The Fallacy of Financial Innovation
And the hardest part
Was letting go not taking part
Was the hardest part
And the strangest thing
Was waiting for that bell to ring
It was the strangest start
Everything I know is wrong
Everything I do it just comes undone
And everything is torn apart
Oh and thats the hardest part
Thats the hardest part
Yeah, thats the hardest part
Thats the hardest part
The Hardest Part -- Coldplay
Perhaps the hardest part of the housing bubble was not taking part in the rally. There was pressure from everyone and the lenders were giving away money. It was very difficult to make a conscious choice not to participate, particularly when people want to own. I felt these desires; I wanted to own again. My intellect and my emotions were in conflict. Now that the bubble is bursting and prices are coming down, I see the light at the end of the tunnel, but it is still difficult to wait. Like Archie Bunker said, "Patience is a virgin." I will only buy once at the bottom, and I want the time to be right.
For those who participated in the bubble, the hardest part (beyond the financial problems) is yet to come. It will be accepting that everything they thought they knew was wrong. As I described in What is a Bubble? a financial mania is supported by a whole series of erroneous and fervently held beliefs. It will take time for the participants to come to the realization that they were wrong, very wrong. Accepting this truth will be even harder. Unfortunately, financial markets have a way of forcing a painful awareness on its participants. Whether they like it or not, each participant in the market will come to realize it was a colossal mistake.
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The cutting edge is sharp. Innovators often pay a heavy price for advancement. Sometimes these advances lead to quantum leaps in human knowledge and understanding. Sometimes the time, effort, and money is merely thrown into the abyss. The innovations of the Great Housing Bubble were of the latter category.
The lending industry touted its "innovation" with exotic loan products. They sold these toxins far and wide. Now that these loans are achieving the highest default rates ever recorded, it is safe to say the "innovations" over the last 5 years were not entirely successful. It is amazing that a group of intelligent bankers came up with this loan and expected a positive outcome. When you really look at the whole "innovation" meme, you see that it is nothing more than a public relations effort to convince brokers the products were safe to sell and borrowers the products were safe to use. It is hard to fathom the widespread acceptance of this nonsense, but that is the nature of the pathological beliefs of a financial mania.
Many in the lending industry think their work is like science that continually advances. It is not. It is far more akin to assembly line work where the same widgets are pumped out year after year. When lenders start to innovate, trouble is brewing. The last significant advancement in lending was the widespread use of 30-year amortizing loans that came into favor after World War II. Prior to that time, home loans were interest-only, short-term loans with very high equity requirements (50% was most common.) This proved problematic in the Great Depression as many out-of-work owners defaulted on their loans. A mechanism had to be found to get new buyers into the markets and allow them to pay off the loan. The answer was the 30-year, fixed-rate amortizing loan. To say this was an innovation is a stretch as this loan has been around as long as banking has existed, but it did not become widely used until equity requirements were lowered. The lenders were willing to lower the equity requirements as long as the loan was amortizing because their risk would decline as time went by and the loan balance was paid off.
Over the last 60 years since World War II ended, a number of experimental loan programs have been attempted. These include, interest-only loans, adjustable rate loans, and negative amortization loans among others. It is this group of loans that has consistently failed in the past for one simple reason: if payments can adjust higher, people will default. It is really that simple. The Option ARM is certainly the most sophisticated loan on the market today. It is a dismal failure, not because it isn't sophisticated, but because it has embedded within it the possibility (probability, no -- near certainty) of an increasing payment. Any loan program that has the possibility of a higher future payment will fail because there will be a certain number of people who cannot afford the higher payment.
Here is where the lenders lie to themselves and to the general public after a financial debacle like the Savings and Loan problems of the 1980s or our current housing bubble: they blame the collapse and the high default rates on some outside factor rather than the terms and conditions the lenders created all by themselves. There are still many out there who believe the high default rates and problems in the housing market in the 90s were caused by a weak economy. This is rubbish. House prices declined for 6 years. The decline started before the economy went soft, and it continued well after it had recovered. People defaulted because they overextended themselves on loans to buy overpriced housing, and toward the end of the mania, many were using interest-only loans. Whenever lenders start loaning people money with total debt-to-income ratios over 36% people start to default. Whenever lenders start loaning more than 80% of the purchase price, people get underwater and start to default. These phenomenons, which we document daily on this blog, are not new. It happened in the early 90s; it is happening again, and it is happening for the same reasons: lax lending standards.
