The 9 page report is worth reading. Lots of good charts. I have included the most significant snippets below.
Bugs – this is part of the banking game – create a bubble in some asset class, profit on the expansion of that bubble, then when the bubble pops profit on the deflation – Goldman will get lots of business (and fees!) from anxious clients wanting to reduce their exposure to CA real estate
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highlights (lowlights?) from the GS report:
3. Home prices in California are 35-40% over-valued
Now that the secondary market for these affordability products has all but evaporated, we expect home prices in California to return to normalized levels (i.e. levels implied by current and forecast disposable income in California as well as U.S. ten-year treasury yields); this implies a 35-40% fall.
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While our model is helpful in estimating the magnitude of house price correction due for the state of California, forecasting the timing of such a correction is trickier; the typical response of the average Californian home owner to the prospect of falling house prices is to not sell. Therefore, a correction of 35-40% could take many years to play out.
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Californian mortgage credit quality is deteriorating quickly
Mortgage delinquencies in California are catching up to the national average
From 2000 to early 2006, Californian residential mortgage debt performed much better than both historical and national averages, thanks to double-digit % annual home price appreciation throughout that period.
Recently, however, home price appreciation in California has flattened out (e.g., up only 2% year-on-year in August 2007), although many counties have experienced declines. Given the recent decline in investor demand for Californian residential mortgage debt (and, subsequently, credit availability for consumers) in tandem with rising state unemployment, we forecast significant house price depreciation leading to credit deterioration in California, which is already accelerating above the national average (see Exhibit 3).
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We remain bearish on the U.S. housing market; house prices are 13%-14% over-valued nationally (which, like in California, could take several years to play out), growth in mortgage debt outstanding continues to fall (driven by house price depreciation and declines in the home ownership rate), and we have yet to see the worst of residential mortgage credit deterioration (reset volumes for subprime ARMs are set to peak in March 2008, and recast volumes for option ARMs are set to peak in June 2010).
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1. National house prices are 13%-14% over-valued
House prices are over-valued and a correction is underway (see Exhibits 4 and 5).
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3. We have yet to see the worst of residential mortgage credit deterioration
Our estimated national schedule for adjustable rate mortgage resets (when low-interest teaser rates reset to current rates) and recasts (when the pay-option expires and borrowers are required to pay the fully-amortized rate) suggests that the worst of residential mortgage credit deterioration has yet to be seen across this country. Reset volumes for subprime adjustable-rate mortgages peak (at $42 bn) in March 2008; recast volumes for pay-option adjustable-rate mortgages peak (at $24 bn) in June 2010 (see Exhibit 7).
