[Allan from Fallbrook]

Stan,

Speaking of The Economist: They are reporting in this week’s issue about private equity issues that are not going, such as US Foodservice’s cancellation of a bond flotation, and the unwillingness of certain banks to extend bridge financing due to worries about downside exposure.

The WSJ has been reporting as of late on the amount of debt service necessary to make some of these deals happen, and the parallels to the late ’80’s LBO frenzy and the amount of subordinated debt that generated.

JWM: There are reports that United Capital is having major problems with their sub-prime lending unit, and that Fannie Mae might ride to the rescue on that one. Speaking of Fannie Mae, there are rumblings about Fannie’s exposure to the sub-prime mess due to their holdings in sub-AAA rated paper. So, the mess continues to spread.

[Allan from Fallbrook]

Stan,

Speaking of The Economist: They are reporting in this week’s issue about private equity issues that are not going, such as US Foodservice’s cancellation of a bond flotation, and the unwillingness of certain banks to extend bridge financing due to worries about downside exposure.

The WSJ has been reporting as of late on the amount of debt service necessary to make some of these deals happen, and the parallels to the late ’80’s LBO frenzy and the amount of subordinated debt that generated.

JWM: There are reports that United Capital is having major problems with their sub-prime lending unit, and that Fannie Mae might ride to the rescue on that one. Speaking of Fannie Mae, there are rumblings about Fannie’s exposure to the sub-prime mess due to their holdings in sub-AAA rated paper. So, the mess continues to spread.

[Allan from Fallbrook]

You mentioned in a previous post about the excess liquidity in the marketplace.

Interestingly, the same pool of cheap funds driving private equity, hedge funds, etc is (was) driving the mortgage funds market.

However, Scruffy and his ilk don’t seem to see this and insist that the housing bubble is built on solid fundamentals (i.e. “they’re not making any more land!”) and is not being fueled by that easy jingle.

I have heard the same catcalls about private equity guys and venture capital (vulture capital) honchos in particular. I worked with a high tech venture out of LA that was seeking angel investment and dealt with quite a few VC people (mainly out of the SF Bay Area).

The ROI/ROE calcs they were demanding for funds invested, as well as the equity participation for same, were astounding. You basically were being asked to hand the keys over in exchange for funding.

I definitely get the feeling that the funds are starting to dry up, though. Whether this is a bellwether for a full-blown credit crunch is anyone’s guess, but the wind seems to be blowing in a different direction.

[Allan from Fallbrook]

You mentioned in a previous post about the excess liquidity in the marketplace.

Interestingly, the same pool of cheap funds driving private equity, hedge funds, etc is (was) driving the mortgage funds market.

However, Scruffy and his ilk don’t seem to see this and insist that the housing bubble is built on solid fundamentals (i.e. “they’re not making any more land!”) and is not being fueled by that easy jingle.

I have heard the same catcalls about private equity guys and venture capital (vulture capital) honchos in particular. I worked with a high tech venture out of LA that was seeking angel investment and dealt with quite a few VC people (mainly out of the SF Bay Area).

The ROI/ROE calcs they were demanding for funds invested, as well as the equity participation for same, were astounding. You basically were being asked to hand the keys over in exchange for funding.

I definitely get the feeling that the funds are starting to dry up, though. Whether this is a bellwether for a full-blown credit crunch is anyone’s guess, but the wind seems to be blowing in a different direction.

[Allan from Fallbrook]

JWM: Don’t forget they also dumped their position with Bear Stearns MBS sub-prime operation a few weeks back.

What is your take on Blackstone and KKR IPOs? My sense is that the smart money has already hit the doors and this is nothing other than a thinly veiled cash out. Just curious.

Also, there was a really good article in The Economist this week on private equity funds.

http://www.economist.com/opinion/displaystory.cfm?story_id=9441256

[Allan from Fallbrook]

JWM: Don’t forget they also dumped their position with Bear Stearns MBS sub-prime operation a few weeks back.

