patrick.net

that graph looks like a double-dip recession. I hope TPTB have learned to "Just dip once and end it"

"The bubble vaporized a lot money."

Mostly it just transfered money from the buyers (and their lenders) to the sellers at the top of the market. Unfortunately many people lent money to the buyers so they were the real losers. But all of the "lost" money went to the sellers, and also to the people who sold other stuff to those borrowers who used home equity loans to buy stuff.

I agree that commercial RE has much pain yet to come.

Zephyr,
The vaporization I'm referring to (which, I'm pretty sure you understand) is the gigantic, gaping hole on the banks balance sheet (which is all a bit ethereal, as the money for lending was willed into existence by the miracle of fractional reserve banking). A lot this 'created' debt was then securitized, and, conveniently, has found a home at the Fed (to shore up the banks capital ratios).

notice that its all timed to end on 2012!

Dec 21

Yes. The money vaporized from the perspective of those who lost it, for sure.

But the money actually went to the parties on the other side of the bad investments made by the borowers. So when I sold at the market top, I got money that the buyers borrowed, and now cannot repay to the bank. So it did vaporize from the bank's balance sheet, but I still have it. The bank has lost their ability to collect it from future income of the borrower. But the bank no longer had that money once they lent it to the borrower, and he gave it to me. So the vaporization was really a transfer. But nobody is following the full path of the "lost" money.

EBGuy,

Every dollar lent out by a bank had to first come into the bank as an actual dollar deposit (or investor capital). Banks do not "will" money into existence. Fractional reserve banking is a restriction on lending that limits the total of all loans to a ratio based on deposits.

Banks are limited to lending only 90% of their deposits. When that money gets deposited back into the bank, the bank can lend 90% of that same money out again. Ultimately this process can result in the bank having lent the same money many times over. But the bank also owes the same money to many depositors many times over. The net effect is that the bank has the same net worth that it started with (before receiving interest payments).

The official money supply measurement does not subtract for the various loans, and counts only the deposit side of the bank balances. It is a gross accounting, not a net accounting. So the real net value is not known, and not reported. The effect is that the money supply counts that same dollar like a new dollar every time it is deposited. So the recycling of the same money increases the measurement of the money supply. There is no magic, just incomplete accounting.

Zephyr, you still have not answered my question: how will the option ARM resets, shadow inventory, increasing NODs, horrible unemployment affect prices? how can you say prices have bottomed if the inventory is held back???

HOW WILL the prices be propped up?

Serpentor says

HOW WILL the prices be propped up?

My ideas:

2.5% fixed for 50
10 year 1% IO balloon loans
Change the tax deduction to a tax credit
Wage inflation resulting in the median wage moving to $80,000.

Are of these are entirely possible, none likely IMO

It is true that we will see high interest rates if & when "inflation expectations" (FedSpeak for wage inflation) returns. As I've stated ad infinitum here recently, I don't see J6P having much bargaining power WRT wages this next decade and compression is the order of the day. Zephyr says consumer spending on luxuries will take the hit, which is possible, while I think/hope land values will (instead).

Zephyr says

So the vaporization was really a transfer. But nobody is following the full path of the “lost” money.

This is an important point and explains the hot money on the sidelines looking for deals right now.

http://research.stlouisfed.org/fred2/series/MZM

But the bank no longer had that money once they lent it to the borrower
No, but they had the debt. And debt=money when you can securitize it and get it off your books. But you already know this (I think). We would not be in trouble (just a lot poorer from real wealth transfers -- which is what you refer to as the 'lost money') if the banks had securitzed (and sold off) everything. Quite a paradox; the problem was, they drank their own KoolAid and either kept some on the books or bought MBSes as investments.

I just read your most recent post, and, obviously we disagree -- I'm going to feel quite silly if you're correct (but hey, I'm teachable). I assert (with a 10% reserve ratio) that for every dollar deposit a bank takes in, they can lend out $9 (which is created supply). You say they can only lend out $0.90 (with dollars having to circulate through the system, redeposited in the same or different banks, many times to hit the 9x multiplier). Yours is definitely more sensible, but not my understanding (I'll see if I can find something from the Fed's website).

