We also have issues on the supply side.  During the peak days of the bubble housing starts were running at a stunningly high rate of 2 million per year.  This at a time when household formation was closer to 1.2 million.  So this enormous imbalance occurred.  The current stall in housing starts is simply allowing the overall market to catch up.  That is one of the big questions regarding when housing will recover.  When will housing starts pick up?  Today we are going to look at 5 major trends that will keep housing prices low for the next few years.

Reason #1 – Household Formation

Source:  The Urban Land Institute

The Urban Land Institute put out an interesting paper in January examining the future of housing.  One of the main trends they found revolves around younger generations living in urban centers.  In fact, on their survey they found that many would accept a smaller living space in order to be closer to work, friends, and entertainment venues.  Another important factor they highlight is those from 25 to 34, a peak household formation range, have seen wages fall in real terms by 12 percent for men and 3 percent for women.  What this translates for housing is less money for housing.

Another big problem keeping households from forming in the current market is the high unemployment rate.  Many of these people are doubling up, moving back home, or simply taking on cheaper rental housing.  Once the employment market picks up we can see a pent up demand for housing slowly pick up but that is why we keep discussing that without solid employment growth, there is little reason to believe home prices will suddenly move up.

The unemployment rate for those from 20 to 24 is 15.8 percent and for those 25 to 34 it is 9.9 percent.  Both of these rates are higher than the current headline rate of 9.7 percent.  Until job prospects improve, the demand for more expensive housing will remain muted.

Reason #2 – Overbuilding and Housing Starts

The above chart shows the massive overbuilding that occurred during the housing bubble.  With housing formation steady the rate is closer to 1.2 million but we were building closer to 2 million.  Now, this has translated into a massive glut of housing.  So the housing start rate plummeted in 2007 as we worked our way through too much demand.  In addition, we added a large number of new homebuyers that were never qualified to own a home to begin with.  This is the group that took out subprime or option ARM loans on homes that clearly were unsupported by their incomes.  As we now know, most of these loans are now gone so now millions that once were “qualified” to buy are out of that buyer pool.  So demand is also falling because people don’t qualify with tighter loan standards.

If we look at the housing start side of the equation, builders clearly realize that the demand side is still weak for new construction:

Although housing starts are up from their depressed levels, they are nowhere near a healthy market level.  We still have inventory that we need to work through before builders start growing at a pace of even 1 million.

Reason #3 – Single Family Home Sales

If you examine the above chart carefully, you’ll notice that up until 2007 both existing and new home sales tracked very closely.  For example, close to 5 million existing homes were selling on a seasonally adjusted rate while roughly 1 million newly built homes were selling from 1999 to 2002.  Then even in the over building days both of these tracked together.  The disconnection has started in 2009 where existing home sales have perked up while newly built home sales are still near the bottom.  Why?  The reason has to do with the amount of distress sales.  The big driving factor in home sales is home price.  In a price conscious market people are gravitating to foreclosure re-sales and short sales where prices are lower to meet with the new economics of households.

Newer homes that carry a bigger price tag have seen demand simply disappear.  In areas even like California, areas that have lower home prices like the Inland Empire have seen sales pick up briskly but prices remain low.  Those areas that still have higher prices have seen sales completely stall.

Reason #4 – Home Prices

Source:  Calculated Risk

If you look at the above chart, the top eight areas with depressed home prices are California, Nevada, Florida, and Arizona.  The one exception is Detroit but this area has seen low prices trending even before this current housing collapse.  One recent stat shows that 70 percent of mortgage holders in Nevada are underwater.  In California that number is 35 percent.  So with these kinds of market indicators it is very likely that in these states prices will continue to trend lower.  Throw in the high unemployment rate in these regions and you can understand why it is so important to get jobs growing in this country again.

Ultimately prices have to reach a level where local households can afford the mortgage.  This crisis has gone on long enough where younger households, hit by a double whammy of low wages and higher home prices have seen older generations now lose their home or struggle simply to pay on a mortgage so big that nearly all disposable income is eaten by the mortgage.  The idea that real estate is “always a good investment” is now gone for a generation.  That is why in recent surveys many are looking to live in city urban centers as opposed to suburban tract homes.  This is another reason why home prices will remain low for a good portion of time.  I just don’t see a massive flood of the household formation generation heading out and purchasing homes in suburbs like baby boomers did.  They will buy but nowhere close to what baby boomers did.

