Posted: 15 Mar 2011 03:30 AM PDT
When a house was viewed purely as shelter, prices were generally stable. Once investment motives entered buyer's decision process, prices begin a wild ride resulting in a cycle of boom and bust.
Irvine Home Address ... 16 FOXHILL Irvine, CA 92604
Most people who bought houses during the 00s did so with dreams of riches. Those dreams materialized in laughter for some, tears and financial slaughter for others.
Property is widely seen as a safe asset. It is arguably the most dangerous of all, says Andrew Palmer
Mar 3rd 2011
The leverage in housing is great when prices go up, but when they go down.... Stocks are primarily investments held with discretionary income whereas houses are consumptive shelter -- a necessary expense of living. When stock prices crash, people may lose some money, but their loses are generally limited to their investment. Even in leveraged investing, a brokerage will liquidate before equity dips below zero. In housing their is no such stoploss. In a housing crash, people are wiped out and go bankrupt.
In other words, the money banks lost is money they didn't have.
We see a microcosm of this phenomenon here where fools deny a housing bubble ever happened.
The investors buying toxic loans were usually purchasing them through collateralized debt obligations blessed by ratings agencies with AAA status.
That is a fancy description of a banking Ponzi scheme.
The credit cycle of boom and bust is just as the author describes. Once you understand the cycle, it is easy to foresee problems like the credit crunch of 2007 -- the timing is always tough, but the inevitability is easy to see. It's a bit like inflation is today. We all know its coming, but nobody is quite sure when.
That's kool aid intoxication. What should be taken as a sign that prices are too high instead motivates more buying. Buy now or be priced out forever, right? Once that fear overcomes a market, the combination of greed and fear motivates some truly irrational buyer behavior. Remember when people used to write passionate letters to sellers to bestow them the honor of ownership?
I outlined a proposal to overhaul the appraisal system in the US to require cashflow valuations of properties in addition to the comparable value method. As the author notes, comparable value simply makes irrational behavior the standard of the market. it does nothing to curb the excesses or keep valuation in line with lender payment schedules. Markets trading at cashflow values don't crash. What price levels would they crash down to?
That is one of Dr. Shiller's more interesting analogies.
These guys are talking about NAr fear mongering. The belief that you need to buy the most house you can afford today because it may be unaffordable in the future is exactly how we got into this mess. Overextended borrowers are the root of housing's woes.
That one is pretty good, but I know a local real estate developer who bought a property for $10M in 1999, sold it for $100M in 2005, and was negotiating to repurchase the property -- with its $135M in improvements -- for $40M in 2010. I don't think he closed the deal, but it would be a remarkable short trade if it happens.
Short positions in real estate using futures contracts will likely never catch on. Who is going to buy a short futures contract to hedge any possible loss in their homes value? In reality, most people who buy believe house prices are going up, and if any such futures contract were widely traded, most people would take the long side and magnify their exposure to real estate rather than hedge it.
Even now, many in Irvine believe their house values never declined. People have a selection bias when it comes to comps for their own property. They will almost always conclude the asking price of a similar but nicer property represents the actual resale value of their own property. Comps that might inject a bit of reality are routinely ignored, and Pollyanna assessments of valuations and appreciation abound.
How do we explain that level of ignorance. How can people be underwater, facing the reality of what a poor investment housing can be, how can these people continue to remain in denial?
I suppose many refuse to admit their mistakes even when maintaining denial is barely tenable. Cashflow real estate can be a great investment. Betting on appreciation is a fool's game more likely to be a great disaster.
Typical California home owner
I was asked recently if I believed Irvine has more Ponzis than other places. Well, compared to poor rural areas, there are likely more Ponzis because more people are given opportunity to show their cosmopolitan sophistication by taking on copious amounts of debt. Plus, there are greater pressures to keep up with the Joneses in places like Irvine that is difficult for many to resist. But Irvine isn't out of control.
The Ponzis here are more flamboyant in their consumption because house prices went up so much, but I don't believe Irvine is Babylon. Although the huge HELOC abuse cases are more interesting, owners like today's are much more common. These owners increased their mortgage, likely in response to burgeoning credit card debt and funding their entitlements, but by and large, they kept their spending under control and didn't spend the house to the point they are in financial distress and facing foreclosure.
This behavior is so common that most don't even recognize is as a dangerous Ponzi scheme.
Look at it this way. In 1997 when this house was purchased, the aggregate DTI was very similar to Las Vegas. Houses were generally affordable, but not inexpensive by conventional cashflow measures. People in both places were paying a similar percentage of their incomes toward housing.
Fast forward to today, and prices in Las Vegas are hovering near their 1997 levels. Any amount of mortgage equity withdrawal -- even the tame Irvine version above -- would put a Las Vegas homeowner underwater. The housing bubble deflated their and is overshooting to the downside. Here in Irvine, the housing bubble has not deflated, and homeowners like today's stand to take a few hundred thousand with them on top of the $150K they already spent.
They should be very thankful banks are allowing their delinquent neighbors to squat in order to hold up housing values.
Irvine Home Address ... 16 FOXHILL Irvine, CA 92604
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