Thursday, June 11, 2009

Why the housing market decline is far from over

This chart shows the recast dates for various loans over the next five years, based on the current rate of negative amortization (copied from CalculatedRisk). I think it would be fair to assume that most of these are going to be defaults, as soon as (or slightly after) the recast time; almost everyone who can afford their house is either already in a fixed-rate mortgage (and thus not appearing on this chart). This virtual tidal-wave of defaults represents roughly $25,000,000,000 worth of housing inventory being added to the market, per month, for the next five years.

For reference, the NAR's latest statistics indicate there are only about $66B in sales of existing homes, per month, total, in the whole US. That lines up pretty well with the latest estimations of total home sales which are foreclosures, which is around 45% (REO's are selling slightly better than non-REO's, cause they are more realistically priced). Most people agree that the housing market is not likely to stop declining until foreclosure sales are back down to a smaller fraction of the overall sales (say under 10%), but the recast chart says sales would have to increase by a factor of almost 4x before that would be the case (ie: higher than the bubble-frenzy rate), and that situation will persist for at least the next five years. Anybody want to bet on that level of increase in sales numbers while the market is still declining? If so, have I got a poker game I want you in...

I used to think my prediction of roughly 50% decline in house values from peak to trough nationally was perhaps a stretch on the high end, and people were incredulous when I was saying it in 2007. These days I revise it by including phrases like "real value", to compensate for the massive inflation I expect the government's enormous deficit spending will create, but I also think it's now a conservative guess. Housing: not going up any time soon, plan accordingly.


  1. I agree completely. In some areas houses are reasonably priced, assuming rates stay low. Rates are low, though, only because of unsustainable monetary policy, i.e. low short-term rates and printing money to buy long-term Treasuries to suppress long-term rates. We can only get away with this because the dollar is so widely used to store value. It could easily spiral into inflation causing long-term rates to rise and forcing the fed to raise short-term rates to contain the inflation. That means expensive adjustable and fixed-rate mortgages, which will affect those rate resets you mentioned and new buyers. Rates could easily double. They were more than double during the 80s, and we didn’t feel like it was a crisis. But this time the high rates would come on top of a situation where we’ve built more houses than people to live in them. The best scenario I hope for is for inflation to mask a slow government-managed deflation of the real estate bubble over the next few years.

  2. I think that's all possible, up to the point where the Fed is "forced" to raise interest rates to contain inflation. The Fed's mandate is to contain inflation, but that doesn't mean they have the will to do so, or the competence to take the correct action even if they do. After all, their other mandate is to keep unemployment low, and minimize disruptions to the US economy, and they created this enormous bubble-burst which is now playing out. Moreover, they have proven more than susceptible to political influence, whether it be the political branches or bailing out insiders at the expense of US currency holders, to the tune of Trillions of dollars.

    In the 80's when the Fed raised rates to combat inflation (successfully), it was a largely different environment. The Fed was more independent, its leaders had more integrity and political will, and the government was less thoroughly corrupt than it is currently. Although I'd personally like the Fed to pay more than just empty lip-service to containing inflation, I have no illusions that the current Fed will keep interest rates low until we're literally wiping our asses with US dollars.

  3. Interesting. The thing no one is talking about is property taxes. I somehow doubt property taxes are decreasing like home values are. We seldom forget it's the whole mortgage payment that put people out of their homes, not just P & I.

    In truth, the solution to bank's liquidity problem is really the fact that people are not paying anything on their mortgage if they can't make the whole payment. Banks should be working smarter to get debtor's money coming in the door instead of holding on to foreclosures, waiting for prices to go up so that they can cash out on their losses.

    I laugh at Krugman who stated the only thing to fear is fear of inflation. The difference with the 70's and now is that there is so much money in circulation and the currency value is already tipping, we have no way of purchasing the currency back so as to take it out of the system without creating more money an protracting the problem. We will either live with massive inflation or default on interest payments. I'm going to go with the later.

  4. In most cases, taxes will not decrease much. In states which adjust their property tax rates to keep income steady, the rate will just go up to compensate for decreasing values. In California, most values for tax purposes are below the real values anyway for people who bought before the bubble, and most people who bought during the height of the bubble have a mortgage which is far larger than their tax payment. I don't think the property taxes are going to push many people people over the edge (than would have gone over anyway).

    It's true that banks "should" be working harder to minimize their losses, but that assumes they have a strong interest in minimizing losses: an assumption which is becoming more and more invalid with every passing action of the Obamanation. It's vastly more important to have friends in the Party in the USSA now than it is to be competitive in the free market, just ask the UAW. The banks don't need to try to stem losses, their primary concern is keeping the TARP money flowing, and you certainly don't do that by being aggressive with your loss-mitigation efforts. After all, as we convert to our new "green" economy, all the rules will be different; it's not what you produce or how well you compete in the "market" (that's the old system), it's now only what allowances you are granted by the Party which determine how prosperous you will be.

  5. Nick - Great post! I saw this thing coming in 2005, I owned a nice place in North County, had since 1999, lucky me. Anyway I recall one weekend, my neighbor friend had her place up for sale. It was priced high, (or so I thought). That particular weekend was witness to a literal traffic jam on our cul-de-sac to see and bid on the place. The final bid from dozens? Nearly half a million on a 1400 sq ft house in North Escondido CA, a nice area but not paradise by any stretch. Anyway I witnessed this and decided for myself that the market in housing was done. It's goose was cooked. It reminded me of the net stocks of the late 1990's... the tulip bulb mania behaviour. I decided then and there to sell my property, I sold it in nov 2006.
    Warren Buffet - Sell when others are greedy, buy when they are fearful.
    Your stats here surprise me none and I am happy to hear it. I rent at the beach......

