New Geography

Tag: Financial Crisis

  • How Phoenix Will Come Back

    I have heard Paul Krugman say that ‘the end is nigh’ so many times that it seemed like the only sensible way to think about the housing market. It was identified as a bubble, and that could only mean that it would eventually burst. A steady diet of NYT editorials and Economist charts leave you with one conclusion — this is not going to end well.

    This certainly seems to be true in Phoenix. Even though I’ve lectured for years about ‘the growth machine’, how the economy in a city like Phoenix depends on building more homes, I did not expect the whole thing to collapse quite so precipitately, and with so many repercussions. The number of passengers going through the airport here is down 10% from last year; numerous restaurants, stores and other services have gone out of business, the State is trying to stare down a $3 billion deficit, the universities have fired hundreds of people—so the cycle keeps spreading like a slow motion disaster.

    Also predictable is the response. Local politicians are planning to slash the State budget and get government off people’s backs, once and for all. If we used foreign phrases such as ‘chutzpah’ around here, that would have to qualify. After all, it takes balls to watch the market behave like a bunch of drunks kicking Humpty Dumpty about, and then blame government for trying to put him back together again.

    Yet, at least here in Phoenix, it turns out that Professor Krugman hadn’t really got it figured out after all. As a rational man, he was distracted by the irrational exuberance of the market, the unsupportable ramping up of property prices, the NINJA loans, and the cynical exploitation of those arriving late to the party, those doomed to buy at the top of the market and be left holding fake mortgages on homes with phony values. The solutions seem simple. More oversight from Big Brother and everything can be fixed. Or, if you prefer to listen to the bizarro-world script over on AM radio, the black helicopters are about to start landing on Wall Street as the UN takes over to install European-style socialism.

    Yet much of this commentary is laughably wrong. The housing market debacle was not just predictable but actually utterly unavoidable. Some of this is simply a matter of money circulating around, which as Niall Ferguson’s book The Ascent of Money makes clear, this is as old as capitalism itself. The difference now is that digital technologies have made the speed of trading and transfer shift. The same rules apply, except that everyone must work harder to keep that cash flowing.

    What I now realize is that the entire economic system is based upon finding more risk. Without more risk in which to invest, the economy can’t keep moving. In other words, this wasn’t a series of calamities or errors or criminal mistakes — it is the market at work, no more, no less. And that is not going to change.

    What I thought I knew is not really so. I thought a bigger banking sector was not just more mysterious but was somehow more efficient and therefore safer; after all, health insurance works best if the risks are spread across larger and larger groups. Yet in reality finance is more like a vast Ponzi scheme. We should, in fact, let Mr. Madoff out of jail, as he was doing nothing particularly wrong — his only crime was that he wasn’t being clever enough in hiding his scheme in sufficiently obscure mathematics.

    What happens to the cities, towns and suburbs left devasted by the financial schemers? As James Surowiecki recently observed in the New Yorker, “banking grew bigger and more profitable but all we got in exchange was acres of empty houses in Phoenix.” So? Isn’t that a small price to pay? Given a choice, what would we rather have: a buoyant capital market and a few distant suburbs and downtown condos without any residents, or what we have today in some cities — double digit unemployment?

    There are real policy issues at work here. We were taught years ago, by the Marxists no less, that the purpose of a capitalist economy is to reproduce itself and the purpose of governments is to make sure that happens. So we make credit available to people; first to buy Model Ts, then to live in Levittown, then to play golf in Cancun, and so forth. And for this to work there has to be more risk in which to invest, an endless supply of new things. Housing has served us well in this regard; people live in condos and McMansions, people sell them, people build them, people manufacture the fixtures and fittings. This is how the growth machine, particularly in places like Phoenix, works.

    An economy like Phoenix is like a shark – it can’t stop, it can’t even run slow. We have to find more buyers — or perhaps we just build the homes now and fill them in the future when the population increases. Or, in line with a previous posting, we should have solved the immigration problem, and the need to sell more homes, by legalizing the Latino population and making them creditworthy.

    In this sense, maybe all this focus on the Valley’s 65,000 foreclosures is a mistake. As I argued last year, perhaps they should just be turned over to rentals and let the market sort it all out; predictably, rents are now coming down in apartment complexes as more families find affordable homes to rent.

    What we need is not to stop the market from repairing itself but we need to do it in a more creative way. Some of those suburbs are looking a bit down at heel, and the homes weren’t that sturdy to begin with — so let’s bulldoze them and do some serious brownfield redevelopment. Perhaps build them right, more sustainably, and less dependent on distant employment centers

    We can all get back to work, we can all feel virtuous as no new desert is being bladed, the infrastructure is already paid for, the journey to work costs will be less, the density perhaps a little higher with more jobs, offices and retail located closer to the houses.

    This approach will let us build more homes and get some more risk back into that market. Let’s repurpose the land. Then we can go back to business as usual, and if I was a betting man, that’s exactly what we are going to do.

    Andrew Kirby is the editor of the interdisciplinary Elsevier journal “Cities.”This is his 20th year as a resident of Arizona.

  • GM, Business, and The Age of Small

    At its peak, General Motors employed 350,000 people and operated 150 assembly plants. It defined “big business” for America and the world.

    But GM was not always big. It grew through the acquisitions that it made in the early decades of the twentieth century. In those days, the automotive industry was populated by entrepreneurial small businesses led by people like Ransom Olds and Henry Ford. There were more than 200 automobile companies in the United States in 1920. By 1940, only 17 had survived.

    As with all businesses, success and failure was measured by a company’s ability to manage and adapt to change. Change in consumer expectations and demographics. Demands for lower prices and more features. Underlying all of this was the need to constantly improve, to challenge core assumptions, and attend to customer needs. The early automobile companies that could not adapt were driven out of business or forced to merge. In the end, we had the “Big Three” in control of all major American automotive brands.

    And so it was, but only for a time. Our economy is dynamic. It is always changing. This is why consumer products are always adding “new and improved” to even their most popular and profitable labels, and why companies produce competing products — like laundry detergents and cereals — within their brand. Control of shelf space is vital in retail, and an expanded offering of products maintains a company’s all-important market share.

    In a free economy, “Big” has some advantages. It has more resources and reach. “Big” companies can define a market and, to a point, control entry into it. But “Big” also has many disadvantages. It is unwieldy, bureaucratic, inflexible, slow to react and unresponsive to small events. This is why in a dynamic free economy “Big” gives birth to “Small”, which forces innovation and change, and ushers in the next Big Idea.

    Apple was started in a garage to challenge the giant IBM. Microsoft was founded by a college dropout who ran with a platform (Windows) that Xerox created and discarded. Hechinger’s was the first big box hardware store. It was overtaken by The Home Depot, which pioneered a better way to service clients with an even bigger box.

    America is all about good, better, best. Google is now the dominate internet search engine. A small part of its success has been its ability to become part of the vernacular. How many of us have said, “Let me Google that?” Microsoft is not sitting back and accepting Google’s success as a given. It recently launched “Bing”, with features not available on Google. Is Bing the next newer, better search engine? The market will determine if it is, once consumers take it out for a search or two and decide whether or not they like the results.

