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Strategies & Market Trends : The Residential Real Estate Crash Index -- Ignore unavailable to you. Want to Upgrade?

To: Bank Holding Company who wrote (240430)	3/10/2010 12:41:40 PM
From: Jim McMannis	Read Replies (2) \| Respond to of 306849

Why California Is Doomed (March 9, 2010) oftwominds.com California is doomed for two simple but profound reasons: the cost structure is too high for most businesses to survive, and a boom-dependent economy. The dysfunctions crippling California would easily fill a volume: a dysfunctional Legislature that has been gerrymandered to protect virtually every seat; a dysfunctional proposition system which enables special interests to craft Protected Fiefdoms via the ballot box; recalcitrant public unions who don't see anything wrong with public servants getting 90% of top-pay in pensions while still earning big bucks as "contract employees," an enormous population of undocumented workers who pay only sales taxes, and whose employers pay no payroll taxes, either-- and that just scratches the surface. I want to highlight two systemic, structural causes for California's impending bankruptcy as a state and as an "economy": a crushingly high costs structure and an economy entirely dependent on the next boom. I know this sounds too simplistic to be meaningful, but I think there is much truth in this statement: Costs are too high because the guy before you paid too much. In other words, you can't afford the $500,000 mortgage on the $625,000 house you bought in 2008 because the guy before you paid $550,000 for a house which sold for $140,000 in 1997. These numbers are drawn from reality: our friends bought a small home in a desirable suburb in the San Francisco Bay Area for $140,000 in 1997. Yes, it was a fixer-upper and yes, our friends completely remodeled it. The fair value of the house after renovation was probably in the $175,000 to $190,000 range, tops. They sold the house in 2005 for $550,000, and that buyer unloaded the house in 2008 for $625,000. This represents approximately $235,000 of actual value (the $175,000 adjusted for inflation from 1997 to 2010 as per the BLS inflation calculator) and $390,000 of "credit-bubble" excess. Yet that "bubble valuation" is an actual cost now that somebody borrowed money to pay that grossly inflated price. This mechanism is absolutely key to understanding the California economy's fundamental insolvency: the apartment rent is high because the landlord overpaid, the office rent is high because the landlord overpaid, the house is too high because the previous owner overpaid and his/her lender ponied up the mortgage based on bubble valuations. You can see the bubble in this chart of median home prices in Califonia: