Home Price Indexes, Prices

Schumpeter’s creative destruction just got more creative thanks to the Internet. Is it just bad timing that it’s coinciding with the end of a giant credit bubble or are the two related?

For those who are curious to see how ridiculous it would have looked to claim during the last housing bust (early 1990s) that it had already bottomed out after just one year, I put together some relevant pictures in this post:

http://streetlightblog.blogspot.com/2006/10/is-worst-really-behind-us.html

Thanks Barry, and Kash.
If we believed the RE BSers, ah..pundits, we would have seen that first there was no bubble, then that we had the first bubble that did not burst, then the we had the first bubble to have a soft landing. And now we have the first RE cycle to correct in 1 year instead of the 5-7 years EVERY OTHER cycle took.

hmm….I think that’s “annoy” (but the poor fellow can’t spell either…)

calmo, anony might’ve just been making an innocent humorous remark.

My hairstylist owns six condos she bought in ’05 only one of which has a tenant – yet still doesn’t pencil. She asked me what to do.

The graphs are pregnant with the possibilty for financial disaster for a meaningful segment of the population if the trends continue. Therein lies the rub, will the future course of housing prices decline precipitously on the back of an illiquid market. Can’t sell a property even at substantially reduced price ?

The Fed wil rescue the people by using “the” magic bullets, which are not inflationary btw. We know they exist, hidden away in a special room somewhere in Washington DC. At the request of George Bush, the Fed has used a machine gun loaded with magic bullets, non-stop, from 2002 until this present day, without causing the “I” thing and supporting the most wonderful period of growth ever. The magic bullet is so special that the chairman enlists the aid of the speculator wall street banks, men (and woman) of unquestioned moral compass, to help guide the special, magic bullet. Sometimes they ask the communists to help. Well, all the time actually. And our economic friends, the Japanese, who are deeply concerned about each of our little families.

So that’s it. The trends indicated on the graph simply won’t happen. Let’s party.

Not to dispute the general message that housing is rolling over, but what smoothing algorithm did they use to generate the dotted lines? They seem particularly smooth given the noise in the underlying data.

My name is Sean Olender and I’ve been expecting a housing bust since 2002. The shift to lax lending and mind boggling repayment terms 2003 to 2006 surprised me and prolonged the boom longer than I imagined.

Clients come to my office with incomes of $45K to $60K who have taken $600K or $700K interest only ARM mortgages to buy houses with ZERO down. A guy was in last week who was 22 and worked in construction with an income of $45K and a $700K neg am mortgage on a house he closed on 11/2006. These loan to income ratios are unbelievable. I wouldn’t be so amazed if it was one person, or three. But it’s almost every person who walks into my office. The most disturbing part is none of them understands any of their loan terms — not even the interest rate. They only know their monthly payment and they don’t know it will change in the future. They don’t believe me when I point out the terms in their own loan after they bring in their papers.

But the one thing that informed me for sure the boom was over and the downturn had begun was when a friend of mine bought a condo in a suburb of St. Paul. This friend is partly supported by parents and probably works 20 hours a week.

Bubbles in any asset (stocks, bonds, real estate, beanie babies, etc.) are defined by price increases as outsiders pile in to buy the asset. People on the outside see and hear about the money being made and want some of the action. The increased demand results in a self fulfilling prophecy that drives up prices. Eventually there are no ‘greater fools’ to pile in and at that moment the market shifts. It’s like musical chairs when the music stops.

Asset bubbles function like a Ponzi scheme but because the action isn’t controlled by a single person or group, it’s legal.

It’s been a long time waiting, but my friend signed papers in December 2005 and closed in January or February 2006. That for me is proof positive that the top was reached. I had lunch with an economist friend of mine in May 2006 and told him that the top was reached a few months earlier and he didn’t believe me. I drew a graph and he kept it. We’re having dinner tomorrow night and I expect I will be treated for my foresight because the data is bearing out my predictions at a slightly faster pace than I’d suggested at our last dinner.

