Greed, Foolish Optimism, and Toxic Mortgages Ruin Financial Lives

Borrowers took on huge debts during the housing bubble from a combination of greed, foolish optimism and an abundance of toxic mortgage options.

Irvine Home Address … 10 HOLLINWOOD Irvine, CA 92618

Resale Home Price …… $975,000

{book1}

Gimme the microphone first, so I can bust like a bubble

Compton and Long Beach together, now you know you in trouble

Ain't nothin' but a G thang, baaaaabay!

Dr Dre and Snoop Dogg — Nuthin But a G Thang

It was all about Greed. The G thang took over. The stories of the Great Housing Bubble are seldom black and white, right or wrong, good or evil. Some of the characters are despicable and deceiptful, but the majority are ordinary folks who succumb to greed, foolish optimism about the future of housing prices, and the market prowess of realtors and mortgage brokers.

Although the media likes to portray loan owners and innocent bystanders who don't deserve the hardship they are facing, the reality is more nuanced. People may not have fully understood the Option ARM, but they certainly did understand that (1) they would have a low payment for a few years, (2) their house would double in value and (3) they would make a fortune — or so they thought.

Few buyers during the bubble contemplated the risks they were taking on. Even today, people are buying with the false assurance that prices have bottomed and that they cannot lose on real estate. ARMs are still popular despite their obvious risks at the bottom of the interest rate cycle, and few people consider the near certainty of an increasing house payment to be a potential problem. Everyone will be make much more in a few years, right?

Many buyers today are making the same mistakes of bubble buyers; they are buying from greed and fear and an overly optimistic set of assumptions about the future of resale prices and interest rates. We are not learning the lessons of history… or are we? How many of today's buyers witnessed the bailouts and numerous government market props and reason that if things go bad the government will step in to bail them out too? The government's response is loaded with moral hazard.

Drowning in home debt

By Lisa Gibbs, senior writerMay 5, 2010: 4:28 AM ET

(Money Magazine) — A transfer in 2005 landed Air Force major Richard Hallbeck, his wife, and two kids in Southern California smack in the middle of the real estate bubble. Home prices in the area had doubled in the past five years and were still climbing. So the Hallbecks swallowed hard and bought an $845,000 four-bedroom in a suburb of Long Beach.

The $3,800 monthly payment was high but affordable on two incomes. (Laurie, now 37, worked as a claims adjuster.) And they figured the market was so strong that when they had to move again, they'd at least break even. "Our house actually appraised over what we paid for it," Richard, 42, recalls wistfully.

Since then, area sale prices have fallen 26% — when properties sell at all. Meanwhile, the recession cost Laurie her job, and the payment on the couple's adjustable-rate mortgage will jump $800 in July. Next year Richard will face mandatory retirement from the Air Force, and his pension will be a third of his current $117,000 income.

Can these people honestly say they "swallowed hard" before they bought this house? That suggests they actually contemplated the risks involved and made an informed decision. This couple, like thousands of other buyers during the bubble were assured by everyone involved in the transaction that everything would be fine, and all of their friends were telling them the same. If they swallowed hard it was to down their celebratory drinks when they got the house. They were about to make a fortune.

All that's got the Hallbecks anxious to move to a more affordable city — like Dayton, where they used to live. But they're just as anxious about how much they could lose on the sale of their house.

A similar home down the street lists for $655,000, $21,000 less than the Hallbecks' outstanding mortgage. At that price, the couple would be out $231,000, including their down payment and closing costs. "The stress has really worn on us," Richard says.

The stress over this huge mistake is exactly why people shouldn't do what this couple did. it is the reason I didn't do what this couple did. They should be stressed. They have already lost a quarter million dollars, and if they sell now, it will also damage their credit. There are consequences for participating in a massive Ponzi Scheme despite the government's best efforts to foster moral hazard by eliminating the consequences.

Nationwide, about one in four home mortgages are now underwater, meaning borrowers owe more than their places are worth. No surprise, California and other bubbly states — Nevada, Arizona, and Florida — lead the nation.

While a bevy of new federal programs aim to help, underwater owners who want to move still face uncomfortable choices: Postpone the move and continue sinking money into a pit; sell for a loss, forfeiting the down payment and some savings to close the deal; desperately try to enter into a short sale; or simply walk away and face the consequences of foreclosure. If you (or your kids) are in this situation, here's how to think about the options.

This article had my attention up to this point. I knew it could go one of two ways: (1) it could discuss the real options truthfully including strategic default, or (2) it could be a load of crap written to appease lenders who want people to stay and keep paying? Any guesses before we move on?

Keep on keeping on

If you don't have to move and can afford the payments, it probably makes sense to soldier on and wait for housing prices to recover, says Denver financial planner Ross Schmidt. Moody's Economy.com projects that prices in 61% of metro areas will return to recent peak levels by 2015.

Here is a half-truth disguised as good advice. First, the projections from Moody's is overly optimistic as shill studies tend to be, and second, the 39% of metro areas where prices will not reach peak levels by 2015 include most of California, Nevada, Arizona and Florida — the areas that bubbled most.

If you live in one of the harder-hit cities — which may take 20 years to rebound — and you're more than 25% underwater, your house won't be a financial asset anytime soon. But as long as you're happy to stay in it for many years, that may not matter.

May not matter? Bullshit. Timing Does Matter. It matters a great deal to the family that will have to do without the significant resources going to a bank for debt service. Lenders need to feel the brunt of their foolish losses. Losing money causes the pain that prevents them from doing it again. Banks should never have extended oversized loans to people who couldn't afford the payments. People renting from the bank at overpriced rates are screwing themselves and enriching stupid, greedy bankers.

In the meantime, you may be able to cut your loan balance — and lower your payments — through a new federal program that refinances existing loans into smaller FHA loans. To qualify, you must be current on payments — but it's up to the lender to agree to it.

I am sure the lenders are lining up to reduce loan balances of those who are paying on time… Not. What possible incentive do lenders have to participate. Unless the borrower becomes a problem to lenders by refusing to pay the note, there is no urgency for lenders to do anything.

The Hallbecks might have been eligible for some of this aid, but Laurie is eager to move with the kids by this fall, rather than waiting until Richard retires — which will be in the middle of the school year.

Beg the bank for a break

What if you need to get out of the house? The Hallbecks initially considered renting their place out. But they'd probably lose money, given the spread between their mortgage payment and rental prices. Becoming a landlord is a risk even in areas where you can cover carrying costs, as you're still on the hook in between tenants, says Maryland financial planner Timothy Maurer.

The fact that rents are much less than the cost of ownership is exactly why this was a stupid purchase to begin with. There was no viable plan B. Renting for negative cashflow is stupid, particularly with an ARM where the negative cashflow can become even more negative.

A cleaner option may be to ask your lender for a short sale, in which it would accept less than the loan amount. To convince the bank, homeowners must show they're at risk of default because they can't make payments or are so deep underwater that they're likely to bail. (With $155,000 in savings outside of retirement accounts, it's unlikely the Hallbecks will qualify.)

Why would a bank agree to a short sale if the borrower has assets? Banks don't want to tell borrowers they don't have to pay the bank even if they can, unless the US taxpayer is paying the difference.

It can take months to arrange a short sale, if you're successful at all. So for best results, work with a "distressed-property specialist," a real estate agent who has experience negotiating with lenders. At realtor.com, select "SFR" under Find a Realtor to search for this type of specialist.

