“Will Psychology Cause Prices To Over-Correct?”
Readers suggested a topic about psychology and home prices. “How long did the ‘psychology’ of the market continue to push home values up even after fundementals were out of line? How long will the ‘psychology’ of the market continue to drive home values down even after fundementals get back in line?”
One said. “I also would also like to know how much will people overpay for a property based on psychology, and it would be interesting to know how people plan to make the payments when they go up, (do they think they are going to get raises, do they count on refinancing etc., do they believe real estate always goes up ?)”
Another, “There was a book written almost 150 years ago called ‘Extraordinary Popular Delusions and The Madness of Crowds’ by MacKay, that chronicles various bubbles (Dutch tulip bubble, South Seas bubble, etc).”
“Although these bubbles took place 200 to 400 years ago, human nature has not changed 1 iota, so the stories read no diffferent. (aside from the toxic loans… ha).”
One replied, “If I recall correctly this topic was addressed as ‘resonance’ and the ‘feedback loop’ in Robert Shiller’s book Irrational Exuberance. Probably not a bad idea to give Shiller’s book another reading at this stage of the bubble.”
Another said, “It’s kind of like reading the crazy revolutionary predictions about the Internet in 1998. Or Ross Perot’s rantings from 1992. Now we can see how foolish we were to believe any of it.”
A new reader added, “Being a total newbie, I have the following question: I realize that prices should eventually come down in places where there is a lot of excess inventory, but what of areas like the LA Westside, where I would like to buy a house?”
“There’s no denying that there are quite a few ugly McMansions and more than a few suspiciously new monster SUV’s. But for the most part, houses are sensibly sized and people drive sensible cars that look a few years old. The Mc Mansion owner is certainly in for some rough times, but I don’t want his/her house anyway.”
“Is it reasonable to expect that a significant number of people who own sensible homes are leveraged to the hilt and will have to sell in a market depressed by the speculators? For the time being, I don’t see that happening. If they are sensible, they will try to hold on to their house unless they absolutely have to move, won’t they?”
“So far, in my area, there are a couple of crappy houses up for short sale, a sure sign of trouble. But they both look like your typical flipper who flopped, nothing like a real house coming into the market at a reasonable price….”
‘it would be interesting to know how people plan to make the payments when they go up’
I can take this one because I read it everyday in 2005. It was usually something like, ‘I am only going to live in this house for a couple of years and then sell.’
The idea that they couldn’t sell in a few days wasn’t considered, nor was the possibility that the credit environment might change.
Or its second cousin “we’l just refinance when the loan resets to a higher rate”. Of course, this assumption was based on actually being able to *get* refinanced. With so many here in California having taken out 100% loans (80/20s), and house prices actually falling a bit, the refinance option is looking less and less certain.
“we’l just refinance when the loan resets to a higher rate”
This assumption is also based on a complete ignorance of the relationship between asset valuations and interest rates. Higher interest rates generally imply lower asset values, and conversely (remember the effect a 1% FFR in the early 2000s had on the “fundamental” value of housing?). Are lenders generally eager to make loans to owners with a vanishing equity cushion?
Ben, two responses to that last sentence.
First, a lot of these newbies have no idea how illiquid real estate can be. However, they are going to find, esp. in this bubble-bursting market. Lesson #3 of real estate, you have no equity until that check clears and is in your hand!
Second, the credit environment is gonna’ change real quick. I see lenders going back to tougher standards, especially if, as many on this board think, that the FED WILL raise rates to save the dollar. Nice job keeping those ARMs and legs in the house! For many, the new credit environment is not only going to be a change, but a painful change, at that!
The Fed WILL NOT raise rates to save the dollar. The US economy will reveal its true weakness, killing foreign demand for US debt. When the FCBs stop buying and begin liquidating US treasuries and dollars, interest rates will rise without the Fed doing anything. Why would anyone buy notes producing returns in an ever-devaluing currency?
GetStucco and others believe they will to keep the USD as the reserve currency. That argument alone makes me think they may be right. However, I am thinking like Bill in Phoenix, that I am under balanced in the metals. Early next year (I hope it isn’t too late by then) I am hoping to buy some platinum, gold, and silver. Not for the emotion of it, but as a hedge against a devaluing dollar. Also, as an investment, but only in the sense that I can pass the metals on to my kids and hopefully they will be smart enough to save it if ever the dollar got to the point where you would really need it.
Started selling treasuries (IEF, TLT) on Friday. Rates will rise soon, because if there is a choice between housing and the dollar, the dollar must win, or the fedgov is gone the way of the Weimar Republic. So rates will rise to support the dollar and housing be damned. Just my opinion.
The market may raise rates, after all, that’s where the decision is made. If buyers of US debt keep taking hits like they did the past two weeks, a currency risk premium is likely.
This is what I can’t figure out re: the Dollar. The currency itself is already discounted, but there is no risk premium in rates - in fact there is a discount if you count real inflation. I find it amazing that this conundrum continues - it’s like the Energizer Bunny (TM) of conundrums.
It is very hard to get your, ahem, arms, around it. Just a couple thoughts - 1) Political risk, and 2) liquidity.
There are no shortage of folks floating around the internet telling us that the United States will be taking both a political and economic back seat to the Republic of Haiti within the next 18 months. I, for one, don’t buy it.
