The Impending Mortgage Crisis 69 comments
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If you read the papers and watch the news, you may believe that we are in and have been in a subprime mortgage crisis for the last year or so. That is true. Many pundits are also saying that the subprime crisis is nearing its end. That is also true, to a point. Subprime mortgage troubles will not inflict that much more damage on the broader economy. However, prime and Alt-A mortgages with toxic features will cause troubles that will make the current troubles look like a walk in the park. Furthermore, broad-based declines in housing prices will start to wreak havoc on housing markets across the country.
The Cataclysmic Shift
The problem with the housing market bulls is that they are thinking within the framework of past housing downturns. The current downturn is unlike any other since the Great Depression, and no other downturn has started with houses so overpriced relative to rents. Few downturns started with such reasonable interest rates, and no other downturn saw double-digit house price declines across the country. This downturn is different, and it is going to lead homeowners (or homedebtors, as the Irvine Housing Blog calls those who have little equity) to change their behavior in ways that only the pessimists, such as myself, anticipate.
The problem with most predictions is that they are linear extrapolations of the past into the future. Have global temperatures been rising? They will continue to rise at the same rate. Has crime been increasing? It will continue to increase at a similar rate. The problem is that significant change often comes suddenly. That is why no one who knows anything is worried about the gradual increases in the Earth’s temperature that will occur if global warming continues. What really scares people is the possibility (however remote) that the changes could accelerate, or could cause something unexpected to happen (such as the jet stream moving or the ocean currents changing). A thorough review of the history of global temperatures reveals that such cataclysmic change is not unusual.
In the case of housing, the cataclysm will come within the next couple years. It will be fueled by two factors: option ARM mortgage recasts and house price declines. (Slate has a worthwhile take on what will happen, but its analysis is less detailed than mine.)
Why House Prices will Continue to Decline
House prices are elevated relative to rents and relative to incomes, especially in the hottest markets, such as California, Nevada, Florida, and Arizona. However, price increases in middle America have been no less astonishing. One example with which I am all too familiar is the house I just sold in the Saint Louis suburb of Maplewood. Zillow has a decent graph of the house’s value, although it is not completely correct. If you look at the county assessor’s website (and search by the address) you can see that the house sold for $100k back in 1997 and then for $188k in 2004. I just sold it for $165k. Over this period of time few renovations of note were done on the property, the neighborhood did not improve significantly, and the employment situation in the area did not change. So, from 1997 to 2004 the house appreciated by 88%, while between 1990 and 1997, during great economic times, the house appreciated by only 25%. In relation to both rents and area incomes, the house is still probably 20% overvalued.
Moving from the anecdotal to the statistical, we can see that this is not an isolated situation. The chart above shows housing starts and permits for the last 30 years. Over this period the population has increased at a fairly steady rate. Since 1993, too many houses have been built, and this will inevitably lead to falling prices.
If you look at the ratio of income to house prices in the above graph (from Piggington’s Econo-Almanac), you will see that house prices are significantly higher than they should be relative to incomes (while this graph is for one area of California, prices are elevated relative to incomes across most of the country). While creative financing can lead to a bubble in prices, there is no way for house prices to remain unaffordable indefinitely.
Another thing to consider is that, over the long term, house prices remain tethered to rental prices. If renting is cheaper than buying, people will choose to rent rather than buy and house prices will fall. House prices have never been so much higher than rental prices than they are now. Above is a chart of the ratio of the OFHEO house price index to the CPI-Owner’s equivalent rent.
Another factor weighing on prices is the increase in foreclosures. Banks that own foreclosed houses are motivated sellers, and they will cut the prices so that they can sell their inventory. Increasing foreclosures will increase supply and decrease prices of transactions. Why pay $200k for a house when your neighbor got his out of foreclosure for $140k? Foreclosures are actually understated because banks often don’t have the manpower necessary to foreclose and sell delinquent properties.
The foreclosure problem will soon get much worse. Considering that it often takes over half a year (and can take much longer) between when a homedebtor falls behind on a mortgage and when the house is repossessed, the current wave of foreclosures began before house prices had fallen significantly. With prices now down 20% in many areas and 30% or more in some areas, the rate of foreclosures will increase drastically over the next year. Those that need to sell and who have little equity will be unable to sell for more than they owe. Short sales are difficult, so foreclosure will be the last resort for many who need to move.
Even though asking prices for houses have fallen dramatically already, they have not fallen nearly enough: witness the low volume of house sales relative to prior years. In the graph below we can see that the spring selling season in San Diego has been a bust, as it has been elsewhere in the country (image from the Bubble Markets Inventory Tracker blog).