    The American automobile industry has reached the end of “Big.” GM recently sold its Saturn brand to Roger Penske, a former auto racer turned entrepreneur. Penske will likely bring new energy and focus to a brand that was only a small cog in a giant corporation. I bet that the brand will reemerge stronger in the marketplace. A Chinese company bought Hummer. SAAB is still looking for a new home. The remaining GM brands, including Cadillac and Buick, will be part of a newer and smaller company. This is the natural economic cycle. It is what would have taken place months ago, and saved the American taxpayer billions of dollars had we simply let GM go into an orderly Chapter 11 bankruptcy.

    The problem is that our federal government is attempting to control this process in order to achieve a desired result. Yes, looking at saving GM as a short term federal jobs program is a valid argument (albeit a God-awful expensive one). But we should not let these actions, taken in the midst of a crisis, instill the belief that government control of markets is a viable alternative to free markets that respond to consumer demand.

    The natural flow of our economy is big to small to big again. We are now entering an ‘Age of Small’ throughout our economy. It is an era in which new ideas will drive innovation, and the nimble will overtake the weak. The only thing that can derail this process is the permanent entry of big government into the mix.

    Government is the antithesis of a market economy. It is unwieldy, bureaucratic, inflexible, slow to react, and unresponsive to small events and to its own consumers.

    It is Big when we are at the right moment for Small.

    Dennis M. Powell is president and CEO of Massey Powell, an issues management consulting company located in Plymouth Meeting, PA.

  • The Fate of America’s Homebuilders: The Changing Landscape of America

    During the first ten days of October 2008, the Dow Jones dropped 2,399.47 points, losing 22.11% of its value and trillions of investor equity. The Federal Government pushed a $700 billion bail-out through Congress to rescue the beleaguered financial institutions. The collapse of the financial system in the fall of 2008 was likened to an earthquake. In reality, what happened was more like a shift of tectonic plates.

    History will record that the tectonic plates of our financial world began to drift apart in the fall of 2008. The scale of this change may be most evident in housing.

    PART TWO – THE HOME BUILDERS

    For decades, home ownership epitomized the American dream. For years, Americans saved their money for the required 20% down payment to purchase their dream home and become part of the great American Middle Class. They saved their money in a special account at the local savings & loan that paid a little more interest than the banks. Interest rates were fixed by law. A typical mortgage was written at a fixed rate for 30 years. Most American home owners stayed in their homes and celebrated the pay-off with a mortgage burning party.

    In this arrangement, it was understood that the savings & loans were allowed to pay more interest because they provided long term home mortgages. They paid depositors 4 – 5% and lent money at 6% making a little profit on the arbitrage for their risk. With a 20% down payment, there was little risk. Mortgage bankers knew the homes they lent money on and more importantly, they knew their clients. The mortgage stayed on the books at the local savings & loan until paid.

    In this time, home builders were mostly small local shops known by their customers and the lenders. For decades the industry was quite stable. Homes averaged 1,400 square feet in 1970 according to the National Association of Homebuilders. A quality home could be purchased for under $20,000. Not everyone could afford to buy a home but almost everyone aspired to this. Savings & loans provided 60% of all home mortgages.

    The first crack in the dam appeared in the late 1970s. Under President Jimmy Carter, America suffered double-digit inflation. As the value of the dollar eroded, Americans sought investments that could protect their dollars from the ravages of inflation. Regulation D prohibited banks from paying interest on checking accounts. A tiny bank in Massachusetts, the Consumers Savings Bank of Worcester, Massachusetts introduced the NOW Account (Negotiable Order of Withdrawal) and began paying a higher rate of interest than the savings & loans. Money flooded into the bank.

    The Depository Institutions Deregulation and Monetary Control Act of 1980 began the six-year process of phasing out limits on interest rate. Money flowed out of savings & loans and into NOW accounts and MMDA accounts (Money Market Depository Accounts). The S&Ls, with long term fixed loans on their books and short term money leaving for higher rates at the banks, never fully recovered. The primary source of funding for America’s home building industry was changed forever.

    In the late 1980s the S&L industry attempt to recapture market share by entering the equity side of real estate development with disastrous consequences. The government was forced to seize most of the S&Ls and sell off their assets through the Resolution Trust Company (RTC). In 1989, Congress passed TEFRA, the Tax Equity and Fiscal Responsibility Act that effectively outlawed direct ownership of property by S&Ls. It was a death blow to the industry and the end of the 30-year home mortgage as we knew it.

    This is where the seeds of the current housing disaster and financial meltdown were sown. Wall Street and politics entered the financial vacuum left by the demise of the savings & loan industry. The Garn-St Germain Depository Institutions Act of 1982 introduced the ARM (adjustable rate mortgage) which allowed rates paid to depositors to balance rates charged to borrowers. Our politicians, filled with good intentions, began down an irreversible path of using the home mortgage for social engineering.

    Seeking to increase homeownership, Congress began to unwind the financial safety net that protected the American dream for nearly 100 years. An ugly brew was concocted with the marriage of too much money and too much power. Congress began to consider housing as a right instead of a privilege.

    Over the ensuing quarter century, Wall Street and Congress conspired to turn the traditional 20% down, fixed 30 year mortgage on its ear. In 1977, they passed the Community Reinvestment Act that outlawed red-lining and forced lenders to make loans to poor neighborhoods. In 1982, they passed the Alternative Mortgage Transactions Parity Act (AMTPA) that expanded the funding and powers of Fannie Mae and Freddie Mac by lifting the restrictions on adjustable rate mortgages (ARM), balloon payment mortgages and the Option ARM (negative amortization loan). When a savings & loan made a mortgage in the past, they held it for 30 years or until paid. Freddie and Fannie became the new absentee owner of the majority of mortgages by purchasing them from the originators in the secondary market.

    Thus the die was cast. Mortgage bankers and brokers became salesman and paper pushers packaging applications for the secondary market and financial investors who never saw the asset they lent money against or met the borrowers for whom they made the loan. But this was not enough to satisfy the greed of Wall Street which invented the CMBS (commercial mortgage backed security) in 1991. This was nothing more than a private label pool of mortgages that they sold off to equally unconnected financial investors in their own secondary market. Home mortgage lending by commercial banks went from nothing to 40% of the market in a matter of years.

    The market could have possibly tolerated this bastardization of the conventional mortgage but neither Congress nor Wall Street could control themselves. There was simply too much money to be made. Congress determined that the credit score was discriminatory and violated the rights of the poor and minorities. In 1994, Congress approved the formation of the Home Loan Secondary Market Program by a group called the Self-Help Credit Union. They asked for and received the right to offer loans to first time homebuyers who did not have credit or assets to qualify for conventional loans. Conventional 80% financing was replaced with 90% loans and then 95% and finally 100% financing that allowed a home buyer to purchase a home with no down payment. The frenzy climaxed with negative amortization loans that actually allowed homes to be purchased with 105% financing.

    In June of 1995, President Clinton, Vice President Gore, and Secretary Cisneros announced a new strategy to raise home-ownership to an all-time high. Clinton stated: “Our homeownership strategy will not cost the taxpayers one extra cent. It will not require legislation.” Clinton intended to use an informal partnership between Fannie and Freddie and community activist groups like ACORN to make mortgages available to those “who have historically been excluded from homeownership.”

