One of my favorite econopundits, the Penobscot Princess (still running in stealth mode), penned an intriguing dissertation on the "Housing Situation."
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First things first: A faithful reader forwarded me this quote from an article in yesterday’s Washington Post which discussed the HELOC/HEL bulletin that had been put forth by the OCC et al. You may wanna’ siddown before you take it all in, it’s that far beyond the pale:
"As long as the housing bubble doesn’t burst, home equity lines should remain strong and remain safe," said Scott Stern, chief executive of Lenders One, a St. Louis-based cooperative of 60 mortgage companies that originate home-equity lines, including some that feature 100 percent loan-to-equity ratios. "As long as the bubble doesn’t burst, there should be no serious problem."
Well, whadda’ ya’ think of that gem, eh? The CEO of a mortgage cooperative acknowledging a housing bubble!
And in the same breath quasi-dissing it as long as it remains intact.
Two things come to mind:1. I surely hope that Mr. Stern has been quoted out of context. Way, way out.
2. I wonder if Mr. Stern understands that they call ’em bubbles because inevitably, they burst. Or has the real estate industry discovered some magical way to let all that air out, a teeny bit at a time?And just to get you further riled up, check out these couple of on-line ads:
Jumbo Interest Only Loans 1.00% "Pick Your Payment" Mortgages Jumbos, Bi-Weekly & more! 5 1 Arm Libor Bad Credit OK. Interest Only Option Fast & Easy Online Application.
Okay, the first one has a "30-second" on-line application. The second one incites the borrower to "ask about our 1% Pay Option ARM and interest-only loans." You gotta’ love it.
A 1% mortgage. As a noted Street pundit commented, this type of home purchase is more akin to renting from the bank with an option to buy later. And since, for all intents and purposes, loans of this crazy nature transfer 100% of the risk to the lender, I’d go a step further and classify the buyers as squatters, not home-owners. And that fact makes a great case for leaving the keys on the kitchen table and walking away very easily when "lights-out" is sounded. Very easily. But alas, I digress.
Now that we’ve got your attention, how about some hard facts? (Ahem):
According to the Mortgage Bankers Association, ARMs accounted for almost 46 percent of new mortgages in 2004 in $ terms and 32 percent by number. Compare to ’03 which marked 29% and 19%, respectively. How telling is it when ARM use is up so significantly when fixed mortgage rates are pretty much flat from ’03?
Stretch. Stretch.
The Federal Housing Finance Board also chimed in on the ARM topic by noting that ARM share is particularly significant and on the rise in the "boom" markets. So there’s your proof as to what this ARM surge really means. And while there are surely some financially savvy players who are benefiting from the ARMs and other exotics, we are very confident in dissing the junk alibi that gets passed around every time the topic of ARM use comes up: simply looking to pay off the house in 3 years and move elsewhere. A cold-water flat sounds about right. Next.
Interest-only mortgages accounted for 23% of the $ value of non-agency mortgage securitizations in ’04. These are high-risk ARMs and it is generally thought that they are being sought increasingly by those with bad credit and/or those who want those no-doc or low-doc loans. (Crack dealers come to mind). Sub-prime mortgage lending jumped to almost 20% of all loans (by number) from 9% in ’03.
This marks a reversal in a 3-yr. decline in same. Now check this out: "The majority of subprime loans have been characterized by short-term adjustable-rate structures, many with prepayment penalties." (Ref.: FDIC citing "Mortgage Originations by Product", Inside Mortgage Finance, 2/25/05.) In for a nickel? In forever.
9% of ’04 mortgages were taken out by investors vs. 6% in ’03. (Newbies: "investors" is French for "speculators".) BUT: In at least some of the red-hot markets, this number is estimated to be as high as 19%.
"Academic studies show that residential property investors are less loss-averse than owner-occupants and thus more likely to sell precipitously in a declining market, thereby aggravating any existing downtrend in home prices." … (Ref.: FDIC citing Loan Performance.)Cover your short in air-sick bags.
Average US home prices rose by ~ 11% in ’04, the largest nominal gain since 1979. That 11% is up from 7% apiece in ’02 and ’03. Want to adjust for inflation? Okay, then call the price appreciation 8% which is still a 30-year speed record.
