Southern California’s Cultural Pathology
Southern California is a beautiful place. The weather is perfect, there is a lot to do, and the people are generally friendly and keep out of your business. For those reasons and many others, I have chosen to make Southern California my home. However, Southern California is not perfect. The culture is infected with pathological beliefs that have led us to the huge problem with house affordability and the impending disaster in our real estate market.
What do I mean by Cultural Pathology? There are certain beliefs if widely held and acted upon by a group of people leads inevitably to collective suffering and/or destruction. One example we all see is in the American auto industry. Before imports hit our shores the American auto industry used to believe the quality of their product did not matter, people would buy their product irrespective of quality. For many years, the industry was successful despite this pathology. This belief allowed offshore competitors to enter the market, build market share, and finally take over the industry. The American auto industry's belief system has had a pathologic effect on their business which has caused much suffering in Detroit, and it may ultimately lead to the bankruptcy and destruction of our major automakers.
The best treatise on the pathology of cultural beliefs was George Orwell's novel 1984. In Orwell's vision, a totalitarian State had convinced the populace the following:
- WAR IS PEACE
- FREEDOM IS SLAVERY
- IGNORANCE IS STRENGTH
Although these statements are clearly contradictory, in the story the slogans do make sense to the State. For example, through constant "war", the State can keep domestic peace; when the people obtain freedom, they become enslaved to it, and the ignorance of the populace is the strength of the State. Just as Orwell's Big Brother convinced the populace the above contradictions were true, Southern Californians (with a little help from their own Big Brother, David Lereah, president of the National Association of Realtors) have convinced themselves the following:
- APPRECIATION IS INCOME
- CREDIT IS SAVINGS
- DEBT IS WEALTH
Just as these statements are contradictory and ridiculous, the proof that these statements are believed is that they are reflected in the actions of Southern Californians. For example, through borrowing against one's increasing home values, appreciation is turned to income; when people obtain more credit, they spend it like available savings, and a large amount of debt used to finance a large, opulent home makes one wealthy. Ask any homedebtor in Southern California, and they will tell you that makes perfect sense.
The problem is rooted in a basic misunderstanding of what separates the rich from the poor: the habit of saving. You have heard the expression, "the rich get richer and the poor get poorer." It is more accurate to say the rich save money and the poor spend it: in the end, the rich will have money, and the poor will have none. This is not one of life's inequities, but rather of of life's simple truths.
When you hear your average Joe tell you he wants to be rich, what he is really saying is he wants unlimited spending power. He wants the ability to spend like the rich people he sees wearing Rolexes and driving BMWs to their mansions in Shady Canyon. This is why, when given the chance, poor people will emulate the rich by spending beyond their means in order to be rich. Of course, in the process, they spend themselves poor.
Appreciation is Income
Look at the difference between the behavior of rich and poor when it comes to home price appreciation. The rich view home price appreciation as adding to their net worth. If lower interest rates allow them to refinance, they will restructure their debt to pay off the loan more quickly in order to increase their wealth. Poor people view home price appreciation as income; free money for them to spend. If lower interest rates allow them to refinance, they will restructure their loan to pull as much home equity as possible and reduce their payment as much as possible so they can spend more. If any net worth happens to accumulate, they obtain a home equity line of credit and spend the appreciation as quickly as possible -- it makes them feel rich even though it really makes them poor.
Credit is Savings
So how do the rich and poor deal with credit? The rich don't carry consumer debt. Why would they pay interest on a credit balance when it almost always costs more than the income they earn on their savings? The rich will use credit sparingly and most often pay off any credit balances each month as the bill comes due. In contrast, the poor carry as much consumer debt as they can afford to service. Whenever they receive an increase in a credit line, they believe they have more money to spend, just like it was savings. In a strange way, a credit account is like a savings account, only it has a negative balance. In a savings account, the saver earns money; in a credit account, the spender loses money. Again, the rich have savings, and the poor have credit.
Debt is Wealth
There are a great many Southern California residents who live in big houses, and they believe that makes them rich. To them, the possession and use of an expensive house makes them wealthy even if they have no equity in the property. The rich buy less home than they can afford and work to pay off the debt in order to maximize their net worth. 
The poor stretch their finances to possess more home than they can afford with loan terms which never retire the debt, or in the case of negative amortization loans, actually increases their debt held against the property. This ensures they either never gain any equity or only gain it by appreciation, and as mentioned previously, if prices appreciate they quickly withdraw the gain to fuel more consumer spending.
It's a California Thing
So what happens when you give poor people money? They spend it. I'm sure you have all heard the stories of people who won the lottery and managed to spend themselves into bankruptcy a few years later. These stories are classic examples of the pathology of the beliefs of spenders. A great many Southern Californians are spenders. This is why I contend that Southern California has a strong cultural pathology. The reason our house prices have been bid up to such dizzying heights is because there is a high percentage of our population in Southern California that subscribes to the spending habits I have described. They went out and borrowed as much money as they could with suicide loans, bought up all the real estate they could get their hands on, and in the process drove real estate prices into the stratosphere. In other areas of the country, reckless spending is not so trendy, and home prices have not been bid up so high.
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I grew up in the Upper Midwest in a rural farm community. Pretentious displays of conspicuous consumption are less common in the Midwest, and consumerism is often viewed with contempt rather than envy. In short, there is a smaller percentage of the general population in the Midwest with the aforementioned pathologic beliefs. To prove this, I would like to profile Minnetonka, Minnesota, a suburb of Minneapolis with very similar income and demographics to Irvine. According to Sperling's Best Places, the median income in Minnetonka, Minnesota is $84,024, and the median income in Irvine, California is $84,253. I think that is close enough to be a good comparable. The median home price in Minnetonka is $305,600 and the median home price in Irvine is $689,000 (92620 Zip Code). If my thesis is correct, one would expect to find a much higher percentage of home loans utilizing exotic loan terms in Irvine as compared to Minnetonka. Remember the Map of Misery?
