‘A Wonderful Time To Get The Heck Out’
The Voice of San Diego has a tip for speculators. “California’s wealthy investors are choosing to invest less and less in real estate, a trend that local experts say should serve as a beacon to all real estate investors in the county. In San Diego, financial advisors who work with some of the region’s wealthiest people are advising their clients to sell their investment properties.”
“The message some financial advisors in San Diego are giving wealthy investors is clear: Those clients who can afford to sell their investment properties should do so. ‘If you have an investment property, this is a wonderful time to get the heck out,’ said Richard Ashburn, an investment manager and financial columnist in La Jolla.”
“Ashburn said that unless a residential property is paying for itself through the rent it is generating, an owner should sell. Any owner paying $1,000 or $2,000 a month to cover the mortgage payments and taxes on their investment property should realize that it’s time to get rid of that investment, he said. ‘If you’re in a negative cash flow situation, you’re nuts to hold onto it,’ he said.”
“Michael Dorvillier, another La Jolla-based investment advisor sings the same tune. Dorvillier said the wealthy investors he works for have recently been moving to liquidate their real estate assets. He said the situation is analogous to what happened during the dot-com crash. ‘A lot of those affluent investors learned their lesson with their Qualcomm stocks and their Enron stocks, and they don’t want to see that happen again,’ Dorvillier said.”
“Anxious investors are likely to unload their additional homes or condos rather than their first homes. ‘There’s a worry that if people start selling [investment properties] then there will be a depressing effect,’ (economist) Alan Gin said. ‘It won’t just be the million dollar mansion, but if people own $700,000, $800,000 homes that they’ve bought for investments, and they suddenly put them on the market, that will have a dampening effect.’”
“Ashburn said it is not what affect wealthy real estate investors could have on the market, but what their activity could signal about the future of home prices. If wealthy people are shying away from real estate, he said, it’s probably for a good reason. ‘They don’t need to go knock themselves out for another $100,000, they’ve got all the money they need. What they want to do is be safe with their money, be wise and safe and cautious,’ he said.”
‘A lot of those affluent investors learned their lesson with their Qualcomm stocks and their Enron stocks, and they don’t want to see that happen again,’ Dorvillier said.’
Sounds like a contradiction in terms - ‘affluent inverstors’ should not be mentioned in the same sentence with Qualcomm and Enron. Something tells me these affluent investors will be hosed in RE as well.
Just like realtors used “savvy” to describe RE speculators who overpaid for properties with ARM and I/O mortgages.
The Fed’s serial bubble program is going to get ugly. People that connect the dots and see the similarities aren’t going to be surprised by a housing pop so the bail out could be much faster.
Any guesses on what’ll be the next bubble after housing? Or do we just get core inflation?
maybe not core inflation, but I’m sure there is a HUGE bubble developing in real inflation.
Looks like the next bubble is already here: metals.
“They don’t need to go knock themselves out for another $100,000, they’ve got all the money they need. What they want to do is be safe with their money, be wise and safe and cautious,’ he said.”
If you are wise, safe and cautious with your money, what the hell are you doing in a negative cash flow property to begin with? Geez Louise.
Eh? Your point makes sense with regard to Enron, but I don’t know why you’d say that about Qualcomm, which is near its 52-week high and has made its investors a lot of money over the past few years. They declined from 2000-2002, but have recovered quite well since then (40% increase in stock price since the beginning of 2003, not counting dividends which are currently $0.48/share per year), and has about a quarter of the market for cell phone chips (making them #2 after TI). They spend a lot of money on R&D and hold a very large intellectual property portfolio in the form of U.S. patents.
I could argue that it’s not wise to go heavy on any one particular company, no matter what the market share is. Big market share is actually a bad thing as far as growth is concerned. Most successful stock pickers look for market outliers with big potential, but once a company reaches its apogee, it usually goes to the crapper of corruption and embezzlement, and it’s time to sell.
Point taken. However many people didn’t have money to catch Qualcomm’s 2nd wave… cuz they blew out on the 1st go round!
I believe the Qualcomm example was referring to the dot-com bubble run-up and crash.
He was probably thinking of Worldcom!
Actually, any company that ends with “com” is probably a crappy one. Notice how new telecom companies kinda avoid that particular ending, and actually try to distance themselves from the whole “XYZ-com” naming scheme of the 90’s - Vonage, TomatoVine, etc.
Yeah, any “investors” that are still holding RE are not the affluent ones. The affluent ones made their money and got out long ago…
we are 305 homes away from the prior inventory record of 19,250 set in July 1995.
Bubble Markets Inventory Tracking, Tracking San Diego County
‘It won’t just be the million dollar mansion, but if people own $700,000, $800,000 homes that they’ve bought for investments, and they suddenly put them on the market, that will have a dampening effect.’”
The inventory is already two high, any additional homes will not just have a dampening effect.
In the exclusive and small town in Florida that we moved to (renting) the inventory is at the highest since about ten years ago. There are unfinished developments (starting price 1 million) all around. Still, the prices have not shown more than a 20% decrease. We wait.
as I keep mentioning (as a warning to all those who think this bubble is going to implode within a few months), in Europe several countries have seen both inventory and prices make new highs again and again in the last years. And that is after prices increases that were far bigger than in the US.
The credit creation is so huge that the law of supply and demand is temporarily suspended.
I don’t follow your logic here. If easy credit was stimulating higher demand and driving median prices higher , all else equal wouldn’t that also reduce inventory (the high demand has to be satiated somehow). I think higher median selling prices and rising inventories might be explained by a shift in mix to higher priced homes rather than across-the-board strength in prices.
Higher prices means that the builders keep building — except that “building” these days means “overbuilding”. There are many more tens of thousands of houses being built than sold every single month.
I think the higher prices in Europe in the last years were mostly caused by a constant increase in fraud, crazy lending and ever more stupid government subsidies.
Supply has been rising significantly for a few years, wages are constant (and real wages declining), interest rates are no longer declining but who cares … people are still paying more every year.
