You may remember the foreclosure story I wrote in July of this year about a professional real estate couple with a combined income of $130,000 a year. Most people welcomed the story since it provided a detailed look of a couple living in Orange County and how the real estate downturn will be a double-whammy for many. First, the declining market cut deep into their high income and second, when it came time to unload their house they were unable to do it because of a softening market and lost it to foreclosure. It happened in what seemed a flash. Many people outside of Southern California had doubts about this story. A few e-mails read like, “how is it possible for someone making $130,000 a year to go into foreclosure?” I can understand how someone in North Dakota has doubts of the massive spending here in Southern California but many on this site will attest to this reality of hyper-consumerism. Keep in mind the story was written the month before the August credit event of the decade. Most don’t doubt this story anymore. In addition, their high class living and massive debt was simply unsupportable. It was a Ponzi scheme and all that was needed was a tiny bump to knock everything off kilter.
If I get the chance, I try to watch CNBC on the weekends since they have some interesting programs. Yesterday I happened to catch the Suze Orman show and it was as if the foreclosure story part two was airing. Imagine a woman in a very elegant gray suit on a split screen with the host of the show. She looked like she was in her early to mid thirties. I wasn’t sure what to expect but when I heard “Los Angeles Real Estate Professional” I decided to watch the segment. Suze does a great job of getting the important details from people and making them feel comfortable no matter how dire their financial situation. No doubt her bachelor’s degree in social work serves her well since financial management has a lot to do with emotions. Either way, the shell of the story is that this real estate professional made $136,000 in 2006 and was expecting to make $40,000 in 2007. This was a compelling story so I wrote down all the details:
Profession: 10 year real estate professional in Los Angeles
Expected income: $40,000
Previous Foreclosure: Rental home (lost due to tenants going through a divorce)
Three Mortgages on Primary Residence
Mortgage #1 – $1,700 month
Mortgage #2 – $600
Mortgage #3 – $440 (for pool addition)
*One of the mortgages is a pay option.
Right from the start of the segment, I was shaking my head. These numbers were simply unsupportable. Suze asked her if she had any savings. She responded that she had spent all her 401(k) and other savings trying to stay afloat. I did feel bad for this person. She was a divorced mother trying to support her kids. My empathy went away quickly when I realized that she had taken out a 3rd mortgage on her home for a pool addition. It was obvious that this person was living a life that she could not support. When asked how much she owed on the home, she said $600,000. Then Suze asked her what she would be able to sell the current place for and the response was $550,000. I’m assuming this is an estimate since the home was not on the market and we know how quickly prices are falling. The area wasn’t disclosed but I imagine it was in the Los Angeles area. When the host mentioned selling the place and renting, you can tell that the guest paused and was not keen on this idea. Suze was trying to drive the point home that she was living well beyond her means and as she said, “you are already bankrupt” even before she files officially. The next response took me a back. “I’ll find a comparable job soon” with the implication that she can jump into another real estate job and be back to her six-figure income. Unfortunately, this market isn’t coming back for many years. And the reality is that she is pulling in $40,000 a year and with her current debt load, there is absolutely no way she can stay afloat. I’m glad to hear that Suze was recommending a short sale and possibly, get this, leaving Southern California. I’m not sure if the guest was pleased with the advice Suze had provided.
Analyzing the Industry
I’m not sure what will happen to the real estate professional on the show. Her expectation that things will pick up quickly demonstrate that she is not ready to move on both mentally and financially. In the interview, not once did she admit any responsibility for her financial situation. Her questions had the underlying expectation of “I will once again be back to a six-figure income so what can I do right now to maintain my style of life into the future?” It is important to understand that the real estate profession has been a national obsession, but here in California it has been the prime focal point for many. Let us take a look at the number of broker and real estate licenses issued here in the state:
From 2000 to 2007, we go from 307,051 licensees to the current number of 543,194. This is a 76 percent increase in only seven years. During this same time span, the California population went from 33,871,648 in 2000 to 37,700,000 in 2007. This increase represents an 11 percent jump. What we are seeing is a massive saturation in the industry. What this also tells us is that states like California are now heavily relying on a solid real estate market. Since California has done relatively well until this past month (at least on paper), we now know that every county in Southern California is negative year over year. What is also interesting to note is how many industries will be impacted by this coming real estate bear market. Here is data from 2004 – which of course was the start of the hyper-bubble so these numbers will be higher – showing the representation of industries employing people in California:
Total Paid Employees Statewide all Industries: 13,264,918
Finance and Insurance: 699,086
Real Estate and Rental and Leasing: 302,014
These industries have a very close connection to housing. Excluding manufacturing, these 3 sectors make up approximately 14 percent of all California employment. Adding in manufacturing, these 4 sectors make up 1 out of every 4 jobs. You can understand why only a few down months has already shown up in budget shortfalls for the state. The state won’t see the major damage of the industry until tax returns are filed in 2008 for this current year. You can also imagine the number of people that will reassess their tax bills to account for the declining market. What will affect the California economy as well, as demonstrated in the CNBC interview, is that many of these high paying jobs will no longer be viable sources for employment. Even if people decide to stay in the industry, they will take radical cuts in their pay. With higher inventory, lower prices, and a glut of workers, the market has reached its critical tipping point. Like the often quoted 2 million jobs lost from the technology bust, this will have a much deeper impact since many of these people will have a hard time transferring their skills into another industry. Since their jobs depend on a healthy housing market directly, the employment numbers still look positive because it is a lagging indicator. Many of the technology workers had college degrees that helped blunt the force of finding a new career. As we know, the barrier for entry for a broker or an agent is nearly non-existent. What other industry will provide a comparable salary? The answer is there isn’t and this will also take a major blow at our consumerist society by; lower tax revenues, less disposable income (thus the link to manufacturing), and a self-feeding cycle of creditors offering less credit for fear of further defaults.
There are many sites digging deep into the details of the mortgage backed security debacle, the nuts and bolts of CDOs, and all other things mustered up by financial engineering. They sometimes miss the forest for the trees and if they would spend one weekend driving to these development ghost towns or looking at how agents and brokers operate in the inner city, they would quickly realize how prevalent the problem really is. No amount of financial alchemy is going to make a frog into a prince. I think many economist and financial gurus have missed one major caveat that cannot be measured in numbers, that of emotion. Whether the emotion is greed, envy, or security these things propelled the housing market into another dimension. I don’t doubt that many people bought homes to raise families and settle their roots. It is an American mental archetype that a “successful” family will have a home with a picket fence and 2 children. Just watch all the commercials for the Christmas shopping season. You’ll see a father pulling into a driveway while his wife and 2 kids throw snowballs (even though it never snows here in LA) at him and he slowly unravels a bag of diamonds for his wife. She slowly stops, offers him a slight smile and all is well in fantasyland. Marketers know what drives sales. And what about cars and car insurance? More money. The housing industry and Wall Street exploited this desire for many years whether it financially made sense or not. They got their fill of greed while folks on the street got this illusion of security and prosperity, real or imagined. Whether people like our guest on CNBC realize that the game is up, is another matter of personal self-reflection and coming to terms to a reality that is now vastly different. Unless you’ve lived in a high priced metro area, it is hard to understand this mass hysteria and irrational exuberance that centered around the real estate nucleus. But even now, the air is full of doubt and many people seem to say “real estate will go up again” more to reassure their own insecurity.
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