Irvine Housing Blog

Median home prices reports include new, used, and condo sales.  New home generally are more expensive which causes the median to be higher during strong housing markets.  Several problems exist today.  1) Excess new home inventory which builders are discounting up to 20-30% to eliminate inventory and to produce cash flow/miminize loses.  2) Loan practices that underwrote marginal loans which in a down market has little to no equity caused excess demand.  3) Jumbo loan rates which are uncharacteristically higher.  The price will be local, in some areas if demand remains high, the price drop is expected to be lower.  Generally speaking, unless the economy falters, the bottom would bounce fast to positive gains.  Using the year/year differences will not predict the bottom well.  There are some great buys in new homes, existing homes generally hit bottom first.  In OC, new home sales prices dropped faster, pulling down the median by about 3%, which after a year will no longer effect the index.  The 11% drop for existing homes are probably 3-5% less depending on the local area.  The higher jumbo loan costs, probably will effect prices by about 5% and over the next year or two, will probably factor out.  The best way to track prices is by local supply/demand data.  When the supply drops near normal (6-8 months) or about half currently, the bottom will follow.  Unknowns if we go into a recession.  A local unemployment drop of about 1% results in another 10% drop.  Generally speaking California jobs look better than back in 1990’s when the price dropped due to the 4% increase in unemployment.  Historically, unemployment generally forces home price drops.  The sub-prime, lending problems generally made median home prices about 10-15% higher depending on local lending.  If employment holds out, I suspect prices will over correct by 5-10%, then increase as demand improves for the first year after the market botom.  I would guess that we are about half to the bottom, and the bounce could occur in 2009.  Interest rates generally cause about a 10% drop for every 1% rate increase.  So this needs to be watched.  Very difficult to predict bottom, but need to watch the homes on the market.  One broad index is at http://www.housingtracker.net/ trackes price and Inventory.  The median drop is probably a little high due to new homes sales and jumbo loan pricing.  Case-Shiller index is better at actual price drop as they do not include new homes.  Year/Year inventory is still increasing primarily due to the credit problems of jumbo loan pricing.  Prior to Oct-07 the situation was improving or stable.  I suspect about 5% of the price drop will be recovered when jumbo loan funding improves in about 1-3 years?  Relative to the max home prices in the 1990’s the relative price is about 5% LOWER (corrected by inflation and interest rates) .  Dataquick indicates from the peak in 2006 the affordability has decreased by about 15-20%, partially due to lower interest rates.  Interest only rates and 5-yr variable loans are viable products that were limited in 1990’s.  With 5-10% down these loans will stay around with attractive rates.  During the down market, lendors factor in a 5% price drop into rates which causes lending to be tighter.  When removed, this helps cause the 5-10% gain in home prices after market bottom. (if interest rates remain the same).  So there is not an easy answer to your question.  You will have to monitor the housing situation on a montly basis.  When inventory drops by 20%/year, the bottom should be close.  I beleive the bottom price will be another 10% lower if the ecomomy/interest rates hold out.  After this the prices will increase back about 5-10% or level off if interest rates increase or unemployment increases.  Inflation may become a factor in effectively reducing prices over the next 3-5 years.  However with higher inflation, rates should increase.  Bottom more likely in summer 2009 is most likely as sales pick up.  Best optimistic case would be summer 2008 if credit/lending practices improve.  The decrease would be about 5% more or about 15%-20% overall.  Hope this is useful.

San Diego real estate was down 11% in the past 12 months. How much lower will it go? Any ideas?

Thanks,
Ames Tiedeman

Just in today ...

UCLA sees O.C. home price reversal in ‘10
October 29th, 2007 by Jon Lansner
Snippet of what UCLA professors wrote in their housing slice of the 2008 O.C. forecast …

Sometime next year, housing demand is expected to rebound modestly: the forecast has the existing home sale market rising 18 percent. This is not a significant bounce in view of the freefall that began in 2006 and continues today. Sales will still remain constrained in 2008 due to:
(1) weaker labor market growth
(2) stricter lending standards that disqualify many potential buyers from obtaining conventional financing
(3) the belief that the housing correction will persist

Consequently, buyers will delay their housing purchases expecting home prices to soften in the future. As adjustable mortgage rates reset, foreclosures will rise to record levels, impacting prices. Home values will decline but not collapse in 2008. The slowdown in home price appreciation which was long overdue will persist into 2009 and reverse by 2010.

The significant risk to this forecast is a greater than anticipated slowing of local labor markets and a more pronounced weakening of the general Southern California economy than expected. Affecting housing demand psychology more than the monthly debt service, credit crunch impacted mortgage rates remaining close to or at 7.0 percent for a prolonged period would keep the demand for homes at current levels.

The Base Forecast: home values decline between 4 and 7 percent in 2008 (or 6 to 9 percent adjusted for inflation). Home prices remain soft in 2009, declining another 3 percent. A more dramatic decline in prices is not forecast because inventory levels have not climbed that high and the fall-out from the subprime mortgage crisis will be less severe in Orange County than other areas of the state.

