Are We There Yet?

If you study the depression of the 1930's, you will find it defined by events like the stock market crash of 1929. But the realization of the concept "This is a depression," didn't become apparent until late 1930 and 1931.

The truth was, foreign commerce was taking away American jobs in the farm sector as early as 1922, the Smoot Hawley Tariff got passed June of 1930 was addressing those problems.

Add to that, the housing boom had started to fizzle in 1928 after the hurricane in Sept 1928 that wrecked Florida's real estate market.

These were major items, but the individual investor had no idea of his perspective to all of these irrelevant events.

Here is a quote from a book on the depression; Quoted from “The Thirties America and the Great Depression” c1967,by Fon W. Boardman, Jr. page 26

Perhaps most ominous of all was the increase in bank failures. In 1929, 659 American banks had failed: in 1930 the number rose to 1,352, and in 1931 to 2,294. Just before Christmas, 1930, the Bank of the United States in New York City collapsed. It had 400,000 depositors, many of them recent immigrants, and its failure, the worst in the country’s history, affected a third of all the people of the city. A bank panic in the Middle South closed 129 banks. As usual, people began to withdraw their money and it is estimated that by 1931 they had taken $1,000,000,000 from the care of the bankers and had hidden it away in everything from safe deposit boxes to old mattresses. And just at the time when the people were losing jobs and money, states and other governmental units imposed new taxes to make up for declining revenues from other sources. Thus the depression was chiefly responsible for the introduction of the sales tax, Kentucky being the first state to have one, in 1930. Other states and cities followed suit.

Whats the prognosis? I believe that there are still two years to go before there is a consensus of opinions that we are in a major depression. Its not that we cannot read the road signs. Everyone in the lifeboat must feel the burden of doom before the perspective of reality hits home and survival mode kicks in.

The people that survive this up and coming event, will be marching to a different drummer.

San Marcos Real Estate Statistics are off!

I normally don't cut and paste other peoples current new stories, but this one deserves merit. It's a better worded summary of what I've been suggesting about the current state of the housing market.

Link to web site: Prleap.com

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Top San Diego real estate broker says San Diego's home prices are off FIVE TIMES the offical data!

(PRLEAP.COM) Bob Schwartz, a Certified Residential Specialist with www.brokerforyou.com in San Diego California says the recently released ‘official’ 1% drop in June home prices for San Diego is in reality approximately five times that figure! Bob explains his findings as follows:

Reviewing the recently released real estate sales data for San Diego, the lay person might conclude that the June home appreciation figures were down approximately 1% as compared to June 2005. The reality is the decline is probably much closer to three or five times the published figures!

The reasons for this are really quite apparent when one considers the following facts:

1. The appreciation figures cited are the MEDIAN sales prices. The upper-end, luxury home market has been extremely strong in Southern California and is relatively immune to increasing interest rates. It operates totally apart from the rest of the real estate market. The sales of these upper-end luxury estates skew the MEDIAN appreciation sales data.

A far more accurate figure would be the AVERAGE sales price. Alternatively, data should exclude, or make million dollar plus sales a separate category.

2. The reported sales data does NOT take into consideration incentives used by not only major builders, but, in today’s market the majority of home sellers, to entice scarce buyers to purchase their properties.

Just open up the Sunday real estate section of your local paper and the magnitude of these incentives becomes quite apparent. Just a few incentives I noted in my July 23, 2005 paper: $15,000 closing cost credit and $25,000 towards an interest rate buy down or upgrades; $50K to help pay your mortgage; seller pays interest portion of your new loan payment for first 6 months, all non-recurring closing costs, plus 12 months of HOA fees. I could go on, but, you must understand that the builders are not being altruistic. No, they just want to move standing inventory, and move it now before any further declines!

While on the subject of builder incentives, it was just a little over a year ago that the majority of builders were not even co-operating with real estate agents. Now, the builder/agent cooperation has gone 180 degrees plus! Typically, builders offer two or 2.5% co-op commissions. Now, agents are being invited to catered brunches and offered co-op commissions up to 5%, as advertised in the July 23, 2006, Union-Tribune!

