Don’t waste your time on jealousy;

sometimes you’re ahead,

sometimes you’re behind.

The race is long, and in the end,

it’s only with yourself.

Everyone’s Free — Baz Luhrmann

Link to Music Video

I have ranted on numerous occasions on this blog about people’s desires to feel superior to their fellow man. I find it to be the least desirable feature of California’s culture. This need people have to raise their low self-esteem at the expense of other people is part of the impetus behind my posts on The Grand Illusion and The Reservoir of Schadenfreude. Releasing the anger caused by these interactions is part of the energy I find for writing on this blog. Today I want to address one of these California traditions and examine why homeowners feel superior to renters and see if there is any validity to these feelings.

Any group that feels superior to another group can live with their happy delusions forever. Every religious zealot or racial bigot carries a false belief of superiority. We can all laugh at them and let them be (assuming the “superior” group is not violent.) If those placed in the inferior position do not share the feelings of inferiority, the “inferior” group is not harmed — their energy is not stolen. It is when this latter group accepts and believes the feelings of inferiority that harm is done. To put it in terms of the housing market, homeowners can feel they are superior if they want to, but it is only when renters believe it that renters are harmed. Other than than the need to prop up a weak ego, why would a homeowner feel superior to a renter?

There was a time when home ownership was obtainable only by people of character. You knew if you met a homeowner, they went through the rite of passage necessary to achieve that status. Demonstrating the character necessary to become a homeowner used to be a good reason to respect someone — not anymore. I wrote in the post, Brio New World, “Previous generations had a formula for a “normal,” happy life. You used to save your money until you had a 20% downpayment, then you bought a house, and if you had increases in income, you could move up to a nicer place. Home ownership was a symbol of success. It proved you could save to reach a goal; it proved you were responsible; it made you happy. It was also a ticket to financial security as your home equity would become a savings account you could use to fund your retirement when you downsized to smaller accommodations. These were the rules of old.

The lending industry changed all of that. They eliminated all measures of responsibility including honesty with “liar loans,” integrity with low FICO scores, and accountability with 100% financing. When homes can be purchased by people who lie, cheat and steal, the prestige of home ownership is diminished — no make that eliminated. Home ownership no longer symbolizes sacrifice and success, instead it now is synonymous with greed and gambling in the commodities market. Welcome to our Brave New World.”

It reminds me of fashion fads. When a new fashion comes out, good-looking people buy the fashion, and it becomes popular. As long as the fashion is the exclusive purview of good-looking people, the fad will remain popular. Eventually, the not-so-good-looking who want to join the club purchase the fashion, and it goes out of style. When people who do not possess the attributes of the club they are trying to join are given access, the prestige of the club is immediately diminished. As Groucho Marx said, “I don’t want to belong to any club that will accept me as a member.”

Many homeowners are still living with the belief they are superior and they are members of an exclusive club. They turned a blind eye to the not-so-desirable element that was admitted to their exclusive club during the rally. Why would they care when admitting these people made them huge amounts of phantom equity?

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However, the fact remains, there are a great many “homeowners” who are not financially responsible, they do not know how to save, and they do not know what it means to sacrifice. These late entrants to the housing club are now defaulting in record numbers. They aspire to the respect homeowners were given in the past; they desperately want to look down on their renting acquaintances with that feeling of moral superiority of generations past; however, they just don’t possess the attributes which made homeowners a group to respect. The presence of these interlopers has made home ownership something to be ashamed of not something to be aspired to.

Flushing these interlopers out of the system is going to be painful. House prices are going to decline to pre-bubble levels when the fundamentals make sense again. It will be as if the bubble never happened. Homeowners who survive will be left with lingering memories of what their houses were temporarily selling for during the bubble. Those who are not qualified to be homeowners will be forced to rent again after the foreclosure. They will end up in the “renting class” all over again.

When this time comes, many “bitter renters” who sat out the rally and subsequent crash with money in the bank will step in to save the day. After the painful purge, the prestige of home ownership will be restored, as only owners will be the financially prudent who can sacrifice and save money — the attributes of respect formerly associated with home ownership. These are the times I look forward to. The next time a homeowner denegrates a “bitter renter,” I hope they realize these are the people who will step up and restore the prestige of home ownership when the time is right.

