At arm's length, nine signs of a bubble
by Paul Petillo
The blind belief that the housing boom will go on forever has fooled most homeowners into taking on more debt than they can pay and in that, may bankrupt our nation.
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July 29, 2005 - (AXcess News) Portland - No doubt, you have heard about all you want to hear about housing bubbles. All the major media concerns have alerted folks to the unreasonable costs for homes but have failed to offer any real reason why this is a problem. But alas, their job is to sensationalize and what better sensation exists than the pursuit of news where there may not be any. But on the other hand, perhaps there is something in the telltale signs listed below that would give even the risk-prone investor some pause to reconsider.
No amount of coverage has stopped folks who intend to purchase their first home from jumping in blindly, using ever riskier means to finance what has become a very expensive undertaking. There is a domino effect in borrowing what these folks may not be able to repay. Few people these days applying for mortgages have calculated their loan in the long term. Getting in was all they concerned themselves with and in doing so, many people financed at what on the surface appears to be inexpensive money.
So why the hype? Perhaps we should ask what's the consequence of such an overheated, often speculative market and even better yet, who should care?
Folks who watch economies such as ours - people like me - are beginning to feel as though we have spoken until we are hoarse and written until our fingertips were calloused, holding a bearish outlook on an obviously bullish market. But we see a disaster on the horizon. Much the way trainspotters or airplane watchers or NASCAR fans do, we are hypnotized by the speed, the seeming wreckless abandon of the participants, and the inherent risk that all good things have an end after a good run.
Here's what concerns me and what should concern the nation's economic leaders:
1 - The net worth of the households in this country is based on a combination of assets including savings, investments (accumulated retirement assets in stock and bonds) and your house. It is a sign of economic strength when those assets are somewhat balanced.
Currently, the housing market has tipped this balance by increasing the net worth of households over 70%. The last time the net worth of households was out-of-whack, so to speak, was when the stock market took off to astronomical heights increasing the worth of equity investments and giving the participants that wealthy feeling.
2 - Housing has lifted the jobs report as well. When new homes are built or current ones are refinanced, not only are the construction industries employing more people, but the ones whose job it is to supply raw and finished materials. Companies whose purpose it is to supply these new homes with durable goods such as refrigerators and appliances as well as other not so durable goods, find their customers increasing as well. This adds new jobs built around the wealth in homes. So far, 40% of the jobs that have been created over the last four years have been a direct result of this increase in the net worth of housing.
Take homes out of the picture though and the numbers of real final sales reported in the last quarter actually dropped. This is worrisome if you consider that the reason the Fed chairman Alan Greenspan is increasing short term interest rates is to slow the economy before it overheats. But it conntiues to be charging - no pun intended - ahead on borrowed funds. The first quarter numbers for these sales excluding housing, on an annual basis has fallen by half since the last quarter of last year.
3 - Lenders have been allowing riskier borrows to enter into this market in a big way. The so-called sub-prime applicants, the ones whose creditworthiness would in less speculative times be more closely scrutinized have been lured by, and this is how the Mortgage Bankers Association refers to it, "innovative" financing. These lower standards increase the risk of default at a time when the nation's bankruptcy laws are about to change.
4 - Those innovations have allowed new home buyers, an estimated 42% of them first time buyers, to get into those homes without putting a dollar down. This is done with a combination of financing maneuvers ranging from interest only loans (ones that carry ballooned payments later in the mortgage cycle or refinance the loan - a process that is predicted to get more expensive as time goes by) and by borrowing both the first 80% on one loan and the down payment on another, high interest rate, second mortgage.
These folks have borrowed all of the worth in their homes, many in the hopes that these houses will continue on their torrid pace of growth in worth. Sixty percent of these new loans are either interest only or option ARMs. In this market, the traditional thirty-year mortgage is the dinosaur.
5 - This so-called housing bubble has spread to 38 states. In these locals, those prices are on a tear having increased year over year by almost 7%. This, if you have not yet made the correlation is outpacing personal income, which has been flat over the same period of time. Housing has added $5 trillion dollars of wealth to the population, much of which should not be repayable with current income levels.
6 - The incomes that are making house payments are now devoting over a third of those wages to house payments. While only a third of the nation is doing so, the real trouble is in the 15% who are devoting half of the their income to paying the bill for those homes.
This increases the cost of debt service, the little recognized cost of borrowing. As the affordability of homes has plummeted in relation to the rise in prices, the cost of borrowing to get into these homes is fast approaching 15% of income outlays - a fancy way of saying that for each dollar spent on housing, 15 cents is going towards paying for the money.
Even in a low interest rate environment, the cost of debt service increases against every dollar earned no matter what the interest rate on the loan happens to be. Loans are being written to pay these fees before any is applied to the principal and this is what increases that percentage.
7 - In some markets, new housing starts and permits may be finally outpacing the need for new homes. It is generally assumed that the average need for new homes year over year numbers around a million and a half. The number of new housing starts, now at 2 million, means that there are more homes than buyers in many markets and this could, if economics suggests, put a damper on house prices because supply is now outstripping supply. Or worse, speculative buyers are purchasing a half a million homes they have no intention of occupying. This problem is evidenced in the new anti-flipping rules added to so many new home purchases of late. Speculators generally buy homes and sell them before they are built in the hopes of turning a profit in these over-heated markets. Remove the speculator and supply of available homes will increase and the result of that is lower housing prices.
8 - Despite some mortgage pressure to stop "flipping", a method of speculative buying and then selling, often on contract, 23% of the purchases over the past year were made with no intention of owner occupancy. This has put pressure on both the lender and the consumer. For the lender, these quick-to-turn homes present investment problems. For one, banks sell these mortgages in baskets as long-term securities to investors who keep money in the pipeline for new loans. With the quick turnaround that is happening with these "investor" buyers, banks are unable to garner the cash they need to keep lending.
The borrowers aren't complaining. They are just attempting to tighten a loose end in the profit chain. They have lobbied hard in Congress to penalize these speculators with hard taxes of up to 45% on the capital gains from these types of investments.
As a side note, over ten percent of these new homes were bought and paid for with the profits from the sale of a first home or from the significant equity available. So with almost forty percent of these new homes, which by the way has set another record with the release of this week's sales numbers, being bought buy speculative and second home buyers, the builders are complaining - all the way to the bank - that the real bubble is simply a supply and demand issue. The demand, they say to their shareholders as they turn in street-beating profits quarter after quarter is outstripping the available lots and this the builders claim, is why prices are so high.
Perhaps, but accommodative money plays a big role and as long as the money stays cheap and the banks are willing to take a slightly riskier stance with their lending, home builders will be eyeing every possible square inch on which to erect another profit center.
9 - Over-the-top bullishness, and I love a good upswing as much as the next guy, has gone as far as it is likely to go. The University of Michigan Consumer Confidence survey asked a simple question, and I'm paraphrasing: Do you think that it is a good time to buy a house? Almost half said that they thought it was but the reason was not because of the need to upgrade, the ability to buy more house for their dollar, or because they thought that owning part of the American dream is worth saving for but because they saw it as a worthwhile investment.
The alignment of a large portion of jobs to a market that may have run its course, loans to household incomes that are stretched by historical standards, and the possibility that much of the heat is being applied by a group of buyers whose whim could change very quickly should make even the most bullish of us just a little wary. That is, unless you think markets like these go on forever. |
