patrick.net

A response to Margie read . . .

"Certainly don’t keep more than 100K in any single bank account. Not sure why you think FDIC won’t be able to insure everybody. Their ability to give you back your nominal account value is infinite."

I think Margie's concern is a valid concern. Yeah, sure, I'm a paranoid nut and what the hell do I know?

I know this . . . To think that it's impossible that a bank will simply stop paying out is ridiculous. I think it is more likely than not within the next 5 years. With a fracitonal reserve of about 1% and banks lending out more and more to risky lendees, I think it's only a matter of time before you see the first bank go under. Smaller, local, etcetera.

But if and when it spreads, and people start to think, "hey, I don't want to have to deal with the Feds to get my "insured" money back," - in combination with more defaults and bankruptcies, then the crap is really going to hit the fan. In the event of monstrously widespread bank failurees, the government will not simple hand out the money. It will not simply print more money to hand to people.

So me? I don't keep much money in the bank either. The way I see it, you're better off having a bit here and bit there - that way, when the crap starts flying, you won't get shut out all at once. Better yet, cut your costs to the bone. Get rid of all excess. The fat will die first.

Forget the illusory 100k gaurentee - it's only as worth as much as the dollar, which is dying.

I disagree. It doesn't take time to bring down a house of cards.

I think it's much like the room full of mousetraps.

The whole floor is covered with mousetraps. Each mousetrap has a pingpong ball on the moving part so that when it's triggered, the ball gets launched into the air.

That's the housing market. The article cited by Inquiring Mind is disturbing. It's dead on, however. It's the worst case scenario unfolding - everybody who has been planning to hold on for a bit longer, who is speculating, who is retiring, is now running for the door.

A single ping pong ball has been dropped into the room, as it were.
I predict nationwide drops in house values of at least 10% by spring, yoy.

I am so freaking sick to death of this type of crappy quote . . .
"Mortgage broker Klingsheim said the community's falling prices doesn't mean the proverbial housing bubble is bursting, rather the market is correcting itself after years of exorbitant growth."'

Here are two more anecdotes.

I was speaking with my mail man the other day. Just shooting the shit about nothing. Out of the blue, he says, "yeah, with the way the economy is going . . . '
Tonight, I'm talking to a guy at a college conference. He's a blue collar guy working for a municipality. Says he lives in an 1100 sf house. I wonder if he got the number wrong. It's possible. He wasn't sure if we were in Iraq or Iran . . . So I asks him, "what do you think of the economy.?" He looks at me, looks down, thinks on it a bit, and says, "I don't think it's doing too good, with housing so expensive and interest rates coming up."

More writing on the wall.

Lisa, that is a good point, buying up distressed properties during the downtown. I always believe that BA has a good fundamental value, just not at the current valuation.

That's why it is critical that we protect our cash well so during the downtown our cash doesn't turn into paper along with the property value. Which one is a better way to go? Foreign currencies vs. oil/gold/commodities? I am also a bit worried that when the world depression hits, all countries will be racing to print money to save their asset bubble asses (RE bubble is now a global problem in ALL English-speaking countries thanks to AG). So, I am more geared towards commodities/gold/oil than paper money from other governments. Any thoughts?

But the USD bond may not compensate me for the loss in USD value.

USD lost 75% of its value since 1970. Did the bond return account for that? My goal is to retain the current buying power of my USD.

Dear members
what do you guys think about the singapore dollar and holding some cash there? Also will we able to liquidate it into whatever currency when we want?

However, somebody on this board mentioned that if there is a global financial crisis that the money would come back to the us. i do sense some logic in that because of the trust that the whole world imposes on the us $. But if the rich banks and their cronies decide to short the dollar and take it to the woodshed all bets are off.

It is scary to think that the fdic can renege on their promise. Well every one will be in trouble at that time. so we will have a lot of camarederie.

Also what if the government imposes the 1933 gold rule?. will other governments across the world do the same thing

I should really read this more. A group of smart people is smarter when they're all listening to each other.

I'm happy you all (well, nearly all) post thoughful comments.

Patrick

Oh, and thanks Patrick. Glad to see you posting here. It was your links site that convinced me. Count me a soul saved from significant financial hardship!

