The economists at the Federal Reserve take an honest look at the inefficacy of their policies.

Irvine Home Address … 12 PLEASONTON Irvine, CA 92620

Resale Home Price …… $660,000

The only way to win is cheat

And lay it down before I'm beat

and to another give my seat

for that's the only painless feat.

That suicide is painless

It brings on many changes

and I can take or leave it if I please.

Johnny Mandel — Suicide is Painless

Most people try to avoid pain, physical, emotional, financial. Anyone focused on playing in the California housing market Ponzi scheme, there is only one painless feat: pass the debt off to another person. Give them your seat and let them own the mortgage. Think about the windfall received by those few that sold in 2005-2007 and rented. Those left owning loans are feeling major pain.

The Federal Reserve exists to foster moral hazard by preventing banks, businesses, and consumers from feeling the ill effects of their poor financial decisions. The Federal Reserve has purchased $1,200,000,000,000 in mortgage-backed securities in an effort to lower interest rates and make the sky-high prices of the bubble affordable. They have printed money through two rounds of quantitative easing, and they help lenders dodge regulation that might expose their insolvency or hinder their business. Given the mission and behavior of the Fed, it is surprising when they publish a fact-filled paper with careful analysis, particularly when that paper is critical of government policy.

The Fallacy of a Pain-Free Path to a Healthy Housing Market

December 2010

Federal Reserve Bank of Dallas

by Danielle DiMartino Booth and David Luttrell

In the mid-1990s, the public policy goal of increasing the U.S. homeownership rate collided with a huge leap in financial innovation. Lenders shifted from originating and holding mortgages to originating and packaging them for sale to investors. These new financial products enabled millions of Americans who hadn’t previously qualified to buy a home to become owners. Housing construction boomed, reaching a postwar high—9.1 million homes were built between 2002 and 2006, a period when 5.6 million U.S. households were formed.

That is a huge supply imbalance. And like Ireland, much of this supply exists in areas where there is little or no demand. Second home communities are inundated with houses that nobody can finance at prices several times what local incomes can support.

The resulting oversupply of homes presents policymakers with a formidable challenge as they struggle to craft a sustainable economic recovery. Usually a driver of economic recoveries, the housing market is foundering as an engine of growth.

Generations of policymakers since the 1930s have sought to increase the homeownership rate. By the late 1960s, it had reached 64.3 percent of households, remaining there through the mid-1990s, in apparent equilibrium with household formation during a period of sustained U.S. economic growth. A fresh push to increase ownership drove the rate up 5 percentage points to its peak in the mid-2000s. Home price gains followed the rate upward.

Reverting to the Mean Price

As gauged by an aggregate of housing indexes dating to 1890, real home prices rose 85 percent to their highest level in August 2006. They have since declined 33 percent, falling short of most predictions for a cumulative correction of at least 40 percent.[1] In fact, home prices still must fall 23 percent if they are to revert to their long-term mean (Chart 1). The Federal Reserve’s purchases of Fannie Mae and Freddie Mac government-sponsored-entity bonds, which eased mortgage rates, supported home prices. Other measures included mortgage modification plans, which deferred foreclosures, and tax credits, which boosted entry-level home sales.

Adjusting for inflation, prices almost certainly will fall. The relationship between inflation and house price that have been stable for over a century doesn't suddenly break down and fail to limit home prices. If we manage to ignite inflation, we may get prices to hold up on a nominal basis, but adjusting for inflation, prices will fall significantly.

Measuring the success of these efforts is important to determining the trajectory of the economic recovery and providing policymakers with a blueprint for future action. New-home sales data, though extremely volatile, are considered a leading indicator for the overall housing market. Since expiration of the home-purchase tax credit in April, sales have fallen 40 percent to an average seasonally adjusted, annualized rate of 283,000 units. This contrasts with the three years through mid-2006 when monthly sales averaged 1.2 million on an annual basis. Before the housing boom and bust, single-family home sales ran at half that pace. Because current sales are at one-fifth of the 2005 peak, new-home inventories—now at a 42-year low—still represent an 8.6-month supply. An inventory of five to six months suggests a balanced market; home prices tend to decline until that level is achieved.

One factor inhibiting the new-home market is a growing supply of existing units. The 3.9 million homes listed in October represent a 10.5-month supply. One in five mortgage holders owes more than the home is worth, an impediment that could hinder refinancings in the next year, when a fresh wave of adjustable-rate mortgages is due to reset. The number of listed homes, in other words, is at risk of growing further. This so-called shadow inventory incorporates mortgages at high risk of default; adding these to the total implies at least a two-year supply.[2]

As predicted, the recasting of Option ARMs and interest-only ARMs is causing many borrowers to stop making payments. Many of those borrowers used that financing because they were in an inflated market. Many of those markets have crashed leaving the borrower deeply underwater and facing a much larger loan payment.

The surprise with the mortgage resets is the lack of foreclosures and foreclosure inventory to push prices lower. Mostly, this is due to amend-extend-pretend and the massive buildup of shadow inventory. These bad loans are out there, and this inventory will eventually make it to the market. How The Lending Cartel Disposes Their REO Will Determine the Market’s Fate.

The mortgage-servicing industry has struggled with understaffing and burgeoning case volumes. The average number of days past due for loans in the foreclosure process equates to almost 16 months, up 64 percent from the peak of the housing boom. One in six delinquent homeowners who haven’t made a payment in two years is still not in foreclosure.[3] Mounting bottlenecks suggest the shadow inventory will grow in the near term.

Notably, not all homeowners in arrears suffer financial hardship due to unaffordable house payments. Those with significant negative equity in their homes may choose to default even though they can afford to make the payments. Such “strategic default” is inherently difficult to measure; one study found 36 percent of mortgage defaults are strategic.[4] Though the effect is not readily quantifiable, the growing lag between delinquency and foreclosure provides an added inducement for this form of default.

Thinking About Accelerated Default? The Average Squatting Time Is Up to 449 Days.

