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More Signs of the Bubble:

Heard on NPR today that S&P warned investors about some newly popular kind of crazy mortgage where the homeowner gets to choose each month how much he pays, and, if he pays less than the normal mortgage amount, the extra is added to his mortgage. And I thought interest-only loans were a sign that mortgage companies had gone out of their collective minds!

Also read that in D.C., 50% of all loans this year are interest-only. When (if?) prices decline sharply, I feel sorry for whoever owns these loans, because some decent fraction of the mortgage holders are going to walk away from their six-figure paper losses, either because they can't afford the adjustable-rate increases, or simply because they'd rather saddle someone else with their loss.

And federal regulators are starting to put pressure on banks and mortgage companies to rein in their wild loans.

Finally, there is www.condoflip.com, launched in Miami (where 80% of condos are being bought by speculators), and coming soon to a city near you. Certainly a sign of the housing apocalypse.

Having missed out on the housing boom, I'd like to profit from the coming bust. LEAP puts on homebuilder stocks (which have increased by hundreds of percent over the last five years) seem very attractive to me. Which publicly traded builders are most exposed to the most overheated markets (Boston, Vegas, Miami, D.C., Boston, etc.?)

UPDATE: New York Times last week: "American homeowners have made a trillion-dollar bet that mortgage rates will remain near record lows for at least few more years ... Deutsche Bank analysis shows only about $80 billion, or 1 percent of mortgage debt this year will switch to adjustable rate based largely on prevailing interest rates; some $300 billion of mortgage debt will be similarly adjusted in 2006; portion will soar in 2007, with $1 trillion of nation's mortgage debt--or about 12 percent of it--switching to adjustable payments."

jallgor (mail):
From everything i have read Florida and California are getting carried away but I don't think they are necessarily indicative of the rest of the national market. I am also a bit less concerned than most about the variable mortgages or interest only mortgages. Most people don't live in one home for very long and many people are taking on these mortgages with the understanding that they will be selling that home and moving before the loan becomes variable.
6.23.2005 10:58am
Keith Wright (mail):
Don't think that the rest of the country is insulated from what happens in NY, CA, DC. If the crash causes loan defaults, the real person who gets hurt are the owners of Mortgage backed security instruments. They will start to demand higher yields on mortgage backed instuments which will directly increase the mortgage rates. The mortgage rates will make payments on new mortgages higher which will make people only able to afford to pay less for their house. This is on top of just the panic that comes with a crash in prices in big houses.
6.23.2005 11:23am
Rob Read (mail):
US bubble set to burst

http://www.physicsweb.org/articles/news/9/6/4/1

"House prices are rising so fast in 22 US states that they have created a "bubble" that could burst in the middle of next year according to two physicists (physics/0506027). The same team previously predicted that the UK housing market would crash in mid-2004."

Bubbles are caused when people buy because the price is rising, and start to ignore the investment yield (the one thing that DOES control the price.
6.23.2005 11:31am
Bill (mail) (www):
Being able to pick your own monthly payment is definitely new to me, but paying less than the interest is not. My professor was talking to the class about "reverse amortization" loans more than ten years ago. Basically, it gets the initial payment low enough that people could qualify for the loan, then jacks it up a few years later. The professor(and I) thought it was a really bad idea.

50% of people paying interest only loans does sound kind of worrying, but then you really need to look at historical levels in order to get a real sense of what it means.
6.23.2005 12:52pm
Robert Schwartz (mail):
House bubbles are not like stock bubbles. There is no DJHI. There are no margin sales to further depress prices, and houses are useful, in and of themseleves, even if they are bad investments.

