More Evidence of Housing Trouble to Come

Marketwatch: Getting in at any price. Homebuyers increasingly approach home loans much the way consumers buy cars, shopping for the lowest possible monthly payment to avoid being left out cold on the housing-boom sidewalk. But the explosion of such products, a sign of looser lending standards, suggests many consumers are taking on complex loans without fully understanding the risks they face when interest rates rise in the future, some analysts say. And that could pose a ripple effect in overheated real estate markets.

See also, from the Washington Post, "It's on the house,", an article about the dangerous trend in which "everybody is paying for everything with (borrowing on) home equity" -- and we, the taxpayers, subsidize this. The home mortgage interest tax deduction is a questionable policy to begin with, but we turn that into a subsidy of totally unrelated spending by extending the deduction to loans on equity for spending that has nothing whatever to do with home ownership.

We are less a nation of risktakers than a culture of reckless spendthrifts.

Comments

[Al]

I've been pondering this and I have a few points:
- the economy is flying along. Did you see the job numbers? We are in a solid growth stage.
- The wealth numbers are good. Debt is much less than assets.
- There seems to be plenty of people that can come up with money to buy these expensive houses.
- Yes, there are plenty of easy credit plans being marketed now-a-days.
- And yes, SOME people will get caught when interest rates shoot up.
- But it seems like there are plenty of people that will take their place and pay the big bucks.

I think a big question is how many people are actually taking on these "risky" loans? More specifically, what is the percentage as compared to more traditional loans???

(And I have to make politcal comment. If Kerry was in office, the job number news would be plastered all of the place. Right?)

[Carl]

We need approximately 140,000 jobs per month to keep up with population growth and people entering the workforce. Job growth was less than 150,000 in November, Decmeber and January, which aren't good numbers. Februrary was a very good month at 300,000 jobs. March wasn't very good, at 146,000 and April was good again at 274,000. So, two of the last six months have been good months for job growth. The other four months have been mediocre. There is no trend (yet) for continuing job growth. By comparison, there were an average of 236,000 jobs per month created during the Clinton presidency.

There are 1,170 articles listed on Google news about April's job growth numbers.

http://news.google.com/news?hl=en&edition=us&ie=UTF-8&q=job+growth+april+274000&btnG=Search+News

Exactly how many more articles do you suppose there would be if Kerry were President?

To answer your question, nearly HALF of California buyers used interest-only loans last year:

http://ktla.trb.com/news/local/la-fi-afford3apr03,0,3784920.story?coll=ktla-news-1

[Alex Krupp]

Dan: You should consider turning your multi-part housing speculation rant into a short essay. A lot of your blogs on this are interesting, but not really comprehensive enough to be worth linking to out of the context of all your other posts. If you turn it into a short essay that makes sense to people who haven't been keeping up with your blog, people will link to it and then your blog might even make the technorati top 100 some day ;)

[Owen]

Dan, I know this is your blog to do with as you wish, but I'm curious: Both in the Mercury blog on technology and the current citizen journalism blog, you keep introducing pieces on real estate bubbles, and particularly the phenomenon in the Bay area. Why focus so intently on this financial and geographical area to the exclusion of so many other examples of market and society foibles?

[anonymous]

"these new products are adding fuel to the fiery demand for homes... But the bullish pace of housing prices has also clearly boosted demand for new products that make it easier to enter the market"

Sort of like the old joke about why the government collects highway tolls: to pay the toll collectors, to collect the tolls.

The upswing in the market, is driving the upswing in the market.

I think Dan is right; this is going to get ugly.

[Dan Gillmor]

Owen, the piece I pointed to here is a national story, not a local one.

The housing bubble worries me more than most because I think the consequence when it deflates could be horrific, more so than when the 90s financial bubble burst. People are grossly over-leveraged this time, unlike the last time. And surveys indicate that the "wealth effect" is much more closely tied to housing values than stock appreciation.

I think it's an overwhelming issue locally because it ultimately puts the Bay Area at a serious disadvantage in competing on the national and international level in the future. I live here and care about that.

[Owen]

Dan - fair enough. Perhaps because I'm a conservative investor and spender, the consequences to greedy or stupid people who try to ride the bubble -- any bubble -- don't arouse pity on my part. But you're correct that the collateral damage to any bust hurts innocent bystanders, so I shouldn't be so smug or insensitive.

[Don Marti]

What about the banks? Could the coming collapse of the Housing Bubble take them down with it? Or are all the home equity loans re-sold to other companies that are at greater risk?

