Investing Decisions: Stocks vs. Real Estate
I'm careful to leave financial planning to the financial planners, and stick to real estate when I work with clients. However, given the drop in many real estate markets since 2005, it's hard to avoid at least touching on the subject, at least when counseling prospective Buyers contemplating such a major purchase.
After my standard disclaimer about not predicting future prices -- and to dismiss anyone who does -- I like to point out the many financial and psychic advantages associated with buying and owning real estate.
Those include the mortgage interest deduction for homeowners who itemize; the capital gains exclusion available on sale to homeowners who qualify ($250k for singles, $500k for couples); the accumulation of equity with a standard, amortizing loan (vs. an option ARM where the principal can actually increase over time); and the fact that, while you can't live in your stock portfolio, you can and do live in your home.
Given the stock market's travails lately, I can't resist pointing out that, while numerous, "big name" stocks have exploded virtually overnight (think, AIG, Fannie Mae, Freddie Mac, Countrywide, IndyMac, Bear Stearns, Lehman Bros., Washington Mutual, Wachovia, Merrill Lynch, Citigroup and many, many others), I've never heard of a house exploding.
Make that almost never.
In the course of engaging in shop talk with another realtor at a conference this week, I heard about a house that literally did explode.
According to the realtor, more than a decade ago her son and daughter-in-law purchased a fixer-upper in a tougher part of town. In between the time the Purchase Agreement was signed and when the closing was to occur, thieves stole all the copper from the home. They apparently were in such a rush that they didn't stop to notice that they cut into the home's gas line. Not long after they left, the house filled with gas and literally, exploded.
I'll still take real estate over stocks . . .
Friday, October 31, 2008
Thursday, October 30, 2008
A Tale of Two Suburbs
Lender-Mediated Sales Loom Large in Current Market
According to the Minneapolis Board of Realtors, "lender-mediated" properties now comprise about one-third of local market activity. The most common types of lender mediation are foreclosures and short sales (the latter require the lender to agree to take less than what it's owed).
Bad as it is, the market-wide statistic masks a huge disparity between the strongest communities and the weakest.
At one extreme, a stunning 64% of all homes currently for sale in Brooklyn Park are now lender-mediated.
By contrast, the equivalent number in Edina is just 6%.
What explains this gulf?
Short sales and foreclosures are correlated with home price: the lower the price, the higher the incidence of lender mediation (for readers of this blog outside the Twin Cities, Brooklyn Park's housing is modestly-priced, while Edina's is disproportionately upper bracket).
People buying less expensive homes were more likely to have poor credit, and end up in sub-prime mortgages featuring low -- but very temporary -- initial teaser rates. It's also a safe bet that people buying homes in Brooklyn Center put less money down than their Edina counterparts -- and therefore have less incentive to hold onto a home that's worth less than what they paid.
Finally, economic downturns simply hit the bottom rungs of the financial ladder harder than the middle and upper rungs.
For prospective home buyers, the lesson is clear: high-demand neighborhoods not only appreciate more in up markets, they hold up better in down markets.
According to the Minneapolis Board of Realtors, "lender-mediated" properties now comprise about one-third of local market activity. The most common types of lender mediation are foreclosures and short sales (the latter require the lender to agree to take less than what it's owed).
Bad as it is, the market-wide statistic masks a huge disparity between the strongest communities and the weakest.
At one extreme, a stunning 64% of all homes currently for sale in Brooklyn Park are now lender-mediated.
By contrast, the equivalent number in Edina is just 6%.
What explains this gulf?
Short sales and foreclosures are correlated with home price: the lower the price, the higher the incidence of lender mediation (for readers of this blog outside the Twin Cities, Brooklyn Park's housing is modestly-priced, while Edina's is disproportionately upper bracket).
People buying less expensive homes were more likely to have poor credit, and end up in sub-prime mortgages featuring low -- but very temporary -- initial teaser rates. It's also a safe bet that people buying homes in Brooklyn Center put less money down than their Edina counterparts -- and therefore have less incentive to hold onto a home that's worth less than what they paid.
Finally, economic downturns simply hit the bottom rungs of the financial ladder harder than the middle and upper rungs.
For prospective home buyers, the lesson is clear: high-demand neighborhoods not only appreciate more in up markets, they hold up better in down markets.
Tuesday, October 28, 2008
Floyd Norris Column
"Voting" your Home, or Your 401(k)?
New York Times business columnist Floyd Norris has a provocative piece today titled "Housing Prices and McCain":
http://norris.blogs.nytimes.com/
Norris' premise is that Obama defections are likeliest in "red" states where home prices have dropped the most. Could be, although you'd be hard-pressed to isolate just one factor in causing a former Bush supporter to switch.
When people are feeling this much economic pain, I doubt they make careful distinctions about the precise source(s) any more. However, as I posted on Mr. Norris' blog, you don’t get a monthly statement telling you how much your home price just dropped. It's also the case that, at any given time, only a small fraction of homeowners are actively in the market -- less as we head into the holidays.
Personally, my guess is that people are “voting” their 401(k)’s more than their home prices this election cycle . .
New York Times business columnist Floyd Norris has a provocative piece today titled "Housing Prices and McCain":
http://norris.blogs.nytimes.com/
Norris' premise is that Obama defections are likeliest in "red" states where home prices have dropped the most. Could be, although you'd be hard-pressed to isolate just one factor in causing a former Bush supporter to switch.
When people are feeling this much economic pain, I doubt they make careful distinctions about the precise source(s) any more. However, as I posted on Mr. Norris' blog, you don’t get a monthly statement telling you how much your home price just dropped. It's also the case that, at any given time, only a small fraction of homeowners are actively in the market -- less as we head into the holidays.
Personally, my guess is that people are “voting” their 401(k)’s more than their home prices this election cycle . .
Realtors, Chauffeurs, & Investment Bankers
What Do Realtors Really Get Paid For?
[Note: this post is a companion to "Do Realtors Really Add Value?]
If all realtors did was chauffeur clients around, realtors should -- and would -- make what chauffeurs do: about $20 an hour.
But what realtors really do -- at least in their capacity as listing agents representing Sellers -- is actually much more strategic, and therefore valuable: they position the Seller's home in the marketplace, suggesting how to look at it, and yes, what to pay for it.
In politics, it's called defining your opponent before they define you. In real estate, it's about maximizing each home's potential, then presenting it to prospective Buyers in the most flattering (yet truthful) light.
Every house, even the most impressive, has warts and blemishes; likewise, even the humblest home has hidden virtues and at least a few redeeming features.
Price Imprimatur
Kim Pease, one of the best realtors in the Twin Cities (and a competitor), once advised me to think twice about holding price opinions (price opinions are a popular way for realtors to solicit input from colleagues on a house whose "comp's" (comparable sold homes) are tricky or unclear). If the realtor does their job correctly, according to Kim, realtors (and prospective Buyers) don't give the listing price a second thought, or if they do, it's an almost subconscious, "oh, yes, it's priced right."
By contrast, if you put a spotlight on price, you invite scrutiny and second-guessing. That's one of the reasons why homes that languish on the market forever get especially beat up on price.
