i-d-r: institute of dynamical reasoning


Real Estate Bubble

Filed under: Articles — trudd @ 3:21 pm

Author:  Terry Rudd – ruddcommodities@hotmail.com

At this writing, the Treasury and Fed just convinced Congress to grant a $700 billion capital infusion to prevent a run on the investment banks.   As a member of the Appraisal Institute, touted the most prestigious appraisal organization in the world, and with 50 years of experience valuing all categories of property … I should have known the extent of the real estate component of this problem.  But except for some key personal insights, I did not become aware, even after attending seminars on this subject, of the incredible magnitude of this financial crisis.   Even as a commodity trader for 30 years, I’m ashamed that I and most of us did not have a clue either.   We didn’t know that a Titanic ghost ship 10 times the size of our exchange markets was running alongside – in the dark!  What iceberg?

John Hill and George Pruitt, of Future’s Truth Magazine, suggested I research this subject and report back.    I accepted … concerned about my own future, as well as helping other commodity traders.    So, I spent the last six weeks trying to make sense of what sounded like non-sensical problems in the mortgage and investment banking industry.   What I discovered is that, on one hand the problems have become extremely complex, but on the other hand remain … unbelievably simple.   To my amazement, we appear to be in surprisingly good shape in regards to the down cycle in residential real estate.   We could afford to pay off every institutional home mortgage if given a few years.   Though such is many times the $700 billion now requested to salvage the banks, it’s several times less than what our country makes as a whole – $15 trillion per year.

But, while we’ve been busy trading markets that continuously display prices and our financial positions, the investment banks trekked far beyond their simple lending beginning, like the movie “It’s a Wonderful World” loaning on houses and Joe the Plumber businesses – to a celestial array of pyramiding schemes in the search for profits without limits and no oversight.   Evolving from 20% risky business 30 years ago, these aggressive banks increased to 80% jungle warfare gaming of unknown magnitude.

In a no-holds-barred predator environment, bank traders preyed on investors, pension funds, hedge funds, and other countries around the world.   This feeding frenzy was brought on by excessive profits extracted by the seller banks.   This brought on ruinous competition and in the scramble to outdo one another, everything was gambled on in the name of investment from interest rates and currencies to bonds, equities and mortgages, even weather.  The stakes were also excessively large, but unbelievably no market prices or party positions were reliably reported – just ledgerdemained figures presented to fleece buyers.   By skirting the exchanges, bank traders became an overly aggressive lot – lying and stealing, even from themselves.  Both sides of the equations both won and lost figures of unimaginable amounts … often not having a clue  where they stood financially, while employing the most scientific and complex mathematical formulas ever augured.

This mishmash of tangled webs ensnared our entire world banking system.  Many citizens have been calling for retribution, but most of the retrievable cash is gone.  Not just the zeros (so easily erased off  the world’s balance sheets), the rapacious traders exacted their horrendous due at the inception of every deal … a giant ponzi scheme eclipsing every multi-level game ever conceived.  Coupled with the desire of almost every player in these games to keep the transactions off the books to avoid taxes and various laws of many countries ensnared, it’s been like a giant commodity exchange allowing selling parties to quote fictitious prices with no one announcing true acquisitions or positions.  They circumvented the futures, options, and security exchanges that were set up to prevent this … and yet now we’re expected to bail them out!

My assignment was to simply find out what went wrong with mortgages and the real estate market.  After I pulled myself up off the floor, I found that foreclosures were only the latest in a whole mountain of problems.   Mortgages were simply the latest play in the derivatives theatre.   After the Nasdaq crash March of 2000 and 9-11, housing looked like it could pick up the economy.  World interest rates and the Fed accommodated.  Soon values took off for the moon and bank traders came running.   Simple house mortgages were leveraged into securitized debt instruments of every kind and variety.   Derivatives had been used for almost 30 years, but never to this degree.   The shadow banking “shearer and sheep” games, that had become obscenely profitable, began turning ordinary house mortgages into traunches (multi-million dollar bundles of loans) which flooded the world.

Investment banks found it easy to convince pension fund managers globally that in no way could they lose on these mortgages.  Every one knows that very few people ever default on their home loan.    These loans were risk free – AAA.    U.S. pension funds, then the Europeans and finally the Asians were sucked into accepting multi-leveled math-modeled mortgage-backed securities, credit default swaps and multitudes of other financial instruments that transferred credit risk from the banks to those who actually financed the housing mortgages to begin with!   It was Nirvana to the investment banks (which by this time included just about every large bank in the world) … being able to regain the very money they lent the buyer – yet passing them the risk, and still taking obscene profits up front and in high interest fees.   No, not just obscene profits, the traders absconded with most of the money brought to the deal.   Bank traders by this point had become so, so successful.

