In recent months we have seen many articles talking about the lack of predictability in big bubbles like the current credit crisis.  Some of these authors argue that bubbles are impossible to predict and therefore preparation is futile.  This observation is false simply because history is littered by people that have predicted events including the […]

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In recent months we have seen many articles talking about the lack of predictability in big bubbles like the current credit crisis.  Some of these authors argue that bubbles are impossible to predict and therefore preparation is futile.  This observation is false simply because history is littered by people that have predicted events including the Great Depression.  And it is nonsense on the surface because if you see your friend having 20 shots of tequila it is very likely that it will not end pretty even though it is fun in the moment.  What makes bubbles seem impossible to predict during the mania is this collective groupthink where the herd dominates most of the conversation drowning out opposing views.  We’ve highlighted many homes during the years here in California and the obvious explanation was a bubble was here and it would burst at a certain point.  Yet there is little reward for being the messenger of bad news and this was the tragedy of any modern day Cassandra.

I’ve noticed a few people in other articles and blogs talk about how great of a deal they got on a California home.  30, 40, or even 50 percent off the peak price.  Yet this discount in itself is meaningless unless we put it into context of the local economy, incomes, and inflation-adjusted home prices for that area.  Yet even today, we see the same psychological trappings of those that bought in 2006 and 2007.  “Well it has to go up because it went up in 2002, 2003, etc” and this was the basis of prices heading higher.  Today, it is more like “I got a home for 30, 40, or even 50 percent off therefore it is a good deal.”  But price alone does not tell you everything.  If a low price was the measure of value, then Detroit would be the ultimate value play but there is a reason homes that once sold for $100,000 which seemed cheap a decade ago are now going for $1,000 or even $500.

Now why bring this up?  We are seeing unique trends in the housing market.  For example, there has been a large amount of sale activity in the Inland Empire:

Source:  DataQuick

The amount of sales in distressed markets is astounding.  From data showing financing on these purchases, we see that many investors are rushing out to buy homes.  But are prices making sense even in these areas where prices are down 50 or even 60 percent?  It is hard to tell because these local economics are feeling the brunt of the recession.  For example the above chart shows some areas in Riverside County part of the Inland Empire.  The sales volume above is intense.  For example, in the Temecula zip code above 38 home sold in December of 2007.  Today that volume is three times that.  The Hemet zip code above is running at double the pace.  So the volume is there.  But take a look at the unemployment rate in the Inland Empire:

Source: BLS

There is a reason for the extraordinarily cheap housing prices when headline unemployment is 14 percent (meaning the underemployment rate is upwards of 25 percent).  As an investor it is hard not to be tempted by low prices.  But going out there to view the market, you see in some cases, home after home either boarded up or completely uncared for.  Many of these communities are dealing with a large surge of Section 8 renters.  Just look at how many rentals are available in these areas and you can see that many investors are getting in over their heads.  They are only focusing on one side of the equation in price.  They are failing to examine the local economy or trends in the area.

MLS

For the first time in three years of tracking the MLS data have I seen a significant jump in inventory for Southern California.  The six counties in Southern California currently have 69,000 homes listed on the MLS.  This is up from the low reached in October of 2009 with 64,000 properties listed.  Part of this has to do with a large number of short sale properties hitting the list but also, the expiration of HAMP offers for many who simply do not qualify.  The housing market has gone from a manic casino to a slow payout slot machine.  But only looking at the MLS data is misleading as we already know.  We recently found out the massive gimmick Lehman Brothers was using to hide toxic assets.  Well the MLS does not tell the entire story.

If we look at distress inventory, we find out that it is true that many Southern California communities have a large amount of distress properties:

Source:  Foreclosure Radar

This is being reflected in the median sale price.  The median sale price in Southern California has gone up since it hit a low in January of 2009 of $250,000 for almost a year.  However, last month it dipped by $17,500.  Part of it has to do with the fact that California has a 12.5 percent unemployment rate.  A lot of the housing volume has come from investors.  Last month 28.9 percent of all Southern California home purchases were all cash.  So either people are looking to flip again or purchase to create rentals.  But the rental market is already saturated:

The California vacancy rate is the highest on record.  So if these investors plan on turning these units into rentals, by supply and demand prices will be pushed lower so hopefully they are factoring this in.  Some are taking solace that there will be no tsunami but in that belief, they assume that there will be no further price corrections.  This is one large fallacy going around today.  Tsunami, trickle, or any other weather comparison prices will correct in many areas simply because they do not reflect the current market.  Did we also mention the massive California budget deficit?

Estimated Balance on Distress Properties

One way to get a sense of how much correcting we have, I dug deeper into the distress data.  Take for example the top 1,000 properties in Los Angeles County that are scheduled for auction or bank owned:

These homes haven’t hit the market.  A handful are on the MLS but not many.  If these homes sell today for the estimated value (unlikely since it is a bit high) we would see an average loss of $195,175.  Now this is only a sample of the 63,000 distress properties in Los Angeles County.  Banks clearly have this data so they rather take on people that have stopped paying their mortgage then realize that $195,175 loss.  But this has a timeframe attached to it.  Just look at a couple of the mortgage balances.  $470,000 would carry a $3,000 to $4,000 total housing payment depending on the interest rate.  The loss on that property is roughly $210,000.  So they can hold off for 4 years ($4,000 x 48 months) but this won’t happen.  The most I’ve seen has been 18 months from when the NOD was filed.  Yet the loss at a certain point will be realized.  And make no mistake, the reason banks are not lending is because of this.  Their internal cash flow is bleeding.  They are simply hoping for a bubble resurgence which obviously is not going to happen.  Why?

California Big Salaries Down

What people don’t want to talk about deals with the reality that many of the high paying jobs were basically cogs of the bubble machine.  Many mortgage brokers, agents, and bankers were getting lucrative income for being sellers of this financial mess, the biggest since the Great Depression:

“(May 2007) Brokers can earn higher commissions – up to 3 percent instead of the typical 1 percent – by having customers buy loans with interest rates that are higher than market rates, with prepayment penalties charged if the loan is paid off before a certain date, and with little or no verification of the borrower’s income, known as “stated income” loans. That’s the difference between a $12,000 and a $4,000 commission on a $400,000 loan.

Leonard said he believes such practices are common, partially because there is no state law requiring the broker to disclose that the borrower is eligible for a lower rate.

Many loans offering the highest commissions have been subprime loans, higher interest rate loans that often are sold to those who have low credit ratings or present other risk factors, such as undocumented earnings. Mortgage industry experts say the majority of defaults in the last two years are tied to these loans.”

With option ARMs outlawed and other toxic junk finding no market in Wall Street, the only game in town is government backed loans that certainly do not carry a $12,000 commission.  So what we have is this:

And many of these people were buying in prime areas like the Westside with inflated bubble salaries that are now gone.  So the pool of qualified buyers is down for mid to upper tier markets.  Going back to the Cassandra effect, the state was satisfied as well because they were collecting large amounts of taxes from these people.  They were getting good money from payroll taxes but also, solid revenues from properties that were now assessed at absurd prices.  There was no incentive for the state to stop the party.  California was an economy that was built by the housing bubble both in employment and housing values.  It is now suffering on both ends of the spectrum.  That is why our unemployment rate is still at the peak while nationwide the unemployment rate seems to have leveled off.  It is also the case why our state government is in an absolute mess.  They counted on the bubble revenues:

So what this means is get ready for higher taxes or more cuts.  Unless we decide to recreate the housing infrastructure to start another bubble but Wall Street is already done with the housing market and is on to better bubbles to chase with taxpayer money.  In other words, California is going to have a stagnant housing market for years to come.

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On Friday the California Employment Development Department released preliminary figures on California unemployment. As it turns out, the unemployment problem ran deeper in 2009 than many had initially thought.  The current unemployment rate is 12.5 percent which means the underemployment rate for the state is probably closer to 23 percent.  Mix that in with Alt-A […]

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On Friday the California Employment Development Department released preliminary figures on California unemployment. As it turns out, the unemployment problem ran deeper in 2009 than many had initially thought.  The current unemployment rate is 12.5 percent which means the underemployment rate for the state is probably closer to 23 percent.  Mix that in with Alt-A and option ARM loans floating out in the market and you can understand why there are still problems in the California housing market.  The unemployment report is in sharp contrast to what is going on in Wall Street.  The stock market rallied even though we have yet to add one net job since the recession started.

The California budget is mired with systemic problems and many state and local government are going to be battling with cuts over the next couple of years even if the economy starts recovering.  If we actually look at unadjusted unemployment figures, the unemployment rate for Los Angeles County and California is a stunning 13.2 percent:

Source:  EDD

Very few of us have ever seen an unemployment rate this high for the region.  And we are starting to see some aggressive price cutting from banks in some select mid-tier markets to reflect this lower wage economy.  It is hard to tell what is going on internally on the balance sheet of many banks but it isn’t good.