In fact, according to the map, in 2006 the Minneapolis area had 8.7% of its loan originations were negative amortization, while Orange County had 32%. In all of California more than 80% of loan originations in 2006 were either option ARM or interest-only. Here we have two groups of people with the same median income, and with the same access to credit making very different choices. Potential homebuyers in Minnetonka and Irvine faced the same decision on taking out a suicide loan and buying more house than they can afford or chosing to live within their means. Very few in Minnetonka chose to overextend themselves, so they did not bid up the values of their houses. Orange County (and the rest of Southern California) chose to utilize exotic financing and thereby real estate prices were bid much, much higher. The high utilization of exotic financing was the cause of the price increase not the result of it. Nobody was forced to buy.
So if we accept the premise that Southern California has a high percentage of its population with the spending habits I have described, so what? Everyone here in Southern California is spending freely, feeling rich, and enjoying life. What is the problem? Where is the pathology? Isn't it true Californians are just more financially sophisticated than the rubes back on the farm in the Midwest?
It is pathologic because it is not sustainable: It is a house of cards. There is an inevitable Day of Reckoning when all debts must be paid. Charles Ponzi (see image below) was the most extreme example of the pathologies illustrated in this post. So extreme was his activities, that the term Ponzi Scheme has become synonymous with the use of ever increasing amounts of investment or debt. 
This scheme is also encapsulated in the expression "robbing Peter to pay Paul." At some point, the debt becomes so large that no lender is willing to loan more money and no greater fool can be found to bail them out, and the whole system comes crashing down. However, while the debt was building, the debtor became accustomed to a certain lifestyle and level of spending. When the credit is cut off, the debtor can no longer spend, and a great deal of suffering ensues (See Dr. Housing Bubble).
We are quickly approaching the Day of Reckoning in our housing market. In my view this will be Armageddon for California debtors: the spending will stop, they will lose their homes and with it their illusion of wealth, and they most definitely will not be enjoying life. The cause of all the weeping and gnashing of teeth will not be some exogenous event, but rather a direct result of the circumstances they themselves created.
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For a refresher read: Financially Conservative Home Financing
P.S. Go back and click on the images.
“The possible reason SoCals are so ready to hurl themselves, lemming like off the cliff off debt perhaps has more to do with their more accurate perception of inflation and how it relates to the economic policies of this country since the inception of the Federal Reserve in 1913.”.
I highly doubt the average SoCal HELOC’d homedeptor based their spending decisions on the economic history of our country. I think for most it was based on vanity.
However, your arguements deserve consideration - thanks for posting them.
Whether “this time will be different” will depend on if Bernake has the backbone to stick to his much-mentioned anti-inflationary policy.
HERES THE LINK MENTIONED IN THE ABOVE ARTICLE
http://video.google.com/videoplay?docid=-515319560256183936
The possible reason SoCals are so ready to hurl themselves, lemming like off the cliff off debt perhaps has more to do with their more accurate perception of inflation and how it relates to the economic policies of this country since the inception of the Federal Reserve in 1913.
Following the dot com bubble, the Fed, instead of letting the market do what markets do, and correct the financial excesses built up, i.e crash - opened the floodgates of money by lowering interest rates to 1% to prevent the aforementioned crash from taking place. This had the immediate effect of putting a floor under the stockmarket, but also had the consequence of creating another bubble in the real estate market. This is also now leading to the collapse of the dollar - another of the Fed’s unstated aims-by flooding the economy with dollars - the value has to fall;the Bank of Japan is also acting as the printing press of last resort to the US consumer, panicked into the belief that unless they lend money to hedge funds at 0.5% to buy US bonds and stocks the dollar will collapse and take with it their economy. The monster of inflation previously thought dead, now appears to be showing signs of rude health. Commodities are soaring in price, oil, gas, food everything is shooting up in price but not, according to the govt’s statistics. To prevent these houses of cards from collapsing requires ever money to be pumped into the system by the Fed. Broad money in the economy is increasing at an annual rate of 13%, yet inflation is curiously subdued so the govt would let you know. So in an environment where the money supply and hence inflation are out of control, it would be a fool who paid off his mortgage and saved his money. The wise man would spend every penny he earned and borrow as much as he could afford to, since the future payments on this loan would be paid for with dollars of ever decreasing value.The people mentioned above with very conservative attitudes to money were probably right for the low inflation environment they were in at the time, but now were are in for a repeat of the hyperinflation of the early 70’s.
So do I see a huge propertyy crash coming - NO - the Fed will always step in to prevent it ever happening, there will be a correction and prices will take years to get back to where they were at the peak but the Fed ALWAYS bails out the lenders, remeber the Savings and Loans crisis in the early eighties? The US taxpayer bailed out one of the greatest frauds and rackets ever carried out in American history, all undewritten by the US taxpayer, as with this disaster unfolding now, the Fed will print more and more dollars to prevent their member banks from losing money.
If anyone isintersted in learning more about the Federal Reserve and its policies and how it came about, despite the best efforts of numerous Presidents (Jackson, Madison, Lincoln and others) see the documentary below, be warned, it is three and a half hours long. If after watching it you still think there will be a property crash I would go and see your physician.
Right on, bra. That was one of the the most ridiculous and foolish scenarios I’ve ever heard.
Our government is so clever! This country has something that people wanted so much - Freedom! People will pay anything for it.
Good point renter. Additionally, it’s not like you can just buy your way in. You have to be investing the money and creating jobs for us citizens in a way that actually risks the money you invest (ex: starting a small business). As stated above, this is not used frequently.
Yes I was aware of the EB-5 visa. Here’s what I found:
http://www.gao.gov/new.items/d05256.pdf
or the text version:
http://www.gao.gov/htext/d05256.html
The number of visas granted under the EB-5 category has been a small
fraction of the approximately 10,000 allocated annually by the
authorizing legislation. According to State Department records, a total
of 6,024 visas have been issued to immigrant investors and their
dependents since 1992. As of June 2004, 653 investors (not including
dependents) had met this immigration category’s requirements and
received permanent legal resident status.
653 people in 13 years? Why are we even talking about this?
