A "Well-Contained" Meltdown

Its always good to keep things in perspective. If you read my last post, it will help to read the text of a recent speech by San Francisco Federal Reserve, President Janet Yellen that was presented on February 21 to the Silicon Valley Leadership Group. She discusses the US Economy 'glide path', or what the media likes to refer to as the 'soft landing'.

She notes that the concern over default rates in the market for sub-prime mortgage backed securities (MBS) appears to be well-contained. Investors have isolated their souring mood to the sub-prime sector, and value of prime MBS are holding well. She suggests that tighter lending standards across the board might not hit with such an impact if the concern remains isolated to sub-prime.

She also discusses the relationship between this marketplace and the housing market, and potential for collapse, saying that "while not fully allayed have diminished".

It sounds like a very calm response to the news from sub-prime. I hope cool heads prevail while this market shakes itself out.

The Liquidity Crack-Down

Last time we talked about the potential for lender guideline reform to clip off the fringe of the buying pool in real estate, and what the implications for this would be to home values, and the economy in general. In the last few days, I have heard more murmer about lenders trying to tighten up so that they don't cut their own throats in the secondary market with a reputation for selling bad paper. Colleagues of mine are seeing their entire business model taken out of the product pool. It seems that some would-be buyers are going to have to be left behind here in the cycle, and the real mystery to me is, how big of a 'fringe' we are talking about...

Often referred to in the industry as a 'liar's loan', stated income loans are facing serious scrutiny. I won't get into when and why these loans make sense and are fair and smart, but I can tell you when it looks suspicious. If an applicant has a job that typically pays a flat steady salary, but they want to 'state' their income rather than prove it, chances are they don't really have the income they are stating. "Stating" is for convenience or inability to prove income, not for concealing or misleading. Lenders historically charged higher rates to off-set the risk associated with not proving income, but as these guidelines have become more and more liberal, the 'stated income' premium has shrunk. Banks and Wall Street knew that the rising value of real estate served as a safety net against any possible default case, so the risks across the board were smaller. Stated? Who cares, the house is doing 12% a year!

But those times have changed. Underwriters know that some people fudge the numbers, and that some people lie. Wall Street, Congress, and Economists are all growing concerned that too much mortgage debt is floating around qualified on false pretenses. With values flat, or declining, borrowers who have over-stated their reach are feeling the heat. Foreclosure numbers are escalating, investors are getting burned, and congress is calling for tighter standards, more regulation, and less throwing money at people who don't qualify for it.

This trend is going to persist for a while. Lenders need to shake out their bad products, get back to basic risk management standards, and deliver quality paper to Wall Street. Risky loans can be great tools for borrowers with the apetite for risk and ample knowledge of how to manage that risk. Risky borrowers can still be homeowners with stable and conservative loan products. But when you mix risky borrowers with risky products, and put them in a flat or declining housing market, look out.

A lot of economists have seen this coming for some time. The excess global liquidity has created an environment where risk premiums have been condensed so far that nobody can evaluate risk adequately any more. Bill Gross talked about this almost a year ago, noting that junk bonds were getting A Paper prices, and concluding that investors were not being fairly compensated for the risk they were taking. In most cases, it was probably not clear how much risk there was. John Mauldin expects this to turn into a full blown scandal in the mortgage debt marketplace, as those who have been buying the subprime debt are paying A Paper prices for BBB- Paper, and have been possibly mislead by creative derivitave products.

Its complicated stuff. Markets ebb and flow. Sometimes the waves get big, and cause a little damage when they smack up against the shore. The longer it takes to correct these problems, the harder the correction hits, and the more it hurts. Ben Bernanke and the Federal Reserve have been working to clip liquidity to the tune of 17 0.25% rate hikes. The Bank of Japan recently came up to 0.50% from a long-time low of 0.00%. This makes it more expensive for banks to lend money, and for people to borrow.

This has helped cool the housing market, but people who shouldn't be borrowing still are. Risky borrowers can still get risky loans, and they have been injecting instability into the system. Now we are going to see institutions step in and self-regulate. And we are going to see congress step in and regulate with red tape. I expect to see the 100% purchase scenario in housing become very difficult relative to the current ease. Stated Income documentation will become difficult for W-2 employees. Down payment, income and credit standards are going to inch up.

If this hits with too big of a thud, there goes the 'soft landing'. Angelo Mozillo said he has never seen a soft landing, and you have to be careful when anybody tells you "this time it's different". Let's hope this all shakes out without a lot of turbulence.

Anatomy Of A Bubble

I'm not convinced that we have seen the bottom in housing. I'm not convinced that we have seen a successful soft landing either. Things definitely slowed down going into the end of 2006, and they are definitely picking up again in early 2007. But I don't see any reason to believe we will return to the hyperbolic growth we saw in previous years - or anything close to it. In fact, there still is some very real concern that we could see a more significant drop in house values.

The Federal Reserve is expected to keep rates flat all year. Some economists think we will see a rate cut late in the year, and some see a rate hike a possibility still. History tells us that the Fed usually starts cutting rates within 9-18 months of their last rate hike.

