The GSEs have strayed from their original mission, and now they are being used to support bloated house prices. They should be dissolved and their function turned over to private lenders.

Irvine Home Address … 2 GLENOAKS Irvine, CA 92618

Resale Home Price …… $815,000

Time Has Frozen Still What's Left to Be

Hear Nothing

Say Nothing

Cannot Face the Fact I Think for Me

No Guarantee

Metallica — Dyers Eve

Should the government provide loan guarantees to subsidize home ownership? The arguments in favor of government subsidies all come down to putting people into homes they cannot afford in a free market. The theory is that homeowners care more for their properties and community and are less likely to cause social unrest. There is no real evidence to support this idea, but expanding home ownership has been the cornerstone of government policy since before the Great Depression. The arguments against are summarized below.

Ten Arguments Against a Government Guarantee for Housing Finance

By ANTHONY RANDAZZO From the Reason Foundation — February 9, 2011

There is a growing belief among mortgage investors, industry groups and some policymakers in Washington that some type of explicit government guarantees for mortgage lending will be necessary to undergird a new housing finance system in America. Yet whether by the sale of insurance on mortgage-backed securities or a public utility model replacing Fannie Mae and Freddie Mac with new government-sponsored enterprises, this would be a tragic mistake, repeating the errors of history, and putting taxpayers and the housing industry itself at risk. This policy summary offers ten arguments for why there should be no government role—explicit or implicit—in guaranteeing housing finance.

1. Government guarantees always underprice risk. All federal guarantees underprice risk in order to provide a subsidy for lending. That is their purpose. And taxpayers will be exposed to losses in the future, as those risks materialize.

This simple truth is inescapable, yet proponents deny this fact.

2. Guarantees eventually create instability. Guarantees failed to prevent the savings-and-loan crisis and subprime crisis. In fact, they contributed to the cause of both by distorting the market.

When people believe they have no risk, they behave in foolish ways. Why wouldn't people take out a $600,000 loan to speculate on real estate if they have no money in the deal. It's like getting the free spin or free bet at a Las Vegas casino.

3. Guarantees inflate housing prices by distorting the allocation of capital investments. The artificially increased capital flow will make mortgages cheaper, boosting demand for housing and pushing up prices, ultimately creating another bubble.

It was private loan guarantees known as credit default swaps that caused so much money to flow into real estate and inflate The Great Housing Bubble.

4. Guarantees degrade underwriting standards over time. Historically, a primary justification for guarantees has been to increase the availability of finance to politically important groups with higher credit risks. It is inevitable that this will continue to happen, requiring the government to lower underwriting standards, and resulting in more risky mortgages.

Actually, the FHA has proven remarkably resistant to lowering its lending standards prior to the collapse of the bubble. The FHA has been around long enough to be a subprime lender — a role it has been forced into since 2008.

5. Guarantees are not necessary to ensure capitalization of the housing market. As has begun already, the jumbo market will evolve and practically any credit-worthy potential homebuyer will be able to get a mortgage in a fully private system.

Guarantees ensure more capital enters the housing market, but the secondary mortgage market is evolved enough now to exist without the GSEs to facilitate them.

6. Guarantees are not necessary for homeownership growth. Other nations have substantially higher homeownership rates in spite of having far less government interference in their housing markets.

Canada has no counterpart to the GSEs, they have no home mortgage interest deduction, and they have a higher home ownership rate than the United States. They either have better borrowers or better government policy.

7. Guarantees drive mortgage investment in unsafe markets. As long as there is a government guarantee covering financial institutions, investors and lenders will look to the government's credit, not the credit of institutions and loan applicants themselves.

This is the problem at the core of all loan insurance.

8. Guarantees are not necessary to preserve the “To Be Announced” market for selling mortgage-backed securities. If needed, a TBA market could easily develop with originators hedging against any short-term interest-rate risks in the private sector.

There is no guarantee the private sector could not provide assuming the risk can be quantified and valued.

9. Guarantees are not needed to prevent “vicious circles” that drive down prices. Mild price movements in the housing market are necessary to keep balance in the market. Keeping prices artificially high reduces housing demand and prolongs recovery. The most common threat of default as prices decline is from borrowers who have little equity in their homes—because they borrowed at high loan-to-value ratios—seeing the value of their homes drop below what they owe. Guarantees support these high-credit-risk borrowers.

Guarantees are not necessary to prevent a downward spiral in home prices because without guarantees, house prices would never become so elevated above fundamental valuations to cause worry about a downward spiral. The current downward spiral in real estate prices has required loan guarantees because prices were so elevated that the repricing of risk would have cut prices in half if not for the guarantees.

10. Even a limited guarantee on just mortgage-backed securities targeted at protecting against the tail risk will slowly distort credit allocation and investment standards, ultimately destabilizing the market and forcing the need to rely on the guarantee.

The FHA experience argues against this last point, but going forward, if we don't do something with the GSEs, reckless behavior will almost certainly take over because the government is backing all the losses. We know what we must do.

The End of Fannie Mae

Treasury wants the company phased out but punts on how to do it.

FEBRUARY 14, 2011

It's enough to make you believe in miracles: The Obama Administration is now on record as saying that Fannie Mae and Freddie Mac should go out of business. It took a global financial panic and $140 billion in taxpayer losses, but on Friday there it was in black-and-white in the U.S. Treasury's report to Congress on reforming the mortgage market: The Administration will “ultimately . . . wind down both institutions.”

This marks a break with decades of bipartisan support and protection for the two government-sponsored giants of mortgage finance. Fannie Mae has its roots in the Roosevelt Administration, and a phalanx of bankers, mortgage lenders, homebuilders and Realtors worked together to keep the companies growing and federal mortgage subsidies flowing. Now even some Democrats—though not yet those on Capitol Hill—admit their business model was a catastrophe waiting to happen.

This is a Wall Street Journal editorial, so the right-wing political posturing pervades the article. However, their point is true: it took a complete catastrophe for politicians to admit failure.

Under the Administration's proposals, Fan and Fred wind down over five to seven years. The two mortgage giants would, in effect, gradually price themselves out of the mortgage finance market by raising guarantee prices and down payment requirements, while lowering the size of the mortgages they could securitize and guarantee. This sounds like a plausible set of first steps to lure private capital back into the mortgage market, where some 92% of all new mortgages are currently underwritten or guaranteed by the government.

