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Foreclosure rescues must recognize housing bubble
January 31st, 2009, 3:00 am · 40 Comments · posted by Mathew Padilla
The problem with government efforts to halt the foreclosure tsunami is that they fail to recognize the deflation of the housing bubble, writes Dean Baker, co-director of the Center for Economic and Policy Research in Washington.
He begins…
“While Congress and policymakers are debating various plans for slowing foreclosures, it is remarkable the discussion is largely proceeding as though the housing bubble does not exist. The determination to ignore reality in the housing market will virtually guarantee more policy mistakes causing further harm to both homeowners and taxpayers.”
Baker argues plans to guarantee mortgages don’t account for future home price declines that could be as high as 20% to 30%. If the government backs a loan modified by a lender and the value of the home drops again, homeowners would “face a strong temptation to default a second time.”
“There have been similarly sharp price declines in numerous other bubble markets. In bubble markets that have not yet deflated, programs like Hope for Homeowners are likely to be very costly to taxpayers and provide little benefit to the homeowners they are supposed to help.”
And here is Baker’s solution:
“It would be easy to design these programs to be more effective simply by tying mortgages to rents, since rents never got out of line with market fundamentals. If new mortgages were issued at a multiple of 15 times annual rent (which could be modestly adjusted for city-specific conditions that have led to long-term divergences from this national average) the problem of guaranteeing a new mortgage at a bubble-inflated price would be eliminated.”
Read the full text HERE.
In other news…
- Bad bank of the U.S. nearly here
- Foreclosure filings rose in O.C., fell in 3 other SoCal counties
- Bank’s job cuts skip O.C., mostly
- Countrywide asking $1.25 million for H.B. foreclosure
- Freddie Mac may need another $35 billion from you
- Half of SoCal homes for sale are distressed
- Obama to tighten rules on mortgage brokers, securities
- Keep the mortgage giants, but control them!
- Fannie mixes firing with hiring
- Is it time to buy a rental property?
- Want instant mortgage updates?
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My OC home is valued today at exactly 15 times annual rent.
As a matter of fact, so is most of OC. A typical 3/2 in, say, Mission Viejo rents for around $2,475. That gets you a value of $445,500, which is exactly what you can buy it for today. It would not be unlike these:
http://www.realtor.com/realestateandhomes-detail/26882-Ayamonte_Mission-Viejo_CA_92692_1102606125
http://www.realtor.com/realestateandhomes-detail/26162-Escala-Dr_Mission-Viejo_CA_92691_1106132180
In Fountain Valley it’s still +20 x for price to rent ratio. Still more pain to come. The era of credit-driven excesses is over. It won’t be as austere as the 30’s but not as shallow as all the recessions since. The faster our mind set adjusts to the new reality, the better off we will be.
Other inflated assets are U.S workers with out-sized salaries. Some forms of income adjustment will also be in the card. Laid-off workers in a weak labor market and a worsening economy will settle for less than previous earnings. High-priced employees must show the company that they are worth every penny of their salary. It is the spiraling deflation the nation is facing despite govt.’s efforts to inflate it. The stimulus package in its details anticipates this scenario. Things will get worse before it gets better and the govt. knows this. Brace for more head winds.
OMG,
Finally, someone who gets it.!
When we reach Rental parity, or somewhere near it accounting for neighborhood differentials, tax deductions, etc., THAT is when we will be at “bottom,” keeping in mind that during high demand times, RENTS also went up during the bubble. Problem is, if they apply this “cure” to their books, the banks would all be belly up.
In many “high end” areas in California, they made loans in the $1-3 Million range for homes that couldn’t rent for more than $4-7K per month. Compare the rent to the monthly payment for these mortgages and its obvious why these properties are not selling.
Losses will continue and will be much more be staggering, especially now that the high end is taking it in the %$$#. The banks know this and likely have known it all along, (pricing bulk mortgages at 30-40 cents on the dollar = they know these mortgages will take at least a 60-70% haircut) but they will continue the charade for as long as possible, claiming to need just a few hundred billion here, and then a little later a few hundred billion there… to keep stockholders and taxpayers stringing along for as long as possible.