Now, depending on whose opinion one accepts, this leveraged disaster we’re caught in could amount to something near $154 trillion in the U.S. alone … and over $500 trillion world wide (so bad it looks like a typographical error).   This is nearly 10 times the world’s $55 trillion GDP.    Those who lost out in this game of musical chairs would like to be compensated.  But, it’s not possible.   It would take the world’s entire output for 10 years at no interest and without eating or sleeping – just chained to our jobs night and day.   Plus most of the recoverable profits are gone.

Paulsen and others, even Greenspan loved derivatives (though he once said if we understood what he said – we got it wrong) contend the U.S. taxpayer will make a profit in the long run.  Sure, like they made well known that the $250,000 FDIC insurance runs out December 31, 2009… Still, were told, we have to save certain banks to keep our economy alive… these same people said the world was fine just a few months ago.  Aren’t we just rolling cars in front of train wreck in the making??

But the credit and real estate market disasters may not be our only problems.   Other calamities may be in the making.    Though we survived “J” curve tsunami bubbles before – like the Nasdaq crash of March 2000, the rural real estate crash of the 1980’s, Japanese Nikkei “cliff dive”… and  further back,   the 1929 Depression … the looming stock market and economic collapses could present us with the mother of all perfect storms.   Experts question whether throwing money at the current banking dilemma is like throwing coal on a fire – slows it, but then it resumes …   Commodity traders know that trends run their course despite all efforts otherwise.  So, maybe we’re using our ‘powder’ too soon?

We still have to worry about the world’s perception of the dollar’s strength, lest they tire of our ability to print our way out of debt (being the world’s trade currency) … and thank you China and others for building us mansions while you clawed your way out of poverty.    Hey, at least we pay (well service) our debt.  But if we shoot all our bullets now – what will we have when the real wolves show up.   Oh, and don’t forget that our production could easily fall from $15 trillion per year to where these burdens would become unimaginable.

The current real estate down turn stems from the meteoric rise of the residential market from 2000 to 2006.  What was supposed to be a down cycle following the 1990’s up cycle (real estate cycles are an average of 9.3 years both ways) may have been this final blow-off peak.  Faced with the Nasdaq crash from its J curve tsunami peak in March of 2000,  9/11, and an economic downturn – it appears the Fed was only too happy to help the explosion in the housing market.  And yes I, along with all other  appraisers who wanted to eat,  had to support this ultimate tsunami with flowing reports bereft of the big picture view.  With all the attendant construction and development – the value of residential housing leaped from $11 trillion in 2000 to $22 trillion in 2006.   Optimism and greed went berserk.   Hey … don’t look away; you were part of this too.

Fannie and Freddie, the main financiers pulled out all the stops to increase profits for their management and stock holders using fuzzy accounting procedures, lobbying Congress, and greatly increased risk taking.    Coupled with every sort of banking scheme, this great elevator full of balance sheet zeros from every corner of the planet reached the weight capacity of the cables and they began to fail.  Human greed is necessary to the free enterprise system and it brought us material goods and wealth the planet has never seen before.  However, human greed knows no bounds and stretches as far as it can go.  Then the “rubber band” breaks and springs back.  Nothing rises forever.  Now $11 trillion, or maybe much more, will need to be erased by probability in balancing its books.   Yet, the government refuses to admit this.   But commodity traders can.  We cut our teeth on the pig cycle graph of supply/demand.

The problem would not have been so great – except that we monetized the balloon in house prices from 2000 to 2006 by way of the mortgage market.  This caused lenders to be drawn into the payback.  And during the meantime, lenders weren’t just holding these mortgages; they were busy   leveraging their payback.  That’s just good old-fashioned capitalistic ingenuity… but again to the extremes?   Could anyone manage this juggernaut of off-sheet asset growth, multiplication of underlying capital up to 45 fold (Merrill Lynch)… debt begetting debt… shadow banking… all

sorts of Collateralized Debt Obligations… Structured Investment Vehicles… hedge funds – on and on.   It appears there were plenty of officials in Washington ignoring their duty for profit as well.

Estimates of an unbelievable $500 trillion in derivatives is now unwinding –  a mad game of musical chairs  could now be the lynch-pin of a perfect storm… an unending deluge coming from  concurrent imploding bubbles.   We commodity traders know about Dewey’s cycles which explained the Great Depression (the U.S. paid for after this debacle but ignored when the upcycle kicked in)  Wheeler’s war cycles (which we follow in spite of all efforts otherwise) and Kondratieff’s 55 year economic cycle (for which he died in a Russian Gulag)… are long overdue.   Still, many don’t believe in cycles because Probability’s bell curve disperses these cycles – keeping them from being perfectly predictable.    Still, they show up, usually when we’ve made other plans.   Though we are slaved to them, we consider ourselves immune to the movements of the universe – until it’s too late.   We love to ride up in the balloon, but seem shocked when the bubble implodes.

