According to this Reuters Article the Treasury Department is working on a plan to reduce mortgage rates to 4.5% on 30 year mortgages. Keeping in mind that home prices are a function of income and loan terms it is a proposal that has interesting implications.
Median household income in CA was $64,086 as of Q2 2008. Assuming a maximum of 35% of gross income towards a mortgage payment, and current interest rates of about 6% on a 30 year fixed rate loan, that would suggest median home prices should be around $311,000. Interestingly, after months of decline the Calfornia Association of Realtors tells us that October’s median home price was $311,060.
Coincidence? I don’t think so.
While many believe foreclosures are driving price declines, they are simply wrong. Affordability is driving price declines. The elimination a year ago of exotic loans that allowed people to buy more home then they could afford has forced prices down to levels that buyers actually can afford to pay given current incomes and loan terms.
Unfortunately this still doesn’t seem to be well understood by most of our lawmakers. They still believe foreclosures drive price declines and are pushing for foreclosure moratoriums and teaser rate loan modifications that fail to address the fundamental problem – that prices have to correct in order for buyers to afford them given current loan terms and incomes.
Which is why this Reuters article caught my attention. Lowering rates from 6% to 4.5% should effectively increase the median price a CA buyer can afford given a median income from $311,000 to $368,000. And by doing so this program actually might lower the number of foreclosures and reduce bank losses as fewer people would be underwater.
Still, it doesn’t completely solve the foreclosure “problem”. To effectively eliminate negative equity would require bringing prices back to peak bubble levels. To do that with traditional 30 year fixed financing at current income levels would require lowering rates to an astonishingly low 1.5%.
And why stop at 4.5%? Why not go all the way to 1.5%? Afterall the fed has already lowered the fed funds rate to 1% – why should banks be the only ones who get to borrow at these ridiculously low rates? And the clamor for short term US Treasuries has pushed their rates to zero. So are 1.5% mortgage rates really that ridiculous? I think they would be.
Ultimately aren’t we better off with lower prices than lower rates? Lower prices mean lower property taxes and insurance. They offer reasonable returns for those willing to be landlords. And higher interest rates give our retirees a better shot at surviving on fixed incomes. It will be a tough transition for sure, but better than socializing home loans at taxpayer expense to artificially increase prices.
In any case the next few months will be fascinating to watch. These
are typically slow months in real estate, and as things stand I think we may see some scary
drops in sales volumes. Yet if we see the Treasury Department manage to lower
fixed 30 year mortgage rates to 4.5% we may see a surprising surge in both purchase and refinance activity – possibly even leading to short term shortages in supply and rising prices.
Great post with plenty of thought about the current “crisis” and somebody who gets it.
Funny how when things are left alone that they just naturally work their own way out with the example you gave on the California market.
4.5% interest rates could make things interesting…
You certainly make a good point about artificially creating higher prices…and for the people I know that have no mortgage… they don’t really care about paying taxes to subsidize mortgages because they already know true freedom.
(Well somewhat true freedom minus the property taxes.)
I’ll be waiting for the fascinating advertising from “sales” people to see how they use this if it does indeed come to fruition.
311K for a family making 64K a year only adds to the foreclosure pile. Think more in terms of 180K to 190K for that income stream and foreclosure activity will again return to its long term trend lines.
The problem as you suggest is affordability but its also excess inventory which is only measured by forsale signs but in fact under the surface we have a large pool of investor owned property based on tax and lifestyle choices, much of this investor owned RE sits empty during the year either as vacation rentals,slow rentals or out right speculation. At somepoint in the shell game the movement stops and it becomes clear that only one of the three shells is occupied. We live in a similiar game with our existing RE.
Not sure where you get $180k – what is your basis for that price point? Do you believe interest rates should be above 10%? Or do you believe households should spend less than 20% of their income on housing?
It can only be one of those two answers, because — as I repeat ad-nauseum — price is a function of income and loan terms.
I recently came across your blog and have been reading along. I thought I would leave my first comment. I don’t know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.
