How Bad Could Bad Get?

Many people when they first discover bubble blogs think housing bears are tinfoil-hat-wearing crackpots with extremely pessimistic outlooks on life. There are perma-bears (Roubini, Shiller, Fleckstein) as well as perma-bulls (Watts, NAR, Kudlow). The truth is generally somewhere in between. I learned long ago that extremists are never happy people because they seldom get their way. As the Buddha noted, it is the "middle path" that leads to happiness. I have spent my voting life as a independent/Libertarian voting for whoever I believed to be the best candidate, most generally a moderate. However, there are times when what is perceived as an extreme is actually the correct view. As Barry Goldwater noted, "…extremism in the defense of liberty is no vice! … moderation in the pursuit of justice is no virtue." Many who read my post "Predictions for the Irvine Housing Market" thought the scenario I described as extreme. It only looks extreme because the psychology of the bubble as skewed the collective perspective of the market. That Predictions post was moderate; this one is extreme.

We have been witnessing a great deal of bad news lately, the impact of which cannot be good. If the perfect storm continues to form over our local housing market, things could become much worse, much faster than even the most bearish among us think possible. Have any of you noticed the carnage in Sacramento? For the doomsday scenario to take place, we would need the following: Foreclosures, unemployment, rising interest rates and tightening credit, and a decrease in home ownership. The combination of these forces could make the price collapse a catastrophe.


We all know the wave of foreclosures is coming.


And it should continue unabated for 5 more years.

Loan Reset Calendar

There isn't much more to say. It is not bad yet, but it will be very bad, and it will go on for a long time.


We know layoffs are coming to Irvine/Orange County. New Century went bankrupt along with numerous other sub-prime lenders based in Orange county. People are already losing jobs. I think it is save to speculate this will have ripple effects through the local economy. Even if unemployment remains low, how much will incomes decline? Mortgage brokers, realtors and others in the REIC have been living on the transactions created by the borrowing of those about to go bankrupt. They may find other work, but the $250,000 a year days are over. The only mystery is how bad the unemployment problem will become. Right now, things don't look good.

Rising Interest Rates and Tightening Credit

We know mortgage interest rates are near historic lows.

Mortage Rates 1963-2006

The large number of foreclosures will make lenders more cautious (either that or the losses will put them out of business). Increased lender caution will result in a tightening of credit and an increase in interest rates to compensate them for the increased risk. An increase to 8%, which is near the historic norm, would seem to be likely. If lenders become very cautious, an overshoot to 10% or more could easily take place. Interest rates have not begun to rise yet, and many are holding out hope that the FED will save them. It won't. Due to the increasing risk premiums, the best one can hope for is a lowering of the FED funds rate to compensate for the increased risk premium. We will have to wait and see.

Credit is already tightening. This cannot be denied. The increased cost and decreased availability of credit will have a severe impact on demand.

Impact of Tightening Lending Standards

Credit Suisse estimates the most recent credit tightening just eliminated 21% of the borrowers in the market. This is assuming further problems in Alt-A or prime loans do not force credit to tighten even further (in other words, credit will tighten further.) This will crush demand and it will also put an end to serial refinancing. The inability to refinance is what will cause all the resets shown in the previous chart to go into foreclosure. Which leaves us with the most important question: Who is going to buy all of these houses in foreclosure?

Decrease in Home Ownership Rates

Ownership rates in Orange County have risen 2.8% between 1994 and 2005. This is actually behind the rest of the country where homeownership rates have increased nearly 5%. This is a direct result of lending money to those borrowers previously excluded from the housing market either because the borrower did not have the downpayment, or they lacked good credit.

Homeownership Rates

Home ownership rates will decline as homeowners lose their homes in foreclosure. With foreclosure comes bad credit; those with bad credit just got eliminated from the buyer pool. Therefore, people who lose their house to foreclosure will move into a rental, and the previously owner-occupied home will likely enter the rental pool. (A popular misconception is that rents will go up. The number of rentals will increase along with the number of renters.)Mr. Housing Bubble

There will be some new buyers (like many on this board) who have cash and good credit; however, this group is small in number, far smaller than the number of foreclosures about to hit the market (if you don't believe me, ask yourself how many potential buyers you know with cash and good credit.) This means a significant number, perhaps a majority, of the houses due to hit the market due to foreclosure will be purchased as rentals.


If the bulk of the houses going through foreclosure are going to be purchased as rentals, prices will have to decline to the point where a rental generates a positive cashflow. Prices are double that today! Home prices will have to decline at least 50% for properties to make financial sense as rentals, so if this is the fate of the bulk of the upcoming foreclosure inventory, prices will decline at least 50% before buyers will enter the market and adsorb this inventory.


