Real Wealth Society

Thursday, February 16, 2006

Pop Goes The Real Estate Weasel (Part 2) By Wayne N. Krautkramer


All attempts at forecasting the end of the housing boom are doomed from the git go! Rational analysis can’t be applied to an irrational process.


We must reduce the problem down into its basic components to solve the equation!

The first problem is one of demand. Demand must be broken down into theoretical demand, and effective demand.

Theoretical demand is the sum of all the population who would like to have the product. Almost the entire population would like to have a new house/condo.
Effective demand is the number of people who can afford to buy and maintain the product.

This is where rational analysis first goes wrong. The real estate market is heavily subsidized by the government. The primary hurdle to home ownership used to be the down payment. Mortgages also used to be paid off, so home ownership costs dropped to maintenance and taxes at some point.
One of the reasons the government started subsidizing home ownership through tax deductions was to make sure that many people would own their home in their later years, thereby removing the threat that they would be burdens on the state. But that was then, and this is now!

Real estate tax deductions quickly became institutionalized, and part of Americana (sacrosanct).

Real estate developers soon arose to exploit the demand for the tax deductions to the owners.

Rather than risk the political consequences of a slowdown in the housing market, the politicians created a number of additional devices to "keep the party going".

In 1934, during the depths of the Depression, Congress passed the National Housing Act to strengthen a deeply troubled housing market. An important element of this legislation was to make mortgage funds available to more Americans by protecting lenders from the risk of default.

The bankers were already accustomed to risk free government money because of this act. In the 1970’s the Congress created the Government Sponsored Enterprise, Fannie Mae.

"For more than 30 years,
Fannie Mae’s mission has been to provide products and services that increase the availability and the affordability of housing for low-, moderate-, and middle-income Americans. The corporation accomplishes this mission by operating in the secondary rather than the primary mortgage market. Fannie Mae purchases mortgage loans from mortgage lenders such as mortgage companies, savings institutions, credit unions, and commercial banks, thereby replenishing those institutions’ supply of mortgage funds. Fannie Mae either packages these loans into Mortgage-Backed Securities (MBS), which it guarantees for full and timely payment of principal and interest, or purchases these loans for cash and retains the mortgages in its portfolio.""Fannie Mae obtains the funds to finance its mortgage purchases and other business activities by selling debt securities in the international capital markets. Fannie Mae is one of the world’s largest issuers of debt securities. As Fannie Mae’s funding needs are so significant and constant, it is important for the corporation to consistently deliver value to its investors by creating securities that meet investors’ needs and adapting its funding approaches to meet the evolving demands of the marketplace. Fannie Mae puts considerable effort into maintaining the integrity of the markets in which its debt is traded.""This publication is intended to give the investor an overview of Fannie Mae debt securities that are issued to support portfolio growth and thus achieve Fannie Mae’s mission of providing capital for low-, moderate-, and middle-income housing."

The law of unintended consequences has now interfered, and all standards for mortgage qualification have gone out the window, yet the taxpayer may be on the hook for all these losses.

The bankers became mere paperwork processors long ago, as that is how they make their living (origination fees). So there is no one investing their money in these mortgages, as they are investing everybody’s money (the taxpayers).
This is some variation of the public property analogy! Just who can use it, and who owns it?

We are now facing an almost infinite demand curve as a consequence of the ridiculous financing standards in use. We could theoretically forecast an infinite price for real estate, but that is an absurd conclusion unless you are a real estate broker!

The second problem in forecasting the end of the housing boom is the commitment of the government to full employment. Construction is a means of creating jobs. These jobs are not just the construction workers, but include all the related activities, including mortgage brokers, real estate sales and related clerical, building materials suppliers, home furnishings including appliances, etc.

The government is legally bound by the full employment legislation to put maximum stimulus into all sectors of the economy. Monetary policy has nothing to do with this problem. It’s fiscal in nature! Ebenezer Scrooge running the FED couldn’t solve this problem.

