Mortgage Equity Withdrawal Syndrome. The 3rd Rail of the Housing Led Boom.

Unless you’ve been living under a rock, it is apparent that there will be no summer bounce in housing. This comes as a grave shock to those that are entwined like a ball of yarn with the housing industry. We’ve created an entirely new generation of folks that think housing equity equals housing wealth. All of us have anecdotal stories of friends, family members, or ourselves tapping into home equity for vacations, consumption purchases, or using the HELOC to pay off other credit cards. The simplicity of getting money out of your home is so easy it is frightening.

Step one, you call the bank.

Step two, you decide between a home loan or home equity line of credit.

Step three, you get a 2^nd on the home after an inflated bubble market appraisal.

Step four, your off to the spending races.

Sounds rather poetic doesn’t it? But aside from the personal stories, how much money was taken out of homes at inflated prices and pumped back into this economy? The answer may surprise you.

Making Your Home a Bank

During the 1990s, in terms of tapping out equity, mortgage equity withdrawals (MEW for short) were roughly flat for a decade. It was flat for a couple of reasons. The collateralized debt obligations market wasn’t as streamlined as it currently is. This made it more difficult and a longer drawn out process to extract money from your home. The next major point is home prices were stagnant throughout this decade. How are you going to extract money out of a dry well? And finally we have declining returns and world wide investors chasing stronger yields. Keep in mind it was very normal to see 35% year-over-year gains in the technology sectors. Why in the world would you want to invest in housing where over a century of gains have trended with inflation? This all changed after 9/11.

After 9/11, we suddenly saw a progressive campaign of rate slashing to keep the economy afloat. Of course, when you decrease the fed funds rate, you increase the money flowing through the economy. Take a look at the below chart:

As you notice, through the 90s MEW stayed flat. Then we see a sudden quarterly jump in 2001. The tipping point started in the late 90s and early part of the decade because many people started jumping ship from technology investments when most seasoned investors realized that annualized gains of 35 to 40 percent were not going to last. They did what any smart gambler would do, they took their winnings off the table. But here come the stragglers, Joe and Susie public, and go tech crazy. No need to dive into that $7 trillion debacle, but suffice it to say that bubbles do pop. As you will notice from the chart, MEW jumped at a whopping 2 to 1 ratio over the following years. Keep in mind that the bull argument was that money that was extracted from the home was being used to pay off debt and not splurge on consumption. Let take a look at some data from the Fed:

As you will notice, we have a normal progressive growth of public debt from the 1970s to about 2000. Then we see something odd happening. We see the angle trajectory of the chart suddenly shift. Somehow I doubt the majority of folks were paying off debt. If anything, they were consolidating credit card debt, only to reuse the damn things again! Kind of defeats the purpose of debt reduction if you are moving your money from different pockets in your pants and thinking you are richer.

So you may say, what does the Fed have to do with this? They don’t lend the money to the consumers. Au contraire my friend. Just because something isn’t directly related doesn’t mean no change is occurring. If anything, you need to ask yourself where do banks bank? They have standards set by the Federal Reserve and the key interest rate is vital for so many reasons. If they lower rates as they did to the 1 percent range, it makes no sense to purchase US Treasuries long-term since inflation will kill your investment. In addition, since the rate was lowered to a historical low, it actually encouraged people to spend. Many reports have been issued showing that Americans actually have less equity as a percentage in their home than in the past. Begs the question of all this $5 trillion housing wealth we’ve been wallowing in. Well somehow it became our patriotic duty to spend (remember the Bush speech) and folks true to form, went out and spent like a drunken hyena. We save so little, we are actually in a negative savings rate. Think about that for a second. We spend more than we earn! You can only do this if excess credit is in the market. With the advent of MEW and inflated housing prices, folks decided to appoint themselves CEO of the Bank of Home.

What Will Happen when Home Bank Forecloses?

Since the dollar is worth a lot less because of inflation and irresponsible monetary policy, you are now able to purchase less with your current income. Think about the nature of inflation. When you print too much money, you devalue the worth of the current money supply. This is basic economics. What makes something valuable? The amount and scarcity of an item in relation to the demand. Money for a few years was so cheap, it made no sense to save and the public followed. The leaders of this consumption used every advertising medium available. If you drive a two year old car you simply were an old school idiot with no taste for the finer things in life. Have you noticed those credit card commercials where the person paying with a check or cash is seen as a leper? Everyone is having a merry time paying with their Visa and Mastercard but god forbid you show cash you dirty rotten animal. How dare you stop the flow of credit to the rightful owners of consumption!

