Monday, September 22, 2008

Manhattan Beach- Beach Cities: FED Bailout... the good...the bad... and the ugly

Real estate values in Manhattan Beach and the Beach Cities have held up fairly well compared to other parts of the nation and the state over the last few years. However, make no mistake, we are headed for some rocky times if the FED can't figure out the right way to solve the current financial crisis. No question Treasury Secretary Hank Paulson along with FED Chairman Ben Bernanke and New York FED President Tim Geithner did their best to find a reasonable solution to a major disaster... the question is whether or not the solution is going to work.

A lot has happened in the last week as credit markets scramble to deal with some massive changes... Fannie and Freddie got a lifeline, Lehman is toast, AIG is saved, BofA got a whole lot bigger, while Goldman Sachs and Morgan Stanley are no longer investment banks and instead have opted for the relative safety of becoming commercial banks. The government is trying to set in motion a new entity to buy up the bad debt that is sucking the life out of our credit markets. The thought went that the bailout would solve everything and settle the economy... however today's stock market doesn't seem to agree.

Contrary to the hopes of boys in D.C. the stock market didn't see the bailout in the same rosy terms as the administration... the dollar fell, oil shot up to over $120 a barrel, gold is over $900, financial stocks are down and the market lost all the gains from Friday... it was a pretty crummy day for all.

As with all things when dealing with the FEDS the devil is in the details. The government is conveniently forgetting that it played a major role in this little debacle. First by pushing the concept of home ownership at any cost to individuals who should never have bought homes and then by allowing Wall Street to create nebulous products to fund a precarious social experiment. Now the boys in D.C. are scrambling to try and fix what they broke.

Part of the reason the market is bouncing around today is because we still don't really know the extent of the problem. There are big questions about how the actual program is going to work... and if it even has a chance of working. While there may be a need for some speed in passing the legislation in order to stabilize markets, Congress should be leery about putting all the country's eggs in one basket with little or no oversight. ... Paulson may be the man for the job but he should not have carte blanc without public scrutiny as is proposed by the current administration. That's what got us here in the first place.

On the other hand this is not a time for Congress to try and squeeze in a bunch of political junk. You can't save people who can't be saved. Sounds a bit convoluted but the bottom line is that the subprime fiasco that started this slide was based on loans made to people who didn't qualify for them in an effort by the government to make everyone a homeowner. Guess what... most of these people still don't qualify and throwing money at them will not solve their lack of financial stability... it's like trying to put water in a bucket full of holes.

So grab your hats and hang on to your wallets ... this ride is going to be very bumpy... even in Manhattan Beach


Anonymous said...

Do you believe that it was just the
people at the bottom that purchased
homes above what they could afford?
Do you believe any of your colleges
here in the SB encouraged people to
buy above their means? I know I heard
many times in 04 & 05 that "this is
where the markets going". Now it
seems that these numbers were inflated even in MB. Your thoughts?

Kaye Thomas said...

Anonymous 4:37,
Obviously things are a bit more complicated then who bought what... The issue with most of the sub-prime loans is that they were deliberately marketed to people with bad credit and zilch financial stability.

Most of the Alt-A loans( I'm guessing you mean these loans when talking about the South Bay) were made to buyers with good credit and most, but not all, had a minimum of 10%-15% down.

That doesn't mean there were not a number of loans made with 100% financing in the South Bay ..there were. Most of those loans were in North Redondo, Torrance, Hawthorne, Lawndale, Harbor Gateway and San Pedro.

California RE has always worked on a 7-10 year cycle. The Beach Cities have been fortunate in that they usually see prices increase more and fall less then in other areas. We are not immune... we just generally do a bit better then other areas.

Prices have fallen about 10% and we will likely see further declines... we just don't know how much. If the gov't can pull this bailout off right then they may indeed cool the market fears and bring back some stability. If not then who knows....

Anonymous said...

Hi Kaye,
4:27PM Here. Can you estimate that out
of the Alt-A loans issued in MB over
the time period of 03 to 05 how many
would you say were issued to people
that were buying above what they could afford? 2%,3%? I would imagine
that as long as the home prices were
on the rise it was not a concern but
what happens in a declining market if
you purchased above your means?

Kaye Thomas said...

anon 4:27/6:04,
If you bought above your means and find yourself in a declining market then you are probably going to be in trouble. The issue will not be just your home but all the other debt you may have incurred. These problems don't happen in a vacuum.

Generally people buying in the price ranges found in the Beach Cities have good credit along with well paying jobs and financial wherewithal. They are far more prudent about their finances then many people believe.

However financial problems are not just related to purchasing a property. There are any number of reasons someone could be in trouble. The biggest culprits are death, health issues, divorce, loss of employment, bad investments or a profligate lifestyle.

While I don't have any verifiable information to answer your question I would guess that you are correct that 2%-3% or less bought above their means in Manhattan Beach and probably 5%-6% or less in the other Beach Cities.

Where you see more of an impact from buying more then you can afford is in areas where prospective buyers do not have the financial background we find in the Beach Cities and other affluent areas. It's not that it doesn't happen it's just that it happens less.

Anonymous said...

Wow, Kaye. You are extremely naive if you believe that.

Kaye Thomas said...

Anonymous 10:13,
Maybe.. but my office took a pole about our office sales over the last few years and we had very few deals where clients were not highly qualified.. Since 2003 I've only had 2 transactions with 100% financing.. one was on a listing I had (not my buyer) and the other was my buyer who made substantial money and bought below what they could afford by a lot. They were looking for a large tax write off.