Where the Freakonomics authors (realtor-scorners both) get it wrong is that they assume houses are widgets: fungible, interchangeable, homogeneous. In other words, a commodity.
To a talented realtor, homes are very much malleable and unique.
I like to tell clients that a listing is like an iceberg: the part below the surface is what happens before the first prospect walks through. It's not unusual for me to spend months working with a client getting their home ready for sale, directing value-adding home improvements, orchestrating the staging, working with my photographer and desktop publisher to get the marketing materials -- online and print -- just right.
Identifying and unlocking potential value, then correctly pricing and selling it isn't what chauffeurs do. It's what *investment bankers -- er, venture capitalists do.
*While it's true that underwriting a new stock issue typically involves a lot more zeroes than selling the average home, as a percentage of the entity value, home selling is much higher. How so? IPO's typically involve selling just a fraction of the company to the public; the "public slice" then establishes the value for all the rest. By contrast, there's no way I'm aware of to sell just 10% of a single family home.
[Note: this post is a companion to "Do Realtors Really Add Value?]
If all realtors did was chauffeur clients around, realtors should -- and would -- make what chauffeurs do: about $20 an hour.
But what realtors really do -- at least in their capacity as listing agents representing Sellers -- is actually much more strategic, and therefore valuable: they position the Seller's home in the marketplace, suggesting how to look at it, and yes, what to pay for it.
In politics, it's called defining your opponent before they define you. In real estate, it's about maximizing each home's potential, then presenting it to prospective Buyers in the most flattering (yet truthful) light.
Every house, even the most impressive, has warts and blemishes; likewise, even the humblest home has hidden virtues and at least a few redeeming features.
Price Imprimatur
Kim Pease, one of the best realtors in the Twin Cities (and a competitor), once advised me to think twice about holding price opinions (price opinions are a popular way for realtors to solicit input from colleagues on a house whose "comp's" (comparable sold homes) are tricky or unclear). If the realtor does their job correctly, according to Kim, realtors (and prospective Buyers) don't give the listing price a second thought, or if they do, it's an almost subconscious, "oh, yes, it's priced right."
By contrast, if you put a spotlight on price, you invite scrutiny and second-guessing. That's one of the reasons why homes that languish on the market forever get especially beat up on price.
Where the Freakonomics authors (realtor-scorners both) get it wrong is that they assume houses are widgets: fungible, interchangeable, homogeneous. In other words, a commodity.
To a talented realtor, homes are very much malleable and unique.
I like to tell clients that a listing is like an iceberg: the part below the surface is what happens before the first prospect walks through. It's not unusual for me to spend months working with a client getting their home ready for sale, directing value-adding home improvements, orchestrating the staging, working with my photographer and desktop publisher to get the marketing materials -- online and print -- just right.
Identifying and unlocking potential value, then correctly pricing and selling it isn't what chauffeurs do. It's what *investment bankers -- er, venture capitalists do.
*While it's true that underwriting a new stock issue typically involves a lot more zeroes than selling the average home, as a percentage of the entity value, home selling is much higher. How so? IPO's typically involve selling just a fraction of the company to the public; the "public slice" then establishes the value for all the rest. By contrast, there's no way I'm aware of to sell just 10% of a single family home.
Monday, October 27, 2008
Citiy Lakes Blog on RealClearMarkets!
Thanks, RealClearMarkets.com!
If you don't regularly read a Web site called RealClearMarkets, you should: it compiles the best financial writing, from hundreds of publications and Web sites, on one (very dense) page of links. Click here to check it out:
http://www.realclearmarkets.com/
Oh, and today, there's a link to this blog (thanks to the editor, John Tamny, for running one of the few "journalism meritocracies" left!)
If you don't regularly read a Web site called RealClearMarkets, you should: it compiles the best financial writing, from hundreds of publications and Web sites, on one (very dense) page of links. Click here to check it out:
http://www.realclearmarkets.com/
Oh, and today, there's a link to this blog (thanks to the editor, John Tamny, for running one of the few "journalism meritocracies" left!)
Sunday, October 26, 2008
Housing's Wal-Mart Effect
"Bargain Bin" Sales, or,
Housing's Wal-Mart Effect
'Home Resales Rise as Prices Fall' --The Wall Street Journal (10/26/08)
Call it the housing market's version of the Wal-Mart effect: as consumers get pinched by a weakening economy, the goods still selling are value-priced staples.
In many housing markets nationally, sales numbers are being skewed by all the purchases being made from the "bargain bin": foreclosed or short sale homes, in poor condition, selling at deep discounts. In especially stressed markets like Florida, Nevada, and Arizona, that percentage apparently is now 40% or more (locally, the number is about half that).
While this phenomenon isn't exactly reason to celebrate, it's not as dire as analysts are making out, for two reasons.
Parsing the Numbers
One. Homes are not commodities. When consumers switch from $4.29 gallons of milk at Lund's and Byerly's (upscale Twin Cities grocers) to $2.29 gallons at Sam's Club, economists might argue, with some justification, that the "average price of milk is plummeting."
By contrast, what does it mean for homeowners in Linden Hills, Country Club, or Tyrol Hills -- all coveted, stable Twin Cities neighborhoods -- when "garbage-y" foreclosures fetch $50k or $75k in tougher parts of town? Very little.
Two. Housing prices are soft because there's too much supply, and foreclosures count as supply. Ergo, soaking up foreclosures is good for the overall market.
If anything, that understates the benefit of a foreclosure sale.
Foreclosures are to the housing market what gangrene is to the body: diseased cells that can spread to and kill healthy ones. Moving a vacant and deteriorating foreclosure from bank-owned hands into a homeowner's arrests that spread.
Housing's Wal-Mart Effect
'Home Resales Rise as Prices Fall' --The Wall Street Journal (10/26/08)
Call it the housing market's version of the Wal-Mart effect: as consumers get pinched by a weakening economy, the goods still selling are value-priced staples.
In many housing markets nationally, sales numbers are being skewed by all the purchases being made from the "bargain bin": foreclosed or short sale homes, in poor condition, selling at deep discounts. In especially stressed markets like Florida, Nevada, and Arizona, that percentage apparently is now 40% or more (locally, the number is about half that).
While this phenomenon isn't exactly reason to celebrate, it's not as dire as analysts are making out, for two reasons.
Parsing the Numbers
One. Homes are not commodities. When consumers switch from $4.29 gallons of milk at Lund's and Byerly's (upscale Twin Cities grocers) to $2.29 gallons at Sam's Club, economists might argue, with some justification, that the "average price of milk is plummeting."
By contrast, what does it mean for homeowners in Linden Hills, Country Club, or Tyrol Hills -- all coveted, stable Twin Cities neighborhoods -- when "garbage-y" foreclosures fetch $50k or $75k in tougher parts of town? Very little.
Two. Housing prices are soft because there's too much supply, and foreclosures count as supply. Ergo, soaking up foreclosures is good for the overall market.
If anything, that understates the benefit of a foreclosure sale.
Foreclosures are to the housing market what gangrene is to the body: diseased cells that can spread to and kill healthy ones. Moving a vacant and deteriorating foreclosure from bank-owned hands into a homeowner's arrests that spread.
Friday, October 24, 2008
Wall St. Woes, cont.