But you can only spend so much and grow an economy on pseudo-wealth. Eventually someone will have to pay for it. And at a certain point, there will be no more money left. Take a look at the below chart:

Source: http://calculatedrisk.blogspot.com/

You’ll notice that suddenly as we hit the housing peak in 2005/2006, MEW dropped off the map. Why did this happen? For one, housing is correcting and coming back down to Earth. Another reason is the Fed was forced to tighten credit standards, otherwise we were on our way toward paying for orange juice with wheel barrows of dollars at Ralphs.

So the perma bull arguments are absolutely false. Housing was artificially inflated by investors looking for higher returns, a Fed that dropped rates faster than muscle growth in the MLB, and finally a society that is based on 70 percent consumption. If you read your history books, you’ll find many great empires collapsing because of massive deficits. However, this is a worldwide glut in credit so this will impact the entire planet. Have any doubt about the bubble? Take a look at these 10 homes and then come back and let us know your thoughts.

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Housing Voyeurism: What Kind of Housing Personality are You?

Housing has become a national obsession. As a kid you were told not to talk politics at the dinner table or ask a person how much money they make. Yet you still had that curiosity. Today there is no need to ask because you can go to Zillow and find out how much they paid for their 2,000 square foot 4 bedroom home. So they say they have a pool eh? We can go on Google Maps and zoom into their backyard via satellite imagery to verify this claim. “So it was an above ground pool Bob was talking about!” And if you turn on the tube, you find the following television shows:

Extreme Home Make Over

Flip That House

Property Ladder

Sell That House

National Open House

Secrets that Sell

Designed to Sell

Bought and Sold

Million Dollar Listing

These shows appear on Bravo, A&E, HGTV, and your regular network stations. The point is, we are incredibly saturated with media marketing real estate. And do you notice a key phrase and underlying message in many of the shows above? Sell your house! Buy a home! If we are to combine a hybrid of the messages above we get something like “extreme flipping that will design to sell your house for a million dollar listing!” I think I’m on to something here. No longer is housing a place to live and raise a family in modesty, but housing is now an investment to propel you into the next dimension of uber-wealth. In reality, the amount of traffic online regarding real estate is unbelievable therefore indicating a wide demand for housing information. Not only that, here in California we have, according to the Department of Real Estate, 534,266 licensed brokers and salespeople. With 12,200,082 housing units in California that gives us one agent or broker for each 22 homes. Maybe we have an agent and broker bubble?

Either way, housing is becoming a massively important part of our culture and economy. Looking at recent employment data, for the past seven years real estate related employment has been attributed to impact 29% of all added jobs. And consumption is so important, accounting for 70 percent of our GDP, without housing we might as well forget the $5 trillion in pseudo bubble housing wealth and we’d be in a recession as we speak. But looking at the psychology of housing, we begin to see in the theatre of life many characters emerge. Since we have the tools to literally piece together every facet of a neighborhood and play amateur James Bond, we can find tons of information regarding our environment. So let us look at the housing personalities emerging in this housing bubble masterpiece performance.

The Five Housing Personalities

1. The Perma Bull Housing Sales Person

This person has never seen a house he wouldn’t sell (or buy). It all depends on the weather and the global positioning of the Earth. These folks have tattooed on their right bicep, “10% appreciation 4 life!” and show it off with glee. Folks that fall into this category are people like David Lereah, former chief economist of the NAR. His ability to spin would put the Harlem Globe Trotters to shame. He reminds us of Iraqi Information Minister Muhammed Saeed al-Sahaf. "We have them surrounded in their tanks" as US tanks rolled into Baghdad. You got to hand it to these folks, they have the ability to say absurd things in the light of mounting disaster. Either way, this personality will always see real estate as the absolute best investment ever. Even if the land is over Chernobyl they’ll tell you that spent uranium is good for brain development or that soon, you’ll be able to flip the property as a national treasure.

God forbid you give these people any facts or historical background. If you do, be prepared for a cadre of verbal assaults. They’ll call you a tinfoil hat wearing bitter renter. Or they will claim that the statistics you pulled out are fraudulent like the Nigerian documents CBS received. They’ll claim that the only truth is that of their all mighty association. Anything diverging from these talking points is tantamount to treason. They offer you a guarantee of appreciation. They’ll use the typical 7 to 10 percent annual appreciate rate; it all depends on what the central pundit hub is dishing out. A formidable foe no doubt.

