March 27, 2007

Housing Premonition: When You Knew it in Your Gut That Housing is Overpriced.


As we enter the peak political posturing season we are seeing that the subprime debacle may have some teeth with Joe and Susie public. Senator Dodd, who seems to be taking the lead on this economic juggernaut, had this to say regarding the subprime fallout today:

"we need answers very quickly."


He also mentioned that regulators “have been asleep at the switch” and need to enforce the regulations already on the books. This is all well and good but these are things that many bears have been discussing for years and now they need answers quickly? How quickly? By November of 2008 sounds good I would think.

The Chatter Begins


If anything, I’m glad a few politicians are shedding light on this monstrous train that is barreling down to main street USA. But when the talk shifts to bailing folks out that is where I put my foot down. In addition the connotation of all this chatter is that somehow we’ve seen the worse of the subprime implosion. Need I remind folks that the first week in March 2007 was when we had the subprime meltdown spread into Wall Street? Didn’t hear too much complaining in 2004, 2005, or 2006 when even a 102 year old man was able to get a 25 year mortgage. Maybe he can refinance when he is 120 into a 50 year mortgage. This credit bubble epidemic is global and as such will have far reaching ramifications.

Wall Street is Owned by Housing

Notice how intertwined Wall Street has become to housing? Last week sales moderately went up and Wall Street reacted with a positive jump. Yesterday further housing reports show that the market is weakening, today Lennar projects lowered revenues, and the market is down nearly 100 points. Amazing how all the pundits talk about the massively diverse US economy and housing being a tiny sliver of it, so any housing impact will be a drop in the bucket according to their reasoning. This will not happen when consumers, the bulk being the middle class, have most of their net worth tied up directly into housing. The perception of lower housing prices and tighter access on credit does not bode well for a credit addicted American public. Don’t take my word for it. Now that we are set to have $1 trillion in loans reset this year, a pace of approximately $100 billion a month, we are definitely at the behest of the housing market. Taking a play out of the book of the permabull camp we’ve heard such things as “housing never goes down” or “if it goes down it is only temporary” and this had been the case for seven decades. However, we’ve had a national median drop in price; only the first time since 1933 has this ever occurred. No longer is this bubble localized or even tiny in the scope of its impact. Considering that the entire US mortgage market is $6.5 trillion we have a big elephant in the room that is finally being given some attention. The US Mortgage market is larger than the US Treasury market for some perspective. Keep in mind when the NASDAQ fell it lost $9.3 trillion. But again, when we discuss the large scope of the mortgage market we see it spreading into every sector because 98 percent of the population either owns or rents. Not everyone was a dot-com junky and we all know how that played out.


Malcolm Gladwell and Snap Judgments


I’ve been reading Malcolm Gladwell’s book Blink and find amazing correlations to what is occurring in the housing market. The Getty was fooled in the 1980s into purchasing an ancient Kouros (Greek sculptures) because expert scientist were looking too much at the data and not at the overall historical context of the item. Art experts had a gut reaction when they saw the sculpture and knew immediately that something was funny about it. It conjured up a repulsive reaction even though they couldn’t put their finger on it. Was it that it was too perfect? Too great of a find? It was hard for these experts to articulate their feelings but after two years it turns out that they were right, the Getty had been fooled. The ten second visual response was accurate and the 14 months of expert analysis was wrong.

Now what does this have to do with housing? In the beginning a few years ago, many housing bears knew something was going on and we weren’t exactly sure what it was – maybe it was a confluence of many factors but we knew something was up. In the infancy of this bubble we were pushed to the fringe. We would try to explain to our friends and families that something about Collateralized Debt Obligations didn’t sit well with us. We couldn’t justify a 600 square foot home for $300,000 in a bad part of town. And each year, sure as the sun rises, the house would appreciate another 20 percent. We were left with our gut feeling of something being wrong and these folks looked at housing bears as from another planet because at that moment, we were wrong. Any investor will understand how to objectively view an investment no matter what it is. A car company will need a steady income stream and solid leadership. A strong newspaper will need to balance solid editorials with a staff of writers who can simplify complex issues into a front page article. These are givens. But as a society we sometimes dig too deep into the data and forget the overall picture; in this case many bears missed the fact that housing psychology + low regulations + behavioral economics led the way to this housing bubble we are currently in. As we were swimming in our data folks jumped into the game.