If the immigrant is wealthy, they don’t really need sponsership. Most countries offer investmentor visa and special immigration allowance. If you can bring enough cash into the country, we’ll give you a a VISA and Greencard.
http://www.eb5greencard.com/
Irvine had a large influx of “new” East Asian immigrants in 1980s and 1990s, but by 2000’s I think the influx of Asian residents are from other cities in Orange County or LA County. If you want an example of a place that’s getting a lot of direct oversea investment and immigration, check Koreantown in LA.
I have seen many Indian and Chinese people come here with newfound wealth due to the booming economies of both countries.
India and China is a new story. However Southeast asian countries, Japan etc. were booming much earlier. Heck there are always rich people around the world no matter what the situation. Doesn’t mean they all end up in the US, probably because they don’t want to or even if they did they couldn’t because of visa issues.
Regarding greencards/visas, many of these families are sponsored by relatives in the US. My family has sponsored a bunch of our cousins years ago when we were first able to.
I know you can sponsor immediate relatives (spouse, parent, children, siblings). That you can sponsor cousins is news to me and I really suspect if this is possible and even legal. BTW even sponsoring close relatives like a sibling can take 12 years and a spouse something like 4-5 years. Also the family sponsored green card quota is very small. So really attributing all this to the housing market boom in OC is silly.
graphrix,
Thank you for the Chase pointer, I will mention it to my mortgage guy.
I think you and I are in the game long enough to see that we only know when there is an appreciation after it appreciated. That is why I accumulate real estate to capture the potential gains, whenever that happens, I do not even bother with any projection. As long as I can balance my cash flow, I am good.
nirvinerealtor - Your payment makes more sense now that you break it down. Not sure if they are over paying for anything but maybe the gardener. I pay that and I know my lot is bigger than 98% of Irvine’s.
With Wells charging .375% for stated income is normal sort of. They used to waive the fee or reduce it as the credit score got higher. But my point was that there is no set fee and it varys by the situation. Tell your mortgage guy to check out Chase they do not have any adds if the file gets approved in their automated system. Wells has something similar too so I do not know why they had to pay the .375% and they could have bumped the rate up by .125% and they wouldn’t have to pay that. So now they have to keep the loan for 33 months in order for paying that up front to break even.
I own and in 8 years I will be surprised if my properties are at the same value as today. Making it a loss when factoring in inflation. I will be elated if in 8 years they keep up with inflation. If we see a drop of 50% then yes I would still have equity but when factoring in inflation I would have lost value. It took ten years if you bought in 1990 to see a minimal profit when factoring in inflation.
IR,
No worry for me. I have these properties for years. I would still come out ahead if price drops 50%.
“I own a few properties and am expecting a double gain in the next 8 years. If market crash, oh well, it’s a gamble. “
A gamble with what? Your money, or did you lie on a “stated income” or “owner occupied” loan in order to make the deal more palatable using thr bank’s money? Uh-huh.
You are exactly what is WRONG with the market: there are too many idiots who bought into housing, not as a place to live, AKA a HOME, but as a speculative asset for gambling with. It’s amazing how many people bought that 2nd home as a vacation home, or simply to let it sit vacant for awhile until the rapid appreciation made it worthwhile to bail out. Think about it: if everyone had TWO homes instead of ONE, what would THAT do to housing inventory? Uh-huh: drive up prices, when everyone’s rushing to make their fortune in real estate ALA Casey Serin (who gobbled up 5 homes at the peak)…
What’s rather bothersome is you’re not even calling it an “investment”, but a “gamble”. Houses (as in shelter for people to LIVE in) should not be objects to purchase for investment purposes (and everyone recognizes that the stock market is more speculative than housing, although that’s NOT ben the case here lately). There’s people who will LOSE their homes, simply because they felt compelled to “stretch” their finances to the breaking point: won’t they be glad to know the market was run-up by realtors who admit to owning “investment properties” that aided the run-up?
I would’ve thought the market “correction” (as you agents like to call it) would’ve flushed out all the Carleton Sheets grads who drove up prices well beyond the point of affordability for any SANE buyer by snatching homes with the “nothing down” method of buying? Guess not....
And unfortunately, our laws make little differentiation between taxing the owner-occupied home vs. the holdings of a wanna-be Donald Trump.
So before we start throwing out methods to fix the market (and throwing out MORE $$$ via FHA is NOT the answer, fellas), we need to tease out how affordability for 1st time buyers was completely screwed up by so-called investors such as yourself. Thanks for making it clear that you’re PART of the PROBLEM.
nirvinerealtor,
It is sad to hear you are so exposed to the market. Hopefully, us housing bears are wrong, and you won’t see a 50% decline.
“I own a few properties and am expecting a double gain in the next 8 years.” Can I get some of what you are smokin’…
rkp,
Actually, in 1999, the appreciation from 1996 - 1999 was averaged 40 - 60%. That why people were telling me that I was “stupid”. And I thought I was insane too! Many people refused to buy between 1999 - 2000. Some of these people finally bought in 2005 for 100%+ higher price.
What I am saying is home prices will go both up and down in the next 3-5 years, depending on how people feel. If you have a target area to buy, I can tell you what this particular market is doing. As one area is going up, the other area can go in the oppossite direction. Even in this market.
I own a few properties and am expecting a double gain in the next 8 years. If market crash, oh well, it’s a gamble. I will continue to be landlord. If I lose all my equities, oh well, I will just continue to work. At least, I do not owe Uncle Sam any income tax.
NIR - I am not sure what you are saying. Do you believe housing will go down, stay flat, or go up over the next 3-5 years? I appreciate your posts and viewpoints but your last post makes it sound like you really believe housing to be a gauranteed great investment. It is good to have a different viewpoint but to believe that it is the best and most sound investment choice sounds less like a thoughtful analysis and more like marketing.
In 1999, when you bought a house, prices were flat for years and no one was buying for almost a decade. Sure, your friends thought you were crazy for buying then but not because the prices were insanely high but because most people thought housing was a poor investment. Today, most people saw how wonderful housing appreciation can be but now, most people can’t afford it. Using your example, it will be a decade again until people cautiously enter the housing market.
renter,
In 1999, interest dropped to record low 8%. Everyone was able to buy THEN. So some people cautiously jumped in the market one-by-one (I was one of these people and got so much rap for it, but I just wanted a dream home and decided to go for it with a wish that prices would not crash too badly, some people told me I was stupid to do so). Then all of the sudden, everyone else jumped on the bandwagon in 2002. It was psychological.