Someday the lending community may actually innovate and come up with some financial product that has low default rates which most people can qualify to obtain -- Not. Unless you change human nature, there are always going to be people who are too irresponsible to make consistent payments. This is the key to any loan program. Either people do or do not make their payments. You can reinvent new terms and schedules as often as you like, and it will always boil down to people making payments. When these fancy loan programs contain provisions that make it difficult for people to make payments -- like increasing payment amounts -- they will default, and the loan program will fail. This is certain.
When lenders create new, "sophisticated" loan programs that require advanced financial management on the part of the borrower, both the lenders and the borrowers fall victim to the Lake Wobegon effect. Everyone thinks they have above average abilities when it comes to managing their finances. In reality, perhaps 2% of borrowers have the financial discipline to handle an Option ARM loan. 
Unfortunately, 80% of borrowers think they are in this 2%. The reason for this comes from the inherent conflict between emotions and intellect. 80% of borrowers may understand the Option ARM loan, but when the pressures of daily life create emotional demands for spending money on one's lifestyle, the intellectual knowledge that this money should go toward a housing payment is conveniently set aside. It is this 2% of the most disciplined borrowers who will cut back on discretionary spending to make their full housing payment. Everyone else will make the minimum payment, fall behind on their mortgage, and end up in foreclosure.
It seems lenders forget basic facts about lending every so often and create a new financial bubble. Perhaps they succumb to the pressure of the investment community or their own shareholders, or perhaps they just start believing their own "innovation" bullshit and forget the basics of sound lending practices. This is why we need the upcoming recession. These pathologic lending practices must be purged from the system or else they will survive to build an even bigger and costlier bubble -- although it is difficult to imagine a bubble bigger than this one, it is still possible.
In the aftermath of a financial fiasco, lenders return to the practices that did not fail them in the past. Some will consider this taking lending standards back 50 years. They would be right. The only program lenders know is stable is a 30-year, fixed-rate, conventionally amortizing loan based on 80% of appraised value taking no more than 28% of a borrowers gross income (36% maximum total debt.) This is what is coming. The last vestige of kool-aid denial I see in the comments is the insistence that equity requirements will not get that high. They will, and it will be a catastrophe for sales volumes and home prices. This is why I always post the downpayment and income requirements on my posts. People need to think about Your Buyer’s Loan Terms.
Why would banks continue to loan 90% of value when there is a likelihood of a greater than 10% decline and banks know high loan-to-value ratios result in high default rates? They are doing it now because they have to to make any loans at all, but they are limiting these loans to those with very high FICO scores, and they are betting these people will not default do to moral reasons or the desire to keep that high FICO score. If they try to extend these loans to lower FICO score individuals or subprime borrowers, they won't stay in business long. Think about the losses we have documented here on this blog. Banks can't sustain those losses indefinitely. Large downpayments are coming back, and government assisted financing will become widely used by first-time homebuyers to overcome the high equity requirements. There really is no other way forward. The credit crunch we have all been hearing about was not caused by some unexpected or unknown factor, it was caused by the failure of lenders. Credit will continue to tighten until lenders stop making bad loans. The bad loans will not disappear until lenders return to the stable loan programs with a proven track record. That is how the credit cycle works.
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Note to Lenders:
I plan to purchase in the aftermath of your most recent failure. Please wait until about 5 years before I am ready to retire before you innovate again so I can sell my house near the top of the next bubble you facilitate.
Thank you,
IrvineRenter
I read this analysis with interest piqued by David Brooks’ recent “Hooray for Wall St. and innovation” opinion piece in the NY Times:
http://www.nytimes.com/2008/01/25/opinion/25brooks.html
So, I guess we should all give three cheers for new, complicated financial vehicles that no one really seems to understand.
I’m speaking to Mike’s astonishment that the cumulative interest paid over the life of a loan can be so large.
If you don’t like the assumptions I chose, pick your own and redo the exercise.
A $50,000 car!?!?
IR, again a wonderfully detailed yet simply put post to again explain basic human nature, financial behavior and their intersection with economics. I marvel at the time you spend at this endeavor. To all who post thoughtful and incisive thoughts, Keep up the great work!
I want to address the behavior of the lending and financial markets and what I have long felt are disturbing characteristics of the two and how they relate to this particular post. My grandad often said, “You can’t get something for nothing unless someone, somewhere gets nothing for something.” Folksy wisdom but Oh so true. “Financial innovation” is an oxymoron, from now on when you hear those two words, guard your wallet! What angers me most about the financial markets is their schizophrenic and contradictory attitudes when times are good and when they go bad. The unofficial mantra being “privatize profit but socialize risk”. When the calf is fat, they’re all about pocketing as much of the profits as is possible, legally or illegally. And heaven forbid Uncle Sam step in and regulate something. But boy does that tune change when the losses start piling up. Then it’s all about why isn’t Uncle Sam stepping in or doing more to save us? So when they create these scams to fleece the masses and the whole thing goes sour, suddenly the “financial geniuses” go all Alfred E. Newmann on us ... what? Who me? What did I do?
