Monthly Archives: February 2010

The Credit Bubble – Part 2

The Credit Bubble

Visualizing the Bubble

With a huge influx of capital into the secondary mortgage market when the Federal Reserve lowered interest rates in 2001-2004, the industry was under tremendous pressure to deliver more loans to hungry investors seeking higher yields. This caused the already-low loan standards to be all but eliminated. All of the worst “innovations” in the lending industry occurred during this period: Negative Amortization loans, Stated-Income loans (Liar Loans,) NINJA loans (no income, no job, no assets,) 100% financing, FICO scores under 500, and one-day-out-of-bankruptcy loans among others. The joke was if borrowers could “fog a mirror” or if they “had a pulse,” they could get a loan for as much as they wanted to buy a house. It is not hard to envision the impact this had on house prices.

Imagine a room with 100 people representing the pool of subprime borrowers. These are new entrants to the market. They were previously unable to buy due to bad credit, lack of savings, and other reasons. All of them are told they are going to bid on an asset that never goes down in value, and they will be given the ability to borrow unlimited funds (stated-income “liar loans”) The only caveat is the borrowed money must be paid back when the asset is sold (not that they care, they already have bad credit). Imagine what happens?

People start to buy the asset, and prices rise. Others in the room seeing the rising prices come to believe that the value of the asset never declines, and they join in the bidding. As the bidding drives prices even higher, a manic quality takes over the bidding and people compete with each other, often bidding higher than the asking prices. Nobody wants to be left out. There are fortunes to be made. Greed drives prices upward at a staggering rate. As the last of the 100 people buy, prices are very high, everyone has made money, and it looks as if prices will continue to rise forever . . .

Then something strange happens: there is nobody left to make a purchase. (A key indication of the end of a speculative mania is a huge decline in sales, as was witnessed over 2006 and 2007). Transaction volume drops off dramatically, and prices stop their dizzying ascent. Nobody is particularly alarmed at first, but a few of the more cautious sell their assets to pay off their loans. Since there are no more new buyers, the first selling actually causes prices to drop. This is unprecedented: prices have never declined! Most ignore the problem and comfort themselves with the history of rising prices; however, a few are spooked by this unprecedented drop and sell the asset. This selling drives prices even lower. Now those who still own the asset become worried, some continue to deny that there is a problem, and some get angry about the price declines. Some of the late buyers actually owe more than they paid for the asset. They sell the asset at a loss. The lenders now lose some money and refuse to loan any more money to be secured against the asset. Now there are even fewer buyers and a large group of owners who all want to sell before prices drop any lower. Panic selling ensues. Everyone wants to sell at the same time, and there are no buyers to purchase the asset. Prices fall dramatically. This asset which was sought after at any price is now for sale at any price, and there are few takers. People in the market rightfully believe the asset will continue to decline. Owners of the asset have accepted the new reality; they are depressed and despondent.

In any group of people, there are always a few who do not believe the “prices always rise” narrative. Some recognize that asset prices cannot rise indefinitely and cannot stay detached from their fundamental valuations. These people witness the rally and the resulting crash without participating. They wait patiently for prices to drop back to fundamental values, and then these people buy. As these new buyers enter the market, prices stop their steep descent and market participants start to hope again. It takes a while to work off the inventory for sale in the market, so prices tend to flatten at the bottom for an extended period of time; however, just as spring follows winter, appreciation returns to the market in time, and the cycle begins all over again.

What is written above is true of any asset whether it be stocks, bonds, houses or tulips. [1] In this case, it is the local housing market, and the room of new buyers represents subprime borrowers, but the concepts are universal. One phenomenon somewhat unique to the housing market is the forced sale due to foreclosure (stocks have margin calls). Even if the psychological factors at work during the panic could somehow be quelled, the forced sales from foreclosures would drive down prices anyway. True panic is not required to crash a housing market, only dropping prices and an inability to make payments. Subprime lending was one of the leading causes of the Great Housing Bubble, and its implosion exacerbated the market decline.

Responsibility for the Bubble

Who is responsible for the Great Housing Bubble? It is one thing to identify who or what caused the bubble, but it is another to assign responsibility and blame. Borrowers, lenders, investors, and the FED are all responsible; it is only a matter of degree. Irresponsible borrowers are like children, if you offer them something they want, no matter the terms, they will take it. The federal government realized this basic fact years ago when they passed predatory lending laws. This does not make the borrower any less responsible, but by definition, subprime borrowers are irresponsible. If they took responsibility for their debts, they would not be subprime. [ii] So if a large amount of money is lent to the most irresponsible among us, it is reasonable to expect them to spend it irresponsibly and not worry about paying it back. In this case, past performance is an indicator of future performance. It should come as no surprise that the subprime experiment ended badly.

Despite the low expectation of subprime performance, people need to be held accountable for their actions. It seems our entire culture is based on having victim status and being irresponsible. Borrowers should not be bailed out by any government program as it would just create more dependence and greater risk taking. The people who paid too much and cannot pay it back have to be allowed to lose their homes. That is life. The responsible should not pay to subsidize the irresponsible. This is one of those instances where irresponsible will be made to take responsibility.

