The Fallacy of Financial Innovation

And the hardest part

Was letting go not taking part

Was the hardest part

And the strangest thing

Was waiting for that bell to ring

It was the strangest start

Everything I know is wrong

Everything I do it just comes undone

And everything is torn apart

Oh and thats the hardest part

Thats the hardest part

Yeah, thats the hardest part

Thats the hardest partColdplay

The Hardest Part — Coldplay

Perhaps the hardest part of the housing bubble was not taking part in the rally. There was pressure from everyone and the lenders were giving away money. It was very difficult to make a conscious choice not to participate, particularly when people want to own. I felt these desires; I wanted to own again. My intellect and my emotions were in conflict. Now that the bubble is bursting and prices are coming down, I see the light at the end of the tunnel, but it is still difficult to wait. Like Archie Bunker said, “Patience is a virgin.” I will only buy once at the bottom, and I want the time to be right.

For those who participated in the bubble, the hardest part (beyond the financial problems) is yet to come. It will be accepting that everything they thought they knew was wrong. As I described in What is a Bubble? a financial mania is supported by a whole series of erroneous and fervently held beliefs. It will take time for the participants to come to the realization that they were wrong, very wrong. Accepting this truth will be even harder. Unfortunately, financial markets have a way of forcing a painful awareness on its participants. Whether they like it or not, each participant in the market will come to realize it was a colossal mistake.



The cutting edge is sharp. Innovators often pay a heavy price for advancement. Sometimes these advances lead to quantum leaps in human knowledge and understanding. Sometimes the time, effort, and money is merely thrown into the abyss. The innovations of the Great Housing Bubble were of the latter category.

Street Smarts

The lending industry touted its “innovation” with exotic loan products. They sold these toxins far and wide. Now that these loans are achieving the highest default rates ever recorded, it is safe to say the “innovations” over the last 5 years were not entirely successful. It is amazing that a group of intelligent bankers came up with this loan and expected a positive outcome. When you really look at the whole “innovation” meme, you see that it is nothing more than a public relations effort to convince brokers the products were safe to sell and borrowers the products were safe to use. It is hard to fathom the widespread acceptance of this nonsense, but that is the nature of the pathological beliefs of a financial mania.

Many in the lending industry think their work is like science that continually advances. It is not. It is far more akin to assembly line work where the same widgets are pumped out year after year. When lenders start to innovate, trouble is brewing. The last significant advancement in lending was the widespread use of 30-year amortizing loans that came into favor after World War II. Prior to that time, home loans were interest-only, short-term loans with very high equity requirements (50% was most common.) This proved problematic in the Great Depression as many out-of-work owners defaulted on their loans. A mechanism had to be found to get new buyers into the markets and allow them to pay off the loan. The answer was the 30-year, fixed-rate amortizing loan. To say this was an innovation is a stretch as this loan has been around as long as banking has existed, but it did not become widely used until equity requirements were lowered. The lenders were willing to lower the equity requirements as long as the loan was amortizing because their risk would decline as time went by and the loan balance was paid off.


Over the last 60 years since World War II ended, a number of experimental loan programs have been attempted. These include, interest-only loans, adjustable rate loans, and negative amortization loans among others. It is this group of loans that has consistently failed in the past for one simple reason: if payments can adjust higher, people will default. It is really that simple. The Option ARM is certainly the most sophisticated loan on the market today. It is a dismal failure, not because it isn’t sophisticated, but because it has embedded within it the possibility (probability, no — near certainty) of an increasing payment. Any loan program that has the possibility of a higher future payment will fail because there will be a certain number of people who cannot afford the higher payment.

The Truth

Here is where the lenders lie to themselves and to the general public after a financial debacle like the Savings and Loan problems of the 1980s or our current housing bubble: they blame the collapse and the high default rates on some outside factor rather than the terms and conditions the lenders created all by themselves. There are still many out there who believe the high default rates and problems in the housing market in the 90s were caused by a weak economy. This is rubbish. House prices declined for 6 years. The decline started before the economy went soft, and it continued well after it had recovered. People defaulted because they overextended themselves on loans to buy overpriced housing, and toward the end of the mania, many were using interest-only loans. Whenever lenders start loaning people money with total debt-to-income ratios over 36% people start to default. Whenever lenders start loaning more than 80% of the purchase price, people get underwater and start to default. These phenomenons, which we document daily on this blog, are not new. It happened in the early 90s; it is happening again, and it is happening for the same reasons: lax lending standards.

Bad Credit

Someday the lending community may actually innovate and come up with some financial product that has low default rates which most people can qualify to obtain — Not. Unless you change human nature, there are always going to be people who are too irresponsible to make consistent payments. This is the key to any loan program. Either people do or do not make their payments. You can reinvent new terms and schedules as often as you like, and it will always boil down to people making payments. When these fancy loan programs contain provisions that make it difficult for people to make payments — like increasing payment amounts — they will default, and the loan program will fail. This is certain.

When lenders create new, “sophisticated” loan programs that require advanced financial management on the part of the borrower, both the lenders and the borrowers fall victim to the Lake Wobegon effect. Everyone thinks they have above average abilities when it comes to managing their finances. In reality, perhaps 2% of borrowers have the financial discipline to handle an Option ARM loan. LendersUnfortunately, 80% of borrowers think they are in this 2%. The reason for this comes from the inherent conflict between emotions and intellect. 80% of borrowers may understand the Option ARM loan, but when the pressures of daily life create emotional demands for spending money on one’s lifestyle, the intellectual knowledge that this money should go toward a housing payment is conveniently set aside. It is this 2% of the most disciplined borrowers who will cut back on discretionary spending to make their full housing payment. Everyone else will make the minimum payment, fall behind on their mortgage, and end up in foreclosure.

It seems lenders forget basic facts about lending every so often and create a new financial bubble. Perhaps they succumb to the pressure of the investment community or their own shareholders, or perhaps they just start believing their own “innovation” bullshit and forget the basics of sound lending practices. This is why we need the upcoming recession. These pathologic lending practices must be purged from the system or else they will survive to build an even bigger and costlier bubble — although it is difficult to imagine a bubble bigger than this one, it is still possible.

Housing Bubble

In the aftermath of a financial fiasco, lenders return to the practices that did not fail them in the past. Some will consider this taking lending standards back 50 years. They would be right. The only program lenders know is stable is a 30-year, fixed-rate, conventionally amortizing loan based on 80% of appraised value taking no more than 28% of a borrowers gross income (36% maximum total debt.) This is what is coming. The last vestige of kool-aid denial I see in the comments is the insistence that equity requirements will not get that high. They will, and it will be a catastrophe for sales volumes and home prices. This is why I always post the downpayment and income requirements on my posts. People need to think about Your Buyer’s Loan Terms.

Why would banks continue to loan 90% of value when there is a likelihood of a greater than 10% decline and banks know high loan-to-value ratios result in high default rates? They are doing it now because they have to to make any loans at all, but they are limiting these loans to those with very high FICO scores, and they are betting these people will not default do to moral reasons or the desire to keep that high FICO score. If they try to extend these loans to lower FICO score individuals or subprime borrowers, they won’t stay in business long. Think about the losses we have documented here on this blog. Banks can’t sustain those losses indefinitely. Large downpayments are coming back, and government assisted financing will become widely used by first-time homebuyers to overcome the high equity requirements. There really is no other way forward. The credit crunch we have all been hearing about was not caused by some unexpected or unknown factor, it was caused by the failure of lenders. Credit will continue to tighten until lenders stop making bad loans. The bad loans will not disappear until lenders return to the stable loan programs with a proven track record. That is how the credit cycle works.

Loan Qualification



Note to Lenders:

I plan to purchase in the aftermath of your most recent failure. Please wait until about 5 years before I am ready to retire before you innovate again so I can sell my house near the top of the next bubble you facilitate.

