Why you and I should not buy houses in Los Angeles County... just yet

My, my, my... If my mailbox and eMail account are any indications, the State of California and the U.S. Federal Government sure would like me to buy a house in my county right now. I have been informed no less than 13 times this month that CalVets and the U.S. Department of Veterans affairs would like me to exercise my right to a VA home loan... real soon. The time has never been better... or so they say.

I don't agree, and I will tell you why.

House prices remain obscene

Much to the dismay of current home owners and mortgage institutions, the price of houses remains obscene. How do I define that? According to classical banking doctrine, you never write a mortgage for more than 2.5 times the annual household income of the borrower. According to various estimates, Mode, Mean and Median household income in SoCal hovers between 76,000 and 85,000. That means that price on an average middle class home should $212,500. That should be the price because that is what the market should bare.

If you have conducted a study of housing prices in the San Fernando Valley of SoCal, you know that the price cap on a middle class home is nowhere near $212,500. 1,500 sqft will cost you $350,000. You can touch 2,000 sqft for the sum of $400,000, but you had better be prepared to do some repair work. In good hood, we're talking about a major fixer.

The consequence of this market structure is very simple: Most middle class people do not own homes. Most middle class people are renting. Those who bought are struggling like hell. Many of them are organizing short sales or being foreclosed. That's what's up in my neighborhood.

This brings us neatly to the question: Why lend no more than 2.5 times the household income? Who wrote that law? Why are we bound to this rule? Why not more?

The answer is pretty simple: We are currently living the consequences of ignoring this unwritten law that was pregnant with the wisdom of the elders. A youth group came up about 10 to 15 years ago that did not understand the reason why, they ignored the rules, we saw massive inflation in the price of housing, and now the mortgage industry is going bust as people cannot afford to pay what they owe.

The elders understood that 2.5X was the limit of what financially healthy people could afford to pay in terms of mortgages. Anymore and you begin to cut into their contingency funds, their health care payments, car repairs, etc. This is an unwise move for a banker to make. You can't cut the throat of the milk cow to bleed her from the neck. The cow becomes unhealthy if you do this, and you will loose your milk supply. Bad move.

Old bankers restricted mortgage loans to 2.5x to keep housing prices in-line with buyer means. Old bankers restricted mortgage loans to 2.5x to keep borrowers financially sane. Old bankers restricted mortgage loans to 2.5x to allow mortgage holders to have enough financial space for a decent life after the mortgage payment was made. This rule was best for all concerned.

Now look where the fuck we are. Houses are now unaffordable by the middle class. Most people I grew up with do not own homes, despite the fact that all our families owned homes. I am 43 and I have never owned a home. I have lived in apartments or a barracks for most of my adult life. There was an occasion when I rented a room in Mill Valley... Those who own homes cannot sell them at all, much less at a profit. Those who need to buy homes cannot afford them. The market is frozen. It is not liquid, vibrant, healthy, functional or alive. Prices have simply reached an untenable point.

The solution is simple: Those who wrote imprudent loans are going to take the ass-end of the coin they flipped when wrote the mortgage. They knew they were taking a risk, now the risk has come up snake-eyes. You lose. Of course they do not accept this! I know they are resisting this conclusion ferociously. They don't want to admit that they have a Forrest of bad paper on the books. Nevertheless, the fact is that they do.

The Market is going to get healthy... soon

Banks used the Bush/Obama bailouts to avoid foreclosing on the bad paper they hold. They only forestalled the inevitable. I believe that the foreclosure wave is coming in March 2010. It takes about 90 days to complete the process of foreclosure and put a naked house on the market. The buying season begins June 1, 2010. To be ready for this, I believe that the foreclosure notifications begin to fly in about 6-8 days. A ton of houses will be on the market June 1, 2010.

The prices will begin to fall at that point. Banks are hoping that putting foreclosures on the market at the hot-point will decrease the rate of decrease, but I think they understand that prices are going to fall. Let's hope it is a lot more than the $50K drop limit they are hoping for. A $50K drop will not restore the real estate market to health. To be frank with you, even a $100k drop will not restore the market to health. A drop from $400K to $300K is still well short of $212K. It is better than nothing, but the price is still steep for mode, mean and media people of SoCal. They really cannot afford $300K.

