The Housing Bubble

It’s Friday desk clearing time for this blogger. “Tens of thousands of Stocktonians owe more on their homes than their homes are worth. Stockton got $16.2 million in Neighborhood Stabilization money. It did not help one person keep a home. Instead, it bought the city 51 vacant homes via foreclosures. Ronald T. Pate bought a home on Denver Avenue for $450,000 in 2005. In 2007, facing balloon payments that would adjust his mortgage sharply upward, he attempted to refinance. His bank said no. The Pates found themselves paying 8.5 percent interest: $2,575 a month. Unable to continue, they are short-selling their home. The ordeal has stressed their marriage and contributed to making them physically ill, Pate said. ‘It took a toll on me and my wife,’ he said.”

“The recession is primarily a housing market collapse. Fixing that market is, or should have been, Step 1 in spurring recovery. Not just in Stockton, but all California. ‘It’s fundamental to our recovery,’ Mayor Ann Johnston said of distressed homeowner assistance from Uncle Sam. Instead, ‘I feel totally abandoned and neglected and the poor stepchild in this nation, honestly,’ she said.”

“In Charlotte, N.C., a foreclosed McMansion is going for half of its 2007 value. Lee Brown, a Realtor in the area, says Charlotte has a community of ’starter castles’ that were built at the height of the housing boom. They have ‘really ornate exteriors’ with French, German and Swiss influence ‘all tossed into the same house,’ she says.”

“During the boom, she says, many people moved to Charlotte for high-paying jobs in the banking industry, but lost them when banks shut down after the crash. One of the foreclosure properties sold for $1.27 million in 2007; Brown expects it to now sell for about $650,000.”

“‘You’re talking a beautiful home, and you can see it’s got the hardwood floors, and it’s got the fancy kitchen,’ she says. ‘And you’re going to get two chandeliers in the dining room — and who needs two chandeliers in the dining room? But you know, hey, there’s something for everybody.’”

“The United States has a confidence problem: a nation long defined by irrational exuberance has turned gloomy about tomorrow. Consumers are holding back, businesses are suffering and the economy is barely growing. A growing number of economists argue that the collapse of housing prices, a defining feature of this downturn, is also a critical and under-appreciated impediment to recovery. Americans have lost a vast amount of wealth, and they have lost faith in housing as an investment. They lack money, and they lack the confidence that they will have more money tomorrow.”

“‘People don’t expect their home to regain value, and that’s really led to a change in consumer attitudes about the economy that we’ve just never seen before,’ said Richard Curtin, a professor of economics at the University of Michigan.”

“Many say they believe that the bust has permanently changed their financial trajectory. ‘I don’t know that it’s going to get better. We just have to get used to it,’ said Sherry DeWeese, whose home in Ocoee, a northwestern suburb of Orlando, is worth less than she paid for it 13 years ago — and about a third of its value at the peak of the market. ‘It was nothing to buy whatever we wanted. Now we just think about what we really need.’”

“Why are people so enthused about owning real estate? For one thing, most individuals have an innate or intuitive feeling that home ownership is a good, safe investment that offers attractive financial returns. Most homeowners don’t have the slightest idea what the annual return is. The median price of a single-family home in California rose from $99,550 in 1980 to $296,820 in 2010, an annual increase of just 3.6 percent. Even if sold at a peak price in 2007, the return would have been 6.6 percent annually. If the $20,000 down payment had been invested in 1980 in a diversified portfolio of stocks returning 10 percent annually, the stock portfolio would be worth $349,000 in 2010 – $52,000 more than the house.”

“At the macro level, real estate can create havoc for an economy as experienced by Spain in the 1970s; Norway in the 1980s; Sweden, Finland and Japan in the 1990s; and Ireland, the U.S. and a multitude of other countries in the 2000s. This is because real estate is subject to speculative bubbles whereby people buy homes not based upon fundamentals such as population growth, rents, interest rates and economic conditions, but simply because prices have gone up and are expected to continue going up. Valuation factors sometimes don’t count as much as collective investor euphoria. It’s as if the laws of supply and demand are reversed. As prices go up, demand should go down. In a housing bubble, as prices go up, so does demand.”

