The latest Case-Shiller Index data had its first nationwide price bump up in nearly three years. I am astounded (but not shocked) by what this has done to the psychology of many. The most recent post highlighting the REO shadow inventory and how banks are keeping homes off the public view instead of convincing people […]
The latest Case-Shiller Index data had its first nationwide price bump up in nearly three years. I am astounded (but not shocked) by what this has done to the psychology of many. The most recent post highlighting the REO shadow inventory and how banks are keeping homes off the public view instead of convincing people that housing has a tumultuous path ahead, the post actually reinforced a group of people that now think the worst is over. Keep in mind the Case-Shiller data set for the LA/OC region is still declining. Yet people are extrapolating nationwide data and transferring it over to the dismal state of California. It may very well be the case that nationwide prices have hit a bottom but not for the mid and upper tier of California homes. Price corrections are virtually assured with the coming onslaught of Alt-A toxic dubious mortgages coming in full force in 2010.
The argument keeps shifting so let me be extremely clear. Some keep thinking that there will be some generalized and clean decline when the Alt-A loans implode. They keep obsessing over tiny details in the market and say, “I thought the implosion was going to happen now! Forget this, I’m jumping in.” Many people are simply impatient and choose to ignore certain facts at their own convenience. The same kind of reasoning occurred in 2006. Even almighty Ben Bernanke shrugged off the housing problems and didn’t see a recession being set off by the housing bubble. Housing in California will be in trouble for years to come. The distress market data tells us that. Yet if you use the median price as your indicator, you will be completely off. In fact, I wouldn’t be surprised to see the median price increase as the mid and upper tier markets implode…simultaneously.
How can this be? Simply put, for the past year the bulk of the sales have occurred in the lower priced cities. Of course, the median price is principally concerned with volume and the volume has been with the low hanging fruit. Many in the mid to upper tier did not sell and still had prices at delusional levels so the volume at the mid to upper tier simply did not make a dent in the overall data. But now, we are seeing sales in these areas with more modest price cuts. Ironically, with more volume in these areas and the lower end working through its funk, prices may increase in terms of the median price. Let me give you a really simple example. Take a home in Pasadena. The hypothetical home might have sold for $700,000 during the peak but now will fetch $500,000. The homeowner bought for $300,000 so they still stand to profit. Life occurs (i.e., new job, divorce, etc) and they need to sell. The home moves for $500,000. Do this many times over and you can understand why you are seeing the median price in Southern California increase:
I think this is what is catching many people off guard. The median price for Southern California has been steady since January of 2009 and has increased in the last two months. You need to understand why this is occurring however. Given our previous example, you can understand that the home can sell for $400,000 or even $350,000 and the owner still will profit and the overall median price for the region will have more fuel to go up. And the Case-Shiller Index would increase in this case as well because it uses repeat home sales over time. The Alt-A implosion will force the hand of many banks to off load homes in these kinds of scenarios. So if you are looking at the region median price, we may have already bottomed. But make sure we are talking about the same kind of dynamics.
But let us look at the nationwide picture first. It helps to look at the entire U.S. housing market. Many of you sent the report from Deutsche Bank AG which stated that 48% of mortgage holders will be underwater by 2011. Interesting point since I have been saying for over a year that California will hit a housing bottom in 2011. Yet how extreme is this contention?
The above chart includes data from multiple sources including the Census Bureau, Deutsche Bank, and Moody’s. It helps to have it all in one spot to analyze. First, a couple of facts from the chart above. Some 31% of homeowners have no mortgage. Next, as things stand today some 16 million homeowners are underwater meaning they owe more than their home is worth and another 5 million have zero equity or a few percent in equity (which is irrelevant if you consider selling costs of 5 to 6 percent). The bottom line is some 21 million Americans already have negative equity or will have no equity in the coming months. What Deutsche Bank is predicting is we will have 25.8 million people with negative equity by 2011 which makes up about half of homeowners with a mortgage. Some see this as some mega epic doomer call. I don’t see it that way. The argument they present is that more issues will start occurring with prime mortgages (the data backs this up) since unemployment will stay elevated for sometime thus pushing up foreclosures. And right on time Fannie Mae announces another stunning loss this time to the tune of $14.8 billion. Keep in mind that most of the GSE stuff is supposedly prime paper. We are still running at record high foreclosures rates by the way:
Nothing will push a home price lower than a foreclosure. And people forget about the impact that foreclosures have in an area. They force comp values lower so appraisers start valuing homes lower in general. I know some in the real estate industry hate this since they only think housing values go up but this is the reality. And with the Alt-A loans largely being based out of California, there is little reason to think that the mid and upper tier markets in the state will stabilize (the average balance is $440,000):
And for what it is worth, Deutsche Bank was early in calling subprime problems so I do give them some credit in their analysis. But you say California is different right? Well let us look into the California housing situation:
Of those homes with a mortgage in the chart above, 33 percent are estimated to be underwater by Moody’s. I would estimate a much higher number given the persistent delusion by many in the mid to upper tier areas. They somehow look at the Alt-A data and think that it will be swept under the rug as if it was a small amount of dirt. That is not the case. If you look at the above data, we now have more people underwater than people that have paid off their mortgage in California! Also, there is nothing wrong with renting in the state given that nearly as many people rent as those with a mortgage. And by the way, with the absurd loan modifications extending loans out to 40-years many homeowners that bought at the peak are basically realizing they have it worse than renters. A renter can pick up and leave. They cannot. Unless they strategically default and stop making payments which many are electing to do but will ruin their credit.
