“(LA Times) Los Angeles Controller Wendy Greuel on Monday said she expects the city’s general fund “will be out of money” by May 5 and that L.A. will likely deplete its reserve funds and be in the red by June 30.

Greuel alerted Mayor Antonio Villaraigosa and the City Council of the city’s dire financial situation after the head of the Department of Water and Power stated he would oppose sending $73.5 million in utility revenue to the city treasury. Interim General Manager S. David Freeman said the council’s vote to block a proposed electricity rate hike last week threatens to put the utility in a deficit.

Greuel urged the council and mayor to immediately tap the city’s reserve funds so that city has enough cash to cover payroll.

“This is the most urgent fiscal crisis that the city has faced in recent history, and it is imperative that you act now. That is why I am asking you to immediately transfer $90 million from the city’s reserve fund to the general fund so I can continue to pay the city’s bills, and to ensure the fiscal solvency of the city,” Greuel said.”

Now when Vallejo went into bankruptcy, many commentators were stating that this was an isolated event.  But what isn’t isolated is the implosion of tax revenues, the lifeblood of state government.  I went ahead and updated the below chart with the latest data:

The above has led to a California state budget disaster.  I spent time over the weekend reading about various issues in the current economy.  One issue that is probably going to hit many from left field is the municipal debt markets.  Unlike the federal government states (and certainly cities) don’t have the liberty of using the Federal Reserve and U.S. Treasury to print their problems away.  Many states including California are required through their constitution to balance their budget.  The above chart with collapsing tax revenues does not help in reaching the goal of balance especially when expenses are still surpassing revenues.  The equation is simple; you either cut further or you raise taxes.

And those pension fund liabilities are coming due as well:

“(LA Times) The state of California’s real unfunded pension debt clocks in at more than $500 billion, nearly eight times greater than officially reported.

That’s the finding from a study released Monday by Stanford University’s public policy program, confirming a recent report with similar, stunning findings from Northwestern University and the University of Chicago.

To put that number in perspective, it’s almost seven times greater than all the outstanding voter-approved state general obligation bonds in California.

Why should Californians care? Because this year’s unfunded pension liability is next year’s budget cut to important programs. For a glimpse of California’s budgetary future, look no further than the $5.5 billion diverted this year from higher education, transit, parks and other programs in order to pay just a tiny bit toward current unfunded pension and healthcare promises. That figure is set to triple within 10 years and — absent reform — to continue to grow, crowding out funding for many programs vital to the overwhelming majority of Californians.”

And all this ties into more pressure for the housing market.  Heck, the housing market is a footnote with some of these bigger issues on the horizon.  Let us however focus on the housing market with this as our backdrop.

California Housing Years of Problems

The first and obvious problem is our 12.5 percent unemployment rate (underemployment over 23 percent).  What this means is we have a smaller pool of qualified buyers and sellers out in the market.  We already know that one-third of all mortgage holders in California are underwater.  So the market has some serious issues.  But let us look at the overall MLS data.  First, Southern California:

Then we add in Northern California:

Through this search we find 90,540 homes on the MLS.  But I wanted to expand the search:

With a wider search we find 115,000 properties (this includes condos).  So let us say that California has 120,000 to 125,000 homes listed on the MLS for public view just to be conservative.  Now this certainly doesn’t seem like a large number for a state with some 38 million people.  In any given time, (this will come off as captain obvious) you should not have more distress property than healthy property on the market.  Right now, the shadow inventory dwarfs the MLS data:

In total California has over 273,000 foreclosure filings (i.e., notice of defaults, scheduled auctions, and bank owned homes).  Keep in mind that the MLS reflects a large percentage of this.  When I was tracking this data carefully for SoCal it was roughly one-third of MLS data.  So in reality, California may actually have 75,000 to 100,000 healthy homes on the market and 273,000 distressed homes.  We have never been in a position like this so to say we are seeing signs of a healthy market are nonsense.  Many are making a bet that things can’t get worse in some markets.  Yet we’ve never had this much distress property so there is no historical tale to give us a hint as to how things will play out.

People do quick math as well on these things.  They say that California last month sold 28,000 homes; of this 44 percent (12,320) were foreclosure resales.  At that rate we’ll burn through the distress inventory in:

273,000 / 12,230 = 22 months

This assumes that foreclosure filings freeze in time today.  Well with option ARMs and other junk entering their judgment period, this number will increase.  Plus, people tend to forget that life actually goes on.  People retire, marry, divorce, have kids, and leave for jobs and this is part of the normal market in typical times.  People ask me what is a good metric to use to figure out when we reach a more normal market.  First, we should look at notice of default filings:

Source:  Calculated Risk, my edits added

2009 was the worst year on record.  Over a 14 year period in more “normal times” (aka no option ARMs, interest only, and other craptastic mortgages) the average number of default notices filed was 100,000.  But keep in mind, that in these times foreclosures were low as well because many loans “cured.”  Take for example Q4 of 2009:

NODs:   84,000

Trustees Deeds Recorded:          51,000

But run these numbers for another time and you’ll see how out of whack things are today:

Q3 2001

NODs:                   18,673  (4 times less than Q4 of 2009)

Trustees Deeds Recorded:          5,104 (10 times less than Q4 of 2009)

Keep your eye on that NOD figure:

Step one in seeing a recovery in housing?  Getting that NOD number back at a rate of 100,000 per year.  But this isn’t some pie in the sky economic theory.  When NODs get filed (if they even get filed if banks aren’t sitting around doing absolutely nothing) this is a reflection of someone struggling.  This is someone that hasn’t paid their mortgage for at least three months.  I’ve had people e-mail me telling me they have yet to get a NOD after 12 months of no payment!  It seems recently things have streamlined but make no mistake, NODs are a reflection of actual economic pain.  So this has to fall before any recovery talk.