That is an excellent idea for phasing out these monsters. If you take away their margins, competitors will slowly emerge and take up the slack.

The $5 trillion question, however, is what would replace Fan and Fred. And here the Obama Administration has punted, offering the “pros and cons” of three broad proposals without endorsing any one of them.

Door No. 1 is the best of the lot by our lights. Under this option, federal guarantees would be limited to Federal Housing Administration (FHA) loans for lower-income buyers and VA assistance for veterans and farm programs—each a narrowly targeted market segment. A Treasury official says this would reduce the taxpayer backstop over time to about 10% to 15% of the mortgage market.

The Administration puts the case for federal withdrawal from the broader housing market in compelling terms: “The strength of this option is that it would minimize distortions in capital allocation across sectors, reduce moral hazard in mortgage lending and drastically reduce direct taxpayer exposure to private lenders' losses.” Bravo.

Treasury points to other benefits: “With less incentive to invest in housing, more capital will flow into other areas of the economy, potentially leading to more long-run economic growth and reducing the inflationary pressure on housing assets. Risk throughout the system may also be reduced, as private actors will not be as inclined to take on excessive risk without the assurance of a government guarantee behind them. And finally, direct taxpayer risk exposure to private losses in the mortgage market would be limited to the loans guaranteed by FHA and other narrowly targeted government loan programs: no longer would taxpayers be at direct risk for guarantees covering most of the nation's mortgages.”

Those two paragraphs more or less sum up 20 years of Journal editorials on housing.

The political right must be ecstatic. They are getting everything they have every wanted with housing. Those two paragraphs from a government report summarize the situation better than I can.

So what's not to like? The Administration says this option could reduce access to credit for some home buyers, and that it would leave the government without the tools to intervene in a future crisis. As for the credit point, other countries have high rates of home ownership with far less government support. If the government stands aside, it would open the way for alternative forms of finance, such as covered bonds, that now can't compete in the U.S. because of government favoritism for the 30-year mortgage model. This would open options for borrowers by increasing the diversity of financing.

As for a future crisis, government intervention is less likely to be needed if the market isn't distorted by government subsidies in the first place.

Amen. Just as affordability products make prices unaffordable, subsidies create the market need for future supports and subsidies.

Behind Door No. 2 is a rump Fan or Fred, one that would stay small in “normal” times but stand ready to step in with Uncle Sam's firepower in a future housing-finance crisis. But as the Administration acknowledges, it would be difficult both to stay small and retain the capacity to go large when needed. We'd add that the political pressure to expand any federal mortgage-lending program would be too great for lawmakers to resist. Within a generation, the winding down of Fan and Fred would be unwound.

Can the GSEs Exist Outside of Government Conservatorship? No. they can't. If they try to keep it around, it will become a political Hydra. Each time we cut off its head, two more will grow in its place.

But the greatest danger lies behind Door No. 3, which looks like Fannie in a new suit. Under this last option, the Administration envisages a group of tightly regulated, well-capitalized private mortgage insurers whose policies would be backstopped by government reinsurance. The government would charge premiums for this insurance, “which would be used to cover future claims and recoup losses to protect taxpayers.” This reintroduces the lethal mix of private profit and public risk by other means.

The problem with Fan and Fred from the beginning was not—despite the Administration's claims—that the profit motive corrupted their benign goals. Rather, the political influence and financial power of the housing lobby ensured that the companies operated outside the normal rules of politics and financial discipline. Thanks to an implicit government guarantee, the market never put any limit on their growth, even as their liabilities climbed into the trillions. Few politicians had the nerve to challenge a housing lobby that would attack them for opposing home ownership. The same political flaws would afflict a future reinsurer and its coterie of putatively private insurers.

The power of the housing lobby is implicit even in the Treasury's refusal to pick a preferred reform. As with entitlement reform, the Administration is leaving the hard work to House Republicans, who will bear the brunt of the political blowback. A reasonable GOP fear is that the Administration, whatever its rhetoric now, will pounce with a veto when it's politically advantageous—in, say, 2012.

Our view is that there should be no federal housing guarantee. If Congress wants to subsidize housing for the poor, it ought to do so explicitly through annual appropriations. One lesson—perhaps the most important—of the financial crisis is that broad policy favors for housing hurt every American by misallocating capital and credit. The feds created incentives to pour money into McMansions we didn't need while robbing scarce capital from manufacturing, biotech and other uses that might have created better jobs and led to a more balanced and faster growing economy.

We realize this is political heresy, but it is the beginning of wisdom in getting government out of the mortgage market. We're glad to see the Administration concede this rhetorically, even if it lacks the courage to embrace its logical policy conclusions.

The conservatives are right on this issue. The GSEs need to be dismantled. The FHA can stay in its current form and continue to provide the emergency backstop market protection it always has. The GSEs are redundant, and their current form of private ownership with public guarantees on the losses is dangerous.

Walking away from $400,000

Today's featured property is not for sale. It is a recent closing in Oak Creek that sold at a loss of about $180,000 after commissions. At first glance this doesn't seem like a big loss, but when you factor in the $200,000 or more this owner spent on upgrades, this house turned into a money pit.

With current financing conditions, this property would cost about $3,500 per month to own. Would it rent for that? If I could afford it, I would pay $3,500 a month to live there. I wouild be delighted to show a deal like this and say I bought it. (I didn't.) Those buyers are as happy as anyone can be that just paid $815,000 for a beautiful tract home in a nice but somewhat noisy neighborhood. I could see spending many happy hours in that pool. I love this house. Isn't the three-car garage cool? 😉

This is perhaps the nicest property I have seen transact at a price I thought was at rental parity.