EBGuy says

Yours is definitely more sensible, but not my understanding (I’ll see if I can find something from the Fed’s website).

http://en.wikipedia.org/wiki/Fractional-reserve_banking

EBGuy,

Remember that assets must equal liabilities (even in bank accounting).

In bank accounting the loan is an asset (money owed to the bank),
and the deposit is a liability (money owed to a depositor).

I personally know people that have made hundreds of thousands of dollars in the stock market since March Lows... The scary thing is that they are still Ultra-bullish.. And see the Dow quickly going back to 14,000 and beyond in the next year or 2.

I'm very skeptical of this since it makes no sense for the bubble to re-inflate so quickly... If that actually happened than people who went into a coma in 2006... would awake in 2012 to a fairly hefty profit margin. I find that hard to believe that someone asleep at the wheel would gain so much in a corrupt market.

Everyone under water on a home loan right didn't release an equal seller who sold at the top of the market. Many people (idiots mostly) borrowed against their house like it was a second job, so follow the trail of lost money to the car depreciating in the driveway and clogging up the garage.

"...so follow the trail of lost money to the car depreciating in the driveway and clogging up the garage."

The money went to the seller of the car, in exchange for the car.

Serpentor,

The middle market and upper market will sustain more price slippage and pain due to a variety of factors, including the items you listed.

The bottom third has already bottomed, and there is strong demand for houses in that category.

The bulk of the damage is behind us. The problems you mention are real, but they are not new pressures on the market – they are lesser continuations of the pressures that have already driven the market down. In order for them to drive the market down further, they must be more significant than that which has already occurred. But that is not the case.

As to specific points, much of the option arm resets have already gone bad, so there will be no reset in those cases. The option ARMs were notorious for also being liar loans, and those buyers often could not afford the lowest payment option. Many of them have already defaulted for this reason, and the recognition that they are way under water and simply stopped paying on a bad investment. As I recall, the average option ARM was for about $550,000. So most of the remaining impact will affect higher priced houses.

In every down market there is a substantial shadow inventory waiting for a better market. This will slow the pace of price increases for a couple years as the shadow inventory emerges on any price increases. However, there is also shadow demand in those who have wisely waited to buy as prices were too high and then falling. In addition, most sellers (about 70%) are also buyers looking to trade up (or perhaps they will trade down now) so there is a substantial offset to the shadow inventory.

NODs are just one step in the default process that continues to bringing a flow of inventory. This will subdue the price increases we are currently seeing at the low end, and will contribute to the continued price declines in the higher end as I have mentioned in earlier posts and above.

Unemployment: The market cannot become healthy again until unemployment declines. I (and most economists) expect unemployment to peak soon, probably by Q2 of 2010.

Foreclosure inventory is moving slowly through the process, and is being sold. Any delays will defer some current pain into the future. This has the effect of reducing the severity of the decline while also delaying and initially subduing the recovery. We saw this effect in the early 1990s downturn as the RTC held massive inventories off the market, and slowly sold them over many years.

Currently the market could use more inventory for sale at the low end, where most foreclosures occur. Inventory to sales ratios have declined significantly over the past year as sales volume increases and inventory for sale declines. The market is approaching a normal balance by this measure. The downward pressure is fading.

Zephyr says

The middle market and upper market will sustain more price slippage and pain due to a variety of factors, including the items you listed.

The bottom third has already bottomed, and there is strong demand for houses in that category.

these two statements are contradictory. If the middle is slipping, then the bottom will also slip.

I agree that there are enough rent-seeking bastards to support any price level that cash-flows.

Unemployment: The market cannot become healthy again until unemployment declines. I (and most economists) expect unemployment to peak soon, probably by Q2 of 2010.

Unemployment is important, but what matters more is the wage base. Lots of useless real-estate jobs got us out of the 2001-2003 recession, but at the cost of of going deep, deep into debt. If those wages don't come back, then those valuations are not coming back, either.

