June 07, 2007

No Free Ride! Housing 2007 Recap. 3 Highlights: Subprime Implosion, Record Inventory, and Zero Appreciation.

The best things in life are free. Free hugs from family members. Taking a brisk jog on the coast. And being able to purchase a home for free? Well with zero down, all you need is a pulse and a valid Social Security number (sometimes not even that) and you are set to go. You’ve been given the green light for $500,000. No need to verify your income. If you tell Mike the broker that you make $100,000 a year you obviously make $150,000; come on, what’s $50,000 between amigos? As we approach mid-year, no longer are we hearing the incessantly Pollyanna housing bulls talking about 2007 being a rebound year. How can you rebound when the impact site hasn’t even been reached? Imagine a basketball rebounding half-way through a dribble and align this to the rhetoric housing pundits are pushing. The trajectory is already set and there is no stopping this silver gargantuan of a train from stopping.

In 2007 we’ve already seen major turning points in the housing market. Today I’ll discuss three major turning points. The first, is the implosion of the subprime market. When you have folks considered by the government to be in poverty buying $700,000 homes, we got some explaining to do. The next issue is record inventory and foreclosures. When you build crazy amounts of homes in a declining market what do you think will happen? Hint, 100 – 40 = a lot of extra homes not selling. And finally people realize that housing cannot appreciate 20% forever. In fact, housing can even decline! Trees do have a finite limit of growth. The eerie silence we are hearing is the pent up hope by housing pundits gearing up for the summer bounce which has occurred each summer since 2000. Anyone think that housing economist have a treatise on summer growth on their Vista desktop ready for dispatch once we have a minor increase in selling?

Subprime Quick and Dirty Exit

What happened to all the talk about the subprime implosion? I mean we are talking about $1 trillion in loan resets for 2007. During the first quarter of 2007 we saw absolute devastation in subprime lenders. Let us take a look at a chart below:

Even though subprime companies such as New Century Financial and Quick Loan Funding are pretty much down and out, they have set in motion a domino effect of housing implosion. Many subprime loans have 1 or 2 year teaser rates. We haven’t seen the full impact of this because even in 2006, sellers were able to unload homes once rates reset in a stagnant market. Many people were simply breaking even. Yet now that housing is declining and rates are churning up, what will happen? Well for one, those holding the bill cannot cover the payment and need to unload. Even though we hear many folks rattle off stats regarding record low interest rates, subprime borrowers pay much more above prime because they are subprime! It is the definition of the loan. Why would you give someone tagged as a risk a prime loan? The only way to cover potential losses is hike up the interest rate and charge front-end crazy points and fees.

The mortgage industry made a mint not only from first time buyers but serial refinancers. People saw their home more like a virtual ATM begging for withdrawals and not like a savings account. Lenders weren’t going to tell people that maybe it would be smart and prudent to save for a rainy day at the chance of losing a massive commission. Do you think this isn’t the case? Take a look at the savings rate:

In addition, the subprime loan was a necessary evil for the continued growth of a bubble already reaching the stratosphere. What closed the door on subprime lending? Wall Street essentially lost the appetite for these loans and suddenly started kicking loans back to lenders for violating minimum payment contingencies. Are you kidding? We have the story of the 102 year old man getting a 25 year mortgage. Yeah, I think Wall Street had enough at this buffet.

Record Inventory and Foreclosures

California is now experiencing record jumps in notice of defaults. Foreclosures are now becoming REOs like our previous Real Homes of Genius. Even in 2006, we weren’t seeing many REOs because most lenders were able to unload homes at moderate discounts before going REO. Not anymore. Plus, we still had the flittering flames of subprime keeping the market going last year. The party kept going even after the lights went out. But inventories are going up at a record pace. Pending sales are dropping like its hot. More homes + less sales = too much homes and record inventory. I’m surprised when I hear housing cheerleaders mention that rising inventories are a symptom of demand not realized. The underlying assumption here of course is that the public will get the memo and join the housing revolution and appreciation will start up again. Yet the game is imploding not because of this, but for the primary reason that you cannot build sustained growth on absurd and irresponsible debt. Have we forgotten our lessons with debtor’s prison? How can we blame individuals when our direct government is spending like Paris Hilton at Saks?