The next indicator?  Tax revenues.  Since California taxes everything (i.e., sales, property, income, corporations) we have actually a fairly good read on the pulse of the state.  If you look above at the first chart, tax revenues are still at the low of this contraction.  Until this improves, no recovery.  And make no mistake, that warning from that L.A. Controller will likely mean higher taxes or less services.  That is the only way to balance.  I’ve talked with a few investors renting property in lower priced areas and they are “shocked” how slow city services are to respond.  Just wait until they have an issue with a tenant.  California is not a landlord friendly state.

Until that time, I’m cautious about any recovery talk especially for the state.  I’m now seeing more mainstream articles talking about the second wave tsunami.  Some of this is coming from an increase in short sales and from banks gearing up the crap that was built up after HAMP failed because it didn’t address the obvious.  Of course it failed.  This is what happens when you spend two years ignoring the main nucleus of the crisis, jobs.  In fact, we are so deep in the rabbit hole that Citi is now offering a $500 temporary mortgage payment for the unemployed!  What the hell is this?  What about renters that are unemployed?  Apparently they don’t count just like the 273,000 properties in shadow inventory that supposedly don’t exist.

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So here we are, nearing a close to the 2009 year and California is still in a difficult position economically.  The unemployment rate is the highest on record and the government is bleeding money since revenues have evaporated.  The access to easy loans is now gone but people can still get lenient terms with FHA insured loans.

My prognosis for California in 2010 is a continuation of a weak employment environment, continuing fiscal deficits, and a popular election that will focus on the economy.  The housing market will continue to remain weak but we will see more price cuts appearing in mid to upper priced neighborhoods.  Let us go through the 10 reasons why the California economy and housing market will face another challenging year in 2010.

Reason #1 – Budget Deficit

There is probably no better indicator of the health of the current economy then current revenues into state coffers.  The state of California has high income, sales, and capital gains taxes that go up in boom times and tank in recessions.  This recession has caused shock and awe to those in Sacramento.  In the last go around the state had to patch up some $60 billion in budget deficits.  People took a deep sigh of relief but the reality is, we are facing another $21 billion budget deficit next year.  The above data highlights this problem.

And it isn’t next year alone.  The Legislative Analysis Office projects $20 billion annual budget deficit up all the way through 2015.  This is going to be a drag on the economy without a doubt.  How did we patch up the last gap?  Big cuts and taxes.  That is the only way to balance a state budget.  Hard choices will need to be made next year yet again.  Whatever the choice happens to be Californians are going to have less money in their pockets.

Reason #2 – Unemployment

I find it troubling that with all the talk of housing programs, tax incentives, cheap mortgage rates, and other subsidies that the most important driver of housing is missing.  Jobs.  The vast majority of Americans pay their mortgage with income they earn from a job.  This is so obvious yet the lack of attention here shows how out of touch Wall Street and banks are from average Americans.  Unemployed Californians are less likely to buy a home.  They are also less likely to buy big ticket items.

One aspect of the California economy that is rarely examined is how closely housing was tied to many big revenue industries.  Finance, construction, retail, and other aspects of real estate industries provided numerous high paying jobs.  Those are gone and probably for good.  The state benefitted from these jobs in higher revenues but now that is gone.  It is a double whammy.  We have yet to see a concentrated growth of good paying jobs in the state (to the contrary, we are still losing jobs).

Reason #3 – Underemployment

In California the headline unemployment rate is at 12.5 percent, the highest since records started being kept.  Yet if we include the underemployment rate we reach an astonishing rate of 23 percent.  How in the world is this good for housing?  Until we see a stabilization in this data point talking about booming housing is absurd.  Housing at a certain point needs to connect with the real economy.

The underemployment problem is at the highest we have ever seen.  Like Japan that has nearly one-third of its workforce on part-time employment, we are starting to see shifts in our economy that may become permanent.  With the high cost of healthcare and other non-wage costs for employers, it may be easier for employers to simply higher consultants or temporary workers and circumvent the need to provide adequate wages to employees.  But that leaves many contenting with high insurances costs and using more of their shrinking salary to pay for costs that are simply going up.

It is hard to see this trend changing.  We have allowed our manufacturing base to simply disappear over the past three decades.  The biggest input cost in manufacturing is labor and it is hard to see how the U.S. can compete with low cost producers overseas.  People have a penchant now for cheap goods.  It is a deal with the devil in many ways.  If we want cheap goods as a country we have to be willing to accept that more and more jobs will be leaving this country.  If this is unacceptable, then we must be prepared to pay more for goods as many Americans are tightening up their budgets.  Both choices are painful.

