Housing Doom

Good thing those banks are solidly solvent without government intervention or assistance. Err, wait.

There’s a post that I made some time ago on Jim the Realtor’s site and reprinted recently related to the issues discussed above… I don’t think banks are willingly withholding foreclosure (unless they themselves are unaware what they are doing which is possible). My thoughts were reprinted here:

http://www.bubbleinfo.com/2009/11/25/high-end-waiters/#comments

Funny things about floods (if you’ve ever been in one, you know what I mean).

I grew up in Iowa, and we got major flooding in Des Moines where the Des Moines river would flow through, so I speak from some experience.

Floods did not come from downpours. They came during normal rains that lasted for a few days. More importantly, it didn’t really need to rain there a whole lot. It was upstream where the flood began. At first, the rivers would just swell and swell. They would stay within their banks and nobody thought much about it. They could even forecast how much they would rise and how fast. Funny thing, though, once it spilled out over the banks, people were falling all over themselves like they had never seen water before. Then it came in torrents, water seeping up through the ground. There were no rivers near some flooded areas, but the ground had become so saturated that the water table was above the ground in several areas. And, it was always the lower-lying areas that were affected.

So, I believe it will be true to the analogy. Except that this is no flood. We will still have falling prices, but not like last year. They will eventually settle in where they should be all along, eventually we will get there. But, as is proven many times, the market can remain irrational longer than you can remain solvent. This oft-used phrase has been used too many times to explain 2 phenomenon: 1. Markets are truly irrational, and 2. Everyone is irrational, regardless of what they think.

Indeed, incredible investors have been stumped for decades when trades wouldn’t go their way. But, these incredible investors only get that way because they know when to exit and stay out.

The option-arm/Alt-A “tsunami” will turn out to be more of a flood, and intentional defaults are being stemmed by efforts to reduce them. Once everyone agrees that the national economy is back again in the black, they’ll forget all about California’s problem and let us sort it out ourselves. It’ll remain a slow and painful decline over another 2 or 3 years, but we’ll get back to affordability, with 7% rates or not.

If you think otherwise, just remember what BofA said yesterday:

We are going to see a spike from now to the end of the year in foreclosures as we take people out of the running” for a loan modification or other alternatives, says a Bank of America Corp. spokeswoman. Foreclosure sales had dropped to “abnormally low” levels in response to government efforts to stem foreclosures, she adds.

Don’t believe me, believe the people who know their business… unless of course you argue that they don’t really know what they’re doing (at which point, I’m inclined to agree with you).

I also said this which is more important in my mind:

OK, for those who don’t know, I studied economics some in my undergrad and grad work. I also did work with Robert Fogel, Nobel Laurate in Economics.

So, I only say that because there are some fundamental flaws in thinking here (that seem to be widely held) that are accounted for in modern game theory. I hope that lends some credence to what I say. Basically, the general thought process is that banks will “slowly trickle out properties” because it is in their best interest. Unfortunately, this is an exact description of the “prisoner’s dilemma”. You can read more about it here:

http://en.wikipedia.org/wiki/Game_theory

The Nash Equilibrium states that this cannot continue if the participants perceive that they will be better of by taking equilibrium or first-mover advantage. I believe we have yet to establish Nash Equilibrium and, regulatory efforts have been the primary force in tilting the table to that point. However, once the “banking crisis” is behind us (and trust me, the world is tiring of seeing “Recession Over!” and “Housing’s Improving!” along with “Banks still need billions in bailouts!” together) banks will resume their foreclosures as quickly as possible. At the present time, banks internally believe that “there but by the grace of (government) go I” and as long as the bailouts continue, they choose the non-equilibrium choice. Foreclosure is more efficient and offers banks better returns than modifications, despite what the media has led you to believe. As soon as they can resume normal liquidation proceedings without invoking the wrath of the financial services committee, they will.

In the meantime, the ground is quickly getting saturated. It get “saturated” several ways:

1. Lowered prices means substantial numbers of undefaulted are underwater unless we return to 2005 pricing, something I have a hard time believing. General perception among homeowners is that we’ll be back to 2005 in a year or two. Once reality sets in, we’ll see more rational defaults.
2. Many investors have blown their load too early in the game. Only flippers remain nimble enough, but they absorb net 0% inventory. While it is still significantly cheaper to rent than own, no significant conversion of renter to owner will happen.
3. The widely held perceptions in #1 along with the tax credits (up to $18000 in Cali) went a long way to saturate the ground by pulling demand forward.
4. Most people with money are buying now, afraid of missing out. We are having a lot of bidding wars, but they often involve many of the same players. I don’t believe the demand exists in the level that people here believe it does. At least not at the current prices in higher-priced areas.

At this point, I believe the water table is nearer the surface than it was 1 year ago. We had a california flash flood last year that picked up a lot of debris, but quickly receeded. Real floods take a long time to go away.

I may be all wrong, but I’m trying to translate technical evidence into a narrative and there are always factors that I cannot see and do not factor into my model. Some possible unforseen events could prevent the water table from overflowing:

1. If the economy markedly improves. GDP growth of +8% p.a. would permanently forestall this, although the attendant inflation would probably make it untenable (+10% p.a.)

2. Widespread amnesty and open border policy, especially greencard-for-homeowners policies mentioned before, although this would have some negative societal consequences that would probably drive me out of California, so I wouldn’t care either way.

3. Expanding homeowner credit, or “New Flipper Credit”. Doubling it would allow us to pull quite a bit of demand forward, especially in normally non-rational purchasers. Incentives matter!

4. New moratoriums, or nationalization of the banking system (although this could admittedly go both ways, as the length of the asset deflation is marked more by the time required to liquidate non-self-liquidating debt. We still have a substantial debt overhang).
I hope everyone luck in this upcoming year, as it is a real test of where we go for the next 3 years.

Chuck ponzi

lawnmowerman (#4) -

Yup, pretty quiet: “Chateaux On Central – Abandoned Condo Development” 12/2