Apr082016

Californian’s share zealous faith in rapid home price appreciation

California has a major cultural “religion” that cuts across traditional denominational lines: the religion of real estate and faith in rapid home price appreciation.

Religious conviction provides meaning, hope, and joy to billions of people. Faith is belief by choice, generally in the absence of evidence, but sometimes even contrary to evidence. Most of the people on earth embrace a belief in a pleasant afterlife in some form.

HELOC_happinessCalifornia is a melting pot of different cultures and a variety of beliefs. It’s not uncommon to hear several languages spoken in public places and to interact with a wide variety people following different religions. One thing that unites Californian’s is an acceptance of the myriad cultural backgrounds and belief systems. Another uniting factor is a shared belief among most Californian’s in the inevitability and sustainability of rapid home price appreciation—despite the periodic price crashes.

Believing in rapid home price appreciation is very pleasant because it makes every homeowner rich. People don’t want to question why home prices rise so rapidly. They don’t want to consider that house price may actually go down. They want to embrace a blind faith that says “Real estate makes you rich.”

The problem with blind faith is that it doesn’t ask “why.” Faith just accepts things as is and doesn’t demand an explanation. Unfortunately, with financial markets, the “why” matters.

How lenders inflated three massive housing bubbles

California endured a housing bubble in the 1970s because lenders adjusted to a high-inflation environment by abandoning long held debt-to-income ratio standards. Lenders allowed borrowers to assume debts much larger than they could afford based on the belief the borrower would get 10% raises every year which would make the house payment affordable after a year or two of extreme austerity.HELOC_temptation

Lenders inflated the bubble in the late 80s through a combination of high debt-to-income ratios and early affordability products. Buyers participated due to a false fear of being priced out, a fear stoked by realtors. (See: The surprising change in buyer behavior caused by the housing bust)

Lenders blew another bubble in the 00s by offering even more dangerous affordability products, most notably Option ARMs, and they completely abandoned underwriting standards, providing loans to anyone with a pulse. And over the last 30 years, mortgage interest rates declined from 18% to 3.5% allowing people to leverage their incomes to ever-larger mortgage balances. (See: Housing market impact of 25 years of falling mortgage interest rates)

The causes of the previous three bubbles were all banned by new qualified mortgage regulations, and since we are at the bottom of the interest rate cycle, mortgage rates are likely to rise. If these regulations remain in place, and if interest rates rise, the “why” that inflated previous bubbles won’t recur again (we hope). Further, with an overhang of properties in cloud inventory, properties not currently on the market, a long period of flat prices once we reach the previous peak seems more likely than not.

So why do people cling to their beliefs about boundless home price appreciation in California?  Rapidly rising prices makes homeowners wealthy and it gives Ponzis boatloads of free spending money.

People believe because they want to believe.

 

Faith in home price appreciation

Californian’s baptize into the church of real estate by metaphorical drinking kool aid, accepting the idea that house prices can and do go up much faster than wages. The fundamental belief of this religion is a belief in the “higher power” of market forces—real estate values always go up. Once people accept this fundamental belief, the dogma of real estate takes over, and rational thought is discarded in favor of the more pleasant (and deluded) belief system. The dogmatic practices of the church of real estate include buying at any price and borrowing any sum made available, traditions eagerly followed with complete devotion.

Since real estate always goes up, it doesn’t matter to the faithful how much they pay because they believe they will always sell whenever they want for more money than they paid—a lot more money. In the church of real estate, value has no meaning.

Also, since devotees can repay any borrowed sums when they sell, it doesn’t matter how much they borrow or under what terms. Debt is something they service but never retire. It’s considered sinful to borrow under terms which pay down a mortgage because equity appears through appreciation, leaving no need to build equity by retiring debt. Besides, the faithful conclude that paying down debt is a slow and painful process while building equity through appreciation is much faster and requires less sacrifice. The church of kool aid requires no sacrifice, which is part of it’s appeal.

The lure of kool aid intoxication is very strong, appealing to the faithful’s fantasies of unlimited wealth and spending power.

People who accept religious tenets often face a crisis of faith at some point in their lives. Any core religious idea that can be empirically tested will face its ultimate challenge. The collapse of The Great Housing Bubble proved that real estate values do not always go up, and in fact, real estate values can decline significantly.

John Spong wrote a book titled “Why Christianity Must Change or Die” in which he devotes a chapter to the Jewish exile to Babylon. It was a cultural crisis of faith where many of the fundamental beliefs of Judaism were challenged. California’s religion of real estate faced a similar crisis. With the devastating house price collapse from 2007-2012, the fundamental belief in endless house price appreciation was challenged, and all the associated beliefs were similarly called into question.

If not for the moral hazard of market intervention, the false beliefs of California’s real estate religion would have been snuffed out. Unfortunately, to everyone’s long-term detriment, manipulations rekindled the flame, and people again foolishly embrace the idea of primary homes as a great investment. How many more busts must we endure before these beliefs are expunged?

Right now with prices rising rapidly, people wonder why they ever lost their faith in permanent and rapid house price appreciation. Loanowners put too much faith in house price appreciation. Many lamented the Day the Market Died, many continue to cling to Southern California’s Cultural Pathology, and many are signing up for a renewal of the The California Social Contract. Has kool-aid intoxication survived? It appears so. The armies of realtor missionaries has set out to convert a new generation.

God help us.

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