Some properties take longer to go through the system than others. This one has been shadow inventory for about 9 months, but now it is seeing the light of the MLS.
The boys of summer Nobody on the road Nobody on the beach I feel it in the air The summers out of reach Empty lake, Empty streets The sun goes down alone Im drivin by your house Though I know youre not home
Nobody in the house, nobody pays the loan, the bottom’s out of reach…
The original owner who was foreclosed on stopped making payments in early 2007. This was a 100% financing deal that went bad that I first profiled and updated here: Salton ** Update 1 **. I have speculated on all the reasons for the buildup of shadow inventory, and some have argued that it does not exist.
Shadow inventory clearly exists.
Today’s featured property was foreclosed on by CITIBANK NA, ; BEAR STEARNS ALT A TRUST 2006-5 MORTGAGE back on 9/12/2008. For the last 9 months, this has been part of the shadow inventory. For the last two years, this property was occupied by a deadbeat and then empty. Nobody has been making either rent or debt service payments during that time; two years as a non-performing asset. No wonder the banks are in trouble.
You can expect to see this trend continue. The lenders have been accumulating REO. Some resisted taking the write-downs because their balance sheets could not take it, some were hoping the Obama Administration would buy these toxic mortgage assets so lenders would not have to recognize the loss at all, and some were simply overwhelmed by the size of the problem. Lenders are now in the mode of foreclosing on defaulting borrowers and selling off their REO. Look for this trend to accelerate in the coming months.
Beautiful End Unit in Irvine. Great inside tract location across from
park. Large floorplan with open living area and kitchen combo. Attached
2 car garage. Close to schools.
If this property sells for its current asking price, the investors in the MBS being serviced by CITIBANK NA, ; BEAR STEARNS ALT A TRUST 2006-5 MORTGAGE stand to lose $219,788. At first glance this looks like an ordinary loss for an Irvine property, but when you factor in the two years as a non-performing asset, the loss is at least $50,000 greater.
This property is being offered for 32% off its peak purchase price.
As the high end of the market collapses, you will see a race to the bottom among similar properties. Today’s featured property is one of three North Korean Tower penthouses competing for buyers who probably are not there.
Desperado, why don’t you come to your senses You’ve been out ridin’ fences, for so long – now. Ohh you’re a hard one. I know that you’ve got your reasons. These things that are pleasin’you Can hurt you somehow.
Don’t you draw the queen of diamonds boy She’ll beat you if she’s able.
Many of us here have been riding fences for a very long time, and most of us “on the fence” will probably stay there for another year or three. We have our reasons; prices are going down, and they will continue to do so. Many others pursued the Queen of Diamonds during the bubble, and she beat them, took their money, took their property, and left them broken.
I have documented other cases of similar properties racing downward to find the few available buyers. One of the more notable cases was back in 2007 in Quail Hill in a post called Stepping Down. Today’s featured properties are all penthouse units in the North Korean Towers at the corner of Jamboree and the 405. All three are high-end properties on the cusp of a calamity. Prices in this building are more than 50% off, and there is no bottom in sight. All three of these units will likely drop 65%-70% before prices stabilize. Right now, they are all priced near what the owners paid; that will change.
There are no buyers for these units, but just in case, these three properties are positioning themselves to capture a knife catcher before prices fall off a cliff. I recently documented this phenomenon in the post School of Hard Knocks on Scholarship, Jamboree Corridor, Irvine. Once prices start falling in these condo towers, there simply isn’t any support beneath prices. Cashflow valuations are a third of asking prices. Someone, somewhere is going to lose a great deal of money.
17th Floor luxurious penthouse with a Dream entertainment balconieswith
panoramic mountain views & city lights. Luxury appliances,
fireplace, granite counters, wood & travertine flooring in living
room, kitchen, and baths; office, 24-hr guard & concierge, billiard
room, pool, spa, media room, fitness center. Entertainer’s dream,
Walking distance to shopping / restaurants.
This unit is owned by the optimist of the group. He actually thinks he can sell it for more than he paid. He will still lose a little bit with the commission, but he really believes he will escape this unscathed.
