If we look at the current decline, it would look something like this:

We’ve seen countless charts and this one isn’t drawn to scale but simply highlights the next phase of the housing decline.  The surge occurred in every segment of housing; low, medium, and high all soared to the stratosphere.  But since the bust, we have seen the low end take the brunt of the price decline while the mid to upper priced areas remain stubborn.  They have started to fall and with the Alt-A and option ARM tsunami coming online later this year we will see these segments begin to fall.  Just be warned that you will undoubtedly hear pundits say, “the median price has gone up” but in reality what is happening is higher priced homes instead of sitting with delusional sellers asking for yesteryear prices and not moving, will now be competing with a surge of foreclosures in these areas that will be sold by anxious lenders.

Today I want to focus on Culver City again because this is the next prime candidate area to take a major hit in the next cycle of the bursting bubble.  These are your mid to upper range areas but not enough to be called “über prime” like Bel Air or areas of Santa Monica.  Let us first look at an example home that is in pre-foreclosure and has already had a notice of default filed on it.  Today we salute you Culver City with our Real Home of Genius Award.

Culver City - The Home Equity Machine

The home we will be examining has a Zestimate of over $1 million.  To give you a sense of the area, the home on the left sold for $860,000 in 2004 (2 beds 3 baths) and the home to the right sold for $385,000 in 1995 (3 beds 3 baths).  The home we are looking at has 3 beds and 3 baths but this home went through what we would call the mortgage equity withdrawal machine.  Now keep in mind all 3 homes have a square footage of 2,600 to 2,700 and this area looks planned so I would imagine many of these homes are built by the same builder.  To confirm, I look at the date built and find that all 3 homes were put up in 1980.  In California, that is a fairly new home.

So that should put this home in context.  According to estimates, these would be $1 million homes.  But let us see why the Alt-A and option ARM issues are going to explode in these areas over the next few years.  The mortgages on this home tell us a story of an epic bubble.

IndyMac was sure busy in Southern California!  The home sold in 1998 for $500,000 and then was either transferred or sold in August of 2003 for $580,000.  At least in this respect, IndyMac wasn’t the biggest gambler on the list which is probably one of the few times you will ever hear that said.  But after that, the home equity withdrawal machine kicks it into the next gear.

Only 4 months after closing, Greenpoint Mortgage Funding issues a $122,000 mortgage on the place.  At this point, in a matter of months some $702,000 in mortgages are placed on this property.

We are now in 2006.  The California housing market is burning at a fever pitch and anything and everything is rising in value.  So in March of 2006, the borrowers on this place get a 1^st mortgage of $735,000 and take out a second for $157,500.  So simply adding up these two mortgages, the home would have a lower range value of $892,500 assuming they went with 100 percent financing.  This looks like an 80/20 situation but the numbers don’t exactly add up.  Either way, this home went from $580,000 in 2003 to approximately $900,000 in 2006.  This would mean that in 3 years this home went up $106,000 each year!  Why work when your home brings in six-figures for you just sitting in it?

Well as we all know the bubble exploded.  The Zillow chart for this area shows exactly what I am talking about regarding the tiered housing crash:

For most of the bubble Los Angeles, Culver City, and this home all trended neatly together but once the bubble burst, we start seeing home price falls segmenting out.  Now this area is in a prime location but prime doesn’t mean $1 million.

Going back to the loan history, we see that in April of 2009 a Notice of Default was filed on this home with $24,018 payments in arrears.  Now for this zip code in Culver City we find that the median home price is now at $637,000 a drop of 21 percent from a year ago.  Here’s the thing, only 5 homes sold in May in this zip code and obviously the homes that did sell are at the lower range.

I looked in this immediate area and there is only one home for sale and it is a 4 bedroom with an asking price of $1.1 million.  Of course, it has only been on the list for 3 days.  As I have discussed the Notice of Defaults are surging in California and this will provide ample inventory in the mid to upper priced areas to depress home values:

This home is a perfect example of the mortgage equity withdrawal machine.  Let us assume they try to sell this home for $900,000.  What would your mortgage look like?  We should assume that you will have 20 percent to buy this place:

Down Payment:          $180,000

Mortgage:                    $720,000

PI:                               $4,911 (assuming 7.25 percent jumbo 30 year financing)

TI:                               $937

Monthly Payment:    $5,848

Many of the government loan mods (aka kicking the can down the road) try to get the mortgage payment down to a 31 percent debt to income level.  So how much income would you need to purchase this home?

If we use gross you would need:        $18,864/per month or $226,368/per year

To stay relatively within safe prudent standards, you would need an income of $226,000 a year and this is assuming you are coming in with an $180,000 down payment.  The median family income in Culver City is $82,000.  I dug deeper in the data and searched for this specific zip code and found that for 2006 some 8,035 tax returns were filed with an average adjusted gross income level of $73,694.  However you slice the data, you will have a tiny number of buyers for this home depending on the price.  If the price were set at $900,000 you would need a household income of over $200,000 and this is only a 3 bedroom home.  This isn’t your prime Beverly Hills location or some home in Rancho Palos Verdes.

You don’t need to be a rocket scientist to realize that prices are going to fall and fall hard in these areas.  Today we salute you Culver City with our Real Homes of Genius Award.

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Real Homes of Genius: The Culver City Mortgage Equity Withdrawal Machine. The Hidden Southern California Housing Disaster.

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Why has the state run out of money?  First, a large portion of money is pulled from personal income taxes and another large portion comes from sales and use tax:

Over 83 percent of the states revenue comes from two extremely volatile sources.  This week I happened to get the wonderful news that Los Angeles County now has a 9.75 percent sales tax!  So not only do you get taxed on your income, now you will get taxed when you go buy goods.  And look at what kind of great government we have in Sacramento for this high tax rate.  The best that IOU money can buy!