    Historically, a good credit score was essential to receive a conventional mortgage. Under pressure from the politicians, lenders created a new class of lending called “sub-prime” and as these new borrowers flooded the market, housing prices rose. Lenders used “teaser rates”, a form of loss leader, to help the least credit worthy to qualify for loans.

    Congress instructed Fannie and Freddie to purchase mortgages even though there was no down payment and no proof of earnings by the applicant. An applicant could “state” his or her income and provide no proof of employment. Stated income loans eventually became known as “liar loans”. Sub-prime loans grew from 41% to 76% of the market between 2003 and 2005.

    This devilish brew caused a record 7,000,000 home sales in 2005, including more than 2,000,000 new homes and condominiums. Mortgage lending jumped from $150 billion in 2000 to $650 billion in 2005. Prices rose relentlessly, pushed by more and more buyers entering the market. The top 10 builders in the United States in 2005 were:

    1. D.R. Horton – 51,383 Homes Built
    2. Pulte Homes – 45,630 Homes Built
    3. Lennar Corp. – 42,359 Homes Built
    4. Centex Corp. – 37,022 Homes Built
    5. KB Homes – 31,009 Homes Built
    6. Beazer Homes – 18,401 Homes Built
    7. Hovnanian Enterprises –17,783 Homes Built
    8. Ryland Group – 16,673 Homes Built
    9. M.D.C. Holdings – 15,307 Homes Built
    10. NVR – 13,787 Homes Built

    Economists and pundits eventually began to identify the phenomenon as the housing bubble. And, bubbles burst. But Congress was not ready to confront reality. Rep. Barney Frank testified he “saw nothing that questioned the safety and soundness of Fannie and Freddie”. Fannie Mae Chairman Franklin Raines was paid $91.1 million in salary and bonuses between 1998 and 2004. In 1998 Fannie’s stock was $75/share. Today it is 67 cents.

    In 2007 as prices stopped rising, the flood of buyers entering the market ceased putting market values into a free-fall. Home building is not a nimble industry. It takes years of planning and development to bring a project to market. America’s homebuilders had hundreds of thousands of homes and condos under construction when the housing market came to a crashing halt in the fall of 2008. New home sales, which topped 2,000,000 units per year in 2005, fell to an annual level of under 400,000 units in early 2009. Prices have retreated to 2003 levels and in some markets even lower.


    What happens to America’s home builders? Do they follow General Motors and Chrysler into bankruptcy? Can they survive? New home sales are down 80% since 2005 – doing worse even than automobile sales. The tectonic plates of the housing industry are shifting rapidly and have not settled into any discernible pattern.

    Residential land has dropped precipitously in value but a case can be made that raw residential land now has a “negative residual value”. There are hundreds of thousands of completed but unsold, foreclosed, and vacant, homes littering the countryside. The chart above demonstrates how dramatically sales have fallen since their peak in 2005. This “overhand” inventory must be cleared out before any recovery can ensue. The prices of these units must be cut by draconian margins to attract the bottom fishers and speculators who will take the risk from the home builders and purchase the outstanding inventory. This will not happen quickly. This is not a market that can generate an early rebound.

    Has Congress learned from its mistakes? Apparently not. In March 2009, Democratic Representatives Green, Wexler and Waters introduced HR600 entitled “Seller Assisted Down Payments” that instructs FHA to accept 100% financing from those who cannot fund the required 3.5% down payment.

    A year from now the landscape of America will be forever changed. Five years from now, will American ingenuity have revolutionized the home building industry? The imperative is to find homebuilders who can speed production and lower costs. And government needs to learn from its own mistakes and realize that a successful housing sector depends on solid market fundamentals as opposed to pursuing an agenda of social engineering.

    ***********************************

    This is the second in a series on The Changing Landscape of America. Future articles will discuss real estate, politics, healthcare and other aspects of our economy and our society. Robert J. Cristiano PhD is a successful real estate developer and the Real Estate Professional in Residence at Chapman University in Orange, CA.
    PART ONE – THE AUTOMOBILE INDUSTRY (May 2009)

  • State of the Economy June 2009

    Nobel Prize-winning economist Paul Krugman was quoted widely for saying that the official recession will end this summer. Before you get overly excited, keep in mind that the recession he’s calling the end of started officially in December 2007. Now ask yourself this: when did you notice that the economy was in recession? Six months after it started? One year? Most people didn’t even realize the financial markets were in crisis until the value of their 401k crashed in September 2008. Count the number of months from December 2007 until you realized the economy was in recession, add that to September 2009 and you’ll have an idea of when you should expect to actually see improvements in the economy.

    Douglas Elmendorf, Director of the Congressional Budget Office (CBO), testified on “The State of the Economy” before the House Committee on the Budget U.S. House of Representatives at the end of May. CBO sees several years before unemployment falls back to around 5 percent, after climbing to about 10 percent later this year. Remember this phrase: Jobless Recovery; it happens every time we have a recession. Employment historically does not increase until 6 to 12 months AFTER GDP starts to improve. Even Krugman admits that unemployment will keep going up for “a long time” after the recession officially ends.

    While some of us are worrying about stagflation – a stagnant economy with rising prices – the CBO report does a good job of describing why deflation is worse than inflation. Deflation would slow the recovery by causing consumers to put off spending in expectation of lower prices in the future. The risk associated with high inflation is primarily that the Federal Reserve would raise interest rates too fast, stalling the economy – similar to what Greenspan did to prolong the recession in the early 1990s. We think the real conundrum is this: how do you deal with an asset bubble without deflating prices? Preventing deflation now simply passes the bubble on to some other asset class at some future time.

    CBO calculates that output in the U.S. is $1 trillion below potential, a shortfall that won’t be corrected until at least 2013. New GDP forecasts are coming in August from CBO. They say the August forecast will likely paint an even gloomier picture than this already gloomy report. Hard to imagine!

    There are plenty of reasons that Krugman and others are seeing encouraging signs in the economy. Social Security recipients received a large cost-of-living adjustment, payroll taxes were lowered so that employees are taking home bigger paychecks, larger tax refunds, lower energy prices – all of these lead to an uptick in consumer spending in the first quarter of 2009. I checked in with Omaha-area Realtor Rod Sadofsky last week. He has seen an improvement in sales in the range of median-priced homes which he attributes to the $8,000 tax credit available to first-time homebuyers (or those who have not owned for at least three years). Along with an up-tick in that segment of the market, those sellers are able to move up to higher priced homes a little further up the range, further improving home sales. However, the tax incentive is scheduled to expire at the end of 2009. When the stimulus winds down…well, there will be no more up-ticks. CBO agrees with Rod and warns of a possible re-slump in 2010 when the effects of the stimulus money begin to wane.

    CBO’s Dr. Elmendorf has a way to solve this problem: to keep up consumer spending, he suggests that people should work more hours and make more money. Duh! We think we hear Harvard calling – they want their PhD back! CBO seems undecided about which came first in the credit markets: problems in supply or problems in demand?

    “Growth in lending has certainly been weak, but a large part of the contraction probably is due to the effect of the recession on the demand for credit, not to the problems experienced by financial institutions.”

    “Indeed, economic recovery may be necessary for the full recovery of the financial system, rather than the other way around.”

