America has built a large part of its economy on homeownership.  Owning a home is part of the ever more elusive American Dream.  Yet over time, owning a home became a larger and larger burden as new buyers were required to take on bigger debt loads merely to buy a basic home.  Incomes weren’t rising so debt was the new subsidy.  The apex of the bubble was reached in 2005 although prices didn’t start falling in drastic fashion for a couple years later.  The U.S. Treasury and Federal Reserve are largely to blame for inciting the biggest housing bubble the world has come to know.  Wall Street is equally to blame for creating the structure that allowed this to happen as they championed de-regulation and completely neglected any fiscal responsibility.

In today’s article, I will dissect the housing market from every angle.  It is easy to get caught up in the day to day data but the bigger picture is usually missed.  Let us first look at the total number of housing units in the U.S.:

us housing units

In the United States we have approximately 129,000,000 housing units.  These are made up of owner-occupied, rented, and vacant units.  The largest of these three categories is the owner-occupied category and most of the media focuses on this number.  Yet the other categories carry as much weight in determining a housing recovery.  Let us look at the vacant housing units:

The vacancy rate for both owner-occupied and rental properties is still near all time highs.  With so many sales, how can it be that this number is so high?  I’ll get into this later in the article.  But part of this has to do with demographics, the makeup of current housing inventory, and years of over building.  It is also the case that we are shifting a large number of would be renters into homes and causing the rental vacancy rate to spike.  Many of these apartment projects are financed with commercial real estate loans and the Federal Reserve is essentially shifting defaults from residential loans to commercial loans.  That is why we are seeing rents fall as owners compete to fill vacant units.

So now we have the universe of housing units including vacant units.  Let us drill down and examine the number of owner-occupied homes and renter-occupied units:

75 million Americans own their home.  The homeownership rate is derived from only looking at occupied units.  That is why it is important to also keep in mind the vacant units sitting on the market.

You’ll notice that the ownership rate does not factor in the vacant units.  The vacancy rate is at historical highs and this is another factor that will drag on the housing market for years to come.  37 million Americans rent their housing.  This can be apartments or actual detached homes.  The number of renters has recently increased as homeownership has fallen:

The chart has a few patterns worth noting.  From 1985 to 1995 the homeownership rate in the U.S. hovered around 64 percent.  The only recession during this time was in the early 1990s yet the rate remained steady.  The first spike started after 1995.  This trend went from 1995 to 2000 and pushed the homeownership rate from 64 to above 67 percent.  Part of this had to do with the technology bubble and the growth in the economy.  But then we hit the early 2000s recession largely brought on by the burst of the technology bubble.  Instead of homeownership declining which is typical in recessions, the homeownership rate expanded upward.  Much of this was due to Federal Reserve Chairman Alan Greenspan dropping the Fed funds rate to record lows.  Wall Street looking for the new-new thing, went from tech IPOs to mortgage backed securities and the toxic mortgage party started.

This easy access to credit and excessive risk pushed the homeownership rate to nearly 70 percent in 2005.  But that was it.  The bubble burst and the homeownership rate is now on a steady decline.  While the above chart is moving lower, one chart is moving higher.  The U.S. home vacancy rate:

Rental properties always have higher vacancy rates merely by the nature of their use.  Someone renting a home is more likely to move than say someone who buys a home and plans to stay in their home for many years.  Yet the above chart shows an unmistakable pattern.  The rental vacancy rate from 1968 to 1984 hovered between 5 and 6 percent.  From 1985 to 1999, it was in a range of 6 to 8 percent.  And finally, from 2000 to our present situation it went from 8 percent to 10 percent.  This is historically as high as it has gone.  You will notice that the rental vacancy rate dipped after the peak in 2005 since many people opted for rental units instead of buying a home.  Yet the pattern is still holding steady.

Now looking at the homeowner vacancy rate shows another story.  Too much building.  From 1968 to 2004, the rate never crossed the 2 percent mark.  Now, we are closing in on 3 percent.  That rate may not be reached now that the market is shifting gears.  But if we do have another foreclosure wave, 3 percent is possible.  What happened here?  Too much building and ignoring demographic trends:

From 2001 to 2006 home building was off the charts.  Single-family housing starts were up to a seasonally adjusted rate of 1.8 million a year even though population growth did not warrant this amount of new inventory.  From 1999 to 2001 the rate was hovering around 1.2 million.  So 600,000 properties were being added each year above the normal trend and this lasted for 6 years.  Of course, this number has collapsed at a pace not seen since the Great Depression but why did it occur?  People ignored the trend and demographics:

