Housing: Where Is the Bottom?

It is generally agreed that housing is a significant contributor to the current economic crisis. Many have said that the credit bubble can not be deflated and the consumer can not return to spending until housing prices stabilize. Others have said that recovery will not be sustainable until the housing market bottoms. I have heard so many people offer opinions (watch CNBC) that the housing market will bottom in 2009 or 2010. A few have offered an opinion of a longer wait. I have not seen a comprehensive discussion of the factors involved in the housing shake-out, so here goes. I hope it’s not a case of “fools rush in where wise men fear to tread.”

There are three aspects of the housing crisis: Falling prices, mortgage defaults and supply issues. They will be tackled one at a time, although they are related. Falling prices increase mortgage defaults, which throw foreclosed houses onto the market, and thus the inventory glut is increased. Additionally, there is a section analyzing the demographics involved in the current housing cycle, which are different from the previous cycles since 1950.

So let’s look at the mortgage outlook first.

Mortgage Outlook

There is a famous graph shown below, widely reproduced in the media and around the internet. It even made it to 60 Minutes TV. What the graph shows that there is a bigger ARM (adjustable rate mortgage) problem ahead than the sub-prime problem, which is in its final stages. The potentially most problematic part of the coming bubble (from the default point of view) is the Option Adjustable Rate mortgage. These have optional payment provisions, in some cases allowing zero payments, until the reset date. All shortfalls from the normal amortization payments are added to the principle. It is like compounding interest in reverse. The mortgagee is compounding the principle upward.

My eyeball estimate from the graph is that these mortgages probably comprise around 20% or so of all the ARM resets in 2010 and 2011. If these mortgages were issued at 80% to 100% of 2006 market prices, and the current value reflects the current national average price decline (around 25%), plus some of the interest payments have been deferred, how likely is default when the reset is made at a higher principle than originally contracted? This is very likely, especially if the low payment option has been used due to limited ability to pay.

According to Credit Suisse, there are 8.1 million foreclosures expected in the four years 2009 – 2012. The projection was made before the dramatic unemployment increases reported in December. If unemployment increases more than assumed in the analysis, the estimate for foreclosures could increase.

This estimate of 8.1 million foreclosures is approximately 42% of the estimated 19 million homeowners that have been estimated will be underwater (owe more than the house is worth) by next year (David Leonhart in The New York Times, The Trouble With a Homeowner Bailout). This 19 million represents about 50% of all mortgages. In the same article an estimate is quoted from Mark Zandi, Chief Economist at Moody’s Economy.com that during the life of their mortgage, 6.5 million will not be able to afford their mortgage payments. The Credit Suisse estimate passes the sanity test if these two other numbers are accepted. If most of the 6.5 million not affording their mortgage payment default by 2013, and if most of them are in the 19 million underwater by 2010, then we only need to have 11-14% of the remaining underwater mortgagees default to get over 8 million.

The Alt-A and Option Adjustable Rate mortgages resets are relatively low in number in 2009, but rise dramatically in 2010 and even higher in 2011. If resets could be made with current interest rates, some of the resets could be managed by mortgagees that would default at higher rates. However, it could be argued that the only way for the current low rates to continue for three or four years would be for continued deflation, much further fall in house prices and much higher unemployment. These factors could overwhelm what might otherwise be advantages from lower interest rates.

The biggest factor in mortgage default will probably be affordability of payments, but walking away from a big mortgage with negative equity may also contribute significantly. The same Credit Suisse report estimates that sixty-two percent of Alt-A borrowers (up from 41 percent in September) and 83 percent of option ARM borrowers (up from 66 percent in September) are projected to have negative equity in the next two years. We will discuss the prospect for house prices over the next few years in a later section.

If the average mortgage balance in the 8.1 million defaults is $300K, the total value of all mortgages defaulted would be more than $2.4 trillion. Assuming a 50% recovery after all foreclosure, maintenance, insurance and property tax expenses, the loss to lenders is $1.2 trillion; with 60% recovery, $1 trillion. If the average mortgage in default is $240K, scale the preceding numbers down by 20%.

Finally, this mortgage foreclosure overhang will add approximately 20 months of inventory at current home sales rates. Current new housing starts are approximately equal to the new home sales rate. If we assume that this balance is maintained, then the current inventory of unsold homes over 11 months (Greg Robb, Economic Report: U.S. data show sales of new homes at lowest level in 17 years), plus the estimated foreclosures represent over 2.5 years of inventory. This is an extreme headwind for the building industry to overcome. The prospects for new housing starts and sales are discussed in a later section (House Supply Outlook).

House Price Outlook

There is a saying: “This time it’s different.” This is often criticized as being wrong, that current events have similarities in the past. Well this time is different. House prices have gotten away from historical relationships with construction costs and affordability. The effect of these imbalances is seen in the graph below comparing decline in house prices in the current cycle compared to the last cycle in the 1990s.

This graph shows a comparison of the percentage change of the Case-Shiller Home Price Index for the housing correction beginning in 2005 (red) and the 1989–1990s correction (blue), comparing monthly CSI values to the peak value seen just prior to the first declining month all the way through the downturn and the full recovery of home prices.

Source: Wikipedia

The graph below shows how out of whack home prices have been recently when compared to construction costs. The graph stops before the house price index top in the summer of 2006 above 226.

Source: Robert Shiller, “Irrational Exuberance”, Princeton University Press, 2005

The following graph shows how house prices and family incomes have varied over the past 25 years. The black reference line gives the reference indicating where the average house price has to come to get back to the historical relationship with income. The data is taken from the Case-Shiller Housing Index and the U.S. Census Bureau data base. The 2008 estimated family income is not available as of this date, so the 2007 data point was repeated for 2008 estimated average family income. To reach the historical reference, average house prices would need to fall to the $120,000 to $130,000 area over the next few years. This assumes incomes continue to grow as they have over the past 25 years. This price target is $40,000 to $50,000 below the December average price (23 -28% lower).

On the graph a target box is drawn showing a price bottom target between early 2010 and late 2011. Of course, if the price decline is steeper than the dotted projection, the bottom target would move in toward the end of 2009. If the drop is more gradual, the projection would move out into 2012 or 2013.

Another estimate of how much more house prices have to drop can be found from data in an article by Ira Artman (What's in Store for Regional Banks? ). Abstracting data from Ira’s chart entitled “US and Metro NYC Prices, Actual & Forecast”, we see a projection of sharply slowing house price losses over the next 18 months. My projection from that chart is house prices 10-15% lower, with a bottom by the end of 2010 in the range of $150,000 to $160,000.

Jim Kingsdale (Deflation Watch) has projected the bottom for houses won’t arrive until 2013 and at average prices around $110,000 (2007 dollars). If we have any net inflation between now and 2013, Jim’s price estimate is not that much different from my nominal price range.

Looking at price to rent ratios, Matt Blackman (Housing Prices: Bottom or Temporary Bear Break?) estimated in September that house prices had about 25% further to fall at that time. Adjusting for price declines since, and assuming the same rental cost now as then, that leaves about 18% further price decline by this metric. (Note: In the text of the article, Matt suggests a 12% drop in house prices is indicated to return to the historic ratio, but my reading of his graph yields 25%.) Applying a linear extrapolation to Matt’s graph would project a bottom in the second half of 2009.

The following quote is from an IMF working paper worth reading in its entirety:

In our best judgment, single-family home prices as measured by the OFHEO purchase-only index were around 14 percent above equilibrium in the first quarter of 2008, with a plausible range of 8 to 20 percent.

We find that the bloated inventory-to-sales ratio, high foreclosure rates, and the large degree of inertia in housing markets imply that recent price declines are likely to continue. Moreover, with the gap between actual and equilibrium home prices playing only a weak anchoring role, the downward momentum could well take home prices considerably below equilibrium.

Source: IMF Working Paper WP/08/187, “What Goes Up Must Come Down? Housing Price Dynamics in the United States” by Vladimir Klyuev (pdf warning)

Although the IMF estimate of over-price levels in early 2008 now appear to be too small, the assessment that there is no guarantee that over-correction will not occur is worth noting.

There may be other estimates of what price and what date will define the bottom of the housing market, but I will move on to the supply issue.

House Supply Outlook

It was pointed out (in the mortgage section earlier) that the current house backlog is over 11 months and that the coming wave of mortgage reset induced (and other) defaults could add another 20 months. This creates a potential sales headwind of 2 ½ years of sales inventory before another house is built. If new construction continues to contract to match shrinking demand, the additions to the sales inventory may come primarily from foreclosure in the coming years. Let’s get to the outlook.

In the graph below is shown the house sales volume (per 100 million of population) over the past 45 years. We have indicated a target for the bottom of this cycle, at about 90,000 units per 100 million of population. This is about 275,000 units at the bottom projected to occur between late 2009 and 2011.

From the graph above we can calculate the new single family home sales (annualized) estimated for the fourth quarter, 2008 is 427,000 (140,000 x 3.05 (hundred million multiplier)).

The next graph displays the total residential housing starts since 1958. It indicates the bottom projected from previous cycles has already been exceeded.

