Posted on 12/28/2007 12:09:11 PM PST by shrinkermd
In 2002, the median price of a single-family home in Los Angeles was $270,000 and the median homeowner's income was $65,000. With a $50,000 down payment, the annual cost of that house (taxes, insurance and payment on a 30-year fixed-rate conventional mortgage) would add up to about 33% of the median household's income -- just under the 35% mark that the Federal Housing Administration calls the upper limit of "affordable."
By 2006, the cost of that same house doubled, to $540,000 -- pushed by unbridled speculation fueled by unparalleled access to mortgage capital. But median income rose a paltry 15%. So today that same set of costs come to 60% of gross income.
That might be a manageable burden when home prices are rising at double-digit rates, creating new equity that can be accessed to support spending -- but not when prices are flat and the home-equity ATM is closed.
There are "experts" out there who once preached that there was no bubble; they now preach that all real estate is local and that prices in your neighborhood won't be affected by foreclosures and price declines elsewhere.
The cold, hard truth is that foreclosures are serving only to hasten the painful process of shifting housing prices back to a level the market can sustain. Prices must and will fall. Everywhere. Probably 25% to 30% from their peak.
(Excerpt) Read more at latimes.com ...
It depends what part of the country you're looking in. I looked at foreclosures in the SF Bay Area a few months ago, but the prices were nothing to get excited about. The amounts owed on houses were almost the same as similar houses on the open market. I figured out that the owners in default had probably been paying just the interest on their mortgages, leaving the principle intact. Then when the higher rates kicked in, they couldn't keep up the payments.
Buying a foreclosed house is not always a straightforward process. In some states, owners can redeem their former property within a year, even after a buyer has purchased it. It would have to be a really good deal before I would get involved in a situation like that.
vaudine
under old bankrupcy code the 150k could be stripped off the house and the mortgage renegotiated for the secured amount HOWEVER the new code dropped that for now.
There is a move afoot to bring the lien stripping provision back either by case law or by legislation.
when they lobbied and were allowed to blur the line between banking and selling securities we got sub-prime products which were packaged by the lenders, bundled, bought sold by the investment house divisions.
some these junk bond investments have gone bad and the bankers and investment houses want a government bailout and have shut down the mortgage mills which fed the housing market
Home prices are falling because lenders don't want to lend
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“That’s my point. The bank’s money went to the original seller. It is a zero sum game.”
But that’s the wrong point. Forget the seller. He’s got his money and is out of the picture.
It’s the bank’s money that disappears. They expect to be repaid the $500k, but instead are repaid only $350k. The 150k is gone.
THAT is the disappearing money.
The problem, of course, is that the assumption that this asset would maintain or even increase its value over the life of the loan was incorrect. The recent, rapid rise in housing prices, which far out-stripped the rate of inflation and which was fueled by speculation and "easy" credit, was clearly unsustainable. Buyers and lenders should have realized this but many let greed cloud their judgement.
Having read the whole thread, I knew exactly what you were talking about. However, I only agree with most of what you say.
JasonC: “No, the real value is the price at which the market *clears* - meaning *every* seller finds a willing buyer.”
That’s exactly what I meant. The market value is whatever it sells for. If you can’t sell it, it isn’t necessarily worthless, but you are likely asking more than the house is worth.
I don’t know for sure how much unsold inventory is out there. From news reports, the crisis is bad. However, they hype things. Personally, I don’t see how it can cause that much grief for people who have owned their homes for several years, who aren’t in an inflated market, and who don’t need to move for several years. For those who purchased at market highs and now need to sell...that’s a different matter.
“The problem, of course, is that the assumption that this asset would maintain or even increase its value over the life of the loan was incorrect.”
Exactly, and the difference between the assumed value and the actual value of the asset represents money that “disappears” - this is the point I’ve been trying to make to Soliton. It most certainly is not a zero-sum game.
The money that “disappears” has a great economic impact - and not just on the former holder of the mortgage - multiply times a million or two, and you get real money disappearing!
I agree, with some limited exceptions. When we bought our first home we knew we wouldn't be staying more than 4 years (my company moved me to a different state), so we got a 5 year ARM at 5.25%. Just under 4 years later we sold, and we have a 6% 30 year fixed mortgage on our current home.
