The next big psychological change to impact housing will be a change in homebuyers relationship with debt. Equity can be created in a home in two ways: you can pay down the debt, and the house price can appreciate. During the bubble rally, it was not fashionable to pay down debt. It is a slow way to build equity, and it requires sacrifice. During the bubble, appreciation happened much faster, and it required no additional funds to go toward a housing payment. Under those circumstances, only the most fiscally disciplined and conservative paid down their mortgage (and they are the only ones whose houses are not in jeopardy.) As the price decline drags on -- which it will for several more years -- people will come to realize that equity does not appear magically, but it is only obtained through retiring debt.
An acquaintance of mine bought a house in late 2007. I consider it my greatest failure of persuasion that I was unable to convince him to wait. The purchase was 70% emotional, but the 30% of him that rationalized the decision had convinced him that he could service the debt for 10 years with an interest-only fixed payment. He would then be able to refinance into another interest-only loan, and in 20-30 years when he went to sell it, he could take the profits to fund his retirement. It is thinking like this that will change. Instead of buying a house he could afford, he borrowed 5 times his income with an interest-only, and he has no funds left over to save for retirement (or anything else for that matter.) Since his purchase, an identical floorplan a few blocks away has been offered for sale for 20% less than he paid, and prices will decline another 20% befor they finish dropping. In ten years, he is likely to be still underwater, and he will either lose the home or struggle with a fully amortized payment on a 20-year schedule. If he had simply waited 2 to 4 years, he could have had the house, and he would have had the money left over to save for the future. There was probably no overcoming the emotional desire to have the house today (sadly,) but it is the intellectual rationalization that I found most interesting.
By 2010, people will realize the thought patterns of the bubble, the religion of real estate, are no longer operative. As this slow process of change grinds forward, people will start thinking in terms of taking on manageable debts with an eye toward paying it off to build equity the old fashioned way through retiring debt. This will be a big change for the market. People will be unwilling to put 50% or more of their gross income toward housing, and our economy will benefit because so much of our local wage income will not be going toward debt service. There is a silver lining in a price decline, and the rebalancing of household finances will be a great boost to our economy. Crushing debt service is like a tax that takes income out of our local economy and sends it to investors in far-away lands. When this money stays home, people have more money to spend on local consumer goods. None of this will happen quickly, as the lingering effects of kool aid intoxication will be with us for some time, but in the end, house prices will be affordable, and the local economy will recover -- not through a Ponzi scheme of ever-increasing debt, but through working, earning and circulating that money in the local economy the way it is supposed to be. Until then, I guess we will keep waiting for the world to change...
A reader sent me today's featured song. It is one of the best advice songs for the housing bubble. "It's not what you thought when you first began it. You got what you want. Now you can hardly stand it though, by now you know it's not going to stop. Prepare a list of what you need, before you sign away the deed. 'Cause it's not going to stop. So just...give up." Sagely advice indeed.
The decline of housing prices is not going to stop any time soon. In fact, this fall and winter, we are likely to have another big drop locally as the summer selling season winds down and a large number of REOs hit the market. This will put even more homeowners in distress just in time for the resets on their Option ARMs. If we see any leveling off of the foreclosure numbers, it will be the calm before the Option ARM storm due to hit over the next two years. Today's featured property is one of those distressed homeowners with an Option ARM. They are selling now because they bought late in the rally, and they are already so far underwater that holding their breath is too painful, and it seems rather pointless. This group of distressed homeowners who give up will drive prices lower and distress a whole new group of Option ARM holders. The downward spiral is picking up steam.
The behavior of HELOC abusing owners during The Great Housing Bubble was tragic. They believed the fantasies of the religion of real estate, drank the kool aid, and now they are losing their homes. The classic Greek tragedy a good person experiences a reversal of fortune most often due to the decisions and mistakes they made along the way. The tragic outcome for many homeowners was not caused by some unforeseeable, random event, but rather it is the direct result of the decisions they made and the actions they took because they subscribed to the fallacies of the religion of real estate. A good tragedy or morality play leaves the audience with mixed emotions. Part of you feels sorrow for the pain and suffering the character must endure, and part of you feels they character is getting what they deserve. It brings up feelings of schadenfreude and a sense of thankfulness that you did not suffer the same fate.