While it goes on, the execs will take as much as they can in salary, bonuses, and fringe benefits they can get, heedless of consequences, because they realize this is probably their last hurrah, and they ALWAYS take care of #1.
If they asked for the whole $5+ trillion or so they know they will need all at once, the bailouts might not be so forthcoming.
I just wonder how long it will take for US taxpayers to get it, and how much more they will have spent in tax dollars to “save liquidity”. Think about it. We are paying tax dollars for what? Yup, we’re giving the banks money… so we will coninue to have the privilege of someday BORROWING OUR OWN MONEY from these banks. If it wasn’t so sad, it would be comical.
The average price of a 3-4 bedroom/2-3 bath home in Fountain Valley sold in the fourth quarter was $$494,173. The average rent for this type of property is $2600. The formula above yields a fair price for these properties of $468,000.
totally agree with the math behind the premise and thus fair value for a home. i especially liked what get real said.
only problem that i see is that using current rents for the comparison is misleading because rents are just now starting to fall. the job market along with supply with dictate where rents stabalize.
“Baker argues plans to guarantee mortgages don’t account for future home price declines that could be as high as 20% to 30%.”
The fundamental problem is that policymakers believe that their actions can actually PREVENT that from happening. It’s not that they’re ignoring the bubble–they seem to think they can actually keep it from deflating. I.e., if they provide enough supports (foreclosure relief, low rates, tax credits, etc.) the can stop prices from going further down. Of course, this benefits current homeowners, but not anyone looking to buy. In my area, prices are still way above rents and historical trends (though vary widely–to my mind a sign of not near the bottom yet).
There is a major flaw in the argument, because it ignores the fact that the rental market is tightly clustered. There isn’t a strong rental market above $5,000 no matter what you get for the money. It also ignores the fact that people will pay a premium for a certain features and certain places. And they do it with much of their own money.
Examples from both ends of the rental spectrum:
Santa Ana / One Bedroom/ 500 sf / $750
12 x $750 x 15 = $135,000 = $270 per sq. ft.
Newport Beach / Five Bedrooms / 5,000 sf / $7500
12 x $7500 x 15 = $1,350,000 = $270 per sq. ft.
Including land, you can build home 1 for less than its rental equivalent. You cannot build home 2 for its rental equivalent. In this example 10 times the price gets you 10 times the square footage, with no premium for location. Or, put another way, 10 times the price gets you 10 times the location, no premium for the square footage.
The underlying formula has some merit for financing purposes, but is too simplistic as it has been presented.
After reading the story again, I see he is saying exactly what I just said:
“It would be easy to design these programs to be more effective simply by tying mortgages to rents, since rents never got out of line with market fundamentals.”
That changes everything.
Never say never
The problem with using rent/home value ratios is the same problem with using stock P/E ratios:
When the E falls so does the P.
http://www.calculatedriskblog.com/2009/01/nyc-rents-falling-fast.html
The final blow is the job market. It is accelerating with layoffs not bottoming. In fact many 100K plus jobs are disappearing daily. Ask OC Pfizer employees who all received pink slips this week. This train wreck is just starting.
Whatflavor*** must be telling everyone on this blog that he paid or bought during the high end of the bubble. Probably also sold a previous owned home, made money off of it but used vary little for down payment on current house.
His home is most likely a future foreclosure, no doubt.
After mulling this over, I came to the realization that banks are already doing this. This is a fundamental part of why loan to value guidelines are already stepped-down as loan amounts rise. The whole reason why a bank would require 35% down when lending $2,000,000 and 5% down when lending $300,000 is that $2,000,000 collateral is considerably riskier than $300,000 collateral, due to its limited buyer pool. This has a direct correlation with the likelihood that a property will have rental parity. You don’t need to double-count these risks, you only need to assess which of the two benchmarks keeps you the safest and implement that. The bulk of lenders, until the very end, adhered to this stepped-down model. HELOCs turned this concept on its head. It’s the maintenance of combined loan to value ratios that is needed.