    We shouldn’t be so hard on Elmendorf. The report makes it clear just how difficult it has been to figure out 1) what happened 2) why it happened 3) what do we do about it and 4) what happens next. CBO seems to be reaching for answers while to us it is obvious they are missing the point by not even considering that manipulation has wrecked havoc on the markets. Whenever things don’t make sense to someone like the Director of the CBO, experience tells us there’s a rat somewhere.

    Regardless of how overly-complicated financial products may become, the economy really shouldn’t be that hard to figure out. Still, no one seems to know how far down the banks can go – if banks don’t lend to businesses, businesses close, people lose their jobs, unemployed people default on loans, banks have less to lend, and banks can’t lend to businesses…Seems we are damned if we do and damned if we don’t: too much borrowing caused the crisis; too little spending worsens it. Do they want us to keep spending money we don’t have?

    While Krugman is admitting that the world economy will “stay depressed for an extended period” CBO is reporting that “in China, South Korea, and India, manufacturing activity has expanded in recent months.” The other members of the G8, however, aren’t faring any better than we are: GDP is down 10.4 percent in the European Union, 7.4 percent in the UK and 15.2 percent in Japan. Canada – whose banks are doing just fine without a bailout, thank you very much – saw GDP decline by just 3.4 percent in the last quarter of 2008.

    Undaunted by nearly 10 percent unemployment – after predicting it would rise no higher than 8 percent – President Obama announced today that the White House opened a website for Americans to submit their photos and stories about how the stimulus spending is helping them. If they can’t manage the economy, they can still try to manage our expectations about the economy.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

  • Rewriting The Oil Stock Story

    Could oil price manipulation have created the rerun of the Great Depression that we are currently enduring?

    Think about it. The doubling of gas prices had a profound effect on disposable income and the affordability of housing, whose subsequent downturn set the stage for economic collapse.

    We now know that Wall Street speculation drove oil from $69 a barrel to nearly $150. But this article purports to explain why.

    Back in early 2004, the nation’s investment banks began making large investments in oil stocks, which became the so-called “story stocks” of the era. The story was obvious. Emerging nations like China and India were driving up demand for oil, and supplies weren’t keeping pace.

    The investment banks had their analysts write papers espousing the profits to be made from oil, and they promoted the commodity itself as an asset class like real estate, stocks, and bonds, suggesting that it was suitable for long-term investment.

    To prove their point, the investment banks began investing in oil in the futures market. But their reason had nothing to do with what they were telling investors. It had to do with the long positions they held in oil stocks, which were certain to appreciate with the rise in the value of oil as a commodity. Exxon-Mobil stock, for example, went from around 40 in the spring of 2004 to a high of 95 on December 24, 2007. Merry Christmas and a Happy New Year!

    It was around this time that the Petroleum Marketers Association, which represents more than 8,000 retail and wholesale home heating oil companies and gas station owners, began getting hate mail. They were being blamed for gouging the public, even though their costs had more than doubled.

    Early in 2008, I received a call from a former stock brokerage client of mine, who is the CEO of a concern with factories and production facilities in China. “Tim, I keep getting these investment letters from the banks telling me how China is slurping up all this oil. But it simply isn’t true. Sure, the country is growing quickly, but no faster than last year, and certainly not enough to double the price of oil in less than a year.”

    Around the same time, Art Rosen, the former president of the National-Committee on U.S.- China Relations, also told me that China could not account for all the price spikes in oil. From what he could tell, there was plenty of product readily available at supply terminals throughout the Middle Kingdom.

    Now we know how this happened. The investment banks went to regulators to obtain permission to increase their leverage from a factor of 12 to a factor of 40 times capital. Much of that leverage was being applied to the already heavily leveraged oil market, where $10,000 controls over $100,000 of product. In the new scenario, $10,000 in the hands of an investment bank controlled $4 million in product.

    The levered effect on the price of oil was such that it began drawing huge amounts of money from stock and bond funds into the commodities markets, and specifically the market for oil. Institutional investors ranging from the Harvard Endowment to sovereign wealth funds got in on the oil action, which rose from $13 billion to over $300 billion in commodities transactions in just three years. At one point the markets were trading 27 barrels of crude oil for each barrel of oil that was actually being consumed in the United States, positions so large that they move the market in the cash commodity. In a single day in the price of oil jumped by more than $25, and yet there were no hurricanes or other supply disruptions that might have accounted for it.

    A report out of the MIT Center for Energy and Environmental Policy Research clearly showed that the dynamics of supply and demand for the cash commodity could not have been responsible for such a run-up in oil prices, which reached its steepest levels during an interval when supply was going up and demand was falling.

    By this time the price of gas was rising to five dollars a gallon. The owner of a $400,000 house who commuted by car suddenly discovered that that the price of gasoline had doubled and his commute was costing more than his mortgage payment. Something had to give and it was his mortgage. Suddenly, the $400,000 houses were worth $200,000, the mortgages were underwater, and the banks were drowning in red ink. The cascade in housing prices was soon mirrored in the price of oil. The money on Wall Street was now pulling out of the oil patch to drive down the bank shares and their mortgage-backed assets, setting the stage for the deepest economic contraction since the Great Depression.

    There’s plenty of blame to go around. But once again (as in Frontrunning and Finance; New Geography.Com), most of it should be borne by the people on Wall Street, best described as a bunch of crumbs held together by dough.

    Tim Koranda is a former stockbroker who now works as a professional speechwriter. He can be reached at koranda@alum.mit.edu.

  • Stimulus Alert Stretches From the Center of L.A. to Suburban Atlanta

    The hundreds of millions of dollars in federal stimulus money are working their way through various systems, en route to a city near you.

    Give President Barack Obama credit for acting boldly to pump the funds into the economy – or take him to task for printing up money on the cuff.

    Either way, the time has come to shift your focus from Washington, D.C., and onto State Houses and City Halls throughout our land.

    You’ll need to keep an eye on your local government officials because our civic culture has grown corrupt, and it’s a cancer that’s widespread. Politicians still don’t quite understand that this is now an open secret – although they’ve at least begun to stir in the wake of the recent and resounding “no” that California voters gave to the latest request for a bailout of a sick system of government.

    Meanwhile, the stimulus money is beginning to flow as pundits slice and dice the results from the Golden State, and the federal funds offer the potential to allow local governments to ignore the clear message from voters who are fed up with corruption and waste. Consider that most local governments across the nation have enjoyed a long run of a strong economy with only a few, brief interruptions over the past 25 years. They’re out of shape, all balled up with bad habits. The stimulus money could serve to finance another year or two of bad behavior if the people don’t watch local government like hawks. And another year or two of bad habits will be too much for all of us.

    Any doubts that these bad habits exist can be dispelled by taking a look at a recent deal that had city officials in Los Angeles ready to spend $5.6 million for a small parcel of land to be turned into a park on the 400 block of S. Spring Street. They eventually cut the offer to $5.1 million – a savings of $500,000 that came only after ongoing coverage by the Los Angeles Garment & Citizen – a weekly community newspaper that covers the Downtown area of the city and surrounding districts – shed light on a number of questionable factors in the deal.