As I've said many times, this isn't the 1930s, 40s, 70s, or 80s. No wealth creation, no wage inflation.

"If the middle is slipping, then the bottom will also slip."

Simply not true. You have it backwards.
The low end of the market leads in the cycle.
The middle relies on trade up buyers from the low end.
The low end MUST bottom before the middle can recover.

Rental cash flow does provide a fundamental support level for housing prices.
And those "rent seeking bastards" are providing housing to those who cannot afford or choose not to buy it themselves.

Very easy monetary policy got us out of the 2002 recession.
But it resulted in excessive use of debt, and over-investment in real estate.

And now the Fed has gone wild.

Remember that assets must equal liabilities (even in bank accounting).
Don't worry, I'm not totally off my rocker (I may have been thinking that the money was created by the Fed and extended as a loan, therefore, when the principal is paid off, the bank repays the Fed -- and the money disappears, with the interest going to the bank. ) At any rate, talk about a conspiracy, Reserve Requirements is "under revision" at the NY Fed.

Zephyr says

Simply not true. You have it backwards.

Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the center cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

And those “rent seeking bastards” are providing housing to those who cannot afford or choose not to buy it themselves.

LOL. Such generosity! I have zero moral problem with investors profiting from the capital invested in creating or improving housing. Profiting from pocketing ground rents, however, gets my back up as a pernicious tax levied on the less well off. That the Brits had a name for this, "Buy to Let", sickens me.

Troy says

As I’ve said many times, this isn’t the 1930s, 40s, 70s, or 80s. No wealth creation, no wage inflation.

If anything we are seeing wage/salary deflation. As is the case with the SF Bay Area tech industries which is common to manage margins. Even after 2002, cost control were fully in place,

In my neck of the woods, former VPs of Finance , Marketing, Engineering are not finding jobs. They are however consulting when they get something. I am talking about people with 15-30 years of experience unable to find full employment. Others have taken demoted positions from Corporate Controller to Accounting Manager position, and a 15-20% cut in pay. Or CFO to Controllership. This has put promotions out of reach for many staffers. It many be a long time for promotions to happen.

We will see a flat to down in wages and salaries.

Zephyr says

Serpentor,
The middle market and upper market will sustain more price slippage and pain due to a variety of factors, including the items you listed.
The bottom third has already bottomed, and there is strong demand for houses in that category.
The bulk of the damage is behind us. The problems you mention are real, but they are not new pressures on the market – they are lesser continuations of the pressures that have already driven the market down. In order for them to drive the market down further, they must be more significant than that which has already occurred. But that is not the case.
As to specific points, much of the option arm resets have already gone bad, so there will be no reset in those cases. The option ARMs were notorious for also being liar loans, and those buyers often could not afford the lowest payment option. Many of them have already defaulted for this reason, and the recognition that they are way under water and simply stopped paying on a bad investment. As I recall, the average option ARM was for about $550,000. So most of the remaining impact will affect higher priced houses.
In every down market there is a substantial shadow inventory waiting for a better market. This will slow the pace of price increases for a couple years as the shadow inventory emerges on any price increases. However, there is also shadow demand in those who have wisely waited to buy as prices were too high and then falling. In addition, most sellers (about 70%) are also buyers looking to trade up (or perhaps they will trade down now) so there is a substantial offset to the shadow inventory.
NODs are just one step in the default process that continues to bringing a flow of inventory. This will subdue the price increases we are currently seeing at the low end, and will contribute to the continued price declines in the higher end as I have mentioned in earlier posts and above.
Unemployment: The market cannot become healthy again until unemployment declines. I (and most economists) expect unemployment to peak soon, probably by Q2 of 2010.
Foreclosure inventory is moving slowly through the process, and is being sold. Any delays will defer some current pain into the future. This has the effect of reducing the severity of the decline while also delaying and initially subduing the recovery. We saw this effect in the early 1990s downturn as the RTC held massive inventories off the market, and slowly sold them over many years.
Currently the market could use more inventory for sale at the low end, where most foreclosures occur. Inventory to sales ratios have declined significantly over the past year as sales volume increases and inventory for sale declines. The market is approaching a normal balance by this measure. The downward pressure is fading.

so as you say, the middle and the high end has a ways to do to drop then why did you say housing has hit bottom?

