Ransome

Why Did Housing Go into a Bubble?

The government forced nothing, it is a fable. The whole scenario was developed on the credit card model. It was why credit scores became the most important credential for a mortgage. The loans were asset backed and most importantly risk was transferred via securitization. Wall Street has a junk bond dream left over from the asset stripping 80's.

Greenspan put the gas pedal down with low interest rates to promote growth to pay for a war. He had is eye on inflation, which never happened. Unnoticed were the dollars and jobs moving overseas. We did not experience inflation because the supply of goods coming into the States was infinite and cheap. It was Asia that experienced the growth.

No bank has ever sent someone knocking on your door begging you to re-finance or obtain a home equity loan to pay off your credit card debt. Remember the credit card come-ons, 0% for 6 months, the same come-on as toxic ARMS. Like credit cards, asset backed lending generated fees with no risk, risk was securitized in bundles and off-loaded. Servicing the loans was immensely profitable, with a penalty fee structure like credit cards, which stayed with the servicer.

Greenspan continued to have low rates and money went looking for other AAA securities. Once the fee fever hit, they could not turn off the machine. Greenspan tried to raise rates but money, offshore "savings", was buying the bundled securities keeping long term rates low, the "conundrum". The savings were the profits from us buying all the imported stuff. The growth Greenspan was waiting for was taking place in Asia and coming back as "savings". Inflation was localized to real estate as supply dwindled and investment banks swindled. Increasingly lax lending to unqualified borrowers allowed commission fueled sales reps wallets to bulge stuffing more lending down people's throats. The inflating housing prices created it's own wind.

Local banks were out of the picture around 2004 unless they did commercial lending for new construction or exceedingly overpriced rental units that were destined to become condos for snow birds. Idiots in town government were floating gimmick securities to build local infrastructure for new construction. People were lining up in the streets to put down payments on condos yet to be built and that were sold three times over before the ground was broken. Any idiot could become a real estate broker, and they did. The old hands were complaining about all the competition. Ultimately, very few were making money because of the insane competition, so they lied as much as they could to make a sale.

It was the best example of out of control capitalism because everyone was making money. No one wanted it to stop, so it didn't. Builders could not build houses fast enough. Rates and terms had never before been seen this favorable (but low rates did not force anyone to buy. Rates are low now, and people are not acting foolishly.) Real estate brokers were touting low rates, gimmick loans and the "better buy now or you will never afford a house in your life time. If terms seem unaffordable, you can sell the house at a profit. If you have bad credit, make payments on an exploding mortgage and re-finance before it blows up."

Fannie and Freddie were out of the picture by 2005, there were no more qualified borrowers. Raines was out for accounting fraud. Mudd had his arm gently twisted by Frank and investors wanting better returns. Frank wanted the poor not to miss out on the housing appreciation "miracle" (but he didn't say make bad loans). Bush wanted everyone in a house so they would buy stuff and keep the economy afloat. Fannie and Freddie bought AAA ABS of loans they would never be allowed to make, even before Mudd. Every bank in the US did likewise. Mozilo offered Mudd conventional loans but he had to take ALT-A and twisted ARMS as well. Mudd was in competition with the investment banks with the exception that he would hold on to the loans or guarantee them.

Then the defaults came, first slowly as HELOCs were used to make payments. Investment banks lost buyers so they turned attention to oil and made that market, drawing in dumb money from pensions and retirement accounts. Remember? Gas at $5 a gallon by the end of the year?. Bear Sterns lost some funds and then Lehman went down and a big freeze settled in.

Case-Shiller Still Predicts Massive 45% Fall from Today’s Values

Zero Hedge collected some excellent material on balance sheet recessions presented by Richard Koo. He had a slide that compared rents to housing prices from 1975. The presentation was prepared in March and the predicted intercept was equivalent to housing prices around the fourth quarter of 2003, which I estimate to be approximately $100 to $125 a square foot.

Property Values Set to Fall 43% from Current Depressed Levels

I am not so sure we haven't hit the bottom. I bought a house for 165k in 1987. In 1997, my neighbor in real estate said it was worth 140k. I am one that refuses to take a loss. Back in the '80's mortgage interest rates were up at 8 or 9%. It depressed the market. When banks started giving money away my house increased in value overnight by about 50% based on a monthly payment without any loan gimmicks. The drop in value over 10 years created a latent demand that was overstimulated by cheap money. Over the entire period from '87, replacement value increased.

We went from a depressed market to an overstimulated market to a restrained market. Taking into account the cost of money and the latent demand, prices seem about right Location still exerts a positive pull on value. The '87 house is on a cul de sac where kids can play in the street and the houses have big lots in a good school district. It has twice the value to a young family than a town house, which sells for 170k. If I increase the value of the house with no appreciation, based on money cost and latent demand it is about 280k (50% + 20%) . Adjust for real inflation at 2% per year (50% + 20% + 40%) * 165K = 345k. The real price is between 280k and 345k which is in the range predicted by the town house price.

I also heard that Dodd may propose opening up the 8k bonus to all comers to help move inventory. The timing would be especially good for local banks who are deposit rich but cautious as they lose more money on development and new construction loans. This could open lending for them, generating badly needed revenue and establish the housing value floor if money is lent prudently. It may unfreeze the ABS market with asset values stabilizing at a low point and lending being prudent. Now we need jobs to support all this.