Irvine Home Address … 2 GLENOAKS Irvine, CA 92618

Resale Home Price … $815,000

Home Purchase Price … $945,000

Home Purchase Date …. 6/19/06

Net Gain (Loss) ………. $(178,900)

Percent Change ………. -18.9%

Annual Appreciation … -3.2%

Cost of Ownership

————————————————-

$815,000 ………. Asking Price

$163,000 ………. 20% Down Conventional

5.02% …………… Mortgage Interest Rate

$652,000 ………. 30-Year Mortgage

$169,138 ………. Income Requirement

$3,508 ………. Monthly Mortgage Payment

$706 ………. Property Tax

$252 ………. Special Taxes and Levies (Mello Roos)

$136 ………. Homeowners Insurance

$136 ………. Homeowners Association Fees

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

$4,738 ………. Monthly Cash Outlays

-$858 ………. Tax Savings (% of Interest and Property Tax)

-$781 ………. Equity Hidden in Payment

$319 ………. Lost Income to Down Payment (net of taxes)

$102 ………. Maintenance and Replacement Reserves

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

$3,520 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$8,150 ………. Furnishing and Move In @1%

$8,150 ………. Closing Costs @1%

$6,520 ………… Interest Points @1% of Loan

$163,000 ………. Down Payment

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

$185,820 ………. Total Cash Costs

$53,900 ………… Emergency Cash Reserves

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

$239,720 ………. Total Savings Needed

Property Details for 2 GLENOAKS Irvine, CA 92618

——————————————————————————

Beds: 4

Baths: 3

Sq. Ft.: 2273

$359/SF

Lot Size: 6,130 Sq. Ft.

Property Type: Residential, Single Family

Style: Two Level, Traditional

View: Pool, Faces Northwest

Year Built: 2000

Community: Oak Creek

County: Orange

MLS#: S633860

Source: SoCalMLS

Status: This home is sold and off the market.

——————————————————————————

Huge corner lot with magnificent custom salt water PRIVATE POOL & oversized 8-person SPA and waterfall. Volcano-blower with FOUNTAIN effect in shallow-end. Flagstone decking, raised patio and Slate-tiled BBQ area. GOURMET KITCHEN with Solid Cherry-Wood cabinets, including pull-outs & easy-touch drawers. High-end STAINLESS STEEL APPLIANCES. Tumbled travertine backsplash with imported tile inlay. SLAB GRANITE COUNTERS. Upgrades galore. Dark HARDWOOD FLOORS in living room, family room, upstairs hallway and Bull Nose stairs. Custom stone fireplace. Custom built-in entertainment center. Decorator paint. Recessed lighting. Luxurious ITALIAN TUMBLED TRAVERTINE SPA SHOWER, huge tub, custom mosaic tile accents, dual sinks. OVERSIZED WALK-IN CLOSET. Shoe closet holds 80 pairs of shoes! Convenient upstairs laundry. 3-CAR GARAGE with storage cabinets. YOU WILL LOVE THIS HOUSE! Really close to the many association amenities, elementary school, upscale shops & restaurants!

Like many good proposals for reforming mortgage finance, lowering the loan limits insured by the GSEs and FHA likely will not happen because it will lower house prices.

Irvine Home Address … 5732 SIERRA CASA Rd Irvine, CA 92603

Resale Home Price …… $1,999,900

The grass was greener

The light was brighter

With friends surrounded

The nights of wonder

Looking beyond the embers of bridges glowing behind us

To a glimpse of how green it was on the other side

Steps taken forwards but sleepwalking back again

Dragged by the force of some inner tide

At a higher altitude with flag unfurled

We reached the dizzy heights of that dreamed up world

Pink Floyd — High Hopes

During the housing bubble rally, the grass was greener and the light was brighter. At higher prices with boundless hope, we reached the dizzying heights of real estate wealth, a dreamworld of unlimited appreciation and personal spending power.

Currently our housing market is completely supported by and dependent on government loan guarantees. By offering to assume all risk of loss, the federal government though the GSEs and the FHA is underwriting loans at historically low interest rates. This caused money to flow into mortgage lending at a time when proper risk management was to flee. This kept some of the air in the housing bubble which allowed the government to get control of the market's descent. The question is how do we move forward?

What do we do with a housing market completely hooked on government juice?

Treasury report advocates slashing GSE jumbo loan ceiling

The bursting of the housing bubble forced the GSEs and the FHA to start making loans to upper middle class borrowers who shouldn't require subsidies. Transitioning the housing market back to a private system with the free market determining interest rates will take a long time, and it will not be painless.

Lower loan limits would severely impact markets like Irvine

I wish I knew where this debate on mortgage finance reform is going. I suspect they will talk a lot, the rhetoric may get heated, but in the end they will do little or nothing now preferring to kick the can down the road to another crisis.

However, if they do lower the jumbo conforming limit from $729,750 to $417,000 or below, the meat of the Irvine market would suddenly have to pay jumbo rates. We would be among the first markets in the country to experience the transition from public to private financing. Jumbo rates are somewhere between half-a-point and one point higher than conforming rates. If future buyers are facing higher interest rates, their hopefully higher incomes will not be leveraged as much, and the loan balance will not be larger.

Markets where jumbo conforming loans ($417,000 to $729,750) are prevalent, the market impact will be the most noticeable. If you combine that with the possibility that loans that large will no longer be tax deductible, and borrowing huge sums to take a position in real estate doesn't seem quite so appealing. Future take-out buyers will not be so leveraged.

$30,000 plus 15 years equals $1,700,900?

The owners of today's featured property paid only $299,000 for this corner lot back in 1996. These owners used a $269,000 first mortgage and a $30,000 down payment. It looks like they tore down what was there and built a new home on the lot. Apparently, it was quite the upgrade because now they think this property is worth many times what they paid for it.

They refinanced on 2/2/2003 for $412,000 which likely paid for the upgrade and renovation. The description says this owner is an architect. If so, he is starving right now, and the 4/27/2010 refinance for $578,000 probably went to pay the bills. This isn't the only architect i know trying to sell their house because they aren't making any money. Very sad.

So this starving architect is selling his dream home. It may be sad to lose a dream home, but if we walks away with over a million dollars, he shouldn't cry very long.

