This is hard for people to imagine.  Recent annual data from 2008 showed that California added 100,000+ new renters in 2008.  When the 2009 data is released late in 2010 we should expect a similar trend.  2009 saw a record number of notice of defaults filed:

So 2009 was the worst year for California housing if we consider people not paying their mortgage as a significant criteria.  And the above chart is largely responsible for the growing number of shadow inventory.  In a typical foreclosure process, after a notice of default is filed a home will be taken back in 3 to 6 months.  Take for example the 135,000 notice of defaults filed in Q1 of 2009.  With a cure rate of 3 to 5 percent according to recent reports we would expect 128,000+ of these homes to be taken back in Q3 of 2009 by the bank.  How many foreclosures occurred?  50,000. Now this isn’t a new trend or something that is shocking.  In fact, with the HAMP initiative it has become a formalized process.  Yet HAMP has only converted some 4 percent of trial modifications to permanent status (they have extended the deadline to the end of January as if this was going to miraculously boost the numbers).  Plus, we have yet to see drilled down statewide data.  California also has toxic mortgages like option ARMs and Alt-A products that largely do not qualify for HAMP.  Many of the option ARMs recast in 2010.

But let us look at the overall California market:

California has an extremely large renting population.  In 2008 we saw a massive shift of 100,000 additional renters.  This number almost perfectly correlates with the 91,000+ drop of homes with a mortgage.  In 2008 California had almost the same number of renters as homeowners with a mortgage.  It is a safe bet that in 2009 we have more renters than homeowners with a mortgage.  I hesitate to call someone with massive negative equity a homeowner.  Of those with a mortgage, nearly 2 million owe more than what their home is worth.  They are worse off than a renter.

Banks have been playing this absurd game with taxpayer money.  Since the recession started we have seen trillions of banking subsidies and direct bailouts.  Yet here we are with foreclosures still near their peak and the economy still in the dumps:

Matthew Padilla at the O.C. Register has a chart showing the growth of the shadow inventory:

Source:  OC Register

So what are we looking at above?  While foreclosures in Orange County have been steadily dropping loans that are 90+ days late are now at a record high!  In other words, banks have been covering up their eyes and pretending everything is okay.  This is the nonsense that is called a “solution” to the current problem.  If ignoring a serious issue like this is good news then a gambler should keep on gambling even if he is in the hole for millions.  This is the shadow inventory.  We have never been in a situation like this.  It is the height of stupidity to give banks the authority to resolve this mess when they are largely the culprits of bringing down our economy.  With the trillions banks have received we could have paid off every single mortgage in the U.S.  But as you have figured out by now the bailouts were never about helping the public.  The bailouts were to protect the entrenched crony interests of Wall Street.

It is amazing that government policy is only now starting to connect the fact that the employment situation is so dismal and that may be a reason for the continued problems with housing.  I tend to believe that D.C. and Wall Street are now one in the same so they already knew this and sold the bailouts as assistance for the people.  That has been a major sham.  Early reports on HAMP show that the process is laborious and painstaking for those trying to get a modification.  You mean the same people that made $500,000 mortgages with your cat as a co-signer in 24 hours are no longer able to rush through paperwork?  The banks are largely lagging because they already have taxpayer money so what is the big rush?  They can simply go back to gambling on Wall Street while the real economy looks like this:

The California unemployment rate went from 8.7 percent in December of 2008 to 12.3 percent today.  Without a doubt this has something to do with the 90+ days late jumping off the charts.  What use is modifying a mortgage if you have no job?  Yet this has been the tunnel vision policy of our government since December of 2007 and we continue to allow Wall Street to write the path forward.  The PR machine is going heavy that things are now dandy because the stock market is up 60+ percent but the reality is much different.  Foreclosures are still sky high and hiring is still anemic.

Is it any wonder why so many loans are underwater in California?  Maybe the market is trying to say something that prices are still too high given the current economy of the state.  We are going to start the year off with a $21 billion budget deficit.  How is this good for housing but more importantly the economy?  Banks will continue to rip people off and drain taxpayer money because nothing has come in the way of solid reform.  There is a commission that is finally going to look into the causes of this crisis but findings won’t be out until late in 2010!  First, banks and Wall Street are the primary causes of this crisis thanks to their bedfellow the Federal Reserve which serves as a pseudo-government agency to funnel money into the banking and financial sector.  Alan Greenspan dropping rates to 1 percent juiced the housing market completely.  Would people be buying homes if mortgages were 10 percent?  They’d think twice.  Plus, the easy interest free money was more a gift to Wall Street to gamble in the global stock markets.  One argument goes “well people should know better than to borrow $500,000 from a bank.”  Poor bank.  How about we only allow the bank to lend their money and let us see if they still make those loans with zero government backing.  Something tells me lending standards would change overnight.

