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Are rising house prices and low-cost Ponzi debt necessary for an economic recovery?

Everyone is focused on making house prices go up. Banks need higher house prices to recover the capital they put into trillions of dollars of toxic mortgages. Loan owners need house prices to go up to avoid damaged credit from a short sale or foreclosure. Home owners want to see house prices go up to feel rich. And politicians need to see rising house prices to keep everyone happy and get reelected.

Economists also play the game by promoting the “wealth effect” of housing. By cloaking what’s really going on with a comfortable euphemism, it becomes easy to ignore the fact we are really talking about Ponzi borrowing inevitably leading to bubbles and severe recessions when the Ponzi scheme unravels.

So what evidence do we have that housing was a giant Ponzi scheme? First, the daily posts I do have documented more than a thousand properties where Ponzi borrowing was the owners method of personal financial management. This was encouraged by lenders, and it went on so long that many borrowers think a personal Ponzi scheme is just how finances are managed. Credit is savings. Appreciation is income. Debt is wealth.

Another point of evidence of the grip of Ponzi finance comes from the high redefault rates on loan modifications. In theory, loan modifications are supposed to help a prudent borrower with temporarily diminished income due to the recession. A reduction in payments would help a prudent borrower survive until better days. Unfortunately, that isn’t reality. Most borrowers applying for loan modifications were Ponzi borrowers who need more debt to make the payments on the debt they have. Reducing their payments doesn’t help them because what they really need is access to more credit to perpetuate the Ponzi scheme. This is the only reasonable explanation for the extremely high recidivism rates on modified loans.

Six in 10 Homeowners with Loan Mods Default Within 18 Mos.

Six out of 10 homeowners who received a loan modification stopped paying their mortgage again after 18 months, but there may be a modest silver lining buried in the high recidivism rates.

A study by TransUnion has found that borrowers who received a mortgage modification performed materially better on new auto loans and credit cards than those who did not receive any help, an indication that some consumers who fall far behind on monthly bills are able to regain their financial footing.

“Once consumers have gone through a serious delinquency, there is still an opportunity to lend to them down the road,” says Charlie Wise, TransUnion’s director of research and consulting. “We’re going to see more and more consumers that had a loan modification and the mere presence of a modification, regardless of whether the borrower continues to pay, would indicate better performance” in paying other debts.

Researchers examined data on five million mortgages including 600,000 borrowers who received a modification between January 2008 and July 2011.

Out of 600,000 loan modifications, 360,000 redefaulted within 18 months. That is a dismal failure if the intent was to really help. In my opinion, banks will consider the program a success because it gave hopeless borrowers enough false hope to make a few more payments before they imploded.

The study found that borrowers who had previously gone delinquent only on their mortgages — but not other loans — were better credit risks than borrowers who went delinquent on other loans as well as their mortgages.

Still, high recidivism rate are a concern since most of the borrowers will redefault within 18 months and are likely to end up in foreclosure. The study also found that nearly 42% of borrowers who received a loan modification stopped making payments within a year.

Most of these borrowers will end up reappearing in shadow inventory, then finally making their way to foreclosure. Ponzi borrowers cannot be saved, and we shouldn’t try. It merely emboldens them to build an even larger Ponzi scheme and increase lender losses in the long run.

Hyman Minsky described the Ponzi problem this way:

“Ponzi’ finance units must increase its outstanding debt in order to meet its financial obligations. A transition occurs over the course of an expansion as increasingly risky positions are validated by the booming economy that renders the built in margins of error superfluous – encouraging adoption of riskier positions. Eventually, either financing costs rise or income comes in below expectations, leading to defaults on payment commitments.”

The defaults on all the Ponzi borrowing lead to the credit crunch in August of 2007 which began the unraveling of the entire Ponzi scheme the US economy was based on.

“… over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy with a sizable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.”

This is exactly what happened in the housing bubble. The only real question is, “What do we do about it?” The answer being given by everyone is to reflate the housing bubble to begin a larger, more massive, and ultimately more destructive Ponzi scheme. It that what we really want?

