Tuesday, September 25, 2007

San Francisco Chronicle: blogger in business

He practiced what he preached, refusing to buy a house. Instead he and his wife rent a Menlo Park bungalow for themselves and their two children. Today, the housing market has indeed slumped, giving his views some credence.

"Nobody calls me crazy now," Killelea said. "I haven't changed; it was just a matter of waiting for the fundamentals to catch up."

Killelea's blog attracts 14,000 readers a day, drawn to his sardonic take on the market and numerous links to news articles that bear out his premise. His site ranks high in Google searches of "housing market" or "housing crash."

The site exemplifies a new real estate Web genre: "bubble bloggers."

There are scores of bubble bloggers who passionately believe the housing market is so out of whack that it is destined to collapse. What Matt Drudge is to political gossip, housing bubble bloggers are to real estate doom and gloom. They range from acerbic to inflammatory but definitely don't mince words. They rail against the real estate industry, sometimes spin conspiracy theories, and lately indulge in schadenfreude about the housing downturn. Bubble bloggers say they inject a healthy dose of skepticism to counterbalance excessive cheerleading from real estate industry professionals.

"Bubble bloggers weren't taken seriously until six months ago, and now everyone's taking them seriously, which is fantastic," said Brad Inman, founder and publisher of Inman News, a wide-ranging real estate Web site. "They really served a purpose when they were a voice in the wilderness."

But many real estate agents are less enthusiastic.

"I laugh at bubble bloggers," said Matt Lanning, a Realtor with Zephyr Real Estate in San Francisco, whose sfhomeblog.com takes a considerably more upbeat view of the market. "I don't claim the world is always going to be stable, but there is no way the San Francisco market will collapse. It's a lot like the sensational journalism we're seeing with subprime mortgages which are far less of an issue than the media is making them out to be."

As for Killelea, Lanning said: "He has not been right about anything. Most of what he does is scour the Internet looking for anything to back up his position as someone who is forecasting the coming apocalypse of the real estate market."

Killelea's rhetoric can be strident, but in person, he is low-key and pleasant. With alert blue eyes behind wire-rim glasses and close-cropped reddish hair and mustache, the 42-year-old seems like an ordinary Silicon Valley tech guy - which, in fact, is his day job.

Killelea does contract programming work but said he can take off months at a time from his $100-an-hour software gigs because he took his savings from renting instead of buying, invested in the stock market and did quite well. His last job ended in March and he's just thinking about looking for a new one.

He would love to work on the blog full time but it brings in only about $1,000 a month.

That revenue comes laden with irony. The blog carries Google ads, which use an automated scan of site content to place ad links, so most ads on Patrick.net feature a selection of mortgage brokers, real estate agents, home builders and "get rich quick in real estate" schemes.

"The sheer joy is that all the people I think caused the problem" advertise on the site, he said. "I can not only complain about them; I can take their money while I'm doing it. They would probably be horrified to know their ad is on my page. "

Killelea spends several hours a day working on the blog: writing entries, responding to every e-mail he receives, reading about 100 news links his readers send in daily, and picking 10 to 20 to post under the banner "Housing Crash News."

Some headlines he linked to on Monday: "We're in deep doodoo," "Worldwide bubble troubles," "The new money pit: Housing bust gets worse" and "Bernanke has snookered us all."

Why doesn't he include news and views from other perspectives?

"I have no pressure to be balanced, and I'm not balanced," he said.

Some of his predictions are so far out there that they seem unlikely to come true. For instance, he thinks Bay Area houses won't be worth buying until the median price is cut in half, to about $300,000.

Could that really happen?

"I have faith," he said, putting his hand over his heart, only half mockingly.

Killelea didn't set out to become an apostle of housing pessimism. He says he just applied the same analytic skills he uses in programming to the housing market after his first brush with house hunting.

In 1999, he and his wife tried to buy a house in Berkeley at the height of both the dot-com bubble and housing mania.

"It all felt rigged," he said. "Everything was set up to get me to overbid and not do an inspection; basically throw caution to the wind. It just felt really wrong. I felt like a sheep among wolves."

After being consistently outbid, the couple decided to rent instead. They found a charming Menlo Park two-bedroom on a tree-lined street for $2,700 a month. After a couple of years when the rental market softened, they asked for a rent reduction and now pay $2,350. "I would be paying out and losing about three times as much" to own the equivalent house, he said. "In some big urban areas like Manhattan and the Bay Area, it may never be cheaper to own" than rent.

