Affordability Mortgage Products Make Prices Unaffordable
I Want It All -- Queen
We all want affordable housing. There are numerous government programs designed to provide low-cost rental and ownership properties to people in all walks of life. Lenders, builders, realtors and buyers all benefit from affordable housing because affordability means an increase in transaction volumes and more money into the pockets of those dependant on the real estate market. The difficult problem with affordable housing is how to provide it without making it unaffordable. Finance is not the answer.
Most of those who worked in the mortgage business really believed the "financial innovation" meme. I have contended that the entire idea is a fallacy. At its core, the belief among financiers is that affordability products reach more customers and permit home ownership for a larger number of people. The statistics during the Great Housing Bubble seem to warrant this enthusiasm.
Home Ownership Rates from 1984-2005
Unfortunately, increasing the home ownership rate also dramatically increased prices and created an unsustainable bubble in both. Why is that? As with all macroeconomic concepts, it emerges from the microeconomic circumstances of individual borrowers and buyers. If you look back to the lending practices which endured the crash of the last housing bubble in the late 80s, you see that the financing arena was dominated by 30-year conventionally amortizing loans with 20% downpayments and conservative debt-to-income ratios. This is the only loan program that has relatively low default rates even if prices decline. So what happens when a new "affordability" product is introduced into this stable system?
Let's look at an example. Assume our would-be buyer makes $100,000 a year and could qualify for a $300,000 loan using conventional financing. He has save $100,000 for a downpayment and costs. He is looking to buy a $375,000 home. In our stable system, he would find a home relative to his income. If he is making the median income, then he would be able to afford a median priced home. Now let's say that lenders "innovate" and start offering interest-only loans with a 10-year fixed term followed by an interest rate reset and a recast to a fully amortized loan on the remaining 20-year schedule (sound familiar?) Our buyer is conservative and does not want to purchase on these risky terms and take the risk on future interest rates or the need to refinance later because he may not be able to afford the higher payment in 10 years. However, other potential buyers will ignore these risks and embrace the new financial innovation because it allows them to buy a house they previously could not afford. The same payment on an interest-only schedule now finances 15% more money, so other potential buyers in the marketplace who are making $100,000 can now finance around $345,000 instead of $300,000. When our conservative buyer goes out in the open market to bid on properties, he now finds himself being consistently outbid on properties. At this point, he has a choice to make: either embrace the new financial innovation and bid 15% higher for the same property, accept a lower quality property, or not buy a home. The affordability product did not make houses more affordable, it made them less so.
Our stable system without affordability products saw annual appreciation of around 4% because this is how much incomes and rents were rising (this was true for most national markets outside of California,) and it reflects the amount of increased borrowing power available to homebuyers each year. With appreciation only running at 4%, market participants do not get excited about making millions in real estate, nor are they worried about buying today because they may get priced out tomorrow. Affordability products change all that. With the introduction of interest-only borrowing to the system, prices can very quickly appreciate 15% as the financing system seeks a new equilibrium dominated by the new affordability product. This sudden and dramatic rise in appreciation can be the precipitating factor that ignites a housing price bubble. Once people start drinking the appreciation kool aid, they begin to stretch their debt to income ratios to buy properties with the belief that the extra investment will be recouped by rising home values. Plus the fear of being priced out compels people to buy for fear of not being able to later. The value of real estate detaches from its fundamental value, and the perception of value is driven by appreciation alone.
Behavioral Finance Theory
The bubble of the late 80s became dominated by interest only products, and buyers began using DTIs well in excess of the normal 28% limit. However, that bubble rally was of much shorter duration and of much lower volume toward the peak, so the majority of owners still had conventional financing. Mortgage equity withdrawal was much less common, so not as many households were overextended. The result was a period of moderate foreclosure activity and slowly declining prices until affordability returned based on conventional financing products.
Debt-To-Income Ratio 1986-2006
What really sets the Great Housing Bubble apart was the "innovation" which took off in late 2003: the Option ARM. As you can see in the table above, the Option ARM, or negative amortization loan, allowed borrowers to finance twice amount a conventional mortgage would provide. Hence, prices were bid up to twice the price level sustainable with conventional mortgage financing -- a price level to which the market is in the process of returning.
In short, affordability products did not make prices more affordable, they inflated a massive housing bubble.
