One thing about economics is that when an asset gets cheap, someone will figure out how to utilize it to make money. If you consider our current housing situation, we see an excess of housing in certain parts of the country because of overbuilding. This has caused housing prices to decrease to the point that speculators are starting to buy them with the hope of future profits.
Now, if you simply put together some charts in a room, the economics of housing in certain areas simply don't look good. We continue to have high unemployment and excess housing, meaning that folks losing their jobs can't sell their houses and end up in foreclosure. Of course, we are starting to hear about some speculative initiatives that may easily impact this.
The simplest solution for banks and perhaps the Government would be to find a way to allow the current occupants to stay in these homes until economic conditions improve. Clearly, it is in no ones interest to foreclose on a house when there is no market for it. It would seem that a program that reduced payments for a period of time, with potential additional losses underwritten by the Government could go a long way to reducing foreclosures and potentially cost the taxpayers relatively little.
For example, suppose there is a family in a house with a payment of $3,000 a month. Now, perhaps the payment has recently adjusted, or one of the owners has lost their job recently and they cannot make this payment. If we assume that the cost of the foreclosure is $20,000 for legal fees and if the house's value in the marketplace is below the value on the bank's book, foreclosing on this house will be an expensive proposition. However, the bank's rules do not allow them to refinance the house since it possibly does not have enough value for the amount owed and the occupant's do not have enough income.
I would argue, that assuming the economy will recover and the occupant's will become employed again, that the bank's work out a payment that allows small payments to be made for a year. I think as part of the stimulus the payments should be backed up by the Government and the bank at the end of the year should be no worse off than they would be today. Effectively, this would mean that the bank would put a gap into the current mortgage and suspend it for a year. During that year interest would accrue up to the point that the payments made did not cover the interest on the mortgage. At the end of the year, the mortgage would either resume or if the situation had not improved, foreclosure would proceed. The increase in the book value of the asset, related to the fact that negative amortization had taken place for the year would be guaranteed under the stimulus plan. So if the bank asset per the mortgage at the beginning of the year had been 400,000 and because of negative amortization it was now 430,000, the Government would reimburse the bank the portion of the 30,000 not recovered in the sale of the asset. So if after foreclosure it sold for 300,000 the bank loss would still be 100,000.
Now, to qualify for a program like this, certain conditions would have to be met and the closer the occupant could come to paying the full interest costs, the less the potential cost to the Government. Also, every foreclosure avoided this way would save the banks a significant amount.
Just thoughts.
Showing posts with label real estate. Show all posts
Showing posts with label real estate. Show all posts
Saturday, September 12, 2009
Friday, August 21, 2009
Real Estate
Starting right now, there should be an uptick in hiring due to the stimulus spending and getting ready for the Christmas season. We are also seeing some increase related to the increase in auto sales.
Will this uptick be enough to reduce the unemployment rate? We saw a very minor tick down in the July unemployment rate that may disappear upon revision. There are still jobs being lost, as there always are, and new people enter the workforce. To offset this we see a certain number of people leave the workforce due to retirement or death and we also have a certain number who partially retire, going to part time work.
We have a very large number of baby boomers who are entering the retirement age demographic. Due to recent economic events, some of them have been forced into early retirement, but more have revised plans due to loss of retirement assets and/or home value.
A lot of the increase in savings we have seen is being done by these very people as they try to recoup or replace these lost retirement savings. Will this new thrift continue? Generally speaking, the baby boomer generation has not shown tremendous ability to postpone gratification. In addition, some of this reaction was inspired by a degree of panic that has started to dissipate.
The increase in stock prices is part of the recovery equation that helps these baby boomers recoup some of their wealth. What is needed next is for their to be an upturn in real estate prices. Now most experts are predicting that prices will continue to fall for another year. Most owners, feel that prices have hit bottom and will start to increase. Why would we have this disconnect? Well their are two clear factors. In some parts of the country real estate is truly depressed. Many people have been foreclosed on and almost all sales are those of foreclosed homes. However in other parts of the country things have just not been that bad. This is related to the number of houses in play so to speak. Where there has been significant new construction and therefore new buyers at the top of the bubble, California, Nevada, Florida, Arizona, the downturn has been catastrophic.