Deborah
http://termlifeinsurance2.com
The article is really informative. The Treasury Departmen`s effort must return some results in near future. I am still amazed that some people still thinks foreclosures are driving price declines, I wonder are they able to understand the foreclosure? Still hope for the best
I believe a good start to solving the foreclosure crisis would be for bank to modify the loans for the current homeowner. I could start paying my loan tomorrow if the principal could be lowered to what the bank will sell it for, or the value of the house. Why pay for a house that is $100,000 in debt more than it’s worth? There is no guarentee with a modification of the interest rate only that hte value will be there in 5 years. Banks would rather and choose to foreclosure on homeowners and sell the house for a value the homeowner could afford, as well as under the value of the house. Yes, they lose money on the principal. But think of the foreclosures we could stop if banks would just lower the principal now, instead of waiting 8 to 12 months to sell a non-preforming loan. Now what would that do to our housing market recovery?
I agree that principal balance reductions are a sensible solution, but honestly don’t believe lenders have the reserves to do it. As such they will continue to drag their feet and take whatever government handouts they can get in order to keep paying bonuses a little longer. Hopefully I’m wrong.
I couldn’t agree more- what causes buyers to come back into the playing field more than low prices? We’re seeing that happen plain as day- sales volume is increasing as we hit new lows..
This blog is about the best I’ve ever seen on the subject because it is based on sheer data- data that simply doesn’t exist at this level for CA anywhere else…as a foreclosure investor it is absolutely priceless- thank you Sean keep it up.
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Thanks for the info Kevin. Having been interviewed for the 60 Minutes “House of Cards” story by Steve Kroft that aired a year ago, I’m looking forward to seeing David Faber’s take.
Low rates can attract more users to take up loans. I think this is a part of marketing strategies where banks are not making enough money and governement need to pump in. If ther rate keep dropping during crisis period too, then it is a doom for all those financial services that gives such low rates.
Stopping Foreclosures will reduce price declines in a way. One of the big reasons prices keep coming down, is because buyers ahve so much selection. Lots of this selection is foreclosures. So if there were no foreclosures, there woudn’t be as many homes on the market, and prices would stop going down…
That is a popular perception, but in my humble opinion it is also pure fantasy, not backed by any empirical evidence. In many of the hard hit CA markets our available inventory is actually quite low, and sales are brisk, yet prices continue to fall. Why? Because that is all that buyers can afford.
Supply and demand are important, but it is ability to buy (as determined by income, savings for a down payment, and loan terms) that is driving this market.
Let’s not forget how many homes were built during the bubble… resulting in oversupply created from the artificial demand.
Something that seems to be left out when it comes to the housing crisis and debates on how to fix the problem.
I think the last good report I saw showed over 2 million vacant homes out there available for sale
… Bulldozers would do more for falling home prices then tampering with interest rates, tax incentives, etc…
Then we can start all over…
I’m a fan of the bulldozer concept in areas that are fundamentally in contraction – especially in those parts of the country where you can buy foreclosures for $1,000.
But again I think the supply problem is largely overstated. We’ve seen plenty of demand for available inventory as prices reach reasonably affordable levels given area incomes.
The primary problem I have with folks focusing on supply and demand is it leads to the fallacious belief that reduced supply will bring prices back to 2006 levels. Folks need to realize those prices were the result of financial engineering… not market fundamentals. As such they are not likely to ever return expect through inflation – or significant taxpayer backed government intervention (think 1.5% fixed 30 yr home loans).
I’m not serious about the bulldozers even though it would probably be more beneficial then plenty of the junk being pushed through.
My point on the supply part is it is just one contribution to the current mess… created from overbuilding due to financial engineering. Follow the new home starts during the financial engineering days and we were building like crazy.
http://www.census.gov/const/www/newresconstindex.html
Follow some of those annual charts showing new home permits and it should not be hard to see correlations between boom and bust days.
