Scenario 2: market (mid-high end in particular) will tank in the next 2-3 years as the peak of option ARMs and Alt-A recast hits. Foreclosure will shoot thru the roof and price will fall precipitously. Housing price will hit the bottom around 2011-2012, and may stay at the bottom for another few years before it begins to go up again roughly at the same rate as inflation. At the bottom the housing prices will drop 50-60% from peak. I think this has become the prevailing view of the SoCal market on IHB and other objective minded blog space.
3.  Scenario 3: we are stuck in a prolonged deflationary downward spiral. Above 10% unemployment rate becomes norm. Real wages and rent continue to fall year after year so a solid bottom thru rental parity and a standard level of income/debt ratio can not be established. Economic growth remains subpar despite repeated fiscal stimuli, low interest rates and other fancy policy tools that failed to quickly revive US during great depression, or Japan over the last 2 decades. And gov’t endless intervention to put a floor in housing market thru all these idiotic, short-sighted measures (foreclosure moratoria, artificial low mortgage rates, housing purchase subsidy programs….) will only serve to drag out the housing correction but can never revert the course. SoCal housing price in this scenario will keep dropping for 10-15 years, and median price will fall by 75-80% at the bottom.

Given the historical precedence (Great Depression, Japan) of previous large credit bubble burst, and the fact that we are still recycling all the policy tools (fiscal stimulus, zero rate, QE ….) that failed to revive Japanese economy in the last 10-20 years, I don’t think scenario 3 is that of a remote possibility. Personally I would split the probability 50-50 between scenario 2 and 3.

Yeah, the new-home (actually not quite finished homes) demo was in So Cal.  Victorville to be exact.  Victorville is worlds away from Orange County.  Although much of Victorville’s build-up over the past 5-10 years was due to the people who chose to live in Victorville and commute to a job in Orange County.

Come on guys, this protectionist, “end of the world” talk is nonsense.  Let’s not turn this analysis of the real estate market, and the associated financial debacle, into a forum for discredited economic ideas.  Tariffs, or, as they call them in Washington, “voluntary import limitations” are the reason that Detroit is bankrupt today instead of being home to the world beating behemoths that used to reside there—the management of the big three decided to collude with their unions and the government to keep from competing with the Japanese.  It seemed to work also, for a time. Our economy will be, basically, just fine until the Microsofts and Ciscos of the world start begging for ‘tariffs’.  And there is absolutely no reason to prefer making hamburgers at $2.50 each to making a transistor for the same price.  Both are equally necessary.

Your diagnoses are pretty accurate but I don’t think scenario #3 is very likely, actually.  The more likely ‘worst likely case’ outcome is that continued fiscal stimulus erodes the value of the dollar and drives up prices—inflation not deflation.  And a 10% unemployment rate is not mutually exclusive with high interest rates and 15% inflation—that’s what we had through much of the period 1968 - 1980.  Governments learned a long time ago that people will tolerate inflation in preference to deflation, and deflation is so unhealthy that the government will only agree. So, even assuming the stimulus doesn’t work very well and unemployment doesn’t budge, the plunging value of the dollar brought on by the deficit spending will bring inflation in its wake, eventually affecting the housing market.  Those who can continue to pay their mortgages will see their liabilities deminished away.  Will the “real” value of real estate decrease?  Probably, but the non-inflation-adjusted prices 10 years from now will almost certainly be much higher than they are today.

Really? There is a lot of people out there who’s mother’s ofter to buy them a cash flow positive apartment building in 1997 and turned it down? I’m pretty sure I’m the only ding dong out there that turned that one down.

I think I understand what your saying about a lot of people waiting to catch the next wave but that is not my plan at all.

When we put the offer on that four-plex we were the only offer and it had been sitting on the market quite awhile. I suspect the same thing will happen this time around, too. Most that have been on the sidelines will buy way before the bottom hits so few will be around with enough cash when the real deals happen.

I doubt the opportunity I was given will every present itself again, though. The opportunity to buy a cash flow positive property will probably come. But to buy one and then sell it for 1.8 million 10 years later… I think that was a once in lifetime opportunity that just past me bye.

Protectionist?  Now that sounds spooky.  End of the world talk?  Why did you hold back?  You forgot about firearm ammunition hoarding and underground bunker preperation.

Nobody said that the world is ending - but the middle class is definitely eroding.  How can you be so dismissive and deny that when the government is using the creation of fast food jobs to pad its manufacturing jobs numbers in order to cook the books?

