The Shoe Shine Boy has a Tip on a Fabulous 3BR/2BA

I don't know if it was Joseph Kennedy, John D. Rockefeller, some anonymous millionaire or just an urban legend, but the lesson lives today, and I am afraid that some warning signs are not being fully appreciated. The story goes something like this:

(Insert preferred Robber Baron here) was getting his shoes shined on a sidewalk near Wall Street, circa 1929. The shine boy was bursting at the seams with unsolicited stock tips. The savvy investor took this as a sign that the market was over-extended with a false confidence. Speculators had pitched valuations to unstable highs, setting the stage for a precipitous crash, and the investor cleared out before the stock tips 'hit the fan'...

Herbert Hoover also blamed the great stock market crash on speculators, suggesting that even "lowly bellboys" were attempting to mimic the legendary returns made by people like Jay Gould and Cornelius Vanderbilt.

This same environmental dynamic also held up under a microscope to the dotcom bust and associated NASDAQ tumble. Volume, valuation, and volatility were all riding high as a deluge of new investors gained easy access to the trading floor, and ignored some of the basics of investing. By and large, they were under-educated in the field of investing, and just like 1929, the fall-out rippled well beyond the speculative investor's financial world.

So what about housing in today's market? Clearly there is a bubble watch going on, as values have hit parabolic growth patterns, and sustainability concerns have set in. But housing data continues to be pretty strong, despite the media's repeated warnings. We have seen statistics suggesting that as much as 40% of the purchase volume in 2005 for houses was for investments or 2nd homes - indicative of speculative buying.

Anybody who has stayed up late once in a while has seen the infomercials catering to get-rich-quick in real estate programs. They usually involve a lot of interview snippets with average people sitting by a pool at some resort in Orlando, quoting their monthly income. They suggest that you should be able to easily buy houses with no investment of your own cash, and tease you to call for more info. And as the frequency of media comments about profits made by investors flipping property, and the huge profits being made in real estate in general, more and more people are sucked into this frenzy for real estate investments. I just worry that the investors are really not taking adequate care to educate themselves about real estate investing, and I sense an instability in this sector of the market.

As I said, the housing industry continues to turn in strong data. Employment growth and income growth are supporting a lot of the gains we have seen in housing costs. The Federal Reserve seems to have a good grip on inflation, and the economy seems healthy, and ready to ease off the throttle a bit. I don’t expect a crash in the values of people's homes. But to the extent that the market could be bolstered by a false sense of confidence - these investors who don't know what they're doing - I would advise exercising some caution when buying anything. History has a tendency to repeat. Be careful following the advice of infomercials.

Flat or Inverted Yield Curve, and Recession Watch

New York Fed President Timothy Geithner made a comment recently that provides interesting testimony on the extent foreign investment in our bond market has subsidized our long-term interest rates and mortgages:

"China's policy of buying dollar assets to keep its currency tied to the dollar masks US financial-market conditions and heightens the risk of inflation in the US . China's purchases of US dollar assets could spur inflation by putting downward pressure on US interest rates and producing more expansionary financial conditions than fundamentals warrant.”

With the Federal Reserve ratcheting our short term money to higher rates over the past 2 years, the expectation was that we would see the yield curve shift upward, with a generally higher interest rate at all maturities - for the most part. Instead, we have seen downward pressure on the long end of the curve, largely due to the Chinese government, who have bought as much as 28% of our recent treasury auctions (high demand means higher prices, and lower yields or interest rates).

Looking at the yield curve, the left side has risen much faster than the right, now to a point where we are seeing either flat curves or inverted curves from day to day. Some pundits argue that a flat or inverted yield curve signals a recession to follow, as the expectation is that rates will drop, making longer term maturities more valuable, so investors bid the prices up making the yields lower. This dated wisdom discounts the impact of the modern global economy, where as much as 60% of our treasury auctions have involved foreign money.

With the Fed expected to raise rates 2 or 3 more times, you can count on this curve seeing a steeper inversion, unless the long-term rates start to really lift. We are already seeing foreign interest peel away, as the European Central Bank and the Bank of Japan have initiated tightening cycles in their markets, drawing attention from foreign investors and competition for our money.

This may lift some of that downward pressure on the long side of the curve. On the short side, the Fed will probably have to lower rates again after the full effect of this tightening cycle has been felt. Its kind of like when you get into a hot car and turn on the air conditioner at full strength; after a few minutes you are cold again, and have to adjust the air back to a balanced and comfortable level. The Fed will do this as soon as they find that counter-inflationary sweet spot. And from there, the yield curve will likely shake its way out to a more natural slope.

Our National Builder Division Hits the Ground Running in San Ramon

We have been busy in San Ramon for the last month helping the first phase of 496 new home owners get their financing together. At the 'Reflections' property, one bedroom condos are selling for as little as 249,900, and 2 bedroom models are getting up around 439,900. The first release took place this last Saturday, and it was a feeding frenzy. Anybody concerned about real estate bubble conditions in the East Bay might want to keep an eye on this project, because they had more than 200 qualified buyers waiting in line for housing.