Uncle Sam would like my help

Of course, Uncle Sam is a wholly owned subsidiary of the Financial Houses on Wall Street. Ergo, Uncle Sam would very much like me to exercise my VA loan entitlement to buy an overpriced house and support the unhealthy market price structure right now.

This is the very best thing for Wall Street and for Uncle Sam. Interest rates are low. This means Uncle Sam won't have to give me much leverage in the mortgage interest tax deduction. This means I will ultimately pay more taxes. Also, if I buy at a high rate now, financial institutions will take a lower loss on the property they sell me from their current supply of bad paper. That's good for the financial institution because I will pay them more money.

I don't want to help

You will pardon me if I am a bid selfish, but I don't want to help. I want the market to get healthy from my perspective. I want to pay less taxes and pay less to Wall Street. I will buy after:

• The wave of foreclosures come
• The rate of interest increases, and my mortgage tax deduction increases.
• Prices go down
• I can buy $100k cheaper

Is the recovery on?

Well, last night there was a great debate on most of the financial news networks about whether yesterday's lovely stock market gains constitute the start of the recovery. Some said yes. Some said no.

So is the recession over, and is the recovery on-going? I'll give you a short answer and a long answer. The short answer is: No, fuck no. The long answer? Let me tell you about it.

There are two fundamental forces driving this recession.
1. Housing prices
2. De-leveraging

First we have the structural economic problem that the housing in America is vastly overpriced and unaffordable. Go do a housing survey in any region. Go do an income survey in that same region. Just about everywhere in the country, you will find the same relationship. Housing is more than 4 times the total annual income level of the typical family or buyer. In afflicted regions such as Los Angeles, San Diego and San Francisco, it is much worse. A typical family home can be 6 or 7 times the annual income of the typical family.

So what? Old bankers will tell you that (historically) the safe formula for mortgages says write a mortgage for no more than 2.5x the house hold income and ensure that the total cost of housing does not exceed 28% of total income. Insurance, HOA, and Mortgage payment must be less than 28% of household income. We are vastly beyond this safety limit right now, and this is the absolute fundamental reason for this horrible banking calamity we are experiencing. People are defaulting on mortgages because they cannot afford them.

Certain politicians and real estate brokers are attempting to re-cast reality to say that this calamity was brought to us by a bunch of unethical loan sharks who wrote nasty loans. The implication is that housing prices don't need to go down, loan terms just need to be adjusted. What...? As if they could have written a good mortgage for these outrageous amounts? No way. Every mortgage looks predatory if you write it for a party that cannot afford the basic price of sale. The absolute problem is an over-bought, over-speculated, inflated housing market that is fundamentally unaffordable for the people. The variable that must be adjusted is base-price of sale. That figure needs to go way down. All the way down to 2.5x average household income.

This can be accomplished in two ways:
1. You can raise average household income, which is bloody unlikely
2. You can lower the base price of sale through a process of default, foreclosure, auction, and short sale. This process is absolutely in progress right now.

That process of price tatonement must run to completion before the recovery will begin. We are not near the equilibrium point just yet, so forget about recovery. I predict that the equilibrium point will occur when average housing prices = 2.5x average income by region. Once we hit that, recovery will be possible.

The second problem driving this recession is de-leveraging.

When the economy had it's stroke and heart attack on September 15th 2008, the wave of panic that shot through the media was totally unprecedented in my lifetime. The U.S. Presidential election cycle stopped cold for several days and was thrown on the back-burner by the news agencies. Barrak Obama and John McCane suspended their campaigns.

This scared the unholy shit out of the people. At our Thanksgiving Day table, we had not a single conversation about anything other than the economy, job loss, the Great Depression, banking collapse, retirement funds, being under-water, etc. We did not discuse McCane or Obama. Our family was pretty dang terrified. I bet you were too.