[url=“http://www.cbsnews.com/stories/2004/02/20/politics/main601336.shtml”]Building Blue-Collar … Burgers?
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Come on.

I know that the mainstream media has been downplaying (or ignoring) the possibility of a prolonged deflation ever since the market meltdown of last fall subsided. But in reality and at macro level we seem to have all the key ingredients in place for a protracted deflationary spiral:
1.  Large insolvent financial institutions are now allowed to zombify and compete against healthy banks – this ensures we will have a sickly capital market for years to come.
2.  All these loan mods will entrap many home owners in continuing servicing their inflated loan amt, and infinitely prolong the debt-destruction process. Income used in servicing inflated mortgage debt will crow out consumption as IR stated in earlier post. 
3.  We are in a synchronized global economic recession and there won’t be any robust external demand to soften the blow or bail us out.
4.  The crushing Medicare/Medicaid/social security liability (as baby boomers reach retirement age) will put tremendous constraints on our government’s ability to re-flate the economy
5.  Change in psychology and attitude towards consumption and saving by US households (IR has dedicated more than one post on this topic)
6.  The imbalance in US economy. The manufacturing base is largely gone, along with any vestige of high-paying blue collar jobs in this country (GM??). In the last 10 years a large part of the corporate profits were generated thru elaborate money shuffling from which exorbitant amt of economic rent could be extracted. That whole system has collapsed once the credit ponzi scheme came to an end, so were millions of fat paying jobs in RE, financial services, investment banking, etc. And there is no new industry on the horizon that can quickly replenish the income drain caused by this structural change. It will take years before the economy re-balances itself (with or without Gov’t help).

Well, having to give each other sponge baths in lieu of retirement sounded pretty apocalypitic to me. 

But, why do you operate on the presumption that ‘manufacturing’ jobs, whatever they are, are somehow superior to ‘fast food jobs’?  Why does a ‘manufacturing’ job somehow support the middle class, and a burger flipping one does not?  I admit that that assumption is commonly held, it is still wrong.  If you are saying that the economy will no longer create jobs whose cost is greater than the value added they provide, well, that is inevitable and in any case a good thing.

Deflation, Japanese-style, is worth pondering.

I am so close to buying mass quantities of long bonds. If only you knew…

Sure, interest rates will be going up for some ARM payers, but that’s only because they’re leaving the teaser period and joining the real world.

For the rest of us, 2% may start to look pretty good. China is still buying treasuries as if they had no choice in the matter, and domestic demand has not yet appeared.

Lock in that 4.3% during 20 years of deflation, and you come out looking like a genius.

You make some good points, except for #6, which is completely wrong.  There will always be a lot of manfacturing done in the US (the defense industry is required to be here, and the coming inflation will make our manufacturing more price competitive) but the idea that the blue collar unionized worker is the backbone of the middle class is discredited.  That man has retired and his kids write software and balance the books for a living.  That is normal and all to the good, since we can’t support our high standard of living with a bunch of low-value-added jobs.

I take your and IR’s point about the zombie financial system, but comparisons with the Great Depression and even Japan 1993-2000 are a pretty big stretch.  Our instincts, unlike the Japan MOF, is to inflate the economy back to life, and with the Democrats running things that is the approach they will take.  In addition, we don’t have anything like the demographic problems that Europe, Japan, and China are facing—we are relatively fortunate in that regard. 

My point, which wasn’t a particularly optimistic one, is that the efforts to stimuluate the economy will debase the currency and create inflation, full stop.  Hell, they may even do it intentionally, since it would allow our fabled ‘manufacturing base’ to become even more price competitive.  I just don’t think a deflationary spiral is very likely or realistic.  An inflationary one (i.e., stagflation), sure.

Interesting comparison and analysis. I especially found it fascinating that if the same % was put toward the home now, the median home price would be $419,000. Wow.

That 2% return won’t look very good with the 10%-15% annual inflation that may be coming.  True, you have to compare that with bad returns you will get with other asset classes, but I wouldn’t put my retiring money into long bonds just yet.

As far as the Chinese buying treasuries as if they had no choice in the matter; that is true.  They have no choice in the matter.  But it won’t be like this forever—the inevitable rebalancing of trade combined with the debasing of the currency will force the US government to push up the rates on future issues, pushing down the value of existing bonds.