Lenders are also responsible in this matter. Mortgage lenders provide a service because without them most people would be dead by the time they had saved enough money to buy a home for cash. However, when lenders start handing out home equity lines of credit for consumption, they are as bad as the credit card issuers preying on people’s reckless irresponsibility. Once mortgage lenders crossed that line, they ceased to be serving the needs of homebuyers and instead began serving the wants of the credit addicted: shame on them.

Of course, none of this would have happened without the contributions of the enablers at the Federal Reserve and on Wall Street. The Federal Reserve lowered rates and then Alan Greenspan told borrowers to take out adjustable rate mortgages under certain circumstances. As one might suspect, he did this so his fellow bankers would not be stuck with low-interest loans for 30 years, but he gave the world of homebuyers the “green light” for taking on high risk loans. Then Wall Street investors flooded with liquidity from cheap money from home and overseas started chasing returns. High-interest, subprime loans looked attractive, and as long as house prices went up and nobody defaulted, everything was fine. Who is to blame for that situation? The Bank of Japan for creating the carry trade? The Federal Reserve for lowering rates to avoid a recession? The financial wizards who invented collateralized debt obligations? The ratings agencies who labeled these investments “AAA?” The investors who were chasing high yields? Or all of them?

The borrowers are certainly at fault; if for no other reason than they signed the papers and took the money. The lenders are also at fault because they should have known better than to give borrowers loans they could not afford, provide loans with no income documentation, and ignore proven guidelines for loan-to-value and debt-to-income. Lenders simply cannot abdicate responsibility in this matter for financial, legal and moral reasons. The Federal Reserve and Wall Street investors are also at fault for creating the situation and enabling this to occur. In the end, all the responsible parties were ruined: borrowers lost their houses and went bankrupt, lenders like New Century went out of business and/or lost billions, Wall Street investors shared in the losses with the lenders, and Alan Greenspan is remembered by history as the architect of the largest, most painful financial bubble in history.

In assigning blame, it is also important to recognize that many innocent people were victims of the housing bust: children of the overleveraged and dishonest, neighbors of homes with dead lawns and graffiti, taxpayers whose money might be used in a bailout, responsible depositors who have to endure returns less than the rate of inflation, condo owners who have to pay the gap left in condo dues on foreclosed units, government employees who were hired in the optimism of rising budgets who are now laid off when tax revenues decline, and bubble buyers who were not motivated by speculative gains but merely looking to shelter their family. The decline of house prices punishes sinners and saints alike.

Summary

The Great Housing Bubble was a credit bubble. It was enabled by the widespread use of structured finance and collateralized debt obligations, and it was inflated by the irrational exuberance of buyers. The infrastructure for delivering capital to inflate the bubble was put in place years prior with the development and evolution of the secondary mortgage market. The system for delivering capital was greatly enhanced by the creation of collateralized debt obligations. Errors in the evaluation of risk to mortgage capital caused money to flow into this market that should have been diverted elsewhere. This free-flow of capital inflated the Great Housing Bubble.


[1] The Dutch tulip bulb mania was documented in the book Extraordinarily Popular Delusions and the Madness of Crowds (Mackay, Vega, & Fridson, 1996). The activities associated with the tulip mania have long been held as the archetype of a speculative bubble. Peter Garber in his paper Tulipmania (Garber, 1989) lays out the case that speculation in the Dutch tulip market in 1634-1637 was not necessarily irrational exuberance. He draws these conclusions based on the similar behavior of modern agricultural markets for rare flowers. The assumption behind his conclusions is that modern markets do not display symptoms of irrational exuberance which is highly suspect. Markets dealing with very rare commodities are always subject to wild price swings due to irrational exuberance because the commodity in question truly is rare. This plays to one of the central fallacies of irrational exuberance that the market is experiencing a severe shortage. Of course, like any market, even if the commodity is rare, if the demand is fickle and prone to irrational exuberance, there is a strong detachment from fundamental valuations due to excessive speculation.

[ii] There are circumstances where FICO scores of responsible citizens may characterize them as subprime. Some people do not use credit or maintain credit lines. They are very responsible, but their credit scores would make them subprime. Also, people who go through divorce, illness, a job loss or some other financial problem may temporarily become subprime. Responsible citizens who become subprime can generally recover their FICO scores in a short period of time. In fact, the original business plan for subprime was based on this idea.

IHB News 2-27-2010

Today's featured REO looks like a 1992 rollback, but I doubt the number is accurate. Trustee sale deals are good, but not that good.

Irvine Home Address … 3832 COSLEY St Irvine, CA 92614

Resale Home Price …… $525,000

{book1}

Three is a magic number,

Yes it is, it's a magic number.

Somewhere in the ancient, mystic trinity

You get three as a magic number.

The past and the present and the future.

Faith and Hope and Charity,

The heart and the brain and the body

Give you three as a magic number.

Bob Dorough — Three is a Magic Number

IHB News

As I review basic writing skills, I am bombarded with memories of Schoolhouse Rock jingles. It amuses when those old memory tapes play; Schoolhouse Rock is my generation's learning experience.

Today, 27 February 2010, is three years to the day I began writing for the Irvine Housing Blog. No nostalgia; it's still fun, and after 1,000 posts, I have more to write.

