The truth about real estate is that most people will buy and sell due to life’s circumstances. If a family wants to own a home for stability and security because they have small children or if a baby is on the way, they are not concerned with whether or not they are properly timing the real estate cycle. Unfortunately, the real estate cycle moves independantly of our life cycle.
We’ve only just begun to live, White lace and promises A kiss for luck and we’re on our way.
The innocent people who got caught up in the housing bubble—and there are many buyers who were not motivated by greed—are paying an hefty price for their own bad timing. Look at what a difference a few years makes.
Let’s say you graduated college in 1994. You were probably a bit bummed because the California economy was not doing that well, but if you found a job, you could begin your life. People in that circumstance might have been ready for marriage shortly thereafter, and they probably bought a house between 1997 and 2000. These people, assuming they did not abuse their HELOCs, are not going to lose their homes in foreclosure.
Now look at the circumstances of someone who graduated in 2001. They should not have been ready to buy until perhaps 2008, but with innovations in home mortgage finance, they were able to enter the real estate market early. They were “pulled forward” into 2004, 2005 or 2006. These are not real estate experts (although some probably thought they were), they are just 20-somethings who were given an opportunity to own a home with little sacrifice or saving on their part. Why would they have turned this opportunity down?
Well, the people who were graduating in 1994 are doing OK whereas those who graduated in 2001 or later are totally screwed.
Is this right? Should the real estate cycle really be allowed to have such a capricious impact on people’s lives? Does anyone think this system works?
The housing bubble is having an enormous impact on the health of individuals, families and entire
communities. As
with any mass delusion, it is difficult to see beyond the comforting
fallacies to understand the deeper truth; however, it is essential to
do so because the cost in emotional and financial terms of getting
caught up in the mania is very high. Foreclosure and bankruptcy are bad
for individuals, bad for families, and bad for society.
So much of life ahead We’ll find a place where there’s room to grow,
When I saw the listing photos for today’s featured property, I couldn’t help but feel compassion for the innocent. (Do you think this means I have emptied my Reservoir of Schadenfreude?) When you see the first photo, your eye cannot help but be draw to the wedding photo on the wall over the fireplace (followed by the bottle on the counter…) Then when you see the kitchen photo, you see all the pictures on the refrigerator. There is another photo with a picture of the happy couple near the TV. (This is horrible staging, BTW).
This couple, this family, is watching their future get destroyed by the housing bubble.
Now before we break out the violins, this was a 100% financing deal, and they owners are not losing any of their money, but their dreams of climbing the property ladder are gone, their credit score will plummet, and they will be shut out of the housing market for the foreseeable future. All because their life cycle lead them to buy at the worst possible time in the housing cycle.
Before the home sits out too long You must flip it
When somethings going wrong You must flip it
Now flip it Into shape Shape it up Get straight Go forward Move ahead Try to detect it Its not too late To flip it Flip it good
When you buy as a flipper, you are a fool. Your task is to find someone more foolish than yourself to buy you out before prices crash. There are bagholders for every price crash. Someone has to own the asset while it declines in value. The trick to flipping is not to be that someone.
Speculative flipping only works when prices are rising. There are a few people who manage to make a few bucks buying at foreclosure auctions and quickly selling before the declining prices take them underwater, but these people are the exception rather than the rule. Most people who made money flipping during the bubble simply bought property, waited for a while, then sold it to some greater fool. That method does not work when prices are falling.
Despite the total collapse of pricing at the bottom of the market and the obvious signs of an impending market implosion, some people chose to buy real estate as speculative flips in recent years. I have already profiled a couple who have changed their minds and are trying to get out, but it is the ones who actually price the property to make a profit I find most interesting. They really believe there is someone out there who is even more stupid than they are.
Today’s featured property is one such flipper. I know the penthouse is supposed to be nice, but is the premium really $900,000 or worse yet $1,575,000? Should people really pay $1,000/SF when properties in the same building are selling for less than $400/SF?
Here at the blog we joke about the “analysis” put out there by some of the local realtors. Most of this is thinly-veiled, self-serving bull$hit, or utterly incompetent nonsense. In either case, the purveyors of this information are not widely respected in the world of land development where those with deep pockets often pay large fees for good information. However, there are a number of very good market forecasters who are respected in big-money land development, and these consultants are well paid for the analyses they provide.
