What Home Sales Numbers Mean to You

The AP has a story today about how January home sales were down 7.7%.  This from yesterday’s press release from the National Association of Realtors.  According to them, the number of existing house sale contracts signed in January, i.e. the number of agreements made to sell a house, was down 7.7% from December.   (That’s a seasonally adjusted number, something you’d have to read the footnotes to their release carefully to discover.  In raw terms January sales were up 18.1% from December.)

What does this mean to you?  That depends.  Are you a Realtor?  Then it is bad.  Business is really slow.  Are you an ordinary non-Realtor, perhaps a home owner concerned about the value of your largest asset or somebody interested in house prices as an important economic indicator?  Then this means nothing.

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The Wall Street Journal Guide to The End of Wall Street as We Know It by Dave Kansas, Part 2

[This is the second half of my review of Dave Kansas's The Wall Street Journal Guide to The End of Wall Street as We Know It.  If you haven't already, you might want to read part 1 first.]

According to Kansas, in September of 2008 the Bernanke-Geithner-Paulson troika thought that a government rescue of Lehman was unnecessary.  “They felt some confidence that they could let Lehman Brothers fail without causing too much of a wider crisis.”  If true, this will go down as one of the greatest misjudgments in financial history and suggests a shocking lack of understanding of markets by those supposed to regulate them.  But Kansas may be scapegoating the troika for a more systemic problem.  Regulators worked hard for weeks to avoid a Lehman failure.  But they did so without a clear legal mandate and without any kind of formalized fund to draw on.  When the Fed convened what turned out to be a weekend-long meeting of Wall Street’s leadership before the terrible Monday, Geithner kicked it off by announcing that “There is no political will for a Federal bailout.”  In other words, elected officials in Washington, afraid of a backlash from voters, would not acquiesce to a bailout and without them the regulators were powerless.

The horrible week that followed Lehman’s death was eventful.   Merrill Lynch was absorbed by Bank America.   AIG was bailed out.   Money market funds experienced panic redemptions.  The SEC banned short selling of financial stocks.   By Thursday afternoon the stock market was down nearly 10% on the week, before rallying on what turned out to be false hopes of a quick government bailout of the banks.  Kansas’ narrative peters out shortly after this, presumably because it is here that he started writing his book.

The second half of The End of Wall Street is taken up with advice for readers  on what to do now with their own finances in light of the “new world order.”  This personal finance advice is undoubtedly the marketing hook for the book, the reason its creators imagined that people would buy it, and the reason they hired Kansas to write it.  (He is Editor at Large at FiLife.com and the author of The Wall Street Journal’s Complete Money and Investing Guidebook.)  Unfortunately, it is also the weakest part of The End of Wall Street.  The advice is not unsound, indeed with regard to reasonableness it is above average.  But it is generic and vague.  Pay down your debts, particularly credit cards.  Young people should invest mostly in stocks, older folks less so.  Do not obsess over the value of your home and think of it as a roof over your head, not as an investment. Read more »

The Wall Street Journal Guide to The End of Wall Street as We Know It by Dave Kansas, Part 1

Of the passel of hastily written books now on the shelves discussing the financial crisis and what to do about it, The Wall Street Journal Guide to the End of Wall Street as We Know It by Dave Kansas may have the best title. But like the other members of its micro-genre, it is not likely to become an enduring classic. Kansas is a web and newspaper reporter by trade and the entire book can be usefully thought of as an extended magazine article, what in an earlier age might have been called a pamphlet. It was written over a few weeks in the last months of 2008, was on shelves as a paperback by the end of January, and will probably outlive its usefulness by late summer. It will next be seen many years from now when unearthed by a graduate student doing research into the contemporaneous reaction to the Panic of ’08, or whatever it is that the current crisis winds up being called.

But as a long magazine article, the book has its merits. If you weren’t paying close attention to events in the financial world last year and now feel at a disadvantage at dinner parties, The End of Wall Street will help. Even relatively close readers of news accounts will find tidbits and pieces of the big puzzle they have missed. For example, the book points out that the average FICO scores of sub-prime borrowers actually improved as the housing bubble grew. While the sub-prime borrower of ten or fifteen years ago might have been sub-prime due to a bad credit history, by 2006 a sub-prime borrower typically had adequate credit but was buying more house than he could truly afford.