This dovetails to many of the themes repeated on this blog. A house is a home, not a financial product. Something is worth what the market fundamentals and historical averages say it is. If it sounds too good to be true, it likely is. You can’t get something for nothing. I for one, want to see regulation, heavy regulation. This is twice in my lifetime “financial innovation” resulted in catastrophic losses that John Q. Taxpayer absorbed. I’m tired of bailing out Wall Street when their schemes go terribly wrong and I’m sick of seeing the carnage in their wake. Meanwhile the rich get richer and the poor get screwed. I’ve been lucky but I’m also a well-educated cynic and I do my homework. Let’s see this latest aberration purged from the marketplace and from now on let sanity and moderation prevail. Sadly, our memories grow ever shorter and delusional thinking ever more pervasive.
The historic Japanese of lifetime employment structure doesn’t seem all that nimble either - hard to reallocate economic resources in a structure like that in the 80s…
Employment in Japan
Sayonara, salaryman
http://www.economist.com/business/displaystory.cfm?story_id=10424391
they kept steadily cutting rates in an attempt to ‘inflate their way out of it’ until they spent a few years near absolute zero - isn’t that exactly what bernanke and the boys are planning to do if the market conditions of the past 9 months continue?
of course, the parallels don’t quite match - you forgot the biggest difference, the trillions of savings in postal accounts the japanese have always had - but the general picture of declining assets, banks clumsily trying to bail each other out, clueless politicians continually cutting rates sure seems familiar. e.g. - warburg’s offer to buy a chunk of mbia, bac with wamu, etc, etc… one sticky keiretsu.
Maybe there are 2 different kirks. I bet this one has no clue what troll we are talking about.
Our bubble burst will be unlike Japan’s for a couple of reasons IMO.
1. Japan’s real estate run-up was far greater, faster, and more extensive across their country than ours has been. Their prices ran up something like 200% in a ten year span. The median across the US has only risen 75% or so over the past ten years. Now in certain markets, obviously the rise has been nearly as meteroic as Japan’s, but that pace is not a national for the U.S. While local drops could be spectacular, we won’t have a system-wide crash such as Japan as we’ve had less participants sharing in the run-up.
2. Japan’s RE crash coincided with an implosion of the Nikkei. Their economy was super heated and super speculative. Japanese corporations were pouring huge money into real estate. Everyone in the world was trying to a piece of Japan (land, stocks, whatever) in the mid to late 80’s. The rampant speculation in Japan drove the Nikkei to more than triple its mid 80’s value in five years. 50% of that paper wealth evaporated dalmost immediately and fueled the housing downturn. Their stock market collapse and real estate collapse fueled each other for many years and they’ve been in and out of recession for decades.
3. Our equity markets, while having been strong in recovering from our last recession, have traded sideways for a year, and are only up 60-70% over a 5-year span. Those increases are much more orderly than the 300% run-up the Nikkei had over a similar time period. Very few are speculating in stocks in the US now so there is unlikely to be sharp drop in equity prices to fuel a depreciation spiral. Any stock market corrections as a result of recession will be much more orderly than the Nikkei’s collapse. You won’t see the S&P at 700 in a year or two. Maybe 1100-1200, but a 15-20% drop is very different than a 50% head shaving.
4. As we aren’t experiencing a speculative, hyperinflated economy across all assets classes here in the US, our monetary policy makers will be more inclined to induce as soft a landing as possible for housing and the overall economy. If they have to inflate their way out of it, they probably will. Japan’s government set off their collapses by attempting to slow their economy down. Our government will probably do the opposite…
IR, nice post! And great to see the site come far enough that I now barely have time to read all the blog comments. 5 months ago I noticed I didn’t have time to read all the forum postings because activity was picking up.
What interesting progress.
SCHB
Sorry, should be a B in there: ABCP. Asset Backed Commercial Paper. Too many acronyms.
IR,
We think alike. “This is ridiculous” was my reaction when a neighborhood house we liked went up 50% to 530K in 2001-2002. Then it went over $750K a few years later. “This is an historic bubble” was my reaction then. I thank g_d my wife didn’t insist on buying because “everything is going up”. Of course I reminded her if we bought she could not shop because we would be house poor.
