Washington Real Estate: 40% overvalued?

I ran across this very interesting analysis of the California real estate market by Goldman Sachs this weekend (PDF alert!). It is the author’s contention that in the past, changes real estate prices could be explained by two factors: disposable income and interest rates. They then go on to demonstrate, as shown below – how accurate this model was from 1985 to 2003. It’s pretty simple, but it makes a ton of sense – the amount that buyers have available to spend and the amount it costs them to borrow drive prices. And the model explains 82% of variation in home prices as represented by the OFHEO index. Genius!

california.png

Then in 2004, values started to diverge from this long term trend. Here’s how the author explains:

House prices are significantly over-valued in California
Our house price model indicates that Californian homes are 35-40% above the price range implied by current and forecast economic conditions (compared to 13-14% over-valuation nationally). As of August the median house price in California was $589K, but economic conditions support prices between $350-380K; material price declines are likely, in our view. From 1985 to 2003, 82% of quarterly variation in the OFHEO index for Californian home prices could be explained by two factors (state-level disposable income and interest rates); but this relationship broke down in 2004. We believe that sales of “affordability products” (e.g., subprime, option ARMs) – which spiked in 2004 – drove Californian home prices above levels supported by economic conditions; now that the secondary market for these products has evaporated, we expect home prices to return to normalized levels (as prices fall and disposable incomes grow).

While I don’t get paid like a Goldman analyst, I figured that I could probably find the data to replicate their analysis and see what it said about Washington state. I was able to find most of what I needed, with the exception of two things: 1) I could only find annual data for disposable income, and 2) I had to estimate the 2nd quarter disposable income for 2007 (which I did on the basis of the growth in overall personal income growth). Given those two caveats, the results for Washington are remarkably similar to those for California.

washington.png

While we see that the boom started a bit later (2004 results are right on the trend line), in 2005 and beyond the prices have soared far above the long term trend line. And in our case, the relationship between the underlying fundamentals and the changes in house prices appear to be even stronger than the GS California model: they explain 91% of the annual variation in home prices in Washington state.

So what does it tell us? Based on the Goldman Sachs approach – Washington home prices were 35% overvalued versus the long term trend at the end of 2006, and a whopping 44% overvalued at the end of the second quarter in 2007. Interesting stuff. We will see how accurate their forecast is for how things fall out. But one thing it points out for certain – the real estate market in our “special” state doesn’t really seem to be all that different than that of our neighbors to the south.

69 comments:

  1. 1
    incessant_din says:

    There is a fatal flaw in this analysis. It is difficult if not impossible to detect a bubble before it pops. Easy Al Greenspan said so.

  2. 2
    jon says:

    A straight line for Disposable Income/Long-terms rates is just saying there used to be a rule that your mortgage payment could be no more than 28% of your income. When they changed that rule the line moved. The graph doesn’t really say where the line should be.

    I think the comment in that other article about how subcontracters used to hang up if you asked about cost has a lot to do with the current drop in prices also.

  3. 3
    Scotsman says:

    Nice work, Tim! You’ve put together another fine example of how fundamentals will always set prices in the long term. While many variables besides income and interest rates can bump prices around in the short term, in the end it will always come back to affordability. And of course interest rates and local income levels are the main determinants there, with a nod to property tax rates and the general economic health/trend of the region.

    One can get the same sense of the data by going to Zillow, selecting the 10 year price history of a specific house, then looking at the slope of the line over time. Remoldels, etc. of course provide exceptions, but for most homes the slope is pretty constant up until 2004 when it starts to climb. I’m betting on prices returning to the trend line, which means they will have to drop about 40% from current levels. And unless inflation starts to drive wages up- which hasn’t happened yet- the drop in prices will have to be real. Inflation, without increases in wages, will not be enough to close the gap. And with the U.S. economy as a whole facing constraints of all kinds I’m betting personal income stays pretty flat for some time.

    Allow me to repost one of my favorite graphs……

    http://graphics8.nytimes.com/images/2006/08/26/weekinreview/27leon_graph2.large.gif

  4. 4
    The Tim says:

    While I’m certainly not one to turn down praise, I don’t deserve the credit for this post. Note just under the title: “Author: deejayoh”

    It is indeed an excellent post.