I’ve got the power hey yeah heh

I’ve got the power

Oh-oh-oh-oh-oh-oh-oh-oh-oh yeah-eah-eah-eah-eah-eah

I’ve got the power

Oh-oh-oh-oh-oh-oh-oh-oh-oh yeah-eah-eah-eah-eah-eah

Gettin’ kinda heavy

The Power – Snap!

Link to Music Video

As you might have surmised, the real estate community is not thrilled with the writings of yours truly and the exchange of accurate, un-bullish information at this blog. Realtors in particular are accustomed to controlling the information regarding real estate, and media outlets like this blog are a threat to their monopoly.

They even have the audacity to criticize anyone who broadcasts a negative truth as if the dissemination of information is the problem and not the information itself. After we published Irvine Realtor Ratings 7-8-2007 the realtors pressured OC Home Review to stop giving the general public access to the information we used in our report. Apparently incompetence and poor performance are OK with the real estate community. It is all part of the old game of blame the media.

Does the real estate community have anything to worry about? Is it possible for the Irvine Housing Blog to have an impact on the housing market?

In an earlier post, How Sub-Prime Lending Created the Housing Bubble, I gave a brief description of the impact of adding a large number of new buyers to the market. However, the title is somewhat misleading because it does not fully explain how the bubble was inflated. In this post, I hope to provide a more detailed explanation of what factors and conditions combined to drive prices so high.

The Great Real Estate Bubble was caused by 4 interrelated factors:

1. Separation of origination, servicing, and portfolio holding in the lending industry.
2. Innovation in structured finance and the expansion of the secondary mortgage market.
3. The lowering of lending standards and the growth of subprime lending.
4. Lower FED funds rates as a catalyst (Lowering mortgage rates was not a big factor.)
5. The negative amortization loan (Option ARM.)

The secondary mortgage market came into being in the early 1970s to provide greater liquidity to banks and other lending institutions to facilitate home mortgage lending. Freddie Mac and Sallie Mae were set up to package loans together into pools and sell them to investors as mortgage-backed securities.

As the secondary mortgage market continued to grow, lending institutions began to sell the loans they originated rather than keeping them in their own portfolio. The banks began to make money by originating and servicing loans rather than through keeping them and earning interest. This was a dramatic shift in lending practices.

With this shift came an equally dramatic shift in incentives: lending institutions stopped being concerned with the quality of the loans because they didn’t keep them, and instead they became very concerned with the volume of loan origination and the fees this generated. This fundamental change in the behavior of lenders leads inevitably to a lowering of lending standards. Lower lending standards opened the door for lenders to provide loans to those with low FICO scores: subprime borrowers.

Subprime lending as an industry barely existed prior to 1998. There were no lenders willing to loan to people with poor credit, and there was no secondary market to purchase these loans if they were originated. The growth of subprime was the direct result of the lowering of lending standards created by the change of incentives brought about the creation of the secondary market.

These factors alone were not enough to create the Great Housing Bubble, but they provided the basic infrastructure to allow house prices to take flight. The catalyst for the inflation was the Federal Reserve’s lowing of interest rates in 2001-2003.

Many mistakenly believe the lower interest rates themselves were responsible by directly lowering mortgage interest rates. This is not true. Mortgage interest rates declined during this period, and this did allow borrowers to finance somewhat larger sums with the same monthly loan payment, but this was not sufficient to inflate the housing bubble. This is also why a lowering of interest rates will not be able to save the housing market. The only thing that would do that would be another massive influx of capital.

Notice that mortgage interest rates have ranged from a high near 7% in 2001 to a low near 5.5% from 2002 to 2005. The drop from 7% to 5.5% would have supported a 15% increase in prices, not the 150% increase in prices which actually occurred.

The lower Federal Funds rate did cause an expansion of money supply, and it lowered bank savings rates to such low levels that investors sought other investments with higher yields. It was this increase in liquidity and quest for yield that drove huge sums of money into mortgage loans.

This is where another of the lending industry’s innovations comes into play: structured finance. Debt is money. If you can find a way to create more debt, you create new money. The problems comes when you create more debt than there is cashflow to service it which is where we are now. There is a tipping point where the debt service exceeds the cashflow, and when this tipping point is reached, the entire debt structure collapses in a deflationary spiral. The structured finance products such as collateralized debt obligations and their derivatives are highly leveraged instruments with a very sensitive tipping point. This is why the hedge funds at Goldman Sachs imploded so quickly and so completely.