Falling Knives, Twirling Machetes
How do you catch a falling knife (plummeting stocks)? With very thick gloves, assuming you're so inclined.
What's happening on Wall Street now resembles something more akin to a twirling machete (not graphic enough? the cover of the current Barron's features a chain saw). The intra-day swings regularly exceed hundreds of points, and whole market sectors -- like energy stocks -- are alternately rocketing and plunging daily (if not hourly). Of course, the overall trend is down, big-time.
Unless you have access to full body armor (deep capital reserves, ala Warren Buffett), the natural, self-protective impulse is to get as far away from the machete (er, knife) as possible.
That, plus margin calls on hedge funds, appears to be driving much of the action in world equity markets now . . .
How do you catch a falling knife (plummeting stocks)? With very thick gloves, assuming you're so inclined.
What's happening on Wall Street now resembles something more akin to a twirling machete (not graphic enough? the cover of the current Barron's features a chain saw). The intra-day swings regularly exceed hundreds of points, and whole market sectors -- like energy stocks -- are alternately rocketing and plunging daily (if not hourly). Of course, the overall trend is down, big-time.
Unless you have access to full body armor (deep capital reserves, ala Warren Buffett), the natural, self-protective impulse is to get as far away from the machete (er, knife) as possible.
That, plus margin calls on hedge funds, appears to be driving much of the action in world equity markets now . . .
Thursday, October 23, 2008
"An Inconvenient (Real Estate) Truth"
Frustrated Sellers Cancel
& Re-List . . . at the Same Price
Usually as a home's time on the market climbs, Sellers become more realistic and accept incremental price reductions.
One standard realtor strategy, after a home has failed to sell after 60-90 days, is to cancel the listing and bring it back on as "new" -- usually with a lower price to spur traffic.
Anecdotally, I'm seeing more instances of Sellers canceling and re-listing . . . but not changing the price.
An Inconvenient Truth?
Clearly, there's some Seller frustration operating here (it wouldn't be the first time that that happened in a soft market).
One might infer that such a Seller thinks that their home is already well-priced, and is just being overlooked by the market. And certainly, if the Seller has just made some mid-course improvements (new paint, carpet, etc.), sticking with the same price might be justified.
However, in my experience, when an otherwise well-marketed home is sitting, there's a good chance that the problem is price.
Choosing to ignore that isn't likely to result in a sale -- and canceling and relisting simply squanders any fresh exposure that might be generated.
& Re-List . . . at the Same Price
Usually as a home's time on the market climbs, Sellers become more realistic and accept incremental price reductions.
One standard realtor strategy, after a home has failed to sell after 60-90 days, is to cancel the listing and bring it back on as "new" -- usually with a lower price to spur traffic.
Anecdotally, I'm seeing more instances of Sellers canceling and re-listing . . . but not changing the price.
An Inconvenient Truth?
Clearly, there's some Seller frustration operating here (it wouldn't be the first time that that happened in a soft market).
One might infer that such a Seller thinks that their home is already well-priced, and is just being overlooked by the market. And certainly, if the Seller has just made some mid-course improvements (new paint, carpet, etc.), sticking with the same price might be justified.
However, in my experience, when an otherwise well-marketed home is sitting, there's a good chance that the problem is price.
Choosing to ignore that isn't likely to result in a sale -- and canceling and relisting simply squanders any fresh exposure that might be generated.
Rehab Hits . . and Misses
Rehab "Misses" are all Unique
"Happy families are all alike; every unhappy family is unhappy in its own way."
--Leo Tolstoy
Substitute "rehab hits" for "happy families," and "rehab misses" for "unhappy families," and you have the rewards -- and perils -- of remodeling in a nutshell.
I just saw an extensively rehabbed house -- done on spec (there's no client yet) -- that is definitely in the "miss" category.
The public rooms are undersized relative to the now-enormous Kitchen; the new upstairs baths are glorious, but don't go with any of the bedrooms (I'm still not clear which one was the master); and the lower level is a maze of newly finished rooms that feels like randomly carved up space (probably because it is).
Price cures all, and eventually a Buyer will step up who likes the value, and the fact that everything's been updated (it also helps that the neighborhood's an A+).
However, I'd say that the chances of "love at first sight" -- that emotional connection every Buyer wants, and every Seller hopes for -- are pretty low here.
"Happy families are all alike; every unhappy family is unhappy in its own way."
--Leo Tolstoy
Substitute "rehab hits" for "happy families," and "rehab misses" for "unhappy families," and you have the rewards -- and perils -- of remodeling in a nutshell.
I just saw an extensively rehabbed house -- done on spec (there's no client yet) -- that is definitely in the "miss" category.
The public rooms are undersized relative to the now-enormous Kitchen; the new upstairs baths are glorious, but don't go with any of the bedrooms (I'm still not clear which one was the master); and the lower level is a maze of newly finished rooms that feels like randomly carved up space (probably because it is).
Price cures all, and eventually a Buyer will step up who likes the value, and the fact that everything's been updated (it also helps that the neighborhood's an A+).
However, I'd say that the chances of "love at first sight" -- that emotional connection every Buyer wants, and every Seller hopes for -- are pretty low here.
Capitalism without Capital
Can you have Capitalism without Capital?
That's the sixty-four thousand (er, trillion) dollar question occupying the financial markets right now.
At the moment, it's not clear whether there is a capital shortage, or, the capital that exists is simply frozen (and therefore not circulating). In truth, the two possibilities are not mutually exclusive ("Duh-uh," as Homer Simpson might say).
If capital is frozen, you thaw it by increasing confidence, which means issuing government guarantees, insurance, etc. That needs to be coupled with clear and complete corporate disclosure, so that depositors, debtors, creditors, etc. can tell the difference between financial institutions that are healthy and ones that are "zombie's" (the term for banks kept on life support by the Japanese government after that country's late '80's bust).
The second explanation, a capital shortage, is more problematic.
If there's too little capital, you need to replenish it. Exactly how to do that is the rub.
If you give more capital -- lots more -- to the entities that just lost theirs (actually, as it turns out . . . ours), you risk perpetuating the problems that caused the original mess (so-called "moral hazard").
However, if you simply let the chips fall where they may, you risk the sort of collateral damage we're now seeing (credit defaults, money market trauma, no inter-bank lending, etc.).
What comes next?
At a minimum, probably some sort of "financial amnesty" to encourage (compel?) key financial actors to produce balance sheets that the markets actually trust. From there, you start the process of "re-building from the ground up," as Paul Volcker just put it.
That's the sixty-four thousand (er, trillion) dollar question occupying the financial markets right now.
At the moment, it's not clear whether there is a capital shortage, or, the capital that exists is simply frozen (and therefore not circulating). In truth, the two possibilities are not mutually exclusive ("Duh-uh," as Homer Simpson might say).
If capital is frozen, you thaw it by increasing confidence, which means issuing government guarantees, insurance, etc. That needs to be coupled with clear and complete corporate disclosure, so that depositors, debtors, creditors, etc. can tell the difference between financial institutions that are healthy and ones that are "zombie's" (the term for banks kept on life support by the Japanese government after that country's late '80's bust).
The second explanation, a capital shortage, is more problematic.