Reason #4 – Lack of Alt-A and Option ARMs

Source:  T2 Partners

When I hear about arguments about the triumphant return of housing values I simply look at the above chart and realize that it is mathematically impossible.  Since the government is now the lender of first, second, and last resort at least they are verifying income even with FHA insured loans.  Yet the chart above showed how absurd lending standards got and were exploited especially here in California.  This was the fuel that flamed the housing price bubble.

Yet the major source of housing appreciation in the state is now gone.  The leverage to lift the world has been removed.  With Alt-A and option ARM products buyers were able to get 10 and even 15 times leverage to purchase a home.  Countless people making $50,000 a year went no doc and bought $500,000 homes.  The $500,000 home in California was the median home back at the peak.  Without this leverage, prices can only go up so high when they do start going up.  Real incomes are unable to support current prices in many places.  The $250,000 median price only reflects the large volume of sales in the lower end.  Next year we will see more price reductions at the mid tier as prices reflect the current economy and lack of maximum leverage products.

Reasons #5 – Option ARM Recasts

The bulk of option ARMs have yet to hit recast dates.  60 percent of current outstanding option ARMs find their home in California.  This is largely a one state problem.  Florida, Nevada, and Arizona have the remaining large share of the loans but no state comes close to matching California.  The problem with these loans are many are in the mid tier markets.  The subprime debacle has already washed away much of the lower end of the market.  Borrowers had less of a buffer in those areas.

Yet the option ARM does a good job hiding problems for a long time.  The teaser payment can last for a few years and once that first recast hits, it is game over.  Currently, 40 percent of all option ARMs are already 60 days late and we have yet to hit the major recast points.  Once these homes start selling at lower prices comps will also take a hit.

Reason #6 – HAMP Failure and Growing Foreclosures

Another argument from the housing bulls was how banks were going to use programs like HAMP to stop the foreclosure mess.  All it did was stall the inevitable.  Last week data on HAMP came out and showed an utter disappointment.  Only 4 percent of all current trial mods have entered into a permanent stage.  California with 148,000 of the trial mods probably saw somewhere around 6,000 permanent modifications.  6,000 modifications at a time the state is seeing over 450,000 notice of defaults being filed in 2009.

Why is HAMP a failure?  Because the offer to borrowers is basically converting them into long-term renters.  Many in California bought as speculators although they won’t say this.  They used products like option ARMs because they were never planning on staying at any home longer than a few years.  Now they are stuck with a product they don’t want.  Banks like Wells Fargo are trying to convert option ARMs into interest only loans for six to 10 years but how much good this will do is yet to be seen.  One thing is clear however and that is HAMP is a failure.

With the failure, we can rest assured that many additional foreclosures are going to hit the market as banks are no longer able to keep homes off the books.  People forget that a home with no payment or lack of payment is costing the bank money.  And at a certain point, reality needs to be confronted.  HAMP started with speed in May and here we are in December with no success.

Reason #7 – Housing Still Overpriced

Home prices in many areas are largely overpriced.  They simply do not justify local economies.  But in areas like the Inland Empire where homes are selling for $100,000 to $150,000 local incomes can now justify current prices.  These areas may have household incomes of $40,000 to $60,000 and this can support the current price even with a government backed loan.

But places like Pasadena and Culver City for example, still have the housing bubble delusion that kept prices inflated for the past few years. Take for example Culver City.  The median home price is $620,000 yet the median household income is $82,000.  There is simply no justification for the current price.  Take even a household making $150,000 and the current price is still much too high.  It is likely that we will see price corrections in these areas in 2010.  We will probably see 10 to 15 percent price drops by the end of the year in the median price.

As a state California income is not off the chart as you can see above.  Even the current median price of $250,000 is too high given income data.  If we simply erase the bubble decade, prices should be near $200,000 to $225,000.

Reason #8 – Allure of Real Estate Tarnished

There was a time, say before 2007, when saying that the best investment you can ever make was buying your home.  Those days are long gone.  Tired, repetitive, and catchy mantras regarding real estate have slowly disappeared.  Buying a home is the biggest purchase for most Americans.  This decision shouldn’t be taken lightly.  But it was.  It was taken for granted that home prices would never fall.  The opposite actually occurred.  Not only were home prices expected to rise they were expected to rise significantly.  Many started depending on home equity lines and home equity loans as new sources of income to make up for stagnant wages.

Yet housing prices can go down and go down significantly.  It is clear that many more people are now exercising more due diligence when they buy a home:

The price drop nationwide has been painful but the price drop in California has been epic.  And just because sales have increased does not mean home prices are going up.  It seems like exhaustion is occurring with first time buyers and investors thinning out of the market.  Even talking with successful real estate investors many are now cautious in jumping into this highly unstable market.

The happy day psychology is now gone.  This consumer behavior added to the mania and this is also largely gone.  Take away the no doc maximum leverage loans and add in massive price drops and people start hesitating when they buy a home.