Today we’ll look at what I would consider a mid-tier city in Los Angeles County that is starting to see some aggressive price cuts.  Today we salute you La Mirada with our Real Homes of Genius Award.

Half Off From 2006

La Mirada like many cities in Los Angeles County saw a massive jump in housing prices.  When prices were out of reach in other locations La Mirada was considered a good middle class place to buy a modest home.  This seemed to be enough to justify massive increases in prices.  The median price peak was reached late in the spring of 2007:

June 2007:           $555,000 (median La Mirada home price)

In that month, 40 homes were sold in the city.  Today the stats look a bit different:

January 2010:     $380,000 (median La Mirada home price)

In January 25 homes sold.  Now, much of this of course has to do with it being winter but a 31 percent price cut in less than three years is significant.  Yet prices are still too high given the household demographics.  We’ll get into that in a minute.  First let us examine the home above in better detail.

The above home is a 4 bedrooms and 1 bath home.  It is listed at 1,312 square feet and was built in 1953.  When I go into the history of California housing this was one of those massive building boom times.  This home was purchased near the peak back in 2006.  This home was financed with toxic mortgages up to the very common 100 percent mark:

Let us run the numbers.  The home was purchased for $514,000 with an 80/20 setup:

1^st mortgage:     $411,200 (80%)

2^nd mortgage:    $102,800 (20%)

Now I know some of you are stunned about this but this was very common in California.  In fact, those toxic option ARMs were being handed out like Pez candy.  The notice of default was filed back in December of 2008, then in March of 2009 the NTS was filed.  It took another nine months from that point for this home to go into bank owned status.  The home hit the MLS on 1/19/2010.

But here is where I’m noticing some reality based pricing.  Back even a few months ago, you would see bank owned homes hit the market at outrageous prices and banks simply sat back and did nothing.  On some areas and some homes, pricing seems to be aggressive on the downside.  Take a look at this place:

Price Reduced: 03/03/10 — $284,900 to $259,900

A 50 percent haircut from the 2006 peak price.  Before you jump up and down this is exactly what we’ve been talking about.  It seems like in some markets banks are being more realistic with their pricing.  And they should be.  Take a look at the household demographics for the city:

So let us run the FHA insured loan numbers here since at the current price, it clearly meets the criteria (4 out of 10 homes sold in SoCal were FHA backed last month).

3.5% down payment:     $9,096

The median household family bringing $61,000 is taking home roughly $3,900 net per month.  So roughly 43 percent of net pay is going to the home payment.  Does this make sense?  It would seem a bit high but it is certainly more in line than other areas and certainly far from the bubble peak.  And this is now the next phase and I expect to see more of this going forward.  We went from areas in the Inland Empire seeing big haircuts, to lower priced L.A. County areas, and now we are seeing certain mid-tier cities cut prices aggressively.  In my book, a 50 percent cut is significant.

Should you rush out and buy a home?  No.  If the numbers work and you find a home you like, go for it.  Yet the reality is, if L.A. County has a headline unemployment rate of 13.2 percent then the unemployment and underemployment rate is closer to 24 percent.  In other words, 1 out of 4 people in L.A. County are either out of work or working part-time for economic reasons.  Does that really sound like a healthy market?  Frankly, many people are focusing on their career and employment and are putting aside the Wall Street and real estate industry obsession with housing as the center of the universe.  Without solid employment, home prices will still go lower.  And keep in mind the current household income figures are based on 2008 Census figures and we won’t have more up to date data until September of 2010.  In other words, the income data is much worse than it appears.

And about that shadow inventory?  Let us take a quick look.  The MLS currently lists the following for La Mirada:

Non-distress:     45

Short Sales:        28

Foreclosures:     13

And this is what is lurking on the bank balance sheet:

Pre-foreclosure (NOD):                 124

Scheduled for Auction:                  188

Bank Owned:                                     39

Some had a question about double counting but these are all unique properties, nothing is double counted in the above data except for the 13 MLS foreclosures from the 39 bank owned properties.  86 properties on the MLS and 351 properties in distress.  This above home is one of those “trickle” down homes that is supposedly going to make the market better because we won’t see a flood.   A 50 percent price cut sure doesn’t seem like prices are going to boom as some in the housing industry would like you to believe and even with a drip strategy for the shadow inventory, prices will still come down to reflect economic reality.  And why would it matter how properties are released onto the market?  The distress is as plain as day.  Just look at the above stats.  People with a NOD, auction scheduled, and losing their homes are not in a stellar financial position.  People now have to go with government backed mortgages and even though these are easy to get, they are based on verifying income.  And with 13.2 percent of L.A. unemployed that is proving to be a challenge in itself.

Today we salute you La Mirada with our Real Homes of Genius Award.

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The banking system has captured our government and frustration is boiling over.  Yet those in the housing and banking industry seem complacent and even self congratulatory that we “have avoided Great Depression 2.0.”  Really?  Now we’re taking advice from the same group of cronies that led the economy off the financial cliff.  And the most […]

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The banking system has captured our government and frustration is boiling over.  Yet those in the housing and banking industry seem complacent and even self congratulatory that we “have avoided Great Depression 2.0.”  Really?  Now we’re taking advice from the same group of cronies that led the economy off the financial cliff.  And the most troubling thing is we are at the height of unemployment even though the headline rate seems to have steadied out.  California’s unemployment rate still continues to move upward hitting 12.5 percent.  Yet all is well in delusional banking world since their idea of a solution is simply not foreclosing.  What is even worse, these banking crooks are now offering fire sale deals to other banks and hedge fund investors!  I’ve contacted a few banks about short sales and in many cases, preference is being given to “all cash” investors.  Glad those bailouts are supporting the crony banking system.

One of the most troubling trends is the belief that all is well because banks aren’t foreclosing on homes or the fact that there is no second wave.  Really?  Let us look at nationwide foreclosure filings shall we?

Who needs a second wave when the first wave is still in place?  Some in the housing industry seem to be patting their back that there won’t be a second wave of foreclosures (even though it is still high) and base this on the mounting distress inventory with Alt-A and option ARMs but no actual foreclosure filing.  The wave is hitting as people stop paying their mortgage.  Take for example option ARMs.  Nearly 50 percent of all outstanding option ARMs are at least 30 days late.  In other words, the borrower isn’t paying the mortgage!  Yet in some form of twisted abracadabra housing logic, this is avoiding the wave because banks are ignoring the problem.  The wave was the distress.  Foreclosures are still on the market.  The bank balance sheet is still loaded with mortgage junk.  But just because banks are putting their hands over their eyes doesn’t mean the issue was avoided.  In fact, it is corrupt to the core and the way they acknowledge this is absolutely stunning.  The fact that we have no solid financial reform after 2 years of major crisis is incredible.  Banks simply ignoring missed payments while taking trillions demonstrates what has become of our financial system and their idea of dealing with the problem.

Take for example HAMP:

“(Huffington Post) As of the end of January there were over 116,000 permanent modifications and over 67,000 permanent modifications pending final approval,” Geithner wrote in his letter, which the panel received last week. “This group of approximately 180,000 permanent and pending permanent modifications represents about a third of the population of total modifications who have completed the trial modification and are at a point in the process where they are able to convert to permanent.”

HAMP has been an absolute failure.  Yet HAMP is symptomatic of the bigger issue.  Banks were able to raid the entire U.S. Treasury and Federal Reserve for $13 trillion in backstops and bailouts, with no questions asked but then start talking about moral hazard when it comes to HAMP:

“Kucinich was pessimistic about the ability of any program that doesn’t involve principal reductions to help floundering homeowners. “Instead, we’re going to stay on this slow path to default, foreclosure and personal bankruptcy,” Kucinich said. “And our economy is going to continue to suffer.”

He added: “It’s funny that moral hazard is a concept when it comes to Main Street but not to Wall Street,” a reference to the massive bank bailouts.

More than 2.8 million homes were lost to foreclosure last year, according to data provider RealtyTrac. The firm expects a record three million foreclosures this year.”

I’ve talked with colleagues who are Republicans and Democrats and both are absolutely appalled by what is going on with Wall Street and the housing industry.  They have transformed our economy into one giant casino and houses are now life sized Monopoly tokens that are traded on the New York Stock Exchange with no regard to local economies.  Moral hazard applies to the masses yet those rules don’t apply to the plutocracy that sits on Wall Street.  While the stock market soars from the March low by a stunning 68%, job creation is nowhere to be found:

Where are the jobs?  Last month they blamed the snow and now next month, we can expect a big boost because of Census hiring.  That is great that we have thousands working at $16 or $17 an hour with no benefits but then what?  Are we going to do the Census every month?  Most Americans realize that things aren’t as rosy as Wall Street is leading on.  And California is certainly not doing any better:

California Doing a Housing Industry on the Budget

“SACRAMENTO, Calif.—Gov. Arnold Schwarzenegger said Tuesday that he vetoed the largest piece of legislation in a package of budget bills because it did not take immediate steps to cut spending.