If there's too little capital, you need to replenish it. Exactly how to do that is the rub.
If you give more capital -- lots more -- to the entities that just lost theirs (actually, as it turns out . . . ours), you risk perpetuating the problems that caused the original mess (so-called "moral hazard").
However, if you simply let the chips fall where they may, you risk the sort of collateral damage we're now seeing (credit defaults, money market trauma, no inter-bank lending, etc.).
What comes next?
At a minimum, probably some sort of "financial amnesty" to encourage (compel?) key financial actors to produce balance sheets that the markets actually trust. From there, you start the process of "re-building from the ground up," as Paul Volcker just put it.
Tuesday, October 21, 2008
"Life Moves On" Department
"So How's the Market?"
That's probably the question realtors -- myself included -- get asked the most.
The quick answer: it depends. On the neighborhood, of course. But also your price point; whether you're selling or buying -- or both; your age; your credit score(s); your intended holding period; and a raft of other factors.
But what's most obvious to me, three years past the market peak, and two years into a marked slowdown, is the extent to which my clients are moving ahead with their real estate plans, regardless of market conditions.
There are two likely reasons for that.
First, no one really knows where the market goes from here.
Not me, not (Fed Chairman) Ben Bernanke, not the smartest economics Ph.d (I only have a bachelor's). My standard, only slightly tongue-in-cheek response when asked about the direction of future prices is, "tell me what interest rates, unemployment, and GDP growth (gross domestic product) are going to be, and I'll give you an intelligent price forecast."
Of course, none of the foregoing variables is knowable with any certainty.
Which brings up reason #2: life moves on.
The clients I'm working with now are moving because they need less space, more space, or space somewhere else (like another city). That's because their families got bigger (babies), smaller (empty nesters), or they got a new job.
Life moves on.
Sooner or later, you stop worrying about what the future holds, and do what makes sense for you or your family, now.
That's probably the question realtors -- myself included -- get asked the most.
The quick answer: it depends. On the neighborhood, of course. But also your price point; whether you're selling or buying -- or both; your age; your credit score(s); your intended holding period; and a raft of other factors.
But what's most obvious to me, three years past the market peak, and two years into a marked slowdown, is the extent to which my clients are moving ahead with their real estate plans, regardless of market conditions.
There are two likely reasons for that.
First, no one really knows where the market goes from here.
Not me, not (Fed Chairman) Ben Bernanke, not the smartest economics Ph.d (I only have a bachelor's). My standard, only slightly tongue-in-cheek response when asked about the direction of future prices is, "tell me what interest rates, unemployment, and GDP growth (gross domestic product) are going to be, and I'll give you an intelligent price forecast."
Of course, none of the foregoing variables is knowable with any certainty.
Which brings up reason #2: life moves on.
The clients I'm working with now are moving because they need less space, more space, or space somewhere else (like another city). That's because their families got bigger (babies), smaller (empty nesters), or they got a new job.
Life moves on.
Sooner or later, you stop worrying about what the future holds, and do what makes sense for you or your family, now.
Quick Sale Was No Accident
"That Sure Went Fast"
"The harder you work, the luckier you get"
--Samuel Goldwyn
One of the things that can happen when a home sells fast -- like my listing near Lake Calhoun two weeks ago -- is that people attribute it to luck.
Well, actually, no.
I like to tell clients that, to a realtor, a listing is like an iceberg: the part below the water consists of all the things that happen, behind-the-scenes, in the weeks (and often, months) leading up to the home's formally coming on the market.
The part sticking out of the water is what's visible to the public once the home is actually for sale.
In that vein, here is a partial list of things I did in my capacity as listing agent to ensure that my clients' Lake Calhoun home would fetch top dollar, quickly:
--Promoted the home via email to 3,000 Edina Realty agents in early September, to let them know about the home and that it would be coming on the market in early Oct.
--Had the home professionally staged; coordinated with the stager to have the home profiled in the Star Tribune real estate section the week it hit the market.
--Had the home professionally photographed, complete with a virtual tour using streaming photos for people browsing real estate listings on the Web.
--Featured the home on my Web site (http://www.rosskaplan.com/) and this blog.
--Did a mailing (1st class postage) complete with a cover letter and marketing literature to 150 neighboring homes in late September, giving them a "heads up" that the home would be coming on the market in a week, and inviting them to the first Sunday open house.
--Got 50 real estate agents to attend the Tuesday broker open by heavily promoting it beforehand with voicemail and email, and at Edina Realty City Lakes office meetings.
--Carefully priced the home after touring nearby, competing homes; soliciting colleagues' price opinions; and analyzing sales activity and trends nearby the past three years.
--Ran ads with photos in three publications promoting the new listing, and the first Sunday open house.
--Collaborated with a professional desktop publisher to design custom marketing literature highlighting the home's unique architectural features.
--Encouraged my clients to buy a home warranty covering their functioning-but-dated mechanicals and appliances, then incorporated that feature into the home's marketing materials.
Note that all those things happened before the first prospective Buyer walked through my clients' front door.
So what happened next? My clients got a strong offer the first two days, which they ultimately accepted after a brief negotiation.
"The harder you work, the luckier you get"
--Samuel Goldwyn
One of the things that can happen when a home sells fast -- like my listing near Lake Calhoun two weeks ago -- is that people attribute it to luck.
Well, actually, no.
I like to tell clients that, to a realtor, a listing is like an iceberg: the part below the water consists of all the things that happen, behind-the-scenes, in the weeks (and often, months) leading up to the home's formally coming on the market.
The part sticking out of the water is what's visible to the public once the home is actually for sale.
In that vein, here is a partial list of things I did in my capacity as listing agent to ensure that my clients' Lake Calhoun home would fetch top dollar, quickly:
--Promoted the home via email to 3,000 Edina Realty agents in early September, to let them know about the home and that it would be coming on the market in early Oct.
--Had the home professionally staged; coordinated with the stager to have the home profiled in the Star Tribune real estate section the week it hit the market.
--Had the home professionally photographed, complete with a virtual tour using streaming photos for people browsing real estate listings on the Web.
--Featured the home on my Web site (http://www.rosskaplan.com/) and this blog.
--Did a mailing (1st class postage) complete with a cover letter and marketing literature to 150 neighboring homes in late September, giving them a "heads up" that the home would be coming on the market in a week, and inviting them to the first Sunday open house.
--Got 50 real estate agents to attend the Tuesday broker open by heavily promoting it beforehand with voicemail and email, and at Edina Realty City Lakes office meetings.
--Carefully priced the home after touring nearby, competing homes; soliciting colleagues' price opinions; and analyzing sales activity and trends nearby the past three years.
--Ran ads with photos in three publications promoting the new listing, and the first Sunday open house.
--Collaborated with a professional desktop publisher to design custom marketing literature highlighting the home's unique architectural features.
--Encouraged my clients to buy a home warranty covering their functioning-but-dated mechanicals and appliances, then incorporated that feature into the home's marketing materials.
Note that all those things happened before the first prospective Buyer walked through my clients' front door.
So what happened next? My clients got a strong offer the first two days, which they ultimately accepted after a brief negotiation.