Nor do I think the dollar-doubters in here are oil sheiks or Asian exporters - ask anybody who actually has $20 billion to look after and ask him where he’s put it and why. Ultimately, T-Bonds are a pretty safe place for mega-bucks -screw the return, guard the principal.
The liquidity issue is also relevent - there are only so many Swedish Krona and Thai bhat to go around - the market is just not deep enough to accomodate massive global inflows. Think about it.
I am about 30% long foreign assets, but just wait for the next, inevitible world crisis. Omar the oil man and Hop Sing the steel guy will stampede to the dollar, trust me. Whoa to he who may be short that day.
That’s not to say the dollar’s not toast over the long term, but I wouldn’t get ahead of myself in the FOREX markets.
The only real “conundrum” is how long it will be before a central bank starts the run on the dollar. I’m guessing it will be sometime in 2007.
DC_Too. Well said.
DC_Too, you are just saying that the US$ is “too big to fail”. That’s what they said about the UK pound about 100 years ago. I sort of think Omar and Hop Sing would want to keep their money in the currency of a country that actually produces things that they want to buy, and that isn’t the US.
You would put it in Yuan? Yen maybe, but the Japs outsource to China more than the US does. USD is a buy, but treasuries are a sell because rates will rise.
Here a snipet from an interview with Dr James K. Galbraith on http://www.itulip.com/forums/showthread.php?t=654
QUOTE
JG: The world will not go on forever using dollars exclusively as reserves. The cost of production of reserve assets is zero versus the cost of producing things; the advantage is not permanently sustainable. Global monetary systems tend to last 30 years or so, and the current dollar-based arrangement that arose in the early 1980s out of the inflation crisis is getting a bit long in the tooth.
EJ: Let’s leave the realm of informed speculation to advance into idle speculation. What events do you think are likely to precipitate the end of the dollar’s reign as the world’s reserve currency? What might a post-dollar world look like?
JG: You might like to design the new system first and then figure out how to get to the new system from here with the least possible transition cost. We won’t be so lucky. Throughout history, these kinds of transitions have been precipitated by crisis, precisely because the transition cost is too high for most of the players in the system.
EJ: In the current instance, the United States.
JG: Right. That said, it’s hard to imagine how any of the players will do anything intentionally to create the crisis that will lead to a transition. Think of a crowded theater where someone yells “Fire!” In the case of the global monetary system, the theater isn’t very crowded. There are three seats in the front row occupied by sleepy, porcine men, representing Europe, Japan and China. If someone in the back yelled “Fire!” the porcine men might wake from their slumber, sniff the air and—noting a lack of smoke—go back to sleep.
EJ: I’ve speculated that one of the nations on the periphery of the system, say, France or Russia, is a likely instigator.
JG: That’s possible. Not France, because France is now part of the euro, though France was the traditional instigator, demanding gold from the U.S. in the late 1960s and forcing Nixon to close the gold window in 1971, ending the convertibility of dollar reserves into gold. But the question remains, why would any of the three big players follow along, and if they don’t, then it doesn’t much matter what these smaller countries say. That gets us back to the question of what event will cause a new U.S., European, and Japanese multilateral reserve system to form. Reforming the dollar reserve system into a collective reserve system with the smallest disruption of trade requires, for example, that the European Union (EU) create a euro bond market that is as liquid and transparent as the U.S. bond market. Today, there is no euro bond market at all, only national bonds issued in euros. Creating such a market is no mean feat. Further, the EU will need to run a current account deficit. Given the retrograde and reactionary crew in charge in Europe today, that seems highly unlikely. Transition to a new system usually requires a crisis, but a crisis is not in the interest of any of the players, and the source of the spark of a real fire is not obvious.
END QUOTE
Btw: James K. Galbraith is not to be confussed with JK Galbraith (the famous economist who departed to the great currency reserve in the sky in April 2006)
Dr. James K. Galbraith is JK Galbraith’s son.
The reserve currency status is the closest to a free lunch you can get in the real world. If/when the US$ is no longer the worlds reserve currency, better get plenty of ammo, canned food and move to a log cabin in Montana. It will be the end of the US consumer society.
From:
http://www.financialsense.com/fsu/editorials/schiff/2006/1130.html
“It never ceases to amaze how televised media reports on the U.S. economy are almost exclusively about shopping. Such reports almost always feature images of sales clerks frantically stocking shelves and long lines of consumers swiping their credit cards. In contrast, reports about the economy of Japan or China typically include footage of smoke stacks billowing, production lines moving, robots assembling, and people actually making things. Doesn’t it ever occur to anyone producing these segments just how ridiculous this is?
Despite the implications that Americans and Asians are simply relying on different types of fuel to fire their respective economic engines, production and consumption are by no means interchangeable. Production is the means, consumption is the end. A society can no more consume its way to prosperity than an individual can. However, just as an individual can consume himself into bankruptcy, so too can a nation.
Americans are not producing wealth, but merely consuming the wealth produced by others. When Americans go shopping this Christmas season (primarily spending borrowed money on imported goods), classic economic theory holds that the principal benefit goes not to the U.S. but to those who supply the goods. In exchange for their production, they receive interest and dividend paying assets (dollars, bonds, stocks, etc), which should provide future wealth. Americans in return accumulate depreciating consumer goods and piles of external liabilities that must be serviced and repaid. So Americans squander the wealth of their parents while their vendors amass it for their children.
