Cheap Homes Selling Fast, Expensive Homes Not

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Home sales have increased dramatically in recent months, but that brisk activity is far from uniform. While cheap homes are positively flying off the shelves, sales have actually slowed in many of the more expensive markets.

The October resale data makes this conclusion starkly clear. I tallied up the 20 San Diego zip codes with the largest year-over-year sales increases (I will refer to these as the fast zip codes) and the 20 zip codes with the smallest increases (the slow zips). As shown in the nearby table, there was huge disparity in the results. The fast zip codes experienced a huge year-over-year volume increase of 186 percent on average. Sales in the slow zip codes, in comparison, were actually down 11 percent.

It's pretty clear that what separates the brisk markets from the slow ones is price. While the fast zip codes averaged to a median price of $279,938, the average price in the slow zips was double that at $561,113. Those lower-end home prices had been harder hit, unsurpsingly -- the average year-over-year price decline for the fast zips was 30 percent versus just 12 percent for the slow ones.

For the curious, the full list of the zip codes I used can be found here.

This bifurcation, while not new, is getting more dramatic. I ran this study back in June and a quick gander at that article will show that the disparity in both sales and prices has increased markedly.

-- RICH TOSCANO

Thursday, November 20 -- 11:13 pm

Homes Sales Up Big in October

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October was a great month for home sales, with resale activity up a huge 89 percent from a year ago. Resale inventory was down 21 percent from last October.

The improving supply and demand made for a new multi-year low in the months-of-inventory figure, which tracks how fast resale homes are selling in comparison to how many are available. The 5.5 months of inventory represents an incredible 58 percent decline from the 13.1 months' worth of inventory available in October 2007.

This is obviously a big improvement, but as always, there are several caveats.

First, sales closed in October generally represent deals inked in September or August. Economic, market, and employment conditions have deteriorated substantially in the past couple months, so future demand may not be so robust as what we see here.

Second, while inventory for sale is declining, the rapid foreclosure rates throughout 2008 imply that there are still a lot of foreclosed homes out there that have not yet hit the market. Eventually, they have to, so there may be a lot of "pent up supply" out there.

Third, a lot of what's selling consists of foreclosures and other must-sell inventory. So sellers may on average be more motivated than the relatively low months-of-inventory figure implies.

Finally, these countywide sales figures fail to reflect the fact that activity has been improving a lot faster in low-priced areas than in higher-priced areas. I will try to write more about this disparity later this week.

-- RICH TOSCANO

Monday, November 17 -- 1:40 pm

Foreclosure Activity Drops Again

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After dropping like a rock in September, San Diego mortgage default notices declined again -- mildly, this time -- in October.

In last month's report, I attributed the decline in default notices (NODs) to a new state law requiring an extra 30 days before homeowners can be put into foreclosure. But trustee sale notices (NOTs), which take place further along in the foreclosure process, slowed down considerably in October. Trustee notices can take place no sooner than 90 days after default notices, so the drop in NOTs can't have been directly caused by the prior month's drop in NODs.

The drop in trustee sale notices suggests that more than just the extra-30-days state law may be at work. Perhaps some of the many and varied bailouts underway have been causing lenders to hold off on initiating foreclosure activity. (If this is the case, however, Treasury Secretary Paulson's just-announced switcheroo from propping up mortgage markets to goosing consumer spending could shake things up). Or perhaps lenders just took a breather as they did last November.

These are all just speculations, of course. The next couple of months should help us put the pieces together a little better.

-- RICH TOSCANO

Wednesday, September 17 -- 10:21 am

A Big Drop in Median Home Prices

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The median price per square foot for single family homes had a pretty typical month, dropping by 2.6 percent. But the same figure for condos dropped an amazing 14.8 percent in a single month. A volume-weighted aggregate of the two property type medians dropped by 6.4 percent for the month, ending up 41 percent lower than it was at the September 2005 peak.

Actual condo prices clearly did not drop by nearly 15 percent in a single month, of course. The drop in the median price per square foot likely reflects some degree of actual price declines, but the bulk of the decrease in the median almost certainly represents a shift in buyer activity toward lower priced properties. This is a phenomenon that has been going on for a while, though not to last month's dramatic extent.

Such are the hazards of measuring what the typical buyer paid for a house or condo without accounting for how nice a property he or she got. Adjusting for square footage helps a little, but it does not account for differences in location, quality, or anything else. More about the travails of measuring home prices can be found here.

So while this month's median price data doesn't give us much useful information about actual prices, it tells us that -- among condos, anyway -- low-priced homes are selling a lot faster than high-priced homes.

-- RICH TOSCANO

Wednesday, September 17 -- 10:21 am

Financial Flood Insurance

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Credit default swaps have been a major element in the ongoing financial crisis. That doesn't mean it's necessarily easy to understand just what the problem is with them. I've taken a crack at it in the past, but more recently I heard an analogy that makes the entire situation a lot easier to visualize.

I heard the analogy during a radio interview with Doug Noland, a mutual fund manager who's been writing dire weekly analyses of the credit market for years. It went something like the following.

Imagine a city near a river that is prone to the occasional flood. At some point, an enterprising citizen gets into the business of writing flood insurance, collecting premiums from insurees in exchange for a promise to pay back the insurees should a flood do any damage to their properties.

Now, imagine that there is an unusually long drought and the river goes a long time without experiencing a flood. Other enterprising types begin to notice that the flood insurer has for years been collecting all this money for doing absolutely nothing. A flood hasn't taken place for ages -- maybe climate patterns have changed so that the river doesn't flood any more. And even if it does flood at some point, they will probably be retired by then. They want in to the easy money flood insurance game too.

So they start writing flood insurance, but in order to gain some market share, they lower the premiums to attract new business away from the original insurer. The lower cost of insurance encourages more people to build houses next to the river, assuming that if it ever does flood again, they will be reimbursed for their losses.

As the years go on and still no flood comes, more and more people enter the flood insurance business, driving the cost of flood insurance to ridiculously low levels. It costs so little to insure against disaster that eventually the entire city gets relocated to the shoreline.

Everyone's seemingly a winner. The insurers are making a lot of money and the citizens get to feel safe and secure in their riverfront properties. Until the flood comes. Then the entire city is wiped out and it becomes clear that the insurers simply don't have enough money to reimburse the insurees for all of their losses.