Luxury PENTHOUSE Located At Park Place, Irvine, California! Premiere
Location, Panoramic Views, An Unsurpassed Lifestyle. With 24 Hour
Concierge, Gated & Guarded Entry And First Class Facilities To Work
And Play. Spacious Interior: Floor To Ceiling Glass Walls, Automated
Window Shade, Gourmet Kitchen, Quality Wood Cabinet With Granite
Countertops, Professional Quality Stainless Steel Appliances, Hardwood
Flooring, Marble Baths and Heater Travertine Floors In Bathrooms…
This second property is nearly identical to the first. It is in the other tower, but the owner paid $100,000 more for this unit, and they are asking $50,000 less. If this one sells for its asking price, and if a 6% commission is paid, the total loss will be $203,800. Unfortunately, it will probably not sell for that much because…
Enjoy this upgraded luxurious penthouse residence. Open free-flowing
floor plan with 2 bedrooms plus den. Floor-to-ceiling windows boast
expansive city lights and mountain views. Top-Of-The-Line Amenities ,
First-Class Services and Facilities all within a exquisite
Resort-Styled atmosphere. Experience the finest in penthouse living.
Also for lease with furniture at $5,500.
The oil painting effect on Photoshop must be the new rage in MLS photos.
This last property is comparable to the first two, and it is $200,000 less expensive than the first and $150,000 less expensive than the second. It may not be quite as nice as the second one as it did sell for less originally, but the discount is such that a knife catcher may pick it instead.
If this one sells for its asking price, and if a 6% commission is paid, the total loss will be $152,440.
The owners of these three units are praying for a knife catcher. If they are lucky, perhaps one of them will find one; probably not. These three will continue to race downward until they either give up and go into foreclosure or find someone else willing to endure the big upcoming drop.
People who try to sell their own house do not use an agent to advise them on what to do or how to price it to sell. Some people do very well on their own; others… not so much.
Hard to find how I feel, please someone help me. Hard to find how I feel, controlling me every step of the way. Hard to find how I feel, you greedy little baby! Greed — Godsmack
Greed is a funny thing. It is an emotion we all feel, yet we are universally repulsed by it. Most religions identify it as a vice, and most people who work in finance identify it as a virtue. When everyone gets to feed their goblins of greed, the gluttony of consumerism satiates their salaciousness of the moment and greed grows unabated. When the system collapses and the greed is exposed for what it is, there is a period of shame and reflection — a fleeting moment before we do it all over again….
So how greedy is the owner of today’s featured property. Well, there is a property for sale down the street from this owner at 1 Lorenzo. It is a larger property on a corner with a view of a park. Basically, it is superior in every way to today’s featured property, and the owner there wants $320,000 less.
But this gets even better, the property at 1 Lorenzo was a WTF property profile from February 2008! (A New Drug) The owner of today’s featured property has priced himself $320,000 over a superior property that was itself grossly overpriced (it has been on the market 250 days now).
Today’s featured property is for sale by owner (FSBO). Savvy sellers can do well on their own, but clueless sellers simply embarrass themselves publicly by putting their properties on the market at prices that have absolutely no chance of selling. Everyone who pays attention to the housing market is aware of this property, and when most people see it, they giggle to themselves. With no agent to bring this seller down to reality, it just sits there and with each passing day, the owner looks more and more ridiculous.
What the Owner Loves: Culverdale Elementary School is about 200 yards.
How the owner describes the property: [silence]
This property was purchased on 8/19/1999 for $455,000. The owner used a $355,000 first mortgage and a $100,000 downpayment. Since then, he has managed his mortgage like most Irvine residents — he doubled it — and now he has significant debt. Of course none of this matters because he plans on selling this house for a small fortune.
If this house sells for its asking price, and if a 6% commission is paid, the owner stands to make $955,000.
LOL!
ROFLOL!!!
If you look at the listing history, you see that he first put this property on the market for $795,000. At that price, he would pay off his debts, but he wouldn’t take much cash with him when he left. Realistically, it might sell for $795,000 as there is still some bubble equity left in the property, but apparently this owner wants to make a fortune instead.
I can understand his greed. The fact that it is on display in such a manner should be humiliating, but there appears to be no shame in California real estate.