Mortgage Modification Limits

One set of policies to aid home-owners in dire straits involves mortgage modifications, though these efforts have only minimally reduced housing supplies. The most far-reaching effort has been the Making Home Affordable Program (previously the Home Affordable Modification Program, or HAMP), in effect since March 2009. After only one year, cancellations—loans dropped from the program before a permanent change was completed—eclipsed new modifications (Chart 2). Since March, the number of cancelations has continued to exceed new trial modifications, which involve eligibility and documentation review, and successful permanent modifications.

In short, to the surprise of no one, the government run loan modifications programs have been a total failure by any performance metric.

The fact that many mortgage holders have negative equity in their homes stymies modification efforts. In the case of HAMP, the cost of carrying a house must be reduced to 31 percent of the owner’s pretax income. Even if permanent modification is achieved, adding other debt payments to arrive at a total debt-to-income ratio boosts the average participant’s debt burden to 63.4 percent of income. In many cases, the financial innovations of the credit boom era, enabling owners to monetize home equity, encouraged high aggregate debt.

You have to love academic writing. Note the euphemism “enabling owners to monetize home equity” when they meant that banks were giving out free money under the guise of “innovation.” The Fallacy of Financial Innovation.

A study found that in a best-case outcome, 20 to 25 percent of modifications will become permanent.[5] In 2008, one in three homeowners devoted at least a third of household income to housing; one in eight was burdened with housing costs of 50 percent or more.[6] Failed modifications suggest that, without strong income growth, the bounds of affordability can be stretched only so far.

Let's stop for a moment to ponder the math: if best-case scenario is for 20% to 25% of loan modifications to work, then at least 75% will fail. With around 10 million distressed loans, at least 7.5 million of them will not cure through loan modification. Far fewer will cure through paying back the loan balance, so that leaves short sale and foreclosure. Since most short sales fail, that leaves only foreclosure. We will see a lot more foreclosures than pundits are willing to admit.

Without intervention, modest home price declines could be allowed to resume until inventories clear. An analysis found that home prices increased by about 5 percentage points as a result of the combined efforts to arrest price deterioration.[7] Absent incentive programs and as modifications reach a saturation point, these price increases will likely be reversed in the coming years. Prices, in fact, have begun to slide again in recent weeks. In short, pulling demand forward has not produced a sustainable stabilization in home prices, which cannot escape the pressure exerted by oversupply (Chart 3).

The data clearly shows the fake prosperity of the tax credit, and the devastating impact of its expiration.

Lingering Housing Market Issues

About 3.6 million housing units, representing 2.7 percent of the total housing stock, are vacant and being held off the market. These are not occasional-use homes visited by people whose usual residence is elsewhere but units that are vacant year-round. Presumably, many are among the 6 million distressed properties that are listed as at least 60 days delinquent, in foreclosure or foreclosed in banks’ inventories.

Recent revelations of inadequately documented foreclosures and the resulting calls for a moratorium on foreclosures—what was quickly coined “Foreclosuregate”—threaten to further delay housing market clearing. While home price declines may be arrested as foreclosure paperwork issues are resolved, the buildup of distressed supply will only grow over time.

Lenders are hoping the inventory problems will simply resolve themselves as a resurgent economy sparks a great deal of household formation and sparks demand for a huge inventory of empty houses. It isn't going to happen.

Perhaps less obviously, some lenders with the means to underwrite new mortgages will remain skeptical about the underlying value of the collateral.

This is the real problem with delaying the bottom. Other than the FHA or the GSEs which are backed by the government, who else is confident enough about the stability of home values to take risk with new home loans? Nobody is. That's why the combined government programs now account for about 99% of the housing market. It is also why very few jumbo loans are being originated.

With nearly half of total bank assets backed by real estate, both homeowners on the cusp of negative equity and the banking system as a whole remain concerned amid the resumption of home price declines.[8] This unease highlights the housing market’s fragility and suggests there may be no pain-free path to the eventual righting of the market. No perfect solution to the housing crisis exists.

Fix the Housing Market: Let Home Prices Fall.

The latest price declines will undoubtedly cause more economic dislocation. As the crisis enters its fifth year, uncertainty is as prevalent as ever and continues to hinder a more robust economic recovery. Given that time has not proven beneficial in rendering pricing clarity, allowing the market to clear may be the path of least distress.

May be the path of least distress? The band aid analogy is best. We should have ripped the band aid off and been done with the pain. Instead, we have gone through heroic efforts to prop up prices and merely spread out the pain over a longer timeframe. The insolvent bankers undoubtedly like the path we chose. I, for one, think it was a mistake.

Peak buyer trying to save what she can

As people abandon hope of another market rally to save them and their finances, they take a hard look at their expenses and ask, “Why are we paying so much for this mortgage?” If there is no additional return on their investment, many will lose faith in rapid appreciation and sell out. It's all part of the capitulation process.

Today's featured property was purchased on 4/20/2007 for $673,000. The owner used a $538,400 first mortgage and a $134,600 down payment. If she gets her asking price and pays commission, she loses about $50,000. So for the last four years, she has been paying far more in cost of ownership than the cost of rental, and she is going to lose another $75,000 to the market. I imagine she thinks that sucks.

Irvine Home Address … 12 PLEASONTON Irvine, CA 92620

Resale Home Price … $660,000

Home Purchase Price … $673,000

Home Purchase Date …. 4/20/2007

Net Gain (Loss) ………. $(52,600)

Percent Change ………. -7.8%

Annual Appreciation … -0.5%

Cost of Ownership

————————————————-

$660,000 ………. Asking Price

$132,000 ………. 20% Down Conventional

5.02% …………… Mortgage Interest Rate

$528,000 ………. 30-Year Mortgage

$136,971 ………. Income Requirement

$2,841 ………. Monthly Mortgage Payment

$572 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$110 ………. Homeowners Insurance

$70 ………. Homeowners Association Fees

============================================

$3,593 ………. Monthly Cash Outlays

-$487 ………. Tax Savings (% of Interest and Property Tax)

-$632 ………. Equity Hidden in Payment

$258 ………. Lost Income to Down Payment (net of taxes)

