All bailout measures have embedded within them serious issues of moral
hazard. Both lenders and borrowers were extremely foolish during the
real estate bubble. To bail them out at the expense of the wise and
prudent will discourage fiscally responsible behavior and encourage
wild risk taking and speculation. For instance, lets say both you and
your neighbor bought a house in 1998 before the bubble inflated. You
both paid $200,000. You sacrificed and paid down your mortgage in the
intervening 10 years, and now you owe $150,000 on your house. Your
neighbor was lured by the free money accumulating as appreciation and
took out an additional $400,000 in home equity lines of credit and
refinancings and lived the good life. This neighbor was driving around
in new cars, taking vacations, buying expensive toys and pretending to
be rich. Now you owe $150,000 on your house, and your neighbor owes
$600,000. Your neighbor cannot make the payments and is asking for a
government bailout, principal reduction and a whatever other handouts
he can get. So now, you the taxpayer, is going to be asked to pay off
your neighbors bills. You, who was responsible while you neighbor was
not, are being punished for your responsibility while your neighbor has
no consequences. What will stop your neighbor from doing this again?
What will stop you from doing this next time? I profile individual
properties every day, and I can tell you
from the property records I view daily that this conduct was not the
exception, it was the rule. There is no bailout program currently
proposed or enacted that does not have this moral hazard issue.
Clowns to the left of me, Jokers to the right, here I am, Stuck in the middle with you.
There are provisions that could be added to a more wide-reaching
bailout proposal that might address some of these problems. In the
recent FHA bailout program, the owner must give up a percentage of
equity to participate. This is a great idea, and I have witnessed
homeowners who were in trouble pass on this option because they were
too greedy to give up future appreciation. Equity sharing needs to be
part of any bailout program. The programs enacted now are offering
workouts, but they are only dangling a carrot in front of borrowers,
there is no real stick to compel them. Ordinarily losing one's home
would be enough of an incentive to do a workout, but when homeowners
are hugely underwater; their best financial move is to let the property
go in foreclosure. This incentive needs to be changed. Congress made a
serious mistake when they decided to forgive the tax indebtedness on
people who do not pay back mortgage debt. This simply made it easier
for people to walk away. It needs to be harder, much harder. If you
really want to compel people to participate in loan workout programs,
there needs to be serious financial repercussions for not doing so.
Taxing debt forgiveness is one potential incentive, but the bigger one
is to make this debt permanent -- don't let people discharge this debt
in a foreclosure or a bankruptcy. If walking away from their mortgage
debt benefits them in no way, people will not walk away.
I would propose the following: When Obama takes office we might see
a 90-day moratorium on foreclosures (by itself, this is a horrible
idea). Put all borrowers on notice, you have 90 days to begin a workout
plan with your lender. If you fail to do so, and if you then go into
foreclosure, you will pay taxes on the loss, and if you have capacity
to pay back the debt, you will be required to work out a repayment
plan. Bankruptcy judges already have the power to force people into
chapter 13 rather than chapter 7 bankruptcy, so this would be easy to
enforce. There is precedence for this kind of bankruptcy protection for
certain loans: government insured student loans are not dischargable in
bankruptcy. Since the government insures these loans, they ensure the
insurance program does not lose money by preventing forgiveness of this
debt. Now that the government is "conservator" of the GSEs, they are
providing a similar government-backed insurance to mortgage debt. They
should have a similar no-bankruptcy policy on this debt as well. The
effect of this policy would be to strongly compel those who need a loan
workout to get one. For those who fail to qualify for a loan workout,
they are exempted from these consequences.
This proposal would effectively force everyone into a loan
modification program who needed one to make their payments. It would
greatly reduce the number of foreclosures that are still in the
pipeline, and it would give the banks as much cashflow as they will see
as the fallout from this mess continues. However, this will not stop
home prices from falling. If stabilizing home prices is truly a
priority, there is no program that can accomplish this. Houses are too
expensive. Prices must fall down to levels of affordability before
prices will stabilize. There are only two ways to make houses more
affordable: either prices must fall or incomes must rise. The housing
bubble was about experimenting with financing terms to increase
affordability. That experiment failed miserably. Making incomes rise is
not something that can be accomplished through bailouts or any
government policy directed at housing. Since financing innovations
failed, and since raising incomes is not a viable alternative, prices
will continue to fall.