There are four main market consulting firms in Southern California that provide detailed market studies for residential land development projects. These are Market Profiles, Real Estate Economics, The Concord Group, and John Burns Consulting. I have met with the principals of all four of these firms at one time or another. They are all highly reputed in the industry.
I recently had a meeting with John Burns just to network and find out what he is seeing in our industry. We ended up sitting and talking for almost 2 hours. He shared with me his proposal for Unlocking the Housing Market Recovery (PDF warning). It is a great report. Over the course of several posts, I intend to revisit many of his proposals to see what the IHB community thinks about it.
The core of his proposal is as follows (from the executive summary):
The U.S. is undoubtedly in the worst financial and economic crisis since the 1930s. Home prices are falling rapidly across the nation, which has resulted in more than $2 trillion in losses in the last two years. The declining stock market has wiped out trillions more. These tremendous losses have created a vicious downward spiral that requires government intervention to avoid a 1930s-style economic collapse. This problem is affecting both Wall Street and Main Street.
There has been a lot of rhetoric and not a lot of facts about the current economic and financial crisis. In this report, we use facts to assess the current situation and provide our recommendations to save the U.S. economy from collapse.
To stabilize home prices, we believe Congress needs to do four things in conjunction with the Federal Reserve and US Treasury Department. Some of our recommendations have already been accomplished, but many of them have not.
1. Stabilize The Banking System - Save local businesses by saving the local employers’ bank.
Continuing insuring deposits up to $250,000 and unlimited amounts in payroll accounts
Close all poorly managed and undercapitalized banks ASAP
Keep lending money to stabilize the best and largest banks
Properly dispose of bad loans, RTC-style, instead of the way it is currently being done
Finance new banks to create competition for good loans
Continue supporting commercial paper liquidity
Continue liquidity guarantees on new bank debt
2. Stimulate Job Growth - Bring more jobs to the economy with short-term stimulus and smart government spending.
Fund infrastructure projects to create jobs
Stimulate short-term spending while recognizing that long-term saving is also needed
Allow companies to utilize their current losses to recapture taxes paid over the last 4 years so they can keep enough cash in the bank to meet payroll
Create government–backed initiatives to help banks lend
3. Stimulate Responsible Home Buying – Stop home price declines by stimulating home buying by responsible individuals, to bring demand and supply back into balance.
Keep mortgage rates low
Keep Fannie and Freddie lending and FHA insuring
Temporarily provide a down payment match to all home buyers
Temporarily double the mortgage interest rate deductions for all homeowners
4. Support responsible loan modifications – Stop home price declines by helping keep responsible people in their homes.
Provide financial incentives for loan servicing firms to modify loans
Create a vehicle to buy loans that have been responsibly modified
There you have it. There is much more detail in the report: Unlocking the Housing Market Recovery (PDF warning). I am not going to bias the comments with any of my own commentary at this time. As I mentioned previously, I intend to revisit some of these proposals.
Just for giggles, lets look at a property offered for sale at 37% off its peak purchase price.
I guess Im always hoping that youll end this reign But its my destiny to be the king of pain
Now let me ask you something: Have you ever felt that you weren’t responsible for the things that you do?
I do not like government paternalism. When Ronald Reagan came to power and began our 25 year experiment with government deregulation, I thought it was a good idea. It used to really annoy me when I would see paternalistic politicians who believed they knew what was good for me and for society, and that their ideas of right and wrong should be legislated. Government intrusions into the lives of citizens should be kept to a minimum, and citizens should have the right to make their own decisions and live with the consequences.
Well, maybe not.
I used to believe all of that, but based on what I have witnessed during The Great Housing Bubble, I see good reasons to bring back a little government paternalism.
First, people are not willing to accept the consequences of their actions. People want the right to do what they want and obtain the benefits of their decisions when things go well, but as soon as things go badly, they want the government to bail them out. This goes for individuals, organizations, and entire industries. I have yet to see anyone step forward and say, “I screwed up, and I don’t think the government should do anything about it.” If gains are privatized and losses are collectivized, then there needs to be a paternalistic government regulator looking out for the collective interest. This means regulation and unpopular restrictions of the choices of individuals and organizations.
