The Spreadsheet

I took this post down for a bit, because I wrote it at 4AM. Google Reader appears to have kept it indexed, so I've just succeeded in confusing people. It's back, warts and all.

There are lots of things I don't talk about on this blog. The housing bubble has been one of these. Housing is about money, and money is like politics and religion--you don't talk about them in public so much. But since awareness of the housing issue has shifted over the last year, it's a bit easier to talk about now.

If you've asked me about housing in the past 18 months (and if I wasn't being careful because you'd just bought a house) I almost certainly talked your ear off. I know lots of statistics. Lots. I rant. I'm obsessive. Sorry.

Lorna and I have been bearishly watching the housing market in Los Angeles since late 2004. We got married in 2006 and really wanted to move out of our apartment. Our friends all say, "You have the money. Why not?" And this is why not, yet.

Lorna found Ben's Housing Bubble Blog back in the very early days (2005), and we've been hawks in places like the nerdy but wonderful Calculated Risk ever since. I'll even confess to meeting people we met on the internet to talk about this. We thought we were insane for the better part of two years.

But the Internet has very much kept us from buying a house.

The problem was that we were aware back in early 2005 that the national income-to-housing price ratios were way off, especially in California. Other than the information we found on the blogs, Shiller's "Irrational Exuberance" (the second edition) was a really early indicator. Shiller posted charts and graphs that would make you say "something is very wrong." In our area, people were frequently spending 15x their income on housing. Expert advice says 3-4x income is actually manageable for most people.

Lorna even did a tongue-in-cheek art project featuring an ad for a $2m zero-down NINJA (no income, no job, no assets) loan. Do you think she made it up? Nope, it was clipped from an actual magazine in Los Angeles.

We studied the usual spate of statistics (LA prices throughout the 1990s) and decided that at some point housing would have to return to some reasonable multiple of income. These cycles had come back to earth twice before in LA, and it made sense that it would happen again, especially because this one was so much more extreme. We knew one or two older people in LA who said, "Wait. It came down last time." Not many, though. Most were of the lemming mindset, "Buy-now-or-be-priced-out-forever."

We were both doing really well from the Google IPO, and we actually could afford to buy a house, or so we thought. We could even buy a big house, maybe in nice part of town, right?

The Spreadsheet

One night, we made The Spreadsheet.

We wrote down a number, for a reasonable house, a 3 bedroom on a modest lot, or a very nice condo. Then we looked at historical values from 1990-1995, and decided that it might depreciate 20-30% in 5 years. Then we added in closing and realtor costs (8%), and taxes (1.2% a year), and insurance. And then we looked at the total.

The Spreadsheet said we'd pay 7 times our rent to live there for 5 years, and then sell.

Double-checked the math. 

Double-checked the rates. 

Double-checked the taxes. 

Double-checked the tax deductions.

Pretended we had a discount realtor.

7 times our rent.

Oh, and the house you could rent for 7 times our rent? A mansion in Beverly Hills with 6 bedrooms (not that we needed that). A big estate on Malibu Beach.

The Spreadsheet is dangerous.

The thing that we realized is this: because housing is financed with so much leverage, nobody can afford a house if housing prices decline. The numbers are incredibly scary.

Peter Viles reported that the median house in California is falling $2788 per week. That means the $550k median house in California "costs" the equivalent of $15,000/month, in rent. That amount should get you a big mansion in Brentwood, not a condo in Inglewood. The median homeowner cannot afford $15,000/month in rent.

In Santa Monica in early 1990, if you purchased the median house, you'd have been underwater in real value for 12 years. It didn't make sense that people who still remembered this sort of thing would do it again. But they did. And the west side of LA was the worst.

I have some thoughts about how we've gotten here. And we've heard the most awful stories, of toxic loans and crazy HELOCs and bad decisions. But how do people who had paid off half their mortgage a few years ago now find themselves in foreclosure?

I believe one big flaw is in thinking about your finances in monthly payments. People who HELOC'd their family home (taking out more than they paid in the first place) simply because the payments would be low (for 2 years at least) never actually tried to imagine that they were taking on massive amounts of debt. They believed that they had earned this "value" and that the debt was secondary to the whole windfall. They didn't try to conceptualize paying it off, or what that obligation would mean to their future.

Now, we're hearing about 7-year car loans, so that quite a decent percentage of people who sell a car now are underwater in their payments. It didn't matter for the first few years, though. There are so many people with loans they can only afford in the short term.

Lorna has been reading up on studies that say that fear and depression beget short-term thinking. (Phew, that's a topic for a whole other post.) But 9/11 and the resultant fear? Perfect time for 2/28 loans. You might not live another year. Why not have a nice kitchen?

There was also a funny psychology about these gains. If you realized that you couldn't actually afford to pay for a house but bought it anyway, it was very likely with the idea that you might sell it, earning a 100% return after a couple years. Great idea, right?

Well...when you move, you pay the difference between two properties, and presuming you bought a similar (or a larger house), that difference would get larger. It seems to have occurred to nobody that you couldn't win at this game. Where would you move after you sold your house so that you could afford to live there? To Arkansas? Kentucky? Or would you just "walk away"? I've actually met some real, live people who sold and now rent, but they are an extremely tiny minority. For most people, once they buy a house, they keep buying houses.

Lottery winners are famous for ending up in bankruptcy. And the short-term mindset is exactly the same. I remember overhearing two 25-year-old guys in a restaurant in 2006. They'd bought 2-3 houses apiece, and were discussing their gains. I still remember their giddy "It's free money!" refrain. Was it, really?

I think it's actually true that many people have "trusted the system" to do what's right, and I have to agree that the system has been extremely broken. Buying junk bonds with 32x leverage is a topic for another post.

Someone told me once that "you can only call the housing market once". As much as I rue the day I committed that to memory, it has been hugely informative. Our Spreadsheet took 10 minutes to make, and it told us a huge amount about what our future held. I really wish more people had done the math. It takes perhaps 8th-grade math to make your own. No calculus or trig.

We still want to buy a house very much, but we'll wait just a bit longer...until the spreadsheet makes a little more sense.