At least our retirement accounts are doing well. Thanks for incredibly thoughtful posts.
That patience is easy to come by when one contemplates that the japanese real estate market fell each and every quarter for something like 15 years until recently and that the first baby boomers have begun to retire in the past year.
2022 may well be a more realistic target for a bottom than 2010. That’s possibly when we’ll finally start to see the light at the end of the tunnel..
assumptions about inflation and projections about appreciation can be horribly off-base.
e.g. = gold 1973, gold 1981, gold 2001, DJIA 1929, DJIA 1968, DJIA 1982, nasdaq 2000, etc.
what with the incredible run-up in real estate prices in the past few years, median real estate 2007 could well fit in the above list (probably next to gold 1981 and nasdaq 2000).
Let’s review Obi-Wan, “that means that a buyer w 1M to spend can buy your stucco box in irvine or nicer digs in Newport Coast, they are going to Newport Coast”
Well by the time your imaginary properties in NC get down to $1M, these similar Irvine properties would be $600-700K. Irvine isn’t going to sit in a some kind of price drop freeze while Newport Coast drops huge percentages. Still will have the same problem with your faulty logic. Yes, your posts defy logic! Woohoo!
You can’t compare today’s Irvine stucoo box pricing with a potential maybe future Newport Coast price. That’s moronic. By the time $1M gets you a 3000sf SFR in Newport Coast, you will be able to a 5000sf mansion in Irvine for the same money.
Indeed, that is likely true. I just found it interesting that the rates for A+ credit types on jumbos are back at pre credit crunch levels… I don’t think the chart basis has changed, i.e. before August it included less worthy borrower types.
Rates on the 10-year are at something like a 3-year low, so a return to August loan jumbo rates isn’t something to really get crazy about. Conventional 30-years appear to be at a 26-27 month low right now. Looks like a well qualified buyer could get a 30-year fixed for 5.75-6% right now.
It takes a good deal of patience to sit the sidelines when things have dropped 15-20% and safe mortgages are below 6%.
I never said the listings were here today.
I said that with 4600 properties chasing 250 buyers, it’s only a matter of time before you see these listings happening.
Patience, young skywalker…
Too true,
I went to Etrade last week and saw the rate on the splash page, then plugged in some numbers to see what I could get and guess what, that number was a lot higher then the teasers posted on the Splash page.
Would you please explain what the acronym “ACP” stands for?
Thanks!
Now… if Jesus got involved then He’d multiply the equity first…
Hey.. can I disparage my ex boss?
What that chart does not reflect is this rate, or any loan for that matter, is only available to a select few customers with very high FICO scores. If rates come down, and loans are made available to a wider range of people, enough knife-catchers may step forward to slow the rate of decline. As it is, prices are in free fall.
not quite unlimited, they had to package the loans and sell them to wallstreet before they could make new ones, and pocket fee’s along the way. No loans, no fee’s.
Very scarry
Thats why we have to go back to the old system, banks need to hold their own loans, that’s they only way they have any incentive to make sure the borrower can pay and that the property value is real and not some inflated BS number.
I was pondering this comment along with Kirk’s comment about using SIVs to get around deposit requirements. I made me realize banks have no tether any more; just a license to print unlimited money. The more I ponder this, the more worried I become about a deflationary spiral. If loans are not paid back, which many will not be, then the entire fiat currency ponzi scheme could collapse. It also gives me a deeper understanding of why Bernanke is willing to trash the dollar to prevent a deflationary spiral. Basically, about a third of the money banks invented so people could buy houses is about to vanish, but the banks will still show these assets on their books. They couldn’t possibly write these loans down if they wanted to because they don’t have the reserves. Bad loans equal deflation. There is no way around it.
Food for thought:
http://www.marketwatch.com/tools/pftools/rates/RateChart.asp?sid=159415
I thought prices were too high in 2003. but did not sell until the summer of 2005. I was waiting to see the downtrend, but just couldn’t wait any longer. And I thought another asset class would be appreciating faster than real estate. I am definitely no genius and less smart than most, but I did listen to some people who actually had a history of making money and not just a history of having an opinion.
ipop - We posers, (posters), here in the IHB have a history of remarking on real estate which is located in OC, but not necessarily Irvine.
Just curious. How many folks understand what Anteaters just wrote?
The bloggers who have enough sense to know they are not geniuses may very well buy at the bottom.