Kansas also provides a modicum of analysis and reflection, roughly what you would expect from a reporter given a book to fill but only a short time to do it. He deftly points out that the troika at the helm of the government’s handling of the crisis in the fall of 2008 was made of Fed Chairman Ben Bernacke, New York Fed President Tim Geithner and Treasury Secretary Henry Paulson. Kansas does not say it, but he clearly means the reader to notice that the new administration has merely contracted that troika into a duo.

And although he cannot resist blaming the Usual Suspects of crooks and overly clever bankers, Kansas does so with a light hand. The fiasco in mortgage bonds was propelled by the same forces that propel the economy in good times, avarice and optimism. As Kansas deadpans, “Creating new regulations that will eliminate greed is practically impossible.” Nor, he might have added, is it necessarily a good idea.

The fuse for the powder keg was lit in June 2006 when, according to the S&P Case-Shiller Indexes, house prices in the US peaked, having gone up 190% in ten years. It took some time to play out, but after years of aggressive lending and borrowing on the almost universally held theory that house prices never go down, the result was nearly pre-ordained. There are wrinkles that made it worse, such as the peculiar structure of the mortgage bond market, but as Kansas makes clear, these are complications to the core disease. A truly vast number of bad loans got written and, due to the nature of the beast, they all went south at the same time.

It is what happened next that made our current situation dire. As Kansas tells us, within living memory there have been several large-scale financial crises that failed to destroy Wall Street, and some of those failed even to cause a recession. The tech-telecom bubble burst at the start of this decade, vaporizing trillions in stock market wealth and littering Wall Street with worthless telecom debt. That came only a few years after the Asian Crisis and Russian Default Crisis culminated in the collapse of Long Term Capital Management, which caused dramatic late night meetings of the leaders of Wall Street, but not, apparently, any long term repercussions. And a few years before that, almost the entire S&L industry went up in flames.

Kansas calls these disasters Dog That Didn’t Bark moments, events that historians will realize hold significance for what did not happen rather than what did. Indeed, the fact that no really terrible damage was done only encouraged further risk taking. But in retrospect, the financial system was lucky to weather those storms as well as it did. The seawalls were just strong enough and the ad hoc and somewhat haphazard government rescue efforts were just adequate enough to see us through. When a slightly bigger hurricane made landfall it was revealed just how insufficient the financial system’s defenses had really been all along.

The levees were breached on Monday, September 15, 2008. That was the day Lehman Brothers failed, defaulting on its debt and turning what had been an atmosphere of fear and foreboding into one of panic. Investors reasoned that if the debt of a firm as significant as Lehman could become worthless then nothing was safe. All of a sudden everybody started hoarding cash, refusing to lend to anybody under any circumstances.

Lehman had been widely known to have been in serious trouble for some time, so a person might wonder why its failure could have come as such a shock to the system. As late as the Friday before, the credit default market was pricing the likelihood of a Lehman default in the following year at only 7%. This apparent incongruity can be explained by the fact that almost everybody on Wall Street believed that even though Lehman was probably insolvent, the government would never allow such a key player to default. Of course, that is exactly what happened.

[Stay tuned for part 2 of this review early next week.]

House Prices: The Long View

There was an interesting post at Debit vs. Credit two days ago suggesting that now may not be the time to buy a house. The gist of the argument was that house prices still have a way to go before they return to normal. This was illustrated with a chart of median new home prices as a ratio to median income since 1963. That’s not the most ideal set of data to use, for reasons that I will spare you.

The most useful measure of house prices are the S&P/Case-Shiller Home Price Indices. They only go back to 1987, but one of the co-inventors of the index, Robert Shiller, has chained together other useful house indexes to patch up a composite going back to 1890. (This is the third post that has mentioned Prof. Shiller in the past month. Just coincidence, I swear.)

I downloaded the data from his site, updated and cleaned up a few things, and produced the following chart, showing the inflation-adjusted sale price index for existing homes since 1890.

If you’ve never seen something like this before, you may be experiencing some shock and confusion. This is normal. Just keep breathing deeply. You thought house prices went up over time, didn’t you? Well, they do, but mostly because of inflation. Recent experience excepted, house prices are generally flat over long periods of time once inflation is factored out.

A few other observations worth making:

1) The last index value in this chart (which is for November 2008) is 144.0, still 13% higher than the 1989 peak of 127.4. That does suggest that we have a little more to go, or at least did as of November. On the other hand, it’s already down 40% from the 2005 peak of 202.5, so the worst may be behind us.