What is your take on Blackstone and KKR IPOs? My sense is that the smart money has already hit the doors and this is nothing other than a thinly veiled cash out. Just curious.

Also, there was a really good article in The Economist this week on private equity funds.

http://www.economist.com/opinion/displaystory.cfm?story_id=9441256

[Allan from Fallbrook]

Excerpt from Merrill Lynch newsletter:

The housing situation is going from bad to worse
Second, the housing situation is going from bad to worse and you can forget about a recovery until next year. The starkest piece of information last week was the news that the national unsold existing inventory of single-family homes and condos surged at an astounding 82% annual rate so far this year. We still can’t wrap that number around our head. The overhang is now up to an 8.9 months’ supply, which is the highest inventory-to-sales ratio in 15 years. By way of
comparison, the months’ supply of inventory was 6.4 a year ago and 4.3 two years ago. The massive excess supply we have on our hands today is simply going to reinforce the deflationary state in the housing market, at a time when home prices on average have already declined at an annual rate of 5% in the past six months, the biggest drop we’ve seen since the summer of 1991, and fully three quarters of the country is now deflating (outside of Manhattan, that is). Clearing out the excess inventory is going to mean at least another 10% downside in average home prices, in our view, which is just going to reinforce the weak performance we’re seeing in the homebuilders, financials and consumer discretionary space.

[Allan from Fallbrook]

Excerpt from Merrill Lynch newsletter:

The housing situation is going from bad to worse
Second, the housing situation is going from bad to worse and you can forget about a recovery until next year. The starkest piece of information last week was the news that the national unsold existing inventory of single-family homes and condos surged at an astounding 82% annual rate so far this year. We still can’t wrap that number around our head. The overhang is now up to an 8.9 months’ supply, which is the highest inventory-to-sales ratio in 15 years. By way of
comparison, the months’ supply of inventory was 6.4 a year ago and 4.3 two years ago. The massive excess supply we have on our hands today is simply going to reinforce the deflationary state in the housing market, at a time when home prices on average have already declined at an annual rate of 5% in the past six months, the biggest drop we’ve seen since the summer of 1991, and fully three quarters of the country is now deflating (outside of Manhattan, that is). Clearing out the excess inventory is going to mean at least another 10% downside in average home prices, in our view, which is just going to reinforce the weak performance we’re seeing in the homebuilders, financials and consumer discretionary space.

[Allan from Fallbrook]

Scruffy, instead of continuing the argument using 1990s employment statistics and how the uber-rich are likely to be unaffected by the downturn, how about discussing this in terms of monetary policy and macroeconomic theory.

This run-up in prices has not been driven by any sense of fundamental underlying value. Hence, it is not sustainable. Rather, it has been driven by cheap, easy money, combined with virtually non-existent loan underwriting standards and kept aloft by real estate “professionals” who fervently believe that prices never go down.

You can look at any market in California right now and the metrics have completely reversed themselves. Sales are down (in some markets like Sacramento, Bakersfield and the San Fernando Valley they are plummeting), and NOD/NOT/foreclosure notifications are skyrocketing, in some cases 150% on a YoY basis (San Diego County is my example here).

How on earth can you believe, let alone push, the assertion that all is well and this is nothing more than a hiccup? I grant that Armageddon is strong word, but a 20% correction in most markets will be devastating, and that is certainly not outside the realm of possibility in that it is occurring right now. Looking at some of the neighborhoods in and around Sacramento right now (Rancho Cordova, Galt, Elk Grove) there are price corrections in excess of 30%. Factor in carrying costs, realtor fees, and closing, and you are talking about a major haircut, especially when you consider that the houses in question are already substantially overvalued to begin with.

You’re not actually David Lereah or Lawrence Yun, are you?

[Allan from Fallbrook]

Scruffy, instead of continuing the argument using 1990s employment statistics and how the uber-rich are likely to be unaffected by the downturn, how about discussing this in terms of monetary policy and macroeconomic theory.

