Dean Baker: The Coming Housing Crash

[PD]

Mephisto, do you live in San Diego or SoCal? When did you buy your house? Do you plan on paying off your mortgage when it resets? Are you making more than 5% interest on your investments? Is it a guaranteed return (NOT in the stock market)? Have you calculated in the cost of the mortgage (fees, etc) when comparing it against the returns you are making with your cash?

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

I too welcome the other side of the argument, but would like some numbers to back it up. Just having my own opinion reinforced will not make me any money. The only thing that makes me nervous at all about my view of a 30% drop that has begun, is that I am so sure of it.

My best trades as a trader are always the ones I am the most nervous about. Whenever I have been sure I was right, I have gotten my …. handed to me.

I do completely agree, that the long term prices of real estate are ever upward. However, just from an analysis standpoint I would challenge the bulls to point out one parabolic price move in any asset class ( you can name it ) that corrected sideways during the ensuing correction.

I have yet to find one, and I do not think we are in the midst of one in RE. For those that are new here, I have a good chunk of money in relatively liquid places waiting for a buy spot. That chunk is well into 7 figures, so do not target me as someone who cannot afford to buy a home. You can classify me as someone who is trying to time the market though. That is exactly what I am trying to do.

Timing markets is what I do for a living, and sometimes I am wrong. I am not so cocky as to think that I have the holy grail model for doing this. As a result, I absolutely welcome the bull side. If there is something I have overlooked I would openly consider it.

I am looking in the 1.5 range so mis timing that by 30% is 500k, and that is not chump change, so I wait patiently as a renter for now. I have bought and sold a few homes in the last 10 years, the last sale being at the end of 05.

It does seem to me just anecdotally, that things have changed dramatically in RE in just the last few months. It does feel like the tide is turning, and the numbers do support it. There are 3 major high rise buildings coming out of the ground in Irvine, with not one single pre-leased tenant combined in them. This is unprecedented. The standard would be about 50%. I am sure the appraisers could comment on this better than I can. Although this is commercial, the two are tied together at the hip. This is a topping sign, raw speculation. Two of them are Irvine Co. developments, so it makes it a little better than if it were anyone else because they have no carrying costs.

The comments on Greenspan made by Rich are the correct ones regarding the 2000 top.

[mephisto]

—
Mephisto, do you live in San Diego or SoCal? When did you buy your house? Do you plan on paying off your mortgage when it resets? Are you making more than 5% interest on your investments? Is it a guaranteed return (NOT in the stock market)? Have you calculated in the cost of the mortgage (fees, etc) when comparing it against the returns you are making with your cash?
—

This is getting pretty off topic, so let’s end it here.

But yes, I have lived in San Diego my whole life. I will probably not pay off mortgage as I get better returns elsewhere – and like many here, I’m hoping for significant price drops so I can buy a bigger place – as I’m said, it’s over priced and needs a correction.

Earning more then 5% these days without stocks, etc? Pretty simple, many Checking and Savings accounts pay ~ 5.15%. T-Bills are paying ~6% for Californian’s. And many CD’s are ~6%+ right now as well.

Again, getting off topic though – and these are more financial discussions outside of Real Estate – so this probably isn’t the place to be discussing them.

I believe you proved my initial point though. You saw the words “Interest Only” and immediately assumed I was living above my means – when in fact, I’m not by a large margin.

Not everyone is/has dug themselves into a world of financial ruin. And my original opinions that there are a large # of people anxiously waiting on the sidelines to purchase once prices go back to a more appropriate price range will avoid any 50% immediate price drops – as much as that would be nice!

Again, just my humble opinions.

[PD]

I am earning over 5% on my cash as well but you are paying more than 3% – 5% for your loan when you calculate in costs. As for answering my questions, they are not off topic as RE and finances are what this site all about. You somewhat avoided my question about where you had your money. You stated that saving accounts are paying a certain percentage but you did not say that was where you had your cash.

[mephisto]

—
You somewhat avoided my question about where you had your money. You stated that saving accounts are paying a certain percentage but you did not say that was where you had your cash.
—

Right now my personal preference is TBills, and I have a large portion in IBonds that are still earning a high percentage (purchased back in the days when you could use a credit card – purchased using a 5% cash back card.. so I really like these Bonds as you can imagine).

Shame you can’t do that anymore. 🙁

I use a 5.15% checking account for my day to day stuff.

I’ve been trying to get more liquid in preparation for the next few years (outside of various savings accounts, 401ks, ira’s, etc…)

That’s just my strategy though. I figure the “real” price reductions will probably be in the next 2 years. But, just my best guess… who knows.

[(former)FormerSanDiegan]

IO role in planning …

Seems to me that mephisto has been using an IO to free up cash flow for investment purposes and to provide a large cushion for a future slow down/rainy day/bubble pop/recession.

Seems like an appropriate strategy for high-income folks who purchased prior to 2002 for riding out the bubble. It depends on their other assets and what portion of their net worth the property encompasses.