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Despite all the poor loans, the total is very small compared to the nations GDP. The problem is mostly how investors will perceive the governments reaction and how much spin the media has put on it. Overall, the total loans debt add up to about 2-3% of the nations GDP. The sooner the fed, banks, and congress deal with it the better off the impact. Basically nationwide the unsecured debt maybe as much as 100K on about 1-2 million homes, the total is only $200 Billion, which is about what we spend in Iraq every year.

Not exactly a crisis. I expect aggressive write down and a lot of these loan terms will be re-written without foreclosure. The fed will continue to drop short term interest rates by another 1 percent thru next march, and banks will make terms easier to refinance the debt into 5-year variable loans which could be written in the 5-1/2% rate. Those owners who have made their loans commitments will be encourages to refinance and banks will be more willing to rewrite terms even if they own 110%-120% of the debt. While not desirable, it avoids foreclosure and puts off the problem for at least 5 years when personal income should grow and spreads the pain. In addition, the banks will be more willing to write down the debts to terms that the owner can afford. This has actually been happening.

The banks know that foreclosure will result in higher losses as the home will need to be sold at a 10% under market value to move it. It is much easier to extend lower interest or special interest rates to owners with good credit histories on existing loans. Rewrite the 10% loss by lowering the interest rate to 5-51/2% makes these home payments affordable. In addition the lenders do not have to write off all the loss.

I suspect a lot of the neg amortization loans will also be offered special terms, perhaps supported by congress or the fed’s actions. The borrowers with good loan history will be salvaged, those without sufficient income may be required to write personal loan commitments, payable in the future, or in some cases prosecuted for fraud.

Home sales will continue to decline until the fed/congress fixes or restores confidence in how to fix the problem. Avoiding a lot of foreclosures is key to minimizing the impact. Basically those who have lost jobs, or had sudden loss of income, etc will be forced thru the foreclosure process.

Typically foreclosures in the past have been related to job losses. Currently the economy is rather strong in most other areas, so there is a lot the fed / congress can do. They do not want additional job losses or loss of confidence in the economy, otherwise we will see added foreclosures and a more rapid drop in home prices and a self fulfilling depression.

Unfortunately since 2002, refinance has added about 1.5% to the GDP growth each year, so I would expect a lower growth rate for the next several years as borrowers cannot refinance to take money out. There is also a lot of people who refinanced and used the money in the stock market for investing. This has actually helped boost the stock market and improved the economy.

Time will tell, but lendor try to avoid at all cost a large reversion in home prices and losses thru foreclosure process. At most nationwide, we will still see about a 10-15% drop, probably 15-20% overall locally. Not exactly a bubble, but home prices will remain flat for the next 5 years as inflation reduces the bubble. There is the possibility of a rebound effect as interest rates become attractive next summer or possibly 2009-2010.  Going into an election year also makes congress more likely to act to avoid a large drop in home prices or foreclosures.

Sub-prime typically results in foreclosures as those had poor credit histories. This may not be the same with non-stated income loans or option arms in which the borrower is more qualified/responsible. The negative am loans never was a viable loan and I am rather surprised so many were allowed. The investors/lenders will suffer the losses from these loans - which they should. Home borrowers will be allowed more affordable options or incentives to minimize their losses. A lot of these borrowers were not well informed of the poor loan choice they were making.

So the primary reason for future forclosures will be driven more by the economy, buyers available income or inability to pay or thru restructure the loans. Those forclosures will be due to job losses, marriage status which are typical or a foreclosure. In 2-3 years, I suspect the problem will be mostly resolved as the total is not alot compared to the nations GDP.

The current rash of loan foreclosures are due to sub-prime lending which is expected to purge by end of next year. These borrowers were never responsible and had made poor choises.  About 20-30% of these are expected to end in foreclosure which is typical for this type of loan.  OC has 2-3 times less of a sub-prime problem than neighboring counties minimizing the effects.

I’d be even worse if the govt does something I didn’t expect (ex. legislation to rewrite my contract, or the bankrupcy laws or whatever).  LIke Greenspan says in his book, investors flock to the US because their property rights feel well protected.  Without that ... why invest here?  Why loan your money out for US mortgages when the US govt may pull some Castro like move and evaporate it?  Better to invest in China since there’s better chance of growth, and who knows, maybe your property rights go farther there…

It’s funny how in all these valuation predictions, people think that in the “recovery”, it’ll be the usual historic standards for getting a loan to buy a house afterwards.

If it was my money that had been lent out to people, and then I had to take some major markdowns and lost a ton of money (ex. reduced prinipal or whatever ideas people are floating), there’s no way I’d even want to loan my money out for mortgages ever again unless it was really really secure (ex. 40% down, like in Germany, super rigrous DTI standards or maybe I’d just pass on the whole thing after eating CDOs - why eat it again when I just threw up?).  So who has 100% of a home saved up ... drumroll ... pretty much no one.  It’s not going to recover well.

Goldman Sacs did an interesting study on housing prices looking at Disposable Income / Long term Interest rates since 1985.  There was excellent agreement in the OFHEO home price index for California showing 82% correlation to the ratio.  Disposable income can be a little difficult to determine, but for California, this is typically higher on average than the nation.  I have seen some sights place it at about 50% of gross income.  Either way, for California, they show hat the current median price is about 35% overvalued.