This fact is important because if the truth of affordability products is not recognized for what it is -- a series of unstable loan programs that inflate house prices -- these products may return to ravage our housing market again. Affordability products do not help buyers get into homes, they prevent buyers from getting into homes under terms which are sustainable. Temporary home ownership is renting. Affordability products simply allow people to rent from a lender. Perhaps some may sustain home ownership, but unless they were one of the first to embrace affordability products, and unless they refinanced later into a conventional mortgage, they will ultimately lose their illusion of home ownership and go back to renting from a landlord rather than the lender. What good came from all of that?
Will lenders learn the right lessons from The Great Housing Bubble? I doubt it...
.
Adventure seeker on an empty street
Just an alley creeper light on his feet
A young fighter screaming with no time for doubt
With the pain and anger cant see a way out
It aint much Im asking I heard him say
Gotta find me a future move out of my way
I want it all I want it all I want it all and I want it now
I want it all I want it all I want it all and I want it now
Listen all you people come gather round
I gotta get me a game plan gotta shake you to the ground
Just give me what I know is mine
People do you hear me just give me the sign
It aint much Im asking if you want the truth
Heres to the future for the dreams of youth
I want it all (give it all) I want it all I want it all and I want
It now
I want it all (yes I want it all) I want it all (hey)
I want it all and I want it now
Im a man with a one track mind
So much to do in one life time (people do you hear me)
Not a man for compromise and wheres and whys and living
Lies
So Im living it all (yes Im living it all)
And Im giving it all (and Im giving it all)
Yeah yeah
Yeah yeah yeah yeah
I want it all all all all
It aint much Im asking if you want the truth
Heres to the future
Hear the cry of youth (hear the cry hear the cry of youth)
I want it all I want it all I want it all and I want it now
I want it all (yeah yeah yeah) I want it all I want it all and i
Want it now
I Want It All -- Queen
IR:
Excellent comment on the fallacy of the creative financing schemes.
Worse yet, when the system is crewed up, we allow the politicians to cover up with various bail out plans that sow the seeds for future problems.
I wonder if you would explore what these future impacts and problems might be?
Complete utter destruction of the the middle class.
It’s like a hook and line scenario. The mor epeople who get “caught” in these schemes, the larger the lower income class grows.
2 class social system. Lords, and serfs, have’s and have not’s, richer rich, and mass poor….
Until we have indentured servitude, and debtor’s prisons again.
Democrats, and many Republicans, try to solve A’s problems by taking from B. B is harmed in the process and most often A is not benefited. In fact, A is harmed in many instances of government intervention. If you pay young poor women to have children, guess what? They’re going to have more children.
Strawman: “If you pay young poor women to have children, guess what? They’re going to have more children.“
Now, argue in reality and we can have a discussion. If you point was to merely add in the law of unintended consequences I agree with you completely. But in the end, your example seemed to feeding some other dialogue.
And please, no “welfare queens”. There’s no doubt that the real welfare queens of this country are entities such as GM who collect the lion’s share of government largesse.
Fair enough - Here’s a more relative example. Irvine, Tustin, & other cities have affordable housing programs where lower income families may purchase new housing at discounted rates. Well then, aren’t the other families buying in these new developments going to pay more for their homes (every affordable housing home set-aside removes a home from supply)?
No - “affordable housing” set-aside homes are not what most home buyers are looking for (too small, too ugly, wrong neighborhood, etc).
You’re looking at the wrong boogeyman. What drove up prices was not government set-asides, but lending to people who had no business having a mortgage. We’ve had government set-asides for decades and it didn’t do much to housing prices. The flood of newly-qualified buyers - people who would never have been able to buy a home without the impetus of having received irresponsibly loaned money - those are the folks that drove prices up.
My intent was not to place blame. It was to highlight how government intervention always adversely affects someone while rarely trully benefiting those claimed to have benefited.
“government intervention always adversely affects someone while rarely trully benefiting those claimed to have benefited”
It’s not the spelling of truly that’s gonna take down your illogical misperspective; it’s the qualifier of “always:
Then the non-response to Katrina was the best thing for the poor folk of New Orleans, huh?
K-Lo writes using the same illogic over at the corner.
Yes. I’m sorry. Completely discount everything I write due to a spelling error in a blog…
Focus on that… forget everything else. Thanks.
I know you are thinking that the 4% increase sounds conservative, but I could show you places in Florida that were pretty stagnant until 1998 or so.
one small quibble with an otherwise excellent (as usual) post:
The affordability product did not make houses more affordable, it made them less so <i> for responsible buyers who are most likely to be able to carry a mortgage, and more so for buyers who are most likely to be unable to carry a mortgage.
In other words, ‘creative’ financing tended to flush responsible would-be buyers out of the system, replacing them with buyers who were more likely to default.
whocoodanode?
