Seth Chalnick's  Instablog

So this weekend, like many of you SA fans, I was reading some articles, logging some comments, and cheering and booing alternatively with the small voice that is my thumbs… when I came across this submission by Reggie Middleton, entitled “Banking Sector: Worst Is Yet to Come”.

The bulls and bears were trading punches over the strength of Reggie’s stimulating argument, whereupon I delivered a somewhat lengthy, extremely bearish left-hook from another (real estate-centric) perspective, which remained unchallenged throughout the thread.

Then, further down the line, a commenter with the handle “dragonpaw” made reference to my post and only half rhetorically asked what in the world am I thinking by continuing to serve in a REALTOR capacity, in light of my somehow missing the ascot-wearing-schmoozey-agent prerequisite, and calling as I do, for an imminent correction to an over-engineered head fake? He also expressed surprise at my willingness to add fuel to the fire.

Dragonpaw, I take your question as a resounding compliment.  Truth is I DID consider a career change before the subprime collapse, where I am on the record as having predicted it, and then again afterwards, when I realized even though I was smart enough to predict it, that I wasn’t smart enough to capitalize on it…  and once more, about a year ago, when I went on record as predicting the future prime collapse.

This year I have been “falling up”… tracking to earn near “boom-time” profits, but working three times harder, and struggling everyday to act out of integrity in the face of blatant stupidity, mass hypnosis, and ruthless competition.

But I’m good at what I do… I love what I do… and btw, in case you haven’t noticed, unemployment is pushing approximately 20% these days, so it’s not like there are many alternatives.  There’s a silver lining to being a free market capitalist type:  I might not make any money… but at least no one can fire me!

Truth be told, my blatant honesty isn’t going to “add fuel to the fire”.  First, the fire is already raging.  And second, nobody seems to listen to me anyway, except for people of like opinion.  But if I can help a few people who aren’t as insulated as they think, to sell a little quicker, for a little less than they had hoped, a little earlier, so that they don’t catch a falling knife later, then there’s some value in that.

And if people look back on my public messages and private advice, with appreciation for separating advice from commission, even as the overwhelming majority took solace in the lukewarm justification of technical statistics and comforting rhetoric… then I will still be in business on the other side of this mess.  And more importantly I will look back with a clean conscience.

Furthermore, right now there is nothing free about this market.  This year 80% of San Diego homes sold for less than $500k.  Currently 57% of all active homes in San Diego are priced higher than $500k.  Last year we had a record number of foreclosures.  Since then, we have only had an increase in loan defaults.  Loans are actually defaulting now at an increasingly faster pace.  And yet inventory is down, not up.  And sales volume does not come close to absorbing the "shadow inventory".  Believe it or not, as a Realtor I am not automatically immune from becoming sick when listening to party line misrepresentation of statistics.

The banks have not been putting their non-performing assets on the market, and they are piling up.  And yet, there is precious little supply on the lower end, where it potentially makes intrinsic sense for certain well qualified buyers to step in on a case-by-case basis.  And there is no demand on the higher end for either the houses that are about to get their value cut by a fundamental correction of another 30%... nor the financing that underpins their transactions.

So as far as I’m concerned, let the government and the banks (what’s the difference anyway?) get what they have coming to them.  Let’s clean house, get through the chaos, and start building value again where there’s value to be had.  The days of smoke and mirrors are behind us.  It’s just a matter of time until Wall Street catches up to this new reality.  We are fast approaching another six-month period where there won’t be enough credit or reasonably priced supply to get any deals done anyway.  Better to take our medicine sooner rather than later, and get on with it, so we can finally put this “other shoe dropping” argument to rest.

I know I’m ready.  I’ve been practicing what I preach for a long time.  I figure this is why I’m still in business while about 75% of my competition is not.  And I know my fellow free market advocates on Reggie’s thread, and other threads like it, are up to the challenge.  And this is a good thing, because the rest of the country is going to need some strong shoulders to carry our sorry selves out of this next crisis.

When people talk about optimism as a method to push through fundamental problems, I think they’re acting out of cowardice.  But when they are ready to be optimistic about what value they can personally create to effect positive change AFTER they see reality for what it is… then I guess we’ll have more reason to take them seriously.

Hey dragonpaw, one of your thumb’s ups came from me.

Disclosure:  long VIX calls, long JPM puts

Last year we had an unprecedented number of foreclosures. Since then loan defaults have only increased. And yet inventory is down, not up. Sales are up, but only compared to last year. They in no way account for these record defaults.

The recent increase in real estate prices has been focused on lower end homes only. Higher end homes are in a flat out stand still. Meantime, the volume on the lower end is anemic. The inventory is at about 10% of where it would normally be and about 1/500 of where it should be.

All this talk about the "real estate bottom" really only pertains to the lower end market, whose technical signs of improvement are being taken grossly out of context.

As far as the technical improvement is concerned... real estate isn't as seasonal as people think. Folks buy homes when they're ready financially, not when the kids are out of school. The $8k stimulus is helping a bit, but the real help is coming from artificially low rates, and even more artificially low inventory. This is creating a temporary buying surge and it can only last so long.

From a fundamental perspective, there is simply no answer for the tens of thousands of loan defaults that sheepishly exist as non performing assets on the phantom balance sheets of the bankernment. And there is virtually no mortgage market for homes above $800k. The prime market is not comprised of folks who are "better insulated". It is comprised of folks who haven’t been tested yet. The 5yr rate resets are just starting to come online now, and people are starting to default again in droves. If a borrower's rate reset stays effectively close to the same rate they originally locked, then the p&i payment shock (from i/o) increases about $1,000/mo on an $800k mortgage. If rates tick up, look out below.

If people think $300 shopping mall coupons have a stimulus effect, just wait for its reverse (times too many)... when the real drivers of our economy start to lose their homes to foreclosure.

The prime reset bucket is… about three times the magnitude of the suprime reset bucket, which... contrary to popular opinion… has not been dealt with… at all. Its been swept under the rug via mark to market switcheroo and shadow inventory holdback.

Btw, the prime reset wave is not limited to the higher-end market, but also encompasses the lower end market too, which folks mistakenly discount as being baked into the subprime collapse. Many lower end homeowners had 5yr i/o’s too.

Also, by "prime"... I do not mean option arm's. I mean option arm's, alt A, and yes, prime too. Remember Fannie and Freddie? They were rated AA the week before they crashed.

And what about the derivative situation? I remember thinking that the stock market didn’t bake them into the equation until the subprime loans actually defaulted. Since the market didn’t predict this and it nearly collapsed the entire world financial system… is the market so smart that it already factored in the prime defaults?

I know a guy who left his home two years ago because he thought it was going to be foreclosed upon. He just got a call from the lender who apparently has been trying to track him down. He still owns the home and didn’t even know it. He assumed it was re-sold, because he noticed that someone else… is LIVING there.

This scenario is more commonplace than the public realizes. This is the wake of the supbrime. Prime has not even started yet.

As Dow approaches 10,000, all I can think about are VIX calls.

Disclosure: long VIX calls.