Irvine Home Address … 5732 SIERRA CASA Rd Irvine, CA 92603

Resale Home Price … $1,999,900

Home Purchase Price … $299,000

Home Purchase Date …. 2/20/96

Net Gain (Loss) ………. $1,580,906

Percent Change ………. 528.7%

Annual Appreciation … 12.9%

Cost of Ownership

————————————————-

$1,999,900 ………. Asking Price

$399,980 ………. 20% Down Conventional

4.99% …………… Mortgage Interest Rate

$1,599,920 ………. 30-Year Mortgage

$413,628 ………. Income Requirement

$8,579 ………. Monthly Mortgage Payment

$1733 ………. Property Tax

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

$333 ………. Homeowners Insurance

$125 ………. Homeowners Association Fees

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

$10,771 ………. Monthly Cash Outlays

-$1650 ………. Tax Savings (% of Interest and Property Tax)

-$1926 ………. Equity Hidden in Payment

$776 ………. Lost Income to Down Payment (net of taxes)

$250 ………. Maintenance and Replacement Reserves

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

$8,220 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$19,999 ………. Furnishing and Move In @1%

$19,999 ………. Closing Costs @1%

$15,999 ………… Interest Points @1% of Loan

$399,980 ………. Down Payment

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

$455,977 ………. Total Cash Costs

$126,000 ………… Emergency Cash Reserves

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

$581,977 ………. Total Savings Needed

Property Details for 5732 SIERRA CASA Rd Irvine, CA 92603

——————————————————————————

Beds: 5

Baths: 5

Sq. Ft.: 5403

$370/SF

Lot Size: 10,160 Sq. Ft.

Property Type: Residential, Single Family

Style: Two Level, Contemporary, Mediterranean, Modern, Tuscan

View: City Lights, Hills, Mountain, Panoramic, Yes

Year Built: 2008

Community: Turtle Rock

County: Orange

MLS#: S646188

Source: SoCalMLS

Status: ActiveThis listing is for sale and the sellers are accepting offers.

——————————————————————————

Stop! You have never seen anything like this magnificent custom home with a unique floorplan that offers the ultimate in privacy, a flexible floorplan, outstanding outdoor entertaining areas built with remarkable finishes. This trend setting home, designed by the owner/architect, offers a huge (1,049 SF) home office with conference room which could also be a separate apartment or in law suite. In addition, the layout offers 2 master suites on the first floor, 2 view retreats, a welcoming 459 sq. ft. outdoor veranda with fireplace and 12' wood beamed ceiling, a huge (813 sq. ft) upstairs wing dedicated to entertaining while capturing the fabulous sunsets, city lights, snow capped mountains and surrounding hillsides. At the heart of the home is the kitchen with exquisite custom mahogany cabinetry designed by renowned Ziething Cabinets w/ gorgeous granite counters and top of the line stainless steel appliances. Over 2,300 sq. ft of travertine stone flooring throughout.

The second leg down in the deflation of the housing bubble is hitting markets previously thought to be immune from price declines. Affordability is improving for ordinary families as prices fall.

Irvine Home Address … 49 CARVER Irvine, CA 92620

Resale Home Price …… $739,900

I am a new day rising

I'm a brand new sky

to hang the stars upon tonight

I am a little divided

do I stay or run away

and leave it all behind?

Foo Fighters — Times Like These

As the deflation of the housing bubble has proceeded, each state, region, town and neighborhood that once thought they were immune to the laws of supply and demand have succumbed to the Ponzi lending virus. Prices didn't become inflated by strong demand from cash-rich foreigners or ordinary borrowers using sound lending programs. Prices in every market needed to correct back to levels sustainable by incomes. Some markets like Las Vegas took the shortest route — straight down. Markets like coastal California have been enjoying a slow downward glide punctuated by turbulence from the occasional REO going for 45% off.

Before the housing bubble is resolved all markets will tumble, its only a matter of when and how much. The bubble will deflate until local incomes support prices. If the tumble is too great, strategic default pushes prices well below fundamental valuations.

If the tumble is a mere stumble, the market slowly drops on a low-volume slide where only the most motivated buyers prevail.

Perhaps Irvine wage growth will continue to outpace California, the US, and internationally. If that happens, house prices here will appreciate at a pace greater than inflation and buyers here will get to enjoy the HELOC riches that accompanies wage growth and house price appreciation. It pays to buy where high wage earners want to congregate. It also pays to buy in areas coveted by savers.

Of course, if the gravy train of high wage growth and HELOC-producing appreciation could be endangered by a any of a number of factors. We have a dysfunctional California government and regulatory system. We are pressured by wage arbitrage from overseas. Existing high home prices make it difficult to attract workers.

Irvine will always command a premium in Orange County, but how much of a premium can OC or California expect to sustain against the rest of the nation or the world?

Housing Crash Is Hitting Cities Once Thought to Be Stable

By DAVID STREITFELD — Published: February 13, 2011

SEATTLE — Few believed the housing market here would ever collapse. Now they wonder if it will ever stop slumping.

The rolling real estate crash that ravaged Florida and the Southwest is delivering a new wave of distress to communities once thought to be immune — economically diversified cities where the boom was relatively restrained.

In the last year, home prices in Seattle had a bigger decline than in Las Vegas. Minneapolis dropped more than Miami, and Atlanta fared worse than Phoenix.

The bubble markets, where builders, buyers and banks ran wild, began falling first, economists say, so they are close to the end of the cycle and in some cases on their way back up. Nearly everyone else still has another season of pain.

Fiserv Case-Shiller: after five years of record declines, slow grinding bottom ahead

The fallacy of a painless housing market recovery

“When I go out and talk to people around town, they say, ‘Wow, I thought we were going to have a 12 percent correction and call it a day,’ ” said Stan Humphries, chief economist for the housing site Zillow, which is based in Seattle. “But this thing just keeps on going.”

Seattle is down about 31 percent from its mid-2007 peak and, according to Zillow’s calculations, still has as much as 10 percent to fall. Mr. Humphries estimates the rest of the country will drop a further 5 and 7 percent as last year’s tax credits for home buyers continue to wear off.

“We went into 2010 feeling gangbusters, thanks to Uncle Sam,” Mr. Humphries said. “We ended it feeling penniless, with home values tanking.”

The market entered the year in denial fostered by a doomed bear rally. The market ended the year facing the reality of the painful decline it thought it had avoided. The market is moving from denial, through fear, and into acceptance.

