Thank you so much for explaining this I found this very helpful and interesting and can see that there will be more people in loan trouble to come.
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Great song.  I grew up canning garden food with my grandmother, picking wild berries, and laying out sewing patterns.  I am now 40 and these are still very sweet memories.  I can’t purchase a $200,000 home, let alone fathom a $200,000 CHANGE in price of the same house.  Poor is a state of mind, but my heart still goes out to those who chases their dreams beyond their means and understanding of finances.  I guess they were students of Def Leppard who taught it was better to burn out than fade away...they just forgot to tell ya sometimes the candle is taller than it looks.

IR:

Another well written piece today. I will make sure my kids read this.

Thanks.

Excellent post.

It is clear the neg-am folks are headed for default. 

The future of the interest only home owner is totally based on how much speculative equity they pulled out.  Someone who has an interest only loan and received normal pay raises should be able to make it work.... assuming they did not HELOC speculative equity. 

You make a great point on the impossible nature of “trading up” with an interest only loan.

I’m sure most interest only buyers in the bubble were sold on “trading up” to more expensive homes.  When you consider the fees of selling, clearly this is impossible.... unless you are moving to another state, or can sustain pay increases considerably greater than inflation.

Why is the inventory chart you posted down so much?  Inventory pulled from sale?  Seasonality?  Surely it’s not that stuff has been sold?

Inventory here always displays a strong seasonal pattern. Rather than look at month to month changes, it is more revealing to look at the same month one year ago. By this measure inventories have been climbing, mostly due to a lack of sales volume. Also, there is a stealth inventory of sellers who have given up but who would relist if there were buying interest.

From the video: “We don’t want to do that to our credit. Why can’t the mortgage company work with us?”

Nothing like irrational entitlement, all the way to the bitter end.

No question irrational entitlement… that’s an awesome video summarizing the future of the OC housing market.

However, the mortgage company should try to extract as much money from these people as possible.

If they can keep these people paying a high interest rate on a higher principal than the liquidation price the bank will do it...... this includes reducing their original principal amount.

The bank does not care about them, or the more qualified people waiting to buy at a liquidation price...... all the bank cares about is minimizing losses.

I think your “negative equity” portion of the graph is too small.  In many cases that loan balance curve NEVER decreases, because the homedebtor cannot afford to reduce the principal.

Very good post, I enjoyed reading it.

That video is amazing. It summarizes exactly how the greed and financial ignorance of the average American kool-aid drinker helped price out high-income working professionals from the RE market.

They took a chance, fully knowing the risks involved, and then blame the lender when they get under water? Amazing!!

Great post and explanation of equity!

I get daily emails from Movoto and today there were 10! houses that had a price reduction and 5 new on market in the 400k to 600k range. One of the new on market ones “stated foreclosure, corporate owned” and one said to “bring the bank an offer today”

Mav- But at what cost to extract that additional money? You are correct that the bank cares only about minimizing losses. Don’t we all? The bank has shareholders to look out for.

Why is it that my family should take a hit because some people make bad financial decisions? In this 60 Minutes interview, they say they can afford the payments. So why did they not buy a 30 year fixed? We have a 30 year fixed on our property, invested in 401K as well as a separate stock account. Those accounts are now tanking thanks IMHO to people who bought into the bubble theory that housing only goes up.

So I want these people to lose their homes. I want home prices to drop to 2001 levels. Then I can leap into a larger home while holding onto my current home to rent out.

Once again, I can not help but be impressed by the Housing analysis that IrvineRenter puts forth on this web site.
It is difficult to argue with the clarity and effort and research that has gone into your housing analysis views (unless of course, you are one of those “unfortunate ones” who bought at the peak and now you are abbout to lose the shirts off your back)

You and Bill Fleckenstein predicted this housing meltdown roughly 2 years ago (could be wrong on the time) and at that time I read both analysis and decided to sell my apartment units in San Bernardino to the city of San Bernardino. The city thought they were cheating me, based on the purchase price they offered (yep with the threat of a “eminent domain gun” to my head ) and I took the deal albeit relutantly at first, then when I visited this website for more info about what was going to happen in the housing market, I was so happy the city came forth to buy my units. Now house prices in that area of town (next to the airport) have fallen by about 35% in 2 years! The house I sold to the city at $560k (after making a profit of $50k) is now worth about $450k and it is still falling like a stone due to REOs.