You can see this mixture of emotions in the comments on the blog which often exhibit both sides of this false dichotomy. Life is seldom black and white, and the tragic outcome for homeowners caught up in The Great Housing Bubble is no different. The full range of these emotions are normal and appropriate given the events we are witnessing. Hopefully, everyone who explores these issues and the outcomes that results from the behavior sees the mistakes these people made and does not repeat them in their own life. If that occurs, the I will feel my work at the Irvine Housing Blog has been worthwhile.
Today's featured property is another HELOC abuser who lost his home. Let's explore how he did it.
It is my observation that people have not fully grasped the changes that will result from the deflation of The Great Housing Bubble. There are many historic parallels with the closest being The Great Depression. When the stock market bubble of the 1920s began to deflate in late 1929, few thought the boom times of the decade were over, and even fewer saw the disaster coming of The Great Depression. The recession we are entering now will not likely reach the severity of The Great Depression, but it will signal the end to the lifestyle to which so many in California have become accustomed.
Right now, there is still a great deal of denial in the general population. The conventional wisdom appears to be that prices will begin to recover once this recession is behind us in 6 months or so. In a normal real estate market experiencing a recession due to a problem in another part of the economy, this thinking might be true. House prices often stagnate when a certain industry is in contraction and resume appreciation when the industry recovers. This works in a healthy real estate market because prices are correlated with incomes. When incomes drop or stagnate, so do house prices, and when income growth picks up again, house prices go along for the ride. However, this recession and the response to it are different. This recession is caused by the collapse of the housing bubble and the disappearance of the mortgage equity withdrawal stimulus and the fearful contraction of lending generally. The general economy will recover, but home prices will not because house prices are not supported by incomes. Even when incomes begin to rise, house prices will still fall until they are in fundamental alignment with income again. This will take time. It will happen more quickly in the new home market because prices are not downwardly sticky when it comes to new homes. Builders lower prices until they find a market and generate sales volume. With sales volumes at historic lows and inventories dropping, new home sales volumes should bottom out over the next several months; however, volume will not recover quickly with all the competition from REOs and prices may decline further (particularly here in Irvine where the price cuts have not been as aggressive and sales volumes are nearly zero because the prices are too high.)
The major area of denial surrounding real estate that I see is the loss of the associated lifestyle. People seem to believe that prices will recover, and lenders will go back to supporting their lifestyles by providing HELOC money for every dollar of appreciation, and the party will go on much like before. This is not going to happen. We have discussed on this blog the short-term memory of institutions and investors and the general level of foolishness, but they are not that stupid. They are not going to lose a trillion dollars then go right back to the behaviors that cost them all that money. Without significant structural changes to our lending system, the practices of the bubble might return some day, but not for 10-20 years or longer. It certainly is not going back to the way it was in the next 6 months or 6 years for that matter. The party really is over, and people have not accepted that fact, nor have they adjusted to it. There are still difficulties ahead, and many sad eyes wet with tears from the losses they must endure.
Today's featured property is another example of the kind of behavior we saw during the bubble that is coming to an end. The buyer put 5% down, quickly withdrew the downpayment plus some spending money, and let the property go back to the lender.
Are the rich foreigners going to come buy our overpriced real estate? Not if they are from this planet. Perhaps ET and his buddies will come down to save us?
Isn't everyone in Shady Canyon rich? Are there pretenders in Irvine's bastion of wealth? It certainly looks that way. When I wrote Southern California's Cultural Pathology, I discussed the idea that debt is wealth. People seem to truly believe that possession of an expensive object through taking on huge debts makes them wealthy. In reality, it makes them extremely indebted. Nobody has ever added to their net worth by using 100% financing. Sure, if properties appreciate, they can gain wealth through the use of leverage, but if they don't... who cares, you can pass the losses on to some stupid lender/investor.
Today's featured property was owned by a HELOC abusing pretender. He leveraged himself into a Shady Canyon home, took out all the equity as it appreciated, and now the lender is holding the bag -- again.
During The Great Housing Bubble California's homeowners were living life in the fast lane. Free money was readily available, and people were taking it and spending it with abandon. Some people got lucky and found the greater fool to bail them out, and some people did not. Today's featured property was purchased with 100% financing at the top of the bubble from a HELOC abuser. Of course, the lender is left holding the bag.