We need data all the time but the market doesn’t. However at the end data and facts will win. They always do. There may be a temporary glitch but overall things revert to a steady drumbeat. We need to trust our gut, just like those folks who saw the fake Kourous and knew something was wrong, and believe in our data. Sometimes snap judgments have a profound impact and we should learn to trust them; for example many looking at a condo costing $450,000 knew deep down that something was wrong. Now the facts back that assumption up. I hate to boil it down to common sense but never let these expert pundits guide you off a cliff; just look at yesterday’s housing data and how off these expert economist were. They are economist and not psychologist or computer scientist. Each of us are fallible to other areas of expertise but we need to realize that housing spans into countless areas. Now looking back at many housing bear articles we can chime in and say we had Nostradamus type insight but deep down even our gut was saying “maybe it is different this time, maybe debt is the new gold standard.” At that moment we need to have the courage to go against the grain and stick with our expertise. We live in a country of 70 percent homeowners, I’m included. But this time the homeowners, lenders, agents, and real estate complex all got it wrong. The bill is forth coming.

31 Comments:

sed said...

Thanks for your thoughts today.

Only in the last year have I spent much time assessing markets in detail, mostly due to inheriting a bit of money and needing to do something with it.

But for years, as a total dumb layman, I've been asking myself just who is buying all these 500K, 1 million, etc. homes, whether in good neighborhoods, bad neighborhoods, whatever. Who ARE they?

It really doesn't take much knowledge to know the average family is not raking in six figures, so just how is it they are handling a $5,000 a month mortgage, buying boats, furniture, paying taxes, feeding their kids, buying plasma TV's and all of that with $75K a year?

I guess I finally have my answer. These homes are all built with cards and it doesn't take much wind to blow it down. And I'll bet most of home buyers in this decade haven't saved a dime, figuratively (and literally in plenty of cases).

Now I have to listen to disingenuous pandering Democrats talk about bailing out all these fools? That better not happen, because if a recession is coming, boondoggles like that will sink us into depression, not to mention permitting these very same people to do it again on the next bubble. Empowering losers. Sadly the main strength of the Democrats. Not letting the other side off the hook either for failing to watch the lending businesses play these games, but no way a dime to anyone borrowing beyond any ability to pay.

Also amazing are the ostriches on Bloomberg today, though they did have Robert Shiller on who painted a pretty bleak picture. But they had plenty of other "capital markets" players talking about the housing market fishing for a bottom in the next few months (yeah, right), a recovery, even recommending homebuilders stocks, like I would go anywhere near Lennar or Pulte or some other public company continuing to build expansive seas of crap condos (which in 20 years, with shoddy construction to maximum shareholder profit) will start falling apart and turn into Section 8 ghosttowns.

Now that I got this out, I can have lunch....

Dr Housing Bubble said...

sed,

I can understand your frustration. Thankfully you held out long enough to see that this bubble is finally deflating. How many "lost souls" that we know personally have fallen to the siren call of homeownership? Friends and family that really don't care much about housing or finance but drawn to the allure of owing a home. The white picket fence illusion of freedom. Unfortunately I am talking with these folks that are choking on a large monthly payment. Rate bomb reset.

Take a look at this CNN Money headline:
1 million homeowners out in the cold

Not exactly Armageddon style rhetoric but getting there. And it is not the words that are used but in the context they are presented. Countless articles last year couched the housing bubble with softeners such as "but this is temporary" or "housing has historically always gone up."