“In other words, ‘creative’ financing tended to flush responsible would-be buyers out of the system, replacing them with buyers who were more likely to default. “
Yes, that is exactly what happens.
That was the plan. And it worked great!
Now it’s cleaning time.
How is a buyer that is putting 100k into the property likely to default because of an interest-only product? His or her payment will not change (except to go lower if principal is paid) for 10 years. The buyer who chose interest-only and 10%-15% or 20% equity 2nd is the one defaulting and the lenders that offered this risky 2nd financing are the ones losing the most. Your example B might have a rate of 5% on his $345,000 (10 year rates up through 2006) for a payment of $1,437 for his $445,000 purchase. He or she is not going anywhere…..
I do believe that the point was the since you’ve introduced more buyers into the market, this drives prices up.
So you have a market of people who can afford thier payments, but who now have to bid even higher to get a desirable home, and people who under strict fundamental lending practices should never have been approved for a loan out bidding the responsible buyer.
Are you saying that a buyer with 100k down payment is irresponsible because of an 10 year I/O. That is ridiculous. What about the seller? Do they not deserve to get the most money for their product? It’s Economics 101 - Supply and Demand.
Interest only products are inherently risky. People who use them take on the risk of higher interest rates, and they have to deal with a higher payment when the loan amortizes. Therefore, they are also betting on either a positive refinancing environment or a substantially higher income. A 10 year term simply pushes the realities of these risks far enough off into the future that people can be in denial about them.
I think that IR is right about the interest-only (or, even worse, neg am) loans. But, I’m not sure that this post, in isolation, hits the nail on the head.
Rather, interest only and neg am loans are attractive and do push up prices, but that effect is exacerbated by low interest rates. Interest only when interest is 10% is much different than interest only at 5%. Also, the “innovative” products combined with low rates fueled the bubble…which then encouraged tons of HELOC abuse by people thinking they had become paper millionaires. (and the best flavor of HELOC abuse Kool Aid is Low Interest Rate).
The addition of 4% of people into the housing market DOES have an impact. A 4% increase in householders in Irvine is about 2080 homebuyers. But, the true impact isn’t the numbers of people…2080 homebuyers is almost like a random fluctuation in moving into and out of Irvine. I think it’s when you COMBINE more buyers, lower rates, and cockamamie loan products that you get the real inflation.
To use interest-only and neg am in the same sentence makes about as much sense as comparing property in Irvine with that in Barstow. For an educated, finacially savvy borrower the interest-only payment makes the most sense. They can always pay the same payment as a P & I loan, but with the I/O the payment will go down. They also would be receiving at least 1/4% lower on the rate than a 30 year (comparing the 10/1). Finally, they might not even be in the home in 10 years. Paying a higher payment now because of worries in 11 years makes little sense.
You are spouting nonsense. You consider it financially savvy to take on interest rate risk, particularly at historic lows? The reason you are getting a better interest rate up front is because you are assuming all the interest rate risk. Whether or not you plan on owning the home more than 10 years is irrelevant. You might have to stay in the same home more than 10 years, in which case you have a ticking time bomb.
Remember, too, that real estate agents, including one who said this to me just last month, said for years, “They’re not making any more real estate (fill in location here)“ and people like Countrywide were pitching us HELOC loans (we still get HELOC checks every month???). So the bubble dynamic had many different causal factors, though, I would agree that the massive increase in potential owners—via these garbage loan products—was likely the primary cause of the real estate price bubble.
IR,
I’m spouting reality, but it’s nice to see
you get off the sidelines. 1/4% on a $500,000 loan is over $100 a month which equates to $12,000 in 10 years. That’s called a good financial decision. There are also fixes with Interest-Only for the first 10 years. Are those bad loans too? If you would take your knowledge and actually live a little than the Shady Canyon dream house that you and your wife dream about might actually happen. Instead you can wait around for a 30 year fix with your 50% down payment and enjoy an 800 sq. ft condo on the 5.
I would probably prefer the condo that I knew I could keep to the house purchased with precarious financing terms.
Interest-only is simply renting from the bank with equity participation. Perhaps this is desirable in a kool aid world of endless appreciation, but in a world like ours where prices can go down and stay down for a very long time, interest-only is a time bomb with a long fuse.
I am a believer that debt should be retired, not endlessly serviced. Right now, I live in a place where I save hundreds each month versus the cost of ownership on any terms. That is financially savvy, in my opinion. When prices drop to where I can save money by owning, I will buy. If you take away the kool aid, and evaluate a purchase solely on its consumptive value, it becomes clear that terms other than conventional financing are only useful for speculation.