Foreclosures, unemployment, rising interest rates and tightening credit, and a decrease in home ownership are all required in some measure to create the doomsday scenario. Do I think this will happen? Probably not, but it could. Did anyone think the NASDAQ could drop from 5200 to 1200 from 2000-2003? Did anyone think housing prices in California would drop from $200K to $177K from 1991-1996 in our last "correction?" Did anyone think real estate prices in Japan would drop 64% between 1991 and 2005? When bubbles collapse, they often drop lower and last longer than anyone thinks.

Today we do not have any of these conditions to an impactful degree. Maybe these conditions will not develop further; however, all indications are that these problems will develop and get worse. So how bad could bad get? Ask them in Sacramento, their party is just getting started.

Irvine Market Decline Extreme

Market Decline Extreme Spreadsheet

Get this party started on a Saturday night

Everbody's waiting for me to arrive

Sending out the message to all of my friends

We'll be looking flashy in my Mercedes Benz


37 thoughts on “How Bad Could Bad Get?

  1. raymond

    It’s funny that your chart should show the Median Home Price crossing Rent Saver value at 7/1/2009. Based on my personal financial outlook and savings rate, that is the exact time I am planning to buy (if the market isn’t continuing on a decline) ;).


  2. graphrix

    Another great post by Irvinerenter!

    I will add some of the job info with the short diatribe I posted over at

    “Some OC job facts for everyone. The data can be found here:…st/ oran$haw.xls

    From 2002 to 2006 OC had added 114,500 jobs of that 44.3% 50,700 jobs were in the construction, RE, finance (credit intermediation and related activities) and architectural/engineering related services. These industries have averaged about 11.7% of the total jobs in OC and that is what is was in 2002 meaning 88.3% was for everything else. Add the 63,800 non-RE related jobs and divide by .883 that equals what a normal job picture would look like with an unemployment rate of 6%. A rate last seen in 1993. Any other industry cracks and the 90s bubble will look like a hiccup. 2002 to 2006 we continued to lose manufacturing jobs and if we didn’t have Ceradyne those losses would be worse.

    UCLA forecasts without Thornburg have gone to crap.

    Chapman blew it in the 90s with Esmael Adibi calling for a recovery in 12/90 that by 1992 OC homes will be appreciating faster than inflation with an annual rate of 9.4% by 1995. In 2004 he was calling for the bubble to burst and again in 2005 and in 2006 they gave up. This year they are probably not bearish enough. Updated report to come in June.”

    The unemployment rate is very hypothetical and doesn’t factor in continued job increases/decreases in other industries, population and career changes but if we had the same amount of work force and the average construction/RE related jobs that is what it would be. Hopefully I can post in more detail on my blog this week.

    What happens to the buyer in Northpark who bought at $720k the same floor plan as 68 Arcata that the bank bought for $620k when it comes to the point when the need to refi? I am not trying to offend anyone but think about that for a minute. No one at the auction wanted to buy it and granted there was back taxes and HOAs (thanks nirvinerealtor) but not one bid?

  3. NanoWest

    In general, I do not believe in dooms day predictions. I do not think that everyone in orange county will have to live on the streets becasue the housing market is going to crash…..however, over the next few years there will be a lot of sleepless nights by “homeowners” that did not realize that it was a bank that was allowing them to live in the home and in fact they were never “homeowners”

  4. IrvineRenter


    Good point, net outflow migration is also occurring, and it does drive down home prices as buyers literally disappear. I would speculate that this is an effect rather than a cause. When affordability is less of a problem, outflow migration should lessen (assuming there are jobs). Outflow migration is a very real problem right now, and it is caused by the lack of affordable housing.

  5. IrvineR

    Considering loose lending standard of last few years, the future rent savers already own home. I am wondeing if rent savers can support the price if it falls. There are though certainly support when cashflow investors get into the game.

  6. Ray

    One thought related to Market Decline Extreme Spreadsheet.
    While Portola Springs and other new communities had a hard time to sell, the construction for new upcoming communities such as Orchard Hills and Protocol II does not slow down a bit, I think TIC and builders try to push them into the market as soon as possible, even it means over supply.

    Because after 20% deduction, TCI still has huge profits to make and the bottom has a long way to go.

  7. RogerSmith8080

    Most Predict OC will fare better than most counties; I think the opposite will take place. They base this off of past performance and that OC is overall a great place to live thus demand will always be high. I would argue that OC has two serious liabilities.

