You may be wondering how appraisers arrive at a market value for a home. In case you haven’t noticed in overpriced metro areas, we’ve been using the unconventional approach of flying by the seat of your pants. This phrase comes from the early days of aviation when pilots had few flight control systems and navigational aids; no GPS and flight towers for these folks. These pilots flew by intuition and experience, sort of like our modern day appraisers. After all, at the heart of speculation is going with your “gut” and making a big profit in a shorter time frame. Speculating in any bubble can be lucrative; as long as there is a greater fool that you can find to pass on your valuable commodity you’ll make money. Once this perception breaks, the market hits a free fall mode and panic ensues. In our current housing and credit market, this doesn’t mean that homes will drop to zero and you’ll be able to go to your local bank with your American Express card to buy a REO home. Real estate does have a value. In fact, there are a few methods to calculate a market value that is based on fundamentals. These haven’t been used in a balanced approach in California, but they will come back as most things revert to the mean over time. The 3 approaches for real estate valuation we will examine in this article are the cost, sales comparison, and income capitalization approaches.

The Cost Approach

The cost approach factors in the price of the land plus construction, material, labor, and all other costs to replicate the home at current market rates. This approach doesn’t bode well for selling residential property because you can find land in North Dakota for dirt cheap (literally) and find that building a home there is cheap. So you build a home but what is the market for other homes? How is the employment base? Will someone give you a mortgage for a property? This method is generally more applicable to builders who try to ascertain the price per property for a project and find a break even point for profit. This approach is also used in special works projects since this may be the only approach that can reflect a realistic price range (i.e., a parking lot).

This approach requires first a value of the land if it was vacant and put to “best use.” In California that means dolling it up and flipping it in 0 to 60 in five seconds or less. Next, there needs to be an assessment of the replacement cost at current market rates for materials and labor. You factor in depreciation and reevaluate your other items including land and replacement cost and you should arrive at your cost approach value. Rarely do appraisers in the single family market use this approach. So what have they been using?

The Sales Comparison Approach v2.0

Location, location, location. We’ve all heard that real estate mantra. Here in California, we’ve been living in a Ponzi Scheme Mortgage Charged Sales Comparison Approach v2.0 mode these last few years. The sales comparison method is great in valuing housing in stable markets because for the most part, it’ll give you an accurate reflection of the current market of your local real estate. Again, that is if the market is stable. But what happens when prices go into bubblelista territory? If 2 homes sold, 1 that is 1,000 square feet and the other 1,500 square feet, for $200,000 and $300,000 respectively in the same area you can easily derive a value for a similar home that is 1,250 feet. First we figure that the square foot price for the previous two homes is $200. We simply multiply this with the current home, 1250 x $200 and this gives us a price of $250,000. Then you need to adjust for additional factors such as upgrades, the lovely granite countertops, nice shiny chrome faucets, and other positives or negatives. This basic approach, in theory, should give you a general idea of the current market price. Think of buying fruit or produce at your local supermarket. Not all apples are created the same but share very similar characteristics so you buy them by weight. You take a look at the red texture, give it a few taps, and pay per/pound. Is a mutant apple worth more simply because it weighs 5 pounds? In fact, you’ll notice scales of economy on certain homes that are too big. That is, you may find the price per foot gets cheaper for super large McMansions.

But what happens when everyone is overpricing their home? Welcome to the sales comparison v2.0 bubble. Say the 2 homes above now sold for, $300,000 and $450,000 a year later, and nothing intrinsically has changed within the home. By the sales comparison approach, our current home is now “worth” a lot more. In fact, our square foot price went from $200 to $300, a 50 percent increase. This is great for anyone in the area because this inflates all homes in the immediate area. Yet you can see the fallacy in using only one approach.

If you were to factor in the cost approach as well, for example getting a true replacement value of the granite countertops and faucets, you may realize the home is only worth more by $10,000. Even if you factor inflation, you would realize that something is going on here. This type of rapid paced housing inflation has no economic fundamental sense. We are also seeing greater transparency in the industry. You can log into Zillow and find average square foot prices from recent sales in your local area. You can also use Google Earth to scout the area. Does your neighbor have a pool? Are you behind a restaurant or freeway? What is the average commute time to your work place? Maybe you are located near fantastic schools, which you can search again via free sources. These are the “intangibles” of setting a price. In a way, you become the future appraiser. There are other items that trained appraisers provide which go beyond this scope, but there is no reason for you not to have a thorough understanding of why the home you are buying or selling is worth the current price. Back to the current market, the reason so many people stayed [are staying] in denial is because they simply relied 100 percent on the sales comparison mode without factoring area income, intangible factors, cost approach methods, or even looking at the potential income of the property.