Are people to blame as well? Absolutely.  But many are paying the price with job losses and foreclosures.  They are taking their knocks.  Yet Wall Street has siphoned off every penny from the taxpayer to ensure that they don’t lose any money in this downturn.  They talk about moral hazard when it comes to the public but when it comes time for their punishment they like to pull the hypocrite card out.

And things are going so good that Fannie Mae and Freddie Mac are having their caps pushed upwards.  Turns out losses are just pouring in.  Do you remember the gall of these people telling us we were somehow going to turn a profit on this?  This was the ultimate sucker play.  If banks had to make mortgages with their own money you can rest assured the interest rate would be somewhere between 8 and 10 percent and they would be limiting who they lend money too (I would assume a more sizeable down payment as well).  But instead, banks with their horrible underwriting standards are actually dishing out government backed loans with artificially low rates.  These are the loans that are now imploding.  Banks don’t give a crap since they don’t hold the note.  So if this is the case, why do we even need the bank?  Why not have the government make the loan directly to the public?  Because banks want to suck every nickel out of your wallet.

So until we get any real reform we can expect to live in a 1984 like world where we hear propaganda that the economy is fine and housing is recovering.  Don’t worry, after all banks were in charge this decade and look how well things went.

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Manias of this magnitude do not happen often.  We have examples in history like Tulip Mania in Holland during the 1600s, the South Sea Bubble, and more recently the technology bubble.  Yet in many previous bubbles the events were largely localized to a group, city, or country at best.  This massive housing bubble went global reaching cities like London, New York, Sydney, Tokyo, Barcelona, and Los Angeles.  The amount of money involved is also historical.

But to predict the future of housing values is now largely thrown into a game of speculation.  And this is a new twist.  It was largely assumed that housing for nearly a century tracked inflation.  Yet during the past decade, because of the mania people started concocting wild stories as to why real estate was appreciating in the double-digits year after year.  The “New Normal” was constant double-digit returns.  An astute reader sent me over the California Association of Realtors’ prediction for 2010.  He also managed to pick up a few of their previous predictions.  I have compiled some of the data on the chart below for easy reference:

The green row is the actual price drop for each year.  The blue row is the CAR forecast for each year.  What the above should tell you is that one massively bad year can wipe out years of steady gains.  In 2006 the CAR forecasted a 10 percent increase and the market went up by 6.5 percent.  Not bad but understated the actual gain.  This is when the median California home was selling for $556,000.  The next year it predicted a price drop of 2 percent but the market nudged out a 0.7 percent gain reaching its annualized peak of $560,000.  Then the market imploded.  The CAR’s forecast for 2008 was a drop of 4 percent when in reality the market lost 38 percent.  This is how off this one year prediction was:

CAR Forecast

$560,000 x 0.04 = A drop of $22,400

Actual Price Drop

$560,000 – $346,400 = $213,600

That is a massive miscalculation.  This is like saying tomorrow is going to be a sunny day but in reality having a category 5 hurricane hitting.  You can have 10 years of sunny days but one massive hurricane will wipe all of those days out.  You would think that people would be more cautious the following year with their predictions.  Let us see how it did the following year:

CAR Forecast

$346,400 x 0.06 = A drop of $20,784

Actual Price Drop

$346,400 – $271,000 = $75,400

That is a sizeable difference in my book.  Given that the median U.S. household income is $50,000 making this kind of prediction error is rather large.  Of course the 2008 forecast was off by nearly $200,000.

Now why is the above important to analyze?  Price is hard to predict because markets are largely unpredictable.  But there is one thing that is certain in bubbles when they pop.  Prices collapse.  California has many wildcard factors like shadow inventory, option ARMs, and failed moratoriums hitting the market in 2010.  What impact will this have on price?  Price predictions in a bubble are nonsense because they follow no logic or economic fundamentals.  Prices will go as high as the speculation and gambling gene will allow people to go.

