FedUpUSA

Archive for the ‘Housing Bubble’ Category

Buying a Home in America today is Expensive Thanks to the Banking Sector: Examining Income and Home Prices from 1950 to the Present. Can Home Prices Fall Another 38 Percent?

A question rarely asked regarding the housing market today is whether prices are affordable.  There seems to be this implicit belief that because prices have fallen so drastically that they somehow must reflect a bargain.  This is not necessarily true.  I think in our consumerist society people are conditioned to automatically assume that a lower price somehow means a good deal.  Go to any mall after the Christmas shopping season and you’ll see “amazing” bargains for 50, 60, or even 70 percent off.  But is it really a bargain?  This question is not often asked yet this is the central tenet to the housing bubble that got many Americans into trouble.

In order to understand the housing market, we need to look at the income of the average American.  Yet this is something that is usually removed from the equation when discussing housing policy.  How do Americans pay for their mortgage?  From an ever scarcer W-2 job yet Wall Street and policy makers have somehow consciously avoided focusing on this connection because headline unemployment is at 10 percent.  But let us look at the relation of income to home prices over the decades:

Source:  Visual Economics

Now this is a critically important chart.  At the height of the bubble it took 473 percent of the median household income to purchase a median priced home.  Compare this to 297 percent in 1975.  The current number is 331 percent.  But let us run our own numbers based on Census data.  The median U.S. household income is $52,029 according to the 2008 Census (this number is lower for 2009 but data won’t be released until September of 2010).  The current median home price is $172,600.

Median Household income:       $52,029

Median U.S. home price:             $172,600

But is this affordable?  Not necessarily.  First, let us look at the home ownership rate in the U.S.

67.6 percent of U.S. households own their home.  The housing situation is very much a majority issue for average Americans.  This is where most Americans store their wealth.  51 million households have a mortgage while 23 million live in homes with no mortgage at all (approximately 30 percent).  Let us run the numbers for someone looking to buy a home today with a FHA backed loan since this only requires a 3.5 percent down payment.  Here are the numbers:

We’ll go ahead and use Texas since there is no state income tax there and it will give a better overall net income to the median income household.  After taxes, the family is taking home roughly $3,570 per month.  How much money down is need for a FHA backed loan?  3.5 percent and let us use the $172,600 median home price:

Down payment:                               $6,041

Now if we run the numbers, things look okay here:

$982.60 / $3,570= 27.5% Debt to Income (DTI)

Many bankers will even go with gross income so you will have a better ratio.  However, taxes and insurance are other costs associated with owning a home.  In Texas, these run anywhere from 2.5 to 3 percent.  Let us add that in as well:

PI ($982.6) + TI ($431.5) = $1,414

Now, your housing payment is eating up nearly 40 percent of your income:

$1,414 / $3,570 = 39.6%

What about repairs?  Landscaping?  Garbage pickup?  These are all other items associated with owning a home.  Keep in mind we are using the median priced home in our example and not some extravagant home.  This is what the average American is facing.

Even going back to 1975, prices would still need to fall to meet that price to income percentage:

$50,029 x 2.97 = $148,586

The median home price would need to fall an additional 13.9 percent to go back to 1975 affordability levels.  I’ve seen a few articles mention home prices falling an additional 10 to 15 percent and this seems to fall in line with the above.  Keep in mind this is important because buying a home is now based on income and monthly fixed outlays.  The maximum leverage products like option ARMs are now a thing of the past.  You now have to demonstrate via reportable income that you can afford a home.  With unemployment so high this becomes a challenge.

I always find it fascinating that most charts looking at home prices seem only to go back to the 1970s.  This is when the U.S. Treasury and Federal Reserve disconnected the dollar from any connection to the gold standard.  But let us look at two other periods of relative good economic times, 1950 and 1960:

1950

Median household income:        $3,319

Median home price:                       $7,354

Home price / income = Percent of 221

1960

Median household income:        $5,620

Median home price:                       $11,900

Home price / income = 211 percent

Now this is interesting data.  If we use the 1960 ratio home prices today would need to be:

$50,029 x 2.11 = $105,561

A 38.8 percent drop from current levels.  The above chart from 1975 to the current housing peak in the late 2000s shows housing prices going up for nearly 30 years.  Many average Americans simply assumed this was the normal trajectory of home prices.

