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The Housing Bubble--A Credit Bubble:

Back in January 2006, I authored a post entitled "Is the Housing Bubble Really a Credit Bubble?" I wrote: "I've seen some persuasive evidence, both scholarly and anecdotal, that a major factor driving the 'housing bubble' is historically loose credit standards: no money-down (or even negative money down) mortgages, cursory (or even non-existent!) checks of reported income levels, qualification based on teaser rates that rise substantially after a year or two, and so on."

With the subprime meltdown, an Alt-A meltdown potentially on the horizon, and evidence of historically unprecedented levels of mortgage fraud, I think it's fair to say that the answer to my original query is "yes."

I also added a prediction: "when the teaser rates expire, and prices stabilize (which they seem to be doing already) so that mortgagees can't simply 'flip' their properties when their monthly payments rise, this is going to get very, very ugly. And the regulators who've dropped the ball on managing credit standards are going to look a lot like the regulators asleep at the switch in the '80s with regard to S&Ls." The ugliness has started, especially in the former Ground Zero of the housing bubble, South Florida, but it will likely take a recession--perhaps itself brought about by the end of the bubble--to get to the "very, very ugly" stage.

Not irrelevantly, my wife and I are going to look at a bank-owned foreclosure property tomorrow night, selling for 100K less than both its county assessment and the most recent (100%) refinance. The house next door, I've discovered from the public records, which had a different owner, has also been foreclosed upon. Bank-owned properties are suddenly popping up in the MLS all over Northern Virginia. [Note: This is not a recommendation to buy now if you're looking for a "good deal." It's way too early in the cycle for that.]

UPDATE: One of the more interesting aspects of the credit bubble is how many people seem to have had no idea about their mortgage terms. Many buyers approached buying a house in the same (foolish) way many buyers approach buying a car: "what's the monthly payment?" They seem not to have taken into account the carrying costs of owning real estate, much less inquired closely as to whether the relevant monthly payment was guaranteed for the life of the loan. If they did inquire, they were told, "don't worry, you can always refinance before the reset," and many didn't inquire beyond that.

M (mail):
You'd better watch out or Alex Tabarrok will start calling you a 'credit snob' for this sort of talk!
4.10.2007 1:37am
2L:
I have to confess, it's hard to feel sorry for people who screwed themselves by getting into mortgages they couldn't possibly afford. Shame that, en masse, they may take the rest of us down with them. I just hope it's feasible to *not* bail out the lenders who put themselves in such a precarious position too.

On the more self-interested note: I've been figuring that 2010 or so will be a very good date to start shopping for a starter home on the foreclosure market. It looks like everything is going according to plan...
4.10.2007 1:43am
Meh (mail):
David Bernstein can post about whatever he likes, but his posts have become remarkably, and hilariously, predictable: he loves the fact that prices will now come down. For someone, such as D.B., who is looking to buy, that's fine and understandable, but it has grown tiresome to read his harangues. Me? I sold my condo in NoVa in 2005 and moved to California, but I still get a kick out of D.B.'s rants.
4.10.2007 1:53am
davidbernstein (mail):
I'm not loving it, because I plan to buy a house very soon and prices are still grossly overinflated. Anyway, predictable, perhaps; I'd say consistent. I said there was a bubble when all the commentators claimed it was just sour grapes and the media was talking about prices going up forever, and I'm certainly not going to change my mind now that the trends comport with my previous predictions.
4.10.2007 2:16am
Meh (mail):
I don't know that prices are "grossly overinflated." In any event, I agree that you've been consistent, but I simply don't remember the part about "all the commentators" claiming that it was just sour grapes and that "the media was talking about prices going up forever." When did this occur? I don't recall anyone claiming that prices would go up forever (forever!!!). Maybe if I'd watched some crazy infomercials, I would've encountered such a thing. In short, wasn't it obvious all along that prices would come down again? No offense, but I'm afraid that you aren't the soothsayer you take yourself to be.
4.10.2007 3:08am
Viscus (mail) (www):
I for one, really enjoy Mr. Bernstein's posts on mortgages. I think they add something interesting to this blog.

By the way, this comes from someone who is not inclined towards friendliness when it comes to libertarians. (Especially libertarians who think there should be no basic right to food.)
4.10.2007 3:11am
ArlingtonResident:
I bought a condo in Arlington a few years ago, and I remember that the market had gone up so much over the previous few years that there were indeed some people who thought it would keep going up for a long time. I remember a mindset of "get in the market now before it gets even higher!" Of course, these optimists were balanced out by other voices (friends, etc.) who thought the market would seriously crash.

When I bought, I figured that there was indeed a bubble -- but that it didn't matter too much for me, as I didn't expect to sell for many years. And heck, I didn't want to wait 5 or 10 years just to see what happened; at the end of the day, it's hard to time life events based on guesses about the housing market! You can drive yourself crazy worrying about that kind of stuff, and it's way out of your control.