I have added more information to the property data for each post. In my previous version, I condensed too much. The additional detail is important as properties with high Mello Roos or HOA dues can add significantly to the cost of ownership, and raising public awareness of these costs is part of our mission. The additional information makes posts longer, but if the information does not interest you, scrolling past is not difficult so a post takes no longer to read.

Last week I mentioned that in my car I was listening to Classic Novels as a series of recorded college lectures. Well, I had an overdose of stuffy academics, so when my CD of George Carlin's Brain Droppings arrived, the college courses got ejected. I have had to turn off the CD to stop from laughing too hard. Personally, I have always liked George Carlin, and he would get my vote as the greatest comedian of the 20th century, for whatever that is worth. He resonates strongly with me now due to my obsession with words, and I will probably get more of his recorded material — that is if I can stop laughing and finish the one I have.

My favorite George Carlin linguistic tirade is his seven dirty words you can't say on television. The video is below, and it obviously has objectionable language. I was an early teen when I first saw the below performance on HBO, so I was at an impressionable age for this kind of humor, but as I age, I come to enjoy George Carlin's comedy even more.

Housing Bubble News from Patrick.net

Duck! Watch out for falling house prices (money.cnn.com)

Better to Wait Until House Buyer Tax Credit Expires? (blogs.wsj.com)

A second trough for U.S. new house sales in January (reedconstructiondata.com)

Most House Sales in CA Forced, Not Optional (centralvalleybusinesstimes.com)

Freddie Mac loses $7.8 billion, warns of foreclosure wave (mercurynews.com)

Maguire sells O.C. office towers at half off (lansner.freedomblogging.com)

New house sales hit record low in January (washingtonpost.com)

New House Sales Unexpectedly Plunge to Record Low; Fannie Mae, Freddie Mac Post Losses (Mish)

Mortgage Purchase Applications at Lowest Level Since May 1997 (calculatedriskblog.com)

11.3 million houseowners underwater on mortgage (marketwatch.com)

Million Dollar House or $3,500 a Month Rental? (doctorhousingbubble.com)

Regulators report 27 percent jump in problem banks (finance.yahoo.com)

Secret AIG Document Shows Goldman Sachs Minted Most Toxic CDOs (bloomberg.com)

A snapshot of income disparity (latimes.com)

Not out of deflation woods yet (bloomberg.com)

24% of residential properties upside down (blogs.reuters.com)

Shiller Says Government Support Is Tied to Housing Recovery (businessweek.com)

Mass Layoffs Summary (bls.gov)

Realtors Want Taxpayers To Guarantee Realtor Commissions Via Fannie, Freddie (online.wsj.com)

The Mortgage Bubble (Mish)

Bank lending plummets by $587B in 2009 (washingtonpost.com)

The Fed now owns more crap mortgages than Treasury bonds (money.cnn.com)

Selling mansion? Expect to wait 3 years! (lansner.freedomblogging.com)

Dry Your Eyes and Lower the Price, Fool (nytimes.com)

Bank-Owned Bargain in Long Beach (longbeachhousingblog.blogspot.com)

Bank-Owned Bargain even cheaper now (redfin.com)

House prices down in all Las Vegas codes in 2009 (lvrj.com)

Real Estate Looks Risky, but Less So for Value Investors (nytimes.com)

Lender's agent forecloses on Stuyvesant Town (reuters.com)

An Easily Understandable Explanation of Derivative Markets (hydle.com)

Real Estate Developers Push To Rebrand Murder Heights Neighborhood (theonion.com)

Irvine Home Address … 3832 COSLEY St Irvine, CA 92614

Resale Home Price … $525,000

Income Requirement ……. $110,196

Down Payment Needed … $105,000

20% Down Conventional

Home Purchase Price … $200,000

Home Purchase Date …. 4/2/1991

Net Gain (Loss) ………. $293,500

Percent Change ………. 162.5%

Annual Appreciation … 5.2%

Mortgage Interest Rate ………. 5.12%

Monthly Mortgage Payment … $2,286

Cost of Ownership

————————————————-

$525,000 ………. Asking Price

$105,000 ………. 20% Down Conventional

5.12% …………… Mortgage Interest Rate

$420,000 ………. 30-Year Mortgage

$110,196 ………. Income Requirement

$2,286 ………. Monthly Mortgage Payment

$455 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$44 ………. Homeowners Insurance

$75 ………. Homeowners Association Fees

===================================================

$2,859 ………. Monthly Cash Outlays

-$393 ………. Tax Savings (% of Interest and Property Tax)

-$494 ………. Equity Hidden in Payment

$211 ………. Lost Income to Down Payment (net of taxes)

$66 ………. Maintenance and Replacement Reserves

===================================================

$2,249 ………. Monthly Cost of Ownership

Cash Acquisition Demands

—————————————————————————————–

$5,250 ………. Furnishing and Move In @1%

$5,250 ………. Closing Costs @1%

$4,200 ………… Interest Points

$105,000 ………. Down Payment

===================================================

$119,700 ………. Total Cash Costs

$34,400 ………… Emergency Cash Reserves (6 Months Net Salary)

===================================================

$154,100 ………. Total Savings Needed

Property Details for 3832 COSLEY St Irvine, CA 92614

—————————————————————————————–

4 Beds

1 full 1 part baths Baths

1,538 sq ft Home Size

($341 / sq ft)