I have often said that with so many variables in the economy, and in the housing market specifically, all it can take is one environmental change to trigger a shift in consumer mentality, and thus consumer behavior. One of these variables that has re-entered the fold in the last few weeks is Wall Streets control over mortgage lending practices. With sub-prime lenders going out of business, Wall St. has raised concern with sub-prime mortgage backed securities. The lenders are responding by tightening their lending guidelines to uphold or improve their credit ratings.

A year ago, congress was advising the lending industry to do this, but lenders were actually relaxing guidelines in an effort to grab more of the shrinking volume of business. So with this pendulum swinging back the other way, you can expect the fringe of buyer access to be trimmed away, thereby reducing the pool of potential buyers, demand, housing liquidity, and ultimately prices. If lenders go too far too fast, either by their own proactive measures, or in response to Wall St. demand, we could see a shock to this system. And if the consumer perceives this to be significant, thats when the potential to freeze up and panic sets in.

Weakening prices slow what Paul Kasriel of Northern Trust refers to as 'household deficit spending', as homeowners cannot spend their home equity on other consumer purchases. If you don't think this is a big deal, take note of the fact that the US Savings rate is at its lowest since the GREAT DEPRESSION, at a negative 0.5%. People are using their homes like ATM's on a National level. Cutting off access to this slows spending, and the economy in general. Enough of this and the Fed is back into rate-cutting territory.

So while I hear agents advising their clients that "the bubble has not burst", and that offers without contingency and 10% above the asking price are required "if you really want this home", I don't like anybody being too anxious to lead with logic when transacting in real estate. It is competitive right now, yes. But I'd be concerned that the housing market is making a head-fake here.

Real Estate and Tax - What's Important To Know

With tax season officially open for the 2006 filing year, its time to refresh the memory on some important tax issues related to real estate. I see a great deal of confusion and misinterpretation of tax rules when meeting with people in my mortgage planning practice. Realty Times has a good reminder on the homestead exepmtion that Bill Clinton gave us with the Tax Reform Act of 1997. Make sure you know the rules for this tax treatment on homes in the year they are sold - especially if you are thinking about renting the home out at any point. Its also important to know the difference between mortgage interest expense and investment interest expense when trying to write off those mortgage and HELOC dollars. I see the majority of people surprised when confronted with the rules for deduction of mortgage interest. The IRS is talking about taking a closer look at these deductions to make sure tax-payers are walking on the right side of this fine line...

You can find a lot of tax resourse on the IRS website, but you may want to consider letting a professional CPA handle your taxes for you. The more complicated your return, the more value a tax planner stands to offer. Let me know if you need help locating a good one.

Where Is Your Retirement Plan?

I am truly amazed at the number of folks I meet with who have either not started, or do not fully participate in a retirement plan. I am especially dismayed by those who fit this description and already have retirement in their cross-hairs. I understand its tough enough as it is to pay the bills, especially in the San Francisco Bay Area, and throughout most of California. Maybe it has been my saturation in the field of personal finance, but I feel like the cost/benefit evaluation of a qualified retirement plan should be as obvious today as the health risks associated with smoking.

OK, maybe I am guilty of hyperbolic analogy. But I'm here to help shed some light, and I want my point to be clear. YOU NEED to understand the time value of money, and the power of tax deferral. The United States government wants you to be capable of taking care of yourself financially when you retire, and so they have created some incentives to encourage you to save now, and not rely on social security. In case you haven't noticed, legislators believe we are critically under-prepared for taking care of the retiring baby-boomer generation; you DO NOT want to go through life relying on Social Security 100%. We call this 'whistling through the graveyard'.

If you work for a corporation, non-profit, are self-employed, or a contractor, there is a plan for you. 401(k), 403(b), IRA, Roth IRA, SEP, Simple, Solo 401(k), pension, etc. Don't get overwhelmed by the big picture here. Find your plan, and GO.

Small business folks have a great resource here. If your company offers a 401(k), here is some great resource as well. Did you know that your company now automatically enrolls you for a minimal contribution unless you opt-out? They're doing you a favor. Most companies match a portion of your contribution - depending on how its structured, thats a 50-100% return on your money in the bank! This is a no-brainer, folks.

You will often hear me say that 'the dollar you don't put in your 401(k) is likely the most expensive dollar you spend'. Others advise to 'pay yourself first'. It all starts here. I know the objections, and I understand them. Its time to get over it.

If you need some help figuring out how to make room for these contributions, contact me. Smart mortgage planning will make room for your financial priorities, and this should be one of your highest.

Mortgage Planners Going Too Far

I was reading an article about Reverse Mortgages the other day, and one tangent paragraph really caught my attention. It was discussing one of the problems with Reverse Mortgages being that it could put "a bundle of cash into a consumer's hands, marking an enticing target for financial product sellers to exploit." The fact that this is an inaccurate statement about Reverse Mortgages (Cash-out mortgages: yes; Reverse Mortgages: no) is obscured by the sentiment behind the statement - which is agreeably concerning. The article sites a California law that prevents mortgage brokers from selling annuities in the process of re-financing your debt. Yikes... Thank you Sacramento...