Well if you can hold out for 10+ years but imagine paying $3,000 or $4,000 a month on something that is perpetually going down. An albatross around the neck.

And you've answered your own question. These people could not afford the homes. They purchased today's goods with tomorrow's earnings. Well tomorrow is today and they now need to pay up. Unfortunately not many will be able to shoulder the brunt of this and that is why we are seeing headlines like the above and politicians acting like they had the pulse on this years ago. If so, why didn't they stop it or push the hand of regulators to enforce the rule book? Just look at their top donators and you'll see the NAR up there for both parties.

Sadly it is those who least could afford it and got suckered into the game at the very end who will be badly burned. Many I would venture to say will never have the desire to purchase a home again.

Anonymous said...

For sale beautiful like new home in Palm Desert, with thee major selling points.
1) When I say like new, I really mean NEW. I nor any one else has ever lived, slept or even spent a single day in this house. Hell this house has never even had a piece of furniture in it that did not come with the kitchen.
2) Quite and peacefull neighborhood. Seriously I know, I own half the houses on this street along while another flipper owns the other half. You could quite possibly be the only person actually living on this whole block.
3) The house as is the whole neighborhood is a great investment. I should know, like most of the owners I own three of them as a pure investment.
4) Plenty of street parking (see #2).
5) You ask who wants to live in Palm Desert? You should be asking who would not want to live in Palm Desert in three years when they start build Death Valley and your priced out Palm Desert. Just wait your friends in Death Valley will envy your 110 degree summers in two years.

sed said...

I just saw the following news headline banner on Bloomberg:
"subprime foreclosures may reach 2.5 million".

Can that be a real number? How many homes/condos were sold via subprime? What percentage of the US housing stock does that represent.

That number is not including Alt A liar loan foreclosures or collateral foreclosures in better debtors that may result from job losses or whatever.

Wow, the news keeps coming faster and faster. How about Prechter's book "Conquering the Crash"?

Mike said...

nice post. i remember back in 2002, when a friend was getting ready to buy a house in encino, that i thought prices were already getting overheated. boy did i look dumb, since prices are up at least 50% since then. but it just didn't sit right w/ me. i knew what most people made and what it would take to afford a $700k mortgage, and i couldn't figure out for the life of me how so many people could afford such high house payments.

my problem was that i had a basic understanding of math, and was in a corporate finance class at the time and was learning all of the annuity formulas, and understood what happened when a teaser rate reset, whereas most of the people buying didn't. if everyone was rational like me about prices and what they could reasonably afford (and lenders were rational in regards to how much their clients could reasonably be expected to pay back) then prices around here never would have gotten to the levels they're at.

similar to what you said, i've been telling people for a while now that in the short run markets can be irrational, and that it's very difficult to tell when an irrational market will begin to behave rationally, but sooner or later it has to happen. looks like some major players (and minor players too, like individual home buyers) are starting to act rationally, so look out below.

Anonymous said...

Dr. Bubble -

So let me ask what is perhaps a dumb question.

I am a 38 year old happily married father of two ages 9 and 12. I have owned my current house for 8 years and have lots of equity. I have a good income (200k) with guarnteed residual income for the next 10 years.

My family needs to move to reduce my commute, get to an area with better schools, and have some room and a pool while our kids are still at home to enjoy it. We have 160k to put down, and a fico score of 800. We would like to keep our currnet house as a rental.

We are VERY specific about what we are looking for and where we want to move. The MLS inventory for the city we want (Chino Hills) seems sparse, and it would seem that the forclosure stuff is mounting. I have no experience in buying distressed properties. It has been suggested that the big banks who own most of the properties haven't suffered long enough to really be willing to deal...YET.

We need to be moved by the start of the school year (September). Waiting until Christmas or next spring is a possibility, but not the prefered course of action for our family.