We cannot base a stable economy on Ponzi schemes. Low debt levels, particularly low signatory debt levels, are better for the economy because it frees up sustainable disposable income. We do not need rising house prices and rampant HELOC abuse to create an economic recovery. I would rather have a real recovery based on sustainable fundamentals rather than a fake recovery based on another mountain of Ponzi debt.

Should taxpayers and seniors fund HELOC abuse?

The way our system currently works, borrowers like the previous owner of today’s featured property take on enormous HELOC debts they never plan to repay, and when the Ponzi scheme unravels, the taxpayer is brought in to pay off the bad debts. Through the various bailout programs for banks and loan owners, they are gorging themselves on taxpayer funds and lost interest payments due to seniors.

  • Today’s featured property was purchased for $340,000 on 6/5/2001. The owner used a $272,000 first mortgage, a $50,000 second mortgage, and an $18,000 down payment.
  • On 6/20/2005 he went Ponzi with a $405,000 refinance of his first mortgage.
  • On 6/16/2006 he refinanced again with a $481,000 first mortgage. Total mortgage equity withdrawal was $159,000.
  • He defaulted in early 2009 and got to squat for nearly three years.

Is the benefit of economic expansion worth bailing out borrowers like this? I don’t think so. If it is, everyone will keep their HELOCs maxed out waiting for the crash next time around.

Fountain Valley Overview

Median home price is $509,000. Based on a rental parity value of $569,000, this market is fairly valued.

Monthly payment affordability has been improving over the last 11 month(s). Momentum suggests improving affordability.

Resale prices on a $/SF basis increased from $261/SF to $266/SF.

Resale prices have been falling for 12 month(s). Price momentum suggests falling prices over the next three months.

Median rental rates increased $182 last month from $2,180 to $2,362.

Rents have been rising for 12 month(s). Price momentum suggests rising rents over the next three months.

Market rating = 4

Proprietary OC Housing News home purchase analysis  

17385 SANTA LUCIA St Fountain Valley, CA 92708

$539,900    ……..    Asking Price
$340,000    ……….    Purchase Price
6/5/2001    ……….    Purchase Date

$199,900    ……….    Gross Gain (Loss)
($27,200)    …………    Commissions and Costs at 8%
============================================
$172,700    ……….    Net Gain (Loss)
============================================
58.8%    ……….    Gross Percent Change
50.8%    ……….    Net Percent Change
4.1%    …………    Annual Appreciation

Cost of Home Ownership
——————————————————————————
$539,900    ……..    Asking Price
$107,980    …………    20% Down Conventional
3.67%    ………….    Mortgage Interest Rate
30    ………………    Number of Years
$431,920    ……..    Mortgage
$100,011    ……….    Income Requirement

$1,981    …………    Monthly Mortgage Payment
$468    …………    Property Tax at 1.04%
$0    …………    Mello Roos & Special Taxes
$135    …………    Homeowners Insurance at 0.3%
$0    …………    Private Mortgage Insurance
$0    …………    Homeowners Association Fees
============================================
$2,584    ……….    Monthly Cash Outlays

($313)    ……….    Tax Savings
($660)    ……….    Equity Hidden in Payment
$130    …………..    Lost Income to Down Payment
$155    …………..    Maintenance and Replacement Reserves
============================================
$1,896    ……….    Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$6,899    …………    Furnishing and Move In at 1% + $1,500
$6,899    …………    Closing Costs at 1% + $1,500
$4,319    …………    Interest Points
$107,980    …………    Down Payment
============================================
$126,097    ……….    Total Cash Costs
$29,000    ……….    Emergency Cash Reserves
============================================
$155,097    ……….    Total Savings Needed
——————————————————————————————————————————————-

[idx-listing mlsnumber="P826195" showpricehistory="true" showlocation="true"]

17395 SANTA MARIA St, Fountain Valley, CA $559,000
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0.1 miles
4 bd / 2 ba
1,628 Sq. Ft.
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