Wisest of the crowds

The National Association of Realtors reported that their “Pending Home Sales Index” for July fell to its lowest level since the post Sept. 11, 2001 period as a result of tightening credit for Jumbo mortgage loans (loans over $417,000).

So what is this index? Directly from the NAR release:

“The Pending Home Sales Index is based on a large national sample, typically representing about 20 percent of transactions for existing-home sales. In developing the model for the index, it was demonstrated that the level of monthly sales-contract activity from 2001 through 2004 parallels the level of closed existing-home sales in the following two months. “

It seems that Three Stooges of the mortgage ecosystem, lenders (Curly), Wall Street mortgage underwriters (Moe), and mortgage buyers (Larry) all woke up after a night of drinking and decided never again (well, at least for a few weeks!) ! These Jumbo loans are NOT purchased by the quasi-government agencies Fannie Mae or Freddie Mac whose job it is to purchase loans from lenders so that lenders have the funds to make more loans - a mechanism to facilitate home ownership for average and lower income home buyers. Jumbo loans do not qualify so they must be either held by lenders or sold to investors via wall street. Since Fannie and Freddie have continued to support loans at the low-end while the high-end has lost free market support, Jumbo’s have shut down for the minority and have gotten MUCH more expensive for the majority. Not surprisingly, the Western part of the US, which has the highest home prices and presumably the most Jumbo loans, got hit hardest being down a whopping 20.8% to 82.3 versus 89.9 nationally.

Will this last? No way. This is a temporary disruption as people reorient their perspective to risk. Will the cost of jumbo’s (as a spread to treasury securities) increase? You can bet on it!

The Washington Post has a hilarious (but real) article discussing the inside of New Century Financial - the sub-prime mess to end all messes that is now bankrupt. I first read about the article at Inman blog, entitled You WILL play ball. Below is a WP sampler:

“The stress in that place was ungodly. It was like selling your soul,” said Hardiman, who worked for New Century in 2004 and 2005. “There was instant notification to everyone as soon as you rejected a loan. And you dreaded doing it because you paid for it. Two guys would come with a bat, and they were all [ticked] off because you cut their deals.”

I have posted several times about the conflicts between the appraisers, lenders, and agents here, here and here. Bottom line is that it may be time for buyers to hire their own appraisers. This doesn’t represent a new expense but rather a disaggregation of a current expense. If a buyer uses cash, rather than having the costs buried in other transaction costs, than the buyers can control quality and appraiser can get on with their jobs with conflicts.

Also, we might consider the conflicts from the lending side as to communicating affordability to consumers. Does it make sense to expect a lender, who is commissioned based on the number of closed transactions, to actually protect the customers side of the equation? I suppose the logic is that its the banks money but in truth, lenders sell loans and loan agents get new jobs. So the buck gets passed, Wall Street just play the odds (and gets a commission), and the financially illiterate get stuck holding the bag. Nothing new from “big business” but certainly NOT something part of the new business models powered by the internet - including ours.

The solutions to these and other vexing consumer problems are being addressed by market forces. Entrepreneurs like us see this problems as opportunities to add value to people by being open and transparent about our businesses. We put people at the center of our model and drive everything to satisfy this focus. Gone will be the days when trapping and or tricking a customer into a piece of business is THE model. Gone will be the oligipoly’s upon which many incumbent industries are based. Power is being pushed down to people and the economics will follow. Selling your soul in sub-prime, or any other industry, is a dinosaur waiting to happen. A lot of other charts will look like the one below over the next few years.

More news from the Commerce Department (pdf) yesterday - the number of homes sitting empty has increased fairly dramatically. Homeowner vacancy increased to 2.8% from 2.1% and rental vacancy increased to 10.1% from 9.5% versus the first quarter of 2006. That means that there are now almost 4 million units for rent, 2.2 million houses for sale and 7.3 millions units vacant for no apparent reason (dead cities?). When looking at homeowner data by area, cities increased 60% to 4% occupancy, Metropolitan Statistical Areas increased 45% to 2.9%, and suburbs increased 33% to 2.4%. Regionally, the South has both the highest rental and homeowner vacancy. The data below:

The Commerce Department released more data and analysis confirming what we know - that housing is dragging the economy. The economy grew just 1.3% (preliminarily) for the first quarter of 2007. From the press release:

The increase in real GDP in the first quarter primarily reflected positive contributions from personal consumption expenditures (PCE) and state and local government spending that were partly offset by negative contributions from residential fixed investment, private inventory investment, and federal government spending.

Here is a chart of GDP going back a few years:

As you can see, things haven’t been this bad since Q1 2003. The markets largely shrugged this off but home builders took it on the chin:

Most of the big names down around 3% but the index as a whole finished down just 1.52%

Looking for a great buy-rent analysis tool? Go no further the the New York Times. My friend Kevin Boer blogged about it here, and I have to further endorse this product. Very cool Ajax interface and has all the things you need to understand the issues. Warning! Do not accept their base assumptions, some of which are in “Advanced Settings”, “General”. The main value to a tool like this is playing with different assumptions so that you can understand the real drivers. I have inputted some assumptions below based on a friends analysis of spending $6,850 to rent a house that might ordinarily cost him $2 million in San Francisco (yes, these are real numbers…it is that expensive here!).

Three Key Assumptions:

- Housing Value increase 4% per annum

- Rent increases 2% per annum (San Francisco is largely rent controlled)

- Investment returns of 6.5%

You can see there is no scenario that allows one to buy versus rent. So what does it take to get the buy-rent math to justify buying? Well if you increase housing prices to 5% increases per year then you get a break-even point of 7 years and if you increase it to 6% then you get a break-even point of 3 years. Although I held investment returns constant at 6.5%, prices increases for housing coincide with general returns in assets so realistically I should probably be increasing investment returns with any increase in house price appreciation . Why is this relationship so important? Because when you have money tied up in your house, that money is no longer available to invest. If you are a crappy investor no problem. If you know your way around, this makes the math even more difficult. So if I increase investment returns to match my original assumptions of 4% appreciation and 6.5% investment returns (2.5% spread), then the following buy-rent trade-off emerges:

So buying is better after 5 years but the gets worse at year 15. Why? Compounding. It seems the real issue is what is the relationship between housing returns and investment returns…something I will blog about in the future.

What was my recommendation to my friend? Rent and look for a distressed seller.

Local Resources:

San Francisco Assessor-Recorder

City of San Francisco Rent Board

My post yesterday entitled “Dead Cat Bounce Revealed” was further confirmed today when the Commerce Department released their March 2007 data (PDF) for New Home Sales that showed a slight increase nationally over last month but terrible data versus a year earlier. Inman covered it here. Here are the facts:

- Nationally, the new home sales increase 2.7% versus February but down 23.5% versus same month last year
- The Northeast is the only bright spot, showing an astounding 50% increase versus February and 18.0% versus March 2006. Note: the Northeast accounts for only 8.4% of the national sales transaction as of the latest data.
- The West is the worst performing region and was down 0.9% versus February 2007 and down 29.6% versus March 2006 . The West accounts for 25.2% of National activity.

- Months of supply decreased to 7.8 months from 8.1 months

- There was no discernable shift in price point composition.

By the way, the dead cat bounce reference is one used by pro’s in the financial markets to describe how a bear market rally bounces similarly to how a dead cat bounces off of the pavement (hint: modestly). Tasteless, but there it is!