6,000 sq ft Lot Size

Year Built 1970

2 Days on Market

MLS Number Y1001152

Single Family, Residential Property Type

Westpark Community

Tract Othr

—————————————————————————————–

GREAT ENDED OF THE CUL-DE-SAC LOCATION IN DESIRABLE WESTPARK COMMUNITY WITH ASSOC. POOL/SPA, REC ROOM, TENNIS AND BASKETBALL COURTS, PLAYGROUND, AND PRESTIGIOUS IRVINE USD. SPACIOUS 4BR/2BTH WITH CA/HEAT, FIREPLACE, PATIO, 2A GARAGE. ((((((((STANDARD SALE)))))))….NOT A SHORT SALE OR REO. PRE-APPROVAL, FICOS, POF, & EMD MUST ACCOMPANY ALL OFFERS. *****RESTRICTED ACCESS PLEASE SEE AGENT REMARKS*******DRIVE BY ONLY, PLEASE DO NOT DISTURB TENANTS*******

This photograph annoyed me because it is showing the neighbor's front lawn and passing it off as if the greenery were on the featured property, but then I saw why the realtor did it….

There is no front yard.

Redfin shows this as selling recently or $220,000, but that amount is suspect. I doubt this was a 1992 rollback. It is, however, real estate owned.

Foreclosure Record

Recording Date: 05/27/2009

Document Type: Notice of Sale (aka Notice of Trustee's Sale)

Foreclosure Record

Recording Date: 02/25/2009

Document Type: Notice of Default

For any of you who remember 1980:

Housing Bubble Deflation Map and Trends

A press release from Nielson Wire has an interesting map of home equity that also reads as a map of the housing bubble's deflation.

Today's featured property is riding the updraft of FED interest air and overtopping its peak value.

Irvine Home Address … 84 DANBURY Ln Irvine, CA 92618

Resale Home Price …… $519,000

{book1}

The boys from North Dakota

They drink whisky for their fun

And the cowboys down in Texas

They polish up their guns

Lyle Lovett — North Dakota

Why would someone write a song about North Dakota? Why would someone live in North Dakota? Why would someone visit North Dakota? I will ask Shevy when he gets back….

I believe North Dakota is the only state to show economic growth during the recession — I guess North Dakota kept on grazing cattle while California developed sophisticated financing Ponzi Schemes those rubes in North Dakota could never understand. For whatever reason, northern states still have housing equity, and southern states do not. They are doing something right in North Dakota.

Housing Bubble demography?

A forgettable post with shoddy analysis, Homes Below the 37th Parallel Most Likely to Have “Underwater” Mortgages, contained a useful map of % equity by zip code. The report itself contained this gem:

“In a way, the housing boom and subsequent bust is similar to the stock market boom and bust of the late 1990s,” notes Greg Fisher, Sr. Data Product Manager, Nielsen Claritas. “Just as unprofitable company stocks soared, new home markets soared without regard to real value. In other words, in many new home markets, the prices skyrocketed and became disconnected with the value of the land the homes physically sat on. Salary increases were far outpaced by home price increases, which was unsustainable. At the same time, established and profitable companies’ stocks endured slower growth and suffered far less damage when the market corrected, just as older housing markets are weathering today’s real estate downturn. These housing markets already had the fundamentals to protect against the worst of the housing bust – stronger incomes and more valuable land.”

This analyst's statement makes no sense. Older housing markets are not weathering today's real estate downturn better than new markets. The real distinction is between subprime — which went through the foreclosure mill — and everything else — which is in shadow inventory and yet to be crushed. This downturn is not due to fundamentals; it is caused by improper asset valuations and the market's need to readjust. The fact that some areas have stronger incomes means that some areas will have higher prices, once markets balance price with income, something yet to occur here. Also, land value is a function of house price, not the other way around.

Map of Housing Market Deflation

The graphic below was developed to present the author's prepositions about migration patterns. Quite honestly, I didn't find much value in silly conclusions spit out by computer models when the authors displayed no functional understanding of the action in the mortgage market that created the effects visible in the graphic below.

The map above is best interpreted as a housing bubble deflation map. The green areas are those where prices have not crashed, where affordability is still low, and where prices are most perilous.

The red areas represent areas where subprime financing dominated, or where prices did not appreciate wildly during the bubble, so any decline submerges borrowers. For instance, Inland California, Florida, Nevada and Arizona were subprime lending dominated markets, and since these markets collapsed before amend-extend-pretend, prices there have been pounded back to the stone ages. Texas and the South saw little bubble appreciation, so price drops there redden the map.

The green areas have lenders worried, particularly in Coastal California and the Northeast, because the dollar amounts involved are so much larger that complete collapse of their Ponzi Scheme, similar to what happened to subprime, would deflate the entire capital base of our banking system. Our Government is intent upon keeping this remnant of the Housing Bubble inflated as well as the enormous commercial bubble they inflated.

From the same article:

What Do Severely Underwater Homeowners Look Like?

  • They earn $23,000 less than the U.S. average.

    • Severely Underwater Income: $35,000
    • U.S. Income: $58,000

  • Their homes are worth $113,000 less than the U.S. average.