With a huge influx of capital into the secondary mortgage market, the industry was under tremendous pressure to deliver more loans to hungry investors. This caused the already-low loan standards to be all but eliminated. All of the worst “innovations” in the lending industry occurred during this period: Negative Amortization loans, Stated-Income loans (Liar Loans,) NINJA loans (no income, no job, no assets,) 100% financing, FICO scores under 500, one-day-out-of-bankruptcy loans, etc. The joke was if you could “fog a mirror” or if you “had a pulse,” you could get a loan for as much as you wanted to buy a house.

The real culprit in the housing bubble was the negative amortization loan. No other innovation or practice drove prices higher than this one because it allowed borrowers to take on so much debt.

The same monthly housing payment with an Option ARM finances double the loan balance. As I stated in, The Anatomy of a Credit Bubble, “Stop for a moment and ponder the math: the same payment now finances 100% more money. Is it any wonder the real estate market was 100% overvalued at the top? People purchasing with Option ARMs were buying at the rental equivalent value. From a financing perspective, the market was not overvalued. People were paying exactly what they should have been paying. They were just doing it with loan terms which were going to destroy them — hence the term “suicide loan.” ” Now that Option ARMs are disappearing, what do you think will happen to house prices?

Conclusions

First, the infrastructure was built to deliver capital to the housing market, which in turn changed the incentives in the lending industry. Next, the FED created conditions where large amounts of capital was seeking a new home (pun intended.) Finally, the lending industry “innovated” and found unique — and inherently unstable — ways of putting this capital to work. What you get in the end is a massive asset bubble.

There is a larger issue here pertaining to the FEDs monetary policy that I hope you see. The creation of the secondary market for mortgages alone was not the problem. The change in lender incentives might have created some issues, but without a huge influx of capital to put pressure on the system, it probably would not have broken. When the FED stimulates the economy through lowering interest rates and increasing the money supply, that money will go somewhere. When it does, it creates massive distortions in asset values and with it a commensurate inefficient use of investment capital. This is not free-market capitalism, it is government welfare doled out to the investment class. Ben Bernanke is taking us down this road yet again. If he continues to lower interest rates, investment capital will flow into a new asset class (no, it will not flow into housing and save the day.) How many more bubbles must we endure before the FED stops creating them?

Ready for a cheap escape

On the brink of self destruction

Widespread panic

Broken glass inside my head

Bleeding down these thoughts of

Anguish… mass confusion

Panic Song — Green Day

Link to Music Video

When I am preparing posts, I scan Redfin for properties. When I first started doing this in the spring, rollbacks were hard to find, and most sellers were still trying to make a profit or at least cover their commissions on a sale. As spring gave way to summer, I began finding more and more rollbacks, and foreclosures and short sales were becoming more common. As the summer progressed, I began finding more REOs and deeper rollbacks. It was a relatively quick (for a real estate market) transition from a bull market to a bear market. However, recently I have noticed a more significant change.

In August when the credit market seized up, sales — which were already low — almost completely stopped. This credit event and the problems it has created has been widely covered by the mainstream media which has brought it to full public awareness. Over the last few weeks, I have really noticed a change in the market I was not expecting until the winter: fear is gripping the market.

In the post Houses Should Not Be a Commodity I described the stages of a bubble market in great detail. IMO, the developments in the credit market have prematurely jolted the consciousness of the market from denial into fear. A change in market consciousness is a gradual transition as each of the markets participants has a different psychological makeup, but the behavior of many homeowners in the market is evidence that this transition has begun.

Back in mid-July, before the big credit market meltdown in early August, I profiled a series of properties in Oak Creek. There were a few rollbacks, but there wasn’t that much inventory, and no real signs of fear or panic. In the last few weeks, there have been several listings of condos and entry-level housing appearing on the market.

Notice the density of green house symbols in certain neighborhoods. In particular the northernmost neighborhood has shown a dramatic increase in the number of listings, and many of these are rollbacks. This is fear in action.

Another neighborhood showing increased listings and more racing to find the bottom is Northwood II.

Like all the new neighborhoods in Irvine, this one is populated by specuvestors who are starting to realize they made a terrible mistake. The homes priced in the $750K to $950K range, so these are not the small condos we are seeing struggle everywhere else. This is the first sign of fear spreading from the low-end of the market to the move-up SFD market.