The fact that even a fairly prosperous area like Seattle was ensnared in the downturn shows just how much of a national phenomenon the crash has been. The slump began when the low-quality loans that drove the latter stage of the boom began to go bad, but the resulting recession greatly enlarged the crisis. Many people could not get a mortgage, and others simply gave up the hunt.

Now, though the overall economy seems to be mending, housing remains stubbornly weak. That presents a vexing problem for the Obama administration, which has introduced several initiatives intended to help homeowners, with mixed success.

Mixed success? Which program specifically had any success whatsoever?

CoreLogic, a data firm, said last week that American home prices fell 5.5 percent in 2010, back to the recession low of March 2009. New home sales are scraping along the bottom. Mortgage applications are near a 15-year low, boding ill for the rest of the winter.

It has been a long, painful slide. At the peak, a downturn in real estate in Seattle was nearly unthinkable. In September 2006, after prices started falling in many parts of the country but were still increasing here, The Seattle Times noted that the last time prices in the city dropped on a quarterly basis was during the severe recession of 1982.

Two local economists were quoted all but guaranteeing that Seattle was immune “if history is any indication.” A risk index from PMI Mortgage Insurance gave the odds of Seattle prices dropping at a negligible 11 percent.

If history is any indication, there are always a fool who makes a statement saying their market is “immune” because it is “different.” Or is it that markets have reached a permanently high plateau?

These days, the mood here is chastened when not downright fatalistic. If a recovery depends on a belief in better times, that seems a long way off.

Those who must sell close their eyes and hope for the best. Those who hope to buy see lower prices but often have lighter wallets, removing any sense of urgency.

Those that have no hope simply walk away and never look back.

Arne Klubberud and Melissa Lee-Klubberud paid $358,000 for a new, 960-square-foot townhouse on trendy Capitol Hill a few weeks after that Seattle Times article was published. Now, with one child and with hopes for more, they need more space. They just put the townhouse on the market for $300,000.

“Obviously, this is not the ideal situation,” said Ms. Lee-Klubberud, a 32-year-old lawyer. They are hoping to take advantage of the sour market to buy at a good price, but first, they must sell for an amount that is acceptable. “Everyone has their limits,” she said. “We have ours.”

On a dark, dank Sunday, a handful of people came to look at the three-level unit. One of them was Katherine Davis, who had just sold her house in the far eastern suburbs. It took 14 months, during which she had to drop the price several times. The equity she had accumulated over the decades disappeared quickly.

Perhaps the equity bestowed on her by the housing bubble disappeared quickly, but if she owned for decades and paid down her mortgage, she will still end up with the equity she would have had if there were no housing bubble. What she is really letting go of is her imaginings of riches not to be.

“At first, I thought it would be nice to come out of this with $200,000, but I adjusted my expectations,” Ms. Davis said. She ended up with less than half of that. Her goal is to buy a small place in the city, but not yet. “Selfishly, I’m hoping the market continues to drop,” she said.

Increasing numbers of sellers are simply surrendering.

This is market capitulation. I know I have used the psychology chart often lately, but these man-on-the-street stories illustrate these stages, and now that several markets are reaching capitulation and despair, these stories put real-life examples behind the abstract concepts.

Put yourself in the shoes of these borrowers as you read their stories. The circumstances they face and the emotions they feel about those circumstances are the essence of capitulation and despair.

Megan and Ryan Dortch tried to sell their one-bedroom Eastlake condo for $325,000 two years ago. They rejected an offer of $295,000 as inadequate. A year later, they relisted it for $289,000, then $279,000, which was less than they paid. Without a sale at that price, they could not afford to buy a place big enough for them and their new baby.

They have given up on real estate. They are renting out their old apartment at a small loss every month, and living in a rented house. “I don’t expect the market to get better,” said Ms. Dortch, 31, a customer service consultant.

Neither does Gene Burrus, another frustrated seller who became a landlord. “Rent is so cheap it doesn’t make sense to buy now,” he said. He might reconsider if 10 or 15 percent more comes out of the market.

Take a deeper look at Mr. Burrus's despondency. He needs house prices to go up, but he also recognizes that buying makes no sense. House prices will not be going up because there won't be stampedes of buyers and loose credit. He is wise enough to recognize that the herd reacting to the same information also recognizes it is a poor time to buy putting him on the wrong side of the trade. He is screwed, and he knows it. The moment he realized it was capitulation. Now he is feeling despair.

Redfin, a real estate brokerage firm based in Seattle, says foot traffic began picking up in the last several weeks. Mortgage rates are rising, which could nudge those who need to buy to make a deal now for fear rates will rise even more.

But whenever the market finally does pick up, all those accidental landlords will want to unload, putting another burden on the market. “So many sellers are waiting in the shadows,” said Redfin’s chief executive, Glenn Kelman. “The inventory is going to expand and expand and expand. I don’t see any basis for significant price increases.”

While almost every economist is expecting another round of price declines for the next few months, many see a leveling off in the second half of the year. Fiserv, the company that produces the monthly Case-Shiller Home Price Indexes, analyzed prices in 375 communities. About three-quarters of them will be stable by December, Fiserv calculates.

“We’re at a period near the bottom but with more volatility than we normally see at this point,” said David Stiff, Fiserv’s chief economist. “This sort of double dip is unprecedented for housing.”

Maybe that is why belief in a bottom is as elusive now as fears of a top were in 2006.

“We would love to have a house,” said Dan Cunningham, a 41-year-old renter. “I have more than enough for a down payment. I’m preapproved for a loan. But I have to have confidence it’s not going to lose another 20 percent.” He plans to wait until he sees prices rising before making any offers.

If Dan lives in an inflated market like ours, his caution is warranted. Although I don't expect a 20% drop here, our prices are inflated, and a decline in prices at the mid to high end is ongoing.

If Dan lives in a deflated subprime-dominated market, then his caution is not warranted unless he is buying an above-median priced house. If Dan is looking at a $150,000 property in Phoenix, he doesn't have much to worry about.

For CalculatedRisk's take on the situation, please read Housing: For many cities “another season of pain”.

A little Ponzi

It doesn't take hundreds of thousands of dollars in HELOC abuse to make a borrower insolvent. Sometimes only a modest increase in debt can be too much if someone becomes unemployed.