Second, even if people were willing to accept the consequences of their actions, sometimes these consequences have impacts on others who had nothing to do with the original decision. If every homedebtor accepted foreclosure, and if every lender accepted the losses without pleading for a government bailout, the economic consequences of their foolishness would still have enormous impacts on all of us who did not participate in the transaction. When people accepting responsibility for their actions still causes excessive collateral damage, then the activity should be regulated to save the rest of us.
Day after day on this blog, I profile properties where the borrowers have spent themselves out of their homes. There is a fascinating, “train wreck” quality to these stories. There are lessons to be learned about managing personal finances in general and mortgage debt in particular. However, most people will not learn these lessons. If given the chance, people will abuse their HELOCs, and lenders will extend the credit to people to allow them to do so. Without restrictions on mortgage equity withdrawal, people will spend their houses and lose their homes.
This conclusion is inescapable. The hundreds of properties I have profiled have clearly demonstrated this phenomenon is not isolated. The hundreds of thousands of foreclosures caused by refinancing and HELOC abuse are a testament to the depth and scope of the problem. If we do not change the system, we will see a repeat of this problem.
Some people are spenders, and some are savers. No amount of education is going to change that. Many of the outrageously pretentious spenders obsessed with conspicuous consumption are not going away. As I pointed out in Southern California’s Cultural Pathology, we have many spenders in our midst. These people will spend and spend until their creditors cut them off. Many are dealing with the painful reality of credit contraction right now. If these people were suffering in isolation and not asking for government handouts, I would be inclined to leave the system alone; however, these people are not suffering alone, and they are begging for the government to give them some of my money to support their foolish ways. This is where I draw a line.
Regulating mortgage equity withdrawal would not be a difficult endeavor. The only problem would be the resistance from individuals who want to spend this money and from the lenders who want this business. That will be some significant resistance. It would take something like a million foreclosures and an economic catastrophe similar to the Great Depression caused by this behavior to provide the political will to make this happen. Well… it looks like the political will might be there.
I would ban all forms of cash-out refinancing except for reverse mortgages and home improvement projects with certain restrictions.
There is no good reason for people to increase their mortgages to fuel consumer spending. Anyone who makes this argument because of the economic benefit of mortgage equity withdrawal obviously has not been paying attention to the fallout of The Great Housing Bubble.
Many will argue that cash-out refinancing to fund businesses is a good thing. Tell that to all the failed business owners who are also losing their houses. I believe it is much better to encourage new business start-ups to find capital from other sources. This will prevent a great many dreamers who do not have a viable business plan from doing something stupid that costs them their family home.
I don’t have an opinion about reverse mortgages. I do see where retirees whose home equity is their primary savings would want a method of accessing this savings. Given the power of the AARP, banning reverse mortgages is probably politically untenable. Perhaps we have to wait until the baby boomers get evicted in large numbers due to these loans before they will be reformed.
Anyone who builds their own house has gone to the bank for a construction loan. These loans require the borrower to provide receipts and other proof of construction progress before the bank will release the funds. There is no reason that HELOCs for home improvement cannot be done the same way. This ensures that the money is only loaned for property improvements. I would also limit this to 50% to 75% of the actual cost. Home improvement projects do not add value on a dollar for dollar basis despite the BS you see on HGTV.
Short of an outright ban on mortgage equity withdrawal—which I think is necessary to really solve the problem—I would propose limiting the home mortgage interest deduction to purchase money mortgages plus approved home improvement projects. If people did not get a tax break by adding to their mortgage, they might be much less likely to do so. If they want the HMID on a HELOC, they would need to go through the construction loan process as outlined above. Years ago, Congress eliminated the deduction for interest on credit card debt. When the lending industry created HELOCs and allowed people to consolidate debts, they effectively eliminated the prohibition on deducting credit card interest. Basically, with HELOCs, all interest can be deducted through loan consolidation. This must stop.
As a society, we have created a system that strongly encourages a borrow-and-spend mentality. Saving in all its forms are punished while borrowing is strongly subsidized and encouraged. The credit orgy of the 00s saw this system taken to its ultimate extreme. The result was a vicious credit crunch, a collapse in asset values, and an economic downturn second in severity only to the Great Depression. Obviously, something needs to change. A little paternalism in the mortgage market is one of a number of necessary regulatory reforms, and despite the idealism of my youth, I now support these reforms.