Another neighborhood showing and increase in listings and a decrease in pricing is Northpark.

In particular, the neighbhorhoods adjacent to the 261 are showing fear transitioning to panic. There have been a large number of foreclosures there, and new listings are popping up to try to get out before the tsunami of REOs washes away whatever equity these owners have left.

Of course, we have our neighborhoods where fear and panic have already set in…

Westpark condos above and Orangetree below…

Quail hill (not shown) is also showing distress. I invite you to go to Redfin and check out the market for yourself.

Fear in the market is not something that can be quantified; however, evidence of fear can be inferred from the behavior of market participants. An increase in listings and lower asking prices is fearful behavior. When the race to the bottom becomes more feverish and sellers start aggressively lowering prices to get out of the market, you will know fear has taken hold and capitulation is right around the corner.

One of the most poignant songs about the frustration and disappointment of unrequited love is Bonnie Raitt’s “I Can’t Make You Love Me.” With a little retooling of the lyrics, it could be equally expressive of the frustration and disappointment of failing to sell a home.

Bonnie Raitt on Video

Bring down the price, bring down the rent

Let me pay back, the money I was lent

Forclose on me, for all of my buys

Just help me close, please qualify — please qualify for me

Cause I can’t make you buy me if you don’t

I can’t make a good deal, I owe too much on my note

I’m near a park, with beautiful flowers

I’ll go way down on price, I’ll re-tile the shower

but you won’t, no you won’t

Cause I can’t make you buy me if you don’t

I’ll close my eyes, then I won’t see

The fall of the market all around me

Foreclosure will come and I’ll do what’s right

I’ll borrow ’til then, to the very last night

And I will give up this fight

Cause I can’t make you buy me if you don’t

I can’t make a good deal, I owe too much on my note

I’m near a park, with beautiful flowers

I’ll go way down on price, I’ll re-tile the shower

but you won’t, no you won’t

Cause I can’t make you buy me if you don’t

I Can’t Make You Buy Me — IrvineRenter

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When the market turned up in the late 1990’s the balance of power in the market shifted. During the last decline, the buyers had an advantage. During the bubble the advantage went to the sellers. The seller’s market went on for so long and became so feverish that people have forgotten (or may never have known) what it was like to see buyers in control of the action. The purpose of this post is to re-educate buyers on how to behave in a buyer’s market.

Buyers have the Power

As a buyer, you must remember you are the one in control. You are the scarce commodity in the marketplace. The seller is one of many for you to chose from, and they are all desperate. They need you. You don’t need them. No matter who you buy from, you are going to leave all the other sellers disappointed because they are going to continue to be trapped in their homedebtor’s prison. You can’t please everyone, so focus on pleasing yourself.

Screw the Sellers

Don’t become concerned with the sellers needs, wants and problems. Does it matter to you if this house is their entire savings for retirement? Do you care if a sale below a certain price puts the seller into bankruptcy? If these issues matter to you, ask yourself this, “Would you give them money if you were not buying their home?” Unless you are running a charity, you should not care about the consequences of someone else’s financial decisions. They created their own problems, it is not your responsibility to solve it by overpaying for a house.

Pay the Lowest Possible Price

This may sound like common sense, but the behavior of knife catchers over the last couple of years shows otherwise. Don’t ask for or take any incentives, and pay your own closing costs. You are paying for this stuff, it is just buried in your loan. You will be paying interest on this purchase for the next 30 years, and you will be paying a 1% property tax on these costs for as long as you own the house. You are far, far better off lowering the price and foregoing the incentives and paying your own closing costs.

Use a Buyer’s Brokerage Like Redfin

Redfin and other buyers brokerage typically kick back 2% to you at closing. Work out a deal with them in advance where they will agree to take a 1% commission at the closing so you can lower the price by 2%. Again, you are paying taxes on the purchase price, so you want to make this as low as possible.

Your First Offer is Your Best Offer

This is the most counter-intuitive part of buying in a buyers market. Ordinarily sellers, or more accurately the seller’s realtor, try to create a sense of urgency to buy the house. They want you to think other people are looking, there is going to be a bidding war, you need to get your offer in today, etc. Remember, in a buyer’s market these ploys are all lies. You are the only buyer, and you can take as long as you want to buy the house. Your task in negotiating is to create a sense of urgency and panic in the seller. This is why you make your first offer your best offer.