The above data exemplifies the housing bubble.  Each year roughly 500,000 homes are destroyed for a variety of reasons.  This of course isn’t discussed in the mainstream media but it helps to figure out a more accurate figure of what is going on.  Most households will buy their first home in the 25 to 34 years age group creating a demand of 1.9 million homes.  We also have homes hitting the market because of the other side of the age equation.  We have 11.6 million households in the 65 to 74 age range and 9 million in the 75 to 84 age range.  Life trend dynamics (i.e,. death and downsizing) add 1.1 million units per year to the market.  In other words, here is the breakdown:

Now this data is using trends up to the end of 2008.  We were burning through 350,000 excess units per year at the end of 2008.  Of course, housing starts have now collapsed and are adding new units at an annual rate of 500,000 homes.  So a significant indicator of returning to a healthy market is more linked to the actual vacancy rate.  In fact, adding up the units we have about 3 million too many units on the market over historical trends.  Depending on our current burn rate, we have:

3 million / 350,000 = 8.5 years

3 million / 850,000 = 3.5 years

And this is the time it will take at current rates to get to a more normal market if there is such a thing.  Yet the 850,000 figure is too optimistic because we now have a new factor in the mix in the sales data.  Foreclosures:

For the past year, each month over 300,000 homes enter some stage of foreclosure.  This is either a notice of default, a scheduled auction, or a home going back to the bank as an REO.  This number actually increases the length of time before we reach a stable housing market.  As you can see from the chart above, the rate is still at a record.  Now why is this the case?  Think of the dynamics of a healthy market.  Those in the household formation age, sell a home and in many cases will buy a move up home.  This can be a new home or an existing home.  Either way, they are clearing some of the vacant inventory off the market with typically two transactions taking place (buy and sell).  With foreclosures, it is normally a one and done deal.  Someone loses their home, and the person buying that home is merely taking over inventory that has already been accounted for.  This is why looking at foreclosure figures is so important.  Even in 2006 foreclosures were elevated.  If you consider that year as normal, foreclosure starts should range around 100,000 per month.  We are solidly over 300,000.

We still have many more foreclosures coming down the pipeline with Alt-A and option ARMs hitting significant recast dates.  This will only make it harder for us to clear that massive amount of excess inventory just sitting on the market.  With nearly one-third of homes sold nationwide as foreclosure re-sales, the excess inventory is sure to linger for a very long time.  Take a look at existing home sale data:

I’m taking the non-seasonally adjusted rate because with historical foreclosure rates, looking at typical data really does little in answering the real question of where we are going.  In September 472,000 existing homes sold.  Add in about 40,000 new homes sold and you are looking at 512,000 total home sales.  However, in the same month 343,000 homes entered into some stage of foreclosure.  Forget the data on HAMP for the moment since the 650,000 or so pre-trial loan mods means very little, the actual cure rates are extremely low:

We’ll be optimistic and use the 6.6% figure.  That means, of those 343,000 foreclosure starts 321,000 units are going to be additional inventory.  So even with 512,000 homes minus the 321,000 added units, we are not burning off excess inventory in any significant number.  And that is why the vacancy rate is still jumping and homeownership rates are falling.

It also doesn’t help that mortgages are delinquent at a rate never before seen (aside from the Great Depression):

Over 9 percent of all mortgage holders are now delinquent on their mortgages.  Of the 75 million homeowners 51 million have mortgages.  So that means as things stand today, close to 5 million mortgage holders are delinquent on their loans.  Since we are not seeing this in the REO data, this must mean the following:

(a)  30+ days late and no notice of default

(b)  90+ days late and a notice of default (reflects in monthly foreclosure data) – or 90+ days late and no action at all

(c)  Auction scheduled

(d)  HAMP – 650,000 in pre-trial

Yet the cure rate is at 6 percent and this is for prime loans.  We know that we have Alt-A and option ARMs coming due in the next few months and none of these qualify for HAMP.  Wells Fargo announced that they are converting over $100 billion in Pick-A-Pay option ARMs to interest only loans but who really knows if this will even help.  Already for the option ARM universe, some 45% of option ARM borrowers are 30+ days late.