However in more stable parts of the country, while much of the sales activity has been in foreclosed homes, most people simply postponed any plan to sell their home, waiting for prices to increase. So, for the relatively small number of homes in those areas that were in foreclosure, prices were very reduced, the number of homes actually impacted and overall sales activity was very slow. Further the reduction in price from the bubble period is not very dramatic.
One area that saw tremendous price escalation was Washington D.C. From May 2006 to now the median asking price of a home there has dropped from 489,000 to 307,000 a 37% drop. However the rate of decline has decreased tremendously recently although it is still happening. Now inventory of home for sale in the D.C area is around 30,000 (it was up to almost 40,000 at the peak). If you look at Dallas TX during the same period you see that median asking prices actually increased from 165,000 to 201,000 during the same period with inventories dropping from a little over 35,000 to a little over 30,000.
Dallas is certainly an exception, but as I look at area after area, it is clear that while most have seen some decline in prices due to worsening economic conditions, most have not seen the dramatic impacts of the states hardest hit. So while the amount of activity has been greatly skewed by the number of foreclosures in the hardest hit bubble states, most Americans don't actually live in those states.
So where national statistics are grim, many local statistics are nowhere near as bad. In fact, I see many real tors in this area trying to get me to sell be saying they have plenty of eligible buyers. I don't intend to sell, but advertisements like that, even if exaggerated would lead me to believe that if I did, I could get a decent price.
Looking at real estate from a National perspective ignores the three fundamentals of real estate, location, location, location.
Will this uptick be enough to reduce the unemployment rate? We saw a very minor tick down in the July unemployment rate that may disappear upon revision. There are still jobs being lost, as there always are, and new people enter the workforce. To offset this we see a certain number of people leave the workforce due to retirement or death and we also have a certain number who partially retire, going to part time work.
We have a very large number of baby boomers who are entering the retirement age demographic. Due to recent economic events, some of them have been forced into early retirement, but more have revised plans due to loss of retirement assets and/or home value.
A lot of the increase in savings we have seen is being done by these very people as they try to recoup or replace these lost retirement savings. Will this new thrift continue? Generally speaking, the baby boomer generation has not shown tremendous ability to postpone gratification. In addition, some of this reaction was inspired by a degree of panic that has started to dissipate.
The increase in stock prices is part of the recovery equation that helps these baby boomers recoup some of their wealth. What is needed next is for their to be an upturn in real estate prices. Now most experts are predicting that prices will continue to fall for another year. Most owners, feel that prices have hit bottom and will start to increase. Why would we have this disconnect? Well their are two clear factors. In some parts of the country real estate is truly depressed. Many people have been foreclosed on and almost all sales are those of foreclosed homes. However in other parts of the country things have just not been that bad. This is related to the number of houses in play so to speak. Where there has been significant new construction and therefore new buyers at the top of the bubble, California, Nevada, Florida, Arizona, the downturn has been catastrophic.
However in more stable parts of the country, while much of the sales activity has been in foreclosed homes, most people simply postponed any plan to sell their home, waiting for prices to increase. So, for the relatively small number of homes in those areas that were in foreclosure, prices were very reduced, the number of homes actually impacted and overall sales activity was very slow. Further the reduction in price from the bubble period is not very dramatic.
One area that saw tremendous price escalation was Washington D.C. From May 2006 to now the median asking price of a home there has dropped from 489,000 to 307,000 a 37% drop. However the rate of decline has decreased tremendously recently although it is still happening. Now inventory of home for sale in the D.C area is around 30,000 (it was up to almost 40,000 at the peak). If you look at Dallas TX during the same period you see that median asking prices actually increased from 165,000 to 201,000 during the same period with inventories dropping from a little over 35,000 to a little over 30,000.
Dallas is certainly an exception, but as I look at area after area, it is clear that while most have seen some decline in prices due to worsening economic conditions, most have not seen the dramatic impacts of the states hardest hit. So while the amount of activity has been greatly skewed by the number of foreclosures in the hardest hit bubble states, most Americans don't actually live in those states.
