Quantum Theology

It seems everything in politics is about how you package things. A bit of slight of hand. Keep peoples attention on the colorful and shiny presentation. Pay no attention to the man behind the curtain! <– thanks to the Wizard of Oz!!! I love that saying.

I go to Google to pick out news facts, and then to blogs to find out the REAL story. Journalists have too much work to do and too little expertise to really do their jobs. Don’t go to the main stream media for real information. There is an outstanding financial blog that goes by the name of Calculated Risk. There are two contributors, Calculated Risk and Tanta, and they really know their stuff. I ran across an exchange between Mish and CR. The recent topic has been the federal response to the mortgage crisis. This response has been called the Hope Now plan.

Mish, those eligible have to have a LTV higher than 97%.

Many of these people have negative equity. They can’t refi - they can’t sell - and when their loan resets, they probably can’t make the payment. They are stuck, and foreclosure is the only way out.

This is a plan for investors!

The idea is to get people to keep making mortgage payments on a loan that is worth more than the collateral. A neat trick! If these “homeowners” really crunched the numbers, they would realize it’s better to walk away, and rent for less money, rather than to keep making the mortgage payment.

The plan is sold as helping homeowners. It is designed to help investors.

There is a lenghty and detailed explanation to be found on the Calculated Risk blog. In summary, this plan was constructed by lenders and investors without the input of home owners. No taxpayer money will be involved. This plan takes advantage of the same people who are known to make poor financial decisions, and attempts to get them to make another poor decision. The lenders profited from peoples poor decision by selling them these loans and pocketing the fees, and now the investors want to maintain their poor investment by attempting to keep them in a home even when the best option would be to foreclose. It’s a very small evil to put your investment interests ahead of some abstract person you have never met, it’s a much larger evil for the government to get involved and to help sell it as being in that persons best interest. People look to the government for aid, and it’s oh so disgusting to leverage that trust to help someone else screw them.

You might think that I have sympathies toward these people in distress. I don’t. Inflated real estate values are a real problem and it was a problem created by lenders who ignored the risks of extending risky loans in exchange for collecting fees, and it was also created by people who purchased homes they could not afford except in the most optimistic of cases. It was a problem that was perpetuated by a few friends of mine who decided to ‘invest’ in real estate. The outcome of this speculative bubble only surprised people with their head up their ass. I say foreclose them all. Stupid decisions need to have consequences or else people will continue to make them. I say let the lenders loose their shirts. Poor investments without losses lead to mal-investment.

P.S. Either something in Wordpress or something in my template is inserting new lines before and after each link … annoying isn’t it?

It seems to me that people tend to assume they are middle class so long as they make some decent amount over minimum wage.

Middle class people need to have a bit of financial independence. Not a whole lot, but a little. Suppose a middle class person looses his job, he won’t go bankrupt for a little while because this person has a reserve of assets. What I am trying to say is that in order to be middle class, you need to have a positive net worth.

Interestingly enough, in San Diego there are people who don’t earn middle class wages who ARE middle class by virtue of asset appreciation. Any Joe Foobar who owned a dump in a crappy neighborhood, got a free ride right up into the ranks of the middle class.

On the other hand, there are people who earn middle class wages, who are NOT middle class due to spending habits and/or getting stuck on the wrong end of the local asset bubble.

I just think it’s funny how many people like to think of themselves as middle class. There should be a new term for the white collar poor. Someone creative needs to think of one.

It’s been quite a while since I wrote on the state of the housing market in the U.S. Well, by now it’s news that the sub-prime lenders are starting to close up shop. The question now is if the problems in the sub-prime market will spread to the Alt-A loans.

I am rooting for a general collapse in real estate values, just to be clear. It hasn’t happened yet and if the problems with the lenders don’t trigger a collapse then I can’t see another event on the horizon that would bring down prices. High real estate values are good for the older generation, but not so good for the younger folk. The older generation had their chance and I don’t give a shit about their retirement plan home equity. The baby boomers are fucking up finances everywhere and I get the feeling that Generation X/Y will be holding the bag.