Conclusion

What can we gather from the above data?  Home prices are falling even though data in the short-term might state otherwise.  This is due to artificial inventory figures because of mortgage moratoriums and banks not moving on distressed homes in a typical fashion.  There is an enormous amount of overhang in the market.  Using typical measures the data doesn’t show up but does show up in shadow inventory data.  The reason home sales have increased recently is because prices have collapsed:

Why are we to assume that if prices go up, people will keep on buying?  The driving force right now is affordability brought on by:

-Large number of foreclosure re-sales (nationwide about one-third of all sales, in California it was up to 50 percent of all sales)

-Government programs including the $8,000 tax credit

-Federal Reserve buying GSE MBS – no one else is buying them

-Artificially lowering mortgage rates (hovering around 5% while 40 year average is closer to 9%)

With all the above, we are merely treading water.  What we can gather from the above is we have years to work through this.  Also, the growing number of baby boomers shifting into retirement will also add to the additional housing units at a higher pace since those in the 25 to 34 years of age group are no longer having families in large size.  Many may opt to rent for much longer since some are delaying having kids until later in life.  In other words, the trend is not conducive to the McMansion world.

There are many factors to consider in the current housing market and it is my hope that this article helps to show the bigger picture of what is going on.  This is how I learned to stop worrying and love the housing bubble.

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The Comprehensive State of the U.S. Housing Market: Learning to Love the Housing Data and Forgetting the Economic Facts. Everything you wanted to know about U.S. Housing Trends.

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On Friday we were served with a chilling reminder that the unemployment riddle has yet to be solved.  Wall Street still managed to perk up.  Why?  Stock market cronies now believe the Federal Reserve will not hike rates for a very long time thus spurring a positive gain even though unemployment is now up to 10.2 percent.  If we look at the underemployment measure of U-6 the rate soars to 17.5 percent (in California the rate is 22 percent).  Yet there is this pervasive school of thought that housing prices are now set to boom even in the face of rampant unemployment.  This is a carry over from the bubble halcyon days.  In fact, I hear people talking about buying up foreclosures and flipping the home for a double-digit profit.  This is reminiscent of 2005 except for the fact that our unemployment rate in California has nearly tripled but don’t let that get in the way of the gold rush mentality.

The real action is in the shadow inventory.  As you might have noticed, those preaching the gospel of “no shadow inventory” are largely gone.  Now their argument has shifted to the obvious that when banks have a REO, they move on it quickly.  Sure.  We can agree on that point.  Yet banks are not moving to the REO stage.  Moratoriums, delays, and flat out incompetence rule the day right now.  REOs are but one small part of the shadow inventory.  The real hidden inventory is with the massive amount of pre-foreclosures and homes that are in mortgage purgatory.  That is, homes that are destined or prime for a strategic default or are already in default but the bank is simply holding back on even filing a NOD.  As I discussed in the last article, Wells Fargo is jumping ahead of the option ARM freight train stating they will convert over $100 billion in Pick-A-Pay loans to interest only loans.  Now why would they be doing this if these loans were in good shape?  Try telling this to those so laser focused on housing that they fail to miss the fact that our economy is in the worst shape since the Great Depression.

Before we examine our Real Home of Genius today in Costa Mesa, let us survey the nationwide foreclosure picture:

nationwide foreclosures

As you can see from the chart above, nothing has stemmed the rise in nationwide foreclosures.  The only thing we have accomplished is creating the greatest generational wealth transfer we have ever witnessed.  And it didn’t take a revolution either.  Every program devised to help the housing industry has failed thus far.  We have committed nearly $13 trillion in bailouts and handouts to Wall Street and the banking industry.  With that amount, we could have paid off every single mortgage in the United States and still have some $2 trillion to go to Vegas and gamble!  Then again, this isn’t really about protecting the American homeowner.  This is about protecting the crony oligarchs on Wall Street.  How much more data do people need?

Take for example the current sham that is sucking a lot of people into the California housing expedition.  Let us first look at MLS inventory for Southern California:

mls inventory socal

Wow, things are going really well!  Forget about the $60 billion in budget deficits we just had to contend with or the fact that 1 out of every 5 Californians is either unemployed or working part-time for economic reasons.  Housing is selling like pancakes.  Or is it?

Let us do a mini case study on a middle class city in Orange County.  We will examine the city of Costa Mesa.  Doing a quick search on the MLS pulls up 172 listings:

MLS listings:                 172

Short Sales:                  40

Foreclosures:                2

Not bad given that 61 homes sold last month.  At that rate, we have less than 3 months of inventory.  But let us look at some shadow inventory:

costa mesa shadow

Pre-foreclosure:            205

Auction:                        235

REO:                            49

Ah ha!  This is where the delusion sets in.  The public can view 42 distress properties but only 2 are actual foreclosures.  Banks own 49 properties.  So 47 are sitting off the books.  This is the tiny number.  Those scheduled for auction and pre-foreclosure are the big deal.  This is where we are going to see massive losses.  Some need concrete examples so let us give them one.