However, the classic economic theory may not actually be in play as the liabilities our “trading” partners are now accumulating will likely be repaid in currency with severely diminished purchasing power. Trade normally involves the exchange of real stuff for real stuff. As illustrated by our yawning trade deficits, we now have a system where real stuff is simply exchanged for currency, which in effect represent IOU’s for future stuff. However, rather than being a source for future spending, the currency must be horded indefinitely. As the Chinese and Japanese clearly understand, any attempt to use their vast amount of dollar reserves would cause their theoretical value to collapse. Therefore they continue to accumulate more rather than to admit the extent of their prior folly.
There are many in economic circles who subscribe to the “it’s our currency but it’s your problem” philosophy. They maintain that China and Japan are compelled by mutually assured destruction to perpetuate the current system. However, they are only half right. There will be destruction for sure, but it will hardly be mutual. While the American economy will surely suffer, foreign economies, perhaps with a few initial hiccups, will actually prosper. Americans will soon learn that they can keep shopping only as long as foreigners continue to support the dollar. When that stops, these sanguine economists are in for a rude awakening. Think about it this way. Imagine an America where we could only consume those goods we produced domestically, and where individuals, corporations and governments could only borrow from domestic pools of savings. Then imagine the rest of the world flooded with all those extra consumer goods and savings that were formerly showered on Americans. Rather than it being “our currency their problem,” it’s more like “their factories, their savings, their goods,” and one huge problem for us when we have to make do without them.
The sad reality is that it is foreign producers that will eventually have the last laugh. Sure we will screw them by repudiating our debts through inflation, but in the end they will enjoy all of the abundance of their productive capacity and we will suffer the wide-spread shortages that result from our lack of it. Their standards of living will soar just as ours plunge.”
I agree. Great post. Consumption, consumption, consumption! Gluttony and fat lazy Americans go hand in hand!
Lots of speculation as though the playing field is level, and the dollar or sterling or the euro etc can all act as a reserve currency.
We need to keep in mind one thing. The US has the strongest, most experienced military on the planet. At the end of the day, no one else is as able to defend their position globally.
Although the buck may rot from within, the psychology security of the state coincides with the security of dollar bills being locked up in your local bank vault.
The only other strong notion of national security combined with strong currency currency I can think of comes from the land of the Swiss.
The US military has lost nearly all its international respect. No doubt we can nuke India and China back to the stone age, but it’s not really an option, is it? They are the long term winners. Sorry to break the bad news.
This is a joke, right? Other countries may not like the US, resent its power, fear it, be jealous of it, but one thing they do is respect its military capability. Military strength and stability contributes to monetary stability, unless otherwise detroyed from within.
Sorry to break the news to you Ronin, but a military that cannot guarantee security in a major US city (guess which one) or win a fight in a sandbox, has the respect of no one.
Actually the military is very capable of winning the Iraq war as well as securing the US. The only caveat (and it is a big one) is that a lot of civil liberties as well as international goodwill must be shed. Any nation that think it can fight a good just war or have a nation of full open security will wake up someday to a splitting headache. I’ll give you a great example. I am Vietnamese but have been in the US for 70% of my life. On those occasions when I have been able to visit Vietnam, the dearth of civil liberties would make the ACLU cringed. The flipside is a nation that is very well under control. No major uprising. No political unrest. A cronist market but very functional one. Would I want to live there? Heck no but it does offered a stark contrast to the free spirit but porous nature of the US. Having said that I believe if and when the time does come for the US to actually have to stand up to real or perceived agression, civil liberties be damned. A safe nation trumped a free nation any day. If any of you are history buffs, looked at all the great empires that came and gone. The greatest time was when the empire were building ang growing. A maturing or matured empire tended to look for faults (real or perceived) in itself as it tried to achieve a uptopic state. Who knows how much longer before the US will go the ways of all other empires? Or will we have the stomach to roll with the punches and take our medicine? Rant off….
Michael
“Why would anyone buy notes producing returns in an ever-devaluing currency?”
The Asian creditors face the same problem with which Donald Trump’s creditors are quite familiar. When the banker’s best customer can no longer make payment, the bank suffers disproportionately. Hence there is a motive for the US’s enabler to keep enabling, even if the risk of losing money on a weakening dollar looms ever larger.
I think in the short time between now and late spring we will see a huge increase in mortgage fraud. Remember their have been a lot of mortgage companies opening up store fronts in strip malls all over this Country the last five years. Look at your average strip mall and you will see a celluar phone store, starbucks, jamba juice, and a mortgage business. The mortgage guys see the housing market as their right to continue their pitiful existence with no consequences. They will resort to desperate measures in order to keep the doors open. Less loans means more creative ways to refinance loans now, which last year would have been unthinkable. Anything for the commission. From what I have seen most mortgage professionals and I use that term loosely have no clue about the negative impact fraudently lending will and is going to cause on our economy.
“starbucks, jamba juice, and a mortgage business”
Damn, you must be thinking about Casey Serin.