Housing update, yes. Ahem. I suggest that if the price of housing does NOT drop by say 30 percent or so, pick up your bags and move somewhere else where it’s cheaper - like me. Seriously, housing is going to be a long term looser over the next 30 or so years unless the market corrects itself.

Well, the question should be ‘Whose crystal ball do I believe?’

I’ll go with Calculated Risk.

It appears that the mortgage lending industry is having some tough problems in the sub-prime sector. One possible outcome of this would be the reduction and/or elimination of 0 down loans and no-doc loans.
The tightening of lending standards should have a heavy influence on the prices of real estate, especially in the highly leveraged San Diego market. Suppose you were no required to have a 5 percent down payment on a 400k property. Factor in closing costs, and you might need 25k in cash to close. For people who are just moving from one house to another, that shouldn’t be so hard as you can use the equity in the previous home. For first time home buyers, coming up with 25k is going to be a major burden.

An interesting piece of morgage fraud happens when the seller jacks the price of the home 5 percent, then gives the buyer the 5 percent in cash to pay for the down payment. This is fraud because the bank thinks that it has a 5 percent equity cushion when in fact there is none since the price was inflated artifically. On second thought, this might be appraisal fraud instead of morgage fraud. Oh well, it’s someones fraud.

Back to my point, it’s possible that if enough lenders loose enough money, the availiabiliy of money is going to drop, removing a portion of the pool of eligible buyers, reducing demand, and reducing prices for homes.

I put an offer in on a house last summer. I offered 180k and the seller didn’t budge at 200k - neither did I. Well, I outlasted the seller as his house was forclosed on last week and is now back in the hands of the bank.

The house just showed up in the MLS for 180k. I should go get it right? Well, the listing states that the water froze in the pipes and now there is water damage. That water damage sounds like the property needs to be discounted 20k - and it was. Only if the house didn’t sell at 200k last year, will it sell at 180k adorned with water damage? I think not.

For kicks and giggles, I should offer the bank 150k.

I can find within myself to extend grace in most circumstances, even when it comes to character assasinations. Still, I have found that I have been unable to extend grace to this guy I don’t know whose name is Casey Serin. He has a blog at http://www.iamfacingforeclosure.com

Finding it within myself to extend grace to this guy just might be the greatest challenge of the year for me.

I put in a verbal offer on a house 4-5 months ago. The seller was trying to get 200k for the property that he had purchased in November 2005 for 182k. I offered him 180k and he promptly declined.

I just noticed today that a Notice of Default was filed 2 months ago, and his property is headed to auction at the end of January. I might have been interested in purchasing the property at auction, but I also noticed that 2 weeks ago Capital One filed a lein on the house.

This was clearly a house flip gone bad since the property was vacant. The rampant rise of real estate is a social ill and I did the community a favor by refusing to bail him out.

At the beginning of the year I made a number of wild predictions:

• Stocks would decline
• The dollar would decline
• Gold would rise
• Housing would tank
• Recession by the end of the year

So, how did I do?

• Stocks went up, now down
• The dollar did decline, but not as much as I was expecting
• Gold did go up, but not nearly as much as I was expecting.
• Housing did slow dramatically, but it didn’t plunge off a cliff like I was expecting.
• We won’t know recession numbers for this quarter until next year, however the numbers don’t point towards a recession.

All things considered, 2006 wasn’t a bad year economically. The biggest number that speaks to me about the past year was the very low unemployment numbers. Right now, we are sitting at 4.5 percent unemployment which is very low by historical standards. Another key factor is the still low numbers of forclosures. They are on the rise, but still very low. The economy is tied to credit, and I don’t see the supply of housing credit dropping unless large numbers of non-performing loans and reclaimed houses clog up the banks books. Indeed, I think the only reason 2006 was a decent year was because housing did NOT take a nose dive. The good news for homeowners is that if housing was going to nose dive, it would have done so already. The bad news for me is that if housing was going to nose dive, it would have done so already.
So, what about my predictions for next year? Well, I think I need to go back and re-jiggle the economic model in my head. Too many numbers don’t make sense. So, I’ll go ahead and make a SWAG now and possibly revise my predictions later following my research.