Thank you,


129 thoughts on “The Fallacy of Financial Innovation

  1. lawyerliz

    I disagree with you about 2 things. People do not understand adjustible mtges. I know, I’ve tried to explain them. They absolutely don’t get the concept of a “margin”, I don’t know why.

    Also, the vast majority of lenders are stupid. They, like economists act just like herd animals. Someday, I’ll start a lenders are stupid thread, but replete with examples, but I don’t have time today.

    The second stupidest thing: I was asked at closing (this was in the 80s) to have the buyers write a letter of explanation about an unpaid debt. The amount of the debt? $3.00. I am not making this up. They looked at each other and said, we have no idea what this is about. I made something up, that is, I LIED, or helped them do so, a sentence or 2 long and they signed it. Who would think $3.00 was significant? Who would create a system where a big deal is made out of 3 bucks? Answer: stupid people.

    I never felt one iota of guilt. I love the story.

  2. OCB

    I’ve read your comments over the past months and you have managed to disparage about every occupation other than your own. Today it’s lenders and economists (I am neither). Just as stupid as asking for an explanation of a $3.00 debt is writing a letter of explanation for a $3.00 debt. That’s the nature of the business in which you work.

  3. djd

    My grad school advisor once managed to overdraw on a research grant, triggering an automated audit check intended to find improper transactions. Several person-hours were spent resolving the issue. The overdraft amount? $0.05

    Moral: unintended consequences turn up everywhere.

  4. Brian

    Irvine Renter-

    Love your blog. Please don’t consider me in the last-vestige-of-denial class, but I am afraid that equity requirements won’t return.

    I hope they do, since I have cash to put down, and the return of the downpayment should reduce availble buyers, but I keep thinking there will be found some way to stay 0-down or 5% down.

    As an aside, is my thinking correct that if the 20% down requirement becomes the new norm that it will create further pricing pressure since many buyers will have to sit out until save the cash. (Seems like few people have savings anymore).

  5. lawyerliz

    I can disparage lawyers too, if you like, but eveybody else does that already.

    Lenders however have really distinguished themselves in the area of stupidity.

    There is more to the 3 dollar story than meets the eye.

    If lender force closing agents to work around their stupidities, people like me will know the difference between a stupidity, and something that says, STOP the presses. Your average closing agent will come to the conclusion that everything is nod, nod, wink, wink, and try to work around stuff, when they should be saying, hey, we can’t close this.

    So, in many cases, tightening standards to the point where they can’t be realitically met, actually has the consequence of loosening standards.

    I wrote some more stuff and it went away. Must go to work. . .

  6. IrvineRenter

    Just because high equity requirements will crash the market does not mean they will not become reality. As I mentioned, there are government programs to help first-time buyers put down less money, and these programs will help the bottom tier of the market get around high equity requirements.

    High equity requirements are the natural result when lenders become risk adverse. During the Savings and Loan disaster in the 1980s, 100% cash-out financing was common on commercial properties. Once the market crashed, equity requirements came back as high as 30%. It was only once the market recovered that equity requirements dropped back to 20% and over the 25 years that followed gradually declined (and of course built another commercial real estate bubble that is just now starting to deflate.)

    My contention that equity requirements will return is based on my observations of past credit cycle events and the recognition of the need for banks to preserve their capital. If you were a lender, would you provide a piggy-back loan in this market environment?

  7. IrvineRenter

    I like your stories, and if you disparage a particular profession, you generally back it up with specific examples of why they deserve it. It is one thing to say lenders are stupid, it is quite another when you prove it.

  8. zornundo

    There are stupid people everywhere. I am convinced that the intelligence of the average American is stupid and then when you start looking at below average, you’re getting pretty stupid. To make matters worse, when people see and talk $$$, they get stupid, fast.

    I am very happy right now to be living in a paid off single-wide and am saving up for a down payment to build a house. I see the FHA loans that are available and they look pretty tempting for somebody without the 20% down payment saved up. I could very easily scrape up the 3% required for an FHA loan, today, and take a loan out. But that would be stupid. Ten percent down may be more likely in a few months’ time and I could hammer down that principal to achieve a 20% equity stake (thank god I own the land!) via our income. I’m guessing I’m ahead of the curve because I’ve at least thought this much ahead.

    I think I may just wait for the 20% down after all. I am quite rational when not fighting a bout of delirious house fever. I’ve lived in this single-wide for over five years. One and a half more won’t kill me or my wife, but oh man is it getting cramped!

  9. Mr Vincent

    In the late 1980s I stated working for a very large Savings and Loan. We had a meeting with the CEO a few years after that and he said the following: “Similar to the monolith in the movie 2001: A Space Odyssey that shows itself as each innovative period of man begins, the advent of the ARM loan has become the same for us.”

    It did not take me long to figure out that anything that is good for the bank is probably bad for the consumer.

    I know there are some people who say things like “Well, my ARM loan served me well between 1994 and 1998” or whatever years ARMs had an advantage. Thats fine, but let me repeat my little story and tell you what an ARM loan would have done to me if I had used it when I bought my first house.

    I bought my first house for 62K in 1978. The price I paid was actually at the top of a mini bubble which occurred in so cal back then. The interest rate on my 30 yr fixed had just jumped to 10% at close of escrow.

    A few years after that, interest rates jumped to around 16% on home loans. Guess what would have happened to me if I had used an ARM loan? I would have lost my house. The importance of that goes way beyond just losing my house. Owning my first house is what got me started as a real estate investor and now allows me to type this message from the comfort of my paid off home, after early retirement at 45.

  10. lee in irvine

    “The first thing we do,” said the character in Shakespeare’s Henry VI, is “kill all the lawyers.”

    Just kidding!

  11. Rock

    “It is this group of loans that has consistently failed in the past for one simple reason: if payments can adjust higher, people will default.”

    I agree.

    But what about the 40 year fixed mortgage impacting “affordability”?

  12. tealeaf

    Mr. Vincent:

    I enjoy your posts, and I have read this tale of yours before. Great story, but it’s now history. I get the point about ARMs, but the dream of wealth from So Cal RE has been deferred for many years to come.

  13. tealeaf

    Do the math. Even at 50 years, the difference in the payment is a pittance. You have to step to *gasp* a very Japan-like 100 year mortgage. No thanks.

  14. tealeaf

    One small note on this: generally, the longer the term, the higher the rate; in this case, that nearly wipes out any advantage.

  15. Mr Vincent

    Sorry for my redundance tealeaf. 🙂

    “but the dream of wealth from So Cal RE has been deferred for many years to come.”

    I can’t argue with that. I am not proclaiming that anyone can get rich in real estate. My main argument is with the type of financing that is used for purchase.

  16. Alan

    Scanned your post and disagree that you blame lenders while downplaying wall street’s role. These loans wouldn’t have been possible unless wall street created demand for them and a buyer.

    The securitization of mortagese into sellable income streams (SIV’s) whas the major “inovation” that allowed the bubble to grow.

    In one of Krugman’s lectures (I’m a big fan), he points out that if you look at who makes the most money in the USA, it’s not lawyers, doctors or Indian chiefs, it’s the shills of wall street. They create these financial vehicals that promise just a little higher yield and sell them, racking up enormus fee’s in the process. Krugman points out that time and again these vehciles (this cycle it’s the SIV’s) were actually risky and eveyone ends up losing money execept the wall street shills who scam their fee’s out of the economy. Krugman’s concern was just what does wall street contribute to the economy, even though they are the highest paid, they function more as parasites since they don’t pruduce anything.

  17. patience2007

    Right now, 20% down is at least $80k. Not too many first-time home buyers have $80k sitting around. So either prices have to come down, or the 20% requirement will have to come down. I think that keeping the 20% down requirement and letting prices drop would be healthiest for our economy. (Although, I have no clue how I’ll ever find the 20% to buy my first home.)