BTW, his site traffic is fading out but I predict he’ll have a big blowoff sometime prior to spring.
http://www.realmeme.com/roller/page/realmeme?entry=iamfacingforeclosure_com_update
For lack of a DollarBubbleBlog could someone educate me on why they think the dollar is fundamentally unsound? Why should the dollar crash in value relative to other currencies?
It seems that people think of currency as something like the stock of a nation. When the government is screwing up, the price of the currency falls.
I understand that, at equilibrium, exchange rates should be determined by purchasing power parity. By this measure, isn’t the dollar valued correctly?
Why are high levels of debt pointed to as a sign of over valuation? Debt can indicate that there is healthy investment in the future. To me it seems that US private debt is mostly of this kind.
I admit that the national debt is essentially consumption today instead of tomorrow. But if investors are suspicious that the US will be forced to monetize the national debt, why aren’t there bullish reactions to smaller deficits and prospects of spending cuts?
OC Dan-
So right there is a big difference between Income and one time gains. So many actually blur the lines in thinking flipping a home is a career generating income.. when its all speculation at the moment.
Overall, the telling sign is ‘no national savings rate’. Prices will fall much further. In SF Bay area expect that to be 40-50%.
Louie, it happens in every bubble. Remember all the kids who dropped out of medical school in the ’90’s to day trade? When you see otherwise rational people diving in like that, start taking some money off the table.
Louie Louie,
Exactly right. People consider flipping as a career path that they can follow for years to come, just like a profession.
That was the mistake right there in thinking that they could do this forever and drop their careers. Come to think of it that’s just what Casey did also.
Robert Kiyosaki and all the late night TV no money down real estate millionaire programs hold a good bit of the blame in starting and sustaining the pop culture psychology of this scenario, as I see it.
give robert a break he did concede a housing crash a couple of yrs back. in his books he states that homes are liabilities.
“Will Psychology Cause Prices To Over-Correct?”
*If* there is a big, sustained drop, the herd mentality will cause prices to overshoot on the downside, just like prices overshot on the up side.
I hope the really overshoot here in south OC, then maybe the sane people can afford again. The again, I still don’t know if I’d buy an underpriced property caonsidering the way these homes are made now and the fact you have no proprty and have to pay HOAs and all that. Don’t get me wrong, I don’t want to mow acreas and acres of lawn, but I don’t want to reach out my bathroom into my neighbor’s house, either.
Would be funny if we - meaning the like-minded cash -paying people of this blog - were the ones who steeped in and bought when house prices made mathematical sense and kept the market from over correcting.
What I am pondering these days is, will the fundamentals cause an over-correction. By that I mean are markets so overbuilt that prices will move below replacement costs? (Think Florida).
I actually saw an ad in the Flagstaff paper for a new house that claimed to be under replacement cost.
Another fundamental that could cause this is a lender squeeze, where vacant homes are dumped on the market.
In every other bubble, the market(s) have over corrected on the down side. Replacement cost is not very useful when we have seen massive bulldozing of new houses in Texas only 20 years ago. If an area of McMansions becomes vacant and crime infested who wants to live there? The Japanese collapse (15yrs) went well below replacement costs. There are still ~5 million empty houses on the market.
I spend much energy trying to get an accurate number of excess or empty homes on the market. Could you please give me the basis of your 5 million extimate.
Thank you
http://tinyurl.com/yfupop
US Census Bureau 3rd Quarter 2006, They express in percent 9.9% vacant - I extrapolated down to be conservative. Caution pdf
From their report: pg 2
There are 126.2 million housing units with 109.6 million occupied.
The 9.9% is rental units. SFR units is 2.5%. I think that is an important distinction.
In places like Arizona and Florida that is very likely to happen. Biggest glut is in those two states. Much of this is based on projected (guess at best) retirement by baby boomers into those regions. That may not happen! They may go elsewhere. If so the glut of inventory and lack of demand may push prices below cost. As I last heard some 40,000 units are on the market today in your area.
“will the fundamentals cause an over-correction. By that I mean are markets so overbuilt that prices will move below replacement costs”
I think it depends on what you mean by “replacement costs”. Do you mean replacement costs now (when materials and labor costs are still high), or at the bottom (when less materials will be consumed, possibly lowering materials costs, and labor will be competing for less and less building activity, possibly lowering labor costs)?
Right, lumber has already dropped and labor will soon with all the builder layoffs.
This is a good point. I think when they refer to “replacement cost” now, they are most likely referring to “built cost”. But that built cost is based on high land prices, high material costs, and high labor costs. When there’s a glut of available inventory, all of the above go way down, so replacement cost goes way down too.
arroyogrande,
Right now there are parts of some MidWestern old-industry towns and cities where you can buy a house below any conceivable definition of replacement value. They’re graphic demonstrations of supply/demand curves when there’s no demand because people are moving out.
It is possible, likely even, that some areas where there is still actual demand are nonetheless going to see the same situation because supply has temporarily outrun it.
Cap rate determines Value. 10 to 12 times annual rent is generally a good buy.