The third problem is the financial system. All this questionable debt will severely impact the banking system, including the pension funds who hold large amounts of the GSE’s paper in their portfolios. The interesting part of this fiasco is the assumption that these money managers made when they bought all the GSE paper. These geniuses assumed that the GSE’s were guaranteed by the US government.
Sir Alan said otherwise, and Fannie Mae agrees with Greenspan!

"The stated intent of the Congress is to use the housing-related GSEs to provide a well-established channel between housing credit and the capital markets and, through this channel, to promote home ownership, particularly among lower-income families. Although prospectuses for GSE debt are required by law to say that such instruments are not backed by the full faith and credit of the U.S. Government, investors have concluded that the government will not allow GSEs to default, and as a consequence offers to purchase GSE debt at substantially lower interest rates than required of comparably situated financial institutions without such direct ties to government.
2 Given this advantage, which private competitors are not able to fully overcome, the housing-related GSEs have grown rapidly in recent years."

When the mortgage market blows up, there will be massive losses in the already severely under funded pension funds. Fortunately, all those public sector pension funds are not covered by the US taxpayer protection. It’s almost funny to see how many of the public sectors pension funds that hold big portfolio positions in Fannie Mae, Ginnie Mae, Freddie Mac, and Sally Mae.
In case of severe financial problems, the local government will just skyrocket property taxes to make up the shortfall. So this just is a local issue for the property owners foolish enough to own property where there are too many government workers who will need feeding.

Nevada is one of those states. As of June 30, 2003, Nevada PERS assets had a market value of $14 billion, but actuarial liabilities of $19.5 billion. To generate a meaningful index allowing comparisons between states, Wilshire then divided each state’s unfunded or overfunded liabilities by the dollar amount of the state budget. A value of 100 percent would mean a state’s pension plan is underwater by the full amount of the state’s annual budget. Nevada PERS percentage is a whopping 269 percent –a slight deterioration from 2002 when the percentage was 267 percent.

No other state pension system can match the magnitude of Nevada PERS underfunding in relation to its state budget.

The fourth problem is rising interest rates. Fixed rate mortgages have gone the way of the horse and buggy. When the VAR’s begin ratcheting the interest rates up, the sales of painkillers will rocket.

We’ll have defaults everywhere as this works through the system. First, housing sales will increase dramatically. This will lead to falling prices, which will lead to real estate incomes dropping, which will lead to Realtors defaulting, which lead to office building income dropping, which will lead to- I believe you’ve gotten the picture by now!

The fifth problem is the problem of objective data. There is no such thing as a real estate market, in the sense of the stock, bond, or commodity market. Reliable data is difficult to find, as the government, or real estate sales/trade organizations provide most of the information. Both these sources have an agenda.

The problem is further complicated by nature of valuation used in Real Estate. The appraisers are paid a percentage of appraisal price, so they are motivated to increase their income by inflating appraisals. As they are so fond of saying, each property is unique!

Applying the word "market" to real estate only misleads the buyers into complacency. A real market is a place where buyers and seller meet/communicate to transact business on an ongoing basis. To call some salesman who will start advertising/looking for a potential buyer is not my idea of a market.

There is no liquidity to real estate because there is no real estate market! Let’s see you sell at the market! What market? Sell To Whom? How can one ever really know the price of thing without confirmed prices?

The sixth problem is what I call border spill over. This is defined as all the money that has been invested in other countries financed by mortgages secured by US housing! Many other countries do not have mortgages, or they are very difficult and expensive to secure.

We know that people have been taking out mortgages, and even second mortgages to buy properties in countries such as Mexico, Panama, and Costa Rica.

We are faced with the absurd problem of the GSE’s financing foreign properties without their knowledge, or consent!
Once either the foreign property market, or the US property market heads down, there will be a probable default on the US property, as the foreign property is beyond legal reach.

In Mexico, many American’s have bought in a third party name’s provided by the locals. Ownership is totally concealed, so there can be no recourse, other than to act against the person in the US. Naturally, these people have already planned to abandon the US, and live in their paid for homes (by the lenders) in their new countries. Houses for free paid for by Fannie Mae!

