IGNORANCE AND LEVERAGE.

"When you combine ignorance and leverage you get some pretty interesting results." Warren Buffet.

Happy Days Here Again? Certainly we all feel better now that the Dow Jones average is above 9,000. There is also some good news in the real estate market that shows the precipitous drop in the housing market is slowing. It can't be denied that this is good news; however, I don't share the optimism of those who are predicting 15,000 in the Dow. What I think might be happening is that the markets are starting to recover from the drastic combination of ignorance and leverage and the rush to de-leverage. Earlier this year, hedge funds had to sell into an extremely weak market in order to pay off huge amounts of leverage which had come due. This pushed the price of many solid companies below fair value as sellers far outnumbered buyers in the marketplace. While this may not be over, it has certainly slowed down. Residential real estate has performed similarly as over-leveraged families found themselves with mortgages they could no longer pay.

What Happened to Government Efforts To Help Families Avoid Foreclosure? These efforts simply haven't worked. Despite the emergence of "Loan Modification Companies" and attempts by major lenders to hire extra labor force to handle the huge demand for loan modifications by troubled borrowers, the foreclosure rate remains high. In almost 50% of the cases where loans have been modified to cure default, the borrowers re-default within a year of the modification. Why is this the case? One of the main reasons is that it may be in the borrowers best interest to default if the mortgage far exceeds the property value. Of course, the benefits are often short term, but it appears that we have become a society focused on short-term benefits. A home owner who owes $200,000 on a house worth $150,000 can skip three or four mortgage payments during the foreclosure process and have the money to move and an immediate $50,000 improvement in net worth after the process is complete. The damage to the borrowers credit report and the trauma of moving the family to a rental is often deemed worth it to the borrower with a large negative equity. Again, this illustrates what happens when leverage and ignorance is combined. Of course, the combination s a two way street as lenders exhibited the same ignorance as borrowers when they financed 100% of the value of a property with little consideration given to the borrower's ability to pay.

The Housing Market Will Cure Itself. Builders are producing very little new housing inventory since buyers can buy cheaper than builders can build. Building activity has slowed to a crawl and existing housing inventories are shrinking. This cycle will continue until supply and demand is brought into balance. This is a regional phenomenon and some areas, like Colorado and Texas will rebound quicker than others. Many local governments, eager for revenue, can slow this process by adding more development and water tap fees for builders, making it more expensive to build new houses. The difference between real estate costs in high affordability states (like Texas) and low affordability states (like California) is often largely a result of high governmental fees charged to builders and developers.

Back To Colorado. Next Monday, I will be flying to Denver with the main objective of solving some problems with real estate I own. I am always eager to make time to visit with clients and friends. Call Susan at 720-449-0200 to get on the list.