So what else do we know?  Look at the chart above one more time.  Look at the 30 year fixed rate mortgage.  It was extremely stable even during the peak years.  That is because in California much of the price inflation came from Alt-A and option ARM products.  These items are now gone for the most part and option ARMs are now banned.  FHA insured loans are now taking over the market because of the low 3.5 percent down payment but there seems to be a cap being hit at roughly $300,000.  Why?  Because incomes simply cannot support any higher prices.  Take a look at the 30 year fixed mortgage history:

Now the above chart shows another Black Swan event hitting with mortgage rates touching a 17.5 percent high in 1981.  Did people see this coming in 1977, 78, or 79?  Probably not if they were being honest with you.  Right now people are assuming mortgage rates will stay artificially low just because they have been low for a decade.  But right now the only reason rates are this low is because the Federal Reserve has bought up over $1 trillion in mortgage backed securities.  Can the Fed keep this up?  It can only keep this game going as long as foreigners keep buying up our debt but the U.S. dollar’s wild swings show a major event is bound to happen.  When?  Who really knows but this path is unsupportable.

And now, the high end market is facing major pain.  Take a look at mortgages that are $1 million or above:

12 percent of mortgages with a balance of $1 million or more are now 90 days late.  Last year, this number was 4.7 percent.  If we look at mortgages with a balance of $250,000 or less we find that 6.3 percent are in distress.  Now this is a stunning piece of data.  You would logically think that those with higher mortgages would have lower distress rates simply because they have higher incomes.  But the math at least with monthly cash flows is simple.  Spend less than you earn.  If you bring in $25,000 a month and spend $30,000 you will have problems.  Now if you bought a $2 million home that is now worth $1.25 million, will you continue to pay?  Many of the California option ARMs and Alt-A loans are connected to these high priced properties.

And as you would probably figure out on your own, a loss on a million dollar loan takes a bigger hit than a $100,000 loan:

“(Bloomberg) Luxury home prices probably will drop another 5 percent before reaching a bottom in September 2010, according to Sam Khater, senior economist at First American.

Those declines may lead to losses on jumbo mortgages that dwarf the “haircut,” or discount to full value, that banks take on short sales or foreclosures of moderately priced homes, said Rodriguez, the agent with JM Group in Miami.

“When the bank takes a loss on a $3 million property it’s a lot bigger than the loss on a home with a $150,000 mortgage,” Rodriquez said.”

This market is completely stalled.  Even with FHA insured loans going up to $729,750 that is not enough for some of these million dollar toxic loans.  And why should it even go higher?  The median price nationally is $173,100.  The only reason to increase anything is to allow the upper crust to have another exit hatch (as if they need another one after the massive banking bailouts).

And the economy of California is still in shambles.  The current employment situation is deeply troubling:

This is really where I find it hard to see any major price jumps for California housing.  How can we predict housing gains when unemployment is still near its peak?  Also, we have a $21 billion budget deficit starring at us squarely in the eyes.  What that means is higher taxes or more cuts.  Either way, this will be a drag on the economy.

The fact of the matter is housing prices in California are still too high relative to the actual economy.  Those spiking million dollar loan delinquencies basically means we are moving onto the next phase of this bursting housing bubble.  The mid tier will also take a hit.  But to try to put an actual price is more for entertainment value.  As you can see from previous forecasts use them at your own peril.  The California housing market is as volatile as a chemistry set and 2010 is sure to bring us things that we simply have no way of forecasting.

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Here in California shadow inventory is massive.  It is likely that we have the same amount of inventory in the shadows as we do in the actual public MLS.  The way home values are derived come from recent local area sales.  Bank owned homes sell for much less so banks are holding off inventory trying to allow the artificial supply to juice prices so they can release inventory onto the market later creating a mini bubble.  The only reason banks can even do this is because of the crony banking laws and the fact that they have trillions in taxpayer bailout money.  The irony of course is that it is a win-win for banks.  They can hold off and sell homes at an inflated price with taxpayer money to taxpayers thus taking them for a ride twice.  At a certain point you wonder if the public will keep on taking this since lower priced homes will make more sense in this climate with high unemployment and lower wages.