    • Severely Underwater Home Value: $103,000
    • U.S. Home Value: $216,000

  • They have 58% less home equity than the U.S. average.

    • Severely Underwater Home Equity: -43%
    • U.S. Home Equity: 15%

  • Their mortgage balance is $7,000 higher than the U.S. average.

    • Severely Underwater Mortgage Balance: $187,000
    • U.S. Mortgage Balance: $180,000

  • They are located in areas where the home ownership rate is 25% lower than the U.S. average.

    • Severely Underwater Homeownership Rate: 46%
    • U.S. Homeownership Rate: 71%

  • They are 21% less likely to be located in areas where the prevalent house type has 1 or 2 units.

    • Severely Underwater 1 & 2 Unit Housing Rate: 52%
    • U.S. 1 & 2 Unit Housing Rate: 73%

  • They are 17% more likely to be located in areas where the prevalent house type is a multi-family unit.

    • Severely Underwater Multi-Family Unit Rate: 34%
    • U.S. Multi-Family Unit Rate: 17%

  • They are 2.3 years younger than the U.S. average.

    • Severely Underwater Householder Age: 47.9
    • U.S. Householder Age: 50.2

  • They have lived in their homes 2 years less than the U.S. average.

    • Severely Underwater Year Moved In:10.4 Years Ago
    • U.S. Year Moved In: 12.4 Years Ago

Those poor poor people; we have good incomes here, so Irvine must be immune, right?

By virtue of having purchased in some bygone era when prices match incomes, owners of properties like today's can get $500,000 for a shoebox. Is this our new reality?

Irvine Home Address … 84 DANBURY Ln Irvine, CA 92618

Resale Home Price … $519,000

Income Requirement ……. $109,060

Down Payment Needed … $103,800

20% Down Conventional

Home Purchase Price … $246,500

Home Purchase Date …. 11/30/1999

Net Gain (Loss) ………. $241,360

Percent Change ………. 110.5%

Annual Appreciation … 7.0%

Mortgage Interest Rate ………. 5.13%

Monthly Mortgage Payment … $2,262

Monthly Cash Outlays …..….… $2,880

Monthly Cost of Ownership … $2,280

Property Details for 84 DANBURY Ln Irvine, CA 92618

Beds 2

Baths 2 full 1 part baths

Home Size 1,127 sq ft

($461 / sq ft)

Lot Size n/a

Year Built 2001

Days on Market 4

Listing Updated 2/23/2010

MLS Number S606538

Property Type Condominium, Residential

Community Oak Creek

Tract Cobb

ELEGANT DETACHED HOME in Oak Creek featuring two generous bedrooms PLUS LOFT, two and one-half baths, two-car attached garage and private yard with low-maintenance hardscape! DESIGNER UPGRADES include beautiful laminate floor, Plantation shutters and more! SPARKLING KITCHEN includes French cabinetry, built-in microwave, dry-foods pantry and under-cabinet task lighting. SPACIOUS MASTER SUITE features walk-in closet as well as master bath with dual vanities and soaking tub. JUST STEPS TO RESORT-STYLE pools, spas, tennis, basketball volleyball, award-winning schools and the Gelson's Marketplace with upscale shops and restaurants.

This must be the rhythmic CAPS LOCK style of writing where random words are EMPHASIZED BY CAPS LOCK.

These owners paid down their mortgage! Hurray!

Irvine Housing Blog No Kool Aid

I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.

Have a great weekend,

Irvine Renter

Feelings and Attitudes Toward Debt Transform in Housing Bubble Aftermath

Perhaps society's current relationship with debt has not changed, but for those with the courage to read today's gripping post, your feelings and attitudes toward debt certainly will transform.

Irvine Home Address … 28 Well Spring Irvine, CA 92603

Resale Home Price …… $4,295,000

{book1}

Abra-abra-cadabra

I want to reach out and grab ya

Abra-abra-cadabra

Abracadabra

The Steve Miller Band — Abracadabra

Hang on, Alice, as we bolt through the rabbit hole on an adventure to financial Wonderland. Come with me on a fantastic journey to the Great Lakes to save fish falling prey to evil bloodsuckers, and along the way we will save borrowers from the evil of debt peddler, Louie the Lender Lamprey.

The Sea Lamprey and the Great Lakes

Prior to canals of the nineteenth century, the Great Lakes were a thriving fishery. With over fishing and the introduction of the sea lamprey through the canals, the fisheries of the Great Lakes were devastated. According to Wikipedia:

The Sea lamprey (Petromyzon marinus) is a parasitic lamprey (a kind of jawless fish) found on the Atlantic coasts of Europe and North America, in the western Mediterranean Sea, and in the Great Lakes. It is brown or gray on its back and white or gray on the underside and can grow to be up to 90 cm (35.5 in) long. Sea lampreys prey on a wide variety of fish. [Pictured right: Louie the Lender Lamprey] The lamprey uses its suction-cup like mouth to attach itself to the skin of a fish and rasps away tissue with its sharp probing tongue and teeth. Secretions in the lamprey's mouth prevent the victim's blood from clotting. Victims typically die from excessive blood loss or infection. [emphasis is mine]

The sea lamprey and the fish the lamprey scrapes and chugs is an allegory for the modern lender and the borrower the lender infests.

