California now enters September with no budget in place and a $19 billion budget deficit.  As we edge closer to issuing coveted IOUs, the spin cycle is out in full force.  A report was issued showing that CEOs at the 50 firms that laid off the most workers since the recession started earned an average of $12 million.  I guess the recovery will depend on who you are asking.  Here in California, looking at income data is a good indicator on how the “rest of us” are doing.  The state of California depends heavily on personal income taxes.  Nearly half the state budget revenue comes from this one source alone.  Common sense would tell you that if more people were working, personal income tax collections would be up.  That is not the case.  You would also expect hiring to pick up and this is something California is not seeing either (with a 23 percent underemployment rate).  The definition of recovery has gotten muddled in this deep recession, the deepest since the Great Depression.  Let us look at 10 charts and try to examine what they mean for the future of California.

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Do anything for long enough and people start accepting it as reality.  Just watch any movie from the late 1980s or early 1990s and you start smiling at the “technology” they used and how advanced they thought it was.  For the time it was.  We tend to forget how quickly things can change.  When I talk with people and show them the median price of homes just from the year 2000, they look upon it as if they just saw their first beeper.  The only difference with housing and technology is that housing hasn’t really evolved in the last decade.  On the contrary, technology has gotten better and cheaper as time goes forward.  Housing has gotten more inflated and expensive even at a time when incomes have not.  That is probably the key factor in this housing debacle.  Home prices inflated away while incomes stayed back with the phones of yesteryear.  Manhattan Beach, one of the most expensive areas in the country had a median home price of $590,000 in January of 2001.  The housing correction is now fully in place for high priced California areas.

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A recent report shows that 11 million homeowners with a mortgage are underwater with a deep red line item on their household budget.  Add into the mix those with less than 5 percent equity and we realize that 28 percent of all “homeowners” are either in a negative equity position or teetering close to it.  States like California have negative equity rates of 33 percent thanks to the growth of highly questionable mortgage products.  Yet California looks like a saint when compared to Nevada with an underwater rate of 68 percent!  If we want to examine the core premise of the debate surrounding the bailouts, it is that higher home values by default are good for the economy.  I would argue that having high home values as a mission is misguided if that is the only goal we are seeking (and that is basically what we have been doing for the last few years).  In fact, the majority of Americans would benefit from lower home prices.  A market with higher home values is only beneficial if incomes and the economy move along in synchronization.  Popping the last few balloons of the housing bubble is a good thing for most.  Let us examine five reasons why falling home prices will be a good thing for the economy moving forward.

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You may or may not know that Angelo Mozilo, former president of toxic mortgage superstar Countrywide Financial is fighting against fraud charges brought on by the SEC.  Countrywide based out of Calabasas California was one of the original option ARM specialists.  Option ARMs are absolutely the worst kind of mortgage ever devised and the current trial is merely a tiny glimpse into this shady underworld of mortgage finance.  The fraud charges against Mozilo and others from Countrywide will provide a view of a mortgage product that never had any right to be in the market place.  Keep in mind that billions and billions of dollars of option ARMs are still out there.  Bank of America is now the proud owner of the Countrywide’s option ARM portfolio.  But let us describe a little bit more of what is going on.

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The only people surprised about the massive monthly drop in existing home sales are those that naively believe that housing is a good investment in the current climate.  The large amounts of toxic mortgages that clog the arteries of the economy are still there.  Last week we found out that Southern California home sales plummeted by 21 percent.  A handful of delusional pundits who think that only California is in a bubble must have been stunned that nationwide home sales fell by 27 percent.  Make no mistake, this is a nationwide housing bubble.  Is anyone going to make the absurd argument that housing values in North Dakota are stable and many other low population states so therefore there isn’t a nationwide housing bubble?  The housing bubble primarily inflated because of de-regulation in the financial markets.  That is the bottom line.  This dates back to the early 1980s and guess what happened shortly after that?  The S&L Crisis and a smaller version of the California housing bubble.  So in 1999 when the Gramm-Leach-Biley Act was passed repealing Glass-Steagall, it was no shocker that the housing bubble took off even before the ink was dry.  California is massively overvalued and we’ll take a closer look at certain cities in Southern California and compare their 2000 prices to current 2010 price levels.

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Housing inflation has run at an elevated pace since the 1970s and ramped up starting in the 1990s.  Yet what masked much of the pain was access to easy credit but also the rise of the two income household.  The housing bubble is worse than many expect and probably for the wrong reasons.  Many readers make the wrong assumption that because we are largely a two income household nation that home values had to rise simply because of this transition.  It was a simple 2 plus 2 calculation.  This is wrong and it is more likely that home values grew in the last decade more on the introduction of exotic mortgage products that didn’t rely on income measures.  There is little debate that many cities in California are still in major housing bubbles.  Yet nationwide home values are still overpriced by 25 percent.  Let us examine why.

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As would be expected, home sales in Southern California have collapsed in near synchronization with the ending of tax credits and tighter lending guidelines.  The July sales figures fell on a year over year basis by 21.4 percent.  This is a significant drop in a summer month that usually has solid home sales.  This is the proof that the market is merely being held up by massive government intervention and incredibly expensive tax credits that serve really no purpose except to provide a short term sugar high for the market.  The size of the decline resembles the declines we saw during the inflection point of the bubble bursting.  As you will see in the next chart, home sales always collapse first and then prices follow.  This is how the market reacts to imbalances and many cities in Southern California are still largely in housing bubbles.  The market is essentially saying that home prices are too expensive without government subsidies.  It is also the case that the job market is incredibly weak even after all the bailouts and stimulus that have been injected.  Let us examine the Southern California sales pattern first.

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People in California bubble cities have a hard time imagining a sizeable correction in their market.  Maybe it is due to our nanosecond culture where if something doesn’t happen in one year (or one hour) then it is likely to never happen.  Yet when we look at current market fundamentals in cities like Pasadena or Culver City it is undeniable that some sort of correction will occur over the next few years.  The math simply cannot support the current price structure.  This isn’t just us saying it but is being reflected by the number of distressed properties that rest in these areas.  In other words, people are unable to make their current payments in a large number of cases even in select prime markets.  There seems to be a large cohort of people in California that simply see no correction in these markets.  Keep in mind that the state median price is off by over 40 percent yet somehow, nothing will happen in these areas.  Let us examine the details of Pasadena with a magnifying glass.

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In a sign that things are slow going in the housing market, foreclosure notices jumped nearly 4 percent from June to July.  Over 325,000 housing units received a foreclosure filing in the month of July.  This elevated level demonstrates that the housing market is still far from any sort of reasonable recovery especially with numerous troubled mortgages floating out in bank balance sheets.  Keep in mind this high elevated amount of foreclosure activity comes at a time when the government has stepped up programs to help people with paying their mortgages.  Let us take a look at the last five years of foreclosure activity.

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The Federal Housing Administration (FHA) was created in 1934 during the Great Depression to give low to moderate income Americans a chance at pursuing the American dream of homeownership.  Even in the best of times, the FHA was only a small fraction of the mortgage market as it was never intended to be a big player.  Today the FHA now backs 30 percent of all loans outstanding and is quickly burning through its reserves.  You would think that the FHA would try going back to its core mission of helping those it initially set out to help.  Instead, it is now being used as a backend tool to fund absurd mortgages that don’t fit into any other current government loan programs.

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