$83 ………. Maintenance and Replacement Reserves

============================================

$2,815 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$6,600 ………. Furnishing and Move In @1%

$6,600 ………. Closing Costs @1%

$5,280 ………… Interest Points @1% of Loan

$132,000 ………. Down Payment

============================================

$150,480 ………. Total Cash Costs

$43,100 ………… Emergency Cash Reserves

============================================

$193,580 ………. Total Savings Needed

Property Details for 12 PLEASONTON Irvine, CA 92620

——————————————————————————

Beds: 3

Baths: 2 full 1 part baths

Home size: 1,703 sq ft

($388 / sq ft)

Lot Size: 4,000 sq ft

Year Built: 1985

Days on Market: 209

Listing Updated: 40540

MLS Number: S620211

Property Type: Single Family, Residential

Community: Northwood

Tract: Othr

——————————————————————————

EQUITY SALE!! NOT REO!! NOT Short Sale!! Beautiful Northwood area. NO MELLO ROOS! LOW tax rate. HOA $70/mo. Single Family Detached Former Model Home. Bright open floor plan, lots of windows, plantation shutters, custom cabinets & crown molding. Beautiful hardwood floors. Living Rm & Dining Rm w/ vaulted ceiling. Family Rm w/ fireplace, custom computer center & sliding French door. Kitchen w/ custom cabinets & Italian tile floor. Master Bedrm w/ walk-in closet & vaulted ceiling. Jetted Tub. Brick patio w/ patio cover, 2 car garage w/ roll-up garage doors & cabinets. Laundry Rm w/ custom cabinets. Across Assoc bbq, tot lot, swimming pool/spa & Orchard Park w/ basketball courts, playground, bbq, picnic area, baseball/soccer field. Walk to tennis courts, parks, aquatic center, library, stores, schools. Great Irvine Unified School District Award Winning Schools. Minutes from OC beaches, museums, Irvine Spectrum, District, Tustin Marketplace, Fashion Island, South Coast Plaza & Great Park.

.

Mortgage interest rates have broken above 5% for the first time since early 2010. Will be see 4% interest rates again?

Irvine Home Address … 27 FIRWOOD 27 Irvine, CA 92604

Resale Home Price …… $304,900

Goodbye doesn't mean forever

Let me tell you goodbye doesn't mean

we'll never be together again

Though we may be so far apart you still will have my heart

So forget your past my Goodbye Girl

'Cause now you're home at last.

Bread — Goodbye Girl

The interest rate cycle is very long, and we are bouncing off historic lows. It is reasonable to think interest rates may go up based on reversion to the mean. The average over the full cycle (down, up, down) is 9%, and interest rates generally hover between 7% and 11%.

Back in early December, I noted Mortgage interest rates hit five-month high. Since then, other pundits are starting to proclaim the end of the era of mortgage interest rates below 5%.

Kiss 4% mortgage rates goodbye

By Les Christie, staff writer — January 1, 2011: 3:47 PM ET

NEW YORK (CNNMoney.com) — The era of near 4% mortgage rates has ended after a quick rate rise since early November. But some industry experts think that may be a good thing for the flagging housing market.

The average 30-year fixed mortgage rate has risen to 4.86% from 4.17%, according to Freddie Mac's weekly mortgage market survey. In the Bankrate.com weekly survey, the rate has risen to 5.02% — crossing the 5% mark for the second time in three weeks — after being as low as 4.42% as recently as early November.

Rates haven't been this high since May and forecasters now predict them to remain between 5% and 6% for all of 2011.

“You can kiss those record lows goodbye,” said Greg McBride, chief economist for Bankrate.com.

Is this a good contrarian indicator? Since everyone is starting to say interest rates are going much higher, will the market reverse and send interest rates back down?

Keith Gumbinger of HSH Associates, a provider of mortgage information said that the market reached a new plateau.

“I don't think we're going back to a 50-year low anytime soon without an economic collapse,” he said. “Rates will probably never revisit those levels.”

That is the essence of the argument: rates will not go back to ultra-low levels as long as their are competing investments where returns are attractive, something which requires an expanding economy.

The increase will push mortgage payments higher for homebuyers. When rates rise from 4.25% to 5% it takes away about 9% of buying power, according to McBride.

“That's nothing to sneeze at,” he said. “But it's still small relative to the steep drop in home prices over the past few years.”

He is right. In Las Vegas where prices are very affordable, a small decrease in affordability will not make much difference; however, in inflated California markets where every penny of affordability is needed to support pricing, rising interest rates will be a serious problem.

Good for the market?

Higher interest rates may even prove stimulating to the still quiet housing market in which sales volume and prices are scraping near their bottoms.

“The initial phase of an interest rate increase generally does not hurt markets,” said Lawrence Yun, chief economist for the National Association of Realtors. “In fact, it can help.”

The rapid rise introduces an element of urgency for potential homebuyers. They may now rush to buy before rates spurt even more.

OMG! It's been a year, but it is worth revisiting: Urgency Versus Reality: realtors Win, Buyers Lose.

The strength of the economic recovery will have far more impact on the housing market that this relatively modest increase in mortgage rates, according to Yun. If hiring gains momentum, housing markets should revive.

“If we add 2 million jobs as expected in 2011, and mortgage rates rise only moderately, we should see existing-home sales rise to a higher, sustainable volume,” said Yun.

Gumbinger said that demand for homes may be tempered somewhat by the increased mortgage costs and so affect home prices a bit but the improving job picture and better consumer confidence matter much more.

“If the other factors are aligned,” he said, “interest rates are not a big thing.”

Economists are correct to point out that jobs are the creator of all real estate demand. The unemployed may desire houses, but they don't effectively add to demand.

What follows will be repeated by the NAR often over the next several years. They will complain that “stringent” lending standards are hindering the market and squelching demand. Of course, realtors embraced the Option ARM because it stimulated demand, so we can't count on the NAR to be objective about what lending standards should be.