There are several reasons why we do not understand what causes bubbles to form.   First, price is not value … It is only one point of value.  Real value is a whole range of prices – both over time and at the same time.  Appraisers typically don’t mention this fact and simply report the last price as value.  Secondly, though we know prices change over time, we are rarely asked to predict future value – a very critical consideration to the payback.  The lending industry is locked into single present value – assuming the future will remain static.

We appraisers have developed very few forecasting technicians.   Commodity markets abound with them.   Though the bell curve spreads performance – at least commodity traders know prices vary cyclically, and most importantly – say so!   And while we are often disappointed in a forecast – we are not dumbfounded.

Another reason that house prices cycle over time is that everything, including ourselves, is composed of sub-atomic particles.  But they are only up and down cycles of energy … displaying points only like prices.  We inherited the propensity.  So why are home owners so shocked – both psychologically and economically?  It’s because mortgages are not tied to changes in the economic cycles.   They are usually fixed over long periods of time…15…20…30 years with no allowance for problems …  Borrowers from 2000 to 2006 expected the government to continue bailing everyone out with inflation and counted on higher resale from rising home prices to be an outlet if mortgages became burdensome.  Few worried about taking on a loan (me too) several loans… no problem… until the bubble popped.

We appraisers are generally not commodity traders.   We were told by our industry, as well as  lenders, that current price was a dependable basis for mortgage loans.  Nothing could be further from the truth- as was pointed out in both the 1980’s as well as the Great Depression.  Those who warned otherwise, couldn’t get any business.  We can’t blame appraisers any more than investment bank traders.  We worked as best we could within the system.  House prices aren’t exchange listed or  borrowings  balanced with lending either.   It’s assumed the free enterprise system will balance itself and take care of excesses… except we don’t want the corrections.   Well, no one ever did – but they came anyway… with the territory.

If only the public understood the much larger range of reason, we could at least explain many perplexing problems in addition to where we are financially.  There are usually many contributing factors creating a problem- not just the most obvious one we blame.  Of course there are single “bullets” which can pierce a vital organ, but generally… many other causes are involved.  Cutting out the supposed bad part, like cancer, is great for headlines, but doesn’t really explain the cause.   Please allow me to use this probabilistic range of explanation as to why results vary- so we can get to the essence of things rather than spitting out the watermelon because of the seeds.

Those who did not mortgage their homes (an estimated 34% according to NAR) did not multiply the numbers payback problem.  Those that did – agreed to pay compounding interest rates which easily double or triple the total payback.  Lender banks counted on and played games with both the rates and paybacks.   But being lent long and borrowed short, their pyramidal cash flow game – when turned over… became an  anvil creating the current money shortage.

I have a client who is in the thick of things, but so far won’t say a word.  On the other hand, an expert on credit derivatives who designed exotic instruments himself, Satyajit Das has stepped forth with numerous publications from which I gleaned most of my knowledge about the subject.    Das is warning everyone, including his mutual fund clients that the jig is up.  He blames regulators who looked aside as U.S. banks designed ways to shift trillions of dollars credit risk off their balance sheets into the hands of unsuspecting foreign investors, hedge and pension fund managers on high-yield debt instruments they trusted us about and financial engineers who built mountains of securitized debt based on flawed math models.  He confirms that defaulting homeowners are only the latest blame.  The majority of the range of reason belongs to the previous inventions which ultimately allowed hedge funds to have high-yield debt for acquisition.  Looks like a multi-level scheme to me – and most of us, whether we realized it or not, gained or suffered as a result.

Das confirmed estimates that $1 now supports as much as $30 of “blue sky” loans.  The upward spiraling of a nearly infinite variety of these ballooned derivatives totaled $485 trillion earlier this year according to Das.   Now this figure, according to the Bank of International Settlements in Basel Switzerland is $516 trillion – or $540 trillion according to Warren Buffett.  This pile stands 10 times taller than the world’s productive output of $55 trillion.    What began as a major problem appears now to be a hopeless quagmire.

I should have been more suspicious when lenders from Fannie and Freddie, on down to our local banks, accelerated their criticism of appraisals… things that had little to do with value.   They claimed the tranches (bundles of loans) that were assembled and sold – changed millions of dollars just based on how reviewers perceived the written reports.  There seemed to be no concern about how ballooned the market was or how crummy the house.  We just said “go figure” – which we should have.

