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You are right, most people who visit this site know what’s really going on. But I can tell you, that 90% of the RE community and the general public doesn’t get it. They now know that things are getting ugly because of the surge in inventory and the recent price reductions, but before August 2005, they had no idea that we were in a bubble. Honestly, it was very frustrating because I couldn’t talk to my coworkers, friends or in some cases, family about it. They either didn’t get it or would think I was nuts. My in laws thought I was crazy. I told my sister in law, to be careful about buying a house. They bought in April of this year. I told them to negotiate and get the seller to pay closing costs. I also told them to prepare themselves mentally that prices could fall after they buy. Of course, they didn’t really believe me. I put them on a 30 year fixed rate first loan that is interest only for the first 15 years and a 30 year fixed rate 2nd loan. They put 5% down. There’s no doubt that prices in their neighborhood will fall and they will owe more than the house is worth. However, they have the protection of 30 year fixed rate loans. They will just have to ride out the downturn.

I noticed the bubble in early 2003. It was just starting to get some publicity. When the multiple offers, escalation clauses started picking up, I knew people were being irrational and a bubble was forming. Also, when I started in 1994, I will never forget sellers bringing money to the table to sell their homes/condos, that they bought in the previous peak around 1989-1990 or so. I knew that RE goes in cycles, unfortuantely, a huge amount of new realtors, lenders, buyers, didn’t understand the cyclicality of the business. Angelo Mozilo, CEO of Countrywide, is quoted as recently saying, “I’ve never seen a soft landing in 53 years in the business”. He’s just pointing out that RE goes in cycles. The problem is this cycle got so out of control that the downside could be much, much uglier than ever before.

I just left the business, not because I couldn’t survive, but because I never liked it. The money could be incredible, but it was mindless work. I also did not like being tied to one area of the country. Once you build your book of business, its hard to relocate without having to start all over. Basically, as a mortgage lender one does the same thing over, and over and over. How many loans can I do this week, this month, this year. It’s the same process everytime, although its been streamlined dramatically since 1994. Now, don’t get me wrong, this year has been very ugly for many lenders, including myself. I saw the latest numbers for my company, everyone’s numbers are off 20-40%. And, we are a very strong mortgage company, because all of our loan officers work in real estate offices and do a large amount of purchase business. Lenders who focused on Refis are finished. If lenders do not have a strong base of builders or real estate agents referring them business they are in big trouble. Basically, lenders can get their business from realtors, builders, accountants, financial planners or past clients. The best source of course is builders or realtors. However, most builders will have their in house lenders which they can steer loans to because they can pay closing costs or offer reduced points. Once a lender has been in the business for a long time, if they are smart, they will build a database of past clients who they will email, mail, etc. to bring new business in. They will also have a loyal following of real estate agents. So the longer one has beeen in the business, the more sustainable their business becomes assuming they are any good. Now, that doesn’t mean that they won’t have huge ups and downs during the cycles. I know many people who were making $300-500k just because they had been in the business a long time. I always considered a loan officer to be very close to a used car salesman. There are almost no barriers to entry, most states don’t require licensing or a test of any kind and no education is required. I also hated being on call 24 hours a day. It just wasn’t worth it to me.

I always tried to steer my clients to the safest loans possible. For example if someone wanted an ARM, I tried to push them into a 10/1, 7/1 or 5/1 at the shortest. Even the 5/1 ARMS are at risk. Our 5/1 has an initial interest rate cap of 5%! So if someone starts at 4%, they can adjust to 9% at the first adjustment. I also, never offered Neg Am arms, I lost a bunch of deals because of that.

[X1Y2Z3]

Ok here goes. Yes, most major RE markets are in housing bubbles IMHO. It was like the dotcom frenzy of the late 90’s. People thinking they were geniuses because the values of their homes were going up. Once the bidding wars started up, I knew the bubble was getting way out of hand. The worst situation that I heard of was a house that had 36 offers on it. Who in their right mind would bid against 35 other people for a house? It wasn’t even in a nice location, in fact it was in a bad location. Here’s what would happen. A couple would get approved for a mortgage. Then the agent would help them make an offer, they would lose the house because they didn’t bid high enough. Then the agent had them, they would say, if you only add an escalation contract you will win the next bidding war. So the buyer probably would lose another house, then they would ask, how high can I go over the list price? It was ridiculous. One agent I worked with called it a “vertical market”, prices were going straight up. So you have everyone trying to outbid each other and virtually no one taking the time to assess whether the prices increases were sustainable. BTW I was an in house Loan officer meaning I worked in a real estate office so I saw everything.