Democratic lawmakers said the bill would have shaved $2.1 billion from the $20 billion shortfall projected for California’s budget through June 2011. So far, the Legislature and governor have agreed to just $200 million in spending cuts.

“It’s extremely important that we immediately jump into action and make midyear cuts,” Schwarzenegger told reporters on Tuesday. “We’re spending, right now, $600 million a month more than we’re taking in. It’s irresponsible.”

This came out on Tuesday by the way.  We still have a $20 billion shortfall and are spending $600 million a month more than what is being brought in.  So what does that mean?  It means more cuts or higher taxes.  How is this good for housing?  More importantly, how is this good for the state economy?  If we look at the unadjusted unemployment rate California is up to 13.2 percent unemployment (headline).  We are seeing 23 percent underemployment.  This is something none of us have seen in the modern era.  Yet those in the banking and housing industry are claiming mission accomplished just because banks aren’t moving on foreclosures.  This is their ultimate solution.  Because that is all they have.  This suspension of belief is their idea of avoiding the second wave.  Humor them and take this out to the logical conclusion.

Many Californians are underemployed as we have highlighted.  Those that are employed, can expect tighter wages and higher taxes thus cutting into their disposable income.  So how does this create higher home prices?  Even if banks “trickle” out inventory once that inventory hits the market it confronts the economic realities people have to live by.  That is why when we show examples of short sales they are selling at deep cuts.  Home prices have to reflect local area incomes and what people can afford.  Unless we plan on bringing back toxic waste mortgage sludge like Alt-A and option ARMs, people can only buy what their income can support.

If things are so fantastic in the housing market for California, I’m sure builders are out there in mass right?

Not exactly.  Because there is a glut of housing on the market.  And more importantly, that second wave of housing is sitting on the banks balance sheet.  So they won’t be making construction loans when they realize just how much inventory is really out there.  Just look at the above chart.  Building permits and construction jobs are at the trough.  No visible turn around.  And take a look at notice of defaults and foreclosures:

The only reason the foreclosure number has fallen was because of HAMP (which as we now know is a failure meaning more short sales or foreclosures will hit the market soon because many on trial mods will not make it to permanent modification status).  Whether it is a flood or just a steady trickle, this will happen.  And these homes sell for lower prices thus pushing area prices lower.  This is the next round for mid to upper tier markets.  They have bought some time but it is running out.  Eventually there will have to be some realization of local economic factors.

I was curious to see what industries were adding jobs:

Who will be buying the homes in 2010?  More importantly, why would people be overpaying for homes?  The above chart shows no real improvement in the real economy.  In fact, all the banking industry is doing is stalling the inevitable but at the same time sucking the taxpayer dry.  With the $13 trillion in bailouts and backstops we could have had enough to pay off every single residential mortgage in the United States and taken everyone to Disneyland.  Instead, we are financing the crony banking system full throttle robbery of the American people.

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

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The banking system has captured our government and frustration is boiling over.  Yet those in the housing and banking industry seem complacent and even self congratulatory that we “have avoided Great Depression 2.0.”  Really?  Now we’re taking advice from the same group of cronies that led the economy off the financial cliff.  And the most […]

a

The banking system has captured our government and frustration is boiling over.  Yet those in the housing and banking industry seem complacent and even self congratulatory that we “have avoided Great Depression 2.0.”  Really?  Now we’re taking advice from the same group of cronies that led the economy off the financial cliff.  And the most troubling thing is we are at the height of unemployment even though the headline rate seems to have steadied out.  California’s unemployment rate still continues to move upward hitting 12.5 percent.  Yet all is well in delusional banking world since their idea of a solution is simply not foreclosing.  What is even worse, these banking crooks are now offering fire sale deals to other banks and hedge fund investors!  I’ve contacted a few banks about short sales and in many cases, preference is being given to “all cash” investors.  Glad those bailouts are supporting the crony banking system.

One of the most troubling trends is the belief that all is well because banks aren’t foreclosing on homes or the fact that there is no second wave.  Really?  Let us look at nationwide foreclosure filings shall we?

Who needs a second wave when the first wave is still in place?  Some in the housing industry seem to be patting their back that there won’t be a second wave of foreclosures (even though it is still high) and base this on the mounting distress inventory with Alt-A and option ARMs but no actual foreclosure filing.  The wave is hitting as people stop paying their mortgage.  Take for example option ARMs.  Nearly 50 percent of all outstanding option ARMs are at least 30 days late.  In other words, the borrower isn’t paying the mortgage!  Yet in some form of twisted abracadabra housing logic, this is avoiding the wave because banks are ignoring the problem.  The wave was the distress.  Foreclosures are still on the market.  The bank balance sheet is still loaded with mortgage junk.  But just because banks are putting their hands over their eyes doesn’t mean the issue was avoided.  In fact, it is corrupt to the core and the way they acknowledge this is absolutely stunning.  The fact that we have no solid financial reform after 2 years of major crisis is incredible.  Banks simply ignoring missed payments while taking trillions demonstrates what has become of our financial system and their idea of dealing with the problem.

Take for example HAMP:

“(Huffington Post) As of the end of January there were over 116,000 permanent modifications and over 67,000 permanent modifications pending final approval,” Geithner wrote in his letter, which the panel received last week. “This group of approximately 180,000 permanent and pending permanent modifications represents about a third of the population of total modifications who have completed the trial modification and are at a point in the process where they are able to convert to permanent.”

HAMP has been an absolute failure.  Yet HAMP is symptomatic of the bigger issue.  Banks were able to raid the entire U.S. Treasury and Federal Reserve for $13 trillion in backstops and bailouts, with no questions asked but then start talking about moral hazard when it comes to HAMP:

“Kucinich was pessimistic about the ability of any program that doesn’t involve principal reductions to help floundering homeowners. “Instead, we’re going to stay on this slow path to default, foreclosure and personal bankruptcy,” Kucinich said. “And our economy is going to continue to suffer.”

He added: “It’s funny that moral hazard is a concept when it comes to Main Street but not to Wall Street,” a reference to the massive bank bailouts.

More than 2.8 million homes were lost to foreclosure last year, according to data provider RealtyTrac. The firm expects a record three million foreclosures this year.”

I’ve talked with colleagues who are Republicans and Democrats and both are absolutely appalled by what is going on with Wall Street and the housing industry.  They have transformed our economy into one giant casino and houses are now life sized Monopoly tokens that are traded on the New York Stock Exchange with no regard to local economies.  Moral hazard applies to the masses yet those rules don’t apply to the plutocracy that sits on Wall Street.  While the stock market soars from the March low by a stunning 68%, job creation is nowhere to be found:

Where are the jobs?  Last month they blamed the snow and now next month, we can expect a big boost because of Census hiring.  That is great that we have thousands working at $16 or $17 an hour with no benefits but then what?  Are we going to do the Census every month?  Most Americans realize that things aren’t as rosy as Wall Street is leading on.  And California is certainly not doing any better:

California Doing a Housing Industry on the Budget

“SACRAMENTO, Calif.—Gov. Arnold Schwarzenegger said Tuesday that he vetoed the largest piece of legislation in a package of budget bills because it did not take immediate steps to cut spending.

Democratic lawmakers said the bill would have shaved $2.1 billion from the $20 billion shortfall projected for California’s budget through June 2011. So far, the Legislature and governor have agreed to just $200 million in spending cuts.

“It’s extremely important that we immediately jump into action and make midyear cuts,” Schwarzenegger told reporters on Tuesday. “We’re spending, right now, $600 million a month more than we’re taking in. It’s irresponsible.”

This came out on Tuesday by the way.  We still have a $20 billion shortfall and are spending $600 million a month more than what is being brought in.  So what does that mean?  It means more cuts or higher taxes.  How is this good for housing?  More importantly, how is this good for the state economy?  If we look at the unadjusted unemployment rate California is up to 13.2 percent unemployment (headline).  We are seeing 23 percent underemployment.  This is something none of us have seen in the modern era.  Yet those in the banking and housing industry are claiming mission accomplished just because banks aren’t moving on foreclosures.  This is their ultimate solution.  Because that is all they have.  This suspension of belief is their idea of avoiding the second wave.  Humor them and take this out to the logical conclusion.

Many Californians are underemployed as we have highlighted.  Those that are employed, can expect tighter wages and higher taxes thus cutting into their disposable income.  So how does this create higher home prices?  Even if banks “trickle” out inventory once that inventory hits the market it confronts the economic realities people have to live by.  That is why when we show examples of short sales they are selling at deep cuts.  Home prices have to reflect local area incomes and what people can afford.  Unless we plan on bringing back toxic waste mortgage sludge like Alt-A and option ARMs, people can only buy what their income can support.

If things are so fantastic in the housing market for California, I’m sure builders are out there in mass right?