Same thing is happening now; only a handfull of people are buying, most people are not buying - same thing, everyone jumps on the bandwagon again.
As the result, builders cut off the pipeline to dry up inventories.
I just saw somewhere of the loan default analysis that said 90% of defaults are results of mortgage frauds for profit.
Last 2 months, mortgage frauds for profit pretty much got cut off the pipe-line. What you think will happen next?
Do you think the money will go to to stock? I would doubt it. Most stocks depreciate to Zero in about 10 years! Why?
Do you think the CEOs are superhuman? Not!
renter - I don’t think a bunch of foreigners suddenly decided OC was a great place to live but rather, a bunch of foreigners suddenly had money. I have seen many Indian and Chinese people come here with newfound wealth due to the booming economies of both countries.
Regarding greencards/visas, many of these families are sponsored by relatives in the US. My family has sponsored a bunch of our cousins years ago when we were first able to. However, none of my cousins have made the move out here because they knew they couldn’t afford anything and would have to work 4 jobs just to start a life here. Now, they CAN afford the US and more and more of them are moving out here.
Can we use OC’s Cultural Pathology model to explain NASDAQ 5000 phenomenon several years ago? Also, more importantly, UK and Australia also experience housing bubble in recent years, can we apply Cultural Pathology examples to these Counties too? If not, how can you distinguish OC with others ?
IMHO, the notion of OC’s Cultural Pathology is the results of house bubble or at most, part of the reasons of bubble but not one of the primary reasons of the bubble.
Yes, the contributory factors that led to the housing bubble are more fundamental to human nature, and can’t be explained by some local cultural phenomenon. For example, Japan experienced a massive credit/real estate bubble in the early 1990’s (Nikkei bubble) that left home prices at 50% of their prior values in only 5 years. Anyone remember the Florida real estate speculative bubble that preceded the Stock Market Crash of 1929?
Anyone remember the South Seas Bubble, an investment scheme which left the brilliant Isaac Newton poorer in it’s wake? After that, he made the statement that “I can calculate the movement of planetary bodies, but I cannot calculate the madness of men”? Dare I mention the tulip bubble? Google “bubbles”, and you’ll see that they’ve spanned centuries and locales.
The common trait of all bubbles is the irrational belief that “this time, it’s different”. As if the rules of sound investments are momentarily suspended, “just for you”.
It’s ironic that now some of those citizens in OC want to think the bubble problem is unique to them (although the actions of all those sub-prime lenders located in OC didn’t really screw up things for the rest of the country!), as if they’re “special”. Rather ironic, since only a few years the common mantra was that a bubble crash WOULDN’T effect OC, since they claimed to be “different”.
Regardless, this speaks to the fact that EVERYONE wants to feel better/superior than others, even when there’s really no reason to justify such a belief. This is simply an updated version of “manifest destiny” that people used in prior centuries to justify taking assets from others....
Well, here is a problem for us local folks, US is a wonderful place to be. These folks take their children to visit US, the children like it here and insist on living here. Therefore, they buy homes in safe neighborhood for their childeren/grandchildren.
Its not that simple. Moving to the US requires a visa/green card. What visa are these folks or their children coming in on.
Back home a 1,000 sq. ft “pad” is going for about $1.2M; that make our home prices “cheap”, not “undervalued”. It creates unfair competition for us. It’s a real eye opener.
So here’s a question for you. I think 1999 was probably a reasonable period in terms of OC housing prices. So what caused the run up in prices since then? Was it these “immigrants” who suddenly decided OC was a great place to live and were generously awarded Green Cards by the US Government, and all these immigrants were able to magically find jobs here? Why were they not so keen to move in before then? Was it because the US was not a great place to live then or not as safe?
renter,
Well, here is a problem for us local folks, US is a wonderful place to be. These folks take their children to visit US, the children like it here and insist on living here. Therefore, they buy homes in safe neighborhood for their childeren/grandchildren. Back home a 1,000 sq. ft “pad” is going for about $1.2M; that make our home prices “cheap”, not “undervalued”. It creates unfair competition for us. It’s a real eye opener.
While we question the median income not suporting home prices; people from countries such as China, Korea, Vietnam, just to name a few, question us (realtors) why homes prices in OC are so “cheap”.
What do you mean by cheap? Bill Gates can come in and say a 100 million house is cheap just because he can afford it. If you mean investors are coming in, looking at the local market and then making the decision that housing is fundamentally underpriced, then that is a different issue. Why do these people think housing is undervalued? I would be very interested to know. Is it because more than 30% of mortgage originations last year were risky ARM loans?
While we question the median income not suporting home prices; people from countries such as China, Korea, Vietnam, just to name a few, question us (realtors) why homes prices in OC are so “cheap”. The Irvine Company must have done a great job markieting the Irvine Ranch. These folks are buying up without even asking if home prices are going to drop tomorrow. And they are paying “cash”. Experienced first hand many times by NIR.
Can we use OC’s Cultural Pathology model to explain NASDAQ 5000 phenomenon several years ago? Also, more importantly, UK and Australia also experience housing bubble in recent years, can we apply Cultural Pathology examples to these Counties too? If not, how can you distinguish OC with others ?
IMHO, the notion of OC’s Cultural Pathology is the results of house bubble or at most, part of the reasons of bubble but not one of the primary reasons of the bubble.
Ummm…close enough? Wouldn’t the fact that Irvine’s population is 4 times that of Minnetonka have some influence on the relative prices of housing?
You can’t just consider population. It may be more correct to consider population density. Minnetonka is smaller in size than Irvine (having checked Wikipedia). So even in this respect they may be similar.
However even population density is not an accurate measure, because in an area with larger population density, houses are simply smaller (like Manhattan). Median income is probably a much better measure (which IrvineRenter considered), because that really measures what people can afford.
