Irvine Housing Blog |  |
| Home equity lowest in seventy years Posted: 10 Jun 2011 03:30 AM PDT With the deflation of the housing bubble, home equity hit its lowest level in seventy years. It will fall further. Irvine Home Address ... 165 ROCKWOOD Irvine, CA 92614
The process of market capitulation requires the individual participants to realize their folly. Their pocketbooks are aching, and they ask themselves how long they should let it go on breaking, and finally they realize they were the fool. As prices fall in the wake of the housing bubble, whatever equity wasn't spent through rampant HELOC abuse is being washed away by falling prices. One data series that shocked me when I first saw it was the graph of home equity during the housing bubble. Everyone assumed home equity went orbital when house prices rose so far so fast. It would have except for one inconvenient truth: people were extracting that equity and spending it the moment it appeared. As a result, the expected huge increase in aggregate home equity from 2003 to 2006 never happened. Loan owners spent it all. Home equity sinks to nearly lowest point since World War IIJune 9, 2011 -- The Associated Press, Bloomberg News
It's called overshooting to the downside, and it is very difficult to predict because the reasons it occurs is part mechanical and part psychological. Mechanically, downside overshoot is caused by excess supply. With the millions of foreclosures lenders have already absorbed, and the millions more waiting in shadow inventory, housing markets everywhere have a huge supply problem. It has been masked over the last 3 years by withholding this inventory, but the problem didn't disappear, it's merely being held in abeyance to prevent a catastrophic price decline. Psychologically, downside overshoot is caused by a change in buyer psychology. Since capturing appreciation was the primary reason people were buying during the bubble, and since prices are now depreciating, buyers who once were enthusiastic about real estate are shunning it like the plague. And they should. Buyers need a new reason to buy, and and realtors calling the bottom is not sufficient. Only when prices are less expensive than competing rentals will buyers find a new motivation to buy real estate. And since rental parity is well below current pricing in markets like Irvine, buyers sit and wait, and sales volumes are anemic.
The main reason for our ongoing economic doldrums is the lack of new residential construction. Housing is the economy. Nearly every recession since WWII has ended when residential investment picked up. Residential investment will not increase until the housing market has found a natural, sustainable bottom. The reason is simple: unemployed construction workers don't buy goods and services and stimulate the economy. When the government tried to stimulate the housing market with tax credits and the federal reserve bought mortgage debt, their goal was to stimulate housing and jump start the economy. It failed. The stimulants all failed because prices had not fallen to the point of affordability where real demand could sustain the momentum. It's like drinking coffee to stay up studying for an exam. You might get a temporary boost, but if the body is tired, it needs sleep, not stimulants. Similarly, if prices are inflated, temporary stimulants may cause prices to rise temporarily, but if what the market needs is a deeper price adjustment, that is what is eventually going to occur. And in fact, that is what's happening now. How could someone tell if the market needed a deeper correction? On a macro level, measures of price-to-rent or price-to-income provide a clue. Plus, simply looking at long-term trendlines reveals prices are still too high. On a micro level, rental parity is the best indicator. If prices are not affordable as measured by the cost of ownership compared to comparable rents, then prices need to come down. By both macro and micro measures prices are still too high in many markets.
The CEO of Bank of America is telling people prices will go down. He is a good person to listen to because he will be one of the primary agents of the decline. Other than the GSEs, B of A has more REO than any other lender, and they are planning to liquidate. They won't dump the properties all at once, but they will liquidate, and their activity will push prices lower.
Did Karl Case just say inflation would be great because it would mask a 25% decline? A professional economist really said that? WTF? Does he really think it's a good thing for prices of everything else in our economy to rise significantly relative to housing is good because it keeps housing prices up? I'm starting to wonder who the real brains behind the Case-Shiller Indices is.
We still have a long way to go to write down all the bad mortgages lenders are holding. Appreciation is not going to bail them out. The moment prices begin to rise, lenders will sell into the rising prices in order to liquidate their inventory. If both prices and volumes rise, lenders will quicken the pace of liquidations to stop the bleeding from their carrying costs. Any increases in lender selling will snuff out appreciation before it gains any momentum. As long as lenders have copious amounts of houses and droves of delinquent mortgage squatters, house prices will not go up. Excess supply and carrying-cost pressures for liquidation will prevent price appreciation. Affordability will be excellent. 100% financing makes everything affordableBy far the dumbest idea that was fully executed during the housing bubble was embracing 100% financing. When lenders ran out of people with down payments and high credit scores, they took anyone off the street and gave them all the money to buy a house. With absolutely no barriers to entry to the housing market, everyone could afford to buy, and prices went straight up. Of course, giving out the money is easy for lenders, but getting it back is more problematic, particularly when they loaned money to people under terms that nobody could meet. What we are left with are properties like today's featured property. The owners paid $245,000 on 7/25/2002, and they obtained a $245,000 first mortgage. They put nothing down. After a refinance for $225,600 and a stand-alone second for $24,000 on 6/5/2003, the owners went back to the housing ATM on 5/18/2006 and refinanced the second for $165,000. Basically, they put nothing down and extracted about $130,000 in HELOC booty during their first four years of ownership. Now that prices have dropped more than 30% for small condos like this one, these owners are underwater and bailing out. Why wouldn't they? They already extracted whatever the lenders was going to give them, and now with the large debt, it costs them far more than a comparable rental. Since they don't have any of their money in the deal, only their emotional attachment to the property or a sense of moral obligation would keep them paying. Since people don't often fall in love with tiny condos, and the moral obligation to repay debt is largely washed away, short sales like this one should not be surprising. This is the type of inventory that will prevent appreciation until it is cleared from the market. Irvine House Address ... 165 ROCKWOOD Irvine, CA 92614 |
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