Record inventory and foreclosures may be the straw that breaks the proverbial camel’s back. In addition we have alternative media outlets. It is amazing that you have the power to find nearly any information on any topic instantaneously. You can read anything you want to read. Think the bubble talk is for folks with tinfoil hats? Simply read the NAR and CAR websites on a daily basis and you’ll be in propaganda heaven. Or you can go to simple blogs like the one here with citizens concerned about the massive credit bubble we are living in. It is hard to reconcile disciplined financial education with what is going on. I’m sure many folks feel the same way. But the majority of the public does not care about the housing bubble. Somehow those interested in being spectators have some vested interest either via investing, purchasing, schadenfreude, or career. After all, California has 500,000+ agents and many more working in lending, construction, and ancillary industries that rely heavily in the housing market. Q1 notice of defaults, that is letters sent to buyers before entering the foreclosure process, jumped an amazing 148% from last year. Q2 results are coming soon and I’m sure many are biting their nails anticipating the results.

Zero Appreciation (aka Bad Investment)

Would you invest in a home if I told you:

  • It would not appreciate for 3 to 5 years
  • You would pay anywhere from 50% to 80% more than an equivalent rental
  • Had a high likelihood of depreciation in the immediate future

If you answered yes then you are the few, the proud, the last people to arrive at the party. No longer is housing going to see double-digit appreciation. No longer will you be able to use your home as the stepsister of WaMu. The well has run dry. I’ve even heard the new party line of many realtors. “Well, if you aren’t planning on selling in 10 years, then you’ll break even.” Say what!? Why not save for 2 to 3 years, buy a distressed property for 20 to 30 percent off, and have the sanctity that your largest asset isn’t tumbling like the Berlin Wall? It is almost like they acknowledge a decrease in price as a minor blip on the radar and appreciation like the best thing next to sliced bread. Housing is done for the near future. I’ve discussed the archaic and skewed stats of the median before. In fact, we may actually see prices move up because:

A: Higher priced homes are still moving

B: Lower priced homes that aren’t selling do not factor into the equation

C: Sellers are still in Wonderland holding out thus increasing inventory

D: Buyers are finally realizing $500,000 for 500 square feet isn’t a good deal

So what you have is a smaller sample size with top heavy assets moving. However I must point out that foreclosures and REOs will equalize this game quickly because they are not in the game of being landlords. They will sell and sell fast.

And as a final caveat, no investor out there has a crystal ball for the future. If that were the case, everyone would have bought in 2000 and sold at peak prices in 2005 and 2006. Wouldn’t we all like a time machine to jump on Intel or Microsoft right? Hindsight is always 20/20. However, there is one universal human certainty; everyone goes into investing to win. Just like every marriage that is consummated it is intended to go the distance. People don’t marry with the intent of divorce but it happens and it happens a lot. This is also the case with investing; you invest to turn a profit. Not everyone does. We have bull and bear markets. However there is a difference between investing and gambling. And not all people that bought in the last few years even care about housing prices; many have enough money that home prices can crater and they wouldn’t sell. The issue arises when massive economic disconnects occur in the system and the underlying asset is no longer reflecting a true return on investment. What are your thoughts for the remainder of 2007?

Subscribe to Dr. Housing Bubble’s Blog to get more housing content and your full dose of Real Homes of Genius.


socalwatcher said...

The ones that are going to get bit hard also are the ones who have to move for job or whatever reason and would never lower themselves to renting to wait out the storm for a year or two...

Anonymous said...

great post. presumably this delayed effect, price drops starting lower on the feeding chain then moving upwards, explains persistent hot spots in higher-end areas like west la and santa monica. i have friends looking in studio city as well who tell me houses are still going for above asking price, multiple offers. when these areas start to stall and drop might be the next benchmark to watch for.

Make Mine A Bubble said...

The hubby and I let a local realtor show us around to some homes in our neighborhood this past weekend. Three things happened that TOTALLY prove your point (and then some)...

First, she showed us EIGHT HOMES in ONE NEIGHBORHOOD and they were ALL VACANT. Not only does it allude to nothing moving and everything going bust, but it sorta creeped me out. Would YOU want to live in a neighborhood where every third house is vacant? And this is 3 miles from the beach, mind you...