Lenders and the Sea Lamprey

The similarities between sea lampreys and lenders are as follows:

  1. The sea lamprey's sole purpose is to attach itself to a productive organism and syphon a steady stream nutrients from the host's bloodstream. A lender's sole purpose is to attach itself to a borrower and obtain a steady stream of cashflow from the borrower's productive financial life. [Pictured right: Louie's courtship dance]
  2. The sea lamprey provides no value to the fish, and once attached it remains attached. The value of lending to borrowers is debatable (mortgage debt is tolerable, but consumer debt is not); however, with the "sophisticated" borrowers of today who believe debt is something serviced and not retired, once a lender becomes attached to a borrower, they stay attached for life.
  3. Sea lampreys were not a problem in the past, and fish populations had to adapt or die when the sea lamprey was introduced. Modern credit cards were introduced in 1958, and with the explosion of debt availability over the last 50 years, our population has come to accept borrowing — and its associated lending sea lampreys.
  4. If the sea lamprey were eliminated, nutrients diverted to its existence would instead remain with the fish resulting in stronger fish populations. If lenders were eliminated, particularly those focused on providing consumer debt, billions of dollars flowing in to lending would be spent by a stronger, debt-free population on more productive economic uses. Consumer credit only benefits lenders.
  5. Sea lampreys tend to seek out juvenile fish because the young have fewer defenses, the young are stronger and more resilient and thereby less likely to die, and the young fish can nourish the lamprey indefinitely. Lenders indiscriminately target 18 to 21 year-olds through credit card offers and mountains of student loan debt in order to acclimate teens to debt and assist them in sustaining debt through their funeral pyre.
  6. If a sea lamprey causes the death of its host, it detaches itself and moves on to another. If a lender bankrupts a borrower — causes a financial death — the lender detaches itself and moves on to another borrower. No emotion when pulling out.

Mortgage Debt

Most home buyers allow lenders to suckle financial excretions through a home mortgage. If the cost of the mortgage is offset by saving on housing expenses, the debt is actually beneficial, and the relationship is symbiotic, like a clownfish (Nemo) and its protective sea anemone, or perhaps the Trill from Star Trek. However, if mortgage interest exceeds comparable rents, the excess lender slurp is parasitic and the borrower loses life force to the lender lamprey.

A typical borrower during the Great Housing Bubble looked like a fish with the two implanted sea lampreys [Pictured right: Big and Little Louie after borrower attachment]. The first mortgage is like the lamprey attached at the throat, and the second mortgage is like the one attached at the nether regions.

Do you know that sensitive spot on the soft tissues of your throat about an inch above your collarbone? Taking on mortgage debt is akin to allowing Louie the Lender Lamprey to drive his dagger teeth deeply into your epiglottis with a cartilage-cracking crunch; let him rasp a gaping gash, ply you with salivary siphon grease, and deflect your financial food toward his gullet.

The pain is necessary evil perhaps, but one to be minimized to the degree possible and removed at the earliest convenience. Unfortunately, most borrowers want to secure the largest toothy leech available and nourish the sponger's growth until the borrower's death. ~Gulp~

The second mortgage — the lamprey biting the borrower's butt — is usually a non-lethal pain in the a$$. In fact, this biting flesh wound is similar to any consumer borrowing like home equity lines of credit, car loans, credit cards, and other payment liabilities like forgotten subscriptions to magazines, websites, or software. Taking on debt may have delivered a fleeting pleasure, but like gonorrhea, debt plagues borrowers until the debt-disease is treated and ultimately banished forever for optimum financial health.

As our foreclosure crisis illustrates, many borrowers who take on excessive debt and hope to manage their parasites underestimate the tissue damage and succumb to the vampiric excess. Like Louie's former customers [pictured to right], many people bought McMansions, they took out multiple mortgages, and they used financing terms requiring accelerating home price appreciation in order to function. The collapse of hundreds of thousands of personal Ponzi Schemes litters America with of rotting financial carcasses — a pungent and painful reminder. Renting-former-owners spend their hours in fear or denial of the collection call yet to come from a long-forgotten mortgage debt holder.

Like most others, I will select a lender lamprey and hope my self discipline prevents him from growing out of control. Images like the ones from this post should ensure I remain focused on his removal.

[seven seconds you will enjoy]

The lamprey earings are a nice adornment, aren't they?

Irvine Home Address … 28 Well Spring Irvine, CA 92603

Resale Home Price … $4,295,000

Income Requirement ……. $902,530

Down Payment Needed … $859,000

20% Down Conventional

Home Purchase Price … $3,000,000

Home Purchase Date …. 8/4/2005

Net Gain (Loss) ………. $1,037,300

Percent Change ………. 43.2%

Annual Appreciation … 7.6%

Mortgage Interest Rate ………. 5.13%

Monthly Mortgage Payment … $18,719

Monthly Cash Outlays …..….… $24,120

Monthly Cost of Ownership … $20,150

Property Details for 28 Well Spring Irvine, CA 92603

Beds 4

Baths 5 full 3 part baths

Home Size 6,000 sq ft

($716 / sq ft)