Sunday, October 19, 2008
All about Commissions
What's Negotiable in Real Estate -- and What Isn't
Everyone seems to know that home prices are negotiable. So it's logical to assume that realtor commissions are, too. Unfortunately, I tell prospective clients, my commission is not.
When I practiced corporate law, my firm billed me out at $185 an hour. Could clients have found a cheaper attorney? Absolutely. Could I discount my billing rate for them? No.
Ditto when I worked as a CPA (although my billing rate was $135 an hour -- I was fresher out of college then, and not a J.D. yet).
Counter-intuitive as it may seem, what really matters when you engage an attorney or CPA is whether they're worth what they charge. I personally know of many attorneys who are a bargain at $250 an hour -- and others who are overpaid at half that.
When you sell your home, what's most important isn't whether you pay your realtor 5%, 7%, 4.5% or some other number -- it's what your home sells for.
When clients hire me, they know -- because I explain all the things I do -- that I'll get top dollar for their home, whatever it is.
Any realtor who can say that and deliver is worth what they charge.
Everyone seems to know that home prices are negotiable. So it's logical to assume that realtor commissions are, too. Unfortunately, I tell prospective clients, my commission is not.
When I practiced corporate law, my firm billed me out at $185 an hour. Could clients have found a cheaper attorney? Absolutely. Could I discount my billing rate for them? No.
Ditto when I worked as a CPA (although my billing rate was $135 an hour -- I was fresher out of college then, and not a J.D. yet).
Counter-intuitive as it may seem, what really matters when you engage an attorney or CPA is whether they're worth what they charge. I personally know of many attorneys who are a bargain at $250 an hour -- and others who are overpaid at half that.
When you sell your home, what's most important isn't whether you pay your realtor 5%, 7%, 4.5% or some other number -- it's what your home sells for.
When clients hire me, they know -- because I explain all the things I do -- that I'll get top dollar for their home, whatever it is.
Any realtor who can say that and deliver is worth what they charge.
Housing Market Cure
How to Fix the Housing Market -- Really!
I never worked for Goldman Sachs, so ipso facto I'm probably disqualified from proposing any solutions to the worldwide financial crisis/credit freeze/housing bust. See, "The Guys From 'Government Sachs'" (The New York Times; 10/19/08).
However, it does seem that, at least at the moment, the government's response(s) are a bit disorganized and ad hoc. So, maybe a little outside advice would be appreciated just about now.
In that spirit, here goes.
Treating Symptoms?
What little consensus there is so far is that falling home prices are at the heart of the financial meltdown. In turn, the housing market's problems are traceable to an imbalance of supply and demand. Solution? Do something -- directly -- to correct that (vs. indirectly, like shoring up banks' capital structure, buying their bad paper, etc.).
Specifically, the government should act to soak up the excess supply of housing.
Once some sort of equilibrium is restored, prices should finally stop falling. Given what's currently happening in the new construction market -- according to the Sept. numbers, absolutely nothing -- it will then only be a matter of time before demand once again outstrips supply, and home prices start rising.
What's the fastest way to help Buyers absorb all the excess supply? Make it cheaper for them to buy a home.
Unintended Consequences
To date, the effect of all the government bailouts and guarantees has been just the opposite.
The credit markets know that trillions in new U.S. debt will create a glut, and are requiring higher interest rates to compensate for that. Result: mortgage rates have climbed steeply from around 5.5% to 6.5% percent since Summer. Way to go, Goldman Sachs alumni.
Since the Treasury is now opening the money spigot, with everyone from Detroit to the state of California lining up (give Ahh-nold credit, literally), why not direct some relief to home buyers? Specifically, create a federal subsidy to temporarily bring the cost of mortgages down to 5%.
While such a program would seem to only benefit current home buyers -- hardly fair -- in fact it would undergird the entire market. Just ask someone whose block has a couple foreclosures on it whether that's affecting their value.
A Modest (12 digit) Proposal
How much would such a program cost? Surprisingly, a lot less than recapitalizing Wall Street.
Last year, about 5 million existing single family homes were sold. If that number gets to 6 million this year, things will definitely be on the mend.
Using an average home price nationally of $200,000, and a 10% downpayment per, means that six million, $180k mortgages would qualify for the interest rate subsidy. Assuming each mortgage subsidy costs $20k, the total package comes to . . . $120 billion.
Compare that to the $250 billion that the U.S. Treasury committed just last week to buy equity in the country's nine biggest banks. Incredibly, that handout came with no strings attached -- not even one requiring the banks to actually use the money to lend to anyone!
I never worked for Goldman Sachs, so ipso facto I'm probably disqualified from proposing any solutions to the worldwide financial crisis/credit freeze/housing bust. See, "The Guys From 'Government Sachs'" (The New York Times; 10/19/08).
However, it does seem that, at least at the moment, the government's response(s) are a bit disorganized and ad hoc. So, maybe a little outside advice would be appreciated just about now.
In that spirit, here goes.
Treating Symptoms?
What little consensus there is so far is that falling home prices are at the heart of the financial meltdown. In turn, the housing market's problems are traceable to an imbalance of supply and demand. Solution? Do something -- directly -- to correct that (vs. indirectly, like shoring up banks' capital structure, buying their bad paper, etc.).
Specifically, the government should act to soak up the excess supply of housing.
Once some sort of equilibrium is restored, prices should finally stop falling. Given what's currently happening in the new construction market -- according to the Sept. numbers, absolutely nothing -- it will then only be a matter of time before demand once again outstrips supply, and home prices start rising.
What's the fastest way to help Buyers absorb all the excess supply? Make it cheaper for them to buy a home.
Unintended Consequences
To date, the effect of all the government bailouts and guarantees has been just the opposite.
The credit markets know that trillions in new U.S. debt will create a glut, and are requiring higher interest rates to compensate for that. Result: mortgage rates have climbed steeply from around 5.5% to 6.5% percent since Summer. Way to go, Goldman Sachs alumni.
Since the Treasury is now opening the money spigot, with everyone from Detroit to the state of California lining up (give Ahh-nold credit, literally), why not direct some relief to home buyers? Specifically, create a federal subsidy to temporarily bring the cost of mortgages down to 5%.
While such a program would seem to only benefit current home buyers -- hardly fair -- in fact it would undergird the entire market. Just ask someone whose block has a couple foreclosures on it whether that's affecting their value.
A Modest (12 digit) Proposal
How much would such a program cost? Surprisingly, a lot less than recapitalizing Wall Street.
Last year, about 5 million existing single family homes were sold. If that number gets to 6 million this year, things will definitely be on the mend.
Using an average home price nationally of $200,000, and a 10% downpayment per, means that six million, $180k mortgages would qualify for the interest rate subsidy. Assuming each mortgage subsidy costs $20k, the total package comes to . . . $120 billion.
Compare that to the $250 billion that the U.S. Treasury committed just last week to buy equity in the country's nine biggest banks. Incredibly, that handout came with no strings attached -- not even one requiring the banks to actually use the money to lend to anyone!
Warren Buffett's Market Call
Do as Warren Does?
Perhaps the most-remarked news in the financial world the last few days -- quite a statement given the current decibel level -- is Warren Buffett's stock market call. On Friday's Wall Street Journal op-ed page, Buffett, Edina Realty's largest shareholder (via his interest in Edina's parent company), famously exhorted fellow investors to step up and buy. Stocks, that is.