The good news is the shadow inventory issue has gone mainstream:

Source:  L.A. Times

“A supply of 1.7 million homes headed for sale because of foreclosure or delinquency looms over the nation’s housing market, which could dampen progress toward recovery should the Obama administration fail in its efforts to aid struggling homeowners, researchers said.”

It is also hard to see what lurks in the shadows when banks have effectively issued a foreclosure holiday:

“Some lenders have declared limited foreclosure moratoriums this year to give troubled borrowers time to catch up on their payments or work out other solutions. Those announcements continued Thursday: Mortgage titans Fannie Mae and Freddie Mac said they would suspend foreclosure evictions from Saturday to Jan. 3, and Citigroup Inc. said it would suspend some foreclosures and evictions from today to Jan. 17.”

That is certainly a nice holiday gesture by Fannie Mae and Freddie Mac but what does pausing the foreclosure process do for someone with no job?  And isn’t that really the problem here?  If incomes and our economy were healthy not many would be concerned about housing prices.  The problem is how we’ve dealt with this crisis.  Everything centered on housing because that is where crony Wall Street had placed its massive bets.  We had equity injections into banks.  Then we nationalized Fannie Mae and Freddie Mac.  When that didn’t work, we started with moratoriums.  Basically this was the “allow the scab to dry” fix to the housing market.  That still didn’t stunt the tsunami of foreclosures.  Then banks straight out allowed people to stay in their homes without them making payments.  The government then stepped in and issued the HAMP initiative.  With this, the government basically decided to give people option ARM lite loans for their problems.  And people are still stunned why foreclosures are near their peak:

9 consecutive months with foreclosure filings over 300,000.  Yet somehow the market is healthy.  Well with moratoriums and banks not moving on non-payers of course everything looks good.  This is like credit card companies only reporting data on those paying their bills.

Yet the underlying problem still hasn’t been fixed.  That is, millions of Americans still can’t afford their mortgage payments.  The growing backlog of shadow inventory is merely a reflection of this problem.  Even so-called prime cities don’t appear so prime when you cut into their data.  Today we salute you Culver City with our Real Homes of Genius Award.

Culver City Duplex versus Shadow on Same Block

The interesting thing about shadow inventory is your neighbor might be gearing up for a strategic default and you have no way of knowing it.  You probably don’t care but what you should care about is what a foreclosure sale will do to your own property values.  If there were only a handful of distress sales it wouldn’t factor too much in a large city.  But have a distress inventory the size of the MLS and then you have problems.

The above home is a duplex for sale in Culver City. The property has been listed on the MLS for 270+ days.  This two unit property has two bedrooms and one bath and another one bedroom and one bath unit.  Let us look at the pricing history on this place:

Price Reduced: 06/03/09 — $695,000 to $650,000

Now for someone buying this place, you would need to approach it as an investor.  Let us assume that you wanted to live in one of those units and rent the other.  Let us first run the numbers on your FHA insured loan:

3.5% down payment:     $22,750

This above chart is so incredibly important.  Just because you can technically afford a mortgage doesn’t mean you should get it.  To buy this duplex someone will need to have a gross income of $180,000 and a down payment of $22,000.  But that is only the first step.  FHA insured will work if you occupy one of the units.  Do you think someone making nearly $200,000 wants to live in a 2 bedroom duplex?  Nothing wrong with that of course but you are spending $650,000 here.  In some states you get a helicopter launching pad for that price.

Some obsess with the monthly payment number.  Okay.  Let us look at that as well.  Your monthly outlay comes to $4,200.  Assuming you live in one of the units, how much do you think you can get for the other unit?  Do you think that you can justify a $4,200 a month outlay here?  That works out to $2,100 per unit (give or take for the bigger unit).  Yet this is the kind of amateur logic that is used when valuing real estate.  What if you have a vacancy?  What if the roof needs repairing?  What about upkeep issues?  Your costs keep on increasing.  It is nice to simply run the numbers and assume you will have a full rent check each month but anyone who owns rental property understands this is merely a hopeful dream.  Reality is much different.

So this duplex is on the market for sale for all to see.  But what you don’t see on the same block is part of the shadow inventory:

The duplex is listed as “A” on the map above.  Oh, and after a bit of investigation we find out that the property is next to the freeway.  At least you have easy access.  The shadow inventory bank owned home is a 3 bedroom and 2 baths home.  It is listed at 1,169 square feet.  This home has an interesting history:

At foreclosure this home had $625,500 in loans.  The home fell back on payments and ended up being foreclosed.  What price did the bank take it back?