The purchase incentive phenomenon is not by any means the exclusive domain of new home builders. Actually, I would say the majority of individual homeowners are also being forced into the incentive game. Though not many are offering incentives from the start of their marketing, after six to eight weeks on the market the idea becomes more appealing. Even without offering any incentives, the majority of offers are now being presented with buyer incentives built-in as a condition of sale!

A year ago one would be hard pressed to find any individual home seller or major new home builder offering incentives. Now, it is just these incentives that also skew the appreciation data. A $500,000 home sale with a $25,000 interest rate buy-down/closing costs package incentive will be recorded as a $500,000 sale. Yet, the $500,000 sale, in reality was only $475,000 or 5% BELOW the reported sales data!

So if the $500,000 sale was just 1% below the June 2005 median appreciation, you can see that the ‘real’ difference was 6% below last year!

Other factors not being mentioned in the press that are important to our market direction are:

Typically the period from late March through September is the strongest for real estate sales. What does both a huge and continuing month over month sales decline and now a home appreciation drop, during this ‘hot’ time, portend for the market as it enters the weaker Fall/Winter period? Lastly, the bulk of the interest only, 100% loans used to prop up our market for the last few years, has two or three year time periods until the re-amortization (at the current prevailing interest rates) of the loan balances. The majority of these interest rate adjustments will occur in 2007 and 2008.

In my opinion, this is no ‘return to normal’ or ‘slight correction’ to the San Diego real estate market. By year’s end there will be no denying we will experience a double digit appreciation decline. A decline that will take years, not months, to work itself out.

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Buying a Forclosure

Back in 1997 I started selling real estate in Vista, California. I specialized in selling VA Repo's to investors. Condos went from 28k to 65k, and houses were going from 71k up to about 165k.

The VA repo is a special animal. You don't have to be a Veteran to qualify for VA financing, and if you were an investor it was 20% down. That was 10k down on a 50k condo that would rent for $800/month. You only needed to write a check for 1K in order to bid. If your bid was the winner, they cashed your check. Otherwise it was returned to you uncashed.

Owner occupied was 10% down. Either way, the real estate agent got both sides of the sale, the full 6%. It was deducted from the sales price of the house and from the resulting assumable loan amount.

A buyer of mine who had a bankruptcy, two divorces, child support, a separation in progress. Won the bid on one of these and qualified for VA financing. We low balled the house Christmas weekend and from what I can guess, we must have been the only bidder.

All of this was happening back after the slump in 1996. It wasn't uncommon to see 20 Repos each week for my area. Condos that they gave away for 28k in 1997 are now selling for 220k--800 sq ft 1 &1/2 baths. By the year 2000 the VA Repo market dried up and I got out of real estate.

Now we are into 2006 and the real estate inventory is still climbing. I notice a lot of forums discussing how to buy foreclosures and REO's. It strikes me as a little absurd to be looking for a deal so close to the top of the market. It s probably going to take about 4 years for the market to become attractive to the investor.

As an investment guide, multiply the monthly rent times 100 and that gives you a purchase price that will provide an excellent return. Right now, we are not even within driving distance of such a concept.

Like I've mentioned before, while studying the last great depression (circa 1929), I couldn't figure out why almost every homeowner had a 5 year interest only renewable loan (I'll bet you thought this was a new banking concept). When the money supply dried up, the loans were not renewed, they were called for payment. From there the banking collapse got worse. I don't think that Congress ever passed a law against interest only loans, the banks just refused to write them after that.

Today, the news is citing a 25% drop in housing sales from June of last year. What happens when it jumps to 50%? My guess, not much. The homeowner can't sell his house so he had better keep his job and hold tight.

At some point between the 25% drop and 50% drop, unemployment has got to increase. And to repeat myself, this meltdown is not going to be a one item (real estate) event. Financial loan markets, real estate, banks, mutual funds and the stock market are all intertwined.

To sum it up, I still have a current real estate license. I am waiting for when the VA Repo lists drop about 80% in price, and I'll be out there bidding---when the price is right.

My Vacation in Las Vegas

My wife and I went to Vegas over the weekend and unlike everyone else I know, we lost money.

When we went last year, The Tropicana still had $2 blackjack tables and most of the other places had $5 and $10 tables.

This year, its a little more expensive. Tropicana had $5 dollar tables and the rest of the strip was running $10 and $15 tables. The dealer now hits on soft seventeen.