But the 1950 to 1960 example shows that after one decade, relative to income, home prices in 1960 were actually cheaper than they were in 1950.  In 1960 the median home price cost about twice the median annual household income.  Some can’t even imagine this number and think this would be ruinous for the economy.  Nonsense from the banking industry.  In fact, the 1950s saw some of the best GDP growth:

Now many would argue that the rise of the two income household has pushed home prices up.  But you can easily argue that it now takes two incomes merely to have what those in the 1950s and 1960s had.  Of course this comes from the insidious ability of the U.S. Treasury and Federal Reserve to siphon off the earning power of average Americans and give massive handouts to the banking industry.  And that is exactly what occurs.  Look back up at the mortgage calculation chart.  Aside from the monthly payment, notice something else?  The “cost” of that cheap 5.85 percent mortgage is going to run you $187,176 after 30 years.  In other words, the interest you pay is more than the actual home price.  Now if banks are borrowing near zero from the Fed why not allow average Americans to borrow directly from the Fed since virtually every mortgage is now guaranteed by the taxpayers?  Because interest and fees, unproductive aspects of our economy are being taken from the banking industry and suffocating the balance sheet of average Americans.

Home prices have gotten more expensive because the crony banking system is hungry for more and more profits.  If banks had to lend their own money, home prices would automatically adjust lower.  Is that necessarily bad?  This would provide more mobility and less of a focus on homes as commodities and more as a place of shelter.  Take for example the current bust.  Say someone in struggling Detroit finds a job in New York but can’t sell his home.  Say that new job utilizes their skills more effectively.  How is their inability to move helping the overall prosperity of our economy?  It isn’t.  Yet this is the position millions now find themselves in.

I would argue that homes are still very expensive yet the propaganda is flying from the banking industry because they want people to buy homes even though they can’t afford them.  Ironically cheaper home prices would help our economy in the long term but this would cut into additional banking profits since they currently hold over priced real estate, both residential and commercial, and want to off load the waste at peak prices to the taxpayer.  The corporatocracy has caused more and more damage to our economy and inflating home prices has been one of the outcomes of giving too much power to the financial sector.

In the 1950s and 1960s when our economy was relatively healthy and booming home prices cost about twice the annual median income.  That number sounds about right even for today.  Yet the propaganda is strong and many simply want to believe that a big drop in prices means homes are now cheap.  Don’t believe it.

“HAFA” – Foreclosure Warning Dead Ahead!

Posted by Karl Denninger

Under the Radar – a bit – came this ditty at the end of November.  Coupled with the “unlimited” Fannie and Freddie “credit line”, this may presage a veritable collapse in house prices this coming spring and summer – along with a massive “dump” of inventory.

“HAMP”, the Treasury’s program to “prevent” foreclosures, did not originally appear to have a “stick.”  Well, here’s the stick folks – for those who cannot qualify for a modification, or who “blow it” while on a trial program and simply don’t get a permanent change servicers are in fact required to offer short sale or “deed in lieu” alternatives when they make sense.

Got that?  Servicers participating in HAMP must follow the guidelines set forth in this Supplemental Directive.

No choices here folks – if you’re part of HAMP, you are required to offer expedited and unified procedures for short sales and, optionally, “deed in lieu” programs.

This goes into effect in April, although servicers can start offering these programs earlier. 

Come the spring selling season you’re going to see the inventory of homes that were “HAMPd” and failed for whatever reason hit the market. 

This is not a trivial number of houses – there are close to 750,000 homes currently under trial modifications, and only a tiny number of them – something like 30,000 – have converted to permanent payment changes.

Thank Treasury for not telling you about this until the “selling season” had ended and we were in the middle of the winter months when sales are slow – and timing the “required start” date for April 1st, right into the maw of the spring selling season.

If you need to sell your house in the next year this is something you need to take into consideration.  A flood of nearly 3/4 of a million houses appear poised to hit the market as short sales and “deed in lieu” sales beginning in April.