Ummm…no, they didn’t. In 2006, potential homebuyers in Irvine faced median home prices that were more than double those in Minnetonka. Increased use of option ARMs were simply the result of housing unaffordability, not of a pathological defect of the average Orange Countian.
That’s a silly statement. Just because housing is unaffordable doesn’t mean I should go to any means to obtain it. I chose to rent. Others may simply choose to leave the area or ask for higher wages. Justifying imprudent, financially dangerous decisions such as option ARMs as a result of housing unaffordability is plain stupid. I wouldn’t do it. Others may decide to do it, but if you do you have to be prepared for the consequences if things don’t turn out as rosy as you had hoped.
graphrix,
Thank you.
This couple got 6.5% for first, 8% for second.
First = $3,900 I/O
2nd = $1,100 PITI
Tax = $1000
HOA= $120
Ins = $80
Gardener = $100
Extra Principle= $400
Grand total = $6,700
Did you see them overpay anything?
They had a Stated Income and Verified Asset loan from WF. WF charged .370% premium for state income—roughly $2,500. Does this sound right to you? Thank you in advance for your help.
Jim Dandy,
“Wouldn’t the fact that Irvine’s population is 4 times that of Minnetonka have some influence on the relative prices of housing?”
No it wouldn’t. Minnetonka is a suburb of a large metropolitan area just as Irvine is. By your reasoning, any large city that is many times the size of Irvine would have much greater housing prices, and they don’t.
“Increased use of option ARMs were simply the result of housing unaffordability, not of a pathological defect of the average Orange Countian.”
No it isn’t. Prices are driven higher by buyers increasing their bids. Buyers in Irvine could have elected not to use this kind of financing and not purchased homes at ever increasing prices. They chose to bid up prices while those who lived in Minnetonka did not. For the use of option ARMs to be the result of affordability would imply people were forced to buy. They are not.
“The fact-skewering on this blog is hilarious. Foreclosure activity is MUCH HIGHER in the midwest than in Orange County, which is the direct result of our demographics (greater population) and employment (better job market). California’s share of subprime mortgage delinquencies is lower than the U.S. average, and MUCH LOWER than that of midwestern and southern states.”
The statement about foreclosure activity you allude to was never made on this blog, therefore, we have not skewered any facts. Foreclosure activity is currently higher in some areas of the Midwest, but more so in Texas and other Deep South areas. This is due to the toxicity of the loan products coupled with their lower level of appreciation. In other words, it hit there first, but it will hit here as well, and it will be much, much worse here. California will break all previous records for mortgage delinquencies and foreclosures in next several years. As for our real estated dependent local job market, that will also not do well over the next few years.
Let’s watch how things unfold, I would be delighted to be wrong.
“According to Sperling’s Best Places, the median income in Minnetonka, Minnesota is $84,024, and the median income in Irvine, California is $84,253. I think that is close enough to be a good comparable.”
Ummm...close enough? Wouldn’t the fact that Irvine’s population is 4 times that of Minnetonka have some influence on the relative prices of housing?
“Potential homebuyers in Minnetonka and Irvine faced the same decision on taking out a suicide loan and buying more house than they can afford or chosing to live within their means.”
Ummm...no, they didn’t. In 2006, potential homebuyers in Irvine faced median home prices that were more than double those in Minnetonka. Increased use of option ARMs were simply the result of housing unaffordability, not of a pathological defect of the average Orange Countian.
The fact-skewering on this blog is hilarious. Foreclosure activity is MUCH HIGHER in the midwest than in Orange County, which is the direct result of our demographics (greater population) and employment (better job market). California’s share of subprime mortgage delinquencies is lower than the U.S. average, and MUCH LOWER than that of midwestern and southern states.
I’m not saying that I’m a housing bull. I think housing is overvalued and the correction (which began in 2005) could last for several years. But we’re not facing a nuclear holocaust.
A terrific piece of writing from IrvineRenter, and I’d like to add a thought or two:
Point #1: It takes some positive reinforcement to learn to think like the rich.
NickStone (the very excellent comment #17) points out that, in our consumerist culture, the lessons of saving vs. spending are far from obvious. NickStone had a smart and wealthy mentor to teach him. I grew up in the consumer insanity of Southern California but had parents who discussed financial responsibility and conservatism at the dinner table. And IrvineRenter has done a great service to all of us who are trying to be savers, but are constantly tempted by the spending fools around us to splurge on the unnecessary – his posting provides some great positive reinforcement. I think the lesson is clear: help your friends and each other (without sounding like too much of an ‘I told you so’ ninny) by reinforcing these lessons. Teach your kids about fiscal responsibility. Provide a good example. It really is possible to lead a sane and responsible fiscal life in an insane consumerist world, but it takes a little help.
Point #2: Beware the outlook that makes salespeople (such as realtors) successful.
Sales is a critical function in any business, and I am not denigrating the role of salespeople. Any good CEO will you that her company would fall apart without a good, aggressive, positive and upbeat salesforce. There’s a reason they make those huge commissions: they are a critical link in the chain.
But here’s the downside: they are encouraged, even required, to be unfailingly positive at all times in order to keep up their motivation and keep selling. Sales seminars tell them to remove all negative thoughts, all critical thinking that could be negative and focus only on the positive. Tony Robbins tells them that anything is possible if you just Awaken the Giant Within! A million other self-help gurus preach the same: Everything is great! Everything is wonderful! Keep positive! Keep selling! Visualize success!
And for selling, it works. But there’s a downside: if everything is so positive, why should I save for a rainy day? If everything is great, why should I even consider the possibility that real estate prices might go down? If everything is positive, what does that mean for adjustable rate mortgages – will they go up after the reset? Of course not – that’s negative thinking! They’ll probably adjust down!
You get my point. There’s a reason to be very skeptical of anything a realtor, mortgage broker, or anyone else with a vested interest in making the sale tells you. It’s not necessarily that they’re lying. It may just be that, if they’re any good at all at their job, they are trained to avoid the critical thinking so important to making a good long-term financial decision. So take their advice at your peril!
Point #3: You’ve got to take some risk sometime – just make sure it’s a calculated one.
