johnnymk

Seventy-one U.S. cities have homes that are extremely overvalued, says a group of economists.

The study, reported in USA Today, reveals that 39 percent of all single-family homes are priced "far higher than justified." Homes fall into the extremely overvalued category when they are priced 34 percent higher than the "statistically normal" home price for that city.

The group of economists from National City Corp. and consulting firm Global Insight looked at prices of single-family homes in 317 metro areas in the first quarter of 2006, taking into consideration income, employment, and other variables to determine the statistically normal home price.

Not surprisingly, the most overvalued cities were in Florida and California. Overall, says the study, 17 out of 20 of the most overvalued markets are in California and Florida. MoneyNews reported a similar study weeks ago that came to the same conclusion.

Naples, FL, Salinas, CA, and Port St. Lucie-Fort Pierce, FL were the three most overvalued markets, says USA Today. The study shows that the median price of a home in Naples is $383,000 - 102.6 percent overvalued.

In comparison, the most undervalued cities in the U.S. are College Station, Dallas and Fort Worth, TX. In College Station, the median price is $94,000, or 24 percent undervalued.

In 2004, says the study, just three markets were overvalued - that's just 1 percent of the nation's single-family homes.

Jenny

Linky?

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Cubsfan

http://www.usatoday.com/money/econom...ces-usat_x.htm

Looks like my city is overvalued by around 10%.

brainsmile

well it's really dependent on the model you make to judge value... not that I disagree but you'll find differing opinions everywhere.

Texas is cheap though

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Kevster

We're looking to sell our home in a couple weeks after getting it ready (new paint, some minor repairs, etc). From the current market analysis the prices have stabilized in our area (no more double-digit value increases, at least this year I think). Still, we're looking to sell our home at a nice appreciation since that is what the market will bear right now according to the latest sales statistics for our zip code.

Now for the new zip codes we're looking at in the Sacramento area, there's a correction that is on the verge of happening so we'll be renting for probably 6-12 months before jumping back into a home. I definitely don't want to buy a home there now only to see that home's value drop 10% or more.

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LegendKiller

Look Out Below
by John Rubino

The world is full of people with little or no real estate experience (okay, like me) who still claim to know the business well enough to predict a crash. It's also full of real estate industry pros who, deep in denial, seem to expect a soft landing followed by another long, glorious boom.

So when an actual real estate expert crosses over to the dark side, it's news.

This morning I'm reading through a 31-page report compiled for internal use by Colorado Santa Fe Real Estate, a company founded by a serial entrepreneur named Marcel Arsenault, one of the rising stars of the commercial real estate business.

Back in the late 1980s, Marcel was a hippy/entrepreneur in the Ben & Jerry mold who had spent the previous decade mixing up vats of Mountain High yogurt, eventually turning the brand into one of the most popular in the West and selling it Beatrice Foods for a nice profit. He then started buying up Colorado real estate. "I couldn't have picked a worse time," he says now. The junk bond implosion was metastasizing into the S&L collapse, and the value of office buildings and shopping malls was plunging.

But he held on, and in a couple of years was rewarded with the mother of all fire sales. The government began liquidating the assets it had acquired from failed thrifts, and prime properties were suddenly available for pennies on the dollar. Marcel loaded up on empty office buildings and leased them out for a fraction of the going rate -- possible because of the low purchase price. The buildings filled up, their values rose, and he leveraged their cash flow to buy more offices, shopping malls and condos. As western real estate values soared, so did Colorado Santa Fe's portfolio. It now manages upwards of $350 million of property and is sitting on well over $100 million of unrealized capital gains.

In other words, this is a guy who has prospered in both good and bad real estate markets, which makes his current take worth noting. And right now he's excited -- about the prospect of another 1990-style crash. Below are some excerpts from the previously mentioned report. The capitalized headings and italicized comments are mine, the rest is Marcel's. As your read this, keep in mind that it's the analysis of someone who for the past fifteen years has been very successfully LONG real estate.

