Posted on 09/23/2006 9:38:39 AM PDT by GodGunsGuts
Reality setting in on real estate
September 2006
American’s castles (homes) are middle class walls of separation from poverty and want. As goes the house goes the family’s ability to fend off tough times and leverage past wealth for opportunity. Borrowing to bridge low income periods, college costs, medical expenses, bail, renovations, retirement and unemployment are all common. This is the proper frame of discussion for the impending debt/depreciation storming of the castle. A few basic facts are worth repeating. $1.06 Trillion in residential mortgages were written in 2005. Nearly 70% of Americans own their residences. The home is by far the largest asset “owned” by the bottom 80% of citizens. For the last 10 years, and particularly the last 6, things have gotten pretty darn wild in the real estate world. Perhaps unreal estate would be a better phrase?
Housing prices, refinancing, building and improvement, buying and fixation have mushroomed. Many have made significant gains in home asset value- at least on paper. There is no longer debate that things have gone way beyond anything that might be sustained. Such debates are silly and are better handled by psychologists and psychiatrists than economists. As a member of the latter, I will defer to those equipped to comment from real knowledge and experience.
The coming return to earth will be uneven, disorderly and proceed in fits and starts. This we know from past episodes and our extensive and growing experience with bubbles- the new engine of the American Macroeconomy. The housing troubles ahead are serious and this is largely symptomatic of the greater shake-out in progress. A significant portion of the middle class is no more. Housing is about to turn onto another serious problem for these beset masses. It will join health coverage and cost, pension woes, massive debt, intergenerational demands and stagnant wages. All of these afflictions are related and interacting. Wages have not kept-up, health care costs run several times the rate of inflation, and college tuitions soar. Aging parents require help with medical costs, children cost more and their early career wages don’t come close to supporting a middle class existence. Thus, longer and more expensive support is often required. There are no savings and pensions are shaky. Rising house prices were a godsend to many- financially and psychically. This will soon run contrary.
Housing appreciation has been the lender of first and last resort to millions of families. Refinancing, cash out or interest rate lowering, has paid for more than meager gains in wages- even after some very modest tax relief. After tax income gain, skewed up by salary scales and taxation changes, was about $375 billion in 2005. Depending on which estimate you accept; approximately $550 billion was extracted through cash out refinancing. It is clear that housing appreciation has become the crutch for many limping families. Rising home prices- unsustainably above trend and already decelerating- have been an essential enabler of bill paying and consumption. Housing appreciation thus, did more for American families last year than wage and salary increases. This is set to reverse. Mortgage News Daily has recently reported an ominous sign of desperation:
During the first quarter the median ratio of old-to-new interest rates was 0.98 which means that one half of borrowers who were refinancing mortgages ended up with a new loan with a rate that was two percent higher than the old rate.[1]
Thus, refinancing is clearly driven by the need for cash from appreciated housing more than rate changes - which should be discouraging. Such refinancing reached record levels across the first quarters of 2006 and accounted for just under half of the mortgages owned by Freddie Mac. 17 consecutive interest rate hikes were no much for the needs and wants of home owners.
Financial firms and employment have been massively assisted by the housing bubble. They are vulnerable to price stagnation and decline. The most recent FDIC Quarterly Banking Profile, while upbeat, offers some remarkable numbers. Across Q4 2005 residential home equity lines and mortgages accounted for 38% of new loans and leases.[2] This simply states that families and financial institutions are dependent on housing price gains. Households also gained - many directly and some indirectly - from the employment generated by housing. Across the early years of the post equity market meltdown (2001-2004), housing and related sectors accounted for over 40% of US private sector payroll growth. Since rate hikes began to effect markets, housing and related sectors have tumbled to account for less than 15% of private sector payroll growth. This is an ominous trend. As housing has cooled new jobs creation has cooled in tandem.
The fragility and risk associated with housing gains is very serious. The Office of Federal Housing Enterprise Oversight (OFHEO) releases a housing price index (HPI) for every quarter. In the 21 most recent quarters (Q12001-Q12006), the mean annual increase measured each quarter was 9.32%. In the 21 proceeding quarters the mean quarterly increase was 4.8%. Thus, as economic growth and labor earnings growth cooled, housing price appreciation rates doubled. In the last 5 years the average house has increased in price by 57%. Over the same period real GDP growth was 15%. The most optimistic White House Estimate of real after tax compensation increased by 8%.[3] Unreal estate price increases are just that. Brace yourself for a dose of reality that will fall heavy on the shoulders of those least able to bare the load.