After the dot-com bubble burst, Killelea assumed prices would return to normal - but instead they continued to soar as the Federal Reserve lowered interest rates.

"I got out there and started looking at things and realized people were bidding even higher than before," he said. "It was pretty clear so many people were getting in so far over their heads that this was going to end in tears for a lot of people."

He started his blog three years ago and soon found a receptive audience.

"It became a full-blown obsession, not just for me but for other people, too," he said.

Indeed, the blog draws a dedicated group of readers and participants, many of them also renters-by-choice.

"I begin every morning with it," said Peter Christiansen of South San Francisco, who first came across the blog in 2004. "For me, it's become the only source of information on the housing market. I don't need anything else. It's the best source of informed participants I've ever participated in on the Web; people really seem to know what they're talking about."

Like many of the site's participants, Christiansen eschews buying real estate. Instead, the mental health counselor owns a mobile home on a rented site.

Patrick.net creates a sense of community, Christiansen said. "We are people I would describe as value investors," he said. "The one thing that probably holds all of us together on Patrick is that we're mostly people who are really suspicious of bubbles."

Killelea has set up one practical proposal to cut out the middleman in real estate through his site. He calls it Real Estate Dating Service, a place where home buyers can post what they're looking for - price, size, location - and sellers can scan the listings and contact buyers directly. About 730 buyers have signed up, but he hasn't tracked whether any sales have occurred as a result.

Every once in a while his two worlds - programming and blogging - collide. Time was, Killelea was best known as the author of "Web Performance Tuning," a geeky manual that helped him get jobs. Now his fame as a bubble blogger has spread - not always to his advantage.

"Once a guy called me in for a job interview just to berate me," he said. "I don't do this language called Ruby that he wanted, so I said, 'Why did you bring me here?' He said, 'I want to talk to you about your Web site.' He complained about how he had overpaid for a house in Palo Alto and couldn't get out of it. It was not a civil conversation."

Monday, September 24, 2007

Credit percentage of GDP - all time high of 340%

Americans may be disappointed that the Federal Reserve's interest rate cut won't necessarily translate into lower monthly mortgage payments and a revival of the housing market. "Mortgage rates won't stimulate demand,'' said Scott Anderson, senior economist at Wells Fargo. "The Fed may be a little impotent here because what caused this housing crash was overpriced housing, not mortgages.''
When trading in any overpriced asset-class slows dramatically, there's only one "cure." That cure is lower prices.

I just received and finished reading a paper by one of my favorite economists, Richard Duncan (he authored the terrific book, "The Dollar Crisis, Causes, Consequences, Cures"). Duncan is one of the very few people who fully understands what's going on in the US and world economies. Please study these two paragraphs carefully.

"Bubbles are easier to inflate than to sustain. The US property bubble is now beginning to deflate, and the risks to the US and the global economy are greater now than they were when the stock market crashed six years ago -- greater because the global imbalances have become so much larger as a result of the US property bubble. If US consumption now begins to contract, as appears likely, US imports will decline, and the world will also go into recession, possibly a very severe one.

"Credit growth drives economic growth. Total credit in the US as a percentage of GDP has grown from 150% in 1969 to 240% in 1990 to 340% today. It is not difficult to understand that rapid credit expansion boosts consumption and investment and employment and asset prices. However, excessive credit growth also eventually causes economic overheating and asset price bubbles. So long as additional credit is forthcoming everyone can simply borrow more this year to pay interest on the money they borrowed last year. Those bubbles pop when the individuals and/or corporations who borrowed the money are unable to pay it. That is the situation we are experiencing today."

Now the world bubble (due to a number of causes and triggered by the subprime disaster) is beginning to deflate. This has created an international credit crisis. If the world bubble continues to deflate, it's going to result in a global recession or worse. The only way to halt this deflation is for the US government to increase its ratio of debt to Gross Domestic Product (GDP). This will require the US to spend additional hundreds of billions of dollars -- maybe well over a trillion dollars to offset the deflationary forces of the credit contraction.

Richard Duncan believes that the US may have to spend a trillion dollars or more over the next four years just to stave off credit contraction and deflationary forces.

The question then arises, how can the US finance the huge amount of spending (debt) that must be created in order to offset the forces of deflation? The usual way would be to sell Treasury securities to our foreign friends and their central banks. But what if the central banks (already choking on US dollar-denominated securities) have accumulated enough dollars? In that case, the US will have to sell bonds to the Fed, and the Fed would create the money needed to finance the deficits.