  5. 5
    christiangustafson says:

    Nice work, Tim. I’ve been saying 40% off for a long time, based on simple intuition.

    To get there … will be great Schadenfreude fun. Get on with it! I love it.

  6. 6
    Scotsman says:

    Yeah, yeah, … he’s good too! ;-)

    Sorry, Dejayooh- nice work!

  7. 7
    A says:

    You tried so many times to prove Washington is not California that I don’t understand you corellating them now.

  8. 8
    A says:

    You can also adjust the time for posted comments.

  9. 9
    laxtosnoco says:

    Good stuff Dejayooh. Much more thoughtful and relevant than choose your favorite gaming system.

  10. 10
    TheDexter says:

    Uh, no. This is wishful thinking. The realm of fantasy, actually. Don’t hold your breath about Seattle real estate being anything but an appreciable asset.

  11. 11
    JayB says:

    Always appreciable, yes. Always appreciating – no.

  12. 12
    finance says:

    Its ironic that another report mentioned that Seattle was about 35% overvalued several months ago.

    However, DJO do you know how discressionary income calculations are made, as stock prices of companies in this region have gone up sigificantly more than the stock market over the past several years…thus more extra income to spend (except for my former employer WaMu, their stock price is dropping at the rate of $1/day, lol). BA, MSFT, AMZN, that company MSFT just bought that jumped 80%…gotta run to work otherwise would look up actual NW stock companies that have done very well.

  13. 13
    SLTO says:

    just pointing out 35% over valued doesn’t mean 35% price drop…

    if X is worth 100 and is 35% over valued it’s priced at 135…

    35% discount from 135 is 87…

    so 100 is actually 25% price drop from 135… doesn’t change the point much… but expect to see a 20-25% price drop based on that graph…

  14. 14
    50% Off says:

    Let’s throw in the concept of ‘reversion to the mean’. Typically when one deviates from the mean and then corrects, there is an overcorrection the other way. With the (re) tightening of standards you’ll get back to the usual DTI mean. But throw in overbuilding, bank REO on the market, general revulsion to real estate (which will happen for a while), and the smaller pool of buyers due to RE related unemployment, BK’s, FC’s, and tighter standards and I’m still believing that we’ll see …. yup, you guessed it…. 50% Off

  15. 15
    deejayoh says:

    Finance

    Disposable income is from the BEA, here. I doubt you will get to far on a personal jihad to prove it wrong via stock prices – but have at it. Then remember how many companies have done well in california.

  16. 16
    The Bruce says:

    Don’t forget the inevitable role hyperinflation will play. Prices should drop, but with our flailing dollar and the Feds continuing to cut interest rates, they won’t ‘look’ they they have been devalued as much as they really will have plummeted..

  17. 17
    on topic says:

    so, prices went up b/c of affordability products.

    affordability products are currently less attainable b/c of questions in the financial sector, they are an unwise financial choice for the buyer in a flat or depreciating market, but they are not illegal (right?)

    so, if the available loan product hasn’t reverted to the historic state, why would the prices revert to their historic state?

    it’ll require a change in psychology. so far, in my work and social circles, there is no evidence of a change in psychology regarding housing

  18. 18
    The Bruce says:

    Question for the economists out there – how long can the Fed continue to cut rates with such a weak dollar?

  19. 19
    Olaf says:

    No change in pscyhology regarding housing? You’ve got to be kidding. The home-owners I know are panic-stricken (the ones who were goaded into buying too high); and the renters I know are relieved they didn’t buy. Asking prices are falling fast — even in the coveted “close-in” neighborhoods. A year ago, everybody’s asking price was at least 20% above the Zestimate. Now everbody’s asking price is below that line — sometimes well below. Go on Redfin and search the Ballard area for the number of homes that have been listed for 45+ days — I’ll save you the work, it’s over two hundred. Just Ballard.

    Sorry, “on topic,” but the psychology changed three months ago.

  20. 20
    betamax says:

    “Don’t hold your breath about Seattle real estate being anything but an appreciable asset.”

    LOL. Ostrich investors said the same in FL, CA, AZ, NV, MA, etc etc etc a short year ago. All wrong.