Trying to make some sense of it all, But I can see that it makes no sense at all, Is it cool to go to sleep on the floor,
Today's featured property hass owners who would not mind the "carrot and stick" approach to solving the housing crisis: they were fiscally responsible. I see so few of these, that I would like to celebrate them when I do come across them.
The word "blossom" conjures up images and feelings of hope, renewal and possibilities for the future. But what happens when these dreams turn into a nightmare? What do you feel when your blossom becomes a turd? Our most famous "turd blossom" is Karl Rove, although I won't pursue that thread much further...
Hope and optimism are wonderful qualities, and Americans are noted worldwide for our abundance of both. It is part of the American spirit. The Great Housing Bubble rally was a period of boundless hope, or more accurately stated, a period of irrational exuberance. Rational or not, periods of great prosperity fill everyone with hope for a better tomorrow. During the bubble, we pinned out hopes on the unstable ground of Ponzi Scheme financing. While everyone thought they were spending free money, they were really borrowing prosperity from the future. Now that the bills are coming due, the illusion of wealth and prosperity are gone; people feel hopeless and despondent.
Today's featured property is a reflection of the American dream, circa 2005. The borrower overpaid for property using an Option ARM to acquire a property he really couldn't afford. When properties are going up in value quickly, there is a strong incentive to overpay. Ten percent if a $1,000,000 is $100,000, whereas 10% of $500,000 is only $50,000. The more you paid, the more you made. It isn't surprising that many people got in way over their heads, particularly when toxic financing and the elimination of standards made it easy to do.
Given the strong incentive to overpay, the foolish assurance that prices could not go down, and the willingness of lenders to give out practically unlimited funds, it should not be surprising to see properties like today's coming on the market. Too many people have borrowed too much money. There are going to be many, many more just like it over the next several years. Even if people's payments didn't increase, their burdensome debt-to-income ratios would push them to sell. With the ARM resets coming and people's payments set in increase significantly, it seems likely we will have a very serious foreclosure problem right here in Irvine.
The Irvine Housing Blog is being featured in the print edition of the Irvine World News this weekend. For any new visitors that found us from this article, I like to say welcome.
The Irvine Housing Blog is a blog devoted to real estate in Irvine, California. As such, we analyze local and national issues that impact prices in our housing market. Since its inception in September of 2006, we have been bearish on real estate in Irvine. The reasons for our bearishness can be found in great detail in the analysis posts found both in the sidebar and on the analysis tab above. These posts are organized into the book, The Great Housing Bubble. We are not a bubble blog, and though we are often referred to as part of that community, we will only be bearish as long as prices are elevated above fundamental valuations and market conditions point to continued deterioration in prices. At some point, we will turn bullish.
In early 2007, we published a series of predictions for Irvine median house prices. The red line in the chart above is the original prediction, and the green line represents what happened through April of this year. As you can see, we have a reasonable record with respect to forecasting future median home prices.
We are a vibrant community of more than 3,000 daily visitors. Our forums have over 1,500 members and over 78,000 posts. Many Irvine residents come to our forums looking for information on Irvine housing, discussions about the economy, politics, or just to hang out and be part of the community. The forums are free to join, and everyone is welcome to participate.
In a typical post, we examine a property for sale in Irvine in our own irreverent, snarky style. There is usually a featured song for everyone's entertainment, a preamble with discussion or analysis of market issues often with a tie-in to the featured song. After there is a presentation of the featured property with two pictures (if available,) and a breakdown of the asking price, the income requirement and downpayment requirement based on traditional financing, the monthly equity burn (the amount the buyer will lose each month assuming prices drop 10% a year for the next 2 years), the original purchase price, the date of purchase, and the address with a link to the listing on Redfin. Below the fold, there is more detailed property information from Redfin and the MLS including the property description. The quality of the writing on MLS listings is often horrendous, and we will ridicule this descriptions just for the fun of it. Then we go in to detail on the mortgage debt on the property showing how much each of the parties to the transaction is going to lose in the eventual sale. The stories the property records reveal are often quite illuminating and instructive -- instructive on what not to do.
If you are new to the site, we encourage you to look around, and please join in the fun by adding your own "astute observation" to the post below. Welcome.
For those of you who are regulars to the site, go check out the article in the Irvine World News print edition. We will also be featured in the OC Register on Wednesday. As a reminder, out IHB get together and book signing will be this Wednesday, November 12, at 6:30 PM at JT Schmids at the District. Everyone is welcome to attend.
