Edd Gillespie Appraisal

A friend sent me an e-mail this AM and I thought you who wonder how things came to be might like to know.
            The US standard railroad gauge (distance between the rails) is 4 feet, 8.5 inches. That’s an exceedingly odd number.

            Why was that gauge used? Because that’s the way they built them in England, and English expatriates designed the US railroads.

            Why did the English build them like that? Because the first rail lines were built by the same people who built the pre-railroad tramways, and that’s the gauge they used.

            Why did ‘they’ use that gauge then? Because the people who built the tramways used the same jigs and tools that they had used for building wagons, which used that wheel spacing.

            Why did the wagons have that particular odd wheel spacing?  Well, if they tried to use any other spacing, the wagon wheels would break on some of the old, long distance roads in England, because that’s the spacing of the wheel ruts.

            So who built those old rutted roads? Imperial Rome built the first long distance roads in Europe (including England) for their legions. Those roads have been used ever since.

            And the ruts in the roads?  Roman war chariots formed the initial ruts, which everyone else had to match for fear of destroying their wagon wheels. Since the chariots were made for Imperial Rome, they      were all alike in the matter of wheel spacing. Therefore the United States standard railroad gauge of 4 feet, 8.5 inches is derived from the original specifications for an Imperial Roman war chariot.  Bureaucracies live forever.

            So the next time you are handed a specification/procedure/process and wonder ‘What horse’s ass came up with this?,’ you may be exactly right. Imperial Roman army chariots were made just wide enough to accommodate the rear ends of two war horses. (Two horses’ asses.)

            Now, the twist to the story:

            When you see a Space Shuttle sitting on its launch pad, there are two big booster rockets attached to the sides of the main fuel tank. These are solid rocket boosters, or SRBs. The SRBs are made by Thiokol at their factory in Utah. The engineers who designed the SRBs would have preferred to make them a bit fatter, but the SRBs had to be shipped by train from the factory to the launch site. The railroad line from the factory happens to run through a tunnel in the mountains, and the SRBs had to fit through that tunnel. The tunnel is slightly wider than the railroad track, and the railroad track, as you now know, is about as wide as two horses’ behinds.

            So, a major Space Shuttle design feature of what is arguably    the world’s most advanced transportation system was determined over two thousand years ago by the width of a horse’s ass. And you thought being a horse’s ass wasn’t important? Ancient horse’s asses control almost everything…     
and CURRENT Horses Asses are controlling everything else.

A recent article in the Washington Post by Simon Johnson and James Kwak commented on the diversion of investment capital into housing to the neglect of productive endeavors.  They said:

“For the long-term health of the economy, we want that money to flow into capital investment by the business sector because that is the best thing we know of to boost long-term productivity growth…

This may seem like an obscure point, but basically it means that even with the low rates of the Greenspan Fed, and even with all that cheap money from overseas, we couldn’t get it where we needed it to go because it was being sucked up by the housing sector. And it was being sucked up by the housing sector because lenders earned fees for making loans that could not be paid back, and banks earned fees for packaging those loans into securities, and credit rating agencies earned fees for stamping “AAA” on those securities, and all sorts of financial institutions — including those same banks — loaded up on these securities because they offered high yield and low capital requirements. In short, we had a dysfunctional financial system that failed at its most fundamental job — allocating capital to where it benefits the economy the most.

 This chart from Tim Duy illustrates the decrease in national capital investment over time,

http://economistsview.typepad.com/timduy/2009/10/hawkishness-dominates.html

Colorado has not been exempt from the “dysfunctional financial system” and is experiencing a lot of the fallout in the form of foreclosures, tight lending and unemployment following the exploded “mortgage bubble.”  Although the fallout may not be as large here as it is in other parts of the United States, it appears that recovery may not be any faster.  Over time Colorado, with the exception of 2007, has been the recipient of a greater portion of the capital investment than its 1.5% of the US population would indicate.

Source:  SSTI

The spike in capital investment during and immediately following the 2001 recession indicates that investment in the business sector may increase once again.

Source:  SSTI

The expansion of capital investment in 2001 apparently did not insulate the economy from the excesses of the financial sector.  What mix of capital investment is right for southern Colorado, and how can it be attracted?

