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Poway,

Oil is traded in free markets and like everything else, its price is driven up and down by speculators in addition to real supply/demand. Like any hot asset, speculators add a premium to the fair price determined by supply/demand, if price of asset keeps going up. On the demand side, China has been the main driver of growth in Oil demand and not the US. The growth in US oil consumption has been relatively flat over last 3 years though oil prices have doubled in last 3 years.

You seem to underestimate the effect money has in both directions on people’s habits. It can spoil and it can also discipline better than anything else. Have you noticed the number of people who car pool to work has increased lot and that demand of hybrid vehicles has gone through the roof whereas demand/price of used SUVs has gone down.

The main reason I see higher oil prices is not in demand but on the supply side problems. I believe in short term oil will hit some inflection point like $100 and then take a tumble. In the long term though, it will keep rising in price due to supply side concerns.

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Colombo,

Chinese govt already provides oil at subsidized rates to its people. If Yuan appreciates, it will happen slowly and there will be no sudden jumps. Have you checked the per capita income of China and US? You don’t seem to understand why savings rates are so high in China. Chinese govt doesn’t promise to provide for its elderly and so people save for their retirement. Houses, Cars, etc are generally bought with huge lumpsum payments since the credit/finance system is not well developed. This is crucial in stoking domestic spending. There is also a change in mentality that will happen as 2 very different Chinese generations switch hands as head of houseold. So yeah the Chinese will start consuming more but they cannot immediately replace the US consumer. A US recession later this year or next year will definitely slow Chines growth and also slow oil demand worldwide and bring down oil prices. In the long term though, I guess everyone agrees that oil will be higher as US and European nations will have to make space for the more afluent lifestyle of Chinese consumer.

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jespd,

Thanks for the interesting history. Could you please elaborate what happened to the European countries in 1920s when they couldn’t pay back their loans? Bankruptcy? Currency devaluation? Huge number of foreclosures or assets were sold to account for the losses.

Why do you think that the Fed can lower rates if foreigners stopped buying treasuries? Who will buy all the treasuries then if rates went down? The reason US could afford to lower rates after the tech recession was because foreigners were buying treasuries and pumping money that was being passed to the US consumer. I don’t think Fed will be able to reduce rates as it was the foreign investor who pumped capital into US and not the Fed.

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sfobserver,
Thanks for pointing out my mistake of not deducting the principal. It is one of those many math blunders that has cost me many grades during college too 🙂

MrWrong,
There maybe gazillion variables at play but only 1 basic/fundamental question. Is housing prices going to go up or come down in next few years? Simple yes/no for this question settles the argument for or against buying.

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Hi DaCounselor,

Welcome to the board and ignore childish name calling as I believe we are mature enough for that kind of stuff. Your comments are most appreciated.

I disagree with your comment that stats supporting housing collapse are taken out of “thin air”. I think you need to understand the concept of economic models, how cyclical assets work and how many times economists have been able to predict with high accuracy about asset bubbles without knowing about specifics of each individual but by working with the average/median stats.

I agree with you that we don’t know about the personal finances of each and every individual in SD but this is not how economists model and predict future recessions/booms. To build any model they have to play with median/average since both tend to be good measures of whole population sample. Now, take a look at the median income to median home prices ratio for SD for last few years that Rich posted and compare that to the historical average. Also check the rent to housing price ratios. These numbers don’t tell me that in general an average SanDiegan is much more leveraged than before to live in his American Dream house.

Now to foreclosures. For Fed, the rate hikes are tied to slower economic growth as Bernanke said last time. Unfortunately, this time the easy credit supply forwarded to US consumer was funded by huge foreign investments which is going to cool off and so low mortgage rates of past are very unlikely. Also, odds are 8/10 that Fed will push economy into recession as they raise rates too high. Recession will also strike because US consumer can no longer trust on the increase on housing equity to keep drawing money from it. With a looming recession and no let up in interest rates, combined with income to housing prices ratios that show how extremely leveraged an averge SanDiegan is, I am going to bet on high foreclosure rates next year.

Investing is all about educating yourself and putting your money with the odds and the odds are stacked in favour of a housing down turn. To me, paying current inflated prices for SD homes with huge risk potential is simply not wise.

The long term view on housing is equally strange to me. In the long term even though your 150K house is worth helluva lot more now, it still doesn’t change the fact that you paid helluva lot more than what you could have. Since housing moves in cycles, all that matters is when you enter (buy first home) and exit the market.

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PS,

Actually, oil was running at around $72 per barrel before mid east crisis began. It had touched $75 in April because of lots of geo political tensions had already been priced into that. Iran’s nuclear program, unrest in Nigeria, Venezuela putting oil fields under state rule, Iraq war going on and on, China’s growing oil demand, etc.

