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
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,
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?
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