My review of "Animal Spirits" now online

Recently, I had the opportunity to interview Dr. Robert Shiller, the Yale University professor and co-author of the new book "Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism," which is now online at BlogTalkRadio. You can also access that interview by clicking on the BlogTalkRadio player on the right hand margin of this blog.

That review was published today by Inman News, which can find by clicking here. An excerpt:

Ever wonder why a seemingly slam-dunk deal suddenly gets thrown off the rails even though none of the terms have changed?

Perhaps you should blame "animal spirits" gone awry, a term economist John Maynard Keynes coined in the middle of the Great Depression to describe the type of "naive optimism" that is a necessary ingredient for businesses to invest, for entrepreneurs to take risks -- and for potential homebuyers to sign those documents at the closing table.

Left to their own devices, however, these same spirits can fall dramatically, thus becoming a psychological barrier to a properly functioning economy.

In their recent book "Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism," economists George A. Akerlof, a Nobel laureate and professor from University of California, Berkeley, and Robert J. Shiller, co-creator of the Standard & Poor's/Case-Shiller Index for home prices and a professor at Yale University, spent over five years researching, dissecting and explaining the importance of these animal spirits in the global economy.

It is their conclusion that longstanding theories of "rational expectations" and "efficient markets" are so flawed on their own that any credible economic models must take into account these spirits to avoid future catastrophes.

Read the entire interview here.

Lessons from the housing bust

For better or for worse, the depth and length of this housing bust is sure to change the way in which many builders do business. Although this blog has been regularly tracking these changes, Builder magazine's John Caulfield has written an article that summarizes just what types of changes we may see in the future.

Even still, given the highly politicized environments at most large building companies, just because someone has a good idea doesn't mean it will make it past the egos potentially in the way. In fact, I know of one senior executive from a top public builder who was shown the door when he was trying to throw up red flags that the market was starting to slow and they should get rid of their land positions -- and this was back in 2004! From the article:

For more detailed information on the six recommendations visit here.

Many builders would argue that recessions come and go, and this one, too, will pass, so why make dramatic changes? But many of these same builders have called this recession the absolute nastiest they’ve experienced, and no one wants to go through this again. So, to help readers who want to avoid such scenarios in the future, BUILDER has assembled six “lessons learned” from the housing bust, based on our reporting since last fall, when the economy took a severe turn for the worse.

Some of these strategies would require simple changes. Others are more complicated to achieve. All of them, though, do ask builders to muster the guts and the vision to look beyond the status quo, and be flexible and open to new ideas for operating a home building business for the long term, through the booms and the busts...

1. Build Smarter

2. Limit Your Land Holdings

3. Find New Cash Streams

4. Respond Quicker to Market Conditions

5. Value Your Workers and Trades

6. Diversify Beyond New-Home Construction

12% of all mortgages and 48% of sub-prime mortgages in default

I'm still waiting for a perp walk of those people who were responsible for the sub-prime debacle, because they had to have known how these loans would end -- badly. According to an AP story, 48% of adjustable-rate, sub-prime mortgages and 12% of all mortgages are in technical default. But now the pain has spread to people who can't pay because their lost their jobs as well as those who bought more home than they could afford:

A stunning 48 percent of the nation's homeowners who have a subprime, adjustable-rate mortgage are behind on their payments or in foreclosure, and that's not the worst of it, new data Thursday showed.

The reckless lending practices in states like Florida, California and Nevada that were the epicenter of the housing crisis are no longer driving up the nation's delinquency rate. Instead, the foreclosure crisis now is being fueled by a spike in defaults in states like Louisiana, New York, Georgia and Texas, where the economies are rapidly deteriorating and thousands are losing their jobs...

A record 5.4 million American homeowners with a mortgage of any kind, or nearly 12 percent, were at least one month late or in foreclosure at the end of last year, the Mortgage Bankers Association reported. That's up from 10 percent at the end of the third quarter, and up from 8 percent at the end of 2007...

The news comes a day after the Obama administration kicked off a new program that’s designed to help up to 9 million borrowers stay in their homes through refinanced mortgages or loans that are modified to lower monthly payments.

Borrowers, however, are being advised to be patient in their efforts to get help because mortgage companies are likely to be flooded with calls...

Meanwhile, debt-strapped homeowners unable to afford their mortgages could get their monthly payments lowered in bankruptcy court under a controversial element of President Barack Obama’s housing rescue plan.

