[powayseller]

I asked my brother, a genius on all things legal, techical, and financial, to comment on this post. In 3 e-mails, I got this:

One of the really big question marks is the largely unregulated derivatives market, which has massive nominal amounts outstanding. From all accounts Fannie Mae is a huge player in the $123 TRILLION notional amount interest rate swap market, and if it collapses and defaults on its obligations, it could cause massive cross-defaults – which of course the gov’t would have to bail out to avoid the collapse of the banking system (and yes, that is actually possible that b/c of the failure of one large derivatives player, say JP Morgan, the entire banking system would become insolvent). See e.g. Gold-Eagle.com:

“Indeed J.P. Morgan Chase dwarfs everyone in this business. The business is derivatives. In the USA J. P. Morgan Chase is over 50% of the derivatives market. According to figures from the Office of the Comptroller of the Currency (OCC) as at December 31, 2001 JPM had notional amounts of derivative contracts outstanding of US$ 23,520 billion or US$ 23.5 trillion. That was out of total derivatives of reporting banks of US$ 45.4 trillion. The aforementioned Royal Bank of Canada had at the end of their second quarter a notional amount outstanding of approximately US$ 1.2 trillion.”

By comparison the US GDP totals roughly US$ 10 trillion and total outstanding debt of all sectors totals just over US$ 19 trillion.

Derivatives are contracts based on the value of some other asset or financial measure. A typical interest swap would say, “I pay you 5% interest on $10 million” (where $10 million would be the “notional amount”), “and you pay me the prime rate on $10 million, payable in net amounts quarterly over the next 5 years”. In this example, if the prime rate is below 5%, I make money; if it is over 5%, you make money.

Of course they get much more complex – you have currency swaps, caps, collars, commodity (based on price of gold vs. price of oil or currency value). They can be used to hedge risk (e.g., Fannie Mae may need to finance itself at a variable rate of interest, but may make long-term loans at a fixed rate, so it may enter into a swap agreement to convert the variable rate it has to pay to the fixed rate it receives) or for speculation.

There are established derivatives dealers. As you saw, JP Morgan is the biggest, but almost all commercial banks enter into them. They are also regulated to some extent (banks need offsetting transactions to keep things in balance, but of course if one side fails, like Fannie Mae, and the bank is not able to cover its position, the balance can get quickly lost and the bank goes insolvent since it may owe billions on the hedge and not get any money under the contract – imagine e.g. a Fannie Mae 10% swap on $5 trillion notional amount, that is $500 billion per year or $40 billion per month).

I am moving my money into two types of funds: Euro / Pacific companies (with investments held in foreign currencies, rather than dollars) and precious metals and other natural resources funds (e.g., uranium, timber, copper). I am keeping 35% in a money market fund as a hedge, everything else I am moving into real assets (the natural resources) or into other currencies (you just know the Yuan will become more valuable a/g the dollar).

[powayseller]

So would you say that environmental regulations double the cost of the large tracts of land? I’ve seen single lots for sale in Poway, and assume the buyer would make sure it was zoned for building prior to purchase. Is there a premium then on that lot too, because all land in SD has become more valuable? This would be an increase in the fundamental cost of a house, and I wonder how much of that will be reduced as housing prices go down. Although Phoenix and Las Vegas don’t have the environmental regulation we have, they are in a housing bubble also. So there it’s purely speculation that accounts for high prices?

How much has construction cost changed since the late 90s? We spent $168/sq ft to build our house, exclusive of land, and it wasn’t a very fancy house. We even used siding in place of stucco because it saved $10,000. Our construction period was summer 2004 – summer 2005. I did splurge on the kitchen, and we needed a long driveway w/ turnout for fire codes, but the grading and well and 1/2 the driveway were already done before. I wonder how much less that house will cost to build in about 5 years. We used inexpensive but good contractors; those with low overhead but many years in the business. I was surprised it cost so much, when I read in your post that it can be done by the big builders for half that. Do you think that high contractor demand caused them to charge much more? They told me it was the workers’ comp, which comes to 40% of their wages. I figured I could have saved 50% on the construction if I didn’t have to pay sales tax on the materials or workers comp on the labor.