The Income Capitalization Approach

As I discussed in a previous article, Los Angeles County is a majority renting county. In fact, homeownership in California hovers around 57 percent, a far cry from the 70 percent of the overall nation. This means that a lot of people are landlords and renters. Most people do not invest money expecting a loss of their capital. It has become an act of futility to try to find an income producing property in the entire state of California. The income approach is used by real estate investors predominantly to arrive at a market price for a property. This is useful in evaluating multi-unit properties because you may not have many sales comparisons of 36 unit apartment buildings in the area. And zoning regulations may void the cost approach altogether. So you need another method of figuring out the value of the place. Let us use an example of a 4 unit property.

First, you need to determine the net operating income. In this case it is:

(Property gross income) – (All expenses excluding the loan payments) = NOI

Say the 4 units bring in $48,000 per year and the expenses amount to $21,600 (a 45 percent expense ratio which most seasoned investors rely heavily upon). So your net operating income is $26,400 per year. What do you do with this number? Well, most investors research the local market and try to find the prevailing expected rate of return for the area. This leads us into the capitalization rate of a home. The “cap rate” gives us a better understanding of what local investors are returning on their investments. Let us say that the area has a cap rate of 7 percent. To find an underlying value of this potential property we use the following information:

$26,400 divided by .07 = $377,143

So if we are expecting a cap rate of 7 percent the maximum amount we should pay for the property is approximately $377,143. Many in the housing industry will say these numbers mean nothing in California or any overpriced markets because land is volatile here and heck, we have the sunshine tax. Sun only hits the west coast, didn’t you hear? Maybe the numbers from the income approach have little reflection on the price, but using 3 methods provides triangulation of multiple perspectives and will give you a better overall picture of the value of the home. It might even save you should you need to sell immediately.

The sales comparison approach will always be the prevailing method of valuation for the single family residential market. The various methods should be used in conjunction to give you a better overall picture of the market. Many people in California were buying “investment properties” with 2/28 loans going negative cash flow because in their mind’s eye, they didn’t care about the $700 to $1,000 loss each month because they were going to flip the property next year for $100,000 more. This worked for a few years but now you are seeing what happens when you rely too heavily on one method for investing. These folks are trying to unload their properties in a market that is saturated and any investor that has some basic knowledge of investing will never pay the current market rate. They’ll be negative cash flowing from here to Canada. Current buyers are looking at recent sales and see numbers dropping and appreciation at zero or even worse, negative. So they stay out. Plus you have brave souls still being brought into the shenanigans of the market but the credit markets are dry and actually checking income statements! The audacity. And then you have sellers trying to unload properties that are simply overpriced by any form of valuation except the flying by the seat of your pants approach. Welcome to the slow decline of housing.

Related Posts:

Why the Housing Market Has Failed You. 5 Major Failures of the Housing Market

Housing and the age of Affluence: Transforming the Definition of Income and Wealth

Comparative Analysis of 3 U.S. Cities: Contrary to What Your Parents Told You, Not all Bubbles are Created Equally.

When I started this blog nearly a year ago, there were a solid number of websites providing information regarding the housing and credit bubble. The mainstream media was slowly starting to produce some stories about the housing and credit markets but not to the level of the online blogging community. Three years ago, I started searching for information regarding the housing market and the amount of resources was limited at best. Very few dissenting voices even commented about the risky nature of subprime lending and the debt being created. The current atmosphere is very different.

I wanted to provide you a list of 55 housing resource blogs that have provided food for thought throughout this housing bubble and will (hopefully) continue to do so. Some of these sites are regional, some strictly talk about mortgages, and some dabble in the art of schadenfreude. Others examine the political nature of the current market. Many provide insight into managing your finances and preparing for a purchase or sale of a home. The list is not ranked in order of importance or significance and is not intended to be exhaustive.