The legislation is part of a broader housing package scheduled for a House vote Thursday. It’s the toughest piece of Obama’s efforts to prevent foreclosures — a stick to go with the many carrots he is offering the mortgage industry to help borrowers afford their home loans.

What will the Boomers' loss of wealth mean to the building industry?

With 401k balances reduced by up to 50% or more and housing prices down by 30% to 40% in many markets, most Baby Boomers find their current wealth to be far less than it was just a couple of years ago. So what will that mean for their retirement plans -- including moving to other areas? A story at BuilderOnline.com tells more:

Many baby boomers who contemplated easing into retirement may now find themselves in far more precarious financial straits in the wake of a collapse in the value of homes that, for a sizable number of boomers, were their primary nest egg.

A new study by the Washington, D.C.-based Center for Economic and Policy Research (CEPR), attempts to quantify how much of boomers' wealth has been severely eroded by the double whammy of plunging house prices and stock values, potentially leaving them little to retire on other than Social Security and other government-funded benefits. The study's findings raise questions about the wisdom of fiscal policies attempting to reduce those benefits, and challenges notions about homeownership being the most effective way to accumulate wealth, given the propensity of housing bubbles...

The median wealth of 55 to 64 year olds in 2004 was $315,400. CEPR projects that this wealth will fall to $168,800 in 2009, or to $143,200 in the worst-case scenario. The average wealth drop would be 29% to $708,000. Even at the top wealth quintile, the average falloff is projected to be 25% from $3.8 million.

The 45 to 54 year old group is generally less affluent to begin with, so the hit it has taken from the downturn in the housing market is starker. The study projects the median wealth of this group will erode by 41% to $101,800 in 2009. In the worst-case scenario, the decline would be more than 45%. This group's average wealth will decline 36% to $408,500, with the losses in scenarios two and three notably larger. For example, in the second scenario, median net wealth in 2009 is $94,200 (a drop of 45 percent) and the average net wealth is $387,900 (a drop of 39 percent).

This age group's median equity in real estate was $83,600 in 2004, but that's fallen drastically since. For instance, in the first scenario, median real estate equity in 2009 is projected to be $27,100—a drop of 68%—while in the third, median equity is projected to be only $6,600, or a loss of 92%. The projected decline for 55 to 64 year olds from their 2004 equity median of $142,000 will range from 47% to 63% in 2009.

The wealth of baby boomers could be further compromised when they are trying to sell their houses. The CEPR study states that only 2.6% of 45 to 54 year olds had less than 6% equity in their primary residences, meaning they'd have to bring cash to a closing when selling their homes in 2004. This year, however, 17% to 28% of each wealth quintile (depending on which they fall into) would need to bring cash to close a resale in 2009. Even households at the top of the wealth ladder won't be immune: In 2004, no households in the top quintile of the survey had less than 6% equity in their primary residences. By 2009, between 10% and 20% of the most affluent households in this age group would need to bring cash to a closing...

The authors of the study conclude that, because of the housing bubble, millions of American families opted not to save during what is considered to be their peak saving years. "Even families in the fourth quintile are only projected to have $215,800 in wealth in 2009 in this scenario. In short, as a result of the collapse of the housing bubble, the vast majority of baby boomers will be approaching retirement with little wealth outside of Social Security."

The authors insist that the government needs to do more than simply let bubbles run their course, which is what they assert the Federal Reserve did during the last housing bubble. They also state that it "should apparent from these projections" that proposals calling for reducing Social Security and Medicare "are unrealistic given the financial situation of those near retirement."

The study's findings, say its authors, "should make clear" that owning a house isn't always the surest path to building wealth. And who is to blame for the mess homeowners find themselves in? Owners, in part. But the authors point accusatory fingers at "the economists and policy professionals who designed policies that pushed homeownership."

Obama announces detailed housing rescue plan

This morning President Obama announced details of his plans to help 9 million homeowners avoid foreclosure. First, a summary from the L.A. Times:

• Remove restrictions on Fannie Mae and Freddie Mac that prohibit the institutions, both taken over by the government last year, from refinancing mortgages they own or have guaranteed when more is owed on a home than it is worth. The White House says this could reduce monthly payments for up to 5 million homeowners.

• Create incentives for lenders to modify subprime loans at risk of default or foreclosure. For lenders that agree to reduce rates to levels borrowers can afford, the government will make up part of the difference between the old monthly payment and the new payment. Participating lenders also will be required to cut payments to no more than 31 percent of a borrower's income. Up to 4 million homeowners could benefit.