Taking demographics into consideration there is no reason why we would have been building all of these homes/condos except for financial engineering…. but that’s another story to add in to make everything even more complicated. (Think Post World War II and Baby Boomers.)
There is no simple solution but just allowing everything to get back to affordability without financial engineering. Otherwise… we are just throwing good money after bad.
Sales are now way up in our area due to affordability… You obviously see the same thing… all without taxpayer subsidized loans…
Paul – I certainly don’t disagree that overbuilding made a bad situation worse. If it had only been that we still would have had trouble, but far less destructive – more akin to the 90’s.
I am finding that most realtors don’t have a clue how to process these “Short Sale!. Slowly but surely they are realizing that I do know my stuff. Three in escrow now all cash.
Great Webinar yesterday. Keep them coming. Your fees are very reasonable for the facts I used to figure manually and had to go the court house. Keep up the good work, Sean.
The latest Foreclosure Report surprisingly shows a big dip for January…it doesn’t seem to come from the moratorium, or does it?
…the report says it would be “irresponsible” to draw conclusions….c’mon, be irresponsible!…whadya think your best guess is for such a big dip?…any thoughts? I keep wondering if we are seeing strength- volume continues to increase, inventory seems to drop (unless shadow inventory is rampant), could we be seeing a support level?….
My best guess is that we already are largely seeing a foreclosure moratorium as many lenders are delaying foreclosure to work through integration issues, or delyaing to try do loan mods, or delaying under govt directive as fannie/freddie are, or delaying in the hopes of having their bad loans bought by the government. If all lenders were to go ahead and foreclose on all the loans that are significanlty behind in payments these numbers would be double or worse.
One more thing… prices and inventory are no longer the problem in this market. Prices are reaching affordable levels, and we see good demand for homes priced at those levels. The problem is that we have approximately 20% of homeowners underwater with about $4 Trillion in negative equity that will need to be dealt with before we can return to a truly healthy housing market. Foreclosure is currently the ONLY mechanism that is clearing this debt. Until we stop talking about foreclosure moratoriums, and start focusing on principal balance reduction loan mods we aren’t likely to see much progress against this $4 Trillion headache.
AMEN to that. If you look at 1995-1997 foreclosures went out of control, inventory actually slightly declined because buyers were scooping it up at those prices, and home prices were fairly stable.
I heard somethign interesting I didn’t know from Mark Hanson that most of the subprime loans are contained. To my thinking that is incredible news because it seems that we are mucking through the foreclosures and even if we have a long way to go at least the majority of the most toxic debt has been purged, no?
Agreed. If I jingle mail the bank, they have
to sell the property short by (in my case)
$100,000, and not in any kind of timely manner.
Why can the next person that occupies my home
live here that much cheaper, but they won’t let
me do it ?
I suppose I could get them to agree to a
short sale, then buy the house at the new
price, move back in….{:-(
Yes.. I guess the foreclosure moratorium put in place back in November by Fannie Mae and Freddie Mac has no impact on the latest numbers being reported.
With the latest requests being made to institutions who have received TARP money to also delay the foreclosure process while the Government works on a solution… we are possibly seeing even more manipulation of the real estate market.
http://online.wsj.com/article/SB123454524404184109.html
Even with all of the really sad inept government reactive solutions taking place at a cost of Trillions of Dollars to Taxpayers that will be paying this back for Generations…
It does not even address the Commercial Real Estate market which is going to be the big news for 2009. Amazing how little information there is on this out there like nothing is going on…
It Reminds me of late 2005 for the Residential real estate Market.
Pre-privatization is now the new code word for nationalization – http://www.capitalismgonewild.com/2009/02/bank-nationalization-for-citigroup-and_20.html
Could do a blog post about shadow inventory? How much inventory that has been foreclosed on but isn’t on the market or resold since the trustee sale.