As for a couple of items that help to shape the direction of home prices, how about we look at:
Rent: +2.7% in ’04 and +2.3% apiece in ’02 and ’03. Oops, these comparatively lame increases surely do not validate soaring housing prices, eh?
Additionally, the rents figure surely make a further mockery of the OER line item in the CPI, but that’s another day another story!
Income: +5.8% in ’04 and +4.2% in ’03. While these figures beat the rent increases, there is still no justification in saying that personal income levels are driving prices. Au contraire, this is further evidence of the big stretch
John Q. is making in order to buy a home. Or three.
The NAR (National Association of Realtors) compiles a "housing affordability index for first-time homebuyers" which utilizes home prices, in comes and interest rates. Last year, that index slipped 3.8 pts. to a read of 77.7.
Now bearing in mind those underlined-above factors considered by this index, it is thought-provoking to cogitate these comparisons: The index also dipped during the recession of ’91. Think income. And the all-time low, 75.9, was marked in 2000 when mortgages were 8%. Think interest rates.
Thus, considering our current mélange of 1) soaring home prices, 2) stagnant wage growth and 3) a rising-rate environment, ’05 is shaping up as a Trifecta in making a case for a further decline in the NAR’s affordability index for ’05, right?
Now go a step further and consider what could happen when first-time buyers are heading towards being shut out of the market. Besides boarding your daughter and son-in-law in the basement for another couple of years, we could make a case for overall slowing sales and of course, lower prices.
Back in February, the FDIC issued a report which called into question whether a housing price boom was always followed by a bust. For some reason which the astute will be quick to surmise, they felt the need to re-issue an updated report on the same topic. A couple of weeks ago. In the May 2 version, they used updated info including the HPI (Housing Price Index) which is put together by OFHEO. (That’s where the above data on rents/income comes from.) Anyhow, the FDIC currently finds that the number of *boom markets increased by 72% last year and "now includes some 55 metropolitan areas".
*Boom according to the FDIC: inflation-adjusted prices up by at least 30% in a 3-year period; the define a bust as a home price decline of at least 15% (nominally) over 5-years.
(And before we go on, please note that the FDIC uses the term "housing boom" which is far less toxic than the term "housing bubble" in that a "boom" has a shot at a soft landing. Dig?)
Here’s what they had to say:
"The broadening of the U.S. housing boom during 2004 may imply a growing role for national factors-including the availability, price, and terms of mortgage credit-in explaining home price trends. To the extent that credit conditions are in fact driving home price trends, the implication would be that a reversal in mortgage market conditions could contribute to an end of the housing boom. While history clearly shows that housing booms don’t last forever, the manner in which they end matters for mortgage lenders and borrowers alike."
A reversal in mortgage market conditions. Ooh, they’re getting warmer, eh? But not quite. Because they concluded in the report that a housing boom does not necessarily lead to a housing bust.
According to the FDIC, bust followed boom in only 17% of the incidences prior to 1998. Cool. Now what? Well, they went on to point out that busts are generally precipitated by some kind of shock to the local economy. I’m thinkin’, for example, certain parts of Jersey when Lucent went haywire. The FDIC also explained that these busts resolved themselves eventually, but only after a period of stagnant prices (the extrapolation of the possibility of a period of stagnant prices in the current speculator-driven frenzy is far too painful to ponder) which played out over time as the economy/household income was scurrying to catch back up with the home prices.
They also opined that owing to the economic-distress factor which almost always precedes a bust, that they feel the metro areas (which are the hottest markets) are for the most part, buffered.
But then they finally turned the screw as they signed off as follows:
"But to the extent that credit conditions are driving home price trends, the implication would be that a reversal in mortgage market conditions-where interest rates rise and lenders tighten their standards-could contribute to an end of the housing boom. While our analysis shows that boom does not necessarily lead to bust, it remains to be seen to what degree the current situation might differ from our previous experience in U.S. housing markets . . . "
Oh, there it is again. "a reversal in mortgage market conditions". That was on May 2. And that report is lengthy and also talks about current, funky lending practices, yada, yada, yada. And then the FDIC joined with the OCC, the FED and other regulatory agencies in issuing that warning/bulletin Monday on the OCC website. Which spoke about higher rates and tighter standards, i.e., a reversal in mortgage market conditions.