Credit default swaps are basically insurance against a borrower not paying back a loan. If the borrower defaults, the insuree is made whole by the issuer of the credit default swap. Writing credit swaps was easy money in flush economic times and everyone jumped on board -- just like being a flood insurer was great as long as the drought went on. Since lenders felt protected against borrower defaults by all that insurance they bought, they made many more loans than they otherwise would have. This vast increase in lending is akin to the buildup of riverfront property. And the mass debt defaults underway are obviously analogous to the flood.

There are a couple of ways in which the credit insurance situation risks are even more self-reinforcing than those for flood insurance. In the modern age we have the credit ratings agencies that declared all that subprime mortgage-backed debt to be safe and sound. Perhaps we could insert the ratings agencies into the analogy by saying that we have a well-respected weatherman study the data and determine that because a flood has not happened for so long, flooding should no longer be considered a risk. (Maybe our allegorical weather expert created a model based on 20 years' worth of data, not realizing that the last big flood took place 21 years ago). The weatherman's soothing predictions would encourage even more people to get into the flood insurance business and collect that free money.

Noland points out an even bigger difference: in the river city scenario, the amount of property built on the shoreline by overly confident insurees does not influence the probability of a flood. But all the extra lending undertaken by overconfident credit insurees -- think subprime mortgages here -- actually increased the chance of future defaults even as the price of insuring against default plummeted.

Noland's analogy ends when the flood takes place. Now that we've seen the real-life version in the credit markets, we can go back and complete the story for our fictional river city: the citizens (whether they built on the river or not) are taxed to repair the buildings, the flood insurers are bailed out, and everyone inexplicably continues to believe the weatherman.

-- RICH TOSCANO

Thursday, November 6 -- 9:07 am

More Case-Shiller Charts

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Kelly Bennett has already done a thorough writeup of the August Case-Shiller home price data, so I thought I'd just add a couple of charts into the mix.

The first shows how low-priced homes have suffered in comparison to higher-priced homes. At this point, the low-priced tier of the index has fallen almost twice as far from the peak as the high-priced tier:

The second graph provides a lot of insight into why this has happened. During the boom, the frenzy of easy lending was concentrated among borrowers of low-priced homes. The huge decline from the peak in the low tier is just the flipside of the incredible boom-time runup in which prices of lower-end homes increased far faster on a percentage basis than those of more expensive properties.

The next two graphs present exactly the same price information except that the prices have been adjusted to account for the effects of inflation as measured by the Consumer Price Index. This approach details how much home prices have changed not in terms of dollars, but in comparison to everything else (or at least that subset of "everything else" measured by the CPI -- but that's a whole other topic).

After accounting for inflation, even high-end home prices are down nearly a third from the peak. Low-priced homes have dropped almost in half by this measure.

Despite the price drops, homes remain 30 percent more expensive on an inflation-adjusted basis than they were in 2000.

Keep in mind that the Case-Shiller data lags quite a bit. The latest figure is calculated based on sales closed in June, July, and August. Here at the end of October prices have almost certainly dropped further than what you see above.

-- RICH TOSCANO

Wednesday, October 29 -- 1:45 pm

Where the Jobs Were in September

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Here's a graph I haven't updated for a while. It shows how many jobs were gained or lost, according to the latest monthly employment estimates, by varying San Diego employment sectors in the year leading up to September 2008. (Sectors that changed by fewer than 300 jobs have been excluded to keep the graph a little more readable).

Here's how this chart looked a little over a year ago. Back then, the leisure and hospitality sector was providing a huge boost. That sector is still growing, but not nearly so fast. Meanwhile the housing bubble beneficiary sectors (construction, finance, and retail) have deteriorated significantly. One bright spot: the manufacturing sector, while still shrinking slightly, is doing so at a notably slower pace than it was last year.

-- RICH TOSCANO

Monday, October 27 -- 9:09 am

Regional Employment Declining Slowly but Steadily

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San Diego County employment declined in September, according to the monthly estimates provided by the state's Employment Development Department.

The housing boom beneficiary sectors acted as a drag once again. Year over year, the construction sector lost 6,800 jobs or 7.8 percent, the finance sector (including real estate) lost 4,100 jobs or 5.2 percent, and the retail sector lost 3,000 jobs or 2.0 percent.

The accompanying graph shows that while the contruction and finance sectors were still losing jobs on an annual basis, the yearly rate of loss was lower than it had been in recent months. In other words, while those two sectors are still shrinking, they aren't shrinking as fast as they were earlier in the year. The retail sector, in contrast, declined faster on a year-over-year basis in September than it had at any time during the current downturn.

Outside the housing beneficiary sectors, job growth was positive by 8,800 jobs or .9 percent, but that wasn't enough to offset the weakness coming from construction, finance, and retail. In total, the region lost 5,100 jobs between September 2007 and September 2008, a decline of .4 percent.

-- RICH TOSCANO

Tuesday, October 21 -- 8:39 pm

Housing Demand Improves Again in September

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September was a good month for existing home sales, at least as things have gone in recent years. Sales were up a whopping 71 percent from last September and were even 18 percent higher than in September 2006.

The inventory of resale homes on the market was also improved, down 18 percent from a year prior.

This made for another big improvement of the months-of-inventory figure, which measures how fast homes are selling in comparison to how many homes are on the market. There were just over 6 months' worth of inventory in September -- a level that is typically considered normal.

Beneath the surface, however, the market is anything but normal. "Must-sell" inventory continues to dominate and, per Kelly Bennett's latest, it appears that there is plenty more to come.

Foreclosure sanctuaries and other forms of government intervention may change this course of events at some point in the future. But until must-sell inventory become less of a factor, the seemingly normal ratio between supply and demand will continue to mask some serious non-normality.

-- RICH TOSCANO

Friday, October 17 -- 9:52 am

Median Price Declines Picking Up the Pace

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The median price per square foot of resale single family homes dropped 2.6 percent in September. The condo median, which took a much harder hit in August, dropped a more moderate .9 percent for the month. An aggregate of the two property types dropped 2.0 percent.

The accompanying graph displays the declines for the size-adjusted median since it peaked three years ago in September 2005.

Home prices tend to move upward during the spring and early summer months. This has even historically been the the case during protracted housing downturns. Such is the power of the current bust, however, that this year's "spring rally" seems to have manifested itself as a period of slightly more subdued price declines.