[Dan Gillmor]

Don, the banks have offloaded the risk to mortgage resellers, for the most part. And the big ones have implicit taxpayer backing -- namely Fannie Mae and Freddie Mac, which are taking massive risks with our economy.

Congress and the White House, of course, wink at all this as they ramp up the twin deficits to historic and utterly unsustainable heights.

We're borrowing from our kids' future. Unfortunately for them, they probably won't be able to pay it back. They're gonna be angry us when they realize what we've done to them.

[Jim Wilde]

Hey Dan,

FYI "Whenever housing prices soar -- in Shanghai, San Francisco or Santiago -- experts wonder whether the cause is a speculative bubble that could eventually burst, causing widespread distress." from knowledge at wharton.
Attention, Speculators: Here's a Lesson from Hong Kong's Housing Bubble

[Chris Yeh]

Mark my words. Throughout history, there have been four statements that marked every bubble.

1. This time it's different.
2. The rules have changed.
3. Prices can only go up.
4. Everyone is doing it.

We have now fulfilled all four of those statements. If only I had a way to short this market....

[Ran Talbott]

"I think a big question is how many people are actually taking on these 'risky' loans?"

Well, about half the loans being written now are ARMs. This is up fromm about a fourth of them early last year, and an eighth a few years ago. Considering that nothing short of space aliens arriving to pass out free pocket-sized fusion power plants and matter transmuters will take interest rates lower, most of those should be considered "risky" in some sense. Some because the buyer couldn't qualify for a fixed-rate loan, and may be forced to sell at the first sign of trouble. Some because the buyer has already decided to bail before rates go up. Both of those groups represent a near-term risk of unusual selling pressure on the market, because they're not planning/able to ride out a dip the way primary residence owners normally can.

The bean-counters at this large mortgage insurance company:

http://home.businesswire.com/portal/site/pmi/

are already estimating odds of 50-50 or so that prices will go down in several of the biggest and hottest markets.

"But it seems like there are plenty of people that will take their place and pay the big bucks."

If you're thinking of "principal residence owners", it looks to me like most of those people have already stepped in: the increasing number of those dicey loans suggests that the supply of buyers who qualify under
traditional criteria is drying up. And paying "the big bucks" already doesn't make long-term investment sense in those markets where costs have far outgrown rental ROI. The "Greater Fool Theory" is more problematic in the real estate market than the stock market, because the size of the purchase usually means that the Greater Fools have to convince someone else to lend them lots of money. As lenders get nervous, that'll become much harder than it is now.

[Ran Talbott]

"Could the coming collapse of the Housing Bubble take them down with it?"

Keep in mind that this is only a "bubble" in some areas, and that even in those areas the major effect for most homeowners will be a loss of some paper profits. Although a bunch of people who foolishly borrowed and spent those profits will get hurt, or even wiped out, the impact on the economy as a whole won't be big enough to take down any big banks.

Rather than any great 1929-style crisis, what we'll see is an especially nasty recession, exacerbated by the fact that most of the fiscal and monetary levers that might be used to moderate it have already been pulled.

Ironically, in areas where the local economy does take a significant hit, the mortgages that the banks sold off will probably be the safest debts, because over-extended borrowers trying to ride out housing slump will tend to delay/default on the consumer loans the banks are still carrying to make their mortgage payments.

[mythago]

People are in serious denial about this. What I usually hear is "Everyone's been saying it's a bubble for years, and it STILL hasn't burst." Ponder the illogic and marvel in its intricacy.

Owen, it's easy to dismiss a lot of people who get ARMs as merely stupid and thus deserving of their eventual fate, but I suspect they're less stupid than desperate. If you're a first-time homebuyer looking to get a house for your family, and all you see is prices going up and up and up, and here's the nice bank person showing you all kinds of numbers that say you too can afford a house--unless the bubble bursts, and what are the chances of that, right? In the face of that, arguments like "There's just no more land in San Francisco" and "Prices will never really go down" sound quite persuasive.

That said, surely Congress could eliminate the deduction for home equity and leave the interest deduction for plain ol' mortgages untouched? That would protect homeowners without giving a bonus to those who are using home equity as a kind of deductible Visa card.

[Bob Rosenberg]

This morning, I heard on NPR that some developers here in Phoenix are requiring signed affidavits from Realtors that the buyer will occupy the residence. If the buyer is, instead, an "investor", these developers are telling the Realtor to forego the commission.

[Smart, Not Angry]

"We're borrowing from our kids' future. Unfortunately for them, they probably won't be able to pay it back. They're gonna be angry us when they realize what we've done to them."

