Historically at the end of 2006 and beginning of 2007, the housing market had shown clearly demonstrable signs of cooling off but by no means a burst of a bubble, at least, not as of this writing. According to Associated Press, 11/20/2006, the National Association of Realtors said sales of existing homes fell in 38 States and the prices of homes slid in 45 Metropolitan areas.  According to the Census Bureau, housing starts plunged nearly 15% to a seasonally adjusted annual rate of 1.49 million in October 2006 from a revised 1.74 million in September 2006. If the housing "bubble" were to burst there would be a few warning signs.  The initial signs of that would be one of a slowing, cooling off.  This would also be consistent with a normal, market correction. These would be the signs to look for:  1. The amount of time that a house stays on the market before being sold (marketing time or days on market DOM) rises. This would be compared to the same period last year and last quarter to get an effective trend.  2. There would be an increasing difference between the "asking" price and the ultimate "selling" price.  At the height of the market, the 'selling" price was sometimes even higher then the asking price.  When the market begins to soften or worse collapse, the differential gets larger; the selling price is less than the asking price and 3. Finally prices begin to fall. This has been happening throughout  the year.  This would be a normal market correction. A "bursting of the bubble" would be substantially more pronounced and continue for a long period of time. More on this subject later.

 Historically, the Stock market in 2003 was about 10,450.  Throughout December 2005 it was about 10,650 - 10,750.   Equity appreciation in the stock market was not the place to be prior to 2006. With Year 2006 that was going to change.  With historically low interest rates and a less than appealing stock market, no wonder real estate had a few banner years prior to 2006. The stock market as measured by the Dow Jones Industrial Average was up 16% for the year.  The S&P was up 14% and the NASDAQ was up 9.5%  

 Real estate taxes continue to be an issue on Long Island.  They have continued to rise.  People’s first reaction is to blame the assessor.  However, the assessor’s role is to “allocate” the tax burden based upon the Fair Market Value of the properties in the assessor’s jurisdiction.  Real estate taxes are set by the operating budget of the County, Town and School.  School taxes are a major issue and unless that is gotten under control, real estate taxes will continue to rise. Increased State aid would be beneficial.  Unfunded mandates contribute to this.  To reiterate, County Executive Thomas Suozzi, way back in his inauguration  speech in 2006  has made addressing the issue (reducing) school taxes a top priority in his administration.  He indicated that it is a substantial drain and burden on the majority of the people of Nassau. His plan is based around "fixing Albany" which imposes unfunded mandates which immediately cause tax increases, getting more school aid and looking more into how the school budget itself could be reduced. On the whole these budgets have continued to rise, decade over decade well in excess of the rate of inflation. Real estate tax refunds as a result of over assessments continue to be a problem.  The current administration wants to return to the previous practice of "bonding" the refunds.  This issues of the "school" tax still have been avoided politically and "legislatively". In Nassau County these taxes represent almost 70% of each tax dollar. I recently did an appraisal of a small, strip shopping center on Merrick Road in Valley Stream. There was a 2,400 square foot store in the middle of the building available for rent.  It is vacant and has been for well over a year.  The asking rent, as per an interview with the owner, is $30.00 per square foot gross of which $12.00 per square foot is for the base year real estate taxes. I estimate that in order for the tenant to "make money" at this location, the "economic rent" can't be more than $20.00 per square foot.  This leaves an $8.00 per square foot rate of return to the landlord, given the $12.00 real estate tax component.  Given the recent purchase price of the property, the cash on cash return to the equity position in in the negative.  If you adjust the purchase price ( value ) to show a competitive rate of return to the equity position given today's interest rate environment, it shows that the landlord overpaid for the property by at least 25%.  ( Yes, all of the other tenants are re-negotiating their lease terms).

  

2008 REAL ESTATE  MARKET FORECAST

Best Investments:  Real Estate, except for housing in particular for sale housing,  and very select stocks will outperform all other competitive investments however the fundamentals and the attention to present value must not be ignored of any type of property or stock. This is the second  time in the 20 years of forecasting that I haven't recommended housing as a best investment. The only other time was last year.

Since housing effects all of the readers; we have a residential mortgage crisis that will have world wide negative implications; residential housing was forecast to decline in the 2007 Annual Real Estate Market Forecast, it will be addressed first in the 2008 forecast along with the "mortgage crisis" ( the what, why, where and how to fix it) along with historical "look backs" on the housing market.

The rest of the forecast will appear following.  In the addenda, will be related items of interest, historical information such as : Questions from the readers along with the answers, World's Tallest Buildings, Long Island Railroad - Plane to the Train and East Side of Manhattan Access, Historical figures for the Dow Jones Industrial Average, Prime Rate.

 

Housing:                         PREFACE

                                                             

                                                Catastrophic news about the housing market, the mortgage crisis and the dire economic impacts, locally and nationally, are everywhere.  This aspect of the economy effects everyone. What has happened in the past year and projected forward for 2008 and beyond effects everyone's economics, "feeling of wealth", finances and view of most peoples' largest asset. Two powerful forces are at work ( mortgage financing and investor confidence).  These two forces have been sharply effected negatively and somewhat suddenly.  The ramifications have the range from a complete financial disaster to a benign blip on one's financial statement. But for 2008 going forward, how can these two, powerful forces, their somewhat complex, but demonstrable interactions with the economy, real estate market, "feelings of wealth" be described, defined and explained in such a way that is simple enough to be understood and acted upon by most, but yet sophisticated enough so that economic policy, financial decisions and every day living decisions be rationally assessed and made. Factors such as "economic multipliers" for example, compound the effects, either positively or negatively, of a change in the value of residential houses or the number of houses being build. I don't want to make this explanation complicated but I think we all know what I mean.

                                                Please note that in my 2007 Annual Real Estate Market Forecast, I did correctly forecast a downturn in the residential real estate market. I also forecast that the Dow Jones Industrial Average would close at 13,150.  It actually closed at 13,264.82.

                                              Who is to "blame"? I have been asked to specifically "name" people, parties, institutions responsible for this catastrophic economic and social situation.  I won't disappoint the readers of this forecast, but it will be done in a responsible way.  So to start, who is to blame? To answer that, lets look at "what" could be the cause of the blame and move from there.

                                                There are a number of "factors" or "inputs" in my real estate market model as there is in the "learned" colleagues' models throughout the United States and the world, both in banking, government and industry. I'm not going to create a Ph.d thesis here, but the ones we are going to pay attention the most, will sound "simple" but will have enormous current and future implications.  All will be carefully defined, complex inter-relationships explained, illustrated, quantified in the appropriate sections of this forecast that follow.  In that process, the "players" will be clearly uncovered for the reading audience.  What are these factors: 1. Mortgage Interest Rates, 2. The Change in availability of Mortgage financing, 3. The Change in Investor or Consumer Confidence.

                                                Were the "players" guilty of a crime? Just doing their jobs?  This aspect of the forecast, as it the entire forecast, an objective, unbiased description of events and a prognostication of future outcomes.  Please remember, all of the three above mentioned factors will be analyzed in the context of our current economic system, which can be casually described as a "free" market economy in which every one is acting in their own self-interest to basically make maximum money ( by using their talents: land, labor, capital, entrepreneurial knowledge, understanding of market forces) while trying to limit their risk.  I will later point out to you something done by one of the "players" that was the catalyst of the "mortgage crisis". You will be shocked, as I was when you discover what is was and who it was.  No, it was not some people cheating on their mortgage applications.

                                                Before we go into the forecast, a few news articles and statistics to set the tone. In a Wall Street Journal article 11/13/2007, it show that housing starts have declined from 2.3 million (estimated from graph appearing in article) to 1.35 million ( estimated from graph appearing in article) in late 2007. It also showed homeowner vacancy rate climbing steadily from 2006 through 2007.  Note these figures are national.

                                                On the front page of a special report by NEWSDAY, 11/11/2007 with follow ups, the headline read, The Loan Crisis -  Your home is no longer a cash machine. - The squeeze on your wallet, your life and the Long Island economy.  In this article, graphic examples of the negative fallout of the sub-prime lending on individuals were portrayed.  Some of the predatory lending practices were initially profitable, the articles were horrific in their portrayal of the dire economic circumstances the borrowers ( and millions of others like them) are now in. By example and inference, the severe, local, national and global impacts were also described. Some of the bullet points - In 2006, 1/3 of all loans on Long Island were sub-prime a total volume of $8.5 Billion. It went on to describe in detail the geographic areas. - with housing prices falling, it estimated that it would take over a year to sell the existing inventory of houses.

                                                Historically, In a New York Times article heading August 6th, 2006 reports that inventory is soaring, buyers taking their time and sellers lowering their sights. Inventory is up across the board.  More on this later. An article earlier on in the year by Newsday, 4/18/2006 headlines that the housing market pace is slowing.

                                                Current statistics and information; according to the Mortgage Bankers Association, as reported by Newsday, 12/72007 the following major housing statistics for the 3rd Quarter are presented.

                                                  1. There were 45.4 million new mortgages nationally of which 5.6% are delinquent  ( 2 million for New York State while 5.3% are delinquent and 1.6% are in foreclosure).

                                                   2. Sub-prime loans nationally, 3.2% are delinquent, 0.7% are in foreclosure while in NYS 13.8% are delinquent and 6.9% are in foreclosure.

                                                   3. More talk on "help" but none of the plans address the masses of mortgages

 

                                                                                                

THE RESIDENTIAL REAL ESTATE MARKET FORECAST - With the explanations and rational to follow. This includes a complete description and analysis of the mortgage crisis, how it effects the housing markets locally, nationally and its impact on the world markets.                            

Current statistics from the Multiple Listing Service of Long Island, whose REALTOR members and broker affiliates, handle over 95% of all residential sales report the following median prices. An important item not reported was the change in DOM ( days on the market).  From a valuation stand point, this factor can consistently point to a direction or a change in direction of prices.

Long Island

COUNTY            Median Price- 1 year ago                Median Price - October 2007                    Median Price - November 2007

Nassau              $485,000                                              $474,000 (down -2.27%)                        $461,500 (down-2.64%)

Suffolk                $395,000                                               $385,000(down -2.53%)                        $387,300( up .59%)

Queens               $505,000                                               $448,500 (-11.19%)                                $417,800 ( down-6.85%)

 

                                                For 2008, in Nassau County the median price of houses is forecast to fall by 5%-10% for the year.   The median price of houses in Suffolk County is expected to fall 6%-12% for the year.  In Queens, the median price of houses is expected to fall  between 3% and 8% for the year. For Brooklyn, the expected decline is expected to be between 2.5% and 7.5%

                                                 For 2008, In New York City,  it is forecast that the condominium market could fall by 3%-5% while the cooperative market could actually rise 3% -5% for the year.  This is caused by the fact that the cooperative prices are extremely low when compared to the other housing prices and thus the demand has shifted to them.  However, there are still pockets of appreciation in Manhattan since it is truly a global city.  For example, my colleagues at Brown Harris Stevens ( who have their own web site and go into substantial detail in this area) report the following:

                                                Manhattan Condominiums and Cooperatives - Brown Harris Stevens

                                                 Time Period        Average Selling Price        Median Selling Price

                                                3rd Quarter, 2007    $1,319,370  *                    $815,000

                                                2nd Quarter, 2007    $1,225,549                      $795,000

                                                1st Quarter, 2007    $1,153,698                        $755,000

 

                                                Manhattan Cooperatives only - Brown Harris Stevens

                                                 Time Period        Average Selling Price        Median Selling Price

                                                3rd Quarter, 2007    $1,065,753                      $640,000

                                                2nd Quarter, 2007    $1,059,060                      $640,000

                                               1st Quarter, 2007    $1,153,698                        $600,000

                                            Please note that these statistics represent "all" of the sales.  The BHS report breaks them further down from studios to 4 bedrooms. The  2-4 bedrooms were reported to have declined significantly throughout 2007 while the studios through 1 bedrooms rose in 2007.

                                               

                                                Manhattan Condominiums Only - Brown Harris Stevens

                                                                                                                                                                    Price per Square Foot

                                                Time Period        Average Selling Price        Median Selling Price          All            4 Bedroom

                                                3rd Quarter, 2007    $1,606,219   *                  $1,029,600                    $1,221        $1,930

                                                2nd Quarter, 2007    $1,429,750                      $980,000                        $1,183        $1,759

                                               1st Quarter, 2007    $1,317,019                         $930,000                        $1,097        $2,012

                                            * This was reported to be up 38% over the prior year setting a new record. 

                                            The 4 bedrooms had the best performance and astonishingly showed a remarkably higher rate per square foot than that of the studios.

                                            In Brooklyn, my colleague, the Corcoran Report ( they have reports on their web site ) highlights some key statistics. In the lower end the average price of condos rose 6% for the year from $582k to $672k, while new condos rose 7% from $683k to $731k.

                                               

                                                Brooklyn Cooperatives only - Corcoran

                                                 Time Period        Average Selling Price        Median Selling Price       Average        Median

                                                 2006/07                   -1%                                      -1%                             3 Bdrm -15%        -19%

                                                                                                                                                                    Studio- +1%        +21%

                                                Brooklyn Condominiums only-Corcoran

                                                2006/07                        +7%                                    -17%

                                                Brooklyn -Single Family ( $1.5 to $2 Million range)

                                                2006/07                            +36%                            +46%

 

                                                My colleagues at Halstead also have certain reports, including an economist report.  Of note, their economist, Mr. Gregory Heym, Chief Economist at Halstead reports New York City added 48,400 new jobs over the last year, a 1.3% increase over the last year.

 

                                               Additionally, the outer boroughs of Manhattan are also being positively affected due to the continued increases of rents and housing prices in Manhattan. However, there is a glut of condominiums on the market, including the "to be builts" in the pipeline.  There are also substantial New Jersey projects, in excess of 10,000 units overlooking lower Manhattan with 6 minute train access time, being held in abeyance.  

                                               Readers will see residential horror story articles around the world and many will fax a copy. This is true, for example, in the NY Times, Business section, front page, 12/23/2007, the title says " This Is The Sound Of The Bubble Bursting" by Peter Goodman, an excellent story. It features Cape Coral, Florida, south of Orlando, Tampa on the west coast of Florida, north of Naples, a solid, midstream community. It had a graphical, statistical representation of key data superimposed on a map.  The gist of is indicated that from 9/06-9/07 existing home sales fell in the 50% range. There was an "*" at the bottom with a caveat there may may been some overlap and one county may not have been included.  For the same time period, the decline in values were somewhat greater than 20%.  As a real estate appraiser, I would have numerous follow up questions but this is beyond the scope of this article.  The article also went on to point out "side-effects" of this real estate market collapse such as falling tax revenues, plummeting sales, business closings, job losses, increase in crime.  Readers interviewed, including a real estate broker, indicated that "greed and speculation created the monster."

                                                Yes, as reported in past forecasts over the years, when most people who are not normally in the market ( other than purchasing their homes) that usually signals the top of the market and to "look out below". When interest rates were at historic lows combined with the issues of mortgage financing covered earlier, the speculation became excessive.  There will be more headlines and stories like this but for the purposes of this market forecast, this is all the coverage that is will get for it is symptom of the underlying issue, not a cause. When the FED began aggressively raising interest rates at some 14 successive FED meetings, it was forecast that this would have a negative impact on residential real estate values and the economy down the line.  It was pointed out, that this is a "leading" economic indicator and that results would follow.  Combined with the mortgage and Wall Street issues, what should have been an "induced" market correction ( a sharp one)  has the makings of a catastrophe or possibly worse.

                                                  EXPLANATION AND RATIONALE

                                                Have the events of a slowing then declining housing market, the effects of the FED's policy of having raised interest rates over the last two years, the mortgage crisis, set the stage for the "perfect storm"?   It is the end of the world?  Will the US housing issues topple the largest economy in the world?  Are we in another housing/real estate crisis similar to the 1989/1992 one? The terms mortgage crisis, housing collapse have appeared in the newspapers, television, internet and every where else.  Housing as we once knew it, seems a distant memory.  Things that we used to depend on a house for such as savings, investment seem gone forever.  Since housing does represent a substantial part of people's lives, a giant factor in the local, national and world economy, a detailed description of how this mess started, where it is now, what will it take to clear it up, and what will the short and long term damages be.

 

                                                The mortgage crisis, housing market meltdown, financial fears about the loss of the home as a solid basis for financial abundance potentially destroyed permanently are topics widely appearing in the headlines of newspapers, magazines and on television.  For most of us, having this topic and related issues presented quickly, simply with all of the related implications sorted out, is a dominant factor in the search for answers.  As such, it will be presented immediately with the rest of the forecast to follow.

 

        The Mortgage Crisis - Housing Market Meltdown-  How Did We Get Into This Situation?  How Do We Get Out?

 

                                                The answer, although initially complicated sounding, will be presented in a simple, easy to understand format as you have come to expect.

                                                Normally, when a bank ( financial institution, lender etc.) makes a residential loan, the bank ultimately "sells" the loan into the secondary market ( Wall Street ).  This actions causes the bank to recover most of its capital to be used to originate ( make ) new residential mortgage loans. The bank retains the "servicing" of the loan.  Normally a package of these loans are accumulated, assembled into a package and then sold to an investment bank which has other packages from other banks. The Wall Street sources may also dictate the "underwriting" that the banks use to grant the mortgages, such as "sub-prime" standards. Investment banks also "originated" pools of financing sources for banks to "lend".