Top 55 Housing Resources Blogs:

Regional Housing Sites

1. Bubble Markets Inventory Tracking – This great site hosted by ocrenter tracks inventory in many metro areas including San Diego, Los Angeles, Riverside, Phoenix, and Las Vegas to name a few.
2. California Housing Forecast – Excellent site examining the Southland and also discussing national housing trends.
3. Dr. Housing Bubble Blog – I may be biased about this one. Site looks at Southern California Real Homes of Genius and examines macroeconomic and mortgage issues that impact the Southland and nation.
4. Irvine Housing Blog – Site examines one of the most overpriced areas in Orange County, Irvine. Examples of overpriced homes and discussion about building issues.
5. LA Times Land Blog – A recent addition to the housing world. Glad to see a mainstream newspaper add a housing blog section. Updates regularly regarding the housing market and the Southern California area.
6. Piggington’s Econo-Almanac – One of the first housing blogs looking at the canary in the mine, San Diego. Examining the San Diego market with excellent charts and analysis.
7. Southern California Real Estate Bubble Crash Blog – Another older blog updated by Chuck Ponzi. Examines media information and provides links to pertinent housing information.
8. The Rancid Truth: Orange County – Blog examining the Orange County housing market with frequent updates and commentary.
9. Westside Bubble - Takes a look at data and examples of overpriced homes in Southern California. Nothing says housing bubble like an overpriced home in Southern California.
10. Sacramento Land(ing) – Excellent site examining the state capital and their overpriced housing market.
11. Sonoma Housing Bubble – An older site examining regional specific issues and offering commentary regarding the housing market.
12. The Central Coast Housing Bubble Blog – Examining housing price inflation and it’s effects on the economy from Santa Maria to Paso Robles.
13. Baltimore Housing Bubble – Blog examining the East Coast market and taking a deeper look at the Baltimore area.
14. Denver Real Estate Bubble – Blog examining floppers in the Denver Metro Area. Real Homes of Genius exist all over the country.
15. Housing Doom Blog – Site examining the Arizona housing market. Provides national commentary and updated information regarding the housing bubble.
16. Northern Virginia Housing Bubble Fallout – Examining the Greater Northern Virginia Real Estate Market as it slowly depreciates.
17. New York City Housing Bubble – Great site providing links, videos, and updates regarding the housing market from a New Yorker perspective.

National Housing Sites

18. Patrick.net – One of the original housing bloggers. Excellent website providing thoughtful analysis of the national housing market. Northern California birth but now encompasses entire housing market.
19. Speculative Bubble – This site collects updated information from multiple housing sites. An excellent resource to briefly examine what is new in the housing world.
20. Calculated Risk – Older site with thorough analysis of the housing market. Excellent articles and top notch graphs.
21. David Lereah Watch – I have to include this blog even though it is no longer updated. Site trying to keep the former NAR chief honest.
22. Lawrence Yun Watch – New site following the new head of NAR. What will they be saying with all that is going on in the housing market?
23. Mortgage Implode-o-Meter – Examining the junk yard of defunct mortgage lenders. The current list stands at 110. Will it grow this year? I’ll take a wild guess and say yes.
24. Mortgage Fraud Blog – Great site examining news articles about those mortgage lenders and brokers that did shady loans. A perspective from an attorney. I’m sure the articles will only be growing as the year progresses.
25. Housing Panic – One of the first housing blogs. Commentary and news post regarding the housing bubble. If you are looking for housing schadenfreude and updated content, this place is for you.
26. Countrywide Foreclosures Blog – Tracking the economic effects of the bubble by looking at the number and amount of foreclosures from Countrywide.
27. Blown Mortgage – Excellent site looking at mortgage issues from someone in the industry. Provides credit tips and commentary regarding the market.
28. The Great Depression 2006 – Providing housing market insight and commentary. How deep will the housing impact go?
29. Housebubble.com – One of the first news link resources regarding the housing bubble. Links to other blogs and headlines.
30. Housing Bubble Bust – Another older site examining links and housing information regarding the housing bust.
31. Housing Wire – Examining the mortgage industry and one of the first bloggers to give an inside look to what was transpiring in the industry.
32. Paper Money – Excellent website with charts and graphs regarding the overall national housing market.