So where national statistics are grim, many local statistics are nowhere near as bad. In fact, I see many real tors in this area trying to get me to sell be saying they have plenty of eligible buyers. I don't intend to sell, but advertisements like that, even if exaggerated would lead me to believe that if I did, I could get a decent price.
Looking at real estate from a National perspective ignores the three fundamentals of real estate, location, location, location.
Saturday, August 1, 2009
Thoughts on the economy
Whether you are a student of economics or not, it can be important to know something about wealth. Wealth is accumulated value and all wealth is subjective. You may say feel some things are not subjective (i.e. gold) but the value of gold is dictated by what people are will to pay for it, and we have seen gold go from very high levels to very low levels. Money of course is subject to changes in its valuation and if you are familiar with history, there are many examples, such as the German Wiemar Republic, where money became essentially worthless in a very short time.
The world creates a certain amount of real goods each year (crops, ores, oil, lumber etc.) that can be said to increase the amount of wealth. These basic products are then turned into manufactured goods and value is added to them creating more wealth. Of course the third stage are the services provided to deliver these goods to the market as well as other services.
As nations develop, they usually start as producers of real goods, commodities, which they sell to more developed nations that turn these items into manufactured goods of some sort and provide services. Of course, some commodities require very little intervention to be marketed while others require quite a bit.
The reason all wealth is subjective is because ultimately the value of anything is dictated by demand. It wasn't very long ago that housing in some parts of this country demanded prices that were double what they can be sold for today. In a dollar denominated system, they have lost 50% of their wealth. Of course, if you own one of those houses, you own exactly the same thing you owned previously, and if you don't have a mortgage, you may actually be better off since it is likely your property taxes may be adjusted, but you would feel poorer.
By the same token, the prices we pay for many other items have also decreased as demand has withered and producers are forced to discount items in order to move them. The big danger here is potential deflation. Now the problem with deflation in a credit driven economy is that it leads to debt exceeding perceived value. If I have a $500,000 mortgage on a $750,000 I perceive that I'm doing OK. If the value of that house drops to $400,000, I am now paying the bank more than I believe I should. It makes better economic sense (depending on how you feel about your credit score) to simply walk away and let the bank have the house. Of course doing that makes the loss real, and you may very well feel that over time the value of your house will recover, but that is a gamble of sorts and requires a certain faith in the economy, or at least a belief that inflation will return.
So what is the natural outcome of an economic downturn, where wealth is lost? With or without Government intervention, prices will drop to a point at which demand is restored. Once demand is restored, the economy will stop contracting, and having eliminated the excesses that led to the downturn, it will start to grow once again. How fast it grows depends on many things, but clearly, as demand grows, employment will grow, helping to increase demand further at some rate.
In the bubble years, we had tremendous demand that was based on credit secured by housing wealth and to some extent loose credit policies that encouraged consumer spending. In fact our economy became dependant on consumer spending, and to a large extent the rest of the world is dependant upon our economy being successful. When we saw the housing wealth decline, that spending declined with it.
Now it would seem that in many parts of this country, housing has neared a bottom. However, because of the reduction in demand, we have greatly increased the number of unemployed individuals and reduced their income. Further, even if housing has stabilized (and it may still decline some more) it is not going to suddenly jump in value (at least not everywhere) so that wealth and associated credit needs to be discounted from the market for some time.
An additional factor is that many Americans have now been scared into saving. They have also been scared into safe investments. These investments simply do not create monetary wealth very quickly.
What does this mean? In a very simplistic way it means that the new American economy is going to be smaller than it was. This can be computed simply enough if you make some basic assumptions. For argument's sake, lets assume the amount of disposable income overall remains stable. This plus credit becomes the amount available to spend. Now credit spending unrelated to housing is down from 2008 levels but very close to 2007 levels. However, housing values in this country are down significantly. Ignoring primary mortgages for now, in the 2004 to 2007 period, there was a tremendous amount of refinancing done in order to tap equity. For a while the number of refinancing averaged over 800,000 a month. Currently more refinancing are done to lower interest rates and the numbers were below 200,000 a month. The implications of this should be apparent, consumer spending will increase/decrease year over year based on the following formula, d-s+c+m to d1-s1+c1+m1 where d and d1 equal discretionary income 12 months apart, s and s1 equal savings for those same two points in time c and c1 represent consumer credit and m and m1 equal cash out refinancing. In the best case scenario, m1 current is much lower than m of 2008. Now as time goes on, m1 will become m and the new m1 may actually be higher than current levels. This will create growth in consumer spending but I can't imagine anyone believes that a year from now cash out refinancing will be anything near where they were a year or two ago.
