Understanding the Noise

Over the past few weeks the "housing bottom" news has been relentless. A big part of this is due to the recent month over month increase in prices in many areas.

However, a closer look at the data shows that a major reason for the rise is due to some of the more expensive homes finally selling at fire sale prices. Let me explain:

Imagine that you live in a community with 200 homes. 100 of the homes were purchased from a builder for $200,000. In another gated section of the neighborhood 100 homes sold for $1 million. All the homes in the neighborhood are currently on sale. Over the past 12 months there have been 24 sales in the neighborhood, all of them coming from the lower priced side. Over the past 3 months sales have looked like this:

May: $205,000/$198,000

June: $195,000/$203,000

July: $190,000/$198,000

Based on the numbers you would say that the price of the homes have only fallen a small amount under the $200,000 price point from a year ago. But what would happen in one of the big homes sold at market value and you had three properties sold that month?

August: $200,000/$200,000/$600,000

The average price of the homes in the neighborhood today is now $333,000! A massive increase. But wait, in reality what happened is that the million dollar homes were just not selling before. There were no buyers.

This is what has recently happened in the market. Either through foreclosure, or through sellers accepting reality, the high priced homes have now entered the market at fire sale prices.

There is another reason why many of these higher priced homes have not sold and entered the market.

Lets say that you are the Bank of Charlotte. You currently have 10 different million dollar homes on your books that are on their way to foreclosure. You know that those homes will most likely sell for around $600,000. That means that each home will be a write off of $400,000 in losses.

$400,000 x 10 homes = $4 million in write downs

This bank has what is called "tier one capital" or "liquid cash" of only $2 million. If these homes hit the market and sold, the bank would not have enough capital to keep its doors open.

This is making banks keep a flood of foreclosures on their books and not listing them. They are hoping and praying the market will turn around before they have to mark down the assets.

The FDIC travels around the country and closes banks every week. They announce the list every Friday night. What is now a steady dribble will turn into a downpour of closings. The FDIC will need hundreds of billions from the Fed to keep the savings accounts protected.

The FDIC cannot let a bank fail because if they did they would have to pay out up to $250,000 per individual holding money there. The FDIC has no money to do this. They have to bail out the banks and sell them to another buyer. The difference in costs is printed from the Fed.

The losses coming are staggering. Commerical loans were kept on the small banks balance sheets because they were considered far "safer" than residential. The commercial write downs are in the early stages.

Comments