Kimberly R. Goodwin, Ph.D.

The Hattiesburg American recently reported the Hattiesburg Association of Realtors announcement that home sales were down in 2011 as they had anticipated.  Hattiesburg is a relatively stable market that is highly bolstered by the presence of two large hospitals, the University of Southern Mississippi, and Camp Shelby.  Year-over-year differences in sales during the beginning of 2011 should have been expected.  Overall, home sales were inflated during the first four months of 2010 leading up to the expiration of the Home Buyer tax credit.

The more interesting question is why the end of 2011 was better for the Hattiesburg real estate market.  Banks were finally lending a little more, consumer credit was rising, and mortgage rates were at historic lows even dropping below 4%.  In fact, data from the National Association of Realtors shows just the opposite trend in major metropolitan areas across the country.

The difference between this data and what is being reported in Hattiesburg may be linked to the price trend.  Notice that nearly all the markets reporting an increase in units sold also reported that prices were flat or falling compared to November 2010.  The Hattiesburg Association of Realtors reported an increase of 6.19% in the average sales price.  That just about equals the percentage decrease in homes sold. From an economic standpoint of supply and demand, balancing the equation becomes a relatively simple matter.  If you want to increase the quantity of homes sold, you need to let prices fall.

Getting a break from teaching allowed me the time to finally sit down and read Thomas Sowell’s The Housing Boom and Bust.

I had the older version published in 2009, but there is also a revised edition published in 2010.  I am pretty sure I got the idea in the original version, but I am interested to know what he included in the revised copy.  Probably a lot of “wow…the government once again intervened only to wreak more havoc on the markets!”  The reader really has to go into the book knowing that the author is very pro-free market and anti-government intervention.  Much of his discussion of the housing boom and bust relates to how government policy itself created the environment that allowed the housing market to bubble in the first place.

The author makes one point with regard to the housing bubble that I had not heard in anyone else’s discussion of the crisis.  A few areas of the country saw the highest highs and the lowest lows – places like California and Las Vegas – due to the impact of restrictive government policies on development.  Since the supply of land zoned for residential development was so limited, demand pushed prices higher at increasing rates.  Prices were not so much higher in these cities until the 1970s when the restrictive zoning laws were put in place.  You can argue for or against these policies, but in the end they caused people to move out of these cities and required the innovative mortgage solutions for even the highest income bracket households to be able to afford to purchase a home in this skyrocketing housing market.  And then those people didn’t give much thought to the downside risk of this innovative mortgage product.  After all, they’d seen prices rising as long as they could remember.

This book does a thorough job of explaining the economics and politics that led us into the bubble and what happened when it burst.  He also points out some lessons we should try to learn as we move forward and try to get out of this crisis (hint: more government policy is not his answer).  I think the only thing somewhat missing from the story is a more thorough discussion of the role of the banks themselves in the whole debacle.

Overall, I highly recommend the book and have considered including it in a graduate level real estate course.

I’ve been working on some new material for the site but have not been able to get to the administration page for a number of days.  New content will be posted soon if everything stays functional.

About a week ago, LinkedIn made its initial public offering.  The stock had been trading in the private markets for about $35 per share leading up to its IPO date.  As such, the initial guidance for the offer price was in the $32-35 range.  Following the buzz from the road show and a sense of an increased market appetite for social media stocks, the offer price was revised upward to $45.  So, LinkedIn went public at $45 per share and made the company a total of about $4 billion.

What happened afterwards is the more interesting story for the market.  The stock promptly began trading in the secondary market (every trade after the initial placement of the shares) for over $90 giving LinkedIn a market valuation of a little over $8 billion.  At first glance, you might think LinkedIn has a reason to be upset with their underwriters.  That price difference means LinkedIn lost out on $4 billion in capital on this stock offering.  You might think the underwriters did a pretty bad job forecasting market demand for the stock.  And while both of these complaints seem pretty reasonable, on this one I am going to side with the underwriters.

What is interesting about this particular offer is that we had some prior indication of value from the privately traded market.  This is a market where the average joe stock trader is not a player.  This is a market reserved for investors in hedge funds, private equity funds, and the like.  The valuation and risk analysis of these investors found Linkedin valued in the $35-45 range.  These investors likely would not have been so eager to participate in the purchase of IPO shares if they had been priced closer to $90.  The average joe traders are anxious to own social media and are willing to pay much higher prices to ride that wave.  The average joe has missed that buzz you get from an upside swing and may be a little too eager.

