Friday, December 7, 2012

A Simple Walk Through: Why Home Prices Have Not Reached Bottom

Most people I know and interact with on a day to day basis do not not that I am a finance nerd. If you met me or even if you are someone that has known me for years it would difficult to discern. I spend a tremendous amount of time with friends, watching sports, playing basketball, and doing "normal" people things. Its only during alone time when everyone is tucked away in their normal lives that I open the laptop or current book I'm reading to delve back into the exciting world of global finance.

I was visiting my cousin last night who was nice enough to welcome me in to his home in Raleigh, NC. We began talking about normal stuff, which somehow led to a financial topic. I began to briefly give me thoughts and he asked me a question, and another, and another, which I went on to explain. Somehow it led to derivatives, which is a place you do not want to go while watching Thursday night football. Anyway, he found out last night that I am a finance nerd.


I bring this up because the discussion finished with, "is this a good time to buy a house" as it so often does. This is always a very difficult question to answer in just a few sentences, which is why I have tried to dedicate a large portion of this website to answering it including this year's massive real estate outlook.

I came across a chart this week that provides a tremendous visual tool to explain a piece of the real estate puzzle: the concept of interest rates.

Imagine that you are an average working American family and you decide it is time to purchase a home. The first thing you most likely do is figure out how much you can afford. That begins with a calculation of your monthly income to determine after taxes, other expenses, and what may be put away in the 401k, how much you have left for a mortgage payment every month.

We'll say that this family, the Thompsons, determine that number to be $1,100 per month. I would guess this is very, very, close to the average number for middle class families in America (based on average income data). 

Now with this number they head down to the bank. They tell the bank they want to buy the maximum amount that $1,100 per month will allow. The bank representative opens up their calculator and writes down a number on a piece of paper. The Thompsons then call their real estate agent with this number in hand and start looking at homes.

Let's pause for a moment to take a look at the most important and misunderstood piece of this entire process: the impact of mortgage rates on the number the bank representative writes down.

The following graph from Iacono Research shows on a sliding scale how much they can pay for a home with an $1,100 mortgage payment. If mortgage rates were at 10.5% today the Thompsons could afford to pay $130,000 total for a home (all these estimate a 10% down payment). If mortgage rates are down at 3.3% (they are at 3.31% this week), the amount they could afford to pay for a home rises to $280,000.


Let's now extrapolate this further because many people (including me) believe that mortgage rates have the ability to fall even further in the short term. If 30 year mortgage rates fell to 2.5% the home price would rise up to $310,000. If mortgage rates fell to 1.5% the home price would rise up to $350,000.

Unbelievable.

Now let's move forward and see how this plays out. If the Federal Reserve and the government, which have nationalized the mortgage market, can artificially push rates down to 1.5%, imagine that the Thompsons had the opportunity to lock in at that rate.

The Thompsons rush out to purchase their $350,000 per month home with only $1,100 per month in payments. They are feeling real good about themselves. Then they hear on the news that interest rates begin rising. "Who cares?" they say, they have already locked in at the low rates making them the smartest buyers on the block.

Interest rates are now rising quickly, beginning to move back toward the normal historical rate between 7 - 10%. Rates stop at 4.5% (still historically very low) when the Fed announces they will purchase another round of mortgages. Two of Thompson's neighbors put their home on the market to cash in on their new $350,000 home price. Buyers show up to look at the home but they have some bad news.

With interest rates now at 4.5% new buyers only have the ability to pay a maximum of $240,000. They like the home, they tell the sellers, but the only way they can afford the monthly payments would be if they dropped the price by $110,000.

After talking to their neighbors the Thompsons have a sick feeling in their stomach. They realize that by locking in at the all time record lowest rates in history they have moved into a coffin. Every tick upward in interest rates means less buyers that can afford their home and a lower price. 

Does this help explain why buying at low interest rates is the worst possible time to purchase real estate? Especially when they are created artificially by the Federal Reserve.The Fed is doing everything in their power to create another artificial bubble. As soon as interest rates either stop going down, or (gasp) begin to rise, home prices will plunge.


h/t Iacono Research

Wednesday, December 5, 2012

The Future Of America: Socialism

Merriam-Webster reported this week that "socialism" and "capitalism" were the most looked up words of the year. This statistic reminded me of another Pew survey I recently came across. The results were terrifying.

According to Pew, 49% of the youth survey responded positive to socialism, while only 43% responded negative (18 - 29 years old).