In short it appears that Treasury has figured out that all these “extend and pretend” games are not converting delinquent loans into sustainable payments and ownership opportunities.  As such the stick has now made it’s appearance.  While this will promote the market clearing (a good thing) one wonders about:

• The propriety of “deciding” to extend an unlimited line of credit to Fannie and Freddie on Christmas Eve in the hope that the market “wouldn’t notice.”  Dennis Kucinich and a couple of other reps have made noise about Fannie and Freddie becoming the tools by which bad loans are dumped on the taxpayer in a back-door bailout of the banks.  Before you applaud Dennis make sure you look at his voting record on the bills that enabled the bailout of Fannie and Freddie – and made Treasury’s actions lawful – in the first place!
• The be really really quiet fashion in which Treasury has tried to play this one.  Remember that there are overlapping programs here, and the quiet nature of some, along with the trumpeting of others, appears to be designed to disadvantage consumers – that is, to SCREW YOU.  Specifically, the “first time” home buyers tax credit (and repeat credit) both require contracts to be signed by April 30th, 2010.  This program’s mandatory effect begins on April 1st, which means that with the ordinary process of approval and evaluation (set forth in the document linked above) that inventory will hit the market right about May 1st.  That $8,000 “credit” may be the most expensive $8,000 you have ever received compared to the deal you would obtain had you waited a couple of months and bought into the maw of the short sale and deed-in-lieu unload.  Thank Tim Geithner and President Obama for hiding their intentions in this regard until tens of thousands of Americans bought (and are still considering buying) grossly-overpriced houses when they were fully aware of their intent to force an unload at an actual market price just a few months later!

The short form is that Treasury has suddenly pulled the stick out of its pocket with regard to the HAMP program and as a consequence those who believe that “housing has stabilized” are very likely to get a truly epic surprise later this spring and into the summer months.

In addition, those who bought during the time period of the “home buyer tax credit” almost certainly, to an individual transaction, have gotten and will continue to be screwed, with the essence of the rip-off being the lack of disclosure of Treasury’s intent to force the market to clear. Indeed, Treasury has sent public signals for over two years that they have NO INTENTION of forcing market-clearing prices - EVER!

If “housing stability” is part of your investment thesis, whether it be in credit the equities, you need to check the premise upon which your thesis is based and adjust accordingly.

I applaud Treasury for what appears to be recognition of what I have advocated for more than two years: The housing market cannot be propped up at artificially-inflated prices and must be forced to clear by a return to fundamental values. 

However, I must object to how Treasury has gone about this.  Rather than being an advocate for the people of this nation Treasury has instead intentionally designed these programs and withheld critical information from the public with regard to their full intentions with the purpose and effect of inducing consumers to enter into transactions that are severely to their disadvantage – all to create yet another rip-off of the public for the benefit of the big banks.

A New Word to Describe Financial Folly

By Bill Bonner

12/23/09 Paris, France – What’s happening in the world of money is that the depression continues… You wouldn’t know it from reading the headlines or talking to economists. According to the official line, the US economy expanded 2.2% last quarter.

How is that possible? Well, here at The Daily Reckoning, we’ve invented a new word to describe it – ledgerdemain. Go ahead. Look it up. You won’t find it. But the word perfectly describes the practice of making things look like what they are not by using accounting tricks. Unemployment is over 10%…and apparently still rising. House prices are punky…probably anticipating an avalanche of new houses for sale, from the ‘hidden inventory’ of places that people would like to get rid of…if there were any buyers. And the typical consumer household is rediscovering thrift.

It’s too soon to know exactly what is going on…but we have a suspicion. The “growth” now being registered is a product of ledgerdemain, not genuine economic expansion. It is growth a la Japan…

Very long time Daily Reckoning sufferers may remember. In the early ’00s we wrote so often about Japan that readers got sick of hearing about it. They threatened to cancel their subscriptions if we didn’t stop talking about it.

In our view, the US economy was following Japan into a long, slow slump…with on-again, off-again deflation…and on-again, off-again growth.

We were wrong. Under the influence of unprecedented stimulus from the feds, the US economy did not go into a Japan-like slump; it went into a bubble.

But now the bubble has popped…and it appears that the US is finally entering the Japanese trap. And there’s nothing much the feds can do about it. Government spending keeps the GDP from collapsing. But it is phony GDP…government giveaways, boondoggles and payoffs to the financial industry.