Exactly.  Consider this though, Blue.  The kool-aid intoxication is hard to shake.  We are still too close to the peak values, the comparitively great deals are enticing but the excitment is fed by artificially low interest rates and good PR work by the Fed (green shoots!) and the NAR.  This process is going to take some time and until the investors and kool-aid addicts take a hit the market won’t return to realistic levels.  Let’s see what several years of falling rents and prices do to them.

Freetrader2,

Yes we all know Fed (and US gov’t) prefers the risk of hyper-inflation over a deflation trap. But the problem is that they may not have much control over our economic future as much as they think they do. So it does not matter what their preference is – the more relevant question is if their policies will ever work to fight the economic collapse induced by a giant credit bubble burst. And history does not seem to support the notion that they will, or maybe we just do not have enough evidence indicating they will.

As we all know by know the past 30-year economic expansion was enabled by excessive credit/debt. During bubble years credit(debt) functioned as real money (think of 0% financing) to push up general consumption level as well as property prices. But since this ponzi scheme imploded the purchasing power supported by debt had largely been wiped out, and we started the deleveraging process. Provided the extreme high leverage we had in the system (corporations, household, even government at various levels) it’s doubtful the debt-destruction can be quickly countered by Fed’s printing press.

AZDavidPhx,

I thought I gave you a pretty straight answer.  It may have been a bit wordy but I felt you received an answer you accepted since you did not jump on me about it like some of my other answers. 

You still have a chip on your shoulder for me because I happen to have bought at the ‘right time’ but when is really the right time? 
When I bought my house, my family and friends thought I was crazy to pay that much (in the 300’s) for a 1500 sq. ft. house when I could have bought a brand new 2250 sq. ft. house in a gated community for $280K about 10 minutes away in another city. 

Just for fun to think about, if I happen to have placed my house on the market for say, $410K, do you think I would get some average offers or do you think I would have had a bidding frenzy ensue pushing up the offers to general market prices for my area anyway?  Would you then say I was expecting the next generation to pay higer prices if I set the bar low and the ‘next generation’ bid to the current market level anyway?   

I am not forcing anyone’s hand to give me anything.  In the end, the market will set my price regardless of what I want or think my house is worth.  Nothing can change that fact.

Did you actually misspell Estate?  Really?

OK, since “we all know” that the Fed prefers to hyperinflation to deflation, if the Fed decides to debase the currency (inevitably causing inflation) then that will happen.  Period.  Economic conditions have not a lot to do with it (I assume you aren’t really suggesting that there is a risk of total economic collapse and a return to a barter economy).  Comparisons with the Great Depression are completely misplaced, partly because the major currencies of the world were then (foolishly) tied together in fixed exhange system linked to each nation’s gold reserves; accordingly, most governments, including ours, had tight money policies that turned a credit problem into a 10-year Great Depression (and not coincidentally, World War II).  Each country tried to defend its currency to increase its stock of gold.  I don’t think its gonna happen that way again.

As far as the last 30 years of economic growth being a giant ponzi scheme as you suggest, “we all know” nothing of the kind.  I agree the MSM makes it seem that way, but the credit bubble was a phenomenon that essentially started in 2002; it was a direct consequence of the internet speciulative bubble and an indirect consequence of 9/11.  The 2002-2006 period is four years, not 30, so your ponzi-scheme analogy, while partly correct within the narrow confines of that period of time, is completely wrong over the longer period 1980-2009.  In 1980, Microsoft was a start up with a dozen employees, Oracle barely existed.  There was no internet.  Are you seriously trying to argue that there was no innovation or ‘actual’ non-finance driven wealth creation during the last 30 years?  I hope you aren’t, because if you are, then you are either severely misinformed, or making an argument that you know to be untrue.

It makes sense to set your price at market minus a tiny bit to get the active buyers to come and buy your property if you want to sell… and it sounds like that’s what you did… and good luck to you.

Thing is though, when you start out and try and learn about this buying a home biz, they tell you not to take on too much debt. They say keep the DTI’s in the 28/36 range - of course that isn’t what they actually do around here.

