Friday, December 22, 2006

US Housing Crash Continues

Prices disconnected from fundamentals. House prices are far beyond any historically known relationship to rents or salaries. Rents are less than half of mortgage payments. Salaries cannot cover mortgages except in the very short term, by using adjustable interest-only loans.

Interest rates going back up. When rates go from 5% to 7%, that's a 40% increase in the amount of interest a buyer has to pay. House prices must drop proportionately to compensate.

For example, if interest rates are 5%, then $1000 per month ($12,000 per year) pays an interest-only loan of $240,000. If interest rates rise to 7%, then that same $1000 per month pays for a loan of only $171,428.

82% of recent San Francisco Bay Area loans are adjustable, not fixed. This means a big hit to the finances of many owners every time interest rates go up, and this will only get worse as more adjustable rate mortgages (ARMs) get adjusted upward. Nationally, about $3,000,000,000,000 (that's trillion) of ARMs will adjust their rates to much higher levels this year and next.

Even if the Fed does not raise rates any more, all those adjustable mortgages will go up anyway, because they will adjust upward from the low initial rate to the current rate.

A flood of risky adjustable rate "home equity loans" draining equity from existing mortgages. Just like the bad primary ARM loans, these loans do not have fixed interest rates. When the interest rate adjusts upward, it can double monthly payments, forcing owners to sell.

Extreme use of leverage. Leverage means using debt to amplify gain. Most people forget that losses get amplified as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss or an interest rate hike, he's bankrupt in the real world.

It's worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is 6%. On a $600,000 house, that's $36,000 lost even if prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less.

Shortage of first-time buyers. According to the California Association of Realtors, the percentage of Bay Area buyers who could afford a median-price house in the region plunged from 20 percent in July 2003 to 14 percent in July 2004. Strangely, the CAR then reported that affordability fell another 4 percent in 2005, yet claims affordability is still at 14%.

Surplus of speculators. Nationally, 25% of houses bought in 2005 were pure speculation, not houses to live in. It is now possible to buy a house with 103% financing. The extra 3% is to cover closing costs, so the speculator needs no money down. Even the National Association of House Builders admits that "Investor-driven price appreciation looms over some housing markets."

Trouble at the builders. They are being forced to drop prices even faster than owners. They overbuilt and have huge excess inventory that they cannot sell at current prices.

Trouble at Fannie Mae and Freddie Mac. They are being forced to reduce their holdings of risky loans. This means they are not going to keep buying very low quality loans from banks, and the total money available for buying houses is falling.

The best summary explanation, from Business Week: "Today's housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low rates of a weak economy. Either the economy's long-term prospects will get worse or rates will rise. In either scenario, housing will weaken."


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