Reason #9 – Too Much Debt

“Dec. 9 (Bloomberg) — U.S. homeowners have lost about $5.9 trillion in value since the housing market’s peak in March 2006 as mounting foreclosures and the recession weighed on prices, according to Zillow.com.

Almost half a trillion dollars was wiped out this year through November as housing headed for a third straight annual decline. New foreclosures and higher mortgage rates in 2010 may hinder a rebound, the property data service said today in a statement.”

Homeowners are too leveraged.  Here’s the problem.  Housing values have fallen by nearly $6 trillion yet the mortgage doesn’t adjust with the market.  Say you bought at the peak for $600,000 and the home is now worth $300,000.  You went in with a zero down loan.  Your home can only fetch $300,000 yet banks claim your home is worth $600,000 and they expect you to pay at that level.  It isn’t like the mortgage adjusts to this new reality.  That is why if you pull up mortgage debt it moved very slightly during this correction:

Notice how little the above dipped?  The way the system is fixing this discrepancy is buy foreclosures, bankruptcies, and defaults.  This is how the average American is forced to deal with this pain.  The crony Wall Street bankers have even poorer balance sheets yet they have unlimited access to the best government money can buy so they operate under different rules.

Reason #10 – Shadow Inventory

Finally, shadow inventory is another big factor in the market.  With HAMP being a failure and banks trying their own mods that will also fail, many of these homes will be hitting the market in 2010.  Sure there was a buffer in 2009 but how long can this go on?  If the economy doesn’t improve a bank can modify all it want but with no income, the home is gone.  You need a healthy economy to have a healthy housing market.  This should be no stunner but banks think they can hide inventory off the market by not moving on non-payers or playing games with HAMP and other temporary stalling tactics but eventually things will need to change.

Many banks with California loans are praying for massive inflation.  They are hoping that eventually wages will speed up and suddenly a $500,000 shack won’t seem expensive.  Yet what is happening with banks is that they are hoarding the money so no money is entering the real economy to cause any sort of inflation.  To the contrary, with access to credit being stifled we are seeing signs of dis-inflation.  Clearly prices collapsing in home values isn’t a sign of price inflation.

Shadow inventory can be hidden for only so long.  This is another variable that will be a factor in 2010.

Conclusion

It is hard to see how the housing market recovers in 2010 in California.  My old prediction that home values may see a trough in 2011 seems like a reasonable estimate.  Given the recast patterns and budget deficits, times will be tough in the state.  Trying to keep home values inflated is merely delaying the inevitable reality.

There is even an interesting micro trend that foreclosure may provide a mini stimulus.  For example, take someone struggling to make a big $4,000 mortgage.  They suddenly decide to strategically default and rent a place for $2,000.  They now have $2,000 more a month to spend in the economy.  We have seen some weird things like this occur in this bubble.

Overall I would be cautious about buying a home in 2010.  We still don’t know how the state is going to patch up the $21 billion deficit and we have yet to see any employment trends show marked improvement.  Until these things hit, the best course of action might be to sit tight.

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It is disturbing that there is a significant school of economic thought out there that somehow jobs do not matter.  This line of reasoning is baffling.  In many ways, this is similar to the collective deep capture that occurred during the housing bubble that somehow prices were justified even in the face of rampant fraud and mass delusion.  They don’t call it mania for nothing.  Take for example the wonderfully unstable budget of the biggest state of our country, California.

Only last week, State Controller John Chiang announced that the state is falling behind $1.1 billion in receipts from a budget only enacted three months ago.  Keep in mind the estimates made only a few months ago were conservative by California standards yet somehow money isn’t coming in.  This is occurring at the same time that the state has hiked taxes and is also front loading tax collections earlier.  To the obvious person on the street, you cannot tax someone without a job.  Well, that isn’t necessarily true because you can tax them on items they buy (in some counties like L.A. that rate is near 10 percent).

We are now 21 months into this recession.  Job growth is no where on the horizon.  It would appear that people are waiting for some ambiguous industry to emerge out of the ashes like some financial Phoenix.  Will it be the green sector of our economy?  Yet even in that optimistic scenario, does that sector have enough to make up for the 8 million jobs lost in this recession and the growing demands from a larger work force?  If we examine eras like the 1920s in Florida and their real estate bubble, prices did not come back for years.  So if you factor in the 1920s coupled with the Great Depression of the 1930s, things didn’t turn around for nearly two decades.  California and Florida are coming off unsustainable highs.  What does this mean?  Let us go back to the State Controller report.  What that translates to in the real economy is less money coming in to the government.  And that means either more tax hikes or more spending cuts.

Let us take a look at a sign of economic vitality.  U.S. Exports:

Source:  Federal Reserve

Does that chart look like a recovery to you?  Keep in mind the above chart factors in every imaginable bailout and trillions funneled into the financial sector.  Yet exports haven’t moved.  Before we can talk about housing rebounding and moving upwards shouldn’t we talk about the real economy first?

In this article we are going to examine 10 charts from housing to auto sales that show not much has changed at the core of the economy.