The real mortgage challenge, according to Yun, is to increase the number of loan applicants winning approvals. Too many potential homebuyers are still finding it difficult to qualify for loans.

“The current mortgage market is a unique situation” he said. “It's less about rates than it is about underwriting standards, which are, in my opinion, still too stringent.”

“If lenders return to more normal, safe underwriting standards for creditworthy buyers, there would be a bigger boost to the housing market and spillover benefits for the broader economy.”

So do you think the era of sub-5% mortgage interest rates is gone for good?

Fannie Mae shadow inventory

In 2011 we will see many properties emerge from shadow inventory. Lenders are not going to let these sit vacant and rot on their books forever. Fannie Mae is moving to liquidate the one that started as a default in mid 2009.

Foreclosure Record

Recording Date: 12/31/2009

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 09/17/2009

Document Type: Notice of Default

Fannie Mae bought the property in May of 2010, and it took them 6 months to get it to market. It must be interesting to be a project manager for the banks. Usually a slow and inefficient project manager wouldn't last long, but they probably rise to the top in the bank's property management department.

• The property was originally purchased on 11/2/2000 for $170,000. The owner used a $165,150 first mortgage and a $4,850 down payment.
• On 12/31/2001 they refinanced with a $166,500 first mortgage.
• On 12/13/2002 they refinanced with a $193,000 first mortgage.
• On 8/3/2005 they refinanced with a $233,558 first mortgage.
• On 1/4/2006 they refinanced with a $258,748 Fannie Mae first mortgage. The GSEs entered the bubble late as a response to losing market share. This was one of the stupid loans they made that we are now paying for in the GSE bailout.
• On 1/12/2007 they obtained a $15,778 HELOC.
• On 5/25/2007 they got a $42,663 HELOC.
• Total property debt is $301,411.
• Total mortgage equity withdrawal is $136,261. Not a lot, but enough to cost them their home.

Irvine Home Address … 27 FIRWOOD 27 Irvine, CA 92604

Resale Home Price … $304,900

Home Purchase Price … $170,000

Home Purchase Date …. 11/2/2000

Net Gain (Loss) ………. $116,606

Percent Change ………. 68.6%

Annual Appreciation … 5.7%

Cost of Ownership

————————————————-

$304,900 ………. Asking Price

$10,672 ………. 3.5% Down FHA Financing

5.02% …………… Mortgage Interest Rate

$294,229 ………. 30-Year Mortgage

$63,276 ………. Income Requirement

$1,583 ………. Monthly Mortgage Payment

$264 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$51 ………. Homeowners Insurance

$299 ………. Homeowners Association Fees

============================================

$2,197 ………. Monthly Cash Outlays

-$150 ………. Tax Savings (% of Interest and Property Tax)

-$352 ………. Equity Hidden in Payment

$21 ………. Lost Income to Down Payment (net of taxes)

$38 ………. Maintenance and Replacement Reserves

============================================

$1,754 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$3,049 ………. Furnishing and Move In @1%

$3,049 ………. Closing Costs @1%

$2,942 ………… Interest Points @1% of Loan

$10,672 ………. Down Payment

============================================

$19,712 ………. Total Cash Costs

$26,800 ………… Emergency Cash Reserves

============================================

$46,512 ………. Total Savings Needed

Property Details for 27 FIRWOOD 27 Irvine, CA 92604

——————————————————————————

Beds: 2

Baths: 1 bath

Home size: 1,000 sq ft

($305 / sq ft)

Lot Size: n/a

Year Built: 1978

Days on Market: 31

Listing Updated: 40545

MLS Number: I11000086

Property Type: Townhouse, Residential

Community: Woodbridge

Tract: 0

——————————————————————————

According to the listing agent, this listing is a bank owned (foreclosed) property.

Great opportunity at a great price! Come see this beautiful condo located in wonderful community! Rich dark wood cabinets bring the kitchen to life! New paint and carpet installed throughout makes the property feel like new! Beautiful views of the bay are within walking distance! Don't pass up on this great opportunity!

What will 2011 bring?

Irvine Home Address … 55 GRAY DOVE Irvine, CA 92618

Resale Home Price …… $1,350,000

But now, I stand alone with my pride

And dream, that you're still by my side

But that was yesterday

I had the world in my hands

But it's not the end of my world (ooh ooh ooh)

Just a slight change of plans

That was yesterday

But today life goes on

No more hiding in yesterday (ooh ooh ooh)

'Cause yesterday's gone

Foriegner — That was Yesterday

For the last few years, I have started with predictions. Last year, I had this recap and predictions:

Recap of Past Predictions

First, I wrote Predictions for 2008, and last year I wrote Predictions for 2009. Nothing too bold or surprising either time:

“Most of the macroeconomic conditions I made in 2008 are still operative, and several of the predictions I made which came true will likely repeat in 2009. These are:

1. 2008 will see the worst single-year decline in the median house price ever recorded
2. One or more of our major financial institutions and one or more of our major homebuilders will fail
3. A severe local recession
4. I predict we will see many more angry homedebtor’s troll the blog

I do not believe 2009 will see median house prices decline as much as 2008, but I do believe they will drop significantly, particularly in high-end neighborhoods. The low-end neighborhoods are closer to the bottom than to the top, so 30%+ declines in these neighborhoods are not likely. The high end neighborhoods will experience big drops. Most did not drop 30% last year, so they have more room to drop. The unemployment rate is high, and the economy is in recession which will put pressures on home prices. The dreaded ARM problem is not going away, and these loans will start blowing up this year and on through 2011.”

Not much has changed from my review of the situation a year ago. Lenders did manage to avoid dealing with the problem for a full year, so prices did not budge, and we now have a massive shadow inventory.

“However, there is one bright spot for the housing market that will blunt the declines in 2009: ultra-low mortgage interest rates. We will see properties at rental parity in 2009. The low interest rates are going to reduce the cost of borrowing to the point that many properties will reach rental parity this year.”

I got that one right, and

“With the low interest rates, and with the foreclosures resulting from this year’s loan resets being a year away, we are in a good position to see our first bear market rally. This summer, we might see two or three months of sustained appreciation.”