When asked about capitalism, 47% responded negative, with 46% responding positive.


This staggering statistic shows the deeply embedded culture in America today that it is the responsibility of the government to take care of the people. If this is already embedded into the minds of the younger generation it paints a horrifying picture for the future of America.

Tuesday, December 4, 2012

ECRI's Achuthan Defends His Call For Recession

I have posted every one of his media appearances since September 2011 when he first announced the coming recession so I will continue to do so here until he is proven correct or incorrect. Achuthan claims that we entered recession right around the mid year point (his late 2011 call) and discusses what a recession means for the ECRI group, which is essentially a slowdown in four coincident indicators: industrial production, personal income, sales, and employment. The first three peaked right at mid year but employment has continued growing (which he discusses in the video below).


The most recent discussion (attack) toward Achuthan.


Sunday, December 2, 2012

Stream Of Consciousness: Visual Thoughts

I was down in Atlanta working for most of the week and I have also been pretty sick the last few days so I apologize for the limited posts. While I made sure to keep up with the markets, I have not had the time to put my reading into words and pictures. Let's do that now with a stream of thoughts on some of the best graphs I came across during the week.

The first is a simple look at the result of the Fed's Operation Twist program. This fancy name essentially means that the Fed sells short term bonds on their balance sheet and buys long term bonds. The result is not an increase in the money supply, and its goal is to reduce longer term rates for market participants (this has worked).

The problem now, seen below, is that the Fed is running out of short term bonds (0 - 3.5 year terms) to sell. Many (including me) anticipate that the Fed will announce a larger QE program in January to keep the purchase of longer term bonds going. This means that instead of selling short term bonds to buy long term bonds, they will print money to purchase long term bonds. It will result in the current QE program (printing $40 billion per month to purchase mortgage bonds) to rise to $85 billion per month (an additional $45 billion will be printed per month to purchase longer term treasuries.


The following graph providing data from the US mint shows that US mint sales in gold went parabolic in the most recent month. Whether this trend continues is something to watch very closely. Dealers are reporting low inventory levels due to China's activity in the gold market. Good article on that topic here.


Does this mean that the average American has now become manic in the gold market? Let's put this recent buying into context. The following shows gold and jewelry demand in 2011 for countries around the world relative to their GDP (total size of their economy). You can see that India certainly leads the group running at 16%. China has recently risen to 4%. The US? A fraction of 1%. Does this chart represent a mania in the US for metals? I will let you decide. As the world continues the currency wars, look for these percentages to rise everywhere as the citizens see the paper levels of currency explode and the amount of physical gold available around the world stay level.


The following chart sums up the transition of the American economy over the last decade. Since 2001, food stamp enrollment is up 158%, medicaid enrollment is up 52%, and government employment has risen by 6%. The category of the country that pays for these luxuries, private employment, has fallen by 2%.


An easier way to sum up this transition is that there is now 1.25 people employed in the private sector for every 1 person that receives welfare assistance or works for the government.


The increase in debt, the only source of growth during the current depression, was 45% over the past 4 years. This 45% increase has led to only a 7.1% increase in real growth.


The source of income that will be used to pay back this debt is household income. How much has income grown during this recent debt accumulation period? Since 2000 real median household income has fallen 8.1%. While we have seen temporary bubbles in stocks and real estate (plus the current bubble in bonds) that create temporary flashes of artificial wealth, the real measure of wealth is seen in employment income which continues to disappear.


Freddie Mac reported new record low mortgage rates this week with the 30 year mortgage at 3.32% and the 15 year mortgage at 2.64%. The 10 year treasury (considered the risk free rate) is at 1.64%. Treasury bonds and mortgage bonds are considered the same today by the market (the government is the mortgage market) so the spread between the two will most likely continue to contract (mortgage rates will continue to fall). Ultimately, both rates will skyrocket as the government debt bubble in America implodes. The debt bubble implosion will provide an excellent opportunity to purchase American real estate, stocks, and bonds (if you like to buy low and sell high).


The restaurant performance index broke back into contraction territory this week. This is a good measure of the strength of the American consumer because restaurant meal purchases are discretionary expenditures.


I'll leave you with the following image, which I think perfectly sums up the most recent election for a large part of those that belong to the older generation.


h/t Sober Look, Zero Hedge, Calculated Risk, Street Talk Live, JS Mineset, Casey Research, DShort