If you are a good money manager, you can walk away from the table up 15 units of play or down 15 at any point in time, its an even money game. If you're a tourist thats never gambled, this place can now get into your pocket at a rather fast rate. Two dollars a hand is a not-too-fast a way to enjoy learning how to play. $15 per hand is a rather "doomsday" way to deplete your vacation spending money (IE you're going to remember that vacation for the wrong reasons).

The real question to ask about Las Vegas, is what is happening? Are we looking at inflation? On the surface it appears that way, but it could be misleading. My wife (who likes to gamble) had three comped rooms for the weekend, one at the Trop, one at the Flamingo, and one at Harris. We stayed in the Trop, relatives stayed in the other two hotels, all my wife did was go to each and register.

In 2000 they list 124,270 rooms total for Las Vegas, this year 310 hotels have 149,846 rooms. The increase in rooms is getting up there. I noticed that the drive from the Trop to the Flamingo is about 30 minutes in the evening---a pure traffic jam---the migraine you were not counting on. Its faster to walk if you count the time it takes to park your car.

Things are not as they appear. My wife's slot machine malfunctioned and a tech came to fix it. Come to find out, he's a laid off LA Northrup Grumman worker that came to Las Vegas, hates the place but he needs the job. Our waiter (at one of our 4 complementary meals for the free slot tournament), was a real estate agent that works for Liberty Realty, real nice guy named Nick. He said the real estate business was good, but you have to wonder about "how good."

So on the last day, we get in the car, I'm grumbling because the wife lost $1,000 at the tables. She tells me, "Where else can you get 3 free rooms, each for 3 nights and all the food you can eat for free?" (She was rationalizing the loss). I kind of had to agree.

Then we started the drive out of town. To my surprise every major contractor had at least one billboard up for condos or homes for sale, some starting in the low 100's. I don't think that I would be exaggerating if I said that I counted 20 full size billboards in one mile on the strip out of town.

Since we also got a free Las Vegas paper, I was reading that on the way home and had to chuckle over the headline that read, "Mountain Falls homeowners enjoy scenic commute--Couple makes 40 mile drive from Pahrump Valley to Las Vegas jobs." I was mentally thinking that if it was this hot in San Marcos, our air conditioning bill would be about $400 a month!

To sum it all up, Las Vegas has changed. No more 2 dollar tables, $15 is the norm. Traffic on the Strip is horrible. The rooms are free if you can prove you like to gamble. I predict several casinos will file bankruptcy in the coming year--the pie is sliced too thin to survive. There are just too many people that I have talked to, that want to leave Las Vegas rather than stay, that makes me so pessimistic about this place. And as for how it ties to The Great Depression of 2006, the party is not over, just yet, enjoy--your HELOC (home equity line of credit) It probably isn't maxed out yet. Reality is lurking right around the corner.

Perception: Your Point of View Verses Mine

After cruising a lot of blogs, I've noticed something that I wasn't really aware of. Ever notice that after you buy that new car, you seem to spot a lot of them on the highway, whereas before the purchase you didn't? The thing that I noticed was, the fact that our minds are sharpened to recognize stimulus that we accept into the model of our perceived world.

The real estate bubble bloggers, see the real estate market falling off of a cliff. The real estate agent sees a return to a more normal market. It's not really a matter of who is right, but rather one of timing. Real Estate has been trying to fall off of that cliff for several years, and yet some real estate agents are making a decent living.

I do believe in the example I have cited with real estate, it will fall off a cliff. The "when" part I am not sure about. What needs to be pointed out is that what you expect to happen, colors how you perceive the markets. It's kind of like the cartoon of two men on a very small island. One puts oar locks to the left and right and puts in two oars and starts to row to the west, the other guy on the island throws his hands up and says "you're rowing the wrong way!"

What needs to be realized is that what we want or expect to see, is far more observable than that what we care little about. Captain Ahab harpooning the great white whale nailed the whale, but the rope was wrapped around his leg--he didn't see it coming.

Our faulty perception of the world can harm us. Real estate could be collapsing and you laugh at the guy that looses his house. With 100% financing, don't laugh at him he's home free. It's the bank that gets hung. And when you trace it back far enough; your retirement fund probably took the big hit.