                                                These investment banks such as Goldman Sachs, Lehman Brothers, Bear Stearns, and others like them take these packages and break them into smaller packages called "tranches".  These tranches are separated into similar groups based upon risk and then ultimately these tranches are sold on Wall Street to ultimate investors.  Note, the higher the risk, the higher the rate of return demanded. This works well since the ultimate investors can buy the risk based tranches and blend them to get a desired rate of return for each monthly cycle. We will come back to this later.

 

                                                A tranche is defined by Forbes Magazine as follows: 

A piece, portion or slice of a deal or structured financing. This portion is one of several related securities that are offered at the same time but have different risks, rewards and/or maturities. "Tranche" is the French word for "slice".

                                                Risk is based upon factors such as loan to value ratios, borrower quality etc. Risk averse investors would generally by tranches with low risk, but with low returns.  Investors desiring higher rates of returns would buy tranches with higher risks associated with it.  This area tends to get a little complicated for there are other things investors could do to enhance returns and lower risk, but is it well beyond the scope of this explanation. But this is an area where "things" could be done to enhance returns and other things.  We will come back to this later too. It is mentioned so that you are aware it it there.  This whole process is actually a very effective, efficient way of processing the mortgage sale business.  It is very lucrative for it is effectively the only way investors can get involved in the mortgage business.  There are lots of fees, profits to be made.  In most cases historically, the rates of return are substantially greater then can be had compared with other Wall Street products while the risk is uncharacteristically low.  There are a few small exceptions with huge far reaching negative consequences, which I'm leading up to shortly.

                                                For simplicity sake, there are two types of mortgages in the residential world.  Of course they can be subdivided but I want to keep this simple for the moment.  Here they are:

                                                                    1. Full documentation - all relevant back up material, employment, appraisal etc.

                                                                     2. No documentation - sometimes called "stated income", where the lender took the word of the applicant when processing the loan.

                                                The full documentation loan had lower interest rates than the no documentation loan due to the perceived low risk, while the no documentation loan had higher interest rates for the perceived additional risk.  The full documentation loan generally had a "fixed rate - self liquidating loan" while the no documentation loan had adjustable rate mortgages, generally starting with a teaser rate substantially below the full documentation counterpart.  These no documentation loans began taking on a name to describe them.  It was called "sub-prime" loans.  Thus, any loan not a full documentation loan began to get automatically classified as "sub-prime" although initially, many were not.

                                                As this forecast is being read, there have been numerous, headline articles and television news reports that substantial lenders, mortgage banks have drastically downsized, completely shut down and or when into bankruptcy. After all, there was a giant amount of money to be made.  One lender, who has appeared in the headlines, Countrywide, became the largest home loan mortgage originator ( as per a November 11th, 2007 piece specifically focused on Countrywide) and its chief salesman who actually created this bank, quoted at being worth $200 billion in the article, from scratch. This is a long and detailed story; it epitomizes what went on in the mortgage crisis; I recommend reading it.  I have enclosed a graph summarizing some of the major statistics, for informational purposes. 

                                                The article went on to say that In 2004, interest rates hit rock bottom ( including mortgage interest rates); that Countrywide became the largest home loan originator; that Countrywide generated revenues of $8.6 billion more than twice the revenues from just two years prior to that.  Rock bottom interest rates helped but other things did also including a shift into other types of loans, including sub-prime.  An interesting chart was presented and is contained here.  It is just for informational purposes so the readers of this forecast get a first hand look at what was going on.  This is the intent of this brief sojourn. What specifically any bank, lender etc. did at at detailed level is well beyond the scope of this forecast, that is why reading the article is recommended.

                                                The problem started when the banks went after a large, untapped market - the borderline buyers. Those were buyers who could almost but not quality for a full documentation mortgage, but with some adjustments, would qualify for a no documentation loan.  So to capture this business, the underwriting standards were relaxed.  While there is no "official source" yet for the number of these loans, it has been estimated that as much as 1/3 of the new loans written are classified as sub-prime. There is a huge profit in this area of business.

                                                To increase the number of potential new borrowers in this area the banks :

                                                        1. Increased the Loan to Value Ratio ( LTV ) -more on this later for there were other participants in this mortgage crisis.  Also with larger loans come larger profits and fees.

                                                        2. The use of an adjustable rate mortgage became common place since it allowed for a low "teaser" rate which made it initially affordable to the borrower ( homeowner ).

                                                        3. Higher interest rates were charged to the borrowers, but with the use of the teaser rates, it went initially un-noticed. 

                                                The use of a teaser rate, in effect, kept mortgage payments initially far below a mortgage payment that would be based upon a traditional, fixed rate, self liquidating mortgage. This was the coup de grace of enticements for it allowed potential homeowners ( borrowers ) to purchase a house, where under "normal" circumstances, they would be unable to do so. This artificially increased " demand " and was significantly responsible for the huge run up in housing values ( to be explored in more detail in another section of the of the forecast ).

                                                There was also huge aggressive and consistent lender pressure brought to bear on the real estate appraisers.  By having higher appraisals, it offset underwriting issues and the negative effects of interest rate increases.

                                                In a 11/2/2007 New York Times  article it says that a large lender had an appraisal firm who inflated appraisals in connection with mortgage financing in the state of New York.  Other, similar reports are heard around the United States. The reports went on to say that the appraisers initially resisted the pressure to inflate the appraisals. But later on the President of the Appraisal Company, told other executives "we have agreed to roll over and just do it".  For obvious reasons, names are not being mentioned.  Please see the actual article.    Appraisers who agreed to do this, had massive amounts of business referred to them.  Higher appraisals would allow a lender to make bigger loans and make greater returns when selling the loans to investors.  This appears to be the tip of the iceberg.  If the defaulted loans currently in existence are scrutinized carefully, the negative effects of the appraisers caving into the lenders will become immediately obvious.  Many borrowers could not have even gotten the loans without the boost of an inflated appraisal.  This is one of the components to the "sub-prime" lending situation.  It is estimated that 20%-30% of the defaulted loans are sub-prime as reported by the news media. Other selected professionals interviewed for this forecast but didn't want to be named report that the percentage of sub-prime loans is more along the lines of 70%. Only a forensic "lookback" can give an accurate, objective,  answer.  A "subjective",   relatively easy answer is as follows.  If,  by the end of the third quarter of 2008 the net effects of this mortgage crisis is relatively light overall economic damage and small relative damage to the residential housing market valuation-wise, then by deduction the percentage of sub-prime loans in the overall portfolio would be relatively low.  On the other hand, if the economic damage is relatively severe or worse and the damage to the residential housing market valuation-wise is bad then, by deduction,  the percentage of sub-prime loans would be relatively high. Had these loans not been made in the first place, the housing market would not have appreciated so unbelievably high over the last 4-5 years and the housing/mortgage market would not be in this position now. The banks, lenders, Wall Street made huge profits during this time.

                                                Lender pressure on appraisers has been a big issue.  The big appraisal organization, The Appraisal Institute, which issues the MAI (commercial) and SRA ( residential) designation to those appraisers who comply with rigorous educational and examination requirements, routinely try an combat this.  However, due to the "quirks" in the federally enacted appraisal licensing law circa 1991, lenders did NOT have to use an MAI or SRA appraiser.  In fact, in the law, the language went out of the way to eliminate The Appraisal Institute and other appraisal organizations from the process.  This let in a flood of low quality, lesser educated and regulated appraisers.  Individually they had to way to combat lender pressure.  As a result, most all of the appraisers involved in these situations are not the "designated" appraisers.  The large appraisal company referenced earlier were not designated members.  In an earlier case, a non-designated appraiser pleaded guilty of falsifying 302 appraisals to a governmental agency for a housing subdivision in.  In effect, when the appraisals and loan transactions were analyzed, the underwriters told the appraiser that the values had to be raised by 15% in order to make the deals work.  It got done, all the 302 loans were done.  A short time later, all the loans defaulted.  When the insurance was to be paid, an investigation was conducted and it was found that all the appraisals were done by the same appraiser on the all the properties in the proposed housing subdivision.  The appraiser plead guilty to a charge of "filing a false instrument", a misdemeanor, which meant the appraiser could keep his license since it was not a felony conviction.  When challenged on this, the appraiser blamed his staff, secretary etc. as to how the revised, inflated appraisals got done and said the guilty plea was to just make it go away.  The New York Times article of 11/2/2007 is probably the tip of the iceberg.  There are other issues in the sub-prime mortgage situation leading to the mortgage crisis, that will be covered later.

                                                 So, with interest rates continually falling at that time, property values rising, this became a huge, profitable, business with seemingly little downside risk.  For example, in 2005, in a certain county on Long Island, the median price of a home went up 38% in that year.

                                                Shortly thereafter, the FED began a systematic approach to raise interest rates - about 14 times in a row, almost at every meeting.  For the fixed rate mortgage homebuyers, not a problem.  But for these sub-prime borrowers, they now had to fear an increase in their mortgage payments when the interest rate could be reset.  Please keep in mind that many of these borrowers could barely afford the teaser rates. Also there is a tenant in real estate valuation that " an increase in interest rates, all things equal, bring about a decline in real estate values".  The result of this started what ultimately became a tidal wave of foreclosures.

                                                The mortgage business ( banks making loans to homeowners, then selling to secondary market) continued but the portfolios of loans packaged to be sold to the investment banks, ultimately to be repackaged with other loans began to be eyed carefully.  One major investment bank used the word "toxic" to describe one of these packages.

                                                Older based risk assessment models were based upon a bank providing liquidity - " funding liquidity"  ( a simplification ).  This is further described as a bank oriented financial system  ( a central bank - like the FED, lender of last resort facilities, deposit insurance, banking supervision to ensure credit quality in loan portfolios which were all targeted at mitigating or preventing the effects of potentially disastrous withdrawals from funding liquidity from the system. Liquidity generally remains with the bank.  However, when there was an endogenous shock ( outside of the system such as a stock market crash) to the financial system, banks provided liquidity which quickly ran out and a wave of "bank runs" and failures started.  During the early times, this went unabated which turned into a crisis. Studies of the Great Depression highlighted that the withdrawal of funding liquidity actually accentuated economic downturns and had a stark effect in influencing the real economy as lending was curtailed to only credit worthy entities.  This retrospectively is referred to as "funding liquidity".  As other market participants stepped into roles formally provided only by banks ( hedge funds, Wall Street, private equity etc.) liquidity crisis were referred to as "market liquidity"

 

                                                By definition, markets ( capital markets ) are considered liquid when any individual trade is unlikely to have a major effect on the asset price because large numbers of willing traders ( buyers and sellers) are on each side of the possible transaction - buy or sell.  The outlet valve here are called "market makers" who have sufficient inventory to meet customer demand which can provide temporary, short term liquidity to "smooth out" short-run imbalances in the supply and demand equation.  This is based upon an assumption that  asset prices will converge to "long-run" fundamentals.  A major source of systemic shocks occurs when one of these foundations is compromised.

                                               The crisis facing us now is a market-oriented crisis since it is made up of a number of players including banks, hedge funds, Wall Street, private equity etc.  It usually begins with a substantial asset price sharp decline which becomes self-sustaining - no self regulating or activating mechanism to initiate corrective measures.

                                                Under "normal markets" conditions, when asset prices decline sharply, bargains appear theoretically and investors step up to capitalize on these opportunities ( basic capitalistic economic theory) which acts to prevent a developing bad market condition from becoming worse.  It is a naturally occurring event ( a stabilizing correction)  when the market is an efficient , well-functioning asset market.  Unfortunately, this well sounding theory continues to fail when there is a systemic shock since investors, traders, other market participants are either unwilling or unable to step up and act.  The most obvious reasons: they have sustained losses preventing them from participating; their risk profiles change forcing them to sell also. Thus, like the old "bank" models, the downward spiral of asset prices continues.  In a sense, this is a failure deemed by lack of coordination amount the participants.  While no one firm is either insolvent or even remotely near it, each firm individually withdraws or reduces it's activity to protect capital.  In the aggregate,  this action reduces financial market activity severely as asset prices continue to fall, possibly harming the real economy in the process.  In this market based systemic crisis, as in the bank model, the beliefs and actions of the individual participants across the the financial system " combine"  to disrupt the entire system negatively even though the vast majority of these participants are not a risk at all of collapse. This too becomes a self-reinforcing negative event.

                                                Any more on this subject, would qualify this as a Ph.d thesis.  It is not intended to be that but just a short continuance to close this aspect for a complete, rudimentary understanding.

                                                Systemic risk doesn't seem to have a universally accepted definition except in anecdotes. Qualified parties agree on a "look" and "feel" of one but there is a continued diversity of academic opinion as to what actually constitutes systemic risk or a systemic event.  One seemingly agreed upon definition is " an event causing a transitions from a stable environment (equilibrium) to an inferior state. Was the event systemic because a system shock (event) propagated across diverse participants because of self reinforcing feedback or was it a policy mistake leading to insufficient liquidity providing the back drop to the Great Depression, for example.  Without a detailed and clear understanding of what constitutes systemic risk inhibiting the formation of an effective regulatory regime that balances benefits and costs.  But, having said that, the previous statement infers that there is one and that could contribute to a false sense of confidence in this area.

                                                In the final analysis, a disappearance of liquidity along the supply chain of mortgage financing appeared.  There came a time in 2006/07 where the outlet market for these mortgage backed securities  ( described earlier) began to dry up meaning the investment bank found it more difficult to sell to the ultimate investors. I This meant that the originating  banks had no effective, new sources of mortgage money to lend, other than new deposits which was woefully inadequate.   Finally, with the negative press and notoriety mounting, the ultimate investor sources completely dried up.  Now with a bank at the retail level with a customer with a potential home to buy needing a mortgage, can't write the loan because it can't sell to the investment bank who can't find an ultimate buyer in the secondary market.  The vicious cycle continues.

                                                 This means that the source of mortgage financing for residential properties is essentially non-existent.  In my book, I said " mortgage money is the life blood of real estate." Rising interest rates had already started slowdown in the market ( there were other factors ).  Now add to that the almost complete shut off of mortgage financing. Neither one of these factors bode well for the residential real estate if left unabated.  Now add the tidal wave of existing and anticipated foreclosures with 100,000's of additional homes coming into an already over-supplied market nationally.

                                                The Perfect Storm - We have a huge increase in the supply of houses for sale and because of the shut off of mortgage money, the "effective" demand has been reduced to zero.  And there is no current market mechanism ( self-invoking) to reverse course to get the market back to normal.

                                                How To Fix The Mortgage Crisis - Housing Market Meltdown

                                                Yes, there is a way to fix this problem.  It will take devine intervention.  I use that word simply because it will take a few of the market participants to work together to reset a few things and then the market can proceed as simply and efficiently as before.  The only issues are:

                                                                1. How much time will this take?  Do we want it to be fixed "fast" or "slow"?

                                                                2. How much in ultimate damages ( locally, nationally, worldwide ) do we want to sustain? and who will ultimately pay for this?

                                                We had discussed earlier, the models used to deal with systemic shock issues originally was "funding liquidity" based where the remedial actions were based and understood around a "bank" providing ultimate liquidity.  However, as time went on and the financial products proliferated and became more complex, the model changed to a "market liquidity" based one where the other player, participants in the market were included.  Questions continue to arise as to whether even now as to the adequacy of the new models in their ability to completely capture the possible channels of propagation and feedback from all of the participants in the market place so that remedial steps can prevent the crisis from turning into a catastrophe. We have not heard a "yes" answer.

                                                Where do we get started. First and foremost, where does the proverbial " buck " stop?  It stops with the end purchaser/investor of the pools of securitized mortgages.  The mortgage crisis ultimately started there and will ultimately end there.  When the end users/purchasers of these pools of securitized mortgages have the confidence collectively to consistently purchase these pools going forward, then the mortgage crisis will end, and not before.  There are some things that can be done ( to be covered later ) that can bring temporary relief to the mortgage crisis and the meltdown of the residential real estate market.  This would also have a positive side effect of  contributing to the  to the temporary and partial  return of confidence to these end users/purchasers of the securitized mortgages.

                                               What first has to happen is for the end investor/purchasers to have the one thing preventing the return of confidence established.  That  is a sense of accountability.  These investor/purchasers typically rely on others ( Wall Street, investment banks etc ) for a sources of these mortgage pools to invest in.  Implied with this is the reliance by  the end purchaser/investors on the due diligence information provided to them.  While all the information, data is not in and won't be until long after the writing of this forecast, certain information and common sense is.

                                                When confidence is returning, it must continue to be enhanced until it reaches a critical mass, enabling psychologically the routine investors who typically bought the pools of securitized mortgage pools ( mortgage backed securities) to do so with the automatic confidence that was once there.

                                                What is confidence exactly?  In my earlier writings ( Evaluating Real Estate Investment Performance) I have described confidence used in the investment world, not as a certainty of a particular outcome of an investment but rather the certainty of a consistently stated risk vs. reward.  This simply means that key risks are stated accurately so that later in the investment memorandum, when the rewards ( return on investment ) are stated, the potential investor is able to clearly evaluate this particular investment within itself as well as other investments offerings competing for his or her investment dollars.

                                               We discussed the differences between the older "funding liquidity" based risk assessment models and the newer "market liquidity" models with the basic difference that the "market liquidity" ones attempt to account for the additional participants in the markets to supplant the areas vacated by typical bank activities.  Some of these participants are - hedge funds, Wall Street, private equity.