Notice the plug for realtor.com? Who do you think sponsored this story?

Also seek free advice from a certified mortgage consultant, whom you can find via makinghomeaffordable.gov, suggests Melinda Opperman, of Springboard Nonprofit Consumer Credit Management. Such an adviser can help you determine whether your loan type allows the bank to come after you for money later. He or she can also help ensure the loan is reported as "settled" to the credit bureaus. A mortgage listed as "settled for less than agreed" can damage your score the way a foreclosure would.

Not exactly. For the truth, please see How Delinquencies Impair Credit Scores:

After a mortgage delinquency, the two scores [680 and 780] would look like this:

• After 30-day delinquency, 680 score drops to 620 to 640; 780 score declines to 670 to 690.

• After 90-day delinquency, 680 score falls to 595 to 610; 780 score goes to 645 to 665.

• After foreclosure, short sale, or deed-in-lieu, 680 goes to 575 to 595 and 780 drops to 620 to 640.

• After bankruptcy, 680 drops to 530 to 550; 780 declines to 540 to 560.

Speaking of foreclosure, University of Arizona law professor Brent White says walking away may make sense financially if you're more than 40% underwater and could rent a similar house for less than your mortgage bill. But doing so has consequences, not the least of which may be a guilty conscience. Foreclosure stays on your credit report seven years — and can cut a 780 score an average of 150 points, per Fair Isaac. That can affect everything from your insurance premiums to your employment potential to your future ability to buy a house.

Do you think Dr. White really set the bar at 40% underwater? Didn't that strike you as such a high threshold that few find themselves in that situation? I believe the reporter intended it that way. Default rates go up dramatically at the water line. People are generally better off if even a little underwater if rents are less than the cost of ownership.

Guilty conscience? LOL! More lender fantasy and projection. I predicted previously that by the end of 2010, there will be no guilt and no stigma associated with strategic default. Lenders have played on borrower guilt for too long, and borrowers are starting to see if for the manipulative lie that it is.

I have an I-Phone with the local AT&T service. The AT&T network in Irvine really sucks, and the moment Verizon gets the I-Phone to work on its system, I will cancel my AT&T contract and pay the early termination fee. I won't feel any guilt about breaking my contract, and it won't make me immoral.

Eat the loss yourself

For the Hallbecks, the best — and fastest — option may be simply selling the house and paying any difference between the sale price and the mortgage out of pocket, says Maurer. That is a good, if not particularly palatable, choice for homeowners who have significant savings and aren't deeply underwater. Selling this way eliminates any credit risks.

Since Money first spoke to the Hallbecks, they have listed their home and attracted an offer of $655,000. That would've meant shelling out the $21,000 difference, plus some $40,000 in commissions and closing costs. So, the couple decided to hold out for more. "Hopefully," says Richard, "our expectations aren't too high."

I would love to joke about the stupidity of their decision, but with the restricted inventory condition caused by lenders refusing to foreclose and clear out the squatters, some desperate buyer may bid them up enough to get them out at even. This is exactly what the banks want. They need a small army of knife catchers to take advantage of the artificially low interest rates and bail out the banks through direct acquisition.

More than the temporary increase in prices, the bear rally does one other very useful thing for the banks: it gives existing borrowers false hope that them may not be underwater soon. If borrowers really accepted that it will take ages to get back to the surface, many more would strategically default. If lenders and keep borrowers in their homes long enough, borrowers become invested in their own bad decision, and they will stay long beyond the point where staying makes sense.

Guilt and paying the mortgage

Have you ever wondered why people associate guilt with certain terms of mortgage contracts? If you examine the terms in the promissory note and mortgage arrangement, the lender is making a loan, and as a contingency in the event an borrower does not repay the loan, the lender has the right to force a public auction to resell the property to obtain their money.

Prior to our era of widespread squatting, failure to repay the loan resulted in a borrower losing the house they consider their home. A borrower who was capable of making the payment but didn't was causing their family to lose their home.

In normal circumstances, losing the house would not be in the best interest of the family, and it could be argued that losing the house is immoral as it harms the family. However, in our current circumstances with prices in many markets well below the loan balance, losing the family home — which may be emotionally painful — is better for the family than sustaining a crushing debt load.

The old moral reason for paying the mortgage to keep the family home is superceded by the greater moral imperative to provide a financial future unfettered by crushing debt.

There is another way to view this transaction. It is the banks that were immoral when they made loans without regard to a borrower's ability to repay. They put people into homes under terms that were not sustainable, and they caused the pain we are witnessing today. Making the loan was immoral, walking away is the just response.

Raiding the Equity Piggy Bank

  • Today's featured property was purchased for $900,000 on 1/17/2003. The owner used a $650,000 first mortgage and a $250,000 down payment.

  • On 3/31/2004 she liberated some equity with a $730,000 refinance.

  • On 10/29/2004 she refinanced with a $767,000 Option ARM.

  • On 12/22/2005 she obtained a $250,000 HELOC, but she may not have used it.

  • Total property debt is $1,017,000.

  • Total mortgage equity withdrawal is 367,000 including her down payment.

  • Total squatting is at least 1 year.

Foreclosure Record

Recording Date: 03/31/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 09/28/2009

Document Type: Notice of Default

Because of the behavior of owners like this, even those who should be sitting on mountains of bubble equity are broke. There is no move-up market. First-time buyers with significant wage savings are sustaining our housing market. What is typically only a small fraction of buyers now comprises the entire buyer pool.

Irvine Home Address … 10 HOLLINWOOD Irvine, CA 92618

Resale Home Price … $975,000

Home Purchase Price … $900,000

Home Purchase Date …. 1/17/2003

Net Gain (Loss) ………. $16,500

Percent Change ………. 8.3%

Annual Appreciation … 1.0%

Cost of Ownership

————————————————-

$975,000 ………. Asking Price

$195,000 ………. 20% Down Conventional

5.07% …………… Mortgage Interest Rate

$780,000 ………. 30-Year Mortgage

$203,495 ………. Income Requirement

$4,221 ………. Monthly Mortgage Payment

$845 ………. Property Tax

$233 ………. Special Taxes and Levies (Mello Roos)

$81 ………. Homeowners Insurance

$140 ………. Homeowners Association Fees

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

$5,520 ………. Monthly Cash Outlays

-$1035 ………. Tax Savings (% of Interest and Property Tax)

-$925 ………. Equity Hidden in Payment

$387 ………. Lost Income to Down Payment (net of taxes)

$122 ………. Maintenance and Replacement Reserves

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

$4,069 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$9,750 ………. Furnishing and Move In @1%

$9,750 ………. Closing Costs @1%

$7,800 ………… Interest Points @1% of Loan

$195,000 ………. Down Payment

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

$222,300 ………. Total Cash Costs

$62,300 ………… Emergency Cash Reserves

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

$284,600 ………. Total Savings Needed

Property Details for 10 HOLLINWOOD Irvine, CA 92618

——————————————————————————

Beds: 4

Baths: 0003

Home size: 3100

($315 / sq ft)

Lot Size: 6140

Year Built: 2001

Days on Market: 35

MLS Number: P728911

Property Type: Single Family, Residential

Community: Oak Creek

——————————————————————————

Atractive home in Oak Creek, very comfortable and inviting for entertaining. One bedroom and office downstairs. The beautiful home is very nicely layed out. There are many conveniences including an artium with an inground spa, built in BBQ with electric and gas in the beautiful back yead. The gated community offers pools, tennis courts, trails and is walking distrance to shopping. Located on a cul de sac street within the community.