Option ARM Recasts
In addition to falling house prices, another factor in the coming mortgage crisis is the coming recasts of millions of option ARM mortgages. Most of you will be familiar with the problem of interest rate resets on ARMs (adjustable rate mortgages). This problem is well-known. Almost all ARMs have fixed rates for the first couple years and then the rates reset to market rates. Considering the current low interest rate environment, this problem is likely overblown.
The greater problem, however, is recasts. Option ARMs allow for the choice of the size of the payment. Homedebtors can choose to pay an amortizing payment (such that their mortgage balance is reduced), an interest-only payment, or a negative-amortizing payment, where their mortgage balance increases. Recent data from Countrywide (CFC) indicates that 71% of borrowers with option ARMs are only making the minimum, negative-amortizing payment. Option ARMs have provisions such that when the mortgage balance exceeds the original mortgage by 10% to 15%, the loan converts into a fully self-amortizing loan. Considering that many of these loans were made over the last few years (beginning in 2005), we should start to see a number of recasts. When a mortgage recasts, the payment size can easily double or triple. Those who could afford their payments before will no longer be able to do so.
Option ARMs are highly prevalent, especially in the most bubbly markets. See the following map (courtesy of the Irvine Housing Blog):
The Coming Crisis
The coming crisis will be caused by option ARM recasts, falling prices, and banks’ increasing reluctance to lend. The crisis will manifest itself in people simply walking away from houses where their mortgage is worth more than the house. Considering how many people have used home equity loans to remove equity, how many have had negative amortization in their loans, and considering how small down payments became over the last few years, very few homeowners will be left with equity in their houses. Economy.com currently estimates that nine million households have negative equity. That figure could easily double or triple as house prices fall by another 20% to 30%.
The assumption on the part of mortgage lenders, regulators, and housing market optimists is that as long as people can afford to pay their mortgages, they will. But homedebtors faced with 20% to 30% negative equity will be much better off going through foreclosure than they will paying off their debts. Helping them is the fact that in a number of states, purchase money mortgages are non-recourse debt, meaning that banks cannot sue to recover the money they lose. The sheer number of foreclosures will mean that banks will not have the manpower to go after domedebtors even when they want to do so.
The rising tide of foreclosures caused by people walking away from houses in which they have negative equity will act as part of a positive-feedback loop to increase the rate of price declines. The housing market is not getting better anytime soon and it will soon get much, much worse.
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This article has 69 comments:
(1) the occupants aren't paying their mortgage (this is a short sale)
(2) the home is indeed on the market
(3) the housing prices continue to decline
Any thoughts?
It could be that banks are overrun by foreclosures and simply do not have the manpower to respond. That would be my guess. That or they're holding out for the markets to improve, which would be a terrible move.
The other option ARMS and Alt A will start to peak around the end of the ear taking the rising foreclosures well into the next year. This will get progressively worse as the home owners struggling to make the new ARM payments work while watching prices tumble finally give up.
On top of this we are about to enter the worst recession since the Great depression. This will NOT be a short recession. I estimate 7-10 years. Oil triggered the stagflation days and we are now seeing another bought of oil prices that exceed those on an inflation adjusted basis. The only think that brought us out of that time was oil prices tumbling to $ 10 per barrel. THAT is NOT going to happen again. If was just the worst housing crisis ever it would be one thing but it is also OIL prices and the Budget deficit and the trade deficit and the total consumer saturation on debt. There is NO WAY we are going to easily recover or quickly recover. One Nobel prize winning economist said that we will be looking at social unrest.
In answer to the previous posters question about banks reluctance to let properties go with larger markdowns,: it has just begun. When they cannot hold any more they will be forced to dump. In some cases when the bank goes BK, and many will, those houses will go at fire sales.
But you proved yourself a loon right from the start.
Banks have a multitude of rules and regs thay need to follow to a) foreclose, b) evict , c) sell a foreclosed property. Did you know that a bank needs at least one appraisal on each property. Then they market it through realtors. They can not sell it at a certain % below that appraised price. They then need another appraisal in order to lower the price. This takes months, in some cases a couple of years - I faced this - working with a typical "workout specialist" at a major lender she was a 26 year old single girl from east overshoe who had never had a mortgage or owned a home. She had no CLUE. So the lender needs to follow all of these regs - why you ask ? because - after it is all said and done, the lender then seeks a judgement for the deficiency and they had better have all their ducks in a row (to justify why they sold the property so low) So this is one of those things in life where you can not be proactive - the process is reactive, and it ain't going to change.
2007 6.3
2006 6.4
2005 5.9
2004 5.8
2003 5.8
2002 6.5
2001 7.0
2000 8.0
1999 7.5
1998 7.0
1997 7.6
1996 7.8
1995 7.9
1994 8.3
1993 7.3
1992 8.4
1991 9.3
1990 10.1
1989 10.3
1988 10.3
1987 10.2
1986 10.2
1985 12.4
1984 13.9
1983 13.2
1982 16
1981 16.6
1980 13.7
1979 11.2
1978 9.6
1977 8.9
1976 8.9
1975 9.1
1974 9.2
1973 8.0
1972 7.4
See those nice low points on your graph? A $100,000 at 6% has a payment of $600 a month. The same loan at 13.8 % in the 1980's? The payment at 13.8% is $1200 or so. At "just" 9% like in 1991 the payment is $800 or 25% more.