The initial loan amounts were $625,500 but the bank took it back for $427,500.  That is a 31 percent drop.  But you know what?  Does a falling tree in the forest make a sound?  Apparently not because this price adjustment isn’t factored into the current median price data.

Culver City (90230):         Median Price ($530,000) y-o-y drop of 9.3%

Culver City (90232):         Median Price ($715,000) y-o-y drop of 4.5%

Now don’t you think that if this home was on the market the above data would be different?  The home was taken back by the bank in September.  So it has been a few months.  Why isn’t it back on the market?  Because banks are using your taxpayer dollars to create an artificial market and trickle inventory back into the city.  This is a lose-lose for taxpayers.  How?  Prices are artificially kept in a bubble while banks keep sucking money like financial vampires on taxpayer money so they don’t write down loans that they made at the peak of the market.  Make no mistake, this is their fault.  And if you think about it, they are the only entity not suffering.  Everyone else suffers above.  Why?

-The previous owner got his punishment by losing his home to foreclosure and bad credit.

-The taxpayer gets taken for a ride because they now are funding the banks little experiment of keeping inventory off the market.  Prices artificially go up so a new buyer pays more because of his own bailout!

-The bank wins because they can keep sucking money from the taxpayer while allowing inventory to trickle out into the market one by one and buffer their write-downs.

This model is clearly unsupportable.  Starting next year, a new commission will be looking into the causes of this financial meltdown.  The fact that they are starting the approach in the past tense is completely wrong.  The crisis is still going on.  Banks are largely responsible for this mess.  This form of corporation run government is troubling.  Clearly people can see the sham that is going on with shadow inventory. This is a complete robbery of the American people.  Think of the case above.  If the REO home were to sell at the market rate prices would depress for the block.  Is this so bad?  Doesn’t that mean that a future home buyer would have to take on less debt to buy a home?  Plus, local area incomes do not support current prices.

The phony numbers will keep coming out but 2010 will be a critical year.  Do people demand transparency in shadow numbers or even the Fed balance sheet or do they turn a blind eye and allow our entire financial system to be run as if it were a Bernie Madoff fund?

Today we Salute you Culver City with our Real Homes of Genius Award.

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It is important to note that MLS data comes from listings that are represented by brokers who are both members of the MLS system and NAR.  The list also expands to Canada.  But with the massive amount of foreclosures many banks are dealing with bulk buyers directly.  In Southern California last month 20 percent of all buyers went with all cash.  Each MLS is geared to local markets but again many argue that the MLS forces membership into the real estate circles.  To that I would agree.  That is why companies like Zillow had to fight hard to break into this game.  The Department of Justice did break some of this up in 2008 and many online brokerages now have better access to data.  But how can you track something that isn’t reported?

I would argue that during the bubble access to information actually fueled the mania.  For every one article talking about housing being over priced, you had 10 articles telling you how cheap homes were and how home prices never went down.  And for a decade checking your estimated home price would have justified your own belief.  In today’s market there is an underworld of information that isn’t easily accessible.  Part of this is the shadow inventory.  And this is a real issue as banks have admitted to holding homes off the market.  The one argument against this data point is a narrow focus on REO data.  Yet to get to REO (bank owned) you must go through various other steps.  More on that later but let us first look at Southern California as our case study:

Now I want to spend a bit of time on the above chart.  I pulled data from a variety of sources including the MLS, foreclosure records, and Southern California home sales data.  What you’ll notice with the blue line is that MLS inventory for SoCal has fallen from over 160,000 homes to below 60,000.  This you would think would be because of massive amounts of sales.  If you look at home sales it is the case that this has increased but not anywhere close to the bubble heyday where we were seeing 35,000+ homes sold in a month.  The big drop has more to do with sales occurring in the foreclosure market.

This is interesting because I was looking at homes that weren’t listed on the MLS and was dealing with a bank directly only a few months ago.  This is happening many times over.  You can see on the chart above REOs with the green line.  It might look like this number has fallen drastically but this has more to do with programs like HAMP that are already proving to be inefficient.  What these programs do is simply shift housing inventory into the shadows and hope that prices somehow go up in the next few months or year.  Yet that isn’t working out.