Not exactly.  Because there is a glut of housing on the market.  And more importantly, that second wave of housing is sitting on the banks balance sheet.  So they won’t be making construction loans when they realize just how much inventory is really out there.  Just look at the above chart.  Building permits and construction jobs are at the trough.  No visible turn around.  And take a look at notice of defaults and foreclosures:

The only reason the foreclosure number has fallen was because of HAMP (which as we now know is a failure meaning more short sales or foreclosures will hit the market soon because many on trial mods will not make it to permanent modification status).  Whether it is a flood or just a steady trickle, this will happen.  And these homes sell for lower prices thus pushing area prices lower.  This is the next round for mid to upper tier markets.  They have bought some time but it is running out.  Eventually there will have to be some realization of local economic factors.

I was curious to see what industries were adding jobs:

Who will be buying the homes in 2010?  More importantly, why would people be overpaying for homes?  The above chart shows no real improvement in the real economy.  In fact, all the banking industry is doing is stalling the inevitable but at the same time sucking the taxpayer dry.  With the $13 trillion in bailouts and backstops we could have had enough to pay off every single residential mortgage in the United States and taken everyone to Disneyland.  Instead, we are financing the crony banking system full throttle robbery of the American people.

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

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People are realizing the problems in the housing market are simply a bigger reflection of the lingering issues in the overall economy.  There have now been a few stories comparing California with the issues being experienced in troubled Greece.  JP Morgan Chase CEO Jamie Dimon echoed his concerns regarding California.  The markets seem to underestimate […]

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People are realizing the problems in the housing market are simply a bigger reflection of the lingering issues in the overall economy.  There have now been a few stories comparing California with the issues being experienced in troubled Greece.  JP Morgan Chase CEO Jamie Dimon echoed his concerns regarding California.  The markets seem to underestimate how profound the issues are in the California economy.  What is more troubling is California is merely a reflection of other states.  The Legislative Analyst Office projects deficits deep into 2014 and each year we experience a deficit will require higher taxes or deeper cuts.  That is why focusing on jobs is such an important barometer for the improvement of the overall economy.  Without one net added job in California people are already counting the next housing boom.  The numbers simply do not reflect this assumption.

I want to examine some of the nuts and bolts of the market because this is where the real story is.  We know that millions of foreclosures have flooded the market.  We can understand how toxic option ARMs have become to the market even years after they were originated.  But what does this mean going forward?  First, let us examine the median sale price and monthly sales of Southern California over the decade:

Source:  DataQuick

This is a fascinating look at the market.  Even during the boom we clearly see the seasonal pattern in sales.  Each fall and winter sales drop as more people take inventory off the market.  Spring and summer overall are bigger sale months because of school schedules, family commitments, and just a general acceptance that this is when more inventory enters the market.  But you’ll notice in 2006 that the trend radically shifted.  The crash hit and sales plummeted.  An interesting phenomenon occurred where the median sale price didn’t peak until the middle of 2007 well into the monthly sale crash.  So it would appear that sales would actually lead future prices.  So the jump in sales would indicate much higher prices going forward right?  Not necessarily.  Even with the jump in sales, we are nowhere close to the average sales per month over the decade.  I ran the monthly sales number for the past decade and the average monthly sale number for Southern California is:

24,604 Sales

This includes fall, winter, spring, and summer.  In January we had 15,361 sales and the last time we had 24,604 sales or higher was back in August of 2006.  Prices have come down but the bulk of the drag to the lower side has been in lower priced home sales.  Much of this has been driven by foreclosure re-sales.  But another important factor to look at is how much are families committing to their monthly mortgage payment?  With Alt-A and option ARM products families were able to stretch their budget.  Since the bulk of loans are now backed by the government lenders are now at the very least verifying income.  Let us look at the monthly mortgage payment over this time:

Source:  DataQuick

The above tells you a lot.  While the median home price in Southern California is down by 46 percent from the peak the typical monthly mortgage payment is down 52 percent from the peak.  People are committing to half the monthly payment amount and this has more to do with the health of the economy.  I know many would love to have a $1,170 monthly mortgage for a place in Southern California.  This is already happening in many areas but not in higher priced regions like Culver City or other parts of the Westside.

It helps to look at a handful of examples to highlight what is really happening.  Let us look at pre-bubble prices in areas that have corrected versus areas that still seem elevated:

Source:  DataQuick

Now this data tells us a lot because over the past decade incomes went stagnant.  The overall inflation rate for California was 25.6 percent:

So if wages don’t explain this rise in prices and inflation isn’t the reason, can it be that some areas are still in mini bubbles?  This is very likely.  And this doesn’t apply to the entire state of California.  Some areas have corrected fiercely and prices seem to be more in line with inflation and wage increases:

You’ll also notice the difference in overall sale numbers.  What on the surface may seem like an enormous crash actually looks like a correction to the inflation adjusted mean.  I find it fascinating to see many communities heading back to the 25 to 30 percent inflation rate of California and are somehow finding a bottom in this range.  But many areas are still over priced and this will need to adjust either with higher incomes coming from better job growth or further price corrections.  Part of what is forgotten when examining the shadow inventory is the fact that these are properties in heavy distress.  The L.A. Times ran a piece confirming what we have been talking about for over a year:

“(LA Times) It’s been 16 months since Eugene and Patricia Harrison last paid the mortgage on their Perris home. Eleven months since the notice got slapped on their front door, warning that it would be sold at auction.

A terse letter from a lawyer came eight months ago, telling them that their lender now owned the house. Three months later, the bank told them to pay up or get out by the end of the week.

Throughout the country, people continue to default on their home loans — but lenders have backed off on forced evictions, allowing many to remain in their homes, essentially rent-free.

Several factors are driving the trend, industry experts say, including government pressure on banks to modify loans and keep people in their homes.”

Now this wouldn’t be such a big deal if it were a handful of mortgages.  But just look at this mind blowing chart:

Source:  LA Times

Mortgages that are 90 days late and a foreclosure hasn’t been filed are up to a record shattering 5.1 percent.  Now think about that.  How is this a sign that things are good?  So we’ve reached a point where simply staying put in your home, rent-free is a strategy being used by banks to deal with the foreclosure crisis.  The big losers are the prudent in this country.  How many Americans are paying their mortgages diligently, probably needing to take a second job if there is one to be had, just to make sure they pay their bills?  Wall Street has the luxury of making disastrous mistakes and yet they are bailed out to the tune of trillions of dollars and offer billion dollar bonuses.  Those that over extended are then put in a lottery essentially where some can stay rent free for one and even two years before an eviction depending on when banks get to it.  Others are kicked out quickly.  Some are put into HAMP.  The big issue?  No clear uniformity to what is going on.  What is wrong with renting?  Half of those living in giant Los Angeles County rent.  There is this stigma attached to renting a home and massive subsidies for homeownership.  This carefully orchestrated play is now being held up even though tens of thousands now are living rent free in over leveraged homes.  Housing seemed to work well when it was a boring, track inflation play that if you were lucky after 30 years, you had a place over your head and no mortgage.  Since when did it become a rule that every 5 to 7 years you had to “trade up” a “starter home” just so you can progress forward?  This twisted logic seemed to make sense because how else were most families going to save $100,000 to $200,000 just for a down payment on a 1,000 square foot home in a decent area?  Of course that broken trend is now unraveling.

So putting this altogether, why would anyone want to buy in this current climate?  Transparency is really not to be found.  What real reform have we gotten after these two agonizing years?  Is this reason in itself to buy?  The headline data seems to tell us things have stalled but if we look at a deeper analysis, foreclosure filings, those 90 days late and with no foreclosure pending, bankruptcies, and other in the trenches data we realize that the market really isn’t healthy.  We have yet to add one net job since the recession started.  How are home prices going to go up?  So let us assume the next big play is to simply turn ourselves into Japan and go for our second lost decade by putting banks into a permanent zombie position and ignoring problems.  Pretending someone in a home that isn’t paying their mortgage is somehow good is probably a clear example of turning our housing market into a zombie market.  Yet how is this good for prices?  The same arguments were made in Japan and prices went nowhere for over 20 years!

It is interesting that the flurry of buyers jumping into the market have tapered off in the last few months.  There was a period of two months where the tax credit and uptick in sales seemed to move a large number of people off the fence.  There was a good amount of e-mail during this time.  This has now waned significantly.  But guess what?  Prices are still near the trough.  Why?  Because incomes are stagnant.  Maximum leverage mortgages are gone.  Unless you plan on staying put for 30 years and can cover your mortgage comfortably, that future buyer is only going to be able to afford what their household income can stretch with a government backed loan.  And looking at that typical monthly mortgage payment for Southern California it isn’t jumping up quickly.  In other words, know the metrics of where you’re buying before jumping in.