Worthy
http://bigpicture.typepad.com/comments/2006/12/is_the_housing_.html
the other issue is credit insurance. Similiar to auto insurance, higher risk behavior leads to higher rates. Lots of attention has been given to FCB lowering long term rates by buying GSE and gov’t paper BUT they have also used credit insurance to lower the risk. In a environment of greater defaults, foreclosures and slower economic activity, credit insurance will increase and put pressure on longer term bond rates.
Here is my approach to bubblicious investments (stocks, real estate, precious metals). I remove all emotion (thus removing greed) in my investing by allocating percentages of my portfolio in different assets. I am way underweighted in precious metals and real estate right now and properly balanced in equities and government securities. My allocation to Real estate should be 1/5 of my net worth. But I look at how much I can buy with 1/5 of my net worth now, and it keeps me on that fence. As for gold and platinum, I can buy now (small amounts periodically) and not have to wait. I’m not sure when I can get to my proper percentage in that area.
This approach to take emotion out of investing has saved me from being a FB. I applied this before I stumbled in on Ben’s blog. Even then, in 2003, real estate prices were way too high.
My policy does not mean I don’t get emotional about real estate. For instance, I saw an advertisement of new villas and apartments (for rent and purchase) in Costa Rica starting in January. But my discipline tells me there will be better deals in the future. This is a big world of wonders. There may be a major stock market crash soon, combined with another 5 years of 7 to 10% RE price drops. But my asset allocation in T-bills, savings bonds, money market funds, CDs and diversified AZ municipal bonds will provide some counterbalance.
>My allocation to Real estate should be 1/5 of my net worth.
Bill - is it:
Home Equity = 1/5 of net worth?
or
Home Total Cost = 1/5 of net worth?
That’s total home cost (= accumulated equity + loan amount remaining). I’m very conservative with my $.
-
a $140k house? what can you buy for that? My guess is you at least have to spend at least $300k post-crash to have anything nice - which by your math means you need $1.5M of net worth to justify? ironically, this will probably end up being where I pencil out so maybe you are on to something with your formula.
Exactly. IMO, my dream home is way overpriced today. I cannot expect the coastal view house in San Simeon soon. But I could get a Tucson place, I think, which is custom and priced below $200,000 with a great view within 5 years. I think I can get something nice there. The other alternative: Save even MORE money and come up with $2,000,000 net worth to afford $400,000 in RE.
Bill - what % do you plan to drop down as a down payment when the time comes? I’d like to ideally buy something for about $300k and put down $100k and have an sleep well at night easy $200k mortgage and try to bang it out in 7 years or less. I’ll take out a 30 year but throw large chunks of it and try to pay it off as a 7 year or less.
My ultimate dream is to have a house that’s completely paid off and have $100k-$200k of passive tax free income derived from tax free money markets, tax free bonds, and some dividends/capital gains. I reckon I need the initial $300k for the house, and another $2.5M-5M to generate the $100K-$200K in net tax annual income. I could live on 4100k tax-free now, but i think with inflation, by the time that i’m “old” I’ll need $200k. Once I achieved this level, I’d keep working, but it’d be nice to have the option of saying “F*** YOU” to my employer. Thoughts?
p.s. and never have to touch the principle.
Gekko, I helped some friends move into a house in Tucson in the late 90s. I kept it in the back of my mind, but I admired their house since then. A few days ago I saw a similar house there in Tucson, with the unique features of my friends’. That house is $200,000 more than my friends’. I zillowed it and figure it should be valued back down to $240,000, while it’s listed now for the mid $400s. Tucson is suffering now in the RE crash. It will suffer in the next few years, just like most other places. I can forget the California coast in a house like my Tucson dream house. Many people here hate desert and heat. But that means more solitude for me. Their loss, my gain.
Gekko, on a $200,000 house, I would put $40,000 down - 20% right? No more, no less. I’m 47 and don’t want to make payments after 65. So hopefully will buy in 3 years or pay off a 15 year in 13 years (purchase agreement in 5 years). I agree with your plan of generating tax-free income and the $2.5 to $5 million in tax free investments. I have similar ideas.
I’m in LA again this weekend and it is very educational to see how the opposite extreme is doing. That is, overweighted in house loans to pay off, underweighted in savings. This is ground zero of desperation - Los Angeles. On their side is climate, high paying professional jobs, and a nexus of great universities. But…LA is not immune from price drops. The people here are screwed. Houses in Hermosa Beach (zillow any for saled house at random) have gone up well over 150% in the last 5 years while incomes have gone up single digit. Same thing with MB, RB, PVE (all South Bay) and other parts of LA and Orange County. These people are really F’d!
How much people put down depends on their opportunity cost, their cost of capital, and their appetite for risk. Everybody mixes these 3 components differently.
The litmus test that I use is what will let me sleep well at night. Sounds like you use the same test.
We bought a new car. I could have paid for it in cash, but I signed up for a 6 year loan at a 5% rate. Over 6 years, I’m very comfortable with my ability to outperform my cost of capital for the car. I sleep well at night. Another person might not be so comfortable with this setup and want to pay it all off. That person sleeps well at night too.
The person who bought his Ford Unjustifiable (Special Edition) SUV with a HELOC on his 2 year old home that might reset? He’s loading up on Ambien.
Hey, maybe we should be investing in Sanofi-Aventis!
