Greg Fielding's  Instablog

A lot of people are asking what I think will happen in the housing market in 2012. But rather than just give a laundry-list of predictions, I’d like to share my thoughts within the context of steps that different type of readers and clients may be considering.

First, a general note on the housing market… Overall, I expect 2012 will be very similar to 2011. Not much inventory, stagnant-to-slightly-lower home prices, and I expect we will end 2012 with mortgage rates very similar to where they are today. Even though there are massive risks out there, such as the enormous shadow inventory of distressed homes, Europe falling apart, and a global economic slowdown, the last four years have proven that all of this can take a long long long time to play out. Our policymakers are hell-bent on kicking the can down the road. Especially in an election year, I wouldn’t bet on too many fireworks.

Prices are determined by the balance of supply and demand. Currently, our demand isn’t great, but supply is even more pathetic. Unless there is a lot of new supply, I wouldn’t expect prices to tank in 2012. Large amounts of new supply could come from either the backlog of foreclosures coming to market quickly, or a big change is social mood where lots more underwater sellers decide they’ve had enough and put their homes on as short sales. This is in large part why Europe, China, Occupy Wall Street, the stock market, and even Ron Paul matter: they affect social mood, which will drive people’s willingness to own real estate.

Sure, there could be a black swan-type of event that could instantly and profoundly impact the Bay Area’s housing market, but that just isn’t likely. Most likely, is simply another muddle-through year like 2011.

One quick note on all of the forecasters that are predicting home prices to bottom on 2012… These are the same clowns that have been wrong every year since the bubble began to pop. And most of them are the same ones that made predictions during the bubble that home prices would rise at 10%+ per year forever. Do not listen to these people.

So what does that mean for you?

First-Time Homebuyers

2012 could be a great year to buy your first home, as long as it (and you) meet some specific criteria. And know this: please do not feel like you have to buy now because prices could go up. Even when prices to eventually begin to rise (organically and for real), they will rise slowly. You aren’t going to be missing anything by waiting in terms of price appreciation.

If you are going to buy your first home in 2012:

• Make sure that it is somewhere you will be happy for at least five, preferably ten years. Why? Because it may take that long for it to be worth again what you paid for it. Keep in mind as well that a home really needs to appreciate about ten percent just for you to break even with all of the buying and selling costs accounted for.
• Make sure the place is big enough and in the right school zone. Buy a place that your family won’t outgrow.
• On that same note, seriously consider NOT buying a condo.
• Don’t be upset if the home continues to fall in price over the next couple of years. Today’s $400,000 could be 2014′s $300,000. You need to be honest with yourself about how well you would cope with this.
• Have a reason other than “building wealth,” like starting a family, etc.
• Don’t stretch yourself financially. Just because you qualify for $500,000 doesn’t mean you should spend $500,000.
• Get a 30-year fixed mortgage.
• Don’t feel pressure to buy because rates are low. Remember that home prices are a function of mortgage rates. If rates rise, prices will fall accordingly. Point is, low rates don’t necessarily mean it’s the “best” time to buy.
• Consider rent. Could you rent the same house for the same as it would cost to own it? If so, what’s the hurry to buy? Conversely, be sure you could the house you buy out for a price that would cover your monthly costs. Just in case.
• Finally, do some homework on the area you are buying in. How much would the house have been worth at the peak? How much has it fallen? How much was it worth back in 1996 before the bubbles began? This might be a reasonable way to approximate a worst-case scenario.

Homeowners With More Than Twenty Percent Equity

If you’ve got lots of equity and are considering selling, 2012 could be a great time to move up, down, sideways, or cash-out and rent for a while. You are in the extremely fortunate position of being able sell and have the cash to buy the house for the next phase in your life.

For some reason, common advice from the rest of my industry would be to wait, because… if you don’t have to sell, why would you. To me, this is bass-ackwards thinking. Today, you can cash-out and rent while you still have a equity.

Think of it this way… if you are going to sell one house and buy another immediately afterwards, it really doesn’t matter what type of market you sell in, as long as you have the equity to logistically make the move. If you wait until your house goes up, well the price of the house you’ll buy will be higher too and you are no better off. But if you wait and your house keeps dropping, you risk becoming physically incapable of selling and having enough cash to buy again.