  18. FairEconomist

    Two points:

    First, more than 80% LTV is acceptable if the bank can make a reasonable assumption of increasing house values, i.e. prices are currently affordable, at rent saver levels, not dropping, and the local economy is stable. This niche might have to be filled by an investor/bank rather than the current banks due to the need for extensive forecasting and analysis skills.

    Second, high LTVs may be sustained by government subsidy. We can already see subsidies from the government for high LTVs in the current FHA programs, and there are serious plans to radically expand it currently in Congress and facing no substantive political opposition. Under these new rules the down payment requirement will be ZERO and the conforming loan limit will be raised to levels where even most Californians will be able to use it. I don’t see any chance for successful opposition, because if any political group managed to block the FHA expansions, they will get blamed for the coming housing crunch and crushed politically. The blame would be unfair, but we’re talking politics here.

  19. IrvineRenter

    “First, more than 80% LTV is acceptable if the bank can make a reasonable assumption of increasing house values, i.e. prices are currently affordable, at rent saver levels, not dropping, and the local economy is stable.”

    This is the exact line of reasoning banks follow after a crash, and it is exactly what facilitates the next bubble and perpetuates the credit cycle.

    “Under these new rules the down payment requirement will be ZERO and the conforming loan limit will be raised to levels where even most Californians will be able to use it.”

    If we allow zero down speculation through the FHA, we will have another S&L fiasco. The only bright spot to the mess we are in now is the the government is currently not the bagholder. I think someone with intelligence in Washington (I know there are not many,) will see the folly of providing zero down loans, particularly in light of the performance of these loans in the crash we are witnessing now. The proposal in your link is merely an attempt to make the government the bagholder for the crash. The sad part is that it might pass.

  20. buster

    I would disagree that the lenders were stupid — or would at least qualify that as “final lender.” The loan originator, the initial lender, the Wall Street banks all were just middlemen passing this worthless paper on to European and Asian investors. They are the final bagholders. They saw the “AAA” rating and didn’t look any further. And it will be them that takes the hundreds of billions in losses.

    The US banks, including WaMU, BofA, Wells, Citibank, etc. got stuck mostly with the toxic waste stuck in the pipeline on it’s way to Asia. It was the stuff originated but not yet sold to the final sucker at the time the music stopped. And it’s basically mice farts when compared to all the crap that already got sold.

    The basic problem comes down a simple, simple issue. The loan originators and the middle men had nothing to lose by giving away money to people who didn’t really qualify: It wasn’t their money. So giving away the money they did, and reaped huge fees for doing so.

  21. John

    As long as prices continue to decline, even those who’ve owned before will have a hard time coming up with 20% for a move-up or move-on.

  22. Alan

    The problem is not LTV 100%, 80%, 70%.

    The problem is the borower, will the borower pay it back.

    If the banks can sell the loans to someone else, making sure the borower can pay it back before they write it is no longer their problem, all they want is the fee’s on the deal.

    Making the banks hold the notes, so that they take care that the borowers’ can pay it back and when it doesn’t, their covered enough so that they wouldn’t lose on the deal, that will solve the problem.

  23. Law_Student

    That is correct.
    Lenders are stupid. Bloggers who rent are smart.

    All the smart people knew they shouldn’t have bought a home in the late 1990’s.

    All the lenders and investors who made millions in the last ten years are stupid.

    The buying opportunity that is coming will be similar to that of the late 1990’s. Are all the blogging geniuses going to be smart enough not to buy again?

  24. NanoWest

    I for one like Lawyer Liz…….she bring that east coast feeling to California…(maybe thats why its raining)….I will get upset if she starts to pick on us nanotechnologists.

  25. Flyovercountry

    Law_student: The great thing about strawmen is that after you beat the crap out of them, you can always build a new one. You’ve managed to sarcastically deflate an argument that no one here is making.

    Most posters here are not saying that anybody buying a house in the past 10 years is stupid. Its the ones who bought a house in a bubble area in the past 3-5 years that are suspected of being less than brilliant… and the ones that did so with loans that they cannot afford that are ones that are confirmed to be less than brilliant.

    If you actually read the posts on this board, most of the people following this blog are the ones who WANT to take advantage of the coming buying opportunity. They are following this blog so that they can tell how big of a buying opportunity it might be, and how long they might have to wait. Even the most bearish of the posters here are people who eventually want to buy, they just aren’t willing to do so in an irrational market.

  26. mark

    “Whether they like it or not, each participant in the market will come to realize it was a colossal mistake.”

    This is an overreaching statement IMO. A “colossal” mistake? Let’s explore the same household making opposing decisions:

    1. Within the last five years this household purchased a median-priced Irvine home ($600K +/-) within their means. The real value lost to date is probably around 15%, or $90,000.

    2. Instead of purchasing within the last five years, this household chose to rent. If they financed a new $50K car (because they’re earning a good income and have plenty of discretionary), their net worth will also lose $90,000 (assuming they’d pay 6.5% servicing the debt instead of earning 6.5% by saving the same over five years; also assuming the car has no residual value which I think is fair considering the $90K saved will continue to grow).

    Now if the value of their home drops 30%, then that’s the same as financing two cars at $50K each. Do you see the moral of my story? There are many financial decisions you’ll make in your life, with many competing interests. Purchasing a home in the last five years will not likely have been a “colossal” mistake, provided you purcahsed a home within your means.

  27. Priced_Out_IT_Guy

    Why is stupidity the scapegoat today?

    The two lenders that I now work with are by no means ignorant. They knew exactly what they were doing–selling as many loans a possible to make the largest commission possible. They knew that the consumers they sold loans to could not pay them back, and that their Option ARMs would self destruct. In fact both of my coworkers admit to repeatedly telling their customers that they absolutely positively have to refinance into a 30-year fixed prior to the recast or face almost certain foreclosure, since the customers could not pay the 30 year fixed to begin with. The customers got the loan anyway in anticipation of appreciation. The originator, broker, and buyer knew what they were doing, they were just gambling. Some won, many lost, and some of us sat around to watch the carnage.

    Are the gamblers that lose are idiots, and are the ones that win geniuses?

    Some of the kool-aid participants may have had lower than average IQs, but I don’t think they existed in sufficient quantities to start blaming stupidity for the bubble.

  28. Purplehaze

    Your argument is more to the point that if people have the means to afford the payments on a home then what does it matter if they spend it on a home versus a car or anything else since they would spend the money in any case – I think I understand the point you are trying to make.

    But what you are saying is different from what IR is saying – people buying something that they CANNOT repay as they do not have the means to do so – have made a colossal mistake. So the two arguments are just two sides of a coin IMHO.

  29. rickhunter

    Alan – I think your post says it all about following the herd. It starts with GREED. People that have money want to make more money. Wall Street creates products to sell to those people. Guess what though, average Joe’s day trading buys into this too etc.

    Lawyerliz – People are not stupid, what they do are stupid as your example illustrates. Everybody does something really stupid in there life one time or another.

  30. rkp

    As usual Mark, you bring some good balance and sanity to the comments section.

    However, I disagree that people would just burn that money on other products. In case 2, the household bought a new $50K car but what if they actually needed a second car regardless. Lets say at the minimum, they needed to buy a $20K Camry or something. Well that changes the loss to their net worth and makes case 1 worse as they would still need a $20K car after buying the house.

    Also, the bigger issue is that they might not be able to refinance into a more favorable loan product now that their house fell $90K.

  31. no_vaseline

    Boy, did everyone get up on the bitter side of the bed this morning?

    I blame the banks who have a responsiblity to make sure the lender can repay the loan – a responsiblity to BOTH the lender and whoever winds up buying the CDO.