There may be some shift - marginal buyers have been shut out of the market, maybe a bit similar to the US. New construction is not a factor in most of Europe (compared to US) because it is relatively less important than existing homes.
You’re right. As long as mortgage lenders are still able and willing to make funny-money loans, this housing bubble can continue on.
yes - in Europe just like in the US (didn’t Fanny loosen up again on credit standard for marginal buyers last week?)
20% of 1M is $200,000.
Call me cheap, but I think that’s a lot of money.
Yes, I’d still wait…
What town is that, Sandy?
I’m in Vero Beach and watch signs sprout every time I revisit a street. The RE classified ads are longer (and now thicker) every week.
heck, we blew through 30,000 this month. Only up some 90% in 6 months.
OT. Check out what $350K buys in Miami. Better hurry, if you define your search $350K-$400K there are only 2,435 properties to choose from. Get in now before rates go up / down, the world ends etc.
http://www.realtor.com/FindHome/HomeListing.asp?snum=4&frm=bymap&pgnum=1&mls=xmls&js=on&fid=so&vtsort=&ss_aywr=&poe=realtor&areaid=661&ct=Miami&st=FL&zp=&primaryZp=&nearbyZp=&mnprice=350000&mxprice=400000&mnbed=0&mnbath=0&typ=1&typ=2&typ=4&mnsqft=0&exft=0&exft=0&exft=0&exft=0&lid=Enter+MLS+ID&sid=067C43C09FFAC&snumxlid=1056629039&lnksrc=00001
Funny! I visit Miami often. What I have learned is that I am better off paying a higher interest rate for a fairly priced house than to get a low interest rate on an overpriced one. There is always a chance I may be able to refinance in the future but I will never be able to make up the overpayment of the home.
That’s what I don’t get. Just because interest rates fell over the last several years people think they’ve been getting a “good deal” in real estate. Huh?
You can (in the current tax rules) write off mortgage interest, but you cannot write off the bubble premium you’ve paid on your property. In some areas, values will have to decline by over 50% before they are back to “fair value”.
sure … in my area of the Netherlands, fair value (historic price trend plus official inflation) is about minus 85%. And that is without considering the overshoot to the downside that tends to occur after manias like this.
Absolutely! It never pays to pay too much.
“The message some financial advisors in San Diego are giving wealthy investors is clear: Those clients who can afford to sell their investment properties should do so. ‘If you have an investment property, this is a wonderful time to get the heck out,’ said Richard Ashburn, an investment manager and financial columnist in La Jolla.”
A wonderful time to get the heck out would have been July 2005…
If you bought 7 years ago and can afford to easily undercut the local competition by 10% on price it’s still a great time to get out. You’ll have the most attractive priced property and still get out with a good profit.
Timing the purchase correctly can give you great flexibility on the sell side.
This just in from those same financial advisors- It’s a wonderful time to sell your Enron and MCI if you can get out.
ISTM that what you paid for it has little to do with whether you should sell or not. If you think your money can earn a higher rate of return in the future somewhere else, you should sell. How much you make money or lose on the sale is an indication of whether your PURCHASE was wise or stupid, not whether you should sell now.
Human’s are funny creatures, until the sale is completed the market price has little bearing on our acceptance of a loss or gain. Also (perhaps more importantly) we feel much more strongly toward a loss than we do a gain. Go play the deal or no deal web game for a few rounds and don’t worry so much about your score, watch your emotions as each suitcase is opened.
“Go play the deal or no deal web game for a few rounds and don’t worry so much about your score, watch your emotions as each suitcase is opened.”
You know, that might not be a bad conditioner for teaching investors to accept a decent gain as opposed to getting greedy and holding out for “the big one”.
I seem to average about $50k playing the online game, and I’ve NEVER accepted my suitcase. Who knows how I’d act doing it “for real,” in front of a national audience, though…
–Which means that some of us have a (possibly excessive) fear of risk. But the dice were rolled when you bought, when you sell, you’re just picking up the dice cup to see what you’ve rolled.
How much you make money or lose on the sale is an indication of whether your PURCHASE was wise or stupid, not whether you should sell now.
Exactly. If houses in a neighborhood are 10% off last summer’s prices, then both the guy who bought last year and the guy who bought ten years ago have lost 10% of their wealth by not selling. More importantly, if prices are expected to go down by 15% this year, then BOTH will lose 15% of wealth unless they sell.
but the difference between these guys is that one of them should be able to hold on to the home (if he wants) when prices go down 30% or 50%, while the other one will be in big trouble (which usually has a severe financial penalty).
climber> Timing the purchase correctly can give you great flexibility on the sell side.
Amen to that.. wise words to abide by, when buying anything of investment value. Over the years, I have found it fairly easy to identify a compelling buy, but practically impossible to identify the perfect exit point. The trouble is, a lot of easy money can be made in the late stage of a blowoff top (as we had recently in housing, and earlier in the stock market) - this can last for months or years. Buying low and early gives one a decent margin of safety when one is tempted to linger while the blowoff is occurrring.
Exactly– These so-called ‘financial advisors’ should have been recommending this strategy at this time last year. As Trump says: You’re Fired!
these are the wealthy though, they can afford to put the property up at a price that will sell easily.
Exactly, I even remember the exact hour at which the bubble peaked. It was a July evening and I was watching local news, where they showed a crackerbox in Marin county, bragging it was worth two mil or something.
Marin county two mil?? Wow! Legends in their own minds. I wonder if Huey Lewis will write a song about this in a few years. LOL!
BayQT~
My sentiments exactly. If the best this investment manager can do is recognize a blatantly obvious trend then he is in the wrong business. I suspect his clients are either a). already long gone from this debacle or b). going to get unnecessarily slaughtered because of this guys ineptitude in the investment arena.
haven’t the numbers of “investment managers” and “financial planners” increased a lot lately, along withthe realtor numbers?! I’m guessing many of them are literate in their fields at about the level of picking up the latest fortunebuilder bestsellers, which would never have had them recommending selling off RE last summer no?