For OC, the disposable income is generally higher than california on average.  This places the median price home about 20% higher.  Economy will drive when the median significanly deop.  There will be alot of incentives to keep foreclosures off the market.  I suspect alot of write downs if the bank determines the homes are not sellable due to the long time to sell on the market.  From the banks point of view, it is easler to write down the loan to the existin fair market value and if the current person has sufficient income provide them the home at a discount.  Congress is in the process of eliminating the tax penalty for write downs.

I suspect the total number of homes that will eventually go thru foreclosure will be significanly reduced to maybe 10-20% on the resets.  The prime reason that will drive foreclosures will be the inability of the current owner to pay at a reduced rate which is typically due to job loss, divorse, etc and economic conditions.  Job loss or inability to pay will determine if a home goes to foreclosure.  The best chance for a home owner is to keep all other credit current and notify the bank they are in trouble.  If possible keep the first up to date, as they will not foreclose on the second 20% loan if you have two loans as there will be no equity in it.

OC is actually better than Riverside, San Bernardino, and San Diego County since the total number of non-stated income loans was 3-5 times less so market conditions should not be as severe locally.

Time will tell, but most major corrections has always been driven by the economy and job loss where the individual cannot even come close to making the payments.

I still do not see more than a 20% correction, however it will be tough times for realestate, home improvements and lendors until home values improve.  A big reason people do not move is because of the added taxes.  If the county were to adopt a plan that limited the tax increase, then more home sales would occur.  Who wants to pay another $300/mo to move up to a larger home now ?

I’ll look for the website reference on how much overpriced homes are, I was trying to update the data to local conditions.  Generally speaking some of the alternate financing may not be as bad as it seems.  A five year variable with no neg was quite attractive 3-5 years ago allowed alot of people to quality.  Today, there income has increased and home values should be sufficient to refi.  The neg am loans are quite troublesome and these are primarily to affect the home prices in 2010-2012.  Sub prime will resove quickly and I belive alot of these will result in foreclosures perhaps as much as 30-50% Most of these will be written off by end of next year.

It is likely that 2008-2009 will be bottom of the market and prices will level off going forward for several years until perhaps 2012.  It will take lendors and congress 2-3 years to figure out the best method of minimizing the pain.  They do not want a full market collapse, the Fed will act to infuse more money to shore up the credit crunch.  I expect to see a 1/2 percent drop in short term rates and an additional 1/2 drop by early next year.  This should force 5-yr arms back down to 5% range allowing the housing market to stabilize in 2008-2009.  At 5%, this will shore up home prices by 10-15% minimizing the overall price drop.

The Fed can actually do alot more if needed, but does cause more devaulation of the dollar.  The fed can force long term rates lower allowing banks to borrow at lower rates to offer affordable loans to borrowers, but this is rather risky and could cause more long term harm to the economy in the future.

Keep in mind that maybe a 2 million loans need to be reduced by on average 100K, to stabilize the US housing market.  This is only $200B, about what we spend in Iraq.  This represents only about 2% of the overall economy GDP.  So the fed will bail out the housing market if it is needed as they do not want a rapid decrease to effect the economy.  Yes it’s bad, but within the control of congress and the fed to correct.  The sooner the better to stabilize the price drop.

Sorry, I forgot.  If you think the credit crunch is stabilizing, you may want to check prices on the various ABSs in the last week.  Even AAA is collapsing.

They are going to drop 70% from the peak by 2012 in inflation adjusted dollars.

Home prices will not drop as much as you may think.  Several other factors influence home prices.

1) Local Economy (OC has one of the lowest).  Every 1% drop in unemployment rate is about a 10% increase in home prices.  Economy is much stronger today than in 1997.  After the exit of the aerospace, local prices had decreased 20% than the US average due to high unemployment rate.

2) Home prices are effected by size.  Alot of newer homes are larger today than in 1997.  This causes the median and the average to shift upwards.  Some of the recent price drops were caused by large slowdown in new home housing as developers agressively dropped prices due to market demand.  Existing single family home prices dropped by about 2-3 times less.  Builders will now be forced to produce homes that are smaller to match buyers price affordability.

3) Interest rates.  Every 1% drop in rates is about 10% increase in home prices.  Overall interest rate trend has been dropping since the 1970’s.  The 1950-1970 rate was slightly lower, close to 5%. 

A better factor to determine correct home prices is to use the cost paid for the loans.  The key will be how much lenders tighten loan requirements this sets affordability and home prices.  Lenders want buisness and will find alternatives for qualified buyers.  In fact if you have 20% down and good credit, they will be willing to give you better terms. 

4) Local income is stronger.  Most homes in the upper priced market typically are not high risk loans, sub prime loans or option arms.  For the most part the upper priced market has remained fairly stable.  The current foreclosure rate in OC and LA is 3-5 times less than Riverside, San Bernardino, and San Diego Counties.  Subprime has been less of a problem locally than other areas.

5) More people with two incomes:  This is huge for OC as more families have two incomes than back in 1996.  More women work today contributing to the family income.  This alone could account for another 20% increase in home prices.