    When I did special assets in the early 1990s, if a loan went non performing, we would continue to satisfy the CDO using bad debt reserves and either get the loan performing or foreclose. Either way, we were on the hook for the loan – if the customer didn’t pay, it was our problem.

    Apparently this current crop of CDO’s doesn’t require lender recourse, which is insane because now the lender doesn’t have any reason to STOP a customer from borrowing money they know the customer doesn’t have any chance in paying back. If they did, they would of never wrote a single NINJA loan.

    Liz isn’t wrong. Take that from somebody who used to work at a bank.

  32. rkp

    Is there any way to find type of loans by zip code? I would love to see how much of Irvine households bought neg am or 3/5-year ARMs in the last 2 years. That data would be extremely beneficial to know if people are living above their means in this area and how much damage we can expect to Irvine RE prices.

  33. Formerbanker

    We refer to the lenders and the bankers as greedy and stupid – and yes, many are.

    But speaking only from my own experience only, the drivers of the meltdown in lending standards are: 1) Lenders that were NOT banks…like Countrywide (yes it’s got a bank arm but it was the non-bank entity that was the origination machine) and all the subprime finance companies (New Century, etc. that aren’t around anymore) and 2) Investors willing to buy the toxic junk (those who bought the securities), without whom these loans never would have been originated in such mass.

    Cut the basic banks some slack. Commercial Banks and S&L’s are far more regulated that all of the finance companies and other lenders. And even if a Financial holding company has both a bank and nonbank lending entities (Countrywide, Citicorp, etc.), the ‘bank’ regulators don’t get a full look at- or a full say about – that nonbank origination world, until it starts resulting in big time risk of loss for the bank itself.

    And thanks (sarcastic) to Greenspan keeping rates mightly low way too long, those losses didn’t materialize until last year. Can you imagine if in a 2005 market, banks said, “we need to be more conservative in lending “? Also, don’t underestimate the pressure that bank regulators get, politically speaking. It’s difficult, when there are no actual loan losses, for banks to be forced or encourage by any regulator to change lending practices that would restrict loans for homes!! There’s no government support for cutting off credit to the ‘common man’.

    Since Wall Street Banks package the loans and sell the securities backed by this stuff – and made a lot of $$ doing so- I absolutely agree that wall street was also a big driver. But the rating agencies didn’t help by rating this junk so high, when common sense told you these were all collateral dependent loans that would deteriorate if values dropped. Bankers and rating agency analysts (I suspect) who kept saying “this is going to hurt” sounded like the boys who cried wolf for years (no loan losses in 03,04, 05, 06, remember ?) and so no one believed them.

    By the way, investors were steering away from bank stocks that could not perform as well as the behemoth Countrywide and the largest of bank holding companies that were making huge profits off the sale and securitization of these loans. Very few regional S&L’s and banks that make mortgages and keep them on their books are around compared to 10 years ago. When there’s a broker around the corner who will offer 0 down, option ARM for a jumbo loan that it’s originating for Countrywide, those banks can either 1) offer the same product and sell it to the street (that’s when banks and S&L’s started ‘originating’ the same product as the non-banks), or 2) the bank was sold because it could not compete.

    Just one person’s opinion.

  34. Alan

    The ones with the real low IQ’s were the real estate agents who bought into the toxic waste they were selling.

    The San Diego blog last week profiled 6 foreclosed homes, 1/2 were owned by real estate agent speculators.

  35. Formerbanker

    There’s a company called Loan Performance that gets loan data from pretty much every major servicer and for a cost, might be able to get you info per zip code – I know several years ago I could get info by city but I’m not sure what it offers now (It was bought by First American since I last used its services).

    sorry, having trouble inserting a link.

  36. Chris

    This kind of lending bubble isn’t really new, and the financial ‘innovations’ aren’t really new either:

    * In one of his B-H essays, Buffett has a great riff on how zero-coupon bonds created a junk bond/corporate debt bubble in the 80s. Its exactly the same sequence: Someone realized that historically, you could get better returns by lending to corporations with bad credit ratings, even adjusting for default risk. Junk bond lending become popular. The availability of credit to corporations decreased the rate of default, making it appear that the strategy was less risky than it was. The supply of attractive junk bond opportunities was exhausted, but to keep the commissions flowing, ever more elaborate deals with interest-only characteristics were invented. The whole thing eventually collapsed. (There is also a fairly good riff on this in Lair’s Poker)

    * Minsky described the progression of debt markets through these stages. Emerging market debt, farm debt, CRE, etc, have all gone through this kind of bubble before.

    I think the ‘innovations’ will return eventually. It may be a long time before anyone decides to apply them to consumers again, but you can be sure that as long as wall street works on commission, they are going to find some way to push ‘innovative’ financial products that climb the minsky ladder.

  37. houseonlegs

    Lenders will usually have a certain investor for a certain product, they write their guidelines for the product based on the requirements of their investors. Investors would pay a certian yeild for a product depending on it’s rate of return. For example, a lender would sell off a bundle of $50 million worth of option arm loans to an investor, the investor would pay the lender a rate of 105%, that is when times were good. When the default threshold was reached on these option arm loans, investors would not pay the lenders 105 to take them, it was more like 88. So the lender would have to pay a pretty high premium for the investors to take these loans off of their books and service them. Guidelines were changing so quickly that by the time the loans were approved and funded, wall street didn’t want them anymore. What happened was bankrupty for many lenders. It is the lenders fault for a lot of it, they knew that if the loans they were underwriting and approving would default, the company would fail.

  38. Flyovercountry

    I didn’t use the phrase “colossal mistake” so I won’t defend it that much… The bubble market as a whole was a colossal mistake. But for most individuals in the past 3 years, I’d call it just a “big mistake”.

    Of course, if you are renting a house/apartment because you can’t afford a house, and are buying a succession of $50k cars…. that would be a big mistake too.

    As for the math in your item “2”. I have no idea what you are talking about. Someone rents a house and buys a $50k car, which would probably still be worth $10-20k at the end of 5 years, and that has turned into a $90k loss?

    I’m gonna pick household #3 that decides in 2004 that houses are way too expensive… so they rent and divert thier the cost savings into CDs, and a mix of stock and bond funds, while driving a late model just off lease used luxury car, or a new accord/camry. They are the smart ones.

  39. Purplehaze

    Ok if today’s discussion is on the blame game, then so be it. But I do not think it is critical from a move forward perspective. Hey blame greed if you want to and the people who created conditions to perpetrate this greed. Given a chance most of us are greedy. But what does it matter which person did it. How does it help you or me?

    From my perspective, I want to buy a nice house and get the most bang for my buck once valuations return to some normalcy. I have accepted what has happened in the bubble including the greed of everyone involved. Now how and when can I buy a new home here in OC? Lets talk about that.

  40. mark

    “Someone rents a house and buys a $50k car, which would probably still be worth $10-20k at the end of 5 years, and that has turned into a $90k loss?”

    Yes. Run the numbers the next time you’re considering financing a car. If you finance a $50K car, instead of continuing to drive a car that’s “paid off,” the monthly cost to service the debt @ 6.5% is $978 monthly. You can safely assume your ins cost will increase as well. If instead of buying/financing that $50K car, you save $1,000+ monthly and earn 6.5%, over five years you’ll have increased your net worth nearly $90K.

    So yes, you can consider the purchase and financing of a $50K car a $90K loss after five years. Sure the car will have some residual value after five years; and the $90K will continue to grow while the car continues to depreciate.

    That’s the problem I have with commenters who talk about how “stupid” ALL home purchasers of the last few years are, and how “colossal” the mistake they’ve made is. It’s all relative. I just want the commenter who makes this claim to look at their purchases and maybe understand the pot sometimes calls the kettle black.