My point is this, what you want to see, you will be able to see, only because your mind is selective. It will notice what you are more receptive to. Therefore my premise: what you want to perceive, you will find a way to perceive, not because it is actual, but rather because it is expected by you to be that way.

If you accept this theory, then you might just question more critically your observations of the world about you. Reality for the individual is all about perceived perception. It is a real reality to each individual. To the group, it may not be. Hence the reality, "I could be wrong!"

It sure feels nice not to have to be right all of the time!

Two Tiered Housing

Almost every article written lately, looks at the housing market inventory problem, as if it was grouped all together. Lets separate it into two different groups; newly built contractor housing and consumer owned housing.

Forget about the cost of the house, and reflect, upon the idea that contractors have been building houses and making a living at it for centuries.

Our house was built by a contractor in 1994 for $191,000 2,400 sq ft. The contractor made a profit. The same house built up the street this year by a contractor sold for about $650,000 and the contractor again made a profit. The only difference between then and now, is that there are more contractors building houses.

Notice, as the used housing market appreciates, the builders inventory also appreciates with no real investment. Figure the return on investment between 15% on up to 50% for the contractor (no real figures here, a rate of 15% is better than giving it to a bank, and a return of 50% or better would explain the sudden increase in building contractors.) I've been in two limited partnerships that returned 50% on condo construction.

Look at the homeowner that gets ready to sell. In a rising market, no problem. In a dropping market, there is realtor fees and competition from newly built houses. The owners selling price is set in stone. His whole future can depend on the outcome of the sale of the house.

Contrast this with a machine that is invested with money that spits out houses, and returns a tidy profit.

The contractor can probably take $150,000 loss in San Marco's on each piece of inventory and still break even and continue on in the world of house building or he could go broke (the investors would take it in the shorts).

As long as the homeowners hold out for a better price, the contractor does not have to mark his inventory lower to move it. At the same time, while looking for raw land to develop, he can demand and get lower land acquisition prices per parcel for new construction.

At this point the contractor is making money at the homeowners expense. More used inventory accumulates.

Now lets look at two different markets. Denver Colorado and San Marcos California. In San Marcos, the housing prices have tripled. In Denver, they have done nothing. Both areas show an oversupply of used housing on the market. Here is where the hair begins to stand up on you neck. This machine that makes houses and the financial institutions that feed it, have created something that is destined to fail in the near future. We are producing housing capacity that is not needed, but it is still very profitable to produce. This is the truest definition of "miss-allocation of resources," AKA "A Bubble." A basic ingredient of any "mind expanding, wallet reducing" recession or depression.

Something will stop this cycle, but at the present, its not clear what its going to be. Stock markets world wide seem to be pointed for a downward plunge. This could lead to a credit contraction that could bring the home construction industry to a halt.

What will Trigger the Financial Collapse?

There are housing bubbles all over the world, stock speculation at absurd levels, hedge funds and derivatives way out of whack. The question arises; what will convince everyone that the game is over?

Here is where it gets tricky. The common denominator of all the different parts is "Interest Rates." The trigger could very well be a panic in the bond market.

What people don't realize is, markets create interest rates. Governments can tweak them for a month or two, but they will come back to some desired level totally irrelevant of government prodding.

The Second Trust Deed Market is very vulnerable, a lot of that stuff was written with 7.5% rates. So lets say a dealer has a $100,000 second that he needs to unload, because the real estate market looks bad. So if he discounts the note to a face value of $50,000 it will pay an equivalent 15% interest. At this point there doesn't seem to be much damage, right?? Wrong!

Suppose you had a 30 Bond for 100,000 paying 5%. After that transaction, with an interest rate payout of 15% you could only sell it for 1/3 of its face amount.

The fundamental not realized, is that bonds have not had this low an interest rate in 45 years. So for a $100,000 thirty year bond at 5% to double in price, the interest rate would have to drop to 2.5%. That's not very realistic. But if we pursue the idea the other way, the same bond would be worth only $25,000 if the interest rate jumped to 20%. It would loose 3/4th of its value. Now that's not to say that you couldn't wait around 30 years and collect the face amount of the bond 100,000. I'd be almost 90 years old, so its not realistic.