Lot Size 29,479 sq ft

Year Built 2007

Days on Market 4

Listing Updated 2/22/2010

MLS Number U10000832

Property Type Single Family, Residential

Community Turtle Rock

Tract Cust

Private Shady Canyon estate evokes the relaxed elegance of the Italian countryside. Nestled on a large lot with only one neighbor and bordered by a nature preserve, the home creates an ambiance evocative of the Italian countryside – with romantic Tuscan architecture and a floorplan designed for effortless indoor/outdoor living and entertaining in all seasons. Lovely Tuscan architecture, interiors with 4 bedrooms, 5 and 3 half baths, in-law suite. Secluded courtyards, loggias, stone cabana, outdoor fireplaces and kitchen, putting green. Adorned in the finest custom finishes of exotic artisan stonework, rich millwork and trompe l'oeil paint finishes, as well as Albertini doors and windows from Italy, the main level offers generously scaled rooms suited for casual everyday living or more formal entertaining, including living and dining rooms, a massive family room, and a large chef's kitchen with catering/prep area and butler's pantry.

The photography is breathtaking.

Everything about these photos is perfect. Top-notch photographic work.

The title of this post is Feelings and Attitudes Toward Debt Transform in Housing Bubble Aftermath, but in fact, this post is the transformation. It is an active agent making this transformation happen.

Some people will undoubtedly react negatively to my overtly manipulative use of powerful images and evocative language; the edge is always a perilous dance. I purposefully went guttural to create a very strong negative association to debt. If you like debt, if you find value in it and want to keep it, I told you how I influenced you. If you want to override the effect, go out and spend some money on your credit card — procure something vacuous that provides immediate gratification, perhaps a massage — make sure you provide direct, positive reinforcement for credit spending, and you will counteract any impact of reading this post. Will that be a happy ending?

The purposes of this post are (1) to entertain, (2) to get you to think about your relationship to debt, (3) to persuade you that debt dependency is a bad thing, and (4) to provide ongoing debt-free reinforcement to those who bookmark this post and return to it when needed. Giving up a debt-dependant lifestyle is overcoming vice, never an easy task. Writing like this helps break down the positive associations of instant gratification and replaces it with negative associations that will make you revile debt. I think that is a great thing, and anyone looking for help putting away the credit cards will agree with me.

This post is not to be taken literally or interpreted as my nuanced opinion on the subject. It was fun to write, it serves a purpose, and I even if you disagree with my attitude about debt, and perhaps you feel my images and references a bit too harsh, I hope you enjoyed the craft of the post. Blogging is a unique art form, and I am enjoying its exploration.

[Artist's Rendering above: Louie the Lender Lamprey — next CEO of Goldman Sachs]

I want to extend special thanks to Sean O'Daniels for his last-minute drawing of Louie. Sean and I are discussing a collaboration on the Monsters of Debt. I look forward to seeing what his creative mind conjures up.

The Coming Tax Nightmare Over Forgiven Mortgage Debt in California

Do you think homedebtors are ready for their California tax bill on forgiven debt? That HELOC will get them.

Irvine Home Address … 74 BLUEJAY Irvine, CA 92604

Resale Home Price …… $699,900

{book1}

There's a fog upon L.A.

And my friends have lost their way

We'll be over soon they said

Now they've lost themselves instead.

The Beatles — Blue Jay Way

As the fog clears over our housing market, those who have lost their debts will find their debts are seeking them.

Patrick.net recently featured this article found on the California Franchise Tax Board's website: Foreclosures and the next wave: taxes due on canceled debt

… If their lender forecloses on their homes, or accepts an amount less than the loan balance from sale of the home, it may result in taxable gain to the homeowner. The type and treatment of the gain will depend on whether the mortgage is considered non-recourse or recourse debt.

In California, purchase money mortgages, which are mortgages where the borrowed funds are used to purchase the house, are generally treated as non-recourse debt. If the bank forecloses on a non-recourse mortgage, then the homeowner is treated as having sold the home for the amount of the outstanding debt. The difference between the outstanding debt and the homeowner's adjusted basis in the house is considered a gain or loss on the sale of the home. If the home is the taxpayer's principal residence, where they have lived for at least two of the past five years, the gain may be eligible for the gain exclusion on the sale of a principal residence. If the foreclosure results in a loss, the loss may not be taken since it resulted from the sale of a principal residence.

With the refinance craze and HELOC boom of the 00s, how many purchase money mortgages exist? In 2006, over 80% of loan originations were refinances; consequently, only the most frugal or those who bought at the peak still have purchase money mortgages. The bulk will be recourse.

If the mortgage is recourse, such as a non-purchase money mortgage or a refinanced mortgage, any foreclosure may result in a gain on the sale of the house, and/or cancellation of debt income. The difference between the fair market value of the house and the homeowner's adjusted basis will result in a gain or loss on the sale of the home. To the extent the outstanding debt exceeds the fair market value of the house, the amount is treated as cancellation of debt income. Any gain on the portion treated as the sale of a personal residence may be eligible for the exclusion on the sale of a principal residence; however, as discussed above, the loss may not be taken on the sale. The portion that is treated as cancellation of debt income is taxed as ordinary income – subject to ordinary income tax rates. Your clients with canceled or forgiven mortgage debts may receive a Form 1099-C from the lender and will be expected to pay federal and state tax on the canceled amounts, at the ordinary income tax rate.

