Fine Line: Sub-Prime Decline – The Richter Scales
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The Credit Crunch
In 2007, the financial markets were abuzz with talk of a “credit crunch.” It was portrayed as some unusual and unpredictable outside force like an asteroid impact or a cold winter storm. However, it was not unexpected, and it was not caused by any outside force. The credit crunch began because borrowers were unable to make payments on the loans they were given. When lenders started losing money, they stopped lending: a credit crunch.
New Century Financial is the poster child for The Great Housing Bubble. New Century Financial was founded in 1995 and headquartered in Irvine, California. New Century Financial Corporation was a real estate investment trust (REIT), providing first and second mortgage products to borrowers nationwide through its operating subsidiaries, New Century Mortgage Corporation and Home123 Corporation. The company was the second largest subprime loan originator by dollar volume in 2006. April 2, 2007, the company filed for chapter 11 bankruptcy protection. The date of their financial implosion will be regarded as the day the bubble popped. The death of New Century Financial has come to represent to death of loose lending standards and the beginning of the credit crunch. Subprime lending was widely regarded as the culprit in starting the cycle of credit tightening, and New Century has been linked to this problem, but the scale and scope of the disaster was much larger than subprime.
The massive credit crunch that facilitated the decline of The Great Housing Bubble was a crisis of cashflow insolvency. Basically, people did not have the income to consistently make their mortgage payment. This was caused by a combination of exotic loan programs with increasing payments, a deterioration of credit standards allowing debt-to-income ratios well above historic norms, and the systematic practice of fabricating loan applications with phantom income (stated-income or “liar” loans.) The problem of cashflow insolvency was very difficult to overcome as borrowing more money would not solve the problem. People needed greater incomes not greater debt loads.
When more money and debt was created than incomes could support, one of two things needed to happen: either the sum of money needed to shrink to supportable levels (A shrinking money supply is a condition known as deflation,) or the amount of money supported by the available cashflow needed to increase through lower interest rates. Given these two alternatives, the Federal Reserve chose to lower interest rates. The lower interest rates had two effects; first, it did help support the created debt, and second it created inflationary pressures which further counteracted the deflationary pressures of disappearing debt and declining collateral assets. None of this saved the housing market.
Credit availability moves in cycles of tightening and loosening. Lenders tend to loosen credit guidelines when times are good, and they tend to tighten them when times are bad. This tendency of lenders often exacerbates the growth and contraction of the business cycle. In the decline of The Great Housing Bubble, the contraction of credit certainly played a major role in the decline of house prices. Lenders continued to tighten their standards for extending credit for fear of losing even more money. This meant fewer and fewer people qualified for smaller and smaller loans. This crushed demand for housing and made home prices fall even further.
One of the biggest problems for the housing market was caused by tighter lending standards was the reinstatement of downpayment requirements. During the bubble rally, 100% financing was made widely available. This made it unnecessary for people to save money to get a house. People respond to incentives. This is basic economic theory. The availability of 100% financing removed the incentive to save for a downpayment. People responded; our national savings rate went negative. Potential homebuyers who ordinarily would have been saving money for a downpayment to get a house, stopped saving, borrowed money and went on a consumer spending spree. This created a situation in the aftermath of the bubble crash where very few potential entry-level buyers had any saved money for the newly required downpayments. This created very serious problems for a market already reeling from low affordability, excess inventory, and a large number of foreclosures.
100% Financing
Once 100% financing became widely available, it was enthusiastically embraced by all parties: the lenders suddenly had a huge source of new customers to generate high fees, the realtors and builders now had plenty of new customers to buy more homes, and many potential buyers who did not have savings were now able to enter the market. It seemed like a panacea; for two or three years, it was. There was a problem with 100% financing (which was masked by the rampant appreciation brought about by its introduction): high default rates. The more money people had to put in to the transaction, the less likely they were to default. It was that simple. The borrowers probably intended to repay the loan when they got it, they just did not feel much of a sense of responsibility to the loan when the going got tough. High loan-to-value loans had high default rates causing 100% financing to all but disappear, and it made other high LTV loans much more expensive, so much so as to render them practically useless. It was all part of the credit tightening cycle.
Besides stopping people from saving for downpayments, 100% financing harmed the market by depleting the buyer pool. In a normal real estate market, first-time buyers are saving their money waiting until they can make their first purchase. There is usually a steady stream of first-time buyers that enters the market each year as they saved enough for their downpayment. When 100% financing eliminated the downpayment requirement, it also eliminated any need to wait. Those who ordinarily would have bought 2-5 years in the future were able to buy immediately. This emptied the queue. This might not have been a problem if 100% financing would have been made available to everyone forever; however, once downpayments came back those who would have been saving were already homeowners, so there were few new buyers available, and any potential new buyers had to start over saving for their downpayment. What was worse was those late buyers who were “borrowed” from the future buyer pool overpaid and many lost their homes. This eliminated them from the buyer pool due to poor credit for several years. Everyone who thought 100% financing was a dream come true found it to be a nightmare instead.
Conclusion
Credit availability moves in cycles. During the Great Housing Bubble, credit was loosened to a degree not seen before, and it facilitated a price bubble of epic proportions. During periods of credit contraction, lenders seek to avoid risk and they make fewer loans. This causes inflated asset prices to drop precipitously. The last period of stability at the bottom of the credit cycle saw 20% downpayments, 28% DTI requirements, and high FICO scores. Is there any reason to believe credit will not tighten to those levels again given the losses the lenders are experiencing? This cycle of credit contraction leading to asset deflation feeds on itself until lending standards become too tight and overly cautious when asset prices are their lowest. Of course, this is when credit should be made available to purchase assets at bargain prices. As safety and sanity returns to a financial market, lenders see they became too conservative and loosen their standards allowing more money to flow into capital markets: the whole process starts all over again…
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As my wife were looking through listings in North San Diego County she couldn’t believe the previous sale prices of most of the homes. I could believe them but only because I spend an inordinate amount of time looking at such things, not because said prices are believable or realistic. They aren’t (or rather, weren’t).
The thing that doesn’t get said enough in this discussion is obvious. Lots of people made money with 100% LTV. Lots of people, LOTS of money. Loan originators, real estate brokers, appraisers all cashed in big time. Suddenly, anyone with a pulse can buy one of these half million dollar homes that everyone in SoCal was supposed to want. Suddenly your home will “double in value” in two years…just because.
And watch a few episodes of any one of three or six shows on the TV and you can learn how to Trump your way to the financial big time by flipping your home purchases. Simple right?
The more buy and sell the better (for all those folks I listed above).
100% LTV, liar loans and the whole list of travesties will come back as soon as they can because so many people made so much money on them. The entire cycle is self-reinforcing.
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100% financing is still available IF, and only if, you have a FICO of at least 750, and the loan is no more than 3X your income. It is also required that you have some kind of cash reserve Also, you can’t have a stack of credit card and car debt. Most borrowers don’t meet these benchmarks.