THE BIG PICTURE

We believe that the apparent 'irrational exuberance' in the real estate market is, in reality, an asset bubble that has been inflated by a flood of capital attracted to real estate. The effect of this flood has been to drive down yields and push up prices. We believe this value trend is unsustainable and that we are at a crucial inflection point. Based on the analysis detailed below, we believe that cap rates will inevitably rise back to trend (and possibly overshoot), thus driving values down dramatically.

HOW WE GOT HERE

Phase I: Stimulus through Monetary Easing. Following the recession and 9-11, the U.S. Federal Reserve implemented monetary easing to a degree not seen in almost 50 years. Cheap money and credit flooded the U.S. economy in an effort to prevent a serious recession (which had the risk of turning deflationary like Japan's). The lax monetary policy had the intended effect of stimulating consumer spending (particularly on assets like homes and real estate).

Phase II: Illusion Becomes Reality. By 2003, prices of real estate began rising faster than the rate of inflation. In effect, investors began noticing how "profitable" it was to accumulate real assets. Rising prices created a "virtuous cycle" whereby more and more buyers participated in the equation of purchasing real estate. While admittedly rising prices were driving down yields, few cared about yield because the Fed was not rewarding saving. The preferred game was appreciation.

Phase III: Lenders "Pile In" (the final period of play). Given a few years of rising prices, real estate began looking very safe; low rates made the cost of debt very manageable, justifying higher prices and larger loans. By 2005 real estate lending was extraordinarily competitive, (after all, default rates were at historic lows). By 2006, cheap and easy mortgages had grown to epic proportions throughout the real estate industry. "No money down" became the way to purchase a home. Foreign and hedge fund capital poured into mortgage markets chasing yields of the "risky" tranches of mortgage paper (why settle for the 5% yield of "A tranche" if the risky "B tranche" yielded at 8-10%?) With rising property values, the "B tranches" were soon re-rated to "A", rewarding the buyers with phenomenal appreciation in their mortgage paper. Mortgages become more plentiful and the tide of easy money rises into uncharted territory, and bringing real estate values even closer to rocky shores hidden beneath a tidal flood.

Phase IV: Inflection Point Achieved (the cost of money rises). Satisfied that it had prevented a serious deflationary recession, by June 2004 the Federal Reserve begins to slowly increase rates. By 2006, the Fed Rate had increased from 1% to 4.5% (the "neutral rate" - not deemed excessively simulative by economists). With yields this high, it again makes sense to hold cash at the bank. By 2006, the cost of mortgage debt is returning to the long term average.

THE NEXT FEW YEARS

Phase V: - The Future: Look Out Below. The problem becomes obvious and virulent when real estate values begin to fall. With debt service costs rising, real estate begins to flounder, and more risky real estate ends up on the rocks. As default rates rise, mortgages slowly become more expensive and difficult to obtain ("real estate becomes a four letter word" in the parlance of an old banker). Only brave and knowledgeable entrepreneurs venture onto the scene of real estate wreckage at the lowest tide. Only a "foolhardy lender" would venture between the rocks of the now quiet ebb tide.

The "virtuous cycle" has completed its turn into the "vicious cycle."

HOUSING AND CONSUMER SPENDING

It is our view that the "irrational exuberance" has transferred from stocks to housing, setting up conditions for a "housing deflation." We expect a serious fall-off of home construction, sales and values, starting in 2006, and becoming very pronounced by 2007. A glut of new houses will accumulate in the next 12-24 months, causing a drop in price and construction of new units, and setting up a serious risk of price decline (similar to the "tech wreck" in the stock market).



With the costs of debt service so low, buyers have been able to pay ever higher prices while maintaining low monthly mortgage payments. In a "virtuous cycle," this has helped continue to push up housing demand beyond supply for several years (2002 through 2005). As a result, prices surged higher, and contributed to a pervasive "wealth effect." Booming housing prices (and sales) have created a boom in allied industries, including mortgage brokerage, retail sales for furniture, appliances and home improvements, magnifying the boom throughout the economy. This spending, in turn, has put off any serious recession. More importantly, the cocktail of low interest rates and rising home values has dramatically stimulated retail consumer spending. However, with interest rates now rising, households are left with an almost unprecedented negative savings rate, and dangerously high debt levels and debt service costs. The economy hinges on housing.