  41. No_Such_Reality

    There’s a world of difference between having $12,000 for a down plus $4000 for a point, plus another $2000 for closing costs and fees plus $6000 for three months of reserves verus $0 and having $150 dollars for a inspection and burying all the costs into the loan.

    3% down requires close to $25,000 sitting in your savings and checking accounts. Zero down requires you curtail a single dinner out.

  42. ipoplaya

    In an effort to generate some discourse other than endlesss pontification re: who/how/what caused the bubble and who/how/what is stupid, I found an encouraging sign today in my scouring of MLS:

    $290 per sf newly added. Not really though, since it was up forever at $949K with a different realtor and expired I believe. These people went crazy with the tile throughout the house, but the home ain’t so bad. Lot size ain’t so tiny. Not backed up to a busy street. Almost buyable… Two blocks away from a good TUSD elementary school and nice park.

    Good luck to these sellers now:

  43. Iblis

    Lenders were not dumb. They had willing buyers for the loans they originated. So they originated them, took their fees and washed their hands. So did everyone else in the food chain.

  44. IrvineRenter

    How about we assume the person who chose not to buy a house instead put the savings versus a mortgage into a bank earning interest. Now rather than owning an asset that has declined in value $90K, they have cash in excess of $90K, and the monthly payments have been the same (rent + savings vs mortgage.) Let’s further assume this person buys a similar house at the bottom and now has an identical asset for $270K less than the person who purchased during the bubble.

    What circumstances would the two parties be in then? The bubble buyer and the crash buyer have identical assets worth the same amount. The crash buyer has equity from the downpayment saved during the crash, and the bubble buyer is underwater. The bubble buyer is spending twice as much as the crash buyer each month on a house payment, so the crash buyer can continue to save money while both parties enjoy the same lifestyle. At this point, the bubble buyer is flushing major amounts of interest payments down the toilet each month because they overpaid while the crash buyer is saving lots of money.

    When you compare the circumstances of the two parties, I think it certainly looks like a mistake. Does that make bubble buyers stupid? No, smart people make mistakes. I never said they were stupid, they just made a very costly mistake.

  45. ipoplaya

    Be careful of your generalizations IR. Over the past 5-6 years of bubble ownership, I have saved approximately $100K owning vs. renting on an after-tax basis. All this while my $50K down has grown into $275K of equity. That $50K would have been $65K or so if I had parked it in a money market and rented over these years. Even if my equity goes to zero, which would be close to another 50% price drop, I am still ahead by that $100K I saved vs. renting.

    Some bubble buyers (you have said 2001-2002 were already bubbly) made wise financial decisions and over-generalizing their behavior smacks a bit of non-buyers remorse. Can you honestly say that you are better off financially today than you would have been if you bought 2001 when you got to SD?

  46. IrvineRenter


    Much of the money you saved during the last several years is because you took on risky financing. It worked out for you because the market moved in your favor, but later buyers will not be so lucky. In 2001-2002, prices were high relative to rents, but one could make the argument that it was close enough to warrant buying, particularly if you could lower your cost below rent with risky financing.

    When I first arrived in San Diego, I did look at buying, but decided against it partly because of price but partly because I did not know how long I would be living there. When I watched prices started to skyrocket in San Diego in the summer of 2001, my reaction was not one of greed or buyers remorse, but one of “OMG this can’t continue.” Of course, it did because it was the beginning of a massive financial bubble, but I certainly do not regret my choice. I think it will be very hard for people to accept the evaporation of their imagined equity.

    Would I be better off today? I suppose that depends on whether or not I had convinced my wife to sell at the peak. By the time prices bottom out, there will be no financial benefit to those who bought and held on versus those who simply rented, and it will be far worse for those who bought in 2004 – 2007.

  47. Stupid

    Eyeball: What might be the housing surprise we’ll be talking about a year from now?
    Burns: There are two things that won’t surprise me but may surprise most: (1) That the banking industry will struggle, with some of the largest U.S. mortgage lenders struggling to survive and many of the regional banks going out of business. (2) That home buyers will need a minimum of a 20% down payment that they will have to prove came from their savings by showing historical bank statements, and that their housing costs and all other debt will not be allowed to exceed 38% of their very-well documented income. In today’s environment, Wall Street considers a 80% loan in California to be a risky loan. For those who are waiting to buy a home and won’t have the down payment for a number of years, you better not wait much longer and you should be sure to consider the values in the new home business. While that is a shameless plug for my home building clients, I am certain that any consumers who do their homework will agree with me.

  48. ipoplaya

    Holy bad decisions Batman, I didn’t realize just how nuts SD went until I looked it up. Almost 50% appreciation in median between 2001 and 2003. Is that right?!

    So IR, if you’d have bought a median home in SD in 2001, price around $300K, could have probably unloaded in 2003 for $450K or so when you came to Irvine. Dude, that tax-free gain would probably have paid all your rent since then and into 2008…

    Even if you would have bought here in 2003 with those gains, you’d likely still have to be better off vs. renting. In 2003 you could have locked up a 30-year in the low to mid 5% range, saved some bucks vs. renting all these years, and still have at least $200K of equity.

    I understand hindsight is 20-20 and all that, but it would be nice to hear, just once in a while on this blog, the other side of the coin. Yes many bubble buyers were stupid, especially those that bought in the past couple of years. But many current renters were stupid as well because they thought prices were too high in 2001/2002 and didn’t buy when they had the chance.

  49. ipoplaya

    Bad thing is a 160 GRM means this Parma place should fall to $650K or so. Feels like a steal right now, but could fall another 25-30% from $290 per sf. Argh, I hate the waiting…

  50. Alan

    IPO, for someone so swavy on the stock market and 401k’s your real esate postings defy logic.

    Look at the latest data from lasner (old already)

    OC has 4669 properties priced $750k or greater chasing only 239 buyers/month w 14 months plus of inventory.

    all the properties you covet are priced over $750k, the laws of supply and demand doom these sellars.

    prices will not fall in a week or a month but glacially slowly over the next two years.

    with the supply of free money gone and a recession inevidable there will be no surge of buyers available to snap these properties up. Since some sellar has to blink first, creating new comps for the rest, the result is predictable.

  51. IrvineRenter

    If I had not just moved to San Diego and knew nothing about it, I might have bought. The prices were high relative to Florida, but they were not too high relative to incomes in San Diego.

    Like any market, if you knew in advance what was going to happen, you could make a fortune. If you spend any energy imagining the perfect trade you would have executed at some point in time, you are only deluding yourself. I could have just as easily bought a place there watched the values drop and be trapped in a place where I did not want to live — like many are facing now. The upside only becomes apparent in hindsight.

  52. ipoplaya

    How can my posts defy logic? I simply posted a link to a home that listed at $290 per sf. Sub $300 per sf has been rare to date and I have opined that it is refreshing to see such a change. What about that is illogical? You might not think it’s a good sign to see sellers recognizing market realities but what about that makes anything I post illogical?

  53. zornundo

    “Since some sellar has to blink first, creating new comps for the rest, the result is predictable”

    firesale, woot woot! 🙂

  54. Kirk

    No, you mean brokers weren’t dumb. Lenders were very stupid, because they used SIV’s and CDO’s that relied on issuing short term bonds (ACP) to fund long term mortgages. Yes, they sold those bonds to Wall Street. Ha ha, it’s Wall Street’s problem now… as long as the stuff explodes before the bonds come due. Oops, the bond holders figured out the scam and didn’t purchase a new set of bonds once it was apparent the mortgages would fail sometime in the future. So, the banks paid back the bonds at maturity and put the mortgages on their books.

    This is the main reason a ton of commercial paper hasn’t failed. Not many people bought the bad stuff. I laugh when people say there isn’t a real problem in commercial paper since most of it paid out. The new ACP wouldn’t pay out. That’s why it’s not selling.

