With a good run on the stock market and even some good news about housing sales I think its time for an example before anyone gets too cozy that the worst is behind us.
To play it safe you need to think about where we are in the economic cycle the same way as an important scene in the movie Titanic. This is the scene where the ship, which has been slowly sinking for about an hour, suddenly levels off when the submerged part of the boat (partially) breaks away. Everyone is relieved that they are floating level when all of a sudden they get pulled down in a rush to the bottom. The sinking part of the housing market just (partially) broke away and everyone is giving that sign of relief. Strike up the band!
Here is why we are in for that second more hellish ride straight to the bottom. In the short term the credit markets will get a swift kick when we finally have a large bank failure come to light. Give it 3-6 months and my FDIC insured money is on Bank of America (eventhough they passed their “stress” test). There goes the financing revival. Second of all housing will get another kick in the pants in two years when interest rates have to start going up again (to combat eventual inflation). We have seen the recent good news being the result of lower interest rates so what happens when those interest rates go up?
Also as any real estate agent will tell you “location, location, location”. Well while prices have begun to level in the outskirts like Vallejo they haven’t really begun their fall in Silicon Valley and the Peninsula. Right now people here think “whew that wasn’t so bad” (only a 10% drop in value) but in reality what these market movements (dramatically falling median home prices) presage is a large fall coming to the Peninsula this year. Yes everyone is buying homes in the cheaper areas of the “bay area” which is what is driving down the median. That means less buyers on the Peninsula (in which you can’t find any homes close to the current depressed median). Its only a matter of time before it finally hits here.
My prediction (or is that a “sinking feeling”) is that this summer will feel “soft” on the peninsula and that will prick the confidence bubble leading to the same panic here that happened last year in the suburbs. This is when 30-40% price drops (peak-to-trough) become a reality in Palo Alto by summer 2010. Additionally the bank efforts to artificially restricted supply of foreclosures will finally give way as all banks decide they need to get out before its too late.
Impossible you say? Remember it was once said that the housing market could not possible crash the same way the NASDAQ did during our last bubble. Really?? Have a look at this graph which offsets the NASDAQ peak to correspond with the peak in Bay Area housing prices.
Oh and lets not forget that the housing market is permeated by many myths that are proving to be quite untrue (and therefore won’t be there to save this market). For a detailed analysis of these myths please point your browser here.
We keep talking about the bailout of the American auto industry but for years now the domestic content (the amount of American materials and labor used to make that car) of the Big Three has been falling while the domestic content of the “foreign” companies has been growing.
Here’s an interesting stat. The Toyota Camry (one of the most popular cars, by sales volume, in the United States) is produced in Lexington Kentucky and consists of 80% American content, the Honda Accord (another one of the most popular) has 70%. The all-American muscle car, the Ford Mustang, consists of 65% American content. Surprised? Well then check out this study by The Federal Reserve Bank of Chicago (one could argue a “pro-American” organization).
One noteworthy quote from that study is:
“Today the distinction between “American” and “foreign” vehicles is not so clear: Some models produced by the American-owned Detroit Three carmakers have a smaller share of domestic parts than models produced by foreign-owned carmakers.”
So ask yourself is a bailout of the Big Three truly a bailout of the American automobile industry or just a bailout of the worst American auto industry players? Also ask, does Toyota get a bail-out as well so they can retool their American factories to build more fuel-efficient cars? Oh, that’s right they already have, my Camry Hybrid came from that Lexington Kentucky plant OVER TWO YEARS AGO.
Shame on the Wall Street Journal today for advising people, as a way to survive this downturn, to refinance their mortgages without giving them the caveat of “save now, pay later” in this article by Brett Arends . The key point is that while you can lower your current cash flow requirements by refinancing you will pay for it on the back end unless the interest rate drop is severe and also depending on where you are in your loan. Worse yet this article encourages people, without warning, that that would be an excellent source of cash. In other words a cash-out refinancing which is what got most people into the current mess by removing the equity cushion from their homes to protect in a downturn.
Here’s an example. You currently have a $300,000 mortgage at 6.5% on a 30 year fixed. You are 7 years into this mortgage.
Monthly payment is: $1896
You have already spent $159,281 (in interest & principle)
You have a remaining balance of $271,248 on it
Your total payout at the end of the loan will be $682,633
Now you decide at this moment to refinance the remaining $271,248 at 6% on a 30 year fixed:
Monthly payment is: $1626 (a cash-flow improvement of $270 per month – that’s good)
Your total payout on this loan will be the combination of what was paid out before refinancing ($159,281) and what will be paid out on the new mortgage ($585,456).
Your total payout at the end of the loan will be $744,737 (an out-of-pocket INCREASE of $62,104 – that’s BAD)
In short improving cash flow now does have its costs and its not a simple solution and requires “doing the math” first. Unfortunately it is this lack of knowledge on the part of the consumer that got us into this mess in the first place. I hope the Wall Street Journal won’t continue to spread half-truths that will only have us in this situation again, 10 years hence.