Many have jumped on the story of the young couple taking on roommates to buy a home. I would also agree that, based on what’s been reported here, it seems they may have taken on an unwise risk and overleveraged themselves. The kicker for me is the 10 year interest-only. That’s a long time to go without building any equity.
But it doesn’t mean that anyone buying a home now is an idiot. I believe prices will drop, but to anyone who can put 20% down and comfortably cover a 30-year fixed mortgage (even if it means taking on a roommate or two), I say good for you. Nothing wrong with making a calculated decision, building some equity, and doing what you have to do to make it work. There’s always risk – risk that you lose your job, a catastrophic event, a costly medical emergency. These are the risks we have to bear. But exotic financing risk? Not a good call.
Interest-only, ARM’s, neg-am, or any other financing scheme that relies on the assumption of (1) rapidly rising wages or (2) rapidly appreciating home values is not a smart, calculated risk. It’s gambling, and I fear for those who roll the dice now.
First to all the people from other parts of the country there are a few albeit rare OC natives who live with the same financial philosophies as yourselves. It is unfortunate but this is the way it has always been and I have many stories of people I know that live well beyond their means. You would think that they would have learned their lessons when in the 90s they saw their family home taken back by the bank and wathcing their parents go through BK.
nirvinerealtor - I know that I have been harsh to you in the past and honestly probably will be in the future but you are a Realtor and you should have thick skin. So stick around. You are a RE bull who just walked into the RE bear cave that just woke up from their slumber and are hungry. What did you expect? Your $6700 a month seems very high. What all does that include and what are the interest rates? Give me the break down. Sounds like you borrowers got hosed. I think you might want to look for a new lender to work with. Did he/she charge $2500 for stated income? You never did answer that one.
RKP - Assuming that they did 80% 1st and 15% second and the first has a of 6.5% the payment on the first would be $3900. In year ten if the index for the 1 year CMT is 4.93% as it is today plus the margin of 2.75% the rate would go to 7.75% (the lender will round up the nearest .125%) and you would have to amortize over 20 years the payment would jump by $2011 a month to $5911 for a grand total assuming that the 2nd hasn’t changed to $8711 total housing payment per month. Actually it would be higher if values continued up since the property taxes would increase with it or it could be cheaper if they go down.
IR,
Thank you very much. I would like to stay as I am learning a lot from you guys. I hope to reciprocate. I do not mind the bashing because you guys do not walk in my shoes; how would you know what I observed and experienced.
This leaves a monthly takehome of $7500 ($90K/12). With a monthly liability of $6700, what they did was fiscal suicide.
mcatboy, though I really liked your earlier posts, I must disagree with your numbers here. I haven’t done an analysis here, but the $6700 probably has a large portion of it as interest and a smaller portion as property tax. During the first few years of home ownership a large portion of mortgage payments are interest and a very small percentage is principal. Assuming a figure of $5000 in interest and property taxes per month, you would save around $1900 per month assuming the same tax brackets you have assumed. So instead of a $6700 payment, the payment is closer to $4800.
Now all this is numbers I am just blindly using out of this forum. For a true analysis, use any of the available online calculators.
These homeowners may actually be able to pull it through, but just because they are able to get 3 roommates for renters and be able to afford their house doesn’t say anything. If they can, good for them, but it doesn’t change the fact that housing is going down. And I think, going down big time.
nirvinerealtor,
I hope you don’t leave. You aren’t a troll, so nobody wants to drive you from the blog. If anything, I appreciate that you come here and tell us your stories and your point of view, and I appreciate your honesty even when you know it is probably going to bring about some rather sharp comments.
Thank you everyone. I think I got enough beating for the day! You guys feel free to tell me whenever you want to boot me off this blog.
OK, I got chopped again. I will spell it out: less than 30 years old. Anyway, message was: these punks think they are entitled to everything NOW!
What the heck! My post got chopped--#75. Must’ve been from the contents of the quotes, which was “
I posted #4. I’m in Silicon Valley, as I mentioned, and I manage ~30 people, half of them are kids (
mcatboy, I read some of your posts and enjoyed them. I also believe prices *should* have peaked in 2003. Some of my sane and intelligent friends believe this will be a normal cycle and the correction will be small, but every instinct of mine tells me this crash is going to be bad, and possibly the worst ever.
NIR - the $6700 payment is only interest for the first 10 years right? What will their payment be after the 10 year mark?
For the rest of the people - I know it is important to live within your means but I think people should make fair and reasonable assumptions about their salary growth. Many of the comments seem to portray that everyone’s salary will suffer and that no one can count on a raise. I am not saying that people should do what this couple did but as with any financial decision in life, there is risk and assumptions.
I think it is fine to assume some level of salary growth by analyzing your industry, your current pay level, and how your company compensates as you grow.
I graduated from college 5 years ago and my salary has nearly doubled since then. I had a strong feeling this would happen but I only planned for a 20% growth over the 5 years because I am ultra conservative when it comes to finances. In any case, most of my college friends have experienced similar raises as well. Hence, it is ok and good to make reasonable assumptions and plan accordingly.
IR - yet another great post. You ever consider submit your posts to the opinion section of the OC Register. You might have to disclose your real name though
NIR
You asked me to recalculate, so here goes: You said the couple makes $130K annually. Given that they are in a Fed tax bracket of roughly 28% for the top end of that, let’s assume that their net tax (state and fed) is about 30%. Couple this with about 8% for FICA (I assume they each make $65K, so neither caps out on their FICA). 38% of $130K $49.4K. I lowered that number liberally based on the interest write-off you mentioned, meaning that their income tax liability is probably $40K. This leaves a monthly takehome of $7500 ($90K/12). With a monthly liability of $6700, what they did was fiscal suicide. A five-bedroom house for two people is a bit much, but it seems like they purchased on the idea that one day they’d fill the rooms with kids (which cost money by the way). Until that time, renting the rooms sounds like a great idea until you do it. The first time they get a rocker, a smoker, or a thrasher will teach them a vital lesson about renting rooms. It makes no sense to anyone here except for the person selling them that home and collecting a commission. Admittedly, if I were the realtor on that sale, I’d push it through as fast as I could, because sales are going to be precious over the next few years. I’d have a rosey outlook for them as well. But deep in my heart, I’d have to think that they are renting until their foreclosure in a few years. They will be one of many casualties in the mrket crash of the next few years.
