Has the bubble burst?

In mid-2004, John and Karen Philbrook bought a home in Sacramento’s North Highlands neighborhood, when buying a house seemed like a sure ticket to security. They opted for an interest-only, adjustable-rate mortgage and counted on the value of their house continuing to rise as a way to build up equity. ...

In 2004, Karen and John realized their dream by buying a house in the North Highlands section of Sacramento that’s situated several miles northeast of downtown. It’s a small, three-bedroom bungalow, with a brick chimney running down its wooden exterior. With John’s two jobs and Karen’s at Safeway, the Philbrooks believed they could manage the mortgage. They were on their way to building their own personal American Dream and creating a secure future for their young daughter, Nicole.

“We prayed and prayed and prayed to have a home,” recalled John, a large, suntanned man, his muscular arms highlighted by a sleeveless blue vest as he sat in his backyard. “This is perfect for us. I come out here, throw up my hammock and lay out here on a Sunday afternoon. It’s perfect. It’s like a park back here. We’ve got fruit trees: oranges, plums, a pear tree there. Those are pistachios.”

“I could own a dog now,” Karen said, recalling her sense of elation when they moved in. “Having a place we could call our own. Not having to worry about apartment rules. Total freedom. It felt really nice to have our own place--we’re achieving something in life.”

For John, it seemed a perfect story of redemption, perhaps even a quintessential American story of second chances and reinvented lives. Then, earlier this summer, a note from the Philbrooks’ mortgage broker arrived in the mail. Overnight, the note informed them, their monthly payment was increasing by close to $500. And the Philbrooks, who had about $900 saved up for their daughter’s future, a few hundred more for emergencies and nothing in reserve beyond that, realized their entire dream now stood ready to fall.

Over the past year, as interest rates have risen and for-sale houses have sat unsold for months, much has been written on various aspects of the housing market.

Journalists and analysts--not to mention homeowners or potential buyers--want to know: Is the current slowdown just a blip in an otherwise vibrant market, or is it the end of a decade-plus bubble? Will national trends be magnified in Sacramento’s suburbs, which have seen startling appreciation in house values in the recent past? Will the air in the bubble gradually leak out, giving people time to adjust their expectations and their financial planning, or will it burst spectacularly? Will interest rates continue edging upward? If so, will the real-estate market collapse, when it becomes impossible for new buyers to make offers that are acceptable to sellers who bought homes when rates were low and prices were high?

Much of the ink spilled on this has examined these issues as a series of isolated problems. It’s becoming clear, however, that the problems are interlocking. Indeed, there’s a fear voiced in real-estate circles that some parts of the country, including Sacramento, might be facing a perfect storm in which the true losers are families who borrowed cavalierly without adequately crunching the numbers. Families like the Philbrooks--who, at the urgings of sometimes-unscrupulous mortgage brokers, seriously over-extended themselves at the height of the housing boom--now will pay a high price for reaching toward the American Dream.

This summer, analysts delivered bad news for Sacramento. It’s now one of the five riskiest housing markets in the country, according to a report issued in June by PMI Mortgage Insurance Co. Factoring in home prices, wages in the local labor market, local unemployment rates and the percentage of families’ average monthly income now spent on covering home costs, PMI predicted that there was a 58.5-percent chance home prices would decline in the next two years. That number was up from 41.9 percent a year earlier, already a far higher risk rate than in much of the rest of the country. Sacramentans, the report warned, paid 30 percent more as a percentage of their monthly income toward housing in 2006 than they did in 1995 before housing prices spiraled so sharply upward.

Another blow came that same month, when National City Corp. estimated that the Sacramento housing market was severely overpriced--along with 39 percent of the 317 U.S. markets included in the survey--to the extent that it was at risk for a price correction.

“We think people are stretching by getting different kinds of mortgages, what Alan Greenspan called the 'exotic’ mortgages,” said PMI’s Beth Haiken. “We do know these mortgages have become much more popular in the last few years. They give you a lower payment in exchange for additional risk. They all work by transferring risk to the borrower--higher-interest balloon payments.”

“You’re seeing people who were living off the equity in their house. It worked real good for three or four years,” said attorney Scott Coben, a bankruptcy specialist who works out of an airy office, built around an inner, roofed atrium decorated with palms and tropical plants, in downtown Sacramento. Seeing their houses keep appreciating, Coben explained, homeowners borrowed against the increased paper value of their property, essentially living off the promise of an eternally rosy real-estate environment. “But now the gravy train is coming to an end. They’ve got the credit cards, crazy loans, 40-year mortgages, and they’ve done refinancing. A lot of them are going to lose their homes.

“People were just totally unrealistic about real estate--refinancing to sustain their lifestyles, or people who got in the game late took out horrible loans to get real estate,” Coben said. “They’re getting killed now.”