So, if you normalize your graph with respect to HOUSE PAYMENTS, not HOUSE PRICES, you will get a MUCH different graph. One that is more appropriate when calculating affordability of housing.
Baby boomers in the bubbly states likely have significant equity appreciation in their current homes and can afford to sell at reduced prices. They may sell to their children, or they may rent out the homes. Obviously more informantion needed.
jcrash,
So... what you seem to be saying is, "Ignore the price and total interest payed over the life of the loan and just focus on Howmuchamonth". And also ignore historical price:rent ratios and historical price:income ratios.
Oh, AND ignore the fact that interest rates today are *still* at multi-decade lows and can easily go *up*. If you get an ARM today, this of course will directly affect you --and not in a good way.
However, if you get a *fixed-rate* mortgage today, then you're immune to interest rate hikes, right? A: Not exactly. If the costs of borrowing money goes up, this also affects the *market/resale value* of your home, as brand-new buyers (who re-establish that market value daily with fresh comps) cannot afford to borrow as much as they could yesterday. Good luck selling if you need to, or HELOCing, or refinancing.
Would you happen to be a used-house salesman?
The "geniuses" in charge are doing the EXACT OPPOSITE.
They are driving down wages via outsourcing and insourcing.
They are pocketing the difference. They are getting richer.
Unfortunately, the Richest 1% can't spend enough of their increased incomes to help housing prices in the long run.
Actions have consequences and these "geniuses" will NEVER, EVER admit they are wrong and destroying America.
Never.
Student debt has tripled since 1991 and given that young educated Americans are the most likely demographic to be "first time buyers" it might be interesting to predict how student debt will lower the immediate pool of first time buyers who are the only demographic who can really help America grow out of the housing crisis.
Thoughts anyone?
You don't get what I am saying. Normalizing on payment takes into account BOTH price and interest rates - both of which are key when deciding affordability. If rates went to zero, affordability would be higher than if rates went to 20%.
So, if you truly want to account for affordability, which the author implies is what he is doing with his graph, then he should not be plotting price versus income.
Just taking 5 points on his graph and normalizing for interest rates,
1976 Payment on $100k is $ 800 (base point)
1981 Payment on $100k is $1400 (a "peak" in his graph)
1984 Payment on $100k is $1059 (a "low" in his graph)
1991 Payment on $100k is $ 826 (a "peak" in his graph)
1995 Payment on $100k is $ 665 (a "low" in his graph)
2005 Payment on $100k is $ 593 (a peak in his graph)
So, his first high in 1981 should be much higher (14/8 * value), or about 200%
His first low point should be higher also, or about 125%
So, these are the equivalents:
1976 100
1981 200
1984 125
1991 140
1995 80
2005 140
As you can see, the parabolic number he shows in his graph is much reduced and suddenly falls well within range of the past values.
Funny, I never called you a 'dolt'. I just implied that you might be employed in a certain profession related to selling used houses.
RE: interest rates and "affordability": Realtors and mortgage brokers *love* chirping about low interest rates almost as much as they love talking up the MID (mortgage interest deduction). The thing is, interest rates can dramatically reduce the monthly payment on a mortgage, yes. However, contrary to conventional thinking on the subject, low interest rates are really not all that great for the *borrowers* (vs. lenders). Here's why:
It’s almost always better (for the borrower) to buy cheap assets with expensive money than it is to buy expensive assets with cheap money. Down the road, high rates eventually do come down, allowing the borrower to easily refinance the loan if he chooses. But you cannot so easily renogotiate the price of the house when the reverse is true. This leaves the low-rate borrower at a distinct disadvantage when s/he needs or wishes to sell or refinance.
As I already stated...
Even if you get a conventional *fixed-rate* mortgage today, then you're still not immune to interest rate hikes. If the costs of borrowing money goes up, this also affects the *market/resale value* of your home, as brand-new buyers (who re-establish that market value daily with fresh comps) cannot afford to borrow as much as they could yesterday. Good luck selling if you need to, or HELOCing, or refinancing.
There are also other recurring costs directly linked to the sale price of the house, that are unaffected by the interest rate of the mortgage, namely property taxes, PMI, and homeowner's insurance.
I take my hat off to you, best analysis I am seen. What it also says indirectly... you can almost predict where the bottom will be... right where incomes can support the prices... which means they still have a ways to go.