“A wonderful time to get the heck out would have been July 2005… ”
That’s exactly the time I visited San Diego and saw all those empty (real) and forthcoming (imagined, coming soon!) condo towers down by the Ballpark (beautiful park, btw).
Afterward, I said to myself, someday there’s going to be “San Diego condos for everyone!” who wants one.
Home loan applications again:
“Fewer people applied for mortgages in the U.S. for the second week in a row, an industry trade group said on Wednesday.
The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity for the week ended April 14 decreased 1.7 percent to 569.6 from the previous week’s 579.4.
Borrowing costs on 30-year fixed-rate mortgages, excluding fees, averaged 6.56 percent, up 0.06 percentage points from the previous week, its highest level in almost 4 years.
The MBA’s seasonally adjusted purchase mortgage index fell 2.7 percent to 407.4 from the previous week’s 417.7. The index is considered a reliable gauge of U.S. home sales.
The trade group’s seasonally adjusted index of refinancing applications fell 0.4 percent to 1526.1 from 1532.4 in the previous week.
The refinance share of mortgage activity increased to 36.4 percent of total applications, from 36.0 percent last week.
The percentage of adjustable-rate mortgage activity rose to 28.9 percent of applications, from 28.6 percent prior.”
Homebuilder stocks are down generally 2-3 percent today. Yesterday’s obvious short-squeeze in reaction to the release of the Fed minutes should be dissipated by the end of the week.
Where’s the PPT?
better late than never ?
these “advisors” ain’t worth 1%
OT, but relevant. The March CPI numbers indicate that housing costs increased at an 0.4% unexpected clip, while wages only increased 0.1%. Some analysts claim that the increase stems from higher rental costs because people cannot afford to buy a house (or refuse to buy). In my opinion, this 0.4% increase is more confirmation of the inevitability of a housing crash, if not a broader depression. (Clearly, housing costs cannot rise faster than wages for long on a national scale without severe adverse consequences.)
I think that a lot of the new supply of housing will help keep rents down, BUT, given replacement costs for apartments, etc. (construction costs are very high), rents will increase as rental supply tightens up.
Over the past 4 years, very few rentals have been built, and construction cost increases have been masked in the inflation numbers since for-sale homes are not included.
So, you have NO new apartment construction without higher rents given where interest rates are going, so after you absorb all the speculators homes/condos, you are going to have tight rental markets, driving rents up.
What does Bernanke do then, since rents ARE part of CPI?
I predict a pause in Fed tightening (perhaps even a bit of loosening over the next 12-18 months, then, as rents rise, inflation rears its head, and Bernanke begins to tighten again.
What does Bernanke do then, since rents ARE part of CPI?
They simply change the CPI to measure the cost of cardboard boxes instead of rent. Since a person can live inside a cardboard box, it can be considered an equivalent substitute for housing. As long as the price of cardboard boxes does not go up, there’s no inflation.
LOL.
CPI numbers are such crap anyway. If they actually included housing prices in the CPI numbers, interest rates would have increased long ago, and we would not be in this mess today.
the statistics agencies of both the EU and the Netherlands (and probably some others as well) are considering to include home prices instead of (just) rental cost in future CPI calculations.
No doubt in my mind that this change in the CPI calculations will occur when authorities are convinced that the housing bubble has topped (which is still a long way to go in Europe).
Course they will - right at the top of the biggest housing bubble in history - so they can show that the cost of living is getting cheaper as the market crashes - allowing them to justify low rates and pumping masses on money into the system to try and inflate their way out of this mess - just masking real inflation using real estate.
I’d expect nothing less from those clowns.
Uncle_Git - I can see this happening, too. And the justification? “Practically 80% (or some such absurdly high fraction) of American households now own their homes, thanks to our successful policies. Thus, switching the CPI to track real estate sales prices, not rents, would better reflect reality”. I cannot even begin to fathom the cynicism of these guys, given their academic credentials.
As long as the price of cardboard boxes does not go up, there’s no inflation.
Just to make sure, they’ll use the monthly-updated blue-book value of used 2006 Chevy Tahoes for a couple of years. Sleeps a family of four!
Exactly John!! Touche’!!
Your post had me ROTFL.
I thought I read there was a nationwide 10% vacancy rate. Rents are cheap compared to housing…people left rentals due to low interest rates and to get in on the boom.
There are too many houses and still 10% apartment vacancies…then something will give. Prices will come down until new construction makes no sense as it will be too expensive. Or maybe it will just take a few years for population to catch up…as long as less newer houses are built.
Much of this conversation ignores the large amount of speculator-owned property that is now for sale and, when it doesn’t sell, will be for rent. Particularly true for condos, which are more easily rented than SFRs in this part of Florida. A lot of speculators will be unable to stomach the thought of a loss-on-sale and will eat negative cash flow to avoid that, if they can get a renter.
actually rents will go up in the short term…believe it or not, i had a 25% jump in rent this year..esp conversions are temporarily reducing # of rentals, but sales are down as well..how long the developer bleeds before these are back on the market ? i think by year end.
Rents may go up, but they’re limited by the price the tenant market can bear.. Plus, fewer tenants in most areas (NY, LA and a few others excepted) means a natural restraint on rent rises…
There were two sides to that story:
1. Your landlord raised your rent.
2. You paid it.
I would recommend looking into alternatives. They are there and growing.
I charge $1100 for a condo where one was just advertised for rent at $925 in the same complex. My tenant is the one who told me, but doesn’t care because I have verbally promised that her rent would not be rising for the foreseeable future. After two years of no increases she believes me. I just spent spent $3K on paint/appliances for her as well.
I also saw my first For Sale/For Rent in North Park here in San Diego on a rundown craftsman surrounded by 70s apartment complexes.
“So, you have NO new apartment construction without higher rents given where interest rates are going, so after you absorb all the speculators homes/condos, you are going to have tight rental markets, driving rents up.”