There is so much talk about the trouble that the market is in, but what should a prospective buyer who can actually afford a house be looking for?

Thanks all for your advice!

Anonymous said...

Excellent points. The RE party fueled by seriously credit drunk novices may be over, but the head pounding hangover has yet to begin....

SoCalWatcher

Anonymous said...

Senator Dodd wants answers? I'll give him answers.

The enormous inflation in home prices between 2002 and 2005, is to blame for the housing crash. It was the price, stupid!

The fuel for the astronomical home price inflation was the easy credit. As prices got higher, Toxic loans

were invented, to compensate for the higher prices, while credit was still easy, which drove prices even higher.

In the end, easy credit and exotic loans could not justify the inflated home prices, no matter what the interest rate or loan type. In the end, it was the price, stupid.

Why does the MSM avoid like the plague, talking about the inflated prices of homes, which is the root
cause of the housing crash?

How about an extended discussion on the blogs about the actual high home prices, which triggered this crash? If the blog discussions focus on price, the MSM will eventually pick it up.

kph said...

I'm a homeowner in Houston, having bought my house in 2003. Recently, I've been reading how Houston is a safe market and should withstand this current downturn.

However, I know that in 2003, the same easy lending standards seen on the East and Wests coasts were also seen in Houston.

My feeling is that Houston will not escape unscathed. But if we decide to move, I'm hoping the principal paid on my fixed rate mortgage will cover the loss of value in my house, and that prices around the country will have fallen proportionately as well.

Anonymous said...

Now is a good time to be a renter.

Anonymous said...

Hi Folks. Here is my take. Myself and the wife, we both make 100k per year. we live in a condo we bought for 80k in 1996 and since paid off. Our condo is small but beatiful windows on the river.

We have been out shopping real estate at the shore. We see 1 floor of a house being sold for 600-700k in Ocean City NJ our favorite shore town.

We look at eachother after running the numbers. We can't afford it, we can't afford a mortgage like that. The monthly cost is too high for our liking.

then we look at eachother and say, if we can't afford it, two income earners (100k each) with no kids and no debt.....then who is buying these houses at these prices? Most people are not like us.

I think we are all in for some real pain here.

sed said...

Nice comment. Clearly you two are down to earth, thoughtful and prefer to enjoy life with reduced stress.

If most people were operating from your vantage point, the bubble itself would not exist. Clever greedy people have suckered in not-so-clever greedy people.

Just hold on a year or two, you might get that shore house at a 40% discount. You can probably afford the $300K!

BTW, Dr. BH -- Beazer Homes sinking, being investigating for fraud in the lending unit by the IRS. Stock market has been very weak/down every day this week. I'm getting very defensive for the near future. Better to miss another run up than be killed on the way down.

Anonymous said...

I think that you can definitely follow your gut and more importantly common sense in seeing that housing is going to take a dump. My parents built our house in the Bay Area back in 1987. I have seen what goes into a house and what it costs. In 2004 when prices in my neighboorhood for ugly houses that I would have never even thought about buying were going for $700k I thought it was a joke.

My wife and I were also newly married and had been thinking about buying in 2004. I had recently finish a graduate degree in finance and new something about valuating assets. Nothing in the present real estate market in the Bay Area could point me to thinking that a home was a wise decision at that point in time. Mind you that it was 2004 when prices were relatively lower than they are today.

I studied and read everything I could on real estate markets and valuation. What I have come to find it that most economists don't understand half of the stuff they talk about. Nor do most so-called experts. In reality there are only a few people out there that actually take the time and fully investigate what's taking place in the real estate market and what will take place. Like the people at UCLA and UC Berkeley's Real Estate centers and Richard Cagan, and the author of this site of course. Not only my gut tells me the market is headed for a multiple year slide downwards. But common sense and rational thinking.

k.o. said...

sed,

You read my mind with your original comment. Thats something i've been wondering myself ever since i've started to look for my own place. Just how the heck are people able to afford these things? I always thought everyone was making 5, 10, 20 times more than me, but I'm figuring out that it isn't the case.