I think an ARM can make sense in limited situations, and if you're not using it because you can't afford to pay the mortgage with any other mortgage type.
RFEngineer: “The money that “disappears” has a great economic impact - and not just on the former holder of the mortgage - multiply times a million or two, and you get real money disappearing!”
The money doesn’t disappear. Let’s say I take out a $500K mortgage on a house. The seller gets $500K from my lender (who gets the $500K from owners/investors). Total cash involved is $500K. No actual money is gained or lost. If the house subsequently drops to $350K, it’s irrelevant so long as I honor my debt. I will still pay the bank $500K plus amortized interest (approximately $1.5 million if I pay off the loan). If I default, the bank loses the difference between the loan and the amount it can recover from foreclosure, or $150K in this case. However, I’m still liable for the difference, unless (I think) I declare bankruptcy, and the original owner still has the $500K. Either way, money was neither created or destroyed in the process.
Another example, let’s say I buy stock at $10 a share. The seller pockets that $10. If I subsequently sell the stock for $5 a share, I have a loss of $5, but that $5 was transferred to the original owner. It didn’t simply vanish. If I sell the stock for $20, the new owner transferred the extra $10 to me. Again, it didn’t actually create or destroy money. It simply moved money from one person to another. Short of the federal government creating more dollars, no new dollars enter the market.
It really doesn’t matter if a stock I purchased for $10 is presently priced at $1 or $1000. Until I actually sell it, I haven’t gained or lost anything.
“If I default, the bank loses the difference between the loan and the amount it can recover from foreclosure, or $150K in this case. However, I’m still liable for the difference, unless (I think) I declare bankruptcy, and the original owner still has the $500K. Either way, money was neither created or destroyed in the process.”
I think that keeping the original owner in the picture only confuses things. Yes, he got his money and now he’s gone.
For all intents and purposes, the bank is now the owner, and they “paid” $500k, and are only getting repaid $350k - under a “short sale” which are commonly being negotiated, the bank takes it in the “shorts” for the $150k - because they know that this debt will likely not be repaid.
It is very unlikely that folks in the subprime market are going to be willing or able to repay the original basis of the loans. So when they don’t pay, and you can’t beat the money out of them, the banks money has “disappeared” as surely as if they threw cash in a barrel and set it on fire.
THAT is the problem - banks made loans they shouldn’t have to people that couldn’t repay them if the market turned down. The banks now have to make up the difference with the capital they have on hand, which makes the credit market even tighter.
This is the very reason why banks used to require a 20% downpayment - so they were only risking 80% of the asset value should the homeowner default. It was a good idea then, and is today, and that’s how it’s going to be in the future - the past 5 years or so will be an object lesson in poor lending practices that will be pulled out for decades to come in economics classes.
OK, I think I see what your gripe is here. The overly broad term ‘speculators’ being used here.
I think you and I would agree that there are smart, or informed, speculators, and there are dumb, or uninformed. I’ll narrow my assessment to “uninformed” or “dumb” speculation here, just as we can agree the late-cycle, dumb stock speculators in the dot-bomb bubble were a problem.
In the “hot” real estate markets, I believe when we finally see the history of this real estate bubble written (or heck, we even write it ourselves), there will be a chapter devoted to the dumb speculators, the small-time folks using interest-only or option-ARM loans, stated income and possibly even mortgage fraud (eg, claimed to live in speculative properties to gain financing).
As for the actions of the Fed: following 9/11, I agreed with the idea/action to inject liquidity into the markets. Where I don’t agree with the Fed was that they withdrew the liquidity far too slowly (why raise the Funds rate only 25bp at a time? What’s preventing 50bp?) and Greenspan’s support for “innovative” mortgage products. There’s a reason why mortgage bankers have required 20% down on properties in the past, and it wasn’t a desire to exclude some people from buying a home. It was simply prudent.
The Fed needs to lose any role in banking regulation and be allowed to only worry about open market operations and currency/monetarism issues. Banking should be re-regulated because we can’t afford these banking industry melt-downs.