Let us run a case study on a new area.  Let us look at home of toxic mortgage superstar Countrywide Financial, Calabasas:

We find that 215 homes are listed in distress.  The MLS has 228 listings and only shows 30 of these.  In other words 185 properties out of a sample size of 413 are hidden to the public.  This is nearly as big as the actual MLS data.  We see this two world scenario occurring in many places.  In some areas it is even worse.  Let us look at Agoura Hills for example.

The MLS has 140 listings and the shadow data is at:

The neighbor of Calabasas and the same trend is spotted.  In this case, the shadow inventory is larger than the MLS data.  In some cities in Southern California the shadow data is enormous and doesn’t resemble anything that is shown on the MLS.  Let us look at Cerritos for example:

Cerritos has 262 homes listed in distress.  The MLS has 70 homes listed.  Last month Cerritos had 23 home sales.  So you either have:

Public perception:  3 months of inventory

Real data:            14 months of inventory (big difference)

It is hard to quantify shadow inventory because many in the industry are too optimistic regarding bailouts.  Unfortunately the industry was so corrupt and polluted for years in the state that Alt-A and option ARM products are going to be trickling out into the market for years.  The only reason we are not seeing defaults hitting the MLS in mass is because of programs like HAMP and suspension of mark to market.  This doesn’t mean there isn’t any problems of course.  It just means that the issues will take longer and be more painful.

This is something we need to wrestle with.  Do we pull the Band-Aid off quickly and deal with it once and for all or do we allow this to become a massive decade long disaster like Japan experienced? It seems like the bankers and real estate industry would rather prolong the misery for as long as possible.  Because what is the worst case scenario?  The market is flooded and homes sell for market prices.  Banks fail as they should.  But instead, banks become zombies and little by little their toxic balance sheet eats away at the productive sector of the economy.  Just look at how well banks are doing:

Some are going to argue that notice of defaults should not be included in the above.  In most normal markets I would agree.  Yet with only 3 to 4 percent of notice of defaults curing this means much of the inventory will reach market.  Could be in six months or as long as 24 months.  But it will hit because home prices are massively underwater and prices haven’t gone up even close to bubble peaks:

And that boost comes at the cost of:

-FHA insured loans requiring only a 3.5% down payment

-Fed buying mortgage backed securities holding rates artificially low

-Moratorium programs like HAMP

-Banks holding inventory off the public view

Yet at a certain point people realize that the MLS is not a reflection of reality.  It is the ideal dream world scenario.  The fact of the matter is each day hundreds of people are unable to make their housing payments.  You don’t need a crystal ball to make that prediction.  You’ll know things are recovering when the shadow data starts thinning out.  Until then don’t believe everything the MLS is telling you.

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Option ARMs are largely a California problem but also to drill down further, a problem attached to many of the overpriced counties.  Many of the lower priced counties (the bulk of current sales) have washed out a tremendous amount of subprime mortgages.  Yet these financially engineered housing products, the Alt-A and option ARMs, are linked to higher priced homes and carry higher average balances.

To say something is expensive we need to measure it with metrics.  If you were looking at a stock to see if it were expensive, you would look at price to earnings ratios.  In other words, how much are you willing to pay for a certain amount of earnings?  With a home, you can look at local area lease rates but also look at local area household incomes.  Some would like to argue against this metric but these people are usually the folks who say, “well that’s not what I’m seeing.  I’m seeing plenty of people with money” as they stick around their one block radius in Santa Monica.  Yet the bigger picture is vastly more important.  I’ve put together 15 large California counties and gathered 1999 home price data and measured it up to 2009 data.  I’ve also included a price/income category to see how expensive an area is:

This chart should tell you the entire story of what is happening.  In counties like Solano, Riverside, and San Bernardino prices have been slammed yet these areas have seen tremendous amounts of sales.  Why?  The price/income ratio seems to be within a fair level.  Some may argue and say that these areas have always been cheap.  Really?  Riverside County had a median price at the peak of $432,000 (a ratio of 7.4 in 2007 but now it is down to 3.4).  Solano and San Bernardino have price/income metrics of 2.7 and 3.3 respectively.  I have argued for years that a good rule of thumb for housing prices is 3 to 3.5 times your annual gross income.  So in these counties, prices may start making more sense.  So why aren’t more buyers buying?  Because unemployment in these areas is through the roof!  The government and Wall Street would like to ignore income and jobs because this is really the driving force of any economy.  Yet in this past decade our economy has become housing obsessed to the point that we are now dealing with the biggest economic crisis since the Great Depression.

