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Author Archive: Irvine Renter

Houses and Commodities Trading Commodities are items of value and uniform quality produced in large quantities and sold in an open market. Although every residential real estate property is unique, these properties became uniformly desired by investors because all real estate prices rose during the Great Housing Bubble. The commoditization of real estate and the active, open-market trading it inspires caused houses to lose their identity as places to live and call home. Houses became tradable stucco boxes similar to baseball playing cards where buying and selling had nothing to do with possession and use and everything to do with making money in the transaction. In a commodities or securities market, rallies unsupported by valuation measures will fall back to…[READ MORE]

Mortgage Equity Withdrawal Mortgage Equity Withdrawal or MEW is the process of obtaining cash through refinancing residential real estate using the accumulated equity as collateral for the loan. Before MEW, a homeowner would have to wait until the property was sold to get their equity converted to cash. Apparently, this was deemed an inefficient use of capital, so lenders found ways to “liberate” this equity with home equity lines of credit or cash-out mortgage refinancing. The impact of MEW on equity is obvious; it reduces it by increasing the loan balance. It has been noted that equity is a fantasy and debt is real, and MEW is the process of living the fantasy with the addition of very real debt.…[READ MORE]

The Size of the Bubble Figure 1 - Median Home Prices 1968-2006   The Great Housing Bubble was an asset bubble of unprecedented proportions. Between 2000 and 2006 Home prices increased 45% nationally, and in California home prices increased 135%. Had this amazing price increase coincided with a period of high inflation, it may not have been indicative of a price bubble, merely the general increase in prices of all goods and services; however, inflation was low during this period. The inflation adjusted price increases nationwide were 23% and in California it was 100%. Figure 2 - Inflation Adjusted Median Home Prices 1986-2006   There are many variables that impact house prices, and some of the variability in prices over…[READ MORE]

Systemic Risk in the Housing Market Credit rating and analysis of collateralized debt obligations and all structured finance products are part of the smooth function of the secondary market for mortgage loans. A credit rating agency is a company that analyzes issuers of debt and debt-like securities and gives them an overall credit rating which measures the issuer’s ability to satisfy its debt obligations. There are more than 100 major rating agencies around the world, and three of the largest and most-important ones in the United States are Fitch Ratings, Moody’s and Standard & Poor’s. A debt issuer’s credit rating is very similar to the FICO score of an individual rated by the Fair Isaac Corporation widely used in the…[READ MORE]

Structured Finance Structured finance is an innovation of the finance industry on Wall Street. It is a method of redistributing risk based on complex legal and corporate entities such as corporations, limited liability companies or some other kind of legal entity capable of entering into contracts. The shares or other interests in structured financial entities are derivatives that obtain their value from an underlying asset. Any asset that has a regular cashflow can be pooled through structured finance to create an asset-backed security. This cashflow can be split among various parties and valued based on the risk of repayment. For instance, the most common form of structured finance utilized to inflate the Great Housing Bubble was the collateralized debt obligation…[READ MORE]

Affordability is a measure of people's ability to raise money to obtain real estate. It is often represented as an index that compares the cost to finance a median house price (50% above and 50% below) to the percentage of the general population with the income to support this house price. For instance, in Orange County California in 2006, only 2.4% of the population earned enough money to afford a median priced home. When affordability drops below 50%, there is a problem in housing; when it drops to 2.4% there is either a severe shortage of housing, or a housing price bubble; most often, it is the latter. The simplest way to envision affordability is through simple supply and demand…[READ MORE]

The Credit Crunch In 2007, the financial markets were abuzz with talk of a “credit crunch.” It was portrayed as some unusual and unpredictable outside force like an asteroid impact or a cold winter storm. However, it was not unexpected, and it was not caused by any outside force. The credit crunch began because borrowers were unable to make payments on the loans they were given. When lenders started losing money, they stopped lending: a credit crunch. New Century Financial is the poster child for The Great Housing Bubble. New Century Financial was founded in 1995 and headquartered in Irvine, California. New Century Financial Corporation was a real estate investment trust (REIT), providing first and second mortgage products to borrowers…[READ MORE]

Selling for Less During the bubble price rally, sellers and realtors, the agents of sellers, had everything going their way. It was easy to price and sell a house. A realtor would look at recent comparable sales, and set an asking price 5% to 10% higher and wait for multiple bids on the property — some of which would come in over asking. The quality of the property did not matter, and the techniques used to market and sell the property did not matter either. As far as buyers and sellers were concerned house prices always went up, so the sellers were thought to be giving away free money; obviously, the product was in high demand. As the financial mania…[READ MORE]

What is Equity? In simple accounting terms, equity is the difference between how much something is worth and how much money is owed on it (Equity = Assets – Liabilities.) People who purchase real estate use the phrase “building equity” to describe the overall increase in equity over time. However, it is important to look at the factors which either create or destroy equity to see how market conditions and financing terms impact this all-important feature of real estate.   For purposes of illustration, equity can be broken down into several component parts: Initial Equity, Financing Equity, Inflation Equity, and Speculative Equity. Initial Equity is the amount of money a purchaser puts down to acquire the property. Financing Equity is…[READ MORE]

Speculation or Investment? Real estate is viewed by many people as a good investment. Realtors often use this idea as part of their sales pitch. As was described in detail in the post What is a Bubble?, this view is fallacious and it is one of the beliefs responsible for creating an asset price bubble. To understand why houses are not a good investment, one needs to understand the difference between investment and speculation. An investment is an asset purchased to obtain a predictable and consistent cashflow. This would include things such as bonds and rental properties or even cash in a savings account. The value of the asset is based on the cashflow, and this value can be determined…[READ MORE]

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In Memoriam: Tony Bliss 1966-2012
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