Finance Sites

33. Bull! Not Bull! – Great site providing economic links and analysis regarding the housing, commodities, and political worlds.
34. The Digerati Life – You need to manage your finances before buying a home (okay, not everyone has followed this path but they unfortunately are now feeling pain). This great finance site provides tips regarding money and enhancing your overall net worth.
35. Dollar Collapse – Excellent site providing information regarding commodities, housing, credit, and political markets. Author of How to Profit from the Coming Real Estate Bust.
36. Economist’s View – You need to understand economics to understand what is going on in the current housing and credit markets. Excellent site providing insight into micro and macro economics.
37. Fall Street – Fall Street provides an excellent headline aggregator providing top stories regarding stocks and the housing market.
38. Fiend’s SuperBear Page – One of the older bear sites online with many links to relevant economic articles.
39. Financial Armageddon – Insights on debts, derivates, and other pressing issues concerning our economy. Excellent site from the author.
40. Financial Sense – Commentary from various articles from multiple industries. Excellent site for reading commentary on various sectors of the economy.
41. iTulip – Older site providing an excellent forum, links, and commentary regarding the credit bubble. One of the sites to predict the technology bubble decline.
42. The Mess That Greenspan Made – Take a guess what this blog is about? Interesting insight into the economic policies of bad macroeconomics and the current marketplace.
43. Money Files – Excellent news aggregator with links on housing, credit, debt, mortgages, commodities, and politics.
44. Steve Quayle – Interesting links and contrarian perspectives. Host of a radio show.
45. W.C. Varones Blog – Perspective regarding many issues from politics, economics, and other issues from our neighbor in San Francisco.

Online Research for Buyers/Sellers

46. Housing Tracker – Excellent resource site examining home asking prices with graphs and trend information.
47. DRE Real Estate Agent/Broker Number - How many people have their real estate/broker license in California? Currently the number stands at 537,038.
48. Real Estate Cycles – Quick look at previous real estate cycles; dates of peaks and intervals between boom and bust. We’ve been here before.
49. Zip Realty – Looking for information on buying or selling a house? You can sign up for free and take a look at home prices, neighborhood data, and inventory numbers with this site.
50. Zillow – The debate goes on about the future of home buying and selling. Zillow is an excellent resource for finding previous sales data and current market numbers in the U.S. Give it a shot and see what your “Zestimate” is on your home. The tool seems more accurate in stable markets that stayed away from the current housing bubble (i.e., large overpriced metro areas).
51. Redfin – Excellent site for researching your next home. Provides detailed sales information and neighborhood data. Not available in all areas. Is this the future of real estate buying and selling?
52. Quick View of Major Builder Stocks - A quick snapshot of how major builders are doing in the stock market.
53. Housing Sales Data – Great site providing tons of information regarding housing sales and information regarding the U.S. housing market.
54. National City Housing Valuation Analysis – One of the better interactive charts giving you an estimate of how over (or under) priced markets are in the U.S.
55. Census – You’re paying for this information with your taxes! Research your community for employment growth, housing stats, and population trends.

So there it is. Plenty of reading to keep you busy and informed regarding the housing market. It is hard to believe how much information is now out there including what the mainstream media is providing. There are many other housing, finance, and business related links that I’m sure come to your mind. Go ahead and post them in the comment section.

So it is established that the housing market is no longer a viable rock solid investment. So what can we expect to face here in Southern California or any other large overpriced metro area in the country? In this article, we will use the clairvoyant power of Excel and run four likely scenarios that will occur here in Southern California. We will use the current median price, current income, and try to predict future scenarios. Consider it a housing premonition.

These are the key reference points we will use:

• Current Southern California Median Single Family Home Price: $502,000
• Current Southern California Media Income: $60,000*
• Los Angeles County Family Median Income: $43,518
• Orange County Family Median Income: $58,605
• San Diego County Median Family Income: $51,939
• Ventura County Median Family Income: $59,379
• San Bernardino Median Family Income: $43,179
• Riverside County Median Family Income: $46,885

(Source: Census.gov)

• Income growth of 5 percent annually.

*We’ll be generous and use an upper-limit since we are looking at the ENTIRE region.

