Friday, May 20, 2005

After Bubble Forms, Warnings Abound On IO Loans

This SF Gate report on interest-only loans includes this warning in the title. "POPULAR BUT DANGEROUS: If home prices flatten, borrowers could lose."

"They accounted for nearly 70 percent of home purchases in the first two months of the year in San Francisco, Marin and San Mateo counties, up from 18 percent in 2002 and 59 percent in 2004. In San Jose, 61 percent of purchase loans in the first two months of 2005 were interest-only, up from 9 percent three years ago. And 78 percent of home buyers in the Vallejo metropolitan area chose interest-only loans, up from 6 percent."

"'This is frightening, frankly,' said UC Berkeley economist Ken Rosen. 'I'm worried that more and more people are using (homes) as an investment vehicle and not as a consumption market, and that's true of the peak of housing markets. This is the edgiest we've been in the market for a long time. This reminds me of the late 1980s."

Here's another quote for the history books. "California Association of Realtors economist Leslie Appleton-Young argues that the loans are just the latest advance in the mortgage market. Little outright speculation is occurring, she said. The popularity of the loans reflects the fact that they allow people to get into homes they otherwise wouldn't be able to afford. 'Instruments that help people get into the housing market are a good thing.'"

37 Comments:

At 10:47 AM, Anonymous Anonymous said...

"Little outright speculation is occurring, she said. The popularity of the loans reflects the fact that they allow people to get into homes they otherwise wouldn't be able to afford."

LOL...hello???

just change "they otherwise wouldn't be able to" to CAN'T!

a question: I'm not familiar with the details of IO loans.

How often do the interest rates change on them?

What index is the rate typically tied to?

What is a typical rate on an IO loan right now?

..DenverKen

 
At 10:53 AM, Anonymous Anonymous said...

Oh, this realtor person is a scream. My favorite line is from a realtor a few months ago who said people who are using IO and various ARMS as being "savy". LOL!! Savy... as in 'I have no idea what kind of loan you're giving me but gee, my monthly payments look a lot cheaper'. I feel sorry for these buyers, I really do. - GC

 
At 10:54 AM, Anonymous Anonymous said...

DenverKen

"just change "they otherwise wouldn't be able to" to CAN'T!"

Oh no,we can't er, shouldn't say can't, these people are just homeowner challenged, and it's not their fault. Blame it on.....

Big Government,
Big Business,
Speculators,
Californians

But not on them. Not politically correct.

 
At 10:55 AM, Blogger deb said...

"With a down payment of $100,000, Michael Kelly bought a $1 million home in Foster City last year despite the fact that he was unemployed at the time. Kelly, 42, landed an interest-only loan using stated income only; that is, he was not required to submit written proof of income."

The extreme optimism of borrowers and lenders alike must be a sign of the top.

How do these people sleep??!!

 
At 10:58 AM, Anonymous Anonymous said...

"Instruments that help people get into the housing market are a good thing"

A crowbar is an instrument that help people get into their dream houses. Is it a good/legal/responsible instrument?

 
At 11:00 AM, Anonymous Anonymous said...

"Instruments that help people get into the housing market are a good thing.'"

This Leslie Young is self-serving.

Next thing she'll be saying is that "it's for the children." They are raking in the dough, and they really don't give a rats butt about the moral aspect of this lending burbuja.

 
At 11:04 AM, Anonymous Anonymous said...

I love how for that IO loan of 650k you get 900 sq ft with the rail road tracks a block from your house and a leaking roof in the Bay Area - the so called "luxury" are of living. And don't forget the people that are saying, IO is the only way to go, everyone's doing it becuase prices are always going to get in. Rich people don't do IO's, people who can't afford most of the house they want do. Guess what, 80% of people in the "luxury" of the Bay Area can't afford a traditional fixed - that's stretching. BTW, I'm getting real estate advice from people that can't balance their checkbook. Any thoughts out there on the Bay Area housing mkt?

 
At 11:06 AM, Anonymous Anonymous said...

I wonder ebay will do well when these houses go on the market?

 
At 11:10 AM, Anonymous Anonymous said...

Awesome site Ben!

Do you know of anywhere I can get info on local (PHX) foreclosure sales? Same for Mortgage Loan defaults?

Not sure when the bubble will burst here in PHX area ... things still seem to be chugging along compared to some other markets where the tide seems to be turning.

JeffInAZ

 
At 11:13 AM, Blogger JLP said...

I can't for the life of me figure out why someone would want an interest-only loan. The only thing I can think of is that it is the only way they can "afford" a house. It just isn't prudent financial planning in my opinion.