For example, if the homeowner has a non-recourse mortgage with an outstanding balance of $250,000, and has an adjusted basis of $100,000, the house has a fair market value of $200,000. If the homeowner's lender foreclosed on the mortgage, the homeowner would have taxable gain of $150,000 ($250,000 less $100,000). If the mortgage had been recourse, the homeowner would have gain on the sale of the home of $100,000 ($200,000 less $100,000), and cancellation of debt income of $50,000 ($250,000 less $200,000).

Many renting-former-owners who have either gone through foreclosure or sold short believe they have no further responsibility to the debt. The lenders are gearing up for collection, but once they give up and begin writing down the debts, they will issue 1099s, and then the State of California will look to collect. This debt is going to linger in one form of collection or another for decades.

Tax on this seemingly "phantom" type of income is due whether the bank forecloses on the mortgage, or allows a "short sale" (allowing the defaulter to sell the house at below cost, and accepting the proceeds as payment in full). A short sale is preferable to a foreclosure only in the sense that it does less damage to the homeowner's credit rating. The difference between the amount owed to the lender, and the amount received is still considered canceled debt, and taxed at the ordinary income rate. Relief of debt is considered income because the bank gave the buyer cash to purchase the home when it issued the mortgage. This cash was not taxable because it was a loan, and the buyer promised to repay it. When the loan is forgiven or canceled, it becomes income in that year since the buyer will no longer repay it.

You must admit, the logic of the tax position is inescapable. Nobody who took out HELOC money and spent it was thinking about setting aside tax reserves.

There are a couple of options for your clients who are caught in this situation:

  • Bankruptcy: Debts discharged in bankruptcies are generally not considered debt-cancellation income.
  • Insolvency: Tax will not be assessed on the phantom debt-cancellation income if your client can prove insolvency existed when the debt was discharged. Your client must prove that all assets totaled less than all debts.

If you have clients who have exhausted their options and cannot pay the additional tax on the phantom income they "accrued" through debt cancellation, remember to look into our offer-in-compromise and payment arrangement programs.

You may also want to check out the IRS new Web page devoted to foreclosure tax relief, and related FAQs.

Bankruptcy or insolvency? Those don't sound like appealing options. Of course, most debtors will claim insolvency and hope they are never asked to prove it, and many, if not most, of those will get away with the deception.

Irvine Home Address … 74 BLUEJAY Irvine, CA 92604

Resale Home Price … $699,900

Income Requirement ……. $147,074

Down Payment Needed … $139,980

20% Down Conventional

Home Purchase Price … $205,000

Home Purchase Date …. 12/23/1998

Net Gain (Loss) ………. $452,906

Percent Change ………. 241.4%

Annual Appreciation … 10.8%

Mortgage Interest Rate ………. 5.13%

Monthly Mortgage Payment … $3,050

Monthly Cash Outlays …..….… $3,800

Monthly Cost of Ownership … $2,760

Property Details for 74 BLUEJAY Irvine, CA 92604

Beds 4

Baths 3 baths

Home Size 1,960 sq ft

($357 / sq ft)

Lot Size 4,300 sq ft

Year Built 1977

Days on Market 14

Listing Updated 2/18/2010

MLS Number S605981

Property Type Single Family, Residential

Community Woodbridge

Tract Ck

STANDARD SALE, CLOSE IN 30 DAYS, STILL GET YOUR CLIENT TAX CREDIT BEST BUY IN ALL OF WOODBRIDGE!NO MELLO ROOS, LOW TAX RATE, LOW HOA. CUL DE SAC STREET IN BEST AREA OF ALL OF WOODBRIDGE 4 BEDROOM AND 3 BATHS, ONE FULL BEDROOM AND BATH DOWNSTAIRS. BEAUTIFUL ENTRANCE OPEN TO LARGE FORMAL DINING ROOM WITH FIREPLACE AND PLENTY OF ROOM FOR ALL YOUR GUESTS, FORMAL DINING ROOM WITH PEACEFUL ATRIUM, OPEN KITCHEN WITH COUNTER TOP OPEN TO ANOTHER EATING AREA AND FAMILY ROOM, BEAUTIFUL BACK YARD FOR ENTERTAINING AND SOCIALIZING VERY LARGE MASTER SUITE WITH DUAL CLOSETS AND VANITIES THIS HOUSE IS READY TO GO AND CLOSE YESTERDAY!

Can you read that? I labor with ALL CAPS descriptions.

The date and price of ownership is unknown, but I have approximated based on available mortgage information. I may be off significantly, but that would only make the HELOC abuse even more egregious.

My view of the property records only goes back to 1998 on this property, but it may be an original 1977 owner for all I know.

  • According the records I do have, the owners had a $164,000 loan on 11/08/2002.
  • On 8/13/2003 they had a $163,000 loan.
  • On 8/13/2003 they tasted kool aid with a $40,000 HELOC.
  • On 9/10/2004 they opened a $125,000 HELOC.
  • On 11/4/2005 they opened a $250,000 HELOC.
  • On 4/17/2007 they opened a HELOC for $100,000
  • Total property debt is $510,000.
  • Total mortgage equity withdrawal is $347,000.