IR, this time I have to disagree with you. Taking on interest rate risk might be worthwhile to **some** folks.
Let me provide you with a perfect example: credit card offering 0% APR on balance transfer with maximum of $75 for transfer fee. I happened to play the game of earning free CD money on 5.25% (thank you uncle Ben for flying your damn helicopter) thanks to this 0% balance transfer offer from various credit card companies a few years ago. Guess what? I actually MADE money from credit card company. The key is to pay back ALL the remaining balance BEFORE the 0% balance transfer expires.
This is somewhat similar to the interest only analogy. Go figure.
It flushes new responsible buyers out. They tend to wait, stay renters, or move elsewhere.
However, this has an interesting implication. Once you get near the bottom, the borrowers who have 20%+ down and can get past the new much tighter underwriting qualifications will have far lower default rates than the 2003-2007 vintages.
In other words, if you weren’t a major mortgage lender before late 2009, it might be a good time to consider getting in the market.
Wow, I don’t say this often but here it is. IR I think you’re missing something here. While I agree with your analysis and conclusions regarding “affordability” I think that term misses the point. You said,
“Temporary home ownership is renting. “
Yes, to a point. There is no reason we cannot work with our financial systems to increase home ownership through access to credit, rather than “affordability”. The point isn’t giving away easy and free money to speculators and investors, the point should be encouraging (generally speaking) younger people and families to tie themselves to a home through reasonable credit.
There’s a lot of blather about who should and who should not own a home. For the most part it’s just the self-interesting opinions of the party speaking. I think it’s clear that many, again to use this one example, young families would like to own a home. I think there is an argument to be made that as a society we benefit when these same groups of people can and do finance a home (that they can afford).
I think we lose something when we conflate “affordability” with access to credit and I think we further muddy the waters when any kind of “first time buyer” program or something similar is suddenly a vehicle for investment and real estate speculation.
I do wonder sometimes what this crisis would have looked like if the lenders had done just one thing differently. Just one thing. If, for instance, they had truly verified that every borrower did indeed live in the dwelling they were financing, if that would have had some impact on the destruction we’re seeing? I know it wouldn’t have been a huge difference but I do wonder what difference it would have been and if that doesn’t, in a sense, point to abject negligence the lenders indulged in to collect their fees and commissions.
But maybe that’s just me.
Something else that needs mention is the “monthly payment culture”.
You can’t truly grasp the cost of home-ownership when all you are looking at is a monthly payment.
We have been trained like monkeys by our credit card masters that we can afford anything as long as the “monthly payment” can be made - even if it leaves 0$ for savings.
The mortgage hustlers have come to depend on the typical idiot who will bend over and gleefully take all of the junk fees and thousands upon thousands of dollars paid in interest without question because it has all been conveniently bundled together for them and finely wrapped with a pretty red bow and called a “monthly payment”.
These creative finance scams assume that the buyer is too much of an idiot to sit down and do the math. With a little smoke and mirrors and slight wave of the hand, the “buyer” is fooled into the illusion that something is affordable because the monthly payment has been engineered to attract him.
When you have an unlimited army of mindless lemmings who are willing to go along with the status quo (since “everyone else is doing it”) its no wonder all of these wolves in the real estate industry were all hustling to make a quick buck.
Along with more conventional financing there also needs to be a shift in the cultural thinking. It’s time to take some stock in the kids and start teaching “fiscal” and “conservative” finance and money management skills from junior high and onward. At present, the credit card vultures are getting to them first and we all know how the story goes from there to our self-fulfilling prophecy.
Maybe the movie I.O.U.S.A will wake some people up.
It’s out August 23..playing at AMC in the District.
Also at the Block in Orange.
..... Orange County should protect our civil liberties and ban this movie…..
..... Al Jazeera made that movie, it is anti american…....
http://www.youtube.com/watch?v=HBo2xQIWHiM
..... from what i hear, the real housewives of orange county are organizing a protest…..
.....complete with signs, that are fake nail and fake everything safe….
Replied to “Banning IOUSA”:
You must be one of these recent immigrants to the US that misses the totalitarian rules of your old country. Do you miss the censorship and oppression that you would try hard to turn the US into your oppressed old country?
I will go to see that movie despite your suggestion of dissolving the first amendment.
OK, so I can detect the sarcasm in mav’s post.
Either I can’t detect the sarcasm in Food’s post, or he couldn’t detect mav’s.
I think it does make sense to give first time home buyers a break in the down payment requirement. I don’t know many young families who saved 20% before they bought their first house. But they do need to save something and prove they can handle credit and make the payments.
