patrick.net

Yes, you've had a number of substantial topics lately, but I have been busier than usual... with travel, and with the markets being dicey. So I seem to have hit after there is already a long string of varied discussions.

Zephyr,

Are you from this planet, or just visiting?

If the cap gains exclusion is simply a "non-factor" why is it that the bubble and this legislation share a birthday? It is at the VERY CORE of the bubble (assuming your acknowledging that we're in one). Please allow me to make this simple. Under the old code empty nesters were permitted to downsize under a ONE TIME exclusion. So, no bubble, no problem. Almost immediately upon it's passage we begin to see housing prices begin to ramp up. To say that this in fact encourages downsizing is just plain dense. Why has the average square footage of homes skyrocketed? Yeah, dangling tax free money in front of people usually has a "negative" impact on prices! Sure it just makes sense. I'm sorry, but I've tolerated some of your bullish rants in the past but I fear you have damaged your credibility beyond all repair. Get with the program.

hmmmmmm

Aussies sinking deeper into money crisis
Sydney Morning Herald May 19, 2006
http://tinyurl.com/qsue4

Australians are sinking deeper into financial crisis, with petrol prices soaring and higher interest rates making it more difficult for consumers to pay off their debts.

And financial counselling services across Australia are finding it difficult to cope with the growing number of people needing their help.

Mike Young, a financial counsellor with Lifeline Western Sydney, said debt crisis was not unique to low income earners.

"It can be a person who's got a very good job but for one reason or another - it may be sickness or it may be the loss of a job - he finds himself unable to maintain the commitments which he had been able to cope with for many years," Mr Young said.

But the effect of this month's interest rate rise on Australians was yet to be seen, he added.

Other factors were also hurting household budgets, Mr Young said.

"We are seeing the start of the effect of the new industrial relations laws," he said.

And recent changes to debt recovery laws were not helping, Mr Young said.

"...why is it that the bubble and this legislation share a birthday?"

DinOR, coincidences do happen. For example I have a nephew who also shares a birthday with the start of the bubble... Is he the cause of the bubble? I raised $100 million in venture capital and started a new company right before the housing market turned upward... does that make me the cause of the bubble? I bought a new car that year... could that be the cause? Correlation does not neccessarily mean causation. Interest rates often rise when housing prices rise... does that mean that higher interest rates are good for housing prices? No... sometimes things that are negative to a condition are also highly correlated to it.

Anyway, the old exclusion was limited to people over age 55. Everyone else had to fully reinvest to avoid taxes - and nearly everyone did. Under the prior law people always sought a more expensive home to avoid the taxes, even if they no longer needed the space. The new exclusion is available to all ages. Thus we have an expansion of the ability to exit the real estate market and downsize.

So the bull market started at the same time that the law was changed... and you think that makes it the cause... You don't think that lower interest rates and an expanding economy had more to do with it? At the start of this bull market we had cyclically low supply growth and accelerating demand - do you think this was not important?

DinOR, I have "been with the program" for more than 30 years - as an investor, market analyst and senior executive in the capital markets and financial services industry.

As for being bullish, I am bullish long term, but have been labelling the market as overpriced since the end of 2003. In 2004 I forecast that the housing market would peak in late 2005, and decline until 2008 or 2009. I continue to hold this outlook.

Just because I don’t expect the sky to fall or the world to end does not make me bullish. Besides, is it some sin or heresy to be bullish (if I actually were)?

There are always some eternal optimists who believe (no matter what the bad news is) that the good times will never end. And there are always some eternal pessimists who believe (no matter how good things are) that severe economic disaster is about to fall upon us. The eternal optimists and eternal pessimists have one major trait in common – they will be proved wrong.

All I can say is that if I continue to have to pay twice as much to buy than what I have to spend on rent, a permanently higher ownership premium is fine with me.
I can buy a house in cash with the saved and reinvested money in less (or much less) than 30 years in almost all plausible scenarios.