Scenario #1 – Housing Goes up 10% Each Year for 5 Years

You may be thinking to yourself, there is no way this can ever happen. Well keep in mind that we did have 5 years and 2 months of 10+ percent year over year gains in Los Angeles County so not only can this happen, it did. In addition, before 2007 hit full stride, we had many housing pundits predicting double-digit growth! Each month after more and more negative housing news, they slowly scurried away and now they are silent in the dark green jungles of mortgage implosions. Irresponsible public policy and financial negligence led to this mess. But let us humor these heroes and take a look at how these scenarios would look if we let them run their course for another 5 years:

Median Home Price: 2012

year	income
2007	$60,000
2008	$63,000.00
2009	$66,150.00
2010	$69,457.50
2011	$72,930.38
2012	$76,576.89

While the current annual income to home price ratio is hovering around 8.3, by the time 2012 hits it will be approximately 10.6! Keep in mind we are also using a higher reported family income. If we were to use current Census data the housing to income ratio would be much higher. What will the mortgage cost look like?

10 percent down with 30 year fixed at 6.5 percent:

Budget 2012

Price	$808,476
Down Payment	$80,847
PITI:	$5,441
Net Income After Taxes:	$4,785

You think we have affordability issues now? Just wait if we hit this scenario. Let us take a look at a more conservative 5 percent annual increase.

Scenario #2 – Housing Goes up 5% Each Year for 5 Years

Now we are being more conservative. As a matter of fact, Southern California is currently up, 2.4 percent year over year. Housing bubble? Not here in the ever resilient SoCal market. Let us take a look at a 5 percent annual appreciation rate (which is more historically accurate):

Clearly this scenario seems more probable. Let us run the numbers once again with the 5 percent annual appreciation rate:

Budget 2012

Price	$640,693
Down Payment	$64,069
PITI:	$4,311
Net Income After Taxes:	$4,785

Okay, now at least we aren’t running into monthly household budget deficits. But the basic monthly nut will consume 90 percent of our net take home pay of the hypothetical median income family. Talk about taking it to the house. Let us now look at some more bearish predictions. First, let us examine a 5 percent annual decline.

Scenario #3 – Housing Goes down 5% Each Year for 5 Years

Even at a 5 percent decline annually over 5 years, we now see the median house price hit $388,438. Many in Southern California haven’t seen the fabled $300,000 mark in many years. Can it be possible that we have a blast from the past? Let us break down this scenario:

Budget 2012

Price	$388,438
Down Payment	$38,843
PITI:	$2,613
Net Income After Taxes:	$4,785

Now this is looking more reasonable. And all we saw was a 5 percent annual decline over 5 years. Not exactly a horrific crash or bubble bursting. In this scenario, the monthly housing nut will only take 54 percent of our net income. Seems like we are approaching a more realistic and reasonable environment. For the heck of it, let us do our maximum doom and gloom scenario of 10 percent annual declines for 5 years. After all, we did see 10+ percent increases for 5 years (sometimes even 20+ percent annual gains) so why not on the downside?

Scenario #4 – Housing Goes down 10% Each Year for 5 Years

Now most folks cannot imagine this scenario. Are you telling me we can actually be in the $200,000 range? If we follow the above scenario that is where we will eventually end up. $296,426 doesn’t even get you a studio apartment so how can it ever purchase a single family home? Let us see how the household budget works out:

Budget 2012

Price	$296,426
Down Payment	$29,642
PITI:	$1,994
Net Income After Taxes:	$4,785

We actually have a monthly payment of under $2,000. Now, the housing nut only takes up 41 percent of the median family’s net income. Keep in mind in more prudent times, most financial advisors recommend that housing not consume more than 1/3 of your household income (some go with net and some use gross). Either way, even with our massive decline of 10 percent year over year for 5 years, we are finally reaching parity with ancient financial standards.

I hope the above gives you an idea of how ludicrous it is to expect 10 or even 5 percent continued annual appreciation rates. Unless income starts going up by 10 or 15 percent a year, the positive scenarios will simply not happen. There are two questions that I’ll throw out:

1. Do you think housing will slowly decline or will it happen faster and more abrupt?

2. Do you think interest rates will go up? Because if rates do go up, the above scenarios will make it even more difficult for the average family to purchase a home and not stretch their budget like Gumby.

Related Articles:

The Housing Tipping Point

10 Real Homes of Genius in 5 Southern California Counties

The History of The Los Angeles Housing Bubble

The Foreclosure Story: $130,000 Income and Going Through Foreclosure

Did You Enjoy The Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information.