If you aren’t in the house you want to be in for the next ten years, then now is the time to make the change.

Homeowners With More Than Ten Percent Equity

You homeowners are also lucky enough to be able to sell and still walk away with some cash in your pockets. Maybe it’s enough to put down on another place with an FHA loan. Or, maybe it’s enough for first and last-month’s rent. Either way, there are tens of thousands of homeowners around here who would love to have the opportunities you have today.

Even though you probably think your situation sucks.

The bottom-line is this: today you can move, but by this time next year it’s going to get iffy. Take a good hard look at this long-term Case-Shiller chart, and this one that breaks it down by price tiers.

If you aren’t where you want to be for the next 5-10 years, then 2012 is definitely the year to make a change. The sooner the better.

Homeowners With Less Than Ten Percent Equity

Your situation is obviously more dire. If you are where you want to be (and you can afford to be there) for the next 5-10 years, then stay. But if you are going to be moving at some point in the next few years, you have better do it now, while you still can.

Even if you have to bring a few thousand bucks to the closing table, it’s a lot better than having bringing tens of thousands of bucks, or doing  a short sale.

Logistically, you are most likely going to get your best price this Spring, with prices fading by the Summer and Fall. The time to act is now.

Rent. Save up cash. Or if you have extra cash and want to get an FHA loan to buy again, go for it.

But you’d better act now while you still have some good options left.

Homeowners Already Underwater

If you are already underwater to the point where bringing extra cash to the closing table isn’t an option, you have some tough decisions ahead.

First, you have to decide if the home you are in is the place you want to be for the rest of this decade. If it is, then keep it, love it, enjoy it, and slowly pay it down without paying too much attention to home prices because they don’t matter to you.

But if it’s not, then you have to decide to take your pain now, or likely later. And by pain, I mean a short sale. Generally speaking, you are going to be renting for 2-3 years after you complete your short sale. And, given that home prices are still slowly falling, this probably isn’t going to be too bad of a thing.

Consider this: people who did short sales back in 2009 or earlier can probably qualify for a mortgage today. Many of them will be buying homes over the next couple of years.

The real issue for you is: Do you want to be buying a home again in 2015? Or even later than that?

It’s said that the best time to plant a tree was ten years ago. The same logic applies to short sales. If you are going to do it anyway, you are better off doing it now and starting the healing process.

For more information on short sales, read the very detailed How Short Sales Work.

Homeowners in Foreclosure

If you are one of the many thousands of Bay Area homeowners who are behind on your payments, you have three options. And, it helps to be proactive.

1. Get a loan modification. For most, it’s worth a shot. If you haven’t applied, it’s probably worth a shot IF you want to keep your home for the next decade.
2. Do a short sale. Again, read How Short Sales Work. If you are in the East Bay, I can help you.
3. Walk away. Live free for a while. Save some money. Maybe ask your lender for a Deed in Lieu. If you just want it over and you don’t want to do a short sale, I would absolutely recommend contacting Jon Maddux and the folks at You Walk Away for further advice.

Trust me, if you are in this situation, you are not alone. Probably not even alone on your street. And, it’s not a death sentence. Life will go on and probably get much better from here. In the grand scheme of things, a house is just a house. And, yes, you will own another one someday.

The important thing is to get educated in 2012. Take charge. I recommend reading the very detailed How Foreclosures Work.

Renters

If you are currently renting, I would consider all of the same points I raised for first-time homebuyers. Especially if you are comfortable where you are, there is no reason to feel urgent about buying a home in 2012.

A common complaint from renters is that they could afford a mortgage for what they pay in rent. But consider as well that, if the price of your “target” home is falling at $20,000 per year, you are still $20,000 ahead each year by not renting.

In the Bay Area, many renters have been “saving” $50,000 to $100,000 or more each year, simply by staying on the sidelines.

This isn’t to say that we all need to try and time the exact bottom of the market. But if that kind of thing does plan into your calculations, rest easy knowing that the bottom isn’t here yet.

Investors

2012 is simply too early for most investors to buy-and-hold. There. I said it.

Why?

Because we aren’t at the bottom yet. Not even at the low end. Not even in Antioch,Richmond, or Concord.