How the investment banks managed to bundle up these grenades they called tranches and paint them gold so they could be sold Triple A rated from S&P and Moody’s is yet to be unraveled.  But they needed to in order to sell them to pension funds and other conservative entities.    These MBS’s (mortgaged backed securities) were then traded for other debt, like baseball cards, for more debt in a giant Ponzi scheme.  At each level the traders were taking most of the profit up front.  There was no concern about logic, laws, or lies.   Even appraisers were caught up in this feeding frenzy.   Lenders were dragging bodies off the street for home loans.   Castles were being built everywhere for people who were living in bungalows just months before.   Even a handsome horse could obtain a loan for a new barn.

Then, one day the “termite mound” reached its top where not one more deposit of defecation, spit and mud could be piled any higher.  When even borrowers without jobs or even wanting to get one could buy homes with no down —- there was simply no one left to push the cart up the hill…  and down it came.   Those triple A ratings began to fall – forcing the pension funds and others (who could only hold triple A paper) to sell their positions.  Now the tables were turned – supply outstripped demand … and the rest is history.  Wall Street now wants us to bail those who didn’t get out in time plus the collateral damage; those left with empty sacks.   How can we?  We aren’t at the bottom yet… and the well could be dry by then.

My original assignment was to determine how much mortgage money might come off the ledgers.  I did this as follows:  The U.S. Census Bureau indicated there were 126,311,823 dwelling units in 2006.  To find out how many were homes vs. apartments, etc. I used the Census Bureau’s 2000 breakdown as follows;

Single Family Residences’s    60.3%  =          76,166,000 units

Attached SFR’s                      5.6%    =            7,073,000 units

Multi Family                           24.4%  =          33,346,000 units

Manufactured Housing           7.5%    =            9,473,000 units

Other                                       0.2%    =                 26,000 units

TOTAL                                                         126,311,823 units

Next to determine how much mortgage money were talking about, I contacted NAR, National Association of Realtors, Zillow, and OFHEO, Office of Federal Housing Enterprise Oversight.  Estimates of the average home price in 2000 were correlated at $120,000 and at the peak in 2006,   $235,000.   This indicated an inflated/growth rate of $115,000 per home, nearly double the price over this period.    S&P Case-Schiller Home Price Indices also indicated a price rise in the major cities from 100 to 200 over the same period.  This doubling supports the numbers concluded.

Next I used the $115,000 price increase to multiply by the number of homes.   I estimated the other unit prices from figures from our files multiplied by a factor 1.424 which is the difference between our market and the national average.  These figures were then multiplied by the number of units as follows:

$/UNIT        TOTAL $ / Trillions

Single Family Residences’s    60.3%  =   76,166,000    x    115,000    =     8.759

Attached SFR’s                      5.6%    =     7,073,000    x      90,000    =        637

Multi Family                           24.4%  =   33,346,000    x      40,000    =     1.334

Manufactured Housing           7.5%    =     9,473,000    x      70,000    =       663

Other                                       0.2%    =          26,000    x      50,000    =         13

TOTALS                                                126,311,823 units                  =    11.442

This figure correlates closely with TFS Derivatives, Zillow, and OFHEO that current housing is worth $22 trillion, and that half of this figure is close to the $11.442 trillion above.

The next figure we need is the amount of price that was mortgaged.  An almost impossible task was helped out by NAR which indicates approximately 74% of existing homes were mortgaged.  This fits with our sampling.    The other major factor needed is the average loan amount estimated at about 85%.  This is balanced by the unsold developed lots estimated at 15%.    Multiplying the blue sky/inflation figure of 11.442 trillion by the 74% mortgaged – arrives at the playground for the lenders of… $8.5 trillion.

Now, the hard part.  Not the multiplication of MBSs leveraged to the “moon” (which probably makes the rest of this moot) but the true underlying debt which normal banks like “Jimmie Stewart’s” held.    There are estimates currently of $1.2 trillion in arrears.  Eventual estimates range on up to 25%, or $2.1 trillion.  Who knows, because it’s the borrowers that will ultimately decide and there is no clearing house to provide us with this kind of information.

Or we could have an “Ollie Ollie Oxen Free” like the ancient Jewish Jubilees (they recognized economic cycles of 7×7+1 =50 years)—- wherein all debt was forgiven.  Even at that, with the $15 trillion we make a year — we could probably survive paying off everyone’s mortgage of $8.5 trillion, if done over time and our GNP stays up… but levered by the banks up to a factor of 30 would indicate a credit derivative total near  $255 trillion!!!

Back to the base mortgages, the greatest default rate could be somewhere around 50% worst case (hopefully, but no guarantees).  This spells out a hit of  $4.25 trillion.    James Lockhart, Director of newly formed FHFA, thinks there is $5.3 trillion in MBS’s.   This could soften the blow, but not if we have to deal with the leveraged debt pyramid.   Over 5 years we could pay for all the housing default itself at $850 billion per year, just slightly more than the current bailout (but for 5 years).  However, this doesn’t address the whole housing pyramid – or a world of other product derivatives.