JLP

AllThingsFinancial

 
At 11:23 AM, Anonymous Anonymous said...

"I can't for the life of me figure out why someone would want an interest-only loan."

I think it is mainly for two reasons.

1) The depression era folks, and even their children are dying off, and the few that are left are considered to be out dated, by most.

2) We don't teach financial fundamentals is school. I think it should be a required subject to have at least one high school course on lending/borrowing.

Can't do muchabout #1, but I think we are all going get a good financial education at the school of hard knocks pretty soon.

 
At 11:29 AM, Anonymous Anonymous said...

Any thoughts on a flattening or decline in the SF Bay Area?

 
At 11:34 AM, Anonymous Anonymous said...

"Any thoughts out there on the Bay Area housing mkt?"

Many signs of pending distress. Should be over the edge in six months.

Please join discussions at

patrick.net/wp

It is mostly BA specific.

(It is not my site but I go there all the time.)

 
At 11:40 AM, Anonymous Anonymous said...

Thanks - I have been on that site in the past and it's great. I hate to see people lose their shirts but the RE industry, cocky home owners and RE agents need a reality check. What ever happend to living in your home and investment as secondary? It's reverse and people are using their homes as ATM machines. It's needs to stop.

 
At 11:41 AM, Anonymous Anonymous said...

--"Instruments that help people get into the housing market are a good thing."--

Sounds like Marha Stewart. LOL

Good for whom? The Realtors of course...

 
At 11:41 AM, Anonymous Anonymous said...

I love how real estate people twist reality. I/O loans are NOT new. They just haven't been around for so long because they are the most dangerous home loans in existence...

A quote pulled from Bankrate.com, entitled:


"Interest-only mortgages target high-priced homes
By Jay MacDonald • Bankrate.com"

"The concept is not a new one; back in the Roaring Twenties, interest-only mortgages were commonplace. At the end of the term, homeowners typically refinanced. The system worked great unless your home lost value or you lost your job.

Which is exactly what happened when the Great Depression hit. Foreclosures skyrocketed and lenders abruptly stopped writing interest-only loans. (The practice has continued elsewhere, however, notably in Great Britain.)"

"New Economy"? No, just a really bad old one. Indeed, how can these savvy new buyers sleep?

 
At 11:51 AM, Anonymous Anonymous said...

I think there are at least five major boogeymen in the domestic U.S. financial arena, with no consideration given to external factors that could add additional pressure on the market. These are not in order of assigned importance:

1. Pension defaults/bankruptcies – it is reported that more than three-quarters of the nation's traditional private pension plans are underfunded. It’s a no-brainer that most United Airlines retirees, or soon to retire employees, are now not interested in a second home or a flip home, if they were before. But there must be a ripple effect, shaking the financial confidence of millions of other Americans who are in defined-benefit pension plans. And this must be damping their RE investment enthusiasm.

2. Minimum credit card payments are doubling for many cards and probably going up substantially for the rest. This takes cash out of the average card debt-carrier’s wallet. Cash-out refis are close to drying up for many people and once that gate closes, cash flow problems ensue.

3. LIBOR and ARM rates should continue to rise, causing all the payment problems discussed in earlier posts today.

4. The new bankruptcy law, to take effect o/a October 15, should see the smarter of the fools doing some heavy calculations by August or September and bailing on much of their speculative holding.

5. Hedge funds and derivatives markets are very unstable – many of the people who invest in these probably also are RE speculators. If their fund takes a bath, they may be forced to liquidate RE holdings.

All of these issues are recent problems -- they have not, to my knowledge, had to be addressed in the past. When you put them all together, I'd think the average high rolling yuppie and flipper have a lot to worry about in terms of cash flow. Insufficient cash and they'll be missing those mortgage payments.

Hope I know when to jump in and buy at the bottom.
Chip

 
At 11:59 AM, Anonymous Anonymous said...

11:41 AM Anon,

Right on... and don't forget the lenders, mortgage brokers, appraisers, home inspectors, etc... it helps everyone except the buyer...

 
At 12:06 PM, Anonymous Anonymous said...

Greenspan's speech topic to the heavyweight Economic Club ostensibly was energy policy, but not a single question after his address dealt with energy as the Wall Street luminaries who led the questioning zeroed in on their preferred issues.

Greenspan acknowledged that he saw a lot of ``froth'' in housing markets but held to his view that there was no general economic threat from a potential collapse in housing prices.

WARY EYE ON HOUSING

``We don't perceive that there is a national bubble but it's hard not to see ... that there are a lot of local bubbles,'' he said.