News flash it's the lower class that is getting the hardest hit in this recession. Manufacturing, service, and other low end jobs are going away. Middle class is suffering but is faring better then the blue collar types. Who's gonna buy up these lower end homes if everyone is getting laid off?

Most of these sellers are not going to be buyers, I don't know where you get your 70% number from but I think you pulled it out where the sun don't shine. There are plenty of figures on foreclosures and people who are underwater to know that 70% is a whole lot of baloney.

The lower end doesn't need more inventory, they just need the banks to start pulling them out of the deep pool of shadow inventory.

thomas.wong87: on that same note, I'm also seeing industries that we thought was immune (biotech, medical device, research instruments, etc) starting to get hit with layoffs due to investment capital tightening up...

Serpentor says

Who’s gonna buy up these lower end homes if everyone is getting laid off?

Millions of Casey Serins looking to get back into the game of easy money. Wonder how his gold stock is going, LOL.

Zephyr says

“…so follow the trail of lost money to the car depreciating in the driveway and clogging up the garage.”
The money went to the seller of the car, in exchange for the car.

Yeah, I guess eventually the money ends up with Kevin Bacon. Interest on debt for the car store paid to a bank.

Serpentor,

"...then why did you say housing has hit bottom?"

I said that the low end has hit bottom. Not the whole market.

"Who’s gonna buy up these lower end homes if everyone is getting laid off?"

Investors. And others as the job market recovers.
But this is not a forecast - the buying is happening now at the low end.

"...70% is a whole lot of baloney."

It is the normal market average. And that average will be the case again as the market recovers.

"The lower end doesn’t need more inventory..."

Tell that to the thousands of buyers who are having trouble buying a starter home because others are beating them to it. Many first time buyers are getting frustrated, as they get outbid on every house they try to buy.

I have been looking for rental properties and not finding what I want. The inventory is very thin (a fraction of what it was a year ago), and very picked over - like a department store the day after a weeklong 50% off sale. At the same time at the high end there are almost no buyers.

Zephyr says

bob2356
The boomers will not die faster than the new births and immigrants replace them. The population of the US is expected to increase by roughly 100 million people over the next 25 years. So, real demand will grow.
And those who replace the dying are always from the bottom of the ladder, and they work their way up. All the people in the middle move up slowly as the oldest retire, and then die.
The replacement demand is already walking among us.

Yes and no. The replacement is about 3 million a year births and 1 million a year immigration so yes there will be 100 million in 25 years. What is missing from this equation is the huge bulge in demographics from the baby boomers. The so called pig in the python that has driven American culture for 50 years. The ratio of baby boomers to gen x's is very high 78 million vs 42 million vs about 60 million millennials. The agreement on length of generations is all over the map but about 15-20 years seems to be average. So there will not be nearly as many people in the income/life style position as the retiring boomers to move up into the baby boomers houses as they retire.

The population curve is actually hourglass shaped at this point. Probably a good thing for Gen X's considering that the job market has imploded and will stay down for a while. When and if the boomers retire (if they can) there should be large opportunities for Gen X's to move up quickly career wise. The bad thing is you will have a huge bulge of houses for sale at the top. The baby boomers, will be trying to sell their peak of career houses (read wet dream mcmansions) past the middle into the low end of the demographics curve. People who for the most part will be looking to buy starter homes or early career move ups.

Add in 15-20 million empty houses currently on the market along with record foreclosures again this year beating last years record and I don't see how we are at the bottom of anything. At least not the long term bottom. If I were investing in real estate again right now (sold everything in 2006) I would be very interested in starter/retirement homes in safe retiree friendly areas of the traditional retirement states. Just a thought.