The rent v. buy discussion is interesting but more complicated. Buying has a security element in long run regarding fixing your cost and long term equity building via debt reduction and tax advantages. From the hip, I could see that someone having a house payment with its tax advanges and equity building in principal reduction (I know, not over the last year or so) of $2,500.00 may be more beneficial than a rent payment of $1,500.00. Also, there are always little twists and turns to this depending on the area.
So, in conclusion, I love this article, great job!
Also, I anticipate the government doing a massive job retraining program in 2009 and much of this education can be done online, so I like Apollo Group and CEC right now as a stock buy.
For all other comments, I liked them and my numbers show a -20 GDP contraction occuring between now and 2012. Energy independence could solve much and I am frazzled at reposting specifics but let's say the President has this plan and it appears he is beginning to act on some of it.
Having lived in Massachusetts, Maine, Kentucky, Arizona, and Tennessee since 2000 real estate really is LOCAL. At one point or another I owned property in 4 of those 5 states and while KY and TN were fairly similar the rest were wildly different. The reason I bring this up is the general predictions in this article, or any nationwide analysis for that matter, are crap.
The market in St. Louis will never mirror Los Angeles other than by coincidence. I purchased my house in Memphis, TN at the 'peak' in 2006. The only previous transaction was in 2001 when the house was built, and the original owner paid only 13% less than what I paid in 2006. From 2001 to 2006 my community and all surrounding communities increased in mean sales price, my community grew significantly, had new schools built, etc. Yet there was no bubble in Memphis.
Conversely I owned a vacant lot in Flagstaff, AZ that I bought in September 2004 and sold in April 2007. I made a 59% profiit in 32 months. Again, no real change in the surrounding neighborhood. That was a true bubble market.
Finally I have a friend in SoCal whose house value is off about 50% since 2005. However his fairly nice house is still worth $90-100/sqft. If that happened in Indianapolis, Memphis, or Nashville NEW houses would be going for $40/sqft. Having built houses for a living that will never happen other than at an auction.
Looking at the 'Map of Misery' (great graphic btw!), payment option mortgages are 25%+ in ONLY California and <5% IN 30 STATES! Realisitically we know Nevada, Arizona, Florida will probably also take it on the chin, but Alt-A's and Option-ARM's are not going to swing the market in areas where they represent <3% of total mortgages.
House prices are not going to fall "another 20-30%" nationwide as this article implies. They are going to fall (and already have) much more than that in some areas and much less in others. That is why financial companies like Downey (DSL) are so interesting from a negative standpoint, because we know that their exposure is not nationwide.
So, I think this was a well researched, well written article based on an extremely flawed underlying assumption that the local real estate markets will suddenly start moving in unison nationwide.
If my suspicion is correct, it would make a large part of this article worthless though I agreed with most everything Mr Goode is saying.
It would be interesting to know if those statistics are based off of current loans still in existence or original mortgage originations. The huge difference would be that in the case of the latter, many of these people would have already, or will sell or refinance before they reset. Sure many cannot if they are upside down of course.
"The greater problem, however, is recasts. Option ARMs allow for the choice of the size of the payment. Homedebtors can choose to pay an amortizing payment (such that their mortgage balance is reduced), an interest-only payment, or a negative-amortizing payment, where their mortgage balance increases. Recent data from Countrywide (CFC) indicates that 71% of borrowers with option ARMs are only making the minimum, negative-amortizing payment. Option ARMs have provisions such that when the mortgage balance exceeds the original mortgage by 10% to 15%, the loan converts into a fully self-amortizing loan."
Some lenders are especially lenient when it comes to getting paid on their option ARMs while earning the high back-end effective rates. Also the loans do not all recast to fully amortized payments when they reach their 110%-125% threshold. Some loans allow for the payment of the interest portion on the capped threshold loan amount. (It doesn't go over this amount BTW) Sure the interest only payment is higher than the negAm payment and it could be a lot higher if the effective fully indexed rate increases, as it changes monthly. So in the end it is a problem but not as bad as fully amortized payments, though it probably would still lead to default.
DISCLOSURE: California Mortgage Broker, short with QID, SKF and SRS, long with GLD, TIP, PWZ and foreign currency.
The author points out that heyday prices were not supported by rents - which was very true. But as former "owners" turn into "renters" and the inventory burns off in some of the "destination" locales around the country, equilibrium will eventually be reached that will ultimately support housing prices. People need to live somewhere. At some point homes will present a desirable CAP rate to someone.
While I believe the reset figures provided correctly show that inventory will be fed fairly consistently over the next 1-2 years buy "option arm/alt-a" foreclosures. I also believe builders have and will cut back substantially. It makes no sense to flood an ocean.