Here is a problem with the current system.  No one has the ability to tell people in the state that we are flat broke!  I’ve noticed the pundits are out in full force again with horrible ideas about buying toxic mortgages and bottom callers are out in mass again preaching to their housing gods.

Dumb and Dumber - I.O.U.

In another smart move worthy of a Noble Prize, the state has decided to offer IOUs:

“SACRAMENTO - In a move certain to draw national ridicule and exact financial hardship on business owners and taxpayers across the state, California is slated today to begin paying billions of dollars in bills with IOUs instead of cash.

Nearly 30,000 IOUs totaling more than $53 million are expected to be sent out by state Controller John Chiang this afternoon, the day after Gov. Arnold Schwarzenegger declared a fiscal emergency in the face of a staggering $24.3 billion deficit. The state Legislature remained in its familiar state of gridlock, raising the prospect of an extended standoff that further damages the state’s financial reputation.”

If you have noticed unlike the early 1990s not many banks have come out and stated publicly that they’ll honor these IOUs.  It is likely that many will honor the IOUs but the banks are flat out broke too!  We are going to give people monopoly money so they can go and deposit their funds into a bank that is broke so it can then lend it out to people with no money!  This is the solution to the $26.3 billion shortfall.

But wasn’t it $24.3 billion on Tuesday night?  Yes it was.  So buy the end of the month people in jail will be getting legit get out of jail cards.

“CHICAGO, June 29 (Reuters) - Michigan has to close prisons to save money. California’s are bursting at the seams.

Both states are struggling with huge budget gaps.

Now, Michigan Governor Jennifer Granholm has offered California some of the state’s prisons that are slated to close at a yet-to-be-determined cost.”

Well I guess we’ve found one export we can depend on.  The budget is in shambles because each year, we go through this song and dance and eventually, a budget does pass but it is basically a patchwork of delaying reality for another day.  That day has come.  Asking the Federal government to bail us out would be a nice form of beggar thy neighbor.  Even though Bernard Madoff is getting 150 years in prison, there are far more corrupt things going on right now.

Two of those things involve California and National Housing.

OCC and OTS Show Country insane like State

Earlier this week the OCC and OTS released their first quarter results on the health of the mortgage market.  As you may have guessed, lenders across the country are as blind as those in California.  Some have thrown out the idea that the government should simply buy up all the toxic debt.  When they say the government, they mean you and every other taxpayer.  The public-private investment program, which ironically is anything but an investment and does not resemble a partnership, is one of these crony banking ideas.  Yet that doesn’t resolve the fact that if you are unemployed or have a mega-mortgage then any housing payment is a burden that isn’t within your budget!  These programs are to aid Wall Street and all lenders that are still living in their delusional crony world of housing bubble economics.

Yet some of the public are taking notice.  During the Great Depression the word banker took on a negative connotation and I don’t see how it is avoided during our Great Recession.  But let us look at those OCC and OTS stats:

This is important information so let us spend some time here.  This data covers approximately 64 percent of all first lien mortgages.  In the data covered by the report, we have a sample of 34 million mortgages.  Of these 34 million mortgages, we can say that 11.8 million loans (the Alt-A, subprime, and other) are questionable.  Essentially 34 percent of the entire portfolio is made up of junk!  Here is the breakdown of the loan categories:

This is junk!  In fact, that “other” category is a mix of Alt-A, subprime, and prime but these are loans made with no credit scores or low documentation!  Who in the world knows what this crap is.  We have a better chance of guessing what is floating in the Los Angeles River.  And those in the housing industry are eagerly waiting to unload this crap to the public.  Let us just assume that the entire portfolio has mortgages with the same balance.  34 percent of $6 trillion is $2.04 trillion!  As you all know 634,000 of those Alt-A loans are here in California with an average balance of $420,000+.  According to data from the OCC and OTS, there are still 3.5 million Alt-A loans floating out there.  But fear not, loan modifications are way up.  Let us look at that data:

The crap California is doing is nationwide.  That is, with loan modifications and workouts the main strategy is to convert loans into option ARM, low teaser rate, 40-year mortgages.  Take a look at those principal reductions!  Bwahahaha!  Now you know why they ripped out all that cram-down legislation.  With bankruptcies skyrocketing many of these loan modifications and workouts are basically converting people to renters and locking in the bubble price of the home.

Think of a situation in our current market.  You buy a home at the peak for $500,000 and the home is now worth $300,000.  Their idea of a workout is turning your loan into a 40-year mortgage with a teaser rate.  But what happens when you want to sell?  You can’t!  Homeowners are now being swindled once again by the same banks that issued this toxic waste under the guise of “helping” you.  Sort of like how Bernard Madoff helped all his investors; things look good until you read the fine print or dig deeper.  The Alt-A and option ARM wave is going to hit California like a tsunami especially in the more so-called prime areas.  Some of these people think they are insulated from the rest of the state economy in silos.  They are going to find out the hard way in the next few months.

What the OCC and OTS data tells us is this problem goes beyond California.  You can look at Florida, Nevada, and Arizona and these states are loaded as well with these toxic mortgages.  Yet you will find the toxic waste in every state.  And to show you how much a waste of time this is look at the re-default rates:

If we extend this out to another year and break the data out by Alt-A, subprime, and prime I bet you would see in some categories a 90 percent plus re-default rate.  The data is telling us this is a waste of time.  It seems like people are hell bound to repeat the lessons from Japan.

Some people have told me, “but California housing is now affordable.  It is a good time to buy.”  I have decided to compile a list of median household income and median home prices for all California counties to show you that we are still over priced in many regions:

The above chart sums up the California situation.  What you have is the lower-end being pummeled and now having more modest price to income metrics.  Yet those higher priced areas, those areas with the 643,000 Alt-A mortgages with a nice average sum of $420,000+ are going to take it on the chin next.  These numbers are simply unsupportable.  Bottom callers are drinking the Kool-Aid once again.  Ironically, we may see the median price stabilize but this does not show the real story. The mid to upper range of the market will fall, creating more sales, and thus creating volume to shift the median price up.  For example, say a place like Culver City has a $600,000 home that sits on the market for ages.  The place has a nice Alt-A, the borrower walks away and the bank is forced to unload it.  It goes for $400,000.  The median price for L.A. County is $300,000 so this gives fuel to a higher median price but the place took a $200,000 hit.  This will happen.