Start with a bid at least 10% below asking price; however, it can be less if the most you are willing to pay is less. Lower your bid as follows:

• If you are actively bidding on the property, make your offers expire in 5 days. If you are still interested in the property resubmit a fractionally-lower offer after 7 days (make them sweat for 2 days.) Don’t make is so much lower as to lose consideration, but make it enough lower that the seller gets the message that they need to come to your price before it gets any lower.
• If the seller makes a counter offer, retract your offer and resubmit a lower one. Works the same as the time decay offer above. After you have lowered your offer a few times, the seller may panic and take your offer before it goes any lower. This is what you are after.
• Lower your offer $500 each time you speak with the seller’s realtor. Every time they communicate with you, they will pressure you to buy. Lower your bid each time they speak with you to send a message that their pressure is not working, and it is, in fact, hurting their client.
• Lower your offer $2,000 if the realtor uses one of the standard lies I mentioned above.
• If the realtor tells you there is another bidder on the property, immediately withdraw your offer and tell them to call you if it falls out of escrow with the other buyer. Since this statement from the realtor is almost certainly a lie, it will cause them to have to explain to their client why the only buyer around has pulled their offer.

Don’t Close the Gap

When the seller starts to counter-offer, it is very tempting to agree to their price to close the deal, particularly if they are below your original offer. Don’t do it. In a buyer’s market, the seller will come to you. You have the power. However, if they are below your original offer, and if you really, really want the house, you may raise your offer one time, but do not get closer than 1% to their counter-offer. The selling broker makes a 3% commission, and the realtor you have been dealing with probably makes 1.5%. By getting to within 1% of the seller’s counter-offer, the realtor can choose to give up part of their commission to make the deal. Since they are desperate as well, you should go ahead and squeeze them. A 1/2% commission is better than no commission.

After you have agreed on price

Just because you have reached agreement on the sales price does not mean you are finished making this deal the best it can be. Go through your inspection sheet and establish holdbacks for all repairs. Make the holdback amount 150% of the lowest qualified bid. Say you are doing this as an incentive for the owner to get this work done before move-in. Also, if there are decorative items you do not care for, use the same holdback procedure for these items. The time to get your granite tops is before you move in.

If you are really tough

For those of you with nerves of steel (and a desire to abuse your power,) I have a few additional suggestions for you:

• A week before closing, tell the seller or realtor you are considering pulling out of the deal because you have found another property you like. See if they offer you an additional discount.
• Three days before the closing, withdraw your offer and say you want an additional $1,000 off. Offer no explanation: You are only doing it because you can.
• Ask the seller to write you an emotional letter thanking you for purchasing their home. Send back the first one they give you saying they did not praise you enough.

Conclusion

Not everyone has what it takes to implement all of these price-busting techniques. However, the more of these you put into practice, the lower the price you will pay for the home you want. You will never see the seller or the seller’s realtor ever again. It does not matter if you offend them. In the end, they will be relieved you bought the house even if you made their lives hell in the process.

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As a buyer, it is time to be upbeat. There is a song that uniquely captures the joy of finding what makes you happy: Sade’s “Your Love is King.” If reworked, it also captures the joy of buyers in a buyer’s market.

Sade on Video

Your cash is king,

Keep you in my bank.

Your cash is king,

never need to thank.

Your diamond ring,

round and round and round my head.

Wiping all the debt from me.

It’s making my soul sing.

Having the very best of things.

I’m crying out for more.

Your cash is king,

Keep you in my bank.

Your cash is king.

You’re the ruler of my account.

Your diamond ring,

round and round and round my head.

Wiping all the debt from me.

It’s making my soul sing.

I’m crying out for more.

Your cash is king.

I’m spending more, I’m spending.

You’re making me rich, inside.

Your cash is king,

Keep you in my bank.

Your cash is king,

never need to thank.

Your diamond ring,

round and round and round my head.

Wiping all the debt from me.

It’s making my soul sing.

Having the very best of things.

I’m crying out for more.

Wiping all the debt from me.

It’s making my soul sing.

I’m crying out for more.

Your cash is king.

This is no bad debt

This is no sad and sorry dream.

This is no bad debt

Your cash…

your cash is real… gotta keep you in my bank,

never, never need to part,

spend me.

Never letting go,

never letting go,

never going to give it up.

I’m spending,

you’re making me rich…

Your Cash is King — IrvineRenter