Hey Bunnyfarts, go back to your looneytunes friends at the Real Housewives of Orange County blog.
Homes should be priced at about 3x the average income. Home prices exploded since 1999 while incomes barely budged upwards. The average home has dropped $250k from the peak. In a rational world it still takes an income of $100k (w/ a 10% down) to qualify for a mortgage on an average OC home today. That means less than 20% qualify. That number needs to increase to 40% which means that the average home needs to drop another $200k. We know wages aren’t going higher. Not for a long time. Deflation has reared it’s ugly head. We will be darn lucky if we still have an functional economy and an intact government without a military takeover a year from now.
Good posts, all! At last the discipline of rent parity is in the discussion mix…had people factored this rule-of-thumb into their buying it may have helped temper the speculative bubble. But alas, we learn the hard way!
As far as the future world, and I am only half-joking, when this is all over, if you have $7500 in the bank, you will be considered a wealthy person.
The psychology of non-savings, and being in debt is ok contributed to rent and home prices. Now that people want to SAVE $, that will contribute to lower rents and home prices.
To whatever….,
Rents are coming down so you need to assess your average rental rate. Matter of fact 15 x is way too high. Historically it is about 100 to 120x rent meaning the most you could realistically expect for the 2475/month property is about 297K. 180X is way too high and is almost at bubble price. For nicer area, 140x to 150x is abot the best you can get while less desirable area should see 80x to 90x. We still got a way to go.
No forclosure rescue! No way, no how!
http://www.beyondthemargin.net/2009/01/politicizing-tarp.html
It looks like this has inspired some false hope in a lot of you. The average rent for a small sfr is around $2300. This formula would mean a loan of $414,000 on a price of $517,500. A larger home rents for around $3500. This would mean a loan of $630,000 on a price of $787,500. This assumes 20% down. There are plenty of places where a lot more than 20% down is the norm. Like I said, this is already effectively being done.
What you are hoping for is price control. This isn’t it.
In fact, I would go so far as to say that people without big down payments will be forced into condominiums in this scenario.
I keep coming back to this: excepting a certain amount of fraud which undoubtedly did happen, every mortgage probably had an appraisal made to justify the price of the home. Every appraisal was made based on the system of ‘comps’. This ensures that when a price bubble begins, the appraisals will ride right up with the bubble, seemingly justifying it.
I’ve seen exactly zero discussion anywhere about changing that system. That means it will still be in place to justify the next price bubble.
And the idiotic rescue plans designed to keep the bubble inflated keep coming.
The masses for reasons that escape me have bought into this notion that sagging home prices are causing foreclosures. This simply is not true. Those buyers who purchased homes with traditional financing (30 year fixed) are not impacted by sagging prices. These responsible buyers may have seen their equity vanish and maybe some of them are underwater but their monthly mortgage payment HAS NOT CHANGED.
These folks may be disappointed that their equity has been wiped out but their monthly mortgage payment HAS NOT CHANGED. If any of these folks find that they can no longer afford their mortgage payment it has nothing to do with sagging prices since their mortgage payment HAS NOT CHANGED.
When this bubble gate started back in 2002 and exotic loan products became available many buyers discovered that instead of limiting themselves to the small condo that traditional financing would allow they could make use of exotic financing (Arm, Option arm) that offered very low rates for a temporary period of time. Many of these folks didn’t even bother to consider what they would do when the low payment period ended. Those that did were banking that the bubble fueled rated of appreciation would allow them to simply refi into another exotic mortgage product so that they could extend the teaser rate longer. I guess their plan was to simply refi every few years forever, never ever paying down the principle.
Then we have the folks who started out with a traditional mortgage with affordable rates who decided to start treating their home like an ATM and drove their payments to unaffordable levels via serial cash out refinancing.