The regulatory solution proposed herein is simple, yet far
reaching. It comes in two parts, the first is to limit the amount lenders can
loan to borrowers with a rather unique enforcement mechanism, and the second is
to increase the penalties for borrowers who commit mortgage fraud. The
following is not in legalese, but it contains the conceptual framework of
potential legislation that could be enacted on the state and/or federal level.
A detailed discussion of the text follows:
Loans for the purchase or
refinance of residential real estate secured by a mortgage and recorded in the
public record are limited by the following parameters based on the borrower’s
documented income and general indebtedness and the appraised value of the
property at the time of sale or refinance:
1.All payments must be calculated based on a 30-year
fixed-rate conventionally-amortizing mortgage regardless of the loan program
used. Negative amortization is not permitted.
2.The total debt-to-incomeratiofor
the mortgage loan payment, taxes and insurance cannot exceed 28% of a
borrower’s gross income.
3.The total debt-to-incomeof all debt obligations cannot
exceed 36% of a borrower’s gross income.
4.The combined-loan-to-valueof mortgage indebtedness cannot
exceed 90% of the appraised value of the property or the purchase price,
whichever value is smaller except in specially sanctioned government programs.
Any sums loaned in excess of
these parameters do not need to be repaid by the borrower and no contractual provision
is permitted that can be interpreted as limiting the borrower’s right to
exercise this right, make the loan callable or otherwise abridge the mortgage
agreement.
This
last statement is the most critical. This is how the enforcement problem can be
overcome. Regulators are pressured not to enforce laws when times are good, and
decried for their lack of oversight when times are bad. If the oversight
function becomes a potential civil matter policed by the borrowers themselves,
the lenders know exactly what their risks and potential damages are. Any lender
foolish enough to make a loan outside of the parameters would not need to fear
the wrath of regulators, they would need to fear the civil lawsuits brought by
borrowers eager to get out of their contractual obligations. If any borrower
could obtain debt forgiveness by simply proving their lender exceeded these
guidelines based on the loan documents, no lender would do this, and regulatory
oversight would be practically unnecessary. One key to making this work is to
prohibit lenders from introducing a “poison pill” to the loan documents that would make borrowers hesitant
to bring suit, otherwise lenders would make their loan callable in the event of
a legal challenge forcing the borrower to refinance or sell the property.
Basically, if the borrower brought suit and won, they would see principal
reduction equal to the deviation from the standards, if they brought suit and
lost, they would have no penalty. Most of these cases would be decided by
summary judgment based on a review of the loan documents thus minimizing court
costs.
Another
pillar to the system is the documentation of income as part of the loan
document package – the “borrower’s
documented income” from the proposed legislation. One of the most egregious
practices of the Great Housing Bubble was the fabrication of income by
borrowers that was facilitated and promoted by originating lenders. Stated-income
loan programs were widespread, and they were the cause of much of the
uncertainty in the secondary mortgage marketduring the initial stages of the credit crunchin the deflationof the bubble.
Basically, investors had no idea if the borrowers to whom they had lent
billions of dollars were capable of paying them back. Without proper documentation
of income, investors lost all confidence in the secondary mortgage market. Stated-income
loan programs were one of the first casualties of the credit crunch. These
programs should be eliminated totally due to the inherent potential for fraud
and the undermining of confidence in the secondary mortgage market
stated-incomeloans create. If
lenders can be sued based on the content of the loan documents, and if
borrowers can be fined or go to jail for committing fraud or misrepresentation
on loan documents, both parties have strong incentive to prepare these documents
completely and correctly. Originating lenders will argue this adds to their
costs and will result in higher application fees. The amount in question is
very small, particularly relative to the dollar amount of the transaction. A
small amount of additional expense here will provide huge benefits by assuring
investors the borrowers to whom they are loaning money really have the income
to pay them back. The benefit far outweighs the cost.
If such
a law were passed, agency interpretation and court case precedents will end up
defining adequacy in loan documentation. A single W2 does not establish a work
history, but 2 years worth is probably excessive documentation. One of the most
contentious areas will likely be documenting the income of the self-employed. In
theory, the self employed must document their incomes to the US government
either through Schedule C reports or corporate K-1s. The argument the
self-employed have traditionally made is that these documents understate their
income. Since many self employed take questionable tax deductions, there is
probably some truth to the claim that tax records understate their income;
however, why should the self-employed get to have both benefits? If the
self-employed had to use their tax returns as loan documentation, they probably
would not be quite so aggressive in taking deductions. A new business without a
tax return or with only one year of taxable receipts probably is not stable
enough to meet standards of income necessary to assume a long-term debt.