According to the U.S. Census Bureau (Quarterly Starts and Completions by Purpose and Design), in 2007 (latest data available), 65% of the total residential housing starts were single family. This implies that in the fourth quarter 2008, about 410,000 single family units started construction (annualized). This number comes from 220,000 (from above graph) x 3.05 (100 million multiplier) x .65 (fraction which are single family). This is very close to the estimated single family residence annual sales rate, 427,000, calculated previously.

If the bottom of the housing market sees sales of only 275,000, sometime in late 2009, 2010 or early 2011, as estimated previously, there must be additional decline in housing starts by about 33% (135,000 units annualized) sometime during the next 1-2 years.

One additional note: Steven Hansen (http://seekingalpha.com/article/104904-it-might-not-be-possible-to-stop-the-decline-in-housing-prices) has reported that the actual number of house that could be in the current inventory, but are not, is at least as large as the 11 month inventory reported (and probably larger), because many “discretionary” sellers are waiting for a better market.

Demographic Factors

The biggest demographic factor on the table is the baby boom. The front wave of the baby boom is now in their early sixties and the wave continues for 18 years. The baby boomers were born from 1946 to 1964, so in 2009 they will be the age group from 45 to 63. In the graph below (from here) vertical lines have been drawn at five year intervals to define the 20 years containing the surviving baby boomers.

As the baby boomers move to retirement, downsizing and increasing mortality, there is a smaller group of successors to occupy the houses of the elders. Increasing mortality has been depleting the front edge of the baby boom but the number of houses they occupy has not been diminished proportionately because of surviving spouses.

The nature of the baby boom housing overhead can be estimated by looking at the younger edge of the boom, now 45 to 50. It shows populations 350,000 to 450,000 greater each year than the fifteen years following (30 to 45). If we add back 75% of the decline from age 50 up (my estimate of the survivor effect, which may be too low), the estimated baby boom households for age 50 to 55 becomes close to the 45 to 50 total. For 55 to 60 the household total is estimated to be 100,000 to 150,000 lower than the approximately 2.5 million to 2.8 million estimated households for the ages 45 to 55 (4.5 million divided by 2 plus an adder for single resident occupied housing). The range in estimated households results from uncertainty in the number of single baby boomer residents – the total of spousal survivors, the separated and the never married.

So my estimate is that the housing market for the fifteen years following the baby boom is 150,000 to 200,000 households less per year than the youngest 15 years of the baby boom. That is a 15 period with demand loss per year which is 35% to 50% below the fourth quarter 2008 sales rate. This 15 year period will be coming in the downsizing peak period of the baby boomers, when some will be moving to smaller houses and wanting to shed second homes.

Steven Hansen (A Tale of Two Housing Bubbles) has written a recent article that reports a rapid growth of second homes (vacation homes and “investment” homes) over the past 10 years from1-2 million in 1997 to about 20 million as of 2006. (This is only includes sales from 1997 forward, so the 20 million may be understated. On the other hand this number does not appear to be corrected for resales, so the 20 million may be overstated.) This is about 15% of all homes in the U.S. These are much more likely to be added to the housing market (offered for sale or foreclosed) than a primary residence when the owner has financial distress. Also, the increasing burden of dealing with two or more homes as one gets older will be an incentive for baby boomers to get back down to one house just at a time when demand for houses is falling for demographic reasons. At current single family home sales rates, 20 million is more than a 46 year inventory!

One final demographic note comes from Spengler (The Devil and Bernard Madoff ) who recently published the graph below.

Prospective home buyers and home sellers in the US:

Spengler argues that U.S. demographics will create a crossover to more people over 50 than 20-50 by 2015. He misleadingly calls the younger group buyers and the older group sellers, while there may be buyers and sellers in both groups. However, he does argue, with merit, that this does not bode well for the future value of large homes, which are less preferred by the older group.

Summary

There are some conclusions worth presenting.

1. It has been estimated that there will be 8.1 additional foreclosures by the end of 2012. This is 21% of all mortgages.
2. It has been estimated that 19 million mortgagees will owe more than their house is worth by 2010. This is 50% of all mortgages.
3. It has been estimated that about 6.5 million mortgagees will not be able to afford their mortgage payments at some time during the term of the mortgage. This is 17% of all mortgages.
4. It is possible that homes for sale inventories, currently over eleven months, could reach as high as 2 ½ years during the next four years.
5. The average additional drop in average home prices (five sources) is estimated to be 20% to reach the bottom.
6. It has been projected that new home starts will fall to approximately 33% (from 4^th quarter, 2008) to 275,000 (annualized) by the time we reach the bottom for the housing market. If this does not occur, the bottom may be lower in price and take longer to reach.
7. Estimates for the time the bottom will be reached (six sources) range from late 2009 to early 2013. Four sources estimate 2010 or 2011.
8. The estimates made above (1-7) might become worse (lower prices, fewer housing starts and later bottom) if negative demographic factors were appropriately included.
9. The estimates made in this summary could also become worse if there is a prolonged recession (or depression) of two years or more. Conversely, if this recession were to end in the next 5-6 months, the estimates might improve.

It is the author’s overall conclusion that Federal intervention to solve the housing crisis would consume too much resource that would be better used to stimulate future economic growth. The data reviewed in this article indicates that the home building industry may never return to the levels of the past decade unless demographics are changed in an unanticipated way by increased immigration or increased birth rates.

Disclosure: The author has a large home which he will probably want to sell in 10-12 years. There are no positions at present in banks, mortgage companies or any construction businesses.

Comments

[nasdog:]

When the tax code encourages speculation in (interest deduction/property tax deductions) real estate. you get a lot of it. A host of goverment programs-VA,FHA.freddi... go on and on. What can one expect?

Jan 08 09:18 AM

[sleepless_o...:]

This is a grim picture. Can anyone take the same facts and make more optimistic projections?

There will be variations in the housing market across the country. Some areas will, as always, do better than average and some will do worse. Is there a good way to estimate how different markets will fare?

Jan 08 10:12 AM

[kruser53:]

Great article. The author has tied together a lot of recent news and analysis and added to it.

Jan 08 11:07 AM

[billddrummer:]

Excellent article.

Another situation that's at work with the Option-ARM is that virtually all loans have a cap on the maximum deferred principal (usually 110%-120% of the original loan balance). So if a borrower elects the minimum payment, the deferred interest is added to the loan balance, When the cap percentage is reached, the loan automatically resets to amortize at the original index plus a margin over the remaining loan term.

In my opinion, this phenomenon has begun to affect Option ARM loans written in the past 4 years. Those loans will begin to reset at much higher payments this year, adding even more stress to the industry, raising default rates, and prolonging the inventory overhang.

Here's an example:

A borrower gets a $300,000 30 year Option ARM with a 1% start rate, 110% cap, and a run rate based on the COFI + 3.45% (common terms in 2006). The initial payment is $964.92. The 'regular payment based on current rates is $1423.61. The deficiency of $458.69 is added to the loan balance each month. In the 65th month of this loan, the loan balance reaches $330,000 (the cap amount). It's then amortized over the remaining term. But that makes the payment over $1700/month, presuming rates remain low (this example assumes a 0.5% COFI).

I submit that most families don't have an additional $800/month in their budgets for higher mortgage payments.

Jan 08 01:55 PM

[John Lounsbury:]

billddrummer - - -

Thanks for you astute comment. Your calculation shows how the optional payment arms can lead to an early reset trigger. This will happen to those who have a high probability of not being able to afford full mortgage payments (they were paying even less than the interest payments) so they have a high probability of default.

I mentioned the increasing principal problem of these mortgages, but your example gives much clarity to something I just mentioned in passing. Thanks.

Jan 08 02:35 PM

[Ricard:]

This is a masterpiece - one of the most comprehensive analytical pieces I've seen on housing. I've found Schiller to be the only voice of reason when it comes to the housing market, and you quote him quite liberally. I have nothing add to your analysis - you've covered just about all the bases. I was going to suggest immigration, and then I read your last sentence. Again, a real masterpiece.

The questions forming in my mind now are how this is going to spill over into the rest of the economy. Consumption will be constrained for a good 3-5 years, and something will have to replace it - I cannot think of any plausible candidates. Nearly every piece of evidence you cite argues for a prolonged recession if not outright depression due to housing's significance in the economy. This is the most enlightening analysis I've read to date to advocate an extremely bearish position for the next 5 years. Perhaps currency devaluation and something just short of hyperinflation really are the only paths to salvation.

As depressing as this all is, thank you for taking the time to put it all together.

Jan 08 02:39 PM

[John Lounsbury:]

Ricard - - -

Thanks for your kind comment. I spent nearly a month getting this together, as you and others may remember from things I have said in comment streams. There are other pertinent facts to be developed in this area (billddrummer just wrote about one above). I hope this comment stream will develop a dialog of other factors and aspects in the housing area.

Jan 08 02:47 PM

[Ricard:]

My solution to this would be to compare real estate as an investment to other investments commonly found in the marketplace. If you can rest assured that the property you buy will earn you a good rate of return, you can probably rest assured that the property will not have much to fall further, if at all.