This run-up in prices has not been driven by any sense of fundamental underlying value. Hence, it is not sustainable. Rather, it has been driven by cheap, easy money, combined with virtually non-existent loan underwriting standards and kept aloft by real estate “professionals” who fervently believe that prices never go down.

You can look at any market in California right now and the metrics have completely reversed themselves. Sales are down (in some markets like Sacramento, Bakersfield and the San Fernando Valley they are plummeting), and NOD/NOT/foreclosure notifications are skyrocketing, in some cases 150% on a YoY basis (San Diego County is my example here).

How on earth can you believe, let alone push, the assertion that all is well and this is nothing more than a hiccup? I grant that Armageddon is strong word, but a 20% correction in most markets will be devastating, and that is certainly not outside the realm of possibility in that it is occurring right now. Looking at some of the neighborhoods in and around Sacramento right now (Rancho Cordova, Galt, Elk Grove) there are price corrections in excess of 30%. Factor in carrying costs, realtor fees, and closing, and you are talking about a major haircut, especially when you consider that the houses in question are already substantially overvalued to begin with.

You’re not actually David Lereah or Lawrence Yun, are you?

[Allan from Fallbrook]

JG: Boy, you take the admonition to bring data quite seriously, don’t you?

I would hasten to add my use of Temecula/Murrieta/Corona was illustrative only in the sense that they are near my home, and I agree that the rot is quite widespread through SoCal (and Central and Northern California, for that matter).

There is a bloodletting of fairly epic proportions going on in Sacto right now, and I have been following the Crisp Realty saga closely through the local news up there. Not for any newsworthy reasons mind you, solely for the prurient thrill and titillation factor inherent to watching David Crisp (he of the Gulfstream jet, Armani suits and Ferrari) brought low.

As far as the Middle West goes, my family hails from Illinois, Michigan and Wisconsin. They seem to be not only more down-to-earth there (in terms of not caring so much about appearances and pretension), but also more careful with a buck. As a kid, I was somewhat appalled at the almost medievel frugality of my Midwest German clan, but now realize the dynamics of what drove it.

A friend of my mine does quite a lot of work in parts south, and travels to Miami frequently as a result. The housing market, and especially condos, is getting savaged down there. Not only that, but many of the highly touted new condo developments on Biscayne have shuttered operations without ever breaking ground.

Maybe us spendthrift coastal types just figure we are smarter and know something our more mundane, and more parsimonious, midwestern brethren don’t.

[Allan from Fallbrook]

JG: Boy, you take the admonition to bring data quite seriously, don’t you?

I would hasten to add my use of Temecula/Murrieta/Corona was illustrative only in the sense that they are near my home, and I agree that the rot is quite widespread through SoCal (and Central and Northern California, for that matter).

There is a bloodletting of fairly epic proportions going on in Sacto right now, and I have been following the Crisp Realty saga closely through the local news up there. Not for any newsworthy reasons mind you, solely for the prurient thrill and titillation factor inherent to watching David Crisp (he of the Gulfstream jet, Armani suits and Ferrari) brought low.

As far as the Middle West goes, my family hails from Illinois, Michigan and Wisconsin. They seem to be not only more down-to-earth there (in terms of not caring so much about appearances and pretension), but also more careful with a buck. As a kid, I was somewhat appalled at the almost medievel frugality of my Midwest German clan, but now realize the dynamics of what drove it.

A friend of my mine does quite a lot of work in parts south, and travels to Miami frequently as a result. The housing market, and especially condos, is getting savaged down there. Not only that, but many of the highly touted new condo developments on Biscayne have shuttered operations without ever breaking ground.

Maybe us spendthrift coastal types just figure we are smarter and know something our more mundane, and more parsimonious, midwestern brethren don’t.

[Allan from Fallbrook]

JWM, my background is in corporate finance and accounting. As a former CFO, my job was primarily financial analysis, and for large general construction and engineering firms that were clients of ours. As such, you get very good at slicing up the numbers and, with construction and engineering firms, cash flow is key.

I make the same point in my conversations with folks about housing, credit and net worth. I have been harping on the housing market for over three years now, and I personally remember the last bust (1989) here in SoCal.