NJ RE Report blog runs a spread sheet on Original List Price, List Price, Sold Price nad Days on Market. I found it revealing:

http://njrereport.com/index.php/2008/02/03/lowball-january-2008/#comments

>>
Ann Says:
February 3rd, 2008 at 1:54 pm
So out of 1537 sold properties on the Excel sheet, only 44 sold for more than 15% off of list.

That goes perfectly with my theory that making offers of more than 15% off of list are pretty much a waste of a buyer’s time. Not that people shouldn’t try if they have time to waste, but don’t be surprised if your offer doesn’t get accepted.

If we raise that threshold to 10% of off list, only 132 properties fit that criteria, which is less then 10% of those properties sold.

The numbers off of original list are more impressive. I would say that the fact remains, sellers must get to reality themselves, you the buyer have a slim chance of getting them there via a “lowball” offer.

Love the video.  But for all those who blame the borrower, please consider this fact.  The LENDER knew, at the time they made the loan, there was some probability of default.  Therefore, the LENDER charged an interest rate that the lender, in it’s good judgement, covered that risk of default and provided an adequate return on capital.

The LENDER knew the law regarding non-recourse home financing.  In effect, the additional amount BORROWERS pay over the “risk free rate” is a “put option” to send the home back to the LENDER on a non-recourse basis.  Well, the BORROWERS are exercising that “put option.” And why not?  They paid for the option by paying more than the “risk free” interest rate.  And if they paid for it, they have a right to use it.  Sorry Mr. LENDER, you sold a put option, collected the premium for that put option, and now it got exercised.  Don’t whine or cry.  You sold the option and the BORROWER exercised it.  Tough it out and don’t make the same mistake again!

I don’t understand why they haven’t stopped making payments already. They’ve made their decision, so why continue making payments at all? What are they waiting for?

I’m not recommending this path. I think they haven’t thought this through or they’re grandstanding.

I agree that the moral hazard impact has some cost associated with it… however I wonder if the banks will consider this moral hazard cost or just consider short term financial results.  I would suspect the latter.

http://calculatedrisk.blogspot.com/2008/01/options-theory-and-mortgage-pricing.html

Calculated Risk did a post on FDIC Chair Sheila Bair’s speech concerning principal reduction.

http://calculatedrisk.blogspot.com/2008/02/bair-on-principal-reduction.html

I have a hard time seeing this idea coming to pass. How would you determine who qualifies, and isn’t this rewarding those who were irresponsible? Plus, Tanta mentions a host of other problems…

Do you really believe that lenders don’t consider, or price into their rates, the probabilty that at least some borrowers will “exercise” their option to dump the property back on the lender even if they can afford to pay (ie, the “ruthless borrower").  And if the lender failed to price that risk accordingly, who is to blame for their failure to do so?

Yes.

The CEO of Wells Fargo and Wachovia have come out on conference calls and stated that they are basically stunned at th amount of voluntary defaults.  You are correct, that they should not be surprised.

Rates and closing costs are dependent on the “5 C’s” character, capacity, capital, collateral, and conditions.  Unfortunately, collateral became the single most important factor.  The sky was the limit when it came to home equity. 

When calculating the borrower’s chances of default, never is the borrower’s voluntary decision to walk away considered.  It is assumed that the homeowner wants to remain in the home, but just cannot afford the payment.

Because if they fall behind, they will eliminate the possibility of qualifying for rate reduction programs. Right now it appears that they can’t refinance to lower interest rate because of LTV issues, not because of credit issues.

They should but they haven’t been in the last 5 years or so and haven’t been much for the last 10 years.

That’s a great post....  there are definitely immediate cost associated with completing the financial analysis on which borrowers qualify for a re-work.

At the end of the day I’m not sure it really matters.  The root cause of price drops is access to loans on the buying side.  I think the supply side mostly impacts the velocity of price drops..... the fate of price drops is sealed either way.

“...completing the financial analysis on which borrowers qualify for a re-work.”

“Re-completing” is more accurate.  Doing the work that should have been done in the first place, like finding out how much a person can truly afford.

I imagine this process is to be subsidized by the tax payers.  Rather, they need to trace back the middle men who did the half-assed job in the first place and make them pay for it out of their ill-gotten commissions.

“...but my heart still goes out to those who chases their dreams beyond their means and understanding of finances.”

I can think of many other people who are more worthy of my sympathy.