                                                While the newer models are inherently more accurate, did they apparently were not suitable in this current situation. Non-withstanding all of the academic talk, the common features in the newer models have the following in common: 1. contagion in the market is witnessed in the self-reinforcing nature of price declines and the transmission of these liquidity shocks across a variety of participants and institutions, 2. mysteresis and multiple stable states can appear in the overall market move to an inferior but stable equilibrium and 3. non linear ( curves rather than straight line relationships) in expectations and investment decisions can lead to acute changes in volatility and covariation of asset prices.

                                                Depending upon which statistics you read, there could be a couple of $100 Billion of bad loans in these pools which could almost mean a total loss for ultimate end investor/purchasers.  Just recently reported and mentioned in this article, Goldman Sachs passed on a purchase of a large pool of these securitized mortgages.  They described the pool as "toxic".  From a common sense stand point, other investment banks had the same information and yet were passing this and other pools ( described as toxic ) to their end user investor/purchasers for their investment consideration and ultimate purchase ( investment ).

                                                Two immediate issues come for the forefront:  1. How is it that only Goldman Sachs ( as reported in the press) saw this pool as "toxic" and passed on the purchase of it? Was the % of sub-prime loans known?  If so, how did this % differ from similar portfolios a year ago, two years ago etc. ? What was the "triggering" point that caused them to pass on the purchase? 2. In this  area of the investment world, a pool does not on its own become suddenly toxic unless there was a major triggering event ( which there wasn't ).  The national and world economy is basically in good shape.  How could $100's of billions of residential mortgages go in the tank under those conditions? 3. This toxic pool previously described as toxic became that way over a period of time and was given birth by prior pools of securitized mortgages that were sold. Were some or all of the prior pools also toxic.  All of the information is not available at the time of the writing of this forecast.  But it is a good bet that the quality pools began to get slowly contaminated by "toxic" input until the point that the toxic input became the dominant input in the pools. If this turns out to be true or predominantly true, this will have whittled the end purchaser/investors confidence to zero. To bring the confidence back to normal levels it will take a concerted effort on behalf of the "packagers" of these securities ( investment banks and others ).  Without knowing all the facts and statistics, this forecast can't present any more detailed information but reserves the right to do so and a subsequent real estate market forecast update to do so.

                                                Many of the defaulted pools of securitized loans came from "sub-prime" loans.  Examples were stated earlier that were mind boggling - (106% loan to value ratios, interest rates at double the prevailing rates ).  But what is boiled down to was that mortgages were granted to people to buy homes who could barely afford them.  They initially could by the used of "teaser rates". Anyone could clearly see ( or should have been able to clearly see) that if the adjustable rate loan payments to the bank were to rise at all going forward, the borrowers could not make the payments.  Additionally, many of these sub-prime loans had over 100% loan to value ratios, meaning the borrower had no money in the deal.

                                                 It was estimated that sub-prime mortgages accounted for 30%-40% of the loans.  So going back a year or so when interest rates were starting to rise ( and the propensity was for interest rates to continue to rise) , these pools being packaged by the investment banks and sold to the ultimate investor/purchasers contained ever increasing amounts of unstable loans with the underlying risks continuing to rise.  In a sense, these sub-prime mortgages that were underwritten by the investment banks and sold to the ultimate investor/purchasers were doomed to fail.  The mortgage brokers, banks initially got their fees, commissions paid up front.  The investment banks who packaged the pools of loans and sold them to the ultimate end purchaser/investors made substantial investment banking fees and commissions.

                                                The main contact that the ultimate end purchaser/investors have to buy these mortgage backed securities are the investment banks. Knowing only what is known at this point, the investment banks have to do what is needed to restore the confidence in the residential mortgage market which will induce the end purchaser/investors to start to invest normally.  This would include adding some insurance products to mitigate risk.  This is a hughly lucrative end of the business and will be again.  The investment banks will have to invest handsomely to win back  the business.  This will include taking advantage of government programs hastily being put together as well as developing a closer relationship with the mortgage brokers who brought most of these deals to the banks in the first place.

                                                Again,  the word confidence used in the investment world, is described not as a certainty of a particular outcome of an investment but rather the certainty of a consistently stated risk vs. reward.  This simply means that key risks are stated accurately so that later in the investment memorandum, when the rewards ( return on investment ) are stated, the potential investor is able to clearly evaluate this particular investment within itself as well as other investments offerings competing for his or her investment dollars. In the case of the sub-prime mortgages as described, was the elements of risk in the residential mortgage pools  ( that teaser rates were used in an adjustable rate mortgage; borrower could barely afford mortgage; if interest rates rose on next adjustment period in the mortgage, borrower wouldn't be able to afford to make the payments and would go into default; that at least 1/3 of the mortgages in the pool being evaluated had such mortgages). If this wasn't done in a way that the potential end buyer of the mortgage pool couldn't see this, then to restore confidence, this would have to be made prominent. What was the reward premium for the purchase of this type of mortgage pool over the "normal" type of pool where there are mostly (conforming, full documentation loans where the default rate is typically less than 2% ).  Unfortunately, this information was not available at the time of the writing of this annual real estate market forecast.

                                                 But absent this information , rhetorical question can point in the right direction.  If a pool of mortgages to be sold to an end purchaser/investor has a face value of $100,000,000.  The predominant interest rate on the individual mortgages is 6%, 30 year fixed rate, self liquidating , full or close to full documentation,  the default rate historically at 2%, underlying economy in good shape, you would be able to come to a purchase decision and amount fairly quickly and consistently and the ultimate performance would turn out to be consistently on target with estimates.

                                                On the other hand, take the same example, and substitute 1/3 of the mortgages as being "sub-prime", with the same caveats about the borrower's ability to withstand and increase in the interest rates and the environment pointing to interest rates increases.  If the example above with no known sub-prime mortgages priced at 95% off the face amount, what should the pricing be for the one with the known sub-prime mortgages?  I think you see the point I'm trying to make.

                                                Along these lines is another, frightening story regarding risk and the informing of investors or rather lack of informing them.  A short except is highlighted.  This issue is in "addition" to the main one mentioned above.

Source:  CnnMoney.com - Fortune 

November 26 2007: 10:15 AM EST

                        The next credit scandal

The real outrage of the credit crunch has been in the way major banks disclosed potential losses. Now, there are billions more in undisclosed risk.

By Peter Eavis, senior writer  

NEW YORK (Fortune) -- The major banks have already reported billions in unexpected losses from complex investment vehicles known as CDOs. Now they face big risks from other corners of the debt markets -- but don't expect them to warn investors anytime soon.   The failure by banks to properly inform shareholders of their potential losses is perhaps the biggest scandal so far of the credit crunch that began this summer.  Earlier this year, for example, Merrill Lynch, Citigroup and Bank of America gave almost no indication that one particularly toxic debt product -- CDOs, or collateralized debt obligations -- could be the source of billions of dollars in losses.  Those losses came to light this fall, blindsiding shareholders and pummeling banks' stock prices.  The lack of disclosure not only has unsettled investors, but also has raised the prospect that large losses are lurking in other parts of the banks' businesses.

In the 12/27/2007 front page of the Wall Street Journal, the main title read, “ Wall Street Wizardry Amplified Credit Crisis “ written by Carrick Mollenkamp and Serena Ng.  It is very well written and has much detail in it. There are other sources that covered various aspects of this, but this article was clear and complete. Earlier, we discussed that “mortgage money is the life blood of residential real estate”.  Besides, bank deposits, where do banks get residential mortgage money to lend.  We discussed that and one of the ways was Wall Street.  By selling the loans to “Wall Street”, the mechanisms at “Wall Street” repackaged these loans and then sold them to “ultimate” investors.  Many of these mechanisms were ingenious, in fact.  In an earlier market meltdown in the 1980, there were similar “mechanisms” and the people creating them were called “rocket scientists”.

 But the long and short of it is that packages of loans were repackaged and sold in pieces (tranches) to “ultimate” investors and “risk” could be isolated, package by package so that each package’s risk could be tailor made to the “ultimate” investor.  Then a CDO ( collateralized debt obligation which has been in use since the 1980’s) known as “Norma” came along ( Norma CDO I Ltd.) Its function or concept is simply a device that “repackages” income from a pool of investments – i.e. bonds, mortgages, derivatives.  For example, a mortgage CDO might own “pieces” of bonds with each bond possibly containing thousands of underlying mortgages.  A bond is the evidence of the debt while the mortgage is the security for the debt.  The concept of diversification was to reign supreme, for this could substantially reduce risk, in and of itself.  The “risk” factor again.  For example, it reduces the “risk” issues of one borrower defaults. 

 In this process, the CDO issues securities so that “ultimate” investors can buy into the CDO, in this case, Norma.  Each “security” has a different degree of risk.  Not to confuse anyone, each “security” could also be called a “tranche”.  This means that the “ultimate” investor could pick and choose a degree of “risk” relative to the “reward”.   Risk and reward work in a simple way.  “Ultimate” investors purchasing lower-risk “tranches” or “pieces” are the first ones in line to receive income, while investors in the higher-risk pieces are the first ones to take the loss.  Sounds simple enough. But in the article, one thing was missing?  Who assigned the “risk” and “reward”?  And upon “what” was this based”?  There were some references made to credit rating agencies.  But ultimately, the reader of this article was not given any tangible way of answering this question from information contained within this article. Please see graph published by Fitch Ratings (below) which graphically describes this.

 But according to this WSJ article, “Norma and similar CDO’s added potentially fatal new twists to the model. Rather than diversifying their investments, they bet heavily on securities that had one thing in common: they were the most vulnerable to a rise in defaults on so-called sub-prime mortgage loans, typically made to borrowers with poor or patchy credit histories.  While this boosted returns, it also increased the chances that losses would hit investors severely.” The article goes on to say..” these CDO’s invested in more than simply subprime-backed securities.  The CDO’s held chunks of each other, as well as derivative contracts that allowed them to be on mortgage-back bonds they didn’t own. This magnified risk.”  Here is where the damage is articulated by the article.  “ Wall Street banks took big pieces of Norma and similar CDO’s on their own balance sheets, concentrating the losses rather than spreading them among far-flung investors.”  Why was basic, sound investment policy for this amount of capital investment seemingly ignored?  The article was silent.

 The article goes into depth as to how the CDO’s, particularly in the case of Norma, went down a different path.  It points to a company called N.I.R. which came from the “penny stock” arena. It would take stakes in hundreds of companies.  But this aspect also generated interest, litigation often because the cheaply traded stocks often became targets of speculation or manipulation.   Merrill Lynch approached this company for it was successful in that area and generated millions of fees.  Some of the details can’t be presented due to time and space.  The bottom line is that this procedure, fees generated ultimately resulted in a proposal to N.I.R. by Merrill Lynch, as per the WSJ article.

 Behind this proposal was simply that one of “ Merrill’s clients, a hedge fund, wanted to invest in the riskiest piece of a certain type of CDO.  ..Merrill worked out the details and structure and N.I.R. was asked to manage it.”

 The article gets very technical and I recommend for those who need to know to read it.  It is fascinating.  The bottom line is that Norma assembled $1.5 billion in investments initially but most were not actual securities, but “derivatives” where the value is “derived” from the underlying asset. These derivatives were linked to  triple –B- rated mortgage securities (the lowest investment-grade rating).  These were called “credit-swaps” and their function was to act as an insurance policy.  Many investment banks favored these “credit-default” swaps since they didn’t require the purchase of securities, a process that could take a few months.  “ With credit-default swaps, a billion-dollar CDO could be assembled in weeks.”

 The risk became magnified immensely by the use of derivatives.  In fact, “ The use of derivatives multiplied the risk, said Greg Medcraft, chairman of the American Securitization forum, and industry association.  The sub-prime mortgage crisis is far greater in terms of potential losses than anyone expected because it’s not just physical loans that are defaulting.”   This extreme magnification of losses are possible simply because this process allowed bankers to create an unlimited number of CDO’s linked to the same mortgage-backed bonds.  ( The article was silent on this.  Obviously, you the readers deserve and answer and it would take a major, research project to get to the bottom of this.  There are also “legal” issues that could easily stonewall any research efforts.  There simply wasn’t time.  The important point has been illustrated.

Its arrival time coincided with the tale end of the US housing boom.  According to WSJ’s article, instead of diffusing the risk of the underlying mortgages of the global housing boom, these instruments instead have “magnified” and “concentrated” the effects of the sub-prime mortgage bust.  WSJ reports that “ they are now behind tens of billions of write-downs at some of the world’s largest banks, including the $9.4 billion announced last week by Morgan Stanley.”

The gist of the WSJ report indicates that this “vehicle” was brought into existence by “Merrill Lynch & Co. and a posse of little-known partners” and the result was that in the efforts of ”keeping a lucrative market going, it took a good idea too far.”

Norma, through the use of derivatives ( here we go again ), “contributed to a speculative market that dwarfed the value of the sub-prime mortgages on which is was based. ( In simple terms, derivatives mean that the value is “derived” from an underlying asset).  “It was also part of a chain of mortgage-linked investments that took stakes in one another.  Ultimately this practice generated fees for a handful of big banks. But as critics say, it created little value for investors in the broader economy.” 

“What was happening was that the “risk” was being passed to the next deal and keeping it within a closed system, according to Ann Rutledge, R & R consulting as reported by WSJ.”  Further on, Ms. Rutledge said of this, “ If you hold my risk and I hold yours, we can say whatever we think it’s worth and generate fees from that.  It is like creating … artificial value.”  This was also referred to as “cross selling” which had the effect of “propping up” values, artificially.

The key point here in this WSJ article is that… “ only after 9 months of selling $1.5 billion of these securities to investors, Norma is worth only a fraction of its original value. Additionally, credit rating firms that once signed off approvingly on the deal, have slashed its ratings to junk.”

Why the sudden risk, volatility, and the other obvious questions.  What about the rating agencies?  When Norma came up to bat and went to face the rating agencies, according to the article, the normal due diligence appeared to be happening.  A “junior” tranche or slice of a CDO, for example, could be assigned to take the first $30 million in losses on a $1 Billion CDO while a Triple – A  “senior” slice would not be affected at all until losses reached $200 million or more.  This is how the system works, and it generally works well, but only if the underlying securities in a CDO are “uncorrelated”, which is the term utilized.  Low correlation means that the underlying “companies” in a CDO are in different businesses.  Take, corporate bonds, if a CDO was formed to do corporate bonds and had an automaker, computer maker, retailer etc. there would be a low degree of correlation because the companies that issue them operate in different industries and statistically, if things go wrong is one industry, it generally wouldn’t affect the others.  In a high correlated CDO – like Norma,  just the opposite is in true in that mortgage borrowers are very similar to one another. They are related or linked to hundreds of thousands of loans around the US.  Anything big enough to trigger a default on a large portion of these loans, such as falling home prices, would likely effect the underlying bonds in a CDO.  Norma, as reported, invested heavily in the “junior” or Triple – B “pieces’“which would suffer losses if losses to defaults on the underlying pools of loans reached about 10%.”

According to the WSJ article, “Merril and N.I.R. took Norma to investors with their 78 page pitch book.  Although in March, Moody’s, Standard and Poor’s and Fitch Ratings gave Norma their seal of approval, Fitch’s report cited growing concern about the sub-prime mortgage business and the high number of borrowers who obtained loans without proof of income.”  In the 78 page pitch book, there were 9 pages of risk factors including the standard ones. “ But Norma offered investors substantially higher rates of returns. For example, on the riskier Triple – B slice, Norma said it would pay investors 5.5 “points” above the interest rates that banks lend to each other known as LIBOR ( London Interbank Offered Rate) which translated into a yield of 10% on the security – compared with roughly a 6% return on the Triple – B corporate bonds. “

 Many investment banks gambled ( by where they invested their money in these CDO’s usually the “super-senior” pieces usually comprising about 60%) that they would be insulated from losses.

 By September 2007, the steep decline of housing prices, rising defaults on mortgage loans and the other “multiplying” factor, the market value of the sub-prime backed securities went into a “free fall”.  Suddenly analysts were saying ..”upped their estimates of total losses on sub-prime backed securities issued in 2006 to 20% or more, a level that would wipe out most triple-B rated securities.

 In October 2007, “Moody’s downgraded $33.4 billion worth of mortgage-backed securities, including those which Norma had insured. Those downgrades set the stage for review of CDO’s backed by those securities – and then further downgrades.” 

 CDO’s like Norma ( mezzanine), since they held riskiest pieces) were hardest hit.  “ On November 2^nd, Moody’s slashed the ratings on seven of Norma’s  nine rated slices from investment grade to junk.  Fitch, the rating agency,  downgraded all to junk, including the two it rated triple – A.

At the end of this WSJ article, it said “ by mid-December, $153.5 billion in CDO slices had been downgraded, according to Deutche Bank.  Because banks owned the lion’s share of the mezzanine CDO’s ( riskiest pieces ) and bore the brunt of the losses.  In all, bank’s write-downs on the mortgage investments announce so far add up to more than $70 billion.”   

                                                When these facts about the sub-prime mortgages and the related issues are made consistently clear and enforceable to the end purchaser/investors, the confidence will return quickly and so will the investors.  The sub-prime market will return and be a dominant factor in the residential real estate mortgage markets again. It will get there but with a slightly different face, including some government programs and probably an insurance component in one way or the other.  There is a huge demand for home ownership that needs to be addressed; a huge market that will be satisfied by investment capital as soon as the confidence is returned to the end purchaser/investors of the residential mortgage pools.

                                                Beside the confidence aspect, another thing that could be done is legislation to affect large swathes of adjustable rate mortgages that would "freeze" the clock on upward adjustments to the interest rates.  This could probably save a few hundred thousand homes from the foreclosure process, have less disintermediation in the supply / demand equation, and considerably limit or eliminate the economic turmoil.