I know you won't believe this but the number of people who buy below their means is much higher then you think.

Anonymous said...

Thank you Kaye. 4:27/6:04 Here.
I thought you answer was very candid.
Not based on stats but I would guess
that the buyers who over extended are
closer to 1% but then take into
consideration the developers who came
late to the party and are now holding
multiple finished properties that are selling slowly then the number may be up to 2% if those developers can't
sell or default.

Anonymous said...

"my office took a pole..." Well, why didn't you say so.

Kaye Thomas said...

Anonymous 12:22,
Thanks.. We are going to have problems in MB if the financial markets continue on their current path. People are going to lose their jobs and/or a lot of money on stocks which will change their lifestyles.

Kaye Thomas said...

Ano9n 112:51,
Make fun if you will but we do a lot of business in the South Bay- Beach Cities.

While we are not as big as Shorewood or South Bay Brokers we handle a large cross section of properties and a very diverse group of buyers and sellers.

Anonymous said...

I'm with Anon10:13, but least now you're acknowledging the bumpy road ahead now. Just last week, you were telling me how you expected the market to merely stay stable for the next two or three years, then start going up again.

Kaye, you always seem one step behind, and your "internal polling" and "private record keeping" always seem to give the best possible excuse to believe the brightest possible future and buy now. When you of all people are prognosticating danger ahead, it means something.

Kaye Thomas said...

Anonymous 4:11,

I think you misunderstand what I post... I'm not a Pollyanna. You may not agree with what I say because it doesn't reflect your philosophy but what I talk about is what I see happening. Like it or not our market has remained relatively stable over the last few years. Just because I don't see doom and gloom everywhere doesn't mean I'm not following the market or acknowledging changes.

I try not to project either good or bad but deal with "now". For a long time "now" hasn't been great but it hasn't been awful. Until last week it looked as if we just might escape the worst of the problems and if that happened then we would see our market stay fairly stable. But the overall economic situation has changed... and our market may well change too.

Frankly I have no idea how much we will be affected... could be really bad if we see a number of job losses or it could be manageable if employment stays stable for most of the South Bay.

BTW I'm not in favor of a government bailout as I don't like the idea of these companies walking away unscathed while the taxpayer shores them up. But I also know that if we don't the situation will get a lot worse and the economy can't handle that. Only an idiot would like to see a complete market meltdown. My parents grew up in the Depression... believe me you don't want to see a repetition of that.

If they can set up something along the lines of the RTC... which worked very well and even made the taxpayer a little money... then they should do it sooner rather then later. The longer you wait to deal with a situation like this the worse it gets... and the more it will cost.

Just because I don't subscribe to the concept of the market crashing back to the 90's doesn't mean I think all is rosy and well. This isn't the first down market I have seen and it won't be the last. Each one has been different so I don't make predictions.

People are going to buy and sell real estate no matter what happens in the overall economy. Some will think this is a good time because of interest rates and the ability to negotiate... others will not buy as they believe the world is crashing. The world isn't going to end but there will be changes.

Anonymous said...

People who buy real estate right now are fools. Why would you roll the dice?

Kaye Thomas said...

Anonymous 12:36,
That's your opinion but not everyone feels the same. You would be surprised to find that there are buyers who think this is a good time to pick up property... just depends on your perspective.

Anonymous said...

12:36 - Couldn't agree with you more. Anticipate more and more people will get spooked by what is happening today with the stock market and inability to find financing. Unless you can get the deal of the Century, rent rent rent !

Kaye Thomas said...

Anonymous 10:56,
Buying a home is a personal decision ...which is why you will rent and not buy...

Anonymous said...

BANKRUPTCY NOT BAILOUT IS THE RIGHT ANSWER. BEFORE calling anymore of us idiots, read this article in CNN today:
Commentary: Bankruptcy, not bailout, is the right answerStory Highlights
Jeffrey Miron: Government encouraged lenders to relax their standards

Mortgages were given to people unqualified to repay them, he says

Miron: Rather than a bailout, government should let firms go bankrupt

Talk of economic Armageddon is scare-mongering, Miron says

Next Article in Politics »

By Jeffrey A. Miron
Special to CNN

Editor's note: Jeffrey A. Miron is senior lecturer in economics at Harvard University. A Libertarian, he was one of 166 academic economists who signed a letter to congressional leaders last week opposing the government bailout plan.

Economist Jeffrey Miron says the bailout plan presented to Congress was the wrong solution to the crisis

CAMBRIDGE, Massachusetts (CNN) -- Congress has balked at the Bush administration's proposed $700 billion bailout of Wall Street. Under this plan, the Treasury would have bought the "troubled assets" of financial institutions in an attempt to avoid economic meltdown.

This bailout was a terrible idea. Here's why.

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.

Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.

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The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.

Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.

So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.

The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.

The opinions expressed in this commentary are solely those of the writer.
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Kaye Thomas said...

Anonymous 2:28,

Actually I agree with a lot of what you say... however there is more to the issue then subprime loans.

How do you fix the current problem using your ideas without going into a massive recession. That's what will happpen if we can't find a better solution. No one wins in that scenario.

This little quagmire we now find ouselves in is a lot more complicated then you may think. I don't know what the answer is... but throwing the baby out with the bathwater never solved anything.