I agree that prices will drop relatively, but most likely not decrease more than 10-15% the first year and level off for the next 3-5 years.  By this time inflation and the price drop will have decreased prices by 30%, similar to what happened during the 1990’s but from economic conditions.

A 30% drop from 450% is 70% of 450%=315%.
The strength of the local economy and conditions along with lower interest rates account for another 20-30% premium over the 250%.  So this would result in the two prices becoming equal at around 310%.

I see a 10-15% DROP and inflation leveling the price decrease over the next 3-5 years.  It is also possible that a 20% drop, could be followed by a quick rise by 10% as those who have been waiting for the crash realize it did not happen as much as they thought.

Also rents have recently been increasing at a more rapid rate as investors get stuck and demand for affordable housing continues.  The rate of rent increase has been greater than inflation.

The major factor that influences market prices is economy and lending practices.  Currently the economy is still strong, lendors will purge foreclosures at 10% below market rates, but only 10-20% of the homes on the market are forclosures.  So overall home prices will stay ralatively stable.

Watch what happens in San Diego, Riverside, and San Bernardino for trends as these are the areas most impacted.  OC will follow, but at about 2 times less the impact.  So if prices drop by 20-30% in those counties, I would expect 10-15% in OC.

Interesting fact is although the number of months on the market for homes have doubled in the last year, the median and average price has not dropped alot overall.  This means that most sellers are not desperate to sell.  Economy effects these people more than sub prime effects, because sub prime lending in OC was not as severe as in neighboring counties.

Another problem is that alot of people do not want to sell and buy another home as they do not want the higher taxes.  So I would expect that the market to remain sluggish.  Alot of homes are taken off the market unsold because they did not need to sell.  I suspect many of these will sell eventually, but are waiting until the sub-prime loans are flushed out which is expected by end of 2008.

The next wave of loan defaults option arms occur in 2009-2011 could be more troublesome for OC if prices do drop and incomes do not meet loan requirements.  Prices should stablized by summer 2008, and possibly increase in 2009, followed by a second decrease in 2009-2011 unless lenders and congress allow for an easy refinance method to limit the number of foreclosures.

One thing is certain, is that the Fed and congress do not want large home defaults or home price drops as this has significant impact on the ability of the economy to grow.  I suspect they will agressively attack this problem before it occurs.  The same for lenders holding these notes.  So I beleive alot of these option arms will be salavaged in one way or another as no one wants a huge housing price drop.  I expect the Fed to act agressively to lower rates to pull up housing prices. I expect the Fed to lower rates another 1% by next summer if needed to create more affordable loans.  (As long as inflation does not increase substantially)

So the bottom is no more than 20% lower than the peak in 2006 at worst unless the economy goes thru a recession which could actually become a depression under some conditions.  This bottom will occur in 2008.  The best time to buy would be next summer when interest rates and credit markets stabilize.

There are also some recent indications that recent tight credit policy is loostening and the number of sales starting to increase.  The credit problems should start to resolve and stabilze by summer 2008.  Next summer will set the pace for real estate going forward.  2009 should improve with potentially an increase in market price if the economy holds out that long.

There has never been a substantial sustained drop in home prices since the great depression over 70 years ago.  Overall the US economy and market controls are much greater to resist this.  The major difference today is globalization.

The greatest reduction in home prices actually occured in the 1970’s when the economy was trashed by high recession , inflation and interest rates.  Home loan rates were in the 12-15% range, so home prices were artifically low.

Re: “However, everyone who can do math will see when it is cheaper to own than to rent”

http://www.msnbc.msn.com/id/20776771/

Since 2002, she’s been a math instructor at Balboa High School, once a hardscrabble school on the city’s south side. Test scores and morale are on the rise, and Devine feels she’s making a big difference by teaching pre-calculus and algebra to the diverse student body.

“I don’t ever want to leave Balboa — I’d love to retire from here,” Devine said as she stacked papers following the afternoon bell. “The only problem is I can’t afford to live here on a teacher’s salary.”

After taxes and a $350 deposit into a retirement fund, she takes home about $2,500 per month. One-bedroom apartments in desirable neighborhoods — near friends and public transit — start around $2,000 per month. Studios start around $1,500.

Devine said she’ll likely settle for roommates — a fate she didn’t envision for herself after college, and a far cry from her dream of home ownership.

Technically, she could afford her own modest apartment — but she wants to heed the standard advice and not spend more than a third of her income on housing. That’s not easy; experts say nearly a quarter of San Francisco renters spend more than 50 percent of their household earnings on rent, and the market has grown tighter as the mortgage crisis deters some young adults from home-buying.

Devine rarely goes out to eat or buys new clothes, but despite a frugal lifestyle has been unable to whittle down $3,000 in credit card debt.

That’s an interesting point. I hadn’t thought of that, but I bet you’re correct.

Some suggest housing in Southern California will drop 75%. I think 30% is possible. Not 75%. In any case, property will be higher in 10-15 years.

cw - In answer to your question above: the only person who pays for my analysis is me and my family.  And the only way we get paid is through our investments.  If the evidence for the validity of my analysis is how much I have gotten paid, then you may want to give my analysis more thought, no matter how simplistic.  Maybe not, after all, you may have invested better than I based on your own analysis.  But, if you haven’t made much on your own analysis, you may want to consider mine for thought.  If you have purchased real property in the last year or so, you may care to give thought to my analysis.  I sold fairly close to the top of the credit bubble.  My investment of the proceeds is doing well.  But, what do I know, because, after all, I think most of what the Fed says and prints are lies.