Implication: Based on the speculative excess we have observed, we believe this housing boom will almost certainly be followed by a long and painful housing bust. We expect that a continued rise in interest rate spreads and decline in housing sales and prices will push the U.S. in recession by late 2006, and this recession will deepen in 2007, as the housing "wealth effect" turns into a "poverty effect." As defaults accelerate, lenders' underwriting will tighten significantly, leading to a precipitous drop in new home sales.

Builders have slowly accumulated large positions in land (2-5 years of inventory), and will be anxious to turn land into cash (even at a loss). Earnings for the home builder industry will go negative, along with earnings in many allied industries (mortgage brokers, title companies, lenders, construction companies, etc.) This housing downturn will ripple through the economy, creating a loss of 2-4 million jobs (10-20% of the employment in construction and housing-related industries).

On the heels of the housing downturn will come a downturn in consumer spending, particularly in housing-related retail sectors (home improvement items, furniture and appliances, etc.). This will happen because variable mortgage rates are rising, fuel costs stay high, and the "wealth effect" of the last 10 years quickly turns into a "poverty effect," forcing the personal savings rate quickly back up to at least the U.S. long term trend of 7.1%. With stocks and housing giving back the "asset bubble" appreciation, the consumer has no choice but to resort to savings (as they have in the past and as they do in all other countries once the "asset bubble" turns into an "asset bust").

As savings returns to trendline, our projections show a drop of 3.7% in consumer spending by the end of 2007 in real dollars. The US economy will, along with the drop in residential investment, shrink real GDP by 3.1% (a fairly serious recession). With housing and consumer spending both going down, business investment spending may also contract, causing declines in the stock market, possibly driving the economy deeper into recession (until the imbalances are corrected). The resulting recession will be longer and deeper than most, likely lasting 3 years.

The rising federal deficit, economic recession, lower interest rates, and declines in real estate will all lead to substantial downward pressure on the US dollar. Falling U.S interest rates will chase out investors, weakening relative demand for the dollar. If the economy experiences an asset deflation recession, the dollar could sink for a period of 3-5 years, reaching new lows year after year.

COLORADO SANTA FE'S ACTION PLAN

There is virtually no upside left, and instead, tremendous downside risk. There will be a significant "flight to quality" by lenders and investors. The risk of remaining heavily invested in real estate is extremely high. Values are far more likely to fall precipitously than to rise modestly. Most real estate should therefore be sold and the extraordinary profits harvested. If our projections are wrong, we have avoided risk and locked in small returns from holding cash. If our projections are correct, we will need cash in 2007 and 2008 for the considerable buying opportunities that may be available at the bottom of the cycle.

2006 and 2007: Sell most existing properties:
• Quickly liquidate condo conversions ($75 million)
• Liquidate most retail and industrial properties ($200 million)
• Short stocks of retail REITs, homebuilders, real estate companies, mortgage insurance companies, and suppliers (construction, copper).

2008-2010: Return to Real Estate (at Cycle Bottom):
• Raise equity pool of $250 million and buy distressed property on a massive scale ($1 billion).

Now here's what makes this really interesting: Instead of just taking some well-earned profits, Colorado Santa Fe is both lightening up and going short. In effect, it's morphing from a real estate developer (which buys and operates, always on the long side), into a hedge fund, capable of going both long and short with outside investors' money. That's a very big change in mindset, hard to pull off but exactly the right approach for what's coming. "I'm an adept buyer," says Marcel. "Now it's time to become an adept seller."



Looking for the link. This is pretty much my outlook on things.

johnnymk

LK...very good article/

To add insult to injury. I was thinking the other day about the cost of gasoline and heating fuel. I calculated that a household with an average size home and two cars will probably spend an additional $2K per year, compared to a couple of years ago. This translates into about $2.7K before taxes, or $50 per week.

That's not chump change. Disposable income has to be dropping dramatically.

LegendKiller

Yeah, this is a huge worry of mine. With disposable being squeezed, ARMS and IO's unlocking, and the potential for a mass job-loss stream from the housing and related sectors, we could be entering into one of the largest downturns since 29. If things were to go on a worst case scenario basis, we could be looking at a massive credit crisis. Now, I doubt that it will, but it's still not going to be easy.