Low rates aren’t going to save this. The fact that rates are near 45 year lows and the market is in free fall indicates that this is about more than rates. If rates stay low, this will be a terrible, drawn out slumping market with significant price depreciation, but probably causing only a short recession in the broader economy — perhaps two or three short recessions as we skip along the bottom of this mammoth credit bubble. But if rates should rise 1 or 2 points, the fast credit and money supply contraction from bad loans being written off might spell a depression.

And I know that all of this has started from the fact that a single person bought a single condominium. It means there’s no one left on the outside waiting to get in. No matter how loose the credit is, absent digging up corpses and giving them stated income I/O mortgages, there’s simply no one left — no ‘greater fool’ to rescue everyone who is in the market now — because I’m fairly sure that everyone is now in the market.

Having a fixed rate loan and not having to worry about foreclosure is nice, but a careful thinker will realize that it’s nicer for the bank than the borrower. If you buy a place for $161,000 and have no problems making the payments, but four years later someone buys an identical place next door for $98,000, it’s hard to feel good about being able to afford one’s mortgage payments. Not least it will make it almost impossible for a large group of people to freely move about because even if they can afford to make their mortgage payments, they won’t be able to afford to sell their houses without a deficiency judgment and the resulting credit stigma (which in my view is better than taking a $60,000 after tax hit to assets on an income of $25,000 a year).

The larger economic and social effects of this bubble will be very different than the last. This time those piling into the market weren’t day traders, investors, risk takers. This time it was EVERYBODY and that’s going to make the ride down have disturbingly broad effects on American society.

Yes, since 2002. Actually, my wife and I bought a place in 2000 and I thought Bay Area prices were lofty then after having risen smartly from 1998 to 2000. But I figured if there was a small drop in prices of 5% to 10% that it wouldn’t sting too much, so we did buy. But by then end of 2002 and into the start of 2003 I was stunned by how long prices had been rising. It made me downright nervous and we sold at the end of 2003.

I think that fundamental values were way off even back in 2003 — when rents, incomes, inflation and historical price movements are considered. I think there should have been a long period of flat prices or a drop in prices equal to 15% or 20% in real terms back in 2003/2004. But what happened after that was AMAZING.

I remember applying for a loan to buy a house in 2000 that was about 2.5 times the annual combined income of my wife and me. The lender scrutinized us fairly carefully. I’m self employed, so I had to provide three years of tax returns and sign an authorization for them to contact IRS directly for income information to make sure I didn’t fake the returns. They wanted bank statements, credit reports, my wife’s pay stubs going back years. They took it very seriously and my wife and I have good credit and the house was 2.5 TIMES OUR ANNUAL INCOME. We only put down 10%. We were nervous because it was such a big purchase and the responsibility of a mortgage seemed so serious.

Fast forward to 2006 and the average new mortgage is 8 times annual income, 10% down payments are seen as overly conservative, and there is virtually no investigation in to one’s actual income. I’ve had one man in my office who is illegally in the United States and he took over his sister’s $650K mortgage because she couldn’t make the payments. He said that she was unemployed at the time she bought the house and just wrote down that she made $90K a year. They didn’t ask for any proof of her income. She used a HELOC to make the payments for a year and then couldn’t so she asked him if he wanted the house and he took over her loan payments and moved in.

The loose credit is unbelievable. I can’t figure out why there isn’t worse price inflation unless (gasp) we’re really facing one of the most serious threats of price deflation since the Great Depression and 10% annual credit expansion is the only thing temporarily holding this place together. But it’s stunning that you can grab a homeless person off the street, get him a shower and shave and buy him a set of clothes and he will be able to borrow up to $600K on a stated income loan. It’s stunning that consumer and producer prices haven’t risen faster.

Whatever comes of this, it’s not going to be good. And I worry that the American character (and associated savings habits) is unprepared for such a shift and the results will be political instability that some interests may use to force through very bad policies and laws. We’ll have to wait to see.