Zephyr
Correlation does not neccessarily mean causation. Interest rates often rise when housing prices rise… does that mean that higher interest rates are good for housing prices? No… sometimes things that are negative to a condition are also highly correlated to it.

hmmmmmmmmmmmmmmmmmmmmmmmmm ;)

that's a tricky one -- lower interest rates seem to have contributed to the boom, and desperate Feds and Reserve Banks etc slowly raised interest rates to try to contain the boom without hurting business too much. This is the trouble with laissez-faire govts which only have 1 lever left to try to manipulate the entire economy, being the setting of interest rates. (OK, I guess they can use selective taxes and rebates as carrots and sticks too.)

There were similar tax breaks offered here in 1997 -- the halving of capital gains tax on investment properties -- which also appeared to correlate with a surge in housing prices. I believe there's a connection, but there have been a number of inputs over the last 18 years, all leading to mini-surges. e.g. 'negative gearing' deductions which let you claim property investment losses against personal taxes.

and also recently liberalised credit offerings from lenders, more adventurous products, etc, all of which act as enablers for property speculation or 'investment'. you can even blame the spruikers and 'gurus' like robert g. allen and equivalent as inputs... it doesn't take long for investment advisers, even sound ones, to start touting the benefits of all the tax breaks etc to their clients, push investment properties their way, etc...

Zephyr,

Looks like we pretty much agree on #1 & #3, though I have to wonder how long the GSEs will continue to be a large factor in the easy money game, especially given the ongoing accounting "issues" at Fannie & Freddie. Privately run MBS/CMOs appear to be here to stay, though if they start demanding higher risk premiums (thanks to collapsing bubble), this will curtail lending & mortgage liquidity significantly. As Peter P says, reflexivity in action.

To some extent I see your point in that the capital gains exemption, mtg. interest deduction and 1031 exchange have all been with us for a long time IN SOME FORM. However --and this is critical-- As DinOR pointed out what changed dramatically in the 1990s was that these programs were vastly EXPANDED.

The 1031 process/red tape was greatly simplified in the Omnibus Budget Act of 1990 --opening the door many who were previously afraid to try it. The Taxpayer Relief Act of 1997 of course greatly increased the amount of tax-free capital gains on primary residences, eliminated the one-time only restriction, and later amendments expanded this benefit to second homes as well. I can't help but believe these were significant factors in spurring greater speculation and turn-over in the housing market. Tax-free money is a powerful lure for any investor, and you can't get any of it if you don't cycle product --the faster the better.

No, I don’t have, never had, and never will have, a HUMMER.

Ok, thanks for clearing that up, Linda --your reputation remains untarnished! ;-)
Now, have you ever given anyone a... no, I'd best not go there. :roll: (*cough*) Never mind, carry on.

I can buy a house in cash with the saved and reinvested money in less (or much less) than 30 years in almost all plausible scenarios.

Girgl,

the only problem with this scenario is actually saving the difference for 30 years - but I agree, I've already thought about this a few times myself - so much more relaxing - save for 30 years, then pay cash for the place you were going to buy after you downsized anyway, in the neighbourhood you want to live in, not the one you moved to for the schools 'cause of the kids, who are now grown... The added bonus is that, if you buy this way, there doesn't have to be room for the kids to move back home!

Different Sean,

All of the specific tangible influences such as tax policy can change the realistic normal trend line or neutral value level. If these changes are viewed as permanent, then they permanently shift the fundamental balance level and do not cause (nor reduce) cyclicality. Of course, the timing of such changes certainly can influence the momentum of the market… but these things do not cause bubbles.

Bubbles are caused by exuberance - by the expectation of further price increases even when prices are viewed as too high. Price movement that is supported by fundamentals precedes the exuberance. It sets the stage for the expectation of further price increases. Then people rush to invest on the momentum. Psychology and rumor then pushes the market. Abnormally high demand is thus created and cannot be sustained… and the tide turns.

Girgl and tsusiat,

The problem with that reasoning is future inflation and taxation are both unknowns. "Safe savings" like CDs rarely keep up with inflation.

Current taxation is clearly in favour of home owners. There is no reason to believe that this may change. No practical chance.

Owning is better than renting. But not at any price. Most of us want to be owners at some point. It's just that the financial risk is very high at this point for many.