Cnn/Money has a research paper from Havard guys, aided by realtors, mortgage brokers, construction, durable goods, and furniture companies, saying that there will be an extended flat period, but no presence of a large downturn. I think this article, while having some kernels of truth, needs to be BS filtered for the obvious bias. It's in those industry's best interest to keep people consuming. Believing it full-on is like leaving the henhouse to the wolves.

I just caution people to not buy out of fear that prices will keep going up and if they can wait a while, they should. I liken the current market to the top of a roller coaster. You know you are going up, you are slowing down, and that plunge can't be seen, but you know it's there. Just how big it will be is a mystery, since all you are looking at is sky.

The stupid thing to do would be to think you will keep going up forever. Even worse would be to think that you will stay at that height. Eventually you gotta come down.

gwilks98

LK, I may have misunderstood, but doesn't that article pretty much explain the commercial real estate 4 quadrant model?

Check out slide 13 of this link: (sorry, I couldn't find anything better than a powerpoint presentation)

http://ocw.mit.edu/NR/rdonlyres/Urba...431_GMch02.pdf

In my past research, I've found this model to be very true at predicting booms and busts in commercial real estate, but not residential.
While I agree, I think the bubble phenomena will stop this year, I don't think you will see a huge bust like this chicken little author suggests.
Prices in residential real estate are set by people who simply can't afford to take a loss on their house. I've been very scared by the number of people who went for no money down or ARM mortgages over the past 5 years. But for those with fixed mortgages (like me), I don't have to sweat a market downturn until I go to sell my house. If I don't like the market price, I just hang on to my house until it appreciates back up in value. (and it will as population rises and land becomes more scarce.)

Houses aren't like stocks, and people don't treat them like the same types of investments as a company would treat commercial real estate. If I don't like what someone is going to offer me for my house, I don't sell. (Unless I ABSOLUTELY have to.)


What I think is going to happen is simple, but alternate to what the author suggests.
1. millions of people with adjustable or overextended mortgages will lose their houses as inflation and fed rates rise. This leads to an abundance of houses for sale
2. Big corporations see an opportunity and buy up the houses for "below market value."
3. Big corporations rent out those same houses for a return on their investement.
4. When the cycle corrects itself and prices rise again, they sell off the land for profit. (At the same time, rent prices are dropping because of the abundance of rental property out there.)

Construction of new houses will still have to happen, it will just adjust to the type of houses the market can bear. We'll stop seeing people building $500,000 houses 50 miles away from cities. We'll start seeing houses being built on half the plot, for half the size, for half the prices. Areas with low population density will suffer a decline in pricing. Areas with high population density with no cheap alternative will retain the most value, as the alternative for that land is to buy a few plots and plant a midrise condo in its place.

People gotta live somewhere.

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LegendKiller

I am going to have to think about this for a while, perhaps respond in depth tonight.

Initially, I would agree that prices are set by people who can't take the risk of losing value on their house. However, just because they *can't* take the risk, doesn't mean they *don't* take the risk. People couldn't take the risk of Enron-centric 401k, or .bomb 401k concentrations, but they did. Many who are near retirement can't take risk, but they do.

This comes to the hubris of many investors, they misjudge their ability to judge risk. Many people get blinded by the rush to get in that they don't take a second to look at the fundamentals that should support their decision.

I have always said that long-term people looking for a house, not as an investment, but as a place to live, will do just fine through this boom-bust cycle. However, those who looked at it even more than 50% as investment, will get burned, horribly. I have told people repeatedly that if you plan to sell in anything less than 5-10 years, then you better not buy, because it's going to take that long to outlast this cycle and finally get back to intrinsic values.

I see stories from Countrywide, Fannie Mae, Freddie Mac, mortgage brokers, Alt-A and B/C issuers, everybody showing that ARM's are huge, IO are huge, No/low doc mortgages are huge. Alt-A lenders are saying more than a *trillion* dollars of mortgages are going to unlock in the next two years.

A trillion f'in dollars!!!!

That means that we will go into a downturn in the economy, where interest rates are high, and more than 3 *MILLION* homes will unlock. Where are people going to get the money to pay for that? What about IO, where the Prin kicks in?