So in the end, Professor B. was indeed accurate about a bunch of things. But on the other hand, there were also a lot of people who were telling me (and who thought) the same things that Professor B. was posting.
4.10.2007 3:27am
Kazinski:
There are local bubbles, but there are parts of the country where prices haven't dropped much and are starting to go up again, such as Seattle where there were healthy gains but no fever.

A lot of what drove prices, besides easy credit, were onerous growth restrictions that affect supply in the highest demand regions, that hasn't gone away.
4.10.2007 3:49am
DB the R/E guru:

I said there was a bubble when all the commentators claimed it was just sour grapes and the media was talking about prices going up forever, and I'm certainly not going to change my mind now that the trends comport with my previous predictions.


That's just silly. For one, "commentators" are not a monolithic group. For another, some people made a ton of money flipping real estate, fully understanding they were exploiting an unsustainable bubble. Those people had every incentive to talk up the housing market, and did so.

For comparison, didn't Greenspan make his "irrational exuberance" comment w/r/t the stock market bubble in 1997? And some years later some "commentators" were writing about the market going up forever.

Please quit with the smugness, DB; you're not as clever as you think.
4.10.2007 5:03am
Armen (mail) (www):
I'm with Viscus. I actually enjoy reading the posts. What really gets me is that there are at least four bloggers on the VC who live and/or work in the DC / NoVa area (has Barnett moved yet?), but we only hear about DB's Quixotic quest to own a home. What's Somin up to? Is Volokh the Younger decorating his bachelor pad with 12th Century Norman one-liners? Is Kerr on the market? Or is he waiting for prices to come down a tad bit more so he can finally get the latest in home security/surveilence measures installed? Are there any foreclosures that come with fixed heat lamps in the closet? These are just a few of the questions I'm dying to know the answers to. DB CAN'T be the only VC blogger dealing with housing issues in the area.
4.10.2007 6:14am
AppSocRes (mail):
The Boston Globe recently had a front-page story about the sub-prime mortgage racket in Massachusetts. The human interest was provided by a woman, whose total before-tax annual income couldn't have been more than $70K. She got stuck with a mortgage whose eventual monthly payment was over $4,000! This to buy a house with an assessed value of about $500K and whose true (non-bubble, market value) was probably closer to $300K. Stupidity like this (on the part of both buyer and lender) deserves to be severely punished. And you don't need to be a financial wizard to realize that mortgages like this will result in default.
4.10.2007 8:41am
Porkchop:

And the regulators who've dropped the ball on managing credit standards are going to look a lot like the regulators asleep at the switch in the '80s with regard to S&Ls.


Actually, the regulated financial institutions don't have nearly the level of exposure that the unregulated (or state-regulated) lenders/originators have. There is, of course, the question whether they can make good on their recourse obligations.

The system is different than it was in the '80's. Back then, financial institutions were the originators of bad loans; now they are mostly purchases of loans. The largest financial-institution-purchasers of loans are pretty good at catching bad loans and sending them back to the originators. In addition, in the 80's, a big part of the problem was ADC loans to developers (often related parties), and the land flip business involved large parcels of raw land using multiple straw buyers to jack up the stated value. That's not so in the present environment. I would not be surprised, however, to see some move toward federal regulation (i.e., licensing) of mortgage bankers. In addition, some mortgages are outside the banking system entirely -- from origination to securitization, so the impact will be felt in the investment-banking world not the commercial banking world.
4.10.2007 9:10am
J. F. Thomas (mail):
That for the last six years we let so many people (both the residents and the brokers and investors who bought the mortgage backed instruments) basically bet their rent money like they were hopeless gambling addicts hanging out at a race track is disgusting. Actually it is worse. because when your neighbor blows his paycheck at the track and loses his house it generally won't drag down the value of your house. But this pyramid scheme has affected those of us who didn't even want to participate in the scam.

I would really like to know what you libertarians have to say about that.
4.10.2007 9:20am
markm (mail):
2L: Better make sure wherever you are saving up that down payment for 2010 is either a well insured account, or in securities that will not be affected by a housing &banking crash...
4.10.2007 9:26am
davidbernstein (mail):
Just to clarify, I'm not claiming I was the only one calling the bubble. Certainly Prof. Schiller ("Irrational Exuberance"), among many others, was. In my comment above, I meant "all the commenters [on the VC, and yes, I realize that's an exaggeration]" not commentators. That's what happens when you write in the early A.M.
4.10.2007 9:50am
davidbernstein (mail):
BTW, the very first house we were interested in when we got engaged in 2004, and actually put a bid on, was purchased by a single woman who put no money down, only gave the seller a $1,000 deposit, and needed $15K in closing cost help. In other words, all indications were that she had no, or virtually no, savings. And the seller, who knew her and spoke to us later, told us that she was only able to contemplate buying the house because her father promised to help her with the mortgage, but they were constantly fighting and he kept threatening to withdraw his offer (which almost led to the seller coming back to us before settlement). Yet someone was willing to lend her almost 600K to buy a house. You can trace my interest in the credit bubble to that.
4.10.2007 10:00am
Anon A. Mouse:
It does come across as as a bit smug, especially for someone who appears to have the mortgagor/mortgagee distinction turned around.
4.10.2007 10:04am
davidbernstein (mail):
Believe me, I'm not smug. If I had made a few million by buying real estate before or during the boom, then, maybe, I'd be smug.
4.10.2007 10:24am
Stacy (mail) (www):
If they did inquire, they were told, "don't worry, you can always refinance before the reset," and many didn't inquire beyond that.


