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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: CalculatedRisk who wrote (74323)	11/19/2006 5:14:56 PM
From: ild	Respond to of 110194

Insider Q&A: Economist Chris Thornberg Christopher Thornberg is a well-known watcher of local real estate markets who recently left UCLA’s forecasting team to create Beacon Economics in L.A. Thornberg’s been warning people about the risks in housing for some time now. We figured we’d see what he’s thinking with the market in a cool-off mode. Q. How bad is it? Can you describe the state of the region's housing market? A. It's bad. Total sales continue to fall, prices have gone to zero growth, and permits for new units are falling rapidly. The spin is still swirling out there, with the (National Association of Realtors) embarking upon a $40 million campaign to promote the fact that they think this is a good time to buy or sell your house. More like it's a good time to earn a commission for a lot of real estate agents wondering how they are going to make ends meet next year. Q. Do you have a firm projection of, say, 2007 price movements? A. There is no such thing as firm projection. But all in all there are two scenarios. The first is that the rest of the economy keeps chugging ahead and the market is stabilized by job and income growth. Price growth remains at zero. This is the good scenario. The bad is that the rest of the economy also cools, and prices fall. But don't expect that prices will collapse by, say, 30%. Housing markets aren't that liquid. Declines will be moderate. Q. Will Orange County fare any better or worse? 2007 projection, or the like? A. No, Orange County is facing the same risks as all of Southern California. While they may hate to admit it, the fact is that the Inland Empire, Los Angeles and Orange County all share a common economy and an integrated housing market. The same tensions exist everywhere. Q. Is this a bubble bursting, or just a natural, cyclical easing after a decade of grand performance? A. It depends on what you mean by the latter vs. the former. If you think the late ‘70s run up in prices was a bubble, and the late ‘80s run up was a bubble, then this is a bubble bursting. The same market characteristics that defined the cooling starting in 1979 and 1989 are what we are seeing today. If you think that what we have seen in the past is just a normal cycle, then this is a normal cycle. The key point here is to remember that a bubble is simply a market mispricing an asset due to excessive speculation. I do believe that houses are substantially overpriced relative to their real value. Housing markets seem very prone to these problems -- probably due to the fact that unlike other asset markets such as in stocks and bonds the amateurs tend to dominate sales and the brokers in the markets are not required to understand anything about assets, what they are and how they work -- unlike the relatively stringent licensing requirements for bond and stock traders. Q. What might change your outlook -- good or bad? A. The key is consumer spending. If people respond to a cooling in housing prices by cutting back on home spending it could get ugly out there in the rest of the economy very quickly. This would turn a bad housing market into an abysmal one. I don't see much upside for the next few years regardless of what may happen. Q. You may have been early on the warnings … A. I was not early on the warnings. This thing started about 2003 which is when I started talking about it. I said even at the time that there is little hope of forecasting the end of it -- these are irrationally behaving markets and thus are close to impossible to time. The funny thing is that it might be rational to buy in a bubble market -- if you think you can get out before the pop. The problem is that people don't understand that risk. They are told by real estate agents and mortgage brokers that this is a no-lose transaction. Anyone who bought in the last year or so is now realizing that this isn't true. Q. Any lessons learned going forward from this unusual housing cycle? A. The same as always: 1. There is no such thing as a riskless investment. And the better the return, the higher the risk. 2. Don't accept advice from people who have a financial stake in you making a decision, one way or the other. 3. History repeats itself. blogs.ocregister.com EDIT: Just found out you've already posted it on your blog.

