Strategic Asset Solutions

Dear Theresa,

Would you like fries with that? 

Economic Notes of Interest

Fast food chains numbers were down for December suggesting that consumers are cutting back.  Generally considered one of the final indicators of a recession, fast food chains site bad weather as much as a bad economy for faltering results.  McDonald's numbers are reportedly the lowest they have been in 5 years. Analysts state that if January fast food results are as bad or worse, we can be certain that we are in a recession period. 

Other significant economic reports out in the last week:

New Home sales in December- Sales of new homes dropped 4.7 % in December but a total of 26.4% overall in 2007, the largest drop since the government began tracking new home sales in 1963.  The largest declines were seen in the West were prices were down 32.2%.  The Northeast saw a moderate gain of 1.6% throughout the year, though the rest of the nation experienced a decline of over 26%.

Existing Home Sales in December - Existing-home sales continued to slide another 2.2% over the previous month, a whopping 22% lower than December 2006.

American Express (an indicator on late credit card payments) - AmEx reported Monday its profits declined by 10% for the fourth quarter of 2007, down from a 10% gain in the same time period of the previous year. The slump was precipitated in part due to an increase in reserve funds of 70% over the previous year in preparation of a $438 million charge for rising write-off and delinquency rates.

California Dreamin'

It has been an interesting month economically.  Investors must be stocking up on motion sickness medication to deal with all the volatility. International markets too have reacted to our economic slowdown, resulting in havoc in their countries which then came full circle to create increased panic within our own market.  It brings to mind the scene from the recent movie "National Treasure" where the three main characters and the bad guy are stuck in a deep shaft on a moving platform and had to spread out to the four corners to keep it in balance.  Each time someone moved slightly toward the middle it jeopardized one of the other three.  They had to work together as a team to devise a way for all of them to escape before the platform became unbalanced to the point of falling down the shaft.  How is that done on a worldwide scale?  Well for one, economies that are struggling seek out funds from foreign countries that have excess, such as the Middle East region, to inject some much needed liquidity.  But liquidity alone is not enough.  In a consumption driven economy, such as ours, falling prices and demand can be fatal.  We need consumption to continue, which is the reasoning behind the tax rebates proposed by the President.  However the mindset of the American people has begun a state of change from relying on further debt that they felt would never catch up with them, to a mentality of living within their means and saving.  This was spotlighted by the underperformance of the holiday shopping season despite the largest discounts ever offered by many stores. Will an extra $600 in their pocket really create a sense of spending euphoria among consumers that will carry them on a spending spree beyond that figure?  And does the government want individuals to continue to spend more than they can afford just to prop up the economy rather than allow the correction cycle to bottom out so we can begin to move forward?  Consumers have reached the pinnacle of the debt mountain and have come to realize they are afraid of heights. This general pullback from the consumer will result in more than a decrease in goods and services purchased.  As homeowners become increasingly weary of keeping up with the payments on their debt while not being able to afford new purchases, the default rates of all debt types will begin an upward spike. In higher priced areas, such as California, the phenomenon of "jingle mail" is already on the rise; lenders receiving keys from homeowners either unable or unwilling to work out a solution to stay in the property.

            Much apprehension has surrounded California regarding subprime, mainly based on mere population size.  The Greater Los Angeles area alone includes all of Los Angeles and Orange counties, the Riverside-San Bernardino-Ontario and Oxnard-Thousand Oaks-Ventura metropolitan areas, or 33,954 square miles.  Half of this is made up of sparsely populated areas of San Bernardino and Riverside counties but the population in this area is still larger than any individual state except for Texas, New York, Florida or obviously California as a whole.  According to the Spring 2007 publication of the Federal Reserve Bank of St. Louis, out of the more than 3 million subprime mortgages originated and sold on the secondary market from 2004-2006, more than 45% were ARMs, about 10% of which allowed negative amortization and approximately 20% were interest only.  And more than 50% of all the non-traditional loans and more than 30% of interest only loans originated in California. But these statistics only paint a partial picture of the scene manifesting itself on the Gold coast.  Due to the home price inflation in California where the median price of an existing single family residence has been well above the conforming loan limit of $417,000 since 2004, jumbo loans have offered the only means to purchase a home.  Per a January 11, 2008 report, the Office of Federal Housing Enterprise Oversight (OFHEO) is quoted as stating, "The jumbo market is much more geographically concentrated than the conventional mortgage market as a whole.  Data from First American LoanPerformance suggests that California accounted for 49% of the dollar volume of first lien jumbo mortgages originated in the first half of 2007 and later securitized."  The report goes on to say "...the data also suggest that interest-only (IO) loans and negatively-amortizing adjustable-rate mortgages (ARMs) comprised nearly two-thirds of the dollar volume of the first lien jumbo loans originated in the first half of 2007 and later securitized, whereas traditional (fully amortizing) fixed-rate mortgages (FRMs) comprised only a quarter of those loans."

            According to a quote in the Wall Street Journal MarketWatch analysts at Goldman Sachs were purported to have stated in a recent research note that they believe option ARM mortgages pushed California home prices to levels 35% to 40% higher than justified by other fundamentals. James Fotheringham of Goldman Sachs further stated, "We expect home prices to return to normalized levels".   This means that if you bought a house mid-2006 at the median home price of $576,000 your true home value, once the market plateaus, will be in the $345,600 to $374,400 range.  A loss as great as $230,000 may make homeowners wonder why they are struggling to makes payments on something that is worth so much less than what they owe. Many stories have been published recently practically encouraging homeowners to walk away from overpriced homes to rent and save while waiting until the bottom of the market before purchasing a more affordable home.  With this type of media encouragement, it seems inevitable that we will see a rise in "jingle mail" even among Alt-A borrowers and those still able to technically afford their payments as long as they are willing to sacrifice the quality of life they were accustomed to before the bubble burst.

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Edna Juarez and Theresa Burton
Strategic Asset Solutions

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The Market

Would you like fries with that?

California Dreamin'

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