In my mind that's neglecting basic due diligence, and any consequences are purely the buyer's own fault. When I bought my condo, I did research that led me to rule out ARMs and interest-only loans, settling on the standard 30-year fixed rate mortgage as my tool of choice. I was lucky to be able to afford something that way, but if I had found I couldn't buy, that would have been that. I think a lot of people knowingly got into sketchy mortgages because they thought owning a house was the key to wealth, and weren't willing to accept the reality that it isn't a holy grail and that in either case they couldn't afford it.
4.10.2007 10:49am
Stacy (mail) (www):
Another thing; there are always bears in the media who call the contemporary market a "bubble" regardless of conditions. However, the real sign of a burst-ready bubble in any market is when the man on the street thinks he's an expert. I live in the DC area and that effect was in full force at least two years ago. People were flipping pre-construction condos and/or just upgrading every year or two and believing themselves to be the next Warren Buffet. The enthusiasm always builds among those who are simply ignorant of fairly easy-to-spot indicators, so the media overall probably didn't jump on the bandwagon -- for example, The Economist called the housing bubble at least four years ago.

Irrational exuberance indeed...
4.10.2007 11:01am
J. F. Thomas (mail):
In my mind that's neglecting basic due diligence, and any consequences are purely the buyer's own fault.

Where is the responsibility and due diligence on the part of the lender? Don't they have a responsibility to ensure that they are making good loans and that the people they are lending are capable of meeting their obligations? Aren't the lenders being just as reckless as the borrower? After all they are making these loans based on the theory that borrower will be able to refinance at the end of the teaser period because the unsustainable appreciation in housing prices will continue. The lenders created the bubble by writing these loans, artificially inflating real estate prices, which created the illusion that the market would continue to appreciate. They didn't care if the borrowers defaulted a few years down the line because the lenders weren't actually lending their own money. But like any pyramid scheme, the suckers who got in too late were screwed. However, unlike most pyramid schemes, even those people who recognized it for what it was were forced to climb on board.
4.10.2007 11:05am
2L:
2L: Better make sure wherever you are saving up that down payment for 2010 is either a well insured account, or in securities that will not be affected by a housing &banking crash...

Already taken care of.

J. F. Thomas: Where is the responsibility and due diligence on the part of the lender? Don't they have a responsibility to ensure that they are making good loans and that the people they are lending are capable of meeting their obligations? Aren't the lenders being just as reckless as the borrower?

Agreed. Both should have to live with their actions, which is why neither the lenders or the borrowers should receive any form of federal bail-out.

Look at the update:
Many buyers approached buying a house in the same (foolish) way many buyers approach buying a car: "what's the monthly payment?" They seem not to have taken into account the carrying costs of owning real estate, much less inquired closely as to whether the relevant monthly payment was guaranteed for the life of the loan. If they did inquire, they were told, "don't worry, you can always refinance before the reset," and many didn't inquire beyond that.

If people can't be bothered to spend five minutes doing their proverbial homework, I'm not sure there's much we can do for them. Is there *anybody* who relaxes when a salesman says, "Don't worry."? Who are these people?
4.10.2007 11:43am
Bruce Hayden (mail) (www):
DB,
I also added a prediction: "when the teaser rates expire, and prices stabilize (which they seem to be doing already) so that mortgagees can't simply 'flip' their properties when their monthly payments rise, this is going to get very, very ugly.
Don't you mean "mortgagors"? The mortgagor is the one who hypothecates his property in order to secure a debt. And the mortgagee is the one who holds that security (initially the lender). The sentence reads like you mean that things are going to get ugly when the borrowers can't flip their properties, and not the lenders.
4.10.2007 11:46am
guest from TX:
When prices come down to where they were three years ago, then it may be time to feel good for sitting it out. I only wish I could have bought three years ago. Three years ago, most row-houses in Glover park were selling for under $500k, with similar growth throughout the region.

I personally think during a credit bubble is a great time to buy, if you don't happen to have a $100k or so to put into a down payment. It takes most people quite a long time to save up that kind of money.
4.10.2007 12:05pm
Bruce Hayden (mail) (www):
About a month ago, a couple of relevant articles came out in the Economist and the WaPo. Apparently, part of the problem is the way that mortgage debt is now being turned into securities. I comment on them in 'No Money Down' Falls Flat and Taxpayers should be afraid, really afraid.

