Jun122013

The long-term negative impact of temporary mortgage interest rate stimulus

Banks are in survival mode. They must reflate the housing bubble, or the losses on their non-performing single-family residential loans will wipe them out. In order to reflate the bubble, the banks must keep these properties off the MLS, a task they are currently succeeding at, and mortgage interest rates must remain low so buyers can bid up prices to peak levels so banks can liquidate without a loss.

The chart above shows the $144.75 billion exposure they have just on their non-performing loans. Since these non-performing loans only represent 9% of the total number of underwater borrowers, the total potential exposure is more than 10 times larger. As I noted, banks are still exposed to $1 trillion in unsecured mortgage debt.

The main argument in favor of very low mortgage rates for a very long time stems from the bank’s dire need for low mortgage mortgage rates. Of course, the federal reserve could lose control of long-term rates at which point, mortgage rates would rise, and the banks would be screwed.

The exposure of the banks to these potential losses drives every aspect of government and banking policy. The federal reserve will certainly try to keep mortgage rates low to fully reflate the housing bubble in every market in the United States. However, not all markets are the same, and the interest rate stimulus does not have equal effects in all markets. Those markets that are stronger are responding quicker to the stimulus, and those markets that are weaker are lagging behind.

There are long-term consequences to the federal reserve’s policies. In the medium-term, mini bubbles will likely be inflated in the strongest markets like Coastal California. As the interest rate stimulus is removed, these markets will weaken because the limit of affordability will stop buyers from paying prices easily financeable today.

The math is inescapable. As interest rates rise, affordability drops. Unless wage growth picks up the slack, which doesn’t seem likely given our weak economy, prices are likely to experience a long, slow grind.

There is much angst among potential homebuyers about rapidly rising prices and the potential for another housing bubble. The cheerleaders in the mainstream media are keen to squelch these concerns, and they argue that affordability is so good that rising rates won’t have much impact. This is where parsing the various markets is important.

The pundits that claim we are in no danger of inflating a new housing bubble are right — in the weakest markets. Interest rates could double, and prices would still be relatively affordable in Las Vegas. That market is so undervalued that an uptick in mortgage rates won’t stop the climb in prices (new foreclosures could, but affordability won’t). Coastal California is a different story. Thanks to the interest rate stimulus, the best markets are already approaching affordability limits. Once we hit that limit, any reduction in affordability caused by rising rates will impact the market. At first, it will merely cause sales volumes to drop, but if the rise in interest rates is large and long term, prices will slowly deflate.

Evidence of the differential impact of interest rate stimulus creating this long-term problem is apparent in the dramatic increase in asking prices in the markets where affordability is the most problematic.

Trulia: Asking Prices Accelerate in Least Affordable Housing Markets

Esther Cho — 6-7-2013

Asking prices are rising at an especially fast pace in the least affordable housing markets, according to Trulia.

Nationally, asking prices increased 9.5 percent year-over-year in May, but in the ten least affordable metros, asking prices spiked 16.3 percent during the same time period.

Shouldn’t the least affordable markets have the lowest increase in asking prices? Over the long term, they should, but in the short term, asking prices represent the movement of the market, and the least affordable markets became that way because prices rose rapidly over the last year and a half.

Trulia also found out of the 100 largest metros, 98 saw asking prices increase over the last year.

Among the least affordable markets, seven were in California. Honolulu was found to be the least affordable metro, where 74 percent of monthly household income is used to pay a mortgage. In San Francisco, households spend 55 percent of their monthly wages on their mortgage.

I thought everyone in the Bay Area was rich. Perhaps they are just extremely over-indebted betting on appreciation. People can’t afford 55% DTIs, and the new regulations limit future loans to 43% DTIs. These new limits don’t impact all-cash buyers, but it will make it much more difficult for the cash buyers to sell to a leveraged buyer later on. Bubble 2.0 has arrived.

In the 10 least affordable markets, households spent at least a third of their income towards their mortgage. The calculation assumed a 3.8 percent interest rate on a home that is 1800 square feet.

In Oakland California, which ranked as the seventh most unaffordable market, asking prices surged 31.2 percent year-over-year in May.

A reader from Oakland emailed me some properties showing 60% or higher increases in prices at the low end. The market was marginally affordable at the bottom. What they have now is a disaster waiting to happen.

On the other hand, Long Island, which followed at No. 8, saw asking prices rise by just 1.1 percent over the last year.

Keith Jurow lives in the Northeast, and he emails me periodic updates on what’s happening there. The judicial foreclosure logjam is starting to clear, and the supply pressures and low affordability are starting to take their toll.

Overall, eight of the least affordable markets saw asking prices increase at a faster rate than the national average.