Yeah, rental watch, this is the argument I’ve been trying to make. Also it appears that in many markets posters are seeing SFHs offered as rentals. But that’s not how it works everywhere. Repo’s here just sit and rot. They are not offered as rentals (unless you’re in or near the city) Bubble hasn’t even hit here yet and you can see homes around that have been walked away from. Some are purchased in time to renovate and some just go into deterioration. God help us when the real bubble moves in.
Yeah, my neighbors sold in mid Februrary and there doesn’t seem to be anyone living there now. Can you say “greatest fool?” Now the house next to them is for sale. In my neighborhood (Northern College Park, a post-war, working class inner suburb of DC) I predict that prices might fall 50% from their peaks within about 5 years. Heck, I thought about selling last year, but I like my commute and I don’t think that I’ll EVER see a mortgage like the one I have now, 4.875% 15 yr fixed.
I don’t think the impact is immediate though. If you measure housing not by housing “units”, but by bedrooms built (a more accurate measure of shelter, IMHO), I think what you’ll find is that a lot of shelter was built in form of SFHs and for-sale condos (big houses, big units, etc.)
At the end of the day, when your ARM goes from 4-6%, do you throw in the towel? Or do you rent out one of your 4 bedrooms to someone (divorced dad, JC student, etc.)? I think you rent the room. Only when this hidden supply of shelter has dried up, including repos and foreclosures, will we see rents really increase. It could take more time in some areas and less in others, but it is inevitable, unless construction costs come down (which they generally don’t).
My landlord raised my rent for my third year renting from him–he was almost apologetic about it. At the end of the day, my rent was increased about 3.5%–an average increase of about 1.7% per year. I’m happy to sign up for another year at that price.
Inflation is not defined as a rise in prices. It is a rise in money supply. It is normal for this too result in higher prices but not always. For example if production increases keep up with the supply of money increase prices should not rise.
When I was a kid, I was always amazed how Wile E. Coyote could walk several feet, even yards off the edge of the cliff before plummeting to earth.
I wonder if I will live to witness a similar phenomenon in the economy, thanks to this housing market that appears to be floating on a layer of helium that seems to be getting thinner and thinner.
Make that hydrogen and we all know what will happen when it pops and mixes with O2.
Bearmaster,
That’s a difficult analogy. Wile E. Coyote was a living cartoon, this economy is unreal!
LOL!
Oh the bovinity! (scroll to see cartoon)
Nice site!
bearmaster,
And do you remember the look on the poor coyote’s face when he realized he was no longer on terra firma? Priceless!
David Lereah will have that look on his face in late May or late June when the national median price of existing homes goes
YOY negative for the first time in the nearly 40 years they’ve been keeping records. Oh to have a hidden camera in his medicine cabinet the day he has to psych himself up for that CNBC interview.
I am thee Dav-id LERE-ah THREE-thousand. I was programmed NOT to say any-thing neg-i-TIVE-ly aBOUT thee market. I have a new and imPROVED chip that allows me to ADAPT to new neg-I-tive DATA.
You humans will NOT win.
Now is a GOOD time to buy A house.
Now is a GOOD time to buy A house.
1010101010001010010101001110101010100110100101010
0100010001010100100101011111011010101010010100101
1000101010101010100101101010101010010100101001010
And more inventory comes to market, and I am willing to bet that many of these wealthy investors can afford to cut prices and pull the rug out from over-leveraged flippers.
The casualty will be the poor family where the wife told the husband, “We can do this,” and “Suzanne researched this.” Suzanne then said, “This listing is special.”
Good luck finding Suzanne a year from now when you lose your house.
Trusting “Suzanne” — who has a vested interest in selling you a house at the highest possible price — to do unbiased research on your behalf is the height of stupidity. “This listing is special?” Yeah, like each snowflake is unique.
Suzanne will still be around…representing the new buyer at the foreclosure sale. Commissions all around!
I had a funny this morning. I emailed a realtor telling her she needed a spelling class. On her site, there were several errors.
This was her reply: “Thank you for the tip. May website is new, and may have some bugs, so I appreciate your candidness. Where did you see the error?”
Come on!!!
And the Realtor™ is probably happily thinking she did the right thing here! Let’s see now:
- Acknowledge your error immediately. Tick
- Think of a way forward. Tick
- Involve your (hoped for) client in the solution. Tick
Yep, that approach is going to get good marks from her small business tutor.
(And given that your post talked about spelling errors, I suppose it was too much to hope for “candour” instead of “candidness”. Sheesh :).
Ben - slightly OT: Article from Salon on derivatives and the housing bubble (you have to watch a commerical to see the article, but I’ve cut and pasted. Skip this text if you want to go directly to the link).
http://www.salon.com/tech/htww/
Wall Street bets on a housing bubble
How the World Works adores economic research papers with exciting titles like “Has Financial Development Made the World Riskier?” When such papers are written by the director of research of the International Monetary Fund, Raghuram G. Rajan, and not some one-man Web crank with a cartload of axes to grind, all the better. After pondering the astonishing growth, last week, of credit derivatives — financial instruments designed to slice and dice risk and spread responsibility for it widely throughout the financial community — we were more than ready for a 43-page analysis of whether innovations in risk management may have increased the chances of financial instability.
Rajan believes, in sum, that new developments in technology and finance have made the world better off, but “they may also a create a greater (albeit still small) probability of a catastrophic meltdown.” But he’s not too worried, proposes a package of minor, “market friendly” reforms and generally seems to think things are on the right track. Still, he concurs with the observation expressed here last week: The new world of credit derivatives hasn’t been tested by a major downturn, so we just don’t know what’s going to happen.
But could we be about to find out? One example Rajan used to illustrate potential problems was the housing sector. The great thing about credit derivatives, as far as a bank is concerned, is that they allow the banks to buy protection for the possibility that borrowers will default on loans. Protection in hand, the banks can then go out and make more loans, ever riskier in nature. This is precisely what has happened in the housing sector, in which banks have bent over backward to offer interest-only, no-money-down loans to customers whose credit rating is, shall we say, dicey.