All of those people, who looked at houses as an investment, especially at the peak, are going to be foreclosing or looking to get out, any way they can. Include in those people companies who took significant bets in MDUs and large developments that are now left with massive inventories. They will be looking for a way out.

As I said before, in the WCS, you are looking at a *HUGE* decrease if this thing snowballs. I am not talking 10% general, I am talking 20-30% general and in some cases 50% local, depending on where fundamentals are.

Again, the longs, who bought to live, will be fine. They can ride it out. However, anybody who used an exotic mortgage to "stretch" into a "dream home" or an investment, or a 2nd home, are going to be hurting, badly.

I fear this thing will snowball, if it does, the entire credit market could fall. If you think of all of the secondary and tertiary effects of credit, how it has been bought and sold in ABS/MBS and the CDO's, you are seeing that, unlike before, capital has been flowing freely and investors are plentiful. If those securitized borrowings or sales start to unwind, you are going to see huge effects. Losses will skyrocket, IO strips will be revalued, and corporate profits will plunge, further eroding the base of those who can afford houses.


Chicken little? I fricking hope so!

zippyjuan

Interest rates are rising, but not dramatically. Gas prices have stablized at a not that high level and even dropped back. While lots of recent mortgages were done at interest only or adjustable, many have converted to fixed and as a percent of all mortages are still a very small number so while defaults may start to rise, I do not expect anything dramatic as far as falling prices of real estate. As qwilks98 cites, if people do not get what they want for their house, they do not usually just sell it for whatever they can get- unless they have to move like say for a job relocation or a financial tragedy- they instead take the house off the market and continue to live in it. It is not like stocks which can be dumped easily at a moments notice. Things are leveling out in many markets and some will see a pull back in prices, but I do not think prices will drop significantly without some other major economic shock. A 50% drop in some areas will only take prices back to what they were just a few years ago.

Lenders will take a bigger hit since they have been making their money writing up new loans. The rate of financing and refinancing will drop more than the price of houses.

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Daedalus

The last RE bust of the early 90s was full of people who didn't want to sell. In fact, many of them didn't actually sell; they simply walked away from homes that were worth less than their remaining mortgages, unable to make the payments. A recession then caused enough pain for enough people; is the idea of another recession in the near future so hard to accept? I was too young to be a owner back then, but old enough to be interested in the news articles of the time. IIRC some areas saw drops of nearly 40%. By most measures--e.g. affordability index, trend deviation, rent comparisons, etc.--today's market is more overvalued than it was 15 years ago. There is 4 times as much inventory now in the US than at the previous peak, and it is growing at a furious pace.
I don't discount the amount of patient money that is poised to cushion a fall, waiting for small drops in prices. I also don't underestimate the buyers who chose variable rate loans; I think most know the risks and have contingency plans. A lot of the refi volume today is by people moving from variable loans to fixed. But only a few things need to go wrong for the snowball effect that LK mentioned to occur. I do think a lot of families absolutely need dual incomes to afford their homes, and a recession would make some of them sweat. If you spend a reasonable 30% of a dual income on a mortgage, and that income is cut in half, I think it's unlikely the average family could keep the home and still pay all the bills. No one ever buys a home expecting to lose money on it, but some do, and cycles occur. There is enough evidence to support the possibility, if not the ouright likelihood, of a RE bust that to staunchly assert otherwise is just hoping.

LegendKiller

Personally, I think you are understating what an unlocking ARM can do. If we assumed it was capped at 2%, a payment could easily go up $300/mo, or about 1/6 on a 300k 5.5-7.5%. That's *IF* you're capped at 2% and you took out 300k. The geometrical effect of a higher cap and a larger amount could spell disaster for many families.

I also think a lot of people have discounted those who took out B/C mortgages with low FICO, no doc, or IO, or a combination of all 3. These people aren't in the best situation, they probably aren't all that financially sophisticated *AND* most likely have higher-risk jobs and are dual earners with families.

From my contacts in the mortgage industry, there is a frightening number of these people in the market and their paper is floating, with mortgage brokers holding higher %'s and then trying to do whole-loan sales or even junk MBS bonds. Or non-junk but heavily enhanced or subordinated senior bonds.