The owner of today's featured property bought back in 1999 for $375,000. His mortgage information is not available. He made a number of small refinances, and on 1/9/2007 he refinanced with a $372,000 ARM. His mortgage debt doesn't exceed his original purchase price, an accomplishment from what I observe. He quit paying in late 2008, and he is still there.

Foreclosure Record

Recording Date: 04/28/2009

Document Type: Notice of Rescission

Foreclosure Record

Recording Date: 03/25/2009

Document Type: Notice of Default

It shouldn't be surprising that houses like this one populate shadow inventory. Banks book missed interest payments as income. They would prefer the borrower actually repay, but from an accounting standpoint, they treat it the same, if they can assume 100% recovery at foreclosure.

On properties like this one that have 40% equity or more, they will allow this debtor to be delinquent forever. The debtor is basically cannibalizing their own equity. With no payment at all, the compounding interest and penalties are like an Option ARM on steroids consuming about 1.5% of equity per month. This guy has been delinquent about 25 months, so that 40% equity is nearly gone.

Irvine Home Address … 49 CARVER Irvine, CA 92620

Resale Home Price … $739,900

Home Purchase Price … $375,000

Home Purchase Date …. 8/13/1999

Net Gain (Loss) ………. $320,506

Percent Change ………. 85.5%

Annual Appreciation … 5.8%

Cost of Ownership

————————————————-

$739,900 ………. Asking Price

$147,980 ………. 20% Down Conventional

4.99% …………… Mortgage Interest Rate

$591,920 ………. 30-Year Mortgage

$153,029 ………. Income Requirement

$3,174 ………. Monthly Mortgage Payment

$641 ………. Property Tax

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

$123 ………. Homeowners Insurance

$0 ………. Homeowners Association Fees

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

$3,939 ………. Monthly Cash Outlays

-$776 ………. Tax Savings (% of Interest and Property Tax)

-$713 ………. Equity Hidden in Payment

$287 ………. Lost Income to Down Payment (net of taxes)

$92 ………. Maintenance and Replacement Reserves

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

$2,830 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$7,399 ………. Furnishing and Move In @1%

$7,399 ………. Closing Costs @1%

$5,919 ………… Interest Points @1% of Loan

$147,980 ………. Down Payment

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

$168,697 ………. Total Cash Costs

$43,300 ………… Emergency Cash Reserves

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

$211,997 ………. Total Savings Needed

Property Details for 49 CARVER Irvine, CA 92620

——————————————————————————

Beds: 4

Baths: 3

Sq. Ft.: 2438

$303/SF

Lot Size: 5,115 Sq. Ft.

Property Type: Residential, Single Family

Style: Two Level, Cape Cod

Year Built: 1980

Community: Northwood

County: Orange

MLS#: S646433

Source: SoCalMLS

Status: Backup Offers Accepted

On Redfin: 7 days

——————————————————————————

Great opportunity in the village of Northwood. Corner lot with great curb appeal. Freshly painted inside and out. Newer roof, brand new A/C and heating, new carpet and more. Desirable floorplan with open floorplan. Four bedrooms upstairs and large bonus. Master with walk-in closet and spacious master bath. Three car garages and large private yard. No assoc. dues and no mello-roos. Steps from park, and mintues from schools, shopping and freeways. Priced to sell.

It's a simple question, why are home prices still falling. The answer is a little complicated, There'a a book on the subject.

Irvine Home Address … 5111 DOANOKE Ave Irvine, CA 92604

Resale Home Price …… $700,000

It's crazy I'm thinking

Just knowing that the world is round

And here I'm dancing on the ground

Am I right side up or upside down

And is this real or am I dreaming

Dave Mathhews Band — Crush

Before we can address the question of why home prices are still falling, we need to address why they fell in the first place. The causes of the initial crash have not been addressed for bubble borrowers, and the repercussions for their earlier borrowing simply cannot be wished away, nor will this financial wound heal itself with the passage of time as most are planning on.

Why did house prices go up?

A financial bubble is a temporary situation where asset prices become elevated beyond any realistic fundamental valuations because the general public believes current pricing is justified by probable future price increases. If this belief is widespread enough to cause significant numbers of people to purchase the asset at inflated prices, then prices will continue to rise. This will convince even more people that prices will continue to rise. This facilitates even more buying. Once initiated, this reaction is self-sustaining, and the phenomenon is entirely psychological. When the pool of buyers is exhausted and the volume of buying declines, prices stop rising; the belief in future price increases diminishes. When the remaining potential buyers no longer believe in future price increases, the primary motivating factor to purchase is eliminated; prices fall.

Why did house prices fall?

From the section on visualizing the credit bubble in housing:

…. something strange happens…[when] there is nobody left to make a purchase. (A key indication of the end of a speculative mania is a huge decline in sales, as was witnessed over 2006 and 2007). Transaction volume drops off dramatically, and prices stop their dizzying ascent. Nobody is particularly alarmed at first, but a few of the more cautious sell their assets to pay off their loans. Since there are no more new buyers, the first selling actually causes prices to drop. This is unprecedented: prices have never declined! Most ignore the problem and comfort themselves with the history of rising prices; however, a few are spooked by this unprecedented drop and sell the asset. This selling drives prices even lower. Now those who still own the asset become worried, some continue to deny that there is a problem, and some get angry about the price declines. Some of the late buyers actually owe more than they paid for the asset. They sell the asset at a loss. The lenders now lose some money and refuse to loan any more money to be secured against the asset. Now there are even fewer buyers and a large group of owners who all want to sell before prices drop any lower. Panic selling ensues. Everyone wants to sell at the same time, and there are no buyers to purchase the asset. Prices fall dramatically. This asset which was sought after at any price is now for sale at any price, and there are few takers. People in the market rightfully believe the asset will continue to decline. Owners of the asset have accepted the new reality; they are depressed and despondent.

In any group of people, there are always a few who do not believe the “prices always rise” narrative. Some recognize that asset prices cannot rise indefinitely and cannot stay detached from their fundamental valuations. These people witness the rally and the resulting crash without participating. They wait patiently for prices to drop back to fundamental values, and then these people buy. As these new buyers enter the market, prices stop their steep descent and market participants start to hope again. It takes a while to work off the inventory for sale in the market, so prices tend to flatten at the bottom for an extended period of time; however, just as spring follows winter, appreciation returns to the market in time, and the cycle begins all over again.

