bostonbubble.com

[john p]

My recent thinking surrounds the overall financial market. Just like realtors typically get a fixed percentage of the price of the house for a sale, financial institutions often get percentages for "assets under management". Just as Realtors like to see inflated house prices because they can get inflated commissions, I wonder if the financial institutions enjoyed the inflated values of equities because it expanded their compensation.

I remember in High School, I took a business class. The professor was a bit odd and said things like "Those funeral home directors, they're making money hand over fist". Anyway, this was going back to the mid 80's and he said General Motors didn't make money selling cars last year, they made money on "financing". What the hell was financing, I thought... Anyway, when you think about it, if they got 8.5 percent in interest on top of the money for the sale, that's pretty good. That percentage certainly outpaced inflation. So then what did we see, we saw some cars selling for a high price with very low interest rates. They realized that they could either get you to pay too much principal or too much interest. People who trade their cars every two years have different strategies than those that like to hold on to them.

Right now you have to see things like stocks are worth like 65 percent of what they were last year. 35 percent represents money that evaporated, sitting on the sidelines, or in other investment forms like treasuries (which is one reason why we have low mortgage rates). House prices in Massachusetts have not dropped that much this year. Could we see a delayed reaction? I saw the refinancing ARM reset bubble coming, I don't underwrite banks balance sheets so I had no idea that that amount could sink banks. I had no order of magnitude and sense of scale for the issue relative to a banks financial structural stability. I assumed that they were run by the best and brightest from Ivy League Schools so they wouldn't be that stupid, but they were. Once I saw the bank meltdown, I could see the layoffs coming. Once the layoffs came consumers stopped spending. Once we elected a populist, I saw the bailout/handout mentality coming. It is so surreal now to see Democrats pushing tax cuts for the wealthy. Obama seems to be backing off his whole WPA infrastructure stuff, which I imagined he would. People are sitting on the sidelines with this whole ultra low mortgage rate scam which may or may not ever happen.

Here's the point, forget the house for a second. On the one hand we always seem to look at banks want to trade today's money for tommorrows money, so we look at inflation premiums. Look at it this way, the banks want our money, as much of it that they can get. Typically we pay for starters up to 36% of our gross income on our mortgage and over time that percentage gets smaller. As people refinance, they often never see that percentage get smaller because they yank out money. The banks want as much of our earning potential as possible because they can control behavior. They can lower rates, create inflation etc. What they didn't bank on was how irresponsible people would be. My wife told me that she saw some lady on Oprah who told her husband that she had 80k in credit card debt. The banks thought that people would fear being bankrupt and be restrained by respect to their obligations to pay back what they borrowed. People just said screw, if you're going to make it so expensive to live here that I have to take some exotic loan to get a house, I'll sign the paper and if I can't pay, come and try to get me off my Homer Simpson chair. I think the banks could have gotten their Pendleton goons or collection agents to put a cattle prod to these types, but when Mom and Pop Smith were forced to refinance to pay for Blake's tuition at Boston University and Pop Smith got laid off because his job went to India, those casualties started piling up and the parasites started to kill the host. I think in the Clinton years we felt invincible. The babyboom was in their peak earning years and they hadn't yet started retiring.

So with all this stimulus they're talking about, and the massive debt and dillution of the US Dollar, why do we have low mortgages? Don't mortgage rates tie to inflation risk? Could it be perhaps because all this money on the sidelines that doesn't want to drop 35% like last year and would rather take the less of a risk in the young professionals with decent jobs who sucessfully lowballed on a house. I mean your credibility right now pays because money wants to find a home with responsible people. The problem is that many responsible people aren't interested right now.

Lastly, think about who's really in pain right now. If you're young and you don't have a nest egg, 2008 was a great year for you. The stocks your going to buy in your 401k's are going to be cheaper, that house you wanted to buy is now cheaper, that mortgage rate is lower, there is more supply of homes for you to look at.

As far as an order of magnitude perspective, we have to look at how many homes actually sold in 2005. what would you guess, one house in every 100? So, it is really only one in one hundred that bought that premium of the peak. To everyone else, that is a benchmark if they happned to sell that year, but make no mistake, not everyone could have all put their houses on the market that year. The ultra low interest rates made one in one hundred actual house sale transactions lever tens of other refinances. So, as yourself, for every actual house sale in 2005, how many refinances did we have? That little advantage the sellers had in the buyers to sellers ratio levered a huge credit wave. People were buying their homes from themselves at premium prices when they refinanced.