    First 1 out of 5 jobs in the OC is real-estate relegated and these jobs pay very well so that they are some of the few people that work in OC that can also afford to live in OC.

    Second I believe these realtors lived what they preached; I think many if not most bought their own home or additional homes using their own product (liar loans and ARMs) and are in the same boat as many flippers. Even the big dogs making $120,000 a year still could not afford a single family home in OC during the peak. I would beat they bought in Fraudara Ranch and other areas expecting to live there for a couple of years, cash out $200,000 then use that as a down payment on a place they would actually want to live at. They could have a double whammy, no job (or minimal job security) and one or more mortgages on places they cannot afford to hold indefinitely. Unlike Joe Six Pack they where racking it in for a number of years and significantly more savings and/or credit thus they can ride this out longer than most. For that reason I do not think you will see OC crash at the same rate as the neighboring counties, but it will ultimately crash. The only hope is if a new secondary industry is able to move in quickly and fill the void quickly. Not likely and this X industry would also need to hire up a lot of mortgage brokers as well to keep them from panic selling and moving to cities where there are jobs.

  8. Jwm in SD

    “Not likely and this X industry would also need to hire up a lot of mortgage brokers as well to keep them from panic selling and moving to cities where there are jobs.”

    Hire them to do what exactly? The job they left 5 years to get into real estate? Not likely. The job they could never get in the first place because of the lack of transferable skills? Not likely.

    A lot stupid people got into OC real estate in the past several years because IT WAS EASY $$$$$. They never would have been able to earn that kind of money in other industries either due to a lack of skills or talent required for such occupations as engineering, finance (non real estate related), IT, etc.

  9. NickStone

    Irvine Renter:

    I have a comment and a question:

    Comment: Someone mentioned to you to not forget the outward migration of Orange County residents into your analysis. I will add that you also need to include UNDOCUMENTED OUTWARD MIGRATION as well. By this I mean illegal immigrants. Regardless of what one’s opinion is on this matter, it is undeniable that illegal immigrants are an important part of the real estate market. When I was in school to get my real estate license, a surprising number of my classmates admitted to me that they preferred renting to illegals, since they had the upper hand when it came time to negotiations…. not very ethical, but that is what I was told. With the strong downward trend in construction that should be hitting in the next 12 months when the current projects are being completed, I would expect a strong departure of illegal aliens to find work in other areas. This number of course cannot be determined, but it will definitely have an effect.

    Question: I have been watching the REO’s stack up and stack up at in California now for quite some time. In fact, it was just reported that Countrywide (who still appears to still be on our side) experienced an increase in their REO inventory to the tune of 40% in one month.

    I guess I am wondering at what point are these properties going to be aggressively marketed (prices dropped). Are these properties being listed on the MLS or just on their websites? Do they have a team of Realtor actively showing these properties?

    It is fairly clear that they have a Catch 22 situation on their hands, since if they flood the market with REO properties at fire sale prices, they will lower the real estate values across the board in California, which in turn would lead to more foreclosures, which in turn would increase their stock of REO’s (since the auctions will most certainly fail)…. well you get the idea.

    So in short… do you have a guess of what their overall strategy is regarding the REO’s? I assume that at one point, regardless of strategy, they are going to have to dump these properties and take the loss.

    (My opinion acutally is that they are experiencing the drag of management inertia. I think they were inundated with foreclosures and the paperwork that goes along with it at a time where they ABSOLUTELY cannot hire more staff to handle it. I don’t actually think that they are attempting to hold property in the hopes of propping up prices… since in a downward market, the goal is to sell as QUICKLY as possible).

    Anyway, I would be curious to hear your opinion on this. Right now the banks seem to be taking the properties back at auction and letting them collect dust in the storage closet.



  10. bought_high

    now that’s a pretty dire prediction. when compared to your earlier prediction on March 11th – I noticed that the rent-saver lines are different : crossing the $400,000 mark in 2010 versus 2015. any reason?

    thanks for posting the charts – as it takes guts to actually say something with substance. Most “professionals” only use vague terms instead of numbers.

    the rent-saver curve obviously depends primarily on two values : first is salaries, then second is the rate of home mortgages. and for people who insist on fixed mortgages – they do not have to save immediately, as eventually your mortgage payment will cross lower than the rising rents.

    so i think a number of rent-savers may step up as the house prices drop – even before the houses come all the way down. but this depends on the economy and fed money policy.