Any time you hire a professional to handle business for you - any sort of business - it is important that they know what they are doing. Too often we see people attempt to wear too many hats, and what happens as a result? They don't wear any of them well.

A Certified Mortgage Planner (CMPS) can help introduce you to concepts related to financial planning and how the mortgage relates to these interests (in fact, if they do not, you might be talking to the wrong one...). BUT, there is a fine line being crossed when this professional tries to do everything else for you. How can they possibly be an expert at mortgages, investments, insurance products, credit counseling, taxes, etc, all at once? Make sure your Certified Mortgage Planner (CMPS) is working with other professionals who focus on these areas, not trying to wear too many hats.

As a former financial advisor, I can testify that the Series 7 licensing and training involves quite a bit of focus on NASD rules and fiduciary responsibility in general. The licensing that allows a person to be a real estate salesperson, mortgage broker, etc has relatively none. CMPS has made some great strides to inject ethics and responsibility into the mortgage industry; make sure you are working with somebody who holds this important designation.

SF Fed President Janet Yellen Speaks on Housing, Economy

I like the general sentiment in Janet Yellen's speech yesterday regarding the state of our economy. Since Economists are generally regarded as dry and boring, I don't expect you to want to read yourself - that's why I talk about it here. But if you're in the mood, feel free here. Lots of other stuff I am reading gets posted on this page as well.

I keep writing about the different vibes being given by credible sources on our economy, where we are headed, and what the implications are for the housing market. Yellen's speech yesterday gives some great insight into the mindset of the Fed right now, and what they are confident about and what they are uncertain about. The general idea is that we are seeing increasing evidence of the 'soft landing' scenario.

You get a great idea of how dynamic the economy is when reading this, as there are so many variables that play into the evaluation, and each one affects the others in direct and indirect ways. Along these lines, as many people are watching the economy to make predictions about housing, others are looking at housing to make predictions about where the economy will go. Sometimes its difficult to see which comes first.

We see analysis that suggest home equity borrowing has specifically contributed as much as 1% to the annual GDP growth. With a current rate of 2-3%, that's a significant portion! With the 17 consecutive rate hikes to the Fed Funds and Prime rates, consumer demand for dollars should drop, slowing spending, and slowing economic growth... Those cuts seem to be working....

A few months ago everybody thought that the Fed was impatient with their pace of rate hikes, and should wait longer to see the early part of the cycle make its way through to GDP figures (arguably a 9-24 month lag time). The fear was that they would slow us too aggressively and put is in recession. (Then we get rate cuts, go the other way to stimulate spending, etc... the so-called pendulum swinging back and forth...) But This side of the rate cycle is looking now to be one of the longest pauses at the top on record. This could change with a big miss either way in CPI, Jobs data, PCE, or other economic reports, but so far things are looking pretty healthy.

Look at this quote from Yellen's speech: "...it looks as if the economy is pretty close to the 'glide path' I mentioned before - growth has slowed to a bit below most estimates of the economy's long-run potential, while the risk of an outright downturn has receded." So much for the pendulum getting ready to swing the other way... its on a nice slow drift into place.

We still expect to see corrections in the yield curve, but the threat of inflation needs to be fully contained first. Still a glimmer left... As I like to say, there are a lot of moving targets out there. The sentiment can change quickly. But for now, it looks as though the big picture is in a fair amount of control.

Are We Going To See A Soft Landing?

The news media has covered the real estate market in the last few years with close attention. As prices have soared to historic highs, some economists have speculated that the value growth has been unsustainable, and that we are headed for a painful value correction. Fear of what the implications of this scenario would look like has fueled the media coverage - remember, they love to keep you on your toes.

Going a little beyond the scope of the nightly news, you might be able to get a more credible view on where we are headed. After all, there's a million Economists out there getting paid a million dollars to research, digest data, and speculate as to where we are headed, but they are often not as 'exciting' as your 11 o'clock news anchor... Because of the immensely dynamic national and world economy, these Economists are all over the board with their predictions. And when the consensus gets scattered, we get that feeling of uncertainty that might make the American consumer take pause (for what it means to the economy when the American consumer takes pause, consult your local Economist... I told you: dynamic!!). There are a lot of contradictory opinions floating around out there - I know, because I read the boring Economist stuff. As a Mortgage Planner I keep a pulse on these things and make recommendations that respect your financial objectives within the context of the mortgage landscape and the economic environment at the time - and going forward.

You can get an idea of what these pundits are looking at to make their assessments of our economy, and register their opinions. It may not be exciting stuff to everybody, but it helps to know where they are coming from. Here are a few items that they are watching to see if we are in fact headed for a "soft landing". In general, inflation concerns bring higher rates, and make housing less affordable.