Before this all happened I thought we were in bad shape because of my government work experience (where employees miss the opportunity of financial failure whether they’ve done a good job, bad job or no job at all) – but things weren’t really that bad.  I just hadn’t looked at the big picture until now.  If you’re in the same boat, look at these figures:  our government is spending about 3 trillion per year;  including about 1 trillion on present and past military; 0.5 trillion on interest of the national debt of about 10 trillion.   Even the 700 billion for the bailout doesn’t sound so bad since were making (GDP) $15 trillion per year.   And, we have quite a few assets:  $22 trillion in housing; industry $16 trillion; business stocks and bonds $25 trillion.  The world has more than $175 trillion in real estate, stocks, bonds, and $55 trillion in production (GDP).   We appeared ok – before all this….

What about my “close encounter” with Fannie?    In 2004 Fannie tried to terminate my appraisal license.  They requested the Dept of Licensing in the State of Washington to take disciplinary action because they took a bath on a house I appraised.  It sold for $70,000 several years after I first appraised it for about $135,000.    Bewildered because the market was still strong, I visited the house, but no one was home… only sheets over the windows.  I left my card and received a call a few days later from the couple who were buying it.  They said the house had been trashed by the previous owners when they “fell off the wagon” and began making crack… chemical spills in the basement;  swimming pool used as a garbage dump;  patches of grass that looked like UFO landings.  No loan payments made.  Still their bad loan was passed around like a hot potato, apparently in a bundled loan package (traunche).  Bargain seekers couldn’t locate anyone to buy the house from.

No realtor or appraiser was ever hired to see what was going on.  Even the title company could not locate the ownership of the loan, though numerous interested purchasers chased the opportunity.  The couple, who never gave up, followed the trail for a year and a half before mortgage ownership could be located.  The couple said the strangest reaction was received from the last loan holder.   First, they didn’t even know they owned the loan because it was buried so deep in a sack of mortgages.  Second, the couple made a low-ball offer and the lender agreed instantly with no counter though the couple was ready to pay an additional $15,000.  On learning this, the State agreed to drop the case against me – but only after saying they were doing me a favor.

Yesterday the Dow dropped 777 points, and to make a point about our lack of value understanding,  CNBC declared $1.2 trillion dollars were lost from the nation’s wealth.  Nothing could be further from the truth.  After half a century of appraising, I’ve come to realize most of us don’t understand price or the marketplace it plays in.   Price, as most commodity traders know, is only the latest indication of market supply and demand.   For example, when a house sells for $200,000, it doesn’t really mean that that house is worth $200,000.  This figure is only the traded figure at that moment based on a number of fluctuating factors.   Current price is not the whole value of anything… though we say it is for convenience.

Value is also a range of prices which looks like a normal distribution curve.  Prices pop up at various points depending on the circumstances surrounding the sale.   Essentially, price can be any figure within its bell curve range of value.  We err in thinking that an appraisal sets value — just because it says it does.  Again, it’s a major misunderstanding promulgated by everyone in the business.  If our house is said to be worth $200,000… it only applies to some price within its bell range at that moment.   We think of the sales level in the market as value but it is only the price extension of what similar items, like stocks, and commodities are selling for – at that moment.  The next moment – changed circumstances – changed prices.

When there are more buyers than sellers, the price tends to rise, of course.  But when there are more sellers, many more sellers – the price can drop significantly.  In fact, according to Law of Diminishing Economic Returns, if all the $200,000 houses in the market were up for sale at one time, the price would head towards zero.  This why it’s ridiculous to state that any indexed price level – is that value.   For instance, a Dow level of 12,000 only means that a few paid at that level.  Most of the other buyers paid different prices – in fact, most lower, but accordingly many higher as well.   Some still have stock purchased when the Dow was at 1,200.   That’s why it’s dangerous for any mortgage purchaser to acquire debt thinking they have value protection over term, without understanding that term. Again, there’s no perfect prognostication – only best estimates.  But at least the enlightened mortgage holder won’t jump off a bridge when they find their future projection wrong.    Futures traders expect their projections to vary and shoot themselves instead.

If you are a trader, tell one your stock holding and “bank deposit” friends that they aren’t investing – just gambling like you – but with one arm tied behind their back.  The price/value of everything on earth changes up and down.  Even what appears as sideways movements are still small up and down cycles.  When you only buy – you are handicapping yourself.  I hear that the radio and TV networks won’t allow commentators to talk about shorting the stock market.   So, a major misconception must exist in the public.  This is germane to the current credit crunch because it’s why so many buyers of the latest derivatives are so shocked about the normal, but very large DOWN   cycles that occur to match the upside.