And keep in mind re: birth rates, the higher the level of income/education the fewer children you have. How many low income, generational poverty kiddos can grow up and buy that McMansion?

"Greenspan’s Fed allowing lending to go completely insane 2003-2006 was the main driver of the speculative blowoff."

Indeed the Greenspan Fed caused this spectacular bubble. But they did it unwittingly, by giving everyone a huge incentive to borrow as much money as possible - super low interest rates. The lenders went crazy because they could make big profits on the margin spreads and fees from selling the loans to institutional investors who were dying for a little more yield, and could get it by buying MBSs. There was a bubble mania in lending that fueled the real estate bubble.

Risk quality did not matter to any of them because they were confident that there would be no significant problems, and that the extra yields for subprime etc. would be enough to pay for the extra defaults that would come from the loose lending. They really did believe this. I personally talked with many of these wall street and institutional people during that time. The easy underwriting was motivated by everyone's exuberant greed chasing the super easy money.

So the Fed did more than just allow the lenders to be stupid - The Fed gave them a big profit incentive to do so.

Besides, they all believed that if things got bad Greenspan would just print more money to keep the game going (they called this the Greenspan Put). But the Fed took the punch bowl away during 2005, and then the money was not so cheap anymore. And the game started to slow down.

Market cycles are normal. But this one became a spectacular bubble because of the gasoline that the Fed poured on the fire from after 9/11 2001 until 2005.

Bob2356,

Based on current census data and forecasts, including immigration, the population will steadily grow during the next 30 years.

And examining the population profile by 5 year age bands (including mortality rates by age band) shows that the adult working age population will keep growing.

And the pop by age band multiplied by the normal household formation ratios shows that the number of households will keep growing.

And the number of households by age band multiplied by the normal home ownership rate by age band shows that the number of homeowners will keep growing.

I do think that the boomer bulge being followed by smaller cohorts will make the McMansions potentially in oversupply. At the same time if boomers look to downsize they will be doing so at about the same time that their children (the echo boom, another bulge) will be looking to buy their first homes. This could cause a shortage of smaller homes while leaving a surplus of McMansions.

Also important is the likely migration to warmer climates. This would exacerbate the surplus and shortages on a regional basis.

Zephyr says

Market cycles are normal. But this one became a spectacular bubble because of the gasoline that the Fed poured on the fire from after 9/11 2001 until 2005.

The interest rate drops from 2001 through 2003 (8.5% to 5%) got the party started but it was "innovation" in mortgage products that kept it going once rates were adjusted upwards 2004-2006.

The Fed was putting the brakes on the larger economy but as the graph shows there wasn't much control authority (using the aeronautic term) over the mortgage market.

In 2006 a borderline-unemployed Casey Serin was able to waltz into the market and "buy" 10 houses, borrowing $2.1M from numerous institutions that are mostly no longer with us now.

Here's what Greenspan said about that, in 2005:

Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s

Part of the Fed's charter is to oversee the financial system. The Executive also has various alphabet agencies charged with this mission, but it can be argued that their failure falls more into the general active malevolence of the previous administration than garden-variety stupidity, perhaps.

http://www.washingtonpost.com/wp-dyn/content/article/2008/11/22/AR2008112202213_pf.html

TMK, the Greenspan/Bernanke Put is essentially ZIRP. QE is actual monetization of the debt.

The problem going forward is running into the Liquidity Trap, where worthwhile, potentially productive borrowers are tapped out, leaving the extra liquidity to fall into speculators and other economic ne'er do wells.

We can helicopter-drop money, but unless it ends up in the hands of J6P, rents and housing values are NOT going to go up. We saw what speculation can do to energy: $4 gas was NOT good for J6P or the housing market, other than heightening the value of housing with a shorter commuting distance (but this is largely zero-sum since it is coming at the expense of housing further out).