Option ARMs are a bad idea, but the correct way of handling them would be to reuire extra dilligence and collateral for the financial institutions that issue them.
6.23.2005 1:00pm
Keith Wright (mail):
"the correct way of handling them would be to reuire extra dilligence and collateral for the financial institutions that issue them"

There is an interest problem with the loan market. The problem is regarding who is bearing the risk when loans go south. You're typical loan works as such: You go a loan broker. He only cares about whether he can sell your loan to a bank or not, and what rates do during the 30-90 days or so that you have a rate lock. He sells your loan to a bank, that does the real billing. But they take all of your principal payment, and all but a little bit of your interest and sell it off, either to Fannie Mae, Freddy Mac, or some private bank. Even if they don't, they probably do the same thing the agencies do next, and that is create pass throughs and structured deals, where the risk of not paying is yet again passed to a new buyer. These instruments are bought by money markets, pension funds, foriegn investors, and to some degree by the banks again. Generally defaults make a pretty small effect on the value of these instuments, far outstripped by the massive uncertainty caused by the likely chance of someone refinancing.

The consequence is that under normal cercumstances, it isn't that big a deal in the grand scheme of things when someone defaults on a mortgage, and no one is that worried whether you are at risk for that or not.

Still a significate amount of defaults, which could easily be caused by a bunch of people holding mortgages they can't afford on houses they can't sell, would have a pretty negative effect on the mortgage security market, which is the market that really directs what rate the bank can afford to give you.
6.23.2005 2:48pm
Ciarand Denlane (mail) (www):
Jaiglor says: "Most people don't live in one home for very long and many people are taking on these [variable or interest only] mortgages with the understanding that they will be selling that home and moving before the loan becomes variable."

Unless they have an well-founded understanding that the price they receive when they sell and move on will be at least close to what they paid, this isn't particularly reassuring. Doubtless many people do have such an understanding, but whether it is well-founded is the worrisome question, no?
6.23.2005 3:31pm
Lance (mail):
David,

I agree on the bubble in many markets. I would be careful on the public homebuilders however. I am not saying the LEAPS won't work, but how they would react to a housing slump is rather unpredictable. While their growth may slow, they are pretty cheap if the growth doesn't actually fall, and a housing slump may allow most of them to pick up marketshare and further consolidate a very fragmented, even if declining, market and still grow earnings. Of course worry might send them lower anyway. Of course those concentrated in the frothiest areas may still get hit hard. Definitely not a sure play even if the housing market rolls over. Long term they are very well positioned even if the market slows so get out quick if it works.

Robert,

I agree with some of what you say, but lack of margin loans is not correct. In essence a morgtgage is a margin loan, which is why rising home prices have been so lucrative, leverage multiplies profits. They unfortunately multiply losses. Our housing market is highly leveraged. Still, your other points are why the housing market can carry more leverage than a stock market.
6.23.2005 3:45pm
jallgor (mail):
Ciarand,
I agree with your point. I think most people assume that they will be able to cover their loan when they move on (and most suspect a profit) and if they can't, problems will ensue. But its a chicken/egg thing. For those variable rate mortgages to become a problem the market has to sag first. Then they might exacerbate the decline. By themselves, I think risky mortgages are a sideshow to the big picture. Info that supply is high and demand is low in the housing market would scare me more than these statistics about variable mortgages.
6.23.2005 4:57pm
Cheburashka (mail):
Personally, I'm betting (hoping!) that its a bubble. A burst is the only way a mere biglaw attorney with student loans could hope to own an apartment in Manhattan.

Here's my concern: Can't government intervention on behalf of homeowners fill-in the bubble?

Hypothetical: The New York bubble bursts. Housing prices start to drop. Mortgage defaults begin. All of the folks who bought apartments in the last two years start to whine and complain. The developers with dozens of multi-million dollar buildings going up around town call Bloomberg on his cell. And...

Presto, chango, 20,000 existing units get rent stabilized, and prices start going up again.
6.23.2005 5:34pm
Fred K (mail):
I am tracking HOV TOL KBH looking for the bubble burst to make me a few $$, as I didn't make any $$ on the way up as I wasn't invested in real estate. LEAPS puts look like a way to profit without having to be precise about the timing of the bubble burst.

Note, as said by a post above, that the builders might not decline too much if they can keep building and selling. If you see a bubble coming, as I do, the builders won't be able to build and sell when it hits. Why? Mortgage rates will skyrocket with the many forclosures. I can't afford a mortgage now in LA, can you imagine how outpriced things will be when rates rise?

Any idea where I can purchase LEAPS online?

Thanks

--Fred
6.23.2005 7:00pm