Barry Ritholtz articulated this issue very well when he paraphrased Lon Witter's piece in Barron's from last weekend by saying Witter observes that we don't have a Housing bubble, what the U.S. has is a lending bubble. Nouriel Roubini goes into some greater detail here that you should read as well.
I have written quite a few times that I don't think there can be a nationwide crash in home prices but this lending bubble seems like a much better way to describe the situation.
Anyone with an interest only ARM, facing a reset they cannot afford is in trouble. Even a refi to a fixed rate will spell trouble for some overleveraged homeowners.
Here's the thing as I see it; there has been an excess. Excesses get corrected. I am not sure I need to correctly predict the magnitude of the correction to successfully navigate it. Chances are you are just trying to avoid something ugly in stocks. If so, you do not need Nobel Prize winning accuracy in predicting what will happen.
I do not think the worst case scenario is the most likely scenario as consistent with my thinking on these things. Usually the best and worst possible scenarios are wrong; the real outcome is usually in the middle.
Here I think the middle is a recession, not depression, consistent with a normal economic cycle. If correct and if it turns out that the lending excess is a driver behind the recession then yes the consumer will be hurt a little worse than in most recessions.
To me this is just common sense not clever thinking. I live in a little cabin we bought as a weekend place in 1998 for $87,000. There are lesser cabins (my wife has redone the entire interior with a little help from me) near by listed (but not selling yet) for $300,000. More than a tripling in eight years is an excess. I don't think this is debatable. The debate, in my mind, is the consequence of the correction.
The 40 year old (my age) guy with $7000 in mortgage payments who makes $10,000 a month is in a much riskier position than the guy with an $800 mortgage making $3500 a month. The first guy won't last too long if he loses his job.
If Jimmy Rogers is correct and housing prices drop by 30, 40 or 50% it will be too bad but won't hurt the homeowner who is properly leveraged. While the bank does not want to take back houses from people what do you think a borrower with a barely affordable, interest only $600,000 mortgage will do if the house is worth $400,000? I don't think declines will be that big but if they are....
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26 comments:
May I suggest that you study the chart from this weekend's New York Times here. And then think about mean reversion.
Personally, I see no reason to doubt that the index in question could decline to somewhere in the 80's - or possibly even lower - before rebounding to its long term trendline somewhere around 110. At least a 50% decline (remember this is real, not nominal) looks to be "baked in the cake".
You could be right, no question.
However it does seem odd to me that the net price appreciation in 116 years, after inflation, is only a double in prices.
This is an asset class after all and the chart is 116 years.
Keep in mind, I do believe that the last few years has been too much. I'm just not sure how to quantify too much.
1. There wasn't the demand component prior to WW2.
2. Why can't people just refi those ARMs when the 5 year adjustment period arrives (into a new 5-year ARM)?
Larry,
They could refi as you say. How many people are paying $800 a month on a loan that does not amoritize? If the were to refi into a conventional mortgage might the payment then go to $2000? Forgetting dollars and thinking about magnitude couldn't 150% increase in the mortgage cause a lot of problems?
The variable is how many people own a hise they can;t really afford. You would know better than I but if the number is too big, kaboom.
I think leveraged homeowners will do everything they can to "ride out" the housing downturn, since taking even a 100% increase in mortgage payment by refinancing is preferable to selling a house with $200k loss.
I think the media here forgets that houses are NOT stocks; there is no margin call. People's perceptions about housing are very different from stocks where a drop in prices is felt not to be real.
Rog: You missed my point. Why can't they go gaet another 5 year (interest-only) loan which buys them another 5 years? They also have 10-year interest only loans now. Both under 6%
"I think leveraged homeowners will do everything they can to "ride out" the housing downturn, since taking even a 100% increase in mortgage payment by refinancing is preferable to selling a house with $200k loss. "
NICE THEORY. BUT, TO DATE, PRICES HAVEN'T FALLEN.
LN, who the hell raised you...oh wait.
So your question assumes that people confronted with genuine financial problems will act rationally.
The idea, now that I get it, of course makes sense. You and I know plenty of poor decision makers. While I don't know how many people facing this problem would be open to you are talikgn about, I think plenty would take no action out of stupidity.
Here's a thought, lenders proactively seeking out borrowers who are their own customers, warning them of the potential trouble and helping them figure out a solution. More fees for the lender and hopefully no crisis for the borrower?
I read somewhere that one of the big lenders, maybe Countrywide, is doing something similar.
Now the fast math:
the $800/month interest only payment equates to a $192,000 loan which when fully amortized over 30 years = an $1146 per month payment.
THE HOUSING MARKET WILL NOT CRASH OVER $346.....lol
I read something somewhere about resets over the next couple of years potentially raising a payment by more than double. Some borrowers will stand pat and do nothing while this happens to them.
The thing with arms is they reset higher as you know.
No, they don't automatically reset higher. They payment resets higher IF needed to fully amortize the loan balance. (not playing with words. It's very different)
And, as you can see by my example, the sticker shock isn't that awful.
I didn't mention it but, someone coming out of an interest only ARM could actually get a new 1.6% teaser start rate (and payment) on a negative amortization loan ACTUALLY LOWERING THEIR PAYMENT for the next 5 years......
Do you see the banking industry or the credit card issuers getting hit hard over the housing down turn? I have noticed that cof has been quietly being decimated over the past week.