For example, in many parts of California, this rate of return, not including a mortgage, is around 4-6%, net taxes, insurance, and maintenance. Once you add principle and interest with a 80% LTV mortgage, most, if not all, of these properties become an incredible monthly drain on your checkbook, to say nothing about the continual plummet in the values of the house.

Other places, such as the Midwest, have rates of return around 8-12%, which is generally a healthy real estate market. Of course, these regions have their own problems with employment and etc. Finding a good medium between healthy employment numbers and a good rate of return on your real estate would be a profitable proposition, and will probably signal a recovery in the property of that region.


On Jan 08 10:12 AM sleepless_on_wall_stre... wrote:

> This is a grim picture. Can anyone take the same facts and make
> more optimistic projections?
>
> There will be variations in the housing market across the country.
> Some areas will, as always, do better than average and some will
> do worse. Is there a good way to estimate how different markets
> will fare?
>

Jan 08 02:48 PM

[Ricard:]

No problem - I can only hope you are as successful with your investments as you are in putting together well-thought out arguments such as this. Cheers, and good luck!


On Jan 08 02:47 PM John Lounsbury wrote:

> Ricard - - -
>
> Thanks for your kind comment. I spent nearly a month getting this
> together, as you and others may remember from things I have said
> in comment streams. There are other pertinent facts to be developed
> in this area (billddrummer just wrote about one above). I hope this
> comment stream will develop a dialog of other factors and aspects
> in the housing area.

Jan 08 02:51 PM

[taking it a...:]

The decrease in working population with the aging of the baby boomers is well known. What about the impact of immigration?

Jan 08 03:23 PM

[mallarde:]

John, this is a great contribution. Great data and analysis. I want to spend time studying it more now, but need to work.

As a longtime renter and follower of this "crisis" I had no idea things were so dire. Again, thanks, and wow!

Jan 08 04:43 PM

[AGreenspan:]

It's "principal" not "principle"!

Jan 08 05:00 PM

[PROXIMO:]

Great article. Very definitely not a case of "fools rush in where wise men fear to tread".

Jan 08 05:38 PM

[John Lounsbury:]

Thanks for reading the article, commenters.

taking it all in - - -

The affect of future immigration has not been included. It is likely that immigration will increase in the future as, without it, we will end up with 2 workers for every retiree. Actually, many "retirees" will probably be part time workers out of economic necessity; but we will still need immigrants.

AGreenspan - - -

Thanks. Corrections of typos as well as for errors in content are welcomed.

However, immigrants are usually not house buyers right away and have the biggest impact on low income rentals. This may put some upward pressure on rents which will be supportive of purchase prices because of the price to rent ratio moving toward favoring "buy" over rent.

I am convinced of one thing regarding immigration: they will not have any influence until after they arrive and I don't see why there should be much immigration over the next few years.

Jan 08 07:40 PM

[John Lounsbury:]

Sorry, taking it all in. I inadvertently inserted my reply to AGreenspan in the middle of my reply to you.

Jan 08 07:42 PM

[Ricard:]

Principle is right. Principal is the guy in charge of a high school.


On Jan 08 05:00 PM AGreenspan wrote:

> It's "principal" not "principle"!

Jan 08 09:47 PM

[Ricard:]

Or not, my bad. Maybe I need to go back to high school myself.

Jan 08 09:49 PM

[Bryan Kavanagh:]

A most insightful article, John Lounsbury! The Australian data point to much the same immediate future for us, although our bubble hasn't yet burst.

The Land Values Research Group here has collated every real estate sale in Australia (because we can down here - even though official sources don't bother doing so), divided that total by GDP and got the Kavanagh-Putland Index. It paints a clearer portrayal of where we are at than your Case-Shiller Index - and it aint a pretty picture!

Jan 09 12:02 AM

[neocon4jesus:]

Great Article. As a baby boomer who owns not one but two homes with 7 bedrooms being used by 2 people, my downsizing idea may have some downside.

Ahh, please tell me that misery loves company again. Please.

Jan 09 12:39 AM

[Steven Hansen:]

John, excellent work. my work over the last few days is indicating our housing analysis may be optimistic. i continue to look for contrary data as i like debate - nothing is black or white. but this housing crisis is like a shaving cut to a hemophiliac.

generally speaking, it is easier to discover negatives than positives - so when i project outcomes i try to use one of the more optimistic resolutions. but this crisis is starting to overrun projections which is a growing concern.

most people are thinking that when the monthly mortgage cost approached rents stability price stability will happen. what if rents are falling (the are!). what happens if this recession is "L" shaped - this means the unemployed will not be returning and you have 10% of the population unable to purchase. under these scenarios john. IMO we are truly screwed.

Jan 09 02:11 AM

[HolidayHome...:]

Great article. Thanks.

My one concern is the way you extrapolate the average home price graph in a straight line, assuming a constant rate of change, which you say may be shallower or steeper than projected.

Prices might well maintain their current rate of decline for a while, but in past declines they have formed a curve rather than dropping to the bottom and leveling off. IMO we are likely to see that rate of decline being reduced year by year gradually to zero at some point in the future. I also expect there will be a great deal of the overshoot that you mention!

..and this is in no way a criticism of your excellent article. Well done!

Jan 09 07:01 AM

[Bigbuilder:]

Great discussion! I agree with the general tone of the analysis, but would add some thoughts:

1. Average house size (and features) is not constant over time. The increased size of homes represents a huge sunk investment of national capital in assets that will generate large future negative cash flows for owners. Taxes, utilities, insurance, maintenance and so forth will render the current housing stock somewhat like the SUV's during the gas price run up. In addition, the capital is fixed in location. As individuals seek to be more nimble in their jobs and living circumstances, the need/desire to own will fall.

2. The historical emphasis on home ownership is based in part on assumptions regarding desire to build "community". As social structures such as public education and safety continue to spiral down, people will be more reluctant to tie themselves down to a fixed asset for the long term.

3. The rate of consumption generally will fall in the future due to the pending bubble/ponzi scheme inherent in social security and medicare. Read "Running on Empty" by Pete Peterson. We will be both taxed to death and burdened with high shares of medical costs. Nothing that D.C. does can change that future. The result will be great belt tightening.

The above factors will shift the demand and supply curves for housing in ways that make the current projections very optimistic. I hate to preach doom and gloom, but that is how I see the future.

I think the current housing bubble is just like the bombing of Pearl Harbor. It signals the beginning of a war. The enemy is our own excessive comsumption and the resulting waste of our capital into applications that deprive us of the ability to generate positive future cash flows. We are in a competition with the rest of planet earth and we ate our seed corn. When the American people realize the extent of this mess, they will blame and savage each other rather than unify to fight a common enemy.

As Pogo said: "We have met the enemy and it is us."

Jan 09 09:42 AM

[2nynbak:]

Great piece of work John, Seeking Alpha is very fortunate to have you as a contributor. For your "next assignment" I would enjoy seeing you weigh in on the issue of apartment building and unit values as this single family crisis continues to unfold. Most of what I see in the current discussion is either single family new vs. existing home prices and then the discussion skips to the larger commercial real estate developer issues. How is the cross-elasticity of single family to the smaller 2-20 building rental unit values going to be affected by these forces over the next few years. To me it's a great question which I'd like to see someone with your analytical drive give us your opinion. Again, Great piece of thinking.

Jan 09 09:54 AM

[Guero:]

This is hands down the best analysis I have seen of our current housing market predicament. A perfect example why I come to SA.

It also illustrates why doing nothing and letting the foreclosures & price/value drops occur naturally might be the best alternative out of a bad lot of choices. It seems that whatever we do to try to intervene in this process will just delay the inevitable, and drag this pain out longer. Many people just were not destined to the homeowners, and the peak market was not set up to understand that fact.

I was in the home building industry most of the decade (sales) here in TX and was amazed at the continuous parade of truck drivers, janitors, school bus drivers, hard-hat types, etc. coming through our doors with $350,000+ equity burning a hole in their pockets.

They had just sold their 1000 s.f. 50 yr-old ranch in SoCal that they had lived in for 20 years and now they were paying cash for two of our McMansions (one for them, one for grandma) and "retiring." Oh, and their brothers, cousins, and uncles had sold their houses as well and were coming in tomorrow to buy two houses each.

The people that bought their 1000 s.f. 50-yr old SoCal ranches for $400,000 used the now-defaulting option-ARM's to pay that exhorbitant price. At the time me & my sales-comrades were astonished & wondered how long this could go on, and how badly would it end.

This is a perfect example of the fact that the peak market had way too much capacity in home production, labor, materials, capital, etc. not to mention the excess in ancillary industries (retail, services, etc.). It is painful to work all that excess capacity out, but it must be done to go back to where it should be.

Possible silver lining--maybe part of the excess that will be "worked out" will be the "Flip this House" type of dreck that has been polluting cable TV this decade.