What is written above is true of any asset whether it be stocks, bonds, houses or tulips. [1] In this case, it is the local housing market, and the room of new buyers represents subprime borrowers, but the concepts are universal. One phenomenon somewhat unique to the housing market is the forced sale due to foreclosure (stocks have margin calls). Even if the psychological factors at work during the panic could somehow be quelled, the forced sales from foreclosures would drive down prices anyway. True panic is not required to crash a housing market, only dropping prices and an inability to make payments. Subprime lending was one of the leading causes of the Great Housing Bubble, and its implosion exacerbated the market decline.

The crash was allowed to proceed in some markets, and the crash was averted in others by allowing delinquent borrowers to stay in the bank's property. The bank even let them stay on title during the mortgage squatting period.

Why are home prices still falling?

Is this a double-dip housing recession? When will values rise again?

By Karen Datko on Tue, Jan 25, 2011 7:19 PM

This post comes from Marilyn Lewis of MSN Money.

The closely watched Standard & Poor's/Case-Shiller Home Price Index is out: It shows home prices are still dropping.

Overall, real estate values fell 1% between October and November, The New York Times says. According to the S&P survey, prices are just 3.3% above the low reached in April 2009. They've fallen 1.6% from the same time a year ago.

Prices fell from October in 19 of the 20 metro areas watched by S&P. And, compared with the year before, just four of the 20 cities studied saw prices grow: Los Angeles, San Diego, San Francisco and Washington, D.C. In eight of the cities studied, prices fell to new lows: Atlanta; Charlotte, N.C.; Portland, Ore.; Seattle; Tampa and Miami.

“Home prices in the 30 metropolitan cities remained at about 3.0% below the levels attained a year ago,” says a separate analysis by FNC, which makes software used by banks to manage their real estate holdings. Nineteen of 30 cities tracked by the FNC 30-MSA Composite Index saw prices fall an average of 1.8% from October to November.

The worst horror stories from the S&P report, as reported by Forbes, were:

• Las Vegas-area prices have fallen 57.2% since peaking in August 2006.
• Phoenix prices are 53.9% below June 2006 highs.
• Miami prices have fallen 48.6% since December 2006.

The price declines in Las Vegas are truly remarkable. I have pulled comps on several hundred properties in Las Vegas. The nicest areas are still holding out in 2004 and 2005 pricing with very few sales. Most of the above-median market is compressing of its own weight similar to here in Orange County. These houses are generally still priced in the 00s. The median price and below is back to 90s levels. Often at auction I am paying prices last paid in the 80s.

Since prices are so low, strategic default is the norm. When nearly 90% of mortgage holders are underwater — prices back to the 90s will do that — everyone in the market has incentive to walk away if they experience payment distress. This creates an endless overhead supply.

Where's this headed?

To understand where this is going, let's break the question down. There really are two questions:

• Will prices keep dropping or is this the bottom?
• If this is the bottom, when is the ride back up going to begin?

Each forecaster takes the same data and describes it a little differently:

• Based on today's report, The New York Times is calling it a “double-dip” housing recession, which makes it sound kind of grim and endless.
• Forbes also likes the “double-dip” descriptor, predicting a double-dip housing recession before spring. (What's a “double dip”? It's if the S&P price index were to hit new lows in both its 10-city and 20-city surveys. Hasn't happened yet, but the S&P price indexes have been dropping for six months straight.)
• S&P/Case-Shiller report founder Karl Case gives it a slightly more optimistic spin: He told Bloomberg that prices could start back up by spring if jobs cooperate.

• But but but I thought the bottom was 2009?
• US Housing Continues Freefall & Is Nowhere Near Bottom
• House prices in US declined for fifth month in a row
• House prices to hit bottom this year, report says
• Fiserv Case-Shiller: after five years of record declines, slow grinding bottom ahead
• High prices, low demand, and large supply means lower prices ahead

Bloomberg reports:

“Prices have gone flat, bouncing around at what I think is essentially a bottom,” Case, a retired professor of economics at Wellesley College, said in a radio interview today on “Bloomberg Surveillance.” “We're really going to have to wait to see what the spring market brings.”

I wonder if Dr. Case sold his vacation home yet? He didn't want to give it away.

In a separate Bloomberg article, Case said:

“There's a good chance of a housing turnaround this year, but it's not going to be enough to give much help to the economy. … We're coming off 50-year lows and we still have to deal with the foreclosure mess.”

Last year this time, home prices were looking good. Weak yes, but rising. They'd bottomed (or so it seemed) — in April 2009. They rose nicely after federal homebuyer tax credits between fall 2009 and late spring 2010. They kept rising until July.

And then, boom, they fell, and kept falling — in some cases even lower than before.

Pardon me while I feign surprise. Whocouldanode?

The bottom engineered by the federal reserve in 2009 was not a natural and durable bottom. The market is like a river, although temporarily diverted, it is flowing to its own course.

However, all's not dark. There are signs of gathering strength, however modest:

• Home construction is showing “stronger activity going forward,” reports Hanley Wood's Market Intelligence report for builders.

I wish homebuilders were doing better. I have many friends who are still suffering and wondering if this recession is ever going to end.

• Sales of existing homes grew, for the second straight month, Market Intelligence said. Sales were up 12.3% in December. But because they'd dropped badly in 2010, the numbers still were less than at the same time the year before.
• The Leading Economic Indicator Index has risen for six months straight, surprising analysts in December by hitting 112.40, a 1.10 point monthly increase, reports Bloomberg.
• The Consumer Confidence Index, also out today, rose to 60.6, up from 53.3 in December.

• Bloomberg reports that the unemployment rate dropped to 9.4% in December after hitting a seven-month high of 9.8% in November.

And, now that mortgage rates are rising, you'd expect fence-sitters to buy while money is cheap. But will they buy in numbers large enough to pull up prices?