There are enough people out there who were able to get funded to overpay for a home which they could then sell on to another idiot who would over pay for a home - and then the music stopped and they took some chairs away… and now the music’s playing again and we all wonder how many chairs will go away next time and how hard it will be to get funded for a loan. So we have the people who would like to buy - and people like you who bought - the price went up and now you’d like to get as much of your profit as you can - after all you are only asking the going rate. It isn’t your fault the going rate is so high. The Arizona dude may have been a bit churlish in his attitude but I kind of agree how can it be right for one generation to demand so much cash from the next one…. but at the same time I figure - well if they are stupid enough to hand it over - they get what they deserve - or some one will eventually.

Prices are what they are because enough people want to buy a home - the good stuff, that is priced right, is going like hot cakes. 110K is good money - unfortunately 110K means you can afford maybe 400K - at a stretch - and maybe you’d be pretty disgusted at how little 400K can buy.
There is always someone richer who wants to buy more I guess.

I’m gonna jump in here.

You still have a chip on your shoulder for me because I happen to have bought at the ‘right time’ but when is really the right time?

You tick me off!

More than not, people that post in here are likely younger than you.  A lot of us were getting our lives started when YOU BOUGHT at the “right time”!  Why should I give a much higher percentage of my income to either bailout some home-debtor, or facilitate an early retirement for someone who bought two decades ago.

The banks created this fuc*ing mess!  And now that the music has ended, sellers expect to get ponzi scheme prices.  Though it’s not working in most of Orange County, the govt is doing everything feasible to assist this bullshit, by awarding huge tax incentives, subsidizing mortgage rates, and encouraging banks to assist home-debtors to stay in houses instead of kicking them out.  It’s all outrageous.

One More Point!  You talk about the free market bidding up your house, but we don’t have a free market!  We have a govt subsidized, too big to fail, bullshit market.

I’m in favor of allowing the market to set the price of your home.  BUT, the rules have to go back to the old way, meaning:

1) MUCH less securitization of debt.
2) Most buyers MUST qualify with a 20% down payment.
3) DTI mush NOT be higher than 33%.
4) The free market must be allowed to determine mortgage rates.
5) NO MORE govt subsidies to buy real estate.
6) NO MORE bailouts of banks or home debtors.
7) Borrowers and lenders must be accountable for every loan they offer and assume.

I wonder what kind of bidding war you’d get on your house then?  LoL

I sure don’t like the idea of holding 4.25% coupon bonds during 10% inflation. The problem is that I am not convinced that 10% inflation is coming anytime soon.

30-year notes look risky, but if this fire sale continues, we may have 5-20 years in which to hold those notes. And if interest rates are pegged near zilch, there will be buyers who will be willing to pay the premium.

If I were as certain as some are about the coming hyperinflation, I would not even be considering treasuries. I don’t yet understand how trade will rebalance, whether the Chinese will destroy their own currency through printing, etc. I don’t buy the popular meme that the Chinese are not-to-be-trifled-with super-sharp operators who will eat us alive. If they were, their government and society wouldn’t be the inefficient and polluted distaster that it is.

I don’t really know whether we will have serious inflation or not—it is certainly one possibility.  I do think that the government will be issuing a lot of treasuries over the next few years and that that might have an effect on interest rates.  My only thought is to hedge your bets through diversification.

I agree with you about the Chinese.  There are not a threat, they are actually a partner of ours who are more dependent on us than we are on them.  They have redirected their national savings to create a price competitive export sector; but that is a long way from having a fully diversified economy, and in any case, their demographic problems are immense thanks to the ‘one child’ policy; as has been said, the Chinese will be the first nation to get old before it gets rich.

Lee,

I have a feeling I was born in the same decade as you.  I am fairly young still but I bought when I was pretty young (in my 20’s) because of saving and a lucky career decision.

Long time lurker here.

To all those trying to speculate where the economy is going from here and when things will get back to normal.  I would argue the answer is never.  The US have been a faux economy for decades.  As AZ David said in some posts above - we don’t produce anything.  Whether it was cars, TVs , washing machines, microchips and routers, even consulting – we once had things the world wanted and needed.  That just is not so anymore.  Union jobs, welfare, military spending, government waste, were all allowed as the greater economy was thriving, we were manufacturing and selling something to the world.  That does not accurately describe our country anymore.  Its taking decades for this to filter through our economy and society.  And those losing their earnings power are going into debt trying to keep their respective standard of living. 

I would argue certain segments of our society are gone for good and never returning. UAW workers are not going to be “re-schooled” in computers and social security pensions, SSI disability, even unemployment will all slowly collapse in the same fashion as is happening to other social services now in California.  We will soon reminisce about enemployment benefits that way we do about free TV.