Based on the reactions I get from people, you’d think I had grown a third eye. Basic macroeconomic theory and fundamental financial principles go right out the window when you discuss housing in SoCal.

The irony is that many of the people I speak with are college educated, white collar professionals with more than a passing knowledge of finance. A quick glance at history shows the Dollar Bubble (1997) and the NASDAQ bubble (2000) bursting, but somehow the housing bubble is not only different, but immune from both historical precedent and the laws of economics.

I saw the exchange with Scruffy a few days back, and he represents an archetype of what I loathe most about this situation: Someone who should know better, and probably does, but steers people into a horrifically bad decision regarding the largest purchase of their lives.

You mention income level. I purchased a house in Fallbrook in 2003 for $425k, with $75k down. The monthly payment represents less than 20% of my monthly net, but I remember being nervous about committing to a mortgage of that size. Looking at some of the mortgages being secured at present, and for houses that are completely over-valued, I realize how truly out of whack both the market and the accompanying Pollyanna mentality are right now.

Hang on and enjoy the ride, because when this market corrects, it’s going to be real ugly.

[Allan from Fallbrook]

JWM, my background is in corporate finance and accounting. As a former CFO, my job was primarily financial analysis, and for large general construction and engineering firms that were clients of ours. As such, you get very good at slicing up the numbers and, with construction and engineering firms, cash flow is key.

I make the same point in my conversations with folks about housing, credit and net worth. I have been harping on the housing market for over three years now, and I personally remember the last bust (1989) here in SoCal.

Based on the reactions I get from people, you’d think I had grown a third eye. Basic macroeconomic theory and fundamental financial principles go right out the window when you discuss housing in SoCal.

The irony is that many of the people I speak with are college educated, white collar professionals with more than a passing knowledge of finance. A quick glance at history shows the Dollar Bubble (1997) and the NASDAQ bubble (2000) bursting, but somehow the housing bubble is not only different, but immune from both historical precedent and the laws of economics.

I saw the exchange with Scruffy a few days back, and he represents an archetype of what I loathe most about this situation: Someone who should know better, and probably does, but steers people into a horrifically bad decision regarding the largest purchase of their lives.

You mention income level. I purchased a house in Fallbrook in 2003 for $425k, with $75k down. The monthly payment represents less than 20% of my monthly net, but I remember being nervous about committing to a mortgage of that size. Looking at some of the mortgages being secured at present, and for houses that are completely over-valued, I realize how truly out of whack both the market and the accompanying Pollyanna mentality are right now.

Hang on and enjoy the ride, because when this market corrects, it’s going to be real ugly.

[Allan from Fallbrook]

JWM, you realize you represent the exception and not the rule, correct?

Most Americans are in “dis-saving” mode (to use the old Econ101 phrase). The majority most likely to feel the impact are those homeowners who not only purchased an over-valued home, but then proceeded to pile debt on top of that, in the form of 2nd/3rd mortgages, home equity lines and credit cards. It is not even a matter of being in over one’s head, people have added so much debt (and at increasingly egregious rates), it exceeds any rational ability to pay it off.

I used a hypothetical example of a Temecula homeowner previously, but actually do know several people in that neck of the woods who fall into this category.

In one case, the family purchased a $635k house (they make a combined $92k in salary), and then added two more HELOCs totaling $194k. The HELOCs were for home upgrades (pool, landscaping, new kitchen and bath), as well as “toys” (new GMC Denali for the wife and a boat). Their 1st was a 2/28 with a teaser rate (1.5% for the first two years) and then prime + following. It resets this month, and they are already stretched due to debt service costs, gas (they both commute to SD each day) and necessities. The house is on the market for $725k (down from $760k), with no offers to date. Ugly? You bet.

But my sense is that in communities like Temecula, Murrieta, Corona, Moreno Valley, etc, this is the norm and not the exception. And the vast majority of families out there are closer to the US median per capita rate ($43k per household earner) than the six figures + per year needed to just service this kind of debt.

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