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California has gone through many boom and bust cycles.  Since it became the 31st state in 1850 California has been home to many speculative manias.  An enormous population boom in the 1800s was brought on by the California gold rush.  Booms like this led to the rise of cities like San Francisco.  Los Angeles in […]

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California has gone through many boom and bust cycles.  Since it became the 31^st state in 1850 California has been home to many speculative manias.  An enormous population boom in the 1800s was brought on by the California gold rush.  Booms like this led to the rise of cities like San Francisco.  Los Angeles in the early 1900s found its footing as an entertainment hub and this led to massive expansion.  Since that time we have seen countless real estate booms and busts.  The current housing boom and bust cycle is the largest and most widespread in the state’s 160 year history.  As we look at historical data there is no lack of hyperbole when it comes to selling California real estate.  It would seem that every year is a good year to buy.  Of course as many are now finding out, timing is usually a bigger factor in determining housing success than investment savvy.

We first should look at the history of housing from a historical perspective because many old paradigms of housing have fallen.  Let us first look at nationwide data from 1910 and 1920:

Source:  Census Archives

I decided to dig up some old Census data to show how dramatically housing has shifted over the years.  Many in the housing industry assume that real estate has always been the way it currently is but forgetting about history can lead many into challenging situations.  In 1910 and 1920 the majority of Americans rented their home.  Of the 20 million dwellings in 1920 only 4 million were mortgaged.  Today, the majority of American households own a home.  The homeownership rate has fallen since the crisis started.  California is not immune to this trend:

The nationwide homeownership rate stands at 67.3 percent down from the peak of 69.4 percent back in 2004.  In less than a century the housing market completely transformed.  We went from a country dominated by renters to one dominated by homeowners:

So how did we go from a large number of renters to a majority of homeowners?  Much of the jump came because of government financing in the housing market:

Source:  Hoover Institution

In the middle of the Great Depression the National Housing Act of 1934 was passed to bring on more affordable mortgages and also created the Federal Housing Administration (FHA) and the Federal Savings and Loans Corporation.  The central reason for this was to stem the issues deep in the foreclosure crisis of that time.  The FHA and the FSLIC created the network to allow steadier access to mortgages in the market.  Some factors that came about from this was the push for suburban sprawl and also less focus on improving inner city housing.

There have always been promoters of real estate.  Even in the depths of the recession people were championing real estate in California:

I found this piece from a 1933 California newspaper.  The cries of available supply, lower taxes, and benefits to the real estate industry were already loud and clear back in the 1930s.  You would think that the Great Depression would at least dampen the spirits of housing promoters but that didn’t seem to stop many.  If a Great Depression didn’t stop the promotion maybe a World War?  Not even that could stop the hype:

The above comes from a 1942 newspaper spot.  One thing is certain when it comes to California real estate.  There is always a boom going on, it just depends who you ask.  Timing is such an important factor in purchasing real estate.  Many who bought in California from 2004 to 2007 took the brunt of this current housing bust.  But the usage of highly toxic mortgages has created a long lasting legacy of problems that we are still working through.  The problems are still embedded in the market and many mortgages sit in a financial state of suspension.  This will continue at least throughout 2010.

Let us look at California housing prices going back to 1940:

Source:  Census

Home prices have gone up steadily since the 1940s.  Some decades saw much higher price growth.  The biggest jump came between 1970 and 1980 when home prices went from $23,100 to $84,500 increasing by a factor of 3.65.  This decade has seen the slowest growth since the 1940s.  In 2000 the median California home price came in at $211,500 and today the median home price is $247,000 (an increase of 16 percent while the state’s inflation rate is closer to 30 percent over this timeframe).  So California real estate has now witnessed a lost decade adjusting for inflation.  The likelihood of seeing  a nominal lost decade in prices cannot be ruled out.  Some areas in California like the Inland Empire are already seeing this happen.

Yet what has really happened in California was the transformation of housing into a speculative commodity.  This can be seen by how much income is eaten up by home prices:

It is tempting to look at the above chart and say that home prices are overall cheaper than they were in the 1980s if we factor in the median home price and household incomes.  However home prices are still too expensive and if we look carefully above household incomes never really caught up after the massive inflation of the 1970s.  Access to debt covered up much of this lost purchasing power.  The current median home price in the state is also deceptive because of the massive amount of foreclosure re-sales in the last two years.  Most of these have come from lower priced markets while mid to higher priced areas remain in bubbles.  The above chart highlights the overall sales in lower priced markets and still comes out showing a very expensive market in California.

Much of the rise in home prices this past decade came because of maximum leverage mortgages that didn’t even take into account incomes that were falling further and further behind.  Many of these mortgages didn’t even look at income.  The above chart pulls points at each decade so we miss the 2007 peak in home prices.  If we include that point the chart would look like this:

When you look at the peak price data, it shows how historical this bubble was.  In places like Los Angeles and the Bay Area many homes that are still selling for peak prices were built back during the last home building craze in the prime counties.  Take a look at this 1942 ad:

Much of this massive construction took place decades ago in some of California’s biggest and oldest cities:

Massive population centers are nothing new for the state.  And a growing population will increase housing demand but not how most think:

Source:  Legislative Analyst Office

California is still lacking in affordable housing.  The days of cheap fuel will make it harder for other Inland Empires to sprout up from the ashes.  People forget that California has an enormous amount of land that is similar to Arizona and Nevada.  The Central Valley has plenty of room.  Why don’t they build this out?  For one, access to employment but also the cost of energy to keep these new cities up simply does not make economic sense.  It is unlikely that we will see $1 gas again so fuel is going to impact the suburban sprawl dream that started back in the 1930s.  New housing has to be smarter and more compact near city hubs.  Look at places like Tokyo for example.  We always hear the real estate building crowd that we need more friendly permits but then they go out and build sprawl just like they did back nearly 100 years ago.  Is this really good for our longer term prosperity?  Also, it might have reached its natural end.  People can’t afford to commute from these outer regions.

There is no arguing that the population will grow in California over the next decades.  Yet to assume that this will mean another real estate boom is incorrect.  Look at China for example.  They are now contending with mini bubbles in real estate and they have massive population centers throughout the country.  The big issue in the coming decade is going to be smart and affordable housing.  Ironically many of the current government programs are making housing unaffordable by propping up failed banks.  It also keeps the current structure in place since so much money is involved.  Yet that doesn’t mean it is smart policy going forward.

So what will we see in the next decade?  It is very likely that the homeownership rate will dwindle lower in California.  As more and more people are classified as “part-time” workers with no employment security, a large part of our population will need the mobility of renting or simply won’t have the income to purchase a home.  When people purchase a home, it requires a level of security in their employment.  If a large part of the population doesn’t have that, many will opt to rent, some by choice but many others because of economic reasons.  City hubs will probably see bigger growth as people move closer to employment opportunities.  This isn’t the 1920s when 1 out of 4 people were farmers.  It will definitely be an interesting decade when it comes to California housing.

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Housing prices in most urban areas will face pressure in the upcoming years because of a variety of factors.  Last month as prices fell in many areas including Southern California, some were surprised because a belief that a trough had been hit had already set in.  This is not the case.  For the most part […]

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Housing prices in most urban areas will face pressure in the upcoming years because of a variety of factors.  Last month as prices fell in many areas including Southern California, some were surprised because a belief that a trough had been hit had already set in.  This is not the case.  For the most part the bulk of home sales are still coming from the distress side.  These homes do not yield the bank the full balance of the mortgage and consequently push overall prices lower.  In many troubled states like California, Florida, Nevada, and Arizona many of these homes are secured by questionable mortgages so the gap between the current mortgage and the market price is rather large.

We also have issues on the supply side.  During the peak days of the bubble housing starts were running at a stunningly high rate of 2 million per year.  This at a time when household formation was closer to 1.2 million.  So this enormous imbalance occurred.  The current stall in housing starts is simply allowing the overall market to catch up.  That is one of the big questions regarding when housing will recover.  When will housing starts pick up?  Today we are going to look at 5 major trends that will keep housing prices low for the next few years.

Reason #1 – Household Formation

Source:  The Urban Land Institute

The Urban Land Institute put out an interesting paper in January examining the future of housing.  One of the main trends they found revolves around younger generations living in urban centers.  In fact, on their survey they found that many would accept a smaller living space in order to be closer to work, friends, and entertainment venues.  Another important factor they highlight is those from 25 to 34, a peak household formation range, have seen wages fall in real terms by 12 percent for men and 3 percent for women.  What this translates for housing is less money for housing.

Another big problem keeping households from forming in the current market is the high unemployment rate.  Many of these people are doubling up, moving back home, or simply taking on cheaper rental housing.  Once the employment market picks up we can see a pent up demand for housing slowly pick up but that is why we keep discussing that without solid employment growth, there is little reason to believe home prices will suddenly move up.

The unemployment rate for those from 20 to 24 is 15.8 percent and for those 25 to 34 it is 9.9 percent.  Both of these rates are higher than the current headline rate of 9.7 percent.  Until job prospects improve, the demand for more expensive housing will remain muted.