“sellers must get to reality themselves”

It’s a little like trench warfare right now.  Sellers are in one trench, Buyers are in the other, and neither wants wants to run out into no man’s land to meet the other.

I like the analogy. I’ll throw in that the sellers have just had mustard gas tossed into their trench.

Couple of escrows and couple of closes (many thanks Zovall, wish I had access to MLS!) to report:

http://www.ipoplaya.com/

Hey IR, I just noticed your Irvine inventory link.  Has that been up for a while?  Little smaller numbers than homeseekers.com shows, but was curious what you thought about the overall inventory figure.  It appears we have only around 10% more inventory today on a year-over-year basis.  Do you expect our Irvine inventory to climb rapidly over the coming months?  Do you see 1400-1500 units in Irvine on the market by this summer?

:mrgreen:  also a skunk is running wild letting out gas in between sellers.  how long before they cant take it any more

Over the weekend I happened across the office of a small Escrow Agent. The office is next to ToGos at the corner of Walnut and Culver. There was posted to the door a “Notice to Quit”, which made me smile. Guess it isn’t just the homeowners who are facing foreclosure.

iPoop…

I’m going to have to switch to Manhattan Beach Confidential.  Instead of reading of every new escrow entrant like it’s a major event, over in Manhattan Beach you get to read that bargin hunter Britney Spears just scored a gated estate in Hermosa for a cool $6mil, 2.5mil off the offering price!  Maybe she’s not as dumb as she looks (NOT!)

Zovall added the inventory graph a short time ago. I didn’t notice it myself until last week. Perhaps he can comment more on it.

Inventory numbers are always difficult to guess at in a declining market because there is a great deal of stealth inventory of potential sellers who gave up last year and decided to wait out the “correction.” (Bad decision, IMO) If we get a spring bounce from the lower interest rates, I predict these sellers will come out in large numbers to try to cash out. I see the potential for an inventory explosion if that happens. Also, the acceleration of REOs is going to add more inventory, and it is this inventory that will crush pricing.

Sellars will be in denial until their agent brings enough comps to the table to convince them that their desired prices are just wishing prices and the market has passed them by.  Or when independent appraisers value their houses less than the sellars wishing price.  We are still so early in the down cycle that there aren’t enough comps so that prices will stay all over the map and sellars will continue to hold out for their wishing prices.

This means that the sales other than those of the most motivated buyers, the few knife catchers (e.g. iPoop) will be determined by the most motivated sellars..  banks and people who must move no matter what the cost.

The next 6 months should really show some acceleration in downside in prices as seasonal inventory rises against the backdrop of the compressed buyer pool.  We are still at low inventory season, inventory could double by June.

It’s really months of inventory that matter. So you need both inventory and sales volume.

Fantastic breakdown. This is a conceptual framework that allows people to break down future equity (something very few can understand) into pieces that are generally either wild speculation (speculative equity) of fairly predictable (everything else). This is the second time I’ve seen a post by you that I think should be required reading of anybody considering buying a house.

The inventory count on the main page is pulled from ZipRealty.  Not sure why it would be different than what you are getting from Home Seekers but the trend should be the same.

Ignoring the video or the testimony of any other homeowner I want ask a question here that I’ve asked before here, and other places, and have never gotten a really good answer to.

To wit, why is moral for a corporation to declare bankruptcy and yet immoral for an individual to do so?  And more to the point of this topic, why is it moral, ethical and principled (in fact, I’ve heard many people advocate that is a corporation’s responsibility to do what it needs to do to survive and profit) for a corporation to “re-organize” or re-negotiate contracts or outright default on contracts when it is considered immoral for an individual to do this?

And to be perfectly clear, I’m not making a case for anything, I’m asking a question based on something I’ve observed and want to know what other people think.

So let me see if I read this right:

http://www.dqnews.com/ZIPOCR.shtm

In December there were 179 sales across all Irvine zip codes.  At the beginning of December, and also now, there were approximately 1000 homes for sale in Irvine. 

Isn’t that less than six months of inventory on the market in the city?  If so, I sure hope the January sales figures are down in the low 100’s or lots of homes hit the market soon without corresponding buying activity…

IMO

Morals spawn from the belief that there is a higher power out there watching over us.  Morals separate us from every other species on this planet.  If you are an atheist, I would challenge you to defend the evolutionary development of your morals.