“It is a depression,” we told a small group of Dear Readers in Paris on Friday night. “It has nothing in common with the typical post-war recession. And it won’t end until it has done its work.”

From The Daily Capitalist
December 3, 2009

Since the biggest financial collapse in world history was built on credit related to housing, it is pretty obvious that we should be paying very close attention to that market. The reasons are complex, but a recovery must be based on the liquidation of bad debt. The sooner that happens the quicker a recovery will happen.

When we mean “liquidation of debt” we are talking about a mountain of credit built on the housing bubble. This phony bubble wealth permeated the entire economy. When home owners saw the price of their home rising, they saw it as a source of capital to use for a variety of things, but let’s face it, most people spent it.

New stores opened, malls were built, financial institutions grew, cars and boats, second homes, vacations, and restaurants all flourished. Credit card debt mushroomed. Home mortgages were increased to pull cash out for spending. Yes, some of it went to good things, like our children’s education, helping our aged parents, and paying off bills. But the reality was that our debt kept growing.

The clever lads created even more phony wealth under the guise of insurance, but as we found out, companies like AIG really had no idea how large their obligations were for credit default swaps written against almost any financial risk. And these instruments were further leveraged without understanding the magnitude of these triple-counted obligations or their relationship to housing.

It all comes back to housing as the fuel for the 70% of our economy that was consumer spending. The thought was that housing has always gone up, and if it went down, it really never went down if you averaged growth since the post-WWII-period. A drop of 10%? Never has happened. 20%? Not even a 6th deviation possibility.

My thesis has been that this was all fueled by the Fed through monetary policies that created and supported the bubble. Aided and abetted by governmental policies and financing schemes that favored housing and risky loans. This was not a “free market” phenomenon. Far, far from it.

My thesis has also been that we can’t recover until all this bad debt is liquidated, and capital generated by savings is created and ultimately invested in profitable enterprises. It would be a mistake to rekindle the bubble. But, as we know, that’s what our government is trying to do. The government creates uncertainty as it flails around with programs, spending, and debt schemes to revive the economy. As a result mark-to-market accounting is thing of the past and banks are guarding their balance sheets, corporations are sitting on a lot of cash, cutting costs, and becoming leaner, and Mr. and Mrs. America still favor savings and debt instruments over equities and spending.

The big question: is the housing market bottoming out? Because once it does, debtors and debt holders will then have a handle on how great their losses are. When the bottom is falling out, it is difficult to get lenders to lend if they are afraid their remaining cash reserves will be needed to shore up the bank because of loan losses. The holders of subprime debt find it difficult to value their assets while housing values are still dropping.

Lenders have been shepherding their cash, reducing debt obligations, and cutting back lending and new investments because they do not know how deep their hole will be until housing bottoms out. Keynes called this a “liquidity trap.” More reasonable people, especially the Austrian school economists, call this a reasonable and necessary response to uncertainty.

The Fed and the federal government have been flogging this liquidity trap issue without let up and basically credit is still drying up. A 0.25% Fed Funds rate is basically a negative rate and they still can’t get banks to lend. The Fed’s balance sheet is at a record high. They have bought $850 million of mortgage backed securities. They are injecting cash into lenders. They have basically suspended mark-to-market accounting.

In Q3, the FDIC reported that bank lending still contracted by 3%:

Loans and leases held by U.S. commercial banks have declined for 10 straight months, falling to $6.7 trillion as of Oct. 28 from $7.2 trillion at the end of 2008, according to a separate statistical release from the Fed.

 

Commercial and industrial loans have dropped to $1.37 trillion from $1.6 trillion, commercial real-estate loans have declined to $1.66 trillion from $1.72 trillion, and consumer loans have fallen to $847 billion from $857 billion at the end of last year.

What do banks do? They have decided they would rather hold Treasury paper instead of make loans. This chart shows what’s been happening. No wonder T-rates have stayed so low despite massive deficit financing.

This is what makes Bernanke, Geithner, and Summers lose sleep at night. “It’s supposed to work, dammit!” Maybe this is why Summers is always falling asleep. No matter what they’ve tried, they can’t get banks to lend. I think they are very worried about this and while they say the economy is recovering nicely, they are crossing their fingers at the same time.

Back to housing.