Reason #5 – Homeownership Rates

Buying a home is an opportunity that should be given to those that have demonstrated some ability to save and pay their mortgage.  That is why down payments were so important.  A 10 percent down payment at least demonstrates that you can save for a few months or years for a big purchase.  This is how it was for generations.  But with no money down loans and easy financing those who should have never bought were allowed to buy to feed the Wall Street beast hungry for any mortgages to securitize.  Now, the only game in town is government backed loans.  And as we saw on Friday, Fannie Mae lost in 2009 over $70 billion.  I just keep recalling the day when we were told that these GSEs were going to turn a profit.  Yeah right.

But we have bigger issues.  The FHA with FHA insured loans is allowing people to buy homes with only 3.5 percent down.  It actually is lower because people can use the tax credit in combination and make this close to a nothing down purchase.  Is it any surprise that FHA default rates are now at historic levels?  Homeownership is not a right but a privilege we have.  This is no different from buying a luxury car.  I’m sure many of us would trade in our current vehicles for a Ferrari if we could but that isn’t how the market works.  But when you allow everyone access to mortgage debt they cannot support it shouldn’t be a surprise that people took on too much debt.  The above chart shows that consumption part of the equation.

But now the homeownership rate is falling as millions lose their homes to foreclosure.  Many more will lose their homes as toxic mortgages do what toxic mortgages do.  The trend for the homeownership rate will be lower for years.  Also, the weak economy is going to keep pressure on housing prices since people do pay for their home payment out of income they get from their jobs.

When we step back, the market is already telling us many things.  Lower home prices will get more Americans to buy homes so having Wall Street and the government trying to prop up prices is a bad thing.  In markets where demand is high prices will remain high because of supply and demand forces.  Why the need for government backed easy money mortgages?  Why the need for all these support programs that only prolong the misery?  There is absolutely nothing wrong with renting and frankly, it is a shame that many in this country look down upon that.  This is similar to those “keep up with the Joneses” folks that had to keep up with their neighbors jet skis, Hummers, and other items that sunk many families.  Just look on eBay and Craigslist and you’ll see many people selling these items trying to downsize.  Buying a home is the biggest purchase most Americans will take on and should be entered with caution.

There is a delicate balance to all of this and currently the market is still out of balance.  How anyone can see home prices booming in the next few years is hard to understand.

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Without a doubt, Alt-A and option ARMs are already causing problems internally on the balance sheet of banks:

Since 58% of option ARMs are here in California, this combined with the fiscal problems of the state will prove to put housing into a precarious state for the next few years.  Let us look at 10 charts as to why the California economy and real estate market will see no recovery in 2010.
Chart #1 – $21 Billion in Budget Deficits

Without a doubt, these are enormous budget deficits that we need to contend with.  In the last cycle, the state had to cut spending and also raise taxes.  There were also many gimmicks in the last fiscal budget since the state government was hoping for a Hail Mary pass that the economy would somehow recover in a few short months.  That didn’t happen and the gap has opened up again.  Combine the current fiscal year and the next, and we are looking at $21 billion to patch up.  Where is this going to come from?

Chart #2 – Deficits for Many Years

One of the large issues in the latest fix is cuts that were supposed to happen but didn’t.  For example, the correction system is over budget by $1.4 billion and Medi-Cal spending is over by $900 million.  If you don’t adhere to a budget, then problems will occur.  But this is more kicking the can down the road budgeting yet the reality is, California hasn’t improved much in the last year.  In fact, unemployment is now up to a record keeping high of 12.5 percent.  Is this good news for the California housing market?

Chart #3 – Optimistic Outlook

The California LAO does a good job at looking at data but their forecasts are a bit optimistic.  If you look at the above chart, the peak unemployment rate for the U.S. is 10 percent and for California it stands at 12.1 percent.  We are already beyond those points.  Given, these are yearly averages but so far the trend is moving in one way.  You will also notice that for California, the LAO sees a doubling in housing permits for 2010 and nearly a tripling by 2011.  So far, we have seen little reason to assume this is going to happen.  With many more foreclosures coming in the future through Alt-A and option ARMs, we are assured more inventory in the next few years.