Here the risks are extreme and the potentially impacted group is large enough to have macro significance. ACORN, a community advocacy group released, The Impending Rate Shock, on August 15, 2006. This report examines 130 metro areas and offers a first glimpse at the extent of risk and fragility of housing finance for lower income Americans. In 2005 adjustable rate mortgages (ARM) accounted for 24% of all residential loans and 75% of sub-prime loans. One million households have either received sub-prime loans or are at risk of foreclosure from mortgage burden. The average sub-prime ARM term to adjustment is 2 years and the base rate is the London Inter-bank Offer Rate (LIBOR) with added charges often equaling 5%. As of today LIBOR is 5.40%. The short adjustment horizon of sub-prime ARM means that many face dramatic upward readjustment soon. This will produce difficulty paying, increased default and lost purchasing power in affected communities. In short, housing wealth effects are in the process of resetting to run in reverse. Clearly this will occur sooner and more extensively in some places than others. This will last several years and be more than large enough to have negative macro effects on a par with the positive effects that we have seen across this long boom- now over!
We believe a pronounced housing slowdown will be followed by localized absolute declines in mean residence price. Given the exaggerated macro benefit that robust housing appreciation, refinance and associated activity have had, we are looking for a virtuous cycle to turn vicious with national and international implications. Low and middle income Americans will have to cut back on all forms of discretionary spending. The coming drastic reduction in purchasing of exports by suffering members of middle class- and soon to be former middle class Americans- will have global impact. Those who earn their keep producing and distributing to these masses will share in the pain as consumption spending is ratcheted down to levels at which America's families can service debts and stay within modest and pressured incomes.
What is good for housing may have been good for America. Likewise we fear the return of reality to real estate will exert a pronounced downward pull on national economic performance and have global economy implications.
(Max Fraad Wolff is a Doctoral Candidate in Economics at the University of Massachusetts, Amherst and editor of the website GlobalMacroScope.)
[1] mortgagenewsdaily.com/532006_Mortgage_Rates.asp
[2] FDIC Quarterly Banking Profile (http://www2.fdic.gov/qbp/index.asp).
[3] www.whitehouse.gov/cea/lazear20060502.html
Color me speechless!
When a guy with a law degree goes "speechless," he must have lockjaw. :)
LOL
Springtime 2009
Where is Carson Park? OK, I looked it up. My pic was 5635 Walnut Ave., not far from Carson Park. Fancy that. Do you know that neighborhood?
Unless you're trying to buy for the first time. Then it's damn-near impossible.
Not here in Ohio, but in many places. My well-above-average income couldn't buy a starter home in these locales unless I wanted to give up niceties like food, heating, water, and clothing.
It ISN'T over $90,000 in the midwest. I couldn't imagine paying $400 grand for that dump.
Jeez I hope not. I hate renting.
I'd rather own "real" estate than unbacked dollars.
That post was SARCASM.
Good attitude...
That's basically my position.
I make no bones about the fact that in CA (and some other areas) real estate is ridiculous, but it always has been (well, since the 80s) by my standards here in the Midwest (and the higher salaries DO NOT compensate for it, I have done the math.)
However, the market seems to work. It might soften a bit, especially in such areas, to where we'll see an inflation-adjusted decline. No mass nationwide crashes. And in the areas that don't have sky-high prices in the first place, I wouldn't expect a decline, either.
A Fed rate cut, though, encourages investment.
None. Unless the massive crash that some chicken-littlers scream about happens, which could affect the economy and therefore your income, but that can always happen.
Personally, as someone employed in such an industry, I have a bit of worry about HAVING a job...but my last post suggests my position on the subject.
The way to make money, dependably, in ANY real estate market, whether it be Cleveland, DC, San Diego, Boston, or Grand Forks, North Dakota, is to buy UNDER MARKET VALUE something that needs some real blood, sweat, and tears, along with some materials.
The guys that buy, wait, and resell without doing a damn thing are the ones that will lose their shirts. I don't think a CRASH per se will occur, but they'll have to hang on longer than they thought and if they're straight investors with no interest in actually keeping the home, they may have a problem.
The guys here in Ohio that buy low-income neighborhood homes for $14000 at the Sheriff's Sale, put $17,000 plus some sweat into them, and sell them to a family for a fair price of $76,000 three months later will continue to do that and do just fine.
figures lie, liars figure...
Bttt
What most people don't understand is that the market os only on the surface driven by supply and demand.
The real question is liquidity.
If the lending institutions for whatever reason start to cut back on available financing, prices could plummet.
Cash would be king.
I hear over and over "Boy, if prices fall I'm gonna scoop up some real bargains!" Only if you either have cash or can get financing. Because you WON'T BE ABLE to get whatever you think your place is worth now.
this is mostly true
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