Housing

As I already said, if housing was going to dive, it would have done so already. It’s poised to nose dive, but I think it would take some heavy unknown catalyst to kick it into freefall. Absent such a catalyst, It looks like housing is going to be a looser investment for the next year. That’s now going to stop large numbers of people from trying to buy though.

An interesting thing to keep an eye on is the movement by Zillow.com into the real estate market of home listings. The days of Realtors are numbered by the internet, along with those 6 percent commissions. I think 2006 marked the high point of realtor jobs, and 07 onward will see a steady decline in this profession.

The Dollar and Credit

I really don’t know enough to make even a SWAG. I’ll have to settle for a simple WAG. I think the dollar will decline another 10-20% against the Euro next year, and what happens to credit will depend on what happens to housing. I don’t expect any substantial changes in the availability of credit over the next year.

For Your Information

Now a word on the federal reserve. The average Joe has no idea what the Reserve does, but the actions of the Fed can be seen in the credit rate your credit card gives you, and also the rate on your adjustable rate mortgage or line of credit. The Federal Reserve likes to tweak the overnight lending rate it charges banks. Right now it is sitting at 5.25 percent. According to common wisdom, dropping this rate is supposed to jump start the economy by making credit cheaper to obtain. Raising this rate slows down the economy by making credit more expensive. It is also expected that raising this rate is a good way to combat inflation (inflation being bad). The current rate of 5.25 percent is making a lot of peoples lives rather interesting, because in the last few years, a LOT of people took out those adjustable rate loans on their house purchases. When they bought, the Fed rate was probably only 1-2 percent.  Since their loan is based on a number that is now around 5 percent, their payments will jump, or have already jumped dramatically. The good news for those folks is that they can refinance into a 30 year fixed. The bad news is that they can refinance into a 30 year fixed. Why the conundrum? Either way, their payments are going up substantially. For folks in California, that could mean going from a 2k a month to 3k a month. Ouch!!!

Oh, one final word on housing leverage.  People like to say that you shouldn’t throw your money away on rent. I agree. However you can just as easily throw your money away on your house. Take for instance the scenario. You buy a house today in San Diego and put down 10k of your own money. Let’s say you buy a condo,  because houses are just too far out of reach. Lets say that condo is worth 300k today. Lets say that this time next year, your condo is now worth 290k, a drop of only 3.3 percent.  Let’s say that you need to sell because of some unknown situation. Ooops, you just LOST all your 10k AND you are out ANOTHER 20k because of that 6 percent sales commission to the realtors. You just blew 30k in only a year. I have not even mentioned the 1500 a month you paid on the  interest only mortgage. That’s obviously a near worst case scenario, but the problem is that this scenario is becoming more and more probable as we move foward. Take for instance the condo that I lived in for a year in Rancho Bernardo. Thanks to public records, I know that my landlord bought in Sept 04 for 405k. Furthermore, I know that a unit in the same complex that is the same size, sold in Sept 06 for 375k. Here is another tidbit, the property tax on that condo for 2006 is over 4000 dollars.

My mother was reflecting on the difficulty in San Diego in selling you home. It was her opinion that the problem was a high level of inventory. To be sure, that is an issue. In my view inventory is an effect, but it is NOT a cause. In San Diego, the root cause is that sellers and buyers have much different ideas on the value of a home. In San Diego, the price is the product expected appreciation, and the expense of credit.  Credit has gotten a bit more expensive over the last 2 years and expected appreciation has also taken a hit.

Selling your house is not difficult, just lower the damn price!!! My mother, who I love dearly, retorted by saying that you don’t want to give away the house. WTF!!??!? Comments like that just make me blink and drop my jaw. It’s especially galling coming from someone who didn’t have enter the traditional workforce since moving to San Diego. Yes, my father raised three kids on a single income. From one side of her mouth she claims that you don’t want to give away the house, and the other side of her mouth is saying that she doesn’t mind that her prosperity is financed on the back of the children she raised. It would take a dual engineers salary to achieve the same quality of life she raised her children in. I’m not the nicest person, and I sometimes I have no problem saying what I mean. For all you homeowners who think that selling at at 90% profit instead of a 100% profit consitutes giving away your home, kiss my ass. I am NOT playing your silly game.

