Seth Chalnick

U.S. Housing Has Bottomed

This comment is a follow up to the comment posted by bondtrdr, because it really lies at the crux of our debate.

As a real estate broker whose income is derived in direct proportion to a recovery, I would be extremely happy if I thought these bottom calls amounted to anything more than wishful thinking and distorted statistics.

I agree there is a misconception about Arm resets, and that some of what Bondtrdr says about resets is true. And I will go out on a limb and assume that instead of saying “Alt-A and Hybrid” Bondtrdr meant to say Alt-A and Prime (because Hybrid = Option Arms… and by definition these are a serious problem for anyone other than sophisticated investors)… so we’ll just go with the implied intent rather than dissect the semantics.

Now, yes, with the 6 mo libor at 1%, its true monthly payments will stay low, but even at 3.5% the loans that re-set to 25yr amortized principal and interest (roughly half of all re-sets), actually increase in monthly payment. Bondtrdr’s bro is stoked because he apparently falls into the category of folks who get the 5 extra year reprieve.

But how long can Libor be expected to stay this low? It would be a mistake to view these short term low rate as a foundation for stability.

Even when the Libor gets to 3%... still very low by historic context… the fully indexed rate that folks like Bondtr’s brother will pay on their mortgage will be around 5.5%. This is pretty equivalent to what they had as a teaser.

But here’s the thing… there are two types of 5yr Arm loans:

-Loans that adjust to variable rate after 5yrs, and extend the interest-only period out another 5yrs (and then switch to principal and interest over a 20yr amortization).

-Loans that adjust to variable rate after 5yrs, and immediately switch to principal and interest over a 25yr amortization.

This is where the misconception comes in… there is an idea that folks in the higher pricing tiers can afford the P&I payment. It does not matter than some, or many, or even most folks can afford the resulting payment shock. What matters is that some folks (many) are making less money than they were 5 years ago, and when their $800k loan at 5.5% switches to P&I… at 5.5%... their payment increases by $1,247 per month.

Even at 3.5% their payment actually increases by $340 per month.

We have the blueprint of how this rolls out from here. If at first you can’t afford, try to refi. If the refi guy says no dice, try to short sale. If only 15% of short sales close, then walk away.

Also, if people are currently walking away from homes they CAN afford because they’re upside down by $100k… is it unrealistic to expect folks to walk away when they’re upside down by $200k? If not, then how about $300k?

There is a further misconception that the lower priced tiers were all made up of subprime borrowers. Many of these buyers had great fico’s and bought with 5yr Arm’s. In fact, there were many more 5yr arms executed than there were 2yr arms. Where does the stability of this market segment go when they experience this kind of pressure?

There is a further misconception that the subprime problems are behind us. Not true. What is behind us is the rate resets. But the fall out is not behind us. We have had to lower rates to unprecedented levels and we are absolutely stuck here. There are pressures mounting to raise rates, but doing so would be catastrophic.

We have dealt with the problem thus far by changing mark to market guidelines and imposing foreclosure moratoriums. To say this problem has been contained is not accurate. I think I was reading Peter Schiff the other day, who made a more accurate assessment… referring to these actions as more of a quarantine than a containment.

From an intrinsic value standpoint and an affordability perspective, the bottom has been in for sometime in the 300k pricing tier… but who cares if the people who want to sell cannot sell and the people who want to buy cannot buy? The low end segment is completely out of whack because there is nothing free about the market. The high end market is extremely overbought and will take a huge correction to set things straight.

But to say the “real estate market” has bottomed at this point, with all these problems under the run, and yet to come, is just not accurate by any true standard.

U.S. Housing Has Bottomed

All real estate may be local… but unemployment, illiquidity, deflation/inflation, debt, taxation, and the question of whether the stock market is dislocated from reality sure seem to have a world-wide impact.

The foreclosure problem has not been addressed. Rather it is gaining momentum. And it is about to increase at an even faster rate as the neg-am, alt-A, and “prime” 5yr ARM’s begin to re-set.

The idea of the Midwest leading the pack is nice, but these conservative values didn’t buoy us during the liquidity crunch, etc, and it is not going to stem the tide of the pressures that are mounting now.

Midwestern values may well serve as an exemplary place for us to return. But I’m afraid we have a lot more falling down before we can pick ourselves up, brush ourselves off, and get back on the road that will take us there.

U.S. Housing Has Bottomed

With respect, I think we’ll look back at this article within the next six months and be floored about how wrong some really smart people could get this. First of all, have all our unprecedented problems been magically addressed by changing mark to market practices and temporarily banning foreclosures? …even while 25% of all US mortgage holders are upside down and foreclosures are increasing at record levels?

Second, the "housing market" right now is not a market at all. A market implies a free exchange where supply equals demand. Today, the “market” is a place where misinformed people confuse shelter with investment, and the government and banks (same thing these days) artificially limit supply on the low end… and then take the resulting statistical phenomena out of context by applying it to the whole universe of data… while ignoring the tsunami of even greater problems that have not yet started.

And as a friendly reminder… there is also effectively no market for high-end real estate mortgages… which means the high-end real estate market has effectively been reduced to an all cash economic exchange.

The problems we have collectively (mis)labeled as “subprime” are not even close to being contained. There are hundreds of thousands of homes that should be on the market that are not due to moratoriums, bank agendas, negative equity, etc. The problem people will start to (mis)label as the “prime” problem… will make the “subprime” problem pale in comparison.

Claiming a housing bottom at this point is optimistic at best, irresponsible at worst.