The formulas can be revised to be more precise, but with savings up and cash out refinancing down, the amount of consumer spending will be significantly less than it was, probably around 20%. If nothing else was to change, and consumer spending equals 70 of the economy, we can expect a fairly permanent contraction of 14-15%. That is about the contraction we have experienced which is why we are likely at the bottom of the downturn and starting to recover.
Now, discretionary income is simply not going to increase dramatically and I don't expect home prices to skyrocket either. Consumer credit is likely to increase somewhat as employment increases but realistically it is very hard to see growth in consumer spending going up fast.
Other sources of demand for the economy include exports and this can be an area of significant growth in the future.
One argument against a rapid improvement in the economy is the amount of foreign debt the nation is issuing. Interest payments on foreign debt will require money being removed from the economy and sent to the foreign holders of this debt. Now, this impact can clearly be mitigated to some extent if we improve our balance of payments and get those countries to use that money to buy US goods. Of course, this does not need to be a direct transaction, if China for example buy a lot of commodities from Russia and Russian spend that money on American products, the money does return to us ultimately. A lot of commentators like to discuss the likelihood of Chinese consumerism, and of course if we can sell items directly that will work, but it doesn't really matter if it is direct or indirect if exports can increase enough.
Can the US handle its debt? The answer is that in one way or another we will, the question is how disruptive will managing the debt be. What needs to be remembered is that every year the US produces tremendous wealth in commodities, manufactured goods and services, and this wealth will increase in value as the economy recovers. After WW2 the US had tremendous debt that the country was able to manage and prosper at the same time. To a significant extent that period was fueled by the redevelopment of Europe and Japan. I believe in a few years we will look back and see that the new prosperity was fueled by the development of China and India and the opportunities they will create for this country.
The world creates a certain amount of real goods each year (crops, ores, oil, lumber etc.) that can be said to increase the amount of wealth. These basic products are then turned into manufactured goods and value is added to them creating more wealth. Of course the third stage are the services provided to deliver these goods to the market as well as other services.
As nations develop, they usually start as producers of real goods, commodities, which they sell to more developed nations that turn these items into manufactured goods of some sort and provide services. Of course, some commodities require very little intervention to be marketed while others require quite a bit.
The reason all wealth is subjective is because ultimately the value of anything is dictated by demand. It wasn't very long ago that housing in some parts of this country demanded prices that were double what they can be sold for today. In a dollar denominated system, they have lost 50% of their wealth. Of course, if you own one of those houses, you own exactly the same thing you owned previously, and if you don't have a mortgage, you may actually be better off since it is likely your property taxes may be adjusted, but you would feel poorer.
By the same token, the prices we pay for many other items have also decreased as demand has withered and producers are forced to discount items in order to move them. The big danger here is potential deflation. Now the problem with deflation in a credit driven economy is that it leads to debt exceeding perceived value. If I have a $500,000 mortgage on a $750,000 I perceive that I'm doing OK. If the value of that house drops to $400,000, I am now paying the bank more than I believe I should. It makes better economic sense (depending on how you feel about your credit score) to simply walk away and let the bank have the house. Of course doing that makes the loss real, and you may very well feel that over time the value of your house will recover, but that is a gamble of sorts and requires a certain faith in the economy, or at least a belief that inflation will return.
So what is the natural outcome of an economic downturn, where wealth is lost? With or without Government intervention, prices will drop to a point at which demand is restored. Once demand is restored, the economy will stop contracting, and having eliminated the excesses that led to the downturn, it will start to grow once again. How fast it grows depends on many things, but clearly, as demand grows, employment will grow, helping to increase demand further at some rate.
In the bubble years, we had tremendous demand that was based on credit secured by housing wealth and to some extent loose credit policies that encouraged consumer spending. In fact our economy became dependant on consumer spending, and to a large extent the rest of the world is dependant upon our economy being successful. When we saw the housing wealth decline, that spending declined with it.
