Came across this article, that talks about the phony wealth of 11 trillion dollars that dissapeared in the crash so far:
http://finance.yahoo.com/news/Where-All-That-Money-nytimes-173741017.html?x=0&sec=topStories&pos=7&asset=&ccode=
People often have difficulty to understand where the money goes when the stock market collapses, and when housing market collapses. For example, when DOW is at 14,000 Mary looks at her stock protfolio that is worth at 140,000 dollars. She assumes she has that much money.
The problem is that she does not have that money. She will only have the money when she sells at DOW 14,000.
Similarly, when a bank gives out a home equity loan, they look at comparable home values to decide what a single home is worth. They then give out a loan based on that number.
What is the problem with this? The problem is that these valuations maybe correct when done in small scale. But at aggregate, when an entire population decides to sell their stocks, or homes at that price, they won't get such price. Price will decline.
That is why stocks are a bubble and home prices have not bottomed.
Friday, April 30, 2010
Monday, April 19, 2010
Is it a good time to buy a home?
Article explains why it is a great time to buy a home:
http://www.msnbc.msn.com/id/36650111/ns/business-real_estate/
This is a great time to buy if we only look at the past few years of bubble. But hey, look at history. There were times when declining home prices have lasted for decades. People have the tendency to say it won't happen again. We will see.
Let us examine the claims made in the article:
"In addition, as first-time buyers, they can qualify for a federal tax credit of up to $8,000 and up to another $10,000 in California state tax credits."
Looks like prices are kept up by subsidy. What will happen when the support dissapears? Or what will happen when we run out of potential buyers as we ran out of borrowers during sub-prime?? Mortgage rates are at historic lows. What will happen when rates go up?
"There are also significant tax benefits, including capital gains deductions for property taxes and loan interest."
If your loan is 150K, I am not sure how big the tax benefit is. Standard deduction for a couple is quite big. If your loan is much higher, than you must be making a lot of money and you may hit AMT.
"A home appreciates in the long run and acts as a hedge against inflation."
And it kills you in deflation. Signs of deflation:
http://www.tradingstocks.net/html/signs_of_deflation.html
"It helps diversify your assets, builds equity and provides a means of forced savings as you slowly pay down the principal."
Diversification is dangerous during deflation. Home purchase is a long term decision. If you plan to hold for 20 years, can you get out on time before deflation hits? Or will you end up riding the tidal wave till prices hit the bottom? A liquid position is much easier to protect.
10 things you should and should not do during deflation:
http://www.tradingstocks.net/html/ten_things.html
"Real estate also is a leveraged investment, unlike most others. If you put 10 percent or $20,000 down on a $200,000 house and it appreciates to $300,000, that translates to a 500 percent return."
Leveraged long bets will wipe you out if deflation hits. It is better to buy what you can afford even if deflation hits. Mortgage rates have one way to go: UP. Who can afford these homes at higher rates? Higher rates will put pressure on prices. Price appreciation is not a sure thing even if CPI goes up. Salaries and home prices can stagnate while CPI moves up (Due to more expensive imports). That will wipe out the housing market.
"Of course, this won't last forever."
There are long periods in history when stock, home prices stagnate or fall. Inflation in US was not due to money printing. It was due to credit inflation. Money supply can deflate. Here is why:
http://www.tradingstocks.net/html/inflation_deflation_credit_bub.html
According to Case-Shiller index, we are still 20% above long term average prices. These long term averages themselves are based on an inflated money supply. Typical bottom comes 20% below average. That is a 40% drop from here. It can happen. Why pay more to take this risk?
If you have alot of money, then buy cash down and then you will save on rent. A little. Your savings will compensate some of your losses if the money supply deflates.
http://www.msnbc.msn.com/id/36650111/ns/business-real_estate/
This is a great time to buy if we only look at the past few years of bubble. But hey, look at history. There were times when declining home prices have lasted for decades. People have the tendency to say it won't happen again. We will see.
Let us examine the claims made in the article:
"In addition, as first-time buyers, they can qualify for a federal tax credit of up to $8,000 and up to another $10,000 in California state tax credits."
Looks like prices are kept up by subsidy. What will happen when the support dissapears? Or what will happen when we run out of potential buyers as we ran out of borrowers during sub-prime?? Mortgage rates are at historic lows. What will happen when rates go up?
"There are also significant tax benefits, including capital gains deductions for property taxes and loan interest."
If your loan is 150K, I am not sure how big the tax benefit is. Standard deduction for a couple is quite big. If your loan is much higher, than you must be making a lot of money and you may hit AMT.
"A home appreciates in the long run and acts as a hedge against inflation."
And it kills you in deflation. Signs of deflation:
http://www.tradingstocks.net/html/signs_of_deflation.html
"It helps diversify your assets, builds equity and provides a means of forced savings as you slowly pay down the principal."
Diversification is dangerous during deflation. Home purchase is a long term decision. If you plan to hold for 20 years, can you get out on time before deflation hits? Or will you end up riding the tidal wave till prices hit the bottom? A liquid position is much easier to protect.
10 things you should and should not do during deflation:
http://www.tradingstocks.net/html/ten_things.html
"Real estate also is a leveraged investment, unlike most others. If you put 10 percent or $20,000 down on a $200,000 house and it appreciates to $300,000, that translates to a 500 percent return."
Leveraged long bets will wipe you out if deflation hits. It is better to buy what you can afford even if deflation hits. Mortgage rates have one way to go: UP. Who can afford these homes at higher rates? Higher rates will put pressure on prices. Price appreciation is not a sure thing even if CPI goes up. Salaries and home prices can stagnate while CPI moves up (Due to more expensive imports). That will wipe out the housing market.
"Of course, this won't last forever."
There are long periods in history when stock, home prices stagnate or fall. Inflation in US was not due to money printing. It was due to credit inflation. Money supply can deflate. Here is why:
http://www.tradingstocks.net/html/inflation_deflation_credit_bub.html
According to Case-Shiller index, we are still 20% above long term average prices. These long term averages themselves are based on an inflated money supply. Typical bottom comes 20% below average. That is a 40% drop from here. It can happen. Why pay more to take this risk?
If you have alot of money, then buy cash down and then you will save on rent. A little. Your savings will compensate some of your losses if the money supply deflates.
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