House of Cards

It looks like 2006 is destined to be the year in which the entire US real estate market collapses.

Is there anyway out of this dilemma. Not really. The more people who pull out now the faster the house of cards is going to fall.

But, Patrick Killelea at Axis of Logic does an excellent job of outlining exactly why the house of cards is finally collapsing.

Why? Prices disconnected from fundamentals. House prices are far beyond any historically known relationship to rents or salaries. Rents are less than half of mortgage payments. Salaries cannot cover mortgages except in the very short term, by using adjustable interest-only loans.

• Interest rates going back up. When rates go from 5% to 7%, that's a 40% increase in the amount of interest a buyer has to pay. House prices must drop proportionately to compensate. 82% of recent Bay Area loans are adjustable, not fixed . . .

• A flood of risky "home equity loans." An adjustable-interest home equity loan[s] . . . do not have defined limits on interest demands. When the interest rate adjusts upward, it can double monthly payments.

• Massive job loss. More than 300,000 jobs are gone from Bay Area since the dot-com bubble popped. This is the worst percentage job loss in the last 60 years. It's worse than Detroit car problems or Houston's oil bust. People without jobs do not buy houses and owners without jobs may lose the house they are in. Even the threat of losing a job inhibits house purchases. Santa Clara County posted its fourth straight year of job losses in 2005, so it's not over yet.

• Salary declines. "[S]alaries have in fact returned to 1997 and 1998 levels." Local incomes are not even half of what they need to be to sustain current house prices.

• Population loss. San Francisco continues to lose population at the fastest rate of any city in the US and most of those are professional jobs. The problem is not only the dot-com crash, but also the outsourcing technical jobs to India, which continues at a frantic pace as corporations realize they can pay an Indian only 20% of what they must pay a similarly qualified employee in the Bay Area. Fewer people in the Bay Area means less demand for housing. It recently (Aug 2005) cost $3623 to rent a UHaul from San Jose to the midwest, but only $1800 to move the other way. This is because far more people are moving out of the Bay Area than are moving in.

• Stock market crash. The NASDAQ at about 2000 is still only 40% of the 5000 it was at the peak of the recent stock market bubble. The crash in the NASDAQ probably hit the Bay Area harder than anywhere else because of all the stock held by employees of tech companies. That money would have been spent on housing, but is now gone.

• Extreme use of leverage. Leverage means using debt to amplify gain. Most people forget that losses get amplified as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss, he's bankrupt in the real world. Even a small price decline will bankrupt buyers with small equity. Buyers foolish enough to buy with no money down are already bankrupt, but still unaware of the fact.

• Shortage of first-time buyers. According to the California Association of Realtors, the percentage of Bay Area buyers who could afford a median-price house in the region plunged from 20 percent in July 2003 to 14 percent in July 2004. Strangely, the CAR then reported that affordability fell another 4 percent in 2005, yet claims affordability is still at 14%. [maybe because there are fewer people!]

• Surplus of speculators. Nationally, 25% of houses bought in 2005 were pure speculation, not houses to live in. [WOW!] It is now possible to buy a house with 103% financing. The extra 3% is to cover closing costs, so the buyer needs no money down. All this is on the unwise assumption that housing will rise ever higher, covering interest payments through appreciation. Even the National Association of House Builders admits that "Investor-driven price appreciation looms over some housing markets." [call it what it is, GAMBLER-driven price appreciation]
  

• Lightbulbs going on in many brains in the Bay Area: "Hey, I can just go to New Mexico or Oregon, buy a gorgeous house outright, and comfortably retire on the price difference. My neighbors just did it, so I'll have friends there too."

• Trouble at Fannie Mae and Freddie Mac. They are now being forced to tighten up sloppy lending. This means they are not going to keep buying very low-quality loans from banks, and the total money available for buying houses is falling. [of course, when fannie and freddie FAIL, tax payers PAY, and banks have gotten away scot free!]
  

Visit their site to read more about WHO disagrees with these rock solid assessments, what they have to gain from claiming the market is rosey, and why they are thoroughly WRONG.

Incidentally, this is what the author suggests that you do if you're a homeowner/speculator:

If you own, consider selling so can [sic] actually keep some of that funny money that appeared out of thin air. It would be a pity to watch it vaporize back into thin air. There is no real profit until you sell. [and leave someone else with the worthless purchase!]

If you want to buy, look around and see that house prices are falling. Why hurry to buy now? [watch the suckers bleed, and] Save your cash and buy for much less in the future. Find a nice cheap rental, sit back, and enjoy the show till then.

Too bad, it's more likely that, by this time next year, you'll need that barrel of cash just to pay for food and gasoline!