If 100% financing had been granted only to borrowers who met stringent tests for income:debt ratios and who had excellent credit, we wouldn’t have had this incredible runup in prices.
If the loan:income ratio had been maintained at 3X income, or better yet, 2.5X the borrower’s income, prices would still be reasonable related to incomes and rents.
Also, the mere fact that a person has a down payment is no reason to drop normal lending standards. A person placing her last $50K in the world is still going to be endangered by a loan 4X or more her income, especially since property taxes and utility rates are always increasing. Moreover, you are usually confronting an array of new expenses related to maintenance- the furnace broke down, the bldg is levying a special assessment for the copper roof- when you buy, that you never had to worry about as a renter, so it is necessary to have a substantial cash reserve, as insurance against those expenses as well as against loss of your income and other personal emergencies.
If I were lending, I might let a buyer slide on the downstroke in order to have his cash available as a cushion, if, and only if, the payments were in line with his income and no more than 10% more than his rent, and the dwelling was being bought for a price related to local fundamentals, the mortgage was no more than 2.5 times his income, the loan was a straight 30-year-fixed,and the buyer were not incumbered with other debt.
But we discarded ALL prudence in lending. I personally know of people out here with loans that are 7X their incomes- a ratio made possible only by option ARMs and low teaser rates of 1%. Around here, these were referred to as “flipper” loans, because you would no intention of hanging around long enough for the loan to reset.
BTW, I could not find the lyrics to the video today as it is a one-off comedy skit. It is very funny and worth the time to watch it.
I think Fed is using “controlled” inflation to bail out of the mess. At least 4-7 % CPI for the next few years will be the norm.
The biggest losers will be short term cash or equivalent holders. The most responsible bunch gets punished further.
In general, standard of living in US will suffer. US dollar continues to devalue against all other major currencies.
I can only express sadness at the coming years and the difficulties we as a country will experience.
In the past, the falling dollar beefed up our export capability and provided real global trade opportunities. Now that we don’t have a viable manufacturing base anymore, I am guessing that we can only be hurt by the dollar falling. It is sad the short term greed that over took the REIC and other industries that has now driven our economy to this point.
I remember the 70’s as a child and I am not looking forward to a repeat. The thought of worse. Well I don’t sleep very well as it is now…
Laura,
Do you know how stringent the requirements are when you start putting cash down at 5%, 10%, 20% levels?
I’m curious how close we are to 20% required down payments.
I fall into your category for someone who could get a 100% financed deal, but I would never even consider that option…. should I ?
How quickly are consumer credit card companies responding to this mess?
Are home debtors allowed to run up huge credit card debt while in the short sale / foreclosure process, or are the credit card companies shutting off the free money valve?
Increasing the interest rates on these people is practically meaningless…. since I can’t imagine they will pay anything back.
The hardest hit people on this 20% downpayment are people who are looking to refinance. I know two people who went to back to refinance and bank denied loans as their hpmes were upside down. Banks were looking at today’s market and marking down 20-25% further. It appears that Banks are factoring in another 25% drop in home prices. In other words, if you need to refinance, banks are not lending above 75-80% of todays market values. I am sure this would apply to new home buyers as well.
Given the fact that Bush signed the bill to waive taxes on earned income on people who lost homes in foreclosures and who ended up owing money to banks and banks foorigve the debt, this is giving all more reason for people to simpy walk away with no liability. In turn, its putting more pressure on home prices.
I dont think credit crunch will get resolved anytime soon. We haven’t seen the dark side of bond insurers and it is believed that over a trillion dollars of insured mortgage securities are worth trash and yet to hit markets which will hit several banks with more writedowns. Lots of bad things to happen before we can see investors getting greedy again.
Fed will take the interest rates down to 0% if needed to extract cash out of people’s savings and fore them to get into equity or securities markets.
“Fed will take the interest rates down to 0% if needed to extract cash out of people’s savings and fore them to get into equity or securities markets.”
alright ! let’s all order shushi ! Saki bomb !
http://youtube.com/watch?v=EpCcelpvkps
From the OC Register:
More Americans tap retirement accounts to make ends meet
Trent Charlton knew the risks when he borrowed $10,000 from his 401-k and cut his retirement savings in half.
But Charlton, a 40-year-old account executive at an Irvine trucking company, said he had little choice because he and his wife could not keep up with monthly expenses after American Express reduced the limits on three credit cards.
Charlton and his wife used the retirement money and $7,000 from savings to pay down their credit card debt. They also cut monthly expenses by pawning a diamond ring and selling camera equipment he owed money on. And he’s looking for someone to take over his $550 monthly payment on a gray BMW 335i he leased last April.
http://www.ocregister.com/money/retirement-loan-percent-1985130-credit-savings
I’m always amused at people who say the United States doesn’t have a viable manufacturing base.
15 seconds of time spent on Google and I found this link:
http://209.85.173.104/search?q=cache:11mPEYHEEywJ:www.nam.org/s_nam/bin.asp%3FCID%3D202325%26DID%3D233605%26DOC%3DFILE.PDF+us+manufacturing+exports&hl=en&ct=clnk&cd=1&gl=us
In 2005, our country manufactured $1.6 trillion worth of goods. (That’s about the size of the entire Chinese economy in 2005) Manufacturing represented 2/3rds of GDP in 2005 and 2/3rds of US exports were manufactured goods in 2006.
How is an activity that represented 12.2% of GDP in 2005 considered “not viable”?
Great post as usual IR, you make complicated finance be comprehensible to us lay-people. The video and the song are great!
I wonder – maybe I missed it- if you’ve posted already this “Bernanke Blues” (aka subprime mortgage blues) one?
https://www.youtube.com/watch?v=13qWw7waSeM
Keep up the great work,
Smurf
WINEX,
Thank you for the info. I am curious as to the ratio 20 years ago? Or in the hey day of manufactuirng? I mean this stat is kind of usless as an island.
12. 2 % of GDP means 87.80 % of GDP is non manufacturing. That seems pretty large to me.
If our export base is so large then we should cheer the falling dollar. I don’t see that happening. People seem pretty concerned about it.
Here it is in even more simplicity folks:
Assets – Liabilities = Owner’s Equity
Accounting 101
Equity is not some entity onto itself, it is derivative of the value of the assets that offset said liabilities. If those assets become impaired for some reason or other, then OE is affected negatively.
This is true for all businesses of any size, shape or form and it is true for the personal financial health of any individual regardless of income or perceived wealth.
The Balance Sheets are not supposed to lie…unless you purposely leave stuff off of them (SIVs).
Another 30 seconds of time reveals the following links:
According to http://usinfo.state.gov/products/pubs/economy-in-brief/page3.html
Production of goods accounted for 19.8 percent of GDP: manufacturing—such as computers, autos, aircraft, machinery—12.1 percent; construction, 4.9 percent; oil and gas drilling and other mining, 1.9 percent; agriculture, less than 1 percent.
Note: This is for 2006. The 12.2% number quoted in the other article seems low even though the decline in the dollar has helped manufacturing companies.