Chart #4 – U.S. GDP Moves Sideways

The above is the optimistic scenario.  In fact, even the LAO is bringing up the Japan lost decade as a possible outcome.  I’ve talked about the Heisei boom and bust in Japan and mentioned this as a possible outcome for us.  Given the current government measures and actions, we will be lucky to have a Japan like outcome.  At this point, the Fed is trying everything it can to keep any audit from occurring since so much toxic financial waste is being funneled into that balance sheet.  So much for transparency.  What the Fed is basically saying is if you take an honest look at what they have, the economy will implode.  How is that for confidence?  The Fed will make Bernard Madoff look like a small town bank robber.
The above flat lining or “V” shaped recovery is not going to happen.  It is simply too optimistic.

Chart #5 – California Weak Housing Price Growth

You would think with budget deficits until 2015, unemployment at 12.5 percent, and a political system that resembles a developing nation, that all of that might throw a wrench into the housing growth crowd.  No way!  It is the immaculate housing recovery.  Who needs jobs for the stock market to go up 60 percent?  Like Wall Street, some people think that housing can recover even if the economy is in a mini-depression.  And in the current budget that we enacted, revenues are a problem but spending is the bigger issue.

In the July budget it was assumed revenues of $84.1 billion for 2008-09 and $89.5 billion for 2009-10.  So far, this year revenue is lower and LAO expects revenues of $83.6 billion for 2008-09, $496 million less than budgeted and $88.1 billion in 2009-10 and that is $1.5 billion less than budgeted.  Yet areas like corrections are over budget by $1.4 billion and Medi-Cal coming in over by $900 million.

So what does this have to do with housing prices?  A lot actually.  There is only a few ways to balance this out.  More cuts (higher unemployment), higher revenues (taxes), or more likely a combination of both.  With elections next year, you can rest assured candidates for Governor are going to be focusing on the economy as issue number one.  Either way, the average Californian is going to have less money one way or another.  The Alt-A and option ARM problem is unique.  This housing bubble is unique.  We have no historical parallel.  How can it be assumed that this will simply disappear with no repercussions like dirt being swept under the rug?  Some think that HAMP or other gimmicks are going to stem the losses.  An unemployed person is not going to be able to cover a $200,000, $300,000 or $400,000 mortgage (fixed, Alt-A, option ARM, subprime, interest only, etc) so how are prices going to go up?

Prices are going up right now for the following reasons:

=Tax credit

=Artificial lowering of inventory (big shadow inventory)

=Moratoriums like HAMP

=FHA insured loans – 2% in SoCal two years ago now nearly 40% of all purchases
We already know how disastrous FHA is becoming.  Defaults are flying off a cliff.  The median down payment for FHA insured loans is 3.5 percent.  Are some putting down more?  Yes.  But half are not.  Plus, California is in a total mess:

“(LA Times) The credit information supplier says that during the third quarter, nearly 10.2% of home loans in the Golden State were 60 days or more past due. That was up from 9.7% in the second quarter and 5.8% in the third quarter of 2008.”

Nationwide things are equally as bad:

“(UPI) In records going back to 1972, the delinquency rate in the third quarter was an all-time high, breaking the previous high of 8.86 percent set in the previous quarter.

The rate does not include loans in the process of foreclosure which, separately, was 4.47 percent in the third quarter. The combined delinquency and foreclosure rate was 14.41 percent, also a record, the MBA said.”

In other words, 1 out of 7 mortgages is in some form of distress.  So the government is left with hard choices.  FHA insured loans are imploding because of the pathetically low money down required (3.5%).  FHA is going to need a bailout in the next few months.  But some are going to expect a pound of flesh.  The only way to combat this is by increasing the down payment requirement to at least 10 percent.  No one is saying eliminate FHA but come on, is 10 percent too much to ask for?  Do that, and the California market is done.  Yet the median nationwide home price is around $177,000; all you need is $6,195 to buy a home!  In Southern California, that can be your first month and last month deposit on a leased place.  Without significant changes the nation is going to have to bailout all the additional failed mortgages coming from California that have a much higher average balance.  This isn’t speculation, this is already happening.