Well guess what — since last September the market for a particular kind of credit derivative, technically described as “credit default swaps on subprime ARM pools,” has taken off. (”ARM” stands for “adjustable-rate mortgage,” and “subprime” means the borrower has a low credit rating.) According to Mark Whitehouse at the Wall Street Journal, who does the best reporting on credit derivatives of anyone in the financial press, such derivatives doubled in price between mid-September to December of 2005. I haven’t been able to find more recent data since then, but given the steady drumbeat of negative news from the housing sector, it’s hard to imagine that the trend line has changed.
So who is doing the buying? According to Whitehouse, the main players are hedge funds that specialize in debt trading: “The new credit-default swap ‘allows us to express a bearish opinion’ on the housing market, says Steve Persky, managing partner at Dalton Investments, a Los Angeles hedge fund with about $1 billion in assets. ‘A lot of people debate whether the housing market is overpriced, but, for sure, the credit quality of home borrowers has deteriorated.’”
The hedge funds are basically betting on the likelihood that there will be a housing sector collapse. They are short-selling the real estate business. The potential for profit is significant. “In mid-September, an investor seeking insurance on $10 million in mortgage securities with the lowest investment-grade rating of triple-B-minus, for example, could have bought a credit-default swap by agreeing to pay an annual premium of about $170,000 a year. Now, with hedge funds and others piling in to buy insurance as the housing market shows weakness, the premium on the same swap has risen to about $320,000, allowing the investor to sell the insurance at the new, higher price and pocket the difference.”
So here’s the deal: The smartest players on Wall Street see the housing market about to implode. So they’re loading up on cutting-edge financial instruments that will theoretically protect the buyer from exposure to millions of homeowners suddenly beginning to default on their loans. And for the moment, they’re making money hand over fist as the value of those derivatives rise with every new data point about slumping housing sales, slow housing starts and rising interest rates.
But what happens if the defaults do start rolling in, and the sellers of those derivatives have to make good on their obligations with cold, hard cash? Will there be enough liquidity in the system to handle the shock? Will state-of-the-art capitalism work as advertised? As Whitehouse reports, the market for credit default swaps that could be applied to pools of home mortgage loans is new — it’s only been around since last June. Again, no one knows how it will play out.
But any prospective homeowner thinking right now about jumping into the market with a no-money-down, adjustable-rate mortgage might want to think twice. Wall Street is betting against you.
Excellent Article. I’m very good at Calculus and this helps to explain how financial derivatives work.
Deriviatives are a rate of change to an original function or the instantaneous rate of change at a certain point of the original function. I just wondered what they were tracking as the original function.
I would love a tutorial if you have a link to one, or have a quick explanation. This is a little over my head, but the gist I get.
LA Law,
You bet on the superbowl. You give 7 points. The outcome of the game monetizes your bet. The 7 is meaningless without the outcome of another event ie. the game. Endless permutations exist for betting on mkt outcomes….
Wow, a derivitaive on the direction of change in the price of a hedge based on the the underlying expectation of mortgage defaults. I stopped at tensor field stress analysis of anisotropic non-linear elements. This one has my head spinning. Let’s see if I can translate. Holders of MBSecs are spreading risk by buying insurance, giving up some yield in exchange for some security. Works fine in theory but there are two problems. 1: there’s no way to price the insurance in unchartered territory. 2: there’s no way these insurers of last resort are adequately capitalized in the event of more than even a few claims. A theoretical example: the $10 million of BBBminus above costs $320,000/yr to insure against loses. A 20% drop in prices would immediately put 10% in default (to start). Remember this is triple B minus stuff. Now the portfolio is $9 million on the books and probably $7 million if you tried to actually resell it. Are the insurers able to cough up $1 million this year and millions more over the next few years? Sure, all they need is to raise the insurance rates. Uhhhh, anyone see the problem here? Say the whole thing is papered over and the MBSecs keep paying all their interest income to insurance just to keep the $7 million portfolio listed as worth $9 million in the hopes of a turnaround supposedly. How much is a portfolio of $7 million in bbb- mortgages that pays no interest that isn’t eaten up in insurance payments worth? Answer, less than zero. At this point the vultures arrive and can pay cash, say $4 million. For those reading and less than 50 years old, this is known as “cash is king.” They won’t pay insurance, they’ll assume the risk themselves. That means less insurance money in the system for the other payouts to other nonperforming MBSec bundles. Scary without a net uncharted territory swimming naked stuff.
Good point. They own the insurance policy and if it comes time to pay, where will they have money to make up the loss? They default and in turn the person who took riskier bets and then spread the risk is screwed, not just because those he lended to was risky, but because his insurance policy won’t be able to pay it.
Good point on this being theory and not proven. Sounds like another field where actuaries are needed but they usually base the risk off of things that have actually been proven. Financial Derivatives haven’t actually been proven to work yet, and this thing could end up blowing up in our faces and being even worse than if we would have never went with derivatives to begin with.
Robert, correct me if I am wrong, but this has my head spinning also and I was a math major lol.
My first paragraph may have sounded a bit confusing.
Let’s assume I am a lender. I lend 10 million dollars. If I buy insurance at let’s say 170k per year to cover that loss should someone default, but I am getting a rate of return around 4% minus the 1.7% Annually so the net is 2.3% with no risk. So this further entices me to make riskier bets. If I can get a high enough rate to cover the derivative and pocket some, then I am ok. Again, more subprime ARMS etc are lended. Also if the derivative jumps because of the perceived risk or the ris in premiums for the higher risk, then I could resell my derivative to someone else for 340k and pocket the difference (If the derivative is worth that much then). So Risk is analyzed by actuaries or whomever and they have actuary tables of risk and maybe as risk is rising the derivative is positive. This goes back to the original function that risk over time is increasing. As conditions improve from a risk perspective, the derivative decreases in value. So it looks like someone can buy at the top as well.
Here is where it gets shakey. If the loans I packaged default, then I turn to whomever I bought the derivative from to reimburse me for my loss. Now think Porperty insurance for a moment and nor loan defaults. Some insurance companies went bankrupts after the hurricanes came through such as Andrew and Katrina. If they didn’t, they took a big losses and premiums were forced to rise. For those who could not collect the insuance just defaulted and of course the loan was not paid. The bank or lender eats it.