Excellent post. There is another reason the government shouldn’t “fix” mortgage rates at artificially low levels: it’s basically a con job fraudulently inducing new, unsophisticated buyers to overpay for a home. As soon as interest rates return to normal levels (about 7% is the 30 year trendline), home prices will fall in exactly the same way that lower rates causes rates to rise. Further, the “law of small numbers” means that a rise from 4.5 to 6.75 translates into a 50% increase in your mortgage payment. If the new buyers purchase at 4.50% and try to sell a few years later when rates are up to 6.75, they will find they have lost all of their down payment and will be stuck just as today’s homeowners are stuck.
The solution is simple: let prices fall to the market clearing price, ie., the price at which an actually employed person with real income from a steady job and a good credit history with a real down payment can afford to buy. That was good enough for our parents, and it should be good enough for our kids. The only people to lose will be the banks with bad loans, land speculators and, of course, the homeowners who have lived for years in a house they couldn’t really afford. Let me rent now, just as millions of Americans who were priced out of the market for years rented.
Great comment, thank you. I’d also argue that artificially lowering rates helped get us into this mess. When Greenspan pushed rates down to save us from the tech bubble that forced those who needed to generate returns to make riskier investments… like subprime loans. Had we kept interest rates at reasonable levels the securitized pools of crap loans might not have found a market.
Sean:
If you didn’t catch it, here is Volker’s speech last week giving his view of the cause of the crisis and his solution: a return to boring, Canadian-style commercial banking.
http://mail.google.com/mail/#inbox/11fa5b2bc3ef8117
BTW, Maudlin’s free e-letter is one of the best with which to follow this crisis. He is not a perma-bear, but was ahead of the curve nonetheless in getting his subscribers out of the market.
You’re right that the medicine the Fed started to apply last year (artificially low rates) is the same medicine Greenspan’s Fed applied in 2002-2004 to “jump-start” the economy after 9/11 and the dot.bomb collapse. The Fed made money cheap but did nothing to regulate how it was leveraged and abused by the shadow banking system.
I’m a bankruptcy attorney and am now seeking things that frankly shock me. Several of my clients run their own businesses and in every single case they have financed themselves with credit cards. One fellow has over $400k of credit card debt, another over $250k, and both of them haven’t made a profit in over 18 months.
We hear a lot about people “living beyond their means”. I’m seeing people whose means are beyond their means. In other words, their income itself was inflated by easy credit, and that income is now permanently reduced and cannot be replaced. And it isn’t just real estate agents and contractors, but wedding photographers, restaurant owners, car dealers, framing shops — everybody but liquor stores and auto repairs.
I think the California legislature is going to be completely shocked by June by the complete collapse of tax receipts this year. They will find out that their budget has been busted in fewer than six months. And sometime soon, I fear the public will begin a massive withdrawal of IRA and 401k money from equity mutual funds, causing another severe leg down in the stock market.
Of course, most of this is now old news. But if you want to see an even bigger crisis brewing, keep your eye on Austria, Switzerland and their bank problems in Poland, Latvia and the rest of Eastern Europe. Their bad loans are twice as big relative to their GDP — and 50% more leveraged — than our bad mortgages. Moreover, their loans were made to people whose currency has recently been cut in half (most of East Europe) compared with the currency of the lenders (the Euro). There are many who were early on the American mortgage crisis now warning that the European crisis will be worse.
Finally, I think by now it is clear that this crisis was not caused by Fannie Mae and Freddie Mac or the Community Reinvestment Act. Although I frankly think those agencies and ideas have outlived their usefulness (and were certainly an important factor in the spread of banking excess) its like saying the Dutch Tulip mania was caused by tulips. No, all of these problems have a common denominator, which is why we are seeing this spread globally where the CRA and Freddie and Fannie never lived: financial “innovation” that was basically a complex version of Ponzi’s original invention.
Thanks for the great comment. I think it is really clear at this point we didn’t have a “housing bubble” we instead had a “credit bubble”, primarily driven by the irrational excuberance of investors seeking unrealistic returns. Like tulips in Holland these irrational investors bought into financial innovation as the next craze not to miss out on.