Chart 1 – Auto Sales

As it turns out, cash for clunkers was merely a way to frontload auto sales.  After seeing a spike in August sales the September number fell back to the year long trend.  As one colleague told me, we helped stimulate the foreign auto maker market since most of the cars bought were non-domestic in brand.  Talk about a horrible strategy.  Given that we now own GM and Chrysler making the U.S. government auto CEO, why would you want to reward your competitor?  Seems like our politicians don’t think things through because a one month boost came with an expensive price tag.

And is this even the right way to go?  Again, non-domestic auto makers make up a big part of our economy even though many provide jobs outside the U.S.  I’m all for open trade.  But why is the American taxpayer subsidizing this?  As we had speculated back when the cash for clunkers program was announced, this was a big gimmick like Hope Now and other policies that have yielded poor results in action.

Chart 2 – Housing Starts

This chart should tell you the big story regarding home building.  Sure, single family building is up a bit but wouldn’t you expect that with trillions being funneled into this industry?  But look at the chart closely.  Notice the multiple housing starts?  Still at record lows.  Why?  Because the market is saturated with inventory!  So trying to spur more building when we are seeing some 300,000 distress actions on homes hitting the market each month just doesn’t make sense.  If anything, it will prolong this housing slump.

Housing starts have fallen so hard that we have to go back to the Great Depression to find another similar trend.  It would seem that those calling bottom somehow believe that we are heading back to those 2005 and 2006 points.  We are not.  In their mind, everything is boom and bust.  No middle ground is allowed.  Let us assume we are back on normal ground.  Then what?  Why rush to buy a home now?  If we are back on normal footing then housing should reflect employment conditions.  After all, most Americans pay their mortgage from wages.  So until employment and wages move up, there is little rush to purchase a home right now and later charts will highlight why.

Chart 3 – Single Family Home Sales

The stabilization with home sales is largely due to the big amount of distress sales going for rock bottom prices.  Couple this with the Federal Reserve buying agency debt and keeping mortgage rates at historical lows and home buying conditions seem prime.  Add fuel to the flame with an extremely expensive $8,000 tax credit and sales go up.  It is simple.  Just like cash for clunkers.  Yet what happens when you remove that tax credit?  Cash for clunkers gives us a crude look at what will happen.

And look at new home sales.  They are off their lows but nothing remotely close to their peak days.  So this chart ties in with the previous chart because all the action is in the existing home market.  No need to build homes when people are buying and selling already made homes.  So much for those construction jobs.

Chart 4 – 30 Year Mortgage Rates

If you look at the chart above you can thank the Federal Reserve and U.S. Treasury.  What you don’t see is the parallel destruction of the U.S. dollar for these cheap mortgage rates.  There is no free lunch.  Mortgage rates are near historical lows.  Rates hovering at 5 percent don’t even mesh with historical standards.  Over the past 40 years the average 30 year fixed rate has averaged 9 percent.  That is, if we even revert to the mean rates will double meaning the amount people pay on a monthly basis will explode.
With Alt-A and option ARM loans not even eligible for these rates, how does this help distressed owners?  It doesn’t.  The market is artificially being juiced with trillions of dollars and at some point, something has to give.  The Fed is betting the economy will miraculously find some other bubble (i.e., technology, real estate, ?) and will expand again.  Yet we may be out of bubbles for the short term.

Chart 5 – Personal Savings Rate

Americans started saving at a pace not seen in decades.  Yet the cash for clunkers program and the home buying tax credit once again got people out and buying.  But is this sustainable?  It is too early to tell.  The recent dip is because of these last two programs.  The next phase will be the holiday shopping season.  Many retailers depend on the November and December months for a large chunk of sales.  We will soon find out how tapped out the average American is.  Last year, people went out shopping like crazy even though economic indicators were equally poor.

Yet over this year, credit card companies have been yanking lines in light of higher default rates.  Without the plastic, will Americans shop till they drop this Christmas?

Chart 6 – Hours Worked

The work week has gotten shorter.  So short, that it is the lowest it has been in record keeping history dating back to the 1960s.  The average American work week is now down to 33 hours.  Keep in mind this is for the employed.  If we look at the under utilization rate (includes fully unemployed and those working part-time for economic reasons) the U-6 rate is up to 17 percent.  The above chart reflects those but also those who supposedly have full-time jobs.

What is occurring is overtime is being cut and furloughs are being implemented like the 200,000 state workers of California that are now earning less.  Earning less means less money to spend.  The state is learning this lesson quickly.  Jobs absolutely matter.  The problem is Wall Street has captured our political process and convinced many that if Wall Street is happy, somehow little crumbs will trickle over onto Main Street and all will be well.  So far, politicians have given everything the bankers have requested and nothing has changed on the streets of America.  How is TARP working out?

Chart 7 – Household Debt Burden

Even as debt is being destroyed through foreclosures and bankruptcies, many households are still in record amounts of debt.  Why?  Because losing jobs and less pay reflect a new reality even though the system is washing out old obligations.  Debt is not wealth as many are now realizing.

This above chart may show why the American consumer is reluctant to go out and spend without getting massive incentives like cash for clunkers and home buying tax credits.  Are we now going to give Americans a $1,000 holiday shopping voucher?  Some in the retail sector have asked for similar goodies.  Make no mistake that the crony bankers will ask for anything to fluff their own profits.