I apologize that my joke was not more transparent.  I completely intended it to be funny and did not intend any ill will.  I thought when I put the ha-ha after it, you would see that I was joking and not serious.  Again, sorry.
Inflation is the increase in money supply, (M3 + new credit), not any effects of the increase in money supply.  Since the definition has become confused within the last few years, some have resorted to calling the first, monetary inflation and the second, price inflation.  But, prices may rise or fall while the money supply is being inflated.
I am curious, and I am not being condescending or patronizing while asking this, (or I hope I am not), but do you really believe what you wrote about the Fed not including food and energy in the CPI because of their stated reasons?  And hedonic adjustments?  And rent equivalient housing costs?  I am curious, because I just assume, maybe mistakenly, that anybody who understands the degradation of the methods used to calculate the CPI for the last twenty or so years, would not actually think it valid.
Again, sorry.  I truly thought my attempt at humor was light, non-offensive, and obvious.  I was just trying to lighten things up a bit.

Make that several eases.

My scenario is predicated on a Fed ease.

It will be interesting to see how this plays out moving forward.

I think the market’s reaction was appropriate and will in fact continue to tighten. Any loosening along the way will be “bear rallies” in credit.

The main reason I believe it will play out this way is because I believe the foreclosure numbers are going to be astronomical. If, by some miracle, all the overextended borrowers out there can find a way to make their escalating payments, the foreclosure picture may improve, and the need to tighten credit may diminish.

Based on the relationship between payments and income, I don’t see people being able to hang on, and once they start going underwater, I don’t see them being willing to hang on. The foreclosure problem will be a downward spiral which in turn will lead to ever-tightening credit. If the downward spiral does not materialize, your scenario of moderate credit tightening may be what happens.

“Are you of the opinion this is an overreaction and the secondary, non-conforming market will loosen its standards and lower its risk premiums soon?”

Yes and No.  Damn I sound like Hillary!

Yes, there is an overreaction in the market, related to the pricing of ABS.  On loosening standards.  As I have stated previously I am looking for 10% down full doc paper to tbe that standard.  I believe this is far tighter than the past few years, but perhaps a little looser than the past 8 weeks.

“The ratings agency misrated the ABS deal by using outdated assumptions. Models always work until they break. Then you figure out what went wrong, and rebuild the model.”

When they figure out what went wrong, they will realize the problem cannot be fixed. The problems was both the loans and the borrowers in the case of subprime. It was the innovation. The failure of valuation just made the problem with innovation become very widespread. When valuations show these loans need to be originated at 18% to make them viable, borrowers will not be able to afford them.

As for 20/20 hindsight, there were many people who saw this disaster in foresight, but they were ridiculed and ignored. The failure of foresight recently caused the CEO of Bears Sterns to lose his job. He was forced out because the Board of Directors said he should have seen this coming and should not have invested so much of the companies money in hedge funds buying all this worthless paper.

“The agencies aren’t the only one buying the paper. But of course, you are just assuming that no one knows that right?”

The secondary market outside of the agencies are buying at a significant premium. Jumbo loans are at least a point higher than conforming and that is only offered to prime customers. The market for non-conforming loans exists, but it is doing a fraction of the volume it was during the bubble. This is not a result of slow sales, it is the cause of slow sales. People can’t obtain easy money any longer.

Are you of the opinion this is an overreaction and the secondary, non-conforming market will loosen its standards and lower its risk premiums soon?

One more thing Graphix.  I would suggest reading the articles you link to before posting them, unless you were actually trying to make my case, then Thank You.

“Most of this borrowing was forced,” said Lou Crandall, chief economist for Wrightson ICAP. The Fed was “deliberately stingy” ahead of the expiration of the reserve maintenance period on Wednesday, he said.
“It’s like a game of musical chairs,” Crandall said.
In essence, the Fed forced the banks that were left without enough reserves to borrow at the discount window by temporarily pushing the federal funds rate above the discount rate at the end of the day on Monday, Tuesday and Wednesday, Crandall said. It was cheaper for the banks to borrow from the Fed than to borrow from other banks.

“The Richmond Fed is full off it” Brilliant.  Awgee, You get paid for that type of analysis?  I would guess the answer would be NO.  Additionally, don’t try to pull the “strawman” trump card with me.  You made the statement that LIBOR will not normalize despite the natural arbitrage.  You have absolutely no basis for this claim, as ALL historical evidence cleary demonstrates. 

IR - The failure was not of the innovation, it was the failure of valuations.  The ratings agency misrated the ABS deal by using outdated assumptions.  Models always work until they break.  Then you figure out what went wrong, and rebuild the model.  Not the best way, but then again hindsight it 20/20.

The agencies aren’t the only one buying the paper.  But of course, you are just assuming that no one knows that right?