Where is the bottom? The historical consensus has been housing should hover around 3 times household income with some variation added for level of desirability to location. So look at the local median household income for your answer. Or - what CAP rate would be attractive to a fixed income oriented investor whose only other option right now is a 3.5% CD, etc? Do the math, and there is another answer. And yes - that investor mat be from outside the country.
Ultimately - housing is the dead horse. The bubble burst and it is deflating back down to fundamentals. There is the crux...while it may have been the catalyst - the fate of housing is now back in the hands of the economy. The cart is back behind the horse - the only pertinent question is "how sick is the horse"?
If you believe Oil and Food cannot be contained...then the horse might already be dead - in which case who cares about housing costs as we will all be fighting one another to the death for a bag of rice at Wal-Mart.
Or maybe there is a solution and American ingenuity will come up with some way to lower energy/food prices and pull ourselves out of this mess. I hope for the latter - but to be honest feel like it is a coin toss. I am just sick hearing about the "mortgage crisis". Please - that was like two crises ago. Now I am off to get back in line at Costco for my next 20lb bag and some bottled water.
"No one who knows anything is worried about the gradual increases in the Earth’s temperature that will occur if global warming continues. Scientists, obviously, don't know anything. They should come to Michael Goode if they want answers about science. Michael Goode is the man. Not only is he smarter than a scientist, but he's handsomer than the handsomest man, and the ladies love him. He's humble, too. Michael Goode is so humble that he shies away from humility. Mothers, don't let your babies grow up to get Ph.Ds. Let them become super awesome bloggers like Michael Goode."
David, since you work close to some finacial aid contacts, my question is more of a reverse of what you asked. gGven for-profit education colleges like DeVry, Apollo, and Strayer, some of them may be homeowners falling into the varioius mortgage options mentioned in this article. I know DeVry and Strayer have minimal exposure to direct private lending, but I am wondering if some students who are in foreclosure trouble will be delaying their educational agendas... thus hurting some of these educational stocks.
For iThinkBig, I'd be somewhat wary of CECO due to their private lending exposure (at last check 18% of total revenues came from this stream). Many private lenders are halting private lending programs to students.
I wrote somethng up about this a few weeks ago:
seekingalpha.com/artic...
While I agree that not all markets will be hammered like CA, FL, AZ, etc. I can tell you that even in midwest markets, rents are significantly lower than mortgage payments for equivalant houses.
I'm in Chicago- an area that has stayed relatively quiet (until this week- see patrick.net) and I recently moved from SC, where, like Memphis, there was steady growth and then a slight decline. I lived on an acre in a golf course community and after 8 years sold my house in Feb (short due to corp relo) for a modest 20% gain over the ENTIRE PERIOD. However, in the desirable Chicago suburb I've moved to, I chose to rent due to the ridiculous asking price for homes. I basically bailed out a guy who just leveled and built a 2800 SF home on a .15 acre lot by covering (in rent) approximately 60% of his carrying cost for two years (locked).
In rough terms, I think that I can safely assume that his CARRYING COST which is about $300K less than what his sales asking price, still exceeds real value by 30 to 40%. Think about that. . . He's a realtor, and got caught with his pants down redeveloping at the end of the bubble. His home is worth likely half of what he was asking. If topped out "mcmansions" like this are going to plummet, imagine the impact to the mean home value. . . although it will not be as steep of a drop, it will decline. Think about the impact to the local tax base?
NOW LOOK AT THE MAP OF MISERY from the article above. Chicago is sitting pretty, right? This whole thing is a major financial catastrophe, that is national, and is only just beginning.
Here's the upshot of what I'm saying. . .
Until investors / owners can PROFITABLY rent space (be it a single family home, or a two flat, etc.) you're in a bubble. One need only play with a mortgage payment calculator to figure out how screwed up rents vs. asking prices are: Find a single family home for rent. Enter the market rent as the payment, use a market 30 yr fixed interest rate, and solve for present value. THAT is the breakeven point for the owner and the actual value of the home (don't forget to allow some room for taxes and insurance etc.) See the following article and website for a solid argument or two- patrick.net is how I've started my day for months since I started my research:
www.oftwominds.com/blo...
patrick.net
"One need only play with a mortgage payment calculator to figure out how screwed up rents vs. asking prices are: Find a single family home for rent. Enter the market rent as the payment, use a market 30 yr fixed interest rate, and solve for present value. THAT is the breakeven point for the owner and the actual value of the home (don't forget to allow some room for taxes and insurance etc.)"
Profit <> Positive Cash Flow.
If I buy something and have payments of X...then I rent it to you for X, I have no cash flow. But, at the end of the payments, I have a paid for asset and you have a rent payment of X.
Rent does not need to equal payments. At the limit of interest rates going to infinity, rent does need to closely equal payments. At the limit of interest rates going to zero, this need is at its minimum.
Why would I buy when I can monthly sock away what I am saving in a market where it is obvious that price appreciation is no reason to own a home.