The state has an 11.5 percent unemployment rate (the highest in record keeping history), the state is slashing the wages of 200,000 employees, more layoffs are in the pipeline, the Alt-A and option ARM problem is not being addressed by delusional loan mods and workouts, and yet this is the bottom.  What high paying industry is being created to give birth to the new era of suckers that will over pay for housing in those so-called prime areas?  Maybe we can start buying homes with IOUs.

Orange County had a median price of $258,000 in 2000 and Los Angeles County had a median price of $192,000.  Just think of that when you see the current median price for Orange County of $411,000 and $300,000 for Los Angeles.  To describe the problem takes much analysis.  Solution?  Let these homes foreclose as quickly as possible and let banks fail.  But too many people believe in the Angelo Mozilo school of, “homeownership is not a privilege but a right!”

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California Budget and Housing Financial Escapades: $26.3 Billion Budget Deficit with State Issuing Monopoly Money. Housing Still Collapsing. Comprehensive look at Mortgages.

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It is amazing that those who have been wrong predicting the housing collapse are now the folks guiding policy.  As I discussed in the last article regarding Alt-A loans and the California Foreclosure Prevention Act, all that is being done is the state is institutionalizing option ARMs which is flat out insanity and would make anyone feel like they took crazy pills.  Why is this nuts?  The so-called modifications include freezing the interest rate, negative amortization, 40-year terms, and gimmicky teaser rates.  However, you can forget about lenders knocking down the principal balance since this will actually eat into their delusional profits (and would most likely make them explode like a piñata).

I love how some people to fit their own agenda (i.e., those in the real estate industry or deeply connected to it) have now taken it on their behalf to use our argument about the coming Alt-A tsunami for further government bailouts!  Dear readers, as I warned you back before TARP became the utter monstrosity that it is for the crony bankers, this kind of thinking will lead to more taxpayer waste.  I recently saw this argument floated but want to address it as quickly as possible:

“(LA Times) One proposal for a debt-forgiveness program was floated this month by the Milken Institute in Santa Monica. The plan, authored by institute President Michael Klowden and regional-economics director Ross DeVol, would refinance existing mortgages of underwater homeowners with new loans from the government.

Klowden and DeVol call it the “homeowner principal forgiveness vesting plan.” Here’s how it would work:

Say an owner’s mortgage is worth $400,000 but his house is valued at $300,000. The government would refinance the $400,000 loan with two new loans. Fannie Mae, the mortgage financier now under government control, would provide a first loan for the market value of the house, in this case $300,000. The Treasury would issue the second loan, in this case for $100,000.”

This is a bad idea.  Since some people are misconstruing what many of us who have been warning about with the Alt-A and option ARM tsunami let me be clear about my position:

These homes should be taken back in foreclosure.  Banks must eat their losses.  If it is game over for them, so be it.  We have a healthy rental market.  People won’t be out on the streets.  To take a loan from an irresponsible gambler (aka lender) and convert it to a government loan is absolute insanity.  It is a scam.  A swindle.  I bet many of you are seething and probably have the desire to punch your monitor now that you know how this housing casino works.  But guess what?  This plan is much more of a crony bailout:

“They estimate that the cost to Treasury (and thus to taxpayers) of saving 1.5 million homes from foreclosure or abandonment with this plan would be between $75 billion and $100 billion. That assumes the government wouldn’t jeopardize the original lenders’ balance sheets by forcing them to share in the cost via haircuts on their loans.”

Oh really?!  We wouldn’t want to jeopardize all those crony banks and Wall Street right?  So let me get this straight.  The purpose of this plan is to:

(1)  Bailout lenders who made irresponsible loans?

(2)  Give over leveraged homeowners and speculators an easy way out?

(3)  Put the toxic waste onto the taxpayers’ bill?

(4)  Expect lenders to walk away with no serious repercussions?

I know many of you are against the prospect of nationalization when I tossed it out many months ago.  These kind of “plans” and additional workouts are actually going to cost us more than simply going in with a strong arm and gutting the system.  That ship alas has sailed politically so fear not.  But take a look at those banking and Wall Street stocks.  Guess who won?  It wasn’t the average American.  However, these are the consequences of allowing the corrupt banking system to guide bailout policy.  Seriously folks, here in California many people should lose their homes and become renters.  Enough with the renting stigma and the notion that everyone should own a home.  If you make your payment and are prudent then you have nothing to worry about.  Yet if you over leveraged yourself and took a HELOC to put in a pool with faux rocks and a waterfall or bought at the peak then why should the government bail you and your lender out?

Some people are making the comparison to the S&L crisis and the Home Owners’ Loan Corporations during the Great Depression.  Here are some facts about the HOLC:

-At the peak it was massive employing some 20,000 people

-HOLC received 1.9 million applications for home loans with 1 million being approved

Even with favorable terms and conditions, 20 percent of these loans failed!  With that kind of rate most banks would sink.  And by the way, the HOLC did file 200,000 foreclosure auctions and this experiment never revived mortgage lending which remained anemic for another decade.  Why?  Because the nation was in something called the Great Depression!  Our housing obsession started nearly a century ago.  If you have a weak economy chances are, you are going to see problems with housing.  The solution isn’t to give more loans to people who can’t afford them.  The solution is to focus on creating a sustainable economy with a laser focus on job creation.

By the way, as crazy as the housing market was during the Great Depression and the S&L crisis, we have never seen the amount of toxic garbage like Alt-A and subprime loans like we have in this market.  So those that use those past experiences have no reference because we have never scorched the Earth with so much toxic waste that we once called “creative financing.”