There are a number of crosscurrents at work in the housing market. Significant job losses appear to be an increasingly higher risk, and not just in the housing-related sectors. At the same time the government is going all out prop up the housing and credit markets. How this all plays out in the end is anyone's guess at this point. For now, the downturn holds sway.

-- RICH TOSCANO

Sunday, October 12 -- 11:51 am

Mortgage Defaults Plummet, For Now

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The number of homes entering the foreclosure process declined steeply in September -- but the drop is likely temporary.

The blue line on the accompanying graph represents how many Notices of Default, which are the nastygrams sent to delinquent borrowers, were delivered in September. The orange line tracks Notices of Trustee Sale, which inform said delinquent borrowers that their homes are about to be repossessed.

The graph makes it pretty clear that NODs dropped like a rock last month. We haven't seen a number of default notices this low since February 2007 -- a breezier time, when it would have seemed laughable to suggest that mainstream media outlets would be publishing stock photos of Depression-era breadlines a year and a half down the road.

Trustee sale notices, for their part, more or less soldiered on.

It's pretty unlikely that the number of folks blowing off their mortgage payments dropped in half (and then some) in a single month. Instead, it appears that the statewide foreclosure legislation I mentioned a couple months ago is making itself known. The law inserts an extra 30 days into the period between an initial missed payment and the eventual NOD. It would explain why NODs fell off a cliff while NOTs remained relatively unchanged.

If the new law is at work, that blue line is likely to start heading up again within a month or two.

-- RICH TOSCANO

Wednesday, October 8 -- 8:03 pm

A Step in the Wrong Direction

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In response to the prior column on the latest bailout, some people asked for more specific thoughts on the Paulson Plan and what would have happened if it hadn’t been passed.

In truth, I don’t actually know what would have happened had the plan not gone through. Most of the people offering predictions on the topic don’t know either; I’m just admitting it.

I do know this. Our economy has become far too dependent on finance and debt-fueled consumption. We need to return to our economic roots of production and saving. This shift will be painful, and one could make a case for some sort of government intervention to ease the transition.

But the Paulson Plan, the central focus of which is to prop up the prices of financial assets that no private buyer wants to touch, is not intended to ease the transition. It is intended to prevent it.

The plan is thus a giant step in the wrong direction. But this is exactly what you’d expect given that it was developed by the same group of people, using the same flawed analytical framework, that has misdiagnosed the problems all along.

-- RICH TOSCANO

Tuesday, October 7 -- 10:31 am

Bailouts Don't Address the Real Problem

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Every pundit on Earth is playing the game of picking the various bailouts apart and proposing their own improved bailout schemes. But I think that most of the conversations going on out there miss a critical point: that this bailout and the ones that will in all likelihood follow it fail to address the root cause of the problems.

That root cause, in my opinion, is that the vast majority of political leaders, regulators, and pundits zealously cling to a deeply flawed analytical framework.

To put it more simply: the people and principles that blithely led us into this mess are absolutely the wrong people and principles to lead us out of it.

The problems we are facing have been coming down the pike for a long time. Many, many people saw them coming. Here at VoiceofSanDiego.org, I wrote about the risks posed by credit default swaps (one of the latest credit crisis bogeymen) in January 2007 and collateralized debt obligations (which were at the heart of the subprime crisis) in June of that year. I wrote about the possibility of widespread mortgage defaults as far back as February of 2006 (my second month of writing for Voice) and I have been writing about the risks of the speculative housing bubble at my own website since mid-2004.

I don't say this to pat myself on the back, but to offer specific examples that these problems were knowable well ahead of time. (This is a necessity, sadly, given the constant historical revisionism practiced by many financial commentators). But it wasn't just me -- a few minutes of Googling will show that many, many analysts identified these problems ahead of time.

So if the problems were knowable to so many people -- including me, a regular guy here in San Diego with no letters behind his name or anything -- then how is it that the people in charge of running the world's largest economy were absolutely blindsided by them?

Consider the following quotes:

"[House] price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas." -- Fed Chairman Ben Bernanke, Oct. 20, 2005

"[The housing downturn] looks to be a very orderly and moderate kind of cooling." -- Fed Chairman Ben Bernanke, May 18, 2006

"All the signs I look at [show] the housing market is at or near the bottom." -- Treasury Secretary Henry Paulson, April 20, 2007

"I don't see [subprime mortgage market troubles] imposing a serious problem. I think it's going to be largely contained." -- Treasury Secretary Henry Paulson, April 20, 2007

“Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited.” -- Fed Chairman Ben Bernanke, May 17, 2007

I could dig up enough to fill a book, coming from these two guys and a whole lot more of our leaders, but hopefully the above quotes are enough to give a flavor. These guys had absolutely no idea what was going on. With homes priced in vast excess to any prior relationship they'd had to incomes, Bernanke came out and actually claimed that prices were supported by those same incomes. Paulson then called the bottom in Spring of 2007, with homes still exceedingly overpriced and a huge glut of foreclosures already in the pipeline. And all along they denied that there would be any ill effects outside of homes bought with subprime loans (this after they and their predecessors had for years denied that subprime loans would become a problem at all).

Given the above statements by Paulson and Bernanke, there are only two possibilities: they are incompetent or they are liars. I tend not to think they were lying, because if they really knew what was going on they would have been a lot more non-committal rather than making statements like those above that could later be proven to have been hugely wrong. So that leaves incompetence as the most likely explanation.

I single out Bernanke and Paulson, by the way, because they are spearheading the bailout efforts and because these two unelected men wield phenomenal power over our financial future. But they are absolutely not alone in having had no idea what was underway -- they are joined in this honor by the Administration and, as far as I can tell most of Congress and the financial regulatory structure.

Yet all these people are still at the helm. And despite their proven and repeated inability to understand the situation, they are for some reason expected to successfully lead us out of it.

It's not that any of these people are stupid. Not by any stretch. The issue, as I posited at the outset, is that they are under the sway of an analytical framework that is dangerously misguided.

I don't want to get too deep into the weeds, here, but by way of providing some justification for the above statement I will outline below a sampling of the misapprehensions that have been at work in guiding us into this morass. The italicized statements below are all core beliefs of what I would contend has been the mainstream view for many years among politicians, regulators, and pundits. They are all, in my opinion, wrong, for reasons explained after each italicized statement.