So back to financial derivatives. I want to collect on my note because the borrower defaulted. Typically I would go to the one who sold me the derivative and file a claim or what have you and I would expect to be paid. But let’s assume foreclosures and defaults are at an all time high and they can’t cover the payments or whoever sold me this financial instrument wasn’t very sound in running their company, so they too declare BK and don’t pay me or just don’t pay me. Now I am stuck and hurting. Especially if it hits the fan, this could be very painful.
What if I sold that derivative for 340k that I bought for 170k. Even though I made 170k per year, the originator of the derivative or who sold the policy is still responsible for that amount?
If anyone else wants to chime in, I am just trying to make sense of these instruments and perhaps come up with a way to explain them in layman terms so that everyone, including myself can understand them.
Thanks!
I found this definition here:
http://www.naviamarkets.com/research/futures.htm#A
Derivatives are financial instruments whose values depend on the values of other, more basic underlying assets.
1. They do not have value on their own
2. They derive their values from another asset or multiple of assets.
A stock index like NIFTY or SENSEX is also a derivative on multiple assets as the value of the index is derived from the basket of stocks that constitute the index.
Motivation to use derivatives
The real motivation to use derivatives is that they are useful in reallocating risk either across time or across individuals with different risk bearing preferences.
Derivatives are basically classified into two based upon the mechanism that is used to trade on them. They are Over the Counter derivatives and Exchange traded derivatives. The OTC derivatives are between two private parties and are designed to suit the requirements of the parties concerned. The Exchange traded ones are standardized ones where the exchange sets the standards for trading by providing the contract specifications and the clearing corporation provides the trade guarantee and the settlement activities
Many thanks to Tom, Robert et al for the excellent explanations. I think I have a handle on the TYPE of gambling that’s currently going on.
I trust Buffet for insurance, but the MBSs?
Funny you should mention Buffett.
I believe he’s on record as saying he thinks the next big blindside event is going to come from derivatives.
He called derivatives weapons of mass financial destruction.
The last couple of reinsurance deals that they are unwinding are costing them hundreds of millions of dollars but they are unwinding them because it is worth it.
So here’s the deal: The smartest players on Wall Street see the housing market about to implode. So they’re loading up on cutting-edge financial instruments that will theoretically protect the buyer from exposure to millions of homeowners suddenly beginning to default on their loans. And for the moment, they’re making money hand over fist as the value of those derivatives rise with every new data point about slumping housing sales, slow housing starts and rising interest rates.
Assuming this is a zero sum game…
So who’s taking it up the wazoo for all that derivative money being made “hand over fist”…
This has always the queer thing to me about WS.
How the f*ck do these guys mfg. boatloads money out of a calculus alogarythm table?
Who and where are the losers???????????????????
Next month they’ll be in the Hamptons on weekends.
candidness is always appreciable!
Shel, you’re right, but did she have to have an error in her reply? Geesh.
The numbers tell the story. According to David Rosenberg of Merrill Lynch, “momentum for new home sales -42% for the 1st quarter which makes it on track for the slowest sales pace since 1981. And, the stock of new unsold homes is at a ten year high”. Here we go!
Peter,
David’s been bearish really from inception of the bubble, did he really say that? Those are incredible numbers! Let’s all stop and think where we were in 1981.
Dinor,
Yes, it was on one of his postings this morning. Remember, we are talking about being on track for slowest sales pace since 1981. These are serious numbers!
Serious indeed! I’ve always enjoyed David’s comments as he was not being “reigned in” by the fact that Merrill was underwriting a lot of REIT’s at the time and yet he still found the courage to speak his mind! His was the kind of sober analysis we all could have used more of. I like John Talbott as well but John (like myself) are really more “cheerleaders” for the crash as much as Lerah was for the bubble.
Why did the homebuilders do well in the stock market yesterday and then take a downhill slide today? What changed?
Yesterday PPI was low… Market rallied on thought that Fed would stop raising rates…
Today CPI was high… Market in stand still as interest sensitive stocks go down as now the market thinks Fed will continue to raise rates…
Funny how the market works…
You remember how CNBC would trot out Abby Joseph Cohen or Joseph Battapaglia every single time the DJII was down 100 during the internet bubble? They’d come on and blather about “a healthy correction” and how “stocks were still fundamentally undervalued” and so on.
The Fed has taken over that role by braying every couple of weeks about how they’re almost done raising interest rates. We little people are supposed to pretend that the only thing that is keeping homebuilder stocks from going up is the possibility of a 7.5% 30-year loan instead of a 6.5% one. The drop today shows that the fundamental trend is unchanged — the future is poor and getting poorer for the HB’s because of low affordability, prices that are simply too high, and a near-zero pool of potential new buyers. Whether interest rates are 6% or 7% or even 5% really doesnn’t matter at this point.
In fact, the only two big moves up for the HB stocks in the past month were directly (and very briefly as it turns out) a result of these Fed touts. The last move up was a memory just two days later.
I brought this up in another thread, but: does anyone think this inflationary trend will re-inflate property values, as investors buy RE to hedge against our soon to be worthless currency? Or do you think rising rates will counteract that? Or will RE fall just from its own weight?
Are you sure you’re not a troll…
I rather doubt she is a toll. I think it’s a valid question. Before you jump on me, I sold my home by luck at the very top last summer & now rent waiting for the bubble to burst. My only concern is that the Fed is talking out of both sides of their mouth. ie, they lie. M3 is gone & they are flooding the country with liquidity. Gold/Silver are telling you that the smart money knows inflation is a big time problem. I don’t think it will work, but they stopped me out of some shorts yesteray with all the yapping about ending rates hikes. Inflate or die is their real motto.
No, saying that our currency will soon be worthless is a bit reactionary. Will the US dollar loss value relative to other currencies? Yes, maybe even 20-30% Will it become ‘worthless’? No. That would imply hyperinflation over a long period of time. The Fed will not allow this to happen nor will the monied intrests in our country which seem to have such an undue amout of influenece in our government. ChromaticDispersion used to post about this.