    Wishful thinking indeed.

  21. 21
    Jonathan says:

    But prices can never go down! You guys just don’t understand The New Economy. Typical of old fogies.

  22. 22

    I’D ADD FORECLOSURE PRICES IN TOO

    There’s almost no savings cash in Seattle or America to speak of. The 401Ks don’t count, no one’s cashing them in before retirement.

    Imagine when the savings cash that’s out there dries up after the recent foreclosure sales dry up even part of this small cash pot, in a few years.

    35-50% reductions at the auctions I predict, from today.

    During the Great Depression almost new used cars were going for 10 cents on the dollar. Have you tried selling a Harley Davidson or a small plane lately, without reducing last year’s price 50%?

  23. 23
    Carolyn says:

    Check this out:

    http://www.nationalcity.com/corporate/EconomicInsight/HousingValuation/default.asp?WT.mc_id=100206

    Seattle and Olympia: 38% overvalued.
    Tacoma: 42% overvalued.
    Bellingham: 51% overvalued.
    Mount Vernon: 46% overvalued.
    Bremerton: 35% overvalued.

  24. 24
    TJ_98370 says:

    Good work once again DJO. Now about that spaghetti monster thing over in the forums……….

  25. 25
    Eric says:

    Sold my house in Bay Area in Oct 2006 (got lucky) and moved to Chicago. Will move back out to the left coast (Seattle area) after the upcoming house price collapse. See you in five years!!!

  26. 26
    Nozferat says:

    I think this whole housing market mess was done on purpose.

    1) To drive prices up to create revenue for the states and the fed…i.e…war is coming.

    2) To raise the bar on what is expected of people to pay for housing per a percentage of their paycheck.

    It’s worked. They’ve driven up housing prices so far that there is no hope of return to what is should be. Even when prices come down, and all dust settles, the graph you’ll see is a step style graph…where this era will show up as a large step up from what the linear graph should have us at.

    The best form of slavery is the economic kind…where people have no room to breath and have to work all the time to support themselves. Poor people in this country are well aware of that. It’s the douche bags driving around in their Escalades, Hummers, Expeditions with stickers of “Support the Troops”, who have 2, 3 kids, live in the dull, drab, and over-rated areas such as Simi Valley, Moorpark, Santa Clarita in their McMansions paying $2500, $3000 per month, big screen TVs, no life…just clean their kids diapers, etc who think they’ve got it made. The douches don’t know they’re stuck where they are and are buried up to their eyeballs in debt. But hey…they drive an Escalade.

  27. 27
    Marc says:

    I think Bruce made a great point about inflation masking a real decline in house prices. If this allows the NWMLS to continue showing year over year monthly and quarterly price gains in Seattle and the East Side, the psychology of the local market is likely to continue its divergance from the national psychology regarding housing. That is to say, a large enough proportion of the local populace may take such price “gains” (or lack of declines) to mean they should refuse stupid-low ball offers, pull their houses off the market if offers are “too low” (or too few), and/or refrain from listing their houses until the market improves. IMHO, on balance, the Seattle psychology is not currently as dark as some of the folks on this blog want to believe.

  28. 28
    B&W Nikes says:

    Thanks for putting that together deejayoh. If real estate in one of the worlds top ten economies is overvalued by more than a third, it is an epic admission. Who is going to accuse Goldman Sachs of being marginal conspiracy theorists, or even of stinkin’ thinkin?
    Dexter probably has a point about Seattle RE remaining an appreciable asset (in the long run). But he and others like him have have the fantasy part wrong. The fantasy lies in *believing* that assets only move unidirectionally in valuation, independent of other influences. Understanding that assets are comprised of both liability and equity may help bring some more sunlight into the misty utopia of endless appreciation through positive affirmation.

  29. 29
    50% Off says:

    Key word is ‘currently’! Also, inflation whether via current gov’t numbers or shadow statistics’ numbers isn’t going to save the numbers from going down in real terms. Inflation will only ‘help’ if wages go up concurrently,which they have yet to do.

    I know, it’s hard to accept that the perfect storm of circumstances is bearing down on the dear old NW along with the rest of the country but those here are ones who have looked beyond the emotions of their own situations and seen the inevitable.