This statement is predicated on the fact that some people have morals and some don’t.  The ones who have morals will see vast differences in them.  I do not believe that we can judge people by comparing their actions to our own unique, moral standard.  Why?  Either you believe in some sort of god/deity and the decision to cast blame/judgement lies with him or her, or, you do not believe in any diety and therefore the actions of others are not subject to any ultimate judgement.

My opinion is these borrowers are ignorant, stupid, and irresponsible.  Since I cannot hold them accountable I must rely on the law.  As far as I can tell, there is no law broken here, just my own law of stupidity.

The argument of BK vs personal BK is different because the corporation or business is not seen as an individual with a sole.  It does not have a face.  I personally do not think there should be any difference between the two.  Both exemplify failures to make good on promises.  That doesn’t make them evil.  Possibly stupid, but not evil.

I took the liberty of going back through IR’s postings re: monthly sales figures, combined that with Zovall’s handy inventory chart, and did a little graph:

http://www.ipoplaya.com/inventory.htm

December sales appear to be very strong compared to trend, as a matter of fact, the largest sales volume month since August. 

Any thoughts on how or why this occurred?  Was it new homes that had been contracted for long ago that finally sold?  A little dead cat bounce?  Any bold predictions from anyone on where this number during Q1?

Holy f*cking sh*t! The couple in the video just kill me! Hello!! You’re making the biggest purchase in your lifetime and you can’t even put in the due diligence you owe yourself to go out and research the issue and educate yourself on all the facets? These people deserve to be shot for their stupidity and arrogance.

I totally agree with IR that if you can’t afford the 30-year fixed, conventional amortizing loan with a reasonable DTI, then you can’t afford what you’re looking at. Sorry, but you’re just gonna have to buy a less expensive place. If that pokes the pride, then too f*cking bad.

I just wanna shake that woman till hear head pops off. It is so mind-blowing to hear people say such poo.

The speaker in the video says that the couple ‘knew what they were doing.’ Yeah right!! We’ll just get a stoopid I/O or an ARM and then refinance later. WTF is the point in that? ‘Real estate only goes up’ So what? Does that change your ability to pay or what you still owe on the property? I would just loooooooooooooooooooooooooooove to audit somebody like this.

“This appreciation is caused by wage inflation translating into higher housing payments and the ability of borrowers to obtain larger loan amounts to bid up prices.”

Its funny how the “allowances” for purchasing a home (such as writing off the interest payments from taxes and being able to use 401K contributions towards purchase of a primary residence) get dressed-up as “helping” people get into a home when really it bids up the prices. 

The higher prices mean more money for the NAR which means more money for the lobbyists to pay the politicians to pass more legislation which “helps people buy homes.”

An ongoing Ponzi scheme conducted by the NAR and politicians against the entry-level buyers.

Amazing what some people do for a living…

Because the rich don’t own stock in people, they own stock in public corporations.

OT, media about homeowner rights vs HOA’s: The right to line-dry laundry. I’m so glad I don’t live in an association… You have to pay dues AND get hassled?

http://www.courant.com/news/opinion/editorials/hc-righttodry.artfeb04,0,4533963.story

P.S. Hey you hippies, I started composting. The city gives away free containers to keep your food scraps in, and they take it away once a week. I didn’t do this for years because I felt it was gross and unsanitary. So far, it’s going OK. I didn’t realize you can compost used napkins and coffee grounds.

Ever heard of the term “God snob?”

Tacos?

Each and every post is really amazing. Great!!

RK
http://www.rentalandrealestate.com

totally wrong.  Houses only go up, so no matter what you pay it’s better than renting.  renting is just throwing your money out the window and making the owner rich.  Everyone knows that home equity is the biggest part of American wealth so if you don’t have any you are poor and missing out.  Land is finite and people are infinite. 

See, my arguments make much more sense, don’t they.  No boring , complicated graphs, minimal logic, no numbers.  And no anxiety.  Dude, you are so getting a McMansion.

And, while I being childish on this blog, the national debt doesn’t matter because we owe it to ourselves.  I have already forgiven myself and wrote the IRS to tell them; that way they lower my taxes since I don’t have to pay myself back my own debt.

God, the USA is the best America in the World!

Where has it ever been said that it is “moral” for a corporation (an amoral entity, btw) to declare bankruptcy?  I think this is a strawman.

