Latest from Clyde Kendzierski, who was hired to set Orange County's books straight after the municipal bankruptcy . Excuse the format as it came as a .pdf attachment from his July newsletter.
Double Bubble
The debate continues over whether the housing bubble is
nationwide. In the past, most real estate bubbles have been
regional. This time, prices in the hot coastal markets soared,
while appreciation in much of the heartland has been
relatively modest. The National Association of Realtors and
others have suggested that the bubble is limited to the hot
coastal markets. Ergo; if there is no nationwide bubble, we
need not fear a nationwide housing bust.
That theory is proving to be dreadfully wrong. Defaults
and foreclosures are rising rapidly in the heartland where
supposedly there is no bubble. What the “head in the sand,
no bubble crowd” missed was the “homebuilding” bubble in
the heartland. Record homebuilding since 2001 was
disproportionately seen where land was cheap. The same
excess building that limited price increases is now showing
up in defaults and foreclosures as the first serious round of
mortgage rate adjustments hit. Massive liquidity creation by
Alan Greenspan’s Fed fueled both parts of the bubble;
excess homebuilding and soaring prices.
Unemployment remains near record lows, long term
mortgage rates are low by historical standards and we are in
the peak selling season for houses. Sales should be soaring,
but they are plunging. What are soaring are defaults and
foreclosures of “affordable” homes in the heartland where
“there couldn’t be a bubble.” The heartland housing bust
has started, and the coastal housing bust is just a couple of
adjustable mortgage payment hikes away.
Traditional measures of housing affordability have
dropped to record lows. The negative impact on
home sales was postponed by a variety of high risk
mortgages. In the past 18 months a record
percentage of low (start) rate and optional payment
loans created the illusion of affordability. In many
hot markets like California, over 75% of new loans
last year were adjustable. Over a trillion dollars of
these mortgages will have their payments reset in the
coming year. That process will continue in waves for
years, because many of the mortgages had their
payments fixed for two to five years. Affordability
issues slow home sales, but other factors are
necessary for a full blown bust. Excess building,
speculative buying, rising unemployment, and
foreclosures usually precede a serious price plunge.
The low rates of 2001, 2002, and 2003 produced a
record excess of homebuilding in comparison with
the number of jobs created. This surplus eliminated
the housing shortage created during the last
homebuilding bust. Since 2003, the building boom
was absorbed by an improving job market as well as
speculative purchases of investment properties and
second homes.
Adjustable mortgages were relatively rare before the late 1980s. The current unprecedented 500% rise in short
term rates from 1% to 5% compounds the coming adjustable mortgage crisis. Until recently, rapidly rising home
prices created instant equity. That equity allowed borrowers to avoid foreclosure by refinancing with another low
(initial) rate mortgage or sell the property. Now price increases have slowed or reversed, and lenders are
becoming more cautious. The result is a record number of unsold homes on the market as highly leveraged
buyers, builders, and speculators return inventory to the market.
Manufacturing jobs are growing, but that world of high productivity, automated output uses a lot fewer
workers per dollar of GDP than the housing industry. Over the last few years 40% of new jobs were related to the
housing boom. With home sales plunging, housing related layoffs have begun. Those layoffs will increase rapidly
this fall when the prime home selling season ends. Home improvement and furnishing sales are down sharply in
the face of higher home equity loan payments and rising energy costs. Defaults and foreclosures are low, but
according to RealtyTrac, defaults in the first quarter of 2006 rose 72% over a year earlier. Surprisingly, the big
jumps in defaults aren’t in “overpriced” areas like Orange County (that will come soon enough). Instead, the four
cities with the most defaults were Indianapolis, Atlanta, Dallas and Memphis; where home prices are below the
national median. Unlike high income borrowers, many low income homeowners can’t even qualify to get ripped
off again. That is why the first big leaks in the housing bubble are in areas where price appreciation was below the
average of the last few years.
The pool of borrowers who can qualify for a mortgage at current home prices and rates is already minuscule,
but is still shrinking. This fall new banking regulations are scheduled to take effect that will raise qualifying
standards for adjustable loans, adding home buyers to the list of endangered species. Meanwhile the legions of
sellers can do nothing but grow, as payments on their adjustable rate loans soar in lagged response to last years
interest rates hikes.
Uncertainties surround the Middle East, oil prices, and
the housing market; but the real market focus is whether
the Fed will raise rates too much, or not enough. The
financial markets (as they have for the last year) believe
the Fed is just about finished raising rates. A pause in
response to the collapse in home sales is likely, but
additional rate hikes remain likely. Inflation is much
higher than what is currently priced into the markets and
there is no historical basis to assume inflation will decline
soon. |