So that covers the lower priced counties.  But what about the more expensive areas?  Ah yes.  This is where the next round is bound to go off.  The most expensive county based on local area household incomes is hands down San Francisco.  With a price/income number of 9.3 there is no justifying the current price.  This area is flooded with Alt-A loans and will have much explaining to do in the next few years.  The next 4 counties are Marin, San Mateo, Los Angeles, and Orange.  These areas will be the next rung on the housing correction.  They all have price/income metrics that are above 5.5.  This is incredibly unhealthy.

Let us graph these 5 counties:

Keep in mind that the nationwide inflation rate over this past decade (1999 to 2009) was roughly 29 percent.  So some of these counties outpaced inflation by leaps and bounds.  Historically housing prices have tracked the inflation rate.  Yet a curious thing also happened this decade and that is income growth hit a wall.  Keeping that 29 percent rate in mind, let us look at the three cheapest priced counties:

I find it fascinating that the areas that have seen the most sales activity are now reverting to the nationwide inflation rate and carried home prices with them.  This only makes sense.  Even as an investor, if you purchase a home to rent out you want to ensure that the local market demographics can ensure some form of cash flow.  Otherwise you are making a bad investment.  In the higher priced markets good luck finding cash flow properties.  People buying in these areas to fix and flip are playing the same card as all the people that got stuck back at the peak of the bubble.  In fact, the metrics tell us these areas are still in major bubbles.

What this data should tell you is that we have much correcting to do in California.  The Alt-A and option ARM wave is coming even though banks and real estate cheerleaders would like to say otherwise.  Take a look at the notice of default wave:

And make no mistake about this, the wave is going to hit and is hitting.  HAMP is a major failure and banks are starting to lose their opportunities to keep these properties off the books with the shadow inventory.  The current yield rate with HAMP for loans to go from trial to permanent modification is 4%.  Since 140,000 or so loans have entered trial mod phases in California, we can expect approximately 5,600 loans to be modified. Great.  We are on pace for 475,000 notice of defaults for 2009.  The moratoriums and can kicking at a certain point will need to stop.  It will start becoming clearer to the public (if it isn’t already) that the Wall Street bailout is merely for the crony Wall Street bankers.  After all, even counties like Riverside and San Bernardino with FHA insured loans are now affordable for many families.  Do you think that San Francisco, L.A., and Orange County will have a helping hand when those mega toxic loans come due for adjustments?

And keep in mind the above ratios take into consideration incomes.  So prices will never be equal simply because of the market trends but they have to reflect local area economies.  Even if we strip out the bubble decade and look at San Francisco, using 1999 household income and median home prices the price/income metric comes in at 5.6.  That is a far cry from the 9.3 number today.  Los Angeles County has a price/income number of 4.7 in 1999 and Orange County had it at 3.9.  In other words, prices need to come down further or incomes need to rise sharply.  With unemployment and underemployment at 23 percent there is little pressure for incomes to rise.  So that leaves one option.

And let us put recent home sales in context.  All you hear about is the massive jump in home sales for 2009.  Yes, it has jumped but as we have discussed it is because of lower priced areas making big moves.  Plus, do people suddenly think that we went from a decade of speculators and charlatans to overnight becoming a disciplined and prudent economy?  In Southern California, 1 out of 4 loans is now FHA insured.  19 percent of November buyers were absentee purchases meaning investors.  In other words, half the market is lower end to investors.  How long can this go on?

Let us look at Southern California’s recent sales in context to bubble year sales:

That jump you see there is thanks to massive bailouts, FHA insured loans, the Fed buying down mortgage backed securities to keep rates low, and the lower end selling like pancakes.  It is all artificial and we are not even close to pre-bubble annual sales figures.

Many counties are clearly overpriced.  If the past is any predictor of the future then there will need to be a correction.  The lower priced counties have already shown the way to increased sales.  Lower prices.  Yet the stubborn mentality of banks and those in mid to upper tier markets will be put to the test in 2010 to 2012.  The data isn’t pretty but what would you expect with toxic uglified mortgages like Alt-A and option ARMs?  When you party hard sometimes you don’t realize the extent of the damage until you sober up.

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