Monday, 14 April 2008

But What of The Viking Range?

This is me clearly thinking more about how well the team has been doing rather than the crap I write about below.

Warning: long. I haven’t spelled out any of my doomsday theories in a while so I thought I’d pose a question I’ve been flipping over in my head for a while and take a dive into the next boogeyman in the closet. After a nice weekend of racing it’s always good to explore the dark side of current events.

First off, Mrs. Wagon and I enjoyed a lovely trip to Sushi-ko's new Friendship Heights outpost on Saturday soir. They haven't ironed out their deal quite yet, and it sucks to sit down to what you know will be an expensive dinner and be seated near a bunch of little kids, but the food is top notch. The soft shell crab appetizer is a more than adequate replacement for their much-loved yet much recently changed for the worse soft shell crab roll. I could also eat crunchy shrimp rolls until I myself crunched.

Buried somewhere in all of the grim housing news is a seemingly forgotten fact: investment in home improvements had an incredible run in the last 4 or 5 years. This is based on the simple and accurate survey technique of counting dumpsters and porta crappers on residential streets. In neighborhoods from the hippest to the zippest, you couldn’t go four houses without hitting either of these sure signs of a home equity loan.

The problem that this causes, in addition to its having contributed even more to the artificially swollen contract capacity of the last half decade, is that baseline values for home prices are impossible to identify. Say you bought a home in 2000 for $250,000 with 10% down. You paid the note (mostly interest at the outset of the loan) for two years and then after they started giving money away and home prices started to go up pretty quickly in 2003 you said “the old homestead sure could stand some improvements,” and went out and did a whole bunch of stuff. Let’s say you replaced some windows (hopefully the new ones are low-E glass and all that good stuff), finished the basement and put in a nice bike workshop (have to stay on topic here) and also put in a nice new kitchen with redone cabinets, granite countertops and stainless appliances. You spent $40,000 on the kitchen, $5,000 on windows and $2,000 on the basement, which you paid with a home equity loan of $60,000. You spent the rest on a vacation.

When you took out the loan, your home was valued at $320,000. Your down payment and appreciated home value gave you $95,000 of equity in the place, and the improvements would appreciate the price even more than what they cost. You figured by the time it was all done you’d have a home worth $375,000, on which you owed $285,000 (purchase price plus home equity loan, minus down payment). As the housing market continued to heat, you started to see comparable homes to yours listing for over $420,000. Things were good.

By now I think we all know that housing prices went based on faulty premises – too much easy access to credit for unqualified consumers, too much money being speculatively invested in housing, etc. So strip away the “speculative increase” of your home’s value, give yourself a very fair (in current climate, quite generous) 5% annual price appreciation and your home, based on being in the same shape as it was when you bought it in 2000, would be worth about $350,000. Not too bad, but what of the Viking range?

You spent $60k on home improvements, so your cost basis for the house is fundamentally $310,000. The key thing to our hypothetical homeowner above is that he’s still “ahead” of the game. He doesn’t have to short sale his house to move. A lot of people went further than our example and are pretty royally fooked.

What should the house be worth given the improvements? This isn’t a rhetorical question, I have no idea what the answer is. Maybe the remodeling boom will have lasting value. Certainly any energy efficiency related improvements are looking a lot smarter than ever, but what of the cosmetic or life style improvements? Is the market going to be able and willing to pay for those? Does the universal house (aka the "splanch" or split level ranch) really need a professional chef's kitchen? Was the American housing stock so badly in need of all of this fancy remodeling that got done, or is it now a bunch of Schwinn LeTours with Record 10 component groups and Zipp wheels?

In the 80’s, the venerable institution that is Lloyd’s of London nearly failed. This was based on derivative insurance, or reinsurance. Reinsurance isn’t a bad thing of itself. It insures insurers against enormous losses. The problem is that with each layer or reinsurance you put on, you take out some of the premium that is available to pay back losses when you pay the broker’s commission. So when people got a little too smart for themselves and reinsured the living bejeesus out of everything down to granny’s tea kettle, they wound up with too many commissions paid and not enough premium to handle the spate of losses that occurred. This is a part of the big danger of the next thing you are going to hear about, which is credit default swaps. These are basically insurance policies that people traded against credit defaults. Not only were they bought and sold and commissions paid on them, they were traded like commodities. In true Wall Street style, all of the meat got stripped away to pay for ridiculous executive compensation and there are just bones left over to cover the very real credit losses which are mounting by the hour.

PS - If you have any interest in business and history, there are a lot of books about Lloyd's which are unbelievably interesting. To this day, my all time top number one job I'd most like to have is a Lloyd's underwriter. No bullshit. Gambling but way more fun than a casino, by many factors.


fabsroman said...