I have enough $ saved up to get me a decent downpayment most places in the country, but not here in SoCal. Go figure, huh...

Here's to hoping things return to something sane

Anonymous said...

To the 38 year old happily married father of two ages 9 and 12:

My advice is to rent in a neighborhood that meets your requirements for the next two to four years until the market bottoms out. Then you can go buy a house at a reasonable price.

- Fred

Anonymous said...

In the last couple of years I was looking in dismay of all people around me rushing and purchasing homes in neighborhoods that they will not considered before for all the money in the world. The amounts just went up and up and I was the only one that was yelling "the king is naked" to receive a look like here is the looser barks again. Not just poor people with poor credit got into those loans, good people with good credit got loans I know for sure they will not be able to pay in a couple of years when it reset, but I was the only one with a sad face when the party was on.

My wife and I have both a credit score of over 800, good saving in the bank with no credit card debt of any kind. Now, when all this is coming and I can see in the face of my friend and couligue that rushed into the game when it was three miles over the red line and I think to myself how lucky I am to be a debt free renter. I know for sure that some will loose their houses and some who don't will have to work hard and to cut deeply in their life style just to make ends meet. One thing for sure they will not be happy to see their neigbor sells his house way below what they keep paying for, it will not matter if they can or cannot make the payment, they will not like that idea, and will not be able to sell to salvage any dime out of it. So this bering me to the conclusion that they actually rented the place from the bank as a landlord and paid twice the rent and with huge property tax and all house maintenance. No more a happy face of WE ARE A HOME OWNERS. Bullshit, you don't own anything, just a huge debt and a ruin credit. Why oh why you did not listened to your senses..

A million flies think shit is great, then they must be right!

Asseteer said...

then we look at each other and say, if we can't afford it, two income earners (100k each) with no kids and no debt.....then who is buying these houses at these prices? Most people are not like us.

You are confusing "making money" with "having money", a common problem when dealing with large assets. Of course it would take a massive income to pay a 700K mortgage, and few people have that kind of income.

But with a big enough amount of money, the owners could either buy the house outright, or make a large downpayment, or use the interest from the money to make the house payments.

So where do people amass a large amount of money? There are many sources. The stock market, for one (even in the dot com boom every transaction had a buyer and a seller). Or the sale of a previous house that went up in value. Or inheritance. These are just a few.

Also, remember that you are looking at highly desirable housing - beachfront property. You are competing against everybody else that also wants beachfront. If you don't have the assets to back up a high bid on a house, you will not get to own it. There are plenty of houses and even vacant land other places that are more than affordable on your 200k household income. But if you want to get the chance to own a desirable house, you need more than income. You need money.

Kevin said...

New delinquency data out from the WSJ.
http://tinyurl.com/ysf5ul

I have the data in an excel file if your interested.

-Kevin

Dr Housing Bubble said...

Anon 38 year old father:

It sounds like you have a definite idea of what you want; good schools, shorter commute, and a home for your family. I can understand the draw. In my opinion Chino Hills is overpriced. In terms of REOs hitting the market this is just beginning. Keep in mind that the entire REO process can take 6 to 9 months depending on many circumstances. So if anything, the earliest I would start looking would be end of Q4 or Q1 of 2008. Again, this may not work for you since you have children that will miss the start of school. So if your mind is set on moving into a specific area why not rent for one or two years in that direct area? Or you can look for lease options such as renting to own. In this way, you can lease a place for a determined amount of time and decide to purchase if the terms are in your favor. If not, you lose the above market premium on the lease but with your income this should be no problem. In two years the market can be a fiercely different place.

sed,

Great comments. I saw Beazer homes get knocked down. Finally the authorities are starting to regulate these behemoths. The market is very tenous at this moment. Two days ago there was a rumor regarding the British troops incident in Iran and Oil spiked $5 in one hour. It went back down after the rumors dispelled but again this shows how quick the market is to turn either up or down on any news.