Even the DINKs out there don't have much to stand on. I have seen too many of them stretch into something higher. They also go to less desirable, but no less inflated markets to further stretch.

If gas prices continue to go up, and they will in the long-term, you might start seeing a sprawl pull-back, creating even more vacuum for them.

Add into the fact that northern states are going to feel the bite of boomers leaving, especially ones who live in the burbs and sub-sub-burbes (boonie edges), you will see even further pullback.

I think this market, as a whole, is a whole lot more overpriced than many people appreciate. Places in the US are 100% over valued, like Naples FL, imagine if boomers started taking a bath there, how much potential consumption and gifting income got whiped out and the economic effects.

As I have stated many times, Shiller's 2nd edition of Irrational Exuberance has an awesome housing index that shows that housing, from 1890 to 1995 went up 20% (100-120), adjusted for inflation, but has gone up 41% (120-170), in the last 9 years, adjusted for inflation. 2x the growth in 10th the time! That is nation wide and *WAY* outstrips costs of purchasing, building, or financing.

There are no fundamentals that can justify that type of increase. Furthermore, mean regression will happen, one way or another. If housing prices stay level, or even if real prices erode due to inflation, it will stay level for a *LONG* time.

I just don't think people appreciate what can potentially happen here. If the right trigger happens, say another major terrorist attack, a major economic event, or a major natural disaster worse than Katrina, we could be looking at a horrible situation

gwilks98

I can think of one: The giant hold over the industry that real estate agents have. Many feel that the system in place allows them the advantage of price setting.

Many agents will look in the surrounding area for other similar houses before pricing one ready to go on the market.
They make money when the house is bought and sold. The commissions are almost always a set rate, with no bargaining power built into them. It's to the agents' advantages to make sure the sale price remains high. While the individual agents may not think of their effect overall macro system, their giant corporate entities sure do (CBG, Century 21.)

What I'm getting at is that you are treating this industry as if it's an open market. I don't think that's the case when the majority of the pricing is done by the same grouping of people.

That being said, if you agree with it, there is no way that the housing market can follow the principles of an economy of scale.


Excellent point. I can only pray that the law stating you can access your credit report for free will help bump the average intellegence on it before it's too late.



Thinking about my points earlier, I may be able to ellaborate more:

I believe the bubble is there, and that it was caused by the cheaper cost of debt and mass marketing of the cheap mortgage.

I believe that there are WAY too many people over their head in ARMS and no-equity mortgages. There are way too many people that spend too much of their income on their mortgage.

As people get forced from their homes due to rising rates and inflation, we'll see a fluctation in the rent market as the demand rapidly grows. However, you'll also see people that bought enormous mansions out in the sticks that can no longer afford them or the gas to commute to work. These people will be forced to downgrade to a smaller and closer house, keeping the lower end of the market adequately saturated.

The realtors will find a way to keep themselves employed. If the housing market tanks, so do they. I have a certain amount of faith that they will not allow price points to go below a certain level in specific areas.

I see this as an opportunity for the rich to get richer and the poor to get poorer. I can see big commercial real estate owners waiting for the right time to buy up property. A foreclosure here...a house that doesn't sell there. Those with the money will pay cash for the property at a discount and then build cramped living so they can fit more money into a smaller space. Those without money will find cheaper house/condo or find themselves renting from those that had the foresight to buy after the bust instead of the boom.

Sorry, I think Benjamin Graham was using my keyboard again.

zippyjuan

It is more the lenders than the real estate agents that caused the prices to go up so high. A person looking at a house usually asks one price in their purchase decision- how much is this going to cost me every month? The total price is not really comprehensible. The lowest interest rates in decades and creative financing allowed people to afford higher prices by not significantly increasing their payments so they were willing to go along. And yes there are a lot of people who will probably get burned when rates do adjust up. My point is that they are not a large portion of the total housing stock, just a large portion of recent financings over the last few years. To get say Southern California back to the trend that housing prices have been on in the last 100 years would require some areas to drop their prices by 65% or more- just figuring about tripling which has been seen around here. That is a major, huge drop. People owning a house would not sell for 1/3 of what they paid for it. They would take it off the market. This is why, again without a major econimic event, I think prices will drop a bit and then level off for quite a while. The lenders will be taking the biggest bite when things slow down.