                                                Currently there are a number of programs, policies that are currently being formulated, enacted, legislated and hopefully being put into place by the first quarter of next year, in time for the traditional buying and selling cycle.  The are enumerated as follows.  These have appeared in various publications. Up to the writing of this forecast, many of the so called " fixes" address only a small portion of the market and not the areas of the market who need it most. For example, one fix is only for homeowners current on their mortgages.

                                                If possible, deals should be worked out with the existing homeowners to keep them in the house and paying something towards the mortgage.  This, in the aggregate, would be significantly financially better for them, the banks, the economy and the real estate market in general.                                                   

                                                New York State

                                                    1.  Foreclosure preventions - providing additional targeted funds ( up to $200 Million ) to HUD - Certified agencies offering foreclosure prevention counseling. It is unclear how this would work with adjustable rate mortgages due to adjust to a higher rate that the borrowers can't afford.

                                                        2. Accountability - Mortgage Broker - A house bill spearheaded by Rep. Barney Frank ( D-Mass) would create a federal licensing system.  Sen. Charles Schumer ( D-NY_ has a senate version that mortgage originators of any kind must abide by when originating new loans.

                                                          3. Bankruptcy - Would have home mortgages excluded from bankruptcy process.  Allow terms to be modified.

                                                        4. Tax Law Changes - Homeowners would be allowed to avoid taxes on debt forgiveness.

                                                           5. FHA - Increase loan limits from $362,790 to $417,000. This would allow FHA to buy back more loans.

                                                         6. Fannie Mae - Freddie Mac.  Increase loan limits up from $417,000 to $625,000.  Also temporarily lift the limits of the mortgage companies by 10% and require that 80% of the increase, estimated at $125 billion, to fund refinancing of sub-prime borrowers. This sounds great but there is a problem.  In WSJ article, 11/21/2007reports Freddy Mac loses 29% of its value or about $10 per share.  This is a large factor in the mortgage area in that they could buy pools of mortgages.  However, the losses left Freddy Mac with a core capital of only $34.6 billion as of 9/30/2007 only $600 million above the minimum amount regulators require it to hold. Regulators have imposed an additional 30% more than required by law.  Given the huge amounts the Wall Street Powerhouses have reported, recently lost ( in the billions of dollars), it doesn't seem Freddy Mac and related company, Fannie Mae, can do much to help at the moment.  Later in the article, Henry Paulson, among other things, calle for policies to be enacted that will effect millions of mortgages quickly and efficiently so that dramatic, positive results and occur before almost irreversible economic and psychological damage occurs.  Such a plan could be to "freeze" interest rates on adjustable mortgages before they roll to the higher ones.  One of the underlying theories being it is more effective and beneficial to have mortgages that are being paid ( albeit at a lower rates) then having millions of mortgages in foreclosure with nothing being paid.  He also expressed frustration in lack of speed to enact legislation over hauling Freddy Mac and Fannie Mae so that they could be a bigger player in the market.  Especially at a time when they are needed most, such as right now.

                                                    7. The FED has also stepped in. In a December 19th, 2008 newspaper article, also reported on the front page of the New York Times, the FED has proposed new rules that would sharply curtail, limit the varieties of high-risk mortgages where have been largely blamed for the "mortgage crisis" leading into the global "credit crunch".  (Please see "Credit Crunch" in this forecast). The proposed new rules have been alluded to in various sections of this forecast and again it all has to do with "risk", the "actual quantification of "risk", and "greed".  Some of the proposed rules seem simplistic and so basic that it begs the question of why was it done in the first place.  This has been covered in other sections of the forecast.  The proposed FED rules are:

                                                        1. That a lender would be prohibited from engaging in a pattern or practice of lending without considering the borrower's ability to repay from sources other that the home's value.

                                                        2. Prohibit a lender from making a mortgage loan by sole reliance on income and or assets that it does not verify.  This was called " stated income".

                                                        3. Restrict prepayment penalties only to mortgage loans that meet certain criterion, including the condition that the penalty expire at least 60 days before any possible payment increase - interest rate adjustments.

                                                        4. Require that the lender establish an "escrow account" ( which many already do) for payment of property taxes, homeowner's insurance.  Borrower and opt out after one year.( My comment, there also should be some kind of mortgage insurance that can only be cancelled when the loan to value ratio is better than 75%.)

                                                It has been estimated that the "sub-prime" purchasers accounted for about 25% to 30% of the purchasers.  Meaning this segment partially made up "effective demand".  Should this go into place starting in 2008, and it probably will even without FED prompting, it will take almost 1/3 of potential buyers out of the market.  Considering this loss of potential buyers, the drastic dry up of mortgage financing, the big hits in "toxic" portfolios many of the large lenders have taken and will spill over into the first quarter of 2008, this will have a "shock" effect in the first quarter.  This will be explained in the housing portion of the forecast. 

                                                Please note a chart of sub prime lending statistics published by :Inside Mortgage Finance which shows sub prime lending activity going back to 2001.    It actually peaked in 2005.  Note earlier, in one county on Long Island ( and this holds true basically across most of the markets in the US at that time, that the median price of a home went up 38%.

 

 

                                                 Note, the market had already peaked in 2005 and started to fall in 2006.  Look at 2007 which is about 75% less than the peak.  Please note the other issue facing the FED presented in the "credit crunch" section in that the normal way the FED could adjust the supply of money - loans is now not effective since loans are "sold" off and don't appear on the balance sheets.

                                                Mr. Paletta and Mr. Haggerty, who wrote this piece, correctly point out the issues.   When you add to that, the tremendous portfolio losses, the mis-pricing/identification of risk of these portfolios to the end purchasers, the extreme, sudden drop off in mortgage financing, there are going to be a number of major, simultaneously occurring financial shock factors all hitting in the first quarter of 2008.  Mr. Edmund L. Andrews, of the New York Times, on December 19th 2007 as well as December 18th, 2007 also pointed out these issues.  He quoted the Fed Chairman, Ben S. Bernanke who said, " Unfair and deceptive acts and practices hurt not just borrowers and their families but entire communities and indeed the economy as a whole."

                                                There will be more of these stories going forward in 2008 as the year unfolds and more information is readily available to be dissected and analyzed. It is expected that it will contain more of the same type of stories. I fully expect Mr. Paletta, Haggerty and Andrews to continue to follow this story going forward.

                                                Please remember that these "sub-prime" loans when made were assembled, packaged by the major Wall Street Banks, financial houses and sold to ultimate end purchaser/investors.  Could this be the "perfect storm"?  Please see the housing forecast section for the forecast, full back up explanation  and details.

                                                                             

                                                OTHER

                                                1.  FHA Secure - an option that gives some sub-prime homeowners making timely mortgage payments before their loans reset but are now in default.  There are some conditions but by refinancing into an FHA-insured mortgage, the borrower and expect lower payments.

                                                2. HOPE now, President Bush to bring major participants together ( mortgage industry, counselors, investors ) together to try an mitigate losses.  A few hundred thousand letters to go out as of the writing of the forecast.

                                                3. Countrywide, Washington Mutual - Various programs to reach 100,000 of borrowers.  Washington Mutual - follow up to mortgage broker due diligence and client notification.  Unclear how this would help in this crisis.  Countrywide, try to help borrowers refinance loans.]

                                                                How To Fix The Mortgage Crisis - Housing Market Meltdown -

                                                            Conclusion and Recapitulation of Solutions

                                            We have discussed much material in relatively simple format highlighting the issues of models used to deal with shocks to the financial system such as the 9/11 attacks on the World Trade Center, the collapse of the hedge fund Long Term Capital Management, how each of the market participants, although acting along, not in any danger of collapse, individually did things to preserve its capital taking it "out" of the market place when it really needed to be in the market place.  The collective actions of these participants actually enhanced the problem.  Additionally there was no consensus of a definition of "systemic risk".

 

                                            We have discussed the bank dominated system ( funding liquidity) to a market system where subsequent participants taking over rolls previously provided by banks ( hedge funds, Wall Street, private equity etc.)  We talked about restoring investor confidence as a necessary condition to turn this crisis around.  In a bank dominated financial system, it is substantial easier to gather the information necessary to regulate effectively against the possibility of systemic shocks or disruptions.  Critical information would flow from fellow bank regulators working with the FED and the banks regulators were examining.  But in a market-dominated environment, of which many financial institutions have a presence not only locally but world wide not to mention cross-business lines, obtaining information on counterparty exposure and risks necessary to develop meaningful analysis and to inform decision makers in a crisis would require substantial "cooperation" across disparate entities many of which would deem this information "proprietary".  This means there would be scant data available and inadequate data sharing among the entities.  This represents a most difficult challenge to the implementation of a market-dominated system at the present.  This doesn't bode well for the restoration of confidence. But information sharing can significantly increase the probability that credit will continue to flow during systemic shocks and disruptions which will result in a lower probability of a prolonged systemic disruption, a reduced need for government intervention and enhanced financial stability.

                                              Each of the market participants has "models" they use for risk analysis, decision making etc. There are considerable differences between the financial system and other complex systems.  A major issue among these differences is the inability to conduct or observe natural experiments on systemic shocks or crises in the financial system since these shocks or crises occur infrequently.  Another "factor" ripe with differences is the role of human behavior in the financial system. How does an individual or class of individuals behave when exposed to crisis events?  This will produce "non-linear" behavior most difficult to account for in a model, regardless of its inherent complexity.  These non-linear behaviors and anticipatory behaviors are factors that are currently largely missing in studies of complex systems, at least in engineering or the physical sciences.

                                            To tackle and resolve this problem, the use of scenario analysis is being utilized as a primary tool to examine systemic events ( shocks, disruptions).  It starts with a basic definition of general equilibrium, a particular scenario about the economy and the inference of conditional expectations and consequences of that particular scenario for markets worldwide and their relative prices.  This approach has advantages in its being grounded in an actual event but the downside is that changes in the market structure since the chosen scenario can lessen the predictive powers of that scenario analysis.

                                            Another way is to simply construct a purely hypothetical event.  The obvious advantage is that is allows one to match the scenario to the particular market structure at the time. But the disadvantage is the difficulty knowing with certainty whether the hypothetical event is at all likely or whether the analysis performed accurately reflects how the event would actually unfold.

                                            The other way is a blending of the above, casually referred to as "hybrid". It side steps the key problems and issues of the above two ways.

                                                All of the above depend upon a clear understanding of the economy, the shock, its reverberations, correctly converting it into a model, assessing the probabilities, system testing the models with observations, statistical analysis, having quality data to analyze.  Any of the systems and following analysis must be extremely careful in its assumptions of probability distributions.

                                                Data, relationships between the data, appropriate quality and quantity of observed events, accurate statistical probability distributions and assumptions must be constantly monitored, various scenario based models should be routinely employed when the cost - benefit analysis warrants it.  There should also be an element of "common sense",

                                                We need better, more complete and reliable information and liquidity at the right time, in the right amount at the right place to be provided quickly and efficiently.  After all is said and done the following is needed:  1. accurate description of the mortgage pools so that confidence can be restored.  Investors are transmitted accurate descriptions and information so that each investor can determine its own risk/reward profile.  2. Liquidity needs to be provided quickly, adequately and consistently on an emergency basis. 3. There needs to be a fully accepted definition of "systemic risk" so that all participants can be mobilized for effective action when there is a systemic shock requiring it. 4. With all the diverse participants in the "market liquidity" based models, first continuing efforts must be made to enhance the quality of the models to insure "all" the feedback in captured and second, a mechanism must be put in place to allow for the quick and effective marshalling of forces to deal with the negative financial consequences of a financial, systemic shock.  The logical choice would be to place it under the auspices of the FED. And #5, as the new models come up, they should be completely, thoroughly tested through "scenario" based testing based procedures.

                                                And the most obvious,  and least written about would be some kind of insurance product.  It is a natural.  By charging 1/4 of a point ( 1/4 of a percentage point) to be paid each month by the mortgagors ( homeowners ) would elevate the quality of each loan as well as the quality of the overall portfolio.  In would substantially reduce risk as well as increase end user investor/purchaser confidence dramatically and quickly.

                                                FORECAST FOR RESIDENTIAL MORTGAGE MARKET

                                                Given what is known as of this writing, I forecast that the residential mortgage market will return to normal by the    buying/selling cycle of 2010.  If the "devine intervention" mentioned earlier can be enacted quickly, end user confidence is restored quickly, I forecast that the normal buying/selling cycle of 2008 will be of half its normal capacity.  This means that the market will probably be running somewhat erratically with a substantial amount of activity later in the selling cycle.  I forecast that the residential mortgage market will return to normal by 2010.

                                                                                                The Presidential campaigns, election will also have a role to play which is unknown now.  If nothing is done, since the US economy represents about 1/3 of the global activity, I forecast that the US economy will be hit with "stagflation". An economy that is almost recessionary but with inflation.  The worst of both worlds.     All of the candidates have "addressed" this.  It is forecast that any President that gets elected would never let this situation deteriorate to cause any preventable damage.                                                

                                                                        

                                                                                            HISTORICAL LOOK BACK AT HOUSING

 As of November 22nd, 2006 the median prices of houses were as follows: Nassau- $480,000; Suffolk- $402,000; Queens-$490,000. In an 11/9/2007 article, these figures were updated as follows: Nassau - $475,000; Suffolk - $388,000 and Queens- $440,000.

Historically, in  a Newsday article dated November 11th, 2006, the median home prices in Nassau and Suffolk houses fell as follows: Nassau $500,000 in October 2005 to $472,300 in November 2006, Suffolk $400,000 October 2005 to $390,000 in November 2006, Queens $462,800 in October 2005 to $477,900 in November 2006. Additionally the number of  homes on the market increased as follows: Nassau 6,575 October 2005 to 9,769 November 2006, Suffolk 9,358 October 2005 to 13,923 November 2006, Queens 6,243 October 2006 to 10,047 November 2006.

Historical Interesting facts:

In this market, setting the right first price is important.  If set correctly, the property will move the quickest.  Numerous agents are working with their sellers and even sharing the cost to bring in an appraiser to help properly set the price.

Glass condominiums were the top choice by architects and residents for residents in Manhattan.

According to a Prudential Douglas Elliman report written by Miller Samuel, new residential construction is almost entirely condominiums which have lead to a 60% increase in condo inventory.  Co-op inventory reported is up about 7%.  Their Manhattan 3rd Quarter 2006 reports two interesting statistics: The average sales prices is down 7% from the prior quarter $1,288,748 current quarter, $1,380,193 prior quarter.  The average sale price per square foot for the current quarter is $1,050 while the average sale price per square foot for the prior quarter is $1,083 down 3%. The number of days of the market (DOM) from the last date went from 150 days in the current quarter from 144 days in the prior quarter, up 4.2%.  The listing discount from last date on the market went from 3.5% to 4%.

Additionally the report addressed the cooperative market.  " Price indicators fell from prior quarter records but remained above prior year levels.  The average sale price of a Manhattan Co-op apartment fell 16.1% from the prior quarter to $1,296,452 but was up 13.8% over the prior year quarter  average sale price of $956,490.

The Miller Samuel report also addresses the mood of the buyers and seller and says ,,," the sense of urgency is missing, standoff between buyers and sellers remains."

In the luxury market, "prices saw greater gains from last year than the overall market. The average sale price was $4,509,833 down from the prior quarter near record average selling price of $5,013,147 but was 17.9% higher than the prior year quarter average sale price of $3,824,079. The average days on market increased 11 days to 161 days as compared to 150 days in the prior quarter. The average sales price of $1,973,569 are virtually unchanged from the prior quarter average of $ 1,974,623 but up 26.2% from the prior year quarter average sales price of  $1,563,388. The average number of days it took to sell a loft apartment was 145 days, 13 days longer than the prior quarter and 29 days longer than the same period a year ago."

In the loft market, " prices weakened from the prior quarter but above prior year quarter. All price indicators fell from the records set in the prior quarter but remain higher than the same period last year."

There are various sources reporting the "market weakness" could last 6 months to a year or so.  This is traditionally a slow time in housing going into the holidays.  The statistics in the 2nd quarter will be more meaningful.

The assessor in Nassau County is sharply expanding real estate taxes of owners of illegal multi family housing according to Newsday article dated October 4th, 2006. A front page article in Newsday earlier dated October 2nd, 2006 showed an old property tax bill on a sample house like this of $5,912 going to $33,765.  Other houses cited showed a 4 to 5 fold increase in real estate taxes.

According to a Newsday article dated October 20th, 2006, New York City will build affordable housing on the Queens site that was part of the Olympics bid.  It will be 5,000 units with the average rent being $1,200 to $2,500 for families in the income range of $60,000 to $150,000. The construction will begin in 2008. It is noted that this initiative will be the largest affordable housing project since Brooklyn's Starrett City opened in the 1970's.

The most common value enhancing improvements that pay off reported by the New York Times, November 5th, 2006 are: renovated lobby, playroom, gym, roof deck, roof replacement, boilers and burners, elevators, full time doormen.

The use of Feng Shui is growing more popular in real estate decorating decisions.  What is feng shui exactly.  It is phonetically pronounced as "fung schway".  It is a methodology of the alignment of living spaces to maximize "chi" or living energy.  It also maximized the flow and balance of natural energy.  It uses a special compass called a "lou pan" or an octagonal map called a " bagua".  Along with either one of these, depending upon the practicioner, numerology and astrology also come into play.  Real estate experts report that it makes the house more marketable, however no known studies have been known to be done along with appropriate peer review.