    Remember, “it’s hard to persuade a man whose living/dreams/beliefs depend on his NOT understanding the facts” (paraphrased from somebody)

  30. 30
    deejayoh says:

    Just to be clear, I’m not making any predictions about where prices go. I’m just pointing out that we are way out of bounds for any historical norm. We could get back to the mean via inflation, 10 years of flat returns, a price drop, or some combination. I’d bet on the combo view.

    as for this comment…

    A straight line for Disposable Income/Long-terms rates is just saying there used to be a rule that your mortgage payment could be no more than 28% of your income. When they changed that rule the line moved. The graph doesn’t really say where the line should be.

    and this one

    so, if the available loan product hasn’t reverted to the historic state, why would the prices revert to their historic state?

    I think they miss the point. There is no “new norm” on lending. It was a fallacy – like the new valuation models that Wall St pushed in the dot-com boom. Easy loans are gone, and I doubt they return. That’s why Citi and Merrill are writing off $10B each, more to come…

  31. 31
    patient says:

    Thanks dj, it’s always nice when someone brings things back to reality based on what really has an impact without the noise of marginal factors as stock prices, lack of land, population growth etc,etc,etc.

    I think this valuation increase is comaprable to a tax increase for the majority of buyers. This is what the fed and the government should be really concerned about, think ~20-50% added tax on the working and middle class. ( Housing is the main expense for these segments ). This is what will be devestating to the consumer and economy in the longterm.
    Their main focus should be to encourage rapid price deflation of homes if they want to save the economy long-term.

  32. 32
    TJ_98370 says:

    50% Off –

    Upton Sinclair

    “It is difficult to get a man to understand something when his salary depends on his not understanding it.”

  33. 33
    Markor says:

    Seems to me that house prices on the Eastside were lower this summer than they were at the end of 2005, a few lucky sellers notwithstanding. I don’t see how Case-Schiller’s or OFHEO’s numbers reflect reality. I don’t trust analyses based on median prices, since such data are easily skewed by, say, mansions.

  34. 34
    50%off says:

    TJ
    Thanks. I figured someone would know what I was referring to.

  35. 35
    Scotsman says:

    I used to think that inflation would be the way out of the current imbalance, but no more, for several reasons. First, the FED has indicated that it was surprised by the dollar’s rapid fall in response to interest rate reductions, and at some point they must act to stabilize the dollar. Recent talk suggests the rate cuts are over for the foreseeable future, and stable/rising rates are anti-inflationary. Second, the government is facing huge entitlement costs for the baby boom generation, and these are all tied to inflation adjusted payments. To have any hope of containing costs, the government must work to restrain inflation. Third, we are about to enter a huge credit contraction, and that means fewer dollars in circulation even if the FED dumps dollars on the street. Finally, wage increases, and hence production cost increases, are the main engine of inflation. Wages are not increasing at any great rate, and foreign competition and out-sourcing are going to continue to exert downward pressure.

    Here in Seattle we’re just coming over the top and starting the downward slope. What many can dismiss now will be much more obvious and generally acknowledged by Spring ’08. Reality always wins out over wishful thinking, and the facts do count.

  36. 36
    Markor says:

    I’d say a falling currency is a main engine of inflation for a country that imports most of its goods. What the excellent analyis by deejayoh does not factor in is the fact that the whole US is falling off a cliff financially, due largely to W’s incompetence (or genius, if you own his buddies’ stock). That’s a big change from the past.

    The most likely way for the fallout to be mitigated is that the feds print money as fast as they can; otherwise the US would default on its debt and all hell would break loose. That means massive inflation, which house prices should keep pace with in the long run. In the long run we should expect to see a big spike in house prices due solely to inflation.

    The government can work all they want to restrain inflation, but that’s not going to happen when two wars are in quagmire status, a third is being planned, and NASA is readying a $trillion mission to pick up a few rocks from Mars.

  37. 37
    Kiran says:

    Nice analysis. But I see house inventory in King county keep decreasing. Few days ago it is more than 11.2K now it is 10.8K. From the basic business principles less supply means more demand so higher the prices will be in the open market. Can some explain why rest of the factors could affect King county when inventory supply is getting less?