RETAIL SALES Report: This comes out monthly and shows the mood of the American consumer. Strong sales indicate that businesses are making profits, and that the economy should keep cooking. Too strong a report suggests too much money floating around, and an environment where inflation can run too high - that can lead to higher interest rates. Sharp declines in this report suggest that the opposite. A precursor to a "hard landing" might be a sharp downturn in this report.

TRANSPORTATION COMPANIES: When companies like FedEx and UPS lower their outlooks or speak of declines in activity, it suggests the American consumer is slowing spending.

DURABLE GOODS Report and BUSINESS CAPITAL EXPENDITURES (CapEx): : Shows when businesses are spending (and growing or looking to grow) and expand capacity for production. The report gives an indication of upcoming manufacturing activity, and when this slows there can be inflationary pressure.

ISM INDEX: Manufacturing index of industrial companies that signals expansion and contraction in this sector.

MORTGAGE FORECLOSURE Rates: When these pick up, it suggests lending guidelines will tighten and shrink the pool of buyers. This lowers demand, and can accelerate a decline in housing activity.

AUTO SALES: A recession predictor, the economy often flows in the same direction as Auto Sales.

Hey, wake up! If you made it through all of that, you might want to consider a career as an Economist - we could use some help figuring out if we are in fact headed for a "soft landing" or not.

When does an Alternative Mortgage Make Sense?

The recent rise in short term interest rates has brought financial strain to misguided and mismanaged mortgage consumers. The media has of course spotlighted this issue and used it to fuel the negative sentiment toward and resentment of Mortgage Brokers. Don't get me wrong - those who know me well already know I agree with much of the critique of my own industry - but I also think the media likes to make examples in extreme cases.

The case for the traditional 30 year fixed (FRM) has always been safety from interest rate risk exposure. In other words, lock in now for 30 years, and you never have to worry if rates go up. You can refinance if rates go down. But even Alan Greenspan thinks this strategy can be wasteful for some consumers. What if you know you will move in a shorter period of time? Or at least think the odds are good? How about if you expect major changes to your income in the next few years? Have near-term financial goals outside of the home, like funding a college education or retirement plan? Statistics tell us that getting to the mid-way point in a 30 year mortgage is highly unlikely. Average loan duration is around 5.1 years.

Mortgage Planning explores alternative types of mortgage financing so that you can adjust the structure of your largest liability to make room for other goals. This may mean lower payments now, and higher payments later. It may mean less certainty in the future, or greater interest rate risk. It may also mean the difference between living 'house-poor' and achieving more of your financial goals. When weighing these risks, you need to also explore the probability that they would even matter. And what do you risk by being too safe?

For a more sterile example of why alternative mortgage products might make sense, see this short essay by the San Francisco Federal Reserve, especially the section titled: "Some motives for choosing alternative mortgages".

Everybody is different. Make sure you have proper guidance so you can fit your mortgage plan within your financial plan - and your life plan.

Interest to Remain Moving Target in 07

The rolling economic data is keeping Ben Bernanke and the Federal Reserve on their toes. And in return, the Fed is keeping the investment community on their toes. As recently as 3 months ago, the futures market had a probable interest rate cut predicted as soon as December 06. By the time December rolled around, those odds had faded, and now, nothing is expected until the third or fourth quarter - if at all.

The Fed is still eyeing inflation as their greatest concern. They have continued to suggest that the "extent and timing of additional firming" will depend on this incoming rolling data. The bias is in fact on a tightening as the next move, but its a pretty modest one at this point.

Through the eyes of Real Estate Finance and Mortgage Planning, this has rates continuing to stay in a narrow range, and they are expected to do so through much of the year.

What Happens when Everybody is Talking About Housing?

"Housing Decline" was the most talked about news item of the year in 2006, according to a recent AP article. This probably comes as a surprise to nobody. But to what extent does consumer sentiment about housing have an impact on the underlying values? Or is it just a good way to get a barometric reading on the financial aspects of the market?

Back in 1999 when I was working as a financial advisor, I remember reading several articles that discussed the relationship between news reporting frequency of key terms and the financial performance of the related commodity. Back then, all the talk was about the stock market, and mutual funds, which had become so prolific that they outnumbered the number of individual stocks listed in the US Market. Inexperienced investors were being drawn to the stock markets in droves, and prices were flying with the influx of new money. On occasion, even hip-hop music - historically boastful about financial prowess - made mention of mutual funds amidst its more commonly urban references.

The significance of this was that the more there was mention of a sentiment in the news media and pop culture, the more likely it was that momentum was being driven to an unsustainable level. We saw it come in 2000, when the stock market hit a major correction. The worst of the decline was felt in the NASDAQ, where most of the new investors had been drawn to the recent fast-paced technology company returns.

We saw it again last year in housing, when everybody seemed to be talking about buying houses, with 'no money down' and making 'positive cash-flow' from the start. All of these infomercial testimonials with the 'average couple' sitting by a pool at a resort in Orlando, discussing how much passive income they received in the previous month... it was a sign that the market was over-heated.