 

 

Historical home price (2005/2006) figures as reported by the Multiple Listing Service of Long Island are as follows:

QUEENS

November 2005            $455,000

October 2006                $477,900

November 2006            $505,000

NASSAU

November 2005            $490,000

October 2006                $472,300

November 2006            $485,000

SUFFOLK

November 2005            $390,000

October 2006                $390,000

November 2006            $395,000

Below are the historical median sales prices of homes for Nassau, Suffolk and Queens Counties.

Year                Median           %change                    Number of                  % change from         

                        Sale                From                           Listings                       Previous Year           

Price               Previous Year

                                                             Nassau County

2005               $490,000       12.64                          28,507                        18.59

2004                  435,000       12.99                          24,038                        17.90

2003                  385,000         6.94                          20,388                        31.25

2002                  360,000       19.60                         15,534                        -4.02

2001                  301,000       20.40                         16,184                        12.83

2000                  250,000                                          14,344

                                   

                                                            Suffolk County

2005               $390,000         8.03                          38,535                        20.73

2004                  361,000       13.34                          31,918                        14.81

2003                  318,500       15.82                          27,800                        26.24

2002                  275,000       19.57                          22,021                          2.82

2001                  230,000       21.31                          21,418                           3.92

2000                  189,600                                           20,611           

                                                            Queens County

 

2005               $455,000       18.18                         27,109                        27.12

2004                  385,000       15.10                         21,325                        12.51

2003                  334,500       15.74                         18,954                        39.31

2002                  289,000       25.65                         13,606                          4.43

2001                  230,000       15.87                         13,029                        -4.01

2000                 198,500                                           13,573                       

 Source: Long Island Board of Realtors

 

As stated earlier, The housing market has shown signs of cooling off but by no means a burst of a bubble, at least, not as of this writing. According to Associated Press, 11/20/2006, the National Association of Realtors said sales of existing homes fell in 38 States and the prices of homes slid in 45 Metropolitan areas.  According to the Census Bureau, housing starts plunged nearly 15% to a seasonally adjusted annual rate of 1.49 million in October 2006 from a revised 1.74 million in September 2006.

For an historical perspective, new home construction slowed in October 2005 with an annualized construction rate of about 2.2 million homes which was a fall of 5.6 % the largest decline in almost six years.  The National Association has an index called the Housing Market Index, which is their way of looking at the statistics.  In October is fell about 6 points to 60 which is mid point for their index.  This “slowdown” is interpreted by many as simply a return to “normal” growth.

2008 RESIDENTIAL REAL ESTATE MARKET FORECAST

When will the housing market be back to normal?  What has to happen for it to occur?

The Case-Shiller U.S. home price index, showing statistics from a year earlier indicate that home prices in 10 major metropolitan areas in October were down 6.7% fro a year earlier as per a release in the WSJ 12/27/07.  (Please see graph below. This exceeded the previous record decline of 6.3% set in April 1991.  The graph that was published clearly shows the down cycle beginning in 1990, peaking at the then down part of the cycle in late 1991, then the up cycle began and that showed a peak of over 20% price increases at the tail end of 2004. Then the "rate" of appreciation continued to fall from that point forward, according to the graph. Finally in 2006, it went in the negative.

To put everyone's mind at ease.  The housing market will recover.  It will have appreciation again.  It will be "normal" again.  The big question is "when" and what needs to be done and what will the ultimate damage be?  Please keep in mind that in most economic risk based models in the entire world, housing is set to be the "least risky" in the overall risk spectrum.

As per statistics reported by the Federal Reserve Bank of Cleveland, the following is highlighted regarding housing starts which in one aspect of the residential housing market, new houses.  This also portends information regarding supply and demand.

Housing Starts (Nov) Single-family housing starts continued to decline in November, dropping 5.4 percent from a downwardly-revised October figure. So far this year, single family housing starts have declined in nine out of eleven months and have fallen by a third to their lowest level since 1991. Permits for single-family homes, which some believe to be a less volatile indicator of the demand for new construction, fell 5.6% in November and are also at their lowest level since 1991.

 

 The housing market is currently estimated to be at a mid phase of the decline cycle where "effective"  demand is continuing to erode while supply continues upward. This is due for the most part to the "mortgage" side of the equation.  Mortgages are drastically more difficult to get reducing " effective" demand by an estimated 50% or more.  Because of the mortgage crisis, foreclosures have flooded the market; new construction in the pipeline continues to push houses into the inventory section.  This has accelerated the build up of inventory.

 When will the normal supply and demand relationships get back into balance and prevail resulting in a stable, residential market with slightly upward appreciation. This normal supply and demand balance is expected to come into focus  late in 2008.  Normal supply and demand is defined as:

                    1. A small amount of marketing time or days on market (DOM) about 3-6 months for the mainstream house.

                    2. A 5% -10% difference (lower) between asking price and ultimate selling price. 

Mortgage money is the life blood of residential real estate.  If the bottom hasn't completely fallen out of the market; divine intervention takes place quickly providing for a re-liquidification of the secondary market ( banks can sell their originations), Freddy Mac and Fannie Mae, possibly FHA can step in and do some "heavy lifting" ( but we have already discussed that this is not likely in the immediate short term); that the FED can lower interest rates but without rattling the currency markets so that the dollar doesn't go into a free fall ( would create severe inflationary scenarios); that legislation get enacted that can affect large swathes of mortgage holders quickly ( such as legislation freezing any upward adjustment on interest rates on adjustable rate mortgages). The housing market is always better with people paying mortgages albeit at a lower rate and remain in the houses - keeping inventory off the market.

As the market gets there, it will go through a phenomenon of erratic behavior, instability, mod mentality behavior for a period of time.  If "devine intervention " occurs before the start of the 2008 normal residential selling season, this would prevent the "bottom of the market" from falling out.  If this happens, the rapid meltdown of the market can be stopped, confidence restored, buyers coming back into the market and the cycle then turning into normal balance.  In 2009 the market could then start to have positive appreciation beginning by July 2009.  This would also curtail the degree of peripheral economic damage since the residential real estate market does represent a substantial portion of the overall economy.  How much depends upon which economist you are talking to.  It is forecast that under optimum conditions the overall housing market decline will be less than 30% and very little in the prime areas of New York City ( Manhattan).

If "devine intervention" does not take place in a timely fashion, the bottom of the market will fall out. The economic damage will be severe and housing values could decline greater than 50%. Yes, there are extreme circumstances where houses could be valueless ( temporary and by definition).  Even the prime areas in Manhattan will suffer.

It is forecast that "devine intervention" will take place ( election year ), it has to some extent already (covered earlier in this forecast) and that ultimately, the most likely scenario that will occur will be between the ideal and most pessimistic as mentioned above.  There will be some changes in the mortgage industry.  But in the end when the housing market does recover and start to produce phenomenal rates of return at some point, lender vying to make greater returns will seek to do so by bringing into the market more, but less credit worthy buyers.  Thus the cycle will repeat.

In this process there will be some market disintermediation at the upper to extreme upper-end of the housing spectrum. Given the juxtaposition to New York City ( the financial and cultural capital of the world) and the overall strong world economy, the housing market in general, as measured by the median sales price, will finish the year 2008 slightly behind than the beginning of the year with low single digit percentage declines  in Nassau ( -5% to -10%), Suffolk ( -6% to -11%) ,  and Queens ( -3% to -5%). The condominium market in New York City is forecast to decline ( -5% to -10%). The cooperative market in New York City is forecast to decline (0% to -5%).  The extreme upper end of the luxury market for existing condominiums and cooperatives is forecast to finish 2008, probably with little movement up or down.  This is due to the fact that there is international demand, less overall supply and most all are in high quality locations.

The condominium market in Brooklyn  is forecast to decline ( -10% to -15%). The cooperative market in Brooklyn is forecast to decline ( -5% to -10%).

Some of my esteemed colleagues in the industry have published detailed housing reports for New York City and boroughs.  Many go through each neighborhood reciting current prices for both condominiums and cooperatives, historical prices and other information.  To access those reports, the web site contact information is listed in the rear of this forecast.   

 

 

CREDIT   CRUNCH        Much of the negative, headlines have been grabbed lately by the mortgage crisis, residential market melt down, rapid decline in residential real estate values. An equally, potentially economically devastating problem is that of business and industrial credit.  Without that functioning effectively, the main components of the business economy could come to a grinding halt.  It would be equally devastating as the mortgage crisis if left unchecked.  In a November 29, 2007 New York Times article, front page, it said " The combined value of two leading sources of credit - outstanding commercial and industrial bank loans, and short-term loans known as commercial paper- peaked at about $3.3 trillion in August, according to data from the Federal Reserve.  By mid - November, such credit was down to $3 trillion, a drop of nearly 9%.  Not once in the years since the Fed began tracking such numbers in 1973 has this artery of finance constricted so rapidly."

                                    Naturally, the FED, policy makers, business leaders are growing increasing alarmed about this problem which is the natural consequence of the mortgage crisis, residential housing market meltdown and related counterparts.

                                    The credit crunch as to do with "liquidity".  Lets take a quick hard look at this, for it will show that the normal ways of dealing with this might not be effective today.

                                    When you talk about “credit crunch”, hand in hand with that is the discussion of “liquidity”.  As the potential for a disaster for the global economy is being exposed, partially in light of the mortgage crisis and its global implications, we come to the chicken and the egg question.  Is the credit crunch causing the lack of liquidity or is the lack of liquidity causing the credit crunch?

                                     The central banks, as always in the past, are moving to stop this shrinkage of liquidity by injecting billions ( lending to member banks ) into the financial system.  This though, unlike the past effect of this, is currently having little or limited effect.  On the front page of the New York Times, 12/13/07 a story appeared indicating that the central banks in North America and Europe on Wednesday announce the most aggressive fusion of capital into the banking system since the 9/11 attacks.  The FED will lend $40 Billion this month, and the European Central Bank, Bank of England, Swiss National Banks and Bank of Canada will lend a total of $502. Billion this month and next. The goal was intended to deal with specific problems with inter-bank lending and would not have much impact with credit problems related to the collapse of the American housing market.  This was criticized by economists in general in that this policy did not reduce the risk that the credit crunch would reduce the risk of the economics sliding into recession.

                                   Normally, this would work, but it isn’t now.  Why?  We need to back up a few years.  Studies then showed                       that                             asset prices on financial sector balance sheets were growing at a multiple of GDP and the money supply that wasn’t.  What was going on?

                                      Thee answer.  During that time, there will little correlation between money and asset prices which seem odd to say the least. As the valuation story goes, unless the returns of the assets, measured by corporate returns on capital, were rising exponentially, there was no justification  for asset prices to be doing so.  Value is the present worth of future benefits.  It income attributable to assets isn’t rising exponentially, why should asset prices rise?  This is a basic valuation principle.

                                      The only other way this could happen would be a cheap source of money and credit.  If money costs X and the asset produces a rate of return greater than X ( after costs ) and the money, credit is available, then a purchase decision is justified.  Carried across the board, this increases demand, the asset base is relatively fixed, so we have demand push asset price increases, although the basic underlying assets don’t and aren’t forecast to produce any corresponding increase in income (returns ). 

                                      So if banks had limited money on their books, where is this capital coming from?  The reason is banks don’t keep  loans on their books (balance sheets) and only loans on balance sheets get counted as money.   Now, as soon as banks make loans, the loans get “securitized” and moved off the books ( balance sheets).               

There are two financially fancy ways of doing this ( well beyond the scope of this forecast ) but in simple terms : 1. was to sell the securitized loan as a bond.  The other was to use “synthetic” securitization with the used of derivatives ( remember those – value is “derived” from underlying things) and lock in interest rates with interest rate swaps.  In the old days this was referred to as “rocket science”. This mean that the bank was free to make new loans without using any of its lending capacity once its existing loans were securitized. This had been going on in the residential mortgage market for years earlier.

                                     So to get new control of the money supply, credit etc. , we must redefine liquidity.  Essentially we must add to the economic, traditional definition of “money”, any and all credit created and moved off banks’ balance sheets and onto the balance sheets of nonblank financial intermediaries.

 

                                    Central banks now can no longer determine how much debt is created. In the old days the central banks could do this by simply limiting the amount of central-bank money they supplied, which was the ultimate base of all loans, and then set up criterion such as “loan reserves” for every loan.  The ultimate effect of this was to make the credit supply finite.  Today, as mentioned, this is ineffective, and credit creation could become “infinite”, in theory.

 

                                     “Risk” desire set how risk was prices relative to central bank rates, but now central bank rates have little apparent impact.  Toward the end before the crisis hit, risk was “mis-priced”.  Please see other section of the forecast.  So optimistic attitudes on risk drove up the over-leveraging.  Now that the crisis has hit the credit is ebbing the other way, lack of it. Now risk is playing a pessimistic role and is driving the market.  As the poor quality assets have to be de-leveraged, a new driving force now as the market works its way through the cycle, they will have to be financed by banks and moved back on to the banks’ balance sheets and this will quickly use up new lending capacity. If these poor quality assets continue to deterioriate, they will have to be written down, thus using up more bank capital.

 

                                    The central banks were essentially powerless to control the “leveraging” while the market was hyper extending upward, and are probably equally powerless to control the “deleveraging” process.

                                     There are obvious other problems, since credit flows “down stream”.  What about a country like China, in a global system like this.  How will it fare in 2008?  Could the big upward juggernaut of its economic bubble burst in 2008.  It has excessive global liquidity flooding into its domestic markets over a quasi-fixed exchange rate and excessive household borrowing firing up the US economy’s consumer demand for China’s goods ( super low prices).  This is a big unknown going into 2008.  

                                    

                                     Credit crunch forecast for 2008:  All though all the numbers aren't in, it is forecast that the FED will supply more than enough market liquidity to insure that business and industrial credit don't cause an economic contraction.  This will probably come first in the form of a rate cut and strong hints of continued cuts and credit easing. But as discussed, this may not be enough.

 

                                    Evidence of this has been trickling in, for example, in a 11/27/2007 Wall Street Journal article, it is reported that the FED will extend loans for longer-than-usual terms to its network of Wall Street bond dealers which would ease, to some degree, funding pressure on banks through year end.  These extended loans ( a/k/a "repos" will be enacted through the FED's open market operations.  Buried within this article was another sign of credit jitters is the fact that the yield on the 10-year Treasury notes dropped sharply to 3.848%, the lowest level since March 2004, from 4.012% Friday.  More likely than note there will be a crescendo of news in this credit easing area late in the year and beginning the new year, which will set the psychological tone for the year.

                                   

 

LEI  Historical Preface:      LEI (Leading Economic Indicators) According to Investorwords.com, the definition of leading economic indicators is as follows.  An economic indicator that changes before the economy has changed. Examples of leading indicators include production workweek, building permits, unemployment insurance claims, money supply, inventory changes, and stock prices. The Fed watches many of these indicators as it decides what to do about interest rates. There are also coincident indicators, which change about the same time as the overall economy, and lagging indicators, which change after the overall economy, but these are of minimal use as predictive tools.

 Historically, on 12/6/2006 according to Associated Press, figures released by the Conference Board indicated that leading economic indicators (LEI) rose 0.2% last month.  The index stood @138.3 versus 139.1 in January 2006.  This index is designed to forecast economic activity 3-6 months ahead.  This result suggests that economic growth is moderating.  The index has been down four of the last 7 months.  John Lonski, chief economist of Moody's Investor's Services said, " Economic weakness skewed toward housing and motor vehicles."  The LEI reading suggests the kind of slow growth we are experiencing now could continue through the winter and into the spring. The LEI (leading economic indicators) will rise fall slightly  for the first quarter of 2007 and then plateau or remain static for most of the year and then rise considerably  for the remainder of the ^4th  Quarter 2008. 

                                    To balance out this aspect of economic description, the counter part of this is called "lagging economic indicators".  Investorwords.com defines this as follows:  An economic indicator that changes after the overall economy has changed; examples include labor costs, business spending, the unemployment rate, the prime rate, outstanding bank loans, and inventory book value

                                    According to an on-line Bloomberg report dated November 21, 2007  http://www.bloomberg.com/apps/news?pid=20601087&sid=amhLtAMBnigU&refer=home    "The Conference Board's index of leading economic indicators fell 0.5 percent in October after a 0.1 percent increase that was smaller than previously estimated, the New York-based group said today. A separate report showed consumer confidence weakened this month." as reported by Courtney Schlisserman and Joe Richter.

 

US LEADING INDEX           The Conference Board has reported on its US Leading Index as follows (12/20/2007):

The Conference Board announced today that the U.S. leading index decreased 0.4 percent, the coincident index increased 0.2 percent and the lagging index increased 0.2 percent in November.

• The leading index decreased sharply for the second consecutive month in November, and it has been down in four of the last six months. Most of the leading indicators contributed negatively to the index in November, led by large declines in stock prices, initial claims for unemployment insurance (inverted), the index of consumer expectations, and real money supply (M2)*. The vendor performance diffusion index and average workweek were the primary positive contributors to the index this month. The leading index fell 1.2 percent (a decline of 2.3 percent annual rate) from May to November, the largest six-month decrease in the index in six years. However, despite continued weakness in the housing permits and interest rate spread components, the strengths among its components remained balanced with the weaknesses during the past six months.
• The coincident index increased modestly in November, and all the component indicators made positive contributions to the index for this month. The index was revised slightly lower in September and October, as a result of downward data revisions to the components. The coincident index increased 0.8 percent (a 1.6 percent annual rate) from May to November and the strengths among the coincident indicators remained very widespread. The lagging index increased again in November, matching the increase in the coincident index for the month, and as a result, the coincident to lagging ratio was unchanged for November.
• After having been essentially flat since early 2006, the leading index has weakened sharply in recent months, and it has declined to its lowest level since the middle of 2005. Meanwhile, the coincident index has continued to increase throughout most of this period, but its growth has moderated recently. In addition, real GDP has continued to expand, growing at an average annual rate of 3.1 percent through the third quarter of the year (including a 4.9 percent annual rate growth in the third quarter). The recent behavior of the composite indexes suggest that while slow economic growth is likely in the near term, risks for further economic weakness have increased.