According to http://www.cato.org/research/articles/reynolds-030831.html (Note: This article is from 2003)
Back in 1995, right in the middle of a nine-year economic boom, Louis Uchitelle co-authored an absurdly downbeat series of New York Times articles on “The Downsizing of America.” That series was full of opinion polls, as though popular illusions could substitute for facts. More recently, there has been hope that scandals at the New York Times might have given new editors at least a casual interest in factual accuracy. Apparently not. A couple of weeks ago, the unrepentant Mr. Uchitelle wrote yet another weirdly apocalyptic piece claiming, that “manufacturing is slowly disappearing in the United States.”
If you were hoping for some proof this time, be prepared to be disappointed again. Mr. Uchitelle says, “Manufacturing’s share of real gross domestic product… has dropped to between 16 and 17 percent, from 18 to 19 percent in the 1950s…. The downward trends are alarming.” Similar statistical exercises recently led to an interesting debate between my old friends Bruce Bartlett and Paul Craig Roberts. Yet the National Association of Manufacturers’ Web site shows that “manufacturing’s share of the U.S. economy, as measured by real GDP, has been stable since the late 1940s…. The overall share remains the same over the business cycle.”
Where is this supposed crisis in manufacturing? Oh, and if you think percentage of GDP coming from manufactured goods is a metric of economic power, then he two greatest world powers are Turkmenistan (with 39.8 percent of GDP attributed to manufacturing in 2000) and Cuba (at 37.2 percent). (Source of info on Turkmenistan and Cuba lifed from the Cato.org article)
Wrong, the FED is not bailing out people or banks with inflation. Number one, the FED is not printing more money. Number two, the FED is trying to slow down what would otherwise be a vicious deflationary cycle at this point.
Let me make this point very clear so everyone understands this:
The FED is not going to save your Irvine House Price Appreciation via Inflation. Inflating away debt is not going to save you because the FED doesn’t want that to happen either.
Now flame away and I will show you the proof later.
I respectfully await your enlightening.
I’d love to see other way out other than inflating out of asset bubble.
First tell me your definition of inflation….
I don’t think many here believe inflation will save housing. As I see it, the task for the FED right now is to create enough inflation to counteract the deflation occurring as asset prices fall and the loans used to purchase these assets go bad. Banks create money out of thin air, so when a bank loan goes bad, and the bank cannot recapture this loan value though foreclosure on the collateral, the money the bank created out of air disappears. The disappearance of money from the system is deflation. Bernanke’s course is to devalue our currency to create inflation to balance the deflation in the system. He is very afraid of a deflationary spiral where people hoard cash (like the banks are now.) The only way to stop people from hoarding money is to lower interest rates so people don’t have a safe place to store it and create inflation so people are encouraged to go out and buy things before the prices go up. Hence, the FED is lowering interest rates.
Winex,
The problems with manufacturing stems back to the last recession. We have been lessening our dependence upon manufacturing for decades, but at the end of the last recession, manufacturing employment never recovered. There has been little or no manufacturing employment growth since the bottom of the recession in 1991.
http://www.clevelandfed.org/research/trends/2007/0807/02regact_080607-3.gif
JWM in SD,
Did you see this one?
https://www.irvinehousingblog.com/2008/02/04/what-is-equity/
IR,
I agree with that position on what the FED is doing. I disagree with you on the notion that most posters don’t think the FED is inflating away debt. Most people don’t understand what is going on at this point. The FED is sending out signals via the MSM to make the general public think that inflation is their concern but it isn’t. If it were, BB would be raising rates.
How many times have you heard the “D” word uttered on CNBC or CNN or FOX news? I bet almost never.
I think there is a perception that companies like New Century Financial and Countrywide are responsible for the bubble and that these players deserve punishment their actions. I for one had thought that Countrywide was as corrupt a company as Enron.
Then I read calcualted risk yesterday, turns out these loan orrigination companies were following script given to them straight from wall street.
From calculated risk…
“I spent most of the early years of this decade, just as a for instance, blowing my blood pressure to danger levels every time I looked at the underwriting guidelines published by ALS, the correspondent lending division of Lehman. ALS was a leader in the 100% stated income Alt-A junk. And I kept having to look at them because my own Account Executives keep shoving them under my nose and demanding to know how come we can’t do that if ALS does it. I’d try something like “because we’re not that stupid,” and what I’d get is this: “But if ALS can sell those loans, so can we. All we gotta do is rep and warrant that they meet guidelines that Wall Street is dumb enough to publish.” Every lender in the boom who sold to the street wrote loans it knew were absurd, but in fact they had been given absurd guidelines to write to. What on earth good did it do to have those originators represent and warrant that they followed underwriting guidelines to the letter, when those guidelines allowed stated income 100% financing on a toxic ARM with a prepayment penalty?”
So put more blame on Lehman and wall street execs!
The down payment is not strictly to give the buyer an incentive to stay in the house.
It’s insurance for the lender. If the buyer puts down 50K and is foreclosed on – the bank still comes out ahead if they keep the down payment and the value of the house has not depreciated. They just re-sell the house to the next guy.
The fact that the buyer has an incentive to not want to lose their down payment is just gravy for the lender. Either way, the lender wins (as long as house values are not dropping!).
JWM, this was what I said:
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I think Fed is using “controlled” inflation to bail out of the mess. At least 4-7 % CPI for the next few years will be the norm.
No, I didn’t , but thanks for putting me onto it. I think that a lot of lay-people are confused about what Equity really means and still don’t associate it with debt. It is at the heart of the insolvency issue that is pervasive throughout the Banking industry and even down to the borrowers themselves…only many of them don’t understand it.
I’ve used this formula to explain the bubble to my in-laws who didn’t understand why foreclosures were in news recently.
Of course.
When you use credit cards to pay off credit cards and never pay down the principle – eventually you are going to max out.
Same principle, no?
I have a series of two posts coming out next week on structured finance and the CDO market. The originators would not have made any money if Wall Street couldn’t package and sell it.
IR, though I am in the R&D side of defense now, most of my defense work as been in defense manufacturing. Though there is no threat of outsourcing in the defense manufacturing world, the same factors that effect employment in defense manufacturing have an impact on employment in non-defense manufacturing, and in manufacturing in all countries.
The first thing you have to look at is productivity. As information technologies become more powerful and less expensive, it becomes possible to automate things that weren’t economically feasible before.
The information revolution has also made it possible to develop data collection and analysis systems that can be used to increase product quality and reduce defects. Elimination of scrap and rework has a direct impact on employment levels.
If you want to see other manufacturing myths, I recommend reading http://www.cato.org/research/articles/reynolds-030831.html
It’s going to take A LOT of inflation to bring it all back down.
100.00 an hour minimum wage?
“he had little choice”
Funny. I would have just sold the BMW and used that to pay off the credit card.
Get a cheaper car. Ride the bus. Ride a bike. Walk. Cut the credit card with a pair of scissors. Point firearm away from foot.
Choices galore.