Your point is wrong… There is simply no comparison. There is nothing on Newport Coast for anywhere near that price of $899K. As a matter fact, the cheapest 4-bedroom I can see is this:
http://www.redfin.com/stingray/do/printable-listing?listing-id=1088268
It’s an attached condo. There is a world of difference between $1.1 and $900K and a world of difference between what is a really big nice apartment in Newport Coast vs. a 3100sf detached SFR in Irvine.
Why don’t you post a few links to any comparable property actively listed in MLS. I’ll make it easier on you. Just find 4 bedrooms and at least 2500sf in Newport Coast… What’s the cheapest you can find?! You can’t find closer to the beach with views or farther from your neighbors anywhere near Newport Coast for a price close to $899K.
Come on, show us all the listings o’ wise one.
my point, if you read my other posts today
is that there are 5000 properties over $750k chasing 250 buyers.
that means that a buyer w 1M to spend can buy your stucco box in irvine or nicer digs in Newport Coast, they are going to Newport Coast.
You may love your Irvine box because you love Irvine but it was not worth what someone paid for it in 2005 because the price then was bid up by funny money and now there are surrounding areas where you can spend the same and get a view, or closer to the beach or farther from your neighbors with a yard instead of a small patio.
I tire of the irrelevance of your posts Alan… I have no idea what point you are trying to make or even if you have one. So Cal is part of the United States too so does that mean we should compare Irvine housing to Detroit’s? If a butterfly flaps its wings in Boise, will that have some mysterious impact on the OC median?
Yes, they are forced to put it back on the books because they can no longer issue commercial paper backed by the mortgages.
If a bank holds mortgages on its books it has to have a certain ratio of deposits to loans. This limits the number of mortgages the bank can issue. So, the bank puts the mortgages into a SIV (takes the mortgages off the books) and issues commercial paper. The buyers of the CP replace the depositors that are traditionally required. I’ve seen it called a virtual bank.
Of course, there’s more to it than that (i.e. more than commercial paper is issued), but this is the gist of it. SIV’s are essentially an accounting trick.
testy today IPOP
Last time I checked Irvine was part of Orange county which was part of Southern CA. You haven’t succeded yet like the Peoples Republic of Santa Monica. What happens by the beach or in the hills affects prices in Irvine too.
Just trying to keep you honest.
Sorry Iblis, I thought of the line from Men in Black too, and didn’t see you posted first.
LOL...so true!
My bad, I miscalculated the M-roos and got over $3000.
I agree though, it’s desireable relative to the Irvine market. Kind of funny though, desireable is essentially, a big detached box with little privacy or free space. The free space is made up by the community space.
Mike: This way of thinking is new to me, but it makes allot of sense. I like the 3-5 year idea allot. Why should anyone pay double for a house. For example a 500k house + 500k interest on the loan= 1 mill.
4% inflation will means your house that was $500k in 2007 will be worth 1,621,698.76 in 2037.
You’re also paying inflated future dollars for today’s purchase. For instance, your final mortgage payment (20% down, 7% interest) of $2,661.21 in 2037 is the inflation-adjusted equivalent of $820.50 in 2007 dollars.
“50% was most common.”
During the Great Depression, the banking system failed, causing a drastic decrease in home loans and ownership. At this time, most home mortgages were short-term (three to five years), no amortization, balloon instruments at loan-to-value (LTV) ratios below fifty to sixty percent.[2] The banking crisis of the 1930’s forced all lenders to retrieve due mortgages.
This way of thinking is new to me, but it makes allot of sense. I like the 3-5 year idea allot. Why should anyone pay double for a house. For example a 500k house + 500k interest on the loan= 1 mill.
Jay: Why the big secret? People are smart, they can handle it.
Kay: A person is smart. *People* are dumb, panicky, dangerous animals and you know it.
/Men in Black
Yes, by Irvine standards, it’s actually a halfway decent place. This is the Irvine Housing Blog right? If you think $1400 in roos is a lot, you must really think ill of Northpark, Northpark Square, Northwood II, Woodbury, Village of Columbus, Portola Hills, etc. All of their MRs for the same lot size are bound to be much greater…
The bottomline is that these houses were going in the $1.1M range not so long ago. They were desirable enough to be sold for OVER $1M and now this one can probably be had for $875K.
I think Alan has a remote cabin outside Lincoln, Montana…
Oh wait, that was Ted Kaczynski. Writings seem a little similar:
http://en.wikisource.org/wiki/Industrial_Society_and_Its_Future
Almost - “De gustibus non est disputandum”.
I like stucco. It’s less likely to catch on fire… If I’m going to live in the “seventh circle of real estate hell” I wouldn’t want my house to burn up too easily.