This will unfold at a glacial pace for the most part. That glacial pace is what makes the middle and end of a housing bust so painful. If you are upside down on your mortgage for only six months, it’s not that bad. If a builder has two or three bad quarters, it’s not the end of the world. It’s being upside down for years or having 8 or 9 consecutive bad quarters with no end in site that destroys things. The relentless grinding nature of the situation with no forseeable hope of improvement is what characterizes a housing bust.
“Will the US dollar loss value relative to other currencies? Yes, maybe even 20-30% Will it become ‘worthless’? No. That would imply hyperinflation over a long period of time.”
The Chinese would never allow this. All it’ll take to push their entire political system over the edge would be 0% growth for a few years.
“Will the US dollar loss value relative to other currencies?”
this is the wrong question! Of course not, Tricky Trichet will make sure that the Euro tumbles at least as fast as the mighty dollar from his friend Helicopter Ben. Hyperinflation IS already happening, it is just that people are not seeing it because they believe all the lies fed to them by the FED and the lizards from Wall Street and the media.
just look at this graph and think about it:
http://tinyurl.com/mltx4
You could buy real estate as a hedge, but as the old joke goes, when it comes to sell, who are you going to sell it to. Free money will go into precious metals, especially if it is perceived — and it would be a correct perception IMO — that the dollar is being debased by the Fed printing press. Never mind that is almost infinitely more liquid than real estate.
“if people own $700,000, $800,000 homes that they’ve bought for investments, and they suddenly put them on the market, that will have a dampening effect.’”
that was the new home prices in east Chula Vista zip code 91914 last year, 2005. According the the San Diego Union article linked last week, this zip code had the largest price drop in the county, 32%. Approx. $250K price drop.
Maybe I’m just stupid, but can anyone explain to me why the Fed is indicating no further tightening, when the CPI is rising so quickly?
In simple terms, because the Fed is beholden to the banks and Wall street, NOT main street.
The minutes that everyone was touting as meaning that they were about done raising rates were from a meeting in March, before the latest jump if fuel costs.
lainvestorgirl, in response to a couple of your comments:
> Looks like the next bubble is already here: metals.
Jim Rogers says that’s NOT a bubble, and I agree with him. His opinions are here:
http://tinyurl.com/qjg6v
If he’s correct, this commodities bull may have a decade or longer left in it. Rogers tends to prefer commodities other than gold for higher profit potential. Personally, I’m pleased to see so much skepticism around gold and silver in “normal” people. This suggests to me that practically nobody is on this bandwagon yet. So the critical question - “Sell to whom?” - is many, many years away. IMO, the action so far is not the commodities going up, it’s paper currencies going down.
> Maybe I’m just stupid, but can anyone explain to me why the
> Fed is indicating no further tightening, when the CPI is rising
> so quickly?
The California Fed governor is apparently concerned about the impact of rising rates on the real estate market. I don’t know why that’s any concern of hers. I thought the Fed’s primary charter is to maintain a sound currency.
I thought the Fed’s primary charter is to maintain a sound currency.
And now you know “based on results” that is not the case!
LA,
The minutes released yesterday were from the March 27-28. The data released since has been robust (read inflationary). 4.7% unemployment (household survey), decent NFP job growth, low weekly unemployment claims, PPI, CPI headline numbers (inc. food and energy). The Fed is not done yet, IMHO yesterday was a little over done.
done or not done with tightening is irrelevant - the FED will make sure that they stay firmly behind the curve, just like the ECB. Real inflation is many percentage points higher than the FED rate and the difference is rising quickly.
Anyone can see that these banksters don’t give a damn about inflation (in fact, Trichet from the ECB has finally confessed that inflation is no longer a factor in his decisions) and will do everything they can to keep the easy credit party going.
NHZ,
Look at the TIPS market. The yield is 2.30% - 2.40% 5yr out to 30yr. The Fed likes to see around 2.00%. Are they behind the curve? Probably. IMO they (the Fed) like where they are now much more then 2+ yrs ago with 1.00% Fed Funds and an unresponsive economy. They were 1.00% away from being the BOJ ie. irrelevant. With the large debt they fear nothing more than deflation. They will error on the side of inflation (see metal prices).
yes, same here in Europe. The ECB is also behind the curve and VERY comfortable with that position. We get upwards revisions of EU GDP growth every week or so; just strange that people have also more trouble making ends meet every month, something does not compute but why worry?
Money is free for the taking (and the interest payments are free money for the banksters), that is all that matters.
judging from the acceleration in metals prices, if will not be long before this gets completely out of hand and the system comes crashing down.
This is how a realtor described a $1.7 million wreck in Santa Monica. Too lazy to even spell words out for her paltry commission.
“An architect’l mid century jewel in prime SM Cyn w/ocn & cyn vus. There is a wonderful pvt garden crtyard entry behind front gates. This is an open flr plan which communicates w/exterior gardens & gorgeous ocn & cyn vus. The spacious kitchn, liv., din. area & mastr bd. have hi ceilings & enjoy space, light & ocn vus. Downstairs is a convertible den w/FP. The 2nd bdrm & den both open to a lovely patio & beautiful yard filled w/mature trees w/room for a pool. A stones throw from bch & Cyn School.”
I liked the “mastr bd.” part. Beavis and Butthead would too.
How about the floor plan “communicating” with the gardens?
Actually, I’d like to see that.
Yeah, she just earned her 7%!