    Those questionable factors indicate that it’s time for everyone who is not a city official – the people, in other words – to take a second look at the situation. The recent coverage amounted to more than stories about a park, or even the price of the land. The stories pointed to systemic corruption in the process that city officials use in spending large sums of the public’s money.

    There are no individuals to single out here – not at this point, anyway. No one got caught with a hand in the cookie jar. That’s the main problem – the corruption of our civic culture is pervasive to the point that it’s tough to catch anyone with their hand in the cookie jar. We don’t even keep our cookies in a jar in Los Angeles anymore – they’re left out around City Hall for the taking by politicians and special interests.

    New rules and ethical standards are needed in Los Angeles – and it’s a safe bet that the same is in order for cities across the country. A good place to start would be a new rule to ensure that taxpayers never again see city officials offer to pay millions of dollars based on an appraisal commissioned on behalf of the seller of a piece of land—the very process originally used in the park deal in Los Angeles. There should be some standard that requires city officials to conduct their own appraisals on major purchases. Many cities have such expertise among their employees. If not, it is surely worth a few thousand dollars to hire an appraiser to work for the city’s interests on deals where a 0.1% savings would cover such extra costs, as was the case on the park land.

    The Garment & Citizen’s recent reporting also shed light on the fact that bureaucrats in City Hall currently have great leeway in such matters. Sometimes they order their own appraisal on land purchases—and sometimes they don’t. The decision seems to be left entirely to the discretion of unelected bureaucrats.

    The problem here is basic because the current set-up begs for abuse. Bureaucrats are human beings, after all, and subject to all of the problems and temptations that life brings. It’s also well known that the career bureaucrats in Los Angeles are subject to political pressure from any number of sources. That includes the 15 members of the Los Angeles City Council, who operate their districts much like personal fiefdoms. The City Council members tend to stay out of one another’s business in a pretense of some sort of legislative courtesy. What they’re really doing is withholding their best efforts at internal oversight, a failure that has helped send the people on a sorrowful journey from engaged participants in our democracy to cynics who don’t even bother to vote.

    The lack of standards on appraisals is only one of the problems that cropped up on the recent park deal. There are many more specific to real estate dealings – and you can just imagine how many additional pitfalls can be found in the way the city purchases motor vehicles, or paper products, or telecommunications services. And so on, and so on.
    It’s enough to make you wonder how many city deals could be trimmed by a half-million here or a couple of million there?

    We’re guessing plenty – and that tightening up on these sweetheart deals would go a long way toward solving the current budget crunch while maintaining many of the jobs and services that might be cut to close a looming $500 million deficit in the city’s budget in Los Angeles.

    You can bet there are plenty of similar savings to be had in State Houses and City Halls across the nation, too. Indicators abound in Gwinnett County, Georgia, just outside of Atlanta. Taxpayers in Gwinnett who want to avoid getting fleeced will apparently have to go a step further than a clear standard on appraisals for land deals. That seems to be the only lesson to take from a recent report in the Atlanta Journal-Constitution, which found that elected officials in Gwinnett County commissioned their own appraisal on a piece of land and still voted to pay twice the price.

    Some of the county commissioners in Gwinnett said that they approved the higher price because land appraisals are “all over the board” these days.

    Commissioner Mike Beaudreau opposed the deal, saying that the wide range of appraisals indicated that the matter should be given more study. He stood alone in his opposition, and the people of Gwinnett County are now set up to pay twice the appraised value for the land.

    So here’s the key question to consider: Will stimulus money paper over such deals in State Houses, County Commissions, and City Halls throughout our land?

    Only the people can say for certain.

    Jerry Sullivan is the Editor & Publisher of the Los Angeles Garment & Citizen, a weekly community newspaper that covers Downtown Los Angeles and surrounding districts (www.garmentandcitizen.com)

  • The Changing Landscape of America: The Fate of Detroit

    INTRODUCTION

    During the first ten days of October 2008, the Dow Jones dropped 2399.47 points, losing 22.11% of its value and trillions of investor equity. The Federal Government pushed a $700 billion bail-out through Congress to rescue the beleaguered financial institutions. The collapse of the financial system in the fall of 2008 was likened to an earthquake. In reality, what happened was more like a shift of tectonic plates.

    In 1912 a German scientist, Alfred Wegener, proposed that the continents were once joined together as one giant land mass called Pangea.

    About 200 million years ago the continents began to drift apart as the globe separated into eight distinct tectonic plates. History will record that the financial tectonic plates of our world began to drift apart in the fall of 2008. They have not stopped moving and the outcome of where they will end up remains uncertain.

    PART ONE – THE AUTOMOBILE INDUSTRY

    Edsel, Packer, Studebaker, Hudson, Nash, AMC – the demise of these brands may have seemed tragic at the time, but were actually a sign of industrial health. In contrast, for the last fifty years the American automobile industry has been static. Despite the proliferation of Japanese, Korean and German imports, General Motors, Ford and Chrysler managed to hold on to a majority of the domestic market, with a dizzying stable of makes and models that grew to near 17 million new car sales in 2007. That epoch is now over. The tectonic plates have shifted under the automotive business and a year from now, the industry will bear little resemblance to the static structure of the last fifty years.

    Fifty years ago General Motors owned more than 50% of the American market and automobile jobs made up one seventh of the US workforce. It was said that when GM sneezed the US economy caught a cold. GM shares now sell for less than a cup of coffee at Starbucks. Now GM is about to enter bankruptcy.

    The brands are dissolving, Oldsmobile was the first casualty. Pontiac and Hummer have been discontinued. When they reorganize, eleven hundred dealers will be terminated. General Motors will close all its plants for three months this summer. Many will never reopen. The New GM, to be known as Government Motors, will be owned by the UAW (20%) and the Federal Government (70%). Twenty billion of tax-payer loans will be converted to ownership to make the UAW pensions liquid. The debt holders will see their senior $27 billion investment converted into just 10% of stock. The shareholders will be wiped out.

    The New GM will become the platform for small fuel efficient cars, hybrids, electric vehicles and experimental technologies mandated by an ever demanding government. Its shareholders vanquished, The New GM will bear no resemblance to the car company that we have known for the last 50 years. Can the Chevy Volt rescue GM? The answer is no.

    GM will continue to shrink as their SAAB and Saturn franchises are sold off to the Chinese. China’s automobile sales are up 10% this year versus declines of 23% in the US and 15% in Europe. Chinese automobile manufacturers are grabbing market share, 30% this year versus 26% in 2008, while their competitors are distracted. Chinese companies unknown to Americans like Geely Motors, Chery Automobiles or BYD Co. will buy SAAB or Saturn for their dealer network. Warren Buffett invested $230 million into BYD, a firm that has been manufacturing cars for just six years. They already provide batteries to Ford and GM and soon will be building the world’s least expensive mass produced hybrid and electric vehicles. Geely plans to triple its domestic sales to 700,000 by 2015 and Chery plans to introduce 36 new models over the next two years.