Today we salute you Costa Mesa with our Real Homes of Genius Award.

Costa Mesa – Million Dollar Home with 3 Bedrooms

Picture in your mind a million dollar home.  Got that image?  Think of how the property would look and where it would be located at.  Let us show you a home that probably reflects your vision:

The above is a 3 bedroom and 2 baths home.  Let us look at some sales history as well:

costa mesa sales

08/12/2004:     $670,000

03/24/2005:     $824,000

You would think that the above is incredible but if we dig deeper into the data.  We see the power of the California housing bubble:

Did you get that?  After the home was purchased for $824,000 in 2005 it was refinanced and the loan amount on the home totaled $995,000.  This was done in 2006.  Nearly one million for a 3 bedroom home in Costa Mesa.  Incredible.

The home is now listed as a short sale selling for $625,000.  The home has $26,000 in back payments so it is likely this home will be foreclosed.  Welcome to big league losses here.  That second mortgage is virtually gone.  Now we are cutting into the first.  You think this is the only home in this shape out of the 205 pre-foreclosures, many that aren’t even listed?  Think again.

Today we salute you Costa Mesa with our Real Homes of Genius Award.

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Real Homes of Genius: Costa Mesa Shadow Inventory. MLS has 172 Listings while Distress Properties Register at 489. 3 Bedroom Million Dollar Home in Costa Mesa?

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The fascinating thing about the Fannie Mae initiative and the Wells Fargo program is that homeowners are converted to renters.  Think about it.  In the case of Fannie Mae, you explicitly sign over the deed to the organization and sign onto a yearly lease like 50 percent of California renters.  Not uncommon but will people be able to cover the monthly rental rate?  They are planning on going with a market rental rate but as we all know, rents are going lower in a financial limbo.  Any short fall is going to be covered by the taxpayer (yet again).  Why not take back the home, sell it for market value and allow the current borrowers to find a rental that is more affordable?  With the Fannie Mae plan, I’m not sure how many people will take this up.

Wells Fargo – From Option ARM to Interest Only

The Wells Fargo plan is another beast altogether:

“(WSJ) Wells Fargo & Co.’s strategy for modifying troubled Pick-A-Pay mortgages looks like a game of kick-the-can-down-the-road.

The fourth-largest U.S. bank by assets holds about $107 billion in debt tied to option adjustable-rate mortgages, a relic of the U.S. housing boom that allowed borrowers to make small monthly payments in return for increasing their mortgage balance. Many such borrowers now own homes worth far less than they owe in mortgage debt, and most can’t afford a full monthly payment that pays down the loan’s principal.

To solve that conundrum, Wells Fargo is taking a gamble: The San Francisco company is issuing thousands of interest-only loans that will defer borrowers’ balances for as long as six to 10 years.”

Now let us run a scenario on why this won’t work.  First we need to look at how the Pick-A-Pay mortgages acquired from World Savings are structured:

Source:  Mortgage-X

Wells Fargo didn’t make these loans.  These were acquired when genius Wachovia decided to purchase toxic lender Golden West at the height of the financial speculation orgy.  That doomed Wachovia.  But here we are nearing 2010 and the option ARMs are still sitting there exploding because of the above worst case scenarios.  Wells Fargo is jumping ahead of this because many of these loans are hitting negative recast ceilings.  That is, 80 to 90 percent of option ARM borrowers went with the minimum payment option that didn’t even cover interest.  Each month, additional principal was added to the overall balance.  That is why even when people talked about “well that is different for Wells Fargo, they have the Pick-a-Pay based on a 10 year model” it didn’t really matter because of the recast ceiling.  Like I have said with option ARMs, no one really cares about the time because the negative recast window was going to hit much quicker than the actual 10 year mark.  In fact, 45 percent of the option ARMs are now 30+ days late.

Take a look at a $500,000 option ARM example:

Here is where it becomes obvious why these mortgages were going to fail.  Borrowers had four payment options:

-1.        30 year fixed payment (principal and interest)

-2.        15 year fixed payment (principal and interest)

-3.        Interest only payment (aka renting)

-4.        Minimum payment (negative amortization – 80 to 90 percent of borrowers went with this option)

So most of these loans are doomed.  But look at by how much the loan was growing each month with the minimum payment:

Interest only ($3,141) – Minimum Payment ($1,666) = $1,475 tacked on to the balance each month (at least)

That is why I wouldn’t jump on the bandwagon that this is a success already.  That minimum payment was so low, that it may be less than the current market rental rate.  And as you can see, the difference between the minimum payment and interest only payment is enormous.  And look at it this way.  Say you bought a home with an option ARM for $500,000.  You were making that minimum $1,666 payment each month.  Since you paid the minimum your balance might be at $550,000 to $575,000 depending on the index being used to calculate your loan.  Yet your home is now worth only $250,000 or $300,000.  What is the interest only portion of a $500,000 mortgage?