Jan 09 10:28 AM

[User 334252:]

I am a surviving spouse with a principle residence, a vacation home and a rental. I am 66 and stopped working full time in 1985. I plan to sell my rental to my renter and pay off my two remaining 15 year mortgages in about nine years (if I stay alive.) My heirs will bear the decline in house value. Great article.

Jan 09 10:41 AM

[1,000,000 S...:]

If the issue emptying houses (as an example) instead of having the Fed provide liquidity along with the Federal Goverment through the 700 Billion (or Trillion Next Bama Plan), why not tap another resource of money to help in the mortgage/banking crisis, Immigration.

If part of the problem with the housing market is not enough "buyers" due to all the other factors and the demographic drought a modest proposal to issue special visa's that bring in individuals (who after 10 years get American Citizenship) would help right? A million entrants into the US with a 1,000,000 would provide not just an immediate injection that would dwarf the 700Billion & other plans, but it would provide an opportunity for all those empty (to be) homes to be sold, occupied.

The fact of the matter is America is the "ultimate gated community" in terms of people trying to get in. It is in fact American Dollars that are being funneled out of the country either through oil transfers to the middle east or through the walmart effect of industry. Trillions are sitting in the sidelines in Asia (China & India) or the Middle East and even in Russia (the recent oil boom and gas shipments to EU).

The problem is not "too much" immigration, its not enough of the right immigration. Fill the empty homes, refund the banks and financial institutions, and get the economy back on track through high income, high talented, risk taking, willing supporters of American values. Give the 1,000,000 Squared plan a chance to work.

Jan 09 11:14 AM

[John Wake:]

The size of the option ARM resets is likely over-estimated in the graph. When a home buyer only makes the minimum option ARM payment, the reset is triggered early (a year or two after origination?) so the first scheduled reset may be misleading. We may be working through the worst option ARM borrowers' defaults now.

Jan 09 11:26 AM

[John Lounsbury:]

Responses to commenters:

2nynbak - I have thought about the rental situation but have not done in depth research. One piece of information I am looking for is how the rates of multifamily construction is or is not changing compared to single family. The other factor I see is the depression of traditional rental rents as unoccupied single family homes (which would normally be sold) enter the rental market. I am seeing reports of rents falling but do not have a national picture. I am concerned that we do not have a good picture of commercial real estate in general, not just multifamily rentals. My sense is that commercial real estate may face a disasterous year in 2009. I just don't have the research to quantify it.

HolidayHomeOwner - My extrapolation lines are arbitrary. I did mention that they could be moved based on how the economy unfolds. I feel the uncertainty is, as you say, whether (and how much) the projected dates for the "bottom" will move out (later). Good observation.

1,000,000 squared - Immigration will be a big factor in the coming 20-30 years. We need it because our demographics without immigration indicate severe economic decline. I don't think that immigration will impact single family housing significantly over the next 3-5 years. Two reasons: (1) Immigration during an economic downturn and recovery, with the accompanying high unemployment doesn't have a driving force; and (2) new immigrants have a high proportion of renters in the first years. You make a good point, but the factor may become important after the time period we are looking at here (2009-2013).

Bigbuilder and The hand - I agree that the actual outcome has downside potential compared to the estimates I made in the article. You both make good points about some of the reasons. It is also possible (but less likely, in my opinion) that the projections are too negative.

Thanks to all commenters.

Jan 09 11:59 AM

[John Lounsbury:]

John Wake - - -

Your comment is correct. Early resets may be happening in 2009, but I haven't found any numbers yet.

Jan 09 12:00 PM

[D. McHattie:]

John, the comments in praise of this article are so unanimous that it almost makes me want to post a word of criticism. Except that I can't - this article is thorough and yet succinct and I can't thank you enough.

Jan 09 02:51 PM

[2nynbak:]

John, thanks for the comment back on the rental situation. I agree with your sense of the commercial real estate market for 2009. Your point about single family houses becoming rentals is a piece of the cross-elasticity I was thinking about. The other thing is just the straight up cost to buy or rent calculation as housing prices fall amidst the unemployment rate trending upward.

Jan 09 03:33 PM

[John Lounsbury:]

WAKEUP - - -

Wow! I understand where you are coming from, but wow!

We have had waves of immigration before and they have been assimilated. I hope that can be repeated.

As far as the economic disaster, Bush was merely an abetter of a process that started at least 25 years ago. He simply did not have the capacity to recognize and deal with what was underway and received no help from a clueless Fed or incompetent advisors. (No, I'm not defending him and I never voted for him. Also, I have no confidence that either Gore or Kerry could have done that much better.)

Now, let me try to be a little more optimistic. This does not need to be the end of a prosperous America. Here are some thoughts.

1. We need to find a way to convince our fellow citizens that there is a better way to personal prosperity than maxing out credit cards and building houses to sell to one another.

2. We need to return to the concept that debt is useful for financing means of production and is corrupted when used to finance additional layers of debt.

3. We need to learn that allowing layers of ineffficiency to build in such fundamental areas as health care is a burden to all citizens and businesses. We must find a way to eliminate the waste (as much as 40% of health care cost) that exists in the form of liability insurance costs, health insurance administration overhead, unnecessary duplication of expensive medical testing, disfunctional medical record systems and high prescription drug costs that underwrite lower costs for the same drugs for the rest of the world. Health care that offers freedom of choice and the same (or better) quality of care at 50-60% of today's cost is achievable. There are powerful lobbies opposed (legal, insurance, pharmaceutical, to mention some big ones).

4. We need to learn that supporting entrenched industries that need to reform (I'm thinking Detroit here, but it could be applied elsewhere) instead of enabling newer businesses with sound business plans to develop is a mistake. The inefficient have lobbies. Many entrepenurial newcomers do not. We must make the action of lobbyists transparent to the public and enable those without lobbies a forum to challenge. Lobbyists open to public scrutiny can do a lot of good. Lobbyists behind closed doors can do a lot of harm. (And have done a lot of harm.)

5. We need to reform our educational philosophy. "No Child Left Behind" is not a bad idea. The implementation that produces "No Child Gets Ahead" is a bad idea. We are getting rid of a president who publicly told students "It's all right to be a "C" student. I am testimony that you can become president of th U.S." Our philosophy should be that every child should succeed. It should not be that every child should succeed at the same level.

There is a bright future for this country. Just because we can not yet see around the next corner does not mean that there is no opportunity there.

WAKEUP, you are forgiven if you tell me that the above discourse is not what you had in mind when you wrote your comment. I hope I am forgiven for unloading a lot of emotional thought.

Jan 09 08:36 PM

[WmPeck:]

John,

I think the one statistic that would put the finishing touch on this well organized overview has to do with the demographics of the US employment pool. It is my understanding that somewhere between 65%-80% of the job creation in the US over the past 15 years has been from construction, finance and real estate. I don't think many of these jobs will be coming back too soon.

Jan 09 11:48 PM

[banklender:]

There's an element to the current crash that all the blogs seem to miss - that is the amount of debt that has been incurred as result of the boom. Not only are asset values falling, but debt levels are FAR higher which has the effect of exacerbating the impact of reduced aggregate income due to unemployment. This is a 'double-whammy' that is placing unprecedented pressure on the economy. We are, indeed, staring down the gun barrel of a new depression.

Jan 09 11:53 PM

[John Lounsbury:]

To the recent commenters - - -

If you really want to get into some details about what's different about the current crisis, you might be interested in Steven Hansen's post (Jan 9) entitled: "Carmen Reinhart and Kenneth Rogoff Compare Economic Crises" which refers to their paper (just published): “The Aftermath of Financial Crises". You can follow Steve's link to Prof. Rogoff's site and then click on publications to access a draft of the paper.

Jan 10 12:13 AM

[prudentinve...:]

John Lounsbury,

Thanks for this excellent summary. Although I've seen bits and pieces of this information here and there, you did a great job of putting it all in one coherent piece.

One of the sad facts is that all this was predictable, and in fact predicted, not just by people considered fringe by mainstream commentators, but also by mainstream economists, and in manstream publications.

For example, "The Economist", which most would consider mainstream and credible, had its main editorial piece predicting this situation, almost precisely. If memory serves me, it was sometime in the 2003-2004 time frame when Greenspan had his first stab at near-ZIRP. I wish I had saved this issue. Prescient as this editorial was, it was so obvious to any objective thinker or reader that a big problem was brewing, and that then was the time to mitigate it.

It is astonishing to see our policymakers and pundits, many of whom were in power or pontificating as this crisis was clearly brewing, now trying to pretend that this crisis is some "act of God" like a tsunami or earthquake, or as unpredictable or unlikely as a "black swan". The reality is that it was both predictable and predicted as these folks cheered it on.

Jan 10 09:40 AM

[CoinMiner:]

Count me in – a great article! My initial thoughts also centered around the increasing demand by immigrants. The author states he finds no reasons why an immigrant would want to move here in the next few years. However, that is the perception form the glass half empty – the realization from a boomer that America is on the decline and thus why would anyone move here. However, look at the situation from the perspective of a possible immigrant and things look much different.

Demographics trump. Just in the Americas the population density alone, generally higher in all other American countries except Belize and Canada, make the US look very attractive. Expanding the view worldwide, the aging white US boomers are outnumbered by the young Asians still too reach their earnings potential.