The problem is that the risks in packages of mortgages have been split up very efficiently into securities of differing risks and rewards. The best paper is rated AAA, and the lowest, the equity "tranches", is unrated. And the reason to be scared is that the wrong people are holding the high yield paper that is liable to go south, notably pension funds. As the Economist points out:
It's a pretty common story: investors with big losses behave essentially like gamblers in a casino, trying to double down in order to recover their previous position. In this case, state and local pensions have enormous unfunded liabilities. This is due in part to unrealistic valuations of their asset base during the stock market bubble, which left them with an enormous hole when the bubble collapsed. It is also due to the massively overgenerous promises politicians made, in part because the bubble inflated tax revenues to unrealistic levels in many localities, and in part because until recently they didn't have to account for their pension liabilities the way private companies do, which made big boosts for public sector pensions feel like a freebie for their supporters in the civil service unions.

So now you have these pension funds pouring into risky instruments that promise higher potential returns in order to close up the holes. Instruments that, from the quotation, they don't understand too well, or keep track of too closely. It's not entirely clear that this fellow grasped the fact that the reason the CDO's offered such attractive returns was that they were extremely risky, potentially leaving him with nothing at all.
4.10.2007 12:05pm
guest from TX:
Meant to add that prices in Glover park pretty much start at $700k now.
4.10.2007 12:08pm
davidbernstein (mail):
Guest, it all depends where you're looking, and what you're looking for. You can get a condo in Arlington by the metro for 2004 prices, and a house in South Arlington for about that. Prices in parts of North Arlington are running about 2004 prices plus inflation. Even less if you go out to PW, Loudon, outer Fairfax, etc. Even Cleveland Park, we looked at very nice house right near the metro for under 900K, something we haven't seen since we started looking in '04 (it disappeared right away, however).
But remember DC prices started at an artificial Marion Barry-induced low.
4.10.2007 12:18pm
Abe Delnore:
I see recorded documents with the mortgagor and mortgagee reversed all the time. Of course in Virginia, Bernstein is actually looking at deeds of trust, which should be a lot harder to mess up.

I think the fundamental fact is that borrowers signed mortgages (or other security agreements) that they could only afford if current conditions continued. That is, if property values kept rising and the borrowers stayed employed, they can keep refinancing up and stay out of default. This condition--increasing assessments, high employment--has prevailed for several years, and many people in the industry, as well as homebuyers, seem to think it's just the natural state of affairs.

Remember, a lot of people working as mortgage brokers and the like right now have been in the industry for only a few years. They got in during the 2001 (or so) interest-rate dip and have been riding along ever since. For that matter, that's when a lot of folks got into title &escrow, real estate sales, and so forth. I mean, there are whole mortgage brokerages and title companies where no one worked in the field at all before 2000. That's also the timeframe in which big institutions got into subprime lending. The individual involved just have no clue that it could all go wrong, and little incentive to get one.

I won't even bother pointing out how profoundly ignorant and optimistic many first-time homebuyers are.

--Abe Delnore
4.10.2007 1:01pm
pete (mail) (www):
<blockquote>
Many buyers approached buying a house in the same (foolish) way many buyers approach buying a car: "what's the monthly payment?"
</blockquote>

And why is this foolish? Isn't that one of the first steps to figuring out a family budget? If the monthly payment is too much then you pass on houses in that range and start looking at cheaper ones.

This was the major reasoning behind how I figured out how much house I could afford when I bought mine a year ago. And when I was buying a car a few months before that. Of course I had a 10% down payment and closing costs saved up and have other savings as well. I got a 30 year fixed interest mortgage and so far the only increase in the payment has been a $20 monthly increase in property taxes that will start in a month.

And as someone who saved up for years to buy a rather modest $110k house I have no sympathy for people who bought more than they could afford. I certainly won't be happy if responsible people like me end up having our tax dollars spent to bail out the irresponsible people who got to live in nicer houses or the irresponsible lenders who gave people mortagages they knew people could not afford.
4.10.2007 2:01pm
J. F. Thomas (mail):
Both should have to live with their actions, which is why neither the lenders or the borrowers should receive any form of federal bail-out.

Although this is nice in theory, the fall-out is going to hurt a lot of innocent people (e.g., responsible homeowners who can't sell their homes because of all the pennies-on-the-dollar foreclosures in the neighborhood and the people who are left holding the bag when the high risk mortgage instruments their pensions were invested in become worthless).
4.10.2007 2:11pm
Stacy (mail) (www):
JF Thomas: "Where is the responsibility and due diligence on the part of the lender? Don't they have a responsibility to ensure that they are making good loans and that the people they are lending are capable of meeting their obligations? Aren't the lenders being just as reckless as the borrower?"

Yes they are, but I maintain that that barely matters as long as the buyer is informed and realistic. Mortgage loans aren't rocket science and even the minimal disclosures required by law should be enough to tip the buyer to any shady aspects. If I managed to know ahead of time that ARMs usually bring enormous jumps in monthly payment, and that interest-only loans are giving up all the benefits of the FHA-insured 30-year mortgage, then I have a hard time absolving others who just let a broker tell them what they wanted to hear. Ignorance isn't an excuse for breaking statutory laws, and it shouldn't be a safety-valve for violating economic laws either.