The ideas being proposed are as bad as the loans that got us here in the first place.  If you want an idea of how this is going to play out you should really examine what Japan went through with their double bubbles just like we did.  In fact, Japan has a tsunami of their own giving us a Scrooge like glimpse into our Ghost of Christmas Yet to Come if we don’t change course:

“(UK Times) A housing loan default problem is looming and likely to begin in the next few weeks. It amounts to the detonation of a ten-year time bomb that, researchers at the Tokyo Foundation say, started ticking around 1999 in the immediate aftermath of the Asian financial meltdown. This is the result of flawed government policy, whereby the state housing loan agency offered mortgages to families that they knew were unable to pay. According to the think-tank, those loans were made on the assumption that the traditional staples of Japanese corporate life - seniority-based pay increases, constantly rising bonuses and lifetime employment - would remain as fixtures.

The impending meltdown, which the Tokyo Foundation believes could affect some hundreds of thousands of households, will be focused initially on the country’s industrial heartlands, where corporate bankruptcy rates are rising. The residential zones around Toyota’s home territory of Nagoya could become ghost towns, Kazuo Ishikawa, the think-tank’s senior research fellow, said.”

Can things get any clearer?  With Americans losing some $13.87 trillion in household wealth, we have seen our own lost decade yet people keep refusing to examine the lessons of Japan.  Now Japan is seeing their own horrific policies of propping up a failed banking system.  No bank should be too big to fail.  And foreclosures are necessary to reach a bottom quicker.  The CFPA for example is merely a kicking of the can down the road policy.  Don’t you find it ironic that whenever cram-down legislation is introduced into Congress the banking industry shoots it down but once the government is involved in sucking up those toxic loans, the lenders come out of the woodwork?  Cram-downs don’t work when lenders need to eat the principal but when they use the taxpayers’ dime, then they are all for it.  The banking industry is still operating under similar terms that caused the bubble and we keep funneling money into this sector.  Are people not outraged anymore?  I remember back only in September of 2008 people were calling up their representatives and mounting quixotic battles for a few billion dollars in proposals.  Now, we are days away from the worthless public-private investment program and the public seems in a daze.

There is now an industry leaching on those in financial trouble:

“(LA Times) David Berenbaum, vice president of the National Community Reinvestment Coalition, called on newspapers to stop running ads by “for-profit racketeers who charge on average $2,900 to consumers for poor advice.” Examples he cited included counsel to not pay the mortgage or contact the service provider. HUD-approved counselors will help consumers for free.”

This is another problem with running programs like the CFPA or any government sponsored help.  You will have these shady operators pop up to scam folks and take any money left from those who really need a call that goes something like, “unfortunately, you are insolvent.  Here is what is needed to file for foreclosure.”  It is that simple financially but I know emotionally, it is difficult.  But don’t you think it will make it harder when you prolong the suffering with gimmicks and scams?  If we kept a simple message and didn’t compound this problem further, we’d have a tough couple of years but now we are risking the fiscal sanity of our country because the banking system has our government in some form of deep capture.

Think for a few minutes.  At the end of the day, someone is going to have to realize those losses on all these toxic mortgages.  The only question is who is going to take the brunt of the fall?  Many borrowers are losing their homes yet somehow, the big banking centers are still up and running and supposedly turned a first quarter profit thanks to the taxpayer bailout.

These bailouts have compounded the mess.  In fact, it has clouded sound judgment.  I think most Americans would have been even okay with say a bailout that went like, “the median home price in America is roughly $150,000.  If you have a mortgage below that, we can take a look.  Anything above that and sorry.”  Instead, we are trying to game the system to unload the gambling happy California and mega-mortgages to the rest of the country.  Need I remind you that the state has 643,000 Alt-A mortgages with an average balance of $420,000+?  Sound policy involves foreclosure but you’ll never hear that from the pundits since they have their hand too deep in the bailout cookie jar.

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The Continued Crony Banking and Housing Industry Bailout: Foreclosure Scams, Japan Subprime Loans Coming Back, and Generally Bad Advice for American Consumers.

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First, before we go forward let us take a look at where we are at in this process (updated chart with gorgeous blue arrow):

As you can tell, much of what is occurring is status quo.  It will remain that way until the end of the year, when we shift from less than $2 billion in option ARM recasts per month to close to $4 billion at the end of Q4 of 2009.  Most of these loans are in California.  Of the over 2 million in Alt-A loans 643,000 are in California.  If you think we are doing much to address this look at these facts:

March 2009 Active Alt-A loans

CA:         651,000+

April 2009 Active Alt-A loans:

CA:         643,000+

If you think this adjustment is occurring because of fabulous workouts and loan modifications, think again.  Much of the losses are occurring because these loans are defaulting left and right and we have yet to hit the major recast wave as the above chart shows.  Alt-A and option ARMs are toxic waste and will be hitting California at a time where the state is financially vulnerable.  That is why when people ask me, “should I buy now in a semi-prime location?” I can only shake my head.  Why buy now?  The largest X-factor is looming less than a year away and you want to jump in to swim with the sharks?  What I have realized is psychologically, many people still believe in the bubble.  When I created the title of this blog, Dr. Housing Bubble - How I Learned to Love SoCal and Forget the Housing Bubble I was word playing with an old Stanley Kubrick film.  In Dr. Strangelove a delusional Brigadier General Jack D. Ripper sets off a chain reaction which leads into a nuclear nightmare because of one bad step after another built on a totally false premise (that the Soviet Union is looking to sap precious bodily fluids of Americans) but with real world consequences.  The housing bubble is this.  Initially, we started with easier lending standards, followed by dropping rates, then subprime, then we entered the Alt-A and option ARM world where we flat out gave fiscal time bombs to borrowers and now the global economy is facing the deepest recession since the depression.

