"Is it subprime?" or is "It Californian?"

Some analysts predicting top to bottom falls in prices of as much as 40 percent, California looks headed for a recession. Don't be surprised too, if in six months the question angry bond holders ask is not "Is it subprime?" but "Is it Californian?"

Make no mistake: California matters. It's the world's 10th biggest economy, it generates 13 percent of U.S. GDP and its homes are collateral for billions of bonds held by investors around the world.

The situation has worsened dramatically since a freeze in global capital markets in August made it much tougher and more expensive to get a subprime or large loan.

And with unemployment rising in the state, in part because of job losses in construction, finance and real estate, things could get a lot worse.

"We are heading into a state recession and that will take an already horrendous mortgage problem and take it over the top," said Christopher Thornberg, of Beacon Economics.

"Prime loans will be in trouble too. We've got a giant mess on our hands."

Essentially, the same factors that drove housing prices upward in California are now conspiring to take them back down again.

Prices in the state have tripled in the last decade, but most of the gains have come since 2003, when subprime and adjustable-rate lending took off. That allowed people to buy homes with debt they really were not able to repay. As long as prices went up, no problem: borrowers were able to refinance when the introductory rate rose or even sell for a new higher price that more than paid off the debt.

But when prices begin to fall - by 6-9 percent in the major metropolitan areas so far - that logic no longer held. What's worse, the investors who had been buying the debt got wise and cut off the tap. Market rates have gone up, lending criteria have gotten tighter and a bunch of borrowers have handed the keys back to the lenders, who then try and sell into a plunging market.

In Sacramento County in September, 27 percent of all sales were by lenders who had repossessed homes.

Alex Barron says if you really want to see how far prices will fall, look at auctions of bank-owned real estate and at some of the fire sales now being held by developers.

"The builders are already pricing their homes 30-40 percent lower than they were at peak," he said.

"(Bank-owned) prices have come down 30 percent or so from where those loans used to trade at, as well. If the last clearing price is that much lower, everything is going to get there sooner or later."

A report released by Goldman Sachs last week called Californian house prices 35-40 percent over-valued in a note to clients.

Gains up through 2003 were largely driven by good fundamentals, rising disposable income and falling interest rates, according to the note. But in 2004, as "affordability" loans such as subprime took off, so did house prices. As of the last quarter of 2006, 41 percent of all loans in California were subprime.

Barron sees top-to-bottom falls of 50 percent, while Thornberg is looking something on the order of 25 percent.

While these are far worse than consensus, falls of those magnitudes in California house prices would have far-reaching effects.

California would tumble into recession, raising the risks of a national recession. The rate of default by prime borrowers would also spike upwards, putting further pressure on bank balance sheets and deepening and hardening the credit crunch.

Those types of house price falls are almost certainly a lot higher than the assumptions used by the ratings agencies, so expect to see another round of shock and losses by holders of so-called safe bonds.

If the bailout fund for bank-affiliated structured investment vehicles (SIVs) is going to be $80 billion, how big a fund will we need for California?

From: Patrick.net news

Home Builders and Calif. decline forcast

The home builders are now getting massive cancellations on their home sales. For the most recent quarter, here are the cancellation rates for the nation's biggest builders.

KBH homes .........50%
D.R. Horton .........48%
Lennar Corp..........32%
Pulte Homes..........28%
Toll Bros...............24%


Oct. 22 (Bloomberg) -- Californian homes are overvalued by as much as 40 percent and stricter lending standards will probably contribute to ``material'' price declines, according to analysts at Goldman Sachs.

Prices in the state ``have proven surprisingly resilient, given the severe curtailment of credit availability and rising unemployment,'' the analysts said in a note to investors. ``However, we believe that a downturn is imminent.''

In August, the median price for houses in California was $589,000, though economic conditions only support prices of $350,000 to $380,000, the analysts said. The average U.S. home is 13 percent to 14 percent overvalued, the report estimated.

Home sales in California, as in the rest of the U.S., are being hurt by the collapse of the subprime-mortgage industry. Lenders are requiring higher credit ratings from borrowers seeking mortgages and are demanding larger down payments. Standards are particularly strict for jumbo loans, mortgages higher than $417,000, which are common in California.