You are spot on!
and the market continues to go up 12,902.77 +139.55 (+1.09%) look out below....
Simply put, a 6% interest rate will pay 50% more interest than a 4% interest rate- and will effectively increase the house payment by 50%. So the interest rate is the main determinant. When you factor that in by simply using the 1976 interest rate and OFEO affordability index as your starting point, and moving through all the years (I plotted it in an excel spreadsheet but I can't display the graph) what you find is this:
House affordability (the lower the number the better)
1976= 100
1980= 77
1984= 70
1988= 92
1992= 132
1996= 118
2000= 115
2005= 217
2008= 282
So even adjusted for interest rates, house affordability is at an all time low.
Both of you live in fairly expensive cities that have had a run up in housing prices. My point remains in that the market in Chicago will not significantly affect Peoria, IL or the Quad cities region on the Iowa border. Of course not many Chicagoans are willing to make that trade down. As far as Seattle, it seems most of the Pacific northwest has seen a large run up in pricing, and I don't know where that "wave" ran out of gas, maybe Idaho.
When I lived in Arizona the people driving the market were predominately from California. They were usually cashing out for $500k+ in the Los Angeles basin to buy a "cheap" house for $400k in Flagstaff or one for $300k in Phoenix. By that time Vegas had already run up. It was literally a "wave" that started in LA and rolled eastward until it petered out around Texas, because, well, Texas is not all that desireable. If I recall correctly the last southwest community to see a major increase in pricing was Albuquerque. At the same time another wave went north from California towards Oregon and Washington, and again, the further one went away from California, the longer the bubble went before popping. Only a year ago people in Portland, OR were still clamoring about how they had escaped the housing slowdown.
So I still think real estate is local, but there is also an equilibrium factor in that when the median home price is 5x different between two major cities (say, Atlanta and Los Angeles), people will make the move. It might take 7x to get them to Memphis, or 10x to get them to rural Iowa, but you get the idea. The spread can only get so large before the wealth redistributes.
1. The question of local vs. national. Real estate is local as long as it is driven by fundamentals. The past few years it has been driven by mortgage 'innovations'. The Case/Shiller price index most recently showed declines in all 20 cities (except Charlotte) that it tracks. While some areas will hold up better than others, prices will go down in most places. I tried to give a glimpse of this by using data from California, Philidelphia, and an anecdote from St. Louis.
www.foxbusiness.com/ma...
2. Regarding the importance of interest rates -- jcrash and HARM. I agree with HARM that we need to consider that low interest rates are not a pure good: as they rise (and considering how high inflation is, they must eventually rise significantly), asset prices will decline. Generally speaking, it is better to buy a cheap asset with expensive financing (you can always refinance later) than an expensive asset with cheap money (in which case if you need to sell you will face a loss).
Ryan -- I would love to have a great short idea. There are the homebuilders, the mortgage insurers, regional banks, and the bond insurers. Take your pick. I am short them all in Motley Fool CAPS but none of them in real life.
No one wants to talk about this but college is just like every other decision out there. You need to find a place that meets all of your needs AND that you can afford. Higher education in America isn't a birth rite....and if you go into huge debt trying to get a diploma simply because the name of the school will get you recognized then you deserve all the "student loan debt" you rack up.
2. A good article in The Economist clearly showed the first re-set peak to be end of june'early july this year and an eye-ball scan said that about 50% of re-sets were under the curve at that point. The curve drops and then rises steeply to ~ the same time in 2009 when the second peak occurs. The shading of the lines was intended to suggest the last 50% might be financially more capable of the reset.
3.I wrote to a number of friends on Sept 9 that the earliest time this problem could end was June 2008 - and that assumed the world was perfect. I wrote then and believe today that we will not live our lives with little concern about this issue and its fallout before early 2010.
Super piece of work- I am inclined to think those who discount this because all markets are local are assuming these are usual times - they are not and national approximations are possibly more valid, particularly since we are not at the home price bottom, the banks will not lend even with lower rates,and recently the Senate was approving legislation that let builders capitalize costs related to holding unsold property which means they'll all start building again if they have a dime - the gentleman who implied they wouldn;t build homes they couldn'[t sell is just ignoring reality. Builder kept building and starting new homes all through the fall - for many excuses (sell the land, etc.) but it was, to me, a form of denial and blinders. again, great article.
of course, at first, they were having a little trouble communicating with some of the locals because of their accents, but you can adjust to a lot when you live in a nice, reasonably priced house with good neighbors, in a warm climate, where the economy is supported by industry, military bases and a tax payer/ family friendly political machine.
the newer part of montgomery is still building houses and a nice 3000 sq ft home can still be purchased for ~ $300K, more if you want to feel exclusive. that still strikes most people around here as a tad high though. so, my question is this: how come so many people in other states felt the need to keep buying tulips? did they smell good? did they look pretty? what?
years ago, when my wife and i finished our education in new york, we immediately searched the almanacs (there was no google or apple). we wanted a nice place to raise a family, with no earthquakes, hurricanes, floods, nuclear waste and a good economy. we ended up here in 1983 and have made a lot of friends since then. funny thing too, after about a year, we could hardly hear any differences in our accents.