So if you want to buy-and-hold in 2012, think of it as averaging-in to the stock market. If your plan is to buy ten homes over the next four years and you want to buy one or two in 2012, then great – that’s a solid, reasonable plan. Go for it. And if you’re in the East Bay, I can help.

But if your goal is to buy one or two rentals to help put your kids through college, then wait. There is no reason to buy now. Keep your powder dry.

Personally, I would rather buy one year too late than potentially three or four years too early. And whatever great returns you are getting today won’t make up for even better opportunities missed down the road.

It really all depends on your goals and how much cash you have to play with. Just know that there will be downward pressure on prices, especially at the low-end, until the bulk of the foreclosure mess is behind us. And we’ve still got a ways to go.

One option that may make sense for some of you is to invest in apartment buildings, bought at the right price and in the right Bay Area neighborhoods. If you are anaccredited investor with $50,000-$100,000 you would like to passively invest in apartments (partially as a demographics-play), then there are some interesting opportunities out there. Please send me an email and we can discuss it further.

Final Thoughts

The housing decline that began in 2005 is entering it’s eighth year. It’s hard to believe that we still have so much deleveraging in front of us. Back in the beginning, I figured prices would crash after three or four years, hit bottom, and then the healing would begin – like ripping a bandage off quickly.

Obviously, that’s not happening. The bandage is getting pulled back slowly, prolonging the economic pain for all of us. I don’t know what the next few years will bring other than that there is still quite a bit of the bandage left.

That doesn’t mean that we need to put our lives on hold. Depending on your and your scenario, 2012 can be a great time to take action. I would just rather you take that action with a realistic understanding of what’s coming, instead of acting on the kool-aide-and-unicorns advice of NAR, CAR, and so many other disingenuous “forecasters.”

Take care. And Good luck. 

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Enough extend-and-pretend. Enough trying to cling to the past. It's time to admit that nothing we've done so far has worked. It's time to actually deal with our problems instead of kicking the can down the road.

I'm not in academia and I'm not an economist -which means my ideas might actually work.

Obama, listen up. In the name of stabilizing home prices, your advisers have confused the disease with the cure.

Here is my 6-point plan to fix the housing market:

1. Immediately stop blacklisting strategic-defaulters and short-sellers. Fannie Mae, Freddie Mac, and The FHA (the GSE's) currently blacklist these potential buyers for three years or more, primarily to discourage them from walking away in the first place. Wrong!  Letting them buy right away and with no extra penalties increases liquidity in the housing markets and helps home prices find their natural value and healthy bottom more quickly.
2. Allow bankruptcy cramdowns for mortgage debt. Firsts, seconds, investment properties, everything. We don't need any national principal reduction program - it would be too big, too complex, and influenced too much by bank lobbyists. Having to file bankruptcy removes moral hazard issue. And instead of a national, one-size fits all solution, bankruptcy judges would review each case on an individual basis. Who better to determine the outcome than an actual, impartial judge?
3. No more foreclosure delays. In fact, do what you can to speed the process up. If a homeowner wants to keep the house, let them either modify the terms through HAMP (or something similar) or else file bankruptcy. If they don't want to keep it, then they need to do a short sale, deed-in-lieu, or be foreclosed on as soon as possible. These bad loans MUST get undone before we can recover. The quicker the better, for everyone. Foreclosures aren't the problem, they are the cure to the disease of loans that never should have been made.
4. Change the number of GSE loans an investor can have from 4, back to 10. Make them put 30% down and scrutinize the heck out of them, but don't limit them to 4. We've got a huge supply of foreclosures and short sales for the market to absorb and we've got a willing contingent of buyers to buy them. This one change would let them.
5. Phase out the mortgage interest income tax deduction. All this does is make our homes that much more expensive, putting us that much more in debt to banks. Consumers lose. Governments lose. Banks win. Even sacred cows must sometimes get slaughtered.
6. Allow student loan debt to be discharged in bankruptcy courts. Predatory banks will happily lend tend of thousands of dollars to 18-year-old kids because they know those kids will have to pay it back - even if it takes their whole lives. In the name of making college affordable, we've saddled an entire generation of young adults with insane amounts of debt. And, of course, college has only become more expensive.This is absolutely disgusting and outrageous. If bankruptcy courts could discharge the debt, then banks wouldn't make the loans in the first place. Demand drops, and the price of a college education falls with it. I include this in my ways to fix housing because the twenty-somethings are going to need to be buying homes soon and these unnecessary debts are standing in the way.

