I wanted to share it here. So who is responsible? Borrowers, lenders, investors, the FED: IMO, they are all responsible; it is only a matter of degree. Irresponsible borrowers are like children, if you offer them something they want, no matter the terms, they will take it. The federal government realized this basic fact years ago when they passed predatory lending laws. Does that make the borrower any less responsible? No, but by definition, sub-prime borrowers are irresponsible. If they took responsibility for their debts, they wouldn't be sub-prime. So if you offer a bunch of money to the most irresponsible among us, what would you expect? I would expect them to spend it irresponsibly and not worry about paying…[READ MORE]

The big discussion on Wall Street today is whether or not the problems with sub-prime will impact alt-A and prime loans and if all of this will impact housing markets and the economy as a whole. I want to examine why and how sub-prime's implosion will impact the housing market. It is estimated that tightening lending standards are going to eliminate 21% of the buyers from the market. We all know intuitively this sounds bad. But what is the impact? For a deeper understanding read The Plankton Theory Meets Minsky. This will result in lower prices. If prices are lower and standards are tightening, serial refinance will come to an end. Many, if not most of the borrowers needing to…[READ MORE]

This is the final installment in my series of related posts pertaining to the Irvine residential real estate market. It is my intention in this post to bring it all together, make a prediction as to the timing and depth of the upcoming crash, and describe the variables that will influence the market decline. Below is a chart I created to demonstrate what I believe will occur in the Irvine Housing market between 2007 and 2013. Median sales price will decline approximately 40% from near $700,000 to near $400,000 over the next 5 years. There will be a multi-year flattening of prices at the bottom. Sustained appreciation will not return until 2013 or later. Peak bubble prices will not be…[READ MORE]

We have speculated a great deal on this board about the future of home prices in our area. The arguments all boil down to a simple conjecture: will prices fall to back to their fundamental values, or are prices going to remain permanently detached and inflated? I make no attempt to answer that question here. The chart link below is a graphical representation of what it would look like if home prices fall back to their fundamental valuations in Orange County.   Below is a link to the excel file I used. It is a bit messy, but experienced users can probably navigate it. Orange County Median Price Projections Worksheet BTW, I was thinking about the current state of the…[READ MORE]

In my last post "How Sub-Prime Lending Created the Housing Bubble," I went through a thought experiment to demonstrate how the psychological and technical factors interrelate to create a speculative mania. In this post I intend to examine the details of the most recent Southern California residential real estate bubble to deflate, and see what it portends for the future. Today, we are just past the market top. Predicting when a top will occur is very difficult, but recognizing when one has occurred is not: The market has topped. Volume is down as the pool of buyers is exhausted, and inventories are increasing. Flippers are looking for renters, and everyone is praying for the big spring selling season to bail…[READ MORE]

A real estate market decline, like any market decline, is part technical, part fundamental, and part psychological. In my previous post “How Inflated are House Prices?” I discussed the fundamental value of real estate and described how and why prices fall to their fundamental values once a bubble has burst. In this post, I intend to describe the technical and psychological factors at work during a speculative mania, and demonstrate how sub-prime lending created this bubble. A Thought Experiment I would like to start with a thought experiment. Imagine a room with 100 people representing the pool of sub-prime borrowers. These are new entrants to the market. They were previously unable to buy due to bad credit, lack of savings,…[READ MORE]

One of the main contentions of the bearish argument is that house prices are overvalued. To determine whether or not that premise is true, there must be some way to appraise the fundamental value of a house. Once determined, this fundamental value serves as a point of comparison to the prices at which houses are currently being bought and sold. If current prices are shown to be above fundamental value, it establishes that house prices are inflated, and it also provides a measure of the degree of that inflation. The corollary argument made by housing bears is that inflated housing prices have not historically remained inflated and have for good reason fallen back to fundamental valuations at each market decline.…[READ MORE]

In my first post, I said I was financially conservative. What does that mean with respect to financing a home purchase? It occurred to me that exotic financing terms are not exotic anymore. Interest-only, adjustable rates, and negative amortization have become so ubiquitous that nobody seems to remember why 30-year fixed-rate mortgages are used (or were used, they aren’t common in OC anymore). That is the focus of this post. To be financially conservative is to be risk adverse. A fixed-rate conventionally-amortized mortgage is the least risky kind of mortgage obligation. If you can make the payment – a payment that will not change over time – you get to keep your home. A 30-year term is most common, but…[READ MORE]