Atractive? layed? artium? inground? yead? distrance?

Future House Prices – Part 2

http://www.thegreathousingbubble.com/images/HomePageImage.jpg

Price-to-Income Ratio

Since incomes and rents are closely related, evidence for the Great Housing Bubble that appears in the price-to-rent ratio also appears in the price-to-income ratio. National price-to-income ratios are quite stable. There has been a slight upward drift with the decline of interest rates since the early 1980s peak, but from the period from 1987 to 2001, this ratio remained in a tight range from 3.9 to 4.2. The increase from 4.1 to 4.5 witnessed from 2001 to 2003 can be explained by the lowering of interest rates; however, the increase from 4.5 to 5.2 from 2003 to 2006 can only be explained by exotic financing and irrational exuberance.

Figure 46: Projected National Price-to-Income Ratio, 1988-2015

If national price-to-income ratios decline to their historic norm of 4.0, prices nationally will fall 9% peak-to-trough, bottom in 2011 and return to peak pricing in 2014. A 10% decline and a nine year waiting period would be difficult on homeowners nationally, but the magnitude and the duration will not be nearly as severe for most as it will be for homeowners in the extreme bubble markets like Irvine, California.

Figure 47: National Projections based on Price-to-Income Ratio, 1986-2015

The volatility in price-to-income ratios caused by bubble behavior is clearly visible in the historic price-to-income ratios from Irvine, California. During the coastal bubble of the late 80s, in which Irvine participated, the price-to-income ratio increased from 3.7 to 4.6, a 25% increase. In the decline of the early 90s, price-to-income ratios dropped to a range from 4.0 to 4.1 and stabilized there from 1994 to 1999 before rocketing up to an unprecedented 8.6–a 115% increase. This new ratio was achieved by the extensive use of exotic financing, in particular negative amortization loans that rendered the new ratio inherently unstable.

Figure 48: Projected Irvine, California Price-to-Income Ratio, 1986-2030

If house prices in Irvine decline to the point where the price-to-income ratio reaches its average of 4.2–a ratio higher above this historic range of stability between 4.0 and 4.1–prices will decline 43% peak-to-trough, bottom in 2011 and return to the peak in 2029. The magnitude of this decline would be catastrophic to homeowners who purchased during the bubble. Twenty-four years is a long time to wait for peak buyers hoping to get out at breakeven.

Figure 49: Irvine, California Projections from Price-to-Income Ratio, 1986-2030

Hyperinflation

The Federal Reserve under Ben Bernanke began aggressively lowering interest rates at the end of 2007 in response to the severe economic downturn caused by the collapse of house prices and the related difficulties falling house prices had on the banks and other institutions that made loans using houses as collateral. [1] Bernanke, prior to taking the position as the chairman of the Federal Reserve, was an academic who studied the Great Depression and wrote extensively on the failures of monetary policy by the Federal Reserve at the time. He also wrote about the crisis of deflation Japan faced when their combined stock market and real estate bubbles deflated throughout the 1990s. [ii] Bernanke believed that quick and decisive action on the part of the Federal Reserve was necessary to prevent a destructive deflationary spiral as was witnessed in the United States during the Great Depression and in Japan during the 1990s. [iii] By lowering interest rates and creating price inflation, Bernanke hoped to devalue the currency and provide market liquidity through both domestic and foreign investment. Once the real rate of interest was below the level of inflation, borrowing would be strongly encouraged as the value of the currency was falling faster than the interest rate being charged. The increased borrowing would stimulate business growth and the general economy minimizing the deflationary impact of falling home prices. In theory, the lower interest rates would also serve to blunt the decline in housing prices as borrowers would again be able to finance large sums to support inflated prices.

Figure 50: CPI Adjusted Median Home Prices, 1986-2006

At the time of this writing, the results of the policies of the Federal Reserve have not become history so the consequences cannot be fully evaluated. The primary foreseeable consequence of Federal Reserve policy is rampant price inflation. An economy that relies for 70% of its value on the spending of consumers will be strongly impacted by price inflation. When a country knowingly devalues its currency, it causes a severe recession as the prices of imported goods and raw materials increase significantly. Perhaps a severe recession and price inflation is preferable to an economic depression like the one of the 1930s in America, but it is certainly not desirable. Since stagflation of the 70’s, the FED has shown a willingness to push the economy into recession before it allows inflation to get out of control. When the FED started lowering interest rates at the end of 2007, it appeared as if they may be moving down the path of hyperinflation; however, it seems unlikely they would take it to extreme. One of the primary functions of the FED is to provide a stable financial system. Once the Federal Reserve begins to see economic growth and liquidity in the debt markets, interest rates may rise as quickly as they fell in order to stop hyperinflation from occurring.

Figure 51: National Inflation Rate, 1961-2007

There will be some benefits to a devalued currency. A less valuable currency is a boon to exporters. The United States has run a chronic trade deficit for many years, and much of the recent deficit has come from inexpensive goods imported from China. The trade imbalance may correct itself with currency devaluation. Of course, this rebalancing of trade will come at the cost of more expensive imported foreign goods and a commensurate decline in spending power from US consumers. Also, prior to currency devaluation, wages in the United States were so high that jobs were being outsourced to foreign countries where people can be paid much less. Wages could not rise significantly from where they were without devaluing the dollar to prevent wage arbitrage from moving jobs overseas. [iv] The devalued currency provided some room for wage increases, and these wage increases could theoretically provide additional support for housing prices.

Figure 52: Inflation-Adjusted Projections for Los Angeles, 1987-2012

Currency devaluation and inflation eats away at the buying power of money. Although this may support house prices at marginally higher nominal price levels, real price levels, the price level adjusted for inflation, will remain unchanged. Imagine if the Federal Reserve allowed inflation to cut the spending power of the dollar in half by 2011, and imagine if this level of inflation allowed house prices to remain stable at 2006 price levels for those 5 years. Many homeowners would feel relieved their homes did not decline in value, but this relief would be an illusion as the buying power of their money tied up in the value of their houses was cut in half. Irrespective of the nominal decline in prices, the inflation adjusted prices will decline significantly going forward. In the Los Angeles market as measured by the S&P/Case-Shiller index, a decline in prices to levels of historic rates of appreciation as previously described will result in a 66% decline in inflation adjusted terms. [v] On an inflation adjusted basis, buyers during the bubble will never get back to breakeven unless there is another real estate bubble similar to the Great Housing Bubble.

An Educated Guess

Each of the four methods of house price valuation described previously makes an independent prediction of how far prices will fall, and when they will recover. Some of these will prove more reliable and accurate than others, but an average of the results of these four methods makes it possible to make an educated guess as to the percentage decline in house prices and when prices will get back to peak levels. Unfortunately, there is no reliable method for projecting the rate of this decline, but if the experience of the coastal bubble of the early 90s is a good guide, then prices should fall for 6 to 7 years before reaching a bottom. This puts the bottom of prices sometime in or around 2011 based on the peak in various markets occurring in 2005 or 2006. Prices will flatten at the bottom because it will take time to absorb the inventory of foreclosures resulting from the drop. Market psychology and the rate of foreclosures will largely determine the rate of price decline, and these forces are difficult if not impossible to model. It is possible to construct a graph that illustrates the path of house prices over time based on the methods of price valuation and assumptions about the timing of the decline.