At least in my geographic area, northern San Francisco Bay, these demographic trends are evident in day to day dealings. The days on market have decreased in the counties I follow b.c. prices have fallen (up to 60% in some zip codes) to the point shown on the third graphic in the article. Namely, house process have decreased from 7x annual salary (the top of the market in October 2005) to about 2-2.5 times annual salary, near the 100 year mean of around 2x salary. The buyers to date seem evenly divided between smart money investors (yes, these homes will now cashflow above the 4-5% stated above) and young asian couples.

This is the view from my neighborhood…

Jan 10 11:15 AM

[Joe Friday:]

Excellent Article. Thank you for putting the time in to put that together.

If there is one thing missing, though, it is a discussion of why this set of facts arose. I would have to agree with the comments by prudentinvestor, the seeds of this catastrophe were sown in the low interest policiies of Mr. Greenspan. I believe many of the graphs support the timing of the start of this problem as coincident with the low interest rates in 2002-2004. The effect was to bring forward demand at an exceptionally accelerated rate, feed price increases and create the positive feedback loop that resulted in the housing mania of the last few years. Trees don't grow to the moon, and clearly the bubble burst in 2006 (approximately). We are now faced with the dillema of having all of these houses go into foreclosure, with the consequent damage to the banks balance sheets, or attempting to reflate again to mask the reality....Terrible choices. In my view, by reflating (ie cutting rates to zero again), we are sowing the seeds of an as yet unknown catastrophe. In my view, we should take the pain, and accept the consequences.

Jan 10 11:17 AM

[Jonster:]

There is a "solution" to all this debt and I feel sure it will happen at some point. That solution is inflation (after the deflation you talk about). Governments around the world are trying to reflate their economies - presently without success because of the huge debt overhang. But I think they will "succeed" somewhere down the line - and with the value of money decreasing due to inflation, buying property could an answer - maybe the only answer if the inflation becomes rampant. Loans (with small interest rates) can of course be repaid quicker in inflationary times. Do any of you have any thoughts on this?

Jan 10 12:55 PM

[Ricard:]

I just watched a WSJ video on "The End of Wall Street" (it's quite good), and they showed a clip of Dubya selling America on buying your own home. I clearly remember the White House making those pitches. Greenspan always seemed a little too comfy with the Republicans, IMHO.

online.wsj.com/video-c...



On Jan 10 09:40 AM prudentinvestor wrote:

> John Lounsbury,
>
> Thanks for this excellent summary. Although I've seen bits and pieces
> of this information here and there, you did a great job of putting
> it all in one coherent piece.
>
> One of the sad facts is that all this was predictable, and in fact
> predicted, not just by people considered fringe by mainstream commentators,
> but also by mainstream economists, and in manstream publications.

>
>
> For example, "The Economist", which most would consider mainstream
> and credible, had its main editorial piece predicting this situation,
> almost precisely. If memory serves me, it was sometime in the 2003-2004
> time frame when Greenspan had his first stab at near-ZIRP. I wish
> I had saved this issue. Prescient as this editorial was, it was so
> obvious to any objective thinker or reader that a big problem was
> brewing, and that then was the time to mitigate it.
>
> It is astonishing to see our policymakers and pundits, many of whom
> were in power or pontificating as this crisis was clearly brewing,
> now trying to pretend that this crisis is some "act of God" like
> a tsunami or earthquake, or as unpredictable or unlikely as a "black
> swan". The reality is that it was both predictable and predicted
> as these folks cheered it on.

Jan 10 01:37 PM

[D. McHattie:]

A little off-topic but here goes.

"We need to reform our educational philosophy."

Not everyone should go to college. Noone should feel like a 2nd-class citizen because they did a technical program and didn't go to college. There are industries that pay well for skilled labor but are lacking trained workers while we sociology, english, anthropology, history, etc graduate students are encouraged to spend many productive years and take on $100k+ debt and contribute very little to our economy. (sorry to those majors, I am one of them - these are all necessary and useful fields but we just don't need so many people in them).

Sorry to thread-jack.

Jan 10 04:29 PM

[mallarde:]

The idea of allowing millions upon millions more people into the our nation's gates in order to fill empty tract houses repulses me. This is the behavior of a desperate country. What of citizenship? Who are these people? Do we still believe we are a country? Can this country hold itself together if we treat our citizenship like penny-stock? When we need to raise more capital, we just issue new shares to strangers who want to live in our country?

If our country does come apart, its own citizens will be to blame. We elected short-sighted and self-interested leaders. Much like shareholders allowed short-sighted and self-interested managers to take control of corporations.



On Jan 09 11:14 AM 1,000,000 Squared wrote:

> If the issue emptying houses (as an example) instead of having the
> Fed provide liquidity along with the Federal Goverment through the
> 700 Billion (or Trillion Next Bama Plan), why not tap another resource
> of money to help in the mortgage/banking crisis, Immigration.

Jan 10 04:48 PM

[TeddyBearNeil:]

On Jan 08 01:55 PM billddrummer wrote:

> Here's an example:
>
> A borrower gets a $300,000 30 year Option ARM with a 1% start rate,
> 110% cap, and a run rate based on the COFI + 3.45% (common terms
> in 2006). The initial payment is $964.92. The 'regular payment based
> on current rates is $1423.61. The deficiency of $458.69 is added
> to the loan balance each month. In the 65th month of this loan, the
> loan balance reaches $330,000 (the cap amount). It's then amortized
> over the remaining term. But that makes the payment over $1700/month,
> presuming rates remain low (this example assumes a 0.5% COFI). <br/>
>
> I submit that most families don't have an additional $800/month in
> their budgets for higher mortgage payments.

Nice analysis. I like it. Actually I believe ALL of these Option ARMS were taken out NOT with the intention of living in the home forever, but with the intention of selling it by the time the payments reset..assuming that the home prices would be rising by that time and they would pocket a nice profit!

Given that the home prices are way below the purchase price of a majority of these homes and the incomes of the owners not exactly sufficient to make the additional payments, the only way these homes could be saved from foreclosure is by allowing them to live in those homes at the pre-reset payment levels!!

Either ways, it is the sensible, diligent and honest individual tax payer who is going to foot the bill in this Bail-out economy!!

Jan 10 05:10 PM

[Ricard:]

Well, I'm going to try to add some optimism here.

From an equity investor (and probably a bond investor) standpoint - it's clear from that option ARM chart that we'll be setting the groundworks for a massive recovery after 2012. It may still take a lot of time to work through all the excess inventory, but at least profligate lending will no longer be one of the causes for it.


On Jan 10 05:10 PM Teddybearneil wrote:

> On Jan 08 01:55 PM billddrummer wrote:

Jan 10 06:18 PM

[driftwood2:]

The problem is, the enemy is us. It's not just our government that is bad. Our government is just a reflection of ourselves.

Jan 10 07:05 PM

[floridauser:]

This is a comment from Oct.1, 2008. Seemed easy enough to implement:

There's Still a Better Bailout Available Since all the trouble rests with tumbling home prices, resulting in massive CDO losses, why not act at the source? Stop issuing new residential building permits until unsold housing inventory is absorbed. Since new house sales are only a small fraction of all sales, this would take some time. Certainly, such a plan would be an unamerican, anti-capitalist program, just like the one being proposed by Paulson to rescue nearly bankrupt financial institutions. However, it would likely be much cheaper to temporarily compensate the new home builders and their suppliers for lost income than to rescue these behemoth banks. About 500,000 new homes are sold yearly at an average price of just over $200,000 resulting in an approx $100 billion/year subsidy. This should have the desired effect of stabilizing the housing price freefall and the value of CDO's. A gradual return to normal permitting could be allowed in several years. The US is simply overbuilt and this can be remedied in time by a growing population if no more inventory is added.
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Jan 10 08:46 PM

[Teutonic Kn...:]

To Dr. John Lounsbury,

Your reputation as a SA contributor is sterling and your credentials are immaculate. However, I would like to tender one exception to your proposals above for solving the current crisis.

Our nation is basically sick, suffering from over-leveraging as we all know only well. Personally I don't think it would be a great idea to start another wave of massive immigration at this time (at this time in italics). The country needs time to rest and heal itself from its self-inflicted wounds, which are by no means mortal as you suggested.

There are social costs involved with immigration. At a time of increasingly high unemployment, where our health care system is primarily employer-based, immigrants and government support resources alike will be hard taxed. The unemployed might view new comers as displacing their already scanty jobs. And worst case scenario, though far-fetched, there might be ensuing civil unrest.

Don't get me wrong. I am not anti-immigrant. After all, I am an immigrant myself, having been privileged enough to come to this great country of ours (ours in italics) from north of the border several decades ago. Our country's is at risk of losing it preeminence when the exercise of prudence is timely and apt.

Jan 10 10:17 PM

[UpstreamSwi...:]

Good work, John Lounsbury.

I was wondering whether anyone else understood what was developing. All of this has been pretty depressing to me over the last decade as I watched it develop year by year.