Financial market prices are always right. Despite having experienced the world's biggest stock bubble followed by the world's biggest housing bubble in less than a decade, people still cling to this one. The mainstream view is that market prices reflect the combined knowledge of all market participants and so they must be correct. Whatever prices are, it follows that that some rationalization should be reverse-engineered to explain them. See Bernanke's laughable attempt to justify home prices in 2005 as an example. But history has proven time and time again, and is once again proving as we speak, that markets get it wrong all the time.

Debt doesn't matter. The economic boom we just went through was greatly dependent upon people borrowing against rising home prices to increase their consumption spending. Most people only looked at the economic growth side of the equation (such as GDP, or gross domestic product) without seeing that on the other side, our level of indebtedness to foreigners was growing faster than economic activity. This is neither sustainable nor desirable.

There is nothing wrong with borrowing if the proceeds are used to increase future productive capacity by building up infrastructure or the means of production, because these expenditures will lead to an increase in our economic potential and earning power down the road. But when the proceeds are used to buy consumer goods that have no productive capacity -- and houses are consumer goods, by the way -- that increases the debt we will have to eventually pay without a commensurate increase in our future earning power. This is bad.

Consumer spending is the basis of our economy. People panic whenever consumer spending drops and many bailouts, specifically the government "stimulus checks," are directly aimed at increasing consumer spending. But long-term economic strength is based on what a society produces, not what it consumes. Seems like common sense, doesn't it? Yet our economic policies are overwhelming geared towards stimulating consumption.

As a nation we have consumed more than we produced for so long that people think that this pattern can be sustained forever. It cannot. Someday we will have not only to produce the same amount as we consume, but to produce even more than we consume in order to pay back all the debt we've racked up. But as we've seen so many times recently, unsustainable trends like these are often ignored and rationalized until they become crises.

This misunderstanding is tied in closely to the above idea that debt doesn't matter. When the debt starts to matter -- as it inevitably will when our creditors eventually come calling -- it will be clear that it would have been much better to encourage the development of more productive capacity and earning potential rather than to stimulate consumer spending.

A rise in home prices is the same as saving. During the boom we constantly heard that it didn't matter that Americans spent more than they earned. Their home prices were going up, we were told, so the country was getting wealthier. This reasoning is very flawed.

An individual who owns a home that goes up in price can indeed become wealthier if he sells the house. But in that case, the person to whom he sells has to come up with the money to buy the house. There is no increase in overall wealth -- just a transfer of wealth from buyer to seller. If on the other hand the owner keeps the house and takes out some equity, he has to borrow money from someone else in order to do so. Again, there is no net increase in wealth -- just a temporary transfer of money from lender to borrower.

Saving is the act of foregoing current consumption in order to use your capital (money, in this case) at a future date. From an overall standpoint, rising home prices (or any asset prices, for that matter) do not lead to any increase in society's accumulation of saved capital.

High asset prices are good for the economy. Over the long haul, society's prosperity is dependent largely on how effectively it utilizes its resources, including its people, its natural resources, its existing means of production, and its saved money. The purpose of the investment markets is to foster the most efficient allocation of saved money. To this end, neither high asset (specifically stock and bond) prices nor low asset prices are desirable.

When asset prices are too high, it is too easy for businesses to gain access to capital (again, money) and many inefficient business ventures will be funded, thus wasting society's resources. Good examples of this phenomenon from recent times include the free-spending yet profitless dot-com companies during the tech stock bubble and the glut of McMansions in the Inland Empire more recently. In both cases, society's resources were squandered because asset prices were too high.

If asset prices are too low, on the other hand, it is hard even for viable businesses to gain access to capital. Society's resources will not be used to their full potential. It's tougher to find recent examples of this phenomenon, given that so much money was until recently chasing financial assets, but it certainly has happened in times past.

If asset prices are too low, it's better for them to go higher. Everyone can probably agree to that. But if asset prices are too high, such that they are encouraging a wasteful use of resources, it's better for society's long-term prosperity that they go lower. A big part of the current (and future, I surmise) bailouts entails propping up asset prices. This is bad for the economy in the long haul.

Inflation isn't inflation unless it shows up in the CPI. A sensible definition of inflation, I would think, would be: "your dollars buy less." As such it makes sense that inflation can occur in anything that can be bought with dollars. Anything can become more expensive, after all. This includes consumer goods as well as producer goods and even financial assets. (What we saw with the tech stock bubble and then the mortgage-backed securities bubble was rampant inflation in financial assets in which prices of those assets rose in great excess to their capacity to generate future earnings.)

But the government has this inflation measure called the Consumer Price Index, or CPI, which measures changes to consumer goods and services prices. There is nothing wrong with this, but the problem is that if inflation doesn't happen to show up in the CPI, it is ignored.

Here's one recent and significant example of why this matters. The CPI happens to measure rents instead of home prices. So when home price inflation raged here in San Diego during the housing boom, it never registered in the CPI. And thus, as far as mainstream economists were concerned, those 25 percent per year home price increases weren't "inflation" -- even though by any common sense definition, inflation is exactly what they were.

Money supply growth does not matter. OK, despite earlier promises I've long since entered the weeds. Last one. It's pretty widely acknowledged that over the long term, inflation is a function of how much money is created. But per the above item, if the money supply increases and the resulting inflation happens to take place in items not measured by the CPI, it's deemed to be a non-issue.

Rampant home price inflation, to continue with the above example, was deemed to have nothing to do with the breakneck pace of money creation that took place earlier in the decade. That was just a coincidence, we were implicitly told. Instead, the home prices were deemed by the establishment to be fundamentally sound despite the fact that prices were far higher than those fundamentals would have dictated. After all, market prices must be right, no?

And with that we've looped around to the first misconception. I'll stop now. I realize that I've blazed through some pretty complex topics here, but I believe that most of what I'm saying aligns with common sense. Hopefully this provides at least an idea as to some of the the flawed, unrealistic, and often nonsensical ideas that infest mainstream economic thought.

The vast majority of policymakers, and Bernanke and Paulson in specific, cling to a dangerously misguided analytical framework. That is a huge problem. The best fix we could put in place for the long-term health of the economy would be to forsake the wrong and now-disproven framework and to embrace a view of the world that, while surely less appealing to quick-fix oriented politicians, is both more realistic and more focused on sustainable long-term prosperity.