Speaking of tulips, I would highly recommend my friend Eric Janszen’s site itulip.com for anyone interested in digging deeper on these topics.
Sean:
Thanks for that great recommendation. The lead article today in itulip was an insightful analysis of the “nationalization” meme that is sweeping the financial blogs. While many bloggers welcomed Greenspan’s remarks (and Lindsay Graham’s similar comments a week ago), something didn’t smell right, and itulip just nailed it: the banks know who is in power now are are using left-wing language to manipulate a Democratic Congress into bailing their sorry asses out. Very clever. They make Ben on “Lost” look like an amateur…
No Job and you got a loan modification? Interesting…
Not everyone is a winner in the current housing market. In fact the winners are the people with cash who can get these great bargains from the foreclosures. But I think we have reached the bottom by now.
Paul is very right “Funny how when things are left alone that they just naturally work their own way out”. Let Treasury and the rest of the government get out of the way and let the free market work.
The article is very informative, but the banks are still not jumping to assist homeowners. It is an up hill battle all the way. They may offer a principal reduction, but they add the reduction back to the end of the loan.
i really love reading your website , although i just started doing overtime recently, so it is less frequent now
What is wrong with EQUITY PARTICIPATION Financing? Here is how I see it working…….It’s been done in commercial real estate and private financing for years.
Homeowner is underwater, owes 400k on a house worth 200k, Original loan 80% LTV / 6%/30 yr. pmnt 1918+taxes (3600). Homeowner will be forced out and will have to live SOMEWHERE and pay Something. Instead of foreclosure what if the lender reduced the rate to 4.5%, cut the payment in half to $811.00 + taxes and took a 50% EQP. Loan would review in five years and be adjusted to market conditions and borrower conditions. Homeowner would be responsble for repairs and maintenance, would not have a foreclosure, family would not be besmirched or disrupted, neighborhood would not see another potentially borded up property, etc. At sale time the mortgage balance and any profit would go to the lender up to a pre-agreed amount. A deed would be held in escrow if the homeowner defaulted. And the lender certainly would not get any less than they could expect now. If state laws interfere…..change the law….These are desperate times.
Al Marczyk, CCIM
Al, your suggestion makes very good sense if you assume the mortgage is held by a bank, particularly a bank that has received TARP assistance. But here are the reasons most lenders aren’t interested: 1) the servicing agents, not the lenders, control the terms of loan workouts, and the servicers receive more fees from the default and foreclosure process than they will from a workout; 2) the “lenders” are securitized entities that have up to 14 different “tranches” of investors. The super senior tranche still receives full payment even if a good percentage of the pools loans are foreclosed upon. This is because the tranches divide cash flow, not profits. Using your example, the foreclosure would generate $200k of cash, all of which (after admin and servicing costs) goes to service the senior tranches. Under your workout, it generates very little cash and, in fact, reduces cash flow immediately. In short, these mortgage pools are run for short term gain not long term profit; 3) the lender-issuers don’t want to admit that their collateral is only worth $200k, as that would mean all their other, similarly situated collateral is worth only that much. If the home goes to foreclosure sale, they can argue that the price is only a “distressed price” and that their remaining loans will continue to pay. If they voluntarily drop their payment terms in half, it will likely cause other borrowers to default and demand the same terms, resulting in a much lower value for the entire pool. This lower value is the “mark to market” issue that threatens the solvency of many of our banks.
Great post.
Excellent information from annonymous 8/19. Also clarifies why servicers have no power or authority to make any decisions. I’m sure many servicer employees don’t know a tranche from a trench as is evidenced when one calls them. In the end however, “it’s worth what it’s worth”, so when the sheriff or auctioneer comes lender still gets 200k and all the attendant consequences are still there. Of course, why should the Senior investor care? Al
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AP – Black and Latinos are at a disproportionate risk in the ongoing foreclosure crisis because they are more likely than whites to have higher-cost mortgage loans and home insurance face higher unemployment rates, a report says.