But wouldn't this process be highly inflationary? Yes, of course it would -- basically, it's monetizing the debt, which is always inflationary. Yet increased inflation is what is needed to counteract the deflationary force of the deflating world bubble.

The question then arises, assuming deflation can be held off, how can the whole mess be solved in some permanent way in the future? The answer, I believe, is that the world must move to a new monetary system with an anchor in something tangible, an anchor that will force discipline. The only tangible item I can think of that will fit is gold.

Friday, September 21, 2007

Market talk and gold

I'm hearing and reading a lot of dire predictions about the market and the economy and where it's all heading for in the ominous months and even the year ahead. The forecasts tell us that the housing mess will get messier. After all, just because rates are lower won't make frightened potential home-buyers want to rush in to buy a house. Furthermore, in the past, contracting credit has almost always led to recessions and bear markets -- so what's so different today? Next year it's a given that we're going to be dealing with an epidemic of home foreclosures, and there's nothing bullish about that. No, there's no shortage of bearish forecasts, you can read about "the coming disasters" in every newspaper and financial publication.
In the meantime, Ben S. Bernanke and the Fed crowd have opened up the floodgates of liquidity, while at the same time they've dropped both the Fed Funds and the Discount Rate a full (and surprising) half-percent each.

The Bernanke dilemma -- move fast to avoid a recession -- or attend to the swooning dollar. It's no contest -- the Fed will avoid a recession at all costs. The Fed has justified it's action by announcing that there's little or no danger of inflation, so why worry if we lower rates? To Bernanke, a recession means the possibility of deflation, and deflation is something Bernanke doesn't want in his vocabulary.

But there are problems. One is that the dollar is falling out of bed, and this has to be worrying our foreign friends, who hold tens of billions of securities all denominated in dollars. As the dollar sinks, our overseas friends are taking enormous losses. Should they sell their US holdings, should they stand pat and take it, or should they simply diversify out of dollars and hope for the best?

Question -- suppose the pessimists on the economy prove to be correct -- or even partially correct? The Fed is currently increasing M-3, the broad money supply, at a 14% rate, and if the economy doesn't respond to that, they'll push the M-3 growth rate even higher -- to 15%, 17% or 20%, whatever it takes. They'll also drop interest rates again -- and again. If, despite all the Fed's machinations, the economy doesn't respond, we could easily experience something akin to hyper-inflation as the Fed funds go totally wild.

Ironically, all this is providing the ideal background for gold. For our protection, it's OK to sell dollars and switch into euros or Canadian loonies (dollars), but what if we're moving into a situation which can best be termed competitive devaluations? That's a condition where all fiat currencies tend to lose purchasing power? And what would these various currencies be losing purchasing power against? Currently, the fiat currencies are losing purchasing power against wheat, soy beans, heating oil, gasoline, basic foods such as bread and vegetables along with the cost of utilities, medical care, college tuition. And, of course, fiat currencies have been losing against gold.

he VIX was down 1.45 to a low for the move at 19.00. Stock market heading up -- investors calming down.

Pretty good action for a Friday in a still-nervous stock market. Market is a bit overbought, and now a lot of left-behind investors are waiting for a decline so they can get in. The market, being the ornery mechanism that it is -- won't oblige.

Thursday, September 20, 2007

Credit Crunch: 4.87 percentage points above Treasuries

The pain has been particularly acute, of course, in housing, where creditors have lost massively and the specter of foreclosure looms over homeowners unable to cover escalating mortgage payments. Nor has the leveraged lending business been spared. The spigot of new commitments has shut tight. The average risk premium on high yield bonds leapt to a recent high of 4.87 percentage points above Treasuries, compared to June's record low of 2.63 percentage points, an almost seismic adjustment for the tortoise-like debt market.

Never before in the history of capital markets has so much money been lent to so many challenged borrowers.

The statistics are indisputable. In 2007 (until the market effectively shut down), more than 32% of new lending was to companies planted on the lowest rungs of the credit ladder, compared to 20.9% in 2006, the previous peak, according to JP Morgan. That brought these borrowers' share of outstanding debt to above 25%, also a new high. Much of that debt was amassed, of course, by private equity buyers, whose average leverage ratios for new deals in 2007 reached 6.6 times cash flow, another record.

So why, given such seemingly incontrovertible worries, have interest rates on junk debt stayed stubbornly low? First, for all the chatter about liquidity crises, vast pools of uninvested capital remain in place in hedge funds and elsewhere, eager for the next "buying opportunity." Even amid the summer ugliness, whenever trading values of outstanding debt appeared about to crumble "value" buyers emerged to prop them back up again. Still more capital is now being raised to invest in this debt, some of it by the very banks whose imprudent practices helped create the problem.