It has been almost 7 months since our last call for lurkers to come out of the shadows. For all you readers out there who have never posted before, please say
hello. We know you are out there. This is another chance to break the
ice...
Welcome to the jungle We got fun 'n' games We got everything you want Honey we know the names We are the people that can find Whatever you may need If you got the money honey We got your disease In the jungle Welcome to the jungle Watch it bring you to your shun knees, knees I wanna watch you bleed
Welcome to the jungle We take it day by day If you want it you're gonna bleed But it's the price you pay And you're a very sexy girl That's very hard to please You can taste the bright lights But you won't get them for free In the jungle Welcome to the jungle Feel my, my, my serpentine I, I wanna hear you scream
Welcome to the jungle It gets worse here everyday Ya learn ta live like an animal In the jungle where we play If you got a hunger for what you see You'll take it eventually You can have anything you want But you better not take it from me Welcome to the Jungle -- Guns n' Rose
Real estate always goes up. I will pay back this loan. Stated Income is OK. The market will recover to peak prices soon. There is a huge pent up demand. They are running out of land. Buy now or be priced out forever.
You all recognize the lies of The Great Housing Bubble. I imagine you could compile a longer list than I can. A great many people believed these lies (and many still do) because they wanted to. As long as prices were going up, any reason to buy seemed like a good one. There is one lie that everyone who buys real estate believes: prices will go up from here. Yes, there are people who claim they know prices will drop further, but nobody who buys think this will be very much or for very long.
I remember reading an article last year where a knife catcher was buying in a suburb of Los Angeles because prices had dropped about 10%. He said in the article that prices might drop 1%, 2% at most. Of course, prices have dropped 30% since then. It has been fascinating to me to watch knife catchers buy properties during this decline. I had always wondered what was going through people's minds when they bought while prices are dropping. From what I have witnessed, they all believe they are buying the bottom.
Close my, close my, close my eyes
There will come a time when prices are still dropping that I may buy. I will do so because the purchase will save me money versus renting. At that price level, there is another valid economic reason to buy. Appreciation does not matter if a purchase has another economic benefit. Today's knife catchers do not have that benefit. They are getting the worst of both worlds. They have equity evaporation, and they have a negative cashflow as compared to renting. It takes blind faith in the lies of the bubble and baptismal acceptance of kool aid to buy in this market.
Today's featured property is actually one of the better deals I have seen. It is still above rental parity, but it is quickly approaching that threshold.
Everyone is wondering when the market will bottom and at what price. For prices to stabilize, they must reach levels of affordability where people can make the payments with a reasonable percentage of their income. These levels are almost completely dependant upon income and financing terms. During The Great Housing Bubble, credit was very loose, and people were able to finance huge sums based on both their real and imagined income. The only limits to prices were imposed by people's dreams and their willingness to lie on loan applications.
Now that the loose financing has resulted in unprecedented default rates and foreclosures, lenders are tightening credit in the hope of not losing even more money. The tightening of credit will continue. This will result in a continued decrease in the amounts lenders are willing to loan which in turn will lower the amounts buyers are able to bid. Prices will continue to fall.
The first signs of market stabilization will be when prices reach levels of affordability commensurate with historical norms. Prices are still far elevated from these levels. When we get to the bottom, prices at the low end of the market will stabilize first. The bottom tier of the market is the foundation of market stability. It is not until these prices stabilize and begin to rise that will people have equity to move up to larger homes. People who are buying more expensive properties today are not taking their equity from less expensive properties to finance a move up. There is little no equity in these low-end properties, and their continued price decline is making an equity transfer to a more expensive property much more difficult. The ongoing erosion of the equity positions of low-end properties coupled with tightening financing is going to continue to put pressure on high-end homes.
Many low-end properties in the most beaten down markets are nearing rental parity. There has been a dramatic increase in sales volumes of low-end properties where prices are at rental parity. Those markets are beginning the price stabilization process. The same is not true of Irvine. Our low-end properties still have further to fall as they have not yet reached rental parity for an owner-occupant. Many of the least desirable will likely fall below rental parity to price levels where investors can generate a positive cashflow. In short, we are nowhere near the bottom.
Today's featured property is a typical low-end foreclosure in Irvine. The buyers used 100% financing about 1 year before the peak, and with prices plummeting and the cost of ownership being double the cost of a similar rental, the owners stopped making payments and allowed the property to go to auction in foreclosure. It is a familiar story, and it is one we will see more of here in Irvine over the next few years.
