May Day? May Day!!!
Run for the hills? No no no, not now! Not until after the election in 2006. Our long-anticipated Recession is not likely to occur until the end of this fabled year, the Year of Our Lord, Two Thousand and Six. Everywhere you read: “The Economy is Good.” “The Economy is Great!” But, really it’s not true. Yes, the numbers you see, the promotion you hear, sounds very good. But, you must remember, take into account why the numbers are so good.
May we have the envelope please? The numbers are based on a house of cards. They are in fact based on unprecedented debt in the housing sector; the corporate debt sector; the government debt sector; in the current account deficit; and, internationally by the fact that we have led the way of credit expansion, and have caused the rest of the world to also grow debt (grant credit, liquidity) in unprecedented proportion. What we’ve done is export our jobs, and worse, we’ve massively exported inflation (it’s all we have left to export besides advanced weapons systems).
Budget Deficits and Current Account Deficits
We can offer no better overall analysis than from Dean Baker. He is an economist and co-director of the Center for Economic and Policy Research. He wrote recently on his blog:
"While news of the budget deficit routinely appears prominently on the front pages (in addition to occupying considerable space on editorial and op-ed pages) discussion of the current account deficit is generally relegated to the inner pages of the business section. Since the long-term impact of the two on the economy is comparable, there is little justification for the difference in treatment.
”This is another Econ 101 story. A budget deficit is supposed to be bad because it pulls money away from other more productive purposes. Specifically it is supposed to raise interest rates and thereby crowd out private investment. (The deficit hawks have a hard time telling this story at present, with real interest rates in the U.S. at near post-war lows.) The result is slower growth and a poorer country in the long-term. There is also a secondary concern, that when the annual deficit and/or debt grow sufficiently large relative to GDP, lenders could begin to question the government’s creditworthiness and then demand very high interest rates. This would have serious consequences for investment and growth.
”A current account deficit means that the United States is selling off assets (e.g. stocks, bonds, real estate) to foreigners. As a result, in the future, income from these assets will go to foreigners rather than people in the United States. In other words, the United States will be poorer, just like with a budget deficit. There is also a secondary concern, that when the annual current account deficit and/or foreign debt grow sufficiently large relative to GDP, lenders could begin to question the country’s creditworthiness and then demand very high interest rates. This would have serious consequences for investment and growth.
”Okay, I shouldn’t have used the exact same words to describe the nature of budget crises and current account crises. The latter will typically take the form of a plunging currency, leading to higher inflation (import prices rise when the currency falls, leading to higher prices generally) and higher nominal interest rates. The result is likely to be a recession, with several years of stagnation and high unemployment (e.g. the East Asian financial crisis in the 90s). A budget crisis is likely to be resolved with sharp cuts in spending and/or large tax increases, also likely to lead to a period of stagnation and high unemployment.
We hope this makes it very clear that we are headed for a serious correction in housing. One economist that we follow has estimated that California housing, across the board, will suffer a reduction of current value of 35% to 40%. No typo. A reduction across the board in residential housing values in California of 35%-40%. When this information was recently presented publicly in a residential investor’s forum in Marin County attended by approximately 200 residential investors, the Shock, Awe and Fear in the room was palpable.
This Housing Market Really is Different
Mortgage rates have recently risen to levels not seen since 2002. The real estate industry says, never fear, they are still low by historical standards. While true, that fact is irrelevant in today’s historically unprecedented real estate market. We point to brilliant economic analyst Mike Shedlock for the following.
”Although current mortgage rates are still historically low, underlying mortgage balances certainly are not. Several years of artificially low interest rates, combined with lax lending standards and the get-rich-quick mindset, have resulted in homeowners assuming mortgage balances unprecedented in history, both in absolute terms and relative to their incomes. For most, such balances have been sustainable only as direct result of extremely low interest rates, and in many cases temporary teaser rates. Today’s stratospheric real estate prices cannot be maintained without these supports. As rock-bottom rates fade away, housing prices must return to earth.
”For example, while historically a typical family may have been able to afford a 6.5% mortgage on a normal $250,000 mortgage, the same is certainly not true when applied to today’s completely abnormal $500,000 balances. The fact that rates may still be low in historic terms is irrelevant if mortgage balances are now twice their historic norms.