When it comes to housing prices, its all about supply and demand, folks. Good old fashioned economics. You will not see prices trail off until demand subsides. For now, strong job growth, and a general lack of supply for housing at this price in this community are going to keep demand pretty strong.

We have met some interesting people, and had quite a bit of fun out there so far. But I think this is the calm before the storm. 496 units makes for some serious paperwork, and some serious weekend hours. Have you ever bought real estate directly from a new home builder, or through a condo conversion? I'd like to hear about your experiences with this process, especially how the financing was handled. Drop me a note and tell me about it if you get the chance...

What is the best Mortgage?

Question: Is your mortgage a big liability, something that you feel an eager need to 'pay-off', and live debt free? Or is it a handy financial tool that can help steer your handling of your overall financial goals? Maybe a little of both?

What is the best type of Mortgage?

-Lowest rate
-Lowest payment
-Most flexible payment
-No mortgage at all!
-other

I would love to hear from you on this. Please email me with a response, and a brief explanation for your answer. I will follow up on this topic based on your answers.

Prime Time!

The Greenspan era came to an end today in the Federal Reserve, and Alan had his red tie on! That means another raising of the Federal Funds rate and the Prime Rate, both having implications for the market for mortgage debt, interest rates, and the economy in general.

The Federal Reserve lowered these rates a few years ago when our economy began to head into a recession. Lowering the cost of borrowing money helps consumers and business borrow and spend money, which generates activity in our economy, and ultimately helps swing the pendulum back into recovery. Now with the economy growing steadily, the Fed has to keep balance. Greenspan has kept a sharp focus on signs of inflation, and used these 'measured' rate hikes to slowly cool the jets in this time of heavy borrowing.

Interest rates are in a rising trend, but the global economy and foreign participation in US Treasury auctions is helping to keep a lid on our long term rates. With a higher cost for access to money, spending should slow a bit, and the demand for goods and services in our economy will lessen. This has been Greenspan's way of keeping inflation at bay. The raising of these short-term rates is putting pressure on the interest rate environment from the short end of the yield curve, which now sits basically flat. Some economists believe that this indicates another recession is around the corner, which would suggest that the Fed was too aggressive, and the general consensus believes that we will get one to three more .25% hikes in the next few Fed meetings.

With this raise of 25 basis points, the Fed Funds rate has been jacked-up on 14 consecutive Fed meetings, for a total change of 3.50%. Prime now sits at 7.50% (up from a low of 4.00%), and is the basis for all of your Home Equity Lines of Credit (HELOC). You might have seen your zero margin HELOCs go from 4.00 to 7.50 since June of '04, and it seems likely that we will see another rise at the end of March when the Federal Reserve meets again under the chairmanship of Ben Bernanke before this cycle ends. Again, some believe we will see an additional one or two raises after this.

Don't panic yet. Your HELOC loan balance probably represents a relatively small portion of your mortgage debt, and therefore the change to your monthly payment shouldn't be too bad. The new rate will go into effect for your February bill. But if you want to compare your new payment to your payment back when Prime was at its lowest, then you might notice a bigger difference. Still, I don't think this is a cause for panic.

So what do you do about it? These adjustments represent the reality of adjustable rate debts. And for the past several years, these rates have been so low, that had you borrowed money any other way, it would have cost you a lot more. So congratulate yourself for utilizing a smart strategy thus far, and consider this a good time for revisiting this strategy going forward.

HELOCs have highly attractive features that 'convenience premium' in their cost. They will continue to be attractive even as the Prime rate rises a little more. They make for a great safety net if you do not keep an emergency fund of cash. You can pay down your balance at any time, avoid the accumulation of interest expense when funds aren't being used, and then re-borrow when needed. This flexible feature makes the HELOC a great option for many circumstances. Interest costs are generally tax-deductible (please consult your tax advisor, or contact me if you need to be put in contact with one), and obtaining these lines of credit is often very inexpensive (if not free). I have one on my house.

Consider a new HELOC if:

• you have a first mortgage only, and need a financial safety net and access to your home's equity
• you have higher cost debt, such as credit card, car loans or personal bank loans
  
• your current HELOC or 2nd mortgage was taken out at a time where your home's value or your income situation was different than it is today

Consider keeping your HELOC if:

• -you have a low margin

Consider converting your HELOC to a fixed rate 2nd mortgage if:

• your current HELOC is maxed out
• your current HELOC represents a large portion of the over-all debt outstanding on your home
  
• a refinance of both mortgages might yield a lower monthly payment

These loans have definitely become more costly as the economy has recovered from its brief recession. Their utility is not lost in these rising rates, however. Let's keep an eye on the moves of the Fed and Bernanke, and the economy in general to see if things change. You should reevaluate your strategy every so often for managing your mortgage debt, and these market changes represent some of the reasons why.

Contact Info

John C. Glynn
San Francisco, CA
415 674 1283 x16
john.glynn@home123.com

Inception