March 23, 2007

The Plague of Housing: Why we Will Feel and Be Poorer Because of the Housing Bust.

“You may require payment from a foreigner, but you must cancel any debt your brother owes you.”

Deuteronomy 15:3

Well it appears that Senator Dodd is taking a page right out of the bible. With the recent congressional hearings there is sudden talk about a bailout for many homeowners who over extended themselves. Every financial institution, news outlet, and citizen is wondering how bad will this housing bubble pop. Keep in mind that only a year ago there was serious doubt that a housing bubble even existed. Any housing bear was seen as wearing a tin-foil hat and running around proclaiming concentric circles appeared in the corn fields last night. But now that we are on the verge of having $1 trillion in mortgages reset this year, the only question that remains is how bad is this going to get? Are locusts clouds going to infest the 405 and 10 freeways? This biblical fire and brimstone talk is fun!

One Trillion is A Lot of Bling-Bling

Keep in mind that the subprime market used to represent a very small portion of the market until the last three years. We always hear pundits talking about “well subprime mortgages ALWAYS existed and housing was always fine.” Well yes, but that was before everyone on Wall Street went nutty for Collateralized Debt Obligations. In 2005 and 2006 $1.2 trillion in subprime mortgages were originated, over 21% of the entire mortgage market. Here is a rough breakdown of the share subprime used to comprise of the entire mortgage market:

1994-1998 – Approximately 2 to 4 percent of the total mortgage market
1998 – 2003 – Approximately 5 to 7 percent
2004 – Approximately 13%
2005 and 2006 – Approximately 21%
*source Inside Mortgage Finance

And what 21% means for two years is $1.2 trillion in risky mortgage debt. Now do you understand why the bloodbath has occurred in the subprime market? Not only that, but keep in mind that we have about 21 months where $20 to $30 billion of these notes will be resetting. We’ve just set this train on its tracks and no one is going to get in its way. So what options are available? Refinancing is out of the question because most of these folks couldn’t afford the place with conventional financing. Selling may not work either because many of these people have zero to negative equity and would need to short-sell the house. Holding out? How long can this last when many of these payments will reset and increase payments by 40 to 60 percent. Homeowners will get to choose their poison. Wall Street is like a cougar waiting to bounce on any sign of good news regarding housing because they have so much skin in the game; the Fed kept rates steady therefore Wall Street cheered. Today housing sales modestly went up (although median fell for another consecutive month) and the market cheered. Now looking at the above data, do you think a 3% jump in sales is going to stop this debacle?

More Bills Equals Less Discretionary Income

Now I know what you are saying, “Dr. Housing Bubble, you are such a neg-head permabear. Why are you trying to make me sad?” Yes, I’m the life of any party. Can you imagine spoiling the fun at a cocktail party talking about CDOs and massive resets with folks that made a mint flipping? No worries, I’m happy to collect my funds from shorting the herd and investing against the grain. Bulls make money, bears make money, and pigs get slaughtered.

But let us run a quick hypothetical. From the above analysis we know that many of these folks will try to pony up and make the new higher payments. So if John and Mary Debthead currently have a payment of $1,500 and there payment goes up to $2,000, where does that $500 go in the economy? Instead of John and Mary buying another disposable DVD player they are now facing a squeeze on their discretionary income. This is known as the reverse wealth effect. If you have a fixed payment such as housing eating up a larger portion of your monthly bill you must forgo something.

Now this leads us to the much touted fact that 70% of our economy depends on consumer spending. And considering that our savings rate is negative we do a damn good job spending every penny we got. So even a slight jump of $500 a month on a housing payment, the ramifications millions of times over is large. And we know many folks are facing resets of $1,000 to $2,000 a month.

A simplified equation can look like:

Rates reset = More Money to Home = Less Money on Consumer Goods = Contraction in the Economy

I loved it when Professors would explain stuff like this. It makes such perfect sense and all us in the bear camp saw this subprime “surprise” way in the past.