Unless and until this happens, I don't expect any of the bailouts to do much good in the long run.

-- RICH TOSCANO

Friday, October 3 -- 4:13 pm

August Housing Supply and Demand

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The number of resale homes sold in August was up 9.0 percent from a year prior. Inventory was down over the same period by 11.2 percent.

Putting supply and demand together, there were 6.9 months' worth of inventory for sale in August -- substantially better than August 2007's 8.4 months and just about the same as the August 2006 figure.

The 6-7 months' worth of inventory we've been seeing lately would in normal times be the hallmark of a reasonably healthy, if not exactly fast-paced, market.

But these are not normal times, as the following graph of foreclosure activity indicates:

More existing homes are entering foreclosure each month (the blue line) than are being sold. That situation is unprecedented, as far as I can tell, and it's clearly not a positive. So while the first graph would indicate that supply and demand are getting back into balance, the ever-fuller pipeline of potential must-sell inventory depicted in the second graph shows that things are more out of whack than they seem.

-- RICH TOSCANO

Friday, September 26 -- 7:31 pm

More San Diego Job Losses

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This month's employment estimates show a deterioration in the retail sector but a slight improvement in the construction sector. Other than that the region's job growth, or lack thereof, has been on a path similar to recent months. So I will simply note that overall employment fell by 5,700 jobs or .4 percent from last year and then move on to the graphs.

The first graph is the usual one displaying the number of jobs gained or lost by the housing beneficiary sectors (construction, finance/real estate, and retail), the rest of the economy, and all sectors combined on a year-over-year basis. Each month's data point represents the year-over-year change for that month (I use this technique to smooth out seasonal effects).

This next graph is the same as the first except that it displays the percent change to the size of each sector rather than the number of jobs gained or lost.

The third graph shows how the three housing beneficiary sectors (in red, dark blue, and light blue) have offset growth in the rest of the economy (in green).

In short, the non-housing portion of the economy continues to grow -- but not as much as it used to, lately, and no longer as much as is necessary to offset the decline that originated with the housing bust.

-- RICH TOSCANO

Tuesday, September 23 -- 9:15 pm

It's Bailout Week!

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Earlier in the week I jokingly suggested that the federal government was limiting itself to one financial industry bailout per day. Well, that was sure wrong.

Let's review the week so far:

• The Fed announced it will lend even more to financial institutions (many of them not under the Fed's regulatory authority) in exchange for even more dubious collateral than before. This allows everyone to continue to pretend that the collateral, such as some subprime mortgage backed securities, is worth more than it actually is, which in turn allows everyone to pretend that financial institutions have more money than they actually do.



• Because the Fed has run low on funds due to all of that lending, the Treasury announced it will borrow more money to give to the Fed so that they can keep up their lending and continue the charade described above.



• The Fed nationalized insurance giant AIG (also not under its regulatory authority).



• The Fed pumped a hundreds of billions of dollars into the system both domestically and globally via loans to foreign central banks.



• In an fit of open market manipulation and blatant industry favoritism, the SEC banned short selling for 799 financial stocks.



• The Treasury announced that it will earmark $50 billion to protect the value of money market funds.



• This is the big one. The Treasury announced that it will start using taxpayer money to take junk assets off the hands of financial institiutions. Remember back in the housing bubble when you asked yourself what idiot was making these super risky mortgage loans that would clearly never be paid back? Turns out that in the end, it was you (and the rest of the taxpayers).

NY Times articles here and here do a good job of describing all the shenanigans.

For years, almost without exception, politicians and regulators have studiously ignored the mounting financial system risks despite the fact that they were growing ever more obvious (we've been writing about them here at Voice since 2006). In fact, many of our leaders cheered on the "financial creativity" and encouraged, by word or policy deed, further risk taking. Now that the consequences have arrived, they are panicking and throwing vast amounts of your money at belatedly fixing the problems that they so recently denied even existed.

Our heavily indebted federal government does not actually have the hundreds of billions of dollars required for the various financial industry handouts. The money will have to come from somewhere, be it via borrowing, increased taxation, or the metaphorical dollar printing press. In the end, it is the nation's savers and taxpayers who will end up on the hook.

-- RICH TOSCANO

Friday, September 19 -- 1:53 pm

Another Huge Bailout or Two

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I spoke too soon yesterday. After Treasury Secretary Paulson apparently refused to bail out AIG, the Federal Reserve stepped in and cut the mortgage giant a check for $85 billion in exchange for 80 percent of AIG shares. That $85 billion of taxpayer money is just a loan, we are told, but I don't quite understand the distinction between and loan and a handout when the whole trigger for this loan was that AIG is unable to pay back its other loans.

Once again, this is being covered everywhere in the MSM. Here's a good overview.

Although a cut in the Fed funds rate had become widely expected by yesterday, the Fed ended up holding rates steady. Perhaps they are trying to limit themselves to one Wall Street bailout per day.

Today is a new day, however. The Treasury has just announced it's going to borrow some extra money to hand over to the Fed.

The Fed, via its assorted acronym-tastic lending facilities, has been lending out money (or Treasuries, aka government bonds, which are just as good) to financial institutions in exchange for assets of more dubious value such as mortgage-backed securities. As I noted in yesterday's post, they just announced that they will accept even more questionable collateral and that, for the first time in history as far as I know, they will accept stocks as well.

These lending facilities allow financial companies to get money (temporarily, admittedly) in exchange for their assets without having to sell them, thus propping up asset prices. The problem is that the Fed has run a little low on funds as a result of all lending. So the Treasury is borrowing more money -- to be eventually be paid back by you, the taxpayer -- so that the Fed's handouts to Wall Street don't miss a beat.

Despite the government's tough talk earlier in the week, the bailout machine appears to remain fully operational.

-- RICH TOSCANO

Wednesday, September 17 -- 10:21 am

One-Two Punch for the Default Swap Market

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A quick update to the last post. This morning I read in Housing Wire that ailing insurance company AIG poses an even bigger threat to the CDS market than Lehman:

AIG sold banks and other investors CDS protection on $441 billion of fixed-income assets, including $57.8 billion in subprime-mortgage related securities. There are likely very few firms with this much exposure into the CDS market...

My snarky comment in the prior post notwithstanding, the folks at the Treasury have to their credit not directly bailed out either Lehman or AIG. (They have stepped up the indirect bailouts, however: the Fed will now be lending more money to more people with more questionable collateral, and word is that they may also cut rates again today.)

