Posted on 08/06/2005 4:39:12 PM PDT by hripka
At Arm's Length: 07.28.05
Nine Signs of a Bubble
No doubt, you have heard about all you want to hear about housing bubbles. All the major media concerns have alerted folks to the unreasonable costs for homes but have failed to offer any real reason why this is a problem. But alas, their job is to sensationalize and what better sensation exists than the pursuit of news where there may not be any. But on the other hand, perhaps there is something in the telltale signs listed below that would give even the risk-prone investor some pause to reconsider.
No amount of coverage has stopped folks who intend to purchase their first home from jumping in blindly, using ever riskier means to finance what has become a very expensive undertaking. There is a domino effect in borrowing what these folks may not be able to repay. Few people these days applying for mortgages have calculated their loan in the long term. Getting in was all they concerned themselves with and in doing so, many people financed at what on the surface appears to be inexpensive money.
So why the hype? Perhaps we should ask what's the consequence of such an overheated, often speculative market and even better yet, who should care?
Folks who watch economies such as ours - people like me - are beginning to feel as though we have spoken until we are hoarse and written until our fingertips were calloused, holding a bearish outlook on an obviously bullish market. But we see a disaster on the horizon. Much the way trainspotters or airplane watchers or NASCAR fans do, we are hypnotized by the speed, the seeming wreckless abandon of the participants, and the inherent risk that all good things have an end after a good run.
Here's what concerns me and what should concern the nation's economic leaders: 1 - The net worth of the households in this country is based on a combination of assets including savings, investments (accumulated retirement assets in stock and bonds) and your house. It is a sign of economic strength when those assets are somewhat balanced.
Currently, the housing market has tipped this balance by increasing the net worth of households over 70%. The last time the net worth of households was out-of-whack, so to speak, was when the stock market took off to astronomical heights increasing the worth of equity investments and giving the participants that wealthy feeling.
2 - Housing has lifted the jobs report as well. When new homes are built or current ones are refinanced, not only are the construction industries employing more people, but the ones whose job it is to supply raw and finished materials. Companies whose purpose it is to supply these new homes with durable goods such as refrigerators and appliances as well as other not so durable goods, find their customers increasing as well. This adds new jobs built around the wealth in homes. So far, 40% of the jobs that have been created over the last four years have been a direct result of this increase in the net worth of housing.
Take homes out of the picture though and the numbers of real final sales reported in the last quarter actually dropped. This is worrisome if you consider that the reason the Fed chairman Alan Greenspan is increasing short term interest rates is to slow the economy before it overheats. But it conntiues to be charging - no pun intended - ahead on borrowed funds. The first quarter numbers for these sales excluding housing, on an annual basis has fallen by half since the last quarter of last year.
3 - Lenders have been allowing riskier borrows to enter into this market in a big way. The so-called sub-prime applicants, the ones whose creditworthiness would in less speculative times be more closely scrutinized have been lured by, and this is how the Mortgage Bankers Association refers to it, "innovative" financing. These lower standards increase the risk of default at a time when the nation's bankruptcy laws are about to change.
4 - Those innovations have allowed new home buyers, an estimated 42% of them first time buyers, to get into those homes without putting a dollar down. This is done with a combination of financing maneuvers ranging from interest only loans (ones that carry ballooned payments later in the mortgage cycle or refinance the loan - a process that is predicted to get more expensive as time goes by) and by borrowing both the first 80% on one loan and the down payment on another, high interest rate, second mortgage. These folks have borrowed all of the worth in their homes, many in the hopes that these houses will continue on their torrid pace of growth in worth. 60% of these new loans are either interest only or option ARMs. In this market, the traditional thirty-year mortgage is the dinosaur.
5 - This so-called housing bubble has spread to 38 states. In these locals, those prices are on a tear having increased year over year by almost 7%. This, if you have not yet made the correlation is outpacing personal income, which has been flat over the same period of time. Housing has added $5 trillion dollars of wealth to the population, much of which should not be repayable with current income levels.
6 - The incomes that are making house payments are now devoting over a third of those wages to house payments. While only a third of the nation is doing so, the real trouble is in the 15% who are devoting half of the their income to paying the bill for those homes.
This increases the cost of debt service, the little recognized cost of borrowing. As the affordability of homes has plummeted in relation to the rise in prices, the cost of borrowing to get into these homes is fast approaching 15% of income outlays - a fancy way of saying that for each dollar spent on housing, 15 cents is going towards paying for the money. Even in a low interest rate environment, the cost of debt service increases against every dollar earned no matter what the interest rate on the loan happens to be. Loans are being written to pay these fees before any is applied to the principal and this is what increases that percentage.
7 - In some markets, new housing starts and permits may be finally outpacing the need for new homes. It is generally assumed that the average need for new homes year over year numbers around a million and a half. The number of new housing starts, now at 2 million, means that there are more homes than buyers in many markets and this could, if economics suggests, put a damper on house prices because supply is now outstripping supply. Or worse, speculative buyers are purchasing a half a million homes they have no intention of occupying. This problem is evidenced in the new anti-flipping rules added to so many new home purchases of late. Speculators generally buy homes and sell them before they are built in the hopes of turning a profit in these over-heated markets. Remove the speculator and supply of available homes will increase and the result of that is lower housing prices.
8 - Despite some mortgage pressure to stop "flipping", a method of speculative buying and then selling, often on contract, 23% of the purchases over the past year were made with no intention of owner occupancy. This has put pressure on both the lender and the consumer. For the lender, these quick-to-turn homes present investment problems. For one, banks sell these mortgages in baskets as long-term securities to investors who keep money in the pipeline for new loans. With the quick turnaround that is happening with these "investor" buyers, banks are unable to garner the cash they need to keep lending.