Now it would seem that in many parts of this country, housing has neared a bottom. However, because of the reduction in demand, we have greatly increased the number of unemployed individuals and reduced their income. Further, even if housing has stabilized (and it may still decline some more) it is not going to suddenly jump in value (at least not everywhere) so that wealth and associated credit needs to be discounted from the market for some time.
An additional factor is that many Americans have now been scared into saving. They have also been scared into safe investments. These investments simply do not create monetary wealth very quickly.
What does this mean? In a very simplistic way it means that the new American economy is going to be smaller than it was. This can be computed simply enough if you make some basic assumptions. For argument's sake, lets assume the amount of disposable income overall remains stable. This plus credit becomes the amount available to spend. Now credit spending unrelated to housing is down from 2008 levels but very close to 2007 levels. However, housing values in this country are down significantly. Ignoring primary mortgages for now, in the 2004 to 2007 period, there was a tremendous amount of refinancing done in order to tap equity. For a while the number of refinancing averaged over 800,000 a month. Currently more refinancing are done to lower interest rates and the numbers were below 200,000 a month. The implications of this should be apparent, consumer spending will increase/decrease year over year based on the following formula, d-s+c+m to d1-s1+c1+m1 where d and d1 equal discretionary income 12 months apart, s and s1 equal savings for those same two points in time c and c1 represent consumer credit and m and m1 equal cash out refinancing. In the best case scenario, m1 current is much lower than m of 2008. Now as time goes on, m1 will become m and the new m1 may actually be higher than current levels. This will create growth in consumer spending but I can't imagine anyone believes that a year from now cash out refinancing will be anything near where they were a year or two ago.
The formulas can be revised to be more precise, but with savings up and cash out refinancing down, the amount of consumer spending will be significantly less than it was, probably around 20%. If nothing else was to change, and consumer spending equals 70 of the economy, we can expect a fairly permanent contraction of 14-15%. That is about the contraction we have experienced which is why we are likely at the bottom of the downturn and starting to recover.
Now, discretionary income is simply not going to increase dramatically and I don't expect home prices to skyrocket either. Consumer credit is likely to increase somewhat as employment increases but realistically it is very hard to see growth in consumer spending going up fast.
Other sources of demand for the economy include exports and this can be an area of significant growth in the future.
One argument against a rapid improvement in the economy is the amount of foreign debt the nation is issuing. Interest payments on foreign debt will require money being removed from the economy and sent to the foreign holders of this debt. Now, this impact can clearly be mitigated to some extent if we improve our balance of payments and get those countries to use that money to buy US goods. Of course, this does not need to be a direct transaction, if China for example buy a lot of commodities from Russia and Russian spend that money on American products, the money does return to us ultimately. A lot of commentators like to discuss the likelihood of Chinese consumerism, and of course if we can sell items directly that will work, but it doesn't really matter if it is direct or indirect if exports can increase enough.
Can the US handle its debt? The answer is that in one way or another we will, the question is how disruptive will managing the debt be. What needs to be remembered is that every year the US produces tremendous wealth in commodities, manufactured goods and services, and this wealth will increase in value as the economy recovers. After WW2 the US had tremendous debt that the country was able to manage and prosper at the same time. To a significant extent that period was fueled by the redevelopment of Europe and Japan. I believe in a few years we will look back and see that the new prosperity was fueled by the development of China and India and the opportunities they will create for this country.
Monday, June 29, 2009
Recovery formula
There are two things that need to happen for a real recovery to take place in the US Economy. The first requires that housing prices stabilize and start to increase and the second is that we need to create jobs.
The current stimulus efforts are directed at symptoms and not root causes. Providing people on Social Security a $300 stimulus check adds up to a lot of money in the aggregate, but not very much to each individual. What are they going to spend it on? First the check went into their direct deposits. Second, they live on a monthly budget and the extra $300 or $600 for a couple is probably not going to inspire them to run out and buy a new car and the odds are they aren't that into smart phones. Since the money wasn't enough to do much for them, it simply stayed in the bank to cover potential increases in health costs, taxes and/or any number of rainy day possibilities. The fact that economists were surprised, if they were, that the money was reflected as higher savings vs higher spending for the most part is what surprises me.