Secondly, most homes we looked at were listed around $620-640k and my hubby asked, "Well, what if we were to offer, say, $400k." At that, a look of sheer panic crossed her face for a blip, then the Realtor mask returned and she scoffed, "Ha! If you were buying, like, 6 years ago, maybe..." We all had a grand chuckle. (I didn't have the heart to tell here we WILL be buying at a six-year discount within the next couple years).

Thirdly, I asked her about the future of the market and where prices were headed...and she actually said (with a straight face), "Well, if you hold this house for at least five years then the worst that happens is you break even with flat appreciation."

Say WHAT? Come now, Realtor. Is that really the WORST that can happen? Within THIS next 5 years?

Oh man, there is still a lot of serious kool-aid drinkin' going on in Realtorville. That, or she's just trying to slip it into my cocktail. Hmmm...


plysat said...

@2:52 PM... Yeah, the "nice" parts of LA (I'm near the grove) seem to be humming along. Sales are down, but prices are still insane. I keep trolling the blogs hoping for insider info that it's starting to crack... Anyway... a friend got a flyer from an agent (CB Sunset Strip) Maybe it's starting... here's the text:

Recent peaks in Westside real estate have occurred in 1973, 1979, 1989 and 2006. These peaks in the past have occurred one or two years prior to the start of a recession.

At the present time Westside values are holding compared to other areas of Los Angeles, but caution is in the air as defaults increase.

If you have considered selling to preserve your present equity, now may be the best time before we enter this new 5 to 10 year down cycle.

For a no obligation evaluation of your property.

CALL TODAY (realtor name)

derek said...

Dr. Housing Bubble,

Thank you very much for creating this blog. I am 25 and have some school debt. I have a good job and rent my 1/1 cheese box in Orlando for $850 a month. My landlord tried to flip the place and is now stuck with a $1,100 mortgage, plus taxes, HOA, and insurance. I am really depressed about what's going on in this country. I am trying to work hard and save. I can't believe what's going on. I bought this book called "Irrational Exhuberance" by Robert Schiller. It's awsome. How can so many people be so stupid? What will the average Joe like us do when the walls come tumbling down?


Anonymous said...

Dr. HB I want to sincerely thank you for doing what you do. I have been following your blog (which I have to say is the best I have found so far) for a few months but this is my first post. If it weren’t for this blog and all the information I learn every time I come here (daily) I think I would have made the biggest mistake of my life. I would have bought my very first home and be upside down.

I just wanted to share some information with the group. I went through the REO inventory that Countrywide has on the web last night and believe me it is a long list, my browser froze a few times before I could get the whole damn thing to load! Today I drove buy one of the properties that caught my eye…on paper…because when I saw it in person I laughed. The house sold for 408K on 2/13/2007. The Zestimate is $505144. It is a 3bd/3bath 1800 sq ft on 11000 sq ft. Countrywide has it for 428K. I was stunned. It needs a new roof, doors, windows, front and back landscaping, garage doors, and paint among other things. I didn’t get to see the inside but I imagine it needs just about everything. Even if they did accept the 300K offer I MIGHT make, I just don’t want to deal with the stress of having to fix so many things.

I suspect things will get worst. The above REO property is proof of that. I know things have really gotten bad where we were planning to buy back in December (Off 15 between 60 and 91). The two new homes we were interested in were $545K and $600K …I went back last week just out of curiosity and they were letting them go for $460 and $545K respectively. That is a 85K or 16% and 65K or 9% price reduction! Sitting inventory special they told me. My jaw dropped. That motivated me to wait a little longer since they are both in early phases and I suspect things will get worst before they get better. Both homes are 4 bed, 3 bath, 3 car garage, and about 2800 sq ft. Do you think that these properties will continue dropping in price?

My wife and I currently rent a 2bd/1bath 1000 sq ft in the IE for $775 on a month to month basis. We are both 25 and are completely debt free…yes it feels good to say that. For the past few months we have eliminated both our car notes and all the CC debt. We have no kids and are 6K+ positive cash flow each month and are just saving like crazy. We are both pretty frugal so we don’t really suffer much. We have lived here 3 yrs and have seen our rent increase only $50. My wife is really tired of living here (she is tired of not having certain amenities) and wants us to either rent a house or a nicer apt both of which are going to be at least $1500. That is not the problem, the problem is that if we do find a nicer place we would have to commit to a lease.