When you think of the credit bubble, what comes to mind? Overpriced Homes? The subprime implosion? Massive credit? Or are you simply indifferent to it? The housing and credit bubble will have a long lasting impact on an entire generation of people living through it. When we see that a certain company has self-destructed or foreclosures are skyrocketing, what does this mean on a personal level for society? In the case study of a couple making $130,000 a year and going into foreclosure, we see that this bubble will impact the rich and the poor including the farmer making $14,000 a year and buying a $720,000 home. These stories drive the point home and make the credit bubble discernable to people from all sectors of society. It is easy for most people that understand housing to assume everyone can read a 30 year mortgage statement or has substantial knowledge regarding investing in the stock market. However, we have examined that the majority of the population is not affluent or what we consider to be really rich.

Very rarely do I come across a personal account that encompasses the entire scope of what a bursting bubble can do to an economy and the people living in it. Bubbles, as examined from the past, have a very similar pattern in the stages they progress. Mass euphoria leads to a case of mass resentment and depression both economically and personally for many families. I came across a letter written from a lawyer from Mason City, Iowa in the Corn Belt recounting the impact of the Great Depression on his town. It is a poignant and somewhat eerie story to read considering the date of writing is 1933. The similarities of what happens in the past raises many questions that I hope to discuss at length and how it will influence our future as a nation. These are things that as a society we will face. Foreclosures, larger numbers of families facing economic problems, and the repercussions of another bubble bursting. Since I found this letter in a very old file, I have decided to type up the large part of the letter since it is a necessary read for anyone trying to diagnosis potential issues we will face. Of course, times are different. We are not in the late 1920s or early 1930s, but human nature, bubble psychology, and the essence of being a person are timeless. Below are paragraphs of the entire letter:

“The boom period of the last years of the World War and the extremely inflationary period of 1919 and 1920 were like the Mississippi Bubble and the Tulip Craze in Holland in their effect upon the general public. Farm prices shot sky high almost over night. The town barber and the small-town merchant bought and sold options until every town square was a real estate exchange. Bankers and lawyers, doctors and ministers left their offices and clients and drove pell mell over the country to procure options and contracts upon this farm and that, paying a few hundred dollars down and expecting to sell the rights before the following March brought settlement day. Not to be in the game marked one as an old fogy, while paper profits were pyramided and Cadillac cars and pleasure trips to the cities took the place of Fords and Sunday afternoon picnics. Everyone then maintained that there was only a little land as fertile as the fields of Iowa, Illinois, and Minnesota, and everyone sought to get his part before it was all gone. Like gold, it was limited in extent and of great potential value. Prices skyrocketed from $100 to $250 and $400 per acre without regard to the producing power of the land.”

Real estate speculation is not a new subject. As noted by the lawyer, people from all segments of the economy were playing the real estate speculation game. If you didn’t play the game, you were considered old school and lacked the intelligence to be financially savvy. Bringing this to the current market, we can see how someone driving a Mercedes may hold a view of someone driving a Honda Civic. Clearly, the person driving the Civic isn’t playing the real estate game or has an understanding of how to manage their finances. Sadly, a large percentage of those in the Civic will perceive the person driving the Mercedes as wealthier even though they have an $800 a month lease and in fact may have a net worth in the negative territory. So many people decided to jump into the game and this is noted by the large increase of employment related to the housing complex in the past decade. The letter continues:

“During this period insurance companies were bidding against one another for the privilege of making loans on Iowa farms at $90 or $100 or $150 per acre. Prices of products were soaring. Everyone was on the highroad not only to comfort, but to wealth and luxury. Second, third, and fourth mortgages were considered just as good as government bonds. Money was easy, and every bank was ready and anxious to loan money to any Tom, Dick, or Harry on the possibility that he would make enough in these trades to repay the loans almost before the day was over. Every country bank and every county-seat town was a replica in miniature of brisk day on the board of trade.”

Many housing pundits would like you to believe that modern real estate products are somehow superior to past products. Either way, you are securing a note onto an asset and the basic concepts still apply. As you can read from the letter, second, third, and even forth mortgages were common in the 1920s. The perception, just like in better housing days, that housing was an absolute secure investment was something held very near to the heart during the lead up to the Great Depression. We also notice that lending institutions were just as eager then as they are today to loan money out to anyone with a pulse. How quickly did the tide turn after the Crash of 1929? It did not happen overnight:

“The drastic deflation of Iowa loans under the orders from the Federal Reserve Board, upon which Smith Wildman Brookhart, depression Senator from Iowa, poured forth his venom, definitely marked the downward turn in the mythical prosperity of boom days. Despite our hopes for the better, conditions have grown steadily worse.”