Actually the subprime market went from 0% to 2% to 25%.  Over that time the agency share dropped by more than half.  from a peak of over $2Trillion in annual originations to less than $1 Trillion.  PRIME borrowers were packaged into ABS deals because the were using non-conforming.

“I could argue that innovation the financial markets, make it far more likely that this whole mess can be sorted out.”

I would argue that the complete, utter failure of innovation in the financial markets we are currently witnessing make if far less likely that this whole mess can be sorted out. We will see.

Some banks are offering 10% down on conforming loans because Sallie Mae and Freddie Mac are buying the paper. The crash is only just begun, and the number of underwater homeowners on 10% down loans is still small. As prices really start to crater, these products may not find a market, and banks will quit offering them.

In the grand scheme of things, the ABX market may survive, assuming their is a viable product left to insure. I am dubious because the premiums will be so high as to make the product impractical.

Subprime went from 2% of the market to 25% of the market. If it shrinks back down to 2% or less, the market will technically survive, but for all practical purposes, at that level of activity it is dead.

$7.9 Billion, the big five banks showing SYMBOLIC support.  N, when push comes to shoves banks, especially those in trouble, would much prefer Fed Funds.

Secondly, it took a month for this to happen.  You think some calls were made?

Thank for helping make my point Graphix.  Much obliged.

Jesus awgee, are you reading from scripture?  The is no God but God! HAHA.

The Greenspan put, is actually the FED PUT.  Greenspan was simply acting on what appeared to be the best interest of the overall economy.  The Fed seeks to ensure STABLE GDP growth.  No easy task, I think you would admit.

I know that Austrians believe that a laissez-faire economy functions best.  But how then can you explain the “Great Moderation” over the past 20 years?

“Greenspan avoided a recession — a recession caused by the fallout from the tech bubble he created — by creating a massive real estate bubble. The fallout from this bubble may result in a depression.”

Greenspan created the tech bubble?  That’s news to me.  I thought the tech bubble was created by a combination of accelerated innovation, he advent of the Internet, and the elimination of fundamentals based valuation on security selection. 

Volcker faced a different set of challenges, most notably rampant and persistent inflation.  I would be that Greenspan would have done the same thing as Volcker under the same circumstances. 

“There is nothing natural about this credit cycle. It is an artificially induced phenomenon resulting from poor monetary policy.”

Please give me an example of a natural credit cycle, and how it differs from the current situation.

Why would I do that?  It is a strawman argument to try to define the problem where it does not exist.  It is irrelevant to the difference between the LIBOR and the fed funds rate, and the Richmond Fed is full of it.

Why are you being mean?

Perhaps you could explain to me what constitutes the money supply under the austrian theory.  Furthermore, I would like you to show the impact of lower rates on money supply by identifying the components affected. 

That would be helpful.  Perhaps you could even persuade me that you are on to something.

Where did the extra $70,000 go?

More importantly, that money represents an artificially propped up local economy for the last few years. The “strong economy” crowd fails to take into consideration the impact a sudden withdrawal of this free money will have locally (as well as globally). This holiday season could be interesting.

You’ll have to explain to me how the arbitrage between dollar deposits in the US and Dollar deposit outside the US has broken down…

“Fuzzy Bush Math
You’re about to hear that the budget deficit is falling. Don’t believe it, warns Fortune’s Allan Sloan. The deficit is much, much bigger than you think.”

08.31.2007
http://money.cnn.com/2007/08/31/magazines/fortune/deficit_sloan.fortune/index.htm

“If you use realistic numbers rather than what I call WAAP - Washington Accepted Accounting Principles - the real federal deficit for the current fiscal year is more than 2-1/2 times the stated deficit.”

Bill Barber park is on Harvard just behind City Hall at the intersection of Harvard and Alton.

Although, I like the name Bob the Builder Park better…

Keynes?  That is why you are so screwed up.  Ha-ha.

It’s good enough for me too ... in the long run, but over the next few months and maybe years, things may have changed.  They have certainly changed this month.  Why do you assume the past = the future?  Why do assume that what was profitable last year will be profitable tomorrow?  Arbitrage will not take place if it is not profitable.

The reason why the FED does this IMO is because energy and food stores are traded as derivatives on the open market, which means their prices are at the mercy of speculators.

It really is sad to see an investment hedge that was originally used to help people, like farmers for example, turn into the craps table at Caesar’s Palace.

Just as the DOW is no longer truly indicative of the US economy due its globalization, the futures market does not accurately reflect consumer spending, and thus is not a great measure of inflation.

Housing is falling, and with the general contraction of credit, the FED realizes that consumer spending has to slow down.  This will help ease inflation on its own.

Where’s the Bob the Builder park???

Capitalism negates the existance of the Fed, and any force other than market force upon interest rates is socialistic.

Inflation simply means the buying power of the dollar has weakened. This can happen while the economy is in depression, stagnantion, recession, growth, or escalation.

The worst time to have inflation is when you are in an economic downturn.  This is not good inflation, and in fact can lead to stagflation--a very hard economic condition to pull out of.

Hyperinflation, if it caused wage inflation, would certainly bring up fundamental valuations.