The bottom line here is that all these bailout programs only benefit irresponsible buyers the majority of which bought more house than they could afford or who never should have purchased in the first place. None of these proposals benefit responsible buyers or those who have languished in rentals having been priced out due to bubble pricing. This bubble was driven in large part by the addition to the buying pool of people who had no business buying homes. And so now we need to take my tax dollars to reward them for their imprudence and continue to make it impossible for responsible buyers from buying?
What is so bad about these folks living in rentals? Will the world come to an end if these folks are forced to pack their stuff up and move into a rental? The vast majority of them were only paying on the loan interest anyways. Most of them purchased with no money down. What is so different about these folks renting from the bank and traditional renters? Why is it so important to keep these people in houses that they never could afford? .
Jim J:
I agree with you, I just read Ramsey Su’s Op in the WSJ and he says the same thing. But the politicians with very few exception don’t care about right and wrong, or what’s better or worse for us. All they care about is the next election. They feel pressure to be seen ‘doing something’ for the voters especially since the housing problem is seen as leading to the economic downturn. In reality, it was overextended credit and people acting irresponsibly. Bailing out banks wouldn’t be such a big issue if the averag US family had savings to see them through. Alas, most family’s idea of an emergency fund was a stack of credits cards with “room” on them for more charges so the idea of not having these banks to borrow from throws everyone into a panic.
If more voters who acted responsibly made their views known. things might become different. But at this point more people who are about to lose their homes and want a bailout are most vocal. Those who as you say acted responsibly aren’t the type to ask their representatives for anything. Email and call your reps to complain. Since all they care about is votes and surviving the next election, give them something to lose.
it was the banks acting irrisponsibly. A person that took a chance and bought a $600k home with no money down was actually making a good decision. teh bank giving the money is the one that was stupid. people took the risk, with no money out of their pocket, and they lost. So what? they didnt even lose any money…. Now, the fact is, the homes were not worth that much and thats what pisses people off. Homeowners in OC still think cookie cutter homes are really worth $2 million. save your money - you will be buying the so called $2 mill home for about $450k in a year or so. and the buyers are going to be teh same people that gave there home back in the last 2 years. Now they are going to own a 5 times better home for half the price and be able to afford the payment. all will be good.
“My OC home is valued today at exactly 15 times annual rent.”
Expect it to fall to 10 times…..
Koolaid:
I seriously doubt your story. It smacks of desperation.
Post your address, credit score, and downpayment and I’ll be able to easily prove if that’s the case.
I have yet to see a house in Orange County (a real listing or closed sale) that is anywhere close to rental parity, or even 15X annual rents.
For example, 3 houses, all smaller than my rental on my street are for sale, all more than $100K more than 15X annual rents (which have fallen since I signed my lease 4 months ago).
Likewise, show us a listing and rental that meet the criteria in OC and I’ll show you a desperate short-seller with no ability to sell and a delusional landlord unable to rent. The market is missing both of these fellows at the present time. We’ll see when they meet.
Chuck Ponzi
Don’t like Mission Viejo? Do you like Tustin?
14421 Pinebrook
3beds, 2 baths, 1608 square feet
Sold for $475,000
Average rent for this home is $2600
$2600 x 12 x 15 = $468,000
Picture is gone, but it was a beauty.
How about some listings?
14321 Raintree, Tustin
Listed at $492,000
14272 Fernbrook, Tustin
Listed at $392,000-$424,000
Can’t add the links, but you can find them easily online.
Don’t like Tustin? Do you like Yorba Linda?