March 2007, Source: Conference Board

 

LEI FORECAST FOR 2008   It is forecast that Leading Economic indicators for 2008 will show, flat and or slight declines for the year.  Given the strength of the overall economy, the resilience is seems to continue to display, the timing of the mortgage crisis ( if it had to happen, it happened at at "good" time), falling interest rates it is forecast to be in the 135 - 136 area.  By year's end, it is forecast to be in the 137-138 area. 

 Recession          This is known as the dreaded "R" word.  It is politically correct to use it in all venues except "economics".  It is   starting to appear with increasing regularity in the press, television, political debates, common conversation.  Financial page headlines use expressions as " recession fears weigh heavily on markets etc. " as later it describes a market turndown.  It also get tied into the credit crisis and implies that if banks "tighten" up on credit after the recent debacle, that will impact the markets negatively.  If consumers' willingness to spend is also impacted that too will lead to a slowdown.  The battering of the stock and bond markets have traditionally signaled an up coming slowdown, recession or possibly worse.  However, the FED ( by lack of aggressive rate cutting and FED "speak" and private economists haven't swayed the feeling of the FED and private economists that the economy can squeak by and avoid a recession.

                                    The financial signals in this regard that the market gives, for example, the DJIA average, the Friday just after Thanksgiving, was at 12,980.88 which is 8.4% behind the market's all time high set this past October.  This large drop, usually signals a slowdown, recession some 3-9 months hence, all things considered.

                                    The sub-prime mortgage crisis, described in various other portions of this forecast, has drastically impacted the residential area of the economy, residential real estate values ( giving positive psychological effects to consumers to feel safe spending when in a positive, sustained direction ) the drastic, negative impact of being able to get a mortgage, the large amount of mortgage defaults, according to Realty Trac in November 2007, the number is well over 600,000 have all had a negative impact both directly and indirectly. It shows that foreclosures were averaging 250,000 in the first few quarters of 2005 and jumping to almost 625,000 in the third quarter of 2007. Banks are being asked to "restructure" mortgages and other "remedies" are being proffered.  Much of this is covered in another area of this forecast.

                                    According to Mark Zandi, Chief Economic of Moody's Economy.com in a 11/26/ 2007 WSJ article, regarding sub-prime lending, particularly the impact of fewer dollars flowing through the economy going forward for the next few years, " Every dollar change in housing wealth results in a change of 5 cents in consumer spending, and that added up to hundreds of millions."  This means if the housing market declines 20% over the next year, leaving the related issues aside for the moment, billions of dollars less are circulated through the US economy.  This would be seen as a clear contraction on any computer model, graph etc.  Any economy linked to the US economy ( name one significant one that isn't ) that contraction will be felt by that economy also.  When you have a few successive quarters of contraction, you have a recession.  A more extended period, that you have a "depression".  Throw in inflation, and you have the worst of both, "stag-flation".

                                The elections are also attempting to formulate new, immigration policy.  According to an Associated Press blurb, appearing in Newsday, 11/26/2007 immigrants add $229 Billion to the NY economy.  The US economy must exercise extreme caution in formulating both economic plans and immigration policy.  Although there are countries that are unfairly benefiting from extremely positive economic growth, thanks to unfavorable trade policies currently in effect and must be changes, free trade, the economic law of comparative advantage ( both covered in prior forecasts) must be carefully adhered to ( including the changes that must be made with at least one, upcoming economic giant) in order to keep the world from falling into a recession or worse.

                                   In a NY Times,11/23/2007 article it strongly points out that the Japanese are shifting cash out of US investments and are using the term "quitting America". Much of the sentiment driving this is based upon the perception that the economic engine of the world, always thought to be the United States, is shifting from the United States to emerging countries and markets.  The sentiment is that the United States lacks growth and energy.  The out flow of capital will further weaken the dollar and take away options the FED has to correct or minimize certain problems.

                                    If the United States loses this position, and it is possible, then in order to correct the problem with the less options it has, it will be forced to do things like drastically reduce the US military committment here and abroad to save billions.  Initially that could work, but then the enemies of the US and the "free world" will begin to have more of a free reign.  Weapons of mass destruction will proliferate.  The seeds of dangerous dictators, having already been sewn, will now have the unchecked ability to grow, mature and attack freedom and the quality of life as we have known it.  We will then be subject to attack and the continued loss of freedoms and quality of life as we have known it, or worse.

                                Recession forecast: Make no mistake, there will be an economic "shock" or "contraction" felt world wide. There are reports of it now.  Only the degree, intensity and duration are the  factors about it being discussed, analyzed and prognostigated. It is forecast that the recession is possible for 2008 but has an 85%  possibility of being completely avoided ONLY if the following is done, much of which is described in other sections of this forecast.  1. Resolve the mortgage crisis quickly - housing market meltdown by the selling season of 2008 - this includes widespread resolution of the defaulted mortgages by having the homeowners stay in the homes and pay a reduced payment until the can afford to pay more.  More details of this are covered in the housing area.  The net effect of this will be to reduce the number of houses on the market, create more "qualified" demand and the ability to finance this "qualified or effective" demand.  When supply and demand get more in balance, then new home construction and continue.  As of the writing of this forecast and before, numerous news stories have already hit the airways with such news. 2. Positively resolve the immigration issue - continue to welcome the positive, economically beneficial immigrants- try to absorb others but some kind of initial limits will have to be imposed.  3. Look carefully at countries that have been reaping an economic whirlwind of positive economic benefits at the US economy's expense.  This will have to be dynamically changed.  How long can the US economy continue to ship jobs and benefits overseas without some kind of positive, economic benefit. It the US economy simply stopped throwing away huge economic resources, it would have immediate and long term positive effects. This, of course, is an oversimplification, but I think the point is made.  A simple way would be to strenuously open up the "closed" markets. It lets our products be sold there. We should focus on the "high value" industries.  The specific ones won't be mentioned for security reasons. Keeping our jobs here.  Sure, it is not a panacea nor meant to overturn the economic law of "Comparative Advantage" but is another step to stop the economic hemorraging.  This will take a "big picture" concerted effort which includes business, industry, academia and foreign governments working together. 4. The staggering losses the US economy has been taking with regards to out and out theft of intellectual property is beyond belief.  This is outright theft.  More importantly, the loss of money to the various companies prevents the appropriate economic return and recovery of investment which is an inhibiting factor to the timely and competitive development of new and related products.  This conditions will cause severe economic damage in the medium and long term.  I have complied the "Howard Jackson Economic SWAT team" to recognize, evaluate then devise and implement strategies and policies to stop and correct this damage.  Since we are at war with terrorism and its implication, the "Howard Jackson Economic SWAT team" and anything about it can't be printed or disseminated for obvious reasons.  Please contact Howard Jackson's office for more information.  5. Immediately enact an energy policy and get the US economy off fossil fuel immediately. This is a huge, economic drain.  It is a hinderance to supercharged economic growth without inflation.  It will also remove a huge economic target from the terrorists and other enemies of the US and its allies.

Unemployment: It is forecast that unemployment will rise in the FIRE sections for the first and second quarters of 2008 but this was a logical knee jerk reaction to the "mortgage crisis".   Overall, New York City and Long Island will remain basically the same should the mortgage crisis be resolved quickly. For historical perspective, for the most of 2006 unemployment rates continued to rise slightly.  The World Trade Center attack played a negative role as well as corporate layoffs and major corporate scandals such as Arthur Andersen, Enron etc.  This also effected investor confidence which in part can influence unemployment. But for the Year 2007, this is now a known, quantified series of events.  Business planning can make effective use of this knowledge which will chip away at unemployment.  On 12/8/2006, CnnMoney.com reports that employers added 132,000 jobs to payroll in November 2006, according to the Labor Department which was up from a revised gain of 79,000 jobs in October 2006.  The unemployment rate rose to 4.5% from 4.4% in October 2006.  The retail sector added 20,000 jobs in November 2006.

                                    Here is the unemployment rates by State as per Bureau of Labor Statistics.

State unemployment, October 2007 «click column headings to re-sort table» Rank State Rate 1 IDAHO 2.5 2 HAWAII 2.7 3 UTAH 2.8 4 SOUTH DAKOTA 2.9 4 WYOMING 2.9 6 ALABAMA 3.1 6 MONTANA 3.1 6 NEW MEXICO 3.1 6 VIRGINIA 3.1 10 NEBRASKA 3.2 10 NEW HAMPSHIRE 3.2 12 LOUISIANA 3.3 13 DELAWARE 3.4 13 NORTH DAKOTA 3.4 15 ARIZONA 3.5 16 COLORADO 3.7 17 KANSAS 3.8 18 IOWA 3.9 19 MARYLAND 4.0 20 NEW JERSEY 4.1 20 TEXAS 4.1 22 FLORIDA 4.2 23 MASSACHUSETTS 4.3 23 VERMONT 4.3 25 OKLAHOMA 4.4 26 PENNSYLVANIA 4.5 27 INDIANA 4.6 27 NEW YORK 4.6 27 TENNESSEE 4.6 30 CONNECTICUT 4.7 30 GEORGIA 4.7 30 MINNESOTA 4.7 33 MAINE 4.8 33 NORTH CAROLINA 4.8 33 WASHINGTON 4.8 36 RHODE ISLAND 4.9 37 WEST VIRGINIA 5.0 38 NEVADA 5.2 38 WISCONSIN 5.2 40 ILLINOIS 5.3 41 OREGON 5.5 42 CALIFORNIA 5.6 42 KENTUCKY 5.6 42 MISSOURI 5.6 45 ARKANSAS 5.7 46 DISTRICT OF COLUMBIA 5.8 46 SOUTH CAROLINA 5.8 48 OHIO 5.9 49 ALASKA 6.1 49 MISSISSIPPI 6.1 51 MICHIGAN 7.7

This is the Northern New Jersey, Long Island area.
Year	Period	labor force	employment	unemployment	unemployment rate

2006 Annual 9290079 8872227 417852 4.5 2007 Jan 9278146 8840339 437807 4.7 2007 Feb 9260978 8835403 425575 4.6 2007 Mar 9229007 8838466 390541 4.2 2007 Apr 9160719 8803712 357007 3.9 2007 May 9168824 8790867 377957 4.1 2007 Jun 9322718 8903445 419273 4.5 2007 Jul 9403183 8914600 488583 5.2 2007 Aug 9326596 8886310 440286 4.7 2007 Sep 9237997 8835812 402185 4.4 2007 Oct 9267806 8868115 399691 4.3

EMPLOYED, UNEMPLOYED, AND RATE OF UNEMPLOYMENT
                                BY PLACE OF RESIDENCE
                FOR NEW YORK STATE AND MAJOR LABOR AREAS, NOVEMBER 2007
                   (Numbers in thousands, not seasonally adjusted)
 

EMPLOYED, UNEMPLOYED, AND RATE OF UNEMPLOYMENT

                                BY PLACE OF RESIDENCE

                FOR NEW YORK STATE AND MAJOR LABOR AREAS, NOVEMBER 2007

                   (Numbers in thousands, not seasonally adjusted)

-----------------------------------------------------------------------------

                           EMPLOYED             UNEMPLOYED       UNEMP. RATE

AREA/COUNTY         NOV      OCT      NOV    NOV    OCT    NOV  NOV  OCT  NOV

                   2007     2007     2006   2007   2007   2006 2007 2007 2006

-----------------------------------------------------------------------------

UNITED STATES  147118.0 146743.0 146014.0 6917.0 6773.0 6576.0  4.5  4.4  4.3

NEW YORK STATE   9083.0   9031.0   9107.0  419.0  417.0  374.0  4.4  4.4  3.9

NEW YORK CITY    3663.8   3626.4   3640.6  192.5  202.9  163.1  5.0  5.3  4.3

 BRONX            479.6    474.7    476.5   34.5   36.3   29.6  6.7  7.1  5.8

 KINGS           1026.7   1016.2   1020.2   58.8   61.9   49.7  5.4  5.7  4.6

 NEW YORK         876.8    867.8    871.2   39.2   41.6   33.5  4.3  4.6  3.7

 QUEENS          1056.5   1045.7   1049.8   49.4   52.0   41.4  4.5  4.7  3.8

 RICHMOND         224.3    222.0    222.9   10.5   11.1    8.9  4.5  4.8  3.8

PUT-ROCK-WEST     669.5    665.5    672.2   24.6   23.8   22.6  3.5  3.4  3.3

 PUTNAM            54.6     54.2     54.8    1.8    1.8    1.7  3.3  3.1  3.0

 ROCKLAND         146.8    145.9    147.4    5.4    5.3    5.1  3.6  3.5  3.4

 WESTCHESTER      468.2    465.4    470.1   17.3   16.8   15.8  3.6  3.5  3.3

NASSAU-SUFFOLK   1422.9   1415.1   1432.5   54.0   52.2   49.5  3.7  3.6  3.3

 NASSAU           669.4    665.7    673.9   24.9   24.3   22.6  3.6  3.5  3.2

 SUFFOLK          753.6    749.4    758.6   29.1   27.8   26.9  3.7  3.6  3.4

                                    The forecast for unemployment for 2008 is as follows:

New York City:    4.2%

Nassau:                3.1%

Suffolk:                  3.3%

                                                      

                                                     Following is some historical background information on unemployment.

The historical unemployment rate for Long Island is:

1991                           5.6%

1992                           7.7%

1993                           6.7%

1994                           6.2%

1995                           5.1%

1996                           4.6%

1997                           3.8%  

1998                           3.5%

1999                           3.4%

2000                           2.8%

2001                           3.7%, Queens 5.8%, NYC 6,8

2002                           5.6% estimated.

 Long Island and New York City should outperform the Northeast due to it diverse and international economies.

 

Noteworthy points:

Concerning jobs and employment, the biggest issues were:

1. The largest companies are locating more jobs off the island.

2. Some reasons for the off island migration of jobs are - the high cost of living, focus on skilled workers.

3. Unable to satisfy high level employment needs on the island so off island solutions are being implemented.

According to the State Labor Department  the job creation on Longs Island is:

1. 1996 - 8,000

2. 1997 - 19,900

3. 1998 - 27,400

4. 1999 - 41,800

5. 2000 - 27,800

6. 2001 - 600

7. 2002 - (-3,100)

8. 2003 - 7,300

9. 2004- 11,100

10. 2005 - 6,700

The job breakdown by sectors are as follows: ( it may not equal 100% due to rounding ).

1. Government                                 16.5%

2. Education/Health                        16.4%

3. Professional/Business                12.7%

4. Leisure/Hospitality                        7.2%

5. Manufacturing                                7.1%

6. Financial                                        6.6%

7. Construction                                   5.1%

8. Other                                                6.6%

9. Information                                     2.4%

10. Retail,Trade,Transport                 21.7%   

The brain drain.  Talent being raised and educated on Long Island.  Then this talent goes outside of Long Island to live and work.  This cycle deprives Long Island of the necessary rejuvenation and re-supply of talent to continue moving the economy forward.  This is called the brain drain.  Please see the later section of this forecast in the "questions" section.

 Inflation:                   Given the reasonably strong  economy expected to take hold after the rebound of the mortgage crisis,  low current inflation, stable but much higher energy prices, stabilized interest rates by the FED ( after almost a year of rate hikes) look for inflation in  1.25% to 2.25 % for the year. Much of this will be driven by continued high and increasing fuel costs. ( This will be given substantial coverage later in the article in conjunction with one of the questions posed by our reading audience. )

Another look at prices, according to the Federal Reserve Bank of Cleveland, the following is stated:

PCE Price Index The Personal Consumption Expenditure (PCE) price index rose 7.1 percent (annualized rate) in November, after an upwardly revised 3.9 percent increase in October. While energy prices had much to do with the spike in the headline number, rising 192 percent during the month, the PCE index excluding food and energy (core PCE) was elevated as well, rising 2.8 percent. Core prices for October and September were revised upward, rising 2.7 and 3.2 percent, respectively. For the first time since May, the 12-month growth rate in core PCE edged above 2.0 percent, as it rose to 2.2 percent in November.

Additionally, from the Federal Reserve Bank of Cleveland, the following is reported:

CPI The Consumer Price Index (CPI) advanced at a 10.0 percent annualized rate in November, driven largely by a 95.5 percent energy shock that pushed the index to its highest growth rate since September 2005. Consumer prices excluding food and energy (core CPI) rose 3.3 percent during the month. The last time the core CPI was above 3.0 percent was in January. The price increases are largely broad based: while the overall CPI grew 2.2 percent over the past three months, every major component of the index rose more than 3.0 percent over the period except education and communication. This recent acceleration is reflected in the median CPI and the 16 percent trimmed-mean CPI, which rose over the past three months 3.3 percent and 3.4 percent, respectively, and in November each increased 3.7 percent.