However, inflation does funny things. First, in an environment of high inflation, mortgage interest rates would rise significantly. Why would a bank loan you money at 6% when inflation is running at 10%? Banks would want to make a return on their investment after inflation, so they will add 4% to the inflation rate to set their lending rates. If mortgage interest rates go up to 14%, buying power is dramatically reduced. Nobody can afford to borrow 6 times income at 14%. The reduced buying power would depress prices.

The impact of wage inflation and house price deflation would bring fundamentals into alignment sooner, but at a price.

There is always the issue of getting inflation back under control. If the FED lowers interest rates to create inflation, at some point they will need to dramatically raise interest rates to get inflation back under control. This will severely impact the economy.

Basically, at some point, we have to pay the price for all our bubbles. There is going to be a deep recession. It is just a matter of when we want to have it.

Yes, yes I forgot this was an Austrian board.  I was referring to teh Keynsian view on inflation. 

velocity * money supply = Real GDP * GDP Deflator

Using this equation, if the money supply is growing through lower rates, while the velocity of money is slowing, real GDP can remain constant and uninflationary.

Awgee (see below)

NTEREST RATE RELATIONSHIPS BETWEEN EURODOLLAR DEPOSITS AND DEPOSITS AT BANKS IN THE UNITED STATES

Arbitrage keeps interest rates closely aligned between Eurodollar deposits and deposits with roughly comparable characteristics at banks located in the United States.20 This is illustrated in Figures 1 and 2. Figure 1 compares yields on federal funds and overnight Eurodollar deposits. Figure 2 compares yields on Eurodollar CDs and CDs issued by banks located in the United States.

As I mentioned before the historical correlation is in excess of .97.  That high enough for me to conclude that the current differential between LIBOR and Treasury curves will normalize.

The document did show the impact of income tax savings, but the cost of ownership was equal to the cost of rental without this benefit being figured in. The tax benefits make it even more advantageous to own, but they are not required to make the numbers balance.

Not to speak for awgee, but I believe as he does that inflation is caused by the increase in money supply.

http://en.wikipedia.org/wiki/Inflation

“Other theories, such as those of the Austrian school of economics, believe that inflation is caused by an increase in the supply of money by central banking authorities.”

Your take on the ABS market is wrong.  I can’t say it any more simply.  Given an improvement in underwriting standards (e.g. documentation of income) and appropriate pricing anything can be valued.  If something can be valued is can be sold.  Yes, there are some less worthy borrowers getting mortgage loans, they will get them again, but they will pay more.

The rates will be higher sure, but loans will be available.  Hell the market has periodic breakdowns in every spread sector, why would MB-ABS become a pariah when what is happening is typical of credit markets.  Do you remember 2002, Enron, Worldcom.  The Asian contagion of 1998.  Junk bonds have since an unbelievable run, EM has never been better…

No, I think the announcement of the death of subprime mortgages is premature.

Why would banks have confidence in 10% loans?  Because they are doing them right now?  Does that answer the question?  High LTV loans will always be available for credit worthy, full doc paper.

“I wish I could see a scenario where credit tightening stops at some interim level. It has never happened before to my knowledge, but I suppose anything is possible.” So credit spreads only widen until we reach a high on rates?!? How much did credit tighten after LTCM?  Credit spreads change all the time.  Why would they go to max value this time?  I could argue that innovation the financial markets, make it far more likely that this whole mess can be sorted out.

“By my estimation the Fed should have stopped the tightening cycle at about 4.00-4.25.”

I would argue the rates should have never been dropped that low in the first place. The Greenspan put has caused 10 years of economic distortions with the commensurate inefficient use of capital.

Greenspan avoided a recession—a recession caused by the fallout from the tech bubble he created—by creating a massive real estate bubble. The fallout from this bubble may result in a depression.

Are we to inject another flush of inflation inducing capital into the system to create another asset bubble to avoid the problems created by our last bubble? When does this cycle of bubble after bubble end? There is nothing natural about this credit cycle. It is an artificially induced phenomenon resulting from poor monetary policy.

Bring back Paul Volcker.

Yep I married an Asian… =)

CW says “No one uses the Discount Window. It is a signal of weakness that banks avoid.”

Really? I guess you missed the news today.

http://tinyurl.com/35d2ta

In the first significant borrowing from the Fed since it lowered the discount rate last month, U.S. banks borrowed $7.2 billion from the Federal Reserve as of Wednesday, the most since just after the attacks of Sept. 11, 2001, the Fed said Thursday.
The average borrowing for the week was $2.7 billion per day.
The Fed data don’t detail the names of the borrowers. The data indicate that $4.9 billion in loans were owed to the Federal Reserve Bank of New York, $1.6 billion to the Cleveland Fed, and $550 million to the Richmond Fed.
Last month, five big banks had borrowed from the discount window in a symbolic show of support for the Fed. The borrowing from the Richmond Fed appears to be a holdover from the symbolic borrowing earlier.
By borrowing from the Fed at 5.75%, the move shows that several U.S. banks could not obtain needed funds from other banks at the federal funds rate, which closed at 5.18% on Wednesday and has averaged 5.01% so far this month.

caliguy

unfortunately even large retailers like home depot do not seem to have a grasp of how hard they will be hit.  just the other day, a statement appeared on bloomberg claiming that home depot did not expect housing to recover until 2008.  i’m sure they will be changing their tune when they realize that the “recovery” will occur much later.