Much was being made about a report released last week from the California Department of Corporations.  The report touts that loan modifications have jumped to a whopping “20,000″ a month.  The report is pertinent because it surveys servicers that work with 3.3 million of the state’s active loans, approximately half the total loans.  But all you need to do is read the report behind the headline to realize what a supreme comedy it is:

Click for sharper image

Now you know the rest of the story as Paul Harvey would say.  Here is the meat and potatoes of the issue.  First, let me clarify the top 3 rows.  This is for January, February, and March 2009 data.  So in March for example 111,000 loan workouts were initiated.  This of course may look good but means nothing since this is only the first step and doesn’t mean anything has happened aside from someone starting the ball rolling.  If we look at how many workouts actually closed, we see the real story.  Only 34,000 of the 111,000 initial workouts were complete.  Not bad you say.  Well if we dig deeper, only 3,430 Alt-A loans were worked out in March which at this rate will take us 15 years to modify all the loans!  Bwahahaha!  A load of crap-o-la being spun as some sort of good news.  Keep in mind, many servicers are now getting $1,000 for kicking the can down the road.  Oh, but it gets better:

This is where you grab your monitor and let out a savage scream and say, “what kind of load-of-crap is this!?”  So now let us breakdown those 34,000 workouts in March.  What is their idea of a workout?  Well for 22 percent of the loans, they basically froze the interest teaser rate for less than five years.  The next option which was used on 16 percent of the loans was lowering the interest rate to another teaser level.  So already, nearly 40 percent of the “workouts” are being dealt with artificially low rates!  This is the damn reason the Alt-A and option ARM loans are so toxic in the first place, they had freaking teaser rates to begin with.  And this is the most popular method of fixing these loans?  Come on now.  11 percent where kicked out the door through short-sales which really isn’t a workout and 5 percent were paid off.  These are probably those folks buying in semi-prime and prime areas jumping in while they miss the next housing bubble.  But you know what I love?  Only 36 loans actually had their principal balance reduced!  Bwahahahaha!  Give me one second.  Bwahahahaha!  Their idea of a workout is basically turning underwater homeowners into indentured servants who have fewer options than renters.  The only way these people will ever sell their home without coming to the table with money is if we have another housing bubble.  This leads us to the ridiculous CFPA.

The CFPA FAQ gives us their idea of fixing the mortgage problem:

“While a sustainable loan modification may be different for different borrowers, the potential ways a loan may be modified include any of the following:

-An interest rate reduction, as needed, for a fixed term of at least 5 years.

-An extension of amortization period for the loan term, for up to 40 years from the original date of the loan.

-Deferral of some portion of the principal amount of the unpaid principal balance until maturity of the loan.

-Reduction of principal.”

The government is basically advocating that these loans all become option ARMs.  40 year mortgages?  Deferral of principal amount?  What is this?  Did the government hire New Century Financial as consultants to devise this program?  Even those prime workouts are being pushed into this crap.  As we have seen from the actual data the reduction of principal is such a joke (see why the banking industry didn’t want cram-downs?).  36 loans out of the entire pool had their principal reduced in March of 2009 for the state of California.  So all this is doing is buying more time for the inevitable.  We all know that notice of defaults are skyrocketing even after the 2008 moratorium:

So these programs are really a joke and basically waste more money but that seems to be the way we operate.  Now keep in mind that we have seen very little plans that actually address the major issue.  JOBS! JOBS!  JOBS! Have people forgotten how you pay a mortgage?  You pay it with a thing called wages which you earn from working.  More and more Californians are losing those wages since we now have an 11.5 percent unemployment rate so how are they going to pay those 40-year mortgage payments?  Maybe on future loan modifications we’ll allow people to use unemployment insurance as their primary source of income.

As you can see, the Alt-A and option ARM tsunami is still heading this way.  Many of these programs being devised are betting (not explicitly) that another housing rebound is just minutes away.  This is utter nonsense.  Say you bought a $500,000 home that is now worth $250,000.  Does a 40-year mortgage and a lower interest rate sound appealing to you?  You are simply a renter.  By definition you won’t be building up any equity given that one of the options in the CFPA is negative amortization.  And do you really think that home will go up again?  If you wanted to sell you would find yourself in the same position as today.  Either a generous short-sale is approved or you walk away.  And for those that think real estate can’t stay down for a long time I offer you Japan:

Japan has seen stagnant housing prices for nearly two decades.  So by 2029 with a 5% 40 year mortgage, you will finally be at $250,000.  Congratulations!  You can now sell your home and get a whopping zero at closing (assuming you pay nothing on a sales commission).  Isn’t that basically renting?  The bottom line is many borrowers are going to look at these terms and if they have any sense, will simply stop making their payments and walk away.  Yet some banks are now using a strategy of not letting you foreclose!

“(WaPo) And even though a delayed foreclosure can be a blessing for some troubled homeowners, for others, it simply prolongs the financial distress, leaving them on the hook for the condition of the property. Even if they move out, they cannot move on.

“I have even begged them for a foreclosure,” delinquent mortgage-holder Charlotte Jensen said. When she realized she couldn’t save her Glen Allen home last year, she filed for bankruptcy, packed up her family and moved out. Nearly a year later, Bank of America has yet to take back the home.”

And since banks like pinching pennies from customers while bleeding taxpayers dry, they would rather a hot body stay in the place and maintain it instead of squatters or teenagers looking to practice their break dancing moves in the home.

The latest data still shows 2 million Alt-A loans floating in the United States.  California’s solution to the Alt-A and Option ARM problem? The solution is to turn more loans into Alt-A and option ARMs.  This is great thinking that we have come to expect from Sacramento.  The easy solution is this; those that over leveraged themselves should lose their home through foreclosure and find a rental.  Nothing to be ashamed about.  Lenders will need to eat their losses.  However, I get the deep feeling that the public-private investment program that starts next month is going to eat a lot of this crap up.  My sense is lenders are merely kicking the can down the road until they can kick the can to you.