$500,000 30 year interest only portion @ 5.5% =         $2,291

$500,000 30 year interest only portion @ 4% =            $1,666

Now that is a familiar number.  Keep in mind Wells Fargo would have to write-down that additional balance growth because they have been calculating that into their revenue thus far.  Even with this move on these option ARMs, major losses will be taken in.  The question is, will people want to be renters for six to ten years in these homes?  I doubt this will be a major success for three primary reasons:

-1.  Strategic defaulters – many bought these places as step-up homes in California.  They never intended on living here for 5, 10, or 15 years.  It was merely a way to get equity to buy that other McMansion.  Since 58% of option ARMs are here in California, this is largely a bubble state phenomenon.  For someone to sign onto this, they will basically become renters since they are not building equity and the only real winner is Wells Fargo because they can still claim that the home is worth $500,000 even though the reality is much different.

-2.  Rents are dropping – Keep in mind that many of the minimum payments were lower than rents.  So even with the interest only loan, many will opt not to stay in their place because they can find a cheaper rental.  We know that 80+ percent of these mortgages were stated income.  Many are defaulting because people didn’t have the money to begin with.  Many won’t be able to prove that they can even afford the interest only payment without a writedown to market value.  But at that point, Wells Fargo can just foreclose and sell the home and be done with it.

-3.  High Unemployment – California now has an unemployment rate of 12.2. percent and an underemployment rate of 22 percent.  Many people will lose their home no matter what is done because of the economy.  In fact, we are hearing stories of people moving back home with parents, doubling up, or other novel ways to make ends meet.  It is much too optimistic that Wells Fargo believes a large portion of their Pick-a-Pay borrowers will stay just because they are now on an interest only schedule.

Fannie Mae Solution – Become a Renter

fannie mae

Fannie Mae is losing money like a drunken gambler in Vegas.  The best analogy I can think of for the current bailout structure is this.  You have a gambler that is told, if you win you get to keep all the winnings but if you lose, the house will cover you completely.  So if this gambler hits a losing streak, wouldn’t they just double down to recoup losses quicker to make up for the past?  After all, the house is assuring that they won’t lose.  Welcome to modern day Wall Street.

Fannie Mae after reporting a quarterly loss of $18.9 billion has the chutzpah to ask the government for $15 billion in additional funds.  We already own Fannie Mae, so this is like having a schizophrenic talk with yourself and answering your own question.  There is madness in the current government structure.

The new “idea” for Fannie Mae is a Lease-for-Deed program.  In other words, after two years of trillion dollar bailouts and failed plan after failed plan, Fannie Mae has come up with a wonderful plan.  “Hey, since these homeowners can’t afford to own these homes because our underwriting is less than Kosher, how about we do something that is completely unheard of in the modern era.  Let us do this thing called renting!”  This is basically the plan:

“WASHINGTON – Can’t pay the mortgage? You still might be able to stay in your home. Government-controlled mortgage company Fannie Mae is going to give borrowers on the verge of foreclosure the option of renting their homes for a year.

The change announced Thursday could give a temporary break to thousands of homeowners, but critics question whether it will only add to the mushrooming losses at the company, which has received billions in taxpayer money.

The new “Deed for Lease” program will allow homeowners to transfer title to Fannie Mae and sign a one-year lease, with potential month-to-month extensions after that. It also helps save money because the lender does not need to complete the often lengthy and time-consuming foreclosure process.”

What does the Fannie Mae and Wells Fargo plans have in common?  They are both methods to fluff the foreclosure numbers temporarily.  Think about this.  Each plan is temporary and both are betting on a quick housing recovery.  Let us use that $500,000 option ARM mortgage on a home valued at $250,000.  How long will it take to reach $500,000 assuming a 5% annual appreciation rate?

future value

15 full years at 5 percent annual appreciation!  Keep in mind that since the recession started, the CPI is running at negative or close to zero.  So the borrower that elects to do this after 15 years, might be lucky enough to walk away from their home with no equity.  The only winner is really Wells Fargo.  There are plenty of rentals on the market right now for excellent prices.  It will be interesting to see what other lenders do here in California.