Uh-oh. They know. They all know. Every agency that signed off on that bulletin knows. But just how far the FED takes the rate-hike game, remains to be seen. Ask Orange County. Ask Mexico. Ask LTCM. Ask your neighbor with the HELOC.
Next.
2/3 of SF Bay Area mortgages are interest only:
http://sfgate.com/cgi-bin/article.cgi?file=/c/a/2005/05/20/MNG5CCS82U1.DTL
(check the graphs too by clicking on the pic on the right). The percentage of interest-only loans is highest in Vallejo, which basically means people who are most stretched in the area…
Barry, is there a link to the Penobscot Princess for this?
TIA
A note-perfect analysis of the current market and its risks, in my opinion.
I would add this however, regarding the expansion of credit and how this has played a part in the boom/bubblette pickle we find ourselves in:
At roughly the same point that the chart of the day bubble-baton was passed (in your previous post), Fannie and Freddie introduced their desktop underwriting software suites (“Desktop Underwriter” (DU) and “Loan Prospector” (LP) respectively.)
[*If you are not familiar, these are credit-based underwriting computer models, or shortcuts. Basically what a banker or broker does, is enter all the application, asset, income, and credit data, click a button, and out comes the approval. Provide this electronic approval to an underwriter, along with the supporting documents for income assets et al, and the loan gets funded. Period. I’d say 95-98% of all Fannie/Freddie product is now originated this way – since they require these loan “findings” in every file.]
Literally overnight, the roll-out and following widespread use of these systems resulted in loosening of traditional underwriting practices that I am sure is unprecedented in the history of banking. How much had they been relaxed? Get this: Prior to “desktop” underwriting, the allowable debt-to-income ratio for a borrower was pegged at about 29%/36% (house payment no more than 29% of income, total debt including mortgage no more than 36% of income)
With the desktop underwriting software, it is now ROUTINE for a borrower, even a first time buyer, to have a debt to income ratio upwards of 55%, and 64% is very common. Let that sink in for a second. Now combine that with the fact that many of these loans are zero down, interest only, ARM’s.
And remember, this is Fannie and Freddie – not even the sub-prime market (which amazingly has lower debt ratio maximums) I’d say that this dramatic, unbelievable, increase in what an individual with a given income can qualify for has had more impact on the increase in sales prices than low rates ever could.
I’ve been talking about this for two years, and have yet to hear anyone else even bring it up. Whenever we hear warnings about credit expansion/risk in the housing market, the conversation seems to focus on the product (zero down, interest only, ARM’s etc.) but never on the underlying underwriting practices – which is really where the dramatic shift has been, and I think most of the risk is. For my money, A 30 year fixed rate mortgage where the monthly payment is 64% of the gross monthly income (can one even get 64% of income to the bottom line, after taxes etc? Not in Minnesota) leaves a lot slimmer margin for error than an ARM whose rate may adjust upwards by a point or two, in a year or two, but was underwritten with a traditional 29/36% debt-to-income ratio.
In fact, I might even take it a step further. To put a first time borrower, with no history of ever having made a mortgage payment, into a loan with a payment that when combined with other debts is 64% of their income, is as irresponsible a practice as I can think of in banking – a lot worse than many of the credit card companies practices, in my opinion.
One might ask – if these practices are so bad, why have we not seen more defaults? Part of the answer might be this: People have mostly been able to get away with it because they were able to tap-in to their home equity rather quickly – within a year – and wrap those other debts into a HELOC or other similar product. What happens when the appreciation bonanza ends, and HELOC rates rise? Some people are going to find themselves in a really tough spot, I think.
This topic has been bugging me over the last year. As long as it is a legal practice to award mortgages to people who can’t afford them, we’re on a bad course for failure. Let’s assume the bubble never takes place; still these people will probably be living this way for years because they start out in a huge hole. Not to mention there is always more wiggle room to borrow more, right? What happens when these people hit 40, 50 and 60 with little show in the retirement fund?
But this is how our country is built; on debt. We do not teach personal finance in high school or college and our parents haven’t passed on the proper education becasue they don’t have it. See, the average worker cannot go up to the factory and rasie 4 kids with Mom at home like it used to be. So when the recent past and current generations get into the real world it is a darker landscape.
My fear is that we could have future generations in worse shape than we are now. I though our children were supposed to have it better? Well, I suppose they do for now. I just authored a book title I’m Not Flipping Burgers When I’m 70 and I’ll be damn sure that I’ll be placing the order. Hopefully I can reach a few people so they do not make too many mistakes.