The natural response to this new threat was to pay off all debt, store up some savings, and prepare for unemployment, should it strike. Just about all businesses and individuals began throwing all new earnings at debt. Consumption fell off a cliff. Businesses starved for customers and demand. This is about as pro-cyclical a move as the American consumer could have possibly made, but we all made that move together. We did it individually and collectively. The result is a deep, agonizing, downward spiraling recession.

So now we have a problem to solve: When does de-leveraging stop? There are two possible answers:
1. De-leveraging stops when everybody is completely out of debt
2. De-leveraging stops when the American consumer gets tired of austerity and breaks out the credit cards again.

Here, I can sound a bit more optimistic. I have little faith in the fiscal discipline of my people. We Americans like to spend and consume. We don't like zero debt for this reason. I expect our good people to half-step here. They will move their debt loads down considerably, perhaps even to safe levels, and then they will begin consuming again.

But then on the other hand... We should also remember that America's favorite shopping tool is the credit card. Certain credit card firms, most importantly Amex and Chase, are in a lot of trouble with consumer credit. They are playing shutdown defense right now. There are more and more reports of Chase and Amex closing accounts, reducing credit limits, hammering long term customers with massive interest increases.

There are some reports of Citibank doing the same thing. I personally have two Citibank MasterCards and they have done no such thing to me... yet. Let's hope they don't. I like my gasoline cards.

Anyway, presuming that consumer credit largely stays intact. Americans might start spending again by Christmas of 2009.

Nothing should be done to support high housing prices

I felt the need to sit down and scribble this out, early this Friday evening, before going to see Watchmen, because there is a gigantic fundamental error circulating in the think-tanks in Washington D.C. Many authorities within the Obama Cabinet are openly declaring that everything that can be done to stabilize housing prices must be done. The free-fall in the value of housing must stop. The reason why the average home owner should buy into the mortgage rescue plan is that it will prevent foreclosures from lowering the value of your home.

Hehehehe...

Well, this would all be very nice political bullshit if it were a mere excuse for rolling out some aid to stricken families. Unfortunately, of late, I have gotten the impression that Obama's boys and girls are serious about this notion. I think the really want to stop the free fall in the price of housing.

Let me make this absolutely and completely clear so that nobody can misunderstand what I am saying: Nothing should be done to stabilize house prices. Nothing could be more dastardly, more terrible or fundamentally wrong for the American people than stabilizing housing prices at current levels and attempting to get them to rise again.

In all this goddamn hoopla about banking collapse, you are forgetting the absolute fundamental reason for this crisis. Hot leverage dollars bid up the prices of real estate to insane levels. We have reached the point where just about every common house is totally unaffordable to every common American worker. Because housing prices are unaffordable, we are seeing a massive amount of defaults on mortgages. It is not just happening because speculators are abandoning ship. It is not just happening because of predatory loans. It is happening because Joe the plumber can't afford his $550,000USD 1,200 SQFT townhome in Receda California. Any loan of this amount to Joe seems both predatory and foolhardy.

Call me foolish. Call me irresponsible. Call me a dreamer. However, I believe that when every common ordinary home is unaffordable to every common ordinary worker, you have a very serious structural flaw in your economy and society. People can't buy houses when they need shelter. They can't sell when they need to move. They can't build when more housing is needed, because there is no hope of finding buyers.

When wage growth is 0.0% after inflation, year after year, housing cannot continue to appreciate at 7.7% year after year. There are no new dollars in the American wallet to cover this massive increase in cost. Banks like Bear Sterns and Lehman might favor the system of life-long debt peonage, but we common citizens do not. Most of us refused to sign off on this system, and that was when the housing market bubble burst.

To get out of this crisis, the price housing must correct. The market is self correcting right now. Housing values are dropping. This is good. It must continue for some time. Townhouses in L.A. need to go down to the $200k range, not the $500K range. Even at this price they are onerous cost items indeed.

If the Obama administration is serious about stabilizing prices they will

1. At best, waste trillions of dollars and barely retard the correction process.
2. At worst, waste trillions of dollars and fuck the very same little people they claim to represent.