Charles Kindleberger notes in his famous anatomy of a crash Manias, Panics and Crashes that "when the world is mad, we must imitate...", capturing the essence of the fuel that is the consumer in pursuit of ROI. Even when we know something is too good to be true, there can be an urge to get involved. If you don't, you risk getting left behind. To this end, the American consumer has the ability to self-fulfill its own prophecy, but it typically leads to excesses, and the last guy in gets left holding the bag. So far the 'housing decline' seems to be moderate in most markets - but not all. Its going to be easy to see in retrospect where the market got overheated. I've discussed it here before, and I will continue to as we cycle through this market.

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Heres a link to some economist sentiment for 2007

Beware the Media!

Long-time friends and colleagues know me well enough to know that I take in my news with a fair amount of skepticism. No matter who you are listening to (in and out of media) its wise to keep mindful of their bias and objectives. Its a pretty simple rule. This is why the nightly news advertises stories about which of your dinner ingredients might kill you tonight!... but the story runs at 11pm... they just want some attention so they can sell commercial time to their advertisers.

Look at the difference between two different stories on the topic of baby-boomers and the implications for housing. From the perspective of Real Estate and Mortgage companies, Realty Times reports of the generation "They've got all the money ... They've got all the real estate, too". The article makes the case for the next wave of Real Estate activity with baby-boomers leading the charge by buying 2nd homes and vacation property. This is no new speculation by the way; stories about this appear weekly.

But look at this article. It basically reports that baby-boomers are far more likely to remodel their homes than move to the beach, or the desert, or to buy a 2nd home on the shore of some lake. And who is behind the so-called study? Home Depot!

The only way you can get a sense of anything out there, especially in the real estate market, is to get as many angles and opinions as possible. Do your best to triangulate reality among all of the self-serving junk in the news.

Blowing Bubbles...

Are we headed for a soft landing? The media has been beating the 'real estate bubble' drum for several years, and in doing so scaring countless would-be homeowners out of buying what would have been a nice investment, not to mention a nice place to call home. But now we are seeing a counter-weight of similar magnitude, in real estate professionals and industry insiders who clamor for the so-called "soft landing" in the housing market.

Stepping back a bit and looking at housing from an economic perspective we might be able to take some of the hot air out of the equation and see what is really happening. Housing is an investment, and an asset in a class of its own based on the function it serves relative to other types of investments. But real estate is still subject to market conditions, cycles, and other typical financial rhythms.

There is no question that housing has seen tremendous gains in recent years, exhibiting characteristics of 'irrational exuberance' that have paved the way to inflated asset prices and preceded significant corrections in value. The most recent memorable example was the NASDAQ and dotcom stock rally that came to an end in 2000. From the peak of the rally to the trough of the correction, the index lost a staggering 71%

Commentary on the asset bubble phenomenon most commonly references a mania in the market for Dutch tulip bulbs during the 1630's, where at the height of the market, people were swapping homes for flower bulbs.

In Extraordinary Popular Delusions and the Madness of Crowds, Charles Mackay wrote "that whole communities suddenly fix their minds upon one object, and go mad in its pursuit." Is this what we have seen in the US housing market in recent years?

The characteristics of a cycle turning over are present in the housing market. First we saw a parabolic curve in home values. The Federal Reserve stepped in to raise rates (while the general goal was to curb inflation, it is very likely that the specific goal was to temper home values), and eventually inventory increased. Now prices are starting to come down.

Paul Kasriel of Northern Trust recently published that in the current housing rally, the dollar volume of all sales was at a record high when represented as a percentage of GDP. The implication is that this is an extreme market, and that we should be facing a similarly extreme correction.

Given that the housing market continued to rally in the face of the Fed rate hikes, demand was defined as 'inelastic'. In other words, people did not care that it was becoming more expensive to buy; they just used more liberal loan products, taking on increased risk, and kept on spending. It took 17 hikes of 0.25% each before the market showed a change in mood.

Several economists think that the Fed tightened rates well beyond the neutral point, and expect them to start lowering as soon as January 2007. Cool the jets with higher rates, then slowly ease back into the comfort zone. Its like getting into a car that has been parked in the sun: put the AC on full blast for 10 minutes, and you'll eventually need to back off and find the middle ground.

Paul McCully at PIMCO recently made the case that all of this suggests that a 'soft landing' in housing is nothing but a pipe dream. Demand for housing, he says, is inelastic on the way down, just as it is on the way up. Once the investors change sentiment, rate cuts are not going to bring them back in droves. We saw this with the NASDAQ, and stock market in general. It took an over-correction and under-valued securities to bring the interest back to Wall Street.

So is housing due for an over-correction? Is the 'soft landing' attainable? Kasriel and McCully make for an interesting case. Next we will look at the Kubler-Ross model laid down over the US housing market, and see if we can find any similarities.

Rock the Vote! TIC Coalition in SF

In San Francisco, affording the home of your dreams takes a lot of money, and a tough stomach!