Patrick definitely deserves some kudo's! I've learned so much from the links posted here and even more from the discussions on the blog. I'm also happy to see a lot of new "regulars" posting. It's always good to have more viewpoints, and new blood keeps it from getting stale.

(thanks Surfer-X, you’re a blog legend!)

I'll second that.

(thanks Surfer-X, you’re a blog legend!)

I agree. And SactoQt is the most eloquent writer here.

I think home price appreciation will level off initially. A lot of RE professionals will say, "see, soft landing". After 6 to 18 months of increasing inventory and slower growth, we will see sharply higher level of foreclosure activities and prices will start to decline.

I believe the most interesting part of the crash will happen when ARMs adjust en mass in the 2007 time-frame. Homeowners will find out the hard way that it is no longer possible to refinance to a cheaper structure. Yet another wave of foreclosure will hit.

Stanman, I don't agree with your assessment of stock options. In a start up environment, they are a smart way for companies to motivate their employees without using up scarce cash. They also are very effective at ensuring that employee incentives are lined up with owners and managers.

Think about it: without stock options your economic incentive is to get paid as much as possible for as little work as possible. It is your bosses job to work you as hard as he can without paying you any more for it.

When you own stock, you are literally a part owner of the company. If it does well, you do well, in a very tangible fashion. I know it has worked to motivate me in the past and does so in the present.

I work for a smalish company that recently went public though, so I am not as much a cog in a machine as say. someone who works at Cisco or Microsoft.

Think about it: without stock options your economic incentive is to get paid as much as possible for as little work as possible. It is your bosses job to work you as hard as he can without paying you any more for it.

Well, it is a market after all. Without stock options, there need to be other compensations to make up for it. Nothing is free, stock options come from unwary shareholders whose ownership gets diluted over time. I think companies should definitely expense stockoptions.

My husband also gets stock options as part of his pay package, but the company doesn't start paying them until the employee works at the company for awhile. I think in this case it's 8 years, but I'm not totally certain. Anyway, I would say that all the long term employee's I've talked to said that most of their wealth is from the stock options.

I agree that in a tech start up stock options are only as good as the paper they're printed on, but an old established co. with a good track record that pays out options can be an entirely different story. So I guess the options are only as good as the company you work for.

---Well, it is a market after all. Without stock options, there need to be other compensations to make up for it. Nothing is free, stock options come from unwary shareholders whose ownership gets diluted over time. I think companies should definitely expense stockoptions.

The argument against expensing stock options is as follows (and it's pretty hard to counter). What expense, in actual GAAP accounting terms, is a stock option? Options have always been required to be disclosed in the 10K. The dilution is known, and it is reflected in the stock price. Why does FASB assume that an otherwise efficient market is somehow unable to factor in this one, singular aspect of capitalization? If options are now expensed, they are double counted because it depresses the P&L, which reduces EPS, which depresses the stock price, which is already considering the dilution. A complication is how to price options. The FASB mandates they should be valued according to volatility and Black-Scholes computation of equity options. But ESOs are not equity options, they are worth far less due to their restrictions. Worse, the SEC just rejected Cisco's and Microsoft's attempts to create marketable securities which mirror the real-world nature of ESOs in an attempt to arrive at the true value of ESOs. Their rationale was that their plans didn't factor in all the restrictions. So what, a less realistic Black-Scholes valuation is better? It's actually quite insaine.

I agree that ESOs aren't free. I'm not arguing that someone (the shareholders) don't pay for them. But, why expense these in a P&L. If anything they should be either balance sheet items or off-balance sheet items. They are an impairment to equity, not an expense.

(but then, I'm not an accountant, either. i just get annoyed at nonsense policy)

Absolutely. It is silly when people talk about stock options as if money grows on trees. The money is coming from THE COMPANY! Most of the time when stock options are exercised, the company needs to use its cash to buy back stock in order to provide the shares to the employee exercising the options. Even in the rare event that the company actually issues new shares upon exercise, that simply dilutes the wealth of the existing shareholders. All it is is a socialist transfer of wealth from shareholders to employees who are getting a lucky deal and earning much more than they would command in a sane market. A market is never sane when its participants think the money is growing on trees.

oops.. Forgot to close my tags.

Absolutely. It is silly when people talk about stock options as if money grows on trees. The money is coming from THE COMPANY!