I've been having a hard time sleeping so my mind's active but it's turning off now. My last thought is is the specific heat, the amount of economic heat required to melt stocks much lower than say houses, in certain regions of the country? When banks lend out to companies, they underwrite the company to make sure they are qualified for a loan. If the company is in a strong market, it makes the loan less risky. What is interesting to see is that mortgages and banking tend to stay in this monolithic mortgage risk assessment. When you have California versus say some other area of the country that may have stayed level, should these areas have the same mortgage rate? I mean when the price to earnings ratio is significantly higher in one region of the country isn't it more risky? I don't understand why in this stimulus we are wasting resources putting water on areas where there is no fire. I think they need to look at this more regionally as it is clear that certain areas heat up and cool down quicker than others. Its like we put spray on fireproofing over steel. Concrete by itself is its own fireproofing typically. We don't need to put fireproofing over concrete typically. This bailout, we're spraying fireproofing over everthing.

As far as government overspending. They need to offer early retirement to babyboomers. They also need to take a certain position like say a janitor and say that the pension cap for that job can not exceed say $35k. This way, most janitors that got paid $50k will get their fair pension, but the politician's cousin who makes $100k can't get an $80k pension. When we made the deal with the retirement pensions it was based on the assumption that these jobs were going to be based on a certain relationship to the median salary of the State. For instance if the median salary is say $50k, and you have janitors making $80k, they are making more than the median salary and when we made the pension agreements they made substantially less than the median income of the State. We need to address problems locally while not penalizing the janitor or teacher that wasn't politically connected and worked an honest day for an honest wage.

[Boston ITer]

Well John, it still appears that you're putting a huge burden on the govt to resolve some social engineering debacles of the past.

How about something more radical?... let the govt have only one social responsibility and that is to pay social security. As long as they can pony up that $1-2K per month per retiree then everyone has an exit strategy whether or not it's living with a comfortable IRA at home { or anywhere else for that matter }, an RV in Northern Maine, or a tiny apartment in Nicaragua (ala low rent Hemingway ex-pat).

And then, if the govt is interested in America's R&D competitiveness, which it needs to be if they want the US to be a 2nd world nation (notice, I'd given up on 1st world-isms), then it needs to focus on getting authentic, non-Pork barrel R&D initiatives up and running. The problem with R&D is that throughout the 90s, science budgets were being cut across the board with MBA-thinking free marketeers shouting that the markets could do research and then the universities started to get in on the whole show business thing and that's how the nano-hype began. A lot of R&D programs started to look like Hollywood film projects for Michael Crichton wannabes. In place of the so-called market, the govt needs to really make research funding and subsequent projects a true National Security issue much like the Manhattan Project under General Grove. Then, we can really turn coal into synfuel, do quantum computing, new materials, etc. Eventually, these discoveries will be commercialized as they always were in the past.

And as far as the markets go, let them do what they do... raise capital, invest in startups, speculate on futures/options,etc. Some financiers will get rich, others will be broke. Yes, it's important to let some go broke. The fact of the matter is that the market was always there. Where the Chicago Business school types fall short is that they have a case of unconscious J Edgar Hooverism. They see communists insurgents in govt but instead, they should see that big money buys big influence in govt. If we simply accept the idea that markets are natural and will always exists, provided you keep Stalin (& friends) out of office & running the armies, then there's no real need to think about it or have academicians spend years in defending it. People have been getting rich &/o poor, either trading &/o engaging in commerce, for centuries before we were born. Today, we just need to strengthen the SEC & others { to keep the Ponzi types in check }, fully support SIPC { and even extend it } while allowing investment banks to fold when their executives fail to maintain adequate nonvolatile assets.

[john p]

http://www.heritage.org/Research/Budget/bg1831.cfm

Great article on the impacts of government spending.

[john p]

http://mwhodges.home.att.net/state_local.htm

Great article showing the scope of government spending (wages) and the growing percentage of public sector workers.