IF all of these policies were enacted now, we would probably still see home prices continue to fall for another couple of years before finding a real, organic bottom. Had we done this two years ago, we would be there already.

These policies would instantly:

• Provide massive debt-relief to consumers.
• More quickly achieve a housing bottom (a good thing!).
• Provide housing liquidity where people can move to take new jobs or downsize to smaller homes or whatever else they need.
• Prove to both consumers and the markets that we are looking forward and building a legitimate foundation for our economy moving forwards.

Confidence. Liquidity. Less debt. We can either get there right now with bold policy, or in a decade with more of the same.

But what about the banks?

Nationalize them. Wipe out the bond-holders and shareholders. Bank of America, Citigroup, Wells Fargo...the only reason that any of them still exist is that we are choosing to live in accounting fantasyland. Bring back mark-to-market accounting.

An economy needs banks, but not necessarily these banks. Instead of spending billions propping them up, let's let them burn and spend our taxpayer money on rebuilding better banks from their ashes.

The losses must be realized before our economy can move forward. No more accounting gimmicks. No more extend-and-pretend.

We've already lost a decade and I don't want to lose another one.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

As a recommended reduction in the recent deficit commission proposal, the mortgage interest deduction has once-again come under fire. Good.

The mortgage interest deduction is a subsidy that takes money from every single American and gives it to banks, home-builders, and real estate agents. The deduction is both economically and morally flawed and should be eliminated as quickly as possible.

Naturally, industry and lending groups who directly benefit from the subsidy are lobbying hard to maintain the status quo, spinning the facts to suggest that what's best for them is also best for society as a whole. Calls-to-action have begun.

What is the Mortgage Interest Deduction?

The mortgage interest deduction is a federal tax deduction where property owners can deduct mortgage interest paid from their taxable income for both primary residences and second homes.

However to take advantage of the deduction, taxpayers must itemize their deductions, something that generally only wealthier taxpayers do. The rest of us are usually better off claiming the standard deduction, which in 2009 was $11,400 for married couples. The value then of the deduction to most taxpayers is their total itemized deductions, minus $11,400, times their marginal tax rate. Obviously, those with higher incomes, marginal tax rates and more mortgage interest benefit disproportionately.

For example, if a married couple's itemized deductions totaled $17,400, minus the standard $11,400, that's an additional write-off of $6,000. At a 40% marginal tax rate, that's a $2,400 subsidy. By giving generally-wealthy homeowners the mortgage interest deduction, taxpayers are, in effect, subsidizing that portion of the borrower's mortgage.

In the example above, there is $2,400 less tax revenue collected from that homeowner, which is a de facto tax on every other taxpayer to make up that amount. For 2012, the federal government estimates the the deduction will cost taxpayers $131 billion.

Making Homes Less-Affordable

But, the cost of the mortgage interest deduction is far greater than just $131 billion. Ron Phipps, President of the National Association of Realtors® states:

“Recent progress has been made in bringing stability to the housing market and any changes to the MID now or in the future could critically erode home prices and the value of homes by as much as 15 percent, according to our research."

In other words, home prices are as much as 15 percent HIGHER because of the deduction. All of us, homeowners and renters alike, are being forced to OVERPAY for shelter by "as much as 15 percent."

If the goal of the mortgage interest deduction was to make housing more affordable, the result has been the exact opposite.

If Americans were polled and asked if the would prefer itemized mortgage interest deductions as they are, or the standard deduction and be able to buy their home for 15% less, the overwhelming majority would choose to scrap the mortgage interest deduction.

What is the Purpose of the Mortgage Interest Deduction?

Like all subsidies, wealth is transferred from one group to another for a specific purpose. In this case, wealth is transferred from taxpayers to homeowners with big mortgages - or more specifically, to the banks where the larger mortgage payments are then made...but for what purpose?

