It has been a few months since I’ve done a thorough analysis of the California housing and economic situation. Given the current changes I think it warrants another close look. The last article I did regarding California with an in depth perspective laid out 10 reasons why I thought California would not face a housing bottom until May of 2011. Since August, all of the reasons laid out in the assessment have only accelerated and thus cement the target date for a bottom.

In addition, I was simply flabbergasted on Monday when the market had its 4th worst point tumble on record. In fact 13 of the 20 top point drops on the Dow Jones Industrial Average have occurred in 2008:

Now of course the above data may not say much given that the Dow is higher as well so it only goes with logic that the biggest point declines will happen as time goes by. But make no mistake, yesterday was the 12th biggest percent decline and that does signify a big drop:

The Dow has seen 4 of the top 20 percent declines occur in 2008. This is significant. Let us run a quick tally from the top 20 percent down days:

2008: 4

1929: 3

1987: 2

1933: 2

1932: 2

1899: 1

1907: 1

1931: 1

2001: 1

1997: 1

1937: 1

1899: 1

Out of the top 20 percent declines on the Dow, 2008 is the winner which should give you a perspective on the volatility we have been witnessing on the market. And the news for the decline yesterday was simply a statement of the most obvious. That yes, we are in fact in a recession. It was incredible that there were a large number of people in the market still believing that somehow beyond all logic and sense of reason that the market was somehow not technically in a recession. The National Bureau of Economic Research stated that we have been in a recession since December of 2007. Even though we had positive GDP growth in Q1 and Q2 of this year this was a pseudo bounce based on the Uncle Sam American Express voucher program that provided a bit of stimulus to the country. So we’ve been in a recession for a year but certainly the problems go back even further beyond that.

The Governator announced to the newly minted politicians on Monday that California is now officially in a fiscal emergency. He had called for a special session trying to resolve the issue but lame duck politicians were on “fact finding” junkets or simply playing hide the salami while Rome burned. These are the people leading our state which is the most powerful economic engine in the 50 states of the union. What an absolute disgrace. These people are getting 6-figure salaries and the only job they have is to represent the populace and they can’t seem to even get that right. Our deficit is ballooning each and every day and budget analysts are saying that we may be broke by February. I’d argue that we are already broke but to many debt is the same as wealth. Today, a group of Governors including Arnold are meeting with President-elect Obama for what I would imagine should be a fascinating spectacle of who can hold out the largest tin-can.

The state budget deficit is gigantic. To first understand this mess, you have to follow the money:

Keep in mind these are estimates. A state as large as California with expenses over $100 billion is no small thing. But anyone can quickly look at the above pie chart and understand we are in serious trouble. The two biggest sources of revenue for the state are personal income tax and sales tax. These 2 areas make up 71% of all revenue sources. Well, you can already see the problem arising here. First, as much as people want to believe that Black Friday was somehow going to resurrect the economy one day does not make a trend. People are not spending as much and subsequently sales tax revenues are going to shock us on the downside. In terms of the personal income tax, well you can pretty much kiss a large portion of that goodbye. High paying bubble jobs like real estate agents, mortgage brokers, financial analysts, construction workers, car salesmen, and others in the FIRE economy are no longer going to be paying Uncle Arnold their chunk of gravy train day salary. The personal income tax damage will be obvious come Q1 and Q2 of 2009.

In addition, those that have no job are literally paying zero into this pot and we are having more and more fall into this category especially here in California that now has the 3rd highest unemployment rate in the nation:

You can expect this number to shoot up even further. JP Morgan recently announced that they’ll be slashing 19,000 WaMu employees, many in Seattle but California has the largest number of retail money spigots which I’m sure will see their cuts. I remember walking into a WaMu once and a mortgage broker/lender/financial analyst/life guru wanted to sign me up for a pay Option ARM because the cheap payments were “awesome” and I’d love it.

So the repercussions are going to be fierce, long, and severe. These folks also aren’t consuming. Some of the biggest consumers of urban tanks, granite countertops, and all other things that carry heavy sales tax price tags were people in the bubble economy. Guess what? They are taking a double hit to the two biggest items of revenues for California, personal income tax and sales tax. You may think there aren’t many agents or brokers in California but I suggest you look at this graph:

Now you tell me, what industries are going to absorb these folks? Even if they get positions in retail, that is a big cut in their paycheck. The government isn’t hiring as much because guess what, we are flat broke! Our politicians are going to be forced to grow a spine here. You have some puritans on both sides. Some say “we’ll never raise taxes” yet don’t give ideas on how to solve the economic problems of the state because if they do slash, they’ll simply create longer lines of the unemployed. Others say, “raise taxes on everyone” yet fail to realize that there isn’t much taxes to raise now that people are getting hammered. There has to be a balanced approach and this will simply help us through the period. There is no easy way out of this folks. A decade of financial decadence is coming home with a very expensive bill. Maybe we’ll think about instituting a constitutional amendment that when times are good, the state be forced to collect extra money and set it aside for financial emergencies like the one we are currently facing. But politics isn’t exactly a logical business. You would think that the best time to raise taxes is when everyone is fat and pigging out at the easy money buffet. Instead, regulations disappear and crony capitalism takes a hold of the entire economy and we spend every nickel that comes in.