The
poor quality of loan documentation during the bubble was a mistake of
originating lenders; therefore, in this proposal much of the burden of
paperwork and liability for mistakes falls on the lenders. During the deflationof the bubble, lenders
paid an enormous price for some of their lax paperwork standards, but much of
the problem was also due to borrowers misrepresenting themselves in the loan
documents. There were instances where lenders encouraged this behavior, but in
the majority of cases, the document fraud was perpetrated by the borrowers. The
only recourse available to a lender is a civil suit as there are few criminal
penalties associated with loan documentation and almost no enforcement. It can
be very difficult and costly for lenders to pursue civil damages, and few
lenders attempt it even when they have a strong case. To create a more balanced
set of responsibilities, the borrowers must face criminal penalties for fraud
and misrepresentation on loan documents. If borrowers know the lender can turn
documents over to a prosecutor who will charge the borrower with a crime if
they make false material statements, borrowers will be much less likely to
commit these acts.
The
parameters of the forming limitations on the debt-to-incomeratioand combined-loan-to-valueare essential to
prevent bubbles in the housing market and to prevent the banking system from
becoming imperiled in the future. People will commit large percentages of their
income to house payments when prices are rising quickly; however, they do this
out of fear of being “priced out” and greed to make a windfall from
appreciation. These are the beliefs that inflate a bubble. Borrowers
cannot sustain payments above the traditional parameters for debt service
without either defaulting or causing a severe decline in discretionary
spending. The former is bad for the banks, and the latter is bad for the entire
economy. This must be prevented in the future. There are a number of reasons
why high combined-loan-to-valuelending is a bad
idea: it promotes speculation by shifting the risk to the lender, it encourages
predatory borrowing where borrowers “put” the property to a lender, it promotes
a high default rate because borrowers are not personally invested in the
property, it discourages saving as it becomes unnecessary, and it artificially
inflates prices as it eliminates a barrier to market entry. This last reason is
one of the arguments used to get rid of downpayment requirements. The
consequences of this folly became readily apparent once prices started to fall.
The
payment must be measured against “30-year
fixed-rate conventionally-amortizing mortgage regardless of the loan program
used.” One of the worst loan programs of the Great Housing Bubble was the
2/28ARM sold to large numbers of subprime
borrowers. These borrowers were often qualified only on their ability to make
the initial payment, and these borrowers were generally not capable of making
the fully amortized payment when the loan reset after 2 years. Regulations like
this would prevent a recurrence of the foreclosuretsunami triggered by
the use of this loan program. It is also important to ban negative amortizationbecause it would allow the loan balance to
grow beyond the parameters of qualification, and it invites property
speculation. Perhaps borrowers would not be concerned because they would
receive debt forgiveness of the expanding balance. Lenders should be wary of
these loans after their dismal performance in the deflationof the bubble, but
institutional memory is short, and these loan programs could make a comeback if
they are not specifically outlawed. This provision is careful to allow
interest-only loans. They are still a high-risk product, but an argument can be
made that these loans have a place, and there is no need to completely ban
them. They will not have a future as an affordabilityproduct capable of
driving up prices if the borrower must still qualify for the fully amortized
payment.
For the
lending provisions to have real impact, they must apply to both purchases and
to refinances, thus the clause, “Loans
for the purchase or refinance of residential real estate.” If the rules
only applied to purchases, there would be a tremendous volume in refinances to
circumvent the regulations. The caps on debt-to-incomeratios, mortgage
terms and combined-loan-to-valueonly have meaning if
they are universally applied. The combined-loan-to-valuestandard is based on
the “appraised value of the property at
the time of sale or refinance.” The new appraisal methods will have impact
here. It is important that the records need only be accurate as of the time of
the transaction. If a borrower experiences a decline in their income or if the
property declines in value to where they no longer meet the loan standard, it
does not mean they can go petition for debt relief.