Today’s featured property was purchased in 1991. The owner is losing the home in a short sale. Any ideas how that might have happened?
Stuck inside these four walls, sent inside forever, Never seeing no one nice again like you, Mama you, mama you. If I ever get out of here, Thought of giving it all away To a registered charity. All I need is a pint a day If I ever get out of here.
My passage with the Credit Siren
I want to share with you a personal experience today: my passage with the Credit Siren.
For those who remember their Greek mythology, the Sirens were singing seductresses who with their beautiful songs lured sailors to their deaths by crashing their boats on the rocks. The Siren Song has become a metaphor for pleasure or vice that leads people to their own destruction. On this blog, I write frequently about the Siren Song of HELOCs that caused so many homeowners to crash on the foreclosure rocks.
Any time someone writes about a behavior like that, there is the risk of the message sounding preachy or coming across as if the author is above falling victim to such things. I write about this issue in hopes that others will learn from it and recognize the folly for what it is. It isn’t about morality, a statement of right and wrong; it is about wisdom, recognition of what is prudent and what is foolish. I am certainly not immune to the Siren Song about which I write.
I have not always been wise about how I have managed my own financial affairs. I don’t know if I am even now. One thing I am proud of is the fact that I have no debt. I have been recently reminded about how difficult a discipline staying out of debt really is.
During December, I had too much activity in my savings account, and I began getting “excessive use” fees. Like many people, I was overspending. When I saw what was happening, I didn’t want to get any more of these fees, so I quit using my checking account until the bank cycle for December had past. I used my credit card for almost 10 days.
I felt like I was spending free money.
I went out to eat with family, bought a few presents for my son, and generally had a great time. Neither my checking account nor my savings account changed. It was really cool. It brought up all the old feelings I used to have when I used (and sometimes abused) credit years ago.
When the first of January rolled around, and I was able to get access to my checking and savings accounts without further bank fees, I knew it was time to pay the piper for my 10 days of fiscal irresponsibility. When I paused to reflect on what I did and how I felt while doing it, I was quite astonished to see how easy it was for me to fall back into old habits. I guess it is like being an alcoholic or drug addict. Once you stop, you better not ever start again.
I won’t be doing much in January. I spent all my discretionary income for January in December. I know where the rocks are, and I know how the Credit Sirens lead me there. Fortunately, I am at a stage in my life where I have the self-discipline not to listen to those Sirens and keep the family boat from crashing and sinking. Unfortunately, it means January is going to be quite boring…
While looking around YouTube, I came across this three part lecture series from former UCLA economist Christopher Thornberg now with Beacon Economics. He is one economist who correctly predicted the housing bubble. This series is excellent.
Real Estate Bubbles and California’s Economic Growth, Part 1
Real Estate Bubbles and California’s Economic Growth, Part 2
Real Estate Bubbles and California’s Economic Growth, Part 3
If you like academic reviews of bubbles in general and the housing bubble in particular, here are two more videos for you:
I heard you found a wishing well In the city Console me in my darkest hour (in my darkest hour) And you throw me down
On Wednesday, we looked at the impact of cash buyers in Irvine’s market and asked, Will Zealots and Foreigners Support the Market? Are those with large downpayments smarter than the fools who used 100% financing? Surely someone who put a large downpayment into a transaction must know something more about the market than a no-risk gambler using 100% financing. Well, perhaps not.
Many of the properties I have profiled have been speculators using 100% financing who bought at the peak. These people were not risking any of their own money, so they had little to lose other than their credit score. These people are the first to give up when prices go south because they have the least incentive to continue pouring their own money into the abyss of ongoing debt service.
The people who have their own money in the transaction are a bit more reluctant to give up because they know their money will be gone forever. We first started seeing people who had 5% or even 10% down a few months ago. Today is one of the first I have seen that has put 20% down on a mid to high range property and decided to sell.
Console me in my darkest hour Convince me that the truth is always grey
Personally, I think it is a bright move on this guy’s part. He is getting out now before prices drop further and he either damages his credit or loses even more money. Very few in his circumstances would do the same. I admire his decision.
The closer people get to falling under water, the more they lapse into denial. Most of the market is simply hoping prices come back soon without any realistic chance of this occurring. Denial is paralyzing because it prevents you from taking action. The owner of today’s featured property overcame his denial and is choosing to sell before it gets worse.