    Chrysler is in far worse shape and will likely never recover. The Federal Government already forced it into bankruptcy. Seven hundred and eighty nine dealers have been told that their franchises are terminated. Its shotgun marriage to Fiat will look more like a surgical amputation of unnecessary body parts than a marriage. If Fiat remains in the game, they will do so for the Jeep brand and a portion of the dealer network. Like Oldsmobile and Pontiac, Plymouth and Dodge brands are doomed as well as most of the Chrysler line. No one will mourn the demise of the Crossfire, Pacifica, Sebring, or the PT Cruiser. Fiat should keep the new Chrysler 300, a beautiful design that deserves to be built. Chrysler has not produced many stars in the last few decades. The trail blazing design of the 300 brought the full size sedan back from the dead.

    Chrysler will jettison the weakest of its dealers in bankruptcy. Fiat will retain the big dealers in the network. They will bring the stunning and iconic Fiat 500 to America, a fuel efficient small car that will enjoy the same success as Volkswagen’s retro Beetle. Fiat will also use the dealer network to bring the Alfa-Romeo back to America. The Fiat-Jeep-Alfa dealer of the future will bear no resemblance to the staid Chrysler-Dodge-Plymouth dealer of today.

    The surprising winner among the American troika of manufacturers is the Ford Motor Company. Ford and Lincoln will survive because they took no government bail-out money. Mercury may not survive but Ford and Lincoln should make it through the transition. The new Ford-Lincoln will be the refuge for auto enthusiasts who want attractive fast and powerful cars. Ford will become the Apple of the auto business, doing its own thing and flaunting political correctness and conventional wisdom. Ford’s namesake CEO has been an environmentalist for many years so Ford was well into fuel economy and hybrids before the tectonic plates began to move last fall. At just $5.00 per share, Ford is a tantalizing buy for the long term.

    One can no longer call Mercedes, BMW, Toyota and Honda imports as many of their cars are made entirely in the U.S. The Japanese system is different than the American counterpart although we are drifting toward their model. The Japanese government plays a heavy hand in their industry, subsidizing the encroachment into new markets until the brands have stabilized market share. But they are not immune. Toyota lost $7.7 billion in the last quarter – even more than GM.

    True imports like Volkswagen will weather the storm because they were well positioned with small fuel efficient cars long before the tectonic plates began to shift. VW is making a huge bet that oil will top $100/barrel again soon and their fuel efficient and clean diesels will be accepted by American drivers.

    The biggest winner is obviously the UAW and their pensions which have been bailed out with tax payer money by an administration beholden to its labor supporters. Who will be the biggest loser? Clearly, it will be America’s small towns. Our small towns will lose their local dealer and their choice in automobiles. They will be forced to buy the brand that remains in town or drive scores of miles to the next closest dealer for service. Most small town auto dealers were also the most generous members of the community. Charitable giving and support will wither as will local sales tax revenues when the big ticket automobile sales tax revenues disappear. Ironically, as the plates continue to shift, America’s small towns could be decimated by the changes in the automobile industry as they were one hundred years ago when the automobile shifted millions from rural communities to the cities.

    A year from now the landscape of America will be forever changed but the plates will continue to shift. Five years from now, will American ingenuity bring about a renaissance of the American automobile industry? Or, will what is left of this industry be gobbled up by the Chinese and the Korean manufacturers as the Japanese did in the 70s and 80s? The key issue may be what role the government will play. Will Americans buy cars designed by government bureaucrats and built by the unions that own the factories? Will an administration devoted to “coercing” Americans out of their cars be able to simultaneously save the auto industry?

    ***********************************

    This is the first in a series on the Changing Landscape of America. Future articles will discuss real estate, politics, healthcare and other aspects of our economy and our society. Robert J. Cristiano PhD is a successful real estate developer and the Real Estate Professional in Residence at Chapman University in Orange, CA.

  • Frontrunning and Finance: Left Foot Forward

    This month, the Obama administration moved to regulate the so-called ‘invisible’ financial instruments that have come to rule the world of finance. Variations of the ‘shadow’ banking system — or, in the preferred language of financiers, market ‘risk management tools’ — have increasingly taken the spotlight during the current crises.

    Jim Cramer, on one of those CNBC webcasts which he must have thought would never be seen by anyone who counts, appeared to admit in December to something illegal when he said, “A lot of times when I was short (stocks) at my hedge fund, I would create a level of activity beforehand that would drive the futures.”

    Might he have been referring to self-frontrunning, an egregious flim-flam that takes place on two separate exchanges almost simultaneously so that one regulatory eye can’t see what the other one sees? On one exchange, the hedge fund manager sells the index future, and on another, he executes a series of short sales in the stocks of which the index is composed. The net effect is to drive the future down to profitable levels. Or, in the case of Mr. Cramer, who goosed the futures after having shorted the stocks, to draw investors in to an arbitrage that he himself created.

    It is strange and striking that a practice responsible for the lion’s share of the trading profits of the nation’s hedge funds and investment banks should remain a secret… even an open secret. But every morning on CNBC’s Squawk Box, commentators comfortably predict that the market will open up or down based on the movement of the futures. And nine times out of ten they are right.

    This type of thing can go on ad infinitum: after having closed out the short position, one might readily go long the index future and likewise the composite stocks and make money on the upside as well. While not foolproof – a critical mass of fools could upend such plans in a jittery trading environment – one can achieve a comfortable margin of safety by working with other hedge funds to go long or short the identical stocks and futures in concert. The effect is momentum investing in the truest sense of the term. And lofty expectations are sure to be met because the law of one price will force the futures in line with the cash every time. Add computers and a little leverage, and your hedge fund will not only spectacularly outperform the market averages, but take on far less risk in the bargain.

    Of course, Wall Street firms which execute trades for hedge funds often have an advantage over the funds because they have inside knowledge of the trading plans. And they can and often do trade in advance of these moves to the detriment of the hedge fund customers. Recently, a jury convicted three former stockbrokers at Bank of America, Merrill Lynch and Smith Barney for placing open telephone lines next to the internal speaker systems to eavesdrop on block orders by hedge funds and other institutional clients.

    The hedge funds are run by bright people. They caught onto this scam quickly. And rather than miss out, they joined forces with the Wall Street firms themselves to combine their financial power in concerted transactions, which makes the markets even more volatile. Mighty orchestrations of computer-driven buy and sell orders then exploit the minute-to-minute differentials of the stocks and their derivatives. Those differentials add up to trillions of dollars.

    Such bold moves trigger wild price swings and send skittish investors to the exits. But the solipsistic trading strategy is so wonderfully profitable to the insiders that any thought of calming the waters prompts snickers. Regulators don’t seem to care; they think these moves improve efficiency, seemingly without realizing that the traders create the conditions under which index arbitrage makes sense.

    A variant of this practice played a major role in sinking the banks during the credit crisis that began last year. Hedge funds began by shorting the banks, and then forced them into the toilet by shorting the same mortgage pools that banks carried on their balance sheets.
    Mark-to-market accounting created the impression that the banks were insolvent. This not only ensured that the short positions were profitable, but forced the Financial Accounting Standards Board to rush rule changes.

    Years ago, when commodity firms first adopted it, marking to the market seemed like a good idea, as investors need to know not only the cost basis of an asset, but also what it would fetch in the marketplace. Today it’s clear that the market transactions may have less to do with an asset’s actual valuation in a normal trading environment than with its desired valuation in a manipulated one.