Stock options granting is the electronic printing press. Money comes out of it, but there are externalities.

Why does FASB assume that an otherwise efficient market is somehow unable to factor in this one, singular aspect of capitalization?

Because the market is not as efficient as one would like to.

All it is is a socialist transfer of wealth from shareholders to employees who are getting a lucky deal and earning much more than they would command in a sane market.

Absolutely. It is a way of privatizing gains and socializing costs.

Effificent market is not a sufficient safegard against socialism.

The options are typically granted at the current market valuation at the time of grant, so the employees are not getting any guaranteed money.

Usually, options are granted at a discount to market valuation. Even if they are granted at market valuation, they still worth something because the employee has all the upside and none of the risks.

Today's Chronicle paints a very rosy pitcure of the Bay Area market and basically says the direct OPPOSTIE of Patrick's points on the main page of this site:

http://sfgate.com/cgi-bin/article.cgi?f=/c/a/2005/09/20/BUGA7EQCSS1.DTL

Thoughts? Is the rent & price ratio really not as bad now as in years past like the article claims, for instance?

1. Somebody posted a link to a graph of inventory somewhere in Cali and wrote . . .
"Second graph down the page showing increasing inventory."

Good spot, inventory is taking off.

How about the third graph? Showing properties "removed" from the listings? That's taking off too. But inventory is not decreasing. Makes you wonder if Realtors are doing the "take it off and put it on again as new"? Yeah, you know it. Oh look, this one's only been on the market for 2 days (months).

2. Hey Patrick, I never did give you my props. When I first got the bug that their was a bubble in DC, I came online and searched "housing crash". I turned up your site. Reading your site, among others, corroborated what I though was going on in DC. I immediately went into emergency mode to sell the house.

It was about the 4th best decision I have ever made.

If you're ever in CT, let me know, dinner on me.

For the rest of you bums, I really enjoy this blog. Most of the people on here are well educated and have reasoned points to make. I even enjoy the ranting, stream of cons. type crap.

If this all blows over, which it won't, I'll have to come out to the Bay Area and go to some open houses. I'll tell them an Investor from Alabama.

Jack wrote -
"No crash. A non-event. 10 to 20 per cent TOTAL correction (at most) and spread over 4 years."

So let me get this. If some poor slob buys a "house" in San Fran for 1 million today, and it loses about 50,000 dollars a year in value every year for 4 years, you would not consider that a "Crash"? Particularly when you consider that virtually everybody who got into the market in the last 20 months would be underwater?

Well, I gues if a plane hitting the ground is not within the scope of the definiiton of "crash," then I'd have to agree with you - no crash.

And some are undoubtedly holding time-bomb loans, (which they have no doubt had a chance to reconsider in the light of the possiblity of declining future prices.

Yes, I sure do wonder...if the US faces a credit crisis, and banks will find themselves with far too much exposure (or no loan default reserves at all), won't easy loans will be a thing of the past?
Therefore, purchasing a home in a flat or negative market that severely strains one's income won't be a possibility--banks won't allow it, and the speculative fervor won't be there. Those factors could severly limit demand, while "late to wake" investors flood the market with inventory. And, if a recession hits, that will further dampen RE demand around SF bay. People are already moving due to above factors, and I have noticed price drops too. I'm not positive, but for the above reasons, I suspect a steeper correction coming.

Today’s Chronicle paints a very rosy pitcure of the Bay Area market and basically says the direct OPPOSTIE of Patrick’s points on the main page of this site

I remember reading it earlier on Inman News. The study was probably sponsored by the real estate industry. The business school has no academic integrity nowadays.

BTW, studies like this one were very common in 1929.

How about a highly acclaimed Yale professor? Does Irving Fisher ring a bell?

Today’s Chronicle paints a very rosy pitcure of the Bay Area market...

Boosterism isn't unheard of in the Bay Area; local businesses and media have a vested interest to pump up the economy, it makes them look good to their clients. The hype permeats as far as the social consensus: many people here believe we have a bulletproof economy, therefore RE carries a premium. Let's just say that's been said throughout history. I'm sure I can guess what the article says already, but I'll give it a read.

Ahhhh, I see you are back to your old self today Peter P, at least judging by your comment. (One line to refute a whole story!) Hope you are feeling better.

