The ACD Method

All these charts don't use a log scale, but looking at them, the dip in the '80s was probably the worst. Nevertheless, the enduring image is of something on a relentless upward path.
 
SteveM said:
I live out in the San Diego area and residential real estate prices are incredibly expensive. Was very hard for me to rationalize why people were willing to spend so much on these unimpressive properties, until I did a little arithmetic on a 30-year mortgage repayment schedule:

Amount borrowed: $650,000
Interest rate paid: 3.44% (today's prime)
Monthly payment: $2,897

Amount borrowed: $458,000
Interest rate paid: 6.50% (rate in year 2005)
Monthly payment: $2,897


If the Fed were to somehow lose control of interest rates, housing once in again is primed to be ticking time bomb, even though subprime is not an issue this time around. Imagine the following scenario:

1) Guy buys shed sized house in San Diego for $650,000 today via historically low mortgage rates.

2) Fed loses control and interest rates rise much faster than anticipated, and mortgage rate climbs to 2005 levels of 6.5%.

3) Guy has no problem making monthly payments, but suddenly needs to sell home to change locations.

4) Due to "normalized" interest rates, prospective buyers can only afford to pay $458,000 for home he purchased for $650,000 (scenario assumes no economic recession dampening their ability to make high monthly payments). He angrily sells for $458,000 - defaults on remaining debt, along with millions of his fellow countrymen. Mortgage issuers take massive writedowns on loan portfolio - financial system once again is brought to the brink. Except this time around the Fed has lost all credibility with the world, and therefore cannot rescue the system. Collapse.

I'm really starting to believe the Fed is running out of bullets here; not to mention some of the states within our country. For example, did you know that the NJ treasury justifies its teachers pension funding by penciling in a 12% per annum projected return from the S&P500 over the next 10 years? If the S&P 500 returns anything less than 8% per year, the fund will be insolvent within 6 years.

The best thing going for the US right now is that the rest of the world is such a mess; our country would be in serious trouble if Russia or China or one of these other countries could ever establish itself as a higher-yielding, safe haven for foreign investment.
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Right...so as rates drop you can buy more house for the same price and that is what stretched median home prices so far. And when rates go back up, the same mortgage buys you a smaller and smaller home. Also lending standards get much tougher, so a 650 credit score that could have taken your home off the market even if they could afford it can longer qualify. Banks can now invest that money risk free and get some yield. So you get about 30% of the buyers in the market get priced out now even if they can afford it.
 
justrading said:
All these charts don't use a log scale, but looking at them, the dip in the '80s was probably the worst. Nevertheless, the enduring image is of something on a relentless upward path.
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Yeah you could just superimpose the 30 year bond chart, looks the same. The more stunning chart really is when you look at home prices from like 1950 to 1990, basically a flat line that tracks inflation almost one to one.
 
Up 450% off the 2008 lows with no leverage. LOL. And you get your 4% divie too. :) This is a 4 billion dollar real estate bundle.

chart.ashx
 
Maverick74 said:
There is a saying in the markets, sooner or later, all things return to fair value. Many of the newer market participants don't believe this because their memories are short and they have only experienced one type of market and they become conditioned to it. I find economics fascinating. And I find very people truly understand economics no matter how many blogs they say they read. Prices matter. Value matters. Money matters. Markets are trading where they are for a reason. Eventually value has to be established. History has shown time and time again that eventually this value becomes realized.

It's not a conspiracy to say that are debt markets are not correctly valued. Bill Gross is saying this. Hugh Hendry is saying this. George Soros is saying this. Even Ben Bernanke. There were circumstances that took us away from fair value that could not have really been avoided. But we cannot stay here into perpetuity. Value has to be realized. People don't blindly do things for no reason. There is a reason. But reasons are always temporary. When that reason goes away, value gets discovered once again. This is not a doomsday forecast. In fact, quite the opposite. The world will be a better place for it and markets will actually trade back to fundamentals which everyone here claims they always want.

