Debt, Speculators, Will Crush Bubble: Analyst
Gary Gordon is the chief investment strategist for UBS Investment Research and he sees the US debt levels stopping the housing bubble in it's tracks. " As borrowing slows, so will spending, and as spending drops, corporations that make the goods will cut back on hiring."
"Gordon believes the 'off-the-charts fantastic housing market' the nation as a whole has enjoyed soon will come to an end. Rising interest rates will put the brakes on home-buying, and then the 'huge number of homes in the U.S.' that are owned by speculators are likely to come suddenly onto the market. Home prices will begin to flatten, lenders will tighten their credit standards and the air will begin to come out of the housing market, he predicted. How soon will it all occur?"
"I’d be very surprised if it doesn’t start within the next six to 12 months."
Borrowers are already pulling back. "MBNA said in addition to the charge, its results were affected by 'unexpectedly high payment volumes' from U.S. credit card customers. The higher payments reduced managed loans in the quarter more than in prior years, the company said."
23 Comments:
Home price appreciation will begin to turn within a year.
Rising interest rates will put the brakes on home-buying, the “huge number of homes in the U.S.” owned by speculators to come suddenly to the market.
Could someone explain to me why everyone seems so sure that mortgage rates are headed up? The fed funds rate doesn't seem to be having much effect. I believe the yield on the 10-year treasury was actually down yesterday after the news of an inflation spike in March.
So what is going to cause rates to go up?
Clark Howard says it's a bubble:
http://clarkhoward.com/shownotes/2005/04/21.html
What will make the interest rates go up ? How about good old classical inflation ? Do you really think that there is NO inflation ? Everything is so phony when it comes to economic data ? Anyways the more the lies fabricated by the government statisticians stand, the higher interests rates will go up. And bet on it, they will go higher much much higher.
(what is going to cause rates to go up?)
There has been a very low "spread" between treasury bonds and other bonds for many months/years. This represented a low perception of risk in the market. That spread has been widening significantly in the last few weeks, especially as GM and emerging markets have had liquidity issues.
That said, I don't think rates have to go up, or go up by much to bring the situation to a breaking point. Thanks for the comment.
http://yahoo.reuters.com/financeQuoteCompanyNewsArticle.jhtml?duid=mtfh48828_2005-04-21_21-43-45_n21614949_newsml
"It is a tough time to be a credit card lender as competition from banks and other credit card companies is fierce. U.S. consumers are increasingly paying down their credit card bills using home equity lines of credit and other mortgage loans".
Melissa,
Great article and it helps with two points.
An example of spreads:
"The price of protecting MBNA Corp.'s debt against default for five years rose about 10 basis points to 62 basis points on Thursday, or $62,000 a year for every $10 million of principal protected. Spreads on MBNA's 6.125 percent notes due 2013 widened 8 basis points to 107 basis points."
"U.S. consumers are increasingly paying down their credit card bills using home equity lines of credit and other mortgage loans."
That may be what is happening at MNBA, and if so, will compound the damage from the bubble.
If people are using re-fi to pay down credit debt, why is it suddenly big trouble for MBNA? Is it because the spending has stopped, but the re-fi hasn't?
Is it the collective final house-ATM withdrawal?
Forget about interest rates. Housing prices can/will fall no matter if interest rates go up, down or sideways.
The last big boom/bust period ran from about 1985 to 1989-90. The median home in Southern California dropped 20-30% in value from 1990-1995, with the most carnage from 92-94. In fact, during 93 and 94, nearly 70% of the homes sold in SoCal were sold AT A LOSS. Foreclosures were abundant.
And what did mortgage rates do? They actually fell from over 10% in 1990 to 7% in 1995. So housing prices were tanking, yet interest rates were falling.
Here are the actual numbers from the Fed (year/inflation rate/mortgage rate)
1995 2.81 7.95
1994 2.61 8.35
1993 2.96 7.33
1992 3.03 8.40
1991 4.25 9.25
1990 5.39 10.13
1989 4.83 10.32
I don't know what will happen in the years ahead. No one does. But if anyone tells you that housing can't go down so long as interest rates stay low, don't believe them.
