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April 03, 2005


K.G. Schneider

And if they have to sell, then prices start to bottom out, putting the owners into another predicament. The stories I'm hearing are beginning to feel like the last madcap activity before the tech bubble burst, particularly the speculation by people with the most to lose.

Do we know how many new buyers have ARMs, btw?


I have seen figures of about 40% ARM's. Of course, much depends on the terms of the adjustments. But regardless, if housing prices start declining, there will be a large number of people who are on the edge and who will try to sell fast out of panic, likely driving down prices further due to over-supply. This can have a cascading effect on prices and on the economy. Add in sky-high oil prices with projections of $100/babble oil and things are not looking very positive for the economy.

From Businessweek -
After The Housing Boom:

Some excerpts:
Another danger to the household sector has been the proliferation of adjustable-rate or no-money-down loans. These new financing vehicles have enabled more people to buy homes. But the negative effects of rate changes will hit these consumers more than their lenders. Bert Ely, a bank consultant in Alexandria, Va., doesn't see a cause for concern as long as the economy keeps expanding. But he does worry about one thing: If interest rates rise much further, the combination of higher payments for adjustable-rate mortgages coupled with rising property taxes from past appreciation could make it difficult for some homeowners to meet their monthly obligations. "We're going to see some people get burned," Ely says.


Of course, predictions that housing is about to peak have been made repeatedly over the past few years. So why does the turn look certain now? "The slowdown is all because of higher rates," says David A. Lereah, chief economist at the National Association of Realtors. True, mortgage rates have bounced up before -- most recently in the summer of 2004 -- but this time economists expect them to keep rising, in part because of the stronger economy. Plus, inflation has picked up, and not just from higher oil prices. In its last survey of regional business activity, the Federal Reserve found that "a number of districts indicated greater ease in passing along price increases."

Higher borrowing costs are already pricing potential home buyers out of the market. In housing, affordability is determined by monthly payments, including taxes and insurance. Take a home buyer with an income of $100,000 and a $40,000 downpayment. At a 30-year fixed-mortgage rate of 5%, the buyer can bid as much as $421,000 for a home. At a 6% mortgage, that falls to $390,000. At 7%, the upper limit is only $362,500. Spread across all income levels, that 13% drop in affordability whittles away at demand and cuts down on bidding wars, which helped drive big price leaps in some areas.

As higher rates dampen demand, the effects will spread to the rest of the economy. In the past three years homebuilding has made an oversize contribution to the growth of real gross domestic product and employment. Residential construction makes up less than 5% of the U.S. economy but accounted for over 12% of average yearly growth since 2002. Similarly, construction jobs tally just over 5% of all payrolls, but hiring at building sites has accounted for 16.6% of all new jobs in the past two years.


More important than housing's direct effect on the economy will be fallout from the slowdown in home-price appreciation. This is where the economy will be most vulnerable. Thanks to the easy availability of refinancings and home-equity loans, consumers have gotten used to tapping into the equity built up in their homes. In a 2002 study the Federal Reserve found that the average household extracted $26,700 in equity with each refinancing. One-third of that money was used to pay off old debts or add to savings; the other two-thirds was spent. The Fed estimated that the extra spending added a quarter- to a half-percent to consumer spending. That provided a welcome boost to demand as recession, terrorist attacks, and a sagging stock market were dragging down household purchases.


I agree with the premise that a housing bubble might burst in California - I even think it likely - but I have one or two nitpicks with this particular article. Regarding homebuyers using interest-only loans, the article speculates that in a few years...:

In the most dire scenario, if they owe more on the home than it's worth, they'll simply walk away.

Sounds like an oversimplification to me. Housing contracts don't just let a person decide to drop their financial obligations in the bank's lap if they feel things aren't financially going their way... they'd have to actually declare bankruptcy. (If I'm missing something please do let me know.)

The article also asserts that:

The boom in interest-only loans... is the engine behind California's surging home prices.

Pretty broad statement. Most analyses/speculation I've read about what's fueling the surge in prices mention many more factors: interest rates being low allowing cheaper loans, interest rates about to go up spurring people to catch the updraft, foreign investment because of the low dollar, people seeking new cash cows in the wake of the tech stock bust. I think the article's author has a case of tunnel vision on this issue.


The vast majority of public officials and the public admire and venerate Sir Alan of Greenspan. His "throw liquidity at every problem, after the fact" approach to FED policy will not only be largely responsible for the bubble followed by larger
bubble pattern of markets domestically, but he has greatly influenced the fundamental pressures which will ultimately debase the $ as the reserve currency of the world. This alone is causing us major internal problems (imbalance of trade and fiscal deficits etc.) Maybe "W" can give him a medal or a promotion like every other major figure who has failed in his or her responsibilities.

K.G. Schneider

One of the twists on this angle is to watch for the bubble to pop in areas with high numbers of military members or single industries that are failing. I knew military members who bought in Texas in the late 1970s and were unable to sell their houses when they were relocated.


People can walk away from home loans in most states without declaring bankruptcy because state law makes real estate loans non-recourse--the property itself is security for the loan. When people with 90% interest-only loans have to default, this will hurt Wall Street because these loans are repackaged as mortgate-backed securities. Your mutual funds may have several of these investments.


someone up there asked about how many ARMs we have here, and speculated on 40%. I read that 'nationally' we have around 30-40% ARMs as a percentage of refi or purchase mortgages. I thought that was high, because when we got our ARM (2002) the percentage that our mortgage broker thought was more like 15%. But, of course they grew in popularity as interest rates fell, I know we were happy that our 5.something ARM became 4.something, and for a couple months was even 3.9something. We didn't refi with a fixed at the time, but we just sold our house so we're no longer exposed to the risk.

so i was astounded to hear that the 30%- 40% rate of ARM activity in Q4 2004 was for nationwide and that in California it's more like 75%. Seventy Five Percent! when rates are on their way up? very foolish...

we're reducing our monthly costs by renting
and using our tax free capital gains to start an LLC that specializes in purchasing foreclosures
in the rapidly approaching Bad Times. Next week the new bankruptcy laws fly though congress...
it's like watching an accident in psudo-slowmotion


loan: "Cash Advance Payday Loans: Yes The Rates Are Higher!By: Greg Ford "
Loans: "Unsecured Loans: The Lesser Known Sibling Of Secured Loans By: Aditya Thakur "
Loan: "5 Signs You Need a Personal Loan By: Holly Bentz "

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