• Keep mortgage rates low for millions of middle-class families seeking new mortgages. Using money already approved by Congress for this purpose, the Treasury Department and the Federal Reserve will continue to buy Fannie and Freddie mortgage-backed securities to maintain stability and liquidity in the marketplace. The department, through its existing authority, will provide up to $200 billion in capital for this purpose.

• Pursue reforms to help families avoid foreclosure. The administration will continue to support changing bankruptcy rules so judges can reduce mortgages on primary homes to their fair market value, as long as the borrower sticks to a court-ordered repayment plan. As part of the $787 billion stimulus package that Obama signed into law on Tuesday, the administration will award $2 billion in competitive grants to communities experimenting with innovative ways to prevent foreclosures.

If you missed the press conference, you can watch it below:

Miss the 2009 Economic Outlook for Orange County?

On Monday night there were about 550 people at the Irvine Marriott listening to economic analysis and forecasts by economist Chris Thornberg of Beacon Economics and his Director of Regional Research, Brad Kemp. I was fortunate enough to be able to introduce them and to suggest why the building industry needs forthright analysts and consultants now more than ever.

Firstly, if you missed the event you can still download their slide presentations here:

Thornberg: National Outlook

Kemp: Regional Outlook & Forecast

Please keep in mind that these forecasts are for "worst-case scenarios," so pricing declines for homes (both new and existing), falls in retail sales or increases in the unemployment rate may be less severe depending on a variety of factors. But if you consider that you're better off planning for a worst-case scenario and hoping for a better outcome, then of course you minimize your risk.

Secondly, the Orange County Register's Jeff Collins was there to report on the evening, and posted some of his thoughts on the Lansner on Real Estate blog:

Chris Thornberg, a former UCLA economics professor who co-founded Beacon, told homebuilders that while the overall economic outlook is bleak, hysteria about the U.S. marketplace is overblown. At worse, the financial picture is about as bad as the recession of 1982 and other severe recessions.

“2009 is going to be brutal. But it’s not that bad,” said Thornberg, who began predicting that a housing bubble was due to burst since at least 2003. “It’s not a depression. … This is sort of a normal, bad downturn.”

Other comments by Thornberg:

• Mortgage meltdown: The collapse of subprime loans was due to reliance on CDO (collateralized debt obligations, a.k.a., mortgage-backed securities). The entire financial market was based on folks making short-run returns. That’s got to be fixed.
• Liquidity crisis: It’s not a liquidity crisis, it’s just that lenders have no appetite for risk these days. “You can get business from the bank. You’ve just got to put skin in the game. … You can get money. You’ve just got to reduce their risk. That’s the new reality.”
• Wealth effect: People stopped saving because they thought they were rich because their stock values and home values had gone so high. They actually never were worth what people thought they were, and assets merely are collapsing “back to normal values,” he said. Americans “just woke up from a 14-year frat party with the mother of all Bud Lite hangovers.”
• Prop. 13: California isn’t a high-tax state. “It’s a dumb-tax state.” It places high income taxes on the wealthy who make up about 1 % of the tax base. The state instead should levy smaller tax hikes on a bigger tax base and it should eliminate Prop. 13, which is inequitable and limits revenues.

Click here for entire blog entry.

Rising tension over homes rented out

Think you'll have no problem renting out a house until the market rebounds? It's a great idea if you can cover (all or most) or your costs, but in many areas of the country, there's a growing backlash from HOAs and some cities in response to complaints that many tenants are ruining the neighborhood. From a story in SmartMoney magazine (hat tip: Brian McDonald):

Renters: neighborhood contagion, or a lifeline to beleaguered homeowners? In growing numbers of American towns and subdivisions, that question has become anything but academic, as homeowners associations abruptly ban rentals. Blame it on the huge slump in the housing market. For owners who have to move or who own houses as investment properties, short-term rentals can bring in some cash and keep them from having to sell at a big loss.

But instead of greeting renters with hosannas, many towns and subdivisions are barring their doors, arguing that tenants usher in neglect, misbehavior and even violent crime. Almost 60 million Americans live in developments governed by homeowners associations, and by some estimates as many as 40 percent of those communities enforce restrictions that keep owners from becoming landlords.

Indeed, many associations are enacting even tighter anti-renter rules — even in the parts of the country hit hardest by falling prices. Often the backlash comes after the rowdy-tenant threat becomes a reality...