Kph,

Texas is an entirely different market. I think many coastal folks see Texas prices as cheap but many Texans realize that land is cheap there and these prices are actually a little high. There is indicators pointing that the reason Texas has run up in the last year is because out of state investors. This may subside with the market correcting and credit becoming tighter.

Anons,

The market is turning. Hard to tell where this is going to lead. The indicators now point to a hard landing as opposed to the soft-landing many predicted. I’m still hearing that folks want to buy in the current market. Even though I would caution folks about buying in high priced areas, I will put out a post on all the free resources available to you to research a property thoroughly.

Anonymous said...

Dr HB,
I look forward to the post on the free resources on property info.

Anonymous said...

Dr HB and others:
I am looking for a little advice (similar to 38 yr old father of two). I have a 2 and 5 yr old and would like to move into a good school district and have a pool.
I have the good fortune of having been able to save some money over the last 2 years--as I resisted getting into the RE market without enough in the bank. More importantly, I was being recruited to the Phoenix area so my employer matched the salary and went one step further by offering me an eight year $100k forgivable loan ($10k/yr is forgiven for the first 6 years and $20k in each of the last two years--all of this gets added as taxable income each amount that is forgiven)---my employer is further helping supplement my income with $50k spread over the next 3 years. All of this only goes into effect if I buy in this calendar year and disappears if I don't. Given that this deal won't be made available when the home prices in SoCal are significantly lower, what areas would folks recommend? If I buy a $600k home and intend to stay put for the next 10 years, is it likely that I will still come out ahead?

Corey said...

US Census data shows housing bubble pop. Graph at http://infohype.blogspot.com

sed said...

Thanks for the link. Things are really appearing volatile now.

Anonymous said...

Dr. Housing Bubble,
You'll like this.....
A blog tracking Countrywide's REOs
Up Up Up!
http://countrywide-foreclosures.blogspot.com/index.html

Anonymous said...

Dr. Housing Bubble-
I stumbled across your blog, very good one at that i will add.
i had a question, what happens to the infrastructure of a community when these houses are foreclosed on and the taxes are not being paid?
Something I have not seen mentioned and it just came into my awareness while reading your blog, just another hidden aspect of the housing bubble burst?

sed said...

Nobody can do what Countrywide can...

Nice link. Notice that the Countrywide "countrywide" foreclosures have gone up around 40% in the last two months. However, the Countrywide REO's for California have almost DOUBLED in 60 days from 540 to 1100. Think that pace will pick up?

Dr Housing Bubble said...

anon,

Great link. I've seen that a few times and have a hard time believing how quikcly foreclosures are racking up for Countrywide.

anon,

The government is already bracing for this. The LA Times discussed this situation in their Real Estate section on Sunday. If anything, many folks that bought at peak prices can reassess their property and have their tax bill reduced thus taking more money out of state coffers. Not sure if it will make any difference this year but I definitely see a larger impact in 2008 with negative yoy values and less tax reciepts.

sed,

It'll keep growing. We've only just begun. I'll be posting an article of the stages of this bubble mania.

Anonymous said...

Father of two,

I am renting an ideal house (10 minute commute, top school district, new, granite, marble, SS, etc, etc.).

The annual cost of renting this house is 3% of the asking price.

Checkout patrick.net for why this is a terrible time to buy: http://patrick.net/housing/crash.html

good luck,

Anonymous said...

Father of two,

If patrick.net didn't convince you, please make sure to read this before starting your home search:
http://libubble.atspace.com/sheeplesguide.html

good luck,

Anonymous said...

The previous poster posted a link to the sheeples guide, however, that link is now dead. The new link is here.

Anonymous said...

How screwed we are how screwed we are. Everybody knows how screwed we are