  6. BTW too Nick, the first time that I read your blog, I was very impressed with your writing and intellect. How did I find you? I read a comment that you left over at Jim Klinge's BubbleInfo blog and thought that what you were saying there was brilliant. That was way before I started blogging myself. Life is funny that way...

  7. conservative generation: Calculated Risk has a post on why it seems like banks are not eager enough to do shore sales . It explains why it seems like banks seem like they're not smart about getting what they can from debtors.

  8. The Fed was more independent, its leaders had more integrity and political will, and the government was less thoroughly corrupt than it is currently.
    I am just over half way through Greenspan's book, and he's talking about this very issue: the need of the Federal Reserve to be independent.

    Greenspan hasn't made this argument yet, but I wonder why people blame him for the housing bubble. The Fed primarily controls short-term rates. It seems like a) low long-term rates and b) lending based only ability to pay at short-term rates caused the problem. I don't see how it's the Fed's fault.

  9. LCR: lol... that's great! I comment on a few blogs, but I always wonder if anyone ever reads them, or if it's "worth it" to comment. I guess I'll have to keep it up. :)

    CJ: I think the banks are failing to minimize their losses on properties because they are overwhelmed with processing loans in various stages of default, or they have basically given up on stopping the hemorrhaging losses because they are already effectively nationalized (eg: Fannie/Freddie, Citi), or both. There may be some rational or psychological reasons for a few of the cases, but in the common case it seems like more of a "don't care" problem, or even a "we know were throwing away money, but that's what the Party wants and they pay our salary" situation.

    People blame Greenspan for the bubble because the interest rate at which banks can borrow money, and the Fed target rate (which the Fed enforces by direct market manipulation), indirectly determine the mortgage rates. The Fed also indirectly determines Congress' actions with respect to the US markets; eg: when Greenspan said all the new exotic mortgage products were exciting financial innovations which benefited the ability of people to buy houses, or when he said there was no way to be sure the market was in a bubble. By keeping rates low while there was an obvious bubble and encouraging all the risky loans and leveraging which fueled the bubble, Greenspan was probably the single largest contributor to the problem.

    In an ideal world, the Fed would be independent, strong-willed, and have the best long-term interests of the US economy and currency in mind. In Greenspan's term, the Fed was semi-independent, strong-willed, and had the short-term interests of Greenspan's banking industry buddies in mind. In Bernanke's term, the Fed is a puppet of the Obamanation, acting against the interests of the US economy and currency, has the short-term interests of Bernanke's banking buddies time-sharing with trying to hide as much of their shady dealings from the US government and people as possible, and has become a cancerous parasite which is quickly destroying what is left of our economic stability and prosperity.

  10. People blame Greenspan for the bubble because the interest rate at which banks can borrow money, and the Fed target rate (which the Fed enforces by direct market manipulation), indirectly determine the mortgage rates.

    Right, but that’s a short term rate. In normal times (not now) the Fed only manipulates short term rates. Apart from publically exposing the bubble, what could the Fed do? Increasing short-term rates seems like powerful medicine that would have affected all aspects of the economy and had not had that much impact on the real estate market. It seems like most of the problem was lenders were lending money on loans with adjustable payments but not verifying the borrowers’ ability to pay after an adjustment. In some cases they weren’t verifying anything. We needed to fix that problem rather than raise the cost of money across all industries.

    In Bernanke's term, the Fed is a puppet of the Obamanation, acting against the interests of the US economy and currency
    President Bush appointed Bernanke, so I’d think he would not be a puppet of Obama. I hope they know what they’re doing and our acting in our long-term interests. Given all the money they’re throwing at the economy, I expected to see inflation by now. It hasn’t appeared. (I’m defining “inflation” as being measured by CPI, even though the CPI is not perfect.) If we don’t see CPI growth exceed 8%/yr in the next few years, I will have more esteem for Bernanke. If the CPI grows faster 10%/yr, then history will have proven you right. I’m hoping CPI stays contained and we see several years averaging 4% GDP growth, proving us wrong about this issue. If that happens at the same time the deficit decreases and we see improved access to healthcare and education for the poor, Obamanation will mean “a period of prosperity bordering on utopia”.

    Maybe you should lay out some benchmarks like that in a post to define numerical success or failure of the economy while Obama is president.

  11. Nick,

    I feel as though I was a little vague in my property tax point. What I was trying to point out is that there is a very real cost associated with a nonpaying homeonwer. It's not just that there is no cash flow, but negative cash flow as the mortgage company must front property tax payments. Instead of being short the loan of a $200,000 house, they are actually short maybe about $225,000 when property taxes are included. I was trying to point out that TARP is also subsidizing local government in a way, even if it is small. I think it would be interesting to see local government's kicking people out of their homes instead of banks. Makes you wonder what the left would do? Of course this wouldn't happen as banks would loose their lien status.

    CJ - The problem is that rates, short term or not, controlled by the Fed are directly linked to the money supply. It may start in the short term rate markets, but sooner or later a whole boat load of easy money is going to start collecting dust and banks are going to put it to use somewhere. The next logical place is long-term mortgages.