Tuesday, September 18, 2007

Stock market and housing

There were 2995 advances on the NYSE and only 334 declines. UP volume was an amazing 96.4% of up + down volume.

Total volume expanded bullishly to 3.40 billion shares.

The VIX plunged 6.13 to 20.75, one of the biggest declines in the VIX I've ever seen. Fear is collapsing with today's super-bullish action.

Looks as though this was another 90% up day, but this time the missing ingredient came in -- EXPANDING VOLUME. The primary trend of the stock market is bullish. The secondary trend of the market is bullish.

The stock market has discounted the worst that it can see ahead, and that's enough for me. There isn't going to be any housing disaster, there isn't going to be any recession. Don't get me wrong, there's still going to be plenty of trouble for the people who are stuck with rotten mortgages, but the stock market is saying that the housing trouble is not going to flatten the economy. The stock market is saying that in due time the housing trouble will be put behind us.

Latest -- On the news of the Fed Funds cut, gold surged over 8 dollars in the aftermarket with the Dec. contract at 731.70.

From: RR

Wednesday, September 12, 2007

"Campbell Real Estate Report": 40% to 50% drop in prices

The great "Campbell Real Estate Report": Bob was the first to call the top of the real estate boom in his August 2005 reports. Robert is now very bearish on the future of real estate pricing. He thinks prices could drop as much as 40 to 50%. I asked him how this could happen without setting off a recession. His answer is that "It can't." He thinks a recession is in our near future.

From: RR

Loan Resets: March of 2008 biggest jump

Here’s a very concrete example to flesh out the issues. You have a hypothetical 2/28 ARM portfolio of $1.2 million original balance. It contains 12 $100,000 loans, one originated per calendar month of 2005. Each loan will have a first rate adjustment in each calendar month of 2007. The “12-month reset projection” for this pool, considering only the first adjustment, is very simple: each month, 1 loan resets, for a dollar amount of $100,000 per month or $300,000 per quarter.

But what if you do not limit yourself to just the first reset? The 2/28 will, if it does not prepay, reset every six months after the first reset. If we assume no prepayment, then, and include subsequent adjustments, we get 1 loan resetting in January-June, but 2 loans resetting each month from July-December. Starting in July, there is 1 loan hitting its first reset and 1 loan hitting its second reset. If you simply counted resets, you would show 2 loans in July-December, for a balance of $200,000 per month. If you tried to total up the monthly balances for a year, you’d end up showing $1.8 million in resets on a $1.2 million portfolio of loans. You could say, in a certain context, that $1.8 million in resets are scheduled for 2007, but that is not saying that $1.8 million worth of loans are “at risk.”

And, of course, not every loan will survive on the books after its first adjustment. It could pay off voluntarily (refi, home sale) or involuntarily (short sale, foreclosure). If you wanted to take a vintage of originations and project out a reset schedule, you would have to make projections of prepayment and default. If you started with current outstandings, you would already have your prior prepayments and defaults removed from your pool, but you would still have to project these into the future, unless your goal was a “what if” scenario that involved no loan paying off or defaulting until its reset date.

Even if you wanted to do that, there’s no reason to assume that all reset-related defaults will be due solely to the effect of the first adjustment. It is the most wicked reset for the borrower, but the ugly fact of the 2/28 ARM is that borrowers who survive the first adjustment, possibly just barely, will get another smaller one in six months, and then another one in another six months, until the loan reaches either fully-indexed (then-current 6-month LIBOR plus margin) or its lifetime cap (usually start rate plus 6.00 points). Given the depth of the teaser discounts, the hefty margins, and the movement in LIBOR since these loans were originated, there is no reason to think many of them won’t keep adjusting upward every six months for two years until they hit indexed or capped. So the borrower who just barely survived the first reset might go down at the second one. The borrower who more comfortably survived the first reset might go down at the third one. There is a point to “cumulative” projections of resets.

However, you would still have to adjust these numbers further. You would also project index values forward (to guess when caps will come into play and loans would stop adjusting), and you would have to take into account varying margins. I could assume for our hypothetical pool that all loans have the same margin, but in the real world they don’t.

You will, therefore, see differing presentations of reset volume, and those differences may have a lot to do with prepayment speed assumptions, underlying index movement assumptions, or the weight of caps and margins in a particular pool of loans. That does not mean that someone is lying to you, although you may or may not find the underlying assumptions reasonable (assuming you can figure out what they are).