Reason #2 – Overbuilding and Housing Starts

The above chart shows the massive overbuilding that occurred during the housing bubble.  With housing formation steady the rate is closer to 1.2 million but we were building closer to 2 million.  Now, this has translated into a massive glut of housing.  So the housing start rate plummeted in 2007 as we worked our way through too much demand.  In addition, we added a large number of new homebuyers that were never qualified to own a home to begin with.  This is the group that took out subprime or option ARM loans on homes that clearly were unsupported by their incomes.  As we now know, most of these loans are now gone so now millions that once were “qualified” to buy are out of that buyer pool.  So demand is also falling because people don’t qualify with tighter loan standards.

If we look at the housing start side of the equation, builders clearly realize that the demand side is still weak for new construction:

Although housing starts are up from their depressed levels, they are nowhere near a healthy market level.  We still have inventory that we need to work through before builders start growing at a pace of even 1 million.

Reason #3 – Single Family Home Sales

If you examine the above chart carefully, you’ll notice that up until 2007 both existing and new home sales tracked very closely.  For example, close to 5 million existing homes were selling on a seasonally adjusted rate while roughly 1 million newly built homes were selling from 1999 to 2002.  Then even in the over building days both of these tracked together.  The disconnection has started in 2009 where existing home sales have perked up while newly built home sales are still near the bottom.  Why?  The reason has to do with the amount of distress sales.  The big driving factor in home sales is home price.  In a price conscious market people are gravitating to foreclosure re-sales and short sales where prices are lower to meet with the new economics of households.

Newer homes that carry a bigger price tag have seen demand simply disappear.  In areas even like California, areas that have lower home prices like the Inland Empire have seen sales pick up briskly but prices remain low.  Those areas that still have higher prices have seen sales completely stall.

Reason #4 – Home Prices

Source:  Calculated Risk

If you look at the above chart, the top eight areas with depressed home prices are California, Nevada, Florida, and Arizona.  The one exception is Detroit but this area has seen low prices trending even before this current housing collapse.  One recent stat shows that 70 percent of mortgage holders in Nevada are underwater.  In California that number is 35 percent.  So with these kinds of market indicators it is very likely that in these states prices will continue to trend lower.  Throw in the high unemployment rate in these regions and you can understand why it is so important to get jobs growing in this country again.

Ultimately prices have to reach a level where local households can afford the mortgage.  This crisis has gone on long enough where younger households, hit by a double whammy of low wages and higher home prices have seen older generations now lose their home or struggle simply to pay on a mortgage so big that nearly all disposable income is eaten by the mortgage.  The idea that real estate is “always a good investment” is now gone for a generation.  That is why in recent surveys many are looking to live in city urban centers as opposed to suburban tract homes.  This is another reason why home prices will remain low for a good portion of time.  I just don’t see a massive flood of the household formation generation heading out and purchasing homes in suburbs like baby boomers did.  They will buy but nowhere close to what baby boomers did.

Reason #5 – Homeownership Rates

Buying a home is an opportunity that should be given to those that have demonstrated some ability to save and pay their mortgage.  That is why down payments were so important.  A 10 percent down payment at least demonstrates that you can save for a few months or years for a big purchase.  This is how it was for generations.  But with no money down loans and easy financing those who should have never bought were allowed to buy to feed the Wall Street beast hungry for any mortgages to securitize.  Now, the only game in town is government backed loans.  And as we saw on Friday, Fannie Mae lost in 2009 over $70 billion.  I just keep recalling the day when we were told that these GSEs were going to turn a profit.  Yeah right.

But we have bigger issues.  The FHA with FHA insured loans is allowing people to buy homes with only 3.5 percent down.  It actually is lower because people can use the tax credit in combination and make this close to a nothing down purchase.  Is it any surprise that FHA default rates are now at historic levels?  Homeownership is not a right but a privilege we have.  This is no different from buying a luxury car.  I’m sure many of us would trade in our current vehicles for a Ferrari if we could but that isn’t how the market works.  But when you allow everyone access to mortgage debt they cannot support it shouldn’t be a surprise that people took on too much debt.  The above chart shows that consumption part of the equation.

But now the homeownership rate is falling as millions lose their homes to foreclosure.  Many more will lose their homes as toxic mortgages do what toxic mortgages do.  The trend for the homeownership rate will be lower for years.  Also, the weak economy is going to keep pressure on housing prices since people do pay for their home payment out of income they get from their jobs.

When we step back, the market is already telling us many things.  Lower home prices will get more Americans to buy homes so having Wall Street and the government trying to prop up prices is a bad thing.  In markets where demand is high prices will remain high because of supply and demand forces.  Why the need for government backed easy money mortgages?  Why the need for all these support programs that only prolong the misery?  There is absolutely nothing wrong with renting and frankly, it is a shame that many in this country look down upon that.  This is similar to those “keep up with the Joneses” folks that had to keep up with their neighbors jet skis, Hummers, and other items that sunk many families.  Just look on eBay and Craigslist and you’ll see many people selling these items trying to downsize.  Buying a home is the biggest purchase most Americans will take on and should be entered with caution.

There is a delicate balance to all of this and currently the market is still out of balance.  How anyone can see home prices booming in the next few years is hard to understand.

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Housing prices in most urban areas will face pressure in the upcoming years because of a variety of factors.  Last month as prices fell in many areas including Southern California, some were surprised because a belief that a trough had been hit had already set in.  This is not the case.  For the most part […]

a

Housing prices in most urban areas will face pressure in the upcoming years because of a variety of factors.  Last month as prices fell in many areas including Southern California, some were surprised because a belief that a trough had been hit had already set in.  This is not the case.  For the most part the bulk of home sales are still coming from the distress side.  These homes do not yield the bank the full balance of the mortgage and consequently push overall prices lower.  In many troubled states like California, Florida, Nevada, and Arizona many of these homes are secured by questionable mortgages so the gap between the current mortgage and the market price is rather large.

We also have issues on the supply side.  During the peak days of the bubble housing starts were running at a stunningly high rate of 2 million per year.  This at a time when household formation was closer to 1.2 million.  So this enormous imbalance occurred.  The current stall in housing starts is simply allowing the overall market to catch up.  That is one of the big questions regarding when housing will recover.  When will housing starts pick up?  Today we are going to look at 5 major trends that will keep housing prices low for the next few years.

Reason #1 – Household Formation

Source:  The Urban Land Institute

The Urban Land Institute put out an interesting paper in January examining the future of housing.  One of the main trends they found revolves around younger generations living in urban centers.  In fact, on their survey they found that many would accept a smaller living space in order to be closer to work, friends, and entertainment venues.  Another important factor they highlight is those from 25 to 34, a peak household formation range, have seen wages fall in real terms by 12 percent for men and 3 percent for women.  What this translates for housing is less money for housing.

Another big problem keeping households from forming in the current market is the high unemployment rate.  Many of these people are doubling up, moving back home, or simply taking on cheaper rental housing.  Once the employment market picks up we can see a pent up demand for housing slowly pick up but that is why we keep discussing that without solid employment growth, there is little reason to believe home prices will suddenly move up.

The unemployment rate for those from 20 to 24 is 15.8 percent and for those 25 to 34 it is 9.9 percent.  Both of these rates are higher than the current headline rate of 9.7 percent.  Until job prospects improve, the demand for more expensive housing will remain muted.

Reason #2 – Overbuilding and Housing Starts

The above chart shows the massive overbuilding that occurred during the housing bubble.  With housing formation steady the rate is closer to 1.2 million but we were building closer to 2 million.  Now, this has translated into a massive glut of housing.  So the housing start rate plummeted in 2007 as we worked our way through too much demand.  In addition, we added a large number of new homebuyers that were never qualified to own a home to begin with.  This is the group that took out subprime or option ARM loans on homes that clearly were unsupported by their incomes.  As we now know, most of these loans are now gone so now millions that once were “qualified” to buy are out of that buyer pool.  So demand is also falling because people don’t qualify with tighter loan standards.

If we look at the housing start side of the equation, builders clearly realize that the demand side is still weak for new construction:

Although housing starts are up from their depressed levels, they are nowhere near a healthy market level.  We still have inventory that we need to work through before builders start growing at a pace of even 1 million.

Reason #3 – Single Family Home Sales

If you examine the above chart carefully, you’ll notice that up until 2007 both existing and new home sales tracked very closely.  For example, close to 5 million existing homes were selling on a seasonally adjusted rate while roughly 1 million newly built homes were selling from 1999 to 2002.  Then even in the over building days both of these tracked together.  The disconnection has started in 2009 where existing home sales have perked up while newly built home sales are still near the bottom.  Why?  The reason has to do with the amount of distress sales.  The big driving factor in home sales is home price.  In a price conscious market people are gravitating to foreclosure re-sales and short sales where prices are lower to meet with the new economics of households.