(If people are using re-fi to pay down credit debt, why is it suddenly big trouble for MBNA?)
They are probably using home equity loans these days. It hurts credit card cos. like MBNA because the balances go down; less interest. But the big money maker is the late fee. I suspect people taking out HELOC's are paying off the cards entirely, explaing the huge drop in profit for the firm.
Lots of folks comparing the housing mania with the dotcom and stock market mania. I agree that there are many similarities in terms of psychology and sentiment---fear and greed, basically. But there are big differences too.
I lived and worked in and through the dot-com bubble in SF so I have some perspective on it. But if you lived and worked in Minneapolis or Omaha or Dallas, you might ask, "What dotcom bubble?"
So the vast majority of people in this country were barely (if at all) touched by the dotcom/tech frenzy. Sure, speculators and daytraders who loaded up on tech/telecom stocks got nailed. Some venture funds and sector-specific mutual funds lost lots of money. But most folks have their 401k funds in bonds and S&P 500 benchmark funds. They might have seen their stocks drop 30-40% over two years, but then again, they saw them run up 10-fold b/w 1982-1999. Now they've risen again 50% in the past two years. And folks already believe that stocks are volatile and risky, but they don't believe that about real estate...at least not yet.
On the other hand, most Americans have the lion's share of their assets tied up in their homes. And 70% now own homes (perhaps a bit less when you consider owners with multiple homes.) A 10-20-30% hit in valuation would really, really bite, particularly if they bought recently or borrowed against inflated equity.
I think the Fed (and Congress) would move heaven and earth to forestall a housing implosion. So I think we're in a box here. I'm not suggesting that the housing boom will continue as it has, but I don't think this country could handle a housing implosion without fomenting a mega-recession or even mini-Depression.
I agree, the fed is boxed in. They can't raise interest rates back up to normalized levels because it would crash the only real juice in the economy. Not much room left to lower if economy tanks on its own. Inability to move on interest rates will let inflation go up even more, especially commodities.
1995 2.81 7.95
1994 2.61 8.35
Inflation must be running at least 3% now. Judging by these numbers we should have a Fed rate of 8% and mortgage rates of 11% or so. That might kill housing, but the rest of the economy could probably survive, after a shock.
I really hope that the Fed doesn't allow inflation to run. That would really hit those of us that have been conscientous spenders. Like I said once before, everything since about 1996 has favored speculators. I hope this time is different.
The conventional wisdom is that home prices, unlike stocks, are "sticky on the downside," meaning that, as the strategist from UBS maintained, house prices will go flat as people are strained to the limit on debt and can leverage themselves no further to keep paying higher prices.
Then, the CW holds, it will be a gradual slide in prices over several years because people live in their homes and most people are on fixed mortgages and would rather ride out the decline than sell at a loss.
However, it may be different this time, for these reasons:
1) More leverage in the system. There is simply more credit creation than at any point in history. The massive consumer debt load, not to mention the fiscal deficit, makes the economy much more sensitive to even small moves in interest rates.
2) More pure speculation. Because of the "moral hazard" universe created by the Fed, many americans are investing in homes and apartments now the way the day-traded the nasdaq in 1999. An important difference: more leverage. People are buying investment properties with 5%, 3%, even no money down. Imagine if during the dot-com bubble, E-Trade let people trade on 2% margin...
3) Speculation in the form of risky finance. Even those who are not "pure" speculators are buying houses to live in they cannot afford by using no-money down, negative-amortizing ARMS. The only way they can expect to accrue equity is for the price to continue to go up. If prices go down and they cannot make their now higher monthly payments, they will be forced to foreclose. Last Year, over a third of all loans were ARMs.
4) Order of Magnitude. According to Robert Shiller, whose article was referenced on this blog, the housing bubble is unprecedented in size. Estimates are that prices in some areas (So Calif.) are 85% over historical average trend, as opposed to only 15% in the last bubble, one that took 6 years to recover.