    At least the banks soaked the equity tranches. That should soften the blow for them. But, they should have offloaded the loans completely. I’ve got no idea what they were thinking. Maybe they really thought this wouldn’t blow up beyond the equity stake.

  55. skek

    Ah yes, the most widely taken out of context quote in history. The plotter in Henry VI was strategizing revolution and felt that the lawyers, who represented independent thinking and the rule of law, were the greatest obstacle to the plan. The quote is the opposite of derision for the legal profession, it is actually great praise for it.

    Lee, I know you were joking and possibly even knew the context of the quote. My comment is just a bit of trivia, not a criticism of your post.

    To anyone else who might respond, I concede in advance that ambulance chasing trial lawyers and their ilk are scum and don’t represent “independent thinking and the rule of law.”

  56. mark

    The buyer you describe will be in a phenomenal and enviable position relative to the bubble buyer! If they continue to make such wise and prudent decisions in all their financial endeavors they’ll amass great wealth.

    However, any gain they make on their neighbor in purchasing at the right time can be lost quickly and easily by any number of life decisions. e.g. purchasing/financing nice cars frequently, having a child or many children, getting divorced, etc.

  57. skek

    That’s the key — first time buyers get assistance to come up with the down payment, either government, parents or because the purchase price on an entry level home/condo is small enough that you can save/borrow the down. Move-up buyers typically use their equity for the down payment on the new home. With declining/flat home prices, the move-up market dies on the vine. This means sellers are competing for a shrinking number of buyers who have the cash, and those buyers know they have the leverage to drive a hard bargain. Prices decline further, cycle repeats. I think this is the market dynamic we will be seeing for the next 12-18 months at least.

  58. gepetoh

    So that must make those of us who bought in 2000 and sold at the end of ’04 brilliant! Or just lucky. All these talk of supposed stupid people are nauseating. The widely accepted notion is that the mortgage bankers and realtors – from an individual to individual standpoint – made out like bandits at the expense of the “less educated” (but not necessarily more stupid) consumers. I find this to be immoral, but not necessarily stupid. They may have been the smartest of them all, actually.

    We the consumers basically roll with the punches for the most part, especially those that are not as saavy financially as most of the people on this board. What many of us possess from the financial knowledge perspective can’t be construed as “normal” knowledge in average America, but rather an educated knowledge. Just because they did not educate themselves in the financial world does not mean they are dumb, just not knowledgeable in that particular field. I mean, I know nothing about calculus or quantum physics but that doesn’t make me stupid, just uneducated in those matters.

    Does it behoove them to learn about finance and investments since it will be the backbone of one’s financial well-being for the rest of their lives? Absolutely. However, the last time I checked our educational system does not REQUIRE someone to learn investments at any level. So maybe it is the education is to blame, but it certainly isn’t stupidity.

  59. rickhunter

    mark – those are very deep statements you made. I totally agree that your spending habits have as much to do with your wealth as well as your investment decisions.

  60. zornundo

    If you’re about to make the biggest purchase of your life, wouldn’t you want to educate yourself on the matter?

    This is how we end up with people only concerned about the monthly payment. They don’t care or know enough or are not curious one bit how this will affect them. Formally educated or not, people should at least give a poop about this large sort of transaction and actually do their homework!

  61. lawyerliz

    I don’t know what a nanotechnologist is. What is it, so I can pick on you?

    Nano means small. Wesley Crusher’s Nanites were always running amuck on the Enterprise.

    You build teensy tiny machines, like I see in Science News sometime?

    I admit, I am too harsh. My attack on Economists was not thoughtful.

    However, I do know lenders, and they are STUPID!!!!!!

    All exclamation points intended.

    I find when a real estate atty says to another one, you have a problem here, the other one takes it seriously. The first re atty may be wrong, but almost certainly has some sort of a point, which needs to be resolved. Litigators are all to often acting like gorillas beating their chests, saying I am biggest gorilla in forest, don’t mess with me. Sometimes this actually works. I find it extremely annoying. But now that I have virtually no real estate practice, and not enuf probate, I find I have to do real estate litigation or shut up shop. And litigators who know no real estate and think they can learn in a few burning midnite oil sessions are the most frustrating of all.

  62. Genius

    I thought prices were too high in 2002, does that qualify me as stupid?

    Don’t confuse luck with intelligence.

  63. lawyerliz

    Ah, let me count the ways. When I have more time, I will post extremely large numbers of stupidities.

  64. Genius

    If you are patient I bet you can pick it up for $650k. Maybe less if the economy is tanking.

    Driveway looks too small for playing hoops though.

  65. lawyerliz

    Lord help me I agree with most of what Kirk says. Kirk, if you can contribute like this, why do you want to act like a troll most of the time?

    But I disagree in that lenders are being forced by something, I’m not sure I understand quite what, to take this trash back on the books. Like Citi.

  66. lawyerliz

    I totally agree. Once you have over a certain amount in income, what matters is what goes out, not what comes in.

  67. lawyerliz

    That is a cute house with a lotta square feet. Still just a bit pricey, but I would blame anybody who bought it.

    My only complaint is that once more, the picture features the driveway. They could have taken it from the other angle and feature the grass, and the entryway by which the human beings enter.

  68. Alan


    maybe the next topic will be how useless these so called experts have become at predicting the future, how they have turned themselves into mouthpieces for the retailers.

    When I was college, I took an economics course, it was taught by one of our trustee’s. He told a story of how when he started out he worked for a paper company and his job in accessing inventory was counting trees.

    It seems none of the purported experts posting these predictions spend any time counting trees anymore. If they did they would say 5000 houses priced at 750k+ chasing 250 buyers, project how much more inventory comes on the market over the next three to six months and how many new buyers may jump in or out… and come to a valid conclusion instead of just spewing “I see a 10% fall in prices in 08” with nothing to back them up, just blah, blah, blah…

  69. lawyerliz

    I think I started this. I didn’t think it would be the mantra of the day.

    Yes, some brokers made a lot of money, but now they’re out of business.

    Yes, many realtors also made a lot of money, but a lot of them are out of business too.

    Yes, the non-banks made a lot of money, but now they are out of business. See the Implode website.

    Yes, the banks made money packaging the toxic waste, but they were stuck with what was in the pipeline, plus are apparently on the hook, somehow, for a lot of stuff they sold.

    So yes, they were very short term smart, but medium to long term very stupid.

    And nobody that I ever tried to explain the concept of margin to seemed to get it. I think I am a pretty good explainer. The average person certainly has a blind spot here. And when I’m closing a transaction, I don’t have all the time in the world to do it in. I answer questions, but the degree of ignorance means that the borrowers really can’t formulate a question.

    Someone above made the very good point that either you competed, or you didn’t make any loans. I guess if you were smart enough you could have decided to not make any loans, and that would have got you fired.

    I suppose you could have tried to offer a product that was less toxic. For example, I know some people who made 10 year interest only loans. Bearish tho I am, I think these people will be doing just fine in 10 years. All this will be over in 2017. If it isn’t, even people like Mr. V and I who own paid off houses, will be more worried about procuring ammo and oiling our guns than who has what kind of mtg.

    And I don’t seriously think this is gonna happen, but we do have guns, ammo, a bit of cash, and physical gold. For a Black Swan event

    (I can’t praise that book enough. Y’all go out and buy it immediately!!)

  70. Alan

    Haven’t read the book but checked the wiki on it.

    Can’t agree that the current bubble pop is the result of a black swan event. This is the normal part of a business cycle, one that could have been predicted early on to a reasonable observer (I consider myself reasonable and I self predicted it) and one that was fuled by excessive greed and outright fraud. That’s like saying that ENRON was a black swan event.

    Sept 11th on the other hand was a black swan event.

    Just because you get a hammer for X-mas doesn’t make every screw a nail.