"However, unlike most pyramid schemes, even those people who recognized it for what it was were forced to climb on board."

Please explain the process by which a housing bubble deprives individuals of the choice to rent.
4.10.2007 2:12pm
Steven Vickers:

Although this is nice in theory, the fall-out is going to hurt a lot of innocent people (e.g., responsible homeowners who can't sell their homes because of all the pennies-on-the-dollar foreclosures in the neighborhood and the people who are left holding the bag when the high risk mortgage instruments their pensions were invested in become worthless).


I don't understand what you mean here. Yes, responsible homeowners are hurt relative to the price they could have gotten in early 2006, but they've still benefited from a huge appreciation over the past decade, and it will take a heck of a lot more than a decline to 2004 price levels plus inflation to talk about people "holding the bag." Or have I misunderstood what you're trying to say here?
4.10.2007 2:35pm
Jamesaust (mail):
While, no doubt, "teaser" rates and generally cheap credit are an important cause of problems with the "subprime" mortgage market, the entire "bubble" reveals core problems with housing in general, two particularly:

1. A massive subsidy by the government of not only middle-class persons but especially upper middle-class persons who make up the vast majority of tax subsidies. Such subsidies are a New Deal leftover established under the guise of aiding the "deserving" working poor to manage to own the roof over their heads. Shockingly, the working poor STILL have problems making it through that first purchase step. For the billions expensed annually on this topic, the government could just buy houses outright for the working poor with money left over for tax cuts! Instead, everyone across the spectrum responds to these subsidies by buying more house - thus, the ever bigger size of American houses.

2. Its not only quantity that's a problem with modern houses but quality - specifically the ever-growing portion of GDP expensed into homes and related items. While a tad cold-hearted, from an economic point of view, every dime spent beyond putting a basic roof over peoples' heads is wasted wealth. Homes are not productive assets and the use of savings they represent are reciprocal to savings not being invested in productive assets, which in turn along with productivity are the SOLE basis for the creation of future wealth. Make no mistake - people may choose to consume rather than save but its quite another thing for government policies to weight consumption over savings (especially when that government is facing massive shortfalls in future revenues relative to committed expenditures as far as the eye can see).
4.10.2007 3:28pm
Jeek:
When the bubble of David Bernstein smugness finally deflates, the result will be very, very ugly... =)


"However, unlike most pyramid schemes, even those people who recognized it for what it was were forced to climb on board."

Please explain the process by which a housing bubble deprives individuals of the choice to rent.


You can rent, sure, but the housing bubble drives up rents and drives down availability, so you will still be affected.

More significantly, the housing bubble still affects people who bought before the bubble started inflating, and those who bought during the bubble but who "bought prudently" (did not use a "liar loan"). One notable effect in the DC area is property taxes. They went up during the boom, and something tells me they won't come down during the bust. Local governments got too used to having all that dough to throw around.
4.10.2007 3:47pm
J. F. Thomas (mail):
I don't understand what you mean here. Yes, responsible homeowners are hurt relative to the price they could have gotten in early 2006, but they've still benefited from a huge appreciation over the past decade, and it will take a heck of a lot more than a decline to 2004 price levels plus inflation to talk about people "holding the bag." Or have I misunderstood what you're trying to say here?

Historically, except for certain areas of the country where there was a good reason for it, housing has been a very stable, safe and slowly appreciating asset, generally raising with or just above the rate of inflation. From the point of view of classic economics, this makes sense as the population slowly grows and housing expands to make the need. People should look at their houses as a long term asset, not a get-rich quick scheme simply because of the dual nature of their home (it is not only an investment it is where you live). Also, stable housing prices encourage investment and stability in a community and prevent people from being priced out of the housing market by speculative pricing.

The last six years or so have turned all this on its head. As housing prices escalated, fueled by the availability of easy credit, people bought simply because they thought they had to buy before houses got even more unaffordable, driving prices up even further, leading to even riskier loans and higher prices. Also, because of home equity lending, people stopped seeing their homes as a saving account and started using it like a checking account. This will make things even worse.

Because this appreciation (my in-laws live in Phoenix and housing prices went up 50% there in 2005) is completely artificial, I wouldn't be surprised if some of the most hyper-inflated markets see all the appreciation of the last four or five years completely wiped out. So then what happens to the person, even the cautious person who bought in 2005, who tries to sell his house when there are four or five foreclosures on his street selling for 2/3 or less of what he paid for his?
4.10.2007 4:05pm
J. F. Thomas (mail):
Its not only quantity that's a problem with modern houses but quality - specifically the ever-growing portion of GDP expensed into homes and related items. While a tad cold-hearted, from an economic point of view, every dime spent beyond putting a basic roof over peoples' heads is wasted wealth

This is another point that is not stressed enough. The residential housing boom, especially the McMansion boom, has been an incredible waste of capital. While we were building these mini-palaces, our roads and vital infrastructure continued to deteriorate. At the same time, China, India, Eastern and even Old Europe continued to spend massive amounts on theirs.
4.10.2007 4:10pm
PDXLawyer (mail):
Jamesaust:

I generally agree that we are *way* over-invested in housing as compared with other sectors. But, you're wrong in saying that homebuilding is consumption rather than investment. A well conceived house has a more-or-less indefinite service life (more often terminated by obsolescence than by wear). During this service life, it produces shelter benefits, which are the consumption.