I regularly tell my friends that Obama/Washington must clearly know that they cannot save Detroit (both the city and the auto industry).  Michigan is Mississippi.  Its Over.  Kaput.  But your president can’t ever publically admit this.  It actually wisest to just let it happen on its own weight and throw them a billion here and there to keep their votes coming your way.  Their kids who want jobs will all move away soon enough.

The US as we know has been changed permanently.  Its like the terms BC and AD.  A period in history so changing that from this point on things will never be the same again.  There is no reason comparing today to 5 years ago.  Its not relevant anymore.  Talk to kids graduating from college now.  $75Kin loans and no prospects for a good job now or in the future. 

We are, even though we are so reluctant to admit it, going to be much more like the world economically.  There will be wealth and poverty, but the middle class will slowly be choked.  Maybe all these gated communities will realize the real reason for the gates.   

But , of course, none of this will be applicable to my subdivision

All this and Irvine doesn’t even rate on the top 100 places in the country.  Why is Irvine special again?!

Lee, you seem to have a few issues and a huge sense of entitlement.  If you know someone who bought Microsoft at $2 a share do you hate them as well?  It’s funny how you rant about the “free market” setting interest rates, then layer on a bunch of requirements (intended, presumably, to reduce demand) that are anything but free market.  I guess the world isn’t perfect enough for you.  Oh, and you forgot to add “No more home mortgage interest tax deduction” to your list of non-negotiable demands.

PropertyOwner -

I’m not suggesting that you should put your house on the market for any particular dollar figure. 

I was just trying to see if you would encourage your kids to buy your house from you if they were interested or if you would feel better about ditching the house on a stranger knowing that whoever buys it is going to lose their money.  You are dancing around the question like a politician and will not give a straight answer.

I also think that you don’t realize that I sold out of the market in 2006 at the peak before everything crashed.  For you to sit there and accuse me of being jealous of your fortune is not going to wash.

My being annoyed has really nothing to do with you, but more the fact that some bank is going to fund a loser-of-a-loan to allow a fool out there to bid on your house and then take bailout money to cover the future losses.

Well, Obama shouldn’t be even trying to save Detroit, althought the bankruptcy option is the correct one.  He is trying to keep as many auto workers employed as possible in the mid-term.

The rest of your post is nonsense, I’m afraid.

If you know someone who bought Microsoft at $2 a share do you hate them as well?

Nice strawman you have going there, General.  It’s a beauty.

You are going to equate the purchase of a Microsoft stock with the purchase of a house? That makes a lot of sense.

You think that a free market implies anarchy with no controls?  Why not allow monopolies and price fixing?  It’s all part of the free market.  Those damn hippies with their entitlement complexes are screwing it all up for everyone.

Keep up the good chest-thumping there, Free-Market-Warrior.  Make Rush Limbaugh proud.

The rest of your post is nonsense, I’m afraid.

Well - that sums it all up, I guess. 

We can remove our tin foil hats and crawl out from our panic rooms now that FreeTrader2 says that our conspiracy theories are just nonsensical ramblings of the unsophisticated.

Rush Limbaugh?  No, never heard him actually.  Adam Smith, maybe.

I like the way how, lacking any semblance of an argument, you go straight for the invective.  Assuming (incorrectly) that I am some kind of right winger, you equate me with Rush Limbaugh for telling you to stop whining—hey, we are in the middle of a housing crash, but prices apparently aren’t falling fast enough for you.  Morons like you are very quick to decide that anyone who disagrees with them is the “other”, whatever the other is—if you were conservative, you would call me a socialist Obama lover (I get that one all the time as well by the way—idiots seem to collect at either end of the political spectrum).  Then you declare intergenerational warfare on a bunch of people who are probably no older than you. 

My Microsoft anlogy was the correct one, and the message is: timing is everything, so stop whining.  I can’t go back to 1864 to buy Carnegie Steel, and you can’t go back to 1980 to buy a house in Irvine for $90,000 (a time when the median houshold income in Irvine was around $25,000, by the way).

Well, at least you’ve still got your sense of humor.