2) The recent run-up in house prices actually began in 1996. (From 1996 to 2005 real prices went up 86%.) It may not have gotten weird enough to be noticed in the media until the last years of the boom, but the index began hitting all-time highs as early as 2000. I mention this because it’s currently fashionable to blame the low interest rates of 2003-04 for the housing bubble. They sure didn’t help, but the worst you can say is that they were gasoline thrown on an already blazing fire.

3) As impressive as the 1996-2005 run up is, it is not entirely out of the ordinary. From 1942 to 1947, real house prices went up 60%, which is the best five year run in history. Further, prices pretty much stabilized after that and did not give back very much of the gain. This needs to be pointed out to those who say, in hindsight, that of course house prices had to fall after 2005, because the rapid gains made in years before were just unsustainable.

So is this a good time to buy a house? That depends. Do you need one to live in? There are many factors to consider, including interest rates, tax breaks and other incentives from the government, and local market conditions. (It is worth stating the possibly obvious that the chart above is a national average. Specifics of a particular area may differ both in the short and long run.)

But if you are looking at a house as a possibly shrewd investment, something you can buy cheap now and sell dear later on, you are likely to be disappointed. Even if the crisis were over today, and house prices returned to their pre-bubble habits, the normal state of things is that they don’t go up very much.

Wall Street Bonus Outrage!

There’s been rather a lot of self-righteous indignation lately about the bonuses paid out for 2008 by Wall Street. The hullabaloo started off with the New York State Comptroller announcing that bonuses were down 44% year-on-year. This was meant as a dire warning that the economy of New York City was going to hell in a hand basket. Somehow, what got picked up was that bonuses still weighed in at $18.4 billion, which some people still consider to be a lot of money.

Very surprisingly to me, some of those people turn out to be the folks in Washington who are planning to spend $887 Billion with a straight face. (How much money is that? See this brilliant post.) Last Thursday our President called the bonuses “shameful” and that unleashed an avalanche of outrage. The ever-level-headed Maureen Dowd called for a “a special prosecutor or three” in her New York Times column. Even personal finance blog The Digerati Life joined in on the fun.

If you have no idea how Wall Street works, don’t understand how many people work there, and are just generally the jealous type, it is easy to be sucked into this. Heck, it’s kinda fun. But the mundane truth is that the term “bonus” is confusing you. Wall Street bonuses are not extra money passed out at year end on top of regular compensation. They are the primary way people get paid for their labor.

Wall Street firms are very decentralized affairs, really more like vast collections of tiny independent operations that share office space and brand names. Strange as it may seem, the great majority of Wall Street workers made money for their firms last year and rightfully expect something like their usual cut. True, a very small number of employees managed to lose spectacularly large sums of money, enough to outweigh all that the profitable ones brought in. And it is also true that in most cases the firms were not contractually obligated to pay all that they did.

But you can only stiff your employees once, and only then in the process of bankruptcy. Nobody would ever work for you again. Vaporizing the big Wall Street firms is certainly a conceivable option, but I think there is general consensus that we should keep them alive.

And then there is the fact that bonuses are down 44% from 2007, which was down some from 2006. Are the car makers cutting pay 44%? Is anybody ready to suggest that to the UAW and then hint that even at that level it is “shameful”? (I know I’m not. Seriously, fellas, it’s just a blog.)

The financial crisis seems to be clouding all thinking as regards money and Wall Street. For example, my hero John Thain has been getting a lot of grief lately. David Brooks’ column in the Times today jokes that Thain got in trouble because “it is no longer acceptable to spend $35,000 on a commode for a Merrill Lynch washroom.” Which is really funny as long as you think that “commode” means a toilet and not the antique sideboard that he actually bought. (Geez, David, don’t you watch The Daily Show? Jon Stewart showed a picture of the thing last week.)

John Thain took over a brain-dead company in 2007 that, we know now, was circling the drain. He kept a good poker face, even spending lavishly to outfit his new office. He then hoodwinked one of the largest banks in the world into paying $50 billion for the company, which was at least $50 billion more than it was worth. That has got to be one of the greatest feats of salesmanship of all time. I’m not sure I would want to work for Thain, but he can work for me anytime.

A lot of the anger and frustration about Wall Street bonuses and office furnishings stems from the fact that these Wall Street types, who are at least partially responsible for getting us into this mess, are now the beneficiaries of government largess. That’s understandable. Why should these irresponsible pinheads get any of our money? It would be like enacting a subsidy for low-end home buyers or creating another wave of cheap mortgages or even passing a law to stop all foreclosures. All of those things would be just a transfer of wealth from the taxpayers to reward the fools that started this fiasco. Can you imagine the outrage something like that would cause?

I know I can’t.