That happened too, and it happened for the reasons described. As I have noted on other occasions, these conditions are not sustainable.

Predictions for 2010

In looking ahead to 2010, I see a number of important factors that will influence the housing market. Many of the issues discussed today will be the focus of future posts.

Mortgage interest rates will increase in 2010

I don't know how high they will go, but mortgage interest rates will begin their ascent to a (somewhat) natural market. Any stable homeowner who has not refinanced should do it now or forever miss their chance.

This one I got wrong, but only barely.

The interest rate on the mortgage averaged 4.86% in the week ended Thursday, up from 4.81% in the prior week, according to Freddie Mac, a buyer of residential mortgages. A year ago, this mortgage averaged 5.14%.

“For the year as a whole, 30-year fixed mortgage rates averaged just below 4.7%, which represented the lowest annual average since 1955, when the average price of a home was $22,000,” said Frank Nothaft, chief economist at Freddie Mac, in a statement.

With the rise in interest rates over the last 6-8 weeks, interest rates are now within 0.28% of where they started the year, and the strength of the trend reversal suggests we will likely see 5.14% interest rates and perhaps higher in 2011.

I have no idea what interest rates will do. I think they will move higher, but I haven't beaten a coin flip so far. Perhaps the explicit government gurantee on FHA and GSE debt will keep money in residential mortgages even as better rates of return in riskier assets entices some investors. If risk adverse money thinks mortgage loans are a bulletproof investment because the US government is specifically backing the repayment of the loan through the insurance sold by FHA and now the GSEs. This guarantee may cause money to pool in residential mortgages for safety and keep interest rates very low for a long time. It could go either way, and I have no foresight for either scenario. Flip a coin: heads rates go up, and tails rates go down. Ask the magic 8-ball, “Will interest rates go up?” It told me, “Maybe.”

The direction of mortgage interest rates is important for two reasons. One, it motivates people to lock in long term rates. The days of floating your rate lock are over. Playing for short term volatility by delaying your rate lock fights against the broader trend. Rising rates will also stop the refinance market. The days of Ponzi borrowing cheap money are over.

The second reason higher rates is important is because higher rates create costs that cannot be passed on to a borrower who is already borrowing at their limit (see everyone in California). As interest rates go up, the amounts people can finance with a 31% DTI go down. You can't escape the math.

1. Incomes must go up — which doesn't seem likely in the face of high unemployment — or
2. Debt-to-income ratios are relaxed so borrowers can borrow more. That is called a Ponzi scheme, so to avoid further losses, the DTI will stay capped at 31% for the foreseeable future.
3. Loan balances must decrease. This is the most likely scenario since incomes are not going up, and neither are DTI ratios.

Smaller loan balances makes for lower bids from potential buyers. The desire for real estate may be strong, the measurable demand will be shrinking along with loan balances. Prices would have to move lower with the inventory that needs to move through the system.

Inventory will increase in 2010

Eventually, lenders are going to have to foreclose on properties, kick out the squatters, and resell the houses in the resale market. Inventory is coming; how much of that we will see in 2010 is anyone's guess, but I believe we will see much more than we saw in 2009.

Affordability will improve as mid to high end properties are released to the market, and prices of the houses of greatest interest to buyers in Irvine should come down because, despite the buyer interest, there are more properties in distress than there are buyers interested in obtaining them.

One year ago there were 446 homes on the MLS. On the last business day of 2011, there were 725 homes for sale in Irvine. That's an increase of over 60%! I mark that down as a win.

Properties selling at or below rental parity becomes the norm in 2010.

As I have noted on other occasions, many properties, even in Irvine, are trading at or below rental parity. This will happen more often, and it will happen at higher and higher price points.

This is what we observed in late 2010 due to falling prices and super low interest rates.

Sales volumes will increase in 2010

Despite the rumors of a healthy real estate market, transaction volumes remain 15% below historic norms on a seasonally adjusted basis. Sales volumes will increase due to greater supply, and prices will go down.

Sales were up slightly, but not much. Unemployment continues to be a problem and the lack of a move-up market continues to plague sales.

Prices in Irvine will fall 2%-5% in 2010

Increasing interest rates will decrease affordability, and increasing supply will force saleguaranteehe market. The combination will cause prices to begin a multi-year slow decline similar to the 1994-1997 period. The price decline will not be orderly, and the relative stability in the median will mask seismic shifts within the market at sales composition changes (more mid to high end properties will sell) and prices of individual properties decline.

Even though the rally fizzled out, it may have carried prices up enough to stop them from going negative year-over-year. I concede defeat.

Basically, my outlook for 2011 is unchanged from 2010. (1) Inventory will go up. (2) Properties selling at or below rental parity will be the norm. (3) Sales volumes will increase. (4) Prices in Irvine will fall 2% to 5% in 2011.

Whatever the result, the leg down in pricing from the double-dip will be the last move down in this market cycle. The housing market will bottom at different times in different market tiers. I think the biggest discounts will be at the high end going forward. The lowest tier of the housing market may have already hit bottom. If not, it will bottom first. With low end support producing the first wave of move-up equity buyers, the slow grinding declines of higher price points can finally cease, perhaps in 2014. During the next three years, expect a range-bound housing market with a slightly lower bias.

If you want a series of projections on the housing market I like, check out Calculated Risk's post:

Question #1 for 2011: House Prices

Two weeks ago I posted some questions for next year: Ten Economic Questions for 2011. I'm working through the questions and trying to add some predictions, or at least some thoughts for each question before the end of year.

1) House Prices: How much further will house prices fall on the national repeat sales indexes (Case-Shiller, CoreLogic)? Will house prices bottom in 2011?

There is no perfect gauge of “normal” house prices. Changes in house prices depend on local supply and demand. Heck, there is no perfect measure of house prices!

That said, probably the three most useful measures of house prices are 1) real house prices, 2) the house price-to-rent ratio, and 3) the house price-to-median household income ratio. These are just general guides.

