I must admit that in recent comments, it appears that Mr. Greenspan has truly removed the gloves with respect to the housing bubble. While I remember the days of the mid 90′s where Alan’s comments were both cryptic and couched in complex thoughts that rarely a journalist could decipher his comments. Recently, I found that I have no troubles understanding one of his most recent and clear comments about housing asset price inflation. I will take an excerpt here:
“This vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent… But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.”
Without being too pedestrian, it’s pretty clear that his “conundrum” has turned into both a bit of fear and a bit of “I told you so”. While so many blame the current asset price inflation on Alan’s own reaction to potential deflation, some of the more egregious problems were caused by ourselves. We have started a debt culture.
This debt culture has created a potential to fail in the future that our country has not seen since the 1920′s. While the stock market crashed in 1929 due to overleveraged stock market participants who were forced to liquidate under decreasing prices to cover losses, much of the same could happen over a much longer period in the US. Japan provides us a sobering look at deflating home prices for the past 14 years. Purchasing 15 years ago there would mean financial ruin for you and your family. The US has an even more transitory population: we move for jobs regardless of where we were born, our employers will lay us off without societal repercussions, and widespread personal transportation allow us more mobility than the Japanese. We also have a higher ownership rate (70% compared to 60%) This increases the churn of homes in the US because Japan does not encourage first-time homebuying like the US (only 13% of 25 to 34 year olds own in Japan compared with 40% in the US). Statistics courtesy of our good friend David Lereah. Therefore, a more liquid market would more likely experience faster and more dramatic asst price appreciation as well as depreciation. All of this points to the fact that US homeowners are more likely to simply walk away from depreciating assets if job losses, sickness, or other economic hardships occur.
Where does this lead us? Well… we’re acting a bit like the japanese in our debt lending by accepting low risk premiums, and the longer this goes on, the greater the risk to all participants, lenders and borrowers. If liquidity were to be suddenly shored up by investors demanding a greater return for thier risk, or if percieved risk were to suddenly jump, borrowing would become much more difficult for buyers. Interest rates will increase accordingly. Even established buyers might not be able to purchase homes due to restricted risk premiums; all of which will only serve to slow the real estate market and put the power of purchasing into well qualified buyers.
It has been my assertion that the housing bubble was caused not by low interest rates, but by excess liquidity that banks could only farm out by lowering lending standards. It was this easy credit that was extended to a whole set of the population that had never before been entrusted with credit; this caused “neverending” demand. Much like college students that max out their first credit card, only to find that the payments exceed their income, many of today’s buyers will be unable to make payments in the future.
Our little “deflationary concern” may soon turn into a financial meltdown since problems tend to spiral: Increases of forced sales trigger lower prices, which triggers lower spending and more foreclosures; lower spending triggers more layoffs; foreclosures trigger financial losses for banks and MBS holders; financial losses triggers less liquidity; less liquidity triggers higher interest rates; which triggers more defaults on ARMs and HELOCs… the list of effects could go on forever. Our economy is increasingly dependent on house price appreciation, but 2 things keep these trees from growing to the sky.
1. Credit has limits, since some risk premium must be attached to borrowing money, and interest must be charged. Investor sentiment is everything here.
2. Even a leveling off will decrease construction jobs that will kick-off the above process, so increasing growth is necessary to keep the merry-go-round going.
I am asking you for your thoughts about the potential of a financial crisis due to excessive borrowing during the housing boom. What do you think the risks are to our economy?
My roommate bought a house. In a few month or so, I expect her to knock on my door to ask for a place to stay. I am still befuddeled of how someone with with poor credit history, credit cards maxed out and living paycheck to paycheck could get a loan for almost half a mil.
Below is an article I did for the local paper and sent to ABC
As we watched this Sunday’s ABC Newsmakers segment on California Housing, we were more than a little concerned that both sides of the housing market equation were not being represented. As panelist, ABC invited Jack Kyser, chief economist of the Los Angeles County Economic Development Corporation, John Karevoll, analyst for Dataquick Information Services, Jim Hamilton, President of California Realtors Association, Valerie Hempstead, realtor, Century 21, and Tony Baia, owner/loan consultant, Leading Mortgage.
As the Host posed the question, “Is there a housing Bubble in California”? Mr. Kyser attempted to share that indicators pointed to the market being overvalued in some areas, and there where what is he considered “Bubblettes” throughout the state, or areas in danger of price declines.
However, Mr. Hamilton of California Realtors Associations view seemed to emphasize only that there was a healthy and growing market in housing that is showing no signs of weakening. He did neglect to mention that most of the activity in the market was in the lower-priced homes or condos, as sales of medium and higher end housing has slowed.
If you ask any Realtor, or most Mortgage Representive in this state and across the country about a bubble, they will deny that the potential even exists. In Sunday’s segment, as soon as the idea of a bubble was suggested, Mr. Hamilton responded with a resounding “What Bubble”? This is the theme that has echoed throughout the Real Estate and Lending industry since the speculation began.