AZDavidPhx,

Well as I believe someone pointed out in the other thread that your question about making your kids pay for your house what you would make a stranger pay is an apples and oranges question.  Of course I would not sell my house to my kids for what I would sell it to a stranger just like I would not ask my kids to pay full price for a used car I may sell or pay $6.95 for that dinner I just cooked for them.
If you are being hypothetical and are stating if I would let my children buy a house from someone asking what I am asking for my house, well my answer is if their need to buy is now and that is what the market is bearing (regardless of gov. intervention since the market is the market if you need to buy now), that is the only choice they have and if they can afford it, go for it because you have to live somewhere and if they choose to live in a pricier area, they will know it will cost more.  Now if I felt the market was going to drop, I would suggest they wait but since I do not own them, they will have to make their own decisions.

I never said you were jealous of the possible profit I would make.  Where did I say that?

Also, I did not know you sold in 2006.  Good for you that you maximixed your profit on your house.  I have no anger toward you for doing exactly what I am doing right now.

Let me clarify on a couple of points:
1.  I was not trying to draw parallel between Great Depression/Japan 90s’ to the current economic recession/depression/great recession (or whatever you want to call it). I mentioned them only because these were the only cases of large-credit-bubble-induced economic collapse we had in the industrialized world in the last century. And my point is that history has shown that it was extremely difficult to fight a credit deflation this magnitude once it took hold in the economy, and we should not dismiss the possibility of such a scenario just because we have not had one in the last 60 years (remember how many people argued back in 2005 that a nationwide housing market decline was nearly impossible?). Of course I know that we have completely different market mechanism and policy responses at work today from what we had back in 1930s’, and US economy is different from Japan in many ways (do a quick search you will find many articles on this topic), but the fact remains that nobody has had any proven success in reviving a credit/debt bubble collapse within short period of time. Fed’s massive liquidity pumping always worked in the garden variety of inventory-adjustment recessions we had since WWII. But this one is not a normal recession and the normal tools Fed/Gov’t have may not work this time.
2.  There have been a lot documented evidence points the inception of this credit bubble building to early 80’s, when both consumer household debt to income ratio and US national debt to GDP ratio both began their steady ascendance. The 2002-2006 housing bubble was the just climax of this credit/debt expansion that finally pushed everything over the edge.

You aren’t that special, PropertyOwner. 

What about the young twenty something who has been equally prudent about saving money and made an equally lucky career choice who is about to lose all his money when he buys your house from you?

Being from Silicon Valley, how Irvine could be special puzzled me too ...

According to Wikipedia, Irvine has several universities and headquarters, including Broadcom, In-and-Out, and the Botox mfg Allergan.

And a nice climate.

The downsides are that The Irvine Company owns the available land, so you pay $400,000+/lot.

And if you lost your job in a small city like Irvine (200,000 people), you would likely have to move elsewhere to find another one.

Thanks for saying nothing.

What COMPARABLE jobs/markets are going to replace auto, construction, finance jobs lost in this recession.

When I see a viable answer to this question, that is when I will believe we will come out of this recession and going back to “normal.’

There is nothing conspiritorial about that at all.

There you go again, dancing around again, PropertyOwner.

You are first trying to divert the topic by going off on how you would not make your kids pay what a stranger must pay.

You then come back and start to go with where my actual question was coming from and you state:

well my answer is if their need to buy is now and that is what the market is bearing (regardless of gov. intervention since the market is the market if you need to buy now), that is the only choice they have and if they can afford it, go for it

Which to me this looks like you are presenting your kids with a false dilemma by implying that buying is the only way to go.  Suppose I show up while you are talking to your kids about buying a house for your asking price and I interrupt and say “Why not rent instead of buy?”

Would you urge your kids to rent the house or take out a loan and buy it?  Renting or buying will solve the problem that you were addressing which is “you have to live somewhere”.

NOT very cool.

I’ve commented on this extensively.  It’s not that all markets are inefficient.  It’s that the single family housing market is inefficient.  Even worse, it is overwhelmingly a market of amateurs.

People can be permabears or permabulls if they want.  What changes is whether anyone gives them money to invest, and whether they have any money of their own to invest.

What COMPARABLE jobs/markets are going to replace auto, construction, finance jobs lost in this recession.

Why do they have to be comparable?  You think that manufacturing a hammer is any different than making a quarter pounder with cheese?

Who has the sense of entitlement? Lee? Or the homowner who demands the next generation pay 40% of their income to own a house because the homeowner is entitled to that enrichment?

This isn’t a matter of entitlement. The homeowner can sell their house at whatever the market will bear, and Lee has the right to wait until the market will bear less.