I look at a house no different then I like at a stock. Houses can be valued on their cash flows they generate and therefore the standard DCF models work fine. When housing becomes too far stretched, they come back down to earth. And no, it does not matter if you live in NY or London or on a lake or with a view or whatever bullshit your realtor fed you to get you to sign the loan documents. Those things are very easy to value and price in. In fact, of all the complex things in finance, housing is probably the easiest to model. Certainly easier then trying to value GOOGL or the path an exotic option can take on a double knockout.

What got me to even write about this in the first place was looking at all these charts that are saying things that contradict the next chart. If incomes are truly not rising and in some cases dropping (ask a programmer what they make today vs 5 years ago), then how can housing prices be at record highs and increasing? If home ownership is really at 50 year lows in real terms, how can sales be going up? And if it's true that hedge funds, banks, pensions, trusts are buying up baskets of homes then is it really true the old saying "people won't sell because they have to live somewhere". That is what my dad always told me growing up. But actually people don't own these homes. Financial players do, and yes, they will the minute they start going down. They always have and they always will.

We have lived so long in this zero interest world that we have become conditioned to it. What happens if that changes. There is no question it will change, the only question will be to the magnitude of the change and what random effects it may cause. Remember, black swans by definition are not predictable. So whatever will happen, we probably won't be ready for it.
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Actually all of this is pretty insightful. If all the homes are being bought by banks, finance people, and alpha seekers then I definitely feel you are correct and I feel that your point about home ownership being flat while sales are up probably is the best support for this. Of course, we don't know when so that sucks.
 
I don't disagree with Mav's thesis that the 1st shock would come from rates, but as Mav said, we could rally another 50% in SPX before it happens. No one knows.

I'm at the epicenter of the Canadian bubble so this isn't new, but what strikes me given the discussion points is that there is 1 thing that could be done for a softer landing: federal regulators/CBs could force a loosening by imposing looser lending standards into the housing market. Suddenly that 550 credit score and 2% down now has access. How they would implement it is beyond me.

1 thing to note is that many of the mainlanders CANNOT get their money out fast, so on an individual level, there will be bids if RE corrects. On a personal level, these people would rather take a 20% hit in RE marks than risk wealth 100% being seized overnight in China.

On capital mkts, I'm aggressively long yield via the swap that these institutions are doing, except I'm in REITS vs physical. I would love physical, especially where I am but I don't qualify. Collecting about 7% net currently. More importantly, being long paper allows better liquidity if/when it all blows up and I've been aggressively building my credit, because when it all blows up holy shit will that be the time to buy.
 
jj90 said:
I don't disagree with Mav's thesis that the 1st shock would come from rates, but as Mav said, we could rally another 50% in SPX before it happens. No one knows.

I'm at the epicenter of the Canadian bubble so this isn't new, but what strikes me given the discussion points is that there is 1 thing that could be done for a softer landing: federal regulators/CBs could force a loosening by imposing looser lending standards into the housing market. Suddenly that 550 credit score and 2% down now has access. How they would implement it is beyond me.

1 thing to note is that many of the mainlanders CANNOT get their money out fast, so on an individual level, there will be bids if RE corrects. On a personal level, these people would rather take a 20% hit in RE marks than risk wealth 100% being seized overnight in China.

On capital mkts, I'm aggressively long yield via the swap that these institutions are doing, except I'm in REITS vs physical. I would love physical, especially where I am but I don't qualify. Collecting about 7% net currently. More importantly, being long paper allows better liquidity if/when it all blows up and I've been aggressively building my credit, because when it all blows up holy shit will that be the time to buy.
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The assumption being that you would want to take on debt. If Maverick and others are correct, all debt will be suspect, interest rates high and going higher, and we will finally get the debt cleansing which many have been looking for for a long long time. It's kind of hard to see right now, but I was around in the 70s and that was the last time there was a debt reckoning on a large enough scale to really teach anyone anything. I was a teenager, and seeing what was going on forever shaped my view of debt. That and having a Russian grandmother who grew her own vegetables and paid cash for everything. And saved string and tinfoil. Sorry I know it's not ACD but I've been lurking awhile and had to say something. Love the thread.
 
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