Plus lets work it from the disaster end. If the interest rate were to jump to 20% you would buy the 30 year bonds paying 20% interest. Or you could buy the old 100,000 bonds paying 5% marked to market at $25,000 (what a deal if you live to be 90)!!! So at that point, if the interest rate dropped from 20% to 10% your bond face value would double. Not bad for a bond, plus you get the interest accrued.

So what is transpiring, is a contraction of actual assets. A doubling of the interest rate in the bond market can literally contract the money supply by 50%. It could from there double again without so much as the of a blink of an eye.

At this point, the hedge fund and derivatives managers would be in a melt down mode. This might seem illogical, but I suggest that these managers, might be invested in something like Google up to the hilt, and at the same time with options and derivatives satisfying their customers asset allocation directives.

Translated into layman's terms, the bond market will have a bad day, and the stock market will have an even worse one. After that, the housing market will have to deal with reality. The party is over.

The Contraction of Liquidity

If you'll notice, most major world markets are on a downward trek, the trend is not up.

Couple that with house prices, they are starting to trend down. Not fast, but the direction has changed from up to down. The amount of inventory has raise quite a few eyebrows. Nobody is launching the lifeboats so everything must be OK.

Long term interest rates have been rising very slowly with no appreciable effect on installment purchases. A rather peculiar side effect considering everything else. A $5,000 liquid plasma TV is only a signature away, no payments for one year.

Want a BMW? "Well, do we have a deal for you!" It makes you wonder where the money is coming from to pay for all of this. The fact is, the money is not there to loan unless the lending standards are lowered.


When you visualize a bankruptcy or a foreclosure, the time it took to get that point doesn't enter into the equation. It takes about a year.

So where are we now? I believe that this is the beginning of "That Year." Layoffs will follow from here. The stock market seems to be in the doldrums. The bond market is stuck between a rock and a hard place. With all of the bad paper out there, it can't go any lower, and if you have a 30 year bond at 5%, you're going to loose big time.

The smart money is going to T-bills. I wonder, if you purchase a T-bill over 100,000, would it show up on the M3 money supply total that has been discontinued? That might be why they discontinued reporting the value. Big money might be bailing out of regular bank deposits. The government very rarely fires bean counters, and to discontinue the M3 money supply report, suggests that the reasoning could have been very well thought out.

The Social Security Morass

F.D.Roosevelt got Social Security going during the Great depression. If you examine the original idea, it wasn't too bad, only about 5% of the population would ever live to collect it. Now over 60% of the population will live to "collect" it.

The Social Security tax is supposed to be deposited into a trust fund. To make the story simple, The Congress has written some IOU's and spent the money. Someone complained about this abuse and the Supreme Court ruled that the Social Security tax was just that, a TAX and the government could do whatever it wished with it.

Did I mention the word Medicare? I know I didn't mention "800 pound gorilla." Why worry about Social Security, that's a nickel and dime game compared to Medicare.

There is another one called SSI (Supplemental Security Income). You can draw this if your Social Security check is below poverty minimums. A lot of immigrants in this country legally over the age of 65 qualify for this payment even if they have never worked a day in their life. These people are also eligible for Medicare. Imagine, a foreigner can qualify for a retirement pension of about $580/month with free medical, not bad!

What we are looking at here is an item called Transfer Payments. The money spent is spent on consumption. There is no investment in new enterprises. This money for lack of a better word is being confiscated from your children before they have even earned it. There is no perceived budget amount set aside for these future expenditures. Its pay as you go.

We are at a fork in the road, similar to the 1930's. Germany decided to inflate and ruined anyone that had a bank account. The US survived with deflation and ruined almost everyone with a bank account.

The real question is; how much time do we have to enjoy these "retirement benefits?" Hint: there is no tooth fairy.

Thirty year vs Three month Interest Rates

The Fed has raised the interest rate 17 times and the 30 year yield has gone up 2/3's of a point. The three month T-bill has jumped up in locked step with the Fed. The curve between the 3 month and the 30 year is so damn flat that you almost have to throw in the "F" word to explain how flat.

As far as the bond market is concerned, there is no extra value being demanded for long term bonds verse short term bonds. There is no reflected risk of investment. There is no perceived long term risk as there should be. What happens if 3 million homeowners default on their 30 year mortgages? At some point, note holders will be discounting loan notes to make them attractive to other investors. Long term interest rates could zoom to 20%. A thirty year note written at %5 marked to 20% is a 75% loss (you could wait 30 years and get your principle back).

