Geithners Upside Down - What Does it Mean?

Mr. Geithner’s real estate headaches are part of the American economic story. LINK We built a society and an economy around housing. 75 million homes are privately owned. Now we are trapped in them. Those home sale numbers that are cheering people up are actually bad news. The majority of sales keep coming from foreclosures or deed in lieu transactions.

Mr. Geithner is trying to sell a $1.6mm home in Larchmont. I know Westchester real estate and will tell you that there are buyers. At least there are people who are interested in buying a home. There is next to no financing available for this price range. If a very solid buyer who has $500,000 per year in taxable income and no other debt wanted to buy Mr. Geither’s home he would have to put up not less than 30% ($500,000). The balance of $1.1 mm would be financed at a minimum of 7% with a ten-year amortization. That comes to $88,000 a year in debt service. Add that to the $27k in taxes and you get a fixed cost of $115,000.

One might be fortunate enough to have the $1.6mm in checking and be able to avoid the nasty bankers. If you are in that position you also know that you can earn a nice buck in the bond market these days. 6% is a reasonable rate to value cash if you’re willing to put it away for a while. That 6% translates into an ownership ‘cost’ of $123,000 when you add in the taxes.

Either way you cut it Mr. Geithner’s house will cost you about $10k a month to own. He is renting it for $7,500. The rent is 25% less than what a real purchaser would be forced to pay. No wonder he is having trouble selling it.

Mr. Geithner is not marketing his home at the wrong price. The offering price is the same as his 2004 purchase price, and he made improvements. At any other point in our history one would have expected that he could have easily walked away with a gain from the investment. Under normal circumstances this house would be sold and the Geithner’s would have purchased another nice home near D.C. The point is we are not in normal times. All green shoots aside, we still have very significant problems. The sale and subsequent purchase of the Geithner residences is a big plus to GDP. Call it $4mm of lost turnover. This loss of National Income is adding up. This type of transaction activity is very productive because of the multiplier effect that it creates. This slow down in transaction velocity is likely to keep the economic recovery at a very tepid pace.

Connected thoughts:

-Larchmont is a great town. Good schools, the Sound nearby, great golf courses, excellent transportation to the City, nice people. It is also the home of a lot of under employed financial types. This is one of the areas where the folks from Bear, Lehman, AIG, Citi, etc. settled. Not at all surprising that the head of the NY Fed would choose to call it home. Also not surprising is that there is an overhang of high-end homes for sale.

-So far this year I have had four contacts from the past requesting a ‘temporary bridge loan’. These are people who were able to pay 10G a month on living expenses and still have plenty left over. Today they are tapped out and, like Mr. Geithner, they can’t sell their homes. Unlike Mr. Geithner they have no job opportunities that will cover their old nut. There is a lot of this going around. Look for default rates on $1mm+ mortgage loans to jump in the next six months. There is more than $1 trillion of this out there today. This is not in those stress test numbers. If this plays out it will not be good for high-end home values in general.

-Mr. Geithner is trying to sell his home at 17 times annual rent. A more realistic value would be 15 times rent. If you took that multiple to high end real estate in the Nation’s metro areas it would translate into a 30% drop in values. That is not in the forecast.

-Mr. Geithner’s house is ‘off the market’. The numbers we see for housing inventory are based on multiple listings. This property, like so many others, can’t get sold for the time being. The hidden backlog of homes for sale is many times the one that is produced through multiple listing services. Housing prices, like the stock market, may recover from the depths of earlier this year. However, we are not going to 1400 on the S&P very soon. It is unlikely we will see 2007 housing values any sooner than that.

-What Mr. Geithner, and millions of other homeowners need is a three-year period where inflation rises by a modest 5% annually. This could be accomplished. While that would solve the financial and family balance sheets of America it would destroy the economy longer term. Does Mr. Geithner have a conflict of interest as he steers us through these difficult waters? I doubt it. However, he and everyone else with a hand on the tiller is leaning on the side of, “A little bit of inflation wouldn’t be a bad thing…” It is very likely they will get what they are looking for.

-Full disclosure: I also own an overpriced home in Westchester. I recently had what looked to be a legitimate offer at a fair price. There was a catch to the deal. I got my price but I had to take 90% paper. The deal was for a private mortgage. 6% interest only, a ten year bullet. I said thanks, no thanks. Two years ago if there was a buyer with 10% equity the deal would have gotten done. Treasury lists Private Mortgages (AKA seller finance) at $2 trillion, 15% of the total outstanding. There must be some terrible dogs in that portfolio.