Real House Prices

The following graph shows the Case-Shiller Composite 20 index, and the CoreLogic House Price Index in real terms (adjusted for inflation using CPI less shelter).

Click on graph for larger image in graph gallery.

In real terms, both indexes are back to early 2001 prices. Also both indexes are at post-bubble lows.

As I've noted before, I don't expect real prices to fall to '98 levels. In many areas – if the population is increasing – house prices increase slightly faster than inflation over time, so there is an upward slope in real prices.

If real prices fall to 100 on this index (seems possible) that implies about a 10% decline in real prices. However what everyone wants to know is the change in nominal prices (not inflation adjusted). If real prices eventually fall 10%, that doesn't mean nominal prices will fall that far. House prices tend to be sticky downwards, except in areas with a large number of foreclosures. That is key a reason why prices have been falling for years, instead of adjusting immediately.

Price-to-Rent

In October 2004, Fed economist John Krainer and researcher Chishen Wei wrote a Fed letter on price to rent ratios: House Prices and Fundamental Value. Kainer and Wei presented a price-to-rent ratio using the OFHEO house price index and the Owners' Equivalent Rent (OER) from the BLS.

Here is a similar graph through October 2010 using the Case-Shiller Composite 20 and CoreLogic House Price Index.

This graph shows the price to rent ratio (January 1998 = 1.0).

I'd expect this ratio to decline another 10% to 20%. That could happen with falling house prices or rents increasing (recent reports suggest rents are now increasing).

Price to Household Income

The third graph shows the Case Shiller National price index (quarterly) and the median household income (from the Census Bureau, 2010 estimated).

Once again this ratio is still a little high, and I'd expect this ratio might decline another 10%. That could be a combination of falling house prices and an increase in the median household income.

This isn't like in 2005 when prices were way out of the normal range by these measures, but it does appear prices are still a little too high.

House Prices and Supply

The final graph (repeat) shows existing home months-of-supply (left axis), and the annualized change in the Case-Shiller composite 20 house price index (right axis, inverted).

House prices are through October using the composite 20 index. Months-of-supply is through November.

We need to continue to watch inventory and months-of-supply closely for hints about house prices. Right now house prices are falling at about a 10% annual rate.

Note: there have been periods with high months-of-supply and rising house prices (see: Lawler: Again on Existing Home Months’ Supply: What’s “Normal?” ) so this is just a guide.

My guess:

I think national house prices – as measured by these repeat sales indexes – will decline another 5% to 10% from the October levels. I think it is likely that nominal house prices will bottom in 2011, but that real house prices (and the price-to-income ratio) will decline for another two to three years.

Some of you take this far too seriously

I enjoy writing for the IHB, and I try to do it the best I can given the new demands on my time. I don't get to spend as much time in the comments as I would like, but i do read them every day and participate from time to time. Mostly I have said what I had to say in the post, and making a comment would have merely restated the post, so i don't bother. I prefer others to have the last word.

When I started out writing for the IHB back in early 2007, people needed to be warned about the impending house price crash, and I was unequivocal in my message not to buy a house. As the price crash ran its course, house prices in many markets became very affordable, but Irvine has only recently seen some deals trade at or below rental parity. In some markets the discount to own versus renting is close to 40%. Can you imagine that?

With the changing conditions, I began to change my message. I began telling people they can buy with the understanding that the house price may likely decline for a few years then recover slowly. If you need to sell in the next 3 to 5 years, don't buy now. Shevy has been saying the same thing since we began working together. It's still true, but the bottom window may be in 1 to 4 years rather than 3 to 5. Buying does not hurt on a nominal basis if you hold for at least 7 years. By then between the loan amortization and the stabilized market, there should be enough equity to pay a realtor and get out, perhaps with a few extra dollars if we inflate another bubble.

When I write for the IHB, i like to be creative, and sometimes that includes trying to capture an emotion or attitude in a cartoon or pull it out of a news story. Sometimes will will advocate positions or write in a certain style because it is fun, not because it is some deeply held belief. I enjoy the humor in the stories, and the culture of home price appreciation Ponzies is a funny item to document. They are part of the housing story. I didn't cast the part, I merely report the activity and note it for what it is. It's the entitlement that is shocking to me. And the huge dollar amounts borrowed and spent is shocking too. These borrowers ripping off the banks that gave them the free money… well, what does two wrongs make?

I don't stress much about the Ponzis. I write about them because they are the story. They are not the majority in Irvine. Most people here are good people who work hard and save money. Kudos to them. However, Ponzies have a significant presence as evidenced by the property records, and the toll the market must pay for their activities is yet to be paid.

The IHB is still just a hobby. I write some crazy stuff about housing, and people stop by to read it. It's a laugh. Don't take it too seriously. I don't.

Seriously, we will continue to improve

Writing for the IHB is a great personal discipline for me. It takes habits and deadlines that must not be missed. I have tried to make each post feel thought through and cared about. I want to continue to present information to a high standard. Unfortunately, I must accomplish this within the time available. I will improve in 2011.

We plan to provide more market data and other information. I don't know what form that will take, but I would like to present understandable housing market data. There are other bells and whistles we are considering, but for now, I will remain mum until we have something ready to debut.

Most people who look for a home in Irvine search on the internet and when they do, they nearly all find the IHB. Unfortunately, not all of these people find what they are looking for. We hope we can serve more of their needs with future site enhancements.