In addition, many of these people will need to be retrained for new jobs and public colleges are cutting back on enrollments or raising fees. Another whammy on this group. The few industries that are still hiring like engineering, healthcare, and accounting require a specific skill set. This isn’t like taking an online video course and getting your DRE real estate license in one week. Even to become a nurse, you’ll have to go to a community college full-time for 18 to 24 months.

California is the heart of darkness when it comes to this economic disaster. We had the highest priced real estate and the largest number of highly paid bubble blowers benefitting from a once in a lifetime gig. It is like hitting 10 blackjacks in a row. At a certain point, you start thinking that you have control over the game until you bust 15 times in a row. Let us look at the county with the largest population in California, Los Angeles to see exactly what is transpiring.

Los Angeles County has 88 cities and 10,000,000 people call the place home. In terms of diversity, Los Angeles is it. You have extremely prime areas like Beverly Hills and Santa Monica and other areas on the other side of the spectrum like Compton or Lynwood. Yet during the bubble even non-prime areas saw outrageous price increases mostly fueled by subprime or toxic lending pushed by greedy lenders who were puppets for Wall Street and blinded by their own ambition. Let us look at the Los Angeles median home price over this time:

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The L.A. median home price topped out at $550,000 in August of 2007. I know that it seems like a lot longer ago but only a year ago, were we sitting at the mountaintop. Now, the median home price for the county is $355,000. A drop of nearly $200,000 in one year. How would you feel if you bought at that $550,000 peak and now knew your home was only able to fetch $355,000 (if that) on the open market? I can tell you how many are feeling. Many are simply walking away from their homes. When I say walking away I don’t mean that they leave on their first miss payment. In fact, idiotic legislation like SB 1137 simply kicks the shiny empty Coke can down the road a few more months and allows many people to stay rent free in a home they clearly cannot afford. They will walk in droves next year. I’ve talked with a few contacts in the industry and they are telling me that if you have a 720 credit score and 25% down you can get a loan at 5.25% up to $725,000. Yet the traffic is not there. Why? Because how many people today have $181,000 sitting around for a down payment on a home? Also, you have to have debt-to-income ratios that keep you under 37% so let us take that $725,000 home and run the numbers:

Down payment: $181,000

Mortgage 30-year fixed (5.25%): $3,003 (Principal and Interest)

Taxes and Insurance: $755

Total monthly payment (PITI): $3,758

Needed net monthly income: $10,156

You will need a monthly net income of $10,156 to afford this home even after putting $181,000 down if we want to keep the 37% DTI ratio with net income. Yes, you’ll have tax deductions but keep in mind that monthly nut of $3,758 comes out of your monthly cash flow stream. You reap the rewards when you do your taxes. But let us not get caught up in missing the bigger picture. There is such a tiny amount of people in California that fall within this range that it is comical. That is why sales have fallen. People are missing the point. It is all about income and jobs. It always was about this. If the median U.S. income was $100,000 I assure you we wouldn’t be having this discussion. But the fact of the matter is the median income is only $46,000.

Many are now losing even that median income job. That’ll depress wages and home prices further. And California had this incestuous relationship with housing. That is, many of the high paying jobs simply existed as a leech to the bubble. Now that the host is gone the vector can no longer survive in the current ecological system. That is simply a fact.

Even with all these foreclosure moratoriums and hackneyed responses to the bubble, the foreclosure rate is still through the roof:

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When this year comes to a close, 2008 will have the highest number of foreclosures we have ever seen. Take a look at the above chart. This chart includes bailouts, the Hope Now Alliance which I actually called up 1 year ago, foreclosure moratoriums, Ben Bernanke dropping rates like there was no tomorrow, and every other gimmick in the world. Yet foreclosures are still at record highs. The reason all the programs have failed is because they don’t explore the household income side of the equation. So long as the unemployment rate keeps increasing, we shouldn’t even begin to discuss a bottom. And even when it levels out, we should take a deep look at the jobs that are growing. The last thing we want is what happened in 2000 when nearly 30 percent of all job growth happened in the finance, insurance, and real estate economy.

California is at the epicenter of all this. In fact, California alone made up over 20% of all nationwide foreclosure activity last month. And this is including every gimmick you can imagine. Just wait until Q1 and Q2 of 2009. That is when the tsunami of pay option ARMs will recast, plus we’ll have the SB 1137 zombies coming to life, and finally the grim tax revenues that unless we have a 100% stock market run up, is certainly going to show us a very poor state indeed.

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