Table 10: Summary of Predictions for National Home Prices

Method

Total Decline

Appreciation Rate

Recovery Year

S&P/Case-Shiller Inflation Support

33%

3.3%

2025

Median House Price and Historic Appreciation

10%

4.5%

2011

Price-To-Rent Ratio

27%

3.6%

2020

Price-To-Income Ratio

9%

3.3%

2014

20%

3.7%

2018

The range of predictions for the decline of national home prices is from 9% to 27% with an average of 20%. The predicted time of peak-to-peak recovery ranges from 2011 to 2021 with an average of 2018. Some will argue price drops of this magnitude are not likely, and these would be unprecedented declines; however, the increases were unprecedented as well. The Great Housing Bubble was a unique and unprecedented event.

Figure 53: National Median House Price Prediction, 2004-2019

The predictions for national prices are based on a 3.7% rate of fundamental appreciation for some combination of wage growth, rental increases and other factors. The origin point for the graph is based on the last period in which fundamentals were aligned in the 1986-1999 period (not shown on the figure). The amount of the decline, 20%, is based on the average prediction of the four methods. The rate of decline was interpolated from the date of the peak to the date of the predicted bottom based on the experience of the coastal bubble of the 1990s. National prices peaked at an approximate value of $246,000 in 2006; they should bottom out at around $196,000 in 2011, and if fundamental appreciation rates hold, they will reach the previous peak in 2018.

Table 11: Summary of Predictions for Irvine, California Home Prices

Method

Total Decline

Appreciation Rate

Recovery Year

S&P/Case-Shiller Inflation Support

55%

3.3%

2039

Median House Price and Historic Appreciation

45%

4.4%

2023

Price-To-Rent Ratio

22%

4.7%

2019

Price-To-Income Ratio

43%

3.2%

2029

41%

3.9%

2028

* The appreciation rate of 3.9% moved up the recovery year to 2025

The range of predictions for the decline of home prices in Irvine, California, is from 22% to 53% with an average of 41%. The predicted time of peak-to-peak recovery ranges from 2019 to 2033 with an average of 2028. Of course, since Irvine is in the heart of a bubble-prone market, recovery may happen more quickly, but then again, that would mean prices have entered another unsustainable price bubble.

Figure 54: Irvine, California, Median House Price Prediction, 2004-2025

Predictions for Irvine, California, are based on a 3.9% rate of fundamental appreciation as wage growth and rental rate growth have consistently outpaced national averages. The origin point is the intersection of the last two stable bottoming periods in 1984-1987 and 1995-1999. The 41% decline is the average of the four analysis methods, and the rate of decline is projected in the same manner as the national statistics. In Irvine, California, prices peaked around $723,000 in 2006, and they should bottom out in 2011 along with the rest of the country. If the fundamental appreciation rate of 3.9% is accurate, the previous peak will be reached in 2025–a 19 year span from peak to peak.

[1] Adam Posen wrote Why Central Banks Should Not Burst Bubbles. (Posen A. , 2006) His conclusions are as follows, “Central banks should not be in the business of trying to prick asset price bubbles. Bubbles generally arise out of some combination of irrational exuberance, technological jumps, and financial deregulation (with more of the second in equity price bubbles and more of the third in real estate booms). Accordingly, the connection between monetary conditions and the rise of bubbles is rather tenuous, and anything short of inducing a recession by tightening credit conditions prohibitively is unlikely to stem their rise. Even if a central bank were willing to take that one-in-three or less shot at cutting off a bubble, the cost-benefit analysis hardly justifies such preemptive action. The macroeconomic harm from a bubble bursting is generally a function of the financial system’s structure and stability – in modern economies with satisfactory bank supervision, the transmission of a negative shock from an asset price bust is relatively limited, as was seen in the United States in 2002. However, where financial fragility does exist, as in Japan in the 1990s, the costs of inducing a recession go up significantly, so the relative disadvantages of monetary preemption over letting the bubble run its course mount. In the end, there is no monetary substitute for financial stability, and no market substitute for monetary ease during severe credit crunch. These two realities imply that the central bank should not take asset prices directly into account in monetary policymaking but should be anything but laissez-faire in responding to sharp movements in inflation and output, even if asset price swings are their source.” His argument is sound, but he does point out that if bubbles get too large, the fallout can be even more disastrous than attempts to restrain them. This argues against his central point, and the Japanese example does show what can happen if bubbles are allowed to get too large. Ben Bernanke also wrote a paper titled Should Central Banks Respond to Movements in Asset Prices? (Bernanke & Gertler, Should Central Banks Respond to Movements in Asset Prices?, 2000). He professes a belief that the activities of the Central Bank should not target asset prices, although his behavior as FED chairman has been interpreted as an attempt to bolster market prices. In a later paper (Bernanke & Boivin, Monetary Policy in a Data-Rich Environment, 2002) Bernanke also explored the uses and aggregation of data by the Federal Reserve. He seemed to be preparing himself for the job of FED Chairman. The focus of policy debate and academic research in the wake of the Great Housing Bubble is likely to be the issue of asset bubbles in general. Central Banks around the world learned how to control inflation in the 1980s and 1990s, but their policies have tended to create excess liquidity which has resulted in financial bubbles.

[ii] (Bernanke B. S., Japanese Monetary Policy: A Case of Self-Induced Paralysis, 1999)

[iii] Adam Posen in his paper It Takes more than a Bubble to Become Japan (Posen A. S., 2003), outlines the causes of the prolonged recession after the bursting of the stock and real estate bubbles in Japan. He agrees with Ben Bernanke’s conclusion that aggressive monetary easing is the solution to the problem, “Central bankers should learn from Japan’s bubble the benefits of a more thoughtful approach to assessing potential growth and of easing rapidly in the face of asset price declines and not be concerned with targeting asset prices or pricking bubbles per se.” In a related paper Passive Savers and Fiscal Policy Effectiveness in Japan (Kuttner & Posen, 2001) by Kenneth N. Kuttner; Adam S. Posen, the authors reaffirm their conclusions on the mistakes of the Japanese Central Bank in handling their asset bubbles. The authors note that despite excessive borrowing of the central government, Japanese citizens continue to by government debt at very low cost and in effect subsidize their own borrowing.

[iv] In the paper Offshoring, Economic Insecurity, and the Demand for Social Insurance (Anderson & Gascon, 2008), Richard G. Anderson and Charles S. Gascon describe the problems associated with offshoring, in particular the increased demand of social services caused by the fear of offshoring.

[v] The inflation adjusted chart for the S&P/Case-Shiller index was drawn by the following method. The index value was then divided by the consumer price index date from the U.S. Department of Labor Bureau of Labor Statistics. The resulting number was converted to a baseline value of 1 so the data could be represented as a percentage change.

IHB News 5-8-2010

Apparently the high end of the market never declined in price. Today's featured property was purchased at the peak, but it has appreciated since then. WTF?