Irvine Home Address … 55 GRAY DOVE Irvine, CA 92618

Resale Home Price … $1,350,000

Home Purchase Price … $1,110,000

Home Purchase Date …. 12/5/2007

Net Gain (Loss) ………. $159,000

Percent Change ………. 14.3%

Annual Appreciation … 6.4%

Cost of Ownership

————————————————-

$1,350,000 ………. Asking Price

$270,000 ………. 20% Down Conventional

5.07% …………… Mortgage Interest Rate

$1,080,000 ………. 30-Year Mortgage

$281,763 ………. Income Requirement

$5,844 ………. Monthly Mortgage Payment

$1170 ………. Property Tax

$450 ………. Special Taxes and Levies (Mello Roos)

$225 ………. Homeowners Insurance

$175 ………. Homeowners Association Fees

============================================

$7,864 ………. Monthly Cash Outlays

-$1511 ………. Tax Savings (% of Interest and Property Tax)

-$1281 ………. Equity Hidden in Payment

$536 ………. Lost Income to Down Payment (net of taxes)

$169 ………. Maintenance and Replacement Reserves

============================================

$5,777 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$13,500 ………. Furnishing and Move In @1%

$13,500 ………. Closing Costs @1%

$10,800 ………… Interest Points @1% of Loan

$270,000 ………. Down Payment

============================================

$307,800 ………. Total Cash Costs

$88,500 ………… Emergency Cash Reserves

============================================

$396,300 ………. Total Savings Needed

Property Details for 55 GRAY DOVE Irvine, CA 92618

——————————————————————————

Beds: 3

Baths: 3 full 1 part baths

Home size: 2,717 sq ft

($497 / sq ft)

Lot Size: 5,227 sq ft

Year Built: 2007

Days on Market: 58

Listing Updated: 40485

MLS Number: S637990

Property Type: Single Family, Residential

Community: Portola Springs

Tract: Lasc

——————————————————————————

Beautifully customized home with spacious floor plan and architectural features such as rounded corners and door arches. Highly upgraded throughout including the gourment kitchen with granite countertops, custom cabinetry, high end stainless steel appliances and a wine frig/bar area. Travertine flooring downstairs, designer carpet upstairs, custom cabinetry in all baths, solid wood doors, custom shutters, surround sound system, epoxy finished garage floor and much more. The tropically landscaped backyard includes over $100k in upgrades with a travertine patio, pool, spa, BBQ, bar and firepit. Must see to appreciate!

gourment?

The bear rally has ended. The next leg down will likely lead us to the true bottom of real estate prices.

Irvine Home Address … 2100 TIMBERWOOD Irvine, CA 92620

Resale Home Price …… $359,900

The Spirit of the Woods is like an old good friend.

Makes me feel warm and good in-side.

I knew his name and it was good to see him again.

Cause in the wind he's still a-live.

Oh Fred Bear

Walk with me down the trails again.

Take me back, back where I be-long.

Fred Bear

Ted Nugent — Fred Bear

As I noted in a previous post, House prices resume their downward trend, the false bottom of 2009 is being tested by a languishing real estate market.

Housing Recovery Stalls

Fresh Fall in Home Prices Is Headwind for Economy; Other Signs Still Strong

By S. MITRA KALITA And SUDEEP REDDY — DECEMBER 29, 2010

A new bout of declining home prices is threatening to hamper the U.S. recovery, just as consumers and the overall economy have been showing signs of healing.

Home prices across 20 major metropolitan areas fell 1.3% in October from September, the third straight month-over-month drop, according to the S&P/Case-Shiller home-price index released Tuesday. Many economists expect the declines to continue into at least next spring, erasing most of the gains made since prices bottomed out in early 2009.

The housing market, which appeared poised for a recovery earlier in the year, now could be heading for a second downward drift.

“This looks like a double-dip [in housing] is pretty much on the way, if not already here,” said David Blitzer, chairman of the Standard & Poor's index committee. “Somebody who thought last year that it's going to be straight up from here was wrong.“

That's right. The bears were right, and the bulls were wrong.

Enough gloating. Back to the serious business of documenting the ongoing collapse of real estate prices.

Other news in recent weeks, however, has offered hope the economy is on the cusp of strong, sustainable growth. Retail sales returned to levels seen just before the recession started in 2007. Manufacturing continues to expand. U.S. exports are back to where they were just before the financial crisis.

Optimism among heads of small businesses and large corporations is also near pre-recession levels. And tax legislation that includes a one-year payroll-tax cut for most workers has boosted prospects.

Yet the twin forces of jobs and housing remain trouble spots. The labor market has added a million jobs in the past year, but that pace is far too slow to offset an unemployment rate that climbed to 9.8% last month.

Job worries are hampering consumer confidence despite strength in holiday sales and a rising stock market. The Conference Board, a business research group, said Tuesday that its confidence index fell to 52.5 from 54.3 in November, as consumers' views about job availability worsened.

The index, after rising through May as the economy showed early signs of improvement, now has retreated to its level of a year ago. The percentage of people planning to buy a home is also back to where it was a year ago, erasing improvement seen in early 2010.

U.S. Consumer-Confidence Index Slips

In the Case-Shiller data, all 20 cities in the index posted month-over-month declines in October.

As for year-over-year data, only four areas—Los Angeles, San Diego, San Francisco and Washington, D.C.—showed prices higher than in October 2009. Six markets hit their lowest since prices started falling four years ago, dropping below their spring 2009 levels, when most regions saw prices bottom out. The six were Atlanta, Miami, Seattle, Tampa, Charlotte, N.C., and Portland, Ore.

Prices in several markets, including Las Vegas and Cleveland, are nearly down to 2000 levels.

The low end in Las Vegas is trading at the early 90s levels. The good stuff still hangs on at 2004 prices. The good stuff will continue to decline, but investors and new owner-occupants will keep low-end prices stable.

The housing index was driven down by factors including the expiration of a federal tax credit for buyers who signed contracts by April 30, which caused demand to fall off.

Prices also were weighed down by a huge inventory of foreclosed homes, which tend to sell at sharply discounted prices.

In recent months, according to the National Association of Realtors, foreclosure and other distressed sales have represented more than 30% of home sales—and more than half in some states, such as Nevada.

Wells Fargo & Co. projects prices will drop 8% more by mid-2011, given high supply. “Demand is still dead in the water,” said Wells economist Sam Bullard.

Prices also face other hurdles: slightly rising mortgage rates, and homeowners who owe more on their houses than they're worth, and thus may walk away as values dip further.

The owners under pressure include Tasha McLaughlin, a 33-year-old mother of two in Sacramento's South Natomas neighborhood. She and her husband, Steve, bought their two-bedroom house in 2004 for $256,000, intending to stay about five years. After 11 months of trying to sell it between 2006 and 2007, the family took it off the market.