  11. RogerSmith8080

    Illegals are a good point, while the Main Stream Media has no interest in covering this elephant in the room we all know they are here in significant numbers. We also know that institutions like banks (BofA) and mortgage outfits (no doc loans for no doc residence) are bending over backward trying to lend these people money. It’s not just Santa Ana with Illegal’s, I live in south OC and we have at least two day labor sites (corners where you see 15-30 construction workers standing around waiting for work) one mile from our place of residence. I cannot imagine these guys are commuting all the way from Santa Ana they live a lot closer than that. With the construction business a bust, one which is loaded with Illegal’s they are going to need to move to green pastures and move out of the area.

  12. IrvineRenter


    The illegals are an issue. As they leave, it will be a bit harder for fraudsters to find straw buyers 😉

    I honestly don’t know what impact they will have on the housing market. I don’t know how many of them may have participated in the housing market with sub-prime loans. I guess they are the ultimate no-doc customer.

    As for the bank REO’s, I think your analysis is correct. They aren’t staffed up enough to sell these things yet; however, I do think they are taking a bit of a wait-and-see approach going into the selling season. If these don’t start to move by August or September (which they won’t), I think the banks will start dumping en masse. I think this fall and winter prices will really start to drop.

    As your your catch-22 about the REO’s, I think you are right on. This downward spiral is the central tenet of the bearish argument for a dramatic price decline.


    Good catch on the different lines for the Rent Saver support. Another factor in the analysis I did not go into was the declining rate of increase in rents. During a recession, rents do not go up very much because wages are not rising. In the latest version, I depressed rents to reflect the recession which will follow the collapse of the real estate bubble. It doesn’t really have a huge impact on prices, so I didn’t go into a long explanation in the post for the sake of brevity.

  13. Tom

    Regarding O.C., some friends of mine bought a what I felt was a really overpriced SFH in Corona Del Mar (Newport Beach) in 2003. Price = $960,000; let’s call it $1M. They sold it near $1.4M; let’s call that $1.5M for the sake of my example. Even if prices around here pull back 33%, that home will still go for $1 million!!! Few can afford that type of living. The prices / cost of living just seems way out of whack with “reality”.

  14. zoiks

    By Shiller I suppose you mean Robert Shiller. How is he a perma-bear??? He’s a very smart, balanced, and distinguished economics professor. He happened to have called the stock bubble of 2000 and the current housing bubble (which hasn’t fully played out yet) but just calling a bubble doesn’t make you a perma-bear.

    Maybe you meant Gary Shilling?

  15. IrvineRenter


    I have local friends who’s parents bought in Corona Del Mar in 1995 for about $550K. Their house recently appraised for about $1.3M. Timing is everything.


    I was referring to Robert Shiller. I suppose it can be argued he is not a perma-bear. I like his work a great deal, and I have a lot of respect for what he writes. I am not familiar with anything bullish he has written (my ignorance does not make it so). His bearish prognostications are legendary which is why I may have incorrectly placed him in the perma-bear camp.

    I forgot about Gary Shilling. I am not as familiar with his writings, but from what you can learn about his views on his website, he is certainly bearish now.

  16. RogerSmith8080

    Corona Del Mar is like the Belair of OC (OC has about 10 Belair’s by the way), it will aways be expensive to live there. OC is a lot bigger then Corona Del Mar, it has two sides, the east side of the 5 freeway and the west side of the 5 freeway. The east side of the 5 is where many non-multi millionairs in the past would live in houses with actual yards. The west side is usually where the most expensive properties where.

    After the crash you still will need to spend close to million to live Corona Del Mar, but you won’t need to spend close to a million to live in Corona. Before the 2005 peak it was looking that Corona in 2010 would cost more then Corona Del Mar in 2005.

    Let’s face it, in Corona Del Mar if your house is not within a short walk of the beach then it will have a spectacular view of the ocean. It’s always going to be pricey.

  17. ezy money

    my friend bought in Corona Del Mar around 2002. He refinanced and bought another home as well. Funny thing is that the loans are interest only. So don’t think that CDM is all wealth, the bubble is alive and well there. The true monthly payments my boy is liable on total around 14K. I ask him what he is going to do when he has to pay the actual nut and he just shrugs and says he will refinance. Corona Del Mar is paradise compared to Irvine. but it is going to get whacked a bit as well.

  18. zoiks

    “His [Shiller’s] bearish prognostications are legendary which is why I may have incorrectly placed him in the perma-bear camp.”

    Yeah, he doesn’t always give these bearish prognostications. Only when he thinks he sees a bubble. He approaches it from a scientist’s perspective (as he should).