Chart #6 – New Demographics

I talk to many younger couples and many are waiting to have families.  The above chart merely verifies this trend.  “Family forming” is a big mover in people buying homes.  No longer does the couple feel like their apartment is big enough for a child so off they go to buy a home.  But if people are waiting longer, it is expected that many may not have that rush or desire to buy sooner.  People are hunkering down.  In fact, in some areas of the country people are lining up outside of Wal-Marts at the end of the month waiting for paychecks or government funds to clear just so they can buy food.

So people are shifting priorities.  In fact, just from speaking to many younger couples, they are perfectly fine in waiting.  Their primary concern is trying to survive through the recession first before making the biggest purchase of their life.  So this throws another factor into the bullish housing argument.  Many couples don’t “need” to buy a home because they are delaying having kids.  Nothing wrong with that.

Chart #7 – Revenues from Volatile Sources

We have discussed that California receives revenues from very volatile sources.  Over half of all revenues for California comes from personal income taxes.  So with unemployment going sky high, it is no stunner that the state all of a sudden isn’t flush with money.  California has been artificially stimulated for two decades.  We had the tech bubble followed by the housing bubble.  There is no other bubble this time so we are basically fixing structural problems that have been decades in the making.  The forecast is dismal but as you can see, we suddenly see a miraculous recovery sprouting out like a card from David Blaine’s hand.  The LAO does a great job dissecting the numbers but doesn’t tell us what industries are going to make up for the lost income.

Also, the LAO is factoring in that COLAs are not going to happen for workers until 2015.  More reason to believe housing is going to go up right?

Chart #8 – Capital Gains

Within the personal income tax revenue section, a big portion of money comes from the wealthy, many who depend on the stock market casino.  If you look at the above chart, you can see how much money can come from capital gains.  During the tech bubble the state was pulling in 11 percent of the total PIT from capital gains!  It peaked over 8 percent in the real estate bubble but is now down to 2 percent.  The U.S. Treasury and Federal Reserve have juiced the stock markets because clearly the average American is not feeling any of the trillions in bailouts.  Their belief is that crumbs will fall from the plates of the banking oligarchs and trickle down to the middle class.  It is hard to believe that with the wild California housing market, cap gains didn’t match the tech boom.

Chart #9 – Unemployment

Good luck finding any real estate analyst that connects housing prices to employment and income.  Like Wall Street, the real estate market doesn’t depend on income and jobs anymore according to this new version of the economy.  The official unemployment rate is 12.5 percent, a record keeping high.  If we look deeper into the data, 23 percent of the workforce is either unemployed or underemployed.  If you are working at a local retail store after losing your good paying job, you are considered fully employed.  If you are working 10 hours at your local Wal-Mart to pay for food but want full-time employment, you are not part of that 12.5 percent.

Employment is such an obvious data point in terms of looking at any housing price movement.  Recent data is showing prime mortgages defaulting in mass not because mortgages are toxic like Alt-A and option ARMs, but because people have now lost their jobs or have seen their incomes fall by the wayside.  Until employment stabilizes, housing recovery talk is nonsense.  People right now are focused more on taking care of their immediate needs as they should.  Yet where do we focus our energy?  Banking bailouts, cash for clunkers, and home buying tax credits.  I’ve been living in this Alice in Wonderland world long enough that being in this sunny rabbit hole we call Southern California, nothing else really surprises me.

And one thing people miss even with FHA insured loans is the amount of leverage that is now gone because of Alt-A and options ARMs:

Take for example the above case.  Say you are looking at a good area like Culver City since I’ve discussed that area over the last year.  You are looking at a nice place that is going for $500,000.  The required household income is approximately $125,000.  Not out of reach for a working class couple.  So you can buy a home that is roughly 4 times your annual gross income.  Yet during the bubble, it was common for people making $50,000 to take on $500,000 mortgages.  Countless Real Homes of Genius were purchased like this.  But that leverage is now gone.  And keep in mind, if employment keeps faltering what if one couple gets hours cut back or fired?  FHA is providing roughly 4 times annual income leverage versus the ten (or even higher) during the bubble days.