“Everyone is saying we should foreclose or claim bankruptcy, but I have a moral issue with that,” said Mrs. McLaughlin. “The more we try to pay the mortgage and pinch pennies, the more we get punished.”

Now, with a similar home down the block listed for $80,000, the McLaughlins are accepting that they won't recoup their losses anytime soon. Their interest-only loan is set to increase their current $1,600 monthly payment to $2,200 in seven years. If they were to default on their mortgage and walk away, they calculate that in about the same time, seven years, their credit scores would be stable enough to allow them to buy again elsewhere.

“I am just going to swallow my pride and walk out. I have to,” said Mrs. McLaughlin. “The market for homes is not going up.“

Housing analysts agree that markets such as Sacramento, Las Vegas and parts of Arizona and Florida are at risk of more declines. “These places relied so heavily on mortgages and real estate for their economy that we're going to see a two-tiered recovery,” said Chris Mayer, a professor of real estate at Columbia Business School. “Luxury spending is not going on across the country—it's happening among highly skilled consumers who live in the places that have seen some recovery.”

Homes remain a key part of Americans' wealth. Households held $6.4 trillion of home equity at the end of the third quarter, alongside $12.2 trillion in stocks and mutual-fund shares, according to Federal Reserve data.

For every dollar decline in housing wealth, consumers reduce spending by about a nickel in the subsequent 18 months, Moody's Economy.com chief economist Mark Zandi estimates. He cautioned that other factors, such as the stock market's strength and tax credits, could offset this effect.

“People feel poorer when their houses are going down in value,” said Jack Fitzgerald, chief executive of Fitzgerald Auto Malls, which has a dozen locations along the East Coast. He is seeing many customers who could buy new cars choosing used cars instead, “spending as little as they can.” While sales are improving, he expects them to grow only slowly, given all the consumer uncertainty.

Still, the overall economy's dependence on housing diminished greatly since the financial crisis, said Ivy Zelman, chief executive of Zelman & Associates, a housing-research firm. “Consumers have shown us they can still spend even if home prices go down,” she said. But falling home values “put a lid on the recovery and the magnitude of it.”

I don't believe house prices will fall a large amount from here. They will go down, particularly at the high end, but with an improving economic picture, demand for housing will improve. Considering it has been hovering near historic lows for years, it is bound to pick up some in 2011. Much will depend on the course of interest rates and unemployment. If interest rates move higher and unemployment stays high, house prices may fall significantly, but if interest rates remain low, and if unemployment drops, we won't see a significant uptick in prices because hte overhead supply, but we could see a big increase in sales volumes. That would be great for clearing the market.

100% financing deal emerges from 2.5 years of shadow inventory

Today's featured property was purchased on 9/16/2005 for $509,000. The owners used a $356,300 first mortgage, a $152,700 stand-alone second, and a $0 down payment. The defaulted about three years ago.

Foreclosure Record

Recording Date: 05/12/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 02/09/2010

Document Type: Notice of Default

Foreclosure Record

Recording Date: 11/02/2009

Document Type: Notice of Rescission

Foreclosure Record

Recording Date: 06/04/2009

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 04/21/2008

Document Type: Notice of Default

Since this was a purchase money, non-recourse mortgage, the bank was in no hurry to foreclose and take the loss. There is no prospect of recovery on this loan. The finally got around to foreclosing on 7/19/2010 for $431,484, then they spent several months preparing it for sale — which looks like they did nothing.

Are the shadow inventory deniers still making fools of themselves, or has everyone accepted that shadow inventory is real and not that hard to find?

Irvine Home Address … 2100 TIMBERWOOD Irvine, CA 92620

Resale Home Price … $359,900

Home Purchase Price … $509,000

Home Purchase Date …. 9/16/2005

Net Gain (Loss) ………. $(170,694)

Percent Change ………. -33.5%

Annual Appreciation … -6.3%

Cost of Ownership

————————————————-

$359,900 ………. Asking Price

$12,597 ………. 3.5% Down FHA Financing

5.07% …………… Mortgage Interest Rate

$347,304 ………. 30-Year Mortgage

$75,116 ………. Income Requirement

$1,879 ………. Monthly Mortgage Payment

$312 ………. Property Tax

$100 ………. Special Taxes and Levies (Mello Roos)

$60 ………. Homeowners Insurance

$242 ………. Homeowners Association Fees

============================================

$2,593 ………. Monthly Cash Outlays

-$311 ………. Tax Savings (% of Interest and Property Tax)

-$412 ………. Equity Hidden in Payment

$25 ………. Lost Income to Down Payment (net of taxes)

$45 ………. Maintenance and Replacement Reserves

============================================

$1,940 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$3,599 ………. Furnishing and Move In @1%

$3,599 ………. Closing Costs @1%

$3,473 ………… Interest Points @1% of Loan

$12,597 ………. Down Payment

============================================

$23,268 ………. Total Cash Costs

$29,700 ………… Emergency Cash Reserves

============================================

$52,968 ………. Total Savings Needed

Property Details for 2100 TIMBERWOOD Irvine, CA 92620

——————————————————————————

Beds: 2

Baths: 1 bath

Home size: 1,270 sq ft

($283 / sq ft)

Lot Size: n/a

Year Built: 2005

Days on Market: 73

Listing Updated: 40526

MLS Number: P755549

Property Type: Condominium, Residential

Community: Northwood

Tract: Cust

———————————————————

According to the listing agent, this listing is a bank owned (foreclosed) property.

Like new! Immaculate one bedroom + loft (used at a bedroom) townhouse built in 2005 located in the desirable Collage complex. Unit features include brand new paint and carpet throughout, fireplace, one car garage, patio with pool views, walk-in closet and storage room. Complex is equipped with beautifully manicured landscaping, pool, spa and secure gate access. Property will be sold with washer, dryer, stove/range and dishwasher.

I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.

Have a great weekend and a happy new year,

Irvine Renter