You should feel free to short the stock market, or any other market with out feeling un-American!!!    Feel free to mortgage anything and diversify the proceeds for a rainy day.  It’s all gambling and advantage seeking – and it’s definitely snowing right now.  We’ve been to this barbeque before.  It’s where character gets broken or molded.   It happens to investment banks too much of the time.

The 1980’s put many, like me, on notice that down cycles can be devastating and brought on by a number of reasons, few of which can be fixed by man.   Rural lands of all types, timberland, grazing, mining, oil drilling, agricultural and all the small communities associated therewith took a massive hit of approximately 62% in value from which only a few contract buyers survived.    Unfortunately, those, like me, who purchased at the top of the market in 1979-80, were trashed during the 1980’s.  Others like a developer in Spokane and a farmer in Hermiston that I’ve done considerable appraisal work for – became so indebted that they never did escape the compound interest “hammer”.

In the early 1980’s I lost $400,000 on a ranch I speculated on.  These were hard earned dollars, not just zeros off some balance sheet.   I thought the ranch would bring me a million dollars ultimately.  But the down cycle drained me financially, and mentally as well.  I came to understand why some jump.  It’s nothing to take personal, but took me 2 years to convince myself and get my animal spirits back.

After nine years of the down cycle of the 1980’s, the market turned around in 1990, right on cue. Again, the government took credit as they did after the economy turned up in the latter 1930’s.  After the cycle turned up in the early 1990’s – it was supposed to culminate in the year 2000.  But at that time, the crash of the Nasdaq in March of 2000,  9/11,  plus recessionary tendencies, caused the world and thus the “following” Fed to reduce interest rates.  And reduce they did!   What ensued was the biggest real estate bubble the planet had ever experienced.  And the Fed had no clue?  That’s really scary…

During this tsunami of 2000 to 2006, those who treated their home as a bank, and there were tens of  millions,  spent heartily their fictitious equity – thinking nothing about the payback.  Why haven’t we taught our citizenry about cycle market action, so they won’t be totally upended during disastrous changes when they occur?   Oh, we haven’t even done that for our leaders.   It appears that neither academic nor government sectors understand or appreciate the problems of free enterprise business.  How the public could be expected to fix what our government can’t… is a sign we could be in serious trouble.    Just wait till the panic hits everybody’s paycheck.

The government programs in the early 1990’s only locked the barn doors emptied in the 1980’s.  They never saw a horse, only dealt with an already smashed market.  Initially, they didn’t even try to keep the insolvent S&L’s afloat because S&L’s didn’t fit into the Feds safety net for banks.  Banks were given free reign… any business can survive when it’s given free money.

As an appraiser throughout the 2000-2006 bubble, I was as most other appraisers, impotent in applying any brakes to the runaway train.  Those who fretted about buying a home at many times its inflated price perceived they had nothing to worry about since other purchasers simply sold their purported mistakes for a profit.  But at the peak, after everyone had stepped into the elevator car, the perceptions began to change and crash they did.  Million dollar houses in Florida began selling for $600,000 and appraisers in California, Arizona and other hot spots in the country were talking about the reversal in fortunes.  I attended a “Meet the Lenders” seminar Las Vegas and received further gut wrenching news when the leading lenders were discussing the carving of mortgages and how grammar in our appraisals could affect the value of these MSB’s by millions of dollars.

What the world doesn’t understand about appraising is that we are simply reporting the current market activity, not an evaluation of the overall history of the market.  We aren’t asked for, nor give a solid basis of value (for which none exists).   Nor do we guarantee in anyway way the price, we call value will be good for more than that moment in time.   Now of course, that’s all out the window except for the blame game.  And society is fixed on last reasoning analysis.  When anything goes wrong, the public through the media, looks for the last single reason to blame – be it person or event.  But, this is only valid in a very few cases.  The majority of events occur as a result of a long chain of reasons, often that cannot be perfectly predicted or changed.   We are now criticizing each others involvement – like counting needles on a burning pine tree.

I would like to be able to offer a perfect solution to the world’s liquidity problem.   But I have too much respect for probability’s demand to balance.   Its solution is to wipe fictitious zeros off the chalk board by any and all means possible.  In the Great Depression, experts claim the U.S. Government did not make an early attempt to avert the various disasters.  This time it looks like we’re going to try, but the pyramided numbers appear too overwhelming?  I, like many others, have not given up on this endeavor.  However, but I’ve become much more fearful of trying to defeat cyclical trends, until they announce their conclusion.