Irvine Home Address … 66 FANLIGHT Irvine, CA 92620

Resale Home Price …… $1,680,000

{book1}

But what a fool believes he sees

No wise man has the power to reason away

What seems to be

Is always better than nothing

And nothing at all keeps sending him …

Doobie Brothers — What a Fool Believes

Real Estate Boom Phrases That Went Bust

The way we talk about real estate has changed dramatically in the last few years as the collective sentiment has shifted from euphoria to panic. No one would dare to say "the only way is up" or "the easy money is in flipping" anymore. Here are a few other phrases that once seemed just as true.

  • "Location doesn't matter."

    Housing was appreciating so rapidly in seemingly every market that some people thought that no matter where you bought, you'd soon make a fortune.

    It's hard now to believe that anyone was promoting such a myth. After all, even people who claim to know nothing about real estate can rattle off the famous adage, "location, location, location." More than anything else, where a home is located determines its long-term value. A state-of-the-art kitchen can quickly become outdated, but a nice part of town can remain that way for generations.

    Even some places that seemed like great locations turned out to be terrible bets. Stephen Smith reported in an American RadioWorks documentary that Las Vegas went from having job growth four times the national average and attracting 4,000 to 5,000 new residents a month to being dubbed "Foreclosure City."

  • "You don't need a down payment."

    Traditionally, the purpose of a down payment is to reduce the bank's lending risk. It shows that the borrower has enough self-discipline to save up 20% of the purchase price of a home.

    More importantly, it means that the borrower is likely to keep making his mortgage payments even when times are tough because he has already put a lot of his own money into the house.

    When banks started giving people mortgages that didn't require a down payment, buying a home started to feel more like leasing an apartment. Even owners with fixed-rate mortgages had little home equity since most of the mortgage payment for the first few years is interest.

    When housing prices dropped, owners started sending jingle mail to their lenders. So what if they could still afford the monthly payments? It didn't make logical sense to keep paying for a depreciating asset that they owned so little of, borrowers reasoned. The sting of a credit score ruined by foreclosure wouldn't last as long as the burn of paying $500,000 for a $300,000 home.

    The lack of down payment is also one reason why so many homeowners ended up underwater. If you purchase a home for $200,000 with no down payment and the market value of your house drops to $160,000, you can't sell the house because you can't pay off the mortgage (unless you have $40,000 sitting in the bank). If you purchase a home for $200,000 with a 20% down payment and the market value drops to $160,000, you still have the option to sell at a loss. Most people who didn't make down payments didn't have money in the bank, though, and when they needed to get out of their homes, they were forced into credit-damaging short sales and foreclosures instead of having the option to sell.

  • "You can refinance before your rate goes up."

    How many people who took out adjustable-rate mortgages (ARMs) heard this line? But since prices were headed nowhere but up, many people, especially subprime borrowers, assumed that in the three or five years before their ARMs reset, they would be able to improve their credit enough to qualify for a fixed-rate mortgage or see their home appreciate so much that they would have no trouble refinancing. Another reason many people took out ARMs and other risky mortgages was because they planned to flip the house and wanted to spend as little as possible on mortgage payments in the meantime.

    When the real estate market crashed, people went underwater and couldn't sell their homes for enough to pay back the money they owed on the mortgage. Not only did they become trapped with the home, they became trapped with an unpredictable and generally much higher housing payment. Because of the poor economy, many of these people also lost their jobs, making it nearly impossible to pay the mortgage.

  • "Just get a home-equity loan."

    During the boom, money trees were suddenly sprouting up in people's backyards in the form of home equity loans (also known as second mortgages) and home equity lines of credit. Homeowners were able to take advantage of the appreciation in their home's value to borrow money – lots of money. Whatever you wanted to pay for, whether it was your kids' college educations or a new kitchen, the home equity loan was the answer.

    Unfortunately, the collateral for these loans is the home itself. Even people who bought homes at reasonable prices and had affordable mortgage payments got sucked into the housing crisis when they borrowed money based on what would soon become unrealistic values for their homes. The loans they took out reduced the equity they had built up and increased their monthly payments. Many people who borrowed against their home equity ended up in the same position as people who took out bad mortgages or mortgages they couldn't really afford.

The Bottom Line

The next time we find ourselves in an asset bubble – and there will be a next time – perhaps the lessons we've learned from the housing crisis will cause us to consider what we hear and say a little more carefully.

Writer's Corner

I want to wish my wife and my mother a happy mother's day. Thank you for all you do.

Housing Bubble News from Patrick.net

Fri May 7 2010

Freddie Mac asks U.S. for $10 billion as losses pile up (washingtonpost.com)

Republicans seek vote on future of Fannie, Freddie (reuters.com)

Obama Backs Financial Reform Except Where It's Needed Most (Mish)

President Obama's Cooper Union speech and the Goldman case (nypress.com)

Cronyism and gambling of financial sector (doctorhousingbubble.com)

Stock market trouble, Fed impotent (patrick.net)

Greece bailout just the beginning? (edition.cnn.com)

Land rezoned for 800,000 more houses than needed in Ireland (independent.ie)

As England Votes, Economic Clouds Hover (nytimes.com)

Bailed out homebuilders collect fat paychecks (reuters.com)

Big mystery is economists' failure to see housing bubble (interest.co.nz)

Was It Really a Bubble? (Economist still in denial!) (economix.blogs.nytimes.com)

ML-Implode Wins Reversal In Court Case; Re-Posts Censored Materials (blog.ml-implode.com)

Prior restraint (en.wikipedia.org)

Real Estate Rescue Scammers Tortured (laweekly.com)

Va. launching portable housing for aging relatives (washingtonpost.com)

Free Trial of the Landlord's Bargain Finder

Thu May 6 2010

You Would Have to Be Fool to Buy a House Now (theaffordablemortgagedepression.com)

Foreclosure is hitting well-off families, too (moremoney.blogs.money.cnn.com)

Drowning in mortgage debt (money.cnn.com)

Mortgage interest deduction not healthy for housing market (cnbc.com)

US Government Now 96.5% of the Mortgage Market (smirkingchimp.com)

Rich farmers get most cash (news.yahoo.com)

What Washington Needs To Learn From Greece (finance.yahoo.com)

Budgets full of pain (theautomaticearth.blogspot.com)

Congress members bet on fall in stocks (finance.yahoo.com)

Oakland California Bankrupt (Mish)

Massive bank fraud still unacknowledged (dailybail.com)

Disorganization at Banks Causing Mistaken Foreclosures (propublica.org)

The Fed: Bubble spotting (economist.com)

Fed transcripts stoke debate on rates (goupstate.com)

Mortgages Could Be Free If Interest Rates Were High Enough (PDF – Vince Loughnane) book cover

Red flags over China's hot property market (business.asiaone.com)

Don't fall victim to a lying house seller Amy Hoak's House Economics (marketwatch.com)

Property Forum now includes street view, prices, rents (patrick.net)

Wed May 5 2010

Why aren't Fannie and Freddie in Reform Bill? (voices.washingtonpost.com)

Geithner: Housing Reform To Come AFTER Wealthy Get Their Money Out (imarketnews.com)

Fed Privately Lobbies Senate to Kill Audit; What You Can Do! (Mish)

Ron Paul: I Think They're Going To Destroy The Dollar! (youtube.com)

Six Degrees of Leverage (old but good – makingsenseofmyworld)

Australia's Central Bank Signals Higher Bar for Rate Increases (bloomberg.com)

Australia poised to lift interest rates for 3rd month running (smh.com.au)

Mortgage Bond Spreads at Widest in Five Months (bloomberg.com)