So initially, the low housing supply/low rates got the bubble started. Then the lenders made it much worse than it had to be by loosening guidelines. When the interest only loans started getting popular a vicious cycle began. They allowed people to buy more home, which drove the prices higher. Then, as the prices rose, people had to use the I/Os or they couldn’t afford the house. Now, remember that regular guidelines were very easy to begin with. At my bank, we allowed debt ratios (mtg payment+ monthly debt/income) of 45% and didn’t even bother with a front ratio (mtg payment/income). When I started in 94, FNMA guidelines were 28/36 for ratios. And I can tell you that the majority of people who got a regular loan were at 44% or so. I had to be very careful with my estimates for monthly tax and insurance or someone could end up at 45.1%. Then as people couldn’t afford a house with either an interest only and a 45% debt ratio, they then opted for a negative amortization ARM or a stated income loan. My bank doesn’t even offer the neg am ARMS (brilliant move). There are basically 3 types of low documentation loans: stated income, no ratio and No doc. Stated income means we ask for income and employment info but don’t verify it. No ratio means we don’t ask for income but verify the employment. No doc means, no job, no income no assets are verified. Stated income loans are very much liar loans. I never liked them because it was so obvious and I was uncomfortable with them. A bank can do quality control and pull tax returns to verify the stated income after the loan closes. I preferred no ratios or NO docs because no one was lying, they just didn’t put their income down. Bottom line is that originally these loans were for newly self-employed people or people who just didn’t want to document their income for various reasons (tax returns were too large and complicated). But today they are used to buy homes that the borrower can’t afford in the first place. Our company tried to separate functions, so I was a “prime” loan officer and I would refer marginal buyers to our subprime loan officers. Every time someone wouldn’t qualify for a prime loan, I would just refer them to the subprime guy and ask him to do a stated, no doc, etc.

Bottom line is that first low supply low rates drove prices up, then interest only and neg am arms helped push them up and finally, when all else failed, just put someone in a stated income, no ratio or no doc to get them qualified. oh I forgot about 100% financing, of course no one buying a house these days has any money saved. Since we can now do 100% to $1M who needs savings. Basically, any one who could fog a mirror could buy a house. This created a massive pool of buyers with a limited supply of homes. Any one who took Econ 101 can tell you what happens with large demand and low supply. Let me give you some examples of crazy loans:

100% to $800k, 1 day out of bankruptcy, credit score 580

95% NO DOC to $700k and some lenders were doing 100% NO Docs: again, no job, no assets needed.

Anybody, anybody could get a loan. Here are some reasons why most major markets are in a bubble:

1) price/rents are way above historical averages

2 price/income way above historical averages

3) look at mortgage volume: interest onlys went from being almost non-existent to 40% of the market and higher in certain areas.

4) Neg am arms again almost nonexistent to a huge percentage of loans, 100% financing a huge percentage. I believe 40% of first time buyers used 100% financing last year.

5) Subprime loans made up 5% of the market in 2000 or so and about 25% now. The majority of subprime loans are 2/28s meaning the rates will adjust in 2 years, these borrowers are finished. The easiest sale in the world for an LO is to say, oh just take this 8% loan and in two years your credit will improve and I will refi you to a standard, loan. It never happens, these people never fix their credit.

6) 2 Trillion dollars of ARMS are adjusting over the next 2 years. Many of these are interest only so they will be hit by a rate increase and have to pay principal.

7) Prices are already coming down much more than the stats show, NAR stats do not include seller concessions, the large majority of sellers/builders are paying closing costs, etc.

8) The NAR stats also operate with a lag. They use year over year numbers so if there was a lot of appreciation in the beginning of the year, but prices are falling now, albeit slowly, it still looks like houses are appreciating. Prices just turned negative year over year in SanDiego, DC, Long Island, NY and many other places.

9) Inventory is going through the roof. RE moves like a glacier. First inventory will rise, then sellers will have to adjust their prices down. Especially ones who can’t afford their ARMS.

10) Psychology will change. Behavioral economics studies how psychology can affect economic decisions. People get caught up in the mass psychology and get burnt, dotcom bust, the coming housing bust. Robert Schiller is a Yale economist who studies this and studies the housing market. His data shows that housing barely exceeds inflation, his data goes back something like 200 years. Now the scary part is as home prices fall, psychology will turn negative. People will hate housing which will drive prices down further. Why would I buy now, if prices are falling, why don’t I wait?

11) people who put 0 or 5% down are already underwater. They will walk away from their homes. Foreclosures are going up across the country. Of course foreclosures were very low recently because all you had to do was throw a sign in your yard to sell your home. Now that homes aren’t selling or are selling for lower prices, foreclosures will continue to rise adding more inventory to the market. Note that foreclosures are a lagging indicator in fact, I think the last time they spiked was in 1996 or so well after the last RE bust of the early 90s.

Oh I forgot, this isn’t just a US bubble. Most major markets around the world have housing bubbles, Uk, South Africa, Ireland, Australia, Spain, etc. etc. The fed caused a lot of this by dropping the funds rate to 1%. Other central banks lowered their rates spurring bubbles of their own. Australia has already seen a downturn in their markets, nothing huge yet, but I have seen declines of 5-10%. The UK is on the knifes edge. Their personal bankruptcies are soaring. The most undervalued market is probably Japan. I’m sure most of you know but their housing market fell 50% or more from the early 90s. Their stock market fell 70% or more. Their housing market just showed some appreciation for the first time in many, many years.

If the US goes into recession, which I believe we will in early to mid 2007, we could bring the whole global economy down. Things could get very ugly. Housing made up a huge percentage of GDP over the past 5 years (after the dotcom bubble), something like 40%. When housing goes, which it is, the US economy will go. My prediction is that 30% of agents, lenders, contractors, builders, painters, etc. will be out of the business in the coming year. It’s already happening. Here’s what makes this so scary, unlike the dotcom bubble, people now have enormous mortgage and consumer debts to service, many of which are ARMS, they are in serious trouble as the economy slows. The FED created one bubble after another and this one (housing) is much more dangerous than the first (dotcom).

Ok that’s enough for now. I apologize for the spelling and grammar. I was trying to type as fast as possible. This is all my humble opinion and worth no more than 2 cents.

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