Contrarian Chronicles
Easy loans now mean a hard landing later
In their desperation to generate fees, lenders are putting homeowners at risk of losing it all when the ugly end of the housing bubble comes.
By Bill Fleckenstein
Like summer, the housing market is swelteringly hot -- and home to hot-air theories. Two weeks ago, I debunked one concocted by a Seattle Times writer: "To be in a bubble, the housing market must be ready to burst. Since it's not ready to burst, it can't be a bubble." This week, I'll begin with another recently floated theory -- that real estate can't be a bubble because so many people say it's a bubble.
Yes, ladies and gentlemen, that nonsensical statement has acquired a bit of credence, although anyone with an ounce of common sense knows that it's completely ludicrous. To thoroughly refute it, all you have to do is think back to the stock market mania -- when the fact that many of us said it was a bubble didn't stop it from being a bubble.
What real-estate bulls could argue: Several recent stories about a bubble existing in real estate may need to be discredited before the party ends. That would be a defensible line of logic. But, for me, the power of a Time Magazine cover -- "Home $weet Home: Why We're Going Gaga Over Real Estate" -- that I wrote about on June 13 would trump that argument. Of course, that debate would just be the bears and bulls promoting their own favorite theory about how long the mania can last.
A bubble's end: Up in the air
The fact of the matter is, what you can't know about a bubble is when it will end. During bubbles, peoples' hopes about how the future will turn out, together with their greed, completely overrule whatever common sense or analytical skills they possess. When markets get as out of control as they do in bubbles (as happened in the stock market mania and as is happening now in the real estate mania), it's impossible to accurately predict the lifespan of that psychology or the magnitude of the lunacy.
Therefore, while we can't know when a bubble will end (notwithstanding our own pet theories), what's knowable is that folks are taking far too many risks. And the collapse, which is sure to follow, is an outcome that we can discuss with some degree of certainty. In an illiquid market like real estate, which is so dependent on financing, when the credit bubble that's been powering the house-price bubble bursts, it will be very ugly.
Up to the rafters in interest-rate risk
Stop for a minute and consider that interest-only and adjustable-rate mortgages now comprise roughly 60% of all home loans (with "interest-only" contributing one-half to two-thirds of that). Just about four years ago, they may have accounted for less than 20%. That's not to say these two flavors of mortgages couldn't become even more popular -- because they could -- but to illustrate the magnitude of the potential problem we could ultimately face.
For those who think that real estate can never go down, I should note, as I did in my May 5 column, a like-minded belief among Japanese property owners in the late 1980s, where values have subsequently declined for the last 14 years. That decline, however, may finally be in the process of changing.
Another prevailing myth in the real estate market: We can always ride out any bumps in the road. While that may have been partially true in the past (assuming you didn't lose your job), it may be less likely in the future, given the huge percentage of people taking out interest-only and adjustable-rate mortgages.
For instance, if you had a 30-year $300,000 mortgage at 5.5%, it would cost roughly $1,700 per month (before taxes and insurance). If you took out an interest-only mortgage, your payments would start out at $1,375 but would rise in a few years to between $1,800 and $2,200, depending on how rates fluctuated in the future, assuming they went up. (Of course, rates could be higher or lower, depending on the prevailing policy.)
If you pick one of the super-duper interest-only mortgages that permit borrowers to basically choose their payment, you could shoehorn into the same $300,000 loan with a monthly payment of about $965. But a few years down the road, that would rise to around $2,200. That's a mighty hefty jump. (These numbers are meant as approximations, just to give you some feeling for the size of the jump that's staring lots of folks in the face.)
A man's home is his lodestone
Thus, I believe that over time, the financial pressure on people who've paid huge prices to get into the red-hot real estate market -- and who have misjudged their ability to ride out what lies ahead -- will only increase. I don't think that's debatable. Furthermore, given that so many people are actually priced out of the market (which is why they've been attracted to these financing schemes that make the impossible "possible"), once the fever breaks, house prices will be under tremendous pressure (meaning those folks will be under water).
Recent statistics that I saw for California suggest that the percentage of households able to afford the median-price home -- now about $520,000 -- has dropped to 16%. I haven't seen the data for other states, but if only 16% of California households can afford a house (which I'm sure is an extreme), while home ownership nationwide is running at approximately 70%, then lots of folks own a house that they couldn't afford to live in, if forced to buy it using conventional financing methods.
Mortgagee motto: Just say 'yes'
That brings me to the point about what has allowed this folly to take place: The fact that financial institutions have totally taken leave of their senses. Rather than being even slightly concerned about getting paid back, they only seem to care about generating loans, such that anyone with a pulse can finance anything.
Somewhere down the road, when home prices begin to sink and problems start to arise, the financing mechanism will change. Then, it will become far more difficult to obtain a mortgage. That will, of course, cause the problems in housing to feed on themselves. To my mind, there's no escaping the fact that a huge financial accident lies ahead. The only question is, when does the trouble start? |