You are right - too many standards got jettisoned all at once. You can give a break in down payment, if you are extra careful in verifying ability to pay and good credit. You can accept poorer credit if there is a big down payment and the buyer can make the payments. You can’t do NINJA loans with no down payment, or disaster ensues.
“I think it does make sense to give first time home buyers a break in the down payment requirement.“
Nope, absolutely not!
It makes no sense to give any type of aid to the first-time buyer because this translates into higher home prices. When no one has the “extra money/aid” to buy the homes, then home prices must…COME DOWN to meet what the first-time buyers can afford!
That’s how it works! Any aid to purchsing homes is a concession to the existing home owners, as their assets gets inflated as a consequence.
I’ve noticed that people have a hard time grasping this metric. I admit it is somewhat counter-intuitive: You help the buyers by NOT helping them because prices will go lower.
Lots of talk about young couples saving that twenty percent downpayment when I think the majority of us were given the downpayment from family as unreported loans. Some of the government programs just filled in for people whose parents couldn’t liquidate some stocks as a gift for a new married couple. I often wonder about some neighbors—whose parents gifted them their downpayment—and are now digging into their one retirement fund to make their newly divorced daughter’s mortgage payments so she can spend time with her four horses.
I paid for my own college. I paid for my own first car - when I was 23! I saved my own damn down payment for my first house. I paid for my own wedding. And I always resented the spoiled young adults whose daddies paid their bills, (and many still do even though my cohort is approaching 40 years old!). Losers! Stop mooching off your parents and take care of your own responsibilities. Hah!
There are other approaches to increase homeownership. This is a bit too rigid for me, but interesting as another way to skin the cat.
http://en.wikipedia.org/wiki/Housing_and_Development_Board
Thanks for another analysis post.
Out here in D.C. people seem to be conflating I/O, Neg AM and other ARMs with Alt-A. (and then concluding that since the inner regions had less Alt-A that they’ll be relatively fine). Can you point to anywhere with statistics on what percentage of the creative financing products were sold to people under normal underwriting and documentation of assets and income? Because these products were not just sold to those with high credit scores that were willing to inflate their incomes, but also to traditional buyers who were getting priced out.
Cara, I’m not sure this is exactly what you are looking but I can relate part of the story of my own home purchase. In 2003, when I bought my current home I was absolutely plagued by pleas, from the realtor and the mortgage broker, to buy a much more expensive home and take much riskier terms. I had a definite idea of what my mortgage should be and stuck to it but I can easily see where someone else in my position might not have questioned their own decision and listened to these “industry professionals”.
If I had listened to the “pros” five years I would be screwed now.
ice weasel-
That’s interesting because it’s EXACTLY what happened to me in 2004. I was so frustrated with my mortgage broker (who had come highly recommended by my accountant whom I respected and trusted) because he kept arguing with me that we needed to be buying “twice the house” instead of what we had decided upon. I am educated and assertive and didn’t budge but have always commented that a less decisive person than me could have been talked into such a stupid move.
iceweasal and irvinesinglemom
I brought this up partially because my best friend bought in NoVa (northern virginia) with a 10 year I/O. They put a huge downpayment down from 12 years of equity accumulation (the normal way) in Connecticut, but still decided on the 10 IO, 20 amoritizing loan (with a balloon payment at 10 if you haven’t kept up with the amoritization) because they got a 1% lower APR. It made sense to them, they have mostly kept up with the fully amoritizing payments but got a lower interest rate and greater flexibility out of it. The balloon payment is a pretty strong incentive to keep up or catch up. (for them)
So, I know there exist semi-conservative people, with easily documented income and assets, who got unconventional loan products. But what I don’t know is how many.
Yes, it is one transaction where you are required to tell exactly how much money that you have. I found that odd, in negotiating a deal, why would you show all of your cards? Real estate is a rotten business. Buying a house is worse than buying a car.
Asking someone who get a percentage of what you spend, how much you should spend, doesn’t seem like the greatest idea…
I don’t disagree with the idea of buying a home on credit, but your statement implies that at present, young families don’t have ENOUGH access to credit. But that just doesn’t make sense.
Some of the FHA mortgage programs require a 3% down payment. 3%! It’s hard to imagine a credit program with more liberal and favorable terms. Are you suggesting that we should liberalize this even more?!? Why isn’t 3% good enough already?
I suppose the FHA could come out with an interest-only or option ARM mortgage, but that just seems crazy. Simply standing aside and letting the market drive prices down to a point where they are affordable to people with conventional mortgages seems like a much better idea.