Why are interest rates so low for housing? Common sense demands that you charge more for a 30 year rate than a five year rate. More can go wrong in 30 years. The words "Government Sponsored Enterprise," (GSE) like Fannie Mae or Freddie Mac come to mind. These two GSE's, through options and hedges, have "taken" the risk out of investing. Another acronym you'll hear is "MSB," "Mortgage Based Security's." It kind of reminds me of spelling out a word so you're little brother won't catch on. The next time you hear a Congressman talk about investigating the GSE's in regard to MSB's, your eyes won't gloss over anymore, you'll run for the exit!

There is a point however, when people will demand more interest for greater risk. At that point, we enter the real world.

In 1929, the Fed raised the interest rates until the stock market crashed. In today's world, the Fed is kind of like a hunter shooting at a sound in the brush. At this point, we know they hit something; we're just not sure what it is!

The Million Dollar Land Grab

When it comes to land, there is no real concept of value that is rational, when you apply it to real estate.

Let’s take farmland; $5,000 per acre with water rights will allow a good return to a farmer. Right now, a farmer would have to clear over $325 per acre in order to have a better return than interest income on the same amount ($5,000) from the bank. An 80 acre farm would net $26,000 per year.

It’s not uncommon for land developers to go into farmland and buy up, say 20 acres. A good market price would be $80,000 per acre.

In California, some of this farmland can fetch 1 to 2 million an acre. The contractor buys the land and then, subdivides it into lots. In some areas, the contractor can literally build 16 houses per acre. That comes out to $62,500 to $125,000 per lot. Now add water sewer, gas etc for lot development and permits, and you would add in about $40,000 per lot. An acre is 43560 square feet. Let’s say 10% of it is road. That leaves 39,000 square feet divided by 16 houses, which equals a lot size of 2,500 feet. The contractor is committed to fixed cost for land of $102,500 to $165,000. Now figure the cost of house construction. The contractor probably can construct a house in a range between $75 to $100 per square foot. If we use 2,500 square feet as an average house, then we have construction costs from $187,500 to $250,000 per unit. Add in the land cost range we used and you get the contractors cost of production between $290,000 and $415,000.

Land-----------$1,000,000 per/Acre----vs--------$2,000,000 per/Acre

Lot Cost----------------62,500------------vs-----------125,000
Development----------40,000------------vs------------40,000
Construction Cost---187,500------------vs-----------250,000
House Cost---------$290,000------------vs---------$415,000

Right now in California, that house is attempting to be sold for $650,000.

Step back for a moment and look at the picture from a different perspective. My figures are rather arbitrary, but examine two groups, the farmers and the builders. The farmer can sell half of his 80 acres for 40 million dollars. The contractor can make $250,000 to $350,000 per lot on the sale side (by the acre, its 4 million to 6 million).

Now, enter the home owner that decides not to sell at these prices and wait for the market to come back. A lot of these houses up for sale are 20 to 30 years old. Who wants to buy and old house when they can buy a brand new one for a lesser amount?

What if I was to tell you, that the house’s cost(my figures), actually included the builder’s profit added in. What if the contractor’s cost per lot dropped $50,000 (in a depressed market).

The farmers selling raw land and the contractor, are not going to stop their business arrangement, their price is determined before the first shovel of dirt is moved. There is an awful lot of money to be made. From farmer to contractor, compare it to a fire storm of immediate wealth.

Does the contractor want the homeowner to hold out for a higher price? You bet he does! He can beat any “used home,” in town at a lower price. He’s in it to make a living; the homeowner is trying to get out alive. The longer “used real estate” prices remain high, the longer the contractor has a “premium” return. A good contractor can’t help but make a profit at these prices, and as prices go down, his land acquiring prices go down.

The one thing that can contradict this is oversupply. More aptly labeled "miss-allocation of resources." The ability to create money at such a fast rate can stimulate an overproduction, which ends in a collapse. The fantastic rate of return and growth in construction real estate, supports the suggestion of an impending collapse of the industry.

As a foot note, I used 16 house per acre, I have lived in an area where it was closer to 20 houses per acre. As for construction costs on condos, which I skipped over, they can be constructed as cheap as $39 per square foot.