Would it be wise for me to sit tight here and patiently be on the lookout for a good deal and not have to worry about the hassles of breaking a lease or is it worth it for us to move since it will take 1yr plus to really find such a “deal”? Any advice from anyone would be greatly appreciated.

Derek I completely feel your pain.

Anonymous said...

Prices and sales have gone down even further than reported because cancelled sales are inluded as actual sales--take those away, which were cancelled because buyers realized they would lose money--and you'd see a bigger decline.

Kevin said...

Anon 9:05,

I'm in the same situation over her in Baltimore Maryland. I'm 27 and my soon to be wife is 24. We are both debt free and we save 75% of our income. We live in a standard 2/1 apt for $1050/mth, but the fiance is starting to get the nesting instinct like crazy. I would never buy a house in this market, but if I left the decision up to my fiance, we'd be moving in next weekend if you know what I mean. We are thinking about moving so we can have enough room for all our wedding "stuff". Were east coast here so people still buy fine china and silver, etc.. for your wedding. We need more room for that stuff and the woman want a "cute doggie" so we need to move. I'm compromising some by moving so I can hold off the nesting for 2 more years, but I realize I'll need an escape plan. So I'm specifically looking for a one year lease that will be month to month after the lease runs out. Some places force you to keep signing new leases. Also be careful about renting from an FB as they may go into foreclosure.

Good luck

socalwatcher said...

Make Mine A Bubble:

Don't forget, the Agent makes their comission from the selling price.

They all know that this is the last chance for peak prices. ;)

Jakob said...

I really appreciate this blog. I'm 28 years old, my wife is 26. We have two beautiful children ages 2 and 6 months. I graduated a few years ago in Electrical Engineering and make pretty dang good money. We are debt free, live frugal, and save like crazy.
Since graduating we have lived in Boise and now Utah. Both states which have been at the top of the appreciation list for a few years now. Although I could afford a house in these areas, I feel it is morally unethical to participate in this market. However, I'm sure you can imagine the pressure of having a family and not owning a home.
The previous generation has really taken advantage of us. I know we all hope that things will return to the fundamentals and those of us who have played by the rules will be left standing confident and victorious at the end of the day. But it feels like there is so little we can do. The rest of the country will seemingly stop at nothing to continue this charade. Heaven forbid the baby boomers be expected to live within their means.
I fear that generation X will be left holding the bill at the end of the day (if we aren't already). Isn't there more we can do? I have written letters to our Congressmen and Senators about this subject. Any other suggestions?

Anonymous said...

A little Bob Marley makeover for your Friday...

No mortgage, no cry;
No mortgage, no cry.

Said - said - said: I remember when we used to sit
In the backyard, our McMansion,
Eatin’ caviar, granite countertops
As our appreciation kept up expansion.
Good rates we had, but, good rates we've lost
Through loan resets.
In this great future, I think I lost the bet;
They just took my Hummer, a-way.

No mortage, no cry;
No mortgage, no cry.
'Ere, little darlin', send back those keys;
No mortgage, no cry.

Have a great weekend!!!


Make Mine A Bubble said...

That last post wasn't annoymous...it was me!

:-) - MMAB

Dr Housing Bubble said...


Or what about people in the housing industry? It’ll be a double whammy. For one, there are massive job cut backs and many people in this industry bought as well. If you are promoting this product it would be very hard not to believe your own line after sometime. Now you have a depreciating asset and a dropping market. I hope these folks planned prudently and have a contingency plan setup.

@anon 2:52,

I agree. If we start seeing measured drops in the higher end markets like Santa Moncia and Laguna Niguel, we’ll know the canary is gone. However I wouldn’t hold my breath on these locals. Southern California has many wealthy people that don’t sweat these prices and will simply buy in high priced areas regardless of market conditions.


Maybe you can buy all 8 vacant homes and flip them? Imagine you and your husband owning a piece of the American dream by owning a street! Again, we are at the summer stalemate and many sellers feel this is redemption time. However they are now competing with the most motivated sellers of all, REOs.