  38. 38
    shotsix says:

    This is depressing (at least for those of us who make responsible economic decisions): http://money.cnn.com/2007/11/01/real_estate/Countrywide_bail_out_bashers/index.htm?cnn=yes

  39. 39
    Angie says:

    Deejayoh, that’s interesting stuff, but I have to wonder about how useful it is to consider these numbers on a state by state basis, you know what I mean?

    It seems hard for me to believe that prices in, say, Weed or Yreka, directly paralelled what was going on in San Diego. Or, in Wash state, if Washtucna saw the same kinds of price changes as Bellevue.

    And, total disposable income in the state? Probably a lot more in the big cities than the rural burgs…

    The lines are pretty, but I’m skeptical about how robust the conclusions are. Location, location, location…

  40. 40
    biliruben says:

    Kiran – the inventory decline is a seasonal effect that occurs every year. We are actually seeing less of a decline that we usually do in November.

  41. 41
    biliruben says:

    You gotta be kidding, Angie. The 5 dollar fried chicken in Washtucna brings all the real estate moguls for thousands of miles. Now Othello, on the other hand; just look at a house sideways in Othello and the price goes down.

  42. 42
    Buceri says:

    This morning on NPR; savings rate in China? 40% (and they don’t earn crap).
    As usual, good article on Bernanke by Jubak.
    http://articles.moneycentral.msn.com/Investing/JubaksJournal/TheFedsNewestChiefIsAWuss.aspx?page=all

    How do you guys do the hyperlinks in this blog?

  43. 43

    HI MARKOR

    What inflation, the 1980+ type CPIs running 2-3%….that foreign deficit you talk about is filling Walmarts with $19 DVDs and the Chinese Chery is about to put Toyota out of business with $2500 luxury cars next year.

    Couple that with Seattleites/Americans making about $44K average household income stagnant since 1999 and there’s plenty of buyers for hey, $200K homes, if all the banks don’t go broke in the next few years trying to bail out the $300K loans and more outsourcing doesn’t lower our wages to $22K per household……

    I can just see Washington Mutual approving $400K home loans lickety-split with all this inflation in housing? Not.

  44. 44
    b says:

    Kiran –

    Inventory is seasonal and always declines during the winter months then goes back up in the spring. Prices will not increase because demand also follows the same seasonal pattern.

  45. 45
    notabull says:

    Markor said: “Seems to me that house prices on the Eastside were lower this summer than they were at the end of 2005, a few lucky sellers notwithstanding.”

    I sold a house on the Eastside at the end of 2005, and follow the market there very closely right now, in similar neighborhoods.

    In my view, the prices are still higher. I would estimate that a house that sold for 450K back in 2005 would likely sell for somewhere in the mid to high 400s. It would probably even be seen as a bargain, assuming a buyer could actually get a loan for it and “afford” the payment. I’m *guessing* that selling prices there (in that price range) are about 7-10% higher right now compared with the end of summer 2005. Listing price is another matter entirely. The listing price for a similar house would likely be 499 to 525K right now.

    Only the least expensive places sell right now, and it seems VERY infrequent that I see anything sell for more than 500K. Properties for less than this sell pretty quickly, as long as they’re not total dumps, or tiny.

    That’s what I’ve been seeing anyway… As I say, I watch this particular market (Issaquah, Samammish, Redmond) pretty closely.

  46. 46
    jon says:

    “Easy loans are gone, and I doubt they return. That’s why Citi and Merrill are writing off $10B each, more to come…”

    Citigroup Inc. (C) Total Cash (mrq): 987.98B
    Merrill Lynch & Co. Inc. (MER) Total Cash (mrq): 730.58B

    Drop in the bucket. And where did all the water in the bucket com from? Competitive loan products.

    I’ll believe teaser rate ARMS are gone when I stop getting advertisements for them in the mail. Sure, it’s down to several a week instead of several a day, but I’m still getting them. (I have a interest-only ARM, so even though it’s fixed rate for eight more years, all the marketing computers think I need to refinance)

  47. 47
    patient says:

    Angie, you might have a point that the numbers and conclusions are are not very accurate for areas outside the main population centers of a state but for the Seattle metro area I think they should be a good indication.