Also, instead of focusing on what should be and I believe will be our new growth industry in renewable energy, money is being given to protect a relatively small number of jobs in politically significant but economically neutral legacy industries. We are not going to see significant new job growth in the auto related industries. We may see some, but new plants will make better use of robotics and there is going to be fewer cars sold as Americans will be thriftier in the near term, keeping old cars longer. If we were to invest the same amount of money in either converting coal to oil, increasing wind and solar, increasing use of natural gas and increasing the use of ethanol, it would create new jobs, improve spending and reduce our balance of trade and dependence of foreign oil. This is a cumulative impact since every equivalent barrel of US energy we use means we need one less imported. Further it would start to position the US towards the future. We need to get to a fully carbon neutral renewable energy future and we need to start getting there now, but smartly.
The current bill that wants to use CAP and TRADE is a heavily compromised attempt to move in the right direction but is probably doomed. It is hoped that the bill will lead to increased jobs but we can get to increased jobs simply by providing funding to private industry to build renewable or at least domestic energy infrastructure.
Improvement in the real estate markets has already started. TARP money should be used to buy distressed properties. Valuations for these properties should be close to Market but having a guaranteed buyer would stabilize those prices. The houses should then be returned to the marketplace at a rate that doesn't cause a further collapse in values. I believe that speculators would be found to buy these houses with the hope of increases. I also believe this was the original intent of the Troubled Asset Relief Program. Yes this interferes with the market, but we have had a tremendous economic crisis that requires Government intervention. I think the cost of this type of TARP program may actually turn out to be much less than anticipated as the assets will start to increase in value. However, getting them revalued to appropriate levels and back into the marketplace with stable mortgages returns them to the tax rolls.
The current stimulus efforts are directed at symptoms and not root causes. Providing people on Social Security a $300 stimulus check adds up to a lot of money in the aggregate, but not very much to each individual. What are they going to spend it on? First the check went into their direct deposits. Second, they live on a monthly budget and the extra $300 or $600 for a couple is probably not going to inspire them to run out and buy a new car and the odds are they aren't that into smart phones. Since the money wasn't enough to do much for them, it simply stayed in the bank to cover potential increases in health costs, taxes and/or any number of rainy day possibilities. The fact that economists were surprised, if they were, that the money was reflected as higher savings vs higher spending for the most part is what surprises me.
Also, instead of focusing on what should be and I believe will be our new growth industry in renewable energy, money is being given to protect a relatively small number of jobs in politically significant but economically neutral legacy industries. We are not going to see significant new job growth in the auto related industries. We may see some, but new plants will make better use of robotics and there is going to be fewer cars sold as Americans will be thriftier in the near term, keeping old cars longer. If we were to invest the same amount of money in either converting coal to oil, increasing wind and solar, increasing use of natural gas and increasing the use of ethanol, it would create new jobs, improve spending and reduce our balance of trade and dependence of foreign oil. This is a cumulative impact since every equivalent barrel of US energy we use means we need one less imported. Further it would start to position the US towards the future. We need to get to a fully carbon neutral renewable energy future and we need to start getting there now, but smartly.
The current bill that wants to use CAP and TRADE is a heavily compromised attempt to move in the right direction but is probably doomed. It is hoped that the bill will lead to increased jobs but we can get to increased jobs simply by providing funding to private industry to build renewable or at least domestic energy infrastructure.
Improvement in the real estate markets has already started. TARP money should be used to buy distressed properties. Valuations for these properties should be close to Market but having a guaranteed buyer would stabilize those prices. The houses should then be returned to the marketplace at a rate that doesn't cause a further collapse in values. I believe that speculators would be found to buy these houses with the hope of increases. I also believe this was the original intent of the Troubled Asset Relief Program. Yes this interferes with the market, but we have had a tremendous economic crisis that requires Government intervention. I think the cost of this type of TARP program may actually turn out to be much less than anticipated as the assets will start to increase in value. However, getting them revalued to appropriate levels and back into the marketplace with stable mortgages returns them to the tax rolls.
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