Billionaire says "Vote For Me, I Shorted Your House" (blogs.wsj.com)

What if other businesses were like Goldman? (salon.com)

30,000 people a month can pay their mortgage but choose not to (doctorhousingbubble.com)

San Clemente takes back house seized in deed scheme (ocregister.com)

Volcker Says U.S. Unemployment Will Be Too High for Too Long (bloomberg.com)

Plunge in state revenue dashes hopes of an easy budget fix (latimes.com)

Anger brews over tax appeal fee (lansner.freedomblogging.com)

Small bungalows made American dream of house ownership possible (latimes.com)

Jay's Tiny House Tour (youtube.com)

Welcome to SurvivaBall: Promotional Program (survivaball.com)

Tue May 4 2010

Low Interest Rates – As Destructive as Usury? (old but good – makingsenseofmyworld)

Greenspan Wanted Housing-Bubble Dissent Kept Secret (huffingtonpost.com)

The bubble makers (network.nationalpost.com)

What the Federal Reserve should have done (washingtonpost.com)

Was There A Plan to Blow Up The Economy? (informationclearinghouse.info)

Despite 2009 restrictions, mortgage and appraisal fraud spiked (washingtonpost.com)

How Widespread Mortgage Fraud Toppled the U.S. Housing Market (realestatechannel.com)

Banks Buying Treasuries Instead Of Lending (bloomberg.com)

Housing market will implode, warns Edward Chancellor (perthnow.com.au)

House price implosion claims ridiculous, says Australian economist (heraldsun.com.au)

China May Crash in Next 9 to 12 Months, Faber Says (bloomberg.com)

China State Media On Corruption and Cooling Off The Real Estate Market (sinocism.com)

The sky's the limit for Israel housing bubble (jpost.com)

Goldman Fraud Case: The Only Email Worth Reading (fool.com)

Sen. Dodd's financial bill ignores Fannie and Freddie (knoxnews.com)

Senate Financial Bill Misguided, Some Academics Say (dealbook.blogs.nytimes.com)

Foreclosure Bargains Hurt by Chinese Drywall (pbs.org)

Ethics of Real Estate Strategic Default (biggerpockets.com)

The Morality of Strategic Default (PDF – patrick.net)

Long-Awaited Baby Boomer Die-Off To Begin Soon, Experts Say (theonion.com)

Mon May 3 2010

Foreclosures mounting in wealthier neighborhoods (ocregister.com)

Foreclosure Woes Loom As Housing Stimulus Ends (npr.org)

House Buyer Tax Credit Costly Failure (realestatechannel.com)

Tax dollars siphoned as credits go unchecked (azcentral.com)

Buy vs Rent Takedown (bayarearealestatetrends.com)

Buy Real Estate Now or Wait? (buygoldandsilversafely.com)

How financial reform could kill the ratings agency business (money.cnn.com)

The U.S. Needs Real Financial Reform (forbes.com)

"Brown Chip" Investing; Bubble Pricing in Vancouver (Mish)

Empty new houses in Ireland should be sold at low price, not demolished (news.bbc.co.uk)

Australian Housing bubble to burst? History says 'yes' (smh.com.au)

Limits to Australia's housing bubble (anz.theoildrum.com)

America Needs to Get Over Its House Passion (theatlantic.com)

The hidden costs of houseownership (latimes.com)

Housebuyers still don't research mortgages (bizjournals.com)

Suddenly, bank account was gone (ajc.com)

Gosh, no one could have forseen the housing crash! (patrick.net)

Power, Transparency and Debt (theautomaticearth.blogspot.com)

The trillion-dollar fraud: Why is the Fed so opposed to being audited? (salon.com)

Small-time counterfeiter had room overlooking BIG counterfeiter (latimes.com)

Bought at the peak

This couple bought at the peak, yet their house has appreciated while the market has collapsed around them. If the greater fool steps up and buys this property, this family has hit the lottery.

Irvine Home Address … 66 FANLIGHT Irvine, CA 92620

Resale Home Price … $1,680,000

Home Purchase Price … $1,415,500

Home Purchase Date …. 9/6/2006

Net Gain (Loss) ………. $163,700

Percent Change ………. 18.7%

Annual Appreciation … 4.6%

Cost of Ownership

————————————————-

$1,680,000 ………. Asking Price

$336,000 ………. 20% Down Conventional

5.07% …………… Mortgage Interest Rate

$1,344,000 ………. 30-Year Mortgage

$350,638 ………. Income Requirement

$7,272 ………. Monthly Mortgage Payment

$1456 ………. Property Tax

$417 ………. Special Taxes and Levies (Mello Roos)

$140 ………. Homeowners Insurance

$105 ………. Homeowners Association Fees

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

$9,390 ………. Monthly Cash Outlays

-$1591 ………. Tax Savings (% of Interest and Property Tax)

-$1594 ………. Equity Hidden in Payment

$666 ………. Lost Income to Down Payment (net of taxes)

$210 ………. Maintenance and Replacement Reserves

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

$7,082 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$16,800 ………. Furnishing and Move In @1%

$16,800 ………. Closing Costs @1%

$13,440 ………… Interest Points @1% of Loan

$336,000 ………. Down Payment

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

$383,040 ………. Total Cash Costs

$108,500 ………… Emergency Cash Reserves

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

$491,540 ………. Total Savings Needed

Property Details for 66 FANLIGHT Irvine, CA 92620

——————————————————————————

Beds: 5

Baths: 3 full 1 part baths

Home size: 3,541 sq ft

($474 / sq ft)

Lot Size: 5,007 sq ft

Year Built: 2006

Days on Market: 3

Listing Updated: 40304

MLS Number: S615843

Property Type: Single Family, Residential

Tract: Wdmf

——————————————————————————

Honey Stop the car!!! Fanastic quiet corner cul-de-sac location. Amazing custom fine cabinetry throughout. The attention to detail is unchallenged, from the curb to the back yard. This is a custom home with over $200,000 in upgrades. Gourmet stainless kitchen/42' cooktop with six gas burners/2 convection ovens microwave refrigerator, Island, Great Room/custom fireplace/built-in TV/surround sound. Formal Dining Room. One bedroom down/3/4 custom shower. Mastersuite, Jacuzzi tub mirrors/custom walk in closets/custom shower++3 bedrooms up. Two of the bedrooms have the jack & jill bathroom. One bedroom is a small master/private full bath/walk in closet ++loft/custom 3 station desk. Travertine,carpet,shutters, Baseboards, Crown Molding, canned lights, house is wired with Cat-5e Data wire, Low-E dual glazed windows, 75 gal. water heater, inside laundry room upstairs, finished garage, cabinets, energy efficient throughout, custom low maintance landscape, near award winning Woodbury elementary.

Clueless Academic Wonders, "Was It Really a Bubble?

I have great respect for many in academia. Some of them actually know what they are talking about. However, I am dismayed whenever I read poor reasoning and a faulty interpretation of data by someone passing themselves off as an expert. It tarnishes the image of academics everywhere.

Irvine Home Address … 27 STARVIEW Irvine, CA 92603

Resale Home Price …… $2,999,000

{book1}

I practice every day to find some clever lines to say

To make the meaning come true

But then I think I'll wait until the evening gets late

And I'm alone with you

The time is right your perfume fills my head, the stars get red

And oh the night's so blue

And then I go and spoil it all, by saying something stupid

Frank Sinatra — Something Stupid

When economists who have no idea what they are talking about get published, it diminishes the entire profession. The gentleman I am picking on today simply has no concept of the underlying causes and motivations of real estate market participants. To start, I want to show one example of his lack of understanding with a paper he wrote about commercial real estate.