One last point to note is that the shares available to purchase in the market right now is limited.  A lot of the IPO shares included a 6 month lockup period which prevents the purchaser from selling the shares at all until later this year.  This coupled with price support by the underwriter always leads to price inflation of some sort for 6-9 months.  In the end, I personally believe LinkedIn is a good company with a good product and that social media is important to the future marketplace.  We live in a social networking world now, which is why as investors we should be careful that we are not leaving our head in the bubble.

Raise your hand if you remember the last tech bubble.  Let me jog your memory.

See 2000 where the S&P 500 peaks around 1500?  See where it then proceeds to lose almost half of its value until it bottoms out around 800?  That was the last tech bubble.  Do you know what happened right after this?  See where the market rises again until it peaks during 2008?  What you are looking at there is the real estate bubble.  When the tech bubble burst, investors decided that they no longer wanted to hold stocks backed by intangible assets and ploughed their money into real estate.  Burned by the overheated tech market, they found comfort in real estate because it was a real asset they could see and touch.  But alas, the mindset of speculation and flipping to earn a quick buck fueled unsustainable growth in real estate.  Look around your town at the number of homes for sale or up for foreclosure auction and the outcome is just as tangible as the real estate assets themselves.

Yet, if you look and listen closely, you’ll notice the set up for the next tech bubble.     If you are reading this, then chances are at some point you gave in to peer pressure and created a Facebook account.  Chances are you are probably checking your daily news feed more often than you are checking your stock portfolio.  It has so infiltrated our culture that we also flocked to see the movie The Social Network, which chronicled the development of Facebook.  Facebook is a privately held corporation right now, but based on a recent private stock transaction its value is estimated at around $75 billion.

That is not a typo.  $75 BILLION!  For reference, that is more than the market valuation of the Walt Disney Corporation.  The problem here is that the valuation is completely based in hype.  If two years from now Facebook becomes the next My Space, it hardly has any tangible assets it could sell to compensate investors.  If we are going to learn from the mistakes of the past, there is a lesson to be learned that this valuation does not make sense.  Donald Trump says that sometimes the best investment is the one you don’t make.  As an investor, I might have to let Facebook pass me by.

But I’m not just “poking” at Facebook.  My husband went to a VC conference this year where they were saying that if you have any idea involving social media, then they had enormous amounts of money to throw at you.  Depressed and defeated by the housing market and high unemployment, we as investors are desperate to catch the next big wave.  Like the highly coveted Birkin bag, we are willing to pay outrageous prices for today’s hot ticket.    While these firms are difficult to value because they are not publicly traded, recent markets have valued Twitter at $10 billion, Groupon at $6 billion, and Living Social at $3 billion.  Rovio Mobile, the maker of the highly addictive Angry Birds, just received $46 million in funding ahead of its planned IPO.  Just remember these last few words of advice.  Just because you love stalking your favorite celebrity on Twitter doesn’t mean you should run out and invest in the company.  Be sure the plan, positioning, and price makes sense.  And don’t forget one of the cardinal rules of finance: If everyone is doing it and says it’s a sure thing, that is the time to get out.

I guess I would consider myself an environmentalist.  I’m not a member of any kind of activist group, and I don’t drive a Prius (yet).  But I love trees, clean water, baby seals, and fresh air as much as the next person.  Still, it seems like what always causes me to break my bad behavior and act on my environmental conscience often turns out to be based in economics.  For instance, I’ve had my eye on reusable grocery bags and produce bags for a while.  Yet, I never bought any and decided to change my behavior until a few weeks ago.

I went to the grocery store to do my weekly shopping, and I didn’t pay much attention to what was happening with the bagging of the groceries until I got to my car.  I was horrified and aghast to find that the kid who bagged my groceries had packed nearly half of my groceries all alone in a separate bag.  Can of soup?  Needed its own bag.  Box of spaghetti?  In its own bag.  Coffee?  Clearly can’t touch anything else and needs its own bag.  I am sure I would have been shouting expletives if I didn’t have my kids with me.  It felt like it took me an hour to get everything into the car and then into the house because there were SO MANY BAGS.  That was my tipping point.  It’s one thing to use the plastic shopping bags at the store because you are just lazy.  It’s another to be wasteful of both the bags and my time.  That was when I screamed “ENOUGH!” and promptly purchased a nice set of reusable bags.