Chart #10 – Unemployment Insurance

With so many people unemployed, the unemployment insurance fund has been running in the red for nearly a year.  We are in the hole to the tune of $4 billion.  The money is coming from somewhere:

“Because of the insolvency, EDD obtains federal loans on a quarterly basis to cover projected fund deficits. To date, the state has borrowed about $4 billion, permitting California to make benefit payments to UI claimants without interruption. Federal loans lasting more than one year generally will accumulate interest charges of about 5 percent per year on the outstanding balance.”

More debt and more borrowing.  We are loaded up with so much debt, that by 2015 the general fund is going to go to debt service and retirement benefits.

All this of course is somehow good for the housing market.  Yeah right.  No need for apocalypse movies when our budgets are this bad.

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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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What is troubling is that instead of stopping the problem, lenders are ramping up their FHA backed loans since banks are hoarding money like packrats.  On Thursday Edward Pinto, a financial services consultant and also a former chief credit officer of Fannie Mae (1987 – 1989) gave testimony to the U.S. House of Representative Housing and Community Opportunity Subcommittee.  So Mr. Pinto must know something about credit risk.  The first chart presented is absolutely astounding:

From 1951 to about 1990, FHA annual foreclosure starts stayed below 2 percent.  The range was tight.  However, from 1990 to our current bust the FHA annual foreclosure rate has doubled and shows no signs of stopping.  You would think that with Alt-A loans and option ARMs we realized how bad it was to give people loans with little or no money down or having Warren Buffet as a co-signer when you work at Wal-Mart.  Precaution unfortunately is not being taken.  In fact, the government is basically stepping in to make up for the lack of toxic mortgage lenders instead of creating a more stable mortgage system.

Both the FHA and Veterans Administration now make up over 90% of all high loan to value mortgages.  The vast majority of these loans have LTV over 96% which is smart if you enjoy driving off economic cliffs.  Keep in mind that the government is now insuring loans even though the housing market has not stabilized.  In the report issued on Thursday another risk highlighted was the ability for people to use the $8,000 tax credit and apply that to the downpayment requirement.  So you have one government program screwing with another.  Think of someone buying a $200,000 home.  For a FHA loan, you would only need roughly 5 percent for a downpayment, or $10,000.  Use the tax credit and you are buying a home for one month of rent!  Can you say zero down?

FHA is basically eating up the slack from imploded toxic mortgage lenders.  FHA insured loans are now up four times in volume from their 2006 pace.  They will constitute some 10% of all outstanding loans by the end of the year.  And in some areas, these new low money down loans are making up a big chunk of new sales:

“(DQ News) At the same time, a common form of financing used by first-time home buyers in more affordable neighborhoods remains near record levels. Government-insured, FHA mortgages made up 37.4 percent of all purchase loans in August, up from 37.0 percent in July and 27.1 percent in August last year.”

Did you get that?  In some regions nearly 4 out of 10 home purchases came from these little money down loans.  This isn’t some low priced region.  This is high priced Southern California.  And this brings us to another risk brought by these loans.  The loan cap is now up to $729,750. Now why do you need such a high cap when the median home price across the U.S. is less than $200,000?  Of course, this is basically allowing major bubble HGTV addicted areas like California and Florida to use up these loans to create basically another housing bubble.  As we realize, even if you have a high income, if you don’t have skin in the game you will walk.  Those Alt-A and option ARM borrowers in California are strategically defaulting even before the 2010 recast wave hits next year.  It is naïve to think people won’t walk away from these loans either.  The only difference now is you have to document your income.  Is that the only lesson we have learned!?  Talk about lack of analysis.

The FHA also has a long history of fraud which is perfect since most defunct toxic mortgage factories were full of fraud as well.  These are basically toxic mortgage-lites and now we can rest assured that since they are looking at two years of income, all is well in Candyland.  And loans are getting crappier and crappier:

If things are getting better in the housing market why are these loans imploding?  This isn’t linked to option ARMs but is linked to poor lending philosophy.  There was also recent legislation requiring lenders to increase net worth requirements on September 18, 2009.  Yet this is a joke since four lenders make up 85 percent of all FHA loans:

(1)  Wells Fargo

(2)  Bank of America

(3)  Chase Home Finance

(4)  CitiMortgage

The too big to fail otherwise known as the Larry, Moe and Curly of lending are now government fronts pumping out near zero down mortgages.  Make no mistake that FHA is now growing in this environment because the government and Wall Street are determined to recreate the ecology that caused this housing bubble in the first place.  Yet it won’t work and it is putting the country at risk.  If the dollar tanking isn’t warning enough, we are going to get a wakeup call next year with commercial real estate and the Alt-A and option ARM tsunami.