Bend it Like the Foreigners

Even though my above equation isn’t exactly E=mc squared there is a lot of truth in it. And there is another equation that we will be hearing a lot about:

We buy foreign goods = they buy our bonds = We get goods while they build a trade surplus

Simple right? So how does this look in our society? Just go to Wal-Mart and marvel at the amazing stuff we spend our discretionary money on. Now imagine what will happen to all this stuff when payments jump. You can’t buy something with money you don’t have. And considering the average American has close to $9,000 in credit card debt many are already financially strapped. Remember the market “crash” we had a few weeks ago? Why did this happen? Well one of the main reasons was talk of credit tightening. We’ve gotten to the point in the game were the only way to keep this going is by making money more abundant. But this creates inflation and ties the Feds hands because in order to keep housing going they need to drop rates. But the CPI and PPI, which are horrible indicators anyways, are still showing signs of inflation. Well of course it is! That is exactly what happens when you print too much money. And now we have a mortgage time bomb that will go off at a calculating pace while we head into a recession. Mark these words, there is nothing that will keep us from a recession. The plague is set in stone and the bush is burning, read these things for what they are.


Make Mine A Bubble said...

OMG...I had something happen in front of me yesterday that perfectly illustrates your point!

I was in line at Target (buying diapers and whatnot for the baby) and there was a 20-something lady in front of me buying a toaster oven and some kitchen towels/utensils as a wedding shower gift.

Her card bounced - declined.

So she asked the sales lady to take away the dish towels and try again.

Her card bounced - declined.

So she asked the sales lady to take away the utensils.

Her card bounced - declined.

So she pulled out $20 and asked her to apply the cash to the toaster oven and try the card again.

Happily, it finally went through on the remaining balance for the toaster.

I couldn't believe it. I was so embarassed for her, but she seemed really nonchalant about the whole thing.

Man, I feel sorry for people getting married or having babies the next few years. They're going to get SHAFTED in the gift department. :-)


Dr Housing Bubble said...


Really good example. You can always offer to pay one mortgage coupon - that is a FANTASTIC wedding present.

Another example you now see is drive through windows with credit card machines. Countless studies show that people spend more when they use credit cards over cash. Out of sight out of mind; basic principles of psychology.

Not only that, think of Vegas and using chips instead of cold hard green cash. Easier to lose a circular black piece of plastic than $500.

Now apply this reasoning to the subprime market and we have attractive rates for 1 year; but multiple years of reality. Instant gratification.

Instead of the toaster they should of given her a piggy bank at Target.

sed said...

Or using credit cards to pay for groceries. I see that more and more at the supermarket. How long can one do that?

And you mention Vegas...I've read that many new slot machines have a card slot for the Visa or your debit card. Heck, since you're about to be delinguent on the third reset payment, why not go for broke? (pun intended).

Oh, and the pet food recall, evidently rat poison applied to wheat imported from China (used to make the "gravy"). We can't even make dog food anymore and who's watching what they spray on food over there?

Last note for the day, Dr. BH, got any opinions on when recession might sneak in. Everybody is bullish again on the market, back to the "pre-China sell off" levels. I even heard talk on Bloomberg today that the subprime problem is a "blip" and "is contained".

bubble_watcher said...

And what 21% means for two years is $1.2 trillion in risky mortgage debt. Now do you understand why the bloodbath has occurred in the subprime market?

This is in no way limited to subprime. Alt-A 'stated income' is another ticking time bomb that is waiting to go off, and once that one explodes, a recession will be well underway with Prime loans being next on the list.



bubble_watcher said...

And speaking of short sales (or put options)..

I think that a low risk entry point may be upon us for a short position on Accredited Home Lenders (AHM).


bubble_watcher said...

Freudian slip..

I ment to say American Home Mortgage Investment Corp.

Anonymous said...

I'll defined the current market.

Listed at 1.496 in SM for 2/2.5 townhouse for $1.495. Sold for $1.395 in Jan 07 since I bought in 1/2000 @625K. Have no complaints. Wish all well. Renting at waiting. The end is near.