  48. 48
    Angie says:

    Bili, the only thing that’s more attractive to real estate investor than the fried chicken in Washtucna is the World’s Biggest Lava Lamp over in Soap Lake. Even the mere *dream* of the World’s Biggest Lava Lamp. Mark my word.

    Patient, maybe this kind of analysis does work if the data gets down to a more local level. But I’m looking at those numbers and thinking, how does Seattle fit in? $317K (the “top” number in the graph, the June 2007 figure) still barely gets you in the door anywhere in the city of Seattle or across Lake Washington. That value reflects the state median—half of prices are higher, half are lower—so pretty much all of Seattle and the Eastside are on the top side.

    The question becomes, what happens to the values along the X axis if you only focus in on Seattle and/or the Eastside? Hard to say off the cuff—cost of living is higher, but all stats say that KC, Seattle, and the Eastside all have higher earnings than the rest of the state, too..

    Just idly wondering. Anyone want to crunch the numbers, knock yourself out.

  49. 49

    Kiran,
    You have to look at year to year comparisons for inventory, such as October 06 vs October 07, and you’ll see that the 07 figure will be substantially higher. It might be lower than the previous month, but prices can’t keep going up if total sales are down and inventory is up. Not for very long, anyway.

  50. 50
    Kime says:

    “The most likely way for the fallout to be mitigated is that the feds print money as fast as they can; otherwise the US would default on its debt and all hell would break loose. That means massive inflation, ”

    This is exactly what has already happened. Keep in mind the Fed does not “print” money. It encourages an increase in credit, which inflates the money supply. The inflation we have seen in the past few years is a direct result of the increase in the money supply caused by the housing boom. The low CPI is just a result of tampering with the evidence by the government, we all know inflation has been rampant on the items they no longer include in the CPI.

    The problem for the Fed is that it doesn’t have any more cards up its sleeve. How are they going to prevent a contraction of this huge credit bubble that has been growing for probably about 20 years but the last few years have been the worst? The sub prime crisis is the beginning and by the end we will see how the upward spiral of the RE boom can turn around and spiral down and the credit (or money supply, or at least a significant part of it) will evaporate into the place from which it came (nowhere) along with all the “wealth”, which really means added debt, that people had from their housing ATM’s, except that people who don’t default will still have the debt but not the wealth. This is deflation. Lowered home prices and lower prices on other things, but not everything, should be the result, along with a lot of problems for the government.

    How is the Fed going to encourage lending with so many defaults? When perceived risk is higher, then either no one will lend, or the rates have to go up, and the Fed can’t change that. If the bond market says higher rates, and I think at some point during this RE bust it will, the Fed will follow, just like it has been following the bond market in lowering rates lately.

  51. 51
    deejayoh says:

    Citigroup Inc. (C) Total Cash (mrq): 987.98B
    Merrill Lynch & Co. Inc. (MER) Total Cash (mrq): 730.58B

    Drop in the bucket. And where did all the water in the bucket com from? Competitive loan products.

    Wow. do you really think comparing a write off (which is INCOME) to the total BALANCE SHEET position of a bank (which includes the money that their customers have with them in their accounts) makes any sense at all?

    Take a look at their market caps:
    MER Market Cap (intraday)5: 48.22B
    C Market Cap (intraday)5: 174.51B

    Drop in the bucket?

  52. 52
  53. 53
    TJ_98370 says:

    Jon – FYI

    Easy loans are going away –

    Fed: Mortgage standards tightening

    ……The Fed survey, which was conducted in early October, found that 41 percent of banks responding said that they had tightened loan standards either “considerably” or “somewhat” for prime residential mortgages, those offered to borrowers with strong credit histories
    The 41 percent figure was up from about 15 percent of banks who said they were tightening standards on prime mortgages in the last survey in July. The Fed’s survey covered 49 banks, including many of the nation’s largest. These banks account for about 75 percent of all residential real estate loans on the books of commercial banks.