The immediate global financial turmoil triggered by the U.S. housing situation and related financial schemes represents one component of an array of major developing problems that Americans will face. The most obvious include the enormous outstanding liability for social security and medicare/medicare together with privately insured health costs, neglected infrastructure costs, and loss of jobs (manufacturing and other sectors). The nation was already headed for trouble, even without the housing bubble, which was entirely avoidable. Addressing all of this will take a lot of creativity, sacrifice, and cooperation for many years.

One factor that was not addressed in detail in the analysis was the trend in recent years for increasing house size (on a per capita basis), which has played a significant role in costs and ultimately ability to pay.

It would also be interesting to see a clear summary statement/estimate of the total current number of standing housing units in the nation presently, addressing both owned homes/condos and rental units. Ideally, that would be supplemented by an analysis of the housing stock by some characteristic or category attributes (size, age, utilization value/disposability). Such an analysis might shed some light on one possible part of the housing problem remedy: occupation adjustment. Uncomfortable as it might be for a while, part of the solution might be to have suffering mortgage owners convert their large single-family homes into duplexes (purchase or rental). For some portion, this would allow them to pay the mortgage and avoid default. The degree of success of this measure would depend on having enough demand for occupation (by financially capable parties). The categorization would shed light on the degree to which less-desirable housing stock could be shed from the overall housing stock. Much of that lower-tier portion has minimal impact on the overall current financial problem, anyway (some has been abandoned). Some portion of that lowet tier could possibly be pooled through government-mediated investment programs to be developed for other purposes such as local markets, industrial, medical or research facilities, schools, nursing homes, daycare centers, parks, infrastucture facilities, etc. This may represent an opportunity to achieve more efficient communities, In the process, lots of construction work might be available.

It may be that success will be elusive. The reality is that we don't have many options. We cannot afford to ignore radically creative solutions which may have some potential. Solid analysis is required first. It is clear that things that would only exacerbate the problem would include paying people to sit on their hands, and throwing money into the black hole of the financial industry.

The new mantra has to be Accountability, in every aspect.

Jan 10 11:12 PM

[Freedoms Truth:]

My solution to this would be to compare real estate as an investment to other investments commonly found in the marketplace. "

Correct. And a Cap Rate or rate of return in the 8-12% range is indeed signalling a 'good buy'. And/or look at monthly rents versus cost of homeownership, which also puts a floor in the housing asset values. The article talks of this and states: "Adjusting for price declines since, and assuming the same rental cost now as then, that leaves about 18% further price decline by this metric." - but this was based on a referenced article using Q2 2008 data, and like all the metrics is highly localized and is changing quickly. Felix Solomon has an article on rents vs mortgages, and the line has been crossed now, at least in some markets. YMMV.

Great article.

Jan 11 12:37 AM

[Freedoms Truth:]

"we sociology, english, anthropology, history, etc graduate students are encouraged to spend many productive years and take on $100k+ debt and contribute very little to our economy. (sorry to those majors, "

Dont apologize. The left-wing liberal arts academic elites need to apologize, for 'the closing of the American mind' that they have created, and the creation of a class of brain-dead economically retarded, culturally debased, and intellectually dead sock puppets brainwashed into political correctness, multiculturalism and cultural marxism/post-modernist nihilism. We spend billions on higher degrees in liberals arts and it is 99% nonsense, destroying values on multiple levels. For most universities, the left have turned them into prisons of indoctrination of garbage. Keep the science math and engineering, and put a torch to the sociology and liberal arts and especially the ethnic studies ghettos - they are actively harming America.

Jan 11 12:43 AM

[Paul Maulden:]

Prof. Lounsbury, Thank you for writing so clearly that a novice student of
economics such as I can understand. I have a question: How does one
account for / quantize the folks who are displaced by foreclosure ? Do
they not become "new buyers" for much lower priced homes, or renters
of such homes ? Except for those who can consolidate households, how
does the foreclosure situation push the market into such drastic oversupply
of walls and roofs ? (I understand the excess of second homes.etc)
Can this be viewed as a mass "downsizing" that is leaving gaps at
irregular places in the market? Thanks...

Jan 11 01:09 AM

[billp37:]

Neat, yet scary, article.

New residential construction has been a VERY IMPORTANT component in Albuquerque, New Mexico's economy.

Water and energy limitations are an increasing concern for the continuation of the construction industry in the Albuquerque area.

www.prosefights.org/ab...

Let's see what happens to the construction industry within the next several years as possibility of water and energy shortage loom.

Jan 11 09:23 AM

[Hamburger:]

I had a neighbor who bragged about owning four houses in town bought
with no down payments who bragged he was going to be reselling them
within the next 2-3 years for huge profits. He is no longer my neighbor and has lost all of them including his own. So it's not just one-family homes, its
four-homes families. Extrapolate that!

Jan 11 10:50 AM

[prudentinve...:]

I did some research and found the article in "The Economist" I had referred to. Published on March 29, 2003:

www.economist.com/surv...



On Jan 10 09:40 AM prudentinvestor wrote:

> John Lounsbury,
>
> Thanks for this excellent summary. Although I've seen bits and pieces
> of this information here and there, you did a great job of putting
> it all in one coherent piece.
>
> One of the sad facts is that all this was predictable, and in fact
> predicted, not just by people considered fringe by mainstream commentators,
> but also by mainstream economists, and in manstream publications.
>
>
> For example, "The Economist", which most would consider mainstream
> and credible, had its main editorial piece predicting this situation,
> almost precisely. If memory serves me, it was sometime in the 2003-2004
> time frame when Greenspan had his first stab at near-ZIRP. I wish
> I had saved this issue. Prescient as this editorial was, it was so
> obvious to any objective thinker or reader that a big problem was
> brewing, and that then was the time to mitigate it.
>
> It is astonishing to see our policymakers and pundits, many of whom
> were in power or pontificating as this crisis was clearly brewing,
> now trying to pretend that this crisis is some "act of God" like
> a tsunami or earthquake, or as unpredictable or unlikely as a "black
> swan". The reality is that it was both predictable and predicted
> as these folks cheered it on.

Jan 11 11:01 AM

[StealthInve...:]

Excellent Article in every way.

Most of the future option arm resets will be modified to keep the existing payment or they will be put into another modification alternative to minimize the effect of arm reset. Mortgage servicers and investors realized that too keep the loan owners making their payments they need to do debt forgiveness/rate freeze modifications.

Jan 11 12:06 PM

[Crocodilian:]

Very nice review of the literature, with good sourcing-- I always appreciate sources!

The only way to bail out housing is to skew the population of the country younger, which is not so easy to do; you've nicely analyzed the demographic data here. The one possibility that I've seen raised to greatly increase immigration. More people=more demand for housing, and immigrants tend to be younger, with larger families. . . they want precisely the kinds of homes that are now in oversupply.

Also: the guys who've been beating the drum for a decade or longer on the impact of demographic change on housing are Comstock Partners-- but they illustrate the danger of being "right" too early.

Jan 11 03:59 PM

[John Lounsbury:]

Paul Mauldin - - -

I have not seen any attempt to measure or estimate just where the foreclosed former home owners go. In most cases, I expect, they do not have enough capital for down payment on a home, plus they have a serious blemish on their credit history. So I don't think many are going to be home buyers in the next few years. I don't see support for home prices from this source for several years.

Some of these (maybe a majority) will become renters. With higher rental demand, rents may increase. This would provide some support to home prices using a price to rent comparison.

Finally, some may become "homeless". I don't mean street people, but doubling up with relatives for an extended period of time until they can get back on their feet. I don't think there will be support from this cohort before we reach a bottom in house prices.

Jan 11 05:22 PM

[John Lounsbury:]

Paul - - -

One more related factor: Some of the foreclosures are of multiple properties owned by one person. The comment by Hamburger mentions one such situation. For those owners, even if they did find the means to buy another residence, it would be one residence replacing several.

Jan 11 06:33 PM

[Financial A...:]

Great article, excellent comments (from the author too!), and a prescription for some soul searching in America.

I especially liked PrudentInvestor's article - seems the Economist saw this coming 5 years ago...thanks again.

Jan 11 07:42 PM

[Jeffrey A. ...:]

Yes, this would work, except for the furniture makers, applicance builders, decorators, etc. My wife had the same inspiration this weekend while walking the neighborhood but without your numbers. For analytical support just consider what happens on the good old family farm where the agriculture department pays farmers NOT to grow crops. Why not do the same for builders et.al.?