HARM,

I agree that the $500,000 exclusion is an attractive benefit. But what it lets you do is sell without reinvesting. The prior law allowed unlimited exclusion for anyone - but you had to fully reinvest. So at the margin the tax law change should encourage some incremental exit from the market (reduced demand). However, I really do think the impact was insignificant, because most people probably reinvested anyway, given what the market was doing.

I have argued this with my friends. This was one of the very very few discussions I actively participated before realizing that it is better to shut up than become a hugely unpopular person. (Reposting from previous thread.)

To me, anyone who buys a house with ARM, or I/O is speculating. It is not investing, it is not for “settling down”, it is not for buying a “home”. They are expecting to various degrees

1. Continuous rise in asset prices.
2. Interest rates being lower when the reset happens.
3. Their income being higher than what it is now.

The first 2 are nothing but speculation. The first one is not happening anymore. Second one is already wrong.

The only way to save this bubble is wage inflation. How likely is that to happen ? Even if BB prints money like mad, the resulting inflation may not translate into wage inflation.

I am keeping a watch on wages. That is more important than the rents. Just because rent went up by 10%, a person may not be willing to take on a huge debt. But if salary goes up by 10% or more, it’s a different story.

HARM,

Regarding Fannie and Freddie, they have lost market share to others. The capital markets have an appetite for the mortgage debt and they will seek it even if Fannie and Freddie were to go away.

Before these entities were of consequence the savings banks would sell their loan portfolios to other banks that had more deposits than loan demand. In those days the liquidity for housing was heavily dependant on consumer savings. During recessions this became a sparse source of capital, and lending liquidity would all but disappear. This pounded the faltering housing market down hard. Today the source of mortgage funds is the world financial markets.

it's the 2 things in conjunction, zephyr -- shrewd investors trade on new tax breaks or liberalised credit products, which then causes a bidding war and prices go up. once joe public sees prices going up, a myth starts about cashing in on the boom, with the whole resultant circus. spruikers and gurus then go round charging $5,000 to learn 'the secrets of the wealthy' or just selling investment properties by touting the new tax breaks etc -- the very nature of market forces ensures that there's a wildfire effect. unfortunately, there's no bounds on human greed in capitalist societies to act as a restraining influence...

but i think there's no question that historically low interest rates post 9/11 definitely started people borrowing more, along with the other effects -- what we are seeing is price readjustments following interest rates -- which makes a 'normal trendline' an almost impossible concept, as interest rates can jump around from 2% to 18% within the space of a few years, totally changing the pricing and investment equation. it will probably roughly track CPI or wage increases as the best indicator over the long run. layered on this is the 7-year 'Juglar business cycle' of capital jumping from property -> shares -> cash etc. (I personally happen to think all this is virtually immoral when it comes to a reasonable social settlement.)

To me, anyone who buys a house with ARM, or I/O is speculating.

however, ARMs are the norm in Oz, mainly because they are 1 or 2% cheaper than fixed rate, so mortgagors try to save significant money in the here and now simply by going for the cheaper option. as long as rates don't go back to the 18% of the 80s, they think it's a reasonable arrangement. a recent study suggested that it was costlier to use fixed rate over a long period under analysis due to low stable rates. the only speculation is trusting that rates won't skyrocket, they're in no way necessarily underwater and praying for capital appreciation in this scenario, or the other 2 items you suggest...

BTW, I saw a report that RE lenders have recently loosened their lending standards. Seems like rather perverse timing.

BTW, I saw a report that RE lenders have recently loosened their lending standards. Seems like rather perverse timing.

they loosened them well and truly a few years ago -- the Prudential Regulatory Authority (APRA) eventually had words with them tho, and tightened them again -- altho it may have reverted. there are now record foreclosures in the last year here (posted on my blogspot www.housingaffordability.blogspot.com) as well as the general financial calamity as posted above of higher fuel prices, increasing interest rates, changing industrial relations laws, etc.

but isn't it odd how untighten and unloosen mean the same thing in english when the roots are opposite???