I'm 25, so perhaps one of these "kids". I realized 5 years ago what's been done to us, over the last 20 years especially. But I'm not angry. I make enough to be ahead of the curve. I'm stockpiling cash (less, lately) and gold (more, lately). I'm moving somewhere "safe" (Australia? or maybe South America) when things start to get really ugly. Um, not when. Before.

[Al]

Carl, the April job numbers far exceeded the estimates. The trend is good and things "feel good" whare I stand. My point about the jobs numbers and Kerry is the magnitude and size of the news would have been much greater. It's not the number of stories, but the lack of excitemnt over the story. I stand by what I said. If Kerry was in, we'd be constantly reminded about it in the media.

Concerning the number of "deferred principal" (this seems more accurate than a "no interest" loan) loans, people need to be educated about them.

Even if the market takes a dive, I'm not sure the bubble will burst. There seems to be a lot people who will suck up the properties and they would "redrive" the prices up.

It will take some serious shock in the system for the bubble to really burst. So I think there will be regional and local corrections but the bubble won't be "bursting" for awhile.

[Al]

Ya know, wait a minute. From a human perspective, not many people want to see a market collapse and we would want to warn people of a bubble collapse. But being a midwesterner, I'm not so keen about moving to, say, California and having to deal with earthquakes, mudslides or fires. Every so often something likes these happen and people suffer. We all know that there is going to be some big earthquake that will hit the bay area at some point. How many people will die and what will be the property damage? It will be huge, right?

The reality is it's none of our business what people do. If these loans are legal, all we can do is educate the consumer. Otherwise, we're being arrogant. Again, it's none of our business. I sense that some people (Dan?) want the government to "do something." Like what? If we're going to stop people from buying real estate because "we" think it's risky, then why not stop building in earthquake zones?

[mythago]

If it's "none of our business," then why bother educating people?

[Al]

Well, maybe "education" isn't the right word. It's more about providing information.

[blue]

I've been wondering just how the people that are going to lose out, will. The most vulnerable are the people that have taken equity out of their house to buy an 'investment' property, seen that property (and their primary residence) grow in value, and are then taking equity loans out of 2 or more properties to buy additional properties.

The nature of this (investment properties require 25% down at a minimum) is pushing people to 'other' cheaper areas, because they're only able to afford 25% of something that is a lot less expensive.

These properties need to be rented but the rent doesn't cover the 75% that is mortgaged. The view of the investor is that while the rent doesn't cover the mortgage, the increase in value of the property over time will more than compensate for having to pay an extra $200-$500 per month to 'carry' the property for a year or two.

In order to keep the mortgage on the 'investment' property as low as possible, they choose 'deferred principal' mortgages for the 75% of the house that they didn't put down.
The 25% that they took out as an equity loan
on their other property is (by definition?) a floating rate loan.

So they 'own' an investment property (or several) that is 100% financed by loans that don't reduce principal AND are subject to rate increases.

It seems to me that they are more invested in interest rates staying low rather then real estate.

Home prices don't need to fall to squeeze these players, if interest rates spike then the cost of carrying these rentals will double. The last time this happened, I remember waiting in gas lines on odd numbered days, and these days we're AT WAR IN IRAQ.

When the cost of carrying these properties in Austin, Reno, etc. gets too high due to an interest rate spike, the investor will want to sell their investment property. They will need to cover the 75% 'first' mortgage with the sale price, so they will become increasingly 'motivated' as prices slide toward that number.
If interest rates are spiking, then there will be fewer buyers looking to purchase a 'rental'.

Keep in mind that they still have a 25% down payment that they took out of another property.
The fact that they took equity out of their other property means that that property is mortgaged out to the upper range of house prices and will need to be sold for full price in order to pay off the existing mortgage and the adjustable second (which is causing the rising interest rate pain).

The 'investor' at this point may sell the most recent purchase for 100% of the purchase price but will lose a portion of that to commissions and the cost of carrying the 'investment' during that time. This will cut off the cost of carrying pain, but will do nothing to alleviate the pain of the adjustable equity loan used to buy it in the first place. They will continue holding the first properties and work overtime to pay the monthly costs.

The nature of the adjustable loans is to steadily increase the principle payments over the first 5 years totally separate from the interest rate, so they might see a 4.5% loan become a 6.5% loan AND on top of that a steadily increasing principal payment. This will mark the bottom of the real estate boom.

The smart thing to do would be, at the first whiff of this, to sell the principal residence and move into the rental in Reno or Austin, but eeEEWWWww it's ssSSSOOOoo hot there!?!?
It's always about location.