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Alt-A and Option ARM Economic Disaster Update: California Solution? Workout 3,430 Alt-A loans in March. Good Job. All we have is an additional 643,000 Alt-A Loans in the State. At this Rate it will take us 15 years to Modify or Alter all Alt-A Loans.

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The most widely followed measure of inflation in the U.S. is the Consumer Price Index (CPI).  As the chart above indicates, we have seen our first year over year decline in the CPI since the 1950s.  Now keep in mind, last year we had the massive oil bubble which means we will probably have year over year declines for a few more months simply because oil nearly touched $150 per barrel last year. For our purposes we are going to look at consumer prices as our measure of inflation and deflation since this impacts most people in a more understandable way.  Now before going forward, it is important to look at what areas are contracting during this recession:

Now this is important to highlight.  The 12 month adjusted data tells us the following:

Categories with decreases:

Transportation

Energy
Categories with increases:

Medical care

Education

Food

Categories neutral or slightly up:

Housing

Apparel

Recreation

Now keep in mind this is over 12 months.  Yet if we look at the latest data, we start seeing that food and housing are now starting to decline.  A large part of this is because of the excess housing on the market and the BLS measures owners’ equivalent of rent (OER) which has been coming down.  After all, with 26 million unemployed or underemployed Americans hiking the rent may not get you new tenants in many markets.  Yet you will notice that in the last 3 months, every category aside from medical care and education has come down steadily.  The evidence so far is we have been experiencing deflation.

Now we are going to examine five major sectors of the economy and look deeper into the deflation and inflation debate.

Sector #1 - Housing Prices

(Deflation or Inflation) = Deflation

I’m not sure how anyone can argue that housing prices have seen any sign of inflation during the current recession.  The largest line item for Americans is housing and it has been contracting at a furious pace.  The reason the BLS over the past 12 months has seen a slight up tick is because of the OER measure.  Initially when the bubble burst, people shifted to renting which either neutralized prices or even slightly increased rental demand.  However, now that unemployment is raging and people are losing their jobs, the rental market is now being hammered which is now showing up in the CPI data.

Housing bottoms normally take two forms.  First, you will see a bottom in housing starts:

This is for 1-unit private housing starts.  As you can tell, the market has completely collapsed.  Yet if you squint, you can see a tiny yellow weed sprouting up.  Of course, this is the non-sense of green shoots, as if superman will suddenly emerge with a construction hat and save the day by building homes again.  In the case of housing starts, we may have hit a bottom but just put that into context in the chart above.  We still have the Alt-A and pay Option ARM disaster waiting for us and this will assure us more cheap inventory for years to come.  So in this sense, we may have already reached a bottom with housing starts but the thing many forget is we will never see peak bubble action like we did earlier in the decade.  Demographics and the flood of inventory via foreclosures assure us ample supply.  The second bottom takes the shape of lower prices and we are still falling in every sense of the word:

Prices are still going down.  The Case-Shiller Index is the best measure since it looks at same home repeat sales.  You have a few people like Jim Cramer talking about housing bottoms but they are looking at the median price.  The problem with looking at the median price is that it is artificially high in the mania phase and low when a flood of distress homes hit the market.  A perfect example is California where over 50 percent of homes sold are foreclosure resales.  Ironically, now that you are seeing more price cuts in mid to higher priced areas you will see the median price go up or neutralize.  Yet overall, prices are still heading lower.  This is something that I have examined in detail when I discuss the 10 Reasons why California will not see a housing price bottom until 2011.  I am looking more at the Case-Shiller data instead of the median price which can fluctuate wildly.

It is rather clear to any observer that we are seeing deflation in the housing market.  There is little debate here.  It is hard to envision any price pressure to the upside with such a horrible job market.  In normal times, people pay for their mortgages with jobs and not high flying banana republic mortgages like pay Option ARMs and Alt-A products.

Sector #2 - Auto Sale Prices and Sales

(Deflation or Inflation) = Deflation

There is little doubt that we are seeing deflation in the automotive sector.  With General Motors and Chrysler hitting rock bottom with bankruptcy, there is little pricing power here.  Certainly auto workers, a large employment sector aren’t seeing wage increases.  First, in 2008 the auto companies’ weak foundation was exposed with the oil bubble.  After all, who wants to drive around an urban tank with a V-10 engine on the 405 freeway?  It isn’t like you are driving in the Serengeti running away from rabid hyenas in treacherous terrain.  I would see one person in these behemoths stuck on the freeway idling in their tank as the $4.50 gallon of oil just evaporated into the atmosphere.

Some people feel bad about what occurred but keep in mind these companies prided themselves on cheap oil fueling their tanks forever and the high profit margins on these vehicles.  Even after the oil bubble imploded, the damage had already been done.  There was no coming back.  Now you can find many of these urban safari all-terrain vehicles on eBay and Craigslist selling for 50, 60, or 70 percent off their once MSRP.  Looking for a Cadillac Escalade?  You can get a 2002 with all the trimmings for a little under $17,000:

The fascinating thing that occurred during this bubble is the notion that everyone was rich and therefore should have the artifacts of the wealthy.  The poor had access to middle class credit.  The middle class had access to upper class wealth.  The upper class spent like a new Gilded Age was here.  The Escalade is a perfect example.  I would drive around areas in Los Angeles County were people were living in run down apartments but out in front you would see an Escalade.  Once again you can thank easy financing here.  You would have people living in giant McMansions with a $700,000 mortgage when they were only pulling in $100,000.  Early last year on the blog, I talked about people going broke on a $100,000 salary.  At the time, people had a hard time believing this.  Now, this is virtually a daily thing and many of these people are the folks living it up with the ticking Alt-A and Option ARM time bomb.