It seems that people who buy houses need a mortgage to close the deal, mortgages require payment and most of those buyers need income to make the payments.  I want to chart the relationship between household income and house prices and I’m digging to find some reliable historic household income and home price data, but in the time being here is a chart of average annual home appreciation from FHFA and average annual unemployment from the Bureau of Labor Statistics:

Sources: FHFA and BLS

The chart reveals an interesting inverse, but not unexpected, correlation between the rates of unemployment and home appreciation in Colorado.  The flush of mortgage money from 2003 to 2005 temporarily impacted the declining rate of home appreciation, but had little effect on unemployment.

 And with respect to unemployment here is an interesting graphic illustration via econbrowser.com, gregmankiw.blogspot.com and innocentbystanders.net comparing what the administration said would happen to national unemployment with and without stimulus and what is actually happening.

The availability of affordable housing is one sign of economic health in a community, but it may be a blessing that only low income communities in southern Colorado actually have.  The scenic southern Colorado mountains have become a desirable place to own real estate.  The supply of land there has remained constant while the demand for “trophy ranches” has increased, and subdivisions and condominiums have added to the supply of second and vacation homes.   The median sales price of homes has disconnected from the US Census estimates of median household income in some of the southerly tiers of Colorado counties.

The following chart compares median income information from the US Census with the median price for 1,300 square foot home reported from the HUD survey of MLS records across southern Colorado.

The blue line tracks the US Census estimates of household income across southern Colorado and shows the trend from Telluride near $60,000.00/yr to Springfield at $30,000.00 per year.  The orange line represents the price of affordable homes of 2.8 times the median income, a commonly used benchmark.  The red line, by way of contrast, tracks the median home price reported by the MLS systems.  The relationship between spikes in median income and spikes in existing median home prices is readily apparent and an intuitive conclusion, but when the benchmark of 2.8 X median household income is applied it is apparent that the indicated median price of affordable housing in many counties in 2007 was substantially less than existing median sales prices.

The median household income estimates indicate that 50% of the people in the county cannot afford the median price of housing; however the median existing sales price indicates that 50% of the houses sold for less than the median price and that results in a balanced market.  It is clear with two or three exceptions that home prices west of Pueblo are significantly exceeding affordability based on median household income.  The likely explanation for the disparity is that while the supply of real estate is certainly local some of the demand for it is not, therefore measuring local household income as an indicator of the demand side of the market may yield a conclusion that has incomplete support.

Studies in the mountain communities of Aspen and Vail have revealed a dearth of housing that can be afforded by wage earners with the result that workers do not live in those communities, making low cost labor scarce, increasing demands on transportation systems as workers commute from more affordable communities and decreasing school enrollments.  All are signs that the economic health of the community weakens as it becomes exclusive and real estate prices rise substantially above affordability.

The chart indicates that conditions in Telluride may mirror the findings in Aspen and Vail, but the remainder of the data indicates the need to ferret out transactions that do not reflect the local markets.

Does the FED rate cause the average 30 yr mortgage rate to move up or down?  The data supplied by the Federal Reserve Bank indicates that with the exception of the period from 1979 to 1981 the FED lags the 30 yr average mortgage rate.  In chart form the two rates plot like this:   

Dan Green, http://themortgagereports.com/, discusses the relationship between the FED and the bank rates as follows:

“This point (FED influence on bank rates) takes on added significance 8 times annually when the Federal Open Market Committee meets.  The FOMC is the policy-setting ARM of the Federal Reserve.  It raises or lowers the Fed Funds Rate to slow down or speed up the economy, respectively.  The Fed’s actions are so important to markets and investors that news organizations like the Wall Street Journal dedicate entire sections to things like “Fed Watching“. Comprehensive coverage doesn’t make the Fed Funds Rate any less misunderstood, however.  Even the brightest of the bright mistake the role of the FOMC in mortgage markets.  The Federal Reserve does not set mortgage rates. Mortgage rates are based on the raw price of mortgage-backed securities plus applicable adjustments based on a person’s individual risk to a lender.  Or, with respect to jumbo mortgages, rates get set by individual banks.  The Fed does, however, influence rates.  Combining rhetoric with more than a trillion dollars, the Fed has helped keep fixed-rate conventional mortgages below 5.500% for the better part of the year.  And now markets are curious: Is the Fed done with its interventions?”

FOMC met September 23, 2009, and, as expected, the FED rate remained unchanged.  But what the FED said was strongly positive and encouraging with respect to the economy.  The FED commented specifically about the improvements in the housing markets.  Good news!

So with no added pressure from the FED, it remains for the banks to assess their lending decisions and modify their lending standards to meet their business requirements.  What happens to unemployment, in the mortgage backed securities market and with FASB bank accounting standards will have a tremendous influence on lending.