“There are a lot of properties on the market now where I see people in that position,” asserted Patti Priess, a local Dunnigan realty agent. “All of a sudden, in a market where foreclosures were not the norm, I’m seeing in the comments 'pending foreclosure.’”

By the early months of the summer, 1,352 Sacramento County homes had default notices filed against them in the second quarter of the year, the highest number in nine years, according to DataQuick Information Systems, a La Jolla company that tracks California’s real-estate market. Surrounding counties also saw significant increases in default activity. That represents an increase from the previous year of 109 percent, while across California foreclosures increased only 67 percent, according to Foreclosures.com. RealtyTrac Inc. ranks the capital region as the second-highest area in the state in terms of foreclosures.

John Philbrook relaxes in the park-like perfection of his own backyard. Photo By Larry Dalton

Some homeowners, while escaping foreclosure, are being driven out of the real-estate market entirely. One couple Priess represents moved to Palo Alto, put their Sacramento house up for sale and watched in horror as the market softened and the house remained unsold. “They’ve been in Palo Alto unable to purchase a new home, and their house here is empty. And we’ve reduced the price and reduced the price,” Priess said. Still, they have been unable to sell it.

The number of people looking to declare Chapter 13 bankruptcy as a way to avoid foreclosure is mushrooming, Coben said. While the filer’s credit goes into the toilet, bankruptcy allows some breathing room to set up payment schedules and avoid losing everything.

The attorney also says he’s seeing an increase in what are known in the real-estate business as “short sales.” In a short sale, the lender gets less than the amount owed on the loan. It’s a better-than-nothing alternative for the lender and often an only alternative for the homeowner or borrower. Short sales strive to avoid a situation like the following. Because most banks issue mortgages for only 80 percent of the home value, some cash-strapped buyers take out second loans to finance the entire cost of their homes. If buyers with these kinds of cobbled-together loans default on their mortgages, the home is sold under foreclosure, and the second lender typically forfeits its lien, losing everything. To avoid this situation, Coben explained, the second lender agrees to a “short sale.” The home is sold quickly at a low price, and the lender of the second mortgage accepts a discounted payment. It allows an escape for the borrower, but the price is temporarily wrecked credit, no money left over from the sale and a tax obligation of thousands of dollars, since the government counts the money not paid back to the second lender as income paid to the borrower.

Borrowing 100 percent of the cost of a home in a changing market may not be the most serious problem some homeowners currently face. A slew of “exotic” mortgage options add their force to the “perfect storm” some argue has hit Sacramento’s housing market. Many of the individuals most at risk took out Option Adjustable Rate Mortgages. These allow borrowers to make monthly payments for a temporary period of time that don’t even cover the interest accruing on their loan. The unpaid interest gets tacked onto the loan, and many buyers never notice the fine print stating that after a couple of years their interest rates will soar. Others bought a variety of loan products, including large loans against future appreciation in equity taken out by some longtime homeowners that are proving risky in a climate of market slowdowns and interest hikes. Still other borrowers, like John and Karen, agreed to interest-only mortgage payments on loans covering 100 percent of the cost of their homes but which don’t permit for the accumulation of any ownership capital in the property they are paying a mortgage on.

In the Philbrooks' case, John and Karen borrowed almost the entirety of the $244,000 cost of their modest North Highlands home: One loan was written for $195,000 at 6.375-percent interest; another financed the remainder of nearly $45,000 at 9.125 percent. The rate on the small loan was fixed. But on the large loan, the rate was fixed for only two years, and after that it was variable.

John said the Realtor who arranged the loan verbally assured him it would never go up by more than a quarter of 1 percent at any time. In fact, in the (very) small-print clauses attached to that loan were four poison-pill provisions.

Having not understood the small print of their contract, the Philbrooks were unaware that the loan’s rate would never be lower than its starting rate--meaning all the risk attached to the variable rate fell on them. Neither did they fully understand that the interest rate could never go up by more than 1 percent in a given month, except for the first increase, when it could leapfrog to 9.375 percent in one go, and from then on rise incrementally to a maximum of 12.375 percent. They weren’t aware that their variable rate was tied not to the prevailing mortgage rates but to a market index based out of London, which circulates money at a far higher rate of interest than does the fixed-rate-mortgage market. The final poison pill--a $7,300 penalty if they chose to seek new financing during the first three years--discouraged the Philbrooks from refinancing once high rates kicked in. Not understanding the first three provisions, the couple were not fully appreciative of the dangers of this refinancing clause.

