The mortgage crisis …that caused the fall in home prices ...that exacerbated the credit crisis …that resulted in a crisis of confidence …that led the over-reaching national government to create an over-arching plan to throw trillions at the guilty and punish the innocent…
There is no question that ill-trained and ethically-challenged mortgage brokers, NINJA (No Income, No Job or Assets) liar loans, bankers who couldn’t decide if they were more stupid or more greedy and finally settled on both, and an avaricious Wall Street that packaged trash and called it trash internally, but marketed it as gilt, all played their role. As we said when I lived in Hawaii, “Yeah, yeah, yeah to all that.” They are all a piece of the whole but the big reason is the one that makes the most sense to those of us with a modicum of common sense -- and it involves the fewest variables, as well. In short, the biggest problem is simply buyers with no skin in the game.
It seems that all the above thieves, idiots, and boneheads working together still didn’t cause problems as long as the buyers made the standard 20% down payment. Putting $50,000 of one’s own simoleons into a $250,000 house gives a little pause before walking away from it.
The latest evidence that too many people with too little equity caused the bulk of the heartache comes from a study by Stan Liebowitz, professor of economics at the University of Texas, Dallas, in an article he wrote for the July 3rd Wall Street Journal. As he wrote there:
The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house -- that is, the balance of the mortgage is greater than the value of the house.
It seems that a lot of people moved into their houses with no skin in the game – or they took out home equity loans in abundance every time they had a merely paper rise in value. Professor Liebowitz notes that 51% of all foreclosed homes had prime loans, not subprime. He analyzed data from McDash Analytics, the biggest loan-level data source available, covering more than 30 million mortgages. Summarized, here’s what it looks like (click to enlarge):
Further research led Professor Liebowitz to conclude that the 12% of homes with negative equity comprised 47% of all foreclosures. That should be no great shock to even the most casual observer. In my earlier example, if you have $50,000 invested in the place in which you live, it doesn’t make sense to up and leave unless you’ve lost your job and can’t make the payments. Since you’re going to prefer living inside to living on the streets, it’s likely you’ll do the analysis and realize that renting isn’t exactly free, that real estate prices will come back at some point, and that every mortgage payment you make builds equity.
But if you started with 0% down and took out a home equity loan as prices for comparable homes rose, you are well-inclined to walk away rather than try to dig out of a very deep hole. Even if they were in identical homes, the former buyer lives on a hilltop, the latter in a swamp.
The good professor’s analysis only reinforces my belief that the government is throwing your money and mine at the wrong targets. Rather than insist that a quid pro quo for TARP funds be that banks insist upon more equity, they are instead jawboning interest rates down, creating an artificial and short-term “fix” that only delays the pain. Worse, the current Administration’s "Making Homes Affordable" plan actually pushes people into buying more home on less income!
It also tells me that people don’t necessarily walk away from their loan because they’ve lost their job or can’t make their payments – they walk because it costs them nothing and they can put their funds to better use elsewhere. Putting more people in homes they can’t afford, or keeping them there by forcing the banks to renegotiate their payments won’t keep a single “homeowner” from walking. They aren’t really homeowners – they’re renters and if they can find a cheaper rent for the same home, they’ll walk and foreclosures will continue to rise.
What’s an intelligent investor to do? I think that the American people are smarter than the yahoos in Washington who are trying to impose I’m-from-the-government-and-I-know-what’s-best-for-you top-down solutions. I think those among us frugal enough to have put substantial equity into our homes and who still have jobs (about 90% of us, maybe as low as 80% if you take with a grain of salt the governments’ hypotheses, suppositions, and heuristic analysis) will continue to make our mortgage payments.
By building equity we will be observing a quaint old custom they used to call “saving.” Those without a home will be “saving” in case they lose their job or, more hopefully, so they can get the down payment to buy a home with actual equity of their own. And we’ll all be “saving” more by traveling less frequently, eating out less frequently, trading in our cars less frequently, and so on.
If I’m correct, and we will all be “saving” more, there are sectors and stocks that will benefit and those that will suffer. For instance, rental apartment REITs like AIMCO (NYSE:AIV), Mid-America Apartment (MAA), Avalon Bay Communities, (NYSE:AVB), Essex Property Trust, Inc. (ESS) and Equity Residential (EQR) may well benefit.
Without having delved into specific securities, I recently wrote an article for SA giving a sector “overview” of those industries I thought we’d be wise to avoid as Americans pull in their horns and begin saving again. You can find it here if you like.
Full Disclosure: We are not long any of these securities – yet. But we’re salivating at the prospect of buying them even cheaper.
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Past performance is no guarantee of future results, and it should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong. Finally, we will always disclose whether we own or are buying the investments we write about.