I think the psychology of overcorrecting is a looong way away, here in L.A. It seems that most sellers, rather than comtemplate reducing prices, are taking thier houses off the market until the spring. Its obviously still inconcieveable for most sellers here that house prices will not continue rocketing up year on year, forever.
People here on the blog have noted that prices are going down in other parts of the country - but I wonder how long it will be until a seller doesn’t think a 200% sunshine/celebrity neighbour/swanky zipcode ‘tax’ is reasonable?
My bet is that in the posher parts of town - like Beverly Hills and Malibu - will still have high inventory, huge DOMs and million dollar plus asking prices in spring 2008 - no matter what the surrounding markets are doing.
How well that will go for them remains to be seen, but I think the concept of ‘overcorrection’ is something that will not be seen here for a very long time.
Personally, I can’t wait. But if the rash of inactive listings, the ‘big house on a small lot’ offerings, and (still) nothing except mobile homes under 400K I’ve seen recently on ZipRealty - I’m not holding my breath.
I really do feel at the moment that ‘its different here in L.A’ - not that house prices will never come down, but that its going to be a longer and bloodier battle to get them down here, than in most other parts of the country.
Speedingbullet, it will be slower in the LA/OC area for one major reason. These people are in debt up to their eyeballs. They can’t sell for less because the HELOC was used for the granite counters, cheery cabinets, pool, and vacation. They can’t sell because they would need cash at closing and the HAVE NO savings. Also, they still have Robert Cote’s wishing price on their mind. Until the sheriffs start putting up numerous foreclosure notices we aren’t going to see any real movement.
Here’s another one from the stupidity column that you guys will like. I post here mostly as a warning we already know, but also as a reminder to those newbies.
Was talking to a friend yesterday you told me about a woman who bought a new home without selling the first. Bad move, but it gets worse. First home asking price 675K, then 650K, now 575K. Still won’t move, originally purchased at about 200K. Anyway, before selling the first, she bought the second. Not even any looky lous. To top it off, she has lost her job. Friend said this woman is extremely stressed. Ladies and gentlemen, I bessech you DO NOT buy 2nd home until first sells! Also, I think we are going to hear about this situation more and more in the coming year.
Speedingpullet, I also see the correction a long way away here in LA, unfortunately. Probably by that time my daughter will be a teenager and it won’t make any difference to her whether she can jump rope in the backyard or not. I guess the only option is to keep yourself very tuned in to the market until something makes sense for you.
OC Dan, I think you are right. People are going to try to hold on to their homes, but I think this is where the other discussion on the general direction of the economy comes in. People will be able to hold on to their houses only if they have a job. Otherwise, they are in a really bad mess.
I also have a similar anecdote for the records. A couple I know bought their dream home in LA, absolutely beautiful. The took a second mortgage on the old house to pay for the new one, and then surprise, surprise, the old house didn’t sell. Long story short, they are now paying two mortgages…
Cassiopeia and speedingbullet - house prices have experienced a downturn in the late 80s to mid 90s in LA. So this can happen again. But I agree that prices there seem to have some resiliency and they should be flat for many years. Remember: they have gone up disproportionately to income in the last four years. Either incomes must go up significantly or sellers have to wait many years in LA.
It will take time. Remember, a good percentage of the last batch of buyers (2005, 2006) were *not* extremely rich people looking to buy with all cash. They were Joe Sixpack and Nancy Pinot Noir buying ever more expensive shacks with 100% financing and no money down. Wait.
Its obviously still inconcieveable for most sellers here that house prices will not continue rocketing up year on year, forever.
I agree with this. The vast majority of sellers do not understand what is about to happen. The sellers are not even in denial yet.
They have absolutely no idea what has smacked them upside the head.
If some of them actually knew what is going on out there we wouldn’t hear quotes like, “I’m not going to just give it away.”
Captain jack this gets us back into the psychology. The seller’s psychology has been ruling for some time now. All sellers think the house is worth what they are asking, and they have comps to prove it. They truly believe that you are either stupid or mean if you make a lowball offer that is totally realistic from the point of view of your buyer’s pshycology. As for me, from my renter/ saver/ conservative investor perspective, ALL houses are expensive, but in reality it is not up to me to decide, the price should be a balance struck between my perception and the seller’s.
I think the original question was whether the pendulum would swing all the way to the other side in such a way that the buyers would end up having the upper hand and dictating prices, at least for a while. I think many of us, consciously or not (including myself) wish for that, especially since we’ve had to put up with being called stupid or having “sour grapes” for years. I wouldn’t object if some of the worst offenders (ie: the flippers who paint a house and want 50K over what they paid for it 6 months later) got their comeuppance. But, to be realistic, I don’t think that will happen. In a truly free market, one would get a little flavor of that, but let’s face it: Hundreds of thousands of FBs WILL get the government’s ear, especially if they are in the same boat as the lenders, who always get it. Besides, people have to live somewhere and they will hold on to their houses for all they are worth, since the alternative is to end upside down AND also having to pay rent. It just doesn’t add up. That is why I tend to agree with the bloggers who think this is going to be looooong and painful. I don’t know nearly as much about economy as some of you guys, but my gut feeling is this is going to end up in inflation…
I am wondering about the photo section, and why it doesn’t work. I have both a Mac and a Windows machine. Are there others experiencing problems?