I’m curious, does Alan own a house? Or are you renting, holding out for something great. Do tell, what requirements must be met for a house to be considered ‘nice’ by you, that you would live in?
I fail to see the desirability of that home.
It dominates it’s lot will little spare space for a yard. You can perhaps BBQ on it, but don’t have too many guests, as in more than four. Look down two doors and you see a lot that barely squeezes in a small wading pool.
The neighbors units are set very close.
It’s west Irvine, far from the beach and likely requires AC to be run 250+ days a year.
It is less than 100 yards from Jamboree and less than a 400 yards from the 261 Toll road.
It has substantial mello-roos on top of the taxes.
Okay, by Irvine standards, this is desirable. But frankly, that’s a low target.
Yeah, I kind of like it too. I guess in Alan’s imaginary Irvine, the houses are more than 10-12 feet from one another. Unfortunately, that is not the reality of the city. As a prospective buyer in IRVINE, I accept the fact that the houses on either side of my future home will be close to me.
Problem with this particular house is they planted all kinds of bushes, vines, and such on the side by the front door. It’s over-grown (drove by there this morning) so it wouldn’t make for a very good picture. You can barely see the front door from the street.
De gustibus non disputandem. Not sure I spelled it all right.
Had time to post that drivel but still couldn’t come up with how I am defying logic with my posts huh?
May I remind you that this is the friggin’ IRVINE HOUSING BLOG. “Welcome to the Irvine Housing Blog! We’ll be focusing on real estate developments in the City of Irvine.” Let me scream it again, IRVINE HOUSING BLOG. If you want to talk about views and the beach, you should be posting to somewhere else. Last I checked, very little of Irvine had views, none of it was close to the beach, and much of it was constructed using stucco…
Depends on how bad it gets. We don’t know yet.
Anyway, read the book.
For me, hurricane Andrew was a Black Swan event, tho predictable, so I gues it wasn’t and “unknown” unknown. I haven’t finished reading the book and will probably read it several times.
More significant, I think, is that this is a desirable property, not some rat trap condo.
Indeed it is. And there are too many cars on the street for my liking as well. Don’t know what the deal is there. Two cars in every driveway plus seemingly another 1-2 on the street…
Ability to do driveway hoops is high on the needs list. Made the mistake of trying to teach my 3-year who all the Lakers were last night. Got a hear him say for a whole half, “daddy, where’s Kobe?” and “Which is one Kobe dad?”.
Cute house, are we looking at the same pic’s
It’s a 2 story, grey-stucco box, 10 feet separting you from your neighbor with almost no yard. It has no view and is not located 2 blocks from the beach.
Oh excuse me…
It’s in IRVINE
Well,
I forgot
That makes it ok
A person is smart. People are stupid.
- Men in Black
Haven’t read the book but checked the wiki on it.
Can’t agree that the current bubble pop is the result of a black swan event. This is the normal part of a business cycle, one that could have been predicted early on to a reasonable observer (I consider myself reasonable and I self predicted it) and one that was fuled by excessive greed and outright fraud. That’s like saying that ENRON was a black swan event.
Sept 11th on the other hand was a black swan event.
Just because you get a hammer for X-mas doesn’t make every screw a nail.
I think I started this. I didn’t think it would be the mantra of the day.
Yes, some brokers made a lot of money, but now they’re out of business.
Yes, many realtors also made a lot of money, but a lot of them are out of business too.
Yes, the non-banks made a lot of money, but now they are out of business. See the Implode website.
Yes, the banks made money packaging the toxic waste, but they were stuck with what was in the pipeline, plus are apparently on the hook, somehow, for a lot of stuff they sold.
So yes, they were very short term smart, but medium to long term very stupid.
And nobody that I ever tried to explain the concept of margin to seemed to get it. I think I am a pretty good explainer. The average person certainly has a blind spot here. And when I’m closing a transaction, I don’t have all the time in the world to do it in. I answer questions, but the degree of ignorance means that the borrowers really can’t formulate a question.
Someone above made the very good point that either you competed, or you didn’t make any loans. I guess if you were smart enough you could have decided to not make any loans, and that would have got you fired.
I suppose you could have tried to offer a product that was less toxic. For example, I know some people who made 10 year interest only loans. Bearish tho I am, I think these people will be doing just fine in 10 years. All this will be over in 2017. If it isn’t, even people like Mr. V and I who own paid off houses, will be more worried about procuring ammo and oiling our guns than who has what kind of mtg.