But while they are finally turning some pigs away from the trough, the government's frantic interventions to date suggest that they will not sit idly by as things get really out of hand. We shall see.

I haven't gone into much detail on this week's drama because for the most part I'd be rehashing what's already been, uhm, hashed many times over. All the mainstream outlets are covering the issue, but for good up-to-the-minute updates and commentary the folks at the blog Naked Capitalism have been doing an outstanding job.

-- RICH TOSCANO

Date: 9/16/08

Credit Default Swaps Back in the News

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Back in early 2007 I wrote about the risks in the market for credit default swaps, a type of financial instrument that basically serves as insurance against bond default. The crux of the article was that some of the insurers in question might not be able to pay when the time came, and that would be trouble.

Almost exactly a year later, in January of this year, I wrote that the Fed's bailout of investment bank Bear Stearns may have been intended to prevent exactly that type of situation (though I noted that I'd expected the trouble to come from hedge funds, not from full-fledged investment banks).

Today, the bankruptcy of investment bank Lehman Brothers may have set some CDS market problems into motion. As this Bloomberg article dryly notes:

Bond-default risk soared worldwide as the collapse of Lehman Brothers Holdings Inc. sparked concern that the $62 trillion credit-derivatives market will unravel.

It turns out that Lehman was one of the ten largest "counterparties" (credit insurers) in the default swap market, so their failure is obviously a big deal.

On the other hand, things probably won't be allowed to get too bad before the next bailout is put into place.

-- RICH TOSCANO

Date: 9/15/08

Median Home Prices Dropped in August

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Well, that didn't take long. Assorted congresscritters are already asking Fannie Mae and Freddie Mac to halt foreclosures. As I've previously noted, trying to fight the symptom (foreclosures) after having long ignored the disease (unsustainably high home prices) is both futile and rife with potential unintended consequences.

We will definitely keep an eye on what wacky antics ensue how that Fannie and Freddie are wholly-owned whipping boys of the U.S. government.

Moving on to a more local topic, San Diego County resale home prices fell again in August, at least according to the median price per square foot.

Between July and August, the size-adjusted median price fell 2.9 percent for single family homes and a hefty 5.9 percent for condos. A volume weighted aggregate of the two property types fell 3.9 percent.

From the September 2005 peak of the series, the size-adjusted median is down 33.9 percent for single family homes, 38.7 percent for condos, and 35.6 percent overall.

Disclaimers apply, as usual. First, these figures lump together areas experiencing widely disparate price movements. Second, since there is a lot more activity in the lower-priced areas than in the higher-priced areas, these figures may overstate the price declines. If they do, however, it's not by much, as a comparison between the size-adjusted median and the Case-Shiller home price index (which compares same-home sales) has so shown the size-adjusted median to be fairly on the spot in recent months.

Bearing all that in mind, it appears that while there is a lot of variation from one area to another, San Diego prices on the whole are still heading down.

-- RICH TOSCANO

Friday, September 12 -- 11:43 am

U.S. Treasury Nationalizes the Mortgage Market

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We just witnessed yet another weekend bailout for the financial markets. The government takeover of ailing mortgage behemoths Fannie Mae and Freddie Mac was no surprise (prior editorializing can be found here and here) and has been jumped all over by the mainstream press. So I'm not really going to get into the details, as anyone interested doubtless already knows them.

However, I thought that the official nationalization of the mortgage market at least deserved a mention here at the Nerd's Eye View.

Someone asked me how this would change the housing and mortgage markets. My initial thought is that it won't. This move was intended not to cause something to happen, but to prevent something from happening. That something was the imminent bankruptcy of the two entities that account for about 80 percent of U.S. mortgage issuance.

Such an outcome would have changed the game, to be sure, but now it's not going to happen. Mortgage rates may adjust downward a bit, but from a big picture standpoint, it will be business as usual. (That is, until the new government-owned entity starts writing down mortgage principal balances for defaulted borrowers and other fun unintended-consequence-inducing activities).

Business as usual, by the way, continues to be declining home prices. The difference is that now they won't plummet into the abyss as they would have had Fannie and Freddie gone under.

The payback is that the government, and by extension the taxpayer, is now on the hook for whatever losses Fannie and Freddie suffer. The Treasury Department tells us that they will not suffer any losses, but their forecasting track record has been horrendous both before and throughout the mortgage crisis (the latest example being less than two months ago when they told us that they wouldn't do what they did this weekend). The potential for loss is unclear, but to put a ballpark figure on it, one former Fed-head estimates that losses could be as high as $300 billion. And that's $300 billion that the government doesn't have.

So the housing market (and all markets, really), have just been bailed out big time -- but not without some future, undetermined, and potentially huge cost.

I know it seems like the U.S. government and our society in general can go into infinite amounts of debt without any apparent repercussions. But it will not always be so. As we saw with the housing and mortgage markets, looming problems can often go a long time without seeming to matter -- until, eventually, they turn out to have mattered very much after all.

-- RICH TOSCANO

Wednesday, September 17 -- 10:21 am

Monthly House Payments, Rents, and Incomes

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Last week we compared San Diego rents and incomes to home prices. Let's now do the same for monthly payments on those homes.

The following charts compare San Diego incomes and rents with the monthly payment on a typical single family home. Non-nerds, avert your gaze from the rest of this paragraph as it goes into the minutiae of how the graphs were constructed. The home price is figured using the Case-Shiller price index rebased to the December 2007 median single family home price. The mortgage payment is calculated based on the average Freddie Mac 30-year fixed rate mortgage with a 20 percent down payment. I've also added in property tax at 1.1 percent (thanks to reader Tom for the suggestion).

Given that mortgage rates continue to be quite low by historical standards, it should be no surprise that homes look quite a bit more reasonably priced when you compare rents and incomes to monthly payments instead of home prices. While the price-to-income and price-to-rent ratio would have to respectively fall by 25 and 24 percent to reach the levels seen at the trough of the 1990s housing bust, the payment-to-income ratio would have to fall 19 percent and the payment-to-rent ratio by just 18 percent to hit their mid-1990s low points.

And the payment-to-income and payment-to-rent ratios are quite a bit closer to the bottoms of their pre-bubble ranges than to the tops -- a characteristic not shared by the price-to-income and price-to-rent ratios. The accompanying charts make monthly payments look downright reasonable on a historical basis.