A house is analogous to, for example, a dairy herd. The herd (a productive asset) produces milk (a direct or indirect consumption item). Any policies which encourage general economic activity will encourage all consumer production industries, whether housing or dairy, which will in turn stimulate secondary producer production, such as cattle breeding or construction. Economic activity that does not result, directly or indirectly, in consumption is pointless.

Of course, you're correct that it introduces a distortion in the economy for the government to encourage the consumption of housing more than entertainment, or food, or anything else.
4.10.2007 4:13pm
PDXLawyer (mail):
Maybe a part of the explanation for the "credit bubble" is that consumer expectations are lagging behind innovations in consumer financing.

We've gone in 100 years from: (1) most people buy homes for cash or with seller financing; to (2) post-WWII 20 year mortgages with 20% down; to (3) 1990 30 year mortgages with 3% down; to (4) now adjustable rate, no-money-down mortgages. Sure, the risks are there to see, if one has the education and patience for analysis. But, if one relies on rules of thumb passed down from parents or grandparents (as most people do) one can't identify a relatively new risk.
4.10.2007 4:26pm
Rattan (mail):
There is a reliable yardstick for offering no money down or little money down loans to aid in buying a house: The monthly payments should deviate no more than about 10% from the rent paid over the last couple of years in a fixed term mortgage.

Beyond such an amount, the rule should be 20% down and adequate income (no more than a set percentage going to mortgage payments etc.)

The funny stuff starts when the interest rates are made more unpredictable- the risk of an increase in passed to a challenged and financially not so savvy party- a clear underwriting error. This is justified by the higher interest rate on such loans, which suggests that the risk of the loan going sour is factored in. Then, if the loan does go sour, so be it.

My experience suggests that at least my friends and I have not seen the terms agreed to actually be there at closing. The banks reward their agents for increasing the interest rate by a quarter point or adding a clause or two, in one case a home equity line that was REFUSED repeatedly.

Reporting and documenting such switching strategies is ineffective because of the extreme leverage at closing. I think better statutory defenses based on protection for borrowers in bankruptcies etc. will put the burden where it belongs-- with the sophisticated lenders who are otherwise adept at whining while walking off with fat commissions. Defenses that allow easier access to bankruptcy proceedings if there is switching of or addition of terms etc. or violation of underwriting standards will greatly curb the irrational exuberance in the lending industry.

However, such legislation is unlikely as the poor continue to be easy marks and inadequately organized voters.
4.10.2007 4:42pm
Stacy (mail) (www):
"One notable effect in the DC area is property taxes. They went up during the boom, and something tells me they won't come down during the bust."

Most of the local governments in Northern VA cut property tax rates in the last couple years for exactly that reason. They'll likely raise them again if the current price slump looks like lasting awhile.

As a renter and now homeowner in that area, the effect on the rental market has been interesting. Just prior to the boom the rental market was quite tight. Prices were through the roof and people literally camped out to be first in line for desirable apartments. As more people began buying houses, it became a buyer's market for rental apartments and rents actually declined. Anecdotally, this had a lot to do with singles and childless couples buying houses and renting out rooms to help cover the mortgage. Then as more and more people were priced out of the housing market, the rental market recovered.

If you want to know when the housing market is in a recovery, you should probably watch for another softening in the rental market.
4.10.2007 5:16pm
Waldensian (mail):

I said there was a bubble when all the commentators claimed it was just sour grapes and the media was talking about prices going up forever, and I'm certainly not going to change my mind now that the trends comport with my previous predictions.

I don't ever remember there being THAT much exuberance. Which newspapers, columnists, etc. made the claim that prices would be going up "forever"?
4.10.2007 5:22pm
Viscus (mail) (www):
Stacy writes:

If I managed to know ahead of time that ARMs usually bring enormous jumps in monthly payment, and that interest-only loans are giving up all the benefits of the FHA-insured 30-year mortgage, then I have a hard time absolving others who just let a broker tell them what they wanted to hear.


There is one really good word to describe this sort of thinking: Self-righteous
4.10.2007 5:48pm
r78:

I said there was a bubble when all the commentators claimed it was just sour grapes and the media was talking about prices going up forever

Didn't you start predicting that the housing bubble would burst back in 2004 or 2005? Long before the market even reached its peak?