Thanks Jack. I still have a headache, but I am feeling better otherwise.

The Chronicle article had a lot of assumptions in it

Yes, they probably assumed that real estate prices never go down.

Give me any conclusion you want and I can usually prove it.

“Studies like this one were very common in 1929.” (Classic Peter P.)

Well Jack, it is not a crime to attack bad arguments with more bad arguments. ;)

“Perhaps they looked at the percentage of interest-only loans used each year, and adjusted their affordability based on that?”

Business schools are more about industry connections than knowledge and truth. I doubt that they have conducted a study at all. It is more like:

"I want to conclude that the real estate picture is rosy, prove it."

It’s not the article you should critique. It’s the actual oped and research pieces by the Columbia & Wharton professors.

Yes, if we can laugh at a Yale professor for "permanentaly high plateau" we can surely do the same to Columbia and Wharton professors too.

I want to wait and see if Marin reacts differently to all those signs than Contra Costa or Sacramento does though.

yeah--you're right in that Marin hasn't seen any major downturn before (at least what I see w/median prices). I wish I had more individual property history to know for sure...
It's good to hear the other side to keep my predictions in check. In all honesty, the BA may possibly have stickyness in RE, and perhaps that has attracted investment too.
Wouldn't it be a wild possibility if RE just flattened for a while, then took off again? I sure wish my salary did that! ;)

Microclimates--yeah, another "intangible" for the list. Someone who moves here can pretty much choose the climate they like...that is if they can afford to live here!
My surprise was to find my new home gets ~ 50% more rain than Seattle--who would've thought that?!

The rise in inventory and interest rates will slow price growth to normal or flat levels for a bit, perhaps even slight isolated reductions, but absent a economic recession significant statewide (CA) reductions won’t occur.

We will see how reflexivity plays out this time.

Just saw this in MarketWatch. Evidently S&P believes that it’s going to be a fizzle, and not a pop.

If they say there is going to be a pop, they will cause one. How many companies have they downgraded before the tech bust?

We will see how reflexivity plays out this time.

Another wild card this time: the number of properties bought by investors--and what will be done with those when the market goes sour.

So how will the bubble be popped--excess inventory plus lack of buyer confidence feeding a downward pricing spiral? Or, an invetibable tightening of credit and loans, large-scale investor pullout, leading to a precipitous dropoff in demand?

Jack -
"By your reasoning, are YOU not in fact “underwater” at this very moment DC, should you have to sell your house immediately?"

Jack, that wasn't my reasoning. My point was only that the percentage of owners who will be underwater after a 5% decline is higher than ever, which, in my opinion, makes a current 5% downturn more of a "crash" than a downturn in a market where everbody has at least 40% equity.

Regarding your analsis of the previous downturns through which you lived, I think now is much different from then.

Now, we have little or no cushion. We have no fallback position.

For us, this is Waterloo. We are the Roman garrison. If we lose here, there is nothing else for which to fight. In other words, without spewing all the detail, we have one straw's worth of mass left to carry.

In 1988, despite many issues and Reagan's deficit spending, there was plenty of fall back space.

Hellboy -
The Wharton school uses imputed annual rent as their cost of housing. Now what’s wrong with that picture? Anybody?

The rent/buy ratio is out of whack, thus resulting in a low imputation of homeownership cost.

If by “downgraded” you mean pointed out the fact that operating capital would run out in a matter of weeks for companies that had never turned a profit, the answere is MANY. Is that the case today?

If you refer to some recent marginal homebuyers and inves-culators, it is the case. ;)

Jack, that wasn’t my reasoning. My point was only that the percentage of owners who will be underwater after a 5% decline is higher than ever, which, in my opinion, makes a current 5% downturn more of a “crash” than a downturn in a market where everbody has at least 40% equity.

Excellent point!

Peter P is a real estate BULL. Can you prove this statement Peter?

Peter P is a real estate BULL because he believes that housing is a good investment in the long run. However, being a bull does not oblige one to being bullish at all times. :)

That Wharton article does have one thing correct–the amount homedebtors are paying per month is lower than prior to the 1989 downturn (in inflation-adjusted and percentage terms).

But inflation was a lot higher back then. I believe real interest rate was higher too.