This topic has been bugging me over the last year. As long as it is a legal practice to award mortgages to people who can’t afford them, we’re on a bad course for failure. Let’s assume the bubble never takes place; still these people will probably be living this way for years because they start out in a huge hole. Not to mention there is always more wiggle room to borrow more, right? What happens when these people hit 40, 50 and 60 with little show in the retirement fund?
But this is how our country is built; on debt. We do not teach personal finance in high school or college and our parents haven’t passed on the proper education becasue they don’t have it. See, the average worker cannot go up to the factory and rasie 4 kids with Mom at home like it used to be. So when the recent past and current generations get into the real world it is a darker landscape.
My fear is that we could have future generations in worse shape than we are now. I though our children were supposed to have it better? Well, I suppose they do for now. I just authored a book title I’m Not Flipping Burgers When I’m 70 and I’ll be damn sure that I’ll be placing the order. Hopefully I can reach a few people so they do not make too many mistakes.
This topic has been bugging me over the last year. As long as it is a legal practice to award mortgages to people who can’t afford them, we’re on a bad course for failure. Let’s assume the bubble never takes place; still these people will probably be living this way for years because they start out in a huge hole. Not to mention there is always more wiggle room to borrow more, right? What happens when these people hit 40, 50 and 60 with little show in the retirement fund?
But this is how our country is built; on debt. We do not teach personal finance in high school or college and our parents haven’t passed on the proper education becasue they don’t have it. See, the average worker cannot go up to the factory and rasie 4 kids with Mom at home like it used to be. So when the recent past and current generations get into the real world it is a darker landscape.
My fear is that we could have future generations in worse shape than we are now. I though our children were supposed to have it better? Well, I suppose they do for now. I just authored a book title I’m Not Flipping Burgers When I’m 70 and I’ll be damn sure that I’ll be placing the order. Hopefully I can reach a few people so they do not make too many mistakes.
This topic has been bugging me over the last year. As long as it is a legal practice to award mortgages to people who can’t afford them, we’re on a bad course for failure. Let’s assume the bubble never takes place; still these people will probably be living this way for years because they start out in a huge hole. Not to mention there is always more wiggle room to borrow more, right? What happens when these people hit 40, 50 and 60 with little show in the retirement fund?
But this is how our country is built; on debt. We do not teach personal finance in high school or college and our parents haven’t passed on the proper education becasue they don’t have it. See, the average worker cannot go up to the factory and rasie 4 kids with Mom at home like it used to be. So when the recent past and current generations get into the real world it is a darker landscape.
My fear is that we could have future generations in worse shape than we are now. I though our children were supposed to have it better? Well, I suppose they do for now. I just authored a book title I’m Not Flipping Burgers When I’m 70 and I’ll be damn sure that I’ll be placing the order. Hopefully I can reach a few people so they do not make too many mistakes.
Read your article regarding the housing bubble on Yahoo. (they said click here to comment – but there was no here).
Excellent and insightful I thought – though when I first saw the premise (there is no bubble) I thought the piece would be a dud. Your logic was well thought out and the numbers made sense.
You did leave one thing out however. That is that when most people buy homes they are heavily margined. If the value drops by 20 percent – it makes economic sense to walk away – and I know many people who did just that (I live in the Los Angeles area). I also had several clients (mortgage lenders – I have a small software company supporting Motgage Loan Origination) go under.
What I see is simple. Housing in the blue states is overpriced and will likely decline slowly over the next 10 years (seems to be the historical cycle). If you have the ability to wait it out, that’s fine. Otherwise hold off at least for a couple of years. If China stops buying T-Bills, then anything could happen. The notion that we have licked inflation is bogus. We’ve licked it so long as there is a divided government. If any single party is in power – then there are no constraints.
Housing is still a good buy in the red states. I am bying rsidential property in Dallas as fast as I can because I can buy quality real esate for less than replacement cost.
The important thing is we have choices and we must chose something – not doing anything is still making a choice. I think holding cash is likely bad, particularly US Dollars. You were right on when you talked about intrinsic value.
Hey there,
I am a full time student currently renting a home. I have come across a home that I feel will benefit me if I purchase it. I was wondering if there is a zero down interest only loan?