This is why I am long commodities and wealth creating enterprises. The only politically expedient way out of this housing crisis is the "stealth" inflation tax. Trading treasuries for bad mortgage debt, keeping interest rates low, and Americans especially gov't piling on debt breed this market discontent. The euphoria from the Fed's recent actions will soon give way to the fundamental reality that your $5 bill should say "legal tender for all debts or one gallon of gas". If it weren't for efficient markets where I could liquidate my RJI in a matter of minutes, there would be NO effective store & transfer of value. My new currency is a share of DBA, RJA, or GOOG.
Michael- You make a great point about fundamentals and how they are essential to locally driven markets. The reason this is national is due to the supply of money being the driver rather than the need for shelter. . . this thing is national, albeit more severe in cities that participated heavily in the run up, which VP of CommonSense astutely noted in his reply above. Well qualified VP.
However, as long as there were mortgage brokers selling Option ARMs in the quad cities and Peoria, there's going to be trouble.
People say we've never seen anything like this- well we did in Commercial Real Estate with the '86 Tax Act which destroyed the passive loss deduction- effectively eliminating the fundamental for Commercial investment in the '80s that led to the overbuilt market. However, this time we're dealing with empty homes instead of empty investment high rises.
My guess is that regulation of the mortgage brokerage and Appraisal industries will be the equivalent of the Tax Act. Remains to be seen whether a "Resolution Trust" will be created. . . but the Fed has already started on its own with Bear Stearns.
Don't tell too many people about how great the south is...I want it to be the same when I return.
Simply put, a 6% interest rate will pay 50% more interest than a 4% interest rate- and will effectively increase the house payment by 50%."
If you used simple ratios based on interest rates, your numbers are all off. Obviously a 1% rate loan does not have half the payment of a 2% rate loan. Bad math, my friend.
Who exactly would do that? Walk away when one can still make payments, because of perceived "negative equity" which in the case of most homeowners will be a temporary condition? No one I know. That is patently idiotic. To summarize, your primary "fear" is that people will ruin themselves financially for years to come, by turning in the keys to their homes - EVEN THOUGH THEY CAN STILL AFFORD THE PAYMENTS AND OTHERWISE HAD NO INTENTION OF SELLING - simply because this market's fewer sales, at depressed prices, intimates to them that they presently have no equity?
Your follow on, comment about "hoping prices fall much more (after taking the loss suggested above) so that you can buy again" is a ridiculous notion, for no lender will extend you the credit you'll need to buy again after you've panicked and turned in the keys on the prior one. Foreclosure, bankruptcy, or deed-in-lieu, they all have similar chilling effects on one's ability to secure credit from traditional lenders.
it is the very definition of irony that a casual reader can find this much straight-from-the-left... slop in a trough that calls itself "seeking alpha', a capitalist moniker if ever there was one.
Something that wasn't explicitly stated, but is implied through this, is that the runup in housing prices was supported by the number and variety of nontraditional mortgage products. At the inception of the neg-am ARM, many mortgage companies would qualify a borrower based on the interest-only, or even the neg-am minimum payment. With lower monthly payments, a borrower could finance a larger loan. With a larger loan in hand, buyers could bid up prices on existing homes. That also contributed to builders and developers packing big homes with upscale features on small lots--the McMansion Syndrome.
As a result, marginally qualified buyers flooded the home purchase market, and everyone associated with the business made money: banks, mortgage originators and the investors who purchased the securities, title companies, builders, suppliers, developers, furniture stores, home improvement outlets, contractors...well, you get the idea.
When defaults became more common with marginalized borrowers (subprime is the media catchphrase--I prefer 'layered risk' because many of these people had good credit but other risk factors such as limited reserves or down payments, or high debt ratios) the market for securities froze. Lenders reacted by tightening lending standards, thus shutting the door to marginal borrowers. With fewer buyers, housing prices had nowhere to go but down.
With all these factors at work simultaneously, it's now surprise that the bottom for housing has yet to be reached. And while I do believe that more losses are afoot, I don't believe the economy will slip into a depression. A long-term recession in housing, and shorter-duration recession in non-housing related industries.