Jack,
That’s realtorese for the termites in the floorplan communicate with the ants in the garden
Sorry to chime in late here (had an early appointment) but the comments made here are so accurate! With “financial planners” like these who needs enemies? When you live in BUBBLE CENTRAL where virtually the entire country has voted YOUR TOWN as the most likely to pop and you’re just now identifying the trend? In a nutshell here’s the problem with these guys. I came up in trading firm. It was hell. There was no “calling in sick” and other than maybe 5 minutes for a men’s room break you were expected to be there. It’s a young man’s game. HOWEVER, so many of these guys have opted for these “management agreements” where they get paid regardless of their effectiveness. Steady income stream, no getting up early, no margin calls, what’s not to like? Well down the road they’re not showing up to their office until 10:00 or later and they can’t be bothered with trivial things like research so they turn the whole thing over to a real money manager and just collect their fees! I understand people that have been in the business for years not wanting to have to put their tie on in the elevator on the way up but the “new service model” clearly isn’t working as evidenced here.
There’s a prominent article at CNNfn.com that talks of a new Internet boom in stocks and says: More important, companies have finally figured out the long-sought key to “monetizing” those eyeballs, mainly by selling advertising, but also by charging for music and video downloads, not to mention for the access itself”.
A little warning from someone in the field — most of the ads are zoned out or X’d out by Web users. You hear screaming from advertisers about TV viewers skipping commercials on TV. Well the Web is 100 times worse. Right now, Madison Avenue sees it as yet one more way to make money and are fanning the fires. But one day, I promise, advertisers will wake up and the honeymoon will be over. And that will be Dot Com Crash II.
http://money.cnn.com/2006/04/18/technology/netboom_fortune/index.htm
You are dead on correct. My Norton Firewall blocks everything.
This new round of internet investors who bet the farm on “the monitizing of eyeballs” are gonna take a cold bath….AGAIN.
Advertisers are lemmings for the “buzz du jour” and often aren’t savvy enough to ask the right questions of their ad agencies - in whom they often trust more than they should. Clearly the Internet has changed the world. But with relatively rare exception, the Web ads are a waste. The industry is drowning in snake oil, just like real estate.
Another set of lemmings are the venture “idiots” who fund the companies who do this sort of crap.
There’s an endless supply of them around here. How about they fund something useful, for once?
Monetizing eyeballs. Jesus. Welcome back to 1999.
A bit OT from this particular thread, but relevant overall.
There’s all this hooey about “the median price is up, the median price is up” all the while sales volume continues to decrease.
Perhaps someone has made this observation before, but this seems just like in the stock mkt when you have a price spike on decreasing volume. This is usually a dangerous technical indicator; basically a mkt’s blow-off, last gasp price spike.
What do you guys think?
With real estate trends, sales volume is highly correlated with price. It is one of the key indicators to follow. Never rely on only one indicator.
I agree. It just happens much more slowly
A key difference is that a share is a share is a share.
The 2/1 that went for $200K last month may not be in the same shape as the 2/1 that went for $210K this month.
The quality may be significantly better, thus the median masks a price drop… or the quality could be worse… thus the median masks a frightening price spike.
True. However, I we were thinking in terms of the transaction dynamics not the underlying value…although, have you ever seen what happens to a biotech stock when it’s FDA approval is delayed?
Why yes, yes I have.
People will be lucky to have their houses regain their value that quickly.
OT: Can you say $73 oil?,, Yeah they are done raising rates… right… now inflation here folks.
I’ve seen lots of long-time RE investors (real ones, not speculators) bail over the past couple of years in SD. The smart money is already out, IMHO.
Funny thing about trying to time the top. Once it becomes obvious to sellers that the top is in, it’s usually pretty apparent to the buyers as well. Always a good idea to leave a little money on the table.
I’ve recently noticed at least a few properties in my area that are listed at almost twice what I think they would sell for in today’s market. For example, there’s one house listed at $2,400,000 when larger homes in the same neighborhood have been listed for two or three months at $1,600,000 and haven’t sold yet. I assume that the sellers and agents must realize that there is no way these homes will sell at anything near the listing price so I can only guess that this is a deliberate attempt to make other overpriced homes in the area appear to be bargins. Has anyone else observed this or have any other rationale explanation for what these people are thinking?
I’ve noticed the same thing around Seattle: Homes on the market at X amount since last summer- unsold. And then someone in the neighborhood putting theirs on the market at an even higher price this spring!
It seems very irrational. So that’s what I’m assuming it is- an irrational response to the end of the bubble by people who don’t REALLY NEED to sell.
If I owned a house in one of those neighborhoods, maybe I’d give it a try too! It’s kind of like playing the lottery. You probably won’t win, but if you do, wouldn’t that be dandy?
How many chances in life do you get to make several million dollars for practically no effort at all?
I think these people realize that the party’s just about over. This is their last chance.
I’ve seen the same thing (Miami area) since moving here last summer. A few homes way overpriced for the neighborhood and still sitting after nine months. I can only think that they are not serious sellers and are just fishing for some rich fool (here it would be a rich Venezuelan or Colombian) who needs to launder some money and fund the sellers retirement. After all, if a realtor takes your way overpriced listing, it isn’t costing the seller anything to fish around.
I have been doing my own research on the Condo situation in downtown San Diego. The Legend seen here:
http://www.thelegendsandiego.com/main.asp
is BOSA’s flagship Condo highrise here in San Diego. BOSA is supposedly the best builder in San Diego right now. BOSA’s previous projects such as the Electra and the Grande North and South sold out in a matter of days. The Legend is only 50% sold and is now breaking ground right next to PETCO Park where the San Diego Padres play. I check the sales figures for the Legend on a regular basis. They basically have not sold a Condo this entire year, despite opening a downtown sales office in January or February. There were 88 units available as of 3/7/2006 and there were 88 units available last week and today there were also 88 units available. There were actually 4 more units in “reserve” status on 3/7/2006. Basically they have lost sales in the last 45 days. Typically banks only allow builders to break ground when 60-70% of the building is sold. This isn’t the case at the Legend.
Be sure to check out http://www.777lofts.com for MAJOR pricing reducions in downtown San Diego.
“I think we have a problem Houston!”
For the long time readers, about 6 months ago we had a fair amount of posters claiming to be long-term landlords and claiming to have cashed out saying they were going to sip tropical drinks on the beach for 10 years and then come back and complete the same cycle.
Overall, the posts seemed genuine. Maybe Ben can dig out some of those old posts. They were good.