It was also about that time that this questions seemed to enter into the news…or maybe my awareness was just raised about the issue.  Now, where I live, I am sure they are rolling their eyes at me and talking behind my back when I hand over my bags.  But they should not because I am saving them money.  In fact, if they had not given me about 50 plastic bags on that fateful day, they would have saved themselves about $1.00.  In an industry where profit margins are small and prices are rising, such a per customer savings could be meaningful to the bottom line.  Some stores are realizing this and changing their bagging behavior to minimize the number of bags they are using.  In the San Francisco area, they have actually banned the use of plastic bags.  Grocers in many cities around the U.S. are charging customers per bag when they do not bring their own bags.

Of course, some people don’t want to give up their plastic bags, and other areas of the country (like mine) probably don’t even recognize the environmental and economic impact of their bagging preferences.  And, of course, some people are going to say that saving the earth may also be bad for your health.  Still, bring your own bag (BYOB) is coming to a town near you, and it makes sense.  You know you are just throwing all of those plastic bags away, and it is waste for no really good reason.  Bringing your own bag is not that difficult or inconvenient.  It saves you time loading and unloading your car.  It saves money.  This is an economic no brainer that is good for the environment.  Win-win…unless you’re the one making the plastic bags.  And if that’s the case, you should see the writing on the bag and start making some reusable bags.

Tuesday the Federal Reserve Open Market Committee released its policy statement.  For those of you who have not taken a class in financial markets and institutions or economics, these are the people who decide what is going to happen with interest rates.  Specifically, their goal is to set a target for the Federal Funds rate.  This is the rate that banks charge each other to borrow money overnight through their deposits with the Federal Reserve.  This base overnight rate that banks lend to each other becomes the base for all the other market lending rates.  They decided to hold that target at 0% to 0.25%.

Their statement yesterday basically said that the economic outlook today looks better than it did in January.  The labor market looks slightly better, growth looks slightly better, and household spending and business investment are showing signs of recovery.  The biggest problem the Federal Reserve now faces is how to manage its dual mandate of low unemployment and low inflation.  You can spin the unemployment numbers any way you want, but they are still out of the comfort zone of the American population and are not improving in a meaningful way.  Low interest rates stimulate business growth because they allow for cheaper borrowing and more positive return investment opportunities.  So, the Federal Reserve needs to keep rates low to combat unemployment.

Luckily, for the past few years of this economic downturn, inflation has not been a problem.  Average monthly inflation for the past 5 years has hovered around 0.5%.  This has allowed the Federal Reserve to focus on growth.  Yet, inflation is now on their radar in a meaningful way, and the way they act to combat inflation is to raise interest rates.  Preliminary inflation rates for January and February were 1.2% and 1.7%.  That is over double and then triple the monthly average in recent years.  Most of this increase is driven by higher oil prices, but higher oil prices will soon be passed down into higher prices for just about every product and service (see graph below of the Producer Price Index).  For now, the Federal Reserve is standing steady and counting on long-term inflation being more steady than we are seeing now.  What they are counting on is some stability in the Middle East.

What do we look for going forward?  Well, a lot may have changed by the next FOMC meeting.  We are only now beginning to wrap our heads around everything going on in Japan and its ramifications for global markets.  Higher oil prices will soon be passed onto consumers in the form of higher prices in other goods.  Keep a close eye on what is happening in Bahrain and Libya.  The volatility of the whole region means volatility in oil prices and uncertainty in supply as we enter the summer months.  I’d like to be a fly on the wall of the next FOMC meeting.

Six months ago the Federal Housing Administration announced an $11 billion refinancing initiative for borrowers who are “underwater” (have negative equity) on their mortgages.  Now 23 lenders have agreed to take part in a new loan modification program.  Sounds good, doesn’t it?  Finally, something that will address the real problem in the housing market.  Well, don’t get too excited just yet.

First of all, the FHA’s “Short Refi” program requires a lot of concessions from lenders.  The lender must agree to write off at least 10 percent of the principal balance, and investors who own the cash flows generated by the mortgage (any form of mortgage backed security) must also agree to the arrangement.  To qualify, homeowners must be current on their monthly mortgage payments and not already have an FHA loan. The size of the new primary loan cannot be more than 97.75 percent of the current value of the property.  Refinanced loans for homeowners whose properties carry second liens cannot exceed 15 percent of the property value.

Next, Fannie Mae and Freddie Mac will not allow loans they hold to qualify for the program.  The three largest banks – Bank of America, Citibank, and JP Morgan Chase have also decided not to participate in the program.