2. The Perma Bear Housing Naysayer

The antithesis to the housing perma bull sales person. These folks are masters of dark and dreary statistics. For every argument a perma bull has, they have an equally convincing argument that claims otherwise. They are ready to do battle from experience either from losing money in certain deals (normally initiated by perma bull rhetoric) and suddenly are sworn warriors to the cause of outing the perma bulls. “Housing appreciation is 10 percent year over year” the housing bulls will say. Oh really? “What about the fact that 100 years of data show housing trending at a slow pace only keeping up with inflation?” Touché.

Their argument is valid and has merit in economic reality. However, in a bubble world they are throwing pebbles into the ocean. They will argue that inflation is cooked by government agencies trying to hide the real cost of living and seeing it as an invisible tax on the people. They will also claim that incomes do not support current market housing rates. Since 70 percent of the US population owns a home, there are less housing perma bears out there simply because of the law of self preservation and self interest. Either way, an equal challenger to the perma bull.

3. Apocalypse Now

A fiery asteroid will hit Earth and burn us to a crisp and then we will see 110 percent price decreases. After the 10 million people that survive the impact, you’ll see amazing deals hitting the market. These folks have a strong case of schadenfreude, that is taking pleasure in others misfortune. Normally many are angry and will throw it in your face that your 10 percent appreciation won’t matter after we collide with intergalactic space rocks. It’s an interesting personality to observe. They usually want to see housing explode and wouldn’t mind seeing a 2^nd depression shake up the world. The psychology behind this is rather fascinating. Whether they have the “moth going to light” syndrome I do not know, but one fact is certain and they want destruction and they are geared up for it.

These folks see housing overpriced by 90 percent. Forget using any income to rent to price ratios, housing will go down to Chinatown no matter what. 10 percent annual appreciation? Not in this world. Some of these folks have all their cash buried in the back yard. Great source for screenwriting a Hollywood script.

4. The Housing is in a Bubble? Person

These folks are your paycheck to paycheck people. They are the folks that signed for a $400,000 loan and forgot to ask if they just got a 30 year fixed or interest only adjustable mortgage. Oh well, unfortunately they’ll get the wake up call on a future mortgage payment in 1 to 2 years. These people really don’t care about a housing bubble. They were at home, watching one of the above mentioned housing shows and somehow subliminally, they learned that 10 percent appreciation always happens. So when Joe the agent showed them how to get into a 3/2 home for $500,000 on an exotic loan, they figured “what the heck!” This personality is a mixture of not really having time or initiative to care about the basic economics of the housing market. They are like a reed in the wind. They are more concerned about making the car, gas, electric, health, food, and other basic bills of life to dig into economic theory.

These folks are usually people who will have $3,000 in a savings account earning 2 percent while carrying a balance of $3,000 on a credit card at 29 percent simultaneously. Many of these folks will be burned once rates resets or they need to sell their home for various reasons.

5. The Hybrid Housing/Bubble Head

This is where the large majority of the population is. They see the value of owning a home. They realize that rent is really not a viable option for the entirety of life but they also understand that a home can be overpriced. It is a challenge for these folks because to a certain extent, they believe in the perma bull argument that housing is a great investment. Yet they also have the gut feeling of many perma bears that housing, after crunching the numbers, is overpriced. They normally don’t think that the world will end but realize prices will come down and in certain areas, significantly. These people normally understand some basics of finance; the major point they get is spend less than you earn. They also try to live within their means, have an emergency savings account, and want to have a safe neighborhood with good schools for their family. Many times, they fight the urge to move to a questionable neighborhood because family safety is more important than homeownership.

Conclusion

Most people interested in housing fall within a few of these personality categories. Imagine that all these personalities have gradients attached to them; some people are on the extreme ends of the gradients but the majority falls within the middle. They exhibit hybrid views on the housing market. What is your housing personality?

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Real Homes of Genius: Today we Salute you Compton with a Short Sale at $375,999. New! Short Sale Search Option.

