Monday, April 03, 2006
How Long Must We sing This Song?
I know past bubbles have taken a very long time. Stock market 1, 12 yrs. Housing bubble 1, 6 yrs. Stock market 2, 5 yrs. I think this will be fast and brutal because so much of the housing market has been liquified. Facing a declining market the note holders will be extraordinarilly impatient. Facing a loss of equity owners will leverage to free up cash leaving no or more often negative equity for the note holder. Institutionals often have little choice about patience, they have to dump non performing assets. Past housing bubbles were stretched out due to the illiquid nature of housing. This time it isn't the housing market but the mortgage backed security market that will drive the correction. It won't take very long at all to correct these portfolios. For simplicity; say a speculator buys a bundle of mortgages at a 50% discount in expectation that half will not perform. When they end up with houses instead of paper paying them interest and principle the last thing they'll want is an actual property with taxes and management issues. They've already zeroed out the cost so as long as they get the transaction costs out of dumping the house they're good. That's extreme, the reality will be somewhere in between but the point is the paper will be priced such that even early foreclosure sales will be phenomenally lower prices. Speed trumps best price. That's the push. The pull is that anyone buying in this environment is by definition a sophisticated and/or well qualified buyer and they are going to insist on rational prices, say rent parity. I just don't see very many people buying on the way down due to a lack of competetion and the new psychology of expected return sans appreciation.
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6 comments:
Didn't get cc'd the memo from Thornberg, Leamer, or even the entire bubble-blogger community of 53 tremulous souls, eh?
Or, perhaps you've just lost the plot again, Robert?
Just when you become a certified Crash Monkey, the Head Baboons are now claiming Chinese water torture is in the tarot cards. Some even going so far as to deny they ever actually believed in a popping bubble.
POP! goes the theory.
I got the memo. I disagree. That's why I have my own blog. All I'm reading these days is "faster than I ever imagined." Feels good. I ain't no crash monkey, I am the janitor. I know better than to catch a falling knife but I am going to be there to pick up free knives when all the clatter has stoped and all the scared/unprepared stand back in shock.
Slow? NFW. Fed overreacting, foreign disinvestment, exausted buyers, tightening credit. We didn't jump off this cliff, we took ten baby steps but the result is the same. The scenario is playing exactly as I described; froth, declining sales volume, prices defying DOM and exploding inventory.
Best part is the next phase, after my 20% haircut the boosters will say, "whew, that WAS scary. So glad it is over." Thereon annualized 7% decreases compounded by inflation. Oh, and the poor renters; with no options and no construction: crushing monthly increases. That wasn't in the memo either.
I'm not happy about the $200,000 I've "lost" so far or the next $400,000 either but I'm not stupid enough to be affected by it either.
Fair enough. I'm "the janitor" as well and, like you I expect, have always positioned myself to have cash for property purchases when the streets run with blood.
I mistook you for a true believer of the "everything will be as it is now but with 50% discounted prices" variety. I've been there, done that, know better, and made a fortune in the process. Seems perhaps you have too.
Cheers Robert, and sorry for the wise ass post.
I'm still in shock someone actually reads my tripe. Thanks for the opportunity to discuss. Nothing wrong with a little wrassalin' as long as we keep it clean.
Hell, I've read this blog for at least 4 months now.
From one old timer to another, I have to say this market is very tough to read: Price to earnings are out of whack, but debt service to earnings are not. Price to rents are out of whack, but rents are currently very low. Affordability is at an all-time low, but ownership is at an all-time high. Interest rates are low, unemployment is low, and credit is available. Perhaps too available.
The old rule was that people with jobs always found a way to make the mortgage payments. A correction would have to occur in the teeth of that history.
The effects of ARM resets has been the subject of very intense scrutiny lately, and found to be a pussycat instead of a bogeyman, with reset-related defaults adding maybe 1% to inventory.
So, am I to understand that people with jobs will decide to sell their homes just like they dumped pets.com? That they will move their families out of their homes and into rentals because a top has been reached or YoY declines occur? Sell their homes and move for purely psychological reasons?
I am an engineer by education (structural and civil), and that makes no logical, rational sense to me. And yet I am also strongly intuitive, which lead me to sell 2 multifamily and 1 retail properties last fall for cap rates of 3.75, 4.2, and 4.5. I did not 1031 them but rather just cashed them out, paid the cap gains, and put the profits in short term bonds and CD's, waiting for...I really don't know what, Robert.
Though my instincts lead me to act contrary to my training, I am in no way as sure as you of the future.
I'm an engineer (mechanical aerospace) by education and reputation as well. You are right about the conflicting market indicators. Don't mistake my tone of certainty for absoluteism, I just don't see the need to waste space with the tedious repetitions of the usual backpedalling. I'm pretty comfortable with the trends and such with the notable exception of oil. I can't for the life of me figure out why oil isn't $38/bbl. I really got and will continue to get this one wrong until I find a pricing rationale that does upset my tidy little worldview. Gold is like that too, IMO should be $450/oz but at least I understand why it isn't.
Anyway the people with jobs will do their best to sit tight as you note but homes are priced on the margin. That means on the way up by the stupidest last one to purchase at the peak. It didn't take me selling my house to have zillow conservatively quadrupling its' value in 6 years. All it took was the house down the street selling for that much. I won't sell on the way down either although the guy down the street who maybe loses his job does and mine gets priced at the margin again. I'll sit here with my Prop 13 taxes and low payments at 4.99% because my home is not an investment vehicle. These are all I respect your views, agree with some and see an alternative conclusion for others type observations. The only place where I see us disagreeing strongly is the impact of ARMs. I see a lot more risk than 1% to inventory. A rise in defaults hetrodynes. Subsequent ARM rates rise in response to an increased demand for a larger risk premium that raises ARM ratrs that... It is also a problem of quality. The ARMed borrowers have no skin in the game, a new untested condition that worries me.
Funny thing is I just sold my last rental yesterday, also no 1031 for me although I am selling to someone who is buying it as a 1031. I'm taking the Federal and California tax hits rather than watch those dollars evaporate. The leftover profits should, if I'm careful, match the rent with investment interest returns.
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