Why only raise rates on home debtors when you can raise rates on everyone across the board?
Must be annoying to be carrying a balance these days!
The banks are also penny pinching on their savings accounts. My savings account interest rate has dropped almost 1% in the last 2 months.
Must be getting desperate over there!
It would be interesting if most of the money forced into the equity market went into inverse ETFs and/or shorts.
I’d at least think the days of any non-full doc loans are gone. If your credit is good enough and you’re not borrowing too much, should have no problem getting money. It’s just real sad that all those middlemen made out like bandits and won’t be held accountable. The game tighented up for most folks, but if you have some clean livin’, you shouldn’t have any problems with obtaining credit.
Wifey and I should be getting a loan with 5% down and ~9%DTI. We’d put more down if we had it, but the home we put an offer on is REO and priced to kill. In fact, the current price is less than what the place sold for back in early 1998. We had to press the button pronto. We’re not overreaching and the price is less than our annual gross. We’re pre-approved, so we’re good to go. Just waiting on word from the selling agent.
As the owner of a small maunfacturing company I can tell you first hand that manufacturing in the US has been decimated over the last 10 years.
At the first of every year we purge/update customer and vendor lists and it is sad to see how many companies just aren’t around any more.
Worse yet, I am sickened that there are so many things that are simply not made here any more at all. Some abrasive tools, sealed lead acid batteries, rare earth magnets to name a few. All of these items are used extensively in national defense. Do you think the Communist Chinese will sell us parts for our warplanes?…On credit?
We can even go on a discuss wages which have been stagnant for a decade in the tooling industry. Why do Americans think that our standard of living, in a “Global Economy”, will not be averaged down? Are we so arrogant to assume that the starving Chinese worker will be content forever just to sell us cheap clock radios?
Everyone involved in the mortgage originating chain, including the borrower, is guilty; however, the ultimate deception was created and nurtured on Wall St. The brilliant (greedy) minds on wall street, hell-bent on making commissions, created CDO’s CMO’s, and all other types of derivatives. They are the ones who created the market for these mortgages. They knowingly deceived not only Americans, but the entire world.
Now as credit/money is disappearing from banks all around the world, people are starting to realize just how bad they got screwed by the wall st puppeteers. There is a special spot in hell waiting for these people.
Could have been worse…
UK Guardian: Three lenders scrap 125% mortgage deals as criticism increases
http://www.guardian.co.uk/money/2008/feb/20/mortgages.property?gusrc=rss&feed=networkfront
haha, SRS anyone?
Singing’s a little rough, song is great though.
Humor:
A businessman was interviewing job applications for the position of manager of a large division. He quickly devised a test for choosing the most suitable candidate. He simply asked each applicant this question, “What is two plus two?”
The first interviewee was a journalist. His answer was, “Twenty-two”.
The second was a social worker. She said, “I don’t know the answer but I’m very glad that we had the opportunity to discuss it.”
The third applicant was an engineer. He pulled out a slide rule and came up with an answer “somewhere between 3.999 and 4.001.”
Next came an attorney. He stated that “in the case of Jenkins vs. the Department of the Treasury, two plus two was proven to be four.”
Finally, the businessman interviewed an accountant. When he asked him what two plus two was, the accountant got up from his chair, went over to the door, closed it, came back and sat down. Leaning across the desk, he said in a low voice, “How much do you want it to be?” He got the job.
This is what always fascinates me…..these people that scrape off .5% of a few billion dollars and then ride off into the sunset…..never to look back at the mess they created.
We also run a manufacturing, sales and distribution company. And we’ve never been doing better. The key is to take away the Chinese advantage — cheap labor. By focusing on productive machinery and equipment, we have lowered our labor burden on a per-unit basis to very small levels.
So, the Chinese labor advantage is minimized. Our investment in productive machinery and equipment is high, but the cost is the same for the Chinese to purchase the same equipment, so no advantage for them.
High fuel and shipping costs are to our advantage because it makes domestically-produced products cheaper to ship. Our turn-around time is faster. The dollar is sinking so our exports are rising. And our export shipping costs are much cheaper than the Chinese import costs for the simple reason that the UPS and FedEx planes come in full and go back to Asia empty. So they give us incredibly cheap rates for export shipping because their planes are empty anyway.
And yes, we manufacture in Irvine of all places. And profits in 2007 were the second highest ever. January was incredible and February is set to break another record with only 21 trading days.
To the Fed – keep making the dollar cheaper and we’ll keep hiring Americans for our exploding export business.
Unfortunately, that’s not the mentality here in the OC.
That BMW = Higher Social Status, even if it means the guy is drowning in debt and taking his family with him. Sad to see, imo
Sorry George, that won’t fly. Simply put, interest rates are the sum of (1) the REAL — ie, inflation adjusted — risk free rate of return and (2) the risk premium and (3) the inflation premium. To the extent there is expected inflation, the interest rates will rise to compensate the lender / investor for that inflation. This will drive rates up (as we have actually seen on the 10-year treasury) and drive housing down.
Why do you think that mortgage rates have not fallen nearly as fast as the Fed has been lowering rates? It’s because investors are demanding higher risk premiums and inflation premiums. Inflation will NOT solve the housing crises, but will only make it worse. In 1987 my interest rate was 9.85% on my first house — and that was with a 1st time buyer discount!
Article says the BMW is leased.
Good catch. You are right.
I guess that leaves him with the choice of giving up the BMW and buying a clunker.
Plus, when he gets it all paid off, he can keep it around for when he sinks himself into debt again with another BMW.
It’d be a lot better than cashing out your retirement nest egg! EEK!
Before you go knock on them, go knock on the people that had money to invest and were very happy to get high rates of return.
This is like the OC Bankrupcy. While Bob Citron was making good money everyone was happy and didn’t ask questions. But once his risky investments came home to roost, then everyone went self righteous and dumped on him.
IR, once again a beautifully detailed and well presented post.
It’s been awhile since I’ve had the time to digest all the wonderful information, form an opinion post a comment but I stay current as much as possible.
I’m reminded of a couple of other side effects of this cycle that are potentially long-term damaging. One major effect of the 100% financing and incredibly loose standards was price became removed from the transaction. The saying goes a fool and his money are soon parted. Never more true than the past few years. With cheap money and foolish people stampeding into the market, we lost sight of the most important factor in the whole transaction, price. As you alluded, the whole thing then became easily de-linked from any reasonable fundamental marker. Add in the fear of being “priced out” and voila! Disaster in the making. This was the fundamental reason I kept saying this whole thing was gonna crash hard, all the other financial pressures were merely additional proof of concept, so to speak. Not only is a return to pricing a welcome return to sanity but essential to any healthy underpinnings to the market.