We are having so much good housing news hit the media that you would think the White House press secretary is suddenly working for the housing industry. Next thing we will find out is the President issuing pardons to anyone who bought a home on negative-interest-option-only-adjustable-rate-suicide mortgages. After all, with the amazing tax cuts the government feels you deserve a get out of jail pass too. Today we salute another Compton property with our Real Homes of Genius award. ZipRealty has a wonderful feature that allows you to search for short sales. This was added in addition to other features, that of “fixer uppers” and “interest level.” I’m thinking that any home hitting as a short sale is probably a fixer upper with low interest level – maybe they should have defaulted the search item and save the buyer a minute. ZipRealty is ahead of the curve on this one since this is a booming market:



On with the home. This 1,089 square foot home includes four bedrooms and two “full” baths. Nestled in the majestic resort town of Compton, you will entertain your friends and family behind U.S. Steel reinforced gates, such as those guarding the Rockefeller Estate. This home uses transcendent features of the 1950s including a patented aqua green color to ward off nuclear attacks from Soviet warships. This moderately priced dream crib is all yours for the rock bottom price of $375,999. This is actually less than the sale price of 2006:

Sale History
06/23/2006: $412,000
10/01/1981: $58,500

So already in less than one year, we are giving you the dear buyer, a $36,001 discount. Or to look at it from another perspective, the median per capita income of someone living in the area. The absurd notion here is that someone paid $412,000 for a home that will rent from $900 to $950 a month. Now the bank is taking it in the shorts, hence the name short sale, and looking at yesteryear appraisals for a market value. Keep in mind this home initially was listed for approximately $400,000 but no bites. I’m not sure how anyone can justify prices like this. It’s almost like sellers went into asylums, removed the straightjacket from patients, showed them pictures of homes, and asked them how much would you pay for this? “$500,000!” Okay. And this home? “$500,000!” When people say we have crazy housing prices they mean it in more than a figurative sense.

And what is the agent thinking? Taking pictures behind bars isn’t exactly making this a hot item. Didn’t they see how unappealing the Paris Hilton mug shots appeared? They need to add some pizzazz or hire some unemployed paparazzi; there is plenty in the LA metro area for a good price. Or maybe you can ask Alan Greenspan to give you a stump speech on how adjustable rate mortgages are good for America. After his speech, he should be dragged to this home, and forced to purchase it via a New Century Financial no money down interest only mortgage. As he stated so eloquently that ARMs are good for the economy. Good job easy credit. Thanks for flooding the world with such lax standards that housing prices are beyond unreliable, we might as well purchase a pregnancy test from the 99 Cent Store to determine whether housing will appreciate in the next year. Let us see…two lines. I guess that means it’ll be 20 percent appreciation again in 2008.

Today we Salute you Compton with our Real Homes of Genius Award.

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Housing and the age of Affluence: Transforming the Definition of Income and Wealth

Most people consider families with 6-figure incomes to be financially secure. Some would even venture to say that this is the upper-middle class. Yet very few housing articles look at income in relation to housing prices if you have noticed. It is almost a foregone conclusion that people earn enough to support Wonderland prices. So how does income distribution really look like in the United States? Looking over data from the Census Bureau, you will be surprised to see how various quintiles breakdown. Considering that a median home in Southern California is over $500,000+, a family earning $100,000 a year is still paying 5 times their annual gross income for a home. Keep in mind a half-million dollar home in California is not what you would see displayed on Lifestyles of the Rich and Famous. You are more likely to find a Real Home of Genius in this price range. I’ve observed housing bulls arguing that housing is being supported by radically high incomes and unbelievable job growth. Do we really have that many people making $100,000 a year to support $500,000 homes? Let us take a look.

The Number Breakdown

F. Scott Fitzgerald once said that the rich are different from us. To which Hemingway responded, “Yes. They have more money.” There is a fascination in this culture with the uber-wealthy. Take a look at shows like Cribs where opulent wealth is showcased. Tabloid magazines make their money from this cultural fascination. What do the rich eat? Do they shop where I shop? What do they do for fun? Where do they live? If you really examine what it means to be rich, you will find some surprising answers. But first, how many rich people are in this country?:

Household income (overall percent of US households over):

Income Percent of Households over:

$65,000 34.72%

$80,000 25.6%

$91,705 20.0%

$100,000 17.8%

$118,200 10%

$166,200 5%

$200,000 2.67%

$250,000 1.5%

$1,600,000 0.12%

Some of you may be surprised to see this data. If anything, it should point out to you that there is not nearly enough of an income base to support the $500,000 median home prices in Southern California or any overpriced metro area in the country. Even a household with dual income earners making $100,000 a year, after taxes they are pulling in a monthly nut of approximately $5,900 without contributing to a 401(k). And what is the monthly mortgage payment on a $500,000 home with 5% down ($25,000) at 6.5% over 30 years? The principle, interest, and taxes will cost you approximately $3,600. After taxes you are paying 61% of your income toward your home. Moreover, this is for families that fall in the top 17% of income earners. Last time I checked, we have a national homeownership rate of 70% and in California, a homeownership rate of approximately 57%. Since we realize that income isn’t the main protagonist of amazingly high home prices, then what is it? Surely there must be an explanation for the radical jump in home prices over the past decade.