I’ve been getting recruiting mail from brokers and agents. Last year, I would simply get a small postcard flyer. Now, I’m getting elaborate packages with personalized messages and very nice stationary. Interesting how quick the marketing tactics change.


Glad you enjoy the blog and I can understand your pain. My reasons for investing out of state are based on the struggle for young professionals to purchase starter homes. Don’t let realtors make you believe that a starter home is a modified Doritos bag. Keep doing what you are doing in Orlando. Florida is leading the way in terms of market declines. Again, I don’t see a buyers market until summer of 2008 or 2009. If you must own for the sense of owning do not do it in over priced coastal regions. Not yet at least. Timing is everything and you’re reading a great book. I would also recommend Manias, Panics and Crashes.

@anon 9:05,

Thanks for your thoughtful post. Keep in mind that the REO game is just beginning. The foreclosure process is a very long and lengthy process. The Inland Empire is ridiculously overpriced. One, the income base is not there to support current prices. Two, these markets benefited from the halo effect of the LA, OC, and SD county markets. Yet this game is done. Arizona builders are now raffling houses off to increase interest. The market hit a brick wall.

From what you are saying it sounds like you need to move and your wife is unhappy with the current place. $6,000 a month is a lot of cash to be saving. I can’t tell you what to do but if I had to make a bet, which I am, I would not buy right now especially in the IE. A lease might not be the worst thing since it may lock you up for another year. The market is not going to go up. Regardless of all the propaganda the market is done for 2007. Next year will be a better buying season. The REO market is going to boom like that last real estate crash in the early 90s. You’ll have much more negotiating power and a larger down-payment. This will also give you power in getting better terms on your mortgage. Brokers will cry wolf and say rates are going up. Who cares. PRICE is what matters, not rates. Would you rather have a $300,000 home at 8% or the same place at $400,000 for 6%? Run the numbers on a 30-yr FRM calculator and you’ll see that massive difference.

Good luck.

Kevin and Jakob,

I’m seeing a pattern and this is exactly what I talk about in this post. First, thanks for reading and posting. So we have people from Orlando Florida, Baltimore Maryland, and Utah posting the same story. Young middle-class professionals struggling to purchase a starter home. We don’t need to go over the Southern California market because you can take a look at some of the homes on this blog and think you are losing your mind. This will not last. Economics and market psychology will collapse this market just like previous asset bubbles. Again, this bubble is isolated to metro areas and predominantly in coastal regions. Many parts of this country are within appropriate housing prices. Yet reality is relative isn’t it? If you drive a BMW in a neighborhood of Ferraris, eventually you’ll feel less than simply by your neighbors.

Why are so many middle-class people feeling the squeeze? You make more than your parents. Supposedly you did everything right but somehow the American dream seems elusive. Well there are two primary reasons for this; one is the devaluation of the dollar and inflation. The dollar has dropped nearly 40% in the last decade. Inflation, aside from cooked BLS data and the hilarious CPI, tell us we have very little or moderate inflation. Oh really? What about food prices? Gas? And the small thing that eats up most of your income, housing. Since the BLS uses owners equivalent rent as their measure, of course housing hasn’t gone up that fast. Again this shows the disparity occurring in the market place. Basic monetary theory will show you that the more money you print, the less it is worth. Simple supply and demand. Well this administration has been spending like crazy and giving tax cuts! Apparently money grows on trees, or the vines of Visa and Mastercard championed by the Fed. Welcome to 2007. Where you make more but you are being paid in Monopoly funds.

That is great you are contacting your Congress person. Let them know how absurd this is. In addition, be prudent in your investing and prepare yourself for the coming housing “adjustment” – it seems crash is too harsh of a word although look for 25 to 30 percent discounts. Keep on learning and contributing to the debate.

Anonymous said...

Hi there,

I have been watching OC real estate since March this year and have noticed priced softening in Laguna Niguel, especially in the 750 to 1 mil price range. Above that, they seem to be relisting at the same price or 10k less and the mls shows it as a new listing. Things are sitting for months.

latesummer2008 said...

