Fake Numbers Mute the Sound of the Housing Crash
“The truth is that the official numbers on house prices—the last refuge of soothing information about the real estate market on the coasts—are deeply misleading.” That’s the key point in David Leonhardt’s excellent piece this morning in the NYT. The reality, says Leonhardt, is much worse that the official stats show.
In other words, millions of ordinary, middle class families are in worse shape than the official numbers are reporting. There’s less home equity to fall back on if anything goes wrong.
But the bigger problem is coming up. For every family (and every investor) that took on a “creative” mortgage planning to refinance if they couldn’t make the payments when rates escalated down the line, there will be no refinancing if market values are lower. Instead, the only options will be forced sale or foreclosure. As more families and more investors get caught in that situation, more housing will be listed for sale—and prices will be pushed down even further.
Perhaps the reason the housing market seems to be making a “soft landing” is that our ears are stuffed with cotton.
One example: Officially Boston prices are up about 1% over the past year. Leonhardt's experts say values have actually declined about 20%. The official numbers are off in part because they reflect only sales, not the growing number of homes in inventory for which the owners have no offers. Leohardt points out that the they are also off because some sales are reported only for certain subsets of the market.
Whenever the hard economic data are called into question, there should be a quiver run through the economy. Mark Zandi says the current state of the housing market is the “the most significant threat to global expansion.” For millions of American families, however, the impact will be much more immediate: their assets will be wiped out, the home will be gone, and they will be left deep in debt.
Since the vast majority of home owners with mortgages bought their houses some years ago when they were worth considerably less than they are still worth today (even with the soft market and falling prices) where is the crisis here? The problem cited here would affect only people who bought at the height on the housing boom, and only some fraction of that population. Also, this presumes that lenders would be unwilling to work out some arrangement with these people, which I find to be unrealistic, as most mortgage holders are loathe to become actually property (as opposed to lien) owners, especially in a bad market, as they would necessarily have to do if they start foreclosing left and right. I suspect that as long as people are current on their payments and have no history of delinquencies, their mortgage holders will work something out with them, perhaps holding the line on interest rates, rather than taking over properties which will then convert from being an asset to a debit on their balance sheets and which they may tehmselves be stuck with for months if not years.
December 6, 2006 9:41 AM | Reply | Permalink
It's not the "millions of ordinary, middle class families" who are most deeply at risk here. It is the speculators who bought homes too large and much more expensive than they could afford. They bought on the gamble that the value of the house would certainly increase. Leonhardt has been warning against this for years.
Contrary to Leonhardt's warnings, most of these people have made out like bandits.
December 6, 2006 10:04 AM | Reply | Permalink
If your comment is primarily on the tone of the post, I can understand your reaction - I find that the esteemed Ms. Warren's much-appreciated zeal for bringing to light these issues and other threats to middle class economic security sometimes prompts her to describe things in more dire terms than the full picture may suggest.
But I think you do yourself a disservice by ignoring this passage:
The withdrawals have been so big that the average household in Boston now has slightly less equity in its home than it did in 2000, according to an analysis by Moody’s Economy.com that took inflation into account. That's a lot debt, and whether the mortage broker eats some and the owner the rest, that loss has to be reported in the books and represents a loss of wealth somewhere in the system. And the only reason that the loan holders are willing to take that kind of loss is that they have generally passed a lot of the risk on to the Maes and/or the securities market. So there are a lot of layers you have to peel back to see what's really going on.
The other point to consider is that a fundamentally speculative real estate market (you can't lose money on real estate... they're not making any more land) causes people to ignore the size of the transaction fees they stand to lose. If your closing costs add up to some $6000-$10000, even if you ignore negative equity and the interest you don't get back, and you end up only losing the closing costs in some kind of forced refinancing deal, that's a pretty big hit for most middle class families, similar to totalling the car without any insurance coverage. But a speculative market and cheap mortgages cause people to ignore these costs and risks because they "pay for themselves". Except that when you turn them back into real money, they put a serious dent in people assets.
December 6, 2006 3:01 PM | Reply | Permalink
I've been trying to get statistics to see just how much of the mortgage base is at risk in a downturn. The best data I've seen come from the following article. To summarize, the national installed base of home mortgage value is about 9 trillion dollars. About one-third of that is on adjustable mortgages, and about one-third of that ($ 1 trillion total) will reset during the next couple years. I suspect a lot of those loans that will reset were exotic or toxic mortgages. Consequently, the impact of a downturn in the housing market will be widespread indeed.
http://www.msnbc.msn.com/id/14251743/
December 6, 2006 5:18 PM | Reply | Permalink
Although as marcf points out below, those refinancing show very large price appreciations -- 33% in the case of FreddieMac refis.
December 6, 2006 8:18 PM | Reply | Permalink
Don't forget that job loss, or income loss, can significantly reduce the market value of a home because to avoid foreclosure it will need to be sold in a hurry. If the market is slow, the value is even worse. That 33% appreciation disappears quickly. There is even a risk that the sale won't cover the loan, depending on the situation. Relying on equity for financial security is just plain foolish.
Jim Anderson
The Truth About Credit
December 7, 2006 11:01 AM | Reply | Permalink
Yup; life's a bitch.
December 7, 2006 11:03 AM | Reply | Permalink
The speculation problem isn't in the transacton fees. It is is the borrowing fees and interest. If people paid cash for the real estate, then they would stand to lose less, and would be at a low risk of losing their investment over a long period of time. It is the debt service that brings urgency and high risk of loss. Debt secured by real estate property is what causes large fluctuations in the real estate market on a macro level, even locally.
Our banking system, including the Federal Reserve Bank, wants borrowing because it gives them the power to create a hidden tax (inflation) and attempt to tame it. The problem is that it eventually will become excessive, and they will lose control. You can't get something for nothing, which they pretend to do by printing a fiat currency. So it isn't in our government interest, nor the interest of banks, to discourage borrowing. They just pass the risk on to the consumer who doesn't understand risk. They don't want educated consumers, it will hurt profits and an easy source of government funding without increasing taxes.
Jim Anderson
The Truth About Credit
December 7, 2006 11:20 AM | Reply | Permalink
It doesn't have to be...
Jim Anderson
The Truth About Credit
December 7, 2006 11:29 AM | Reply | Permalink
I'm puzzled that most discussions of this issue treat residential real estate as one undifferentiated market. There is a substantial difference in the supply and demand dynamics of single-family/stand-alone homes versus multi-unit dwellings such as condominiums and townhouses.
Most new construction is in multi-unit dwellings, as there is less land available to develop on and local governments see higher property tax revenues from greater density. This further widens the gap in price stability between the two segments.
This being the case, the numbers for variable rate mortgages really mattter when you break them down between houses and condos. I suspect (but can't find numbers to support) variable rate mortgates are much more common among houses, due to their higher prices. Since that is the more stable end of the market due to higher demand, the asset to value ratio is much more likely to stay positive.
On the other hand, if a large number of condo buyers used variable rate loans, whether to jump in to a market that was growing out of reach or because of weak credit, that would imply a much more substantial risk of a price crash in the condo/townhouse market.
I'd like to see a breakdown of variable rate mortgages - preferably by number rather than dollar value - of multi-unit versus single-unit dwellings. That would let us evaluate the risky loans in the risky part of the market - and it is the intersection of those two axes of risk that yields (potentially) a price crash point.
December 8, 2006 7:25 AM | Reply | Permalink