According to Buffett, the winning investment strategy is to "be greedy when others are fearful, and fearful when others are greedy."
Judging by just about every metric there is -- the media, the VIX (volatility benchmark), consumer sentiment, etc. -- fear is running quite high. Ergo, it must be a good time to buy, right? Maybe.
Copying Buffett
Before anyone emulates Buffett, however, they should ask themselves three questions: 1) what is my time horizon? (Buffett's is effectively infinite); 2) do I have the resources to weather further market reversals? (Buffett, with a net worth of $60 billion, certainly can); and 3) can I get the same terms as Buffett?
If you're planning on retiring in a few years, sending your teenager(s) to college soon, or saving for a house downpayment, you probably have a very un-Buffett-like, finite time horizon and resources.
Meanwhile, Buffett gets preferential treatment when he invests because . . . he's Warren Buffett. At both Goldman Sachs and General Electric, he is receiving a 10% dividend, indefinitely, on his preferred stock, with warrants to buy more at below-market prices. Good luck trying to get that on your own.
That doesn't necessarily mean Buffett is wrong about the stock market, or that his advice is bad. On the contrary, his main observation -- stocks are historically cheap now -- is almost unassailably true.
My guess is that investors will take Buffett's advice to heart. However, the people heeding his advice likely aren't stock buyers, but would-be Sellers.
The main consequence of Buffet's advice -- and quite possibly the purpose of his op-ed piece -- is to persuade millions of people who are already in the market to stay there (vs. sell, and add to the panic).
Perhaps the most-remarked news in the financial world the last few days -- quite a statement given the current decibel level -- is Warren Buffett's stock market call. On Friday's Wall Street Journal op-ed page, Buffett, Edina Realty's largest shareholder (via his interest in Edina's parent company), famously exhorted fellow investors to step up and buy. Stocks, that is.
According to Buffett, the winning investment strategy is to "be greedy when others are fearful, and fearful when others are greedy."
Judging by just about every metric there is -- the media, the VIX (volatility benchmark), consumer sentiment, etc. -- fear is running quite high. Ergo, it must be a good time to buy, right? Maybe.
Copying Buffett
Before anyone emulates Buffett, however, they should ask themselves three questions: 1) what is my time horizon? (Buffett's is effectively infinite); 2) do I have the resources to weather further market reversals? (Buffett, with a net worth of $60 billion, certainly can); and 3) can I get the same terms as Buffett?
If you're planning on retiring in a few years, sending your teenager(s) to college soon, or saving for a house downpayment, you probably have a very un-Buffett-like, finite time horizon and resources.
Meanwhile, Buffett gets preferential treatment when he invests because . . . he's Warren Buffett. At both Goldman Sachs and General Electric, he is receiving a 10% dividend, indefinitely, on his preferred stock, with warrants to buy more at below-market prices. Good luck trying to get that on your own.
That doesn't necessarily mean Buffett is wrong about the stock market, or that his advice is bad. On the contrary, his main observation -- stocks are historically cheap now -- is almost unassailably true.
My guess is that investors will take Buffett's advice to heart. However, the people heeding his advice likely aren't stock buyers, but would-be Sellers.
The main consequence of Buffet's advice -- and quite possibly the purpose of his op-ed piece -- is to persuade millions of people who are already in the market to stay there (vs. sell, and add to the panic).
Thursday, October 16, 2008
Unintended Consequences
Bailout = More Debt = Higher Mortgage Rates
So much for the calm.
Yesterday's stock market plunge was the biggest, in percentage terms, since 1987. As financial institutions, investors, and government officials alike take stock of events -- and what's likely to happen next -- one quick consequence has been a spike in mortgage interest rates. From around 6% less than a week ago, 30 year rates are now between 6.5% and 6.75%.
What happened?
The money for the federal bailout/bank equity purchases/debt guaranties is going to be borrowed. Trillions (potentially) in new government debt "crowds out" (as economists would say) private borrowing. In layman's terms, all that new supply drives down prices, which is equivalent to pushing up interest rates. (If you were the Chinese government, wouldn't you require higher rates to lend to the U.S. now?)
So the single biggest component in the cost of housing, mortgage rates, is now more expensive, at least temporarily.
So much for lessening the pain in the national housing market, which supposedly triggered all the economy's financial problems in the first place.
P.S.: congrats to Steve Devitt at U.S. Bank, who encouraged my clients to lock last week when rates were 5 7/8%! Nice call!
So much for the calm.
Yesterday's stock market plunge was the biggest, in percentage terms, since 1987. As financial institutions, investors, and government officials alike take stock of events -- and what's likely to happen next -- one quick consequence has been a spike in mortgage interest rates. From around 6% less than a week ago, 30 year rates are now between 6.5% and 6.75%.
What happened?
The money for the federal bailout/bank equity purchases/debt guaranties is going to be borrowed. Trillions (potentially) in new government debt "crowds out" (as economists would say) private borrowing. In layman's terms, all that new supply drives down prices, which is equivalent to pushing up interest rates. (If you were the Chinese government, wouldn't you require higher rates to lend to the U.S. now?)
So the single biggest component in the cost of housing, mortgage rates, is now more expensive, at least temporarily.
So much for lessening the pain in the national housing market, which supposedly triggered all the economy's financial problems in the first place.
P.S.: congrats to Steve Devitt at U.S. Bank, who encouraged my clients to lock last week when rates were 5 7/8%! Nice call!
Tuesday, October 14, 2008
Emergency Heart Transplant
In the ICU, Signs Weak But Stable
The relative calm currently afoot in the financial markets is exactly what you'd expect after major surgery: the financial system just underwent an emergency heart transplant (the Paulson artificial heart -- model A4-271).
That's effectively what Congress' $700 billion bailout of Wall Street just turned into. Instead of buying up the banks' balance sheet-cluttering, toxic paper, the Treasury is now deploying a big chunk of that cash to take equity positions in them. For now, the recipients are the big, name-brand money center banks; eventually, smaller banks will also be brought into the fold.
Meanwhile, the Federal financial life support system continues to function at 100% of capacity (if not more). Witness Treasury's barely-noted directive to Fannie Mae and Freddie Mac to begin buying, ASAP, up to $40 billion in bad mortgages per month; the unfolding (and increasingly expensive) custodianship of AIG; and the government's unprecedented venture into the commercial paper markets.
Mortgage Rates Up
So how are the patient's vital signs?
At least for the moment, that almost seems besides the point: the patient is alive.
Yesterday's 900 point-plus stock market rally would seem to confirm that. However, the new heart's rhythm is weak and erratic, and the weakened patient must now be given potent drugs to guard against rejection (plus lots more units of fresh capital to offset post-operative hemorrhaging).
Danger signs abound, including a still severely impaired commercial paper market; an elevated LIBOR (rate at which banks lend to each other); plus now-rising mortgage interest rates. That last development is precisely the opposite of what's needed to support real estate prices (can you say, "hoarding cash?").
In sum, it's far too soon to declare the operation a success.