5) The Mortage Banking/Credit Creation Complex is waking up from its 7-year drunken orgy. When things start to go bad, they will turn off the spigot and come to their senses. All the poor folks leveraged up to their eyeballs in ARMS will try to lock in a 30-year fixed (if they can make the payments) only to find that their mortgage banker all of a sudden remembers things called underwriting standards. The liquidity dries up...
For all these reasons, I fear that the bubble will burst more sharply than anyone expects.
(I fear that the bubble will burst more sharply than anyone expects)
Great post, thanks.
Great blog, glad I found it.
Most of the stories on housing speculators seem to focus on the California area, Florida, and the Northeast. But here in Denver, we have those pesky speculators too. All you have to do is check out the rent listings on Craigslist, or drive through a new housing development, and you will see those For Rent signs on the new properties.
It's still a hell of a better deal to rent here. You pretty much have your pick of apartments and lease terms. A lot of nice places too. And you pay a lot less, I think an average of 53 percent less, to rent than to buy. Without bothering with those pesky HOA fees you'd get on a similar size condo. (Realtors like to call them "lofts" here, but really, they're condos).
I haven't looked at applying for a mortgage for a while, but damn, I'm shocked. What is this garbage about not having to prove anything but a pulse for someone to loan you a chunk of money? I took out my first car loan in 1998. The credit union refused to do anything for me until I cleared off a $50 collection charge off my credit report (from 6 years earlier!) and put down a $1500 deposit. For a $6500 loan. So I find it really scary that mortgage companies are giving people with even less credit that I had at the time these huge sums of money. No wonder why foreclosures in the Denver area are at an all-time high. Honestly, you need to learn how to deal with credit in little bits and chunks, rather than a big bite all at once, in order to successfully handle it. Otherwise, you're screwed. And how long do foreclosures stay on your credit report anyway, for 7 or for 10 years?
--alissa
Warren Buffett is the smartest investor in history, and he still lives in the house he bought 46 years ago. It's a nice four-bedroom house maybe worth around $350,000. The one thing you can learn from him is to live within your means. I think in one of his annual letters to investors he said, "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." Can people learn something from that?
Exactly, live within your means.
So many kids jump into the world of credit and finance without knowing what the potential consequences are. I think it should be required for every kid to take a credit management course before they graduate high school. Would save them a hell of a lot of crap in the long run. Although it would probably make the credit card companies not very happy.
--Alissa
"And how long do foreclosures stay on your credit report anyway, for 7 or for 10 years? "
I think it depends upon the state. I've heard that in California, the entire restitution for the lender is the property itself (applies to 1st mortgages only.) Therefore, someone would simply walk away from the house and I'm not sure that would even affect your credit. With all of the 80/20's out there I don't know how many people would be able to truly get away with this.
I realize this sounds strange and I haven't found a good government source that deals specifically with this issue in detail, although it is a hugely important one.
ken
Foreigners getting into US real estate:
http://www.msnbc.msn.com/id/7564205/
Maybe they need a 2nd home too.
When is this market going to get back to fundamentals ????
Foreigners getting into US real estate ... Maybe they need a 2nd home too.
May be they are recycling their petrodollars and they don't mind taking a loss on their condo, as long as they have a cheap place to vacation.
---foreigners buying 2nd homes in US...maybe they need a nice place to vacation by recycling petrodollars---
Maybe that would explain NYC, SF and parts of Florida. But how does that explain Chico, Merced, Fresno, etc?
We've only lived abroad for a short time, so my comments must be limited for now to what my husband has experienced in his own company (American owned, currently expanding European operations). Apparently, employees from Germany negotiate hard for company cars, as they are a huge status symbol there. And the cars are so important because real estate ownership is very difficult as the homes are passed down through the generations, and are otherwise very expensive. Most people rent huge flats--but I'm not sure how the rent prices compare. Otherwise, a woman in my French class, who's from Germany, and two others who are familiar with its economy, say that they know that people from Germany have invested in Florida property in large numbers, but that their OWN economy will probably force them to have to sell, as it is not doing well.
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