The median price for houses and condominiums in California will probably drop 4 percent to $553,000 in 2008, the Association of Realtors said Oct. 10. That would be the biggest decline in 15 years.

Baby Boomers - Social Security - Gold

The monster drain on money as the first segment of the Baby Boomers helps themselves to their share of Social Security. These are the people who were born in 1946 and are now 61 years of age. Shortly, an increasing number of these "baby boomers" will be taking early retirement.

Why do I say that? Heck, read the papers. All you hear are these four words -- "escape," "vacation," "travel" and "retirement." But as I said, it's just starting. We're beginning to move into what I call the "Social Security Express Lane." This is the period when those people who were born between 1946 and 1964, 80 million in all, will qualify for Social Security.

The boomers are from a different era. The boomer dream appears to be -- "I made a fortune at age 45, and I retired. Now I'm playing golf seven days a week and lovin' it."With the SS trust fund bare, cleaned out and holding only government IOUs, how are all these boomers going to be paid? On top of that, there's Medicare, which is now paying out more than it's taking in. Looking at the whole picture, the Heritage Foundation warns, "This is the single greatest economic challenge of our era." You think the US government's balance sheet is over-the-top now? Listen, over coming years, these programs will rack up $50 trillion in government obligations. How's it all going to work out?

I have my own thoughts on the Social Security and Medicare situation. I believe that the US government will address the situation two ways. The first way will be to scale back on the benefits -- there's just no other choice. The second way that the US government will address the situation will be through monetary inflation. The government will have to print the money to cover the coming tidal wave of unfunded liabilities. This process will have a brutal impact on the dollar. The purchasing power of the dollar will continue to head down. In my lifetime I've seen the purchasing power of the dollar lose 80 percent of its value. And I have to wonder what the dollar will buy ten years from now -- fifteen years, twenty years. It's very sad, indeed.

This is the reason to own gold. I hear a lot of talk about gold not keeping up with inflation, gold spending twenty years between 1980 and 2000 doing nothing or simply declining. Forget it, that was then, this is now. As I see it, the third phase of the great gold bull market lies ahead. Gold is fated to rise to "impossible" heights in terms of current US dollars. I know this sounds far-fetched to today's impatient holders of gold.

But for a great move to materialize, it has to be considered to be "almost impossible" in advance. Another way of putting it is that for a move to by huge, the public has to be clean of the item to start with. Ideally, nobody should be in the item. And today the US public is "clean as a whistle" when it comes to owning gold.

From: RR at DowTheory

Third phase of the stock market

I envision the housing mess slowly being resolved. I see the "cheap" US dollar rendering US manufacturing very competitive (at last). I see world liquidity staying at high levels, and I see a period of coming extraordinary prosperity. In the meantime, with communication and computers increasingly available, the downtrodden populations of the world will see the benefits of freedom or at least the benefits of free enterprise.

Note that the Dow is pushing subtly higher and higher. Where's it going? It's going ever closer to the "big show," that's where it's going As a matter of fact, I believe the Dow is leading the way to the "big show." Yes, the Big One, the mega-third phase of this bull market lies ahead. It may take into next year, but it's a'comin'. So hang on to those Diamonds (DIA).

How about Dr. Copper? I haven't talked about this "international barometer" of world health for a while. As a matter of fact, Dr. Copper is pressing against its ceiling, the ceiling being outlined by that extended horizontal blue line. China is a major user of copper, and so is most of Asia. If copper still possesses its barometric properties, then the world economy continues to be in good shape -- actually in better shape than the US is in, since the US is still wrestling with its housing "sickness."

From: DowTheory

Outlook for the economy

We expect overall job growth to slow during the next six to nine months, as the declines in home sales and residential construction ripple through the broader economy. Rising mortgage rates and higher energy costs will also cut into discretionary income, causing consumers to cut back.

But even with all the challenges we see today, spending will still increase. The rise will simply be less than we have seen in recent years. Real personal consumption expenditures should average a 2.2 percent pace over the next three quarters.