For those that did home improvements, I hope it is because they planned on staying in the home for quite a while. In this kind of market, about the only thing that home improvements will do is sell your house quicker than the neighbors, but not necessarily for more money. Plus, what one person likes, the next might not.

My wife and I bought a townhouse for $333,000 four years ago and we put another $30,000 in improvements and probably $30,000 of my sweat and broken back into the place. In this market, I seriously doubt we will get it back. We had planned on staying here 7 years when we decided to do the improvements, but now we are hoping to move before we hit year 6.

I represent a couple of home improvement contractors and they are having a tough time of it now.

What I have seen in the last 3 months of preparing taxes is rather scary. A real estate agent had a $40,000 NOL for the year, and with itemized deductions that are not part of the NOL he had a negative cash outflow of $70,000. Another couple refinanced their $400K home to pay off $95K in credit card debt. A 55/54 year old couple has 28 years remaining on their $260K mortgage and they make $40K a year and have nothing saved for retirement. I've also had two clients approach me about bankruptcy, which I don't handle, and the reason for their being in such trouble is because they didn't believe me when I told them the economy was eventually going to slow down and they should start putting money away for when it happened.

The only question is how long is this going to last, who is going to weather the storm (i.e., grasshoppers versus ants), and who is going to come out ahead.

GamJams said...

If you see the price of Viking Ranges start to freefall as well, you be sure to let me know.

Jim said...

The one upside to home improvements is if you're stuck in a somewhat underwater equity situation, and you're in a nice home, life isn't bad. One part about the bubble that is really overblown, is most people are doing just fine making their mortgage payments. Even if they've cashed out hard (dumbbbbb) or bought on low/no downpayment, they have a place to live and will build equity given some time. That isn't a terrible thing, provided they don't piss the equity away on Hummers, Escalades, and other fatuous purchases. (Oh, I see so much of that...)

A lot of the bitching, in other words, is coming from the speculators who were counting on an ever-growing bubble to keep growing the ever-growing bubble. The builders, banks who pushed the limits, and people who accepted really crummy loans (e.g. exploding ARMS) based on the premise that home prices would keep going up 15-20% per year.

Not all marginal loans were bad. My wife and I missed the window to buy at a reasonable price in this area so building up a substantial downpayment wasn't going to be possible. We agonized over it for a year, sure that the housing market was a bubble, and bought in our area when prices dropped 10-15%. We got a low downpayment loan, but it was a 30 year fixed at a reasonably low rate. As first time buyers with a low downpayment, I guess we were marginal borrowers, in spite of good jobs & credit. Prices in the neighborhood have remained pretty steady since then (great schools, older brownstone neighborhood in Crofton) and we've used the minimal equity in the house to eliminate consumer debt and to start to do necessary repairs, and with sweat equity some luxury upgrades. (It *really* puts luxury features within reach if you learn how to do your own minor plumbing work, how to tile floors, wire lights, things of that nature). So we're probably right about at 0 equity or just a little better than that, but our mortgage payment is quite reasonable, we don't mind being "stuck" in a nice neighborhood for a few years, and even if the market doesn't start rocketing up (a fair chance out there given Base Realignment And Closure changes to Ft. Meade) we will have a decent place to live for 5 or 10 years. And the post-law-school decimated credit rating I had is looking swell, banks are trying to throw cheap money at us to buy a much bigger place, but I think we'll stick where we are for now until we can move on with some equity in hand.

The point being some of the loan programs being talked down as eee-vil are actually pretty beneficial if you use them right. I think the problem is a lot of people had very unrealistic expectations of the market, dreams really, and now they've been burned they want somebody else to bail them out. Gambling that a 10 year bull housing market will continue indefinitely and then asking for taxpayer bailout is like going to Vegas, losing your ass, then asking the casino for your money back. That isn't how it works.

jim e said...

Good Read. Is this what my county is in deep dookey over (credit default swaps)? Jefferson county, Al. is near Bankrupcy on 4+ billion. Great run up today on the street. Why? 115$ oil. Is the market feminine? Do any of you ride bicycles for A to B transport? Might be worth thinking about. The Spring Classic is the next event for me:

Cullman Cycling Club Presents:

7th Annual


It’s a party with a 50 mile bike ride!

St. John Farm 2:00

Jerseys and Helmets Required


Route includes two main climbs with KOM awarded at top of second. Short route option only includes one climb and meets at the KOM finale

Long route – depart 2:00, 50 m.
Short route – depart 2:15, 35 m.