Top five ways to sabotage the housing market

To sabotage the housing market, remove homeowner equity and raise borrowing costs. The result is a collapse of the move-up market and very low sales.


Sometimes to find the best solution to a problem, examining how the problem could be made worse reveals options and perils that might otherwise be unnoticed. Unfortunately, upon close examination of the housing market, the path to destruction may disguise itself as the path to recovery.

How the property ladder works

In the real world, most first-time homebuyers use an FHA loan and buy a low-cost property. The reason for this is simple: it takes too long to save 20% for a down payment on a conventional loan. First-time homebuyers use FHA loans because the 3.5% down payment is within reach. Further, once these buyers are in a property, they simply wait five or ten years for loan amortization and wage-based appreciation to magically give them 20% to 30% equity in a property to use on their move-up purchase.propert_ladder_pressure

Once the owner has enough equity to get a closing check large enough to fund a 20% down payment on a move-up property, they go shopping. Since this is usually quite some time after buying their FHA financed property, it’s likely the household’s wage earners are making more money. They take their larger family income and their 20% down payment and buy a more expensive move-up property.

Top five methods of housing market sabotage

To stop the orderly progression up the property ladder, it’s imperative to decrease equity and reduce mortgage balances. If potential homebuyers don’t have sufficient home equity, or if they can’t borrow enough money to complete a move-up trade, the entire chain of move-ups grinds to a halt, and home sales will plummet. So what are the best ways to accomplish this?

  1. Inflate a bubble that bursts, and trap an entire generation in their starter homes with no equity.
  2. Turn off subsequent generations on the entire idea of owning because of the high cost of bailing out the previous generation.
  3. Remove most equity from the system with unlimited mortgage equity withdrawal.
  4. Remove supply from the MLS to limit the options of those buyers willing to pay the high prices required to bail out previous buyers and the banks.
  5. Raise mortgage rates to lower aggregate loan balances to prevent wage growth from causing home price appreciation.

Generation X has little or no equity thanks to the housing bust and rampant mortgage equity withdrawal, so they can’t make a move-up. Millennials don’t want to play the game, so they are choosing to rent instead leaving the entry-level market in shambles. Between the two, we have home ownership rates at 48-year lows, a dearth of housing supply, inflated house prices, and little hope of improvement in the short term due to an impending rise in mortgage rates.

In other words, to sabotage the housing market, we simply need to stay the course.


Who Will Sell?

Demographics and housing’s supply shortage. Recovery’s biggest challenge is not a scarcity of willing and able buyers, but rather willing and able sellers and builders.

By John McManus, September 21, 2015

Buyers, or the lack of them, normally get the blame for all that ails housing. …

Knock on wood, that doesn’t seem to be a problem of the moment. …

The pace of sales may slow, the mix may shift, traffic flow may be off and on. But few question the fact that if there were a healthy supply of good homes in good communities–new and used–at varying price points and offering a variety of fair finance options, there would be a steady stream of demand.

If a market is creating jobs, or sustaining them, or casting a spell of allure to people–like retirees–to move there, there is demand. We see it now in the form of household formations. We do not see it in terms of transactions.


Because potential homebuyers are broke, many have poor credit scores, and many of those who do have the down payment and credit scores don’t want to take the risk of overpaying for an house when the prices are artificially inflated by interest-rate stimulus.reluctant-seller

Risk, for one. Demographics, for another. …

From the “Joe-Borrower” perspective, one of the biggest risks is that if one owns something now, and has locked in “dirt cheap” borrowing costs on that property, it’s a crapshoot to sell that property and possibly get higher borrowing costs on a new one.

That becomes a greater risk in an era–which we’re in–where interest rates for mortgage loans drift upward. This would de-motivate more people from selling. …

This is a myth. (See: Locked-in low mortgage rates will not dissuade today’s homebuyers from selling later) Low interest rate loans amortize much more quickly than high interest rate loans. Even if the move-up buyer only sells for enough to cover the transaction costs, they will still have a significant amount of equity to put 20% or more down on a move-up sale, and they will be able to complete the move-up trade.

As for the demographics part of the equation, have a look at this analysis from Harvard Joint Center for Housing Studies senior research associate Dan McCue. His dive into the numbers illustrates the substantial “hit” to the norm the housing economy took as a result of the two-pronged force of the economic downturn and the movement of Generation X through their prime homeownership years of 35 to 45.

McCue writes:

Traditionally, the 30s and 40s are key ages for housing market activity – particularly for trade-up and new home purchases. Indeed, homeowners aged 35-44 historically make up the majority of trade-up buyers (Figure 5).


Fewer current homeowners in this key age group has meant fewer potential trade-up buyers and sellers, meaning fewer people putting their homes on the market, adding to tight inventories of for-sale homes.

Complete nonsense. Demographics have little or nothing to do with it. It isn’t that there are fewer people in this age group, it’s that there are fewer of them with the equity to make a move-up trade.


Why do you think generation X didn’t execute move-up trades over the last 10 years? The answer is simple and obvious: they either paid too much and lost their equity in the crash, or they borrowed too much and spent their equity during the bubble. Either way, a lack of equity is the primary reason this age cohort isn’t buying homes.

See numbers 1 and 3 from my list of five ways to sabotage a housing market.

Lenders sabotaged the housing market

a_housing-bubble-clearance-saleIn past real estate boom and bust cycles, lenders were forced to write down bad loans, foreclose on the houses, and liquidate their inventory for whatever they could get — which is why the bust nearly always overshoots fundamentals to the downside.

This time around, the problem was so severe that following the market-cleansing process of the past would have displaced another 10 million families and bankrupted the banking system, so another solution was implemented: lenders kicked the can with loan modifications. Instead of an MLS flooded with clearance sale properties, the MLS is missing those properties occupied by underwater loanowners waiting for higher prices before they can get out.

Move-up Equity Saved the Banks

bubble-moneyIf the bust and recovery had resolved the bad debts like previous busts, when prices rebounded, a new crop of equity owners would be able to make a move-up trade, but since the old debt was not purged, most of what would have been home equity ended up bailing out the banks.

The move-up market functions when equity accumulates; however, unrestrained mortgage equity withdrawal during the housing bubble plus a large number of peak buyers left many homeowners with little or no equity. Without this accumulated equity, the the move-up market only finds support from the continued withholding of supply by owners who can’t or won’t sell for a loss — a temporary market manipulation, not fundamental support.

The only groups with equity are those long-term owners who didn’t borrow and spend their equity and those who bought from 2009 to 2014, and as we know from the chart on originations, the number of buyers who purchased in that window is relatively small.


Plus, many more buyers than usual are either small investors or hedge funds. In a normal market about 35% of purchases are for investment (the inverse of a 65% home ownership rate). Over the last few years, about 50% of home purchases have been investors. Investors don’t sell their properties to complete a move-up trade, so 15% of the market that ordinarily would have been move-ups will not be over the next decade.

As I pointed out in One man’s mortgage debt is an entire neighborhood’s equity, the equity that would otherwise be accruing to homeowners is instead recollateralizing the bad loans on underwater properties. With so many properties underwater, a huge portion of the move-up market won’t have equity because that money will instead be going to a bank.

The banks are delighted by the market manipulations because it saved their businesses. Unfortunately for everyone else, their actions sabotaged the long-term health of the housing market.

Blast from the Past

Last night I chanced to look through my old presentations to investors pitching the Las Vegas investment back in 2011. I edited the slides for brevity, but the core of the presentation is below. My crystal ball was fairly clear.

Download (PDF, Unknown)

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