The Fed's policy in sharply cutting U.S. interest rates from 2001 to 2004 to 46-year lows -- before initiating a round of rate rises in June last year that continues -- was criticized by some analysts as having sown the seeds for a potential nation-wide bubble as house prices soared.

 
At 12:16 PM, Blogger deb said...

"Without calling the overall national issue a bubble, it's pretty clear that it's an unsustainable underlying pattern. What we see are a number of forces, which are, as far as I can judge, not infinitely projectable," Greenspan said.

So, according to him, it's not a bubble, but "lots of local bubbles" with an "unsustainable underlying pattern" that is "not infinitely projectable"!!! How to not call something a bubble, while calling it a bubble!

http://money.cnn.com/2005/05/20/news/economy/fed_housing.reut/index.htm

 
At 12:17 PM, Anonymous Anonymous said...

If the Fed's cutting rates caused mortgage rates to go down, why are the Fed's rate increases not causing mortgage rates to go up? Is it because they have not raised them enough? Or is someone/something else messing with the system?

 
At 12:26 PM, Anonymous Anonymous said...

Another article on AG's comments...

http://www.bloomberg.com/apps/news?pid=10000103&sid=azb8fwbe5Fqw

 
At 12:27 PM, Blogger desi dude said...

"If the Fed's cutting rates caused mortgage rates to go down, why are the Fed's rate increases not causing mortgage rates to go up? Is it because they have not raised them enough? Or is someone/something else messing with the system?"

something what AG called conundrum!
Even he does not have a clue.

some pointers>
setting long term interest rates depends on demand for Bonds, which is very high. therefore rates very low go lower
It means AG doesnot have control over them, because US is issuing too much debt. there are buyers who are buying with equal ferocity.

for a better understanding of the same visit
financialsense.com
safehaven.com
etc.

 
At 12:31 PM, Anonymous Anonymous said...

Deb,

Thanks for the link... i particularly enjoyed greenie's last quote... the one about... if you just recently purchased a home during this run-up, you might have some problems... gotta love this guy and his little CYA statements...

 
At 12:31 PM, Anonymous gus the grump said...

('Instruments that help people get into the housing market are a good thing.'")

Cute. I like the Martha Stewart touch, "It's a good thing."

Of course, the question is: For whom is it a good thing?

Unquestionably, it's a good thing for realtors™. The higher the price, the bigger the commission. And don't think I'm being harsh. For 90% of RE agents, that's the ONLY thing they care about.

If buyers have to stretch to afford homes by using flaky and dangerous financing schemes, it's no skin off the realtor™. In fact, if the buyer ends up in foreclosure, that's a goodthing™ too because it means another potential sale. Churn is good for brokers, period. Same as with stocks. The more stocks traded, the more sales commissions generated. That's a verygoodthing™.

 
At 12:40 PM, Anonymous historybugg said...

(They just haven't been around for so long because they are the most dangerous home loans in existence...)

Actually they've been around since the 1920s, as far as I know. They just aren't used much. They were one of the reasons the Florida Land Boom of the 1920s turned into a bubble and then a crash. Folks could get loans with no-money-down and interest-only to be the proverbial "swampland." That didn't turn out so well. Obviously, Florida recovered nicely but most of the "investors" of that period weren't around long enough to cash in.

 
At 12:41 PM, Blogger John Law said...

("They accounted for nearly 70 percent of home purchases in the first two months of the year in San Francisco, Marin and San Mateo counties, up from 18 percent in 2002 and 59 percent in 2004. In San Jose, 61 percent of purchase loans in the first two months of 2005 were interest-only, up from 9 percent three years ago. And 78 percent of home buyers in the Vallejo metropolitan area chose interest-only loans, up from 6 percent.")

damn.

 
At 12:48 PM, Anonymous Loren said...

I'm not sure it's fair to put this on 90% of the realtors. They didn't print the money chasing houses nor did they relax the lending standards. I think most of the blame lands squarely on Greenspan, Congress, OFHEO, and the desperate signing on the dotted lines.

What's really going to bite the Realtors too, is that so many new people are chasing the profession they've got a bubble of their own that's going to crash. In about 1-5 years there will be about 1/2 the number (or less) working in their industry, and the ones left won't be living nearly as well as they are now.

With our real economy gutted, there's not much option left for a lot of folks, but to become hawkers.

 
At 1:03 PM, Blogger deb said...

Speaking as a realtor, most of them honestly believe that buying a home is the best financial move for their clients (just like 99% of the rest of the population). I will place some fault on the way statistics are presented and spun by the Realtor Associations. Realtors don't make the market. I remember lots of clients blaming realtors for "allowing" houses to be sold to cheaply in the early 90's. Bottom line, a house is worth what a buyer is willing pay for it and what a seller is willing to sell for. Giving realtors any credit for engineering this mania is way to generous. (They probably would have if they could have though!)