The fact of the matter is, auto sales have fallen off a cliff:

With all the attention being given to the housing bubble, we sometimes forget to mention that we also had an automotive bubble.  What allowed the automotive bubble to explode?  Easy and dubious financing once again.  Since the early 1990s auto sales never went below the 14 and 15 million annual sale mark.  This lasted well into May of 2008.  Think about that.  The stock market was already crashing and housing imploding yet we were still over 14 million auto sales per year!  Nuts.  The chart above is rather clear.  Annual sales have been cut virtually in half in one year.  So the dynamics in the auto industry reflect housing prices to some extent.  Lower prices.  What people also fail to examine is cars last much longer than they did in the past.  There is no reason to replace a car every three years with a new model.  A good car with proper maintenance can last you a decade.  Suddenly many people have no choice but to fix and hold onto their current car.

The Federal Highway Administration lists 247,264,605 motor vehicles in the United States.  From this number 134,000,000 are automobiles and 110,000,000 are trucks.  As of 2000 there were 105,000,000 households.  So basically we have two cars per household here and this does not include buses and public transportation.  So it isn’t like many people need new cars.  People are holding on to their cars more tightly and as you can see from the sales chart above, people are voting with their wallets.  Easy financing built up the housing and auto industries for the past decade.

Sector #3 - Cost of Education - Higher for Public but non-Elite Private will Implode

(Deflation or Inflation) = Deflation for non-Elite private and inflation for Public

As we highlighted early in the article, only two areas are now seeing inflation.  Those are medical care and education.  Education I hate to say is also experiencing a bubble with easy financing.  How many people do you know who went or sent their kids to a private non-elite college paying $40,000 a year in tuition to pursue a career that wouldn’t pay more than $30,000 a year?  Clearly, many of these people would have never been able to afford the tuition cost if it wasn’t for easy access to student loans.  That of course is now changing.  The Chronicle of Higher Education had a fascinating article examining this trend:

“Is it possible that higher education might be the next bubble to burst? Some early warnings suggest that it could be.

With tuitions, fees, and room and board at dozens of colleges now reaching $50,000 a year, the ability to sustain private higher education for all but the very well-heeled is questionable. According to the National Center for Public Policy and Higher Education, over the past 25 years, average college tuition and fees have risen by 440 percent - more than four times the rate of inflation and almost twice the rate of medical care. Patrick M. Callan, the center’s president, has warned that low-income students will find college unaffordable.

Meanwhile, the middle class, which has paid for higher education in the past mainly by taking out loans, may now be precluded from doing so as the private student-loan market has all but dried up. In addition, endowment cushions that allowed colleges to engage in steep tuition discounting are gone. Declines in housing valuations are making it difficult for families to rely on home-equity loans for college financing. Even when the equity is there, parents are reluctant to further leverage themselves into a future where job security is uncertain.”

I am not surprised at all by this.  It was stunning to see many people go to private schools to study a career that was fading and dishing out $50,000 a year to pursue their “dream” field.  Again, this notion of having access to everything right now is the fuel that made people feel that they needed the “dream house” and the “dream car” and the “dream vacation” only to wake up in a debt induced nightmare.  Few of the fields like engineering, education, or medicine appeal to Americans because why go into these fields where you have to learn “math” when you can go into selling real estate for six-figures a year with only a GED.  Of course that game is now over and probably many of these private institution catering to these dream degrees will fade as well.

What we will now see is value added for certain educational fields.  No longer will a B.A. in Basket Weaving land you a promising job into the middle class.  I do want to make a distinction here.  Private elite colleges will still have some pricing strength because of their names.  And many public schools will have fierce demand because they are lower priced and offer a lucrative option to many.  Take for example the University of California and California State University systems here in California.  Both institutions are hiking tuition by 10 percent (again) and they are actually taking less students:

“(Daily Sundial) An even larger proposed budget cut is anticipated for the entire CSU system.

The original planned budget reductions, which would have fallen just below the $100 million mark, could now reach as high as $400 to $700 million.

For CSUN, this large discrepancy would mean cuts of up to $49 million, far from the first figures of just under $7 million.

“California is dealing with a budget shortage of more than $24 billion. A financial meltdown,” said Erik Fallis, the media relations specialist at the CSU chancellor’s office. “As a consequence, the CSU is facing an unprecedented cut in state support.”

Unprecedented is the key word in these latest figures. When Gov. Schwarzenegger announced the first proposals in 2008, CSUN had already pooled money in reserves in preparation for this type of situation, said Harry Hellenbrand, CSUN’s provost and vice president for academic affairs.

According to CSUN’s budget update web site, if the CSU budget for the upcoming year is cut by approximately $600 million, all campuses will have to reduce their incoming students by 40,000 instead of the projected 10,000.

While tuition increases and class reductions are obvious, other solutions to curtail the budget aren’t definitive.”

There you have it.  We are assured that the UC and CSU will be hiking fees for the next few years because of California’s horrific budget planning and $24 billion budget deficit.  And with California’s 11.5 percent unemployment rate (the highest in record keeping history) you can rest assured that many will go back to school to pursue a degree (or another one if they have fallen into a career with little viability.  So in education you will see a split in the market.  Public universities will accelerate tuition hikes, curtail enrollment, and become more like private elite institutions.  Non-elite private colleges will have the hardest time adjusting since people will begin questioning the value of degrees and also, lack of loans will slow enrollments down.

Sector #4 - Employment - Wage Cuts - Hours, Furloughs, and Layoffs

(Deflation or Inflation) = Deflation

There are few things more deflationary than unemployment.  Would you work one month for free if your employer asked you to?  Well if you work for British Airways, they have already asked this question:

“(Yahoo!) British Airways is asking thousands of its staff to work for free for up to four weeks, spokeswoman Kirsten Millard said Tuesday.

In an e-mail to all its staff, the airline offered workers between one and four weeks of unpaid leave — but with the option to work during this period. British Airways employs just more than 40,000 people in the United Kingdom.