Was There a Commercial Real Estate Bubble?

By CASEY B. MULLIGAN

A few economists have likened the commercial real estate market of the last 10 years to the housing cycle. In fact, the commercial and housing markets were fundamentally different.

As recently as last week (see also here), Paul Krugman claimed that the commercial real estate market followed a bubble much like that of the housing market, and thereby concluded that the housing bubble could not be blamed on anything unique to the housing sector.

Mr. Krugman observed that real estate prices went up, and then came down, in both the residential and nonresidential sectors. For example, he has presented the chart below comparing the Case-Shiller index for housing prices with a commercial real estate price index from Moody’s.

In Mr. Krugman’s view, both “bubbles” had some of the same determinants. For example, lenders were hungry for risk, and they fed their appetites by investing in a variety of assets, like houses and office buildings. Thus, he takes comfort in his observations that the two sectors had real estate prices that moved roughly together. Continue reading →

Harvard: Lax Underwriting Standards Did Not Inflate The Housing Bubble

A recent Harvard study concluded, "the boom and bust in housing over the last decade was not primarily caused by low interest rates, reduced downpayment requirements, or laxer underwriting standards"

I cringe with embarrassment for them….

Irvine Home Address … 20 VILLAGER Irvine, CA 92602

Resale Home Price …… $950,000

{book1}

Now I like takin' off

don't like burnin' out

Every time you turn it on

makes me want to shout

We keep getting hotter

movin' way too fast

If we don't slow this fire down

we're not gonna last

Cool the engines

red line's gettin' near

Cool the engines

better take it out of gear

Boston — Cool The Engines

The wisdom of song lyrics eludes everyone in a market rally. Prices can only rise so fast in a stable market. Fundamental constraints can be ignored for a time, but wicked bear markets signal their return when the collective insanity that grips the market wanes.

Academics study the problem, but so far, progress in the field of economics has been very slow and prone to decades long wastes of time on theories like Efficient Markets. Greed and fear are the features that move market prices. What we really need is to learn how to cool the engines; instead, we strive to go faster and we blow the engine apart.

New Harvard Kennedy School Study Questions Direct Link between Lower Interest Rates and Higher Housing Prices

Contact: Doug Gavel

Phone: (617) 495-1115

Date: May 05, 2010

Cambridge MA. — Contrary to the assertions of many economists and others, the boom and bust in housing over the last decade was not primarily caused by low interest rates, reduced downpayment requirements, or laxer underwriting standards, conclude Edward Glaeser, Joshua Gottlieb, and Joseph Gyourko in “Did Credit Market Policies Cause the Housing Bubble?” a new Policy Brief published by the Rappaport Institute for Greater Boston and the Taubman Center for State and Local Government at the John F. Kennedy School of Government at Harvard University.

… “It isn’t that higher mortgage approval rates aren’t associated with rising home values. They are,” they add. “But the impact of these variables, as predicted by economic theory and as estimated empirically over many years, is too small to explain much of the housing market event that we have just experienced.” Specifically, the authors found that the 1.3 percentage point drop in real interest rates between 2000 and 2006 was responsible for only a 10 percent rise in prices, about a third of the average price increases nationally during that time and even a smaller share of the increase in many metropolitan areas, including greater Boston, where prices rose by 54 percent between 2000 and 2006.

I reached the same conclusion when researching the Great Housing Bubble. With a spreadsheet, anyone can input the income data, apply the appropriate debt-to-income ratio and calculate what a proper loan would have been. Add an appropriate 20% down payment, and you arrive at what houses should sell for. This simple math predicts housing prices in less volatile markets. Prices deviate from expectations when irrational exuberance takes over.

If banks didn't allow DTIs above 25%-32%, we would not inflate housing bubbles. In the late 1970s, lenders allowed DTIs to go well over this safe range because both the lenders and the borrowers anticipated more wage inflation. A borrower can take on a 60% DTI if they believe they will be making 10% more in salary each and every year. In a few years, the DTI would be under 30% and falling quickly. In the face of rising wage inflation, taking on debt at fixed interest is very attractive. This is the trap of inflation expectation the Federal Reserve had to bring under control under Paul Volcker.

Irvine debt-to-income ratios 1975-2009

Our latest housing bubble was built on a different mechanism: the toxic loan. DTIs were again allowed to rise above the stable range because the terms of repayment provided borrowers with a manageable DTI on a temporary basis. First it was the interest-only loan, then it was the Option ARM. Once lenders started making loans based on the temporary affordability these loans provided, they inflated a massive housing bubble sure to deflate once the unstable loan terms blew up. The terms of the toxic loans were the direct cause of the housing bubble. The reduced underwriting standards merely allowed lenders to give toxic loans to more people and make the bubble go on a little longer.

Glaeser, Gottlieb and Gyourko did find that the price effect of interest rates was greatest in metropolitan areas such as Boston, San Francisco, New York, and Seattle that have less land, more regulation and/or topography that is not conducive to new buildings. However, that impact was not enough to explain the full magnitude of the housing bubble in those places. They estimate, for example, that reduced interest rates should have caused prices in greater Boston to rise by about 14 percent between 2000 and 2006, significantly less than the actual increase of 54 percent.

The authors also found that contrary to the assertions of many analysts, including Benjamin Bernanke, chairman of the Board of Governors of the Federal Reserve System, reduced downpayment requirements did not greatly contribute to the housing bubble. Rather, they found that on average the share of the purchase price covered by a mortgage was basically unchanged over the course of the boom, rising from about 84 percent in 1998 (before the boom began) to 88 percent at the peak of the bubble in 2006 and then dropping to about 80 percent by 2008 after the bubble had burst. Moreover, the changes were even smaller among the share of people who borrowed as much as possible. Nationally, in 1998 one-quarter of home purchasers put down only about 96 percent of the total purchase price; by 2006 this figure had risen to 99 percent.

While the data do not explain the housing bubble, the authors do contend that the “the relatively modest link between interest rates and housing prices makes us more confident about rethinking [other] Federal housing policies,” most notably the ability to deduct mortgage interest from federal income taxes, a politically popular policy that many analysts believe is inefficient, unfair, and environmentally unsound. They also suggest that states such as Massachusetts that have restrictive local land use laws could reduce the extremity of its housing price cycles via policies that supersede local zoning or reward communities that allow for more housing.

I like their two policy recommendations, but neither one has any chance of passage.

Diana Olick didn't see the wisdom in this study either, and I will let her have the first shot.

Loose Lending Didn't Create the Housing Bubble

"Contrary to the assertions of many economists and others, the boom and bust in housing over the last decade was not primarily caused by low interest rates, reduced down payment requirements, or laxer underwriting standards."

My sixth grade English teacher always told me never to start with a quote, but in this case, how could I not?

Read it again, if you will; I read it three times just to make sure.

Yes, after years of bashing the mortgage industry for lax underwriting, bashing the Federal Government for negligently low interest rates and blaming investors for vacuuming up homes with no-money-down loans, three guys from Harvard say they're all off the hook.

Thank you, Diana. I am not the only one dumfounded at the ignorance of their assertions.