 
At 1:07 PM, Blogger John Law said...

similar article here:

http://www.rockymountainnews.com/drmn/real_estate/article/0,1299,DRMN_414_3792420,00.html

 
At 1:50 PM, Anonymous boulderbo said...

someone asked, io rates are actually higher 3/1-upper 4's, 5/1-lower 5's, 30 yr fixed mid 5's, the real cash flow savers are the option arms, 1.0%, 1.25% etc. all neg am. don't know how many of you are aware of this, but the end buyer of most of this non-agency paper is in fact fannie/freddie, which is why ag is a little upset.

 
At 2:17 PM, Blogger Ben Jones said...

boulderbo,
Your right, if you dig into Fannies corporate communications, you can read that they are holding, not just bundling, billions in ARMs, etc.

 
At 2:25 PM, Blogger John Law said...

this bubble is national, it's even international. think about colorado. it has 2 Mil, half the pop of the state. you think they rest isn't involved?

 
At 2:48 PM, Anonymous Anonymous said...

A friend of mine is a baby sitter and her husband has not been employ for almost 4 years. They signed a contract on 2 br condo with no down payment using io loan. Their agent told them "if you dont buy now, you wont be able to buy it later. And it only take about 6 months, your equity will build up at leat 20K"

 
At 4:00 PM, Anonymous Anonymous said...

2:48, I hope for your friend that she's has no saving so that she can walk away if that no downpayment/interest only plan doesn't pan out as her realtor told her.

 
At 4:02 PM, Anonymous Ghostwriter said...

The international dimension of the bubble has to do with the codependency relationship between Chinese manufacturers and Californicators (and other "local bubble" market residents) who own homes. The housing markets in the U.S. and China both have blossomed into a speculative frenzy for closely related reasons.

We might consider the exercise of the Greenspan Put (read a prolonged period of negative real interest rates) after the dot com crash and then again after 9/11 as the earthquake which has set off this tsunami of Ponzi schemes in the international asset markets (especially housing). It is pretty clear why the Fed is interested in peddling the message that all housing bubbles are local...

The asset price tsunami is propogated through the trade relationship between the US and China. You may have noticed that quite a few of the items available at the local WalMart have the "Made in China" label on them (kinda reminiscent of the "Made in Japan" labels which seemed so prevelant twenty-five or so years back). Now the way many Californians manage to purchase the piles of stuff accumulating in their condo garages is to first get a cashout mortgage -- take out the 10%+ home equity gain in the price of their condo over last year's price -- and use it to enable them to trade green paper for stuff made and shipped here from China.

Now the Chinese have accumulating piles of worthless green paper, which they believe can more profitably be invested in GSE debt (the mortgage bonds that Fannie and Freddie issue) and US Treasury debt than left under the proverbial matress. This purchase of GSE and Treasury debt has the effect of depressing U.S. long term (read "home loan") interest rates to much lower levels than they would otherwise be set by risk averse U.S. bond market participants, who have already started to wonder whether it is more likely that the Federal government will (1) raise taxes and lower spending or (2) slip in a higher level of future inflation to get rid of growing piles of accumulated debt. Quite a conundrum, wouldn't you say?

This all has gone along on autopilot for a long while, but now enter the Bushies and their political allies in Congress, who catch wind that U.S. manufacturing is being hurt by Chinese manipulation of their currency, which artificially depresses the value of Chinese manufactured goods. So now we are talking loudly and beating the Chinese with a big stick to get them to increase the value of their currency, which will result in lower purchases of their (now more expensive) stuff by US consumers, a strong incentive for them to divest from our long term bonds before losing lotsa money after the revaluation, and an upward adjustment in long term U.S. (read home loan) interest rates. The long-running win-win relationship between US consumers and Chinese producers ends at the same time one of the props under the housing bubble is knocked out.

Once we convinced the Japanese to revalue in 1989, their currency started appreciating relative to the value of everything else in their economy (read housing and stock prices), and this trend continues unabated 16 years down the road. For puzzling reasons, the US and other major Western economies have somehow thus far not been affected by any obvious sort of contagion from the Japanese deflationary spiral, despite the fact that they are the world's second largest economy. However, given China's massive population and their hugely growing influence as a player in the world's markets for resources and manufactured goods, we are unlikely to be as lucky if our efforts to get them to revalue their currency succeed.

As they say, watch out what you wish for ...

 
At 4:08 PM, Anonymous Anonymous said...

Californicators!!!

Hey, I resemble that remark.

 

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