Last month, the company posted a record annual loss of £400 million ($656 million).”

Now think about that.  This only adds more pressure to prices on the downside.  When you yank the pay of an employee either through cutting hours or asking them to work for free, they have less money to spend.  This is also happening in the U.S. where companies are furloughing people or cutting back on overtime.  In our country where nearly 70 percent of GDP is consumption based, what do you think this will do for spending?  Of course people point to the trillions in bailouts but I haven’t seen any of that money rolling my way.  Have you?  Unless you are part of the crony banking syndicate you are basically bailing out those who created and financed this mess in the first place.

With 26,000,000 unemployed and underemployed Americans, there will be more pricing pressure on the downside.  This chart below shows how weak the market is in terms of pricing power:

Some people point to the 1970s of a time where inflation raged and we had price jumping up in the face of recession.  This was the so-called stagflation.  Yet much of this was again based on energy but also, the nature of globalization wasn’t as big as it is now.  We still had some control.  Now, we have essentially out sourced our entire manufacturing base and became a service driven economy.  Nothing was more prominent than when GM filed for bankruptcy, Wal-Mart announced it would be hiring 22,000 more people.  Trading $20 an hour jobs for $10 an hour jobs.  That is deflation in wages.

But if you notice the above chart, both aggregate hours worked and inflation are both plunging.  What does this tell us?  That deflation for the moment it taking hold of consumer prices and wages.  Aggregate hours is a more sensitive indicator than overall employment since it looks at aggregate weekly hours worked.  In fact, this may be a good indicator of when things may start turning up since companies may not be hiring people early in the recovery when it comes but instead, using the British Airways example will start paying those employees who took the month off for the month.

Even major strongholds like state governments will be cutting wages and not hiring as much:

“LOS ANGELES, June 21 (Xinhua) — In response to California’s budget crisis, more than half of the state senators have agreed to reduce their 116,208-dollar salary this year, most taking a five-percent cut starting July 1, it was reported on Sunday.

During budget negotiations last week, Senate President Pro Tem Darrell Steinberg took the lead by offering to have his salary reduced by five percent, according to the Los Angeles Tims.”

Now of course this is a joke especially here in California where we have one of the most dysfunctional politicians up in Sacramento.  But tens of thousands of state workers have already been furloughed in effect taking a 10 percent pay cut.  Does that sound like inflation to you?  And the power of the unions which once had a say in pricing power has little clout in a global marketplace.  How are you going to compete with China and India and their wages?  You can’t.  Plus, Americans like cheap goods.  Unless we do boneheaded moves like the Smooth-Hawley Tariff Act we can expect more pricing pressure to the downside.

Sector #5 - Stock Market Losses

(Deflation or Inflation) = Deflation

The stock markets are off by 40 percent from their 2007 peak which shows the depth of the collapse since we have had a virtually non-stop rally since the March 2009 lows.  I’ve been re-reading Charles Kindleberger’s The World in Depression 1929 - 1939 which is a fantastic read about the global collapse during the 1930s.  It is a dense read but worth it if you really want to understand the multiple factors that led to the Great Depression.  Some are arguing that the current pains we are feeling are because of the stock market crash.  I tend to believe the crash of the stock market is a symptom of the global debt bubble we went through.  This is what Professor Kindleberger had to say about the stock market crash during 1929:

“In the light of the sudden collapse of business, commodity prices, and imports at the end of 1929, it is difficult to maintain that the stock market was a superficial phenomenon, a signal, or a triggering, rather than part of the deflationary mechanism.  One should not be dogmatic about it, but it is hard to avoid the conclusion that there is something to the conventional wisdom that characterized the crash as the start of a process.  The crash led to a scramble for liquidity on the part of both lenders to the call market and owners of stocks.  In the process, orders were canceled and loans called.  The action of the Federal Reserve in buying securities in the open market and lowering the rediscount rate in New York brought credit markets quickly into good order.  By this time, however the deflation had been communicated to fragile commodity markets and durable goods industries.  The stock market crash is less interesting for the irony it permits the historian, bemused by the foibles of greedy men, than for starting a process that took on a dynamic of its own.”

In our current case, the stock market crash was merely reflecting the collapse in the credit markets and the housing bubble bursting.  The stock market did not create this recession but is merely reflecting  the reality on the street.  When we hit the peak in 2007, it reflected the peak of euphoria.  When it busted, it reflected the panic.  The current jump is optimistically betting on a second half recovery which fails to adequately analyze the commercial real estate bubble bust which is going to hit us and the immense amount of toxic assets still in our system.  Even if we dump all these toxic assets onto the taxpayer, they will fail and guess who will end up paying for it?  In the end, prices will still need to find a bottom.

Let us take a look at the Dow World Index:

Now if we look at the Dow World Index, we see that prices nearly fell by 60 percent to the March bottom.  And since that bottom, it has rallied by 47 percent but is still off by 40 percent.  The bottom line is that the world is in recession.  This is not isolated.

Looking at these five major sectors you realize that deflation seems to be the major issue at our door.  And what people fail to realize is that American households have lost a stunning $13.87 trillion in wealth from stocks and real estate.  So even though the Fed and U.S. Treasury are saving their crony banking buddies, the bottom line is the average American is still suffering.  The Atlantic has a great break down why most Americans feel like they are getting shafted in the current scheme of things:

So while American households just lost $13.8 trillion only $700 billion or so will be felt by the average American.  The rest of the trillions will go to bailout and patch up the Swiss cheese balance sheets of the Wall Street cronies.  By this time during the Great Depression we were already marching people down to the Pecora Investigations bringing justice to those who brought the economy to a halt.  Today, we are still giving more and more power to those who are largely at the helm of this mess.  So for the time being, demand destruction is leading to price deflation.

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Deflating our way to Prosperity: Five Major Sectors of our Economy Pointing to Demand Destruction Price Deflation. Education, Wages, Housing, Stocks, and Automobiles.

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