One of the many areas of political battleground on the streets here in San Francisco is that of affordable housing. There are some interesting social intersections here where the typically egalitarian political mood of San Francisco meets with the stratified financial footing of its residents. I won't go off on a political rant here; I am more interested in distributing some useful info on the coming elections...

In San Francisco, the cost per square foot of house is on the upper end of the spectrum nation wide. In an effort to cut some costs, people have taken to buying multi-unit buildings by joining with other buyers - often times strangers - to pool resources and buy the entire building. They take title as Tenants in Common, which essentially gives each party ownership in the building as defined by percentages rather than by area or a specific unit within the building. In many cases, the next step is to legaly convert the building to condominiums, thereby granting each party exclusive ownership of their respective unit, and the freedom to finance or sell separately from other building owners.

Tenancy in Common housing and condo-conversions have really become a political hot-button in recent years. Because a condo has fewer strings attached from the perspective of the owner, it is usually considered more valuable as an asset, thus the tendancey to want to convert. But proponents of affordable housing issues argue that if the city converts too much inventory into condos, they will eliminate relatively affordable living space for the thousands of people in need.

As is with any political battle, the laws swing back and forth between the two competing interests, and currently represent San Franciscos predominantly liberal politics. There are extremists on each side. There is probably an acceptable range of middle ground for a solid utilitarian community. But at times there needs to be resistance to hold the balance in this middle ground. For example, under current law, some owners will wait 5 years before being allowed to convert, and the process itself takes 2 years (if you are lucky!) just to wade through the bureaucratic process that the city requires. In recent years, legislation has pushed this timeline out to be as long as a decade in some cases.

To many, the idea of owning real estate but being legally prohibited from controlling what you do with that real estate is a seagull poop on the statue of the American Dream. To this concern, the San Francisco TIC Coalition has united as a force to represent the interests of home owners. In a recent advisory, they recommended voting "NO" on Prop H, and cited this page for more info. One thing I will rant about politically is the uneducated voter - so do your homework! But consider them a good resource for the home owner in San Francisco - especially if you are involved in a TIC.

* Several interesting reports on Affordable Housing can be found here.
* More info about the SF TIC Coalition can be found here.

Growing Momentum for Change in Realtor Broker Compensation Models

Dating all the way back to the 1970s, there has been debate about the traditional compensation model for Real Estate agents, and the politics and laws surrounding the debate.

In the last few years, the expectation that technology would cause dramatic change to this long-standing model has been at the forefront of the debate. And in the last few weeks alone, there has been a lot of chatter and news about the debate as it stands currently, and some signs that changes are happening...

An extensive report is provided by the AEI-Brookings Joint Center for Regulatory Studies, and goes into much detail about some of the complaints voiced about the current model, as well as the challenges faced by those making an effort to change. Some are political, some economical, and some are logistical. It is not without flaws in my opinion, but does not claim to have all the answers either. Very much worth the read.

And then look at this special report from the Real Estate Journal about 'Careers in Real Estate'. 3 of the 6 articles in this report relate to flat fee sales, competition to the MLS, and a la carte models of paying for various Real Estate Transfer services. These are all concepts raised by the Joint Center study as well.

Last year there was a fantastic book written by Stephen Dubner and Steven Levitt called Freakonomics. The authors use economic principles to evaluate some interesting social dynamics, and devote one section to relating Real Estate Agents to the Ku Klux Klan. Needless to say, this is not a favorable write-up. More evidence of their distaste of Realtors exists on their blog.

There are some valid and well-composed arguments in all of these pieces. I also feel that each of them go too far at times. If the issue is of interest to you, give these a read. There are some new ideas out there. And if you are not so interested in this topic, you still should read Freakonomics. As a student of both Economics and Sociology, I have a particular fascination with it. But it is wildly entertaining; brilliantly thoughtful and explorative, and humorous as well.

Income Taxes of the Rich and Famous

According to a recent analysis done by our friends at the IRS, based on 2004 tax revenue:

• The top 1% of income tax filers paid 36.9% of all tax dollars, yet they received only 19% of total adjusted gross income (AGI).
  
• The top 5% of income tax filers paid 57% of all tax dollars, and made 33% of AGI.
• The bottom 50% of all filers paid 3.3% of total income tax
• The lowest income earners paid negative tax rates, based on credits, etc.

Wow! Are you incorporating tax avoidance strategy in your finances? Proper mortgage financing is one of the best ways to limit your exposure. Make sure you talk to a professional mortgage planner as a part of your financial picture.

Some more interesting numbers:

• Top 1% of AGI = $328,000 and up
• Top 5% of AGI = $137,000 and up
  
• Top 10% of AGI = $99,100 and up

Don't get caught trying to keep up with neighbor Jones, but it's helpful to know where you land. Good financial planning might help you cross into a new zone next year. Let me know if you need help finding a Financial Planner, CPA, etc.