What does all of this mean?  Qualifying for this program is incredibly difficult.  Borrowers cannot be delinquent on mortgage payments, and getting approval from the lender and any other stakeholders may be arduous.  Also, when you consider all the parties not participating in the program, the majority of borrowers are already exempted from the program.  Yet, you are still going to be surprised to find out how many people this $11 billion initiative has helped so far.  44.  You read that right.  44 borrowers have received a loan modification through this program.  Sounds like a lot of people are still waiting for that life boat.

The last post looked at some of the reasons the Home Affordability Modification Program was an overwhelming failure and is being slotted for cancellation.  The final reason the program was such a failure is the fact that borrowers whose home was now worth less than the outstanding balance on their mortgage did not qualify for a mortgage modification.  Unless you were in a markets that did not see much of a bubble (most large southern cities with the exception of Florida as well as most mid-western cities), this was probably your biggest hurdle to getting help from the federal government.

As a matter of fact, according to the Case-Shiller average home price index across 20 major metropolitan areas, if you purchased your home any time in the last 7 years, it is probably worth less today than it was when you bought it.  In fact, if you put down less than 20% on a mortgage in the last 5 years, you are likely to be under water on your mortgage.  There are no mortgage modifications for you.  The federal government will bail out financial firms and auto makers, but they will offer nothing for you.  Your only hope to avoid foreclosure comes from two places: (1) a change in policy allowing for more short sales to clear out the supply of homes on the market or in distress (though, yes, this will also depress prices further for a short period of time) or (2) hope that miraculously home prices turn around in the near future (sadly, the evidence seems to point to just the opposite).

Unfortunately, the damage doesn’t appear to be done for some of these cities.  A huge amount of supply, tight credit conditions, high unemployment, uncertain economic forecasts due to rising oil prices, and a plethora of foreclosures yet to hit the market, a double dip in housing sounds like a fair bet.  In fact, some cities already look like they are headed in that direction.

Last week the House Financial Services Committee voted to close down several programs aimed at providing assistance to homeowners at risk of losing their homes due to foreclosure.  Why?  The programs are poorly designed and don’t work!

The first program on the chopping block is the Home Affordability Modification Program.  HAMP began on March 4, 2009 and provided an incentive of $1,000 per borrower that mortgage servicers recruited into the program.  The servicer would receive an additional $1,000 per year up to the first three years that the borrower remained in the program.  Borrowers in the program could permanently reduce their mortgage payments.  The lender first had to bear the cost of reducing the payment so that monthly payment of principal interest, tax, and insurance was no more than 38% of monthly income.  The government would then step in and bear the cost of reducing that payment down to  31% of monthly income.

There were almost 3 million foreclosure filings in 2010 alone.  The number of borrowers who received permanent modifications from the Home Affordability Mortgage Program?  A mere 600,000 over 2 years.  The program was a failure because it so inadequately addressed the problem.

First, the incentive for servicers to place borrowers into the program was often not enough to offset the loss they would incur by permanently reducing mortgage payments.  Furthermore, many borrowers who did get recruited into the program were later dropped from the program because they could not provide the necessary documentation to receive a permanent payment reduction.

Second, many borrowers could not meet the requirements to get a permanent reduction of their payment.  The value of the ratio MONTHLY PAYMENT/MONTHLY INCOME already has to be lower than the value set by HAMP to receive a conventional insured mortgage.  Therefore, the only way borrowers would qualify for a payment modification was if they are now receiving drastically less income than they were when they initially took out the mortgage.  While this was the case for many borrowers who plagued by a bad labor market are now unemployed or underemployed, this was minor compared to the larger reason people could not pay.  The problem lies not in wages but in debt.  Nowhere in this equation do you see total debt burden.  But the difficulty in making a mortgage payment is highly correlated with the amount of debt the borrower is also carrying on student loans, car loans, credit cards, home equity loans. etc.

Third, many borrowers who were having trouble making mortgage payments were strategically choosing to exercise their option to foreclose.  Even with the lower payments, many mortgage holders found themselves struggling to make payments on a home whose value had declined far below the amount the actually owed on their mortgage.  Faced with the prospect of selling the home and not receiving enough proceeds from sale to repay the outstanding balance of their mortgage, many borrowers are choosing to foreclose.

For the billions of dollars the government set aside to deal with the housing crisis under the Troubled Asset Relief Program, their efforts have had an almost negligible impact on mortgage markets.  Might as well go ahead and kill the program and let the market work this one out on its own.