I’m also reminded that we’ve now entered a peculiar cycle of inflationary pressures on prices while our currency devalues, an almost classic stagflation. However, this might be the one thing that is TRUELY different about this credit cycle. My college econ classes are woefully inadequate for me to fully understand how this might correct without a great deal of financial pain felt by all. I just don’t see how lowering interest rates or increasing the money suppy is going to help this one. As you pointed out, there is simply not enough savings or pent-up/trapped money sitting on the sidelines I can see that will come save us from our sins this time around. The more I consider the implications, the more frightening it becomes. Is it possible a prolonged deflationary and financial meltdown could haunt us globally for more than a simple 5 years? I’d love to hear thoughts on this subject. I know there are plenty of folks smarter than me on this blog to help paint that picture.
Thanks and be well!
Price less than your annual gross…
Where is this house at? If you’re in OC then
(1) you are mondo rich in which case you won’t bother with an REO,
(2) you are moving into a neighborhood with people well below your economic caste;
(3) you are NOT in OC but somewhere in the boonies.
He only had 20K in his 401K?
We took a LOT of money from our 401Ks last month and they’re sitting on CDs in the credit union. It’s purely a hedge position because the options we have in our 401Ks are not designed to deal with a bear market.
I just re-read my post and felt the need to further explain my last comment.
As out currency devalues and inflationary pressures push prices up, the consumer will see his dollar buy less and less yet more and more of the things he buys get increasingly more expensive. This affects us all clearly.
So spending our way out isn’t an option. More of the middle class (the largest consumer base) will go bankrupt or simply shift into the lower classes, possibly requiring more public assistance to survive. More assets grow increasingly devalued and even the wealthy begin to feel the pain. Demographics begin to enter the picture. We’ve got the largest segment of the population leaving the job market (retiring), less people being productive in the marketplace. Less overall GDP, less national wealth. Another related thought … Even from a purely numbers exercise, there aren’t nearly enough wealthy people to miraculously somehow become super-consumers and start buying up existing inventories from cars to widgets, putting factories back to work. (see earlier about assets devaluing).
YIKES. This is really, really depressing. 🙁
Indeed — every newpaper article is the same. Sad debtor portrayed as “victim” until you start reading between the lines. Camera equipment he owed money on? Lemme guess, financed himself a prosumer digital camera and HD camcorder? Leased $550/mo BMW? Diamond ring? Yet he only has $20k saved for retirement. Yeah, this is less about the economy and more about bad choices.
I agree, zornundo. I don’t think 100% financing is going to be the fatality of this. I think it will be the stated income, no-doc liar loans. I can’t see those coming back until Wall Street’s institutional memory of this mess is purged.
By the way, good luck on your offer. Let us know how it goes.
I think we are seeing the market implode in so many of the new communities. I would not be surprised to see 50% turnover in these new communities that were built out after 2004.
What do you guys think is really happening in Tustin Field?
It seems weekly, that a foreclosed or short sale listing is popping up. I think people did the usual – 100% financing, but when the market turned down, they couldn’t afford the monthly payments.
There are over 10 homes for sales now in this community of approx. 60 homes.
The foreclosed / short sales homes are on sale about 250k less than the purchase prices.
I feel sorry for the listings of people (non-bank) that want to get out, but can’t because of the REO homes.
Does it make sense to look at these or is there worse to come………
For ex. a 1.2 million (2006 purchase price) home for 880k at 821 Polaris listed over the weekend –
http://www.redfin.com/stingray/do/printable-listing?listing-id=1503380
It seems like a good deal if it can be had at 825k. If it can be bought for 825k for example, is it worth it? 30% drop from purchase price and at my magic # of 250/SF.
I know it will go lower, but you can never time it – So confused!
If you put tons of mileage on the beamer, you can’t get out of the lease right away without penalty. Once you got used to the comforts that these luxury vehicle affords, you just can’t do without the power window. I mean, who want to use the hand to crank up the window nowadays?!?!
I don’t know How on earth those fixed income investors around the world are going to trust the US financial, credit ratings, mortgage originators and bond insurance companies after this?
Usually fixed income investors are of the conservative type, they expect their monthly dividend, interest payment, distribution, I can see retirees, senior citizens, disabled people depending on this to live.
As long as recent home buyers keep walking away from their homes in the months to come, when the losses are going to stop for all these fixed income investors? How future US home buyers will get enough financing?
Everything must change (and radically) before the US home financing system attempts to go out and find investors that could buy CDOs:
tight credit origination , new credit ratings (current ratings don’t reflect risk accurately) , bond insurance.
Capitalism is very good to destroy things that can’t be trusted anymore, that don’t preserve capital or generate profits and it doesn’t show any mercy in the process. That’s what I expect.
Personally, I’m a big fan of the OC residents who lease a BMW or a Mercedes and IMMEDIATELY de-badge their rides.
Wouldn’t want the neighbors to know you “only” sported for the 328.
I know a guy who bought a 530i a few years back and promptly slapped a 545i emblem on it.
That kind of behavior speaks volumes about the OC mentality.
“Comment by lendingmaestro
2008-02-25 09:59:46
There is a special spot in hell waiting for these people.”
If you call the Cayman Islands then yes, I would agree…
My hub’s 10 year old Saturn has a window hand crank.
Engineers at NASA are more likely to compete as to who has the worst rust bucket at all, that who has the most expensive car. At one point his GS 15 colleague had a car that you could watch the road go by under your feet it was so rusted. He finally did get a nice new car. He was a service retiree, so was double dipping. He doesn’t do drugs or gamble with his money either!
What is described is con artistry. ie, criminal behavior. Which doesn’t mean I want to waste a court’s time on it necessarily.
These people should be publically shamed, not respected.
Oh, god/dess, somebody is stupider than us? Unbelieveable. Is there stuff like this lurking everywhere?
Link to Businessweek Credit Crunch article
Borrowers Are Out In the Cold
It’s no longer just people with bad credit who are feeling the squeeze. Americans with good credit at all income levels are now caught in a full-blown credit crunch.
http://www.newsweek.com/id/114713
10K in 401K, 40 years old, and drives a BMW and has purchased other toys on credit. Amazing!
However, I get the feeling that this dude is not the exception. So, the question is, in 25-30 years or so, what are these people going to do? I fear that somehow (thanks to pandering politicians) I’ll, along with all the other prudent people, will have to support him and his ilk.
That’s why I don’t get “sad”, but mad when I hear these stories!
I worked at New Century in IT. It was very interesting to see the whole bursting occur while in the belly of the whale. One thing I can say is New Century was the front man for the whole Wall St/CDO/MBS machine. The minute the wholesale lenders pulled the lines, applications were were no longer accepted. The deal worked great for Wall St., New Century provided a huge supply of loans Wall St. could layer fees on top of, with out supporting Ncen’s 7,000 employees and a lot of the bad press that came when the party ended.
One small problem, Wall St. is now stuck with all the bad paper created by the likes of New Century.
I remember telling co-workers to keep on their toes a year before the music stopped, telling them the sub-primers will be taken out back and shot. They looked at me like I was nuts. By the time the end was near, 98% of the staff was gone so there was no one to say “I told you so” to.
