The only element I never understood was WHY anyone would lever themselves 30-1. As a finance person, any slip up anywhere and you are underwater. Those assets all had a downside, few of them had an upside.

They were all just waiting to die.

To top it off, their funding models had them running to the markets every 5 minutes for cash. If you are going to lever up like that, just take out the cash in a big lump and hold on until you die. No one wants to loan more to a stone loser.

In any case, what you describe is a nice micro-economic way to look at one facet of the consequences of easy money policy and how it played out in the $ billions of losses for the housing market. Now if you want to understand what this did to Wall Street and why there are no longer investment banks, and how this played out to $3 trillion of losses, Michael Lewis’ article IS a good one.

http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom#page1

By the way, anyone who claims Wall Street was ‘bailed out’ doesn’t have a clue. Wall Street was left to die. All 5 major I-banks either went under and evaporated overnight (Bear, Lehman), were bought for nothing (Merrill) or converted themselves to regular banks (Goldman, Morgan) and are in the process of de-levering froim 30:1 to 10:1, and unloading most of their non-fee-based staff in the process. The ‘bailout’ was designed to keep main street banks like Citi, B of A and National City from going under and losing ma and pa’s accounts in the process.

As such, I’ve been able to see this crisis unfold from the inside.

Here is how it happened from my POV:

1. 2000 – 8-9 percent rates, relatively low house prices, conventional financing is most common but there were “BCD” lenders that were financiall responsible. They required 20% equity, time since delinquiency to pass before issuing mortgages, documented income, 6 months worth of payments in the bank, etc.

2. September 11 happens. The stock market is hit and the panic results in interest rates in the 4% range. People can suddenly afford more house for their money, or see this as an opportunity to cash out their equity and keep their payments similar. Demand for homes increase, increasing the price of homes. Rates are steadily low for years, and prices steadily increas. Investors are buying properties, making huge gains, repeat.

3. After about 4 yrs of large and steady value increase (5-20% per year), mortgage lenders get aggressive. In an inclining market, it’s easy to lend as much/more than the house is worth because the value will catch up later. This may seem like a short term view, but when 95% of homeowners sell or refinance every 2-3 years, that’s all these lenders needed.

4. Enter: Interest Only and Minimum Payment loans. Now, not only are the rates low, you don’t even have to pay principal on the first, or most of your interest on the latter! Minimum payment loans defer the interest yearly that is not being paid back onto the loan balance. It’s like making a minimum payment on your credit card and your montly balance increases.

At this point the situation looks like this:
-Increasing house values
-Low interest rates
-Low documentation loans
-Loans with increasing principal
-Lower credit score, asset, income requirements

This provides us with the perfect storm for buyers who can get into a huge house with little credit, income, assets or equity and make minimum payments. And as home prices more than double in some areas over a 5 year period – there’s no end in sight!

But alas, we here in the US have a thing called Free Market. When the supply of items exceeds the demand for the same, price corrections are bound to happen. The first to go were the most agressive (Minimum payment “option arm” loans). Then people’s adjustable mortgage payments increase. Foreclosures hit the market further decreasing the value of property, resulting in more foreclosure. Banks close by the hundreds, making it difficult for people to qualify to buy. Fewer buyers further punish the house prices. Mortgage insurance companies go out of business. And since they’re the ones that insure any mortgage over 80%, only the perfect buyer can get away with 0-10% down. FHA loans are the wave of the future, requiring only 3%. More mortgage companies go out of business for lack of new responsible loans, and a large default on their bad loans.

So here we are.

Which brings me to the point of this post. You say that Rent vs. Own is perhaps not worthwile in a time like this. Consider this:

-New loan guidelines are as strict as they should have been this whole time. You must prove that you are absolutely capable to buy a home and pay the mortgage to purchase right now, keeping the sneaky agents and brokers (those devils) from steering a client into a bad loan. Any incling of risk will get you turned down these days.
-By not purchasing more fuel is added to the housing crisis fire. The fewer the buyers, the more the price will fall, the stricter the lender guidelines will be. At some point the price must fall to a point where people will buy homes at bargain prices, again stimulating housing prices to grow.
-Buyers, lenders, investors need to stop looking at homes as short-term investments. Over time, prices of homes increase. They’re a necessity. You have to live somewhere. Even if you rent, the guy you rent from has bought the house.