Today, Reuters reports this:
About $75 billion in adjustable-rate U.S. mortgages are going to reset in the fourth quarter, most of which will emerge next month. Of the loans resetting, around 75 percent are subprime mortgages.
As far as I can determine, this $75 billion number includes only the first reset of any ARM (the date on which it changes from “fixed to floating” rate), based on Q207 securitized outstandings, and has no prepayment adjustments. If you assume even conservative prepayment speeds, the actual number of resets will be lower. However, if you “add back” subsequent adjustments for loans that survived their first adjustment, the raw number of resets is higher. The Bank of America chart CR posted several weeks ago shows securitized plus non-securitized, which is why it has such large numbers compared to the Reuters number. I believe, but cannot verify, that it also includes only the first adjustment.

From: http://calculatedrisk.blogspot.com/2007/08/arm-reset-charts.html

Sunday, September 09, 2007

Getting a Jumbo Loan: testing today's market

If wholesale lenders have difficulty finding buyers, this will be reflected in the prices and other terms they quote to mortgage brokers and small lenders. And that's what I decided to look at.

My data consists of wholesale price quotes from 12 large wholesale lenders. As a base case, I first defined a "cream-puff loan" -- this is a 30-year fixed-rate mortgage for $417,000 on a single-family property being purchased as a permanent residence for $550,000 by a borrower with a FICO score of 720 and who fully documents income and assets.

All 12 lenders quoted prices on the cream-puff at various rates. The prices are points plus small fixed-dollar fees, which I combine into one price. At each rate, I have the price quoted by each lender, so I know not only the best price, but also the dispersion of prices by the different lenders. The quotes are as of Aug. 7.

For example, at 6 percent, the lowest price was $4,039 and the highest was $6,589, with other quotes in between. This is a spread of only $2,550, which is exactly what one expects to find in a well-functioning, competitive market.

In my second pass, I upped the loan amount to $418,000, leaving all the other features of the loan unchanged. It remains a cream-puff loan in all respects other than size -- it is now a "jumbo" loan, ineligible for purchase by the agencies.

At the same price, jumbo rates were 0.625-0.75 percent higher. I do not have a comparable figure for the period just prior to the recent market upheavals, but I have looked at the spread on many occasions over the years, and it was always 0.25-0.375 percent. To my knowledge, the current spread is larger than it has ever been.

The price dispersion was also higher on the jumbos. For example, on a 6.625 percent loan, the best jumbo price was $4,494, but the highest was $11,639, a spread of $7,145. On 7.5 percent loans, the best price was a rebate of $5,059 while the highest was $14,987, a spread of $20,046. Two of the 12 lenders did not provide any price quotes on the jumbo.

With my third pass, I changed the jumbo loan from a purchase loan to a cash-out refinance, and from full documentation to no documentation. Everything else remained the same. This moved the loan into a much riskier niche.

Only four of the 12 lenders quoted prices for this loan, and one of the four was way off the mark. At 8 percent, the best quote was $3,253; next best was $10,623; and the worst, $13,218. The best quote by the fourth lender was $14,091 for a 9 percent loan.

“Everything was great until about a month ago. Then, on one day – Thursday, Aug. 9 – everything changed as lenders shot up rates on jumbo loans to 9 percent and further tightened guidelines,” said Syd Leibovitch, owner of Beverly Hills-based Rodeo Realty, which mostly deals in homes worth more than $2 million.

“It became almost impossible to find a jumbo loan.”

For 10 days, Leibovitch said, sales of high-end homes came to a screeching halt. “We lost about a half-dozen deals,” he said.

Finally, towards the end of the month, sales picked up a bit as alternative sources of financing – chiefly savings and loans and credit unions – began to step in.

The mid-range market went through similar turmoil last month.

“We had a dramatic slowdown in activity in August. When the credit crunch hit, people didn’t know what to do and they just froze. It was like the Sept. 11 aftermath all over again,” said Gregory Holmes, associate manager with Coldwell Banker residential brokerage in Studio City.

Holmes said that “shock to the system” washed out almost all the buyers with less than prime credit or those who were unable to come up with 20 percent down payments.

However, he said there are still some buyers who do qualify for prime loans and can come with a $150,000 down payment on a $750,000 home. “They are just a little harder to find now than a year or two ago when we had all those bidding frenzies.”

This is bad news for all borrowers other than those seeking cream-puff loans for $417,000 or less.