I nominate today's featured song as the ode to The Great Housing Bubble. If you drank the kool aid, I mean really drank the kool aid (like today's owner), life must have been very good. All this free money allowing you to do whatever you want whenever you want. Life must have been very good to those who lived off their houses. There is nothing wrong with living well, and there is nothing wrong with becoming accustomed to a certain style of life, it just isn't very wise to build this life on an unsustainable foundation of Ponzi Scheme financing -- it will collapse, and you will lose the life to which you have become accustomed.
Perhaps I should nominate Tequila Sunrise by the Eagles? The hangover must be a killer...
Wikipedia defines faith as "a belief in the trustworthiness of an idea that has not been proven." Religious faith is a collection of beliefs based on ideas which are neither testable or provable. If you accept the core beliefs of a religion on faith, you generally get a feeling of peace and well being that serves to reinforce the "correctness" of the acceptance of faith. Most religions build on these core beliefs and assemble a series of ancillary beliefs for guiding human behavior known as religious dogma. California has a major cultural "religion" that cuts across traditional denominational lines -- the religion of real estate.
Baptism into the real estate religion is a metaphorical drinking of kool aid. The fundamental belief of this religion is a belief in the "higher power" of market forces -- real estate values always go up. Once you accept this fundamental belief, the dogma of real estate can take over. The dogmatic practices of real estate include buying at any price and borrowing any sum you can. Since real estate always goes up, it doesn't matter how much you pay because you can always sell later for more money. Value has no meaning. Also, since you can pay back any borrowed sums when you sell, it doesn't matter how much you borrow or under what terms. Fabricating income on a mortgage application to qualify for a larger loan is perfectly acceptable behavior. Debt is something to be serviced not retired. It is foolish to borrow under terms which pay down a mortgage because equity appears through appreciation. There is no need to build equity through retiring debt. Besides, paying down debt is a slow process, and building equity through appreciation is much faster and requires less sacrifice. The lure of kool aid intoxication is very strong. It appeals to our fantasies of unlimited wealth and spending power.
People who accept religious tenets often face a crisis of faith at some point in their lives. John Spong wrote a book titled "Why Christianity Must Change or Die" in which he devotes a chapter to the Jewish exile to Babylon. It was a cultural crisis of faith where many of the fundamental beliefs of Judaism were challenged. California's religion of real estate is facing a similar crisis. The fundamental belief in endless house price appreciation is being challenged, and all the associated beliefs are similarly being called into question. Right now, most people are still in denial clinging to their faith in the forces of the housing market. Many will come to lament the Day the Market Died, many will continue to cling to Southern California's Cultural Pathology, and many will bargain for a renewal of the The California Social Contract.
Any core religious idea that can be empirically tested will face its ultimate challenge. The collapse of The Great Housing Bubble will prove that real estate values do not always go up, and in fact, real estate values can decline significantly. All of the associated beliefs built on this fundamental premise are equally false. People will be forced to examine the beliefs which guide their purchase decisions and their relationship to debt financing. Like any other crisis of faith, the loss of comforting and secure beliefs is emotionally painful, and the cleansing process will take time. Will kool aid intoxication survive? Probably, but there will be fewer faithful until meaningful appreciation returns and the army of realtors missionaries sets out to convert a new generation.
Figuratively, today's featured property is a church (just like all other houses in California.) The fact that it is located on Church Street is testament to the faith the buyer had in its continuing appreciation. Based on the resale history, there was reason to believe prices would always go up. Our faithful owner borrowed 100% of the money necessary to worship here.
Our market is experiencing wave after wave of pain. Will the owners endure, or will they give in and sell? It depends on the circumstances and the constitution of each owner, but those with little to lose are giving up without much of a fight, and they are passing the pain on to the lenders. Today's featured property is a classic illustration of kool aid intoxication and bubble behavior. The owner bought with 100% financing late in the rally, she managed to pull out a bit of spending money, and now that prices are crashing she is bailing out and leaving the losses to someone else. The losses to the lenders are accelerating along with the decline in prices. This one is gonna hurt...
People who accept religious tenets often face a crisis of faith at some point in their lives. John Spong wrote a book titled "
