ARC's 1st Law: As a "progressive" online discussion grows longer, the probability of a nefarious reference to Karl Rove approaches one

Tuesday, March 11, 2008

I Seem to Remember a Prediction I Made I Made about a "Housing Bubble"

I have held off mentioning this, but as I watch the dollar melting down, perhaps this is the time.

Somewhere in the archives from more than a year ago on this blog there is a post from me saying that housing prices were running out of control. At that time they were heading up, fast. Now the worm has turned.

Low interest rates driven by the geniuses at The Fed, made buckets of money available for home buying. And buy they did! And then they bought some more. "Flipping houses" became part of the language. Nothing was actually being produced. Money chased money. Prices bore less and less resemblance to value.

The response I got to that post can be boiled down to this: "A house is worth what someone is willing to pay for it."

Well, in our neighborhood house prices were approaching one million dollars for three bedroom ranches in 2006. Today those same houses are going for something under seven hundred thousand and are still sinking. The bottom is not yet in sight.

What do we say to all the folks who bought houses in 2005, 2006 and early 2007?

If someone bought a house for $900,000 and it is now worth $700,000 and he does not have $200,000 in cash on hand, there is a word for that person, bankrupt.

All this does not take into consideration the effect of all those ARMs out there.

Well, as Rush might have said, I told you so.

And what are we doing now? Cutting rates further. Now we may not fuel a bubble but only facilitate otherwise bankrupt people in hanging on.

And when the inevitable inflation comes, see the $109.bbl of oil, what then?

What a mess.

Your Co-Conspirator,
ARC: MontereyJohn

Addendum: The Original post from September 2005 (Thnx to St.W for finding it)

Stuffing Money Under the Mattress and Consequences Thereof

From Reuters:

"The national median home price rose to $220,000, up 15.8 percent from a year ago, the report showed. That was the largest annual increase in prices since July 1979."

I may be crazy, but with what is going on in the housing market, the incessant bidding war among buyers that is driving the price of housing to astronomical levels, looks to me like the behavior of folks expecting the next deluge and their house is their ark.

Is there anyone that thinks the intrinsic value of housing is actually rising at 700% the rate of inflation? Does that make sense to anyone? And if it does not make sense, just what is going on here and what are the likely consequences of this behavior?

I have a conservative bent (duh!), but my suspicion is that we may see something that makes the dotbomb look like a Sunday school picnic. This has been going on way too long. Something has to give.

What happens when a bank that is carrying on the books a property against which it has a mortgage for $500,000 and suddenly the property is worth say $400,000? Multiply that by thousands of such properties and loans. What are the bank examiners going to do when they look at the books? Does ANYONE remember the S&L crisis?

Our banking system is far more centralized then it used to be. The failure of one large bank in Chicago nearly brought the whole system down a number of years ago (the Feds bailed them out). What would happen if the behemoth in Charlotte failed? Or the big boys on Wall Street? I shudder at the thought. I have visions of Weimar Germany and wheel barrels full of money that is worth nothing.

Just a thought.

Have a peachy day and sleep well.

Your Co-Conspirator,
ARC: MontereyJohn

Comments (7)
Brian said...

Strange, i seem to remember a lot more doom and gloom in your post from way back when.... Like the entire banking system was going to fail...

Some banks are going to fail, but only those that are most exposed to subprime. Just as those hedgefunds that were most exposed to subprime credit issues have already failed.

I agree now (and back then!) that real estate in select states and regions (Florida? And definetely California!) is/was way overpriced.

But so far we have only taken (depending on your study a 7-15% hit in prices). Depending ont he pundit we could expect another 0-10%. In 10 years that deficit would be expected to be erased. So if you just bought that million dollar home, its now worth 800-850k... If you sold it! But your still paying the same mortgage you did before because you have to live someplace.

As I believe I said before, this is going to absolutely KILL those "investors" that watched Flip this House and felt they could be millionaires in a few months. But to your average family that took a 10% down, 30 year fixed mortgage this is a non-issue.

As to your example:

If someone bought a house for $900,000 and it is now worth $700,000 and he does not have $200,000 in cash on hand, there is a word for that person, bankrupt.

No he has a -200k net worth. He's not bankrupt until he can't pay is obligations out of cash flow.

So simply "giving up the keys" isn't going to do him any good despite what the media says. He'll simply be sued for 200k, and he won't have credit to make another stupid mistake. He'll be a renter like he should.

Note that if said buyer in your example put 250k down, then he has a net worth of 50k....

Let's face it despite the media's attempts to portray otherwise a vast majority of all homes out there do not have suprime adjustable rate mortgages with no equity in the house.

If your buyer in your example was simply buying his house to flip it in a year, well then he made a bad financial choice. And he'll still need to come up the mortgage balance at closing to sell it. Or the bank will foreclose and sue him for the difference.

And its a bad thing for the bank to have to foreclose.. They could lose (in your example) over 250k worst case.. but thats not losing 900k...

Oh, and lets not forget about all those PMI payments people were making to make up for all those low down payment loans....

The people that ultimately will pay for all this are new home buyers, as they will not likely be able to qualify without large down payments. But as they say, "thats a good thing."

