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.