We both agree on housing slowing down and taking US consumer with it, right? How will it effect China until either Japan or China itself can create a consumer base able to replace the whopping US consumer? Why would you bet on oil and commodities with an impeding recession? China is suffering badly with huge pollution issues in main cities due to its inefficient use of oil and natural resources. As per the Chinese minister, China is going to increase energy efficiency by 4% this year increasing to much bigger %age in 5 years. note that with the huge pollution problems, China is facing, this is utmost priority for Chinese government and they can afford to sacrifice bit of growth for that. Also, when oil becomes expensive then after a certain threshold demand starts to drop. Even more siginificant is that this deman may not return as people will not remove insulation from their houses or sell their hybrid cars or remove solar panels from roof tops. So extremely high oil prices are dangerous for OPEC as they may drive the consumer to alternative energy sources and they may not return even when price has come down. So that covers the demand side of the argument.

Now to the supply of cheap oil. I have no idea about the rest of the geo-political issues but they can come up or get resolved as quickly and have been mainly affecting oil supplies. OPEC predicts to increase oil supplies from 4.2million to 6.1million by 2010. Important part of the supply side argument is about the time frame you are looking at. What is the time frame do you see oil hitting 100, 200, 300 per barrel?

BTW, I like COP, VLO as well as they are dividend paying companies that have some growth potential too. Do you plan to play the oil sector by investing in COP? Why not buy oil tracking ETFs if you are sure it will hit $100 since the upside is sweeter (COP stock may not hit $100 even if oil hits $100)?

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I am going to trust you on all the rent, buy and HOA numbers you have provided though HOA seems little conservative for new condos. Anyway, Please note that only interest in your mortgage is deductable and not your pinciple payment. Also, can anyone confirm if HOA dues paid are tax deductible? I don’t think so since they pay for water&gas utilities, exterior maintenance, etc so I haven’t included those in calculation but being a small number they should vary result by just about $70. Note that I am giving you this calculation for nealy 7-8 years as it is a very optimistic belief that you will stay in this smallish condo for 30 years considering marriage, children, job loss, emergency and everything. Here is the low down for you and please correct me where I am wrong.

BUYING:
Average Equity built per month = ~ 460.
HOA = 200.
Tax deductable Mortgage Interest + Property Tax = 3938 – 460 – 200 = 3278.
Per month aftertax return on downpayment of 120K at 4.5% = ~$480
Maintenance = 100.
Appreciation = 0.
Tax benefit if you itemize = 3278*0.34 = 1115.
Per month cost to buy = 3938 + 100 + 480 – 1115 = $3400.

RENTING:
Per month cost to rent = $2300.

AMOUNT YOU OVERPAY FOR BUYING = ~$1100 per month.

So MrWrong let me know what you think I have missed. You seemed to imply in earlier post that the principal you are building is some kind of investment that will grow but note that this growth is actually appreciation on your house which is pretty much 0% or even negative for next 5 years. Why would you like to start putting money (principal equity built for 5 years + 20% down) for next 5 years on the worst piece of investment possible in current scenario when you know that you can get the same condo for much less in next 5 years? Why not rent and use that down payment + monthly principle payment to invest in equities, precious metals, commodities, international markets, etc or diversify as you may like. Also note that these investments are much more liquid as compared to your condo, in case life throws something bad at you. Oh and I haven’t including all the costs for selling your condo (5% of condo price).

To me, since the ammount you are paying to buy is nearly 45% more than current renting price, so the price of that condo needs to come down to around 450K for me to consider it attractive. MrWrong, I hope you make the right decision.

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I don’t understand the “long run” rational. Housing goes in cycles and the average bottom to top difference is 30% of the home price. So if you entered (bought first home) at a cyclical top as opposed to a cyclical bottom, then you lost equivalent to 30% of that home’s price. No matter how long you live in it you have missed on that much money. If you buy now and your friend buys 3-5 years later at bottom, then it doesn’t mean tht in 30 years both will have same bottom line. Just for being prudent and patient, your friend will have that +30% more than you for now and after 30 years too.

Also, the current rent equivalent (cash flow) value of a UTC condo to give decent return (6%) on your downpayment is around 180K (using average 1BR rent of 1250 in UTC and average HOA of 250, 6.5% interest rate and ofcourse zero appreciation in future 3-5 years).

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A dead cat bounce happens because there are bargain hunters like us, awash with more than 20% downpayment money but waiting to jump in to the market. So some of us will lose patience and be sucked into the market as prices start to really tumble causing a dead cat bounce or maybe a false bottom. Also there will be some people who would set targets like 20%, 30%, etc to jump in and maybe at psychological levels of 300K, 500K or something and will jump in, even though fundamentals haven’t changed completely. It is similar to the slight reduction in prices that happened in 2004 as bubble bloggers started to emerge and some of my friends sold their houses as they felt housing was in bubble. But the uptrend still kicked in again and continued till summer of 2005. On both up and down cycles, greed and fear make the market over correct.

To me, no number is certain. Interest rates and incomes are the key in my opinion. From today’s prices, I believe there will be 50% reduction in real dollars but it will happen in 4-5 years. That means, assuming real inflation of around 4-5%, prices will be down around 30-35% from current prices in 5 years. However, if we suffer from hyper-inflation and dollar takes a tumble then its anyone’s guess what may happen.