What does all of this mean? When the contract is teased apart, it’s clear the Philbrooks signed a real-estate deal guaranteed to boomerang back on them two years later in a staggeringly unpleasant way. “Life’s a losing gamble without Jesus,” reads the decal on the bumper of the Philbrooks’ old pickup truck, part of a package of religious iconography that dots the family’s vehicles as well as the walls of its house. Quite possibly, the Philbrooks’ failure to read the fine print represents a similarly blind roll of the dice.

On the day of the couple’s 14th wedding anniversary, John said, “We got a notice saying the payment had increased from 6.375 percent to 9.375 percent in just one month.” Sitting at his small dining-room table, he recalled his startled reaction that day: “Oh my gosh. How am I going to pay the mortgage? What am I going to do with my family? I can’t afford this.”

Overnight, the monthly payment on the $195,000 loan went from $1,350 to $1,841. Factor in the payment on the smaller, second loan, and the Philbrooks now were paying $2,250 a month servicing their mortgage. Since Karen and John bring home a total of about $4,000 after taxes each month from their three jobs, this was a crushing burden. Add in two hefty car payments, utilities and insurance bills, and that didn’t leave much left over for such necessities as food.

“This was our first time purchasing a house,” Karen said. “When the interest rates went up, we were told it would go up just a little bit. When it went up more than that, it went up nearly $500. My husband had to get a third job, give up his Sundays. It made me feel like, 'Wow, you can’t trust anybody anymore.’”

Undoubtedly, John and Karen were staggeringly naive in signing such a contract. The problem is that the Philbrooks aren’t alone. During the heady days of this most recent real-estate boom, increasing numbers of people borrowed 100 percent of the costs of their homes. And since banks are reluctant to finance such risky mortgages, frequently these homebuyers ended up signing contracts with fly-by-night operators whose profits, while legal, were largely generated by convincing clients to sign dubious deals such as the one bought into by John and Karen. With today’s shifting real-estate sands, those contracts are starting to hurt, and badly.

“Loan officers, they’ve replaced car salesmen as the shadiest people you deal with,” John said, bitterly.

As the summer unfolded, staving off insurmountable bills and foreclosure on their home became the Philbrooks’ overriding priority. They wouldn’t, couldn’t, accept that a dream they’d adhered to so obstinately was rapidly becoming a nightmare.

“I told my wife, 'We’re not going to lose this place,’” John said in early August, with a determined, if somewhat hollow, optimism. “I’m not going to do anything illegal ever again, but I’m not going to lose this. I’ll get a third job. I don’t want this to be taken from us.”

John applied for yet more employment, eventually getting an offer to work another several nights a week as a security guard at a local country club. Ultimately, he wouldn’t have to start this job. If he had, though, he would have been working well over 80 hours a week, missing several nights’ sleep and hardly ever seeing his daughter. It was a steep price to pay, but for John and Karen it seemed the only way to keep their house.

“[The realty company we chose to sell our house] gave us a sign last week. But we haven’t put it up yet. I guess we’re embarrassed. My wife’s humiliated that our neighbors will see we’re selling our home. I don’t want to rent my whole life. As corny as it sounds, it’s the American Dream--it’s the dream for most people. I don’t think we’ll lose our house, because we’re praying for it. And I don’t think God would leave us like that.”

Reluctantly, the Philbrooks put their house up for sale, listing it at $279,000. At that price, they would be able to walk away from their venture into Sacramento’s housing with a few thousand dollars in their pocket. If it sold for less than the asking price, however, they’d start losing money on the whole deal. Worst case: They couldn’t sell at all, a not-unlikely scenario in a housing market glutted as of the end of June with more than 16,000 homes for sale in the surrounding region--a more than 60-percent increase since the start of the year. In that case, they’d lose their house to the mortgage company and go into bankruptcy in the process. That fear explains why they readily listed their house for $21,000 less than its appraised value of $300,000.

“Because there’re so many houses on the market right now,” John explained. “After we’d paid all the fees and stuff, we’d probably come out with $10,000.”

As it turned out, the Philbrooks were lucky. After working the phones and approaching several different brokers, they managed to get a new mortgage in August. They ditched their interest-only, variable-rate mortgage and locked in a 30-year, fixed-rate loan at a little over 6 percent.

But luck in this uncertain market is more a matter of not losing everything than of actually coming out ahead. In fact, the Philbrooks’ two-year venture into Sacramento real estate will, over the decades of their mortgage, cost them a huge amount more than they’d originally anticipated.

After two years of making monthly payments that covered only the interest on their $240,000 initial debt, they now had to borrow to pay the $7,300 opt-out provision and cover the debts they’d incurred during the chaotic summer of 2006. In the end, they borrowed $260,000--$16,000 more than the initial cost of the house--at a higher rate of interest than they were paying when they first bought the house in 2004.