Zephyr,

I'm not sure why you paraphrased everything I just said. I used the imprecise measure of generations because it shows much more dramatically the differences. Check your demographics again on the issue of oversupply of medium to large homes vs shortage of small homes. It's going to be a very big deal down the road.

Zephyr says

Based on current census data and forecasts, including immigration, the population will steadily grow during the next 30 years.

Forecasts by who? Last I checked we had flat population for the decade. Most of the inflow
coming from northeast while Californians are moving out into the SouthWest.
Only forecasts showing growth are from local governments and realtors associations.

Zephyr is correct. Births are at about 3.5 million a year, deaths are at 2.5 million a year, immigration is at about 1 million per year. So we will net about 2 million people per year.

Zephyr is also correct that the EVENTUAL replacement buyers for the current and future overhang of baby boomer housing are in the system or coming. I just strongly disagree that it will be a linear process. There will be large amounts of adjustments in the mix and pricing of housing before an equilibrium is established again. Mostly to the downside in the early and especially middle stages.

Here's a nice bar chart to show my original point.
http://www.censusscope.org/us/chart_age.html

It's off the 2000 census so the 35-49 bulge is now in the 45-59 area and in 10 years will be in the 55-69 range. The differences don't look all that dramatic until you lump them into 15 or 20 year bands instead of 5 year bands. Then the bulges really stick out.

Using popularly labeled "generations" is too crude. The first of the boomers will be retired while the last boomers are in their peak spending years. We will have totally different demand characteristics within one "generation" group. Thus it is misleading to look at the boomers as one group. It is far more important to know how many people are in each 5 year age band. This allows consistent comparisons of population profiles over time.

The key demographic relates to the cohorts who are followed by substantially smaller cohorts. The people who are now about 45 to 55 years old are critical because they are the peak of the bulge and are now in their peak spending years. So it is their retirement that will have the most meaningful affect on demand.

Household formation, household formation, household formation. With a net increase in population, its hard to avoid the inevitable, but we certainly can try....

Jobs, jobs, jobs.

Just making more mouths to feed isn't going to pay the rent. Though cousin Juan just back from Tegucigalpa actually does help.

AFAICT this decade was a total smoke & mirrors economy, with so many high-powered careers based in the FIRE sector, which, aside from incidental construction, doesn't produce one thin dime's worth of new wealth.

FWIW, I think the Fortresses are going to do OK this next decade -- simple supply & demand. Middle-class housing, though, I just don't see the upswing pressures, though if the dollar is devalued 50%, or mortgage rates fall to 2% then there could be some big-ass price rises.

Interestingly, there may be a link there. If the dollar devalues 50%, then maybe China & Japan will have more dollars to lend us -- it'd be play money to them at this point -- and they'd settle for those 2% returns. TBH, I have no idea what's going to happen this next decade. Too many moving parts, and this is bat country.

Jobs, jobs, jobs.
Just making more mouths to feed isn’t going to pay the rent.
Certainly not going to disagree with you there, and if these are Deflation Nation WalMart jobs, household formation goes nowhere fast. Interesting, here's where the jobs are:
Many of these workers have become dissatisfied with their compensation or advancement opportunities in the U.S. and perceive better opportunities back home or in other parts of the world... with the unemployment rate at 5.7% in Australia, Ms. Morand considers the career opportunities in her home country better. "Certainly compared to New York [the outlook] doesn't appear to be as critical," she says.

I think we lost sight of worth, and what merits a premium and is a luxury. And what is just plain necessity and only serves a facilitate propose. A home or a house that you buy to shelter your family, will never be worth more than what a market can pay for it. That market of course being the median income in that area can afford. There's no such thing as a fortress how ever. Because there are other factors besides it's a nice home on a nice plot of land. That can change based on finicky whims of how "Desirable locations" are defined. That can and will change periodically. I'm sure there was once a point in history when Detroit real estate had it's fortresses through out the town. But as long as the wealthy are willing to consider desire over value, because they can afford to pay 700K ++ for a house and the zeros on their last pay check says they can afford it, then it's really up to the rich Jones' to slug it out.