One would think that today’s housing market is precariously weak, and can potentially tip over if certain things happen, and enter a vicious cycle. So the question is, what is the tipping point?
First, how does the latest selling price set the “appraisal price” and “market price” for the next transaction (refinance or purchase)? Say if a house is just sold at 10% lower than the previous comp; and now there are two neightbors, one wants to refinance due to cash flow problem, and one wants to sell.
a) The one that wants to refinance needs to get an appraisal — so is the appraisal value 10% lower now or is an average of sales in the past 6 months or the last 10 sales or whatever? In that case, almost for sure the appraisal value is higher, so the neightbor may refinance his way out;
b) The new seller probably is facing a harsher reality, so he may get even less. That’ll influence the next refin.
I think that the tipping point happens when the financial markets “wise” up, and tighten lending standards significantly and demand higher rate. That’ll cut so many people’s “way out” that a vicious cycle will have to start.
But how does the financial markets know? If a portfolio of mortgage backed securities is sold, and its “Loan/value” ratio at the time of mortgage initiation is 80% so it looks like a solid portfolio. But now “value” based on the current transaction is 15% less, so loan/value is only 94%, but does the market know? Or it only knows when
a) the loss rate goes up;
b) loss ratio doesn’t go up into dangerous territory as long as people can refin their way out;
c) appraisal values lag the latest transaction value on the way down so there are always some people who can refin to buy more time, instead of sell or walk away.
So therefore it’s going to be a slow process when you think about how each stakeholder (home owner, lender, financial buyer of mortgage paper) behave and their individual incentives/emotional attachment, and how there is this inate “delay” of using the latest transaction to re-evaluate all previous asset level on the way down…
So I believe that it’ll happen, but we’ll probably only know what that tipping point is in retrospect.
ps: a story. A relative (not in San Diego) bought his house many years ago for 150K. It’s appraised at 480K (which he thinks is insane). He just refinanced, and now his mortgage is at 300K. In his mind, he’s been very conservative because of the low loan/value ratio of 62.5%. Since he took cash out, he automatically has more time. But it’s a 30 year mortgage, and he’s about 45. So what happens when he’s ready to retire at 65? In his mind, 20 years is too far off, and for sure he could sell at a good gain. But then he’ll have no place to live, so his retirement living expense will be high due to housign… anyway, collectively the country has mortgaged its future, and if there is no painful correction soon, the suffering will only be stretched out years down the road.
I’d think we’d have a sharp drop in house prices in the next year. Inflation in the form of Commodities ( think milk, meat and eggs ) will slowly rise over time, housing will drop slowly and in ~5 years we will be back to where we were in historic terms – we’d spend relatively less on housing and more on food and make a little bit more than now for the same type of work and be firmly set in an inflation cycle for everything except housing. That is likely to the the real bottom for housing. 2011 or so. Then housing actually starts to reverse course and joins in inflation at right about under the rate of inflation as it has done historically.
The slow drop like japan cannot happen here cos our savings rate is pathetic. Its negative, they are at like 15% average isn’t it.
Cool.
Cow_tipping.
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