MrCoffee
Possibly you have scripting turned off? Javascript needs to run a whole bunch of stuff to make it work. That may also mean that an old or oddly configured browser might not work. The method for going back and forth is to hover the pointer over around the middle side area and a button will appear, but the code for that may be slow and clumsy on older machines.
Do you not see pictures, or just have trouble going to the next one?
the market will over-correct due to:
1. psychology
2. tighter credit standards
3. recent past/current demand was stolen from the future
4. more inventory coming online in the near future
5. increasingly onerous levels of credit debt will keep 1st-time buyers out of market
Question for the financial wizards. My partner and I own a commercial property that we had built in 2003-2004. Right or wrong, we listened to our broker and did a five year arm at 5%, which will come to term in November 08. Our thought process was to keep our costs low until we could lease all the units.
Thankfully it was not a problem filling the units. We are at full capacity w/ long term leases (3-5 years) so we have no cash flow problems. Also, the land paid off before we built so we have pretty good equity. Question, should we refinance to a 15 year mortgage now, or should we wait until the five year term expires?
In closing, I understand that nobody has a crystal ball, I am just looking for some common sense information b/c I am not street wise regarding markets, dollar values, etc. Thanks.
For Christ’s sake, you don’t need a crystal ball! If you’ve got and can keep positive cash flow with fixed paper, do it. Do it now!
Don’t know where you are or what the rules are for commercial loans in your world, but if you can get a fixed loan, at prevailing rates, you are effectively transferring all risk to the lender. If rates were to drop even lower, you can refinance and throw even more risk at the lender.
Don’t be penny wise and pound foolish, man.
Alternatively, depending on your view of your location going forward, you might want to consider selling, taking your (I presume) profits and living with any CG tax.
You should have no difficulty finding a buyer for a fully-leased commercial property.
I think your key issue is well debated at the top of this thread, i.e. are the Fed going to defend the dollar or not. If they do, then interest rates rise, possibly long term as well if there is systemic weakness in demand and more people move into GBP, JPY, EUR & CHF. Of course, if they do this, the housing market will tank even more than we all see it is already as affordability ratios will get even worse.
The alternative is trying to create internal economic growth by dropping rates and saying “hang the dollar” and trying to get back the fundamentals.
Given the horrible balance of payments and proportion of internally generated GDP, I think the latter is more likely, but don’t blame me if I’m wrong.
I guess you could hedge your bets - could you afford/would it make economic sense to buy a swaption (i.e. an option to fix rates at today’s prices on the date your financing rolls)…?
Regards,
Loafer
Here in Michigan, where the economy is slightly worse than that of a poor African nation, many people still assume they will make more money in the future. I suspect it is due to the labor unions that guarantee raises and COLAs every year regardless of performance. Most everyone I talk to just assumes they will make more every year until they retire. Therefore, a higher house payment won’t be a problem in the future.
I absolutely agree house values could drop lower than replacement value. It happens all the time here. There are mansions built in the early 20th century in formerly rich areas of Detroit that sell for less than 20% of their replacement cost. All those arrogant Californians who think L.A. and S.F. are the center of the universe should remember that Detroit was too until the 1960s. The economy was on fire, there were tons of jobs, growth, high wages and “everybody wanted to live here”. Things change, California will look like the rust belt in 20 years.
Only too true, MotorCity Jim, only too true. We live in a nice area of a working-class city west of Detroit ( but before Ann Arbor ) — you can probably figure out the general vicinity.
(note - open space) My husband paid $ 174,900 for a 10-year old ranch model house in 2002. We got married in 2004 and refinanced the house ( nothing taken out on the refi - there was a 30 percent down on the home originally ), standard 30 year-fixed rate - nothing fancy here - and it appraised for $ 194,000 with a partly finished basement we had a friend put in, etc.
The house next door ( identical model on a bigger lot ) went into foreclosure the same year. It recently finally sold after 2 1/2 years for $ 158,000. The pipes had all frozen because it wasn’t properly winterized during the the period it wasn’t occupied, so they had to put in new everything. Plumbing, paint, electrical, flooring, carpet, everything. The bank originally was asking $192,000, and the real estate kept getting them to lower the price. I thought for sure it would sell when it had gone down to $169,900. Nope. $ 158,000.
The guy got a screamin’ bargain. But do I think Calif. is going to hold even a high percentage of its so-called present-day valuations ? Nope.
Real estate “AGENT” kept getting them to lower the price. I’m suffering from ” leavawordoutitis ” today.
I don’t know about a screaming bargain when all the pipes froze. Usually when they freeze they burst and cause extensive water damage. And if the house froze, I would wonder about other areas being damaged due to condensation forming and whatnot. It was probably a real fixerupper.
I don’t think its psychology so much as the market is in a state of ruin. People that would have waited jumped in and are stuck. Other people that maxed out their HELOC but are not in cash flow trouble will sit it out. There will be considerable number of people forced out. The number of really qualified people will be small. Comps will be hard to find. People will begin to get realistic about their holding costs and there will be a variety of shakeouts in govt spending & property taxes. Take about five years to sort all the mess out.
I believe the theory of reflexivity holds in the case of residential real estate and has since the run-up.