Chart 8 – Household Debt Service

Now the above is a fascinating chart.  What we see is a trend of less financial obligations for renting households.  Rents have been falling across the country.  This only makes sense since people are earning less.  However, the financial debt obligation of homeowners is still near peak levels.  Same amount of debt on a home that has seen equity evaporate.

Many people are now unable to qualify to buy a home and that is okay.  We need to remember that during the bubble anyone with the desire to own was given that opportunity.  Alt-A and option ARM products were the mortgage of choice for many.  We are dealing with the repercussions of those decisions even today.  In fact, we have yet to deal with them since 2010 to 2012 will bring many of these home loans to roost.

Chart 9 – S&P 500 Double Bubble

The above is perfect chart of the double bubble we have experienced in the last decade.  It is interesting to see the recent trend as if a triple bubble is in store.  The market is trending as if we will have a V shaped recovery.  As we have seen with all the data above, if anything the cliff diving has stopped but this does not equate to a booming recovery.  We are betting on another bubble even in light of no job growth and also trillions in bad loans coming due soon including commercial real estate.
The market price/earnings ratio is still high.  It believes that 2010 will somehow bring back a 2005 year.  But digging beyond the debt, 2005 wasn’t a stellar year.  The only reason it looked stellar was the mania in housing and absurd financial sector profits.  The financial sector profits are back with taxpayer money but the boom in construction is nowhere to be found.  Unemployment is also officially nearing 10 percent.
Chart 10 – Health Care Employment

Maybe the next bubble is in healthcare?  This chart tells you the story of an aging population that doesn’t make much anymore since it has outsourced a gigantic portion of its manufacturing base.  Many younger workers are looking at boomers who lived up the 1960s and 70s, got serious in the 1980s and 90s and now are expected to shoulder the burden of their entitlements all the while understanding that they will not have those benefits when they retire.  If anything, just look at the ages of those on Wall Street.  The young brokers were merely fodder in the recent downturn as we saw these young Gordon Gekkos walking out of places like Lehman Brothers brown box in hand with desk goodies and a sad look on their face.  Yet their bosses made out with millions in bonuses.  So much for company loyalty.

Healthcare costs are growing and so is this part of our economy.  With many boomers retiring in the next few years, an inordinate amount of stress will be put on our system.  Younger generations are not having gigantic families anymore.  So there are fewer people paying into the system for an enormous size of our population who will now start collecting.  Social Security is minimal with average payments around $1,000 to $1,300 a month.

Yet younger workers are looking at this and also seeing these workers with pensions of $4,000 to $6,000 per month (and higher) and are now told to put their money into the 401k casino and hope it makes out because Social Security will be a shell for them when their time comes.  Many have lost thousands in this recent crash that was the deepest since the Great Depression.

I doubt healthcare will be the next boom.  This is a cost to our economy that is only set to go higher as people retire.  What is the boom going to be in?  Viagra?  With annual sales of over a billion, maybe this is the boost the economy needs.  I mean is this what it now boils down to?  We need to get back to making things.  The economy for much too long depended on youngsters in front of Bloomberg terminals punching in keys and trading billions of dollars as if it were the new version of Halo.  Then the “real economy” was largely based on everyone dressed up in a suit pretending they were the next HGTV flip this house expert and trading homes like baseball cards.  It was so easy.  Paper pushing and house flipping.  Heck, at least in the technology bubble we were left with some great companies.  What are we left with after this housing boom?  Gigantic McMansions for families that don’t even plan on having that many kids.
Until jobs start showing up, any talk of a rebounding housing market is moot especially with this entire artificial stimulus still bouncing around the economy.  And collapsing tax revenues are not a good sign.  I don’t buy the jobless recovery argument and the government tends to agree.  If all is well, why is the U.S. government and Fed buying $1.25 trillion in agency debt to lower mortgage rates, putting in place an $8,000 tax credit, boosting car sales with gimmicks, encouraging risky low money down loans with FHA insured products, and extending unemployment insurance to a record 92 weeks in states like California?  Do these things sounds like policies of a booming economy?

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One issue rarely talked about is how the weak dollar is going to impact foreigners buying real estate.  For the most part, I’m not sure how much of an impact this will have on residential real estate.  With commercial real estate we may see a good amount of buying if the dollar continues to get pounded.  Yet it is important to look at what currencies make up the U.S. dollar index:

Source:  Akmos

By far the largest weighted currency is the Euro.  Yet many of the countries within the basket that make up the U.S. dollar index are facing their own demons.  That is why I am hesitant to think the dollar will simply fly off a cliff while every other currency goes up and foreigners suddenly get an urge to buy up every Real Home of Genius on every corner of America.

What is fascinating is how connected the U.S. dollar and stock market have become.  I was unable to find charts that overlay the S&P 500 and the U.S. dollar index so I matched them up to give you a clear perspective of what is occurring:

As the chart above highlights, the dollar had been falling hard for all of 2007.  When the market peaked late in 2007, both the dollar and stock market fell in the U.S.  This was the brief period of decoupling or belief in this misguided notion.  This lasted until the dollar bottomed out at 70 in early 2008.  But after that, the world re-coupled and the U.S. dollar soared up until the March 2009 stock market low.  For this period, the stock market was tanking but the U.S dollar was going up.  To twist your mind further, since the March low the stock market has moved lockstep in opposite directions from the dollar.  It is a near perfect match!