LegendKiller

I am still thinking about a large part of the above points.

To address a few smaller ones...


1. Blaming the financial markets for investor stupidity is like blaming Ferarri for making the Enzo in which people break the speed limit, crack the car up, or die. Yes, the financial, housing, and car markets and manufacturer give people the *ability* to go fast and invest more, but it doesn't violate people's free will to do so.

I think the primary difference is the primordial fear of actually dying, which inhibits stupidity in a vehicle, usually. However, the fear of losing money isn't quite as balanced, as people are way too confident in their ability to pick winners and avoid losers. They do not correctly weigh the downside, because they are largely ignorant of it, or because they think they can do better than everybody else.

They incorrectly balance their willingness, ability, and overall risk and return assessment. This is so much more difficult than balancing speed = death. It requires ironclad discipline and knowledge of the tradeoff, something many people do not think enough about, or educate themselves on well enough.

Now, that isn't to say that the financial markets are blameless. Part of my appeal towards the CFA was it's stronger ethical drive. My b-school ethics class focused on corporate/social ethics and not on personal/psychological/moral ethics (whether to take advantage of slave labor as opposed to violating investor/client trust). While it's up to the individual or investment advisor (mortgage broker, realtor...etc) to make their own ethical judgements, there also needs to be a structure ready to kick them in the teeth if they fail.

Too many companies, in their zeal to drive higher profits, forget that real people are on the end of that interest only, no doc, low fico, 70% income mortgage. They *should* turn them away, but the appeal of a sub-prime interest rate and whole-loan sale is too great.

Which is where Securitization has revolutionized the business. To be able to shove that bundle of mortgages to somebody else and write off the consequences are huge. The whole process has driven spreads to new lows and increased the debt capacity tremendously. Before, banks and companies were limited in the amount of capital they could raise and use by Regulatory cap ratios, Fed ratios, or simple investor equity and debt economic limits.

Securitization changed that, by transferring absolute risk through true-sale, it allowed companies to churn and burn through paper like never before. This also has lead to massive profits in FAS 140 sale-accounting, giving companies windfall profits when valuing the IO strip, recognizing the gain on sale.

However, the risk is that, if the credit markets turn down, then the whole ball of wax starts to burn. The peels of the onion fall off and the core gets exposed. This can happen pretty quickly and precipitously.

I don't blame the financial companies wholly, nor do I totally blame the capital markets for supporting such foolishness, but I don't blame borrowers in total either. The whole thing is a symphony of stupidity, greed, and fear.

The big question remains, if the downturn happens, if the house of cards starts to fall, how bad will it get?

The really scary question is, how much garbage is *really* out there? We know that 1Tril in arms are unlocking in 2 years, we know that there are now 50-year mortgages being used in CA, we know that many people have far exceeded 50% pmt/income, and we also know that many people have taken a lot of IO loans. But we don't know what % of the aggregate issuance that has been.

Why? Because securitization has masked a lot of it. Selling and then shoving off balance sheet has hidden the true effects.



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I agree that people won't *WANT* to take a 60% hit, but will they have a choice?

gwilks98

Something I didn't really think about: My perspective on the real estate situation is severely limited to the saint louis area. I really can't speak much for the trends people were following in CA, FL, AZ and what not. (There weren't a whole lot of people jumping on 50 year mortgages around here.)

VTGreg

I think that the impacts of the housing bubble will vary greatly based on your location. I live in Charlotte, where according the USA today article, is 4.6% undervalued. Is Charlotte going to see precipitous drops in housing prices, probably not. However, your major metro areas, the San Fran, NY, DC's of the country and vast areas in FL and CA are going to be greatly affected.

__________________
It only ends once... Anything that happens before that is just progress.

Courage is not the absence of fear but rather the judgment that something else is more important than fear.

brainsmile

well for me I'm hoping to have a sizeable amount of cash available to purchase some of these homes when the market finally returns to an upward trend. In the meantime I just have to keep paying the payments and being happy I guess.