Even if it is, the recovery is likely to be slow and drawn-out. Finally, unlike real-life heart transplant recipients, when the patient is sufficiently recovered . . . its new, government-issue heart has to be swapped out. Instead of the old, defective private market one, the replacement will need to be fundamentally redesigned and improved, not just repaired.
The relative calm currently afoot in the financial markets is exactly what you'd expect after major surgery: the financial system just underwent an emergency heart transplant (the Paulson artificial heart -- model A4-271).
That's effectively what Congress' $700 billion bailout of Wall Street just turned into. Instead of buying up the banks' balance sheet-cluttering, toxic paper, the Treasury is now deploying a big chunk of that cash to take equity positions in them. For now, the recipients are the big, name-brand money center banks; eventually, smaller banks will also be brought into the fold.
Meanwhile, the Federal financial life support system continues to function at 100% of capacity (if not more). Witness Treasury's barely-noted directive to Fannie Mae and Freddie Mac to begin buying, ASAP, up to $40 billion in bad mortgages per month; the unfolding (and increasingly expensive) custodianship of AIG; and the government's unprecedented venture into the commercial paper markets.
Mortgage Rates Up
So how are the patient's vital signs?
At least for the moment, that almost seems besides the point: the patient is alive.
Yesterday's 900 point-plus stock market rally would seem to confirm that. However, the new heart's rhythm is weak and erratic, and the weakened patient must now be given potent drugs to guard against rejection (plus lots more units of fresh capital to offset post-operative hemorrhaging).
Danger signs abound, including a still severely impaired commercial paper market; an elevated LIBOR (rate at which banks lend to each other); plus now-rising mortgage interest rates. That last development is precisely the opposite of what's needed to support real estate prices (can you say, "hoarding cash?").
In sum, it's far too soon to declare the operation a success.
Even if it is, the recovery is likely to be slow and drawn-out. Finally, unlike real-life heart transplant recipients, when the patient is sufficiently recovered . . . its new, government-issue heart has to be swapped out. Instead of the old, defective private market one, the replacement will need to be fundamentally redesigned and improved, not just repaired.
Sunday, October 12, 2008
Whose Rules??
Playing By Their Own Rules
As forecast earlier, the mother of all market melt-down's is likely to eventually to turn into the mother of all lawsuits.
Already, it is possible to glimpse what the heads of AIG, Lehman Bros., Washington Mutual, etc. are likely to say in their defense: "we complied with all applicable rules governing accounting, disclosures, etc." Translation: no laws were broken.
Even if that were true -- which is highly unlikely -- it simply begs the question, "who designed the rules?"
Specifically, who lobbied Congress to dissolve Glass-Steagall, the Depression-era law separating investment and commercial banks?
Who lobbied Congress to exempt what may end up being north of $100 trillion in credit derivatives -- Warren Buffett's "financial weapons of mass destruction" -- from any regulatory oversight whatsoever?
Perhaps most reckless and irresponsible of all, who lobbied Congress to allow lightly regulated investment banks to heap on leverage approaching ratio's of 30:1, 40:1, or even 50:1?
Sure, Wall Street firms played by the rules -- they made them!
As forecast earlier, the mother of all market melt-down's is likely to eventually to turn into the mother of all lawsuits.
Already, it is possible to glimpse what the heads of AIG, Lehman Bros., Washington Mutual, etc. are likely to say in their defense: "we complied with all applicable rules governing accounting, disclosures, etc." Translation: no laws were broken.
Even if that were true -- which is highly unlikely -- it simply begs the question, "who designed the rules?"
Specifically, who lobbied Congress to dissolve Glass-Steagall, the Depression-era law separating investment and commercial banks?
Who lobbied Congress to exempt what may end up being north of $100 trillion in credit derivatives -- Warren Buffett's "financial weapons of mass destruction" -- from any regulatory oversight whatsoever?
Perhaps most reckless and irresponsible of all, who lobbied Congress to allow lightly regulated investment banks to heap on leverage approaching ratio's of 30:1, 40:1, or even 50:1?
Sure, Wall Street firms played by the rules -- they made them!
Saturday, October 11, 2008
Great Staging . . Quick Sale!
Textbook Staging + Great Marketing
= Quick Sale
The real estate section in today's (Saturday) Star Tribune features my new listing at 3840 Xerxes Ave. South, just south of Lake Calhoun in Minneapolis:
"Updating, but maintaining 'Frank and Dino' Vibe" (Star Tribune; 10/11/08).
http://www.startribune.com/homes/sell/30685974.html?elr=KArksLckDiUvckDiUiD3aPc:_Yyc:aULPQL7PQLanchO7DiU
The article discusses what my stager, Lori Matzke, did to show off the home's architectural appeal, and accentuate key features like the Living Room fireplace and nearby wall of windows. I'm hardly objective, but the difference between the "before" and "after" photos is startling.
So does staging really work?
The first showings were last Tuesday, and a deal was signed Wednesday night.
Oh, and it might also have helped a little that, in addition to the staging, I took out ads in 3 publications; publicized the home to 3,000 Edina Realty agents weeks before the listing hit the market, and again right before; got 42 realtors to come through the broker open on Tuesday; had the home professionally photographed and prepared professionally designed brochures; did a direct mailing piece to the neighborhood; persuaded the owners to buy a one year home warranty, to address the dated mechanicals; carefully priced the home after spending hours analyzing the market, etc., etc.
= Quick Sale
The real estate section in today's (Saturday) Star Tribune features my new listing at 3840 Xerxes Ave. South, just south of Lake Calhoun in Minneapolis:
"Updating, but maintaining 'Frank and Dino' Vibe" (Star Tribune; 10/11/08).
http://www.startribune.com/homes/sell/30685974.html?elr=KArksLckDiUvckDiUiD3aPc:_Yyc:aULPQL7PQLanchO7DiU
The article discusses what my stager, Lori Matzke, did to show off the home's architectural appeal, and accentuate key features like the Living Room fireplace and nearby wall of windows. I'm hardly objective, but the difference between the "before" and "after" photos is startling.
So does staging really work?
The first showings were last Tuesday, and a deal was signed Wednesday night.
Oh, and it might also have helped a little that, in addition to the staging, I took out ads in 3 publications; publicized the home to 3,000 Edina Realty agents weeks before the listing hit the market, and again right before; got 42 realtors to come through the broker open on Tuesday; had the home professionally photographed and prepared professionally designed brochures; did a direct mailing piece to the neighborhood; persuaded the owners to buy a one year home warranty, to address the dated mechanicals; carefully priced the home after spending hours analyzing the market, etc., etc.
Thursday, October 9, 2008
Financial House of Cards -- But Insured!
Financial House of Cards -- But Insured!
Question: What do you call a financial house of cards that's insured?
Answer: an even bigger financial house of cards.
Just as portfolio insurance was fingered as a prime culprit in the 1987 stock market crash, another kind of insurance -- against credit defaults -- is rapidly emerging at the center of today's unfolding stock market crash and spreading global financial crisis.
But first, the house of cards.
It's no secret that Wall Street leverage reached unprecedented heights the last few years. Unlike regulated banks, which are allowed maximum leverage of about 10:1, investment banks like Bear Stearns, Lehman Bros. and others staked out positions levered at 30:1, 40:1, or more.