Agricultural subsidies, for example, transfer wealth from taxpayers to farmers to help ensure that we have a ample food supply regardless of drought, floods, or fluctuating world food prices. Finer points can be debated, the purpose is clear and there is definite societal value in a sufficient national food supply.

So what is the social value in the mortgage interest deduction? What are the benefits that make the $131 billion and 15% higher home prices worth it? In a letter addressed to the deficit commission, National Association of Realtors® President Ron Phipps warns:

Never dismiss or underestimate Americans’ passion for homeownership, notwithstanding the current crisis. Calling homeownership the "American Dream" is not a mere slogan, but rather a bedrock value. Owning a piece of property has been central to American values since Plymouth and Jamestown. Homes are the foundation of our culture, the place where families eat and learn together, the basis for community life. The cottage with a picket fence is an iconic part of our heritage. Do not take that imagery or that passion lightly.

The tax system does not ―cause homeownership. People buy homes to satisfy many social, family and personal goals. The tax system facilitates ownership. The tax system supports homeownership by making it more affordable.

First off, by Phipps' own admission, the mortgage interest deduction makes homes 15% more expensive, not more affordable. Second, despite Phipps' denial, the "American Dream" as homeownership is exactly a marketing slogan, pushed by NAR and other industry groups for the last 30 years.

But, does this tax system actually facilitate homeownership? The vast majority of homeowners would probably still own a home if they used the standard tax deduction instead. Granted, some might buy less-expensive homes, but only a fraction would otherwise be renters.

Is there really much value to society in some people buying marginally more expensive homes? Or in getting a few more people to buy instead of rent? Enough to justify 15% higher home prices?

The History of the Mortgage Interest Deduction

Ron Phipps writes:

"The tax deductibility of interest paid on mortgages is a powerful incentive for home ownership and has been one of the simplest provisions in the federal tax code for more than 80 years.

Though technically, sort-of true, the spirit of the law was never to actually subsidize home-ownership until quite recently.

When the first modern federal income tax was created in 1894, all interest was deductible. This was struck down by the Supreme Court as unconstitutional, but the constitution was amended and all interest was deductible again in 1913.

Homeownership was certainly not on politicians minds because residential mortgages didn't yet exist. Nearly all interest paid in those days was business expenses. The landscape changed in the 1930's and the birth of Fannie Mae. Homeownership rates began to grow with the new availability of financing. By 1960 the homeownership rate reached 62%. It was in the 1970's, when credit cards became popular, that changing the interest deduction was first considered.

Roger Lowenstein writes in The New York Times:

In any case, the growth of credit cards in the 70's began to turn the interest deduction into a serious loophole. People were becoming plastic junkies; if you paid for a washing machine on credit, the I.R.S. would give you a subsidy. By the 1980's, this threatened the entire system of revenue collection. There was some talk that the Treasury was looking at eliminating deductions, including, possibly, the interest deduction. Economists thought it was a good idea. "Tax economists tend to be skeptical about preferences in the tax," says Joseph Thorndike, the director of the Tax History Project at the nonpartisan Tax Analysts. "Are they targeted to the right people? We give tax breaks for college; do we send more kids to college or help middle-class kids who are going to college anyway?" Fine and well, but was an elected official really going to risk fooling with the mortgage deduction?

President Reagan was not. Addressing the National Association of Realtors in 1984, he said, "I want you to know that we will preserve the part of the American dream which the home-mortgage-interest deduction symbolizes." He didn't mention that it also symbolized the American love affair with debt; after all, it encourages people to pay for their homes with a mortgage instead of with equity. Two years later, in the tax-reform act of 1986, Congress ended the deductibility of interest on credit-card and other consumer loans; it left the mortgage deduction in place.

But Congress did set a cap. Today, a taxpayer can deduct the interest on mortgages worth up to a total of $1 million on his or her first or second homes. Also, you can deduct up to $100,000 on a home-equity loan. (And what prevents you from using a home-equity line to buy a flat-screen TV and then deducting the interest? Absolutely nothing; go for it.)