I keep reading that baby boomers are driving the demand for second homes. Some even buy larger homes, sort of as a status symbol. Your observation that the buy smaller homes makes sense, and should be scary to all those builders and buyers who build/buy the ultra-large homes. Perhaps we will return to the homes of the 50’s, where a family of 5 was content to grow up in a 2bedroom/1bath house. At that time, the desire for status and keeping up w/ celebrities wasn’t as important. Increasing demand for smaller homes would be a market shift.

Your position of having your house paid off is very fortunate. If we’d had our house paid off, we wouldn’t have sold either.

When you say you have cash holdings, do you mean money market or CD? I checked w/ Vanguard, and the money market can hold GSEs. I’m concerned about the systemic risk of them going under, as Alan Greenspan alluded to, so I am pulling out of the money market. Am researching where to go instead. Euros, metals?

How much do you think housing prices will decline, and what will be the floor, due to the environmental laws that have increased the cost of land? How much excess due to speculation do you see, vs. the permanent increased cost of land zoned for building and the temporary increased cost of construction from high demand for contractors?

[powayseller]

Thanks for educating me on the cost-per-square foot issue. It sounds like builders use that term differently than homebuyers and the MLS.

How is business now in your industry? Are the buidlers still asking for lots, or focusing on building out the ones they started? You’ve been doing this long enough to know it’s cyclical and probably have a backup plan.

How can the big builders still make money, increase units sold, and increase profit? How could Lennar post a profit last quarter? Is it because the rising sales in the other regions negated lower sales in the West? Was the lower profit in Western states overcome by selling off some of their land?

How did the subdividing business change in the 90’s? Did you experience a contraction in the 80’s as well? Could you make a prediction about how the new ice age will play out?

If the zoning/govt’ regulations are increasing the cost of land, then we have a valid increase in the higher price of land. How much of the land runup is due to the cost of subdividing, how much due to speculation, in your opinion?

[powayseller]

What you write is definitely possible. Assuming all will come to pass as you say, how would one be prepared to survive it, financially and physically?

[powayseller]

You’re right, only the early adopters can make this strategy work. There aren’t enough rental houses to allow everyone to rent. The early bird gets the worm.

Also, make sure your landlord is not too cash-flow-negative. If he can’t afford to carry his property any longer and needs to sell, you’ll have to move again.

I’m puzzled about your friend’s story regarding the UCLA Anderson Forecast. They’re one of the most respected economists in California.

According to the Los Angeles Business Journal, “The UCLA Anderson Forecast has provided forecasts for the state and national economies for the past 50 years. The forecast predicted both the seriousness of the early-1990s downturn and the strength of the state economy’s rebound since 1993”.

[powayseller]

You raise an interesting point, that is also in the book Sell Now. Per the author, the housing bubble occured in our nation’s most exlusive communities: the coastal cities, plus vacation destinations like Aspen. He attributes this to the desire for status among people who live in those towns. People in the Midwest are more grounded and conservative, he says, and don’t chase the exclusivity of the status home. He delves into the economics of status buying, where supply and demand are inversely related. For a status buyer, the more expensive the product, the higher the demand. In a large city, people set themselves apart by having a better house than their neighbor. The role of psychology and emotion surely played a part in the runup. That is Talbott’s explanation, perhaps other people have different views.

rockclimber, as far as timing the market, I am sure I didn’t miss a run-up, since we sold after the peak and prices were already softening. At the time we listed, there were isolated reports of high pricing, and the PMI study had come out. But the mainstream media, like TV and the U-T, still had headlines of rising median price.

[powayseller]

OT: Sdrealtor, thanks for the apology, and I accept it. As I said before, the world needs more men like you!