What’s nagging at me still is – did I finish my assignment?  I keep hearing about gold derivatives and gold bullion banks.   And how safe is our money???  I’m making that my next assignment.  These are different times than Jimmy Stewart’s movie and yet leverage and confidence are still the keys.  Banks which are normally leveraged 10 to 12 times are now leveraged up to 45 times and nobody really knows at that.  When I bought that ranch (on contract) I didn’t realize until I backed out that I had inadvertently created over $2 million dollars of the same credit money, and I was just one person.   The seller bought property on contract too… and the next seller did the same thing… on and on.  I believe in the greatest freedom possible, but there still needs to be a scoreboard somewhere.

I hope we don’t make a witch hunt for problem banks and their rapacious traders.  Ironically, they are the backbone of our free enterprise success which is basically a jungle.  The big predators produce the most because of their voracity.  Best if we keep them chained into competing productively, not robbing the banks.    I’m sure they helped spread capital to industrial markets.   But, like a football game wherein powerful men pitted against each other make wonderful by-products, rules are required now that weapons of mass destruction are available.  Otherwise, football would be nuclear warfare.  Also, we need to be able to watch the game- lest we allow announcers from giving us different action that would put dollars in their pockets (the whole derivatives industry did that).  Instant replay also keeps the refs honest and accurate, well as good as can be.  Yes, football is a wonderful example of free enterprise.

Greed should also be appreciated.  We all have it.   Without it where would be the competitive quest which has made our world unbelievably wealthy.  Otherwise, we may not have made it past the lions.  And government as referees works fine, but trying to make productive coaches out of people not tied to their success – won’t cut serious competition.  Nor can we pull spectators out of the stands as referees, unless they are well experienced.  Where are the Teddy Roosevelts when you need them?

Though free markets are not imperfect, so imperfect that chaos rules their behavior, the net result in the long run has no competition from socialistic programs run by inexperienced spectators from the stands.  For one, the basic greed and fear that run the markets can turn disastrous in the hands of a single or small group of similar human beings who otherwise lacking a monopoly and faced to compete with the other lions and tigers, over produce and under price items that we, the populous, have benefited from to a greater degree than any population in this corner of the universe.  Capitalism works by way of Herculean efforts of competitors to eliminate each other through both risk and reward when no pain- no gain is actually no gain.  As with our bodies, hurt saves what we haven’t damaged.  We need to buck up.

These cycles only reshuffle the pain and gain, perhaps though we have become too weak having sucked on the world’s investment cash so long that we cannot survive without the Chinese banks and Mid-East oil sheiks.  I just hope that we don’t take to inflating our money like Germany did in the 1920’s when they couldn’t make all the French repatriations and it took a wheelbarrow full of money to buy a loaf of bread.  Whatever we do, it’s probably in the cards as the market doesn’t just abhor a vacuum, but doesn’t allow tampering with its patterns.  Well that’s the subject of another article.

The market is not perfect, just better.  We evolved in a competitive environment which is why competitive management.   Only learned students of the free enterprise system know not to whine when the collapse of a tsunami wave yaws. Pain of corrections is almost unbearable, but at least we are not thrown into a Russian gulag never to be seen again like Kondraiff who in 1926 taught in Moscow that the expected Marxist crash would always rebound like an ocean wave.

We failed to teach our young how free enterprise business works.  It’s not the government who built this country, it was the old fashioned jungle gorillas that first grabbed the country, of course illegally, that’s how all new lands were gained – and then pitted all the lion and tiger entrepreneurs against each other with government only the referees so that the by products they produced would dwarf anything the world had ever seen.

The problem is when capital does not find its way into greater production.  Hence, we end up with the financial collapse that should have been known to everyone.  The tsunami bubble was not a bad thing, except for those who got caught in this end game of  musical chairs.  We commodity players know that all capital gains go up and down, as we’ve all lost fingers and hands trying to grab more than the carousel would allow.  The government, no election prone, is trying to quiet the sheep so they will be content to leave their zeros where they can be reaped.  Yes, Dorothy, it’s all gambling, from the most secure bank deposit to naked option writing.  Nothing is safe, even our most revered savings, but it’s still  the best system ever invented, though it depends on the freedom of fear and greed.

Few talk about free enterprise.  Everyone should know about cycles, tsunamis.  We only have the homes we do because mortgage money is available.  While gambling, however, supported the profit wave so that many paid many times more than there is money is this part of the universe.

More people have homes than ever before but at what eventual price.  We are about to find that out.  Perhaps if appraisers had been so charged, they might have warned us about this multi trillion dollar bubble.  But that’s not been our job as we aren’t market analysts like those that exist in the commodity markets.  The readers of future truth know the game, appraisers don’t.  And what about institutional  directors.  They are only further blinded by greed.  How about the government?  They helped design the tsunami.  We are now in the hands of dynamic probabilistic action because all corrections are beyond our ability to control.  Those zeros were never meant to be paid back.