Thank you so much for your great article. You invested great amount of knowledge and should be appreciated.
Just a side opinion on the Option ARMs. Yes, it seems that the only ones that would not default on them were flippers that actually used these products short term (2 years max) and were able to sell the properties before the great housing decline in 2007. Right now, Feb 2008, if you have an Option ARM, you have 100% chance of default. The only options are: if you’re lucky have a short sell, if not foreclosure. Guaranteed!

Thank you
Laker.

Does anybody have that womans phone number? Body language tells me there’s more than a financial breach coming.

Comment by lendingmaestro

Good Lord, Mr. Lendingmaestro, that was the most cogent and universal explication of morality, ever! Are you by chance looking for a disciple to hang on your every utterance, and preserve for a grateful posterity your every thought? Cause I am so ready to take that job. Oh, I’m not worthy, but perhaps I could prove myself in time, sir.

My dear lendingmaestro:

I have always relied on the Atkins diety. Lost a ton of weight on it.

It’s clearly moral for a company to declare bankruptcy, as it is for people to do the same.  We don’t have debtor’s prisons anymore, because indentured servitude did more harm than good.  There has to be a mechanism for people to clear the decks and get on with life, with shared losses across debtors and creditors to reduce moral hazard.

That said, bankruptcy in a business context is a decision that has no analogue in the personal sense.  A bank that loans money to a business explicitly takes on the risk that the business can’t pay it back, and will seize the business if the loan defaults.  In a “pure” bankruptcy model, what many call “British bankruptcy,” the shareholders troop into court, tell the judge, “can’t pay,” the judge looks at the bondholders and says, “Okay, the firm is yours,” and everyone goes for a beer.

This is called Chapter 7 in America, I believe.  You can think of it as analogous to the restaurant business: by the third or fourth time that a particular restaurant location has gone bankrupt, the leasehold is finally amortized and the newest owner can now make a go of it.

Workouts and such exist in many countries primarily to give managment another chance, allow lawyers to collect more fees, get the government involved (especially if there’s a public interest such as pension funds).  But business bankruptcy is a fundamentally different animal than personal bankruptcy.

The reason that personal bankruptcy has no similar context is because of credit implications.  There is no way for a person to recapitalize himself after suffering a huge loss.  The only option is to clear the decks, and slowly recover.  Plus, the stain sits on your record for years.

For people, there is no such thing as debt in the corporate sense: a person is fully equity financed because all loans are recourse to your credit history.  All debt is bad for people, some debt is good for corporations.  If you must take on debt as an individual, say, to buy a house, prudent financial planning requires eliminating it as soon as possible.  I don’t see this as a character issue, just common sense.

Maybe we will get back to that someday.

I bought a townhome in 1990 when I was just starting out in my professional career - never used it as an ATM; never took $$ out of my HELOC (BTW, B of A gave me the HELOC w/out any proof of income, etc. about 3 years ago & solicited me to take it); just lived in it for 16 years and only re-fi’d the interest rates to a lower rate.  Didn’t live above my means; never went into cc debt—bought things when I could pay cash outright, or pay them off within 2 billing cycles.  Enrolled in the equity accelerator program, and was close to getting the loan paid off.  I just sold it at the end of 2007 - at a reduced price (original list was 539K), and walked away with over 300K in cash.  The nice young couple who purchased the property did an interest only loan, and borrowed 417K.  I understand from your analysis that they’ll probably never be able to move up—and will probably be stuck in an aging Mediterrean pink condo, in an aging community which isn’t faring well, b/c HOA board members governing this community leave much to be desired in terms of business acumen, vision and foresight (in fact, they’re outright morons).  Now I’m renting in a newer, ‘luxury’ community; all of the proceeds $$ from the sale is parked in a 5.1% CD & am waiting for sellers in the Turtle Ridge/Newport Coast area to get a clue.  Housing units I looked at about a year ago - to purchase - are either pretty much headed towards REOs, or are now on the rental market.  IMO, the price my buyers paid was still totally inflated, even though the sales price was still substantially less than original list.  My former community is not aging well, and decay was setting in; water pipes bursting & slab leaks, etc.  It will only get worse in terms of neglect and decay - and the HOA will have a hard time with maintenance, unless they dramatically raise monthly fees. My sale was a definite comp killer, and foreclosures were beginning to pop up even as I was in escrow.  I expect the next round of sales to be somewhere in the low - mid 300s, maybe even in the 200s.  Amazing stuff.  Readers should also go to www.patrick.net and housingpanic.com + Mish’s blog (EXCELLENT economic lessons & comments by financial pros), for much more detail and insight.