In Defense of The Option ARM

Business Week recently published a scathing article about Adjustable-Rate Pay-Option Mortgages (aka The Option ARM) that has sent a pretty good ripple through the lending community. Well, big surprise, this one-sided eye-grabbing piece is typical of the flesh-eating virus style of media-induced panic.

Before I defend this loan product outright, I want to be clear on something: there is no doubt in my mind that this is an often-abused and often-misunderstood product. But I do feel the need to point out a few problems with the article, and and present another side to these loans. Read the article here.

The key benefit for Option ARMs is the payment flexibility, where a borrower is allowed to make minimal monthly payments on their home loan. It is a strictly cash-flow driven financial tool, and generally is not the cheapest type of loan available. As is with any other time value of money concept, you are paying a premium for this flexibility. This may be in the form of higher interest cost, higher risk of increasing interest, or in the current rate environment, both.

Business Week makes a fair claim that many mortgage brokers are pushing this product for inappropriate borrower scenarios, and this is a real problem that I agree with. The simplified sequence looks a little like this:

Home owners are attracted by the low minimum payments - commonly featured in mortgage broker's radio and print advertisements - and do not ultimately understand how the loan works before they sign up. They make minimum payments for a while, and then get caught by surprise when they realize that (A) their loan is growing in size and (B) their payments minimums are adjusting to keep pace with this increasing balance. Add to the mix a realization of a slowing appreciation rate for US real estate, and the stage is set a full-blown panic. All the media needs to do to sell a few magazines is run headlines like "Nightmare Mortgages".

Throughout this article, BW gives examples of some people who are feeling the pinch of rising rates and payments on their Option-ARM. She presents that they have been screwed by their mortgage broker, and that the mortgage broker has been led along like a puppy by banks to sell these products by offering high margin revenues for the product. Its the man stickin' it to the people yet again, and the result is a shaky American financial infastructure, ready to buckle beneath its own weight when Mr. & Mrs. Average Homeowner come up short on their upwardly adjusting mortgage payments.

Let's not forget how the media makes a living. Do I have to make the case that they have a history of blowing things out of proportion? Is it obvious already that they sell more magazines, more commercial time, more web impressions when they have really dramatic news to talk about? A recent James Bond movie made fun of a corrupt media mogul who was creating global conflict to sell newspapers. Its a parody, but it comes from the every day media machine.

And they are blowing things out of proportion here...

First, no responsibility is put on the borrower, the consumer, the buyer to educate themselves. The American consumer is presented as a feather in the wind, succeptable to any mortgage broker's lousy self-serving advice. I don't buy it. The consumer controls the mortgage process more today than ever, educated (albeit in a commonly misleading way) to a dangerous degree. They think they know it all, but they dont know enough. They surf the web for info, and think they can walk into the transaction telling the mortgage broker what is best for them in the mortgage universe, and how much it should cost. What choice does a mortgage broker have but to tell them what they want to hear, that the lowest payment out there is based on a 1% Option ARM start rate?

Well, that is your common mortgage broker for you. So who can blame the consumer for making every attempt to arm themselves with the latest info, and come in to the transaction with their defenses in place? The consumer fears the mortgage broker, and the mortgage broker fears the consumer. This is a recipe for a bad deal. From my perspective, this is the 'Nightmare Mortgage'. All this drama about Option ARMs is just a symptom of that problem.

In most of the case studies, there is no mention of the situation prior to the Option ARM. Most of these people are in over their heads already. Harold can't afford any mortgage product on the income quoted. The Shaw's dont have enough income to qualify for their mortgage, etc. Did the Option ARM really get them in trouble, or are were they already headed there? Maybe they mismanaged their finances, or just had some tough turns in life. It happens.

But lets not let these folks get away with blaming everything on the bank or the broker. While I do agree with some abuse from inside the business, is the consumer not required to take responsibility of their own situation? Not reading the terms? Not taking the care to find a reputable broker? I mean, I can go into WalMart and buy a shotgun, but if I shoot somebody with it, I am not allowed to blame it to the blue-vested clerk who rang the register...

These loans are promoted with 1%-2% pay rates as the hook. Does it not seem too good to be true? It is! Theres more to this story - a lot more! I hear radio ads for these, and I get the flyers in the mail. Most of the advertisements seem criminal to me. And I do think that a large segment of this industry is participating in a misleading game, and delivering a back-handed slap to people in a time-sensitive, major financial transaction - often leaving them with little choice or time to react once they realize the bigger picture.

To date I have talked more people out of the Option-ARM than I have put into the Option-ARM. But we still put them together for the right situations.

In todays marketplace for real estate finance, there are countless options. There are so many products that can be tweaked to fit a loan scenario, where you can emphasize one goal over another - financial, personal, etc (related to taxes, investments, inherritance, divorce, retirement, education, timing... the list can go on and on...). The Option ARM represents one of the most sophisticated tools available, but you need to know when and why it is right for you. A Certified Mortgage Planner isn't likely to lead you astray; make sure you are working with somebody who can educate you, and plan with you to weave the mortgage product with your greater financial goals.