On Jan 10 08:46 PM floridauser wrote:

> This is a comment from Oct.1, 2008. Seemed easy enough to implement:
>
>
> There's Still a Better Bailout Available Since all the trouble rests
> with tumbling home prices, resulting in massive CDO losses, why not
> act at the source? Stop issuing new residential building permits
> until unsold housing inventory is absorbed. Since new house sales
> are only a small fraction of all sales, this would take some time.
> Certainly, such a plan would be an unamerican, anti-capitalist program,
> just like the one being proposed by Paulson to rescue nearly bankrupt
> financial institutions. However, it would likely be much cheaper
> to temporarily compensate the new home builders and their suppliers
> for lost income than to rescue these behemoth banks. About 500,000
> new homes are sold yearly at an average price of just over $200,000
> resulting in an approx $100 billion/year subsidy. This should have
> the desired effect of stabilizing the housing price freefall and
> the value of CDO's. A gradual return to normal permitting could be
> allowed in several years. The US is simply overbuilt and this can
> be remedied in time by a growing population if no more inventory
> is added.
> Oct 01 23:22 pm |Rating: 0 0 |Link to Comment |View article
> Your Comments Stream Stats
>
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Jan 11 10:05 PM

[E.T. Explorer:]

I f Leonardo was living today he would paint a picture of the most hedious gargoyle he could imagine. Mr Lounsbury, using words rather than paint and a brush has done just as much as Leonardo could have done in painting the Mona Lisa. Personally, I think that most of the above responses and the authored article of S.A., is like a heard of mice fleeing a sinking ship without realizing that they are going to drawn anyway.

Is the "finanacial collapse, the housing bubble,the energy crisis or the national debt", the end of the beloved "Ame rica", or just fatigue dozing at the wheel? No one on this planet loves to be poor! and not everyone loves to be "rich", but I would not be wrong to say that everyone certainly enjoys and would not feel safe, secure and comfortable if they had a choice between having and not having their own living quarters or living out on a park bench. Having made this point I like to return to my opening remarks at the begining of this paragraph. The national debt is a drop in the bucket if it is used by government to put money into circulation. Energy, is the Genie of the lamp that grants us every wish and desire we can realize . The Housing Bubble and the construction industry? What BUBBLE, How can any intelligent creature built more houses than they have people to live in them? Moronic isn't it? The construction permit issuing office must work from population data that would determine the life expectancy of a structure and the living population at any one day of that turnover housing life expectancy vs. the population life expectancy. when people move from one area to another certainly construction moves where people move to, and by the same token destruction of the existing homes if not demolished would become unhabitable within a twenty to 50 year period. there is another issue to consider here, that is that many homes are apt to be renovated , made additions to or demolished and rebuilt. which all of this activity impacts on jobs and the construction industry. The question is if a family of four can pleasantly live in a 1200 Sq. ft. bungalow or a 5000 sq. ft ranch house. The answer is simply How much it cost to heat-refrigirate and maintain those two choices. The answer of course is obvious.

"Financial collapse?" Really! while some form of monatery exchange has always been used by all advanced societies thoughout human historical time, The only thing that changes is what is the most difficult means available to prevent counterfeit. This phenomena can be traced throught history, I'm amazed that no social historian has had the time to comment on this "financial' issue. Some means of money was necessary for an illiterate society, with the pruduction of paper and paper money, literacy became the biggest challenge to mankind. Now that we have evolved to literate creatures, We do not need this insecure, timewasting form of rationing our appetite for consumption. We are entering the era of virtual money. With computers shrunken into the size of a flip phone who wants to carry an overstuffed wallet full of paper bills, plastic cards or pockets full of coins? NOooo- boDY.

This financial REVOLUTION is at the same level as the early days of the telephone era. within five years, just like the cellular spread out of the portable telephone the new virtual "cash" will be downloaded in everyones virtual account. All cash registers will be replaced with electronic terminals that through your cellular telephone you can receive payment for any transaction you may be involved in. From a pack of cigarette to the purchase of a bottle of water, a movie ticket or a bus ride. Who can counterfeit such a system? Nooo- Body. Why, because 1- You need a deposit or a loan to your account in order to make a transaction and 2- you need an account to deposit the value of the transacted goods or services and the different levels of governments will get their TAX revenue on the spot whether you drink to it or use toilet paper.
After all if you stop and think "what is a bank", It is just a bookeeping office, A "SCROOGE or a SANTA CLAUS". Interest on savings was necessary to get people to accept the currency in use and accountability to the bank. How one qualifies for credit and limit his credit is the mathematical calculation that a bank works out on your past earning / spending history and your likely service life span, add insurance for any unexpected life event, and everyone qualifies for credit, everyone gets an allowance, and if you work you get a pay check as a bonus, if you invest say buy a house and manage to get a profit from rental income you get a return on your investment. Credit balances don't earn interest but debit pays an account management fee. Who will manage this new concept Banking system? Your friendly IRA or Revenue Office in some obscure depth of every corner of the globe, linked by fiber optical cable and internet. WELCOME TO THE TWENTY FIRST CENTURY and THE SECOND COMING OF JESUS CHRIST. I hope the POPE has a backup plan for his Holiness!

Jan 11 10:10 PM

[Jeffrey A. ...:]

Excellent article, thanks for all the hard work. I got foggy brain syndrome (possible side effect from age) from all the data and information that will take some time to clear but I will reread the article and then, ... try to figure out what to do. For the vast majority of comments, thanks also. Great stuff.

Jan 11 10:15 PM

[E.T. Explorer:]

I f Leonardo was living today he would paint a picture of the most hedious gargoyle he could imagine. Mr Lounsbury, using words rather than paint and a brush has done just as much as Leonardo could have done in painting the Mona Lisa. Personally, I think that most of the above responses and the authored article of S.A., is like a heard of mice fleeing a sinking ship without realizing that they are going to drawn anyway.

Is the "finanacial collapse, the housing bubble,the energy crisis or the national debt", the end of the beloved "Ame rica", or just fatigue dozing at the wheel? No one on this planet loves to be poor! and not everyone loves to be "rich", but I would not be wrong to say that everyone certainly enjoys and would not feel safe, secure and comfortable if they had a choice between having and not having their own living quarters or living out on a park bench. Having made this point I like to return to my opening remarks at the begining of this paragraph. The national debt is a drop in the bucket if it is used by government to put money into circulation. Energy, is the Genie of the lamp that grants us every wish and desire we can realize . The Housing Bubble and the construction industry? What BUBBLE, How can any intelligent creature built more houses than they have people to live in them? Moronic isn't it? The construction permit issuing office must work from population data that would determine the life expectancy of a structure and the living population at any one day of that turnover housing life expectancy vs. the population life expectancy. when people move from one area to another certainly construction moves where people move to, and by the same token destruction of the existing homes if not demolished would become unhabitable within a twenty to 50 year period. there is another issue to consider here, that is that many homes are apt to be renovated , made additions to or demolished and rebuilt. which all of this activity impacts on jobs and the construction industry. The question is if a family of four can pleasantly live in a 1200 Sq. ft. bungalow or a 5000 sq. ft ranch house. The answer is simply How much it cost to heat-refrigirate and maintain those two choices. The answer of course is obvious.

"Financial collapse?" Really! while some form of monatery exchange has always been used by all advanced societies thoughout human historical time, The only thing that changes is what is the most difficult means available to prevent counterfeit. This phenomena can be traced throught history, I'm amazed that no social historian has had the time to comment on this "financial' issue. Some means of money was necessary for an illiterate society, with the pruduction of paper and paper money, literacy became the biggest challenge to mankind. Now that we have evolved to literate creatures, We do not need this insecure, timewasting form of rationing our appetite for consumption. We are entering the era of virtual money. With computers shrunken into the size of a flip phone who wants to carry an overstuffed wallet full of paper bills, plastic cards or pockets full of coins? NOooo- boDY.

This financial REVOLUTION is at the same level as the early days of the telephone era. within five years, just like the cellular spread out of the portable telephone the new virtual "cash" will be downloaded in everyones virtual account. All cash registers will be replaced with electronic terminals that through your cellular telephone you can receive payment for any transaction you may be involved in. From a pack of cigarette to the purchase of a bottle of water, a movie ticket or a bus ride. Who can counterfeit such a system? Nooo- Body. Why, because 1- You need a deposit or a loan to your account in order to make a transaction and 2- you need an account to deposit the value of the transacted goods or services and the different levels of governments will get their TAX revenue on the spot whether you drink to it or use toilet paper.
After all if you stop and think "what is a bank", It is just a bookeeping office, A "SCROOGE or a SANTA CLAUS". Interest on savings was necessary to get people to accept the currency in use and accountability to the bank. How one qualifies for credit and limit his credit is the mathematical calculation that a bank works out on your past earning / spending history and your likely service life span, add insurance for any unexpected life event, and everyone qualifies for credit, everyone gets an allowance, and if you work you get a pay check as a bonus, if you invest say buy a house and manage to get a profit from rental income you get a return on your investment. Credit balances don't earn interest but debit pays an account management fee. Who will manage this new concept Banking system? Your friendly IRA or Revenue Office in some obscure depth of every corner of the globe, linked by fiber optical cable and internet. WELCOME TO THE TWENTY FIRST CENTURY and THE SECOND COMING OF JESUS CHRIST. I hope the POPE has a backup plan for his Holiness!

Jan 11 10:24 PM

[Randy_H:]

Many of us saw all this coming, including using about half of those same graphs, 4-5-6 years ago. The record is in the blogs, my own included. If I had 1% of the median single family home price where I live for every time I was called a "bubblehead", "doomer", "tin-foil-hat" prior to late 2008, I'd own half of Southern Marin county by now.