I just came across this blog cause I had nothing better to do since MTV’s VMA show was horrible!
The 1% Option Arm isn’t a bad product. It’s really inteded for people who either feast or famine – such as entreprenuers, business owners, 100% commission sales people, etc.
Unfortunately, the vast majority of lenders don’t really understand this product and they’ll sell this product to anyone and everyone. If you have a decent lender they won’t jack you with a high margin.
I have been talking about this for 4 years. I have been warning all my friends (fellow homeowners) just as long. I lived in Bubble Country (Orange County, CA) until 2 years ago. That is when I put my money where my mouth is. I sold at a huge profit in just 5 years, taking my gain with me. This is what I think is going to happen over the next few years from a CPA’s perspective, with each step causing the next step (steps 1-6 have already occurred):
1. Housing markets increase, slowly at first. Faster in the “Hot Markets”
2. First-time homebuyers get scared, want in, and need low payments. Homeowners want to enjoy newfound equity (upgrade older homes), especially in “Hot Markets”
3. Lenders oblige by aggressively marketing Interest-Only loans (mostly ARMS) and HELs, and relaxing requirements to obtain such loans. About 50 – 70% of all new loans in “Hot Markets” are IO/ARMS
4. Potential for huge gains using IO loans attracts new (but naïve) real estate investors (as well as seasoned investors) who use equity in primary home to finance investment propert(ies). This all combines to fuel an unprecedented demand for housing.
5. Interest rates rise, imperceptibly at first, to fight inflation levels, partly caused by rising housing prices.
6. As Interest-Only periods start to end, payments rise as much as 70% (based on only a 2% rise in interest rates) because (1) catch-up principal payments (2) shorter amortization period (20-25 years for remaining loan) and (2) rising interest rates. If rates are still low enough, some borrowers will refinance into another IO loan to avoid the large payments, postponing the inevitable for 5 to 10 years. (I believe this is where America is today because interest rates have not yet significantly risen.)
7. IO loan borrowers tap out remaining resources (Stock market/banks) to make payments. Stock Markets drop as money flows out to meet the higher payments.
8. Unsophisticated investors are hit with 2 or more rising mortgage payments at the same time, leading to foreclosure/bankruptcy because (1) a double/triple, etc, effect with no increase in income and (2) inexperience in timing market changes and setting sales price, leading them to ride the market down.
9. Sophisticated investors unload property, priced for quick sale. Lenders unload foreclosed properties as quickly as possible to limit their losses.
10. Property values start to plummet as properties flood the market.
11. Most IO borrowers cannot refinance, especially if steps 6-10 happen simultaneously because (1) new fixed rates will be higher than ARMs and (2) outstanding loans will exceed property values.
12. Steps 6-10 will repeat over and over, causing ever increasing declines in both the stock and real-estate markets, as (1) houses get harder to unload due to market supply, (2) lenders with a significant IO position go under, (3) money is pulled out of the stock market to mitigate the huge losses and payoff IO loans, and (4) Fannie/Freddie losses are reflected in the market.
13. Record foreclosures/bankruptcies will follow as property values plummet, particularly in the previously “hottest markets” where most of the IO loans originated.
14. Given the new bankruptcy laws that work more like “reorganizations” than a “fresh start,” thousands will carry this debt and bad credit ratings for decades. Some will never recover. Many, many will never be able to afford a home again with a government bailout. Today, more than ever before, there is no “walking away” from a mortgage. The effects on our kids’ futures could be devastating as well.
I have to agree with James, the Option ARM is NOT a bad product. BUT, there are BAD brokers who sell them to others just to make $$. We can argue all day as to who benefits or who doesn’t from the POA, but that’s not the issue. The issue is the moron brokers who sell this product to the people who shouldn’t get it. If that’s you, please get out of the mortgage business, we have our quota of morons as it is. This type of mortgage is NOT designed to get people into bigger houses. If it’s sold that way, the person selling it is dead wrong, period.
Also, to have the best effect for the borrower, you should have at least a 20% equity position in your home. I have heard of the Pay Option Arm being sold at a 100%ltv. If someone tries to sell you on that product….RUN AWAY!
Be careful of the person selling the product, not the product itself.
I’m just giving my 2 cents worth when dealing with the Pay Option Arm.