Work with an expert. Get a referral from somebody you trust. And then let them work with you to provide a mortgage plan. Only you know your financial habits and objectives. And I guarantee you that a good mortgage planner knows a lot more about their business landscape than you do. If you can't put trust in them to help you navigate real estate finance decisions, then its not the right person to work with.

Recession 2007! ... ?

How many economists does it take to hit a moving target?

The financial and economic communities are abuzz with tension right now, as the Federal Reserve is undoubtedly fine-tuning the structure of their remarks in tomorrow's policy meeting. A few weeks ago the markets were betting heavily on this meeting to be the first where the Fed did not raise rates since they began the current tightening policy in June of 2004. As I have mentioned before, the CPI numbers have been supporting the notion that inflation in the US economy is uncomfortably high. And for the last several weeks, the Fed Governors have been popping up all over the place, like a giant game of Whack-a-Mole, peppering the news with one common sentiment: Inflation persists, and is of current concern to the US Federal Reserve.

Its a different picture than a few weeks ago. This whip-saw reading on the economy is unkind to the markets, which have seen a consistent down-turn accross asset classes in the past month. Whether this is a modest correction or a trend reversal is yet to be determined. So is the economy slowing down? Is inflation still too high? The worst case would be "yes" to both.

We sit today with the markets 100% convinced that rates will be hiked tomorrow, 0.25%, to a Fed Funds rate of 5.25%. Some believe we could see a more definitive move to 5.50%. More think we will see 5.50% in August. And some think the 'terminal rate' will be as high as 6.00%.

What does this imply for our economy in the near future? As usual, there is a rainbow of opinion out there right now, ranging from healthy to worrisome. But its not the same old boom-time we have seen in recent years; current forecasts mention words like Recession, Stagflation, Asset Bubbles, etc:

• Along with the Fed, other central banks in the world are tightening, taking liquidity out of the system. The Bank of Japan has had a huge impact recently, to the tune of some $200 billion over the last few months according to George Soros. This is in the process of throwing a cold shower at the global economy.
• Commercial banking guidelines remain very liberal, but the tightening of liquidity on this level will be the likely next step, according to John Mauldin. Goodbye easy institutional money, and goodbye easy consumer money. How can we continue to spend and propel the economy at this pace?
• The folks at Northern Trust provide some discourse on the inverted yield curve, and second-guess the popular notion that 'this time it's different' with respect to the yield curve / recession correlation. Hints of the Fed going too far and causing economic damage here.
• Stephen Roach suggests that the central bankers view the recent market slowness as a correction, and are still interested in slowing the economy to a more moderate pace. Everything looks healthy; we needed this.

So lets add these ideas up a bit. Rising rates & shrinking liquidity, slowing housing markets, tightening lender guidelines... all of this has to cool off the housing market. It has to. It does not guarantee a decline, or correction in housing, but it certainly makes the idea of investing in real estate one where the risk/reward balance has shifted more in the direction of risk. The growth rate cannot be sustained, and we are seeing some hints of this in recent housing data.

It is often argued that real estate is a unique investment, in that a home both an asset, and a place to live. I support this concept, and believe that especially in the long-term view, you cannot go wrong. The media has been talking "Real Estate Bubble" since 2000. If you got scared off then, you missed one heck of a run...

Just some things to consider in the face of an increasingly gloomy economic outlook. Its a moving target. The next few months CPI, GDP, Employment and Housing data will all be interesting to watch, and should provide for further speculation, and hopefully some increased clarity on what comes next.

Bubble, Inflation, Fed, Recession

To get a handle on where the economy is headed exactly is nearly impossible. I am always amazed at the volume of data available and the number of analysts who all look at the same data and come up with wildly different projections.

Today's Consumer Price Index (CPI) came in showing inflation growth a little higher than the market expected, and the bond market is having a fit over it. This all but guarantees another Fed rate hike for the end of June, and the bond market is adjusting to this ahead of time.

Many economists seem to feel that the Fed historically goes too far when tightening rates, and many believe that we could wind up in a mild recession by the end of the year or early 2007 if they push it any further. Financial markets were clinging to the idea that the Fed would go on 'pause' as of the last rate hike, but today's news is changing the outlook. Ben Bernanke has to be aware that inflation is a lagging indicator, and today's news reflects 6-24 months ago's economy, but as the new chairman, he also faces political pressure to appear vigilant in fighting inflation, hence the expectation of another adjustment.

What this means is, if you are going to do something soon, you might consider locking in pricing before it gets any worse. However, I would be hesitant to pay too much up-front for the transaction, since a sputtering economy means that rates should come down again in the next few quarters. If today's refinance objective is to consolidate debt and lower payments, then don't wait. But if the Fed goes too far, the odds increase that you may find an opportunity to obtain better rates & terms in the coming months.

If you have questions about how to navigate this market, and make mortgage decisions right now, or about what this chart above means exactly, please email me.

* Graphic courtesy of Mortgage Market Guide

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.