And I don’t seriously think this is gonna happen, but we do have guns, ammo, a bit of cash, and physical gold. For a Black Swan event
(I can’t praise that book enough. Y’all go out and buy it immediately!!)
Oops would not
IR,
maybe the next topic will be how useless these so called experts have become at predicting the future, how they have turned themselves into mouthpieces for the retailers.
When I was college, I took an economics course, it was taught by one of our trustee’s. He told a story of how when he started out he worked for a paper company and his job in accessing inventory was counting trees.
It seems none of the purported experts posting these predictions spend any time counting trees anymore. If they did they would say 5000 houses priced at 750k+ chasing 250 buyers, project how much more inventory comes on the market over the next three to six months and how many new buyers may jump in or out… and come to a valid conclusion instead of just spewing “I see a 10% fall in prices in 08” with nothing to back them up, just blah, blah, blah…
That is a cute house with a lotta square feet. Still just a bit pricey, but I would blame anybody who bought it.
My only complaint is that once more, the picture features the driveway. They could have taken it from the other angle and feature the grass, and the entryway by which the human beings enter.
I totally agree. Once you have over a certain amount in income, what matters is what goes out, not what comes in.
Lord help me I agree with most of what Kirk says. Kirk, if you can contribute like this, why do you want to act like a troll most of the time?
But I disagree in that lenders are being forced by something, I’m not sure I understand quite what, to take this trash back on the books. Like Citi.
If you are patient I bet you can pick it up for $650k. Maybe less if the economy is tanking.
Driveway looks too small for playing hoops though.
Ah, let me count the ways. When I have more time, I will post extremely large numbers of stupidities.
Not just no, but hell, no.
Hey IR, love that comic about the MBAs.
I thought prices were too high in 2002, does that qualify me as stupid?
Don’t confuse luck with intelligence.
I don’t know what a nanotechnologist is. What is it, so I can pick on you?
Nano means small. Wesley Crusher’s Nanites were always running amuck on the Enterprise.
You build teensy tiny machines, like I see in Science News sometime?
I admit, I am too harsh. My attack on Economists was not thoughtful.
However, I do know lenders, and they are STUPID!!!!!!
All exclamation points intended.
I find when a real estate atty says to another one, you have a problem here, the other one takes it seriously. The first re atty may be wrong, but almost certainly has some sort of a point, which needs to be resolved. Litigators are all to often acting like gorillas beating their chests, saying I am biggest gorilla in forest, don’t mess with me. Sometimes this actually works. I find it extremely annoying. But now that I have virtually no real estate practice, and not enuf probate, I find I have to do real estate litigation or shut up shop. And litigators who know no real estate and think they can learn in a few burning midnite oil sessions are the most frustrating of all.
If you’re about to make the biggest purchase of your life, wouldn’t you want to educate yourself on the matter?
This is how we end up with people only concerned about the monthly payment. They don’t care or know enough or are not curious one bit how this will affect them. Formally educated or not, people should at least give a poop about this large sort of transaction and actually do their homework!
mark - those are very deep statements you made. I totally agree that your spending habits have as much to do with your wealth as well as your investment decisions.
So that must make those of us who bought in 2000 and sold at the end of ‘04 brilliant! Or just lucky. All these talk of supposed stupid people are nauseating. The widely accepted notion is that the mortgage bankers and realtors - from an individual to individual standpoint - made out like bandits at the expense of the “less educated” (but not necessarily more stupid) consumers. I find this to be immoral, but not necessarily stupid. They may have been the smartest of them all, actually.
We the consumers basically roll with the punches for the most part, especially those that are not as saavy financially as most of the people on this board. What many of us possess from the financial knowledge perspective can’t be construed as “normal” knowledge in average America, but rather an educated knowledge. Just because they did not educate themselves in the financial world does not mean they are dumb, just not knowledgeable in that particular field. I mean, I know nothing about calculus or quantum physics but that doesn’t make me stupid, just uneducated in those matters.
Does it behoove them to learn about finance and investments since it will be the backbone of one’s financial well-being for the rest of their lives? Absolutely. However, the last time I checked our educational system does not REQUIRE someone to learn investments at any level. So maybe it is the education is to blame, but it certainly isn’t stupidity.
That’s the key—first time buyers get assistance to come up with the down payment, either government, parents or because the purchase price on an entry level home/condo is small enough that you can save/borrow the down. Move-up buyers typically use their equity for the down payment on the new home. With declining/flat home prices, the move-up market dies on the vine. This means sellers are competing for a shrinking number of buyers who have the cash, and those buyers know they have the leverage to drive a hard bargain. Prices decline further, cycle repeats. I think this is the market dynamic we will be seeing for the next 12-18 months at least.