The above implications are rather clear to someone that has been following the California housing market for a decade and is also cognizant of its historical trends. One key factor not being addressed however is housing affordability. Clearly lower home prices will make prices more affordable - only if the assumption is based on a stable economy. Yet what use is having more affordable home prices if the economy is firing people left and right? And if you haven’t noticed, California’s economy with an 11.6 percent unemployment rate is still going up. Some analysts estimate a 13 to 14 percent peak. That is why when you look at what regions have underwater homeowners, you will also find economically depressed regions included with the bubble maniac states like Nevada and California:
There are two sides to the housing equation. First is the home price and second involves the local economy. This is simple to understand. Michigan has incredibly cheap housing prices. Heck, I’ve seen some homes going for $1 to $100 simply because the local governments want someone paying some property tax and maintenance for the home. So the price is fine since you can’t get cheaper than $1. Yet the second part of the equation is a disaster. Employment is in shambles. What use is it living in a gigantic cheap home if you have no job in the area? And we are a social bunch. You might think it prudent for you to live in your cheap mansion but what of your friends or family? You’ll need something else to do instead of sitting in your big empty home counting your cash while those around you struggle financially. That is why plans like those for Flint are openly talking about demolishing parts of towns. Like a Phoenix rising from the ashes except those ashes will be cemented over in a housing graveyard.
California has one of the highest unemployment rates in the country. We have the bulk of those toxic Alt-A loans which include the tasty option ARM variety. For this entire decade, most of the new high paying jobs revolved around the real estate industry in the state. Short of us having another bubble, that industry is gone forever. So what is going to replace that function in the equation? What is incredible is even after the major price adjustments, housing in California is still unaffordable. People say, “look at that $100,000 home in the Inland Empire” while failing to realize the near 20 percent unemployment rate in some cities in that area. The California is different argument held water when our economy was booming. That argument holds no water in a state with a $26 billion budget deficit and is chopping services left and right.
For many, the American dream of homeownership has become a nightmare. It really is too bad. Private property ownership has worked well for our country. I would argue that it is an important part of the stability of our economy over the last fifty years. Yet the perverse crony real estate industry tag teamed with Wall Street and decided to transform this once boring industry into a casino on the backs of the American public. Forget about long-term stability when you can sacrifice it all for short-term gain. They now openly chide the American public since they did after all sign on the bottom line while at the same time they are taking money from the Federal Reserve and the U.S. Treasury. It is the ultimate hypocrisy. I believe that those homeowners that overleveraged themselves should lose their homes. That is why I am adamant against using taxpayer money for loan modifications especially when they are designed more to protect the banks. I am even more adamant about letting those lenders who participated in this mess to fail. Too bad during the earlier days of this crisis we didn’t reward prudent lenders with taxpayer money since they were the ones who demonstrated how to actually conduct banking. Instead, the money flowed to the most culpable in creating this mess.
So don’t be fooled about this short-term delusion. Has the freefall stopped? Sure. But that doesn’t imply a robust recovery is around the corner (the stock market rallying 50 percent since the March low believes in the “V” shaped recovery). What industry is going to make up for the lost financial and real estate jobs? How much home can you afford while working a service job? The fact that we have 21 million Americans with negative equity or zero or little equity is simply astounding.
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Rich Dad, Underwater Dad: 21 Million Homeowners with Negative Equity or No Equity in Their Homes. 33 Percent of California Mortgages Underwater.
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