  71. Alan

    Cute house, are we looking at the same pic’s

    It’s a 2 story, grey-stucco box, 10 feet separting you from your neighbor with almost no yard. It has no view and is not located 2 blocks from the beach.

    Oh excuse me…

    It’s in IRVINE


    I forgot

    That makes it ok

  72. ipoplaya

    Indeed it is. And there are too many cars on the street for my liking as well. Don’t know what the deal is there. Two cars in every driveway plus seemingly another 1-2 on the street…

    Ability to do driveway hoops is high on the needs list. Made the mistake of trying to teach my 3-year who all the Lakers were last night. Got a hear him say for a whole half, “daddy, where’s Kobe?” and “Which is one Kobe dad?”.

  73. lawyerliz

    Depends on how bad it gets. We don’t know yet.

    Anyway, read the book.

    For me, hurricane Andrew was a Black Swan event, tho predictable, so I gues it wasn’t and “unknown” unknown. I haven’t finished reading the book and will probably read it several times.

  74. ipoplaya

    Had time to post that drivel but still couldn’t come up with how I am defying logic with my posts huh?

    May I remind you that this is the friggin’ IRVINE HOUSING BLOG. “Welcome to the Irvine Housing Blog! We’ll be focusing on real estate developments in the City of Irvine.” Let me scream it again, IRVINE HOUSING BLOG. If you want to talk about views and the beach, you should be posting to somewhere else. Last I checked, very little of Irvine had views, none of it was close to the beach, and much of it was constructed using stucco…

  75. ipoplaya

    Yeah, I kind of like it too. I guess in Alan’s imaginary Irvine, the houses are more than 10-12 feet from one another. Unfortunately, that is not the reality of the city. As a prospective buyer in IRVINE, I accept the fact that the houses on either side of my future home will be close to me.

    Problem with this particular house is they planted all kinds of bushes, vines, and such on the side by the front door. It’s over-grown (drove by there this morning) so it wouldn’t make for a very good picture. You can barely see the front door from the street.

  76. No_Such_Reality

    I fail to see the desirability of that home.

    It dominates it’s lot will little spare space for a yard. You can perhaps BBQ on it, but don’t have too many guests, as in more than four. Look down two doors and you see a lot that barely squeezes in a small wading pool.

    The neighbors units are set very close.

    It’s west Irvine, far from the beach and likely requires AC to be run 250+ days a year.

    It is less than 100 yards from Jamboree and less than a 400 yards from the 261 Toll road.

    It has substantial mello-roos on top of the taxes.

    Okay, by Irvine standards, this is desirable. But frankly, that’s a low target.

  77. 25w100k+

    I’m curious, does Alan own a house? Or are you renting, holding out for something great. Do tell, what requirements must be met for a house to be considered ‘nice’ by you, that you would live in?

  78. ipoplaya

    Almost – “De gustibus non est disputandum”.

    I like stucco. It’s less likely to catch on fire… If I’m going to live in the “seventh circle of real estate hell” I wouldn’t want my house to burn up too easily.


  79. ipoplaya

    Yes, by Irvine standards, it’s actually a halfway decent place. This is the Irvine Housing Blog right? If you think $1400 in roos is a lot, you must really think ill of Northpark, Northpark Square, Northwood II, Woodbury, Village of Columbus, Portola Hills, etc. All of their MRs for the same lot size are bound to be much greater…

    The bottomline is that these houses were going in the $1.1M range not so long ago. They were desirable enough to be sold for OVER $1M and now this one can probably be had for $875K.

  80. ex-Tangelo

    Jay: Why the big secret? People are smart, they can handle it.
    Kay: A person is smart. *People* are dumb, panicky, dangerous animals and you know it.

    /Men in Black

  81. Mike

    “50% was most common.”

    During the Great Depression, the banking system failed, causing a drastic decrease in home loans and ownership. At this time, most home mortgages were short-term (three to five years), no amortization, balloon instruments at loan-to-value (LTV) ratios below fifty to sixty percent.[2] The banking crisis of the 1930’s forced all lenders to retrieve due mortgages.

    This way of thinking is new to me, but it makes allot of sense. I like the 3-5 year idea allot. Why should anyone pay double for a house. For example a 500k house + 500k interest on the loan= 1 mill.

  82. ex-Tangelo

    Mike: This way of thinking is new to me, but it makes allot of sense. I like the 3-5 year idea allot. Why should anyone pay double for a house. For example a 500k house + 500k interest on the loan= 1 mill.

    4% inflation will means your house that was $500k in 2007 will be worth 1,621,698.76 in 2037.

    You’re also paying inflated future dollars for today’s purchase. For instance, your final mortgage payment (20% down, 7% interest) of $2,661.21 in 2037 is the inflation-adjusted equivalent of $820.50 in 2007 dollars.

  83. No_Such_Reality

    My bad, I miscalculated the M-roos and got over $3000.

    I agree though, it’s desireable relative to the Irvine market. Kind of funny though, desireable is essentially, a big detached box with little privacy or free space. The free space is made up by the community space.

  84. ex-Tangelo

    Sorry Iblis, I thought of the line from Men in Black too, and didn’t see you posted first.

  85. alan

    testy today IPOP

    Last time I checked Irvine was part of Orange county which was part of Southern CA. You haven’t succeded yet like the Peoples Republic of Santa Monica. What happens by the beach or in the hills affects prices in Irvine too.

    Just trying to keep you honest.

  86. Kirk

    Yes, they are forced to put it back on the books because they can no longer issue commercial paper backed by the mortgages.

    If a bank holds mortgages on its books it has to have a certain ratio of deposits to loans. This limits the number of mortgages the bank can issue. So, the bank puts the mortgages into a SIV (takes the mortgages off the books) and issues commercial paper. The buyers of the CP replace the depositors that are traditionally required. I’ve seen it called a virtual bank.

    Of course, there’s more to it than that (i.e. more than commercial paper is issued), but this is the gist of it. SIV’s are essentially an accounting trick.

  87. ipoplaya

    I tire of the irrelevance of your posts Alan… I have no idea what point you are trying to make or even if you have one. So Cal is part of the United States too so does that mean we should compare Irvine housing to Detroit’s? If a butterfly flaps its wings in Boise, will that have some mysterious impact on the OC median?

  88. alan

    my point, if you read my other posts today

    is that there are 5000 properties over $750k chasing 250 buyers.

    that means that a buyer w 1M to spend can buy your stucco box in irvine or nicer digs in Newport Coast, they are going to Newport Coast.

    You may love your Irvine box because you love Irvine but it was not worth what someone paid for it in 2005 because the price then was bid up by funny money and now there are surrounding areas where you can spend the same and get a view, or closer to the beach or farther from your neighbors with a yard instead of a small patio.

  89. ipoplaya

    Your point is wrong… There is simply no comparison. There is nothing on Newport Coast for anywhere near that price of $899K. As a matter fact, the cheapest 4-bedroom I can see is this:

    It’s an attached condo. There is a world of difference between $1.1 and $900K and a world of difference between what is a really big nice apartment in Newport Coast vs. a 3100sf detached SFR in Irvine.

    Why don’t you post a few links to any comparable property actively listed in MLS. I’ll make it easier on you. Just find 4 bedrooms and at least 2500sf in Newport Coast… What’s the cheapest you can find?! You can’t find closer to the beach with views or farther from your neighbors anywhere near Newport Coast for a price close to $899K.

    Come on, show us all the listings o’ wise one.

  90. awgee

    The bloggers who have enough sense to know they are not geniuses may very well buy at the bottom.

  91. awgee

    ipop – We posers, (posters), here in the IHB have a history of remarking on real estate which is located in OC, but not necessarily Irvine.