Lander said...

Are locusts clouds going to infest the 405 and 10 freeways?

How about clouds of West Nile-bearing mosquitoes?

AnalysisGuy said...

No question we're feeling poorer and it will lead to slower spending. My question to the group is when it turn into a recession / depression. Q1:2008 or even later.

By the way I shot up the San Luis Obipso year end report

Dr Housing Bubble said...


Yes, Alt-A is the next game in town. We'll digest sub-prime for a few more months since it only imploded a few weeks ago. Next we'll get a taste of Alt-A. In my view many Alt-A buyers are wannabe real estate moguls. Late night infomercial buyers ready to speculate on property. A subprime buyer can only afford one place for the most part, these Alt-A folks have a semblance of good credit so they over extended themselves (i.e., Casey Serin). And for that, they may be able to take a few months more of resets and declines.


You got out at the peak. Excellent. Kudos to you. Not sure how easy it'll be to predict the bottom but it'll probably be easier because we have data showing the rate of resets. With appreciation, it was essentially pie in the sky. It was good until it wasn't. Now we have a set timeframe of 2 to 3 years where rates are going to reset in a timely fashion.


West-Nile? Well we do live in the west-side so I wouldn't be surprised. These mosquitoes are living in style in $500,000 600 square foot boxes.

Marty said...

The other shoe is the "carry trade" brought about by borrowing extremely plentiful and cheap yen, turn around and buy CDOs. With a rising Japanese rate and declining value of the USD, the money is going elsewhere, maybe even home.

Anonymous said...

Today's new home sales report: Demand down 1/2 million. Contractor bankruptcies loom. More at

Steve the Dog said...

I think a better phrasing of "Keep in mind that only a year ago there was serious doubt that a housing bubble even existed." would be:

Keep in mind that a near limitless supply of real estate professionals (pun intended)could be found in front of any available TV camera that there was, in fact, no bubble, and that anyone even repotely suggesting that there was would clearly be priced out of the market forever, because now is a perfect time to buy."

Steve the Dog.


Dr Housing Bubble said...


Only so much foreign debt that can support the US. Same thing happened in the previous real estate boom. I remember Japanese executives buying up high priced homes here in SoCal. We all know how that ended up.

Steve the Dog,

I agree. Not only that, just take a look at the DRE agent and broker stats. As of 2/2007 we have:

526,308 Real estate and broker licenses in California.

This is an increase of 100,000 in two years. No bubble here either considering we have 36,000,000 people in the state. 1 agent for every 68 people including children under 16. Hey, maybe we can market homes to kids on Nickelodeon? I think I found the new sub-prime market.

Dr. Housing Bubble

kph said...

Mortgages falling behind are an undeniable force, but easy credit affects everybody in the economy. There are many renters that are drowning in credit card debt as well. They too will have to deal with rising rates and tightening standards.

Man, things are gonna get rough.

Maxim said...

I totally agree with you, Dr. Housing Bubble.
And, I hate what this mess is doing to the American middle class. But, I'm missing something here. Can you please, explain ? You wrote:

""Rates reset = More Money to Home = Less Money on Consumer Goods = Contraction in the Economy""

More money paid to the banks means banks and people working for the financial institutes will get more income. Welthiest become even more welthier. So these people, this tiny layer of the society, will spend more money. Is it going to help to keep the American consumption on the right level ?


Anonymous said...

Another good example of where we are heading can also be shown by Target. If you look closesly at you shopping cart the next time you are at Target take a look at the inside of the front of the cart. Not always, but many times you will see a littl ad that says "Charge it, the easy way to pay."

Now if that doesn't slap you in the face I don't know what would.

Dr Housing Bubble said...


You've got it right. For example, say your payment jumps from $1,500 to $2,000. In essence that is $500 a month you cannot spend. And look at the average net worth of the middle class; they essentially spend everything they got and save very little. Most of their wealth is tied up in their home equity. Now imagine that equity dropping or going away completely for many of the sub-prime buyers? This pain multiplies out because of the wealth effect.