Since they weren’t paying anything toward the principal of their mortgage between 2004 and 2006, they didn’t have any more equity when they refinanced in 2006 than when they moved in. For those 24 months, all John and Karen had done was pay close to $2,000 a month servicing their debt. This was a far higher monthly payment than if they had been renting during this time.

And to cap it off, instead of only having 28 years of mortgage payments left, they were back to square one, owing 30 years of payments at an additional $150 a month, making for an extra $54,000 in payments (spread over three decades) more than their first mortgage. By any measure, this wasn’t exactly a sound business proposition.

“I don’t feel secure,” Karen admitted. “I feel like I have to keep my house. I feel grateful, though, that we’ve come this far. But I don’t feel as secure as before. I feel I have to pay more attention, be more alert, watch the spending and everything now. I can’t relax.”

"Forget the drug industry! All of those super-dooper machines and tests and LAW SUITS are what has mostly increased the disastrously high costs of health care today. And the overuse and misuse has been of criminal proportions for the last 30 years."

The lawsuits are a major problem with the delivery of health care by providers; doctors, clinics, hospitals, etc. And personal injury attorneys really have done a lot of harm in that regard. But though they have had some effect upon the increases in prescription drug costs, they are not the major source of the rise in prices. The figures gleeaikin has put up about profit margins must be considered part of the mix. The prescription drug industry does enjoy a higher margin of profit than most other industries by comparison, and that fact cannot be divorced from the rising prices of the goods they sell.

". . . You really have to drop your inclination to unadulterated MARXISM. This IS a CONSERVATIVE forum. All if this damned class warfare and replies filled by same, is just out of order here. . . ."

There is nothing Marxist about asking questions of the social impact of current policy. The "Marxist test" is in the solutions one advances and I saw nothing in gleeaikin's posts which suggests public ownership of the means of production. What I see in gleeaikin's argumentation is a call for more intelligent regulation. Now the subject of regulation does bring conservative principles into view, because we conservatives do not favor an intrusive government that interferes with market forces, but there must be limits. To say there can be no regulation is to deny that there is such a thing as "price gouging," and that goes too far.

To judge whether or not the prescription drug industry is engaging in price gouging requires the presentation and examination of two types of evidence; external, or what we can see "from the outside looking in," and internal, or what we can see "from the inside." To go to the internal evidence first, there has been very little argument advanced in this thread thus far to show that, by an examination of the individual prices for specific medications prescription drug manufacturers are charging, that their pricing policies either are or are not justified. gleeaikin has presented the external evidence, which is their profit margin. And on that basis we can say that we at least have reason to question whether or not price gouging is taking place, given that the profit margins the prescription drug industry is enjoying are quite a bit above other major industries.

So do we leave conservative principles behind whenever we raise the question of the regulation of prices charged for prescription drugs? My clear answer to this question is "no we do not because unregulated prescription drug prices directly impact federal spending, which true conservatives wish to control." A significant portion of the costs of prescription drugs are borne by a segment of our population, the elderly, who are in large part dependent upon the federal government for their material well being. Many of them count upon Social Security and Medicaire to make their lives affordable. We are already seeing that the Medicaire prescription drug benefit will be much more expensive than anticipated -- this will amount to hundreds of billions of dollars of unforeseen costs over the next 10 - 15 years -- and fiscal responsibility, a true conservative value if ever there was one, demands that we address the problem. I will not deny that a true conservative can advance the argument that the federal government never should have taken on the responsibility of funding prescription drug costs for seniors, but the fact of the matter is that the legislation is in effect and there is no political will to repeal it. So if we operate within the realm of the possible, we must come to grips with the fact that rising prescription drug costs threaten the fiscal integrity of the federal budget and that could potentially lead to tax increases. And I know of few issues that separate conservatives from liberals more readily than tax policy. We must get prescription drug prices under control because, if we do not, taxes will be raised destroying a significant part of what we conservatives have accomplished over the past 25 years for America.

-------------------------------------------------------------------------------- To: churchillbuff "In the Philbrooks' case, John and Karen borrowed almost the entirety of the $244,000 cost of their modest North Highlands home: One loan was written for $195,000 at 6.375-percent interest; another financed the remainder of nearly $45,000 at 9.125 percent. The rate on the small loan was fixed. But on the large loan, the rate was fixed for only two years, and after that it was variable"

stephenjohnbanker wrote: "There will be a TRILLION dollars in keys mailed back to the mortgage companies. And the fed will bail many out.

13 posted on Friday, September 22, 2006 8:56:35 PM by stephenjohnbanker (Our troops will send all of the worlds terrorists to hell in a handbasket with no virgins!) [ Post Reply | Private Reply | To 1 | View Replies | Report Abuse]

A thousand internet points for your foresight ;^)

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