    And I wouldn’t even say he “called” the current housing bubble so much as he helped popularize the notion of asset bubbles, and included lots of interesting information about the real estate biz, mortgage biz, psychology, economics, etc., and basically compared favorably the current conditions to classic bubble economics, making a compelling case that we are experiencing another asset bubble. But he didn’t really say “hey this is a housing bubble everybody sell your homes and rent”, like some say.

    But he’s not the broken-clock-right-twice-a-day type, as he’s only identified these asset bubbles near their peaks. Really smart and level-headed dude, that Robert Shiller. Irrational Exuberance is very informative and an interesting read, especially now.

  19. IrvineRenter


    I wish I could take credit for finding those fraudsters, but I did not expose them. Interesting article.

  20. Kevin

    Irvine Renter –

    Love your posts man…helps me out a ton and I appreciate that.

    A story just broke on MSN detailing how mortgage companies are already beginning to “alter” mortgages rather than forclose on them. Is this going to get in the way of our “return to traditional valuations”?


  21. IrvineRenter


    It would take something pretty radical to save the FB’s. There problem is not the loan terms, it is the amount they borrowed. When you are already in negative amortization on a teaser rate, there is no way to reduce the payment, and the bank is not getting back its principal.

    The only solution I see is if the banks took a portion of their note on a zero coupon basis and took their money at the sale of the property. This solution has political implications as the “saved” homeowners will essentially give up all equity to a huge bank note when they sell the house. It kicks the can down the road, but the day of reckoning will still come.

    I may do a full post exploring this idea.

  22. granite


    I see my “gut feel” coincides with your graph. Having owned a house during the last 90s bubble I know it took about 4 years to reach the bottom. So I signed up for another year lease at my Tustin Ranch apartment. Fortunately my wife understands because she can still shop because we aren’t “house poor”. I anticipate buying by 2009 where the risk of major loss will be much lower.

    Thanks for such thoughtful and entertaining posts.

  23. Todd

    A relative who works in Irvine, is considering buying a condo several miles west of Irvine.

    One of the considerations for him is the cost of the condo. Condo prices are more desirable several miles west of Irvine. But from all indications, with business booming in Irvine and south OC, anything he buys in Irvine or south OC will appreciate in value better. But on the other hand, he’s been advised not to buy right now at all, now is not the time to buy, wait it out a few months or maybe a year.

    It is (in my opinion) nice to know that the El Toro area will not become an airport. With the great park, the community at large will at least have another peaceful, quiet area. I dont know much about the housing market. Is he right to wait it out a few months before he buys in Irvine.


  24. IrvineRenter


    The longer he waits the less he will pay for the condo. Prices will be dropping for the next 5 years. Prices in Irvine have gone from WTF to OMG to LOL. The correction we are starting to see is the bursting of a very large bubble.

  25. Darin

    The median income you got from the BLS I see. Is that median price for 1/1/07 and 4/1/07 NAR or Case-Shiller or somebody else?

    The reason I ask has to do with the quality of the home you are getting for median price. I did a quick search on your blog for Case Shiller, but came up empty. Needless to say, there are many problems with median income. I don’t want to diminish your fabulous work here and I think that it is still valid using median home price.

    Like many others, I am on the sidelines with cash in hand, waiting for the right time. Median income prices are very imprecise at the peaks and troughs, but are great for trend. Seeing the explosion seems to be the easy (and often schadenfreude). It’s that transition that I’m seeking the most clarity on.

  26. Darin

    Something else…
    The mix of income in San Diego is different than OC, but the real estate market is the same. Here, we have biotech, military, and government and tourism. We have recently had a major shift from construction and real estate to tourism and retail services. I doubt a similar shift will occur in OC especially in Irvine.

    My point is similar to some of the others here, predictions on future income are necessary to run the model, but adjust accordingly if your local labor market goes up or more likely down as housing turns south.

  27. ltokuda

    Thank you, Irvine Renter. Your analysis is always very interesting and a great read. This article was no exception.

    One thing I would disagree with, however, is characterizing Shiller as a perma-bear. After reading his work, I would consider him a realist. Of course, he became famous for his Irrational Exuberance books. But contrary to popular belief, he doesn’t give any doomsday preditictions. He just tries to look at things in a historical context, much like the analysis you do. And in interviews, he says straight up that he really doesn’t know what’s going to happen with the housing market. It might go up. It might go down. All he claims is that the values now are out of whack with historical averages.

    Darin, regarding the Case-Shiller Index: The Los Angeles index actually covers both Los Angeles and Orange county. You can look up the composition of each index here:

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