Why are people selling for a loss? Nobody wants to lose money when they sell their house. Many of the sellers we have seen to date put no money down, so they were not losing any money, only their credit score. Lately, I have been seeing more and more sellers who have lost some of their own money. So why are they selling? In the crash of the early 90s many people submerged beneath the debt on their homes. They were unable to sell, and the few that had to sell due to job loss, divorce or other circumstances created the foreclosure problems of the early 90s. However, for as bad as the foreclosures were then, we have already quadrupled the previous peak, and the problem is only getting worse.
I suppose the easy answer to why people are selling is that the owners cannot afford the payments. Many probably still believe real estate is a great investment and all the other kool aid nonsense they believed when they bought the property. Unfortunately, they were unable to hang on long enough to enjoy the benefits of their great purchase. The ones who have capitulated already are the lucky ones in many ways. The disaster is over for them. Now they can go back to living within their means in a rental, and the crushing debt service payments are a distant memory. The owners who have not capitulated yet, the ones who have the means to hang on longer, they are the ones for whom this price collapse will be a major disaster.
Bear markets are self fueling. Once a price decline gains momentum, the "weak hands" are shaken out, and as they are, they sell and drive prices even lower. This puts a new series of owners in distress and creates a downward spiral. The only thing that stops a bear market like this one is capitulation among owners who give up waiting for prices to come back to breakeven, or a new influx of buyers.
Larger numbers of buyers will not enter the market until prices are affordable. This isn't because it is financially prudent or because people started reading this blog. Once a vicious price decline gets underway, the tightening of credit prevents many buyers from committing financial suicide. Whereas lenders were willing to give anyone $600,000 a few years ago, now they are only willing to give $300,000 to a select few with good jobs and solid credit ratings. The realtor spin about "pent up demand" is complete bull$hit. There is probably a lot of pent up desire for housing, but demand is measured in dollars, and there is a major lack of demand with the absence of lender funds, and a large and growing "pent up supply" of REOs.
I have mentioned a number of times that I believe this fall and winter will see another major leg down in the market. The economic recession will be in full swing. When times are tough and jobs are uncertain, it is not a time when people commit to large purchases like houses. Also, it is becoming increasingly obvious there is strong downward momentum in prices. This is prompting many to put off purchases because prices will be lower later. As the foreclosure problem worsens and more and more loans begin resetting to higher payments, supply will continue to enter the market.
Usually there is a strong seasonal component to inventory. This year we did not get a big inventory spike in the summer. Perhaps it is our "inverted year" and we will see ballooning inventories this fall and winter. There are many REOs that are not listed yet, and these will hit the market eventually. The lenders would have been better served selling them this summer when there was some volume. Now many of these will hit in the fall and winter when few buyers are around. Since this is must-sell inventory, it will push prices lower.
There are many ways people lose their houses. Borrowing two and one-half times what you paid for it is one method unique to the Great Housing Bubble. Perhaps I am just naive, or perhaps it is because I had never lived in a bubble market prior to moving to California, buy I had never heard of mortgage equity withdrawal for anything other than necessary home repairs and improvements. The whole idea that one could or would add to a mortgage to pay off other debts, buy consumer goods, take vacations or supplement one's lifestyle is an alien concept. In fact, I did not realize how common this behavior was until I started studying what went on during the bubble. I am still astonished every time I see a property like today's.
Last Friday, I wrote a post titled Downpayments Are Back. After taking the weekend to contemplate what this really means for homeowners who are thinking about walking away from their obligations, I have changed my mind on what I believe they should do. If they can manage their payments, they should consider trying to hold on, even if the house value has dropped well below their purchase price. There are still a great many overextended homeowners and speculators who cannot possibly manage their payments, and trying to hold on until the market comes back is a foolish waste of time and resources. The market is not going to come back before they go under. However, for those who can make the payments, there emotional benefit of home ownership may be worth the financial hardship it entails. When downpayment requirements were eliminated during the bubble rally. Many people who are not in the habit of saving were suddenly able to purchase a home -- albeit at a greatly inflated price. For people who do not have the habit of saving money, they will never come up with even a 3% downpayment to obtain an FHA loan much less a 20% downpayment like everyone else will need. The house they are in right now may be the only house they ever own in their lifetime. If they bail out, the new (and permanent) downpayment requirements will probably ensure they never own again. Under these circumstances, even if they are upside-down on their mortgage, and even if it might make more sense financially to go back to renting, there is a strong emotional desire to own a home, and this may be their only chance to satisfy this emotion. Many of our decisions in life are not based purely on a basis of economics. Having children is not a great economic decision, but the love of family makes the economic sacrifices worthwhile. If satisfying the emotional desire to own a house is worth the sacrifice in terms of elevated household expenses, perhaps it is the proper decision for those owners on the margin to stay put. It is not the right financial decision, but perhaps it is the right life choice.
I have another piece of advice for the homeowners who are facing an exploding Option ARM that will not save them from foreclosure, but it may provide a way for them to reenter the housing market at some future date. Freddie Mac recently changed their servicer guidelines and eliminated compensation to servicers who foreclose quickly. The effect of this change in incentives will be a longer foreclosure process once people stop making payments. This is where the advice comes in. When owners with an Option ARM face their loan recast, there is little hope of affording the payment, so they should not try. What they should do is immediately start saving the amount of the payment they used to make on their mortgage. If the foreclosure process drags out a year or more, they could easily save the 3% necessary for a downpayment on an FHA loan. They may have to wait a while for their FICO scores to improve to qualify for the FHA loan, but when they do, they will already have saved their downpayment. Will many people do this? Probably not. Many people will simply spend the money they should be saving and be no better off for not having a housing payment for an extended period of time, but for those that do, they have the opportunity to save and prepare for home ownership again.
So what do you think? Should they stay, or should they walk?
Today's featured property is a short sale. It is owned by a speculator who already got what he could out of the property, and now he is walking away.
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.
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.
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...
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...
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Why are people selling for a loss? Nobody wants to lose money when they sell their house. Many of the sellers we have seen to date put no money down, so they were not losing any money, only their credit score. Lately, I have been seeing more and more sellers who have lost some of their own money. So why are they selling? In the crash of the early 90s many people submerged beneath the debt on their homes. They were unable to sell, and the few that had to sell due to job loss, divorce or other circumstances created the foreclosure problems of the early 90s. However, for as bad as the foreclosures were then, we have already quadrupled the previous peak, and the problem is only getting worse.