Some people say that mortgage lending is discriminatory against certain racial or ethnic groups, and that easier credit terms need to be made available to these groups to combat a history of discrimination, but I’ve never bought this argument. FICO scores and incomes are color-blind and do not discriminate, and banks will lend to whoever makes them money. I do business with plenty of members of racial and ethnic minority groups. Why would I turn away someone who wants to pay me for my services? It makes no sense.
There is nothing wrong with buying a house on credit. Although it’s been abused lately, credit can stimulate the market—plenty of people who wish to purchase a car don’t have $25,000 in cash are perfectly capable of paying $400 per month for it. I myself try to avoid using credit whenever possible, but not all credit is insanely risky. It does stimulate demand; GM, Toyota, and Mercedes would not sell nearly as many cars if they didn’t make credit available to their customers.
Joe, I assume you’re responding to my post so here is my response.
Joe wrote, “”
Joe wrote, “I suppose the FHA could come out with an interest-only or option ARM mortgage, but that just seems crazy.“
I have to admit I’m not exactly what I am proposing. What I can say is that I definitely not proposing that. That would be,as you say, crazy.
Joe wrote, “Some people say that mortgage lending is discriminatory against certain racial or ethnic groups, and that easier credit terms need to be made available to these groups to combat a history of discrimination, but I’ve never bought this argument. “
Anecdotal arguments are frequently much less compelling than passion put into them. Because you’ve never “bought into it” doesn’t mean it does not exist. But again, I made no specific proposal because I don’t have one. And, to address your point a little more specifically, I think this is not simply a matter of race. It’s a matter of where the home is located and many other things. FICO scores are as blind as the person interpreting them wishes them to be. They are by no means an absolute measure or, I would opine, how did we get where we are today? Lowering FICO requirements was only one part of the picture. We’ve already seen many high FICO borrowers walk away from their loans which, I think, tends to undermine any argument that FICO is the best judge.
Joe wrote, “FICO scores and incomes are color-blind and do not discriminate, and banks will lend to whoever makes them money. I do business with plenty of members of racial and ethnic minority groups. Why would I turn away someone who wants to pay me for my services? It makes no sense. “
To follow up a bit on the above I would only add this, racism and prejudice never “make sense”. Saying something “makes no sense” isn’t argument that it does not exist. We have volumes of evidence of lots of people and business entities acting in a manner that direcetly contradicts their best interest to discriminate on other terms. And before you or someone else says it, no, “the market” doesn’t deal with these people or businesses either.
Again, dealing with racial prejudice was, by no means, the thrust of my comments, it’s one aspect surely but not the totality of what I was talking about.
Being a product of the 70’s I see conspiracy’s in everything and tend to think that everything in life is done to benefit the rich and keep the poor impoverished.
I have yet to see any evidence to the contrary.
This snafu is just another example of the average working class american being sold snake oil.
Sure, the banks will lose billions but the executives will be fine, I dont think we will be able to say the same thing about the average american who thought they were finally given the chance to achieve the “American Dream”.
(does anyone really think that finance majors didnt know that these toxic loans were gonna blow up) LMAO
“ dont think we will be able to say the same thing about the average american who thought they were finally given the chance to achieve the “American Dream”. “
Here is the problem: the “average American” I feel doesn’t wish to spend the 10 minutes it takes to run the numbers in order to decide if they are making a sound decision. Then this “average American” refuses to take responsibility for their actions and blames everyone else in the system for their bad decisions and consequent misfortunes.
I am an “average Irvinite” at least in regards to my income. I had ample opportunity to buy into the bubble and even was looking at real estate several times during this period. I had outstanding credit and was approved for enormous sums of money, but each time I had to pull away because the bottom line just didn’t make sense.
I believe peoples biggest problem is thinking that everyone does or should posses the same skill set as them…...They dont. As much as the world would want you to believe that “no child should be left behind”, there are many children that lack the mental capacity to complete the coursework.
It’s great that you were able to “run the numbers” and not taken in by this ponzi scheme, but many people were. They were lead astray by an entire nation of bankers, brokers, agents and appraisers. These were not door to door salespeople peddling diet pills, they were respected institutions, business associates and neighbors.
It’s not money that is lacking in this society, it’s compassion.
You both are making some compelling arguments here, but camsavern really stated the thing that needs to be said upfront:
“It’s not money that is lacking in this society, it’s compassion.“
These aren’t academic subjects we’re discussing; real people’s lives are being affected, and in a very bad way.