…I found a lot of this quite hard to digest, given the debate I've been covering for the last four years, from peak to trough to recovery. So I called Prof. Glaeser, who very affably took my questions.

Diana: If loose lending and over-borrowing didn't cause the housing bubble, what did?

Prof. Glaeser: The historical relationship between these variables and the housing market is just to small to explain this. In terms of understanding it, we believe that neither we nor anyone else understands this. The mechanics of bubbles, they certainly are associated with all sorts of irrational exuberant beliefs of future price changes. That's' always been true of housing. What specifically caused this thing? A strange cocktail that brought together things that created the bubble.

It is clear that Professor Glaeser does not understand what happened, but there are many people who do understand it. I explained it clearly above, and I will expand more now.

There is a mechanism by which prices are inflated. Prices do not increase by magic. A borrower is given a loan by a lender to buy real estate. The standards the lender applies and the terms of the loan determine who gets the loan and how big it is. It isn't mysterious; It is how our housing market works. All causes of the housing bubble must be explained by their impact on loan terms and standards. In fact, the failure to make this link is the weakness of all housing market analysis based on macroeconomic conditions.

There is a basic connection between what individuals do and the results of the collective actions of individuals. Individual borrowers taking out very large loans from stupid lenders bid up the prices on houses. The collective action of all these individuals is rising market prices and a bubble. I hope everyone who reads this is capable of explaining it to the Harvard professor. All of you now know more than he does.

Diana: But didn't subprime lending drive prices higher by bringing certain fiscally ineligible buyers into the market?

Prof Glaeser: The subprime mortgage market is different than the housing price boom. We think that it did drive prices higher. But even the historical relationship of LTV is a very small fact relative to the boom that occurred.

I pushed the professor on the loose lending some more, and he agreed that it was certainly an ingredient in the cocktail, but not the sole driver of the housing bubble.

One thing I do find interesting about this study is the conclusions they draw from their work.

So what are these researchers are trying to prove? Well that comes at the end of the press release:

While the data do not explain the housing bubble, the authors do contend that "the relatively modest link between interest rates and housing prices makes us more confident about rethinking [other] Federal housing policies," most notably the ability to deduct mortgage interest from federal income taxes, a politically popular policy that many analysts believe is inefficient, unfair, and environmentally unsound .

Prof. Glaeser argues that the mortgage interest deduction is not healthy for the housing market, and, while he didn't say as much, perhaps more dangerous than low, low mortgage interest rates or no-money-down loans. Why? Because it gives borrowers a continuing, long term incentive to borrow more than they should.

How did the home mortgage interest deduction get dragged into this? The professor is correct in his observations, but there is no linkage to his study. If the HMID somehow inflated the bubble, the argument would have greater strength, but since it didn't, the professor's argument looks like a pet idea he included because he couldn't figure out what really caused the bubble and what anyone could do about it.

The truth is lenders giving out Option ARMs and other toxic loans enabled borrowers to inflate prices, and the Desire for Mortgage Equity Withdrawal Inflated the Housing Bubble. The evidence is clear. And the government's response to the problem with HAMP is simply bringing back the Option ARM. Temporary interest rate reductions and principal deferment are the two characteristics of Options ARMs that made them unstable, yet that is the cornerstone of the government's loan modification program.

If the professor wanted to analyze the problem and suggest a change in government policy, he should go after the ridiculous bailouts and loan modification programs rather than proposing a battle against the politically impossible to repeal HMID.

Problem solving begins with a clear grasp of the problem. If the problem is not defined correctly, all solutions that follow are likely to fail. So far, we have defined the problem as foreclosure, so all our solutions are designed to delay or prevent foreclosure, and they have all failed. In reality, our problem is too much debt, and foreclosure is the solution. When policy makers finally realize this, perhaps they will get out of the way and allow the cleansing foreclosures to go forward. We can only wait and hope.

Irvine Home Address … 20 VILLAGER Irvine, CA 92602

Resale Home Price … $950,000

Home Purchase Price … $1,148,000

Home Purchase Date …. 5/28/2005

Net Gain (Loss) ………. $(255,000)

Percent Change ………. -17.2%

Annual Appreciation … -3.8%

Cost of Ownership

————————————————-

$950,000 ………. Asking Price

$190,000 ………. 20% Down Conventional

5.24% …………… Mortgage Interest Rate

$760,000 ………. 30-Year Mortgage

$202,116 ………. Income Requirement

$4,192 ………. Monthly Mortgage Payment

$823 ………. Property Tax

$300 ………. Special Taxes and Levies (Mello Roos)

$79 ………. Homeowners Insurance

$82 ………. Homeowners Association Fees

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

$5,477 ………. Monthly Cash Outlays

-$1036 ………. Tax Savings (% of Interest and Property Tax)

-$873 ………. Equity Hidden in Payment

$395 ………. Lost Income to Down Payment (net of taxes)

$119 ………. Maintenance and Replacement Reserves

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

$4,081 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$9,500 ………. Furnishing and Move In @1%

$9,500 ………. Closing Costs @1%

$7,600 ………… Interest Points @1% of Loan

$190,000 ………. Down Payment

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

$216,600 ………. Total Cash Costs

$62,500 ………… Emergency Cash Reserves

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

$279,100 ………. Total Savings Needed

Property Details for 20 VILLAGER Irvine, CA 92602

——————————————————————————

Beds: 5

Baths: 4 baths

Home size: 3,537 sq ft

($269 / sq ft)

Lot Size: 4,057 sq ft

Year Built: 2002

Days on Market: 104

MLS Number: P716076

Property Type: Single Family, Residential

Community: Northpark

Tract: Bela

——————————————————————————

According to the listing agent, this listing may be a pre-foreclosure or short sale.

This property is in backup or contingent offer status.

Attention Investors!!! Attention Buyers!!! Looking to Start 2010 with a Bang? Want the Deal of the Year? Nestled in Irvine s Prestigious Northpark Square & Priced to Steal, this HANDSOME Residence boasts STUNNING CURB APPEAL & LUXURIOUS Comforts that Surpass Every Home in this Price Range! Spacious Open floor plan offers 5 Bedrooms & 4 Baths w/2-Car Garage in approx. 3,537 sq.ft. Inviting Living Room & Elegant Dining Room is perfect for Entertaining. Gourmet Kitchen w/Granite Counters & Chef s Island opens to generous Family Room & Breakfast Nook. Spacious Master Suite w/Huge Walk-in Closet plus Large Secondary Bedrooms offers Abundant Closet Space! Wait till you see the HUGE Bonus Room. Near Shopping, Dining, Entertainment & Schools including community Pool, Spa, BBQ s, Sports Courts, Outdoor Amphitheater, Parks, Walking Trails, Bike Trails, Tot Lots & More! Make No Mistake This Home Will Not Last, So ACT FAST! Only ONE like this!!!

That is one of the worst descriptions I have read in quite a while. I ran out of room for graphics. it has almost every convention of bad realtor writing in one paragraph. Stunning!

Defaulting owner

This property may be facing foreclosure due to unemployment. The owner paid way too much back in 2005, but he put $229,600 down. He refinanced and pulled out a little, but he still stands to lose $200,000 when this property sells. He is trying to short sell, and squatting until it happens:

Foreclosure Record

Recording Date: 09/03/2009

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 05/29/2009

Document Type: Notice of Default