OT again: the MLS gave my realtor a zip code override; the house was listed in the MLS as a Poway zip code when we first bought it, and we listed it that way when we sold it. The buyers knew the address was Lakeside, but it was not in Lakeside either but in the unincorporated area of SD County. There was a disclosure form, where I noted this address issue in the comments. The Tax Assessor records show our property as Poway, so I made sure the buyers knew it was not in the Poway city limits. The agents who showed the home all knew it too, because when you go to mapquest to enter the address, you have to enter the mailing address city to get the address, so you have to enter Lakeside when you use mapquest. So everyone knew the address/school district difference. People move to Poway for the schools, so it’s common for the properties outside the Poway city limits which are fortunate enough to be in the Poway school district(and there are only a handful), to use the Poway zip code in the MLS.
Perhaps this is useful information for you, sdrealtor. Some realtors don’t know you can do this, and one house in the Poway school district was once listed for sale without advertising itself as such. Too bad for the sellers. I believe being in the Poway school district made my house more valuable. I would not have purchased that house back in 2000 if it had not been in the Poway school district. As far as the name calling, I’m going to overlook that.

[powayseller]

Can you elaborate on the expected decline in the equities market? I know the P/E is at a historic high, and the recent runup (last few years) has been historically high as well, so a period of flat or declining stock prices is reasonable. I haven’t been following the stock market, but just letting the index funds ride… Any insights would be appreciated.

[powayseller]

I must say, I was uncomfortable that he figured out who I was, searched for me, and then posted my personal information. I knew all along that by giving out personal information, such as my city, kids’ school district, dates of sale of my house, that someone could find me. As a realtor, he found me only via the information I posted here. That’s all that happened.

It was fair that he looked me up, but he looked pretty foolish as a realtor, getting the info all wrong.

Another question for Sdrealtor, if you come back: Would your neighbors and sons’ friends be just as supportive in a time of need if you had been a renter instead of homeowners? My guess is: yes.

[powayseller]

Rightside, how did you get the idea that I regret selling my house? I’ve been bragging about it, and perhaps that’s not so good either. It’s the best financial decision I ever made. The second best was staying out of tech stocks. I feel very confident about my housing move, but lack knowledge about what to do with my profits and retirement portfolio. That’s why I’m trying hard to read, to learn more about the capital markets.

Poway is hot, but we moved here for the schools, which are consistently ranked as the best in San Diego Country. Poway has more open space than any other city in SD County. We have 13,000 open space acres, whereas the other 18 cities combined have 25,000 acres. It’s the City in the Country, and if you’re middle class like me, and can’t afford Torrey Pines schools, then Poway is the next best thing. If I had more money, I would live in one of those good school districts near the coast. But even though now we rent, I will not uproot my kids just be near the coast. Stability of schools is important. Yes, even renters can have stable lives 🙂

As far as berating my financial understanding, I guess I’m fair game. I don’t have all the answers, I readily admit that, so I’m here to learn, as well as to pass on what I’m learning myself. In previous posts, I’ve asked for your opinion, and appreciate the feedback you’ve given me.

You poked some fun at me, so I must ask: What did I write that upset you, that made you come out swinging? Was it my post about Sell Now?

May I suggest that we all behave a little more civil. Let’s stick to attacking ideas, not people.

[powayseller]

Sdrealtor, I actually think that realtors with a conscience, such as you, are having a harder time justifying their professions. It’s difficult to be a contrarian on your own product.

The housing runup was caused by greed, loose lending, and the powerful influence of the realtor lobby. The public believed the realtors who said prices could only go up. A realtor in Poway told me that last week: prices in Poway cannot fall, because people love the Poway schools.

As I said before, a person with a conscience must use all kinds of denial tactics to convince themselves they are doing the right thing. So in your case, you believe a house is a collection of emotions, and you can only connect with neighbors if you pay your monthly payment to a lender rather than a landlord. If you admitted that renting a house is superior to buying a house, in today’s market, then you wouldn’t be able to do your job. So you cannot admit that.