To: CalculatedRisk who wrote (74323)	11/19/2006 5:34:14 PM
From: ild	Respond to of 110194

Nice discussion on your blog: Our ARM-gamblers will have reset, and our 40%-income payers will have survived two years of house poverty. If you can hold on for that long then you can hold on. That isn't to say prices will take off again... but pump enough liquidity in & folks might be able to tread water long enough I'm not so sure about that; in my experience the only thing that ever bails out 40% HTIs over the longish haul is rising income, not ever more strenuous budgeting or another refi or the next-door speculator managing to unload at break-even. We used to make 40% HTI/41% DTI fixed rate loans only to young first-time homebuyers, on the theory that it's doable when you are far from your peak earning years and "history" implies you have nowhere to go but up, income-wise. (In those days, of course, the models figured annual appreciation of 3-4% and young buyers were expected to eventually upgrade out of the starter home with a cash downpayment derived from a couple of years of saving the difference between 50% rent and 40% mortgage payment. The DLQ rate was icky, but there were options for both borrowers and lenders besides "nothing." Lordy, how old I am.) I just can't see where borrowers who qualified at the peak of their earning years at 40% or more going to housing payments at the top of the RE market with zip equity are going to find the additional income to bring that debt service load down to sustainable while they wait out the RE market "just" another year. Is anyone predicting real income gains, cheaper medical costs, or substantial deflation in food and fuel in the next year or so? A substantial drop in long (or longish) rates sufficient to put these folks in the money for a rate/term refi powerful enough to beat inflation? Realtors (and Atlas Van Lines) volunteering to work for free and lenders waiving all their closing costs so that these folks can relocate for a better job without bringing cash to the closing table? Noteholders discovering a magic way to "work out" a loan that started out one step away from impossible and then got worse? Subprime lenders staying solvent long enough to be there when the worm turns? If these folk "hang on" for another year their loans get old enough to hit the "historical" prime years for default. Maybe in the brave new world all you have to do is somehow manage to get through the first 24 months, then you break out of "historical" default expectations. I don't have a crystal ball either, but the number of stars, planets and miscellaneous asteroids that have to line up for this horoscope to be even moderately cheerful is too much for me. Maybe it's just because I bought both orange juice and coffee yesterday. I'm going to have to learn to get a buzz out of tap water . . . Tanta \| 11.19.06 - 7:09 am \| # -------------------------------------------------------------------------------- Tanta - as usual insightful and informed. Not being in the industry, aside from the direct mertis of your assessment, how much of the industry makes it's decisions on that kind of careful thinking ? Judging from the idiot..scratch that...the young and foolish voices on the phone pushing interest only ARMS or somesuch unsinn not a lot. But then again don't know many decision-makers. I ask because it helps me(us) get a read on the broader outlook. Thanks. DaveL \| 11.19.06 - 8:52 am \| # -------------------------------------------------------------------------------- DaveL, I spent 2001-2004 working for a mostly-conduit (bought closed loans from direct lenders, sold them in securities or in limited cases held them in investment portfolio). I hadn't had my nose in credit policy all day long for about five years prior to that. Even in that short period my approach to credit analysis had clearly become, um, stale. The universal answers to any question I or any of the other Grizzled Vets would occasionally waste meeting time with: 1. The average homeowner moves every seven years. This proves that they won't stay in the home long enough for the ARM to reset. 2. You can always refi before [anything bad happens]. 3. Mortgages have always been the safest investment out there. 4. This isn't a "bubble." It's fundamentals! 5. Leverage is the key to wealth. People aren't stupid. 6. But you are obsessing about cash flow and forgetting the tax advantages! 7. We can always make the correspondent buy the loan back/indemnify us against losses. Nothing is more stable than a mortgage banker's net worth! 8. The carry trade can't explode faster than we can unwind our positions, because we're more sophisticated than you poor buggers with your 486K PCs were back in 1994. We've got QRM, dude. 9. But we priced that risk. 10. Investment property loans are really safer than owner-occupied, because the borrowers are business people and Have A Plan and don't get all emotional about their properties (I actually heard this one in a meeting of mortgage professionals). Plus there are all these immigrants who are going to need a place to rent. No, we aren't also counting on them to be buyers, you're missing the point. Feel free to circle any of the above that still sound plausible. Tanta \| 11.19.06 - 10:12 am \| #