Feedback loops are an engineering term that I first leaned about formally in my control systems class at UCSD. If you want a decent description of what a feedback loop is, check out wikipedia. Fortunately, to illustrate my point you only need to know the negative effects of positive feedback. The shrieking noise that you get when you put a microphone too close to a speaker is a common occurance of positive feedback. Positive feedback systems tend feed on themselves, creating a sustainable trend that is not easily broken. This can be good or bad depending on the situation.

In the world of finance, a positive feedback system can be seen in a wage/price spiral. In the 80’s inflation went for a wild ride for a while. What happened is that as inflation increased, workers demanded higher wages to compensate for their decrease in purchasing power. Higher wages resulted in higher prices for goods, which further increased inflation. This yet higher inflation resulted in still higher wages, …. and so on. Wages and prices created a positive feedback loop, yikes!

So now we are nearing the end of another positive feedback loop in housing. This was a price/profit spiral. I don’t know what started it, but it became obvious quickly. As prices on homes started to go up, so did the potential for profit. The expectations for profit fed into higher prices. Higher prices created even more expectations for profit. This higher profit expectation fed into still higher prices, … and so on. This cycle fed on itself until exhaustion took over. The cycle is broken.

Now, the big question is if another positive feedback loop will start - a deflationary feedback loop. According to classical economic theory, a deflationary loop moves in the opposite direction to an inflationary loop. A good example of a deflationary loop was the Great Depression. An even better example is Japan. According to Wikipedia:

Deflation started in the early 1990s. The Bank of Japan and the government have tried to eliminate it by reducing interest rates, but despite having them near zero for a long period of time, they have not succeeded. In July 2006, the zero-rate policy was ended.

Systemic reasons for deflation in Japan can be said to include:

• Fallen asset prices. There was a rather large price bubble in both equities and real estate in Japan in the 1980s (peaking in late 1989). When assets decrease in value, the money supply shrinks, which is deflationary.

• Insolvent companies: Banks lent to companies and individuals that invested in real estate. When real estate values dropped, these loans could not be paid. The banks could try to collect on the collateral (land), but this wouldn’t pay off the loan. Banks have delayed that decision, hoping asset prices would improve. These delays were allowed by national banking regulators. Some banks make even more loans to these companies that are used to service the debt they already have. This continuing process is known as maintaining an “unrealized loss”, and until the assets are completely revalued and/or sold off (and the loss realized), it will continue to be a deflationary force in the economy. Improving bankruptcy law, land transfer law, and tax law have been suggested (by the Economist magazine) as methods to speed this process and thus end the deflation.

• Insolvent banks: Banks with a larger percentage of their loans which are “non-performing“, that is to say, they are not receiving payments on them, but have not yet written them off, cannot lend more money; they must increase their cash reserves to cover the bad loans.

• Fear of insolvent banks: Japanese people are afraid that banks will collapse so they prefer to buy gold or (United States or Japanese) Treasury bonds instead of saving their money in a bank account. This likewise means the money is not available for lending and therefore economic growth. This decreases the supply of money available for lending and economic growth. This means that the savings rate depresses consumption, but does not appear in the economy in an efficient form to spur new investment. People also save by owning real estate, further slowing growth, since it inflates land prices.

• Imported deflation: Japan imports Chinese and other countries’ inexpensive consumable goods, raw materials (due to lower wages and fast growth in those countries). Thus, prices of imported products are decreasing. Domestic producers must match these prices in order to remain competitive. This decreases prices for many things in the economy, and thus is deflationary.

So now, to my point. We know that the lending standards are already beginning to tighten, decreasing the supply of money. We know that national home prices are in decline. Stimuli for a deflationary cycle have just struck, will it be enough to start a deflationary cycle? I’m betting that it will by holding large amounts of cash and gold. I could be wrong, and the worst thing that could happen to me if I am would be a lot of hard cash sitting in the bank.

I fully expect the U.S. Government to do everything in its power to avoid a deflationary cycle. I may be betting on deflation, but I think the odds are still against a broad based deflationary cycle in the near term.