Use of other key words like “lack of supply”, “high demand” and “increasing values” on the part of realtors have fueled the fire and instilled fear in many Californian’s and Americans to hurry and buy, or run the risk of being left out.
It’s this kind of propaganda that formed the initial suspect bubble, and has continued to raise the question of its’ growth, and potential bust. It is also the foundation for the lender created, and now commonly used, “Exotic Mortgages” that buyers have been led into. With housing prices quickly outpacing household incomes, less the 15% of the population are able to afford a home.
The percentage of affordability is reduced even further when is comes to conventional 30 year mortgages.
This suggests the need to use more creative financial options (prudent or not), thereby forcing prospective homeowners into utilizing these types of hybrid loans. Interest only, adjustable rate, and option ARMs seem to be the answer to everyone’s problem. Temporarily anyway.
A bubble, by most economic standards, is escalated growth within a normally stable market whereas investors are flocking to participate based on the speculation that the market will continue to grow at the same accelerated pace.
The Real Estate and Mortgage industry have become extremely wealthy over the last few years and are doing all they can to maintain that momentum and market mentality.
The real concern is that many people, especially first time buyers, don’t fully understand the volatility of the loan and its ramifications. Increasing interest rates and the required principle payments after the start-up period could be a disaster waiting to happen.
A couple of close family members recently purchased homes with these types of loan. When I questioned them on the specifics, they both responded with the “ we expect we should have more equity in the house in few years, and we can refinance or sale” statement. This is the bill-of-goods they were sold by the lender and realtor, without really understanding what the refinance might entail.
Although both are intelligent consumers and previous homeowners, neither of them seemed to be acutely aware of the potential downside of the loan because no one ever explained it to them. I don’t think all lenders are disclosing the risks involved with these loans, and how the buyers might prepare themselves for the necessary future adjustments. Buyers are becoming so consumed with qualifying, that once they here they can be approved under these new programs, they are just relieved to know they can get in.
Responding to the question of affordability, both Tony Baia of Leading Mortgage, and Hamilton advocated the use of these new loans explaining there is no lack of funding available, and that people were having little trouble qualifying for the inflated priced homes.
More than half the Californians who purchased a home in the last two years ignored the federal guidelines by allocating more than 30% of their incomes to housing. Some are spending as much as 50-60%. I am not sure how lenders view that as affordable.
Hamilton and Baia neglected to discuss any of these potential hazards or how a shift in the economy could further strain their already stressful situation.
When asked about people’s old-fashioned idea of paying off their mortgage in 30 years, Baia responded by saying “those ideas were outdated since most people move after about (7) year’s in a residence”. While this may be true, there are a lot of future retirees who will count on not having a mortgage payment when that time comes, as many will be on fixed incomes.
Perhaps more investigative reporting should be done on these loans and the lending practices of the individuals presenting them.
However, the concerns that over shadow the situations of individual households are the ones that may impact the economy of California and/or the nation as a whole.
A whole new generation (my children and yours) will be completely priced out of the market and the dream of owning a home, subsequently affecting the future economy. We have already considered moving our business out of California because we feel the pressure of having to increase employee salaries for them to even have a chance to purchase a home. Manufacturing businesses will be at the head of an Exodus as they find themselves unable to either keep key employees, or maintain profitability based on increased costs associated with larger salaries.
Ms. Hempstead of Century 21 even made the comment (I think inadvertently) that many people were moving out of California because of affordability reasons. The comment was quickly smoothed over my Mr. Hamilton
This of course effects businesses in the state and will further threaten the strength of the economy that is being viewed as catalyst for this market.
Many economists paint a much bleaker picture and suggest major downturns in the housing market and the economy as a result of what is happening. Americans have increased their debt dramatically over the last few years through housing costs and home equity loans. They fear that when it comes time to pay, many will be unable to.
Foreclosures and bankruptcies may become commonplace and destroy Americans quality of life.
Whether or not there is a bubble that will burst still remains to be seen. However, I think a more thorough representation of all the facts and possibilities are critical in order for everyone involved to make calculated decisions as they risk their futures on one of the biggest investment they will ever make.
Extremely concerned native
The bubble is nothing but air. The mortage brokers, agents realtors and whatever call it healthy because they all have a pet appraiser in their hip pocket who will give them any number they want, any pictures they want, and always report a property in perfect condition.
Then the agent falsifies the income, falsifies the debt to income ratio, forges a few signatures and bang, you have a deal.
If it weren’t for fraud, there wouldn’t have been a “Boom”. The “Boom” is in lack of enforcement of Bank Fraud rules.
I know…I burned my appraiser license, rather than join the mafia.
[...] reminds me of a post I made back in the heady days of September 2005, Greenspan’s Interesting Clarity. Yes, nearly 2 years of blogging ago. Where does this lead us? Well… we’re acting a bit like [...]