Soros on reflexivity: “…financial markets cannot possibly discount the future correctly because they do not merely discount the future; they help to shape it. In certain circumstances, financial markets can affect the so-called fundamentals which they are supposed to reflect.”
The run-up was reflexive in that appraisals began to reflect (maybe they always do?) speculation that led to greater lending and even higher prices. This process became self-perpetuating. Of course, there are other parts of the boom that were also reflexive such as real estate/ contruction employment leading to more real estate speculating, etc., and these just added to the fire.
The downside can also become reflexive and I believe it will/has. It only takes one low comp to move appraisals in the other direction. This too can become self-perpetuating. Add in the typical human nature of wanting to buy when prices are increasing and waiting when prices are decreasing and I believe we get a bust.
Finally, I believe that all the talking-heads that keep saying we are at the bottom are are having the opposite effect than they would hope. I wouldn’t be suprised if a greater % of people decide to list their house when they hear an “expert” state this than otherwise would. I don’t have a real good feel for this last point, but my feeling is that it delays all capitulation.
Shiller’s quote on negative bubbles from Irrational Exuberance:
Precisely this happened with value stocks (industrials/tobacco/oil) in 1999-2000. Tons of companies that profitably sold real products and paid handsome dividends had single-digit PEs in early 2000. Everyone was ignoring them because they wanted to buy Yahoo at $300 instead.
Btw: I wouldn’t recommend McKay’s book. I recently bought it at half price books and it just a catalog of manias that is not well written. If you want analysis behind it and the physcology of crowds, forget it.
“Manias, Panics, and Crashes: A History of Financial Crises ” by Charles P. Kindleberger is much better.
I’m still open minded that inflation could devalue our way back to normality.
Suppose a 30% fast haircut from 2006 to 2007, followed by 7% inflation for ten years. For example: a home that sold for $550k in the spring of 2006 takes a hit to $385k, and the value of 2017 dollars at a sale of $385k, would be approximately the same as $196k next year is.
That’s kinda the pattern of the 1990s CA bust.
“I’m still open minded that inflation could devalue our way back to normality.”
‘Money’ does not exist until it is borrowed into existence.
How does one inflate out of debt with the creation of more debt?
Mozo,
The problem with your logic is that a 30% fall from 2006 to 2007 wouldn’t be a “fast haircut”. It would be financial Armageddon.
Apply that percentage fall across the entire US, and that’s a $6 Trillion wipeout. Some of that is of course going to come off lender’s balance sheets, which would itself have massive consequences, but I suggest the majority of the loss would hit owners.
And it would hit them hard.
You’re assuming that wages will keep up with inflation, and that’s a really big assumption. Also inflation will result in much higher interest rates. In other words nominal prices cannot be supported by inflation.
Regarding the psychology of people and the real estate market .
In prior downturn cycles I noticed that people would hold on ,change plans ,and do anything rather than go into foreclosure .
I don’t know about this new breed of homebuyer that doesn’t have any skin in the game ,(no down payment,high payments ).If I wanted to make a guess I would say “easy come,easy go “psychology .
Also ,I do not believe we have had this level of fraud in Lending ,(with maybe the exception of Florida in 1926),so this factor alone with create some easy walk situations with someone getting the money out .
I think we might see more desperate actions than in prior downturns and I am already seeing some pretty weird stuff going on especially in the area of purchase contracts and fraud involving the lender .Right now every appraisal is suspect .
The level of optimism on this board still astounds me. Guess it’s a tribute to human nature. [Sigh]
Regarding the blog subject, yes… psychology will reign supreme over the coming collapse. The problem here is that prior busts were simply correcting for the excesses of the boom years that preceded them, whereas this time we’re going to pay dearly for nearly a century’s worth of accumulated over-indulgences. The result isn’t simply going to be cheaper housing, folks.
General thoughts today.
It is true that foreclosure people have no skin in the game (no deposit). It is also true that they have no cash and cannot rent (no first, last and security deposit). This makes them hang on to their home with tenacity. It was also their American Dream (on financial drugs ~ option arms).
Currently, banks are doing everything not to foreclose. When they do, there is a huge back-up in land court (Boston) for filing. They hold the auction; the bank buys back 80% of the properties. They order a BPO (broker’s price opinion). The property sits for a few months. The property is given to an REO (real estate owned by bank) Broker, cleaned up then put on mls as a standard house for sale. It is put on way too high. It sits. The broker must hound the bank to keep lowering it. The broker cannot speak to the bank about offers. Offers are entered into the bank’s own software, a computer decides to take the sale or not, very inefficient. These REO Brokers are frustrated.
People in the REO industry expect the banks to start being realistic about prices in 6-8 months. Then properties will be sold or auctioned at price that will sell. These lower prices will get into the comps and lower the valuation of neighborhoods. As it is now, many houses for sale actually lowers valuations.
It seems in MA that regular houses only sell when they are 15 to 20% below the asking price of similar homes. The statistics on house prices drops are completely wrong. The drops are actually much higher. If a particular statistic claims a drop of 5% yoy, the actual drop may be 20%. As an example, if the median was 300k last year and is 285k now, what doesn’t show is that a year ago the 300k house was in average (or less) condition. The 285k median house now is the best condition house on the market and may have been 375k a year ago.