”Compounding the problem is the record number of families who now own vacation homes, or “investment” properties that produce negative cash flows. This means that higher interest rates will be particularly burdensome as many households now have multiple mortgages to service.
”Even more troubling is the significant number of borrowers who relied on adjustable rate mortgages, or worse, temporarily low teaser rates to qualify for their loans. When those mortgages reset at today’s higher levels (or tomorrow’s even higher ones) and in some cases are applied to even larger loan balances as a result of negative amortization, the payment shocks will be that much more intense.
”Furthermore, the fact that mortgage rates are still historically low merely indicates just how much higher they could potentially rise. In addition, given the low supply of domestic savings, accelerating inflation, and a wave of mortgage defaults likely to further suppress mortgage credit, mortgage rates are likely to rise to historically high levels. Applying high mortgage rates to today’s extremely high mortgage balances is like putting a match to gasoline. If sky-high prices were merely the inverse of extremely low interest rates, a sharp rise in the former implies an equally severe collapse in the latter.
”In addition, [recent] action in the bond, precious metals, energy, and foreign exchange markets, which included simultaneous declines in both bonds and the dollar and break-outs in gold, silver, and crude oil, (all of which I am on the record as having accurately predicted) indicate that a major inflection point could be developing; one which would either send the dollar though the floor, interest rates through the ceiling, or a combination of both. Either scenario is bearish for real estate and bullish for gold, and could turn the American dream into a nightmare a lot sooner than even most housing bears believe possible.”
Thank you Mike Shedlock, we couldn’t have said it better. Pressed for time right now, we’ll leave it at that with one caveat. The spring-summer 2006 real estate market is going to be the last/best one in some time to come. If you’re holding and living in one home with an ARM, immediately obtain a fixed rate mortgage. If you can’t afford to do that, PLEASE, realize that you’re over extended, and sell your home and rent and wait. If you own multiple homes (you’re an investor even if a second home is a vacation property), the same advice applies. Fixed rate mortgages will be your only protection. If you don't, it clearly shows that you are a Speculator, rather than an Investor.
Specultor's, amateurs, often lose mony. Investors do better.
Investor’s realize the end of home appreciation is over, foremost among many reasons is that over $1 Trillion, 500 Million ($1.5T) of ARMs will reset between now and December 2007. If you continue to own residential investment property during this period of time, then clearly you don’t/won’t believe in the age old concept: buy low and Sell High. High is now. Sell is now. For a final confirmation of our economic/real estate analysis please take note: That antiquated metal, gold, is up nearly 50% in one year over the dollar. We sincerely hope you will take the time to understand what that means for your family’s future.
While merely a REALTOR (we’re not an investment advisor), we strongly recommend that you talk to a certified investment advisor who actually understands why the significant rise in the price of gold is PROOF that the dollar is vastly over-valued, and that entities that are not our friends (notably China) actually control our future destiny because we owe them money. A lot of it. A historically unprecedented amount. Our debt to China, held largely through US Treasury bonds, will require them, actually demand of them that they invest in and actually own our corporations. If Congress doesn’t allow it, they will not continue to take losses by holding US Treasuries, will sell at a loss, and move their excess investment capital into gold (they are doing that right now, which is one major reason gold is so high).
This will force interest rates in the U.S. up, and will destroy, rather than merely flatten the housing market (above all else remember that the ARMs are coming due for reset), and the U.S. domestic economy. The Fed will hold the line until after the November 2006 election. Do you remember, “It’s the economy stupid.” Greenspan was (some say) appropriately blamed for causing Bush Srs. defeat by Bill Clinton. Ben Bernanke is not going to allow that to happen on his watch in his first year on the job.
Else, he’ll be fired in December, 2006. Left with an untenable economic condition, moreover, with an overriding command from politics, he’ll be forced to dither (remain relatively accomodative, not tighten strongly) until after the 2006 election, and then, after the election, Rome Will Burn. That means home values (residential property values) will drop precipitously. The evidence is above, please read it again if you have any doubts.
The ramifications, the implications, are world wide, and can bring an extended World Wide Depression. Can you say: “I got out of housing just in time, thank you Ken.” We sure hope you will say that. If you are still in doubt, give us a call. 415. 897.5345