The buyer you describe will be in a phenomenal and enviable position relative to the bubble buyer! If they continue to make such wise and prudent decisions in all their financial endeavors they’ll amass great wealth.
However, any gain they make on their neighbor in purchasing at the right time can be lost quickly and easily by any number of life decisions. e.g. purchasing/financing nice cars frequently, having a child or many children, getting divorced, etc.
Ah yes, the most widely taken out of context quote in history. The plotter in Henry VI was strategizing revolution and felt that the lawyers, who represented independent thinking and the rule of law, were the greatest obstacle to the plan. The quote is the opposite of derision for the legal profession, it is actually great praise for it.
Lee, I know you were joking and possibly even knew the context of the quote. My comment is just a bit of trivia, not a criticism of your post.
To anyone else who might respond, I concede in advance that ambulance chasing trial lawyers and their ilk are scum and don’t represent “independent thinking and the rule of law.”
No, you mean brokers weren’t dumb. Lenders were very stupid, because they used SIV’s and CDO’s that relied on issuing short term bonds (ACP) to fund long term mortgages. Yes, they sold those bonds to Wall Street. Ha ha, it’s Wall Street’s problem now… as long as the stuff explodes before the bonds come due. Oops, the bond holders figured out the scam and didn’t purchase a new set of bonds once it was apparent the mortgages would fail sometime in the future. So, the banks paid back the bonds at maturity and put the mortgages on their books.
This is the main reason a ton of commercial paper hasn’t failed. Not many people bought the bad stuff. I laugh when people say there isn’t a real problem in commercial paper since most of it paid out. The new ACP wouldn’t pay out. That’s why it’s not selling.
At least the banks soaked the equity tranches. That should soften the blow for them. But, they should have offloaded the loans completely. I’ve got no idea what they were thinking. Maybe they really thought this wouldn’t blow up beyond the equity stake.
“Since some sellar has to blink first, creating new comps for the rest, the result is predictable”
firesale, woot woot!
How can my posts defy logic? I simply posted a link to a home that listed at $290 per sf. Sub $300 per sf has been rare to date and I have opined that it is refreshing to see such a change. What about that is illogical? You might not think it’s a good sign to see sellers recognizing market realities but what about that makes anything I post illogical?
If I had not just moved to San Diego and knew nothing about it, I might have bought. The prices were high relative to Florida, but they were not too high relative to incomes in San Diego.
Like any market, if you knew in advance what was going to happen, you could make a fortune. If you spend any energy imagining the perfect trade you would have executed at some point in time, you are only deluding yourself. I could have just as easily bought a place there watched the values drop and be trapped in a place where I did not want to live—like many are facing now. The upside only becomes apparent in hindsight.
IPO, for someone so swavy on the stock market and 401k’s your real esate postings defy logic.
Look at the latest data from lasner (old already)
http://lansner.freedomblogging.com/2007/12/31/oc-home-supply-measure-doubled-in-year/
OC has 4669 properties priced $750k or greater chasing only 239 buyers/month w 14 months plus of inventory.
all the properties you covet are priced over $750k, the laws of supply and demand doom these sellars.
prices will not fall in a week or a month but glacially slowly over the next two years.
with the supply of free money gone and a recession inevidable there will be no surge of buyers available to snap these properties up. Since some sellar has to blink first, creating new comps for the rest, the result is predictable.
Bad thing is a 160 GRM means this Parma place should fall to $650K or so. Feels like a steal right now, but could fall another 25-30% from $290 per sf. Argh, I hate the waiting…
Well said Alan!
Holy bad decisions Batman, I didn’t realize just how nuts SD went until I looked it up. Almost 50% appreciation in median between 2001 and 2003. Is that right?!
So IR, if you’d have bought a median home in SD in 2001, price around $300K, could have probably unloaded in 2003 for $450K or so when you came to Irvine. Dude, that tax-free gain would probably have paid all your rent since then and into 2008…
Even if you would have bought here in 2003 with those gains, you’d likely still have to be better off vs. renting. In 2003 you could have locked up a 30-year in the low to mid 5% range, saved some bucks vs. renting all these years, and still have at least $200K of equity.
I understand hindsight is 20-20 and all that, but it would be nice to hear, just once in a while on this blog, the other side of the coin. Yes many bubble buyers were stupid, especially those that bought in the past couple of years. But many current renters were stupid as well because they thought prices were too high in 2001/2002 and didn’t buy when they had the chance.