Jun042014

Is the cycle of boom and bust in California real estate truly over?

With the elimination of toxic mortgage products, high prices cause demand to falter, as it should; it also signals new mortgage regulations work as planned.

huge_paymentEveryone wants to buy a home and see it go up in value. Most people assume the greater the increase the better because they don’t want to believe there is a natural limit to home price appreciation determined by income growth. During boom times, people blithely assume the magic appreciation fairy doles out free money with no end in sight; however, that free money was created by the last buyer in the neighborhood establishing a new comparable sales value for everyone. Everyone cheers the new comparable sale while the last borrowers who set that value struggle with payments on a huge mortgage, sometimes not making it.

Last week in the post Large real estate investor purchases steeply decline in California, I described how rising real estate prices doesn’t trigger the same market reaction as in year’s past:

In the past, whenever affordability became a problem, lenders would come up with some innovative toxic loan product, allowing people to buy homes they really couldn’t afford; thus the cycle of Ponzi lending and borrowing would begin. During the bubble from the late 80s, toxic products such as adjustable-rate interest-only loans became common, and prices were pushed up to the limit of fake affordability these products created. During the most recent housing bubble, we hit what should have been a peak in late 2003, but lenders “innovated” again and began originating and securitizing option ARMs that pushed prices up to ridiculous levels.

To prevent the deflation of that housing bubble, the federal reserve engineered low mortgage rates by first lowering the federal funds rate to zero then printing money to buy mortgage-backed securities to push mortgage rates down from 6.5% to 3.5%. In the process they made stupid bubble-era prices affordable — which is where we stand today.Nemo_loan_teaser_rate

The difference today is that lenders must now deal with the Dodd-Frank restrictions of qualified mortgage rules and the ability-to-repay rules. These two rules effectively ban the toxic mortgage products used in the past to make unaffordable house prices temporarily affordable. So what happens when prices get too high and toxic mortgage products are unavailable? Home sales volumes crumble. Combine that with a pullback of institutional buying, and you end up with sales volumes well below last year’s below-average levels.

Over the last week as I thought about this outcome, I began to question whether or not the legislators who passed the Dodd-Frank financial reform would succeed in preventing future housing bubbles. Back in January of 2013 I wrote that the new mortgage regulations will prevent future housing bubbles, and I recently wrote that new mortgage regulations change how real estate markets work. Based on the recent evidence — declining sales caused by higher prices — I am becoming more hopeful that we really and truly are witnessing the end to the cycles of boom and bust in California real estate.

The last piece of the puzzle is whether or not people’s attitudes change. Real estate is religion in California, and the resurgence of kool-aid intoxication is an ever-present threat, but if people start to accept that house prices only rise with inflation and that excessive mortgage debt is a real burden, then the market lacks a key ingredient necessary to create a full-blown financial mania. Perhaps I succumb to my own optimism bias, but I want to believe people finally want to stop the madness.

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The housing bust and our psyche

If Americans are less than enthusiastic about real estate, who can blame them?

By Froma Harrop, May 30, 2014 at 11:16 AMlouie_lender_lamprey

Real-estate mania lives on at the HGTV cable channel, where house shoppers still holler for granite on their kitchen islands and his-and-her sinks in their en suite bathrooms. But in the non-TV reality of middle-class America, the bloom is definitely off the real-estate rose.

The rose isn’t dead, mind you. Surveys show an enduring desire to own one’s home, despite the trauma left by the real estate meltdown and recession. But the love is not what it was.

So customer demand continues, Jane Zavisca, a University of Arizona sociologist, told me, “but not homeownership at all costs.”

Are all these negative stories about home ownership a contrarian sign that we are at the bottom of the cycle, or is it a sign that the cycle is broken and we are on a new path?

Young people who’ve seen others’ lives ruined by the pain of foreclosure seem especially wary of taking on a mortgage, according to Zavisca, who studies attitudes toward homeowning. …

Furthermore, many members of the middle class with jobs and savings no longer believe in a future of plenty. They’re seeing their neighbors slide down the economic chute.So taking on a mortgage seems a scarier prospect than before. Zavisca cites studies confirming that holding a mortgage weighs heavier on psychological well-being than it used to.

McBill cartoon  (Howard McWilliam)During the housing bubble, people made a dangerous psychological shift: they came to believe they would not be responsible for paying off a mortgage out of their wage income — the house was supposed to do it. The house itself became regarded as a wage earner rather than an expense. Once people came to believe they were no longer responsible for the mortgage, then the size of the mortgage didn’t matter. Perhaps this blissful ignorance was good for their emotional well-being, but it was a disaster for their financial well-being.

Even for people with a lot of equity, just having a mortgage makes them feel more insecure than they did five or 10 years ago,” Zavisca said. With a mortgage now comes heightened anxiety.

Great! That is what debt is supposed to do. People should not be comfortable with debt. I think debt anxiety is a great thing as it will prompt people to carry far less of it.

Though Americans clearly do want to own homes, they are much less optimistic about the potential for large gains in equity.

I’m always concerned I see what I am looking for, but I have not seen the return of crazy beliefs about future home price appreciation even with a strong rebound in prices from early 2012 through mid 2013.

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That said, the idea of a home as a means of saving for retirement — as something one could sell in hard times — persists. It is a financial asset, Zavisca said, “but not in the sense that the average individual should be making a living buying and selling real estate.

What? You can’t live off home price appreciation anymore?

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What amazes me is that more Americans aren’t seething over one of the biggest con jobs ever perpetrated on an unsuspecting public. The housing bubble was a product of public policy.

The Fed under Alan Greenspan kept interest rates low to keep the speculative frenzy going. Financial deregulation let lenders push snake-infested mortgage contracts onto the shoulders of ordinary people.

When the bubble splattered, ordinary people were left bankrupt, foreclosed upon and devastated both financially and psychologically. If Americans are less than enthusiastic about real estate, who can blame them?

The biggest disappointment from the housing bust was the lack of accountability. The people responsible kept their fortunes, their reputations, and their status, and nobody went to jail.

I suppose I can live with that if I can believe Americans learned the lessons of the housing bust, prompted their legislators to implement the proper regulations to prevent future housing bubbles, and let go of the foolish beliefs of the mania.

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