With over a trillion dollars in ARMs resetting in each of the next two years, lending business should boom again (here comes the fees).
Credit card companies, however, are all going down with the economy.
Okay, let's assume everyone acts 'rationally' in the shorter term and lenders remain eager and willing to refinance marginal borrowers for the next 5, 10 or whatever years on relatively congenial terms. The problem with that is the Fed has already made it clear that it wants higher-risk lending practices curtailed and the percentage of marginal loans reduced, that it sees a wider threat developing as the country's economy slows down and is flat not willing to see the credit snowball just keep rolling down the mountain until it becomes too large for anything to stop.
So, if the Witter article is correct -- e.g., that more than 15% of 2005 home buyers have a negative equity of 10% or more and 10% of total home owners have 0% equity -- then that implies at least some homeowners will not be able to find a lender willing to refinance the original cost at any price and that those who bought as much house as they could afford on a monthly basis will not be able to refinance at two to three times that monthly nut even if they have positive equity because they will have increasing difficulty finding a lender able to give them a better deal; i.e., mortgage lenders can't issue money (credit) de novo like a bank can and it appears banks are going to experience increasing scrutiny WRT loan origination from the money centers where they get _their_ money.
As in previous credit crises, the most recent being the S&L debacle of 20 years ago, there may be a bailout at the state or institutional level but there will be nothing for the retail borrower or investor so caveat emptor. I have no idea what the scope and magnitude of the cooling trend in housing and concomitant credit backlash will be but there are other interesting investments out there with more quantifiable risk/reward profiles so that's where my money has gone: I don't even own mortgage backed securities any more much less any stock in a mortgage lender.
Roubini's big argument is that there is a dovetail effect from each mortagee who gets into trouble. The builder, mortgage broker, real estate agent, half dozen or so specialty craftsmen who actually build the place and others all suffer when the building boom reverts to the mean. That, along with a litany of other ailments to the economy, is how he comes up with a recession call. I have read his stuff carefully and it seems somewhat pessimistic and laced with invective language. I'm with Roger on this one seeing a slowdown, possible recession coming. Roubini's only mischeivous statement I saw was that he said property values have/will declined sharply in the Midwest. That is possible in some urban areas but not in a general sense throughout the whole area. Roubini worked for the last administration prior to the current. I get the sense that he and his cohorts are kind of enjoying this downturn under Bush's watch.
Sorry, I forgot to sign my last post. Tom in Indy
This is all good stuff, thank you!
to Tom's point, I hadn't thought about the political aspect I can't refute it either. I do think Roubini is smart and I think I can learn from him. If his scenario is right (not saying it will be) it will hurt the country, the markets and perhaps my clients. As such it makes sense to me to delve in and really try to understand is argument even if I don't draw the same conclusion/magnitude.
RW makes a great point in the debate between my brother and me. The thing with this issue is that the more articlate point(my brother's) doesn't have to be the correct point.
There are excesses. Some portion of people will be hurt by this whole thing. If it is 1-2% well that will be too bad with no horrible systemic outcome. If 50% of home borrowers are hurt by this it will have hiddeous consequences. No doubt the real number is in the middle somewhere and the person that can guess the number correctly might win the Nobel but it won't be me.
"LN, who the hell raised you...oh wait."
A PACK OF POT-SMOKING, FREE SEX, NO NUKE, END WAR, PRO-CASTRO AND CHE, ATHEIST, NOBEL PRIZE nominated (only), ANTI-RECOMBINANT DNA ENGINEERING ECONOMISTS. That's who. (and, a part-time Sox fan)
Larry, take it easy on Roger. lol.
bh
Actual home (investment)closing in Ohio last week.
Home bought in 2001 for 32g
Rehabbed add 8g (wholesale)
Land Contract in 2001 for 56g
area us declining/meth labs/police target area
Land Contract bust 2006 (June)after
two homicides in home with gang members
For Sale at 28g net to owner
Sold (July)
City appraised home at 33g
Appraiser for mortgage company appraised at 75g
Closing Statement:
Sales price 75g
Mortgage originator fees 8g
Misc fees 4200
Cash to new owner for "repairs" :) 34800
Cash to seller 28g
This home will be walked away from and reposessed by December, 06.The bank will then buy back the home at auction because no one will come close to bidding their loan costs.
And you wonder why the housing market is in trouble...and how bank loan portfolios are loaded with fraud.
This is not the exception in our metro market. It is the rule.
I would move, especially if I had kids.??? It's the rule??? Something must be wrong with our kindergarden programs........
Not sure how prevalent T's story is, but I had the impression that midwest and deep south RE markets are much different than what we hear about elsewhere. Maybe not
A couple of points.
Many won't be able to refinance, period. Many barely qualified with a low payment due to an exotic mortgage. Add in a decline in the appraised value and higher payment and they're stuck.
Nobody "chooses" to sell a house far below what they owe on it. If they had the cash to pay off the balance they wouldn't be in trouble in the first place.
Many will be stuck in a house they can't refinance and can't sell. If they can make the higher mortgage payments they will. If they can't, foreclosure.
If everyone's aware...it won't happen.
Duh!
Don't be embarrassed Rog.... every family has one. Keep up the great work!
What a great debate! I can't always decipher the acronyms but that's not too bad a problem. The Economist has been carrying articles on the coming housing bubble in the USA for three of more years now. Why is it still a surprise? And so many people are still in denial. Pete in Pokomo
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