Another shocking yet not surprising highlight in the report is the ever diminishing fund for losses with the FHA:

Just like the FDIC DIF going to zero a few days ago, we can expect this fund to do the same thing.  But guess what?  We are on the hook for these loans since they are government backed!  Instead of heeding the warning from that first chart above, FHA insured loans are being pumped out in mass because crony banks don’t mind gambling with your money while keeping reserves hiked up for the losses they know are coming down the pipeline.  What did TARP do?  It allowed toxic banks to survive courtesy of taxpayer charity.  As I predicted when TARP was put in place over a year ago, the American people have gotten nothing in return.

And while people are pumping their fist in the air for victory because of loan modifications, does anyone even bother to look at the details of what constitutes a loan mod?  Loan modifications are glamorous versions of rearranging the deckchairs on the Titanic and a waste of money.  Let us look at some details:

If you want to sum up the above it is extend and pretend.  First, overdue interest is capitalized into the actual mortgage increasing LTV thus increasing risk.  This is negative amortization-lite by the way and one key problem with option ARMs.  Another smart move is basically extending the term on the loan up to 40 years!  Good times in the government mortgage sausage factory.  They took the ideas of the sewage industry, otherwise known as subprime and Alt-A mortgage brokers and made them government policy.  If you need any more support how pathetic the success rate is, just look at the 59.1% re-default rate.

Want a simple solution?  Instead of giving these loan servicers $1,000 per modification, how about you give $1,000 to the owner so they can use the money for a rental deposit?  Isn’t that more efficient in the long run anyway?  They clearly cannot afford to live in their home and that is okay!  Owning a home isn’t a right by the way.  Why not give out a rental tax break?  Rental vacancies are now sky high and this will add pressure to commercial real estate.  Then again, we are asking for some logic here from Wall Street and our government and they have proven to us that government, Wall Street, and housing simply do not mix like drinking and driving.

We get some excellent suggestions regarding FHA insured loans in the testimony:

Yes, yes, yes, and yes!  10 percent should be an absolute minimum and no, you can’t use any tax breaks for the downpayment.  This is money that you save.  Not a damn nationwide subsidy.  And one point that is absolutely obvious is how in the world is a $729,000+ loan a low to moderate home price?  This is nuts!  Lower the cap to national median prices.  The Federal government subsidizes this so it only makes sense.  You want a $400,000 loan?  Then let Bank of America hold the loan on their book with no government backing.  We can rest assured they’ll be doing better due diligence.  Keep on pumping out FHA insured loans and what do these banks care?  These are the same toxic banks that were responsible for the housing bubble so we can rest assured we are in good hands.

I love in the attachments Mr. Pinto includes an article showing the problems going on with the FHA.  But this chart just cracks me up:

So it is true!  The perfect correlation is increased disposable income in gambling tying in with higher gambling with toxic mortgages.  What is so maddening about these reports is that it was showing clear cases of where the risk was in the system.  Take a look at this report by Fannie Mae in 2006:

And of course this chart is only worse today.  So it isn’t that no one saw this entire mess coming.  What really occurred is no one in a position of power had the fortitude to act.  That is the issue.  The system was flooded with plutocrats listening to their lobbying masters and these Cassandra’s were merely pushed down the funnel of oblivion.  Until we can reform the governing system, we can expect more crap to fly.  That is why the tax credit is being championed by the real estate industry shills even though the cost to taxpayers is counterproductive and such an utter waste of money.  Yet these shills kick money down to our beloved Congress.  And that is why even though we have hard data showing the train that is coming down the rails with FHA instead of applying the brakes, the government is greasing the track!  Then you have the real estate industry cronies jumping up and down at the prospect of the credit being removed.  Most credible analysts and economists do not stand behind the tax credit.  It is a waste of money.

You can download the full report with attachments here.  It is worth a read.  Too bad the plutocrats will continue to sleep with their lobbyist and FHA is merely another problem for another day.  FHA is the loan of choice for fellow comrades.

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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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