In addition, there are many studies showing that the wealthiest of our population do not spend. Ever read the Millionaire Next Door? These folks get rich because they don't spend! This is the bulk of millionaires in our country. Of course we always have the 2 percent that needn't worry about money but they won't sustain the economy.

And more money to banks will do little good when they are combating REOs and trying to unload these properties in a decline market. If anything, it will buffer them against further losses but what will buffer the middle class?


I've seen that. Not only at Target but also at Ralphs and Albertsons. If you lack the cash swipe the plastic. I'm surprised they haven't incorporated instant HELOC at the checkout line.

Anonymous said...

New consumer confidence numbers may point to housing-led recession:

Anonymous said...

I use a credit card but pay off the balance at the end of the month. So not all run up balances. Great way to earn miles and free airfare to Hawaii.

Anonymous said...

Hey "Dr Bubble"

You stupid, likely under 40 jerk. People losing their homes may create "biblical" in your pea-brain, but the "fun" you're having is nothing compared to the real "fun" if someone in your family lost their home - or even better, if someone you loved contracted some terminal disease, like cancer. Now THAT would be fun, you jerk.

Dr Housing Bubble said...


Really great comparison between losing your home and wishing cancer in my family. I've had family members pass away from cancer and a cousin who lost his home through foreclosure so I'm familiar with both sides of the story. And trust me, both are not remotely close.

And being under 40 is true, no denial there. Never have I wished someone losing their home and not once have I wished a terminal illness on anyone. You need to look at yourself in the mirror and reconcile the two; even though I'm under 40 I'm old enough to realize that there is something different between being over leveraged and losing your home and losing a family member to a devastating cancer. In one you have control about being financially imprudent and that is a choice you consciously make. On the other hand folks who I've known to have cancer have never chosen that path. I find it interesting how you reconcile the two but wish you the best.

Steven said...

Just wondering why that extra $500 per month that Ken and Mary have to pay on their mortgage after it is reset won't be spent by Bill and Ted, who own the CDO?

Dr Housing Bubble said...


Great question. Unfortunately many people will not be able to make the higher payment. So it isn't a direct transfer to the entity holding the CDO. They may be able to make a few payments and push off default for a few months but then, as many studies are showing, most folks will simply stop paying.

Now, you have a cash strapped consumer who has ruined credit thus stunting further spending and an investor who is now holding the note to a $500,000 property that is worth $450,000. That is an overall net loss for both parties.

Anonymous said...

I use a credit card but pay off the balance at the end of the month.

And you, my friend, are what the credit card companies refer to as a "deadbeat". Ironic, but true, as you're NOT paying them profitable finance charges and late fees, etc. They earn almost nothing from responsible borrowers like you, and want to seek out the irresponsible borrowers.

Here's a good article explaining how the subprime debacle isn't confined to mortgages, but is rampant and widespread. The underlying problem will take it's toll on many other industries (in this case, Harley Davidson Financing).

The collapsing mortgage companies are just the early salvo in the problem of a massive credit bubble: we're living in a "subprime economy", with consumers leveraged to their teeth (remember that commercial with the guy living in a nice house riding his lawn mower, smiling while saying, "I'm in debt up to my eyeballs"?).

With the deregulation of predatory loan practices in the 1990's, the 800 lb gorilla is coming home to roost. You ain't seen nuttin' yet, as the ARM loans are coming due for resetting, and dwindling equity was the illusion of wealth that led lemmings over the cliff.

Dr Housing Bubble said...


I think you make a good point with the illusion of wealth. Debt is an excellent provider of this illusion. It creates the mirage that everything you own today is really yours; well stop making one payment and find out how much you really own.

If anything, the upcoming credit crunch will force many in the public to realign their balance sheets with reality. Living in perpetual wealth may seem fun when times are good but when things start unraveling that is when we see who really had a house built on a facade.