Awgee, I am sorry, perhaps I misunderstood, what definition of inflation were you referencing?  Or were you simply reference asset price increases.  I guess I don’t see the distinction between asset price growth and inflation.

Please clarify when you have a moment.

By the same token shouldn’t the Fed have never began raising rates beyond the market rate?  Keep in mind the Fed inverted the yield curve through brute force.  Those weren’t market forces causing the inversion.

By my estimation the Fed should have stopped the tightening cycle at about 4.00-4.25.

When my kiddo was 1, he didn’t notice doodly squat about our home.  Now that he’s 4 and we live in an IAC townhome with a pool, within walking distance to three parks, and a short drive away from the giant Bob the Builder park, he’s happy as a clam.  Like he cares it’s a rental?  Not!

Lower rates allows banks to (1) lower lending rates or (2) lend to riskier borrowers at higher spreads.

Remember the carry trade is dependent on several things (1) low real rates in Japan (2) Lack of currency appreciation, against the pressure of the international Fisher relationship (3) spread opportunities in foreign (from Japan’s POV) markets.

The Carry trade will go away when Japan finally gets their economy going, which they seemed on track to do until recently, and normalizes rates.  Obviously not now…

Though if you were short the Yen over the qtr you got hurt pretty bad.

“Do you think maybe that any action or interference by the Fed is antithetical to capitalism?”

I was wondering when someone might point that out.

It seems our intrepid capitalists only want free markets when prices are going up. The moment there is a problem, they want government help.

Japan has a different problem—one that was caused by their response to their real estate bubble—a Liquidity Trap.

http://en.wikipedia.org/wiki/Liquidity_trap

They have been pushing on a rope for more than a decade. All the money they are creating with their low interest rates have been flowing oversees through the carry trade. They have been exporting the inflation they desire for their own economy to the rest of the world.

“ABS market is in shambles. This is temporary.”

Why would the ABS market recover? Subprime is dead. Both the loans that were offered and the borrowers who took them were not stable candidates for investment. They never will be. Confidence in this market will not return for good reason: it is a losing investment strategy.

“LTV standards are indeed tightening but I believe they will end up at 10% down/equity.”

Long-term this may be a true statement, but it will go through an extended period of 20% down and 28% DTI first. Markets will retreat to what is known to work. Now that the experiment in loose credit failed spectacularly, the baby will be thrown out with the bathwater. If you were a bank, would you only require a 10% downpayment on an asset very likely to decline in value by more than 10%?

The period of tightening credit will collapse all the way back to the most stringent standards. That is what happens in the credit cycle. It happened in the late 80s after the S&L disaster. It happened in the great depression after the collapse of margin trading on Wall Street.

Why would it stop half way? Why would banks or investors have any confidence in 10% down loans, particularly when LTV has been shown to be the most reliable indicator of default? Why would banks continue to allow high DTI ratios when they know overextended homeowners default when they go underwater?

I wish I could see a scenario where credit tightening stops at some interim level. It has never happened before to my knowledge, but I suppose anything is possible.

I don’t believe this because I just like being bearish. I usually try to find the “reasonable” middle ground. This is the most bearish I have ever been on any financial market (perhaps with the exception of the Nasdaq in 2002.) I wish I could find a plausible scenario where this isn’t a complete disaster. I just don’t see it.

Ok so drop rates so banks have higher spreads without have to increase rates, what does that actually do for the housing market?

Huh?  That doesn’t make much sense.  Ex. Japan has really low interest rates, but no inflation - they have deflation problems.

Hey, where did Janet go?  You know, the RE agent (I think) poster from the weekend that got all pissy about your analysis?  I’d sure like to hear her views on this post!

Do you think maybe that any action or interference by the Fed is antithetical to capitalism?

“the carry trade will go away.”
The carry trade will go away?  I am speechless.  You have got me on this one.  Ok, it will just go away.

Here are a few more older, somewhat classic links for those who haven’t seen them yet

Map of Misery
http://www.businessweek.com/common_ssi/map_of_misery.htm

Breakdown of how many of different kinds of mortgages are out there

Nice summary of how the whole mortgage machine worked
http://www.nytimes.com/imagepages/2007/08/05/weekinreview/20070805_LOAN_GRAPHIC.html

I do not have to assume anything.  I have only to know the definition of inflation, and it is not an increase in prices.

Arbitrage ensures nothing.  Without profit there is no arbitrage.  There is nothing in the statement by the Richmond Fed or reality that guarantees the LIBOR and funds rate will move together.  Yes, it all boils down to valuation, and to assume the real value of the existing over the counter derivatives is anything other than painful reality is just an assumption.  Once the market knows the risk/reward profile on the various ABS and derivatives, the market may value them for pennies on the dollar or any other amount.  To assume otherwise is just conjecture with no basis in fact.

That the problem with evils.  They both suck.

Patience-
I agree with your viewpoint. However, correct me if i am wrong: in 1997 document above they did factor in $141 in income tax savings. In think IR overlooked that.