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Rising oil/gas costs may not stay here for long term.
http://www.bloomberg.com/apps/news?pid=20601087&sid=akcF0U0fhysw&refer=home

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Also, if this is essentially a credit bubble, there are 2 ways for the US Govt to get out of that increased liquidity bubble.

1) Keep increasing interest rates and tighten money supply irrespective of the economy until the resulting increase in savings brings back the equilibrium in liquidity. This will help the “savers” like most of us but will kill the commodity bubble (housing, metals, etc). This option, however, maybe somewhat unpopular.

2) Naturally, the second way is that since there is a lot more greenback out there, its value should come down. So Govt doesn’t increase rates further and instead chooses to cut rates back and let the dollar decline. This will also boost US exports, help reduce the huge trade deficit and reduce our foreign debt automatically. However, this will be very bad for savers like most of us with most of their savings invested in CDs, MMs or other dollar denominated securities. It will boost people owning hard assets like homes and may well save housing from a hard landing.

Consequently, if you tend to believe that point # 2 is more likely of the two scenarios to happen then what are the strategies or backup plans for such scenario, if it happens? Shouldn’t we have some backup plan for scenario # 2 or is it a very unrealistic scenario? Gold and PMs seem to be over valued due to lot of speculation right now. So where to put money then? Foregin Currency ETFs or Foreign Currency CDs by EverBank or buy Treasuries of countries like Canda? Or put money in Global Bonds Funds? What percentage should be invested in foreign currencies? Please comment as I would love to hear what more senior and experienced members on this board think who have actually seen previous recessions or bubbles.

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Wanted to comment more on “where to put cash”.

Folks, since most of us agree that the housing bubble is essentially a credit bubble then there are 2 ways for the US Govt to get out of that increased liquidity bubble.

1) Keep increasing interest rates and tighten money supply irrespective of the economy until the resulting increase in savings brings back the equilibrium. This will help the “savers” like most of us but may kill the housing, general economy, stock market. This option will be extremely unpopular among politicians and big corporates lobbying for them.

2) Naturally, since there is a lot more greenback out there, its price should come down. Govt doesn’t increase rates further and instead chooses to cut rates back and let the dollar decline. This will also boost US exports, help reduce the huge trade deficit, reduce our foreign debt automatically. However, this will be very bad for savers like most of us with most of their savings invested in CDs, MMs or other dollar denominated securities, wiping out our saving for just being frugal. It will boost people owning hard assets like homes and may well save housing from a hard landing.

If you tend to believe the point # 2 is more likely of the two to happen then what are the strategies or backup plans for such scenario, if it happens? 100% in MMs or CDs doesn’t seem to be a good move. Gold and PMs seem to be over valued due to lot of speculation right now. I agree with Poway that with the downturn in housing bubble and the ensuing recession, commodities bubble will also perish so I don’t like investing in commodity ETFs either right now. So where to put money then? Foregin Currency ETFs or Foreign Currency CDs by EverBank or buy Treasuries of countries like Canda? Or put money in Global Bonds Funds? I am confused.

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Fed is not targetting bubbles, they are targetting inflation. The point was that main contributing factors to inflation now are the high commodity prices (including oil) and the high living costs (another measure used in CPI). If Fed is really as serious about containing inflation as they talk to be, they need to kill these 2 speculative bubbles to contain inflation. It will hurt economy as well but this is the only way out. Basically, there is too much easy money out there (thanks to greenspan) and it keeps showing its face as one bubble or the other as hedge funds follow the hottest thing around.

And I said, I “liked” comments by an analyst because it made sense to me. It will be presumtuous of you to assume that I agree or believe in anything analysts have to say. But thanks for your concern and references to different analysts.

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I liked an analysts comment that the Fed need to kill RE and Commodities bubbles to contain inflation (and from recent Fed talk, they look serious about inflation). The Fed has to increase rates to kill both these bubbles as higher rates will slow economy (reducing demand for commodities), strengthen dollar and bust Real Estate. Any attempt for a way out through more money printing, will be disastrous.

I now believe that Fed is going to raise rates that will create a mini recession causing a bust in demand for real estate starters, as well as commodities (including oil) and will hence contain inflation. We will need to build our economy from there onwards but it seems to be the only way forward.

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Poway,

Thanks for the reference to the link. I am in touch with all the blogs on iTulip and others portending a bust in stock market, the dollar crisis taking down the world economy, etc. I didn’t recommend investing in emerging markets but in huge companies from developed countries.

The whole idea about not touching retirement funds was that historically, most of us are bad at timing the markets. Also timing the market is a very dangerous game. The whole idea of investing for retirement is that since you are looking at 30-35 years time frame, you can benefit from the historical statistic that an index fund (dollar averaging and compounding) over this time period will beat most of us, managing it ourselves. Over 30 years, whether you succeeded to sit out a recession or not, wouldn’t really matter.

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