MSV: you are correct, most people just don’t even want to make the effort. However, to think that losing a home and going through the pain will make them wiser next time…well, I know a few things about human nature and one of them is people don’t learn lessons well. Especially when it comes to something like a home, in which so much social standing and self-respect is tied up in. Rationality tends to go out the window with decisions like that. Not for everyone (you sound like you’re one of the few who wouldn’t fall for this), but for most people.
CAMSAVEM: you too are correct. People are suckers. And it has nothing to do with mental capacity or the ability to do schoolwork; smart people are easier to put one over on, as they think they’re too smart to fall for a scam.
“does anyone really think that finance majors didnt know that these toxic loans were gonna blow up”
Finance is not a science, however much we might wish it were. It’s intimately tied to human greed and human desire, with a lot of wishful thinking thrown into the mix. Look at Greenspan and Bernanke - Greenspan knew better but invented excuses to blow the bubble up anyway, and Bernanke is so scared of bringing the market down around his friends’ ears that he’s not willing to take the necessary steps to stop the dollar from plunging into the abyss of inflation. And these two are at the very top of their fields. So I suspect that most “finance majors” had no clue what any of these loan products would do, as they have been taught in school that these business practices make sense.
Obviously, they don’t.
This is the best thread in the whole comments today!
“does anyone really think that finance majors didnt know that these toxic loans were gonna blow up”
Well, I’m a finance major, and I certainly saw the mortgage problems. I went from expecting the bubble to start deflating in 2004 to doing more serious research and calculating how immense the damage would be as prices rose through 2006. I convinced a few people of what was going to happen. More often my comments were just taken as odd, because people knew I was thorough and generally optimistic. Starting in late 2007, I started to hear “I’m afraid you might be right”. By mid 2008, I was hearing “It’s just like you predicted”.
Lots of highly compensated Wall Street people got tossed onto the streets as a result of the credit crunch. Many of them had nothing to do with mortgages or securitization. I was very nearly one of them. However, because of some rather unusual knowledge I have in a growth area I was able to move elsewhere in my firm. About 70,000 Wall Street people weren’t so lucky. My guess is less than half of them were in mortgages, real estate, or securitization. Some of the casualties were in places like issuing municipal bonds, handling student loans, and doing IPOs.
Those other casualties have the potential to help companies manage risk better. In universities, in Series 7 exams, and at employee and shareholder meetings, wealthy Wall St types should be reminded that irresponsible lending and risk management elsewhere in their firms can cost you your job. It can even blow up the whole firm. In addition to unemployment, you could also end up with worthless stock and stock options. Much of what you thought of as savings is gone.
My firm has good continuing education. Even so, they certainly could drive this point home a lot better. Avoiding money laundering and fraud are worthy topics, but poor risk controls and stupid lending are the causes taking down our competitors.
Fascinating stuff—thanks for the insider view on this. And excellent point on the continuing education thing.
http://www.ft.com/cms/s/0/e114d850-5b48-11dc-8c32-0000779fd2ac.html
“It took foolish borrowers, foolish investors and clever intermediaries, who persuaded the former to borrow what they could not afford and the latter to invest in what they did not understand.“
-Martin Wolf, September 5 2007
Nice work. I love the neg-am/rent equivalency connection.
IR and others
My post about this issue on friday almost went un-noticed.
I am not sure if you read or come across about the new issue Irvine is facing. Have a look at this site and if appropriate, educate others.
http://newsoc.org/
newsoc.org/PDF_Docs/El Toro Contamination Map.pdf
I came across this in one of blogs on OCR
Thanks
Think I will buy south of the 405. Problem solved. Nobody is responding because how does one verify this information? Also, it will be a temporary situation.
If you posted on Friday and it “almost went un-noticed”, it may be that others just don’t see this as a critical issue. Or maybe the news source in your link just didn’t provide enough credibility in their reporting.
Personally, I am always wary of “sources say…“ or “an expert in the field…“ when they do not contain names or specifics to the claims or information provided. And IMO a “home in Woodbridge” where the residents name or even street is not provided is not considered credible news. Frankly, that shower curtain reminds me of one from my college days. I’m not sure if Isla Vista had TCE vapor, but I know we rarely cleaned.
Lasty, the citing of a Latham & Watkins client alert is curious as it over two years old and doesn’t reference either El Toro or Irvine in any manner.
Go Gauchos!
You should do a search in the Forums on this topic. I know there have been a number of discussions about it. Here’s one:
http://www.irvinehousingblog.com/forums/viewthread/1089/
Strange to me that an objective news reporting organization would have:
- Private domain registration (http://reports.internic.net/cgi/whois?whois_nic=newsoc.org&type=domain)
- No contact information on the website
- No specific references in its articles
- No article bylines
BTW, what is ILTTWEL?