Jan 11 11:11 PM

[tagthatstock:]

i dont see a 'bottom area' in housing until about Halloween 2010 according to the reset models. (even then the bottom may not bounce but instead just flatline) we still have not absorbed the no-doc loans, the reverse mortgage problems of the future and our population has 'peaked if not rolling over'.

cramer is pushing housing so that should be a tip off we are near another bounce peak,,,,,,,,,imho,,,,,... are better off investing nursing homes to bank on the growing elderly population. that category is about to momo considerably annually.

back to the 'population',,,,,,only 4% of the people IN america call themselves 'American' the rest are semi-americans,,,,ie: they are african, mexican, german, norwegian or whatever,,,,they have not yet committed to be Americans,,,,,,,i really dont know how many generations have to pop out before a real American comes from them.......but somehow hanging onto a 2nd or 3rd world status country as their primary identity is not a positive thing for the true Americans who have already committed to America.

America is a mixed pot of many cultures,,,,,,,,,each deciding that this country was the greatest place on earth even its worst of times. that takes commitment.

Jan 12 06:30 AM

[Randy_H:]

Q3-Q4 of this year will mark the "bottoming", not the "bottom", per se. The rate of declines will probably slow dramatically towards the end of the year. But prices will continue to slowly decline until at least 2012, perhaps as long as 2015.

And that is simply modeling the last 3 cycles without considering scale. As one of the author's graphs shows, the scale this time is so disproportionate that it's hard to rely upon old cyclical notions entirely.

I know that my area has seen maybe 20%-30% nominal price reductions from the peak 2005/2006 wishing-prices. But those highs represented upwards of 300% deviation from the very-long run trend. So a mere 30% reduction, as it were, "ain't nuthin".

Jan 12 11:22 AM

[Matthew Miller:]

John: I wrote a comment that became a post -- view it at: seekingalpha.com/artic...

Jan 13 02:14 PM

[Kittyfool:]

Some of this is too deep for my little brain, but I do appreciate the effort that you have put into this.
And another thing that I appreciate is the response that you made to WAKEUP. It's nice to see someone thinking of ways out of the hole, instead of panicking and asking for a bailout. This is in line with my thoughts, especially No. 3. I do hope that you have written these thoughts to Pres. Obama and your Representatives/Legisl... I believe that they need a clue and I've tried to say these things, but I'm limited by my ability to utilize the English.
To change the thread a bit - Could we convince the "boomers" to invest into real estate?
The people who were thinking of retirement are hurting, with the retirement accounts losing money. And I'm thinking that the unemployment situation is worse for them as well. Now we are making noises of taking away Social Security. So, I'm thinking that it would be a good idea, for some people (40+ group) at least, to invest in rental properties. This would stabilize the housing market a little bit. And I just saw some graphs with the housing prices - it looked to me that most of the markets (with the exception of California and Arizona) are flattening out.
I don't know how to convince people that this is a good idea, in the fear climate in the nation, but it's just a thought. What do think?

Jan 23 03:22 AM

[Epiphany:]

Survival 101: Track every dime spent, limit discretionary spending for the next few years to absolute essentials, use every penny to pay down debt, and ideally build a 2-3 year reserve to cushion protracted income loss as an absolute minimum.

In 2007 as economic storm clouds filled the horizon, and my 401K plan was falling by hundreds of dollars every month, I shifted my entire $50K 401K balance into the Wells Fargo guaranteed fund. Even at less than 2% return, I was making several thousand dollars a year. While my co-workers lost over 50% of their 401k balances, my $50K balance increased between 2007 and today.

After my company failed in December 2008 and I was laid-off, I learned a terrible truth. The $25K+ saved by switching to the guaranteed fund will extend my safety net for months. Others who were laid-off, wiped out by having been fully invested in the market when it crashed because that was the smart thing to do, will face serious economic hardship and possible foreclosure.

The moral of the sordid economic crash story: Don't get greedy! Resist buying into the "spend to save the economy" propaganda! If retail establishments require consumers to max out credit cards to keep them afloat, then to hell with them! Treat the coming years as a last chance to "get it right" even if your lack of spending throws retailers in front of the bus!

For every dime you spend from this moment forward, project yourself mentally into the future. Ask yourself, "will I look back and regret that expenditure?" Focus on a financial life of no regrets from this moment forward. Embrace the ideal goal of retiring wealthy. Know that if you fail or fall short of that goal, you will have the satisfaction you literally did everything humanly possible to get there. This may not ease the pain or suffering of financial failure, but at least it is certainly less emotionally painful than looking back and feeling foolish, filled with regrets, for doing something (or not doing something) that left you impoverished now, which was once considered "decades later" from a past perspective.

I find it interesting that if a person earns, let's say, $50,000 per year, they will earn $1,000,000 over 20 years. That person obviously does not consider themselves a "millionaire" because their yearly salary will equal a million dollars in two decades. Their friends don't get out a calculator, figure out that person is going to have earned a million dollars in 20 years, and expect handouts as if that person won the state lottery.

Now consider winning or inheriting $1,000,000. All of a sudden, everyone comes out of the woodwork. If someone earns $150,000 or more a year, earning $3,000,000 or more over 20 years, that's somehow "different". Win a million or more all at once, clobbered by taxes, and everyone suddenly becomes your friend. Even if someone gets payments for winnings or an inheritance over the next 20 years, people still think they're somehow "rich". Money officially "earned" by "working" (which is defined by jumping through hoops at a job to earn a salary, and making a profit for the employer) or made selling investments totalling a million or more, is somehow psychologically "different" than getting the same amount won or inherited. Why? Money is green. If it is legally given to you, its value is the same aside from all the psychological baggage carried from childhood.

How many people have the financial maturity to amortize a sudden windfall, like an inheritance, lottery winning, or getting out of a lucky investment, as income over a period of 20, 30 or more years of retirement? Why doesn't employment, earned through exhaustive effort, cause people to treat every earned dollar with respect? Why do people live beyond their means now, either because the money came effortlessly, or with great toil, only feeling deep remorse after it is too late? Why do the majority of people become economic prisoners during their retirement years, in exchange for extravagant spending during their youth? Like in the Old Testament when Esau sold his birthright for a bowl of lentil stew, people sell their future for a cruise or even the latest wide-screen TV.

Regardless of the excuses so many will give, one thing is certain. Developing the level of economic maturity that considers every dollar that comes into one's possession now as future retirement income, regardless of whether it is "earned" or windfall profit, separates the men from the boys! This seemingly unimportant emphasis on quality of life in the future determines who lives a dignified retirement (maybe even very nice one), and who suffers in abject poverty in a retirement "hell hole" until they die in despair.

Nobody in these times, living for the moment, wants to think about this fact now. Someone said to me recently, "Stop being so negative! I'll enjoy life now, and figure out what to do about my retirement income when the time comes! Life's way too short to worry about this thing you call retirement! Enjoy life now! Besides, while you save, I'll spend. [Laughter] If I'm broke, you'll take care of me. [Laughter]" Do you think so, dear friend? Are you in for a surprise! Today is "thirty years later" and nobody suffering economic hardship today, is comforted because they remember taking an expensive cruise in 1979. In the future, it will become today, and 2009 will become "thirty years ago".

My friend who believes in spending now, saving later, may arrogantly approach those who saved for a handout in the future. After they are told, "no" that individual may sit in an armchair in front of a television, watching reruns of Oprah or whatever, for 20-30 years forward. While those who save travel, their life is punctuated by nodding off to sleep and waking up to realize there is no food in the kitchen. It might be 110 degrees in the studio apartment because they cannot afford to pay the utility bill for air-conditioning. They will likely commit themselves to a state nursing home after their social security check is not enough to live on, after their friends who saved deny them free room and board. Imagine your friend saying basically, "You scrimp and save while I live lavishly, because you'll end up supporting my retirement"? The present economic crisis is really a psychological crisis of a generation of people telling themselves others will care for them in the future in order to justify their living lavishly.

Jan 23 06:07 AM

[billddrummer:]

John,

I appreciate your comments, and am impressed as well by the other viewpoints shown on this thread. You've opened a dialogue with impressive statistical evidence, which bears repeating and action at the highest levels of government and business management.

Thank you again.


On Jan 08 02:35 PM John Lounsbury wrote:

> billddrummer - - -
>
> Thanks for you astute comment. Your calculation shows how the optional
> payment arms can lead to an early reset trigger. This will happen
> to those who have a high probability of not being able to afford
> full mortgage payments (they were paying even less than the interest
> payments) so they have a high probability of default.
>
> I mentioned the increasing principal problem of these mortgages,
> but your example gives much clarity to something I just mentioned
> in passing. Thanks.

Jan 26 07:30 PM

[Lsente:]

Thank you very much for this detailed submission. An exceptional read.

Cheers and good trading to all of us!

Feb 08 02:00 AM

[wcanyon:]

Looks like NYT is catching on to this: www.nytimes.com/2009/0...

Aug 26 06:42 PM