By that standard, perhaps you should start making weekly posts about how the housing market is undervalued. No doubt if you start doing that you will be correct in a few years, too.
4.10.2007 5:50pm
Jamesaust (mail):
PDX -
I don't believe I said that houses are not investments but rather non-productive assets. Your analogy to cows is actually informative. Just like cows, houses provide various benefits to their owners as well as being a store of value. Unlike houses, however, cows have calves and the cow herd has a natural rate of increase. In contrast, houses do not produce anything beyond themselves. Thus, they are an investment, perhaps, but one akin to gold or postage stamp collections - all quite attractive to human interests and reasonable stores of value ... but not productive assets like, say, a new microchip manufacturing plant or maybe revitalized port infrastructure would be.

J.F. Thomas - infrastructure investment is, as you note, important. But "Old Europe" is not a good example. Whatever their infrastructure investments, they, like their American cousins "waste" wealth at extraordinarily high rates ... in Europe they just do it with "quality of life" expenditures instead of McMansions. Their children and grandchildren will still struggle to maintain their relative if not absolute standard of living as a result of excessive (and/or inefficient) investment in non-productive assets. (Again, I'm not questioning the individual decisionmaking about how to spend personal wealth - I certainly wouldn't want to live like the Japanese in "rabbit hutches" for homes while the government converts the nation's wealth into concrete-pouring projects to build 4 lane roads to rural towns. Rather I'm commenting on public policy decisions that interfere, negatively, with balanced and informed personal decisions and create systemic imbalances.)
4.10.2007 5:59pm
tsotha:

You can rent, sure, but the housing bubble drives up rents and drives down availability, so you will still be affected.


This is not true, or at least not true where I live. In Northern Califonia, where $700,000 for a forty-year-old cookie cutter development home is normal, the bubble drove down rents quite a bit. For one thing, all that easy credit put a relatively low limit on landlords' pricing power.

Also, as in every bubble towards the end the speculators decended in droves. Normal people were buyng four or five houses they planned to flip a couple years later. This created a glut of rental properties on the market. You can still rent that $700k house for $1,400 per month, which is at least five hundred less than you could have rented the same house for an 2003. When the house was worth less than 300k.

As a renter I'll be sorry to see this bubble burst.
4.10.2007 6:28pm
Hattio (mail):
All I want to know is when the bubble is going to burst in my area so that I can buy a place I want....of course, if I told y'all the prices here, you wouldn't feel very sorry for me.
4.10.2007 6:57pm
RainerK:
Here goes my own prediction:
The references to the S&L crisis are all too true. Who remembers how fast a United Congress acted to bail out the mess? Same thing is going to happen again. Those who stupidly put themselves in over their heads need not fear. The rest of us will be forced to their rescue. The political pressure will be irresistible.
4.10.2007 11:32pm
Steven Vickers:

So then what happens to the person, even the cautious person who bought in 2005, who tries to sell his house when there are four or five foreclosures on his street selling for 2/3 or less of what he paid for his?


Ah, I think this is where we differ. I don't think someone who buys at the peak of an obvious run-up in prices is being cautious (which isn't to say he's being reckless either). But then again I am fairly risk averse in my finances. And remember, said person selling his house for less than he paid will also be buying into a much cheaper market, if he is staying in a similar area.
4.10.2007 11:34pm
Norseman:
Well, I for one love this "crisis". Only in America will mortgage lenders FIGHT to give people no down payment mortgages with limited documentation. I think this is a good thing, not a bad thing. So some people over extended and will have their home foreclosed (though not nearly as many as people are saying - most banks prefer a workout rather than spend the legal fees &time of foreclosure) - so what? They'll go back to renting an apartment (or frequently stop trying to flip houses for a living). For others, the risk will pay off and they will be able to manage the payments and achieve the dream of homeownership.

As for the mortgage holders - that's what the market does - it prices risk. Investors lose some, they win some. Looking at the returns in the markets over the past 5 years in the credit markets suggest they've been overearning recently, but who am i to know more than the market?
4.10.2007 11:40pm
Jeek:
said person selling his house for less than he paid will also be buying into a much cheaper market, if he is staying in a similar area.

That's if he can sell at all. How many people can sell when they have to bring cash to the table (on top of the cash they have to put down to buy)?

Most of the local governments in Northern VA cut property tax rates in the last couple years for exactly that reason. They'll likely raise them again if the current price slump looks like lasting awhile.

They cut the rates, slightly, but nevertheless their revenues have increased much faster than inflation since 2000.
4.11.2007 10:54am
Stacy (mail) (www):
"There is one really good word to describe this sort of thinking: Self-righteous"

That's two words. And I don't have any special knowledge of banking. I bought a couple of books about mortgage finance and did a lot of research on the web, running the numbers etc. Anyone in a position to consider buying property has the means to do that. If they don't, and instead just take the word of a third party, then they have very little standing to blame others for any surprises. Of course the lenders and mortgage brokers are predatory -- you should just assume they are. Nobody but you has your best interest at heart, especially someone who stands to make money by convincing you to buy something.
4.11.2007 11:19am
J. F. Thomas (mail):
And remember, said person selling his house for less than he paid will also be buying into a much cheaper market, if he is staying in a similar area.