Mr. Vincent
Excellent post! You must admit, we are the luckiest of the age groups, because we were in the right place at the right time for many things (computers, stocks, and housing). And while I have to agree that most realtors are right there with the men and women of insurance and car sales, no one has anything on stock brokers when it comes to questionable, self-serving advice.
But no matter what the person pushing the sale is saying, it still comes down to you (the buyer) to make the right choice. Having made a few poor investments in life, I have no one to blame but myself for those. It’s how you learn. The impending bubble burst will unfortunately teach a bunch of people this lesson. And we’ll soon start reading about people who should have learned from the past, which will be a nice change from the “who knows what the future will bring” that seems so commonplace.
And to anyone who sees or hears the news clips with realtors or underwriters saying it’s still a strong market, doesn’t it make you want to hurl right there? The more they try to do damage control, the more you know that the reality of their impending slumber period is upon us.
Tom,
You sister-in-law was probably figuring she could quit her job and have the baby now that they have the home appreciation to make up for her lost income.
Regarding the 25-year old newlyweds that are renting rooms out to make their $6,700 / month nut: they were sold the false story that “owning is always better than renting” and “real estate always goes up” and “real estate is the best investment you can make”. I’ll bet anyone 10 to 1 they will lose that home; unfortunately for them that description of their situation already looks like blood in the water. A know-it-all sister-in-law of mine, and her husband, recently bought a $950k home in the Bay Area. $100k down, 10-year interest only loan (I’m not sure if adjusting later; not sure of interest rate). Combined income is approx. $190k, BUT, they just announced they are pregnant with their first. They assume Bay Area real estate always goes up; that’s all they have seen in their young lives!!! This very naive and I feel greedy financial decision on their part could very easily cost them their home, and it is not a far stretch to say their financial future.
How did this post about bling bling cultural pathology turn into realtor-bashing for NIR. Just ignore the guy (gal)! Stupid People who take on enormous amounts of debts to purchase their “dream home” are home-debtors, not “homeowners” as NIR so proudly proclaims! Enough said.
DONT TRUST ANYONE WHOSE INCOME DEPENDS ON THEIR ADVISE.........
gepetoh made my comment for me:
I moved here from the Chicago suburbs a few months ago, so I appreciate all the midwest references and analysis of differing philosophies. I am very young with a family and supporting my wife and kids and trying to make sense of Californians in general and OC-ites specifically. I have been a home owner paying out on a mortgage, a home owner who owned free and clear in fee simple absolute not subject to any mortgages or liens of any kind, and I have been a renter.
True paid-off ownership of a large, beautiful home is definitely my favorite (as you can probably imagine), but renting beats “owning” a home that is losing value before your very eyes, especially when you owe a bank for the right to witness that heartache and evaporating wealth firsthand.
If you have done the math, there is no way to justify buying right now . . . simply no way to do it . . . unless you like throwing away large sums of money. Renting is just fine until the numbers make sense again, even for those of us who have every dime we need sitting in a completely liquid account.
*****
Different thought: OC vs. Midwest - on some level I understand the thinking of the superficial, hedonistic, materialistic, debtor consumers we call friends and neighbors. On some level it makes sense: enjoy the good times hoping that they last forever and trust that someone else will bail you out in a problem; we have enough people here living that way that someone is going to bail them out. It will probably be me and you and the financially sound and fiscally responsible who read these kinds of blogs: we will be called on, in the form of taxes or some other means, to save our fellows, and we will step up and do so.
So I understand why people see “Life in the Fast Lane” living it up on borrowed money as a win-win: they enjoy the riotous lifestyle and share the pain of the downturns with everyone, through a bankruptcy, forcing them to rent while the market corrects, taking their bailouts, and everything else. But just because I can understand it and will be willing to step in and bail out as many as I can does not make it right . . .
Regarding the “happy newly-wed couple” that has to live with 3 roomies: do they realize that the $6700 mortgage payment will be for 30 years (only 29 to go)?!?! And, as others have pointed out, that doesn’t include all the other costs of ownership. Oh, wait, I forgot the tax break they are getting…
Also, they must have a pretty bullish outlook of their future financial situation if they expect they’ll be roommate-free in 3 years and be able to afford the entire mortgage without the extra income from the roomies… Maybe they expect their salaries to appreciate as much as real estate has in the past several years. Good luck with that! Seems to me that $65k per person for a 25-year-old with a college degree is pretty good money already. Of course, that could change if they go back to school, but I won’t go into how they would finance a graduate education considering they are financially maxed out already.
Regarding Nirvinerealtor’s example in post #33, I have a different opinion.
In the example given, the couple purchased their home in 1990 for $300k. This was quite a large sum of $$ back then, and I’m assuming that they got a 30-year loan (and not 15-year).
If they worked hard and made their payment on time, and used their annual tax return to make an extra payment, the 30 year loan could be paid off in ~22 years.
We’re now in 1997, which means they had been paying for 17 years, with 5 years to go. The house would be completely paid off in 2012 assuming they didn’t get tempted into refi and taking $$ out.
Suppose if we go with mcatboy’s example (post #37) and say the property value drops from $975k today to $475k in 2012. Yeah they lost a lot of equity, but the house is paid off. No more mortgage or rent payments, happy retirement. Rent the house out for positive cashflow and go enjoy life in Cebu or Phuket.
The slow, short and stubby legged tortoise method isnt’ very attractive, but it’d still get you over the finish line. Just make sure you buy what you can actually afford, otherwise that turtle shell will be too heavy on your back…
“They also are working very hard to hold on to their dream home; is there anything wrong with working hard?”
Nobody is denigrating hard work. There is working hard, and there is working smart. These people are not working smart. They will work hard, and they still might lose their home (or their sanity trying to keep it).