The borrowers aren't complaining. They are just attempting to tighten a loose end in the profit chain. They have lobbied hard in Congress to penalize these speculators with hard taxes of up to 45% on the capital gains from these types of investments.
As a side note, over ten percent of these new homes were bought and paid for with the profits from the sale of a first home or from the significant equity available. So with almost forty percent of these new homes, which by the way has set another record with the release of this week's sales numbers, being bought buy speculative and second home buyers, the builders are complaining - all the way to the bank - that the real bubble is simply a supply and demand issue. The demand, they say to their shareholders as they turn in street-beating profits quarter after quarter is outstripping the available lots and this the builders claim, is why prices are so high. Perhaps, but accommodative money plays a big role and as long as the money stays cheap and the banks are willing to take a slightly riskier stance with their lending, home builders will be eyeing every possible square inch on which to erect another profit center.
9 - Over-the-top bullishness, and I love a good upswing as much as the next guy, has gone as far as it is likely to go. The University of Michigan Consumer Confidence survey asked a simple question, and I'm paraphrasing: Do you think that it is a good time to buy a house? Almost half said that they thought it was but the reason was not because of the need to upgrade, the ability to buy more house for their dollar, or because they thought that owning part of the American dream is worth saving for but because they saw it as a worthwhile investment.
The alignment of a large portion of jobs to a market that may have run its course, loans to household incomes that are stretched by historical standards, and the possibility that much of the heat is being applied by a group of buyers whose whim could change very quickly should make even the most bullish of us just a little wary. That is, unless you think markets go on forever.
Comments about NW NJ housing are welcome since we are considering an upgrade, NOW.
Actually, one strategy is to sell now, wait for the bubble to burst and then by in again at bargain (or at least lower) prices.
This strategy is based on the fact that rents are lagging home prices. This, in itself, is evidence of a bubble.
I don't know what the real situation is but I thought you should get a response.
Paul
Bubble Ping
That was very informative. Thank you for that post.
I have no intention of buying a home until the market is way, way down from where it is now.
I'd rather buy a home when interest rates are very high, which decreases demand and forces prices down, so I get a good price on the home...
And then wait for however long for interest rates to come down again and refinance to get a better rate.
That is a gamble, of course, too...
However, even if interest rates remained high, I am in a better position to rapidly pay down the principal on $150K loan than on a $400K loan.
I think that (duh) refinancing while rates are low is very wise, but -buying- a new home when rates are low will likely mean you will be paying an inflated price, because of the increased demand and cheap money.
Restated: Buy a home cheap at high interest, refinance when rates go down. Do yourself a favor and make extra principal payments to hedge against rates staying up long-term. If you're lucky, you'll be able to refinance and gain a lot of equity. If you are unlucky, you will still have minimized the high-interest damage by those extra principal payments.
But, that is kind of like saying, eat well, exercise, and be healthy... Knowing that is the right thing to do only barley increases the likelihood that we fools that call ourselves humans will act accordingly.
You sell now, put your money into some safe investment, such as bonds or a diversified mutual fund, then rent for a year, and then next year you purchase an even bigger and better foreclosure house (or two) for less than you paid 10 years ago.
In Arizona an additional cause is the surge of California investors buying homes, even in lowly Yuma and out in the hinterlands. Yuma is popular for retired people and snowbirds, since cheap medical and dental are across the border.
Homes in Phoenix sell the same day after multiple bids above the asking price. Our home has almost tripled in value in seven years.
I knew someone who speculated in homes years ago. He was rich until no one would buy his latest new home. He also had a high end furniture store. That is something no one needs during a recession. He went bankrupt.
Me? I am re-financing for a lower interest rate. My credit rating has improved steadily, but the added equity in my home is a great boost in getting cheap money.
I hear many stories about risky mortgages. They will collapse when the slowdown occurs. I know one couple who spent their equity in their old home on three new cars. Soon a lender was asking me where they were. They had a new home they probably cannot pay for due to their over-spending. Their income of 75k plus is enough, but they have to keep up with their flashy friends.
To me the greatest danger is in younger couples spending all their money on new cars and cell phones. Both are money pits. They will never build equity.
Unless you are a venerable senior, you can;t hold on to that capital indefinitely without being hit with a large capital-gians tax.
That money has to be reinvested in a home short-term, or you get that fun little tax,
I lot of people refinance and use the equity to remodel.
If the so-called Bubble pops, who is going to get hurt? Not the person who has owned the house for a couple of years. The pop will be more like a fizz, with the housing market flattening or maybe a correction in some of the super heated areas. There is also 300,000 being destroyed each year, which the statistics don't account for.
It is free and clear, so we pay zip. We are retired, at three score and six, I am into risk aversion at this stage of life.
Theoretically, you could profit by selling, and renting while prices decline, and then buying again. The problem is that nobody has good enough timing to pull that off. You could also move to a smaller, less expensive house. Then, when prices decline, you take less of a hit. Once again, you need to get your timing right.
The only thing that you can do that will reliably put you in a better spot, probably, is if you are in one of the super-bubble regions like California or the NYC area, you could sell and move to a place that hasn't seen much of a run-up in prices.
See post 13 for my thoughts on that concept.
I know a couple who just borrowed 300,000 for a house last week with no income and no assets. They got a 30-year-fixed at 6.75% with fees under $1000.
Gee, is that a bubble?
Some interesting stuff out there on offer.
Last year I bought two investment properties...good tenents, great appreciation.
Looking for a shore property to buy before year's end.
Not worried about any 'bubble'.
Best time to buy real estate was yesterday!
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