This is very much the "standard" by which inflation is measured.  It is forecast that inflation will be in the 2% range for 2008.  Although housing ( mortgage crisis, decline in housing values) may take a lot out of the momentum of inflation, items such as energy will continue to rise in 2008.

 

GDP :   The US is now in a global economy and in some part is subject to market/economic forces over which is has little or no control.  In the early 1950's and 1960's the US enjoyed 5 major advantages: 1.  A large capital base, 2. Large and unrestricted market share, 3. Superiority in education, 4.  Little or no competition, 5.  Ease to implement technological advances.  Over the last 2 decades many of these advantages have been equalized. It is upon this background the GDP forecast is made.

  It is forecast that the GDP growth for the US will be "choppy" mainly due to the effects of the "mortgage crisis" which has been clearly presented and exhaustively discussed earlier.

1st Quarter:     -2%% - +1%

2nd Quarter:     1% - 1.5%

3rd Quarter:    1% -1.5%

4th Quarter:     1.5% - 2%

According to the Federal Reserve Bank of Cleveland as well as data as of December 2007, summarized and presented by Blue Chip Forecast, the following is stated:

Real GDP (3Q-Final) Real GDP increased at an annualized rate of 4.9 percent in the third quarter, according to the final estimate released by the Bureau of Economic Analysis, unchanged from the preliminary estimate. Although headline growth remained the same, there was a small upward revision to personal consumption expenditures that was offset by a downward adjustment to private inventories. Third quarter corporate profits (released with GDP), decreased $20.5 billion, after rising $94.7 billion in the second quarter.

 

According to Wikipedia's definition Gross Domestic Product is as follows:

A region's gross domestic product, or GDP, is one of several measures of the size of its economy. The GDP of a country is defined as the market value of all final goods and services produced within a country in a given period of time. It is also considered the sum of value added at every stage of production of all final goods and services produced within a country in a given period of time. Until the 1980s the term GNP or gross national product was used in the United States. The two terms GDP and GNP are almost identical. The most common approach to measuring and understanding GDP is the expenditure method:

GDP = consumption + investment + government spending + (exports − imports)

Please see rear of article for expanded and detailed information on the formulas. It also shows in great detail the limitations and the critique of GDP.

Historically, according to BEA, National Economic Accounts, 11/29/2006, the GDP is as follows:

Period                            % Change from prior period       

1st Quarter 2005                        3.4%

2nd Quarter 2005                        3.3%

3rd Quarter 2005                        4.2%

4th Quarter 2005                        1.8%

1st Quarter 2006                        5.6%

2nd Quarter 2006                        2.6%

3rd Quarter 2006                        2.2%  

Consumer Sentiment:

According to the Federal Reserve Bank of Cleveland, 12/21/07 the following is stated:

Consumer Sentiment The University of Michigan’s Index of Consumer Sentiment slid another 0.6 points to 75.5 in December, and is now down 21.4 points from the beginning of the year (January’s index value was 96.9). The consumer expectations component fell to 65.6, its lowest reading in two years. The current economic conditions component dropped 0.5 points to a value of 91, after falling 6.1 points in November. Short-term inflation expectations ticked up in December, rising 0.1 percentage points to 4.4 percent. Longer-term (5-year to 10-year) inflation expectations rose to 3.5 percent, up 0.4 percentage points from October’s low of 3.1 percent.

It is forecast that this will improve substantially by December 2008.

Current Economic Conditions:  Following are the results of a Gallup poll regarding the perceptions of economic conditions and related factors in the United Stated.

CBS News/New York Times Poll. Dec. 5-9, 2007. N=1,133 adults nationwide. MoE ± 3.
				.
"What do you think is the most important problem facing this country today?" Open-ended
				.
		%
	War in Iraq	25
	Economy/Jobs	12
	Health care	7
	Immigration	4
	Environment	3
	Gas/Heating oil crisis	3
	Poverty/Homelessness	3
	Terrorism (general)	3
	Other	36
	Unsure	4

 

 

ABC News/Washington Post Poll. Sept. 4-7, 2007. N=1,002 adults nationwide. MoE ± 3. Fieldwork by TNS.
				.
"Thinking ahead to the November 2008 presidential election, what is the single most important issue in your choice for president?" Open-ended
				.
		%
	War in Iraq	35
	Health care	13
	Economy/Jobs	11
	Terrorism/National security	6
	Ethics/Corruption in government	6
	Immigration/Illegal immigration	5
	Morals/Family values	2
	Other	13
	Unsure	9

It is forecast that the Presidential Elections, the mortgage crisis and related issues will be the biggest headline grabbers and have the most effect on the world, national and local economies.  It is also forecast that the concerns will get greater during the mid year but that the Presidential elections will have an effect of condensing major issues, acting as a catalyst for unity and action behind remedial and proactive courses of actions which will have the uniting effect causing a greater sense of economic well being increased consumer confidence. This, in turn, will cause ( in ways too long to articulate here) increased positive economic activity which will translate to better economic statistics by the year's end.

 Real Estate Taxes:  Historically, real estate taxes on Long Island are the highest in the United States.  News stories through the year continue to talk about rising real estate taxes attributable to mostly to schools. In Nassau County, for example, the school taxes are about 65% to 70% of the tax dollar. In Nassau, there are 56 districts while in Suffolk there are 68. Historically, according to a study on "Budgets and Taxes" published in Newsday on May 1st, 2006 a complete summary of the 124 districts, the proposed budgets for 2006-2007 and the % change over the prior year was published.  While there were a small amount of districts with slightly lower or no change budgets, the predominance of the districts showed single and double digit growth.  The largest proposed increase was 33.42% in Suffolk and 15.01% in Nassau.   It is forecast that the taxes will again rise in 2008 predominately caused by the school taxes. There are quirks to the school tax system in Nassau County, covered in prior forecasts and won't be repeated here.  The sum and substance of recommendations then, which are applicable now, is that each school system should be a separate system (after eliminating all the duplicity, waste etc.). They should assess real estate in their jurisdiction, collect their school taxes and should any property owners successfully challenge any real estate tax assessments, the school district should replay the over-assessment ( real estate taxes associated with it) 

Mortgage Interest Rates 

Historically, the Fed had raised interest rates successively through most of 2006 and part of 2007.   In fact during October and November mortgage interest rates have been declining.  As of November 22nd, 2006 the 30 year fixed rate was 6.36% down from 6.46% the prior week.  The 15 year fixed rate was 6.06% down from 6.18%. The 1 year ARM was 5.84% up from 5.76%

By the 4^th Quarter, economic activity should prompt the FED to start to raise interest rates again which will negatively impact mortgage rates and this should start the rates on the upward cycle going into middle of 2008.

According to Home Finance of America, 12/8/2006, the basic mortgage rates are as follows:

        30 Year Fixed: 5.750%, APR: 5.89 %

        15 Year Fixed: 5.50%,  APR 5.60%

As of the close of the year the rates posted were:

Interest Rates
	Avg
Mortgages - 15 Year Fixed	5.33%
Mortgages - 30 Year Fixed	5.79%
Mortgages - 5/1 Year ARM	5.53%

 

It is forecast that the mortgage interest rates will  fluctuate by 20-40 basis points during the course of of 2008 but will wind up almost exactly where they are now or slightly lower

 Historically, as of December 31, 2005, the 30 year fixed rate mortgage is approximately 6.4%.  The 15 year fixed rate mortgage is approximately 5.9% while the 1 year adjustable rate mortgage is approximately 5.75%

Prime  Interest Rates

The prime rate is currently 7.25% and has been so since December 11, 2007 since the FED had their meeting to lower interest rates. The FED lowered rates in response to the mortgage crisis and related issues explained in great detail in another section of this forecast.

 How is the Prime Rate defined? The general consensus is that the Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers (usually the most prominent and stable business customers). The rate is almost always the same amongst major banks. Adjustments to the prime lending rate are made by banks at the same time; although, the prime rate does not adjust on any regular basis. The rates reported below are based upon the prime rates on the first day of each respective month.

 Historical Graph

 

 

Historical Chart

 

Prime Rate
Month	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006	2007
Jan 1	8.25%	8.50%	7.75%	8.50%	9.50%	4.75%	4.25%	4.00%	5.25%	7.25%	8.25%
Feb 1	8.25%	8.50%	7.75%	8.50%	8.50%	4.75%	4.25%	4.00%	5.25%	7.50%	8.25%
Mar 1	8.25%	8.50%	7.75%	8.75%	8.50%	4.75%	4.25%	4.00%	5.50%	7.50%	8.25%
Apr 1	8.50%	8.50%	7.75%	9.00%	8.00%	4.75%	4.25%	4.00%	5.75%	7.75%	8.25%
May 1	8.50%	8.50%	7.75%	9.00%	7.50%	4.75%	4.25%	4.00%	5.75%	7.75%	8.25%
Jun 1	8.50%	8.50%	7.75%	9.50%	7.00%	4.75%	4.25%	4.00%	6.00%	8.00%	8.25%
Jul 1	8.50%	8.50%	8.00%	9.50%	6.75%	4.75%	4.00%	4.25%	6.25%	8.25%	8.25%
Aug 1	8.50%	8.50%	8.00%	9.50%	6.75%	4.75%	4.00%	4.25%	6.25%	8.25%	8.25%
Sep 1	8.50%	8.50%	8.25%	9.50%	6.50%	4.75%	4.00%	4.50%	6.50%	8.25%	8.25%
Oct 1	8.50%	8.25%	8.25%	9.50%	6.00%	4.75%	4.00%	4.75%	6.75%	8.25%	7.75%
Nov 1	8.50%	8.00%	8.25%	9.50%	5.50%	4.75%	4.00%	4.75%	7.00%	8.25%	7.50%
Dec 1	8.50%	7.75%	8.50%	9.50%	5.00%	4.25%	4.00%	5.00%	7.00%	8.25%	7.50%
Copyright 2007 MoneyCafe.com

Source: Federal Reserve Board

Continued History of the Prime Rate

According to Citibank as of 11/30/20006 the prime rate was 8.25%

Historically the prime rate is as follows:

          Prime Rate                    Date

1. 8.25                            July 1st, 2006

2. 8.00                            May 11th, 2006

3. 7.75                            March 29th, 2006

4. 7.50                            February 1st, 2006

5. 7.25                            December 15th, 2005

6. 7.00                            November 2nd, 2005

7. 6.75                            September 21st, 2005

8. 6.50                            August 10th, 2005

9. 6.25                            July 1st, 2005

10. 6.00                            May 4th, 2005

11. 5.75                            March 23rd, 2005

12. 5.50                            February 3rd, 2005

13. 5.25                            December 15th, 2004

14. 5.00                            November 12th, 2004

15. 4.75                            September 22nd, 2004

16. 4.50                            August 12th, 2004

17. 4.25                            July 2nd, 2004

18. 4.00                            June 27th, 2003

19. 4.25                            November 7th, 2002

20. 4.75                            December 12th, 2001

21. 5.00                            November 7th, 2001

22. 6.75                            June 28th, 2001

23. 7.00                            May 16th, 2001

24. 7.50                            April 19th, 2001

25. 8.00                             March 21, 2001

26. 8.50                            February 1st, 2001

27. 9.00                            January 4th, 2001

28. 9.50                            May 17th, 2000

29. 9.00                            March 24th, 2000

30. 8.75                            February 2nd, 2000

31. 8.50                            November 17th, 1999

32. 8.25                            August 25th, 1999

33. 8.00                            July 1st, 1999

Bond Interest Rates:       Here are the bond rates, as reported by CnnMoney.com as of the end of 2007.

yr 100 12/32 +4/32 3.05 -0.06 5 yr 100 22/32 +4/32 3.47 -0.03 10 yr 101 24/32 +12/32 4.03 -0.04 30 yr 109 +26/32 4.44 -0.05

  

Is this the beginning of the inverted yield curve? Probably not, but what will the Fed Chairman do?  It remains to be seen but this will be high on the priority list. The FED is fighting two problems, whose solution for each is counter to the other - the weak dollar, the mortgage crisis ( preventing a recession or worse, if possible).

This is an inverted yield curve on the left.  Note that the yield is very high for the short term maturities and very low for the long term maturities.  It should be just the opposite.  A normal yield curve is on the right.

                               

Historically, an inverted yield curve has been viewed as an indicator of a pending economic recession. When short-term interest rates exceed long-term rates, market sentiment suggests that the long-term outlook is poor and that the yields offered by long-term fixed income will continue to fall. More recently, this viewpoint has been called into question as foreign purchases of securities issued by the U.S. Treasury have created a high and sustained level of demand for products backed by U.S. government debt. When investors are aggressively seeking debt instruments, the debtor can offer lower interest rates. When this occurs, many argue that it is the laws of supply and demand, rather than impending economic doom and gloom, that enable lenders to attract buyers without having to pay higher interest rates.  There is merit to this thinking but, if you continue the logical reasoning, could US debt continue to mound and still have falling interest rates? (To learn more, see Forces Behind Interest Rates and Trying To Predict Interest Rates.) 
 

But there is a problem here.  On one hand, there is the mortgage crisis, credit crunch meaning the economy could go into a recession or depression. There are many world wide headlines featuring this prominently.  The FED can fight that .  On the other hand, on the back side of the headline page, there are contradicting stories indicating that the FED is worried about inflation, not deflation.  Depending upon what the FED is worried about would dictate FED policy.  For inflation there would be one basic policy, for deflation, another policy.  If there is a mis-diagnosis, the policy would take the economy down the wrong path and the results would be disastrous. There is also the issue of a weakening dollar. ( Who said this was going to be simple)

  An example of this is an 11/28/2007 Wall Street Journal article " Bond Yields Harken Back to 2004".  At that time, the US economy was recovering and coming out of a steep recession and had received 13 interest rates cuts.  The FED was clearly fighting deflation ( recession ). To give a brief snapshot, here are the key statistics:

Item                                                March 31, 2004               November 27, 2007

10- Year Treasury                            3.841%                            3.944%

Consumer Price Index                    1.7%                                  3.5%

Federal Funds Rate                        1%                                        4.5%

Conventional Mortgage                    5.52%                                6.20%

3-Month commercial paper            1.02%                                    4.32%

Investment Grade Corp. bond          6.15%                                6.41%

5-Yr. Adjustable Mortgage                3.99%                                    5.65%

High Yield Bonds                                7.52%                                9.50%

The forecast for 2008 Bond Interest Rates is as follows.  It is forecast that there will be a flight to quality in bonds for the first quarter which will in effect raise rates for the lower grade bonds.  This is a result of the unwinding of the mortgage crisis in the news. It does not appear to be the start of an inverted yield curve, at least not now.

In other sections of the forecast, the economic indicators point to a strong economy.  After all is said and done, interest rates in general will probably move about 50 basis points, up or down,  and all relative time and quality will be adjusted from there.  More likely than not, it is forecast that at the end of the year, interest rates will probably be in the same place as they will be at the start of the year.  Interest rates will probably drop slightly at the start of the new year.

Historically according to  CNN Money.com  as of December 8th, 2006, the interest rates and yields were as follows:

Bonds

Dec 8 11:35am ET † Price Change Yield Yld Chng 2 yr 99 31/32 -4/32 4.63 +0.06 5 yr 100 1/32 -6/32 4.48 +0.04 10 yr 100 27/32 -9/32 4.51 +0.03 30 yr 98 1/32 -11/32 4.62 +0.02

Historically, as of December 30^th, 2005 the yield for the 30 year bond was 4.53% while the yield for the 10 year bond was 4.38% and the yield for the 5 year was 4.35% and the two year bond was 4.40%.

  

Consumer Confidence

 Historically, The Conference Board reported on December 29th, 2006 that consumer confidence shot up to an eighth month high of 109.0  in December. This is the first December in three years where the consumer confidence level went down.  RBC financial group said, "that its monthly measure of U.S. consumer confidence dropped more than 5 points to 86.9 from 92.4 in November, as consumers expressed concern about current and future economic conditions, as well as investing."

Hurricane Katrina's effects, the attempted rebuilding of the World Trade Center In Lower Manhattan ( New York City ), the continued war in Iraq, issues with Iran, imbalanced world trade, continued to influence consumer confidence both locally, nationally and world wide.

The following Conference Board Consumer Confidence  Index was released 11/17/2007 which indicated that the Index is now 87.3 down from 95.2 in October 2007.  It began the year just above 100.  This decline was based in part due to all the negative news. An index this low does generally not auger well for future positive economic news.

As of December 27, 2007 the Conference Board reports the following: 

The Conference Board Consumer Confidence Index, which had been declining since the summer, posted a slight increase in December. The Index now stands at 88.6 (1985=100), up from 87.8 in November. The Present Situation Index, however, decreased to 108.3 from 115.7 in November. The Expectations Index rose to 75.5 from 69.1.

Consumers' appraisal of present-day conditions continues to paint a dismal picture. Those claiming conditions are "good" decreased to 20.3 percent from 22.5 percent. Those saying conditions are "bad" increased to 20.0 percent from 18.9 percent. Consumers' assessment of the job market was also less positive. Those saying jobs are "hard to get" rose to 23.5 percent from 21.4 percent, while those claiming jobs are "plentiful" declined to 22.7 percent from 23.3 percent in November.

The Consumer Confidence Survey is based on a representative sample of 5,000 U.S. households. The monthly survey is conducted for The Conference Board by TNS. TNS is the world's largest custom research company. The cutoff date for December's preliminary results was December 18th.

Source: Conference Board- December 2007 as excerpted from publication in the Press

The above graph depicts rapidly falling consumer confidence. The actual effects of the mortgage crisis, residential real estate market and related components won't be fully factored into the market until the first quarter.

