Yesterday, we wrote about how foreclosures will lead this housing correction and the reported numbers are breaking all sorts of records:

California – 1st quarter 2008

• 113,676 Notice of Defaults issued – Up 39.4% from the previous quarter.
• Notice of Defaults are up 143.1% from first quarter 2007.
• Actual foreclosures totaled 47,171 – Highest since DataQuick started tracking in 1988 (20 years ago).

According to DataQuick, the increase in foreclosures can be contributed to a significant drop in property values and the wave of exotic mortgage made in 2005-2006. Remember the Map of Misery? It gives you an idea of where the largest numbers of exotic mortgages are concentrated in.

These red states experienced incredible price appreciation leading up to the peak of the housing bubble. As reflected on the map below, they are now experiencing the brunt of decline.

Although we sounded crazy predicting a long and hard housing crisis, it looks like Wall Street is starting to reach the same conclusion that many housing blogs came to last year. According to a Goldman Sachs analyst, “the correction in national house prices is only halfway through” and,

Arizona, Florida, Virginia, Maryland, California and New Jersey, could see further price declines of 25% or more.

If you refer back to last week’s Inventory post, I had listed the number of home sales for 1st quarter of 2008:

That’s a total of 99 homes sold in Arcadia over the last 3 months. How does this compare to previous quarters when the bubble was in full swing? On the chart below, we’re currently on the very right at just under 100 sales.

Sales skyrocketted during the last half of 2003 and for 4 years Arcadia quarterly sales remained around 200 transactions or more per quarter. That’s averaging about 66 homes a month. We’re currently reporting half those numbers for 2008.

If you look at the Median Price line (in red), it tends to follow the general trend of sales activity. Back in March, our friend over at Dr. Housing Bubble had posted a similar looking chart but it was tracking the median price for LA County.

Unless income increases significantly, it looks like Arcadia will continue to follow the general trend of the rest of the county, state and country. And although real estate here will always command a certain premium in terms of pricing, I see 1,000sf, 67 year-old homes listing for $775,000 and my only question is, “WTF?”

This property was bought on January 4th, 2008 for $600,000. I cannot imagine how this home could have commanded a $175,000 premium in just under 4 months.

From the listing:

MUST SEE TO APPRECIATE, MOTIVATED SELLER WILL LISTEN TO ANY REASONABLE OFFER. HURRY HURRY HURRY!!!!!

Hey, look on the bright side. At least it comes with a professionally installed greenhouse.

Real estate always goes up.

Land is running out.

Rich foreigners are pouring in by the boat load.

Real estate is a great investment.

So why in the world are we facing the largest housing and credit crisis in U.S. history?

The Culprits

Lenders started pushing sub-prime loans so people with bad credit and no down payment could afford to buy homes. Lenders such as Countrywide even scammed prime borrowers into taking out sub-prime loans. Why? Because back-end commissions were higher and Wall Street eagerly paid for these risky loans.

Artificial demand was created when otherwise unqualified borrowers began buying up houses left and right. There was no significant growth in income or even population. Million dollar homes were bought up by people making less than $100k a year on zero down, interest only, adjustable rate mortgages.

Wall Street somehow decided it was a good idea to securitized these sub-prime loans and sell them on the open market.

Builders decided to increase their home production even though there was no marketing data supporting the need for a significant increase in housing.

The Outcome

Greed – Greed – Greed. That’s what this housing bubble comes down to.

• Lender such as Countrywide and New Century are wiped out.
• Homeowners are losing their homes through rapidly increasing foreclosures.
• Wall Street giants such as Bear Stearns, Citi and WAMU are in major distress.
• Public builders such as KB Homes, Lennar and Centex are in a financial mess. Local builders are shutting down left and right.

Feel free to share this post with friends, family and coworkers the next time they ask, “So what got us into this mess?”

I recently had the opportunity to meet with 3 individuals who “specialize” in real estate investments. I say this with a sarcastic tone because these guys started flipping properties in 2003 and rode the real estate bubble to success. With all the news lately regarding the drop in real estate prices, increase in foreclosures and other record breaking data, these real estate professionals claimed that we’ll hit rock-bottom this Fall and it’ll be time to jump in again. Since I was the youngest in the meeting, my attempts to explain that we are at least 2 years away from bottoming out were dismissed as ludicrous.

There is no doubt that there will be plenty of knife catchers out there and even many self proclaimed real estate gurus will be victims. What many people don’t realize is that unlike stocks, real estate is not a very liquid asset. It takes several years for values to run up and equally as long to crash.

Let’s take Wall Street’s recent poster child for failure as an example. Countrywide Home Loans’ stock soared alongside our current housing bubble. It went from $13 in 2003 and peaked at $45 in early 2007.

As soon at the subprime lending market tanked, it took only 6 months for Countrywide’s stock price to hit $8. It has since bottomed out around $4 before Bank of America decided to bail… sorry, I meant buy them out. Gosh, that sounds awfully familiar.

Unfortunately for us, real estate transactions take 30 days or longer to complete so data is always lagging behind. Because this is the case, historical figures and graphs from providers such as DataQuick and the Case-Shiller Housing Index are valuable resources (below).

According to this data, Los Angeles home prices peaked around mid-2006 and it has been dropping for over 18 months now (20 if you count February and March). If you look at home prices between 1995 and 1997, you will notice that the market bottomed-out and stayed that way for approximately 2 and a half years.

I keep hearing that us Arcadians now have this psychological barrier when it comes to home prices and the days of desirable $200-400k homes or condos are long gone. If you believe this then be my guest and purchase a home this Summer.

As for me, history says that buying in these market conditions is equivalent to catching a falling knife: the pain will come fast and hard as your neighbor’s REO wipes out any equity left in your home.

This post inspired by my clueless associates and Patrick.net’s Don’t Catch a Falling Knife.