But taken in isolation, monthly payments aren't the right metric to use in order to judge home valuations.

It is pretty clear that for most of the history displayed on the charts, the payment-to-income and payment-to-rent ratios hewed pretty closely to mortgage rates themselves. Typically, the monthly payment ratios would move up when rates were moving up and down when rates were moving down. It wasn't until the recent housing bubble, when the payment ratios shot up while rates dropped and then languished at generational lows, that this relationship broke down.

But the recent bubble is an abberation in which home prices rose not due to low rates but to an extended period of incredibly reckless mortgage lending. Looking back beyond this risky-lending-induced bubble, there just isn't much historical data to suggest that homes should necessarily be more expensive when mortgage rates are low and less expensive when rates are high.

The point can be further illustrated by comparing the recent bubble peak to the early 1980s, when double-digit mortgage rates prevailed. If monthly payments are a good valuation metric, then these charts suggest that the overvaluation of the recent bubble was not nearly as large as that seen in the early 1980s. This is ridiculous, of course. The recently burst bubble absolutely blew away prior booms in terms of magnitude, as a quick glance at the bubble aftermath depicted in this long-term foreclosure graph easily demonstrates.

While payments aren't a good valuation metric by themselves, however, they do have an influence. Monthly payments are a crucial element of the rent-or-buy calculation and will thus affect the level of demand coming from renters or investors jumping into the market. This phenomenon can perhaps be seen in the fairly consistent payment-to-rent "floor" in the second chart above.

All told, it's certainly worth keeping an eye on how monthly house payments compare to rents and incomes. But we'll keep an eye on everything else, too.

-- RICH TOSCANO

Wednesday, September 17 -- 10:21 am

Home Prices Making Their Way to Normalcy

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Now that we've gotten Case-Shiller home price data for the first half of 2008, let's check back in on the long view of how home prices stack up with their underlying fundamentals: local incomes and rents.

As of the last update to these charts, which included data through December 2007, San Diego home prices -- despite having dropped substantially -- were still higher in proprtion to rents and incomes than they had been at either of the two prior bubble peaks.

That is no longer the case. At least, not with the home price-to-income ratio, which has now dropped below prior peak levels and could as a result be considered within the bounds historical normalcy (though admittedly very close to the upper bound).

As of June 2008, by the measurement approach described in the above chart, the ratio of home prices to area incomes had dropped 39 percent from the peak was back to a level last seen in January of 2002.

In order to reach to the low point seen during the last housing bust -- and I'm not saying that's necessarily going to happen -- the price-to-income ratio would have to drop a further 25 percent from here.

The June price-to-rent ratio, on the other hand, was still above the peaks achieved at the heights of the prior two bubbles. It nonetheless tells a similar tale to the price-to-income ratio: the June price-to-rent ratio was 37 percent down from the peak, falling to a level last seen in March of 2002.

It would have to drop a further 24 percent from here in order to equal the 1997 post-boom low point.

Now for some clarifications. First, as is always the case with these graphs, we are making some very broad generalizations by aggregating all home prices, incomes, and rents in the county at any given time into just three numbers. These calculations serve only to provide a very big picture view of approximate relative valuations over time.

Second, while the rent figures are fairly up to date, the income data ends in 2007 and income has been extrapolated into 2008 based on 2007 growth rates. It's probably pretty safe to say that per capita income is growing more slowly in 2008 than it did in 2007, so the more recent income figures above are likely slightly overstated. However, that doesn't really matter all that much because home prices swing a lot more wildly than incomes. The vast majority of changes to the price-to-income ratio over shorter intervals are caused by changes not in incomes but in home prices, for which the data is pretty well up to date.

Finally, I've included 30-year fixed mortgage rates on the chart to show that despite substantially different interest rates over time, the price-to-income and price-to-rent ratios have tended to remain fairly contained. The exception would be the sky-high valuations of the recent bubble, which I maintain owe more to incredibly loose mortgage lending standards than to low rates.

Next week we will put mortgage rates at center stage and take a look at how rents and incomes have compared to monthly mortgage payments over time.

-- RICH TOSCANO

Wednesday, September 17 -- 10:21 am

A Spring Rally! Kind Of!

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The Case-Shiller home price index for June indicates that San Diego home prices fell 1.5 percent between May and June. There was an unusual bright spot, however, as the high-priced tier of the index actually didn't decline for a month. High-priced home rose .3 percent in June, according to Professors Case and Shiller. This may not seem like much but it's the first actual increase for over a year.

The other tiers didn't fare so well, as usual. The mid-priced tier was down 1.6 percent for the month and low-priced tier was down 2.4 percent. As I'm fond of pointing out, and as the next graph demonstrates, the different post-bubble performance between high-, mid-, and low-priced homes is the flipside of how nutty each price tier got during the boom.

From their respective peaks, the high tier is down 19.9 percent, the middle tier 31.2 percent, and the low tier 39.5 percent. The aggregate San Diego index is down 29.5 percent from its November 2005 peak.

Check back soon for a long-term comparison of local home prices, rents, and incomes.

-- RICH TOSCANO

Wednesday, September 17 -- 10:21 am

Bottom Calling: Now Its Own Genre

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I think it's funny that the folks at the North County Times have created a "Bottom calling" tag in their new business blog.

The titular bottom-calling in their inaugural post for the new category was made by longtime DataQuick pundit John Karevoll. In addition to opining that sales volume had already hit bottom, Karevoll said:

“I'm pretty sure we're at or very close to the bottom here in true values. The only thing that could throw things out of whack is if there is a nasty recession or a year or two of nasty inflation that would push interest rates up and prices would have to come down. But I don't see either one of those happening, so I think we're very close to the bottom.”

Karevoll was pretty circumspect -- in addition to the disclaimers above, he noted that the market is likely to "drag along the bottom for a while.”

Nonetheless, this is a fairly bold call. We already appear to be in a recession here in San Diego, to address Karevoll's first disclaimer. And to address the second, inflation is already at a level that certainly seems to me to qualify as nasty (although I admit that the mortgage market seems not to have noticed).

In addition to job loss and inflation problems, foreclosures keep piling up every month, the mortgage industry has utterly fallen apart, and San Diego homes remain overpriced based on their historical relationship with rents and incomes.