The
regulations would only need to apply to loans “secured by a mortgage and recorded in the public record.” People
can still borrow money from any source they wished as long as the lender knows
they will not have any claim on residential real estate. If a lender wanted to
issue a loan secured by real estate outside of the outlined standards, the
borrower would not have to pay back that money. If a borrower has non-recorded
debts which create a totally indebtedness requiring more than 36% of their
gross income, they would not be eligible for a home equityloan even if they met
the other qualifications. In such circumstances, it is better to limit
borrowing than increase the probability of foreclosure.
Many
states have non-recourselaws on their books. These
laws serve to protect the borrower from predatory lending because the lender
cannot go after other assets of the borrower in the event of default. In theory
this should make lenders more conservative in their underwriting; however, the
behavior of lenders in California, a non-recourse state, during the Great
Housing Bubble was not conservative. These laws do serve to protect borrowers,
and they should be enacted for purchase-money mortgages in all 50 states.
Since
one of the goals of regulatory reform is to inhibit the behavior of irrational
exuberance, the sales tactics of the
National Association of Realtorsshould be examined and potentially come under
the same restrictions as securities brokers through the Securities and Exchange
Commission. After the stock market crash which helped precipitate the Great
Depression, Congress created the
Securities and Exchange Commission to regulate the sales activities of securities
brokers. There are strict regulations in place governing the representations
made concerning the future performance of investment opportunities. These
protections were put in place to protect the general public from the false
promises made by stockbrokers in the 1920s which many naïve investors believed.
The same analogy holds true for Realtors. The National Association of Realtors has launched numerous
advertising campaigns suggesting erroneously that residential real estate is a
great investment and appreciationwill make home buyers
wealthy. The mantra of all realtors is that house prices always go up. There are
currently no limits to the distortions and outright lies realtors can tell
prospective buyers with regards to the investment potential of residential real
estate. Buyers are already prone to believe the fallacies of unlimited riches
in real estate, and these fallacious beliefs lead to housing bubbles. Realtors
should be prevented from making representations concerning the investment
potential of real estate. Since the regulatory framework for this kind of
regulation and oversight is already in place under the auspices of the
Securities and Exchange Commission, Congress would merely need to make Realtors
subject to these regulations in order to solve the problem.
The
result of these restrictions will be that all homeowners will have at least 10%
equityin their properties unless they have borrowed
from a government program like the FHAwhere the combined-loan-to-valuecan exceed the
limits. This equity cushion would buffer lenders from predatory borrowing and a
huge increase in foreclosures if prices were to decline. Home equity in the
United States has been declining since the mid 1980s, and it actually declined
while prices rose during the Great Housing Bubble due to the rampant equity
extraction. The lack of an equity cushion exacerbated the foreclosureproblem as many
homeowners who owed more on their mortgage than the house was worth simply stopped
making payments and allowed the house to fall into foreclosure.
In 2008 the National
Association of Realtorslaunched a commercial advertising campaign
claiming that residential real estate doubles in value every 10 years. Besides
the obvious inaccuracy of the claim, it is the kind of claim no stockbroker
would be allowed to make.
Great location,walking distance to the District for shopping,dining and
entertainment! This townhome has upgrades galore,including granite
counters,a kitchen island,and plantation shutters throughout! Come see
this deal of the summer!
This property was purchased on 1/19/2007 for $671,000. The owner used a $536,750 Option ARM first mortgage and a $134,250 downpayment. Basically, she cannot afford the place.
If this property sells for its asking price, and if a 6% commission is paid, the total loss will be $107,000. The owner’s credit will be saved, but most of her downpayment is lost.
The big news this week was the introduction of regulatory reform of the financial services industry. I hope they get it right. Calculated Risk has a great overview of the reform proposals. It contains links to many documents including the governments white paper on the subject.
We have been updating and expanding our library and knowledge base. It is a work in progress.
In the two and one-half years I have been writing for the blog, I have completed many detailed analysis posts. The complete list can be found in our Analysis section (soon to be renamed Library). The goal is to organize all of the posts into different topics so finding them is easier. Also, I plan to add links to outside posts and academic papers people may find interesting related to the topic. Another project I am working on is to document the collective wisdom of our forums. There are a number of frequently asked questions that have been discussed at length in the fourms. This library project will be ongoing, and I will incorporate additional data as I find it or generate it myself.