Unfortunately the U.S. Treasury and Federal Reserve are doing everything they can to damage the dollar.  In fact, the only reason real estate isn’t correcting faster is because of the artificial money being pumped into the system.  Forget about jobs (26 million Americans are unemployed or underemployed).  Ignore manufacturing:

Right now the market is one giant easy money casino.  In fact, saving money is now on par to stuffing it into your mattress.  For example, let me tell you about U.S. Saving I-Bonds.  I’ve bought a few of these in the past as additional diversification to my investment portfolio.  The idea with I-bonds is they will keep up with inflation and pay a fixed rate.  Well over time, that fixed rate has slowly disappeared:

Okay, well at least we have the compounded inflation rate right?

That’s right!  The CPI had deflation.  So for the first time ever the I-bonds are now paying the awesome rate of 0.00%.  Bwahahaha!  The U.S. Treasury issues these products.  If they really wanted Americans to save they could up the fixed rate.  Instead, they cut the amount of these you can buy to $5,000 a year from the previous $30,000 a year and then make the rate so unattractive that putting money in your shoes seems like a wise investment move.  Get the hint?  They don’t want you to save.  They want you to blow every penny you have on cars, homes, and every other consumer hamster gimmick you can think of.  Only problem, the consumer hamster is reaching retirement and is loaded up with Prozac and Red Bull and is about to collapse.

I would show you the big bank savings rate but suffice it to say they are offering basically 0 percent.  However, banks are now making good dough on the difference between what they borrow and what they lend even with historically low mortgage rates:

Thanks to the trillions in taxpayer subsidies, banks are able to borrow for virtually zero and lend out at much higher rates.  So any rate above zero is a gain.  And since banks can now be picky regarding customers, they are experiencing some crazy yields.  If you want an idea why banks made enormous profits this decade just look at the Fed funds rate.  Yet this is now all coming at a cost.  The U.S. dollar has lost over 40 percent of its value since 2002.  How this will play out in housing will be interesting to see.
The U.S. Treasury and Federal Reserve seem to want an outcome that does the following:

a.  Slowly devalues the dollar

b.  Encourages home buying and selling putting a floor on prices

c.  Reviving the financial and real estate industries

d.  Back to happy days

I doubt that is going to happen.  So much focus has been devoted for 21 months since the recession started on the banking industry bailouts that I think the Fed and U.S. government have forgotten that you need good paying jobs to make a sustainable economy.  It is interesting to follow the rhetoric of Fed officials about pulling stimulus out of the market.  They claim success but for who?  Sure banks and their profits are back up but has the economy fundamentally corrected?  It just shows you how out of touch they are with those on the ground.

With commercial real estate and Alt-A and option ARMs coming on stage in 2010 in a big way, I still think we haven’t seen the end of this recession.  Technically we may be out of it already but that is because of the massive stimulus juice.  We are assured a double-dip with the trillions in bad debt still on the books.  If you travel the country you will find some strip malls that are simply empty.  Some newly build CRE has never been occupied.  Will it ever?  Those loses are still coming forward.

One of the many unintended consequences of the U.S. Treasury and Federal Reserve is falling rents created by the $8,000 tax credit, rising unemployment, and problems with CRE.  For example, many failed condo conversion projects are simply going back to being apartments thus adding inventory to the already saturated market.  Also, many people are consolidating households to make ends meet.  Given that owner’s equivalent of rent is the biggest component in the CPI, we may see additional pressure on the downside here.  In other words, the needed inflation won’t show up in the data.  Let us watch this closely because the reporting agencies might try to play fast and loose with the data here.

With lower rents there is less incentive to buy in today’s market.  You need to remember that over 40 years of data shows us an average 30 year mortgage rate of 9 percent or nearly twice as high as the current rate.  You might be able to buy that home at the low rate with massive tax credits but what happens when you sell in 3, 5, or 7 years?  You think the Fed can keep rates this low with the coming baby boomers drawing like crazy on Social Security, Medicare, and other entitlements?  Just saying, but zero percent seems awfully low for all that risk.

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California has now reached Great Depression unemployment levels.  Many are now calling the end of the recession but there is no sign that California is inching closer to prosperity.  Last month the unemployment rate shot up to a post-World War II high of 12.2 percent.  This is only the official headline number.  The unemployment and underemployment rate is up to 23 percent putting California into its own mini depression.  The great housing bubble is still beating down on the state economy.  Alt-A and option ARM products are staring us squarely in the eyes for 2010.  Many of the banks and lenders were probably assuming that somehow by this point in the cycle that the economy in California would be bottoming out.  It is not.  What this means is housing will take another leg down.

When will California see peak housing prices again?  According to Moody’s, not until 2030:

If that is the case you probably shouldn’t hold your breath on going back to the bubble halcyon days.  Let us first look at the unemployment rate:

The only data that we have for California is the official headline number.  However, we are also able to access U-6 data from the BLS for previous quarters to arrive at our current U-6 figure.  Officially 2,248,000 Californians are out of work completely.  That is where the 12.2 percent figure is derived from.  But how many are working part-time for economic reasons?