This guy should buy my ride: a top-of-the-line, 1987 BMW convertible in pristine condition. Yes, I drive a 21-year-old car. In Orange County. The only other people I see driving one like mine are 20-somethings with tattoos and purple hair. I am going more for the “youthful” image than the “coto de casa midlife crisis” image.
Walter,
I know someone who “left” the residential lending arena after New Century went under. He had made over $1.5MM over the course of two years and never once did he suspect that this sort of income would stop flowing.
It’s 2008; he can’t find a real job ($50k /year? ptshh) and has zero zero savings. The only thing in his name is a Hummer, “luxury apartment,” and a gf who thinks my associate is still in the game.
Idiot.
Isn’t this guy embarrased to use his real name? I’m roughly his age and have 20x his amount in my 401(k). Of course, I also drive a 7-year old POS Ford Focus but at least I sleep worry-free at night!
#2 and #3 – somewhere in the boonies in TN 🙂
Yeah, but you don’t look “successful” driving that car.
/sarcasm off.
Two doors down from me there’s house in foreclosure. It was listed at 289K two days ago. Now it’s listed at 269K. It’s a modest house that has a little potential in a lower middle class neighborhood.
http://www.homeseekers.com/Scripts/detail.asp?_org_id=usbbh&_uid=DA1F2B8C-9BCE-4D75-BF7A-0331CC1CF7E5&_current=3&mls_property_id=4470864&_per_id=&_vp_cb=
About ten houses down from me a new foreclosure was just added to the market.
http://www.homeseekers.com/Scripts/detail.asp?_org_id=usbbh&_uid=DA1F2B8C-9BCE-4D75-BF7A-0331CC1CF7E5&_current=3&mls_property_id=4470864&_per_id=&_vp_cb=
The second house is wedged into a tiny corner lot where the sliding glass door into the kitchen faces the street. The carport has been converted into a live in barn. There has been at least three families living there over the past two years. There’s a reason that they aren’t showing pictures. The place is a dump. Yes, they have listed this second house at 441K.
My God.
We bought in 2000 for 210K.
I’m wondering if the first house is a floor or not. It sure doesn’t seem like it.
Dr. Housing Bubble recently interviewed Mish. Link below:
http://www.doctorhousingbubble.com/interview-with-mish-from-global-economic-trend-analysis-deflation-housing-the-credit-bubble-and-bond-insurers/
I agree with his assessment that we are in for a consumer lead recession of such severity as to make the bears look conservative.
“Does it make sense to look at these or is there worse to come………”
I would not be surprised to see $150-$175 SF in this community. There is definitely worse to come…
Tustin Field – I remember I checked them out in 2005. I figured that with the taxes and HOA even with NO MORTGAGE it would cost about $1,200.00 just to live there! When I pointed this out to the “sales associate” she paused and said, “well you don’t have to pay the taxes every month” I couldn’t even reply………..(and I’m blonde!)
There’s a third house just listed about five houses down that we originally bid on in 2000 at 240K. It’s a four bedroom that was in better shape than the one we got. Somebody out bid us by 20K on that house and we weren’t going to chase it.
http://www.homeseekers.com/Scripts/detail.asp?_org_id=usbbh&_uid=DA1F2B8C-9BCE-4D75-BF7A-0331CC1CF7E5&_current=4&mls_property_id=4149999&_per_id=&_vp_cb=
Question:
What happens when the comp down the street sells for almost 50% less then what is listed?????
Hmmm…. so you don’t consider the multiple recent new treasury bond offerings (auctions) as ‘printing more money’?
Do tell…
Great point, my friend drives a plain 3-Series but it’s got an M3 badge on it. He also substituted M3 rims and tires to complete the false look.
It’s worked for me. SKF was fun for a while too.
Many items are no longer manufactured in the US due to environmental regulations. To the extent we make it more costly to manufacture, say, lead acid batteries or chemical solvents, we are indeed sending some manufacturing overseas.
The rare earth magnets thing had to do with the ChiComs buying the US company which owned all the patents. Make of that what you will.
These people should be publicy flogged, not shamed.
publicly*
This just the opposite of some ER doc’s I knew who worked in some less desierable parts of town. The bought old beaters to blend into the neighborhood then put in some steel plates and bullet proof glass to keep the bullets out.
The really freaky thing is people who let the car become their social life. I’ve seen it. Hanging out at the BMW dealer every Saturday for the free car wash, coffee and chit chat with other owners. That’s the deep end of the pool of sad.
No, not when you consider what Bernanke has been doing with the SOMA balance:
http://www.garynorth.com/public/3118.cfm
Take a close look at chart 9 and look at what has been happening since November.
That is not Inflationary……
You wanted proof, you got it.
what did he spend that kind of money on?
Forgot to add, it’s not just the guys here in the OC pretending. There are a number of women I know who are just as bad. Quite a few sport fake LV, Prada, and Coach bags, not to mention “faux” Gucci and D&G sunglasses. The conditioning in the OC is very strong.
Still – I follow Tustin Field pretty closely. We were in escrow on a house there on Sun Dial and fortunately bailed out before the end of the contingency period. Foreclosures have been ripping through there since mid 2007. Polaris should be the poster child for the bubble burst.
I actually like the 821 Polaris plan. It’s the same one that Countrwide had back in the summer, 833 Polaris I believe, which I think sold for mid $900s and is now back on the market. Unfortunately 821 backs straight up to the wash and Jamboree.
IMO Tustin Field was bought out by speculators. They are walking away since their gamble failed. The location is bad, smack between Jamboree, Harvard, and Edinger. Many houses there back to noisy, busy streets. Parks are weak, no other amenities. In a buyers market, why should anyone pay big bucks to live in a location like that. Prices there are off by almost 30% already and as more VoC places come on to MLS, they’ll go down further.
For something like 821 Polaris, $200-225 per sf is a very real possibility.
Alert! Alert! Huge price reduction coming:
http://www.redfin.com/stingray/do/printable-listing?listing-id=1311920
This lovely Northpark home is dropping list a whopping $34K. Guess that makes all the difference (NOT!) considering the last two homes sold in this size in Northpark went for $1.025 and $1.015M respectively.
This is a exact copy from the Irvine MLS today 2/25/08. Maybe this house hasn’t sold yet because it doesn’t have a bathroom. Perhaps there’s an outhouse not mentioned?
MLS Link
http://www.tempo.socalmls.com/SearchDetail/Scripts/PrtBuyFul/PrtBuyFul.asp
Realtor.com Link
http://www.realtor.com/search/listingdetail.aspx?ctid=12221&mnp=37&bd=6&typ=7&sid=5a7010b8fc3e45d9ae45a0f01dff3999&lid=1095296145&lsn=1&srcnt=113
P620986 Media: 0 Builder Tract Other (OTHR)
Bed 5 Model (0)
Baths 0 Style Other Stories Two Levels Floor
View No View HOA Dues $ 60 + $0 Land Lse/Yr $
ASqFt 2,060 Estimated YrBlt 1973 Estimated Land Fee
ALotSize 5,000 Other Dim Acres
Prkng
Garage 2 Rem Spc Cprt RV Acc Range $: No
Walking distance to shopping center & Irvine High, Greentree Elem. Opened floor plan with cathedral vaulted ceilings in living & dinning room. Upgraded in, kitchen laminated wood floor on first floor including stairs, double pane windows on all windows including kitchen & master patio doors, central heating & air conditioner, base molding, custome paint. Beautiful chandelier. Romantic upgraded fire place in living room.