In a healthy real estate market, people only take on as much debt as they can afford, and they work to pay it off as quickly as possible. Debt is something to be retired not endlessly serviced.
If you look at the equity curve of real estate, you see that equity is built in 3 major ways:
Speculation.
Inflation.
Debt Retirement.
A truth that everyone is becoming painfully aware of is that speculative equity is not stable. Prices once detached from fundamentals will return to them at some point. The return to fundamentals is either accomplished through actual price declines or a period where prices increase at a rate less than inflation. It is usually the former. Speculative equity cannot be counted on, and it is only captured through careful analysis or blind luck. It is usually the latter.
Inflation equity is really not equity at all. If your house doubles in value in 20 years, but the value of the currency has cut in half, you really haven’t gained anything. On paper you have a gain, but the money you get out has no more buying power than the money you put in, so you really haven’t benefitted as much as you think you have. Inflation equity will preserve your wealth, but it will not add to it.
The real way to make money through long-term ownership of real estate is through obtaining financing equity. You get this by paying off your loan. This method of building wealth, the only one that really works, has been much maligned over the last decade as fantasies of easy money through boundless appreciation gripped the market.
Pay me or go to jail Pay me my money down
The last time we had a healthy, fairly valued market was from 1995-1999. During this period, people did not believe in endless appreciation because prices had been declining since 1991. Buyers realized the only way to make money in real estate was to borrow a small amount and pay it off or pay such a small amount that you could rent the place for positive cashflow. Once prices start going up, people see that they can profit from appreciation, and the slow, steady method of building wealth through retiring debt seems rather quaint and old fashioned.
Once prices start really going up, paying down mortgage debt is an unnecessary financial burden. Why bother paying an extra $500 a month toward your housing debt when the house is going up in value about $5,000 a month? Why not just use interest-only financing and spend that $500? Well, that is such a good idea, the next step is obvious: why not utilize a loan where you don’t even pay the interest and free up that payment money for consumer spending. The Option ARM is born.
But why be satisfied with only falling behind $500 a month on your mortgage when house values are going up $5,000 a month? Why not borrow more? Why not go withdraw the equity in huge lump sums? After all, it is accumulating far faster than it can be spent. If you refinance or open HELOCs periodically, you can extract this free money as soon as it becomes available. Why not?
Do you see how speculative equity is a slow seducer? The foolish and irrational seems completely logical when you look at the changing circumstances.
When a Ponzi Scheme is built on debt, like it was during the Great Housing Bubble, each person in the chain must assume a larger debt than the person who came before them. Since nobody is paying down debt, and since most people are furiously adding to it, the amount of debt buyers needed to take on in order to pay off the debts of the seller becomes very large. There is a point where the debt becomes too large for people to service, and they default on their payments. Once banks stop getting paid back, they stop making loans: a credit crunch.
The challenge for lenders in the wake of a crashing Ponzi Scheme is to rediscover the debt-to-income levels people can support for residential real estate. Historically this number has been around 28%. The challenge for the market is to endure the crash back to pricing levels consistent with stable borrowing levels. We are in that process right now.
During the price decline, market psychology will also change. People will slowly recognize that the personal financing methods they believed were stable during the bubble (interest-only and negative amortization loans at high DTIs) are not stable and should not be used. As long as market participants believe in the fantasy of speculative equity, they will utilize whatever means of financing is available to them to acquire as much real estate as possible. It is the knife-catcher mentality. The slow grind of declining prices will pulverize this faulty thinking over time, but in the interim, people will continue to overpay for real estate to the degree that they can.
Eventually, it will become widely recognized that borrowing a small amount and paying down a mortgage is the only real method of accumulating wealth in real estate. Of course, when this happens, the market is at the bottom, and the whole cycle begins all over again…
Today’s featured property is an example of how people get seduced by the free money of speculative appreciation. They were not bad HELOC abusers: a refinance here, a HELOC there, but over time this habit has more than doubled their mortgage obligations, and now they must sell their home before they fall underwater. Are you ready to assume their debts? Whoever buys this house is going to. They took out the free money and spent it, and now they need to find someone willing to pay off this debt before it becomes a short sale.
All their equity—initial, speculative, and inflation—was wiped out by their method of financing and mortgage management. Seventeen years of ownership, and they have nothing to show for it.
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