The effects of the mortgage crisis will not be fully known for some time.  The major reason is that the ultimate consumers, homebuyers, have their selling season in March through August 2008.  That will have a major impact on consumer confidence.

The forecast for consumer confidence, for 2008: It is expected that the consumer confidence index will have a rapid rise mid year as the announcements, enactments and preliminary results of fixes to the mortgage crisis, residential housing market collapse and the business credit crunch will unfold. The residential selling season will be in full swing.  The forecast will range from 80 in January, will rise to 110 during the residential real estate season but will fall at year's end, since many of the buyers taken out of the market by the collapse of the "sub-prime" mortgage situation ( it added about 25% more buyers to the market) won't be back in the market, at least not this time.  The lack of buyers will contribute to a lackluster residential market overall, which seems to always have a negative effect on consumer confidence ( lack of feeling of wealth).

Consumer confidence will also be influenced by the rebuilding efforts of the damage of Hurricane Katrina, a solution to the war in Iraq (exit strategy), rebuilding of the World Trade Center, The Presidential Elections,   ironically and probably initially most importantly, the ability of the US economy to avoid going into a recession as of a result of the economic contraction of the economy resulting from the mortgage crisis and the extreme economic circumstances resulting from the business and industrial credit crunch.

 

Other Measures        The Gallup poll has numerous other measures of key indicators. On a USA Today web site in cooperation with       Channel 7 News  ( http://www.usatoday.com/news/politics/election2008/2007-10-31-mood-cover_N.htm) is shows a graph charting people's satisfaction and dis-satisfaction and stresses that it is a year before elections.  While not absolutely scientific, it is something tangible and in some way relates to consumer confidence. This is put here for information purposes.  It show that the Satisfaction level for 2007 is 26 and the Dis-satisfaction level is 72.  Compared to 1999 with a booming stock market and economy, the Satisfaction level for 1999 was 71. 

Budget Deficits                                       

Historically, according to the White House Office of Management and Budget, the projected deficit for 2006 will be -$423.2 billion and for 2007 it will be -$352.2 billion. Following is an excerpt from a web site regarding the budget deficit and related issues.  It is appropriate this being a Presidential election year.  Here is the web address: http://www.federalbudget.com/

 

The National Debt is $9.1 Trillion!
Updated 21 October 2007.
Check the debt yourself at the U. S. Treasury Department web site, it changes daily.

In Fiscal Year 2006, the U. S. Government spent $406 Billion of your money on interest payments* to the holders of the National Debt. Compare that to NASA at $15 Billion, Education at $61 Billion, and Department of Transportation at $56 Billion. So how do we fix this growing debt problem? Here is one suggested solution. What's your solution? FAQs and Answers on the Balanced Budget Amendment and Article V of the Constitution. And here is an Opposing View (Other opposing views below). And learn more about Article V of the Constitution.

 

The U. S. Dollar is being replaced by the Euro as the international trade standard. Could our large national debt be part of the reason?

President Bush put in tax rate cuts. This boosted the economy and tax revenue is up. So it wasn't a "tax cut", because tax revenue increased. It was a tax rate cut and it worked perfectly. Now if we can just get Congress to cut spending....and pass the Fair Tax Bills HR25 and S1025.

Your money is spent through Appropriations Bills passed by Congress and signed by the President. This chart is based on the Appropriations Bills. The Government does not have any money, it takes your money from you and spends that! Press Release on Tax Code and the IRS.

--- "Budget Deficit" vs. "National Debt" --- Suppose you want to spend more money this month than your income. This situation is called a "budget deficit". So you borrow. The amount you borrowed (and now owe) is called your debt. You have to pay interest on your debt. If next month you don't have enough money to cover your spending (another deficit), you must borrow some more, and you'll still have to pay the interest on the loan. If you have a deficit every month, you keep borrowing and your debt grows. Soon the interest payment on your loan is bigger than any other item in your budget. Eventually, all you can do is pay the interest payment, and you don't have any money left over for anything else. This situation is known as bankruptcy. Each year since 1969, Congress has spent more money than its income. The Treasury Department has to borrow money to meet Congress's appropriations. The total borrowed is more than $8,000,000,000,000 and growing. Even when government officials claim to have a surplus, they still spend more than they get in. We pay interest on that huge debt.

According to Mr. Kneeland, "...all dollars come from the people. Where do [you] think Coca-Cola gets the money to pay its taxes, Exxon gets its money to pay the Exxon Valdez fines, Denny's gets the money to pay its Justice Department fines, or even Microsoft gets the money to defend itself? It all ultimately can come from only one place, and that's from individuals."

"For society as a whole, nothing comes as a 'right' to which we are 'entitled'. Even bare subsistence has to be produced.... The only way anyone can have a right to something that has to be produced is to force someone else to produce it... The more things are provided as rights, the less the recipients have to work and the more the providers have to carry the load." Thomas Sowell, quoted in Forbes and Reader's Digest.

Don't harm your customers. Take care of your customers. Think internationally! Your customers may be in some other country.

"A politician cannot spend one dime on any spending project without first taking that dime from the person who earned it. So, when a politician votes for a spending bill he is saying that he believes the government should spend that particular dollar rather than the individual who worked for it." Neal Boortz.

"There is no such thing as government money - only taxpayer money." William Weld, quoted in Readers Digest.

The interest expense paid on the National Debt is the third largest expense in the federal budget. Only Defense and income redistribution (The Departments of Health and Human Services, HUD, and Agriculture (food stamps)) are higher. Do you have "Compassion" for the lower income earners? (You may note that social spending is the largest item in our federal budget. (Anyone complaining about the run-up of the deficit, should note that almost all of it is going to social spending).

Social Security is not part of the Federal Budget general fund. It is a separate account and has its own source of income. Social Security payments do not go into the general fund, they go in the Social Security trust fund, and should NOT be counted as general revenue. The trust fund is supposed to be used to pay future benefits. But....keep reading.... Currently, there is more being payed into the Social Security Trust Fund than is being paid out to beneficiaries. What's left over is routinely being "borrowed" and used as if it were general budget revenue. Government agencies using that money promise to pay it back (IOUs). All of the money in the Social Security Trust Fund has been spent! That's part of the National Debt. So Social Security is just a very large tax collection tool. Beware the term "Social Security Surplus"; there is no such thing. Social Security is a Ponzi Scheme, there is never more in the Trust Fund than will ever be needed. Another Ponzi link. Social Security will need to be fixed. Here is a debate page.

It is forecast that the budget deficit will rise again for 2008 and 2009.

Office Rents:             $45.75 to $54.50 ( not including the extreme upper end i.e. penthouses etc.)  per s/f effective rent Class A Manhattan with higher rents probable in the new buildings with spikes for penthouse spaces,  $29.50 - $33.00 per s/f effective rent Class A on Long Island. But there has been developing shadow office space a/k/a sublease space.  It has been coming on the market in significant quantities over the last year. The market has been reasonably strong but office vacancies have been reported to increase in the last quarter of 2006. Cushman & Wakefield report office vacancies at 5.7% but rents are are not skyrocketing according to a 12/19/2007 article.  Studley in the same article reports leasing 6.7 million square feet of space this quarter up from 6.5 million square feet last quarter but down from 7.6 million square feet of space leased during the 4th quarter of 2006. The consensus is that there is not significant sublease space in Manhattan.

                                     New office construction doesn't make economic sense unless rents are greater than $30.00 per square foot on Long Island and $50.00 plus in Manhattan. At the present time there are four  significant projects  underway and all report doing well on Long Island.  Most notably  the Times Square office section is doing very well.

 Overall office vacancy rates in both Nassau and Suffolk County are expected to increase slightly.  In Nassau is could rise to 8.2% while in Suffolk is could rise to 11.50%.  Office vacancy overall in Manhattan is forecast to be in the 7% to 8% range for the upper level space in the mid-town market.  The downtown market is forecast to be in the 8% range for the high end space.

         Historically, Manhattan office buildings have been selling for over $1,000 per square foot.  Late in 2006, reported by Newsday, 11/28/2006, The Towers, a 150,000 square foot building at 111 Great Neck Road sold last months to Philips International for $52.5 Million or $350 per square foot. It also reported the following: EAB Plaza now Reckson Plaza sold just under $250 per square foot last year and the Computer Associates headquarters sold for $263 per square foot. However with the mortgage crisis, property sales statistics are meaningless going forward, at the moment.  The reason is that reports of higher amounts of equity are being required for financing.  Since equity get compensated at a higher rate, this would affect the capitalization rates, thus "selling" prices.  As such, any realistic forecast would have to wait until the "dust" has settled in the commercial real estate financing market.  Best guess -  the market will probably stall for the first quarter or two ( unless a disaster occurs) and then sales will continue normally.  It is expected that the "blue chip" properties will continue to show strong, but abated appreciation.

From an historical perspective the office markets in both New York City and Long Island are about at the same point in the economic cycle.  There is little  speculative building.  In New York City there was a lot of space being taken by start up companies financed by venture capitalists.  Since venture capital money is typically short term  or about 2 years, what happens is these companies don't perform well and the venture capital money is called. Should the international business influx continue into New York City, this also will continue the economic picture  positively.

Since the first beams of the World Trade Center have just been installed ( 12/19/2006 amid the speeches and ceremonies)  the statistics of the World Trade Center loss will be summarized in the addenda. The rebuilding has been very slow but steady.  It should make substantial headway in 2008.  Added to that will be the World's Tallest Buildings so that a comparison between the New World Trade Center, a building you have in mind and the world's tallest buildings can be examined and compared.

                                                                 

    Industrial Rents: 

                                     $4.75 - $6.05 Net in Brooklyn & Queens

$5.60 - $6.75 Net on Long Island

$9.90 - $11.25 Net on Long Island for new flex space

 

Retail Rents:       $60.00-$70.00 triple net + in the major malls on Long Island

$25.00 - $35.00 prime power centers on Long Island

$600.00 -$650.00 + in Manhattan in the prime retail areas i.e. 5^th and Madison Avenues, 57^th Street. Areas such as Tribecca, SoHo, the Village and Union Square will show double digit rates of growth. Chelsea should approach double digit growth for the quality locations. The downtown area will show modest gains but will be poised to show double digit gains as the World Trade Center and related buildings become completed and online. This is estimated to be three years away.

All other areas a 1%-2% increases until the mortgage crisis clears up then 2% - 4%.

 

Capitalization Rates: Due to the mortgage crisis the amount of equity required has gone up substantially. The NYT reports ( 12/19/2007) that sale price of office buildings continued upward as a dizzying pace, with sales prices approaching $2,000 per square foot. Record sale price per square foot after record price per square foot continued.  Now, for example, a major real estate owner talks about the credit squeeze this way. The company Stellar Management, the building "Milk Studios", agreed to buy the building for $160 Million, still a handsome profit from the price the prior owners paid in 2004 ( $55 Million plus $15 Million in upgrades).  But the broker at Eastdil said that: " the buyer ( Stellar ) would have to contribute $90 million of  equity ( prior to the mortgage crisis just $10 million of equity).  This requirement has also had an effect on the sales prices.  There hasn't been any $1,000 per square foot price sale since the summer when Larry Silverstein bought 1177 Avenue of the Americas from CALPERS .

Here is an example of what I'm talking about.  Here is a common method of developing a capitalization rate, a bit sophisticated, but please notice the inputs on the left, the mortgage and equity.  Each represents a certain percentage of the total investment with certain rates associated with each position.  Notice the equity position, the 2nd position has a higher compensation to the equity position.  I'm going to present a "normal" financing capitalization rate development and the "current" one, hopefully temporary, in which the banks require larger equity.  I'm keeping all other variables the same.  In reality, there would be some differences.

THE CURRENT MORTGAGE SITUATION (NORMAL)

M = Mortgage Ratio	65.00%	0.65	M   x	0.094845	K  =			0.061649
E = Equity Ratio	35.00%	0.35	E   x	0.110000	Y  =			0.038500
I = Mortgage Interest Rate	7.25%	Weighted Rate						0.100149
T = Mortgage Term/year	20
E = Equity Yield Rate	11.00%	Less: Credit For Equity Build-up
N = # Payments per period	12	0.65	M    x	0.326773	% PD x	0.059801	SFF =	0.012702
K = Mortgage Constant	0.094845
HP = Holding Period (Years)	10	Less: Appreciation
Annual % Appreciation in Value	1.00%	0.10	APP  x	0.059801	SFF		=	0.005980
App = % Appr. over HP	10.00%
SFF = Sinking Fund Factor	0.059801	Equals: Overall Rate						0.081467
@ Y(Rate) & HP(Period)
% PD = % Mtg. Paid Off Over HP	0.326773					Rounded to		8.10%

THE NEW MORTGAGE SITUATION REQUIRING LARGER EQUITY

M = Mortgage Ratio	50.00%	0.50	M   x	0.094845	K  =			0.047423
E = Equity Ratio	50.00%	0.50	E   x	0.110000	Y  =			0.055000
I = Mortgage Interest Rate	7.25%	Weighted Rate						0.102423
T = Mortgage Term/year	20
E = Equity Yield Rate	11.00%	Less: Credit For Equity Build-up
N = # Payments per period	12	0.50	M    x	0.326773	% PD x	0.059801	SFF =	0.009771
K = Mortgage Constant	0.094845
HP = Holding Period (Years)	10	Less: Appreciation
Annual % Appreciation in Value	1.00%	0.10	APP  x	0.059801	SFF		=	0.005980
App = % Appr. over HP	10.00%
SFF = Sinking Fund Factor	0.059801	Equals: Overall Rate						0.086672
@ Y(Rate) & HP(Period)
% PD = % Mtg. Paid Off Over HP	0.326773					Rounded to		8.70%

Notice the difference in capitalization rates with a 15% change upward in equity requirements. It is about 60 basis points higher. Yes, arguments could be make about the other factors in the capitalization rate that could or should also change along with the equity requirements. For example, (depreciation- future value of the property forecast to be lower) would result an even higher capitalization rate. The mortgage term could be lowered which also would result in a higher capitalization rate.  As of the writing of this forecast, the probabilities of changing the other factors in tandem are not fully known or quantifiable.  This example is for illustrative purposes.  Please note in many real estate tax appeal cases, a simpler capitalization rate formula is utilized.  Similar results would be produced.

                WHEN MARKET STABILIZES                                                            UNDER MORTGAGE CRISIS CIRCUMSTANCES

Industrial                       9.750% - 12.00%                                                                                        10.5%- 15%

Office                           7.75% - 10.5                                                                                                   9.5% - 12%

Retail                           7.50% - 10.75%                                                                                              9.00% - 12%

Hotel                            8.75% - 10.75%                                                                                               9.25% - 12.25%

Assisted Living          9.00%  - 11.00%                                                                                              10.00% - 13.00%

Multi-Family               7.25% - 10.00%                                                                                                  8.00% - 11.25%

 

Property Appreciation Rates:

     WHEN MARKET STABILIZES                                                            UNDER MORTGAGE CRISIS CIRCUMSTANCES

Retail                            1%-1-1/2%                                                                                    FLAT TO SLIGHT DECLINE

Office                           1%-2%                                                                                            FLAT TO SLIGHT DECLINE     

Industrial                      2% -4%                                                                                           FLAT TO SLIGHT DECLINE

Multi-family                  2%-3%                                                                                             FLAT TO SLIGHT DECLINE

Hotel                            2%-4%                                                                                              FLAT TO SLIGHT DECLINE

Assisted Living          1% - 2%                                                                                             FLAT TO SLIGHT DECLINE

 

Stock Market:    

As of December 31st, 2007  ( as per CnnMoney.com), here are the statistics for the Dow Jones Industrial Average for the year 2007. Note it closed the last day down 101.65 points.

Dow Jones Industrial Average
13,264.82 -101.05 / -0.76%   Dec 31 4:02pm ET † Open: 13,364.16 High (day): 13,364.73 Low (day): 13,246.53 YTD%Change: 6.43% Volume: 167,243,368.00 Prev. Close: 13,365.87 52-Week Range (Low - High): 11,939.61 - 14,198.10

Here are the statistics for the rest of the major markets for 2007 as reported by CnnMoney.com

Dec 31 5:00pm ET †	Change	%Change	Level
	Dow	-101.05	-0.76%	13,264.82
	NASDAQ	-22.18	-0.83%	2,652.28
	S&P	-10.13	-0.69%	1,468.36
	DJ Wilshire 5000	-92.05	-0.62%	14,819.58
	Russell 2000	-5.73	-0.74%	766.03
	Philadelphia Semiconductor	-1.95	-0.48%	408.04
	Dow Transports	-55.02	-1.19%	4,570.55
	Dow Utilities	-4.64	-0.86%	532.53
	NYSE Composite	-63.57	-0.65%	9,740.32
	AMEX Composite	-18.60	-0.77%	2,409.62
	Morningstar Index	-23.66	-0.66%	3,571.26
Open    Market Closed      *as of previous close

 

For comparison purposes, historically, as of December 8th, 2006 according to CnnMoney.com the market statistics were as follows:

Dow Jones Industrial Average
12,313.90 +35.49 / +0.29%   Dec 8 11:44am ET † Open: 12,271.28 High (day): 12,332.88 Low (day): 12,258.54 YTD%Change: 14.90% Volume: 88,062,793.00 Prev. Close: 12,278.41 52-Week Range (Low - High): 10,661.15 - 12,361.00

Put in perspective at that time, the rest of the market indices were as follows at that time ( 12/31/2006):