In reality, it was not until 1986 that the mortgage interest deduction was singled out as a stand-alone subsidy. Is High Homeownership Even Good? Beginning with Reagan, and accelerating through Presidents Clinton and Bush, the federal government has promoted homeownership versus renting. Unquestionably, some of the policies passed through these years contributed to the housing bubble and bust. But, on a society-level, is a high homeownership rate a even a good thing? Certainly, a mobile workforce is more dynamic than a workforce where people can't move as easily. Also it makes little sense economically to have so much wealth tied up in such an illiquid asset as a house. That's money a renter could have used to pay for schooling or start a business. Others would argue that higher homeownership rates help stabilize communities and bring a host of other iconic, intangible goodies to the table. But, common sense suggests that it is commitment to a community, rather than commitment to a mortgage that brings those positive externalities. Felix Salmon writes:

For me, it’s important to distinguish between two things which are separate, if highly correlated: homeownership, on the one hand, and the amount of time that you expect to stay in your home, on the other. A lot of the rhetoric about the upside of homeownership elides these two things; and for a long time doing so made perfect sense. After all, someone with a 30-year mortgage is likely to stay put for much longer than someone with a 1-year lease.

...

So it seems to me that owners, with shortening time horizons, are less likely now to do things like install high-efficiency appliances and invest time and effort into their local schools, while renters, with lengthening time horizons, are more likely to. Probably homeowners still score higher on the positive-externality front than renters do, but the difference is narrowing.

...

My feeling is that a lot of what we’re seeing is related to rental properties generally being designed for and marketed to the childless, while families, who tend to stay put if only to give the kids continuity, are more likely to own and to build up real local communities. Parent-teacher meetings are a great way of getting to know your neighbors. But if and when families start to rent nice places, they’re just as likely to build strong communities as those who own. It’s not homeownership that creates the positive externalities, so much as simply intending to stay where you are for a while.

Has the Mortgage Interest Deduction Resulted in Higher Homeownership Rates?

While homeownership as public policy can be debated at length, the issue here is that the mortgage interest deduction is being sold to us, in part, as a policy that facilitated homeownership. Does it?

Consider this chart, via Carpe Diem. The majority of these countries do not have any form of home mortgage interest deduction. The notable exceptions beyond the United States are The Netherlands, Sweden, Switzerland, and India, which all have some variation of deduction.



The U.S. is on par with England, Canada, and Australia, none of which have a deduction. Clearly the mortgage interest deduction does not foster homeownership. It is Time to End the Mortgage Interest Deduction The mortgage interest deduction:

• fails to make housing more affordable and in fact caused housing to more expensive for everyone
• fails raise homeownership rates
• costs taxpayers over $100 billion per year
• disproportionately benefits the wealthy
• is not an 80-year-old sacrosanct pillar of our economy
• only exists today because of industry lobbying efforts in the 1980's
• primarily benefits real estate agents, mortgage lenders, home-builders and banks as higher home prices and loan amounts create higher commissions

Even the wealthy with large deduction amounts would probably prefer to simply pay less for their homes.

A Practical End

The deficit commission proposal was refreshing because it addressed the mortgage interest deduction, among many other proposals, which most politicians wouldn't touch with a ten-foot pole. Specifically, the panel called for a a cap on deductions for mortgage amounts beyond $500,000 - hardly the end of the world.

Falling home prices aren't the problem, they are the solution. Excessive debt is the real problem. Policies that encourage debt, like the mortgage interest deduction, facilitate the illness, not the cure.

Even the National Association of Realtors® knows that the mortgage interest deduction is a crap policy. Shockingly, the straightest answer came in 2005 from then NAR economist and infamous spinmeister David Lereah. Form the Times article:

If you scratch deeply enough, not even the real-estate lobby thinks that the interest deduction makes much sense economically. It's just a goody that homeowners, not to mention real-estate agents, have grown used to. Lereah, the economist for the National Association of Realtors, said: "If you're rewriting the book of Genesis, I might have a different approach. But if you make changes in the middle of the game, it's going to have a negative impact of the value of property . . .reduce people's retirement nest egg, funds they have available for college. You're going to cause a great dislocation."

As much as it kills me to say it, David Lereah was right (about this and this only) - this would cause a great dislocation.

So where to from here?

The only practical solution is a gradual phase-out. The $500,000 cap is a reasonable place to start. Homeowners with big mortgages won't be happy about this, but that doesn't mean it isn't the right thing to do.

Disclosure: None Mentioned