Newer homes that carry a bigger price tag have seen demand simply disappear.  In areas even like California, areas that have lower home prices like the Inland Empire have seen sales pick up briskly but prices remain low.  Those areas that still have higher prices have seen sales completely stall.

Reason #4 – Home Prices

Source:  Calculated Risk

If you look at the above chart, the top eight areas with depressed home prices are California, Nevada, Florida, and Arizona.  The one exception is Detroit but this area has seen low prices trending even before this current housing collapse.  One recent stat shows that 70 percent of mortgage holders in Nevada are underwater.  In California that number is 35 percent.  So with these kinds of market indicators it is very likely that in these states prices will continue to trend lower.  Throw in the high unemployment rate in these regions and you can understand why it is so important to get jobs growing in this country again.

Ultimately prices have to reach a level where local households can afford the mortgage.  This crisis has gone on long enough where younger households, hit by a double whammy of low wages and higher home prices have seen older generations now lose their home or struggle simply to pay on a mortgage so big that nearly all disposable income is eaten by the mortgage.  The idea that real estate is “always a good investment” is now gone for a generation.  That is why in recent surveys many are looking to live in city urban centers as opposed to suburban tract homes.  This is another reason why home prices will remain low for a good portion of time.  I just don’t see a massive flood of the household formation generation heading out and purchasing homes in suburbs like baby boomers did.  They will buy but nowhere close to what baby boomers did.

Reason #5 – Homeownership Rates

Buying a home is an opportunity that should be given to those that have demonstrated some ability to save and pay their mortgage.  That is why down payments were so important.  A 10 percent down payment at least demonstrates that you can save for a few months or years for a big purchase.  This is how it was for generations.  But with no money down loans and easy financing those who should have never bought were allowed to buy to feed the Wall Street beast hungry for any mortgages to securitize.  Now, the only game in town is government backed loans.  And as we saw on Friday, Fannie Mae lost in 2009 over $70 billion.  I just keep recalling the day when we were told that these GSEs were going to turn a profit.  Yeah right.

But we have bigger issues.  The FHA with FHA insured loans is allowing people to buy homes with only 3.5 percent down.  It actually is lower because people can use the tax credit in combination and make this close to a nothing down purchase.  Is it any surprise that FHA default rates are now at historic levels?  Homeownership is not a right but a privilege we have.  This is no different from buying a luxury car.  I’m sure many of us would trade in our current vehicles for a Ferrari if we could but that isn’t how the market works.  But when you allow everyone access to mortgage debt they cannot support it shouldn’t be a surprise that people took on too much debt.  The above chart shows that consumption part of the equation.

But now the homeownership rate is falling as millions lose their homes to foreclosure.  Many more will lose their homes as toxic mortgages do what toxic mortgages do.  The trend for the homeownership rate will be lower for years.  Also, the weak economy is going to keep pressure on housing prices since people do pay for their home payment out of income they get from their jobs.

When we step back, the market is already telling us many things.  Lower home prices will get more Americans to buy homes so having Wall Street and the government trying to prop up prices is a bad thing.  In markets where demand is high prices will remain high because of supply and demand forces.  Why the need for government backed easy money mortgages?  Why the need for all these support programs that only prolong the misery?  There is absolutely nothing wrong with renting and frankly, it is a shame that many in this country look down upon that.  This is similar to those “keep up with the Joneses” folks that had to keep up with their neighbors jet skis, Hummers, and other items that sunk many families.  Just look on eBay and Craigslist and you’ll see many people selling these items trying to downsize.  Buying a home is the biggest purchase most Americans will take on and should be entered with caution.

There is a delicate balance to all of this and currently the market is still out of balance.  How anyone can see home prices booming in the next few years is hard to understand.

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The banking system has captured our government and frustration is boiling over.  Yet those in the housing and banking industry seem complacent and even self congratulatory that we “have avoided Great Depression 2.0.”  Really?  Now we’re taking advice from the same group of cronies that led the economy off the financial cliff.  And the most […]

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The banking system has captured our government and frustration is boiling over.  Yet those in the housing and banking industry seem complacent and even self congratulatory that we “have avoided Great Depression 2.0.”  Really?  Now we’re taking advice from the same group of cronies that led the economy off the financial cliff.  And the most troubling thing is we are at the height of unemployment even though the headline rate seems to have steadied out.  California’s unemployment rate still continues to move upward hitting 12.5 percent.  Yet all is well in delusional banking world since their idea of a solution is simply not foreclosing.  What is even worse, these banking crooks are now offering fire sale deals to other banks and hedge fund investors!  I’ve contacted a few banks about short sales and in many cases, preference is being given to “all cash” investors.  Glad those bailouts are supporting the crony banking system.

One of the most troubling trends is the belief that all is well because banks aren’t foreclosing on homes or the fact that there is no second wave.  Really?  Let us look at nationwide foreclosure filings shall we?

Who needs a second wave when the first wave is still in place?  Some in the housing industry seem to be patting their back that there won’t be a second wave of foreclosures (even though it is still high) and base this on the mounting distress inventory with Alt-A and option ARMs but no actual foreclosure filing.  The wave is hitting as people stop paying their mortgage.  Take for example option ARMs.  Nearly 50 percent of all outstanding option ARMs are at least 30 days late.  In other words, the borrower isn’t paying the mortgage!  Yet in some form of twisted abracadabra housing logic, this is avoiding the wave because banks are ignoring the problem.  The wave was the distress.  Foreclosures are still on the market.  The bank balance sheet is still loaded with mortgage junk.  But just because banks are putting their hands over their eyes doesn’t mean the issue was avoided.  In fact, it is corrupt to the core and the way they acknowledge this is absolutely stunning.  The fact that we have no solid financial reform after 2 years of major crisis is incredible.  Banks simply ignoring missed payments while taking trillions demonstrates what has become of our financial system and their idea of dealing with the problem.

Take for example HAMP:

“(Huffington Post) As of the end of January there were over 116,000 permanent modifications and over 67,000 permanent modifications pending final approval,” Geithner wrote in his letter, which the panel received last week. “This group of approximately 180,000 permanent and pending permanent modifications represents about a third of the population of total modifications who have completed the trial modification and are at a point in the process where they are able to convert to permanent.”

HAMP has been an absolute failure.  Yet HAMP is symptomatic of the bigger issue.  Banks were able to raid the entire U.S. Treasury and Federal Reserve for $13 trillion in backstops and bailouts, with no questions asked but then start talking about moral hazard when it comes to HAMP:

“Kucinich was pessimistic about the ability of any program that doesn’t involve principal reductions to help floundering homeowners. “Instead, we’re going to stay on this slow path to default, foreclosure and personal bankruptcy,” Kucinich said. “And our economy is going to continue to suffer.”

He added: “It’s funny that moral hazard is a concept when it comes to Main Street but not to Wall Street,” a reference to the massive bank bailouts.

More than 2.8 million homes were lost to foreclosure last year, according to data provider RealtyTrac. The firm expects a record three million foreclosures this year.”

I’ve talked with colleagues who are Republicans and Democrats and both are absolutely appalled by what is going on with Wall Street and the housing industry.  They have transformed our economy into one giant casino and houses are now life sized Monopoly tokens that are traded on the New York Stock Exchange with no regard to local economies.  Moral hazard applies to the masses yet those rules don’t apply to the plutocracy that sits on Wall Street.  While the stock market soars from the March low by a stunning 68%, job creation is nowhere to be found:

Where are the jobs?  Last month they blamed the snow and now next month, we can expect a big boost because of Census hiring.  That is great that we have thousands working at $16 or $17 an hour with no benefits but then what?  Are we going to do the Census every month?  Most Americans realize that things aren’t as rosy as Wall Street is leading on.  And California is certainly not doing any better:

California Doing a Housing Industry on the Budget

“SACRAMENTO, Calif.—Gov. Arnold Schwarzenegger said Tuesday that he vetoed the largest piece of legislation in a package of budget bills because it did not take immediate steps to cut spending.

Democratic lawmakers said the bill would have shaved $2.1 billion from the $20 billion shortfall projected for California’s budget through June 2011. So far, the Legislature and governor have agreed to just $200 million in spending cuts.

“It’s extremely important that we immediately jump into action and make midyear cuts,” Schwarzenegger told reporters on Tuesday. “We’re spending, right now, $600 million a month more than we’re taking in. It’s irresponsible.”

This came out on Tuesday by the way.  We still have a $20 billion shortfall and are spending $600 million a month more than what is being brought in.  So what does that mean?  It means more cuts or higher taxes.  How is this good for housing?  More importantly, how is this good for the state economy?  If we look at the unadjusted unemployment rate California is up to 13.2 percent unemployment (headline).  We are seeing 23 percent underemployment.  This is something none of us have seen in the modern era.  Yet those in the banking and housing industry are claiming mission accomplished just because banks aren’t moving on foreclosures.  This is their ultimate solution.  Because that is all they have.  This suspension of belief is their idea of avoiding the second wave.  Humor them and take this out to the logical conclusion.