In order to make this a reality, loan regulations were continuously relaxed and minimized until the concept of rational conservative lending limits was destroyed. Our Great Indebted are still assured that home prices will rebound and once again increase in value, and that theirs will always be payable, if they just held on and waited a few years until their return on invested property catches up with their heavy level of borrowings; then they will refinance and speculate once again. They are convinced that the more they borrowed on their homes, the easier it will be to put off the payback of their loans from their expected future income. But their Income has stopped rising, their income is not keeping pace with house costs, and they are now forced to sell, only to discover the horrifying fact that other members of The Great Indebted Society, are facing the same indebtedness. and unable to sell their homes. to buy an over-debited piece of real estate.
The Great Indebted are reluctance to accept this reality by not being willing to accept their fate that their homes can no longer be resold to recapture their investment within their walls, and they lack the ability to continue to run up this debt.
It is not over, The Great Indebted are now turning to their Credit Cards and high interest rate short term unregulated debt to get them over this Valley of Indebtedness, only to discover that Foreclosure and Bankruptcy await them on the other side of the chiasm.
"Who exactly would do that? Walk away when one can still make payments, because of perceived "negative equity" which in the case of most homeowners will be a temporary condition? No one I know. That is patently idiotic. To summarize, your primary "fear" is that people will ruin themselves financially for years to come, by turning in the keys to their homes - EVEN THOUGH THEY CAN STILL AFFORD THE PAYMENTS AND OTHERWISE HAD NO INTENTION OF SELLING - simply because this market's fewer sales, at depressed prices, intimates to them that they presently have no equity?"
Lots of people -- it is being mentioned practically every day in the news. It is happening so much that there is a cute term for it: "jingle mail." Look here:
seekingalpha.com/artic...
Or you can google "jingle mail."
You should really get out more, even Fox news (of which you are no doubt a fan) covers the problem of "jingle mail."
"Who exactly would do that? Walk away when one can still make payments, because of perceived "negative equity" which in the case of most homeowners will be a temporary condition? No one I know. That is patently idiotic. To summarize, your primary "fear" is that people will ruin themselves financially for years to come, by turning in the keys to their homes - EVEN THOUGH THEY CAN STILL AFFORD THE PAYMENTS AND OTHERWISE HAD NO INTENTION OF SELLING - simply because this market's fewer sales, at depressed prices, intimates to them that they presently have no equity?"
Lots of people do that which you call "patently idiotic" -- it is being mentioned practically every day in the news. It is happening so frequently that there is a cute term for it: "jingle mail." Look here:
seekingalpha.com/artic...
Or you can google "jingle mail."
You should really get out more, even Fox news (of which you are no doubt a fan) covers the problem of "jingle mail."
Smart or not, it is happening.
Assuming they can manage the payments, many may well conclude that sticking with the shelter they have is a better option than renting, though the cost of leasing might be marginally less. There tends to be more than just dollars and cents invested in a piece of property that has become someone's "home". That psychology might just trump sound economic decision making.
Finally, don't discount the desire to own a house that has been paid off. A lot of people in this country work towards that goal and while the absolute value is important it is secondary to the perceived security of owning a house that is free and clear.
In the end I'm not arguing with your premise that this could get a lot worse, just suggesting that there are some mitigating factors.
Without a doubt, according to our modern understanding of mathematics, a 50% increase in interest rate (4 to 6%) will increase the interest paid by 50%!!!
True, it will not increase it 50% exactly if you are paying regular (principle and interest) mortgage. However, in the first 5 years of your mortgage, you are paying mostly interest for sure! Since we are talking about people who have bought in the last five years, and/or people who are paying interest only mortgages, this is quite relevant!
Dont believe me? Check out the math for yourself:
1st months monthly payment on a 100K 30yr mortgage at 6%= $599.55
Principle=$99.55 interest= $500.00
1st months monthly payment on a 100K 30yr mortgage at 4%= $477.42
Principle=$144.08 interest= $333.33
Ratio of interest paid at 6% vs 4%= 500.00/333.33= 1.5= 50% more!
If you pay an interest only mortgage your payment absolutely increased by 50% when you went from 4% to 6%.
If your are paying a classic P+I loan your payment still increased by by 25% ($599.55/$477.42)= about 1.25.
I agree that a ratiometric equation may not be precise, but my point holds true: Interest rates determine raw buying potential more than anything else. However, despite lower interest rates in previous years, allowing more buying power, housing is still far less affordable that it has ever been due to price increases.
"This is incorrect "regarding the interest rate discussion jcrash started:
Simply put, a 6% interest rate will pay 50% more interest than a 4% interest rate- and will effectively increase the house payment by 50%."
If you used simple ratios based on interest rates, your numbers are all off. Obviously a 1% rate loan does not have half the payment of a 2% rate loan. Bad math, my friend."
As to the question of whether people would walk away, consider that many people move frequently. People who will stay in an area may keep paying, but someone who is forced to move will gladly walk away from negative equity. The more people who do that, the less aspersion society will cast upon those who do it, which will encourage more people to do it.