    Having ruined the banks, these same swindlers turned on the insurance companies whose short interest skyrocketed in tandem with the crashing of their shares because their annuity products were backed by the same triple-A rated mortgage bonds that reposed on the banks’ balance sheets. Ironically, some firms, such as Lincoln National, ended up buying banks to qualify for bailout money so that they could continue in business.

    The stakes to the economy may seem smaller when insurers — as opposed to banks — appear insolvent, but many alarmed customers were quick to move their business elsewhere at merely the whiff of insolvency. The consequences to both industries were such that for the first time in 16 years the finance and insurance sectors of the economy actually shrank by 16 percent. They now have to raise more equity just to keep their customers.

    The transactions at the source of these woes were the result of what one financial writer termed “regulatory somnambulism,” in that it allowed for the elimination of the up-tick rule — which stipulated that short sales be entered at a price that is higher than the price of the previous trade — and of naked short selling, which can sink a flagship faster than a broadside beneath the water line.

    Naked short selling is a vicious twist on the usual. Normal short selling occurs when investors borrow shares and sell them, hoping the stock will fall and they can buy back the shares at a lower price. Naked short selling artificially increases the supply of a security as one can sell them without first borrowing them and thereby might technically sell more shares than actually exist. This utterly speculative practice has no bearing on the efficiency of the markets, contrary to what its practitioners claim. Its only purpose is to flood the market with sell orders and drive down share prices.

    In doing so, it contributes to an inaccurate picture of financial stringency that plays a major role in the price and allocation of credit and capital, which is central to the proper running of the world economy. It’s a true tail wagging the dog phenomenon that enriches well-placed gamblers at the expense of everyone else.

    Tim Koranda is a former stockbroker who now works as a professional speechwriter. He can be reached at koranda@alum.mit.edu.

  • Betting against the USA — told ya’ so!

    More than once in this space, I’ve said that derivative financial products set up a perverse incentive where investors have more to gain from the failure of companies and homeowners than their success. If you haven’t seen it yet, take a look at the longer version of my description of the causes and consequences of the current crisis to understand how failed financial innovations, like credit default swaps, contributed to the meltdown of 2008. I wrote that article back in November.

    Once again, only Bloomberg.com is out front on this story. More hedge funds are catching onto the casino-like qualities of betting against America’s economic success. Reporters Salas, Harrington and Paulden could have quoted my NewGeography writings directly: “companies [have] more credit-default swaps outstanding than the bonds the contracts protected…” and, referring to Clear Channel Communications, “some of its creditors stand to profit from its failure.”

    Told ya’ so!

  • Housing Downturn Update: We May Have Reached Bottom, But Not Everywhere

    It is well known that the largest percentage losses in house prices occurred early in the housing bubble in inland California, Sacramento and Riverside-San Bernardino, Las Vegas and Phoenix. These were the very southwestern areas that housing refugees fled to in search of less unaffordable housing in California’s coastal metropolitan areas (Los Angeles, San Francisco, San Diego and San Jose).

    Yet now the prices in these hyper-expensive markets are beginning to fall. Once considered widely immune from the severe housing slump, the San Francisco area now has muscled its way into the list of biggest losers. The newly published first quarter 2009 house price data from the National Association of Realtors indicates that prices are down 52.5 percent from the peak. Only Riverside-San Bernardino and Sacramento have experienced greater losses out of the 49 metropolitan areas with a population of more than 1,000,000 for which there is data (see table below). Other metropolitan areas that have seen prices drop more than 50 percent include Phoenix, Las Vegas and, for very different reasons, that rustbelt sad sack, Cleveland.

    Table 1
    Median House Price Loss: Metropolitan Areas Over 1,000,000 Population
    Rank Metropolitan Area
    Median House Price % Loss from 2000-2008 Peak
    Median House Price Loss from 2000-2008 Peak
          1 Riverside-San Bernardino, CA -57.7% $235,600
          2 Sacramento, CA -56.5% $219,600
          3 San Francisco, CA -52.5% $444,800
          4 Phoenix, AZ -51.9% $139,200
          5 Cleveland, OH -51.5% $74,300
          6 Las Vegas, NV -51.3% $163,800
          7 Los Angeles, CA -48.8% $289,400
          8 San Jose, CA -48.0% $415,000
          9 San Diego, CA -47.5% $291,900
        10 Miami-West Palm Beach, FL -47.3% $185,200
        11 Orlando, FL -43.1% $117,200
        12 Tampa-St. Petersburg, FL -42.2% $98,800
        13 Washington, DC-VA-MD-WV -37.3% $165,900
        14 St. Louis, MO-IL -35.8% $56,300
        15 Chicago, IL -35.2% $100,900
        16 Atlanta, GA -34.4% $60,600
        17 Memphis, TN-MS-AR -34.0% $49,400
        18 Providence, RI-MA -33.6% $102,600
        19 Boston, MA-NH -32.5% $140,200
        20 Cincinnati, OH-KY-IN -28.6% $42,600
        21 Richmond, VA -27.9% $66,800
        22 Indianapolis, IN -26.6% $34,300
        23 Minneapolis-St. Paul, MN-WI -25.9% $60,800
        24 Columbus, OH -24.5% $38,400
        25 Denver, CO -24.1% $61,200
        26 Birmingham, AL -23.2% $39,300
        27 Jacksonville, FL -22.4% $44,600
        28 Charlotte, NC-SC -22.1% $48,700
        29 New York, NY-NJ-PA -21.9% $104,700
        30 Virginia Beach-Norfolk, VA -21.2% $54,000
        31 Kansas City, MO-KS -20.4% $32,400
        32 Seattle, WA -20.1% $79,500
        33 Pittsburgh, PA -19.0% $24,300
        34 Hartford, CT -17.7% $47,800
        35 Portland, OR-WA -17.0% $51,100
        36 Baltimore, MD -16.3% $47,900
        37 New Orleans, LA -15.6% $27,800
        38 Philadelphia, PA-NJ-DE-MD -15.2% $37,000
        39 Louisville, KY-IN -15.1% $21,500
        40 Rochester, NY -14.5% $18,000
        41 Houston, TX -13.6% $21,800
        42 Dallas-Fort Worth, TX -13.5% $21,100
        43 Buffalo, NY -13.1% $15,000
        44 Milwaukee, WI -12.1% $27,800
        45 Salt Lake City, UT -6.7% $16,500
        46 San Antonio, TX -6.2% $9,800
        47 Austin, TX -6.1% $11,900
        48 Raleigh, NC -5.3% $12,600
        49 Oklahoma City, OK -3.3% $4,500

    Cleveland, the newest entrant to the “over 50” club, fell largely because of the collapse of its industrial economy. It remains the only one of the thirteen mega-losers without prescriptive land use policies (sometimes called “smart growth”), which raise house prices by rationing land for development and imposing more stringent regulatory requirements. Cleveland illustrates a point made in a previous commentary: that the huge house price losses in the housing downturn have spread broadly from the original metropolitan areas that precipitated Meltdown Monday, the Lehman Brothers bankruptcy on September 15, and the Panic of 2008.