[john p]

Great article from 1915 regarding public versus private pay. Obviously, the New York Times has changed quite a bit.

http://query.nytimes.com/mem/archive-free/pdf?_r=1&res=9B0CE0DD1238E633A25751C2A9649C946496D6CF

[ped]

Interesting site
I find ironic so many people following the same herd mentality on the downside that got us into the problem initially - wishing Boston housing to be cheaper is fun but not necessarily valid. As Tom Keane said in a Globe magazine article a while ago - 'our high prices reflect desirability' So we are not Buffalo or Detroit.
The Globe never gets it right -- -every month they take the (useless) Warren median data and write that prices declined 18% last month when it was a yearly number.
Case Shiller is the only good source of data....
I work in commercial real estate -- and there is little discussion about the relative paucity of supply ( in good locations) and the compelling demographics. For several years no homes have been built-- and we will see no more more apartments built for many years. Rents iin 2010 and onward will be climbing -- materially --
The interim census data is useless -- I have watched the route 93 traffic in medford materially climb over the last 5 years -- guess what -- that came from more people
I am pleased this site seems to encourage good research --cause the general press is terrible on this issue. As Benjamin was told -- one word -- demographics....

[balor123]

High prices can reflect desirability but around here I don't think that's the case. These are the factors: necessity, politically guided limited supply, access to credit, ignorant buyers, expectation of increasing wages, and cheap credit. The last is probably the most significant. At 8% people won't be paying $600k for houses unless their incomes rise dramatically. A better reflection of the desirability of Boston is how the population changes and by that metric people don't really like the state anymore.

[john p]

My house zillows at more than $100k less than I paid; yikes! The flip side is I still get the MLS listings for my range and based on the array of houses and their current price structure, I'm still ok.

I did like this place:

http://www.realtor.com/realestateandhomes-detail/27-Rosewood-Dr_Kingston_MA_02364_1107485885

When I drove by, I wasn't super thrilled abou the lot so I didn't feel as bad.

However, although I'm hanging tough with the price point to some degree (I don't know how much off asking things are going for) but I would have gotten about a 5% rate for cost of capital as opposed to the 6.5 I got in 2006.

The current discount in the cost of capital would have brought me up to this price point:

http://www.realtor.com/realestateandhomes-detail/Kingston_MA_02364_1107239789

[balor123]

If I lived in that house, could afford it, and it went down a bit, I wouldn't care one bit. If you're house is like that, then you should be very happy Though I would prefer no pool in the backyard.

The problem I have is that $550k is a stretch and if I'm going to be stretching I want more than a house like 15 Parker Rd Newton, MA.

[john p]

In this instance, I'm assuming I could get/haggle the $675k place for $625k at a 5% note.


The $550k place at 6.5% is relative to the $625k place today with a 5% rate.

I'm trying to point out that I should have waited. Although on the whole, my place is in the same price point, the savings in mortgage rates give me another $75k of house price. The delta is to some degree straight line, but the real bonus lies in the notion that every once in a while you get some amazing place very well priced. These places don't usually last very long in a normal market but you see more of them today. The bonus is in selection.

I think Newton is an awesome place. I lived in Waltham and used to head over to Newton quite a bit. Although it is nice to be close to Boston and have a really quiet and peaceful place with a great school system, you pay for it. Moreover, the Pike going east is jammed in the morning and Newton is mostly busses right? They have that green line if you live over by there. I think Newton has its act together, limited amount of nonsense over there...

So that $550k place in Newton, what do you think that will go for? I'd bet it would go for $515k and you could get a 5% note. Those types of places could be "tired" and maybe could use a new kitchen or bathroom or roof, etc. If you get a place that is pretty updated and ready to go, that would be a great place to camp out for ten years or so. If you only have one or two kids it might be just right for the long haul.

[JCK]

[john p]

Tell me about it.... I am absolutely swamped at work so I had the wife work the phones a little on it.

The intial trouble we faced was our Loan to Value ratio given that they say our place is worth significantly less.

What bothers me is that they are not putting the novacane on the toothache. Although I don't expect a bailout, if they are going to offer one, shouldn't it be for people that played by the rules and were victims of circumstances.

This statement goes against my constitution because nobody put a gun to my head and told me to buy. I took my risk and I am happy to deal with my decision. It is just a bit unfair when someone who bought prior to the bubble can refinance and enjoy the low rate even though they weren't damaged in any way by the bubble; I guess that's my point. Further, although first time buyers deserve some relief, they are not going to suffer as much as the first time buyers in the prior 5 years, given the cards they were dealt.