So I'm going to go out on a limb here and offer the opinion that we are not at or very close to the bottom for San Diego home prices.

I will qualify this by saying that some areas are a lot closer to the bottom than others, and that I am referring here to countywide prices in aggregate.

Incidentally, the "true values" bit in Karevoll's quote alludes to the oft-discussed (here, anyway) shortcomings of the median price as an indicator of actual home price changes. Fortunately, the Case-Shiller index will be able to tell us who ends up being right on this call.

-- RICH TOSCANO

Thursday, August 21 -- 2:12 pm

Punish the Savers

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According to last week's update of the Consumer Price Index (CPI), consumer prices in the United States increased by 5.6 percent between July 2007 and July 2008.

Meanwhile, the Federal Reserve's funds rate -- which is the rate you are always hearing about the Fed raising or lowering -- has sat at 2 percent ever since the Fed's final (so far) rate cut in April. The Fed funds rate was as high as 5.25 percent back in 2007 before the Fed began slashing rates in the wake of the mortgage crisis.

The Fed funds rate heavily influences short-term interest rates such as those paid out by bank accounts or CDs. The Fed's rate-cutting campaign has resulted in an average savings account interest rate that is, according to bankrate.com, under 2.6 percent per year.

So to sum it up, people are able to get a 2.6 percent return (before taxes) even as they've watched the purchasing power of their savings decline by 5.6 percent over the past year.

It's pretty clear that the Fed has only pushed rates so low because the speculative boom that took place in the housing and mortgage markets has now reversed so violently. The unnaturally low Fed funds is just another form of bailout -- one by which savers are watching their real wealth disappear for the benefit of the housing market and the financial industry.

I'm kind of surprised more people aren't upset about this.

-- RICH TOSCANO

Tuesday, August 19 -- 6:04 pm

Employment Weakness Continues to Spread

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San Diego County shed jobs again in July, according to the EDD's latest estimates. As in the prior month, the problem wasn't that the housing-related sectors accelerated their decline, but rather that the non-housing sectors were unable to make up for housing's weakness as they had in the past.

The construction industry was hardest hit, as usual, down from the prior July by 7,500 jobs or 8.4 percent. The financial sector, which includes real estate, was down by 4,700 jobs or 5.8 percent. And the retail sector, which I have grouped in with the housing-related sectors because it had previously benefited so greatly from the home equity ATM, was down by 2,200 jobs or 1.5 percent.

The remainder of the economy had been bouncing along at a year-over-year growth rate of about 15,000 jobs. The non-housing economy has weakened, however, and for the last couple of months has grown at closer to 10,000 jobs (July in specific saw growth of 9,800 jobs or 1.0 percent).

As growth in the rest of the economy has become less able to offset housing-related weakness, the overall employment picture has darkened. In total, San Diego lost 4,600 jobs on a year-over-year basis, a decline of .4 percent. The county's unemployment rate rose to 6.4 percent.

-- RICH TOSCANO

Friday, August 15 -- 12:02 pm

Mortgage Defaults Slow -- Kind Of

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While the number of homes entering the final stage of foreclosure hit another all-time record in July, the number of homes entering foreclosure actually declined.

This decrease may not be very meaningful, however. To begin with, the number of notices of default (NODs, which notify owners that they have entered the foreclosure process) is only slightly down from its recent record heights. As the accompanying graph shows, the number of NODs filed in July was substantially higher than anything seen during the region's protracted 1990s housing bust.

In addition, even this decrease may be temporary. A recent Wall Street Journal article notes the significance of California's recent foreclosure legislation:

A new state law in California requires lenders to wait an additional 30 days after a homeowner misses the first payment before filing a default notice and use more "due diligence" to attempt a loan modification. The law took effect July 8.

The article goes on to cite some experts as believing that the new law has simply caused a temporary respite in new foreclosures, and that the numbers will surge back up again within a few months as delayed foreclosures eventually get processed.

If this explanation is correct, then we can probably expect further decreases in NODs for at least another month and a corresponding increase soon thereafter.

-- RICH TOSCANO

Tuesday, August 12 -- 11:44 am

More Home Sales, Less Inventory in July

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Housing resale volume increased in July, ending up 16.4 percent higher than it was last July. At the same time, resale inventory declined to end up 9.7 percent below where it was a year ago.

So both elements of "months of inventory" calculation -- which measures how much supply there is in comparison to demand -- improved to 6.3 months of supply. In addition to being a vast improvement over the 12 months' worth of inventory seen late last year and early this year, this reading actually beats out either of the prior two Julys. And 6 months' worth of inventory -- just a hair's breadth away from the July reading -- is considered by many to be a "normal" market.

So is normalcy returning to housing? For the answer to that question I direct you to the latest writeup on monthly foreclosures. As positive as the improvement of overall supply and demand is, it doesn't seem positive enough to outweight the negative effects of all those forecslosures piling up and waiting to be sold.

Normalcy does not appear to be forthcoming until foreclosure activity comes back to earth. And I'm not talking about a temporary decrease in official foreclosure filings that could be the result of, I don't know, a "foreclosure sanctuary" or something like that. I'm referring to a purging of bad loans such that the vast majority of remaining homeowners are willing and able to make their mortgage payments.

The pickup in volume is a good thing for the market, but it alone will not be enough to restore normalcy until the lending system itself has become healthy once again.

-- RICH TOSCANO

Wednesday, September 17 -- 10:21 am

Median Home Prices Drop in July

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The median price per square foot of resale homes sold fell again in July. This metric is not as accurate as the Case-Shiller index discussed last week, but it is available two months sooner. And outside of the distortion caused by the subprime lending implosion in early 2007, the median price per square foot -- aka the size-adjusted median -- has been a pretty accurate predictor of the Case-Shiller index. So it's worth looking at.

The size-adjusted median for single family homes dropped a fairly hefty 3.6 percent last month -- its worst drop since February. The condo size- adjusted median, on the other hand, actually increased by 2.4 percent. But considering the drubbing inflicted upon the condo median over the last few months this rise is not so impressive. Even after the July increase, the median condo price per square foot was 9.4 percent below where it had been just three months earlier.

Combining the two property types, the overall size-adjusted median price was down by 1.6 percent for the month. It has declined by 33.0 percent since peaking in September 2005.

-- RICH TOSCANO

Wednesday, August 6 -- 4:45 pm