    During Phase I of the housing downturn (through September 2008), the largest losses were concentrated in the “Ground Zero” markets of California, Florida, Las Vegas, Phoenix and Washington, DC. In each of these 11 markets, median house prices dropped at least 25 percent, with per house over $100,000 except in Tampa-St. Petersburg during Phase I. These markets, all with more prescriptive planning, accounted for nearly 75 percent of the gross house value loss in the nation, with other more prescriptive markets accounting for another 20 percent. The more responsive markets, where land use regulation follows more traditional market-driven lines, accounted for slightly more than 5 percent of the loss.

    The Chart below and Table 1 in The Housing Downturn in the United States: 2009 First Quarter Update financial collapse, however, now has spread the losses much more generally. In Phase II, the Ground Zero markets represented 44 percent of the loss, the other more prescriptive markets 38 percent and the more responsive markets 18 percent.

    As of the first quarter of 2009, prices had dropped in all major metropolitan areas. The average per house loss in the Ground Zero markets was still the highest, at 48 percent, though the overall all loss had increased to 34 percent.

    There are indications that the housing downturn may be slowing. The latest data indicates that the median house price increased in March, though not enough to forestall a loss in the first quarter. Another indicator is the fact that the Median Multiple (median house price divided by median household income) has fallen to a national level of 3.1, which is slightly more than the 2.9 historic rate and well below the 4.6 peak.

    The best news of all is that the Median Multiple has dropped to 3.8 in the Ground Zero markets, which is equal to the historic level and well below the peak of 7.3. In the other more prescriptive markets, the Median Multiple is at 3.5, above the 2.9 historic average but well below the peak of 4.8. In the more responsive markets, the Median Multiple has dropped to 2.6, just above the historic average of 2.5 and below the peak figure of 3.2.


    Prices have fallen so much that they now stand at historic 1980 to 2000 Median Multiple levels in 18 of the 49 metropolitan areas. Critically, this includes the Ground Zero markets of Riverside-San Bernardino, Sacramento, Phoenix and Las Vegas.

    Other Ground Zero markets have seen much of their price inflation whittled away, but still have a way to go. Prices need to decline $33,500 to reach the historic Median Multiple level in Los Angeles, $32,300 in Miami, $31,200 in Washington, $18,500 in San Francisco, $11,100 in San Diego and only $1,700 in Tampa-St. Petersburg.

    In other markets, however, prices still have some distance to go before the historic Median Multiple is reached. The largest decrease would have to occur in New York, at $122,000, followed by Portland ($95,000), Seattle ($94,000), Baltimore ($75,000) and Salt Lake City ($74,000). Other markets, including Philadelphia, Virginia Beach, Milwaukee and Ground Zero San Jose would need to have price declines of more than $50,000 to restore their historic Median Multiples. See Table 2.

    Table 2
    Median House Price Reduction Required to Reach Historic Price/Income Ratio (Median Multiple)
    Median House Price Reduction Required to Reach 1980-2000 Median Multiple
    Median Multiple
    Rank Metropolitan Area
    1980-2000 Average
    2000-2008 Peak
    Current (2009: 1st Quarter)
          1 New York, NY-NJ-PA $122,200             3.9            7.7           5.8
          2 Portland, OR-WA $94,700             2.7            5.4           4.4
          3 Seattle, WA $94,400             3.3            6.2           4.7
          4 Baltimore, MD $74,700             2.6            4.6           3.7
          5 Salt Lake City, UT $73,800             2.6            4.3           3.8
          6 Philadelphia, PA-NJ-DE-MD $61,500             2.4            4.2           3.4
          7 San Jose, CA $55,400             4.5          10.2           5.1
          8 Virginia Beach-Norfolk, VA $53,600             2.6            4.7           3.5
          9 Milwaukee, WI $51,400             2.8            4.4           3.8
        10 Boston, MA-NH $41,900             3.5            6.1           4.1
        11 Los Angeles, CA $33,500             4.5          10.1           5.1
        12 Miami-West Palm Beach, FL $32,300             3.4            7.0           4.0
        13 Jacksonville, FL $32,000             2.3            3.6           2.9
        14 Washington, DC-VA-MD-WV $31,200             2.9            5.3           3.3
        15 Providence, RI-MA $29,400             3.1            5.4           3.6
        16 Raleigh, NC $26,700             3.3            3.9           3.7
        17 Austin, TX $20,500             2.8            3.3           3.2
        18 San Francisco, CA $18,500             5.0          11.2           5.2
        19 Denver, CO $18,000             2.9            4.3           3.2
        20 Minneapolis-St. Paul, MN-WI $15,700             2.4            3.6           2.6
        21 Hartford, CT $14,300             3.1            4.2           3.3
        22 San Diego, CA $11,100             4.9            9.5           5.1
        23 Buffalo, NY $10,900             1.9            2.5           2.1
        24 Charlotte, NC-SC $10,100             3.0            4.1           3.2
        25 Richmond, VA $9,500             2.8            4.1           3.0
        26 Louisville, KY-IN $8,100             2.4            3.1           2.6
        27 Chicago, IL $7,800             2.9            4.8           3.0
        28 San Antonio, TX $5,200             3.0            3.3           3.1
        29 Orlando, FL $4,000             2.9            5.2           3.0
        30 Pittsburgh, PA $3,400             2.1            2.8           2.2
        31 Tampa-St. Petersburg, FL $1,700             2.8            4.7           2.8
    Las Vegas, NV  At or Below              3.4            5.3           2.7
    Riverside-San Bernardino, CA  At or Below              3.7            6.6           3.0
    Sacramento, CA  At or Below              3.6            5.6           2.8
    Memphis, TN-MS-AR  At or Below              3.0            3.1           2.0
    New Orleans, LA  At or Below              3.1            3.3           2.8
    Phoenix, AZ  At or Below              2.8            4.7           2.4
    Atlanta, GA  At or Below              2.4            3.1           2.0
    Birmingham, AL  At or Below              3.0            3.5           2.7
    Cincinnati, OH-KY-IN  At or Below              2.3            2.8           2.0
    Cleveland, OH  At or Below              2.2            2.8           1.4
    Columbus, OH  At or Below              2.4            2.9           2.2
    Dallas-Fort Worth, TX  At or Below              2.7            2.7           2.4
    Houston, TX  At or Below              2.5            2.9           2.5
    Indianapolis, IN  At or Below              2.1            2.3           1.7
    Kansas City, MO-KS  At or Below              2.5            2.9           2.3
    Oklahoma City, OK  At or Below              2.8            2.9           2.8
    Rochester, NY  At or Below              2.2            2.4           2.0
    St. Louis, MO-IL  At or Below              2.2            2.9           1.9
    Median Multiple: Median house price divided by median household income.

    These price reductions may or may not occur in over-valued metropolitan areas like New York, Portland and Seattle, all of which are also experiencing serious increases in unemployment. However, given the pervasive evidence that the market is returning to the vicinity of historic price ratios, it would not be surprising if significant price reductions happen in these metropolitan areas, which were previously seen and saw themselves as immune to the fallout that hit the less well-regarded ground zero markets.

    Additional information is available in:
    The Housing Downturn in the United States: 2009 First Quarter Update

    Wendell Cox is a Visiting Professor, Conservatoire National des Arts et Metiers, Paris. He was born in Los Angeles and was appointed to three terms on the Los Angeles County Transportation Commission by Mayor Tom Bradley. He is the author of “War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life.”