“During the year after the great debacle of 1929 the flood of foreclosure actions did not reach any great peak, but in the years 1931 and 1932 the tidal wave was upon us. Insurance companies and large investors had not as yet realized (and in some instances do not yet realize) that, with the low price of farm commodities and the gradual exhaustion of savings and reserves, the formerly safe and sane investments in farm mortgages could not be worked out, taxes and interest could not be paid, and liquidation could not be made. With an utter disregard of the possibilities of payment or refinancing, the large loan companies plunged ahead to make the Iowa farmer pay his loans in full or turn over the real estate to the mortgage holder. Deficiency judgments and the resultant receivership were the clubs they used to make the honest but indigent farm owners yield immediate possession of the farms.”

So we realize after the “great debacle” that foreclosures did not peak until 1931 or 1932. So it took 2 to 3 years for the pent up excess credit to hit the market. With our 24/7 media coverage and online to the nanosecond updates, most people think the bubble burst or later recovery will happen tomorrow. Unfortunately, it will occur over a long and drawn out period while people silently scream. The denial of the current credit bubble is extremely similar. By looking at the numbers conservatively, we see that we are going to have much of the same in 2008 and 2009. Not only will it be the same, but we are eliminating the “safety” feel of real estate and compounding it with growing foreclosures and declining prices. We recently had a first national housing median price decline since - guess when - The Great Depression. And it is not uncommon for people to start taking sides at this point. Some want to call bottom and those financially conservative realize we have a long way down before we hit bottom. The letter also highlights the sucking dry of savings and reserves of many families. Well, we already know that we have a negative savings rate so I’m not sure how long a family could stay afloat without using credit cards or blowing through their retirement funds (if they have any). How did this impact society’s view on real estate?:

“Men who had sunk every dollar they possessed in the purchase, upkeep, and improvement of their home places were turned out with small amounts of personal property as their only assets. Landowners who regarded farm land as the ultimate in safety, after using their outside resources in vain attempts to hold their lands, saw these assets go under the sheriff’s hammer on the courthouse steps.”

We have this mentality in the current market place. The majority of folks that invest heavily into renovating their homes are looking to flip the property for a larger profit. Not everyone, but with shows like Flip This House you begin to realize that home is a temporary pit stop for many in our society. And then we have the generational psychology shift that housing isn’t a safe investment in every circumstance. Foreclosures started going through the roof shortly after the psychological shift:

“During the two-year period of 1931-32, in this formerly prosperous Iowa county, twelve and a half per cent of farms went under the hammer, and almost twenty-five per cent of the mortgaged farm real estate was foreclosed. And the conditions in my home county have been substantially duplicated in every one of the ninety-nine counties of Iowa and in those of the surrounding states.”

Growing foreclosures start to hit multiple counties in Iowa during the tidal wave period of 1931-32. Currently we are facing incredibly large foreclosure jumps in California, Colorado, Arizona, Florida, and Michigan to name a few states. This is something that has only started. It has moved from the center of wealth in the 20s of the farm and industrial cities, to the urban metro centers of the 2000s. Like the previous bust, it took about 3 years for the general market to realize there were major issues. When times change they change quickly:

”We lawyers of the Corn Belt have had to develop a new type of practice, for in pre-war days foreclosure litigation amounted to but a small part of the general practice. In these years of the depression almost one-third of the cases filed have to do with the situation. Our courts are clogged with such matters.”

“Gone, too, is that pride of ownership which made possible the development of stock and dairy farms with their herds of fat cattle and hogs, their Jersey cows, their well-kept groves and buildings which beautified and developed the countryside. The former owners were willing to use a large part of receipts from a farm’s income to increase its value and appearance but the present absentee owner regards it only as a source of possible dividends.”

“From a lawyer’s point of view, one of the most serious effects of the economics crisis lies in the rapid and permanent disintegration of established estates throughout the Corn Belt. Families of moderate means as well as those of considerable fortunes who have been clients of my particular office for three to four generations in many instances have lost their savings, their investments, and their homes; while their business, which for many years has been a continuous source of income, has become merely an additional responsibility as we strive to protect them from foreclosures, judicial receivership, deficiency judgments, and probably bankruptcy.”