It is like digging for buried treasure. You can work very hard digging deep holes everywhere and have nothing to show for it, or you can get a map, dig in the right place and get the treasure. Working hard doesn’t count for much if you are not working smart as well.
Who knows, we might all be wrong, and double digit appreciation will make homeowners rich beyond their wildest dreams, and us fools will be left on the sidelines waiting forever for prices to drop? I am wagering this will not happen.
gepetoh,
Sorry for sounding less than polite. I truly meant it’s a choice that people made. Being a home owner is not always rosy. From time to time, it can be a hardship and painful.
DanT, this couple just turned 25. They have not forgotten having roomies. They hope to boot all the roomies out in 3 years. They also are working very hard to hold on to their dream home; is there anything wrong with working hard?
For the record, this couple is reporting the roomie incomes. There is nothing worst than having one of the roomies report them to the IRS for profit share.
‘Many differences of opinion here; this explains why some people are called “renters” and some are called “homeowners”.’
That comment resembles a slight condescension… I should realize that many of us have owned a home up to recently, but have decided to sell and hold on to the proceeds because we feel the prices are out of hand. It’s not all just vain jealousy, some of us have done calculations and just think this market is wrong from a very objective standpoint.
“The buyers were a newly wed couple of 1 year. College grads making a combined income of $130K. This couple found an executive dream home, 5 bedroom, 4 ba, 3 car-garage, 2 year-old, $900K. With 5% down, their total monthly payment 30-fix, 10I/O. Total housing cost came out about $6,700 before-tax benefit. By the time they closed escrow, they already got 3 roomates paying at $800/room.”
Have they considered renting a couple of rooms in that same place for $1600/mo ($800/room x 2), invest the $1900/mo difference ($3500 net - $1600 rent) for 3 years, take their $45000 down + $75000 savings and put a $120,000 on that same house at a depreciated price of $800K? They’ve lived in the exact same condition, but now have a $680K mortgage instead of $900K, and if they still insisted on I/O, then would probably get that $3500/mo payment with no roommates. Or, maybe they can put that $120K savings towards something they can actually afford, say, a 3bd/2ba, 1600sf TH, which will probably be around $500K by then. Now, they’re looking at a $3000/mo mortgage on a prime, 30-yr loan, including principal! Novel idea, eh? A couple with $130K salary has no business buying a $900K home.
“The buyers were a newly wed couple of 1 year. College grads making a combined income of $130K. This couple found an executive dream home, 5 bedroom, 4 ba, 3 car-garage, 2 year-old, $900K. With 5% down, their total monthly payment 30-fix, 10I/O. Total housing cost came out about $6,700 before-tax benefit. By the time they closed escrow, they already got 3 roomates paying at $800/room.”
Have they considered renting a couple of rooms in that same place for $1600/mo ($800/room x 2), invest the $1900/mo difference ($3500 net - $1600 rent) for 3 years, take their $45000 down + $75000 savings and put a $120,000 on that same house at a depreciated price of $800K? They’ve lived in the exact same condition, but now have a $680K mortgage instead of $900K, and if they still insisted on I/O, then would probably get that $3500/mo payment with no roommates. Or, maybe they can put that $120K savings towards something they can actually afford, say, a 3bd/2ba, 1600sf TH, which will probably be around $500K by then. Now, they’re looking at a $3000/mo mortgage on a prime, 30-yr loan, including principal! Novel idea, eh? A couple with $130K salary has no business buying a $900K home.
Living their dream with THREE roommates? Sorry, my roommate days ended when I graduated from college. What is your privacy worth to you?
NIR, I think the worst case is someone who bought in 89-90 and had to hold for 7+ years to get above water again.
They weren’t back above water until 2000. A decade is a dang long time when you’ve got a mortage eating 40% plus of your income.
NIR paints a rosy picture, let me paint another, true story a co-workers with his dream house out in Temecula back in 1993, bought it 1989, great view, huge yard w/ fruit trees, fighting with ulcers because in 1993 they could no longer afford to keep carrying their ARM and couldn’t sell their place because they were upside down by a years worth of income.
replace renter with “financially sound” and replace homeowners with “financially handicapped”
If you have a mortgage then you ownly own the portion which you put down. Sorry but the bank owns the rest.
I’ll elect not to pay 4,000 a month and upgrade the banks home. I’ll save my discretionary income and enjoy my life until prices are in line with real wages and rent.
Good post IR!
My opinion:
This may be the last real estate boom we see for several decades. The current bust may take many years to reach bottom.
One of the main things that drove inflation in the 70s, stock bubble in the 90s, and the real estate boom in the 2000s can be attributed to demographics.
The baby boomers, known as the greatest consumer known to mankind, will finally run out of the ability to overinflate everything they touch(except healthcare costs).
There will never be a generation with this size and voracious appetite to spend. The boomers are always looking for an easy way to early retirement. In the late 80s they drove up housing prices because they really wanted a home for “nesting” purposes. This latest mega boom was brought on by greed, status and another attempt at early retirement after the tech bust. It did not work for most.
The oldest of the boomers are already trying to liquidate assets and move to cash. The rest of them will follow.
The boomers need cash in retirement, not some illiquid money pit.
This is the last real estate boom I will see in my lifetime. Im a 48 yr old boomer who was a real estate investor for 30 yrs.
PS: No offense to any real estate agents that post here, but after having dealt with so many over the years, I trust a used car salesmans advice more than I trust a Realtors advice.
Many differences of opinion here; this explains why some people are called “renters” and some are called “homeowners”.
In Buddhist teaching, the law of Karma, says this: `for every event that occurs, there will follow another event whose existence was caused by the first, and this second event will be pleasant or unpleasant according as its cause was skillful or unskillful.’
Whenever I think the housing bubble might not crash, I ask myself this question: Can anyone think of a time when so many acted so foolishly and did not get some kind of comeupance? Have the laws governing human affairs been set aside this time?
“Share a room of $800/month”.
Yes, what I see here they are trying to do is not really to own a house, instead they are doing some kind restate investment. Technically, they really don’t own a house because it is all shared with lot of strangers and also only 5% down.
So it makes more sense to share a room at current market condition.