Doctor Housing Bubble,
First of all, thank you for linking my website, WestsideREmeltdown on your site. You have a realistic view of the RE market and where it is headed. So many are still in denial, even as the facts become more evident.
I have noticed that Condos, are taking decent hits all over the Westside. And, just recently, Some BIG hits have occurred in the sacred "North of Wilshire" area of Santa Monica. I live in Santa Monica and believe it is getting ready for a good-sized decline, this summer. These Higher End areas are not immune. Perhaps more affluent areas can hold on longer, but, once the declining market becomes front page news, many of these people wil rush to the exits.
In my opinion, price declines are going to happen faster than most people think. Because of the rapid appreciation, the down side may be fast and furious, due to quickly, deteriorating market fundamentals.
Hence the name "Latesummer2008" I believe over the next 15 months we will see serious undercutting of prices due to bloated inventory, foreclosures, REOs etc...etc...etc.. Some of the worst pain will be felt by, the end of next summer, and then we will drag along the bottom for years...

bear cave said...

@ all the young middle class people saving:

Why do you hate America? It's communists like you that have bankers losing sleep over paying out those 5% rates on their deposit products. Quit saving and start ramping up those credit card purchases on depreciating assets or the terrorists win.

Seriously, Dr. Hobub has put it right. It comes down to two things: perspective and inflation. The first is easy. Most "professionals" work under and for people who make much, much more money. Earning 60/year with 2-3 years experience makes you better off than the average family, but to do it you have to work for people raking in hundreds of thousands a year and oftentimes are in the over-moneyed urban areas. An entry-level analyst or trade-runner starts at about 38, but is walking down the same hallways and riding on subways and busses with multimillionaires. You'll feel crazy even though you really are well off and have a shot to earn more.

Then there's the far more insidiuous issue, inflation. Wages have risen but not anywhere near the rate of inflation. I'll compromise with the government and accept 3% (considering the 15% returns on 1980-1981 CDs this is a hefty compromise on my part) as the rate of inflation for the past 27 years. That means prices have more than doubled; average wages have increased less than 60%--simply put, no wages save the very highest quintile have kept up with inflation, at all, and for that matter, the rise in real estate prices has, even historically at 6%, outpaced the rise in wages as well.

You can still be earning substantially more than your folks and feeling left behind, because you are even though by all standards you'd be getting ahead! It doesn't help that for that the Fed and Son of Bush were busy pimping ARMs to prop up prices and make savers and those who sat the bubble out feel like second-class citizens.

I think it's a noble effort to contact your representative, but chances are it'll end up in the hands of an illiterate but ambitious 22-year-old congressional staffer who probably watches "Flip Dat", thought the 20% YOY rise in Georgetown condo prices would last forever, and believes that supporting/banning gay marriage and setting up a carbon credit system, not everyday economics, are the most pressing issues of the day. In the words of Stephen Roach, "Congress doesn't do macro", or micro, for that matter.

The impression I get from the baby boomers I know, including my parents, is that they think student loans and credit cards are free money. This whole situation is ridiculous and is going to have an effect in society--there's a book about this, "The Fourth Turning" (which I have not read)--and the change is going to seem sudden.

Anonymous said...

"We have the story of the 102 year old man getting a 25 year mortgage. Yeah, I think Wall Street had enough at this buffet."

Sorry, but lenders are not allowed to discriminate based on age. That's been illegal for some time now.

ruinean said...


Here is a repossession that simply has to be an example of chicanery in the market. Clearlake Oaks California, a rural and drug infested little hamlet with high crime and a median house price that was under 100K just a few years ago, has this little gem available, and the price has already been reduced some 40K.

This "cottage" has a fair market value of about 80K and THAT is obscene if you ask me. Two bed, 1 bath, evaporative cooling, and a full 880 square feet.

I lived in that county and built new low income housing in the early 1990's when you could get a new SFR for $55,000.

To have had this place qualify for in excess of 300k in financing was just flat out fraud. The bank will eventually let it go for less than 90K. And the person that buys it, well, I have this bridge in SF with great income potential.

Trent said...

I wouldn't worry about the fate of those that are appended to the housing industry. Most of them drive, big jacked up deisle trucks (construction) or luxury cars(mortgage/realators/title) that they can sell if times get tough for them.