    The Fed’s quarterly survey of senior loan officers found that 60 percent of the banks that offered nontraditional mortgages had tightened lending standards, up from 40 percent in the July survey. The Fed’s definition of nontraditional mortgages covers such products as interest-only loans and “Alt-A” mortgages that require limited verification of income.
    The survey found that 56 percent of banks still offering subprime mortgages tightened standards in the latest survey. However, the survey said that 40 of the 49 banks surveyed said they are no longer offering subprime mortgages. Of the nine banks that are still providing such loans, five said they had tightened standards while four said lending standards were basically unchanged…..

    ————————————–
    Below is a link to Citigroups 3rd quarter 2007 financial statement

    Citigroup 8K

    I claim to be no expert on reading financial statements, but it appears that Citigroup is carrying $40B of delinquent securitized receivables (loans held for sale) in 3rd Q of 07, $36B of same in 2nd Q of 07, yet held zero of these type loans in 3rd Q 06. Are these the now legendary “junk” status mortgages that nobody will buy in the secondary mortgage market?

  54. 54
    deejayoh says:

    Calculated Risk: Citi’s Assets: Opaque and “Stinky”
    Mish: Citigroup Fighting For Its Financial Life

    And of course, both Merrill and Citi fired their CEOs. And their stock prices are down (MER from ~$90 to $56 in six months, C from ~$55 to $35). No big deal. Happens all the time.

    Now GM has written down $39B of assets today. yawn.

  55. 55
    jon says:

    “Wow. do you really think comparing a write off (which is INCOME) to the total BALANCE SHEET position of a bank (which includes the money that their customers have with them in their accounts) makes any sense at all? ”

    Sure $10B is a lot of money in terms of profit to companies that sell identical products and compete solely on price, and hence have very narrow margins, but to the underlying market it’s not that big a deal. So losing $10B out of a year’s profit sucks, but compared to $1T of deposits it can be handled.

    The reason the subprime market isn’t going away is because it provides a valuable service. It’s just that it was introduced so fast that it created distortions in the market that Wall Street’s pricing models didn’t account for. After this initial wave goes through (by no means the first wave of overbuilding in history), adjustment and refinements will be made, but mainly the market will again be stable but at a higher level that is supported by the new way of financing.

    When paper money was first introduced, there were plenty of abuses, but the concept survived. The same will be true with tranches. In this case low lifes at WaMu ran scams, and builders overcharged, and that caused big problems, but in tamer markets, possibly including Seattle (only time will tell) the market may be able to absorb the sudden change.

    So back to the graph, the new line will remain at a different level than it was before once the crooks are uncovered and the market gets back into a steady state.

  56. 56
    deejayoh says:

    So back to the graph, the new line will remain at a different level than it was before once the crooks are uncovered and the market gets back into a steady state.

    Jon – that’s a rather sanguine view. I’m not sure it is shared by many of the former employees of these guys .

    I think your definition of “steady state” is very different than mine, cuz the last 3 years have been anything but.

  57. 57
    b says:

    jon –

    The ABX indexes (http://www.markit.com/information/products/abx.html) disagree with your assertion that subprime is going to be around forever. BBB rated stuff is getting 20 cents on the dollar, with AAA rated getting 76 cents on the dollar. NOBODY is going to want to touch this stuff again.

    For some further reading on why these 10b here, 10b there writeoffs are a big deal see http://www.rgemonitor.com/blog/roubini/224871.Most of these IB’s have level 3 (aka mark to made up) assets that are much larger than their capital base. If these IB’s were forced to actually mark these assets to their fair market value, all of them would be INSOLVENT. Let that sink in for a minute. This is why our corrupt Treasury secretary tried to create the super SIV, to help fraudulently hide these assets with made up values until a bailout can be created. Fortunately that plan seems to be DOA because everyone knows a shit sandwich when they smell it.

    If you look at how weak the dollar is, and how it is basically dropping like a stone every day, you can see what the rest of the world thinks of our market right now. The game is over, the only question now is how much you and I will pay in taxes and inflation to bail out Wall Street.

  58. 58
    Joel says:

    When paper money was first introduced, there were plenty of abuses…

    Man, it’s a good thing that isn’t happening anymore.

  59. 59
    jon says:

    “BBB rated stuff is getting 20 cents on the dollar, with AAA rated getting 76 cents on the dollar. NOBODY is going to want to touch this stuff again.”

