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
I'm glad you admit that emotional garbage coming from me would truly come as a shock to you. You are absolutely correct IMHO d:op
I think the authors point went right over your head and parted your hair. Read it again.
Returns to earth are often painful.
According to some on this thread, what goes up, stays up...forever.
http://www.schwab.com/public/file?cmsid=P-1536370&filename=5.gif
Is that in Pasadena, by any chance?
"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."
Maybe "made in USA" will make a comeback.
Now there's a thought! I wouldn't say that too loud on this thread. Some might find it un-patriotic!
It's like when our local city council gets a $25M property tax increase instead of a $28M increase and one of the coucil members throws a fit because of "budget cuts"
It's like when our local city council gets a $25M property tax increase instead of a $28M increase and one of the coucil members throws a fit because of "budget cuts"
What zip code is that house in? You know, location, location.
What he is saying is that the housing prices have become unaffordable for first time buyers or for buyers with little equity who earn what he earns today.
Your argument makes his house "affordable" only because he already owns the house which he bought at good value in 1991 and you calculate the equity as part of his net worth. Your argument also assumes that he has not mortgaged his equity away by taking out a home equity loan.
Gimmick loans have flooded the market with dollars that the borrowers will not be able to repay once the interest-only grace period expires, the increased interest rates kick in and the principle repayment is compressed all into the remaining term of the loan.
That easy money has artificially inflated prices way beyond the actual value.
The situation is analogous to banks loaning everybody in a small town $3 million at terms they cannot repay and then seeing the price of a gallon of milk go up to $75 per gallon at the local supermarket and people in that town calculating their "net worth" by how many $2,500 pairs of Docker's slacks they own and by how their kid just bought a $100,000 mutt puppy dog by exchanging him for two $50,000 mutt kittens that the kid next door wanted to sell.
The only way you can afford to buy houses today is to either enter into an extremely foolish loan arrangement or pay for the new house with money that you received from someone that has entered into an extremely foolish loan arrangement.
Those "greater fools" are now in extremely short supply and the last ones who entered the Ponzi scheme are now getting fried.
Those of us who bought our houses at good value and have not mortgaged our equity away will do just fine.
We bought value. We did not buy a lifetime of mortgage slavery.
Long term rates have been going down for months, and that trend is going to continue. Foreign central banks have already pulled back their purchases of bonds. Guess what? There have have been plenty of other buyers and rates keep going down.
Yup.
What if the Mullah's incinerate D.C.?
Beleive me, I've heard the argument ad nauseum and memorized it. My point, supply and demand works. If something is overpriced, don't buy it, and don't take out a ridiculous loan to leverage something you can't afford. Buy something small and out of the way and you'll do fine. Unlike the doomsayers, there is plenty of real estate under $150,000. Plenty. And if you can't find it in the place you want, well, when the dreaded "crash" comes, there will be.
I believe its located in the inner city area of Long Beach, in Los Angeles County.
doom
Here's what Trader Dan from JSMineset has to say on the subject:
Net Flows and Treasury Purchases
Dear Jim,
Attached are two charts – the first details the balance of trade and compares it to net capital flows for each month. As you can clearly see, this morning’s report on net flows was abysmal. The shortfall was the largest in the last 3 years detailed on this chart, coming in at - $35 billion.
The second chart details the rate of purchase of Treasuries by the big three Asian economies, China, Japan and S. Korea. I have also included Great Britain since I believe there are some “funny” goings on there with hedge fund buying of US paper going through London. Needless to say, they have been carrying the slack in the US debt market. Look at the huge percentage increase coming from Great Britain for the last two months when compared to 12 months ago.
In another one of those “counterintuitive” and “perverse” moves in the dollar that we are becoming accustomed to of late, the dollar basically shrugged off the data and instead, participants chose to focus instead of the G7 communique which was viewed as less “threatening” to the Asian currencies and thus dollar bullish.
As long as the interest rate differential between the yen and the dollar is where it is, the yen carry trade will remain in full force. This could help to explain the huge surge in Treasury buying out of London but I am convinced there is more to that than meets the eye. Regardless, the yen has become the whipping boy against the Euro and the dollar as a result. It seems as if everyone and their mother is selling the hapless thing. The Japanese monetary authorities must be jumping up and down in uncontrollable joy.
Best wishes from your pal,
Dan
Two PDF charts:
http://www.jsmineset.com/cwsimages/Miscfiles/3422_Charts_for_09-18-2006.pdf
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