And please, we could cut the rates to zero and not affect the dollar much more. This will all be over in less than 18 months most likely, barring some major terrorist attack.

This is a bubble/bust cycle. Not a imminent collapse of capitalism and the banking system.

Even with the low dollar there is not a better place I'd rather live, work, or raise a family.

As evidenced by the millions streaming over our borders..

St Wendeler said...

MJ - Your prediction RE a housing bubble were correct. By the way, your prediction was made on 9/26/2005 and can be found here.

However, I'd like to point out something about the example you provide of someone having a $900k mortgage on a $700k property...

The only time that the value of the house comes into consideration is when the property is up for sale. eg, the banks won't care about the value of the asset as long as the person on the mortgage continues to pay the monthly payment.

For the idiots who took a mortgage which they couldn't understand nor afford (this also applies to those that borrowed 100+% of the value of the home at the time), they may choose to walk away from the property - resulting in the bank having to foreclose on the property. But the bank won't initiate foreclosure just because the asset is now worth less. Should be noted that property values are determined through analysis of recent transactions in the same neighborhood.

Many people are deciding to do just that. However, as Henry Paulson pointed out, many lenders and borrowers are working out arrangements to keep people in their homes (and paying their mortgages).

If the borrower is still able to make the payments and decides that walking away from the property, declaring bankruptcy, and living in an apartment (or their car) is not in their best long-term interests, the value of the house is not an issue.

For example, the value of my house has probably declined since I bought it 4 years ago, at least based on prices for comparable houses in my area. However, since I'm in a conservative, fixed rate 30 year mortgage (which is within not only my current income, but potentially manageable at a lower salary), I don't have any intention of moving in the near future, I'm not concerned.

I expect that home prices will eventually turn around... and that the hardest hit regions will see increasing prices in the future.

Like the dotcom bubble, some companies will fail... some people will be hurt (aka those who are taking unnecessary risk). buying 10,000 shares of or Webvan on margin is probably just as boneheaded as taking an adjustable, interest only loan for 100% of the value of a home you're buying.

I just hope that the politicians can find enough brainpower to show some restraint...

Brian said...

I'll also point out your prediction was 2 years too early.... :) Everythign didn't start going to a hell in a handbasket till last summer.

St Wendeler said...

Brian provides a link to this post at Housing Bubble blog which I think is instructive:

From ABC 7 News. “The high number of home foreclosures in Vallejo is one of the reasons why the city is facing budget problems. Today, on Mare Island, homeowners in danger of losing their property are getting help from real estate experts.”

“Tonie McGee and Matthew Criswell are trying to hold onto their 1,200 square foot condo. Their adjustable mortgage just went up two points and will rise again.”

They bought the condo eight years ago for $160,000. Over the years, they borrowed on equity and now owe $294,000. Similar condos next door won’t even sell for that much.”

“‘It’s either we’re going to afford it, we’re going to lose it, or we’ll be getting second jobs,’ says Criswell.”

They bought a property and ended up borrowing 1.8x what they paid for it?

And I'm supposed to feel sorry for them?

Over the 8 years they've lived in the condo, they've taken $134k out of their house? Or, added $17k to their income each year in the house?

And, when they decided to do this, they opted for an adjustable rate?!?!?

What the @#$$% were they thinking!?!

Monterey John said...

Hey guys, that increase (read: wet dream) in value figure back then was a national median figure not just California or Florida. My point was could value of housing really increase at 800% the rate of inflation? The answer to that was obviously and emphatic "no."

As for the banks, Citi is on the ropes. Our Arab friends have bailed it out once. Will they do it again? There is NO instituion in this country, not even Uncle Sugar, who can bail them out. What if the Arabs, or someone else, don't? Will they put good money in after bad? What will be the cascading effect of the failure of one of the world's largest banks?

As for bankruptcy, Brian, the situation I illustrated is the very definition of banrupt.

Prediction two years to early?! LOL! The truth is the truth. The handwriting was on the wall way back then. Only problem was, damn few people were reading it.

Monterey John said...

"The only time that the value of the house comes into consideration is when the property is up for sale..."


Let's say a large bank has one million loans. Those loans are no longer supported by real estate at the book value to the tune of $50k per loan on average. That's a cool $50 billion dollars backed up by nothing.

You really don't think that is a problem for the bank???

Believe me, the bank's investors, not to mention the bank examiners are not going to be as sanguine about that as you are!

St Wendeler said...

I do think that the bank has a problem... but that doesn't mean that the bank is going to enter into foreclosure if the borrowers are still paying. (although, some mortgages have a short-sell option...)

Believe me, the bank's investors, not to mention the bank examiners are not going to be as sanguine about that as you are!

The banks and the investors certainly won't be happy about that. And what will result?

The stocks of financial companies will crash (as they have since August) as investors and banks who "bet" on real estate backed securities will head for the exits. Citi may go down further than it's current $20 price tag... it may have hit a floor. For every seller who thinks C's crashing, there's a buyer who thinks the price is heading in other direction.

BTW, some financial institutions correctly hedged against the coming storm (eg, Goldman Sachs) and made a mint... that others were over-levered to mortgage backed securities speaks to the poor investment decisions.