Source:  OC Register

Add these two groups together and you will find that 3,603,000 California are either fully unemployed or are working part-time for economic reasons.  These are levels reminiscent of the Great Depression.  If you factor in those who are discouraged and have left the work force it is readily easy to see why the U-6 figure would be at 23 percent.  Yet those in the housing industry are quick to say this is a housing bottom.  This notion is simply misguided.  They are focusing completely on the buying and selling side of the equation.  What many fail to understand is that much of the bubble was also related to the selling, flipping, manufacturing, and finance side of real estate.  Those industries are still bleeding jobs:

This makes perfect sense.  If 50 percent of homes being sold in the last year are foreclosure resales in the state, these are homes that are already built and chances are will only turn out one transaction.  Meaning?  These are one and done sales.  In more normal markets you will typically see someone sell a home and then, purchase another.  Each sale in effect created two transactions.  That does not occur with first time buyers and investors who have been lured into the market with gimmicks like the $8,000 tax credit.

Take a look at this chart showing new permits and construction employment:

We are now working the years of bubble excess out of the market.  California is still seeing record amounts of foreclosure activity.  So even though sales got a temporary boost, employment in these sectors is still at a bottom.  And keep in mind that we have hundreds of thousands of mortgages in the Alt-A and option ARM category that will go bad from 2010 to 2012.

If you want to look even closer, let us look at jobs in the financial sector:

The trend is very clear here.  We are losing jobs in sectors directly linked to housing.  Many times, these were the same people buying the mid to upper tier market homes.  So you are losing customers as the months roll along.

And we are already seeing some gas running out of the California buying spree.  Here is recent California sales data:

July 2009 Sales:            45,079

August 2009 Sales:       39,811

This includes resale homes and condos.  This is a drop of 11.7 percent.  This is incredible especially the amount of homes being sold at lower prices.  But again, you are selling homes in a state that is in a financial depression.  And for perspective on those sales figures, the August peak was reached in 2005 with sales at a stunning 73,285.  The average August sales figure for the state going back to 1988 is 49,467.  So even with a 50 percent price drop in the state, the $8,000 tax credit, and real estate pundits cheerleading home sales the market still can’t make a 21 year average.  Now we enter the fall and winter selling seasons that are slower and exhaustion is creeping into the markets. Add the Alt-A and option ARMs into the mix for 2010 and you can understand why we are starring at a second leg down.  For last month, the median price dropped to $249,000 but keep in mind, when you see many of those mid to upper tier markets taking hits you might see the median price creep up even though prices are falling.

But a simple thing anyone should understand is that anyone that is unemployed or underemployed is not in the mood to buy a home.  The state is borrowing money from the Federal government to pay out unemployment insurance since it has gone broke in its fund:

And if you think this trend is reversing, it isn’t.  A senior job fair in Irvine pulled in 700 people.  The parking lot was over filled.

“(OC Register) Seniors seeking jobs increased 40 percent this year, the Pew Research Center reports. Sixty-eight percent of research participants said they work because they want to, and job satisfaction was cited even when jobs were “dumbed-downed”.

But that leaves 32 percent of seniors who work because they have to. Sandie Monnier, 62, said she has been out of work for more than a year and her unemployment benefits expire soon.

“I will probably work until I am 70,” she said. “I’ve lost my 401-k.”

While the Census Bureau’s poverty rate for seniors was revised this week from 10 percent to nearly 18 percent, Pew’s data say adults 65 and over have already downsized their lifestyles and are dealing with the recession better than any other age group.

Peter Chiarle, a general contractor, says he’s doing all right since his construction company closed it doors. But he is not ready to retire.

“I’ve built thousands of homes and worked my way up through the trades. Plumbing, electrical, you name it. But I’m not finding jobs that require construction skills,” Chiarle said.”

This is impacting all age groups.  So the Pollyanna talk from the housing and financial industry is unwarranted.  The only reason we are seeing minor moves up is due to the U.S. Treasury and Federal Reserve juicing up the market with easy credit and every other imaginable gimmick.  Let us run down a brief list:

-HOPE Now

-Stimulus Bill (~$700 billion)

-Tax Rebate #1 (~$168 billion)

-  TARP (~$700 billion)

-  Banking Bailouts and Backstops (~$12 trillion)

-  Cash for clunkers (~$3 billion)

-  Home tax credit (~$15 billion)

Yet unemployment is at record levels and foreclosures are still sky high.  If you haven’t caught on after two years, the pretext of the bailouts was to help the American public especially the homeowner but all this money was laundered into bailing out the crony Wall Street financial industry.

So as California is experiencing its own depression we have a group of people trying to sucker people back into buying homes.  The rhetoric seems eerily familiar to the bubble days.  “If you don’t buy you’ll be priced out!” or “you’ll miss the next move up!” and people jump on this.  Many are going to be shocked as 2010 rolls around.  Anyone can logically understand that an economy with depression like unemployment is not a good place for a housing market.

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