Many Californians are underemployed as we have highlighted.  Those that are employed, can expect tighter wages and higher taxes thus cutting into their disposable income.  So how does this create higher home prices?  Even if banks “trickle” out inventory once that inventory hits the market it confronts the economic realities people have to live by.  That is why when we show examples of short sales they are selling at deep cuts.  Home prices have to reflect local area incomes and what people can afford.  Unless we plan on bringing back toxic waste mortgage sludge like Alt-A and option ARMs, people can only buy what their income can support.

If things are so fantastic in the housing market for California, I’m sure builders are out there in mass right?

Not exactly.  Because there is a glut of housing on the market.  And more importantly, that second wave of housing is sitting on the banks balance sheet.  So they won’t be making construction loans when they realize just how much inventory is really out there.  Just look at the above chart.  Building permits and construction jobs are at the trough.  No visible turn around.  And take a look at notice of defaults and foreclosures:

The only reason the foreclosure number has fallen was because of HAMP (which as we now know is a failure meaning more short sales or foreclosures will hit the market soon because many on trial mods will not make it to permanent modification status).  Whether it is a flood or just a steady trickle, this will happen.  And these homes sell for lower prices thus pushing area prices lower.  This is the next round for mid to upper tier markets.  They have bought some time but it is running out.  Eventually there will have to be some realization of local economic factors.

I was curious to see what industries were adding jobs:

Who will be buying the homes in 2010?  More importantly, why would people be overpaying for homes?  The above chart shows no real improvement in the real economy.  In fact, all the banking industry is doing is stalling the inevitable but at the same time sucking the taxpayer dry.  With the $13 trillion in bailouts and backstops we could have had enough to pay off every single residential mortgage in the United States and taken everyone to Disneyland.  Instead, we are financing the crony banking system full throttle robbery of the American people.

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California has gone through many boom and bust cycles.  Since it became the 31st state in 1850 California has been home to many speculative manias.  An enormous population boom in the 1800s was brought on by the California gold rush.  Booms like this led to the rise of cities like San Francisco.  Los Angeles in […]

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California has gone through many boom and bust cycles.  Since it became the 31^st state in 1850 California has been home to many speculative manias.  An enormous population boom in the 1800s was brought on by the California gold rush.  Booms like this led to the rise of cities like San Francisco.  Los Angeles in the early 1900s found its footing as an entertainment hub and this led to massive expansion.  Since that time we have seen countless real estate booms and busts.  The current housing boom and bust cycle is the largest and most widespread in the state’s 160 year history.  As we look at historical data there is no lack of hyperbole when it comes to selling California real estate.  It would seem that every year is a good year to buy.  Of course as many are now finding out, timing is usually a bigger factor in determining housing success than investment savvy.

We first should look at the history of housing from a historical perspective because many old paradigms of housing have fallen.  Let us first look at nationwide data from 1910 and 1920:

Source:  Census Archives

I decided to dig up some old Census data to show how dramatically housing has shifted over the years.  Many in the housing industry assume that real estate has always been the way it currently is but forgetting about history can lead many into challenging situations.  In 1910 and 1920 the majority of Americans rented their home.  Of the 20 million dwellings in 1920 only 4 million were mortgaged.  Today, the majority of American households own a home.  The homeownership rate has fallen since the crisis started.  California is not immune to this trend:

The nationwide homeownership rate stands at 67.3 percent down from the peak of 69.4 percent back in 2004.  In less than a century the housing market completely transformed.  We went from a country dominated by renters to one dominated by homeowners:

So how did we go from a large number of renters to a majority of homeowners?  Much of the jump came because of government financing in the housing market:

Source:  Hoover Institution

In the middle of the Great Depression the National Housing Act of 1934 was passed to bring on more affordable mortgages and also created the Federal Housing Administration (FHA) and the Federal Savings and Loans Corporation.  The central reason for this was to stem the issues deep in the foreclosure crisis of that time.  The FHA and the FSLIC created the network to allow steadier access to mortgages in the market.  Some factors that came about from this was the push for suburban sprawl and also less focus on improving inner city housing.

There have always been promoters of real estate.  Even in the depths of the recession people were championing real estate in California:

I found this piece from a 1933 California newspaper.  The cries of available supply, lower taxes, and benefits to the real estate industry were already loud and clear back in the 1930s.  You would think that the Great Depression would at least dampen the spirits of housing promoters but that didn’t seem to stop many.  If a Great Depression didn’t stop the promotion maybe a World War?  Not even that could stop the hype:

The above comes from a 1942 newspaper spot.  One thing is certain when it comes to California real estate.  There is always a boom going on, it just depends who you ask.  Timing is such an important factor in purchasing real estate.  Many who bought in California from 2004 to 2007 took the brunt of this current housing bust.  But the usage of highly toxic mortgages has created a long lasting legacy of problems that we are still working through.  The problems are still embedded in the market and many mortgages sit in a financial state of suspension.  This will continue at least throughout 2010.

Let us look at California housing prices going back to 1940:

Source:  Census

Home prices have gone up steadily since the 1940s.  Some decades saw much higher price growth.  The biggest jump came between 1970 and 1980 when home prices went from $23,100 to $84,500 increasing by a factor of 3.65.  This decade has seen the slowest growth since the 1940s.  In 2000 the median California home price came in at $211,500 and today the median home price is $247,000 (an increase of 16 percent while the state’s inflation rate is closer to 30 percent over this timeframe).  So California real estate has now witnessed a lost decade adjusting for inflation.  The likelihood of seeing  a nominal lost decade in prices cannot be ruled out.  Some areas in California like the Inland Empire are already seeing this happen.

Yet what has really happened in California was the transformation of housing into a speculative commodity.  This can be seen by how much income is eaten up by home prices:

It is tempting to look at the above chart and say that home prices are overall cheaper than they were in the 1980s if we factor in the median home price and household incomes.  However home prices are still too expensive and if we look carefully above household incomes never really caught up after the massive inflation of the 1970s.  Access to debt covered up much of this lost purchasing power.  The current median home price in the state is also deceptive because of the massive amount of foreclosure re-sales in the last two years.  Most of these have come from lower priced markets while mid to higher priced areas remain in bubbles.  The above chart highlights the overall sales in lower priced markets and still comes out showing a very expensive market in California.

Much of the rise in home prices this past decade came because of maximum leverage mortgages that didn’t even take into account incomes that were falling further and further behind.  Many of these mortgages didn’t even look at income.  The above chart pulls points at each decade so we miss the 2007 peak in home prices.  If we include that point the chart would look like this:

When you look at the peak price data, it shows how historical this bubble was.  In places like Los Angeles and the Bay Area many homes that are still selling for peak prices were built back during the last home building craze in the prime counties.  Take a look at this 1942 ad:

Much of this massive construction took place decades ago in some of California’s biggest and oldest cities:

Massive population centers are nothing new for the state.  And a growing population will increase housing demand but not how most think:

Source:  Legislative Analyst Office

California is still lacking in affordable housing.  The days of cheap fuel will make it harder for other Inland Empires to sprout up from the ashes.  People forget that California has an enormous amount of land that is similar to Arizona and Nevada.  The Central Valley has plenty of room.  Why don’t they build this out?  For one, access to employment but also the cost of energy to keep these new cities up simply does not make economic sense.  It is unlikely that we will see $1 gas again so fuel is going to impact the suburban sprawl dream that started back in the 1930s.  New housing has to be smarter and more compact near city hubs.  Look at places like Tokyo for example.  We always hear the real estate building crowd that we need more friendly permits but then they go out and build sprawl just like they did back nearly 100 years ago.  Is this really good for our longer term prosperity?  Also, it might have reached its natural end.  People can’t afford to commute from these outer regions.

There is no arguing that the population will grow in California over the next decades.  Yet to assume that this will mean another real estate boom is incorrect.  Look at China for example.  They are now contending with mini bubbles in real estate and they have massive population centers throughout the country.  The big issue in the coming decade is going to be smart and affordable housing.  Ironically many of the current government programs are making housing unaffordable by propping up failed banks.  It also keeps the current structure in place since so much money is involved.  Yet that doesn’t mean it is smart policy going forward.

So what will we see in the next decade?  It is very likely that the homeownership rate will dwindle lower in California.  As more and more people are classified as “part-time” workers with no employment security, a large part of our population will need the mobility of renting or simply won’t have the income to purchase a home.  When people purchase a home, it requires a level of security in their employment.  If a large part of the population doesn’t have that, many will opt to rent, some by choice but many others because of economic reasons.  City hubs will probably see bigger growth as people move closer to employment opportunities.  This isn’t the 1920s when 1 out of 4 people were farmers.  It will definitely be an interesting decade when it comes to California housing.

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