[SD Realtor]

Just a quick comment about inventory and the buyer sentiment. As a Realtor I cannot overstate the effect of the buyers sentiment changing. Personally, this has been the most profound change. Now I am not a 20 year veteran agent but I believe the change in attitude is much more responsible for the declining sales then anything else. While alot of sellers are still clinging to outdated pricing levels, there are a good majority who have priced more agressive. Mortgage rates are down significantly from the spring as the 10 year has rallied. Yet sales are SUBSTANTIALLY down. The fact is that the psychology is much different. Buyers do not feel they will be left out of the market by waiting.

Inventory levels should actually drop over the next few months due to seasonal factors. The heaviest listing volume always occurs in the spring. So in the fall and winter you see new listings decline and stale listings drop off due to cancellations and expirations. You also get people who gave up and decided to rent out thier home or sit tight. I feel the tide is going out (inventory wise) but the fun really begins in February when it comes back in. It would not surprise me to see it dip down below 20k into the high teens even. However don’t delude yourself, analyze the data and if the drop in inventory is not matched by a gain in sales then that would confirm that this is simply seasonal.

I believe that the months inventory is a great measure but it can be misleading when there are inventory fluctuations that are seasonal. So even that months (the fall months)inventory may be somewhat optimistic as we tread into the fall.

BTW Chris Johnston – If you ever need a lackey I am your man!

[powayseller]

mephisto, people like you, who are choosing to get an I/O loan, are the ones these products were originally made for. The problem is that 80% of San Diego mortgages last year were some kind of unconventional loan, many made with stated income. Most of these, I would say over 75% of these loans, were made to stretch into a house, because the buyer thought his house would keep appreciating. Why am I so sure? Because the median family income in San Diego is $51K/year. Since the median house is $500K, that is a multiplier of 10! The usual multiplier is 3-3.5.

When I bought a house in 1987, and in 1997, the general rule was we could get a mortgage for 3-3.5x income.

Now people are qualified on the basis of teaser rates, not the fully adjusted rate, and they can *state* their income. This easy lending has led to escalating home prices, as more and more people rushed in to buy homes.

The housing bubble got so much bigger this time due to this exotic lending. For this reason, you see home prices weakening nationwide. I don’t know if we have ever had nationwide home price declines and overbuilding since the depression.

So while there may be a few people here and there sitting around with cash, they are not the median San Diegan.

We cannot plan the future of the housing market around 2% of the population.

I do like your argument though, mephisto. It would make sense if there were indeed many people like you describe. But the data just doesn’t support it. If you look at credit, MEW, and wages, the picture paints a wage earner whose income is stagnant and who makes ends meet with credit.

The banker associations and government agencies are concerned about the effect of $2 trillion of mortgages resetting over the next 2 years.

Whether 1% of the population, the wealthy, can still pay cash for a mansion in Rancho Santa Fe, does not affect any of this one bit. The wealthy are in a different league, and their housing market in the +$3 mil category march to a different drummer. Stock market gains, option grants, all that kind of stuff.

To understand where the market is going, we have to look at the masses. The economy leading indicator is wages, and the wages of the masses is what is causing this all to unwind.

Just out of curiosity, how did your friends come across their riches? And to round out this discussion, for anyone reading this,
1) how many people told you they have money sitting in the bank to buy a house, and
2) how many do you know who already own a home, so they would not buy regardless of how much money they have saved
3) how many people have adjusting loans without an adjusting income to match (but they will *never* tell you; I bet not even your dearest friends would confess to such a shameful thing)

I’ll go first: I know only 1 other family with cash ready to buy and know several renters who are undecided about what to do; I could name 100 people who own; and I have no clue how many of my acquaintances have ARMs. I talk to a lot of people, since I am kind of a social butterfly, and my experience is very different from mephisto’s, both anecdotally and in the stuff I read every day.

But I am fascinated to hear more about your view, mephisto, that a large group of people sits ready with cash to bail out a housing decline. Please ask those people why they would buy while prices are dropping. Why wouldn’t they wait until prices *stopped* dropping, just to be safe?

[(former)FormerSanDiegan]

Median income earners and homebuyers …

Since San Diego County home ownership rate is historically in the 50-60 % range, why should we consider the median wage earner, relative to median prices ?

Shouldn’t we consider the upper 50 % of wage earners when considering affordability ratios ?

When has the ratio of median wage to median home price ever been in the 3-3.5 range in San Diego ?

[anxvariety]

Just trying to add a cautioned perspective to this thread..

I dont really see how it’s fair to talk about people not on this forum as “they” and say they are less intelligent.. the writing isn’t yet on the wall, and if you believe that a housing crash is 100% immiment you’re just as nuts as they are in my opinion.. how can it be 100% when you don’t have much control of the outcome?

What if global warming kicks in and the seawater rises 3 feet.. I wouldn’t mind buying some houses a few blocks off the beach.. those would now be beachfront! There’s almost an unlmited number of outcomes… what if a nuke goes off in New York and people on east coast decide they want to move here.. that would gobble supply right up…

I would be careful not to let ourselves be blinded by the self fulfilling excitement about this forum.. just because you have an opinoin and others agree doesn’t mean it’s the right opinion or definitely going to happen… we’re talking about the future here that involves imagination and imaginary events.