So summing it up, if you bought before the bubble, you get a bailout in refinancing, if you bought during the bubble and you can't afford your place, you get a bailout, and if you never bought a house during the bubble you get a bailout. The families that got the direct hit just have to deal. It's like someone got shot and the EMT's are rushing to help the people that didnt' get hurt in the first place. I guess my position is I'm not asking for a bailout and we should not to give a bailout to anyone.

The softer side in me says some people stuck in ARMS did get a rogue hit with adjustments because of the debasement of the US Dollar in the middle part of 08 (remember when gasoline prices went up, that coincided with a lot of resets tied to LIBOR). My remedy to this would have been to offer a 40 year note to these folks so it wouldn't hurt those that didn't do ARMS.

Further, the softer side of me thinks that it is good for first time buyers to get an incentive because they are absorbing some risk and we want them to take that risk to help this market bottom more gradually. Believe me, I want this market to get back to sustainable levels, but I want it to come down like an elevator ride and not like a falling watermelon that goes splat when it hits.

There is a voice in my head that says toughen up, be a pure capitalist, you should have seen this coming. The basis of this position is to have had the foresight to take accurate measure of the greed and stupidity of bank owners, politicians in the Senate and House of Rep's i.e. Barney Frank, mortgage brokers, home buyers, etc. Think about how the economy wasn't the primary issue in the election until like September of 08. Not many saw this coming to this degree, I mean people saw the stress but not many people had the balance sheets of these banks and saw the real weight of these assets.

Before you chastise anyone that bought keep this one thing in mind: The United States Government guaranteed many of these subprime loans, so if they were morons, you're saying that the general public chose leaders that were entirely wrong with the assessment of the subprime loss potential. That guy who e-mailed Barney Frank ought to forward that communication beause as Frank put it, he said that he can now have some measure to determine who was right, and Frank was wrong. Further, if you can get past that our elected leaders guaranteed these poor loans, how can you blame investors for investing in something that the US Government guaranteed?

Essentially if you fault anyone who bought in the recent few years, you're basically saying that they underestimated the wrecklessness and stupidity of politicians and Ivy League Bankers. That being said, there was enough evidence to guard yourself in the prior few years as there were enough charts and graphs to depict the complete overvaluation of homes. I wrote off some degree of this to the expanded money supply as although we know water boils at 100 degrees, if the FED throws salt in the water, it deforms the solution and we're not talking water, we're talking salt water and that has a different boiling point.

Guys, please filter out the ego in my writing and sift through to the potentially meaningful insight or blindness....

[JCK]

john p. Agree with you 100%. I think allowing people to refi like you (and people who are stuck with ARMs) would do a lot more good than harm.

For me, I see that the rates have gone down, but the cost to refi has gone way up. Condos now require 75% LTV, or you get hit with additional points on the closing costs. Makes the refi a lot less attractive (or, rather, unattractive).

You might want to shop around though. I think there are places that will 90 or even 95% LTV, as long as you're credit is good, but like with the condo situation, you probably have to pay some points to get a higher LTV loan. You'd have to run the numbers to see if the savings are there (or, rather, how long it would take to realize those savings). But a 1.5% rate savings is pretty big, and may be worth paying some cash (or adding to your loan size) to make it happen.

There are some good web calculators out there than can give you your break-even times on a refi, which I've found very helpful. Check out www.decisionaide.com

[john p]

Thanks so much for the help.

The other thing is that who knows what's up Obama's and Geitner's sleeve? So many people aren't sure what they're offering. I mean there is no bound that restrains them so what if I pay the closing costs now and they just decide to give out some candy in a few months.

Basically, people that played by the rules don't know what to do now because the rules have changed. I've heard rumors that the government might take action to lower mortgage rates. I admit it, sometimes when I'm busy and don't have time to research stuff, I keep stuff in the back of my mind that is baseless. That is part of politics, to raise concerns, suspicions or hopes knowing that people don't make the time to do your homework. I'm usually better than that, but it hurts my brain to try to sort this out 24/7 because there is no discipline or fundamental basis that I'm finding ties this all together.

Is it true that if you run a credit check that it hurts your credit rating? I'm told that if you do it frequently in a period it raises concerns for lenders as it might imply that your under financial stress. I think we had them run it in December when we found out about the LTV issue. This is another rumor I'm not sure of...

I think what I need is a couple of local comperables that I can benchmark against that would help in my valuation...

Thank you again.

[JCK]