Saturday, August 18, 2007

10% of the home owners (now and potential)... gone

I used to have a few co-workers who lived in Boston in the 80's. In the 80's Boston had a massive real estate boom that ended in a bust. Two stories stood out in my mind:

1) when the first guy sold his condo, he had to bring actual cash to the closing because the sales price wasn't enough to cover the mortgage debt
2) the second story was more complex. A woman's parents lived in a small house in an affluent area near Boston. The couple was up to date on their mortgage payments. However, the value of the house plummeted to a point where the mortgage was significantly higher than the value of the underlying house. As such, the bank had the right to "call" in the mortgage even though her parents were current on their payments. Since they didn't have enough money to refinance, they lost their home

Now the real estate boom is collapsing, but not due to plummeting housing values (like the Boston crisis, above) but due to a liquidity crisis. Existing buyers who put little or no equity into their homes are going to find that they can't refinance - per this article (which is consistent with what I have seen elsewhere) deals aren't getting done unless the buyer has a solid credit score and is willing to put down 10% of the value in a down payment. New buyers also face this 10% down hurdle which will effectively shut them out of the market for more expensive homes.

The liquidity bust will have some initial impact, and then a much longer term "tail". Initially, those who did a two year interest only deal and can't make the new payments when the rate ratchets upward will likely lose their homes, and these homes will be put back on the market by mortgage companies who want to get rid of them quickly. These repossessed homes will put a chill on the market and add to the already bloated inventory (the SUPPLY side).

On the DEMAND side, there is a whole class of people who simply won't be able to buy homes anymore. 10% down payments and solid credit scores will put more expensive homes out of reach to buyers in many markets. These individuals will have to rent, instead, or move somewhere cheaper where 10% isn't that much money. Another impact to DEMAND is that "jumbo" loans of more than $417,000 which can't be bought by Fannie Mae (the quasi-Federal agency that buys up mortgages) are now selling for a significant premium, which will make it even harder to qualify for these more expensive homes.

The likely "end state" of this is that there will be a significant dent in the pool of home owners in the next two to five years. The ex-owners will consist of those with poor credit, those who lost their homes and now have that on their record, and those who can't save up 10% for a down payment. Realistically, many of these people should never have been shopping for a home in the first place.

Eventually the markets will come back into balance, as prices are reduced to a more manageable level. Prices for assets like homes cannot always keep increasing above the rate of wage increases; it isn't sustainable. The rent / buy equilibrium will get back in balance; that is to say that the value of a home should be some reasonable multiple of its rental value; if you start buying relatively modest homes in places like NY or California for above $500,000 - try to do the math on what you'd have to rent the home for in order to cover your mortgage and costs; it is very daunting.

A couple of wild cards are property taxes and the AMT; it is unlikely that state and local governments, addicted to increasing revenues, will reduce property taxes; they will just raise the rate to come up with the same dollars (as the assessed value decreases). Under the AMT these dollars are not deductible, so the pain of property taxes will be even more pronounced, as asset values fall or are stagnant.

It is interesting that the prick in the asset bubble was caused by a liquidity crunch due to the fact that securitized mortgages weren't selling rather than the traditional fall (which takes much longer) in property values, such as occurred in Boston in the 80's. The disinflation will be much faster than in previous busts. There isn't really an historical framework for this type of fast correction, so think hard before making any moves or predictions.

Cross posted at Chicago Boyz

1 comment:

gerry from valpo said...

Tuff life these days, huh?

I bought my first home for $64,000 in 1981. Put down $10,000 and financed at 13% fixed.

Sold it ten years later for $130,000. We refinanced during those years and the best we got was 8%.

Things could be worse.