Risky Loans and Easy Credit

How can a family earning $65,000 a year, jump into a $500,000 home? Easy. We can lock them into the world of subprime loans. Only a few years ago, it was incredibly easy for a family to go stated income and jump into a 2-year teaser rate mortgage with a 1.25% rate. The rate would adjust but by that time, you could flip your home and make a nice little return. Don’t know how? Just watch the show Flip this House. I remember a mortgage broker telling me, “it is easy to get anyone into any home. All they need is the willingness to find a place and sign.” He even told me about his ability to squeeze in families with $50,000 incomes into $500,000 homes and got joy how he was churning $10,000 a month in commissions. That was 2005. Fast forward to 2007. He is no longer working at the company since it imploded early this year. When I last talked with him, I asked him what his plans are now that he is unemployed. “I’ll go work for another lender but one that focuses on foreclosures. That’s the next big market.” Didn’t want to burst his bubble but in a bear housing market, sales drop massively therefore cutting into the churning of transactions. Therefore, his $10,000 a month will only be seen again if he has some advanced college degree or sells crack on the streets. Ironically, this person has nothing saved up after 3 years of being in the business and making $100,000+ each year. The product of conspicuous consumption and financial irresponsibility – easy come easy go.

This is only one case of many. The person above is young. But so many people got caught up in this housing frenzy and believed it was a ticket for easy street. They under funded their retirement accounts in belief that Social Security will be there for them. But think about the culture of credit that they blossomed in to. They entered the workforce with a national negative savings rate, credit cards being given out like candy at colleges, and cash becoming almost a thing of the past. People even pay for $1 cheeseburgers at McDonalds with a credit card! So is it any wonder that they have no fear issuing out or taking on absurd mortgages? Credit will always be there for them. It was there in the past, why not in the future?

Age and Culture Conflict

I have a colleague telling me how buying a home is always expensive. He tells me about earning only $30,000 a year and buying a home that cost $110,000 back in 1988. He is also proud that he would not be able to afford his current home if he bought it at today’s market value. It is a sense of pride that he can’t afford his own home, “if I were in the market today, I wouldn’t be able to afford my own home!” This from a baby boomer nearing retirement with a locked in pension. Looking deeper into the income stats, we realize that the top earning households are those headed by working baby boomers. The exact range of top earners is 45 – 54. The conflicts of managing a high cost of living seems to be disconnected from those from the 25 – 39 age group. For one, we do not have the luxury of having a Social Security safety net, therefore many of us actually have to over fund our 401(K) if we do not want to live off government cheese. Yet we pay 15% of our income into a fund we will not see. Not only that, but many companies are now eliminating defined pensions and passing on the cost of health insurance to the young working class. The cost of living is much higher even though incomes on the surface may seem high for young working professionals.

In addition, housing has never been this expensive in relation to income. Even though buying a home may stretch a family’s budget, anyone buying a home in today’s market would need the flexibility of Gumby to purchase a starter home. There is a generational divide in our culture. Many young folks feel they are getting advice from a person that has a locked in retirement, years of Social Security, and locked into affordable housing – things that are not in our lexicon. These items are remote to any young professional. So the “live and spend” culture of today has some direct correlation to the psychology of both generations. Even though I disagree with this mentality, I can understand where it comes from.

Yet this housing market also affects baby boomers. Many are counting on their equity in their home for retirement. I’ve talked with many people telling me that in 5 years when they retire, their home will be worth $1 million and they’ll use the equity to downsize. When I ask them how they know 10% annual appreciation will occur from 2007 to 2012, they reply, “real estate always goes up.” So not only does this housing market hurt families looking for a starter home, it also hurts those nearing retirement with an inflated few of their home and a perceived idea that a built in safety net will always be there for them. In general, the young overestimate the difficulty in paying back large amounts of credit (i.e., buying a $50,000 car) and the older generation underestimate the need for a larger retirement nest egg (i.e., American’s nearing retirement have an average nest egg of $50,000).

In the end, looking at income numbers, home prices do not justify their current market rates. These rates are inflated on bubble psychology and easy credit that is slowly evaporating. The market will contract and a major shift in cultural psychology will occur.

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