A house is not just a home anymore. As millions of people are about to find out as they face foreclosure. A house has become a financial instrument of devastation to personal lives.

As far as my personal time, and spending too much time on the keyboard, I probably do :). You’re right about that. My two weaknesses are reading and running. But I’m also a social butterfly, and dote on my family. This morning, my husband went to work 3 hours late, so he could spend the morning with me. Enough for the personal stuff. I regret that I feel the need to defend myself.

I do like having you on this board, sdrealtor. I hope we didn’t chase you away by asking some tough questions.

Best wishes to your child, and I hope you can stick around. I for one won’t pick on you any more. I think you’re working hard to provide for your family, and that’s honorable in itself.

[powayseller]

Great, you found me! But you are wrong about your assumptions.

The house was 2293 sq ft plus garage when we sold it. We got our Certificate of Occupancy on 9/6/05. The buyers had an appraiser, and I still have my blueprints from my construction.

We used the Poway zip code of 92064, because we are in the Poway Unified School district, and the property was 2 blocks outside the Poway city limits. The property is in the unincorporated area of the County, and the mail is delivered by Lakeside (thus the Lakeside mailing address).

I think the lesson for you, sdrealtor, is you don’t need to come out swinging when you are honest.

And I will accept your apology, if you care to make it.

[powayseller]

Finally, homebuyer behavioral economics! Great article. Where have you been leung_lewis?

[powayseller]

I will counter each of your arguments. They are the same old ones I hear over and over again, about why you couldn’t possibly sell your house and rent.

First, selling a house is the only tax-free gain I know of. Take the $500K capital gains tax exclusion ($250K for a single person), invest the profit in a CD yielding 5%, and then buy back in when your house is worth half. Heck, you could pay cash for the house in 5 years! Where else can you earn $500K and not pay any taxes on it. I think the government wants us all to sell our homes 🙂

Second, if you stay put, and need to sell for some reason before prices go back up (12 – 15 years?), you would lose all that paper profit. It won’t be there in 5 years.

Third, this is the easiest opportunity to cash out. How many years does you have to save, nice and slow, into that retirement plan, to get the same amount of money you can get by selling your house? In our case, it was about 25 years of saving that equalized our housing profit.

Fourth – the kids argument. I’ve heard that same lame line over and over, that renting is bad for kids. Why? Rent a house in a great location w/ a pool. That’s what we did while we were building. For 2 years we lived in a very desirable area of Poway, called Green Valley. Unfortunately, after we sold the house we built, it was January, and the rental choices were less, so I didn’t get the prime property I wanted. The realtor, who helped me find a rental, told me there’s always a lot more to choose from around the summer, a time when people move. We may stay put, or move in the summer. Either way, wherever we end up by the end of summer, is the house we’ll stay until prices bottom out.

Also – consider that realtors and mortgage brokers have been pushing ARMs because “most people only live in their homes for 2-3 years anyway”. Ok, so owning a house for 2 years is great, but renting for 2 years is not??

My old neighbor, an upwardly mobile professional, has been moving his kids and wife across the country every 2 years, since his kids were born. When things went downhill at Gateway, his Senior VP job wasn’t looking so good anymore and he went back to Chicago. They just completed their 6th new-city move. Oh, and they were homeowners each time. Are their moves sanctioned as a higher quality of moving, because they owned their homes? Would their moves be disdainful and harmful to their kids if they had been renters instead?

The people who say that kids need the stability of the same house: if you had a job offer in another city, would you forego it because you don’t want your kid to live in a different house?