Yet the Fannie Mae plan converts homeowners to renters.  The deed is given over to Fannie Mae.  Will people want to do this?  Hard to say.  The data so far isn’t encouraging:

“In the first nine months of the year, Fannie Mae took ownership of nearly 2,000 properties through a process known as a deed-in-lieu of foreclosure. That pales in comparison to the 90,000 foreclosed properties the company repossessed in the period.”

Now these are actual foreclosures.  That is a “deed-in-lieu” is essentially handing over your rights to the property to the lender.  If stats like this go with the lease for deed program, it will be another failure.

Glad our bailout money is being used for creative and innovative ideas.  After all the talk and trillions funneled into the abyss, the answer now looks to boil down to renting.

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Fannie Mae and Wells Fargo Announce Creative Mortgage Solutions: A New Thing Called Renting. Option ARM Scenarios, Lease for Deed, and Delaying the Financial Future.

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It is always good to put things into context.  We can all admit that in 2009, sales did jump up in Southern California.  Over half the state lives here, so this is a good overall barometer of how things are playing out.  How significant is the sales jump this year in relation to other years during the decade?  Let us find out:

At the peak over 362,000 homes and condos sold in Southern California in 2003.  Assuming the “torrid” pace of 2009, we are on track for 230,000 to 240,000 sales this year.  That doesn’t even come close to any of the boom years.  Also, 45 to 50 percent of all home sales in 2009 have been foreclosure resales.  So this is another factor to keep in mind.  The bottom line is even with massive price drops, the market is nowhere close to the bubble days.  Let us break down the data further:

What this chart tells us is that home sales increased because of massive price drops.  That is, if half the market is distressed sales and these are sold at markedly lower prices by default (otherwise they wouldn’t be distressed) then we are to reason that the movement has occurred because of lower price points.  In other words, wouldn’t you think an increase in price would stifle this trend?  Absolutely.  The Alt-A and option ARM issues will start resonating stronger in 2010 and this will begin to add pressure on the mid to upper tier markets.  Yes, delusional folks who can’t see outside their tiny niche market don’t look at charts like the above that show the median price falling by 50% and still being near the bottom for the entire region.  After all, their area is special.

And easy lending has allowed another surge in mini bubbles.  People are once again jumping into over priced homes in California.  Yet I believe this is merely a false bottom.  Why?  First, the state is still in a fiscal mess that really seems to go on for a few years.  People should gear up for more cuts and tax hikes.  Those that believe Prop 13 is sacred should ask Texas and New Jersey how their property tax rates look like.  California is a tax happy state.  High personal income tax, sales tax, and other taxes so why are we to believe that anything is off the table?  I’m not saying this is good or bad but when you box a big tiger like this in a corner, don’t be shocked if you get bitten.  And for better or worse, property tax revenues are a much more stable source of income than say, personal income taxes and sales taxes that directly fluctuate with recessions.

Setting that aside, the Alt-A and option ARM problem is still there.  Getting a loan is not as easy as you once thought.  Take this for an example.  Notice how much fewer credit card offers you are getting in the mail?  Well this is because in Q3 of 2006 credit card companies sent out a stunning 2.1 billion in direct mail solicitations.  For Q3 of 2009 389 million were sent out.  What do credit card companies know that the recovery cheerleaders don’t know?  Could it be that defaults are through the roof?  Possibly.  It could be that 22 percent of California is unemployed or underemployed:

This above rate is unprecedented.  So why is it good news that we are lending big mortgages through FHA insured loans in many cases, to people that are stretching their dollar much too thin?  Isn’t this what got us into this crisis?  Yes.  Are we to expect a different outcome?  No.  And riddle me this.  If this economy recovery is legit why are we now talking about a second stimulus and needing to extend the home buyer tax credit welfare voucher?  Go by actions, not by words.

California Insurance Fund

As you would expect, our unemployment insurance fund is bleeding money:

“(OC Register) California’s unemployment insurance trust fund is bleeding money with state officials estimating it will be $27.3 billion in the hole by the end of 2011, according to a new state forecast.

Officials already were projecting major deficits in the fund a year ago, before the full impact of the banking crisis hit in late 2008.  The fund’s losses accelerated this year as the country plunged into its deepest recession in 70 years with California’s unemployment rate hitting a modern-day high of 12.3% in August.

Employers, who support the fund through a tax on each worker, are expected to contribute $4.3 billion  this year but that is nowhere near the $12.5 billion that is projected to be paid out in benefits. After eking out a $326.2 million surplus in 2008, the trust fund is expected to be $7.4 billion in the red by the end of this year.”