The vision of the IHB has always been to be a free resource providing real estate education to everyone. The development and expansion of our library is part of our ongoing committment to provide you with the information and analysis you want. If you have any comments or suggestions, please let me know.
Back when I started writing for the IHB, we used to get about 500 visits a day. Now we get about 5,000. As I was setting up the library, I came across one of my early posts that I had forgotten about. It was one of my more creative efforts, so I thought I would revisit it here today. If you missed it the first time, I hope you enjoy it. From May 21st, 2007:
So, bye-bye, Miss American Pie Drove my Chevy to the levee But the levee was dry And them good old boys were drinkin’ whiskey and rye Singin’ this’ll be the day that I die This’ll be the day that I die
One of the hallmarks of a great song is its ability to be interpreted in different ways. American Pie is an allegory of our times, an ode to the death of our housing market.
With leverage drying up, the party is over. The last drink is for the
death of the market itself, and with it’s death, the death of the
American Dream of home ownership for thousands of overextended
homedebtors.
When a bubble in a financial market pops, it doesn’t explode in
spectacular fashion like a soap bubble, it is more comparable to a
breached levee which releases water slowly at first. Once the financial
levee is ruptured, the equity reservoir loses money at increasing
rates. It washes away the imagined wealth of homedebtors everywhere
until the reservoir is nearly empty and the torrent turns to a trickle.
Ultimately, the causes of failure are examined, the financial levee is
repaired, and the reservoir again holds value, but not until the dreams
and equity of homedebtors are washed away.
New Century Financial
Do you recall what was revealed The day the music died?
The poster child for the great residential financial bubble of the
00’s will be New Century Financial. The date of their financial
implosion will be regarded as the Day the Market Died. The
death of New Century Financial will come to represent to death of loose
lending standards and the beginning of the cycle of credit tightening
as I described in my last post, The Anatomy of a Credit Bubble. Many people currently see the elimination of sub-prime lending as being the problem. It is much larger than that. It is the changes in behavior caused by loose lending standards epitomized by New Century Financial that will be the undoing of the housing market.
100% Financing
The most damaging change in buyer behavior was caused by 100%
financing: potential buyers quit saving. Once 100% financing became
widely available, it was enthusiastically embraced by all parties: the
lenders suddenly had a huge source of new customers to generate high
fees, the realtors and builders now had plenty of new customers to buy
more homes, and many potential buyers who didn’t have savings were now
able to enter the market. It seemed like a panacea; for two or three
years, it was.
Now for ten years we’ve been on our own And moss grows fat on a rollin’ stone But that’s not how it used to be
There is a problem with 100% financing (which was masked by the
rampant appreciation brought about by its introduction): high default
rates. If you want a glimpse into the irresponsible mind of a typical
100% financing borrower, go read the post and comments in Update: an FB situation 14 months later. The FB stated in the comments,
“However, I take exception to the idea that I’m taking
food out of someone’s mouth by sticking the bank with the loss. An
appraiser made the valuation, and I got a loan. No one forced New
Century to give me the loan to buy the house, but they did. They
confirmed the value, and thus, assumed all risk, especially since I
went no money down with an, at the time, 720 mid-FICO, and the wife as
well.”
This borrower signed papers promising to repay money to New Century.
He gave his word. How does it follow that New Century took all the
risk? How does the presence or absence of a downpayment impact whether
or not a borrower will live up to their commitments and
responsibilities? We all know the answer: When people don’t put their own money into the transaction, they don’t feel responsible for what happens. At one point, the FB was celebrating, “I was planning on claiming insolvency to the IRS through my job loss, anyway, but they didn’t even give us a 1099!” Does it make you want to turn him in?
The courtroom was adjourned No verdict was returned
The more money people have to put in to the transaction, the less
likely they are to default. It is that simple. Taken to its extreme,
100% financing becomes the ideal tool for fraud. The FB from above
probably intended to repay the loan when he got it, he just didn’t feel
much of a sense of responsibility to the loan when the going got tough.
People who commit fraud have no intention of repaying the loan from the
start. Fraud is much easier to commit with 100% financing because the
bank will loan you the full amount of an inflated appraisal. It is much
harder to commit fraud when the bank will only loan you 80% of a
property’s value.