“The old maxim of three generations between shirt sleeves and shirt sleeves is finding a new meaning out here in the Corn Belt, when return to very limited means in a formerly prosperous population is the result not of high living and spending, but of high taxes, high dollars, and radically reduced income from the sale of basic products.”

A few things to note. The impact on a societal level is time and productivity will shift into protecting faltering estates. Folks will try to save their homes, try to avoid bankruptcy, and we will have collectors focusing on bringing accounts current (if they can). This is time spent from other economically productive activities. However, it is an unavoidable evil of any bubble to wash out the excess liquidity. The letter also discusses the loss of homeownership pride. I’ve thought about this many times here in Southern California. Most of the time, I hear folks saying, “do you know I have $300,000 in equity and if I upgrade the bathroom, it’ll be worth an additional $25,000?” I ask them if they are upgrading for their family but normally it is to sell it off to the next highest bidder. We are starting to see dents in this mentality. Why invest so much in your home if appreciation is stagnant or declining? If you really wanted to be a proud homeowner, you would do these things simply for improving your home. Many did upgrade via mortgage equity withdrawals and second mortgages. However, when the market bottoms out you realize that many did it as a ploy to inflate the value of their home for a future time to market and not for the betterment of their families’ well being. Either way, folks can do whatever they want with their home and money but clearly, homeownership pride for many in Southern California and other large metro areas is based on how much equity you have amassed. The lawyer recounts a sad story of a client:

“George Warner, aged seventy-four, who had for years operated one hundred and sixty acres in the northeast corner of the county and in the early boom days had purchased an additional quarter section, is typical of hundreds in the Corn Belt. He had retired and with his wife was living comfortably in his square white house in town a few blocks from my home. Sober, industrious, pillars of the church and active in good works, he and his wife may well be considered typical retired farmers. Their three boys wanted to get started in business after they were graduated from high school, and George, to finance their endeavors, put a mortgage, reasonable in amount, on his two places. Last fall a son out of a job brought his family and came home to live with the old people. The tenants on the farms could not pay their rent, and George could not pay interest and taxes. George’s land was sold at tax sale and a foreclosure action was brought against the farms by the insurance company which held the mortgage. I did the best I could for him in the settlement, but to escape a deficiency judgment he surrendered the places beginning in March 1^st of this year, and a few days ago I saw a mortgage recorded on his home in town. As he told me of it, the next day, tears came to his eyes and his lips trembled and he and I both thought of the years he had spent in building up the estate and making those acres bear fruit abundantly. Like another Job, he murmured “The Lord gave and the Lord hath taken away”; but I wondered if it was proper to place the responsibility for the breakdown of a faulty human economic system on the shoulders of the Lord.”

“When my friend George passes over the Jordan and I have to turn over to his wife the little that is left in accordance with the terms of his will drawn in more prosperous days, I presume I shall send his widow a receipted bill for services rendered during many years, and gaze again on the wreckage of a ruined estate.”

“I have represented bankrupt farmers and holders of claims for rent, notes, and mortgages against such farmers in dozens of bankruptcy hearings and court actions, and the most discouraging, disheartening experiences of my legal life have occurred when men of middle age, with families, go out of the bankruptcy court with furniture, team of horses and wagon, and a little stock as all that is left from twenty-five years of work, to try once more – not to build an estate – for that is usually impossible – but to provide clothing and food and shelter for the wife and children. And the powers that be seem to demand that these not only accept this situation but shall like it.”

Powerful writing isn’t it? Hard to believe and even conceptualize a time when prudence and financial discipline were esteemed. This is the sad account of many folks being demoralized and unable to recuperate a substantial nest egg to retire. Their main concern shifted to providing the basic necessities for their family. Keep in mind that the majority of Americans store their wealth in home equity. Many people that grew up during the depression seem frugal and downright strict with their budgets and lifestyles. It left a visual scar on their psyche. How could it not? We look at our current culture and hear prominent financial gurus telling people to walk away from their home if they have no equity. Just leave. Don’t try to fight to keep it. Default and declare bankruptcy if necessary. My main question is who will pay the eventual bill? If you say the government then that means you will be paying back for the mass irresponsibility of financial institutions, imprudent government policy, and the mass greed of many. Unfortunately, this bubble will affect everyone in some form since all of us need shelter and this credit bubble was built on the over appraisal of a shingled laden roof over your head.

What do you think of the lawyer’s letter in relation to our current economic situation?