The conflicts help explain one of the more bitter ironies of the real estate scene. Even though demand for rentals is at an all-time high, there are now 18 million vacant housing units in the U.S., according to the Census Bureau. More than a third of those properties are being left vacant by their owners intentionally, a trend that’s being exacerbated by local renting rules. To be sure, some communities are easing restrictions in a bid to lure buyers. But other subdivisions are digging in their heels even as homeowners beg for relief...

Click here for full story.

Mortgage fraud UP in 2008?

Just when we thought that the miscreants who were largely responsible for the housing bubble & bust were gone from the mortgage lending industry, a story in the New York Times cites a report that says mortgage fraud actually rose by 45% during the second quarter of 2008 over 2007 levels. Considering lenders rarely pursue people who lie about their financial situations and instead bury their losses in higher fees and interest rates, is it any wonder borrowers and their enablers still try? From the story:

MORTGAGE volume may have fallen last year, but not incidences of fraud. In fact, according to a recent report from the Mortgage Asset Research Institute in Reston, Va., occurrences of fraud among loan officers, brokers and other industry professionals actually outpaced 2007 levels by 45 percent in the second quarter of 2008, the most recent reporting period.

The Research Institute, a consulting firm, does not release specific figures, which it compiles from surveys of lenders that make most of the nation’s mortgages each year.

The report, released in early December, found that 36 percent of the fraudulent mortgage activity involved loan professionals’ misrepresenting borrowers’ incomes, while another 20 percent involved misrepresentations of borrowers’ employment.

Lenders did not specify how much of this activity was simply stretching of the truth by loan professionals on the applications, categorized as “fraud for property,” as opposed to “fraud for profit” schemes, in which bogus loans are taken out to defraud lenders of money. Fraud for property is far more common.
Click here for full story.

My most recent column for Builder & Developer magazine now online

My column for the January issue of Builder & Developer magazine is now online.

For the new year, I wanted to focus on what role many economic & feasibility consultants had in the housing bust:

When I first started writing market studies in the late 1980s, figuring out the demand for new homes in specific price ranges was a requirement for a full-fledged analysis. But by the late 1990s, as the market began to rebound and public home builders snapped up local companies, the only data many clients wanted to see were the prices and sales velocity of their top competitors...

Indeed, some companies offering consulting services to developers owe their entire growth strategies to their reputations for providing supposedly objective reports – at least from the unknowing point of view of compliant construction lenders – that would magically hit pre-set targets for prices and sales velocity...
Click here for entire column.

Did the Bush Administration stoke the housing bubble?

There's a detailed story in today's New York Times (hat tip: L.A. Land blog) detailing how policies of the Bush Administration and ignoring important warning signs (such as prices rising much faster than associated rents) served to stoke the housing bubble. From the story:

Eight years after arriving in Washington vowing to spread the dream of homeownership, Mr. Bush is leaving office, as he himself said recently, “faced with the prospect of a global meltdown” with roots in the housing sector he so ardently championed.

There are plenty of culprits, like lenders who peddled easy credit, consumers who took on mortgages they could not afford and Wall Street chieftains who loaded up on mortgage-backed securities without regard to the risk.

But the story of how we got here is partly one of Mr. Bush’s own making, according to a review of his tenure that included interviews with dozens of current and former administration officials.

From his earliest days in office, Mr. Bush paired his belief that Americans do best when they own their own home with his conviction that markets do best when let alone.

He pushed hard to expand homeownership, especially among minorities, an initiative that dovetailed with his ambition to expand the Republican tent — and with the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards.

Mr. Bush did foresee the danger posed by Fannie Mae and Freddie Mac, the government-sponsored mortgage finance giants. The president spent years pushing a recalcitrant Congress to toughen regulation of the companies, but was unwilling to compromise when his former Treasury secretary wanted to cut a deal. And the regulator Mr. Bush chose to oversee them — an old prep school buddy — pronounced the companies sound even as they headed toward insolvency.

As early as 2006, top advisers to Mr. Bush dismissed warnings from people inside and outside the White House that housing prices were inflated and that a foreclosure crisis was looming. And when the economy deteriorated, Mr. Bush and his team misdiagnosed the reasons and scope of the downturn; as recently as February, for example, Mr. Bush was still calling it a “rough patch.”

The result was a series of piecemeal policy prescriptions that lagged behind the escalating crisis.
Click here for full article.