BTW, I saw a report that RE lenders have recently loosened their lending standards. Seems like rather perverse timing.

Good Lord! I guess business for sub-prime has dropped off to the point where they're not generating enough business churning condos for illegals and dead transients. What's next - marketing NAAVLPs to 4th graders?

If you have a link for this, please post it --thanks.

I think I saw it in the WSJ a few days ago.

On delinquencies, I read that subprime is starting to show noticable trouble already, while the higher quality loans are still doing fine with very low levels of trouble. However, one must keep in mind that delinqencies and foreclosures are lagging effects.

The California state tax burden is not really that high, 22nd overall:

http://www.ppic.org/content/pubs/jtf/JTF_TaxBurdenJTF.pdf

I don't know where everyone gets the idea that it is, it is one of those urban myths that keeps circulating around.

Different Sean,

Agree with your points on market effects. It is iffy to pick a normal or balance value. This requires assumptions of course. I believe one must make a base assumption about where the prevailing level of interest rates will be. From this (combined with many other variables) you can make a base line or normal trend line for prices, and compare actual to expected.

Good Lord! I guess business for sub-prime has dropped off to the point where they’re not generating enough business churning condos for illegals and dead transients.

that's a good point... the whole sorry RE business sector adjusts to new heights of loan size, volume of loans, etc, so when it slows down as the boom runs out of steam (still higher per transaction commissions than 10 years ago), they panic and liberalise again -- they can't cope with the idea of activity reverting to earlier sensible levels...

In the spirit of the topic, a passage from Edwin Lefebvre attributed to Jesse Livermore, the early 20th century stock operator, after losing big on cotton:

When we got to Philadelphia I drove to a broker's office. I
saw that there was the very dickens to pay in the cotton market.
Prices had broken badly and there was a small-sized panic on. I
didn't wait to get to New York. I called up my brokers on the
long distance and I covered my shorts. As soon as I got my
reports and found that I had practically made up my previous
loss, I motored on to New York without having to stop en route
to see any more quotations.

I bore the cotton market no grudge for taking a million
dollars out of me and I did not hate myself for making a mistake
of that calibre any more than I felt proud for covering in
Philadelphia and making up my loss. My trading mind concerns
itself with trading problems and I think I am justified in
asserting that I made up my first loss because I had the
experience and the memory.

I particularly like the line: My years of experience in trading told
me that the line of least resistance had changed from up to
down.

How many real estate operators are going to dispassionately play their real estate hunches, and recognize that the path of least resistance has changed from up to down before it is too late?

Re the effect of the IRC121 $250K/$500 2yr exclusion:

Zephyr said:

"I agree ... attractive benefit. But what it lets you do is sell without reinvesting. The prior law allowed unlimited exclusion for anyone - but you had to fully reinvest."

I thought the prior law only allowed deferral of gain above the lifetime cap?

I agree that some folks took their excluded gain and spent it, pumping up the economony or other asset bubbles. So that could reduces some price pressure on the costliest houses (say above $1M). But some here sense that IRC 121 added fuel to the flipping fire, pumping a lot of hot air back into the lower and more moderately priced properties. IE the flippers can take their gain, spend some and split the rest up to buy one or more cheaper houses to start all over again. When the recyling of gains back into speculation is coupled with dramatically relaxed mortgage standards (even Bernanke now sees it) you have the recipe for a speculative bubble.

Corretion: Nothing is moderately priced today.

This web site tracks listing inventories in various metro areas. Don't miss the amazing graph of current and historical inventory in Sacramento.

http://bubbletracking.blogspot.com/

Supply and demand, baby.

The sheer fact that you didn't have to "reinvest" BECAME the attraction! Back when we did things more correctly (the old tax code wasn't perfect but look at the alternative) you could make a huge profit selling your home but alas, unless you were over 55 you HAD to reinvest! So there wasn't a lot of incentive to move up, out or otherwise (until you reached 55!) For the most part folks stayed put, built equity and made improvements based on needs (not curb appeal or the "wow" factor). This lead to the "housing ATM" you've heard so much about. Hell you don't even have to sell the damn place to access the tax free money. Just wait by the phone for about half an hour and a mortgage broker will call to make delivery! This is what lead to fluffed up appraisals, pumped up income on mortgage applications and a consumer driven economy on steroids.