Dianna MacDavid
First Team Real Estate
IR – many thanks for the link. VERY informative.
What I wonder about is not just the deflationary pressures on housing as you and others have well documented that subject but how this all ties into and perhaps more accurately put, leaks into the economy as a whole.
Clearly the dried-up housing ATM is the first wave in the downturn of consumer spending and I’d say we’ve passed that mile marker already.
Consumer debt is next. I hear all the time about people living off of credit cards and even using them to pay the mortgage (that’s such destructive behavior it boggles the mind). Of course this is nothing new. The difference being incomes are not keeping pace with the accumulation of debt and neither is the HELOC available. Savings are clearly non-existent or long burned during the heady run-up in consumption. Next or in conjunction with, we see payrolls getting slashed so incomes begin to disappear altogether.
Then we add into the mix the retiring boomers, unemployment going up, currency devaluation, asset devaluation, healthcare costs continuing to rise at four times the COL, oil prices rising, cost pressures on corporate balance sheets, junk bond status for many heavily leveraged CDO’s. I see record bankruptcies both personal and corporate and the real blood-letting will be the banking industry.
Depressing indeed. Frankly I don’t know how we can even be questioning whether or not the US economy is in recession. Seems to me it’s clear, just that we’re in yet another denial period. My fear is this cycle downturn will be “different this time” due to it’s scope, breadth and duration. Worse, those of us who’ve been prudent during all this will suffer along with the idiots who brought this on. I can say this, whenever I hear “financial innovation” and/or “innovative financial vehicle” or another other such euphemism from the Wall St. crowd, I’m running the other way… actually maybe I’ll bet against them and make some money off their stupidity.
Indeed.
Productivity today is FAR more than it was even in 1980.
Today I can get work and research done in one day that would take me two whole weeks ( or more ) back in 1980.
I am one of those Wall Street bankers, but I never dealt with mortgages or corporate takeovers. Still, I do understand the part about taking half a percent and riding off into the sunset.
There are an assortment of times when investors start to demand much more of something, and the investment bankers have a hard time finding enough of it. A current example is alternative energy. Much of it is quite promising. The difficulty is what happens when a few hundred billion of capital is suddenly interested. There is also quite a bit of demand for infrastructure investment, and you have to be careful not to just overprice or make up projects that might sound good.
As with most businesses, there is pressure to do more deals, larger deals, and to get those done sooner. One of the things I find most interesting is that deals which benefit the clients the most usually can only be done very well by a one or two firms. Junk tends to get produced by imitators, low cost competitors, and people with more access to investors than to good analysis. I work in a highly technical niche and have saved our clients tons of money without anyone getting screwed. Some of our competitors have blown similar transactions and created extra problems and costs.
One of the things that still surprises me is how often you can spot the next large mess. Even people involved in creating it can often tell. Remember how even noneconomists were saying “if you can fog a mirror, you can get a mortgage” in 2005? Even if they didn’t think real estate prices would go down, they knew those loans were trouble.
Without getting too technical, different Wall Street banks have very different attitudes about what constitutes risk, risk tolerance, diversification, and internal controls. Many of the banks who are in trouble now have competitors barely bothered by mortgage problems. It’s not just chance. It has to do with their management.
You do know there is a place actually called Hell in the Caymans?
Consider what is happening to be an intervention, rehab, or detox. Sure, it’s painful, but it’s good for you.
Not all detox is created equal. And rehab could fail.
Remember that getting people clean and sober often means educating those around them. It also often means helping others recover from the messes their alcoholic/meth/coke user relatives have caused.
Don’t be so depressed. The CPI doesn’t weight the cost of buying a home. While the CPI is going up, the big item it misses (the price of buying a home) will be coming down rapidly.
With lower interest rates, we might also find a decent chunk of current homeowners with extra money to spend (i.e., those who’ve owned for a while and didn’t do helocs).
If the cost of owning a home goes from 50% of median income down to 30%, that’s a big savings. If it goes down to 20%, a lot of people will be able to own a home, consume a lot, and actually save for retirement. imagine that.
I love the HUGE back yard! It’s almost as big as the paved driveway!
Do you know what 833 Polaris sold for? Its not on redfin yet? Curious to see what the most recent sales were.
There are definetely negatives in this community, but if you can get a practically new house about 150k less than Irvine homes of the same caliber, we might be interested.
It might be noisy but you are less than a mile away from everything you use everyday – district and tustin market place.
I think too that prices will come down there as more homes come on the market.
The neighbours of all these REO homes must be really sweating right now………….
Yeah, SRS was a great buy. Wish I would have had some more.
Great read:
“Countrywide Home Loans, the nation’s largest mortgage lender and a company whose practices are being scrutinized by the Illinois attorney general’s office. Countrywide made mortgages of $450,000 on the property. Now it is likely to lose it all because it financed the sale of a home whose rightful owner was in no condition to sell ” (because the owner was dead!
http://www.chicagotribune.com/business/chi-sun_fraud_0224feb24,0,3601248,full.story
Bathrooms are overrated anyways. My parent have some property in Arizona (quite literally in the middle of nowhere.) They have neighbors with an outhouse. It even has a moon cutout in the door. That is the way to live.
JWM – I am unsure of how you define inflation, and whether you are speaking of monetary inflation or price inflation or both, but why did you only refer to SOMAs as evidence of inflation. If you are speaking of monetary inflatiion, would it not be prudent to look at M1, M2, M3, MZM, bank credit and consumer credit? And especially the annual change rates of each and their relative 2nd derivatives?
IR – I like the poll at the beginning. It reminds me of a saying.
The markets will make the most people wrong at the least expected time.
AZDavidPhx: Funny. I would have just sold the BMW and used that to pay off the credit card.
lee in Irvine: he’s looking for someone to take over his $550 monthly payment on a gray BMW 335i he leased last April.
How old are you, and how much do you have in personal retirement accounts?
…I’m not directing that question just at you, really. Anyone on this board. I’m curious what normal might be.
“Many of the banks who are in trouble now have competitors barely bothered by mortgage problems. It’s not just chance. It has to do with their management.”
So, I would like to think the successful banks are lobbying Congress to NOT bail out their loser-competitors.
Ya think that’s happening?
I think 833 Polaris went for $945 still. It has a monster sized corner lot though. I think lot size was 7500sf or so… Weird that it is for sale again. I saw cars in the garage the other night so people are living there.
I agree TF is very centrally located. I work on Von Karman, not far down from Barranca, so I’d be obscenely close to work. I want my kids to be able to walk to school eventually though and the TF schools are all over in Woodbridge. Too darn far. If Plaza Vista served TF, it would make a lot more sense and be more desirable since that is school isn’t that far away.