That’s my two cents, anyway.

m and v represent the entire philosophy of the Chicago School of Economics from whence the “Chicago Boys” came (to fix the economy in Pinochet’s Chile).

http://en.wikipedia.org/wiki/Monetarism

http://en.wikipedia.org/wiki/Chicago_school_(economics)

http://www.econweb.com/MacroWelcome/monetarism/notes.html

I’m just hoping for some tech discovery that will offer a good ROI.

Oil prices are dropping and that’s beneficial, but if the value added by manufacturing doesn’t pick up……

There is a considerable social stress involved in multi-generation housing. Especially since the US populace isn’t used to it as much anymore. I’m afraid the birth rate will drop even more.

” Having the family support the housing needs of the non-working members means they are not on public assistance.”

True enough for WRT homeless shelters and the like, but assistance which comes in the form of a check in the mail won’t be much different.

This would be a good outcome – it lowers the expected default rate.

[i]What might happen is in an effort to fight the deflation ( measured in 10 to the 12ths) the governments get to the point where they are obviously printing money and then inflation or hyper inflation starts.[/i]

We are obviously printing money already. We subtracted $3.5 trillion from the (m x v) money supply via the credit contraction and the consequential fall in v.. Hyperinflation will not occur until either the rest of the G-7 stop printing, which they won’t because of same problem or until V starts to come back, which will take years before creditors forget the pain of their burned fingers which won’t happen until a generation of executives retire.

[i]I finally got the guts to take a look at the Baltic Dry Index and the sea shipping costs for raw materials has dropped by about a third.[/i]

To the extent businesses can stay in business and individuals can keep jobs, lower commodity and energy/oil price helps increase the savings (aka Investment) rate which will eventually recapitalize lenders (who use savings to lend) and restore V. Key word: EVENTUALLY.

[i]I’ve looked and talked to some people and owners of large houses have gone from say Granny Cottages add ons to putting in “wet bars” that are in effect mini-kitchens. You’ll have many more houses with rental rooms defying restrictions and the multi-generation in one house is going to include not only grandparents but children in their late twenties and thirties that can’t afford to live on their own or get married in a lot of cases. So called starter homes are just to damn expensive in relation to pay these days. It will get like Italy.[/i]

This is a normal and also positive outcome. Good thing they have the extra kitchen area. Having the family support the housing needs of the non-working members means they are not on public assistance.

[i]I’m afraid that it is going to get real nasty for small children and we are going to see and increase in throw away kids.[/i]

Free abortions for all (people who can’t afford to take care of their kids or get a rich family to adopt them)!

What might happen is in an effort to fight the deflation ( measured in 10 to the 12ths) the governments get to the point where they are obviously printing money and then inflation or hyper inflation starts.

I finally got the guts to take a look at the Baltic Dry Index and the sea shipping costs for raw materials has dropped by about a third.

I’ve looked and talked to some people and owners of large houses have gone from say Granny Cottages add ons to putting in “wet bars” that are in effect mini-kitchens. You’ll have many more houses with rental rooms defying restrictions and the multi-generation in one house is going to include not only grandparents but children in their late twenties and thirties that can’t afford to live on their own or get married in a lot of cases. So called starter homes are just to damn expensive in relation to pay these days. It will get like Italy.
I’m afraid that it is going to get real nasty for small children and we are going to see and increase in throw away kids.

Lord how I hope I’m wrong.

I would also like to know at what point the many real estate flippers are going to come under scrutiny. It’s no secret that the centers of the burst bubbles are in California, Florida, Las Vegas and North Carolina-all markets that has their housing costs driven by ever increasing, or at least the perception of increasing, demand. Many of the defaulted loans were ones written for just this type of transaction. While I don’t want families out starving in the cold, I have a problems with funding someone who used a loophole in the system to fund what amounts to some sort of get rich quick scheme.