There was a time when couples took about 30+ years to cycle through their "starter" home, an intermediate home, their dream home and after 55 their "empty nest" home/vacation or 2nd home. Thanks to the 500K exemption we've now compressed this chronolgy to about 5 years. After you've made about 24 mortgage payments you should have enough "equity" to take it out and custom build your 2nd home. You have arrived! You can now buy, sell and trade vacation homes! If you're creative (and a little gutsy) you can show this as a "primary residence" and bilk tax free money from that too! What's the ruling here? Any two of the last five years? Conservative estimates show that in 2005 35%+ of home sales were "2nd homes".

If the 500K exemption is such a "non-factor" why did the President's bi-partisan panel look at it so hard last fall (along w/ the deductibility of ridiculous amounts of mortgage interest) and why is the RE lobby marching on Washington to make sure it stays in place?

Coincidence?

Makes sense to me.

Garth Farkley,

You know HARM and others have very courteously brought it to my attention that I have beaten this thing like a "rented mule" and....... well..... they're right. The reason I took the pains to document the "home buying chronolgy of couples" is to exhibit just how distorted the exemption has made things. In addition to creating at least two (possibly three) generations with the belief that retirement savings are for suckers (leaving them seriously under funded to face the golden years) the exemption has de-stabilized our neighborhoods, fostered a false sense of security and left a nation with more debt than the government bond market. I say give the people what they want! Uh, are we still so sure?

SFWoman,

Alright! Now that you have "cracked the cover" on the NIMBY portion of our discussion did I mention I have a "rented mule" that you could take a turn beating? Go on! I'll hold the bridle.

O.K, that's quite enough.

FAB,

Huh?

The whole ball of wax that corrolates with this thread, which has been the foundation of frusturation amoungst all of us, and one that we don't like to admit is that as products of a generation that for the most part could work and procure a fairly decent middle income exsistence, we naturally expect a procession of ethical opportunity.
We expect to be rewarded for our hard work, our climb up the professional ladder, our careful spending and saving habits, and the other seemingly innocent advancements into the future. I'd say that most of us are at a similiar stage in our lives. We're married, or serious with someone we love, have been in our chosen industry for some time now, and now the next logical step is into a starter home of some sort. We've signed off on all our checklists. All the I's have been dotted and T's been crossed. Yet we've struck a wall. Ok- so we've saved up reasonable sums of money, have studied the market, and have the education needed to survive in the modern world... yet we can't afford that sort of mediocre house in Oakland? What in the hell happened?
The answers that we're continually seeking here is : Can what appears to be unethical practice, and what we percieve to be unfair be something that the "bad guys" get away with? Will our hard work be rewarded, just as it was for our parents, who haven't done anything diffrent than we have? Will those who took huge risks, made a bet by taking out an IO loan combined with an ARM really in the end be the ones who can sit back and laugh about how miserable they were, only to be able to pay for it thanks to a combination of government changes in taxation and "forgiveness" laws?
Sometimes I do some basic analysis of my own. I walk to work downtown every single day. On my way, I pass through the business district. A sea of 70k bimmers and men wearing $3,000 suits are the majority of those that populate this area, and from 9-5 every weekday.
We acknowledge that indeed the business district is comprised mostly of wealthy white men. We do so because that's just the way it is. Does anyone question whether this is ethical? Not really. Is it? Well, if you apply the same ethics that apply to this topic, then yes it is unethical.
So that brings up the final question that haunts many of us yet we're afraid to admit it: Is the BA turning into a place that will eventually be comprised mostly with upper income, primarily white, well-to-do people? The answer is that the high cost of housing is just a step in that direction. There has been a dramatic shift in class structure here. We view people who buy what we in Tennesee would call a "small home" as well off. The fact of the matter is that you could compare a kid with 3 pennies on a table and sliding one into the rest, where the last penny bounces off the opposite end. The middle class is now no longer the middle class. We are now the working class, the working class are now the working poor, and the wealthy are simply more prevelant in number. The uncomfortable truth could very well be that the BA is turning into an elitest location.
I went to this silly "boycott housing" site the other day. The sheer numbers of people who made good money, didn't own, owned, or rented were sayin the same thing: " ya, it's a great place to live... but I'll move if things don't get better." John mentioned the prevelance of mass immigration to "Pentobia". meaning the fleshing out of areas besides NY, CA, ect. We've discussed this countless times, but in my opinion, if people here are looking for what may never return to the BA, then "penturbia" is where it is heading.