Yeah, I think that’s why Michigan and Ohio are the bustling, successful Shangri-La that they are. Because US manufacturing is not only stable, it’s booming. Everybody can see that GM can’t find enough workers to fill their insatiable demand for manufacturing labor.
My current company is pushing manufacturing to China. It’s extra funny because we get the parts from China, do the design & development, and set up manufacturing in China, so we can sell to… Asia!
I don’t know where this idea comes from that US manufacturing is thriving. It’s more and more just IP and design work here. Look at wifi cards for a laptop: they’re pretty much all made in a factory or two in China, and American companies such as Belkin put their label sticker on there and market them at Fry’s. That’s how most consumer products are these days. Get it made cheap and quick, slap your sticker on there, and see if you can out-compete your rivals on marketing.
Maybe its the broadening of the term “manufacturing” to include, say putting burgers together, or it might just be that there’s fewer employed in manufacturing, but those who are are getting paid more money, and are perhaps more specialized. But I can tell you people I knew who worked manufacturing jobs 10 years ago are now hair stylists, donut shop owners (where they manufacture donuts), real estate agents, and the like.
The subprime crisis is just the tip of the iceberg. Fundamental changes in American life may turn today’s McMansions into tomorrow’s tenements.
by Christopher B. Leinberger
The Next Slum?
http://www.theatlantic.com/doc/200803/subprime
Whether or not you should consider 100% depends on many things.
It might be better to go this route and keep your downpayment as a cash reserve against disasters like loss of income, sudden large expenses, or necessary repairs to the dwelling.
However, it’s only good if you are getting a place that is very reasonable priced, and you buy rather less than what you would buy with a downpayment.
For example, if you make, say, $50,000 a year and have $20K or so in reserves, you might do better to buy the smaller place for $125K and finance it completely, keeping the $20K in reserve. In order to offset the lack of downpayment, you would want to make extra $100 payments against the principal, over and above your set payment, every month, to build your equity and reduce your interest.
I know of a number of people who have done just this over the past 15 years. There is a man here in town who owned a number of fine old 20s-vintage apt. buildings he converted and sold to carefully selected moderate-income buyers with 100% financing at 6% that he underwrote himself. These people made $45K-$55K a year, and one of them, a friend of mine, purchased a wonderful old 5 room 2 bed place for $145K back in 2000. She is doing great- made extra payments against the principal with the goal of getting the place paid for within 20 years. Needless to say, she has not HELOCed herself to death, but has maintained a very low debt load. This lady had just gotten a reasonably decent job when she bought the place, thus she had very little cash. She’s pretty decently set now, though. The seller she dealt with has been paid back handsomely in the form of reliable, steady interest income by financing people like her, who have mostly made the most of the opportunity and now have substantial equity in their little homes. He selected his buyers well.
The ticket is to maintain strict underwriting standards, which should not be compromised just because the buyer is making a substantial downstroke. You should absolutely buy a cheaper place with 100% financing than you would with a downpayment. We have seen, on this blog, how many people made fairly substantial downpayments and then went on to destroy themselves with HELOCs.
Great point, my friend drives a plain 3-Series but it’s got an M3 badge on it. He also substituted M3 rims and tires to complete the false look.
I like to laugh at poseurs like that…
Coke, whores, booze, Vegas, Tahoe, Mexico, Hummer, Morton’s, Roy’s, Ten’s. I distinctly remember these douche-bags at parties and clubs, bragging about their successes back then. It’s wonderful to hear that they’ve fallen equally hard. The hangover will be a bitch…
So, assuming the Fed is indeed lowering the amount of money available ( deflation ) how about capital coming in from overseas?
Where is that measured?
Isn’t it possible for the global flow of capital to overwhelm what the Fed wants to do.
OTOH, if this is true, then anyone investing in gold and foreign currencies is in for a hard crash.
I think the problems with GM, Ford and Chrysler are mostly their own doing.
American Honda is doing quite well in Ontario, Ohio, Alabama…. and they build most of their products (including engines and transmissions) in the US.
The difference between the Auto Big Three and the Japanese “transplants” is that the latter look at the long term and treat their suppliers as part of the team to buiild a better product and lower costs via team efficiency.
The Big Three always look at the short term, ignore the engineering, follow fads and try to squeeze the last dollar from their suppliers. Loyalty to their suppliers is a four letter word.
A very different way of doing business and you can see what is happening there.. Nothing with the inability of the US to manufacture, just a bunch of MBAs with a time horizon no longer than three months…. and the UAW…. yuck!
“Isn’t it possible for the global flow of capital to overwhelm what the Fed wants to do.”
Really? With Bernanke cutting rates? Citi group had to pay 14% for their money from Dubai recently. Foreign money ain’t gonna be cheap my friend.
Inflation – Increase in monetary supply resulting in price effects in particular commodities and goods.
You need to re-read what I said. I cited SOMA as evidence of Deflationary pressures not inflation.
MR- good points! However do you really suppose there are enough prudent people like you mention to actually bail out this sinking ship?
I must be a pessimist (though I’ve often thought of myself as a realist, which might be shorthand for slightly optimistic pessimist … but I digress) … because I just don’t see the light at the end of the tunnel.
Sure, with continued savings and a keen eye to the market, I will likely be able to buy a more than adequate home here in OC for a “reasonable” price and manage it comfortably until I retire. That IS a silver lining! But I fear there are just not enough of us around to make any real changes until the whole US economy jumps the tracks with a resounding thud.
I’m reminded of two sayings I’ve heard over the years …
“A rising tide gathers all ships.” Very true. We can all profit together just as easily as we can all suffer together.
“It’s only when the tide goes out do we learn who’s been swimming naked.” That one’s from Warren Buffet … how true, how true.
“the successful banks are lobbying Congress to NOT bail out their loser-competitors”
Well, yes. If you followed the big failed project to bail out SIVs last fall, the more responsible banks couldn’t be convinced/cajoled into doing it.
There is an interesting problem for responsible banks. There is so much more demand for responsible banks that they often don’t have enough people and enough capital to expand fast enough. There are capital requirements for conducting various types of business. Even the good banks have often reached their limits for particular exposures.
This is probably the most well thought out and non “Sky is falling” blog entry I have seen on this board in a looooong time. Instead of making fun of the stupid banks losing their assets and the poor saps who are losing or walking away from their homes (which could very possibly lead to your OWN financial “implosion” due to job or business loss brought on by the NEXT ripple of the credit crunch…and wouldn’t THAT be ironic…I’d imagine a lot of people would be making fun of you all then…hehehe…better start hoping some of these folks “ride it out” after all!) you carefully explain all the various factors that made and MAKE “Credit crunch”s happen…these are cycles…cycles giveth, cycles taketh away! Good article! I disagree with you on prices dropping another 20-25% (barring an epic recession with epic job-loss of course) but on this you were really spot-on! Great job!