Kids don’t know whether you own or rent, unless you tell them they can’t paint their room. Lighten up – spend a thousand dollars painting their bedrooms. Chances are the landlord will appreciate your nice paint job. (More women list painting as the #1 reason they couldn’t possibly rent. How shortsighted! Paint is much cheaper than the alternative of losing $500K of housing profit. Take the emotion out, people.) For stability, keep them in the same school. From my experience of moving, I found that kids are not even fazed by the move if stay in the same school. I moved twice in Phoenix, and 4 times in SD, keeping the same school. I saw that the kids were excited about each move. My kids find it exciting and wonderful to move. Kids are move like dogs in that regard, always looking for an adventure. If they have to change schools, it can be stressful for a few weeks, so you can avoid changing schools if you wish. Again, mobile career people have kids who change schools frequently.

Fifth – “moving is a pain, I have pets, I have guinea pigs, it’s too much work to pack them all up”. If you give that argument, you probably aren’t in the military. Moving takes a couple weeks: packing and unpacking, getting situated. Definitely hire a moving company to help you out. Yes, it’s a pain, but so is going to the dentist, cleaning out the fireplace, and running up a mountain. Oh, and the dog survived just fine.

Bugs, someone who bought pre-1997 for $200K has an even better reason to sell: take the profit. It’s the oldest investment mantra: take your profits while they’re there. Take the capital gains exclusion, and pay cash for your house in 5 years. You won’t even care what the interest rates are.

I can’t figure out why anyone is still holding on to rapidly depreciating assets. The only reason would be emotional attachment.

If I handed you an envelope with $300K inside, would you take it? Yes. If I told you, this envelope is yours, but you have to move? Now – different story. The thought of moving is not worth several hundred thousand dollars to some people. I’m just mesmerized by this, I can’t figure out why not. Am I superficial, to put a value on a physical structure, to be willing to sell it?

What makes you all so attached to your homes, that you are willing to work 5-10 years of your life to save the money that you could make by just selling your house? I am seriously wondering.

I know this is long, but I hope I covered all the lame arguments about why it’s impossibly difficult to rent. I won’t bore you with all the commentary on the advantages of renting, but here’s a list:
1. no property taxes
2. no maintenance fees. Call landlord when something breaks.
3. renters insurance costs less than homeowners insurance
4. earthquake insurance costs less on a rental (yes, make sure y’all have that earthquake insurance)
5. if you’re just getting into the market, rent is much cheaper than a mortgage
6. I can afford to rent in neighborhoods where I can’t afford to buy
7. No money spent on the constant improvements. No ongoing projects.
8. Husband has more free time, since he’s not gardening, fixing, building, improving, and being a guy in his castle. More time to work on hobbies and spend w/ family.
9. No ties to a depreciating asset.
10. No mortgage, no debt. Financial freedom.

The only reason that I personally would stay in my house is if the house is almost paid off, or paid off. I might still cash out, but would have to handle the adjustment from zero mortgage payments to paying rent.

[powayseller]

Are you saying, sdrealtor, that a San Diegan wanting to move-up should go ahead and make the move, since a decline will hit you the same, whether you live in your current house or in the new house?

I’m sure sdrealtor and others who are bearish are having a difficult time reconciling the conflicting obligations of earning a living and telling people that this is the worst time in the history of the US to buy a house.

Personally, I felt somewhat guilty selling my house. My buyers were basically clueless, and I felt I deceived them by giving them the opportunity to buy my house. Free markets, yes, but I’m the one who socked it to them. My big windfall will be paid for by them. They’ll have to work many years to pay my windfall. They may end up in bankruptcy. They took a 5/1 ARM, 100% financing. But I had no fiduciary duty to these folks. A realtor does, or so the ethics state.

Honorable realtors convinced themselves of one of many denial points, so they can live with themselves and keep making the sales pitch. They say the market can never go down, that it is softening but will pick back up, that you can lose money by staying put as well as by moving so you might as well move, etc. If you didn’t mislead yourself, you would have to get out of the business. So denial is the easier way.

Realtors must know they are leading every new homeowner toward potential bankruptcy. That’s an enormous burden. Personally, I’d have to change jobs. I couldn’t do that to people.

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