  92. awgee

    I thought prices were too high in 2003. but did not sell until the summer of 2005. I was waiting to see the downtrend, but just couldn’t wait any longer. And I thought another asset class would be appreciating faster than real estate. I am definitely no genius and less smart than most, but I did listen to some people who actually had a history of making money and not just a history of having an opinion.

  93. IrvineRenter

    I was pondering this comment along with Kirk’s comment about using SIVs to get around deposit requirements. I made me realize banks have no tether any more; just a license to print unlimited money. The more I ponder this, the more worried I become about a deflationary spiral. If loans are not paid back, which many will not be, then the entire fiat currency ponzi scheme could collapse. It also gives me a deeper understanding of why Bernanke is willing to trash the dollar to prevent a deflationary spiral. Basically, about a third of the money banks invented so people could buy houses is about to vanish, but the banks will still show these assets on their books. They couldn’t possibly write these loans down if they wanted to because they don’t have the reserves. Bad loans equal deflation. There is no way around it.

  94. alan

    not quite unlimited, they had to package the loans and sell them to wallstreet before they could make new ones, and pocket fee’s along the way. No loans, no fee’s.

    Very scarry

    Thats why we have to go back to the old system, banks need to hold their own loans, that’s they only way they have any incentive to make sure the borrower can pay and that the property value is real and not some inflated BS number.

  95. IrvineRenter

    What that chart does not reflect is this rate, or any loan for that matter, is only available to a select few customers with very high FICO scores. If rates come down, and loans are made available to a wider range of people, enough knife-catchers may step forward to slow the rate of decline. As it is, prices are in free fall.

  96. alan

    Too true,

    I went to Etrade last week and saw the rate on the splash page, then plugged in some numbers to see what I could get and guess what, that number was a lot higher then the teasers posted on the Splash page.

  97. alan

    I never said the listings were here today.

    I said that with 4600 properties chasing 250 buyers, it’s only a matter of time before you see these listings happening.

    Patience, young skywalker…

  98. ipoplaya

    Indeed, that is likely true. I just found it interesting that the rates for A+ credit types on jumbos are back at pre credit crunch levels… I don’t think the chart basis has changed, i.e. before August it included less worthy borrower types.

    Rates on the 10-year are at something like a 3-year low, so a return to August loan jumbo rates isn’t something to really get crazy about. Conventional 30-years appear to be at a 26-27 month low right now. Looks like a well qualified buyer could get a 30-year fixed for 5.75-6% right now.

    It takes a good deal of patience to sit the sidelines when things have dropped 15-20% and safe mortgages are below 6%.

  99. ipoplaya

    Let’s review Obi-Wan, “that means that a buyer w 1M to spend can buy your stucco box in irvine or nicer digs in Newport Coast, they are going to Newport Coast”

    Well by the time your imaginary properties in NC get down to $1M, these similar Irvine properties would be $600-700K. Irvine isn’t going to sit in a some kind of price drop freeze while Newport Coast drops huge percentages. Still will have the same problem with your faulty logic. Yes, your posts defy logic! Woohoo!

    You can’t compare today’s Irvine stucoo box pricing with a potential maybe future Newport Coast price. That’s moronic. By the time $1M gets you a 3000sf SFR in Newport Coast, you will be able to a 5000sf mansion in Irvine for the same money.

  100. granite


    We think alike. “This is ridiculous” was my reaction when a neighborhood house we liked went up 50% to 530K in 2001-2002. Then it went over $750K a few years later. “This is an historic bubble” was my reaction then. I thank g_d my wife didn’t insist on buying because “everything is going up”. Of course I reminded her if we bought she could not shop because we would be house poor.

    At least our retirement accounts are doing well. Thanks for incredibly thoughtful posts.

  101. socalhousingbubble

    IR, nice post! And great to see the site come far enough that I now barely have time to read all the blog comments. 5 months ago I noticed I didn’t have time to read all the forum postings because activity was picking up.

    What interesting progress.


  102. ipoplaya

    Our bubble burst will be unlike Japan’s for a couple of reasons IMO.

    1. Japan’s real estate run-up was far greater, faster, and more extensive across their country than ours has been. Their prices ran up something like 200% in a ten year span. The median across the US has only risen 75% or so over the past ten years. Now in certain markets, obviously the rise has been nearly as meteroic as Japan’s, but that pace is not a national for the U.S. While local drops could be spectacular, we won’t have a system-wide crash such as Japan as we’ve had less participants sharing in the run-up.

    2. Japan’s RE crash coincided with an implosion of the Nikkei. Their economy was super heated and super speculative. Japanese corporations were pouring huge money into real estate. Everyone in the world was trying to a piece of Japan (land, stocks, whatever) in the mid to late 80’s. The rampant speculation in Japan drove the Nikkei to more than triple its mid 80’s value in five years. 50% of that paper wealth evaporated dalmost immediately and fueled the housing downturn. Their stock market collapse and real estate collapse fueled each other for many years and they’ve been in and out of recession for decades.

    3. Our equity markets, while having been strong in recovering from our last recession, have traded sideways for a year, and are only up 60-70% over a 5-year span. Those increases are much more orderly than the 300% run-up the Nikkei had over a similar time period. Very few are speculating in stocks in the US now so there is unlikely to be sharp drop in equity prices to fuel a depreciation spiral. Any stock market corrections as a result of recession will be much more orderly than the Nikkei’s collapse. You won’t see the S&P at 700 in a year or two. Maybe 1100-1200, but a 15-20% drop is very different than a 50% head shaving.

    4. As we aren’t experiencing a speculative, hyperinflated economy across all assets classes here in the US, our monetary policy makers will be more inclined to induce as soft a landing as possible for housing and the overall economy. If they have to inflate their way out of it, they probably will. Japan’s government set off their collapses by attempting to slow their economy down. Our government will probably do the opposite…

  103. soapboxpolitico

    IR, again a wonderfully detailed yet simply put post to again explain basic human nature, financial behavior and their intersection with economics. I marvel at the time you spend at this endeavor. To all who post thoughtful and incisive thoughts, Keep up the great work!

    I want to address the behavior of the lending and financial markets and what I have long felt are disturbing characteristics of the two and how they relate to this particular post. My grandad often said, “You can’t get something for nothing unless someone, somewhere gets nothing for something.” Folksy wisdom but Oh so true. “Financial innovation” is an oxymoron, from now on when you hear those two words, guard your wallet! What angers me most about the financial markets is their schizophrenic and contradictory attitudes when times are good and when they go bad. The unofficial mantra being “privatize profit but socialize risk”. When the calf is fat, they’re all about pocketing as much of the profits as is possible, legally or illegally. And heaven forbid Uncle Sam step in and regulate something. But boy does that tune change when the losses start piling up. Then it’s all about why isn’t Uncle Sam stepping in or doing more to save us? So when they create these scams to fleece the masses and the whole thing goes sour, suddenly the “financial geniuses” go all Alfred E. Newmann on us … what? Who me? What did I do?

    This dovetails to many of the themes repeated on this blog. A house is a home, not a financial product. Something is worth what the market fundamentals and historical averages say it is. If it sounds too good to be true, it likely is. You can’t get something for nothing. I for one, want to see regulation, heavy regulation. This is twice in my lifetime “financial innovation” resulted in catastrophic losses that John Q. Taxpayer absorbed. I’m tired of bailing out Wall Street when their schemes go terribly wrong and I’m sick of seeing the carnage in their wake. Meanwhile the rich get richer and the poor get screwed. I’ve been lucky but I’m also a well-educated cynic and I do my homework. Let’s see this latest aberration purged from the marketplace and from now on let sanity and moderation prevail. Sadly, our memories grow ever shorter and delusional thinking ever more pervasive.

  104. ex-Tangelo

    I’m speaking to Mike’s astonishment that the cumulative interest paid over the life of a loan can be so large.

    If you don’t like the assumptions I chose, pick your own and redo the exercise.

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