Housing Bubble - News from the Front

Inside Larry's Head has an article that starts "Dear Housing Bubble People" where he talks about the fed having signalled that the end of hikes in rates are likely near, and speculates that this means there is no housing bubble.



Sadly, no.



There's no sense of glee in this. I would be happy to be wrong on this one. The Fed rate was 1 percent even 2 years ago. Now it is 4.25. Whereas this has no direct effect on available interest rates for consumers, it can be looked at as the cost of short term money to the bank. In turn, it influences things such as a bank's decision as to what it's prime rate will be.



The thing that's more indicative of longer term rates, the 10 year bond rates, is sitting right at 4.5. This isn't bad, and actually isn't too far from where it was two years ago. On the other hand, the two year is right at 4.375. Two years ago, it was three points lower than that. This is an extremely narrow spread. In some measurements, the two year rate is actually higher than the ten year - indicating that people may think we're in for a rough patch for a while.



Furthermore, whereas I think there are many areas of the country that will be fine, the higher priced urban areas of the country have a lot of problems not directly related to future interest rates. The incidence of short-term, interest only and Negative Amortization is over eighty percent (!) of all "purchase money" loans in the last two years in San Diego. I doubt that the rest of California is much different. It has always been something of a tradition for people to stretch and purchase more house than they should, but for the past couple of years, various members of my profession have been encouraging it via negative amortization and interest only loans. I've taken quite a hit, income wise, by being unwilling to place people in inappropriate loans - but if I won't do it, they can always find someone who will. Nor is it like the standards have not eased considerably. When I first bought, the standard debt to income limits were twenty-eight and thirty six percent of gross income. Fifteen years later, A paper backers Fannie Mae and Freddie Mac will go thirty-eight and forty-five (and occasionally higher through their automated underwriting programs), and some subprime companies will go to sixty (!) percent of gross income.



Furthermore, a much higher proportion of borrowers are using stated income as opposed to full documentation loans, and this includes people who get a regular, set paycheck and a w-2 at the end of the year, not commissioned salesfolk or the self employed. The only reason to go stated income with a w-2 borrower, where income is trivially easy to document, is if they don't really make the money. I have heard fellow loan officers call, quite rationally, for the abolition of stated income loans. I wouldn't go that far, as for commissioned salesfolk and the self-employed, they are a valid resource if not abused, but I would agree with prohibiting it for hourly and salaried borrowers.



Add it all up, and in high cost areas of the country, you have a lot of folks who've been encouraged by members of my professions to buy houses they really cannot afford, lest they be permanently "priced out" of the market later. The problem is that this demand curve has been artificially inflated by precisely this phenomenon. Families who make $60,000 per year should not be purchasing $850,000 homes. They should be purchasing a three bedroom condo, or something similar, but they've been encouraged to stretch beyond their means by the inducement of an artificially low payment. Unless their income somehow doubles, they are not going to be able to adapt when the period of artificially low payments comes to an end. Since few people already working in a stable profession have that happen, most are going to be in trouble.



As the stock market bubble of a few years ago illustrates, it doesn't take many sellers to deflate the price. After stock prices started coming down, volume of trades went way down - but those who were buying, and those who were selling, nevertheless determined the price. The same will apply to the housing market. Right now, sellers don't want to sell for what they can get, which is less than they could get just a few months ago. Buyers don't want to pay peak, or even near peak, prices for fear that prices will erode further and they will be out their investment. And when you're thinking about the next use, renting, the numbers are against it. Nobody can make a cash-flow profit renting recently purchased homes, locally.



In short, the ride was good while it lasted (especially for members of my profession), but like Chuck Yeager and the F-104 in "The Right Stuff" the plane has been milked for all of the altitude it can get, and now it has no power left and is starting to fall. And there I will leave the analogy, lest I push it too far, but however far it drops, a lot of people are going to get hurt badly by the fall, especially in the most heavily populated areas of the country.



Caveat Emptor