1. How long do you plan to stay in the property? Renters in this area, by and large, are people who are in transient situations where they don’t plan to stay in the property more than a year or two.

2. Do you have enough income to itemize deductions, in order to get the mortgage interest deduction?

3. How important are the ameneties of living in a rental property (having maintenance taken care of, the swimming pool and party room of the typical apartment complex, etc.) vs. the conveniences and freedom of owning (having yard space, no upstairs/downstairs neighbors, having a garage or other parking of your own, being able to modify the property to suit yourself)?

I’m not sure how the current deflation is effecting the local market. Construction of new housing has slowed, but looking at the Sunday morning real-estate shows, I don’t see prices for existing properties coming down very much.

(Apologies to Carl for wandering from his post.) Now that you mention the railroads, Toad, it seems to me that now would be an excellent time to go back to the future and create a rail system would benefit the country immensely (inexpensive travel and shipping – pennies vs trucking-dollars per mile we’re told; employment in construction and maintenance). Expansion and modernization of an existing system would provide some economies in construction and would, in the end,I imagine, provide benefits similar to the interstate highway system work of the 1950s.

Consider this book for some good ideas:

http://www.amazon.com/Coming-Generational-Storm-Americas-Economic/dp/0262112868

The remark that it is ‘a lot like gold’ is apt. It appreciates a lot like gold (parallel to inflation) but you can live in it.

The remark that property taxes are passed to the tenant except in new york is incorrect. Tenants always pay the market price for the housing, irrespective of the Landlord’s costs of operating it. High operating costs over time my result in a slow increase in additional supply, but this will only increase rents if the value of labor in that region goes up faster than inflation.

The demographics aren’t good on top of that. The baby boomers will not be consuming nearly as much and they won’t be producing either. We are all ready starting to see an increase in growth of the multi-generation house. The US could become like Europe. College graduates in there thirties living with their parents because the don’t make enough to live on their own. Grandparents in the house because the money is too tight for the fancy assisted living places.

The money for research will also get tight. There is some argument if a rational energy policy or a breakthrough on fusion power would help, since we’ll be short on intelligent productive people. The products from our public schools and way too many universities are turning out to be dumb an lazy…….Want fries with that.

(Note here that my record as an investor is not particularly good.)

It’s averaging a loss. It works as long as the market recovers in a reasonable amount of time, where “reasonable” is a function of your patience, leverage and risk tolerance. Stocks tend to go up in value over time, but there have been long periods when it was not profitable to hold stocks. If, per typical dollar-cost-averaging advice, you regularly buy stock all the way down in what turns out to be a major bear market, you may have to hold it for years to get back to even. It doesn’t sound like this is what you are doing, since per your description you are basing your stock purchases on market conditions rather than the calendar. Also, I am not giving you or anyone else trading advice. I am not a good trader myself. I am merely pointing out that the DCA investment model falls apart under some market conditions, much as the real-estate investment model Carl is discussing does.

Jonathan,

I have been given this advice over and over by people with alot more investing experience than me, but I did precisely this during every major market downturn during my adult life and made out great. I admit I do not fully understand all of the reasons and statistics why this is a bad idea, I only know that it has worked extremely well for me. I would agree that doing it in companies/funds that you would normally invest in as a matter of routing during a regular steadily growing market is not wise, but there has always appeared to me to be systemic opportunities in the market anytime *everything* goes down. I would concede that statistically they are probably right to tell me this, but it alwasy amazes me how vehemently my “in the know” investor friends tell me this…it is inversely proportional to how well it has actually served me.

Oh and one more important point, I ususally start buying after a bit of downward activity. I guess if people are warning against doing it immediately when a downward trend starts then I would agree. Perhaps someone who is savvy and not just lucky like myself on here can explain in detail why I shouldn’t be doing this any more?