I have been saying that I think the housing market is finding a bottom. I thought that low prices and rising affordability was the main driver of the housing market. If this were so, then housing prices would reflect real market valuations and this would finally bring about the liquidation of assets and debt wastefully invested during the prior artificial credit cycle. Lenders would know where they stood financially and would liquidate bad assets and rebuild their balance sheets. No more waiting around wondering what the Fed or the government would do to save housing.

I was wrong.

The housing market I now believe is being sustained almost entirely by the Fed and the federal government. This rekindling of the housing bubble is counterproductive and will hinder a real recovery of the economy because an artificially backed market will delay the necessary liquidation of the prior cycle’s malinvestment of capital.

Here is why I changed my mind:

First, 59% of new home buyers are relying on government-backed FHA, the Veterans Administration, and the Department of Agriculture loans. Most of these sales are driven by the first-time home buyers tax credit. The tax credit program has been extended through April, 2010.

Second, existing home sales are being driven by the tax credit and by foreclosure and short sales. Existing home sales are up 10.1%. Distressed sales — mainly foreclosures and short sales — accounted for 30% of transactions in the third quarter. And. according to the NAR, home sales are being driven by first time home buyers trying to make the previous November deadline.

This will have a negative impact on future sales. Like Cash for Clunkers, these government-driven sales may just be eating into sales that would have occurred in 2010. Many economists are referring to this phenomenon as “payback.”

Third, mortgage rates are now at 30 year lows. Another Fed related gift to home buyers. The average 30-year mortgage rate was 4.95% in October, down from 5.06% in September, according to Freddie Mac. Today, Freddie said the rate was down to 4.7%.

But … home prices are still falling. The S&P/Case-Shiller index of prices fell 8.9% for the July-through-September period from a year earlier. That was an improvement from the 14.7% drop in the second quarter and the 19% decline in the first three months of 2009. Median prices of existing homes fell in 123 of 153 metropolitan areas during the third quarter compared with a year earlier. The national median price was $177,900, down 11.2% from the third quarter of 2008. [Don't ask me to explain the disparity. Case-Shiller and NAR measure this differently.] Last month the median price for an existing home was $173,100, down 7.1% from $186,400 in October 2008.

Thus, despite record interference in the housing market by the government, home prices are still falling. There are several reasons why it is likely that home prices will continue to fall.

Almost 25% of home owners are upside down with their mortgages. Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic. This shadow market is huge:

Home prices have fallen so far that 5.3 million U.S. households are tied to mortgages that are at least 20% higher than their home’s value, the First American report said. More than 520,000 of these borrowers have received a notice of default, according to First American. …

 

But negative equity “is an outstanding risk hanging over the mortgage market,” said Mark Fleming, chief economist of First American Core Logic. “It lowers homeowners’ mobility because they can’t sell, even if they want to move to get a new job.” Borrowers who owe more than 120% of their home’s value, he said, were more likely to default.

 

Mortgage troubles are not limited to the unemployed. About 588,000 borrowers defaulted on mortgages last year even though they could afford to pay — more than double the number in 2007, according to a study by Experian and consulting firm Oliver Wyman. “The American consumer has had a long-held taboo against walking away from the home, and this crisis seems to be eroding that,” the study said.

This overhang will continue to drive prices down. There is no way the Feds can force lenders to modify enough loans to make a serious dent in this overhang. It’s imply too big. Eventually the losses from forced modifications will mount and the FHA or any other agency will not be able to pay off their guarantees to lender. Nor should they try.

Mark Zandi, who correctly predicted a crisis in the housing market, but not the Crash, said on Wednesday, “The housing crash is not over.” He said the lull in foreclosure sales for the past few months, due to the government’s pressure on lenders to modify loans, has resulting in higher prices. He expects Case-Shiller to bottom by Q3 2010 with an overall price decline of 38% (now at 32%).

“Foreclosure sales will increase, and home prices will resume their decline by early 2010 as mortgage servicers figure out who will not qualify for a modification,” he said.

 

Zandi said 7.5 million foreclosure sales will have taken place between 2006 and 2011. The majority of these sales, however, have not emerged yet, with 4.8 million foreclosure sales expected between 2009 and 2011.

What this means is that the housing supply, now down to a 7+ months supply, will rise again, and prices will continue to decline. We haven’t seen the bottom yet.