The point here is not about being irresponsible or committing fraud,
it is about defaults. High loan-to-value loans have high default rates;
this will cause 100% financing to disappear, and it will make other
high LTV loans much more expensive, so much so as to render them
useless. OC Fliptrack documented the elimination of the 100% LTV loans
at HSBC. It is all part of the ongoing credit tightening cycle.
The problem for the future housing market created by 100% financing
is that people quit saving money for downpayments. People respond to
incentives. This is basic economic theory. The availability of 100%
financing removed the incentive to save for a downpayment. People
responded; our national savings rate went negative as people stopped
saving and borrowed instead. This is going to create a huge problem
going forward: nobody has the newly required downpayments.
Elimination of Entry Level Buyers
Oh, and there we were, all in one place A generation lost in space With no time left to start again
People who currently own entry level housing (2 bedrooms or less and
small 3/2s) are bagholders. With the elimination of 100% financing,
they have missed their chance to sell to a greater fool. Even if these
fools were still out there (they have been decreasing in number), they
no longer have the ability to borrow all the money required to buy, and
they have no way to make up the difference. The entry level market was
destroyed the moment 100% financing was eliminated because nobody has a
downpayment.
Collapsing from the Bottom Up
The players tried for a forward pass With the Jester on the sidelines in a cast Now the half-time air was sweet perfume While the Sergeants played a marching tune We all got up to dance Oh but we never got the chance
Housing markets collapse from the bottom up. The
first sign of a troubled real estate market is a dramatic reduction in
volume. This is particularly pronounced at the lower end of the market
for reasons outlined above. Since the lower end of the market has a
more dramatic drop in volume than the top of the market, the median
stays at artificially high levels which is not reflective of pricing of
individual properties in the market. In other words, things look better
than they are.
The graphic on the right (borrowed from Calculated Risk) shows the
problem when the entry level is eliminated. For a more detailed
analysis, please read Why the Sub-Prime Meltdown is a Problem.
As the problem at the entry level becomes more serious, more and more
transactions higher up the house chain fall out of escrow. Volume
plummets, and the whole market seizes up. That is where we are today.
There will be no summer bounce this year.
Helter Skelter in a summer swelter The birds flew off with a fallout shelter Eight miles high and falling fast
Eight Miles High and Falling Fast
The market will not stay seized-up forever. Many bitter renters have
complained about greedy sellers, but it isn’t the sellers who determine
market prices, it is the buyers. Think about this: what if every seller
in the market decided they would not sell for less than $10,000,000?
Would houses suddenly become worth $10,000,000? Of course not because
no buyers could afford to pay that much. Buyers determine the market
price by putting in competing bids. Sellers can decided to accept or
reject the highest bid. If all bids are rejected, there is no market
because there is no transaction.
Buyers are never forced to buy, it is always a choice; however,
sellers may face circumstances when they are forced to sell. Over the
past several years, greedy buyers motivated by rising prices and fueled
by loose lending standards were able to bid prices up to ridiculous
levels. None of them were forced to buy. The exotic financing was not a result of high prices, it was the cause of high
prices. Those of us who are financially conservative and do not wish to
take on debt under terms which will put us into bankruptcy have been
competing with those afflicted with Southern California’s Cultural Pathology. It is a competition we were all better off losing.
Now the tables are turned. The once greedy buyers are becoming
desperate sellers, their dreams of riches from perpetual appreciation
in tatters. Many will be forced to sell due to their inability to make
their mortgage payments. Those that hang on will be homedebtors with
50% or more of their income going toward paying off an asset which will
be declining in value. It is not a set of circumstances I envy.
Prices will fall. We will see weakness at the bottom first, but it
will work its way through all market strata. It is only a matter of
time. Will you remember The Day the Market Died?
A long, long time ago… I can still remember How that music used to make me smile…
I can’t remember if I cried When I read about his widowed bride, But something touched me deep inside The day the music died…
I met a girl who sang the blues And I asked her for some happy news But she just smiled and turned away I went down to the sacred store Where I’d heard the music years before But the man there said the music wouldn’t play
And in the streets the children screamed The lovers cried, and the poets dreamed But not a word was spoken The church bells all were broken And the three men I admire most The Father, Son and the Holy Ghost They caught the last train for the coast The day the music died