And where is this person going to get the money to buy his hypothetical new house when he had to take a loss on his old house or couldn't even sell it? You need to stop discussing housing like it is some economic theory and face the real problems that real working people face every day. Real problems caused by greedy people who created an artificial run up in the real estate market and now are going to cause pain for people who wanted no part of their get-rich-quick schemes.
4.11.2007 1:03pm
Steven Vickers:

And where is this person going to get the money to buy his hypothetical new house when he had to take a loss on his old house or couldn't even sell it?


1) "Couldn't sell it" implies an incredibly unlikely level of illiquidity. That's greed, when you blame the market for not getting the price you "should" on your investment. True "no buyer" situations are going to be very rare.

2) I never said the person wouldn't take a loss, and such a person may indeed have to move down to a lower-priced house. That's what happens when you make a large financial bet (buying a house) and circumstances change such that the bet is no longer advantageous. That's not caused by greed, that's caused by life. If you're asking for a situation where a highly leveraged (even under traditional 20% down payments) investment with high transaction costs won't cause some people pain, you're not going to get your wish.


Real problems caused by greedy people who created an artificial run up in the real estate market and now are going to cause pain for people who wanted no part of their get-rich-quick schemes.


Whose greed are we talking about here? People who are willing to pay a certain amount for a home, or people who are willing to lend it to them? Why is either action greedy (excepting, of course, truly predatory loans and the like, but I've never seen compelling evidence that those have driven prices)? The value of home ownership varies strongly with interest rates (play around with them at this site) and don't you think low interest rates and stock declines are a more compelling reason for the run-up than a sudden outbreak of greed?
4.11.2007 3:42pm
J. F. Thomas (mail):
The value of home ownership varies strongly with interest rates (play around with them at this site) and don't you think low interest rates and stock declines are a more compelling reason for the run-up than a sudden outbreak of greed?

What in large part caused the sharp increase in home prices was the easy availability of credit, which in turn was caused by turning mortgages into a commodity that could be traded in bulk on the equities market rather than held as individual loans. That is the greed I am talking about.
4.11.2007 4:26pm
Stacy (mail) (www):
"
What in large part caused the sharp increase in home prices was the easy availability of credit, which in turn was caused by turning mortgages into a commodity that could be put a gun to thosetraded in bulk on the equities market rather than held as individual loans. That is the greed I am talking about.
"

What in the world does that have to do with a buyer's decision to take out the loan? I am just blown away by your insistence on blaming everyone but the dummy who bought a house s/he couldn't afford. It makes absolutely, positively no difference how easy it is to get the loan or how it's traded afterward. The buyer's only decision point is whether they can afford the loan, and there are way too many cheap/free research sources available for anyone to be able to claim ignorance or that the mortgage broker lied to them. I'm sorry for the people who got in over their heads, but nobody forced them.
4.11.2007 6:19pm
David Muellenhoff (mail):
I have a hard time believing this is going to be as bad as everyone seems to think it is. Yes, 100%+ financing is no more, but all those "creative" appraisers are still out there, and someone in desperate straits to keep his or her house would probably be perfectly willing to refinance into a 30-year-mortgage with a 50-year payment rate and a balloon payment at the end, which seems to be the new hot mortgage product. And why not? The payment's still low, and that gigantic balloon payment (just a bit less than the original amount financed) is awful far away. I'll bet these loans will find just as many buyers on the securities markets, too.
4.11.2007 7:05pm
J. F. Thomas (mail):
What in the world does that have to do with a buyer's decision to take out the loan? I am just blown away by your insistence on blaming everyone but the dummy who bought a house s/he couldn't afford.

It doesn't have a lot to do with the decision to take out the loan, but it has a hell of a lot to do with whether to make the loan. If the risk to you of making the loan is almost zero, you don't really care whether it will be paid off or not.

I am not absolving the borrowers nearly to the extent you are apparently forgiving the supposedly sophisticated lenders who lent money to people who had no hope of paying back the money they borrowed. The lenders' only hope of getting their money back was for the loans to be paid back early. The only way that could possibly happen was for housing prices to continue to appreciate at rates that were historically unheard of and completely unsustainable. They only way to keep the market red-hot was to write even wackier loans to even greater credit risks (create demand by creating more unqualified buyers) and inflate prices even further. This is a classic pyramid scheme. And like all pyramid schemes, you simply run out of people to fill the base and the whole edifice collapses.

My entire point is that reckless borrowers and lenders have created a situation where careful and responsible borrowers and lenders are going to be left holding the bag and harmed. Turning mortgages into a tradeable commodity is an unmitigated disaster.
4.11.2007 7:31pm
Norseman:
"Turning mortgages into a tradeable commodity is an unmitigated disaster"

Well, it allows US consumers to borrow significant sums of money at interests below what most sovereign countries borrow at. That's a neat innovation, and it has been around for +30 years, through GNMA paper. Markets go through cycles, we went from a new peak and will likely retrench, though I doubt as bad as the early 1990s. In the end, this experiment in low down/low doc mortgages provided a lot of opportunty for people to own homes. Some will fail, but most won't.
4.13.2007 9:43pm