Prices are not pulled up by buyers. Prices are pushed up by buyers who increase their bids with cheap money. As I have noted, cheap money is not the answer. Low Interest Rates Will Not Create Demand. Further, money is not getting any cheaper because you will not see 4% mortgage interest rates again in your lifetime.

The real problems going forward are twofold: (1) Supply will exceed demand due to huge foreclosure inventories and a diminished buyer pool. And (2) The cost of borrowing is going to increase making loan balances smaller and preventing borrowers from raising their bids. Even if employment and income numbers improve, the supply and demand imbalance and the increasing cost of borrowing will be persistent problems plaguing the housing market for the next decade.

We may still keep prices inflated and unaffordable. Kool aid intoxication is powerful, but the weight of inventory and the need to liquidate may be enough to crush the financial hopes of even the most ardent appreciation buyer.

The dark tunnel

“The enormous supply overhang of existing homes (particularly factoring in all those in foreclosure or soon to be) promises to keep pressure on prices for some time,” Joshua Shapiro, chief U.S. economist of MFR Inc., told the Times.

And that's the issue: The huge glut of foreclosure properties — homes now in the hands of banks and other homes soon to be in the hands of banks. Not just are there a lot of homes on the market now, but many more are coming. Buyers — lots and lots of them — must chew through this mammoth “inventory overhang” before prices will rise.

As analysts at Radar Logic explain in their (subscription) newsletter:

If housing demand increases because of improvements in the employment and other sectors of the economy, financial institutions will respond by putting more of the homes in their inventories on the market, and home prices will remain depressed.

On top of that, there's an uncounted but presumably huge group of homeowners who would put their homes on the market right now but are holding off until prices improve. So, given a little price recovery, you can count on this pent-up supply to be added to the market, further stringing out the housing recovery.

How The Lending Cartel Disposes Their REO Will Determine the Market’s Fate.

Prices won't rise until buyers have fewer homes to choose from and they are forced to compete with each other to get a home they want.

“Everything in this report is unfortunately still sagging and still pointing downward. … We still seem to be at best scraping along the bottom,” David Blitzer, S&P Index Committee chairman, told CNBC. Prices could fall three or four more percentage points, nationally, in the next month or two, Blitzer added.

The light at the end

Radar Logic, whose economist Nouriel Roubini was nearly alone in predicting the 2007 housing crash, tells newsletter readers to expect home values to keep falling until spring. After that, it'll take time before they start rising again. The newsletter says:

Given the current supply of homes for sale, the enormous shadow inventory of homes in bank inventories plus mortgages in default and foreclosure, and the millions of at-risk homeowners with negative equity in their homes, we do not expect home prices to increase on a sustained year-over-year basis until 2012.

Prices may not see sustained appreciation for quite some time, but we may have other bear rallies while the overhead supply from the housing bubble is worked off. It is difficult to forecast because so much depends on interest rates, job growth and household formation, and government policies toward real estate. Right now, the market faces many obstacles to sustained price appreciation.

Resisting temptation

Some borrowers refinanced for various reasons during the bubble. Rates were near historic lows (the lows we took out when the federal reserve went to zero) so many borrowers refinanced to lower their payments. At each refinance, the temptation to take a little free money was there. During the bubble, these cash-out loans were aggressively peddled by mortgage brokers who were often making large incentive payments for pushing borrowers into dodgy loans.

At each transaction there must be a willing borrower. Some simply say no. Unfortunately, those that said no are going to have to pay for the losses on those that gave in to their temptation and spent their houses.

Between 1997 and 2004 the owners of todays featured property added somewhat to their mortgage, it went from $197,000 to $210,000. Their mortgage was never larger than their original purchase price — an accomplishment in Irvine from what I've seen. There is a later HELOC but no evidence they used it. The last mortgage they recorded was the smallest of all.

These people at least tread water during most of the housing bubble while many of their cohorts went Ponzi.

Irvine Home Address … 5111 DOANOKE Ave Irvine, CA 92604

Resale Home Price … $700,000

Home Purchase Price … $246,000

Home Purchase Date …. 6/23/97

Net Gain (Loss) ………. $412,000

Percent Change ………. 167.5%

Annual Appreciation … 7.7%

Cost of Ownership

————————————————-

$700,000 ………. Asking Price

$140,000 ………. 20% Down Conventional

4.99% …………… Mortgage Interest Rate

$560,000 ………. 30-Year Mortgage

$144,777 ………. Income Requirement

$3,003 ………. Monthly Mortgage Payment

$607 ………. Property Tax

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

$117 ………. Homeowners Insurance

$0 ………. Homeowners Association Fees

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

$3,726 ………. Monthly Cash Outlays

-$734 ………. Tax Savings (% of Interest and Property Tax)

-$674 ………. Equity Hidden in Payment

$271 ………. Lost Income to Down Payment (net of taxes)

$88 ………. Maintenance and Replacement Reserves

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

$2,677 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$7,000 ………. Furnishing and Move In @1%

$7,000 ………. Closing Costs @1%

$5,600 ………… Interest Points @1% of Loan

$140,000 ………. Down Payment

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

$159,600 ………. Total Cash Costs

$41,000 ………… Emergency Cash Reserves

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

$200,600 ………. Total Savings Needed

Property Details for 5111 DOANOKE Ave Irvine, CA 92604

——————————————————————————

Beds: 4

Baths: 3

Sq. Ft.: 2329

$301/SF

Lot Size: 5,500 Sq. Ft.

Property Type: Residential, Single Family

Style: Two Level, Other

Year Built: 1970

Community: El Camino Real

County: Orange

MLS#: P768305

Source: SoCalMLS

Status: ActiveThis listing is for sale and the sellers are accepting offers.

On Redfin: 6 days

——————————————————————————

Absolutely Stunning Home in a Quiet Neighborhood, Two stories, 4 bedrooms with 2 Master suites and remodel bathrooms, new guard rail for balcony, wood-laminate flooring, Kitchen with granite counter top, Re-faced cabinets, New windows and doors, New A/C unit, new Heatng and A/C ducts, Stonework on the garage, the stairs, and on the balcony. Swimming pool and Spa in the backyard, with new filter and pump. No HOA, No Mello Roose, Excellent School district. Close to Library, park and shoping place. Show and Sell !!!!!!

shoping? Mello Roose?