    Back in the 80’s the big scare was over junk bonds. They too went below 20 cents on the dollar (source), and that market is alive and well (under some stress under the current correction of course). The innovations behind how that market works were carried over into the mortgage market, so not only did that market survive, but it spawned a new one.

    “If these IB’s were forced to actually mark these assets to their fair market value, all of them would be INSOLVENT.”

    That’s true only if you assume the fair market value is very lower than the model, which it may or may not be.

  60. 60
    Mr. Stock Market says:

    “MER from ~$90 to $56 in six months, C from ~$55 to $35”

    Stay away from Seattle Real Estate; too risky.

  61. 61
    TJ_98370 says:

    So back to the graph, the new line will remain at a different level than it was before once the crooks are uncovered and the market gets back into a steady state.

    Jon – you may be right, but I suspect major changes (like improved transparency) have got to occur before investor’s trust securities like CDO’s again, and I do not see that happening overnite.

  62. 62
    The Pat says:

    How can you all have missed the food bubble? Prices have gone up dramatically more than wages or CPI. They are unaffordable and totally out of whack with the fundamentals. (Look at the incredible mismatch between a gallon of milk and McDonald’s dollar menu).

    While some fools bankrupt themselves at the grocery store, I will sit on the sidelines. When the crash comes, I’ll use my savings to feast on filet, (down 45%).

  63. 63
    Markor says:

    notabull,

    Let’s say selling prices in Issaquah/Redmond (in that price range) are about 7-10% higher right now compared with the end of summer 2005. The link above (http://www.nationalcity.com/corporate/EconomicInsight/HousingValuation/default.asp?WT.mc_id=100206) shows about 18% during that time (from $343K median to $406K). The bubble numbers reported seem to be a lot higher than house prices have actually appreciated. 7-10% could just be 3-4% annual inflation. From memory, gas prices have risen about 40% since then.

  64. 64
    b says:

    Jon –

    The difference being that junk bonds pay extraordinary yields comparatively, and cannot be purchased by most large investment funds. I would be pretty surprised if anyone could make money selling mortgages to deadbeats at credit card rates, which is what they will have to do to sell the securities, especially on a depreciating asset. The market may not disappear completely, but it will be about 1/10000th the size it is now.

  65. 65
    Marc says:

    I for one agree with Jon that the market for subprime loans is not going away indefintely. Especially with an election year coming up. If there’s one thing we can count on it’s the ingenuity of Washington to figure out a way to maintain the status quo in hopes of squeezing out an election day victory.

    I also think the markets and the public have an increasingly short memory for scandalous financial events. In less than half a decade Enron is little more than a catch phrase and a business school case study. Long Term Capital Management, Russia’s default, Asian stock meltdown? Mere hickups in the chase for the almighty dollar, err, euro.

    I’m not sanctioning such political ingenuity, simply pointing out the new (or not so new) reality.

  66. 66
    jon says:

    “The difference being that junk bonds pay extraordinary yields comparatively, and cannot be purchased by most large investment funds.”

    That’s the whole point of the CDO’s behind the growth of the subprime market. By splitting the mortgages into difference tranches, the senior ones are then safe enough for AAA funds. The remaining tranches are riskier and higher yielding, which is more appealing to other investors. That kind of specialization adds value and is how the IB make money.

    Where it went wrong is that the sudden infusion of that money that CDO’s made available then created short-term problems related to driving costs up because now everyone can afford granite countertops. The builders saw the sudden demand and charged above the equilibrium price. Nothing wrong with that, but Wall Street didn’t take account of the fact it was a one time event, and that costs would soon revert normal. So now replacement costs are back down by 10% or so, taking existing home prices down with them.

  67. 67

    […] Washington Real Estate: 40% overvalued? […]

  68. 68

    […] analysis may remind you of Deejayoh’s excellent post that compared disposable income, interest rates, and home prices from 1985 through 2007. The data is slightly different, but the conclusion is largely the same. Today’s home prices […]

  69. 69

    […] of increase in both of these is governed by increases in income over time (as discussed here and here by Tim and myself, and in the aforementioned […]

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