Among the 10 most affordable metros, asking prices averaged the same rate as the national rate at 9.5 percent. Detroit ranked as the most affordable metro, where just 8 percent of household income is used to pay a mortgage. Detroit, along with Atlanta, Memphis, Fort Worth, and Dallas, all saw year-over-year double-digit gains in asking prices, but they were still among the most affordable metros.

Jed Kolko, Trulia’s chief economist, gave two reasons for why the gap in affordability matters.

For one, it leads to a migration out of less affordable markets.

“[M]ore people in expensive markets like California will look to relocate to cheaper markets like Texas when the time comes to buy,” he said.

We saw a lot of that over the last 10 years, and we will likely see more in the future. California is driving out the middle class with high taxes and high house prices.

He also added that the disparities in affordability make it more difficult to come up with “one-size-fits-all” national housing policies as local markets become more different from one another.

That’s the rub with interest rate stimulus. It can’t just be applied in Las Vegas or Phoenix, it must be applied everywhere. When Bernanke drops money from a helicopter, he can’t control where it lands. As a result, the least affordable markets risk a mini-bubble that will deflate as this stimulus is removed.

Don’t buy for appreciation

I have never been an advocate of buying for appreciation. It’s a fools game. With rapidly rising prices comes kool-aid intoxication. Buyers today need to understand the risks and be realistic about the long-term prospects of making a fortune in appreciating California real estate.  Becoming a homeowner with the right expectations is the key to long-term happiness with the purchase, and buying for appreciation sets the wrong expectation. Everyone would nod in acceptance if the same were said about forex trading and the stock market. According to https://www.forex.academy, many new traders come into the industry with the wrong expectations and pay dearly for it. So, seek wisdom from proven track records and stick to them.

She left money on the table

Many of the Ponzis I profile each day extracted every penny of appreciation the moment it appeared. However, some borrowers were somewhat more prudent and tried to keep their borrowing under control. Unfortunately, once a borrow goes Ponzi, there is no turning back, and even the more prudent Ponzis, if there is such a person, still lost homes during the housing crash.

  • Today’s featured property was purchased on 8/31/2000 for $508,000. The owner used a $431,800 first mortgage, a $15,240 second mortgage, and a $60,960 down payment.
  • She promptly obtained a HELOC on 9/27/2000 so she could liberate her equity if she wanted.
  • On 11/25/2003 she refinanced with a $475,000 first mortgage.
  • On 6/24/2004 she opened a $118,000 HELOC.
  • On 6/16/2005 she refinanced with a $600,000 first mortgage.
  • On 4/24/2006 she refinanced with a $650,000 first mortgage.
  • On 8/22/2007 she opened an $83,000 HELOC.

At the peak this property was likely worth more than the $733,000 in debt she had on the property. She could have borrowed more. Right now, she probably wishes she would have.

She quit paying the mortgage in 2008, and she squatted for about three years, so I guess she got her money’s worth after all.

[raw_html_snippet id=”newsletter”]

[idx-listing mlsnumber=”PW13106766″ showpricehistory=”true”]

4300 DEODAR Dr Yorba Linda, CA 92886

$724,395    ……..    Asking Price
$508,000    ……….    Purchase Price
8/31/2000    ……….    Purchase Date

$216,395    ……….    Gross Gain (Loss)
($57,952)    …………    Commissions and Costs at 8%
============================================
$158,443    ……….    Net Gain (Loss)
============================================
42.6%    ……….    Gross Percent Change
31.2%    ……….    Net Percent Change
2.7%    …………    Annual Appreciation

Cost of Home Ownership
——————————————————————————
$724,395    ……..    Asking Price
$144,879    …………    20% Down Conventional
3.98%    ………….    Mortgage Interest Rate
30    ………………    Number of Years
$579,516    ……..    Mortgage
$136,984    ……….    Income Requirement

$2,760    …………    Monthly Mortgage Payment
$628    …………    Property Tax at 1.04%
$0    …………    Mello Roos & Special Taxes
$151    …………    Homeowners Insurance at 0.25%
$0    …………    Private Mortgage Insurance
$0    …………    Homeowners Association Fees
============================================
$3,539    ……….    Monthly Cash Outlays

($561)    ……….    Tax Savings
($838)    ……….    Principal Amortization
$200    …………..    Opportunity Cost of Down Payment
$201    …………..    Maintenance and Replacement Reserves
============================================
$2,541    ……….    Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$8,744    …………    Furnishing and Move-In Costs at 1% + $1,500
$8,744    …………    Closing Costs at 1% + $1,500
$5,795    …………    Interest Points at 1%
$144,879    …………    Down Payment
============================================
$168,162    ……….    Total Cash Costs
$38,900    ……….    Emergency Cash Reserves
============================================
$207,062    ……….    Total Savings Needed
[raw_html_snippet id=”property”]