I responded to it belatedly (actually a response to luckyguy’s reply to yours):
“Thanks for the link (though you have an extra trailing “newsoc.org” on there).
The author of the site seems like a bit of a crank. There’s a lot of very questionable reasoning in his discussion of IRWD statements, tons of unsourced claims (as you also allude to). And in that shower photo, can’t tell for sure due to the low resolution, but to me, the pink stuff looks clearly like common Serratia marcescens bacteria, and the darker stuff on the floor like soap scum (and/or non-water-soluble lube residue ;^>) stained with dirt / oils / dead skin / mold.
But yeah, obviously a very important topic, and I hope it’s getting a thorough treatment from non-conspiracy-nuts.“
IR,
you make a good point, but there are a lot of reasons for the bubble. Lower interest rates engineered by the Fed made housing more ‘affordable’. Mortgage brokers- what happened to banks?- had no skin in the game and no incentive to do proper loan documentation. Virtualy every organization in the chain was corrupted or compromised to some extent- mortgage insurers, appraisers, etc.
BTW, the 30 year mortgage was itself a financial innovation, back in the late 30s I believe, though they didn’t really take off till after WWII. Of course the auto and interstate highway system opened up lots of land for building, and cheaper housing construction, etc. kept supply up.
So housing really did become affordable for large numbers of Americans.
If lower interest rates were the only factor driving the bubble, you would have seen similar price increases throughout the US, which didn’t occur.
Furthermore, the Fed Funds rate is not what fixed rate mortgages are based on, nor is it even the most common index for ARMs (LIBOR is more common).
Another great analysis IR.
Can you guide/link to sources of the data sources that you used for the last chart? I’d be interested in understanding what this would look like for other parts of the country to see how much this was a US phenomena and how much a Southern CA issue. For example I’m in northern NJ where median income is near $100k in many towns, so similar to Irvine but I don’t believe affordability products took off to same degree here.
http://www.flickr.com/photos/29568266@N02/2775322730/
California had much more Alt-A ARM activity than elsewhere. For raw data, go to http://www.newyorkfed.org/regional/States_AltA_2008_06.xls and look at column 6. CA had 45.5 Alt-A loans per 1000 housing units, NJ had 16.5. That’s not per 1000 units sold in any period of time. It’s 1000 units total, about 700 of which have mortgages of any kind.
Hmmm. Why didn’t the map show up?
http://www.flickr.com/photos/29568266@N02/2775322730/
Maybe this.
So if we get an earthquake on the west coast that knocks California and Washington into the sea and if a hurricane takes out Florida the national real estate market will get much better..
IR,
Thanks for your perspective on housing costs.
The conventional wisdom is that high prices (“values”) are good, and thus all housing affordable programs simply try to get people with low incomes into houses with high prices. I agree that high house prices and high house inflation are intrinsically bad and are the fundamental impediment to more ownership.
I learn from your posts, but more importantly it’s the one place I can read about housing without feeling crazy for thinking that high housing inflation is bad in the same manner as, say, gasoline inflation or inflation in the price of blue jeans.
In looking at the debt to income ratio chart, I’m assuming that’s median income to median home price. Is that correct? If so, it either shows that the median home is being bought by above median income households or that California is an exception case and allowed to run DTIs above 30% even in the bottom of the market.
If I recall my affordability ratios from the OC Register correctly, I believe is the later. My recollection is that OC/California has been plagued by low affordability for an extended period.
At the bottom in 1996, the median home price was 4x the median household income in LA/OC. The national average was 2.8x in 1996.
and in ‘96 gas was ~$1.20/gal too. Should be interesting to see where things go this time around with energy being MUCH more expensive.
Hey, it worked out for Freddie Mercury….oh wait.
From the DTI chart, it certainly looks like *something* went wrong right around 2002-2003. The ratios looked like they were flattening out and getting ready to revert to the mean, and then they took off again.
IrvineRenter, I remember a while back when you posted the median price chart showing antcipated drop in prices going into next 5-10 years. I think the prices fell much faster than you anticipated. Could you update that chart showing “Anticipated” vs “Actual” on where we are today to get a snapshot on how fast further decline will occur? that would be really helpful.
Thanks
This is really an extension of the fact that our money is based on purely imaginary value. Ponzi schemes beget ponzi schemes.
Sorry to get on the Ron Paul soapbox, but it is true. The economic climate of 1972-1981 and 2001-present is really the rule, not the exception, when an economy is built on a foundation of funny money.