The federal government will forgive the interest for this year and next but the clock starts ticking in 2011.  As if we needed any additional future burdens.  Again, data like this shows us that the housing market is now at risk for a bigger risk factor.  The actual reality based economy.  This is more typical in previous recessions where housing would start declining after unemployment hit.  This time, so many toxic mortgages were floating out there that all it took was for home prices to level and the entire Ponzi scheme came crashing down.  With home prices declining as they have, it is revealing massive budget deficits.  This is to be expected when you plan revenues from nefarious and transient sources.  Those are not coming back.  Just ask Bernard Madoff how well that works in the long-run.

We also have to remember that in terms of prices, Alt-A and option ARMs helped boost housing prices and the ridiculous leverage buyers had in California.  Home buyers in California had maximum leverage of OPM (other people’s money) even though incomes did not reflect absurd valuations:

You look at the above and then you throw in the state income and it all becomes too apparent:

How in the world is a $60,000 median income going to support a $500,000 home?  At the maximum end, it would prudently be able to afford a $200,000 home (and that is stretching it).  The current state median home price is $251,000 but keep in mind, much of this is because of foreclosure resale homes.  The next ballgame to look at is the mid to upper tier markets that largely have not corrected based on their own bubbles.  Their dynamics reflect more esoteric loans such as the Alt-A and option ARMs.

The Path Ahead?

There will be many odd movements in the market next year.  You may see the median price move up because of lower priced mid to upper tier homes moving in larger amounts of volume.  That is, someone that bought a Culver City home in 1998 for $200,000 and at the peak in 2007 would have sold for $750,000, is now selling for $500,000.  This is actually a significant price increase from the first sale and will show up in the median price but also, the Case-Shiller repeat sale index.  So watch for things like this.  The Alt-A and option ARM recasts that will happen, will add higher priced distressed inventory on the market.  Much of the subprime problems are behind us now.  That is why you see homes in say the Inland Empire now selling for $100,000 to $150,000 that only a few years ago seemed impossible.

We can expect the state to have another major budget deficit.  Expectations range from $7 billion to $20 billion.  But the stock market is up and rich people pay most of the taxes right?  Yes.  But keep in mind they pay estimated taxes and these are significantly down even after the casino has gone up.  Why?  Many of the wealthy have accountants unlike the working stiffs that can carry over losses from 2008 over to many additional years.  In other words, don’t expect the state to get a 60 percent jump in revenues just because the stock market is up by this much.

So what should you look for in a bottom?  Well first, we need to see job growth.  Enough of this “job less” recovery non-sense.  People pay for bills from wages.  Also, if you buy that home today, your future buyer may not have your same incentives.  That is, the tax credit can’t go on forever.  FHA is now looking at a government bailout and will probably have to become more stringent because they are bleeding money thanks to their near toxic underwriting.  Plus, if you haven’t notice, the US dollar is getting hammered because what a stunner, we are simply spending money we don’t have.  If even a tiny currency crisis happens and the Federal Reserve is forced to raise rates (can’t go much lower than 0), you can kiss goodbye to those cheap 30 year mortgages (which are at 40 year historical lows – can’t get any lower).  In other words, a future buyer may not even be able to afford your home so get comfortable because you might be staying there for a very long time.

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California Economy and Housing in Depth: SoCal Homes Sales up But Significantly Down from Peak. W-2 Earners Expect a Smaller Paycheck. And Unemployment Insurance looking at a $23 Billion Deficit by 2011.

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I have been covering the option ARM fiasco for a very long time now and as I have highlighted before, this is very much a California problem.  Apparently I’m not the only one that has realized that option ARMs are a ticking time bomb just waiting to go off.  None other than our own attorney general, Jerry Brown is going after the top option ARM banks and servicers.  He has a few of the same questions that we have.  How in the world are banks going to deal with the coming recasts?  Have banks done anything since the crisis has started in addressing these loans?  Inquiring minds would like to know.

The AG has been busy in the last year.  He went after toxic mortgage poster child Countrywide successfully and recently, has gone after State Street.  Jerry Brown recently came on CNBC regarding State Street:

Source:  Zero Hedge

If anything, the AG is one of the few people that is actually going after the crony bankers and Wall Street for their financial robbery against the U.S.  We should be saluting the AG for this.  Instead, CNBC with their typical pandering and cheerleading for Wall Street tries to make a mockery out of the interview:

“I don’t dispute that $56 million is a lot of money, I don’t dispute the merits of the suit but you had a big press conference, you’re coming on C….N….B….C…. all this surrounding publicity over this $56 million, what do you say to people who look at this and say this is a perfect example of the demagoguery that attorney generals [sic] use when they want to run for governor.”