To illustrate what extreme leverage does to investment returns, imagine the consequences of buying a $1 asset with leverage approaching 50:1.
To translate, 50:1 leverage means that you are buying a $1 asset with two cents of your own money and 98 cents debt. If the asset even goes up a modest amount, to say, $1.05, you've done enormously well: your two cents has turned into seven cents -- a return of 350%!
However, consider what happens if the $1 asset drops to 95 cents: you're wiped out.
As long as housing kept rising, the former scenario held and Wall Street made fabulous amounts of money. However, housing nationally peaked more than two years ago, and has been falling ever since. Wall Street is now very much on the wrong side of that double-edged sword.
"Honey, I blew up the financial system"
Exacerbating matters exponentially is what Wall Street firms did to reduce the risk of a downturn.
Mindful that it was building a financial house of cards, Wall Street wizards, in their infinite wisdom (and cupidity), decided not to design a more stable financial structure, but, incredibly, to conceive yet another financial instrument, this one designed to protect against collapse -- or at least the horrific fallout from a collapse.
Called "credit default swaps," these insurance instruments were supposed to make the firms lending 98 cents on the dollar whole should the borrowers ever default.
In fact, credit default swaps became so popular that they became a way to speculate on almost any outcome, financial or otherwise: some economists estimate that, in a $50 trillion world economy, the amount of outstanding credit insurance instruments totaled as much as ten times that. Even better, the premiums on credit default swaps represented an important revenue stream for insurers like . . AIG.
So no more house of cards, right? Wrong.
It turns out that the companies writing the insurance had a small fraction of the reserves needed to make good on all their commitments. Voila! The financial kings suddenly have no clothes. Or capital. So they need ours -- a lot of it, and very quickly, please.
What does that ultimately mean?
Instead of acting as a bulwark against market collapse, that potentially $500 trillion of credit default swaps became the biggest financial card of all in Wall Street's now very much collapsed deck.
As Warren Buffet might put it, it appears that Wall Street's "financial weapons of mass destruction" are now detonating. The punctured housing market simply lit the fuse.
Next post: redesigning the system.
Question: What do you call a financial house of cards that's insured?
Answer: an even bigger financial house of cards.
Just as portfolio insurance was fingered as a prime culprit in the 1987 stock market crash, another kind of insurance -- against credit defaults -- is rapidly emerging at the center of today's unfolding stock market crash and spreading global financial crisis.
But first, the house of cards.
It's no secret that Wall Street leverage reached unprecedented heights the last few years. Unlike regulated banks, which are allowed maximum leverage of about 10:1, investment banks like Bear Stearns, Lehman Bros. and others staked out positions levered at 30:1, 40:1, or more.
To illustrate what extreme leverage does to investment returns, imagine the consequences of buying a $1 asset with leverage approaching 50:1.
To translate, 50:1 leverage means that you are buying a $1 asset with two cents of your own money and 98 cents debt. If the asset even goes up a modest amount, to say, $1.05, you've done enormously well: your two cents has turned into seven cents -- a return of 350%!
However, consider what happens if the $1 asset drops to 95 cents: you're wiped out.
As long as housing kept rising, the former scenario held and Wall Street made fabulous amounts of money. However, housing nationally peaked more than two years ago, and has been falling ever since. Wall Street is now very much on the wrong side of that double-edged sword.
"Honey, I blew up the financial system"
Exacerbating matters exponentially is what Wall Street firms did to reduce the risk of a downturn.
Mindful that it was building a financial house of cards, Wall Street wizards, in their infinite wisdom (and cupidity), decided not to design a more stable financial structure, but, incredibly, to conceive yet another financial instrument, this one designed to protect against collapse -- or at least the horrific fallout from a collapse.
Called "credit default swaps," these insurance instruments were supposed to make the firms lending 98 cents on the dollar whole should the borrowers ever default.
In fact, credit default swaps became so popular that they became a way to speculate on almost any outcome, financial or otherwise: some economists estimate that, in a $50 trillion world economy, the amount of outstanding credit insurance instruments totaled as much as ten times that. Even better, the premiums on credit default swaps represented an important revenue stream for insurers like . . AIG.
So no more house of cards, right? Wrong.
It turns out that the companies writing the insurance had a small fraction of the reserves needed to make good on all their commitments. Voila! The financial kings suddenly have no clothes. Or capital. So they need ours -- a lot of it, and very quickly, please.
What does that ultimately mean?
Instead of acting as a bulwark against market collapse, that potentially $500 trillion of credit default swaps became the biggest financial card of all in Wall Street's now very much collapsed deck.
As Warren Buffet might put it, it appears that Wall Street's "financial weapons of mass destruction" are now detonating. The punctured housing market simply lit the fuse.
Next post: redesigning the system.
Saturday, October 4, 2008
Anger as a Negotiating Tactic
"I never lose my temper -- I always know where it is."
--Senator Ted Stevens (R-Alaska)
Besides generally lower prices and longer market times, another hallmark of today's housing market can be more strained negotiations between Buyers and Sellers.
Sellers -- especially those who bought recently -- are often dismayed to hear what their house is likely to fetch. First, their realtor tells them. Then, once the house is listed, prospective Buyers may weigh in with -- to be charitable -- offers that can discount even more.
Meanwhile, Buyers are worried about selling their own homes, as well as about making a big financial commitment in uncertain economic times. In their eyes, (some) Sellers' prices reflect stubbornness and denial.
Enter the realtors.
Just as people vary in how emotional they are, so do realtors. An emotional client, represented by an emotional realtor, can be an especially volatile combination.
In my experience, anger can -- occasionally -- be a strategic tactic in negotiations. When one party overplays their hand, or stakes out a too-aggressive position, the appropriate response sometimes isn't just "no," but "Hell, no."
Well-delivered, such a parry can serve to reassert control, (re)establish boundaries between the parties, etc. The downside of anger is that it can elicit a similar response from the other side, causing things to quickly deteriorate.
So the trick is to use anger without being angry. Once it has served its purpose, it is important to quickly turn down the heat.
--Senator Ted Stevens (R-Alaska)
Besides generally lower prices and longer market times, another hallmark of today's housing market can be more strained negotiations between Buyers and Sellers.
Sellers -- especially those who bought recently -- are often dismayed to hear what their house is likely to fetch. First, their realtor tells them. Then, once the house is listed, prospective Buyers may weigh in with -- to be charitable -- offers that can discount even more.
Meanwhile, Buyers are worried about selling their own homes, as well as about making a big financial commitment in uncertain economic times. In their eyes, (some) Sellers' prices reflect stubbornness and denial.
Enter the realtors.
Just as people vary in how emotional they are, so do realtors. An emotional client, represented by an emotional realtor, can be an especially volatile combination.
In my experience, anger can -- occasionally -- be a strategic tactic in negotiations. When one party overplays their hand, or stakes out a too-aggressive position, the appropriate response sometimes isn't just "no," but "Hell, no."
Well-delivered, such a parry can serve to reassert control, (re)establish boundaries between the parties, etc. The downside of anger is that it can elicit a similar response from the other side, causing things to quickly deteriorate.
So the trick is to use anger without being angry. Once it has served its purpose, it is important to quickly turn down the heat.
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