People who have used this technique to buy rental properties in Costa Rica, Mexico, Panama, etc. will find their anticipated income dropping as the US property market heads down, due to lack of American tourists. This will further pressure the US property market as these people default on their US properties.
One can only speculate how big a liability this might be, as hard data is impossible to find! I only know that the taxpayers are soon to pay for the party!

Matthew 16:4 "But he answered and said unto them, An evil and adulterous generation seeketh after a sign; and there shall no sign be given to it, but the sign of the prophet Jonas:"

Whales are scarce these days, but we might have a substitute for you! By all logic, we should leave you in the hell of your own creation, but compassion is our weakness, and we will give you a guide!

When the DJ US Home Construction Index has a monthly close below it's October 2005 monthly low, pain is in the forecast! This assumes that Real Estate is breaking when the home construction industry collapses. Should real estate not break after this, there is something seriously wrong with the data we are using!

One might think that the best indicator should be
the mortgage brokers , as they have been the group that has gotten the lion’s share of the Real Estate boom’s wealth.

Some of the few mortgage broker firms that are listed are already in bankruptcy. There is no practical, safe way to use these vehicles to forecast real estate. Some of the major stocks are discussed below.

American Business Financial (ABFIQ) is in bankruptcy.

Fannie Mae (FNM) caved so long ago that it has proven that it does not correlate to housing prices

New Century Financial made is final top in December of 2004, and is in a major bear market.

Countrywide Financial has split their stock so many times that it will take forever and a day for the stock to start functioning normally. Yes, the laws of supply and demand do apply to stocks. All those splits added a lot of supply!
The mortgage banker stocks are in a major bear market, but real estate is still going up!

Greenspan informed the world that the GSE’s, who have been financing the boom, are not guaranteed by the government. Yet real estate still goes up!
The mortgage bankers have been laying off, but real estate keeps going up!
We must look elsewhere for the indicator, other than the sign we have already given.

We know that the mortgage broker industry is in rout, and still no admitted breaks in real estate!

Perhaps admitted breaks in real estate is the key! They might all be lying through their teeth.

The mortgage banker/broker industry is primarily composed of nomads, who will move on to the next hot market. There is reason to believe that many have already set up their tents in the Forex marketing arena.

An article, FOREX FOREVER, in the current issue of Futures, February, 2006, (pg.74), asked, "Has the growth on retail forex gotten out of hand? We’re not sure but an indication may be when brokers start using approaches usually received for college students offering help or trying to unload used furniture".
Meanwhile, back to the housing boom analysis How does one analyze group social behaviour? That is what this problem is all about!

Congress might rush a bailout plan to save whoever from the coming whatever! They always seem to be saving someone from themselves. All situations are caused by an untreatable syndrome (by definition). Therefore, that we must accept, and assist because we believe in compassion! Occasionally, one must wonder if compassion is not the truly untreatable syndrome!

Some of the elements that are effecting, or will effect the real estate markets have been touched on in this article. There are other factors, but the main issues have been discussed.

We’re not dealing with a real market, and we are not dealing with real economics here. We are not dealing with reality at all! The problem is political!
The fiscal policies of the US government are driving the real estate boom.
Countries such
China, who do not subsidize real estate, are already seeing a turn for the worse in their property markets.

As the problem is political/cultural, we may be forced to accept the worst economic scenario, but the most probable social/political solution! That is a long, slow period of always decreasing prices, accompanied by rocketing property taxes. It’s sort of a very slow, painful, expensive economic death, as we prey on each other to survive! Economic cannibalism in the extreme. Share the pain and talk about it in the group. How therapeutic and bonding!

You have voted for the legislation to prevent the market from pricing to economic reality, and only you can demand that your Congress vote to repeal that legislation. The Congress is too comfortable with the current situation to do it voluntarily!

Wake up, people! The Age of Heroes is over!
You created it, and you’ll have change it. That’s
called Democracy!


Wayne N. Krautkramer


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