Zephyr Says:

> BTW, I saw a report that RE lenders have recently
> loosened their lending standards. Seems like rather
> perverse timing.

Most "RE Lenders" are actually "loan originators" who make tons of fee income originating loans (that they know have a high probability of defaulting) before they make tons more money selling the debt to stupid bond buyers (so they don't give a shit if every loan they originated goes bad)...

FAB,

I'm totally sure I don't know where you're taking this thing. However; if we're going to be silly (and it is Friday) then in distinguishing between correlation and causation we could then imply that the smoldering couches, torn down street lamps and empty plastic cups littered up and down fraternity row are not necessarily "correlated" nor "caused" by the free kegs of beer we dropped off the night before?

I mean, how could there possibly be a more direct and clear connection between the cap gains exemption and the housing bubble? Now that you and Zephyr have somehow put the burden of proof back into my court I'll simply ask you:

If cap gains (STCG or LTCG) were due on every transaction on every penny above your cost basis would everybody be so eager to sell, move and "lock in their gains"? If the ever abundant "serial refinancer" were told that every dime he/she took out in the form of a HELOC was going to be added to their AGI would they be chomping at the bit? I (for one) don't think so. You guys can pooh pooh it all you like but if it's it really a "non-factor" either of you mind if we change it back? I mean, since it doesn't really matter anyway?

SFwoman,
The one thing that always strikes me as being really off is the lack of children in the BA. What I mean by this is that while these days there seems to be a verifiable sea of newborns, it seems that there are no children between the ages of 5-15 or so.Either that or the prevelance of older, 45-50-something parents with young children. I think most younger people that have kids these days simply pack up and leave.As a parent, haven't you noticed this as well?I gauge this as a way of telling how many middle income families are actually still here. I'll retract my statement about a majority of white populace, but while I agree with the Brazil model, as has been mentioned a number of times by me and others here, I think that the model could very well be heavy on the upper class side, and very low on the middle class side, with an almost equal lower income class, and a massive sea of young, transient, unsettled single professionals. This transient population could potentially be a bad thing for business that relies on long-established experience.

FAB,

The 500K exemption and recent run up has caused lots of people to think of their primary residences as investments, rather than a conservative savings account + durable good. Thus, lots of people are buying the biggest house possible and buying/selling as often as possible, to cash in on their "investment". So during the upswing of the bubble, it causes more speculative buying and higher bid prices.

I definitely agree with you about the impact of the 500K exemption on the way down. This will dramatically reduce the cost of selling for long time owners, something that a future buyer should keep in mind and take advantage of.

Astrid,
Yup. It still strikes me as very strange the number of people I've met who readily ackowledge that they're planning on selling, buying something else as soon as they can. Most recently, A client remodled their kitchen. They spent over 50k on it, and subsequently had just bought the place less than a year ago. Selling it was already an option for them. Why remodel a kitchen when you aren't there to enjoy it?

astrid,

I couldn't think of any "schmizing" that ryhmes with downsizing. On that I agree, would you prefer the 20% a year appreciation on our 500K "investment" or would you prefer the 20% appreciation on our 1 mil. "investment home?" Let's see?

There is so much evidence (anecdotal and otherwise) in nearly every facet of American life today. Frankly, I didn't really anticipate there would be much to "debate" here at all. I thought we would be treating it more like an "intervention" where the "problem/abuse" has already been identified and we are now plotting a path to recovery! Folks, it's a problem. Let's fix it.