[mephisto]

Powayseller –

Oh, I certainly agree that the IO/NegAm/etc type loans have been horribly abused and a lot of people are really going to lose their shorts.

I don’t so much think people waiting to buy are going to bail out a housing decline – I think they are going to constantly buy during the decline causing a slow decline.

Prices are still going to drop, inflation is goign to eat away for several years, etc. IMHO. I personally just don’t believe prices are magically going to drop 40-50% overnight like so many people are waiting for. If you are hoping for your $600,000 house to be selling for $300,000 tomorrow – I think you are going to be eternally waiting.

In 7-9 years, in “real dollars” that may or may not be the case. But that’s a completely different concept then what so many people seem to be thinking.

Houses will go back to places you buy to live in, and not to flip for quick cash. Good thing.

Of the people I know, how did the ones with a lot of cash stock piled get it? All sorts of different ways really.

Some made a lot on stocks. Some made a lot on RE. One person moved back home with his family saving $5,000+ a month in order to buy (started about 6 years ago – he’s salivating for prices to go down and frequents these boards more then me!). Some just make a lot of money.

And if you are dual income, that only makes things easier. I’m not rich, none of my friends are. But we don’t try to live extravagent lifestyles we can’t afford.

Having decent paying jobs, living well below your means, and working hard to save money – thats how I try to get by at least.

Why buy as “the knife falls” as some will say? Like everything else in life, good luck timing the bottom. Anticipation will have its toll, tired of waiting, or just a sweet deal. There are advantages to a large inventory – your selection is much larger.

My one friend living at home saving like crazy has already begun creating his MLS “watch list” of properties he wants to check out as prices go down. You see the same thing mentioned all over the place on these forums.

For every X vultures that start circling above a carcass, a given number will give in and dive in for some food. I don’t know the formula, but I’m pretty certain this is what will take effect.

And at some point, trying to time the market only costs you. 5 years of rent at $1,500/mo is roughly $90,000 give or take some additional expenses. 10 years is $180,000… and so on.

(Ok, if your price range is the 1.5million mark like the poster above.. timing the market has a bit more of a consequence 🙂 ).

If you really want a house (and so many people who believe there is a bubble do – which says a lot for setiment) – then at some point the price and property will line up perfectly in your eyes.

People keep saving, even as house price stay the same or slowly go down.

But then again, who knows. When I bought this place a few years ago, I knew quite certain the housing party was not sustainable and would have a correction. But then again, that was about about $60,000 in money I would have spent on rent ago or something by now. And another 20+% “appreciation” (that I expect to go away) on my place.

Personally, I got sick of renting – sick of moving, tired of roomates, tired of being landlord. Owning, for me, is worth quite a bit of money just to not deal with all that other hassle. So I’m quite happy. 🙂

[(former)FormerSanDiegan]

Rich –

Agree that we must work with data that are available.

I was trying to find the data to support PS’ statement :
“Because the median family income in San Diego is $51K/year. Since the median house is $500K, that is a multiplier of 10! The usual multiplier is 3-3.5.”

This is misleading. Unless the median income (in nominal dollars) is the same now as it was in 1995, we were above the 3-3.5 ratio even in the darkest days of median home prices in San Diego of 1995.

No way that is the usual ratio of median income to median price.

[bubba99]

Chris,

I completely agree that the most troubling factor about the bubble is the belief by so many that it will happen. In the past that kind of assurance has been met with surprise when some un-predicitable factor like the fed and money supply stepped in and shocked the system

Plus I now am sitting on way too much cash. I can get 5% on short-term treasuries, or .8% on Swiss Francs, but the lack of any real robust returns has left me un-comfortable – like what am I missing?

[powayseller]

FormerSanDiegan – I need to correct what I wrote. Typically you can buy a home for 3-3.5 x family income. Typically, 64% of people nationwide owned homes, so you’re right, we cannot use the median wage earner’s income at a 3 multiple. The charts in the Bubble Primer show this: the ratio is typically between 9 (peak) and 7 (trough).

mephisto – timing the real estate market is easier than people think. Don’t use the median – it lags by one year. Use months inventory and most important, work with an honest realtor who will know from his daily work in the field when the tide shifts, sales pick up… But not to worry if you are a few months late; real estate moves very slow. Eventually prices will stop dropping, and rise, but I expect that rise to be gradual before picking up momentum. There should be an entire year in which to make a decision.

As for me, I am not looking at MLS, Open House, or visiting builders. I am content to rent for 5 years. Why in the world would I want to look at homes now? To me, a house is like a big stone around my neck, a big turn-off, an albatross. Looking at homes now is like reading the Lucent Annual Report in 1999. One word: yuck! Sorry to offend anyone, but homeownership today, to me, is just plain yuck!

[Author]

Posts