In the following table for 126,311,823 dwelling units:

Average home price near $150,000 doubled in value during that period including inflation but excluding compound interest.  The following percentages are based on the 2000 census:

allowed has been:

SFR                                         $150,000 per unit

Attached SFR                         $100,000 per unit

Multi Family                           $  40,000 per unit

SFR                                         60.3%  =          76,166,000

Attached SFR                         5.6%    =            7,073,000

Multi Family                           24.4%  =          33,346,000

Manufactured Housing           7.5%    =            9,473,000

Other                                       0.2%    =                 26,000

Not yet including land development, commercial and industrial lending, it’s estimated that financing Manufactured Housing           $  70,000 per unit

Other                                       $  20,000 per unit

Total potential lending including private and sellers is estimated at $10,474,503,000,000.  I think it can be safely assumed that at least 10% of this figure will be questionable loans, which will be approximately $1 trillion.  Depending upon how the new RTC handles the problem, there could be an additional 70% totaling near $8,379,602,000,000 but in by way of contagion.  The national debt at $10.6 trillion, our debt payment could double, if we are able to make the payments.  In affect, we would have two national debts.  The debt is not bad.  There is a bell curve to it with many advantages and other disadvantages.  Debt is a problem when you can’t meet the repayments, but can be favorable to the economy when the financed funds are economically employed.

One can see that if there is debt forgiveness, everyone wants their debt forgiven and it wouldn’t stop at just housing.  I and everyone else who has ever lost money in mortgage real estate would want repaid as well.

The people to best manage the system would be players, not just uneducated employees reading rule books.  Any guide book needs to be the size of a barn and even then the next situation is different.  Referees must be experienced players, not just fans dragged out of the stands.

Pyramid schemes are always a major part of the front end of a tsunami upcycle.  When they reverse, however, they become anvils.  Even Japan did not justify the real estate crash in the 1980’s.

There are some 23 different value definitions and that’s just within a single point in time.  However, there are no single-points, there is always a beginning and end of the time range with the upper end in force on the front wave and lesser values in the down wave.

Just because one share of XYZ Corporation sells for $100 per share today, it doesn’t mean that if all the shares came up for sale…

Price depends on market supply and demand funneled through the principal of diminishing economic returns.  We don’t have a real handle on the value of things, particularly large numbers.  But when we finance all those zeros from fictitious sales of property, those fleeting fickle prices look cast in stone, but nothing doing.

Profits have a way of breeding competition.  Even just the hint of profits can breed ruinous competition but when perceptions change, ruinous greed even the most assured should be viewed negatively.  No matter how effective the incentives become in the current real estate market, the previous fires of enthusiasm require many years of forgetting.  And we can’t stay level in a moving ocean.  Even the oil platforms aren’t safe.

Since markets must move up or down or die, a declining real estate market appears impossible to stop until the cycle decides.  Anthropically, perceptions move mysteriously through hidden hands to fulfill the cycles.  Commodity trading allows both up and down betting, so there is always hope.  Commodity traders are the wisest of the free enterprise entrepreneurs even though only a few are winners.  There is a lot of trading of capital but a loss to the commodity trader doesn’t diminish their knowledge, though it may steal their health and wealth.  A favorite saying is that to end up with a pocket full of money, you need to start with two pockets full.

So value is only an elusive perception expressed in price and that price is elusive as the chaos pattern of subatomic items from which it springs.  Not that probability is totaling unpredictable, because it leaves patterns that some have been able to predict better than others.

Risk and ruin

Reward or ruin

People are bell curve ranges.  The same great people in non-risk jobs can equal disaster that even average people in reward or ruin employment can produce great miracles.

1.3 million homes foreclosed on in 2007.

International investors fleeing dollar to gold.

Periodic crisis of over population

600,000 job losses

Marxist believes in organizing workers to establish an ownership society.  However, some one needs to hold the reins and without competition, no management of that individual is successful.

We are still a long way from the bread lines and 25% unemployment of the Great Depression.

Deregulation of the banks in 1999 by Congress which repealed the Glass-Seagall Act of 1933.  Therein separated the investment in commercial banking was not real then and over zealous commercial banks involved stock market investment as well.  When it was repealed, the banks would get into real gambling, high risk investments like in mutual funds and consumer packages.  Easy credit fuels  greed.

The new RTC Corporation is trying to prevent contagion, however such does not stop the flu, it eventually makes  you throw up before you get better.

1 Comment »

  1. Looks like you have done some good research and I would like to hear more.

    Comment by Bob — 07/27/2009 @ 4:18 pm

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