Smart speculators, or professional speculators, are useful and necessary in a free market. On this, you and I will agree, I’m pretty sure. Without speculators, we lose rapid price discovery, we lose market liquidity, etc. Dumb speculators give the professional speculators a bad name.
What I believe is necessary to weed out the bad speculators from the good speculators is a requirement of at least 10% margin in a speculation. That’s what is necessary in the commodities markets, that’s what used to be the rule in the stock market. In this most recent RE run-up, tho, we see a huge disparity in the margin required to speculate in commodities and stocks vs. residential real estate. Think about how leveraged these speculators were with the loan products out there that allowed them to pay only interest on a $250K house - that’s huge leverage, inviting some really outlandishly poor risk management. It would be as if you or I were buying stocks (with poor liquidity to boot) on margin with only 1% in the trade. That’s gonna attract some really stupid speculators who will be wiped out, to be sure. A professional speculator would look at this behavior and know that the market is going to fall - because the professional speculator knows when too many people are on one side of a trade.
Any loan involves risk, even one secured with hard assets (those assets may not be worth assessed value). There’s nothing wrong with risk taking so long as the risk takers bear the responsibility for failure, but it seems risk wasn’t always accurately predicted in this housing bubble. Too many people expected great profit with little or no effort. That’s nearly always an indicator of an unwise investment.
Exactly right — and that gets to the crux of the macroeconomic situation here. Problem is, how do we design a system in housing whereby people who are caught up in the debt melt-down don’t lose their homes, but yet we deliver the appropriate losses and pain to unwise speculators?
There aren’t any easy answers here, because as discussed previously, even if you could perfectly determine which borrowers are which and foreclose on the speculators with ruthless free-market efficiency, the dynamics of residential real estate markets will punish the real homeowners by the mere presence of unoccupied houses previously owned by speculators driving down the valuations in entire neighborhoods.
This, I suspect, is why there is anger out there at residential real estate speculators: if you choose to not speculate in stocks, and the stock market crashes, you and your checking/savings accounts are pretty much unaffected. If you own investment grade bonds for the income (as many older folks do) and junk-grade bonds take a crap on a collapse of speculation frenzy, you’ll still clip coupons quite safely for years to come.
But in residential real estate — even if you’re an honest, mortgage-paying homeowner — if there was significant speculation in your neighborhood/development, you’re going to suffer the results of speculator foreclosures and bankruptcies - increased crime, decreased valuations, etc. There was nothing you could do to prevent it, and there’s nothing you can do to hide from it in some places.
This, I believe, has something to do with the anger directed in an unfocused way at “speculators.”
Prices have already fallen that much in some places in CA....
As a rule, I don't think that lenders are able to collect this difference when borrowers default on their mortgages. So, for all practical purposes, lenders do lose money in these situations.
I’m a big fan of the free market, but I think you’ve hit on a key point. If a market melts down due to speculation, everyone suffers. On the other hand, I’m no anarchist, and neither are most Americans. Perhaps this is an area where government regulations need to be changed to #1 force lenders to properly rate the amount of risk and #2 force speculators to put up a greater percentage of their own money/assets. As I recall, some sort of AAA financial devices were involved that essentially hid the risk. I don’t see how a sub-prime mortgage could ever qualify as a low risk investment unless the borrower had on-time payments for years. Did government regulation have a part in this meltdown in the first place?
Do you guys read your own posts? The difference between assumed value and actual value is simply a faulty assumption, not the loss of real money. Edie Murphy assumed that the prostitute he picked up was a woman. When he looked under the skirt and there was a winky under there, didn't mean that the universe was suddenly bereft of one bagina. He made a mistaken assumption.
For money to be truly "lost" it must be destroyed. Otherwise it just moves from one person/ entity to another.
“The difference between assumed value and actual value is simply a faulty assumption, not the loss of real money”
But the bank loaned real money......and that money is not going to be repaid.
If I loan you $100k, and you repay me $50k we have more than just a faulty assumption at play. This is what is happening every day now. Real money disappearing.
I really did not think this was going to be that hard to communicate, but hey, I’m gonna keep trying....
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