Do you think this is at rental parity?
http://www.realtor.com/realestateandhomes-detail/21784-Kern-St_Yorba-Linda_CA_92887_1105573541
Brea?
http://www.realtor.com/realestateandhomes-detail/Brea_CA_92821_1104974896
Costa Mesa?
http://www.realtor.com/realestateandhomes-detail/2100-Federal-Ave_Costa-Mesa_CA_92627_1106112984
Ladera Ranch?
http://www.realtor.com/realestateandhomes-detail/5-Mill-Ridge-Farm_Ladera-Ranch_CA_92694_1105560122
Huntington Beach?
http://www.realtor.com/realestateandhomes-detail/5802-Marshall-Dr_Huntington-Beach_CA_92649_1106372404
Koolaid,
We are renting a house in Fountain Valley for 2800/mo and the house is still assessed in the low 700k. Although some listings in this neighborhood have trended down in price but no where near the sustainable level of 15x rent. Another renter we know in our area has relocated to a similar house in the same neighborhood for lower rent. The adjustment is ongoing until sustainable level is reached. As of now it is not the case. We have had a housing glut, a direct result of a bigger and more problematic xs credit era, and the spiraling price re-valuation is bringing down both home prices and rents, on top of a shrinking labor market…. We are the living proofs of this housing metrics that are currently out of whack.
WFIYKA, of course it makes good financial sense to lock down a home that is trading even in the vicinity of rent prices….that is something a retarded simian could comprehend. The problem is that those same retarded simians that ran out to buy in 2006 and 2007 with no-money down that have “lost” their homes still have no money to put down, have now HORRIBLE credit that won’t recover for years, and are losing their jobs by the hundreds of thousands….this is why home prices in MOST areas are now at or BELOW area rents! I have to say, I did not forsee that happening except in the worst recession imaginable…and now it is here!
The herd has stampeded in the other direction! The opportunities now to scoop up property is great…but it will only get MUCH better as the herd panics and runs OVER the cliff! If you can keep your income stream and continue saving in the coming year the prices likely available in 2010 will be stunning…and everyone who can will be clammoring to buy…but for now your examples will just become more numerous…it is stupid to stay a renter in most areas now based on cost…but more stupid not to wait a little while longer. I’ll be real interested to see how many of the “perma-renting” perpetual savers on this board actually buy in the next year or so? Fear is a great paralyzer….who will it freeze out of the market this time around?
Unfortunately, the housing market won’t turn the corner until the economy finds its footing. After years of debt-driven, asset-dependent growth, what will be the next economic engine to keep the economy humming along? The credit bubble now has been pricked and inflated asset prices are undergoing devaluation; moreover there is no technology break-through on the horizon that can propel the economy forward, just buckle up, stay debt-free and keep employed at all cost. The light at the end of the tunnel will shine through maybe by 2012.
Banks have a cartel-like control over home prices now. With 1 out of every 2 transactions occuring on distressed properties, banks control how slowly we revert to fundamental price/income and price/rent ratios. I think it may be a slower reversion than most of us imagine, as banks have the ability to hold inventory off the market, just like OPEC holds oil off the market to limit supply. The only good deals out there are for short sales, but there’s no guarantee of getting bank approval and it can take 6 months just to hear back on an offer. A lot of the purchasers are still overpaying on short sales and getting caught in silly bidding frenzies, mostly due to impatience.
Whatflavorisyourkoolaid, My sister a roommate and I rent a house out in Simi Valley for $2,300 a month.
Mortgagemaker, You are wrong in one area these people did lose something its call their credit. Plus you are putting a positive note on unethical behavior. Basically you are saying its okay for people to be irresponsible and make other people (the tax payers) pay so they can get a house that they never could have afforded in the first place.
Yes the banks were stupid due to their lax underwriting practices, but the borrowers that got these loans they couldn’t afford were just as stupid as the banks.
Oh and that thing called Credit is going to hamper anyone that lost a home from being able to get another loan for a home in the future and this isn’t even mentioning a down payment requirement.
So unless these people that bought more then they can afford are able to stay in their homes they will be renters not buyers. With screwed up credit good luck getting a home loan in two years.
Too bad that the government already guarantees trillions of dollars worth of mortgages. However, that fact does not justify guarantying trillions more.