This is precisely what is fundamentally wrong with the financial press.  Here we have a public official who has gone after Countrywide, is going after State Street, and is now openly questioning the practice regarding option ARMs that are arguably the worst loan products ever devised and CNBC has the gall to mock him for “$56 million” because in their journalistic circles, this is a tiny amount that only the proletariat would worry about.  Contrary to their comrade circles, $56 million is a lot of money plus, there is the need to stop the financial thievery that has engulfed this country.  Who else is going after these institutions legally?  I realize that next year is a big election year and Jerry Brown is the front leading Democrat but come on financial press, we should be seeking out folks like this and Elizabeth Warren who are actually on the side of the consumer.

So what is in the letter you ask?

As I just recently noted and the AG recognizes, most of the options ARMs are here in California.  We also recognize that nothing has really been done to remedy this issue.  The AG is merely asking the top 10 bank and servicers of these loans to answer what they have been doing in regards to option ARMs.  They have until November 23^rd to respond which is plenty of time for them to type in corporate legalese “we haven’t dun a damn thing AG!”  It’ll be interesting to see what happens since it appears the AG is diverting from the White House and Wall Street plan of extend and pretend and is actually pushing toward principal reductions.  In other words, something banks have been fighting against vehemently.

I appreciate the AG understanding the issue before it implodes and recognizing that this is a major issue for the state.  Sure, some realtor and housing cheerleaders have been ignoring shadow inventory and these toxic mortgages but I’ll side with the AG on this one.  Instead of CNBC thinking $56 million is chump change, I’ll side with people who seem to be fighting on the right side instead of shilling for Wall Street.

And if you think the actual housing insanity is done in California, you have got to get out and smell the roses.  Or if you prefer, you need to get your self into a 400 square foot condo.  Today we salute you Santa Monica with our Real Homes of Genius Award.

Santa Monica – The Westside Miniaturized

The coveted Westside is on the radar of many SoCal blogger readers.  Many forget that SoCal is a gigantic region with over 20 million people.  Some forget that in the Inland Empire, it is easy to find homes between $100,000 to $200,000 yet evidently prices haven’t collapsed in their tiny niche markets so therefore the housing correction never happened.  If we look at the Westside in terms of overall SoCal sales, it is but a tiny fraction of the overall market.  And in this niche online force of readers, many are secretly lusting over their piece of Santa Monica real estate.  Well the wait might be over for you my friend!

I pulled this place up on Zillow and it is listed at 390 square feet (ZipRealty has it at 400 square feet).  Now really, are we going to argue about 10 square feet?  The only one that may have an objection to this number might be your pet cat but otherwise, we are talking a rather small location.

Officially there is no bedroom on this place.  It does have 1 bathroom which is useful in a home.  For $258,900 I think most of us would expect that at the very minimum.  But of course, this condo has the obligatory HGTV paraphernalia:

The place has been listed on the MLS for 179 days.  Now you would expect anything under $300,000 to fly off the shelf in Santa Monica but it might be hard to show that you are a certified “baller” when you bring your date back to a 400 square foot condo.  In the battle of location versus size, what will come out ahead?  Only in Westside would you have these kind of battles.

At least we know that we have a bathroom though:

I may not be doing this place justice.  Let us read the ad:

“Amazing asking price for this charming cottage style bungalow in the heart of santa monica. Subject to lende’r approval but approval is now in final stages of full approval and is imminent!! Do not miss, second & final negotiator has established this acceptance price!! Unit overflows with light and charm,bamboo floors,new eat-in kitchen with granite counters and new cabinetry.All new bath with pedestal sink & tiled floors. Huge private outdoor patio with redwood fence.Garaged parking space.”

Huge private outdoor patio?  Bamboo floors?  Granite countertops?  Where do I sign!  One small thing of course.  This is freaking 400 square feet for $258,900!  You’d get more room by getting a roommate and a regular apartment.  Let us assume we decide to buy this place with a FHA insured loan and 3.5 percent down:

Down payment:            $9,061.50

Monthly PITI:               $1,726

Now is this place worth it?  You tell me.  As a bachelor gig to show the “310” this might not be bad, but certainly no family is going into a 400 square foot place.  The price is certainly doable for Santa Monica.  Yet you have to ask whether this price will hold in the long-term.

In many other places in the country with $258,900 you’ll be getting a nice McMansion.  But this is California and as we have shown with option ARMs, we do things very differently here.

Today we salute you Santa Monica with our Real Homes of Genius Award.

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Real Homes of Genius: $258,900 for a Condo in Santa Monica? One Catch. It is 400 Square Feet. Attorney General Has Eyes Set on Option ARMs.

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