“In the U.S. today, 25 percent of the homes have less value than owed on the mortgages. As in Japan, where housing prices fell by 75 percent in the 1990s, housing will be a drag on the U.S. economy for at least another five years, and that is probably being optimistic.”

“Who is to blame for the housing bubble and subsequent mess in the U.S? Almost everyone – the U.S. government, mortgage lenders, investors, home speculators, ratings agencies, the Federal Reserve, regulators, financial innovation and a host of others. There is enough blame for everyone involved. It has created a mess for the U.S. economy with no easy solution.”

“Homeowners being pushed into the foreclosure pipeline are typically eight months behind on their mortgage payments and owe a median of a little less than $20,000, DataQuick reported. It currently takes about 10 months for the foreclosure process to be completed. Most of the loans going into default continue to originate from the 2005-07 period, when underwriting standards were at their weakest, according to DataQuick.

“CSU Channel Islands economist Sung Won Sohn thinks there are more foreclosures to come. ‘So many houses are ‘underwater,’ he said. ‘In California alone, there are probably about 2.5 million homes underwater, where the loans are higher than the value of the house. ‘Given the lackluster employment outlook, the indications are that we will see more of it, not less.’”

“Pressure from government officials and problems with paperwork held banks back from a lot of foreclosure activity and now they are moving forward again, Sohn said, adding that the drawn-out process is bad. ‘These are homes that would be foreclosed on sooner or later, and it’s better for banks and for consumers to get it done quickly,’ he said.”

“The idea that big banks damage the broader economy has considerable resonance on the intellectual right. The mainstream political right, however, has been reluctant to take on the issue. This changed on Wednesday, with a very clear statement by Jon Huntsman in The Wall Street Journal on regulatory capture and its consequences. Before the 2008 financial crisis, he wrote, ‘the largest banks were pushing hard to take more risk at taxpayers’ expense.’”

“And now, he added: Eugene Fama, father of the efficient markets view of finance, had it exactly right when he said, in the same interview that ‘too big to fail’ ‘is not capitalism; capitalism says - you perform poorly, you fail.’ ‘Too big to fail’ is not a market-based concept; it’s a government subsidy scheme - of the most inefficient and dangerous kind.”

“It’s not enough just to wish that big banks could fail or to promise not to support them next time. This is not a credible commitment - and the ‘resolution authority’ created under the Dodd-Frank regulatory legislation is a paper tiger with regard to winding down the biggest banks. If the choice is global economic calamity or unsavory bailout, which would you - let alone any Republican president - choose?”

“Mr. Huntsman has joined the dots. There are various ways to directly address and remove the implicit subsidies that the largest banks receive. Bloated size and excessive leverage can be effectively taxed. As he said: ‘The euro zone is on the verge of calamity in large part because its members built very large banks with huge implicit subsidies, and this facilitated an irresponsible accumulation of public sector debt. During the Dodd-Frank debate last year, we heard repeatedly from people - including senators on both sides of the aisle - who believed that reducing the size of our largest banks would somehow put the rest of our private sector at a disadvantage.’”

“Who now would like to emulate in any way the disaster that the Europeans have brought upon themselves? Mr. Romney, please explain how you would prevent our largest banks from becoming ever larger and taking on more risk, and, as they did, continuing the reckless buildup of debt throughout the global economy.”

“As a card-carrying member of the leftist media near-elite — alas, I’m not nearly rich or famous enough to be regarded as a 100% elitist — it pains me to see my brethren sinking like the sun in the west. But we have nobody to blame but ourselves. We’ve been out of touch with what people on the streets are thinking. The problem is twofold. We didn’t care to listen to them, and by the time we heard them we had missed the opportunity to break the story and inform the public. We were followers, not leaders.”

“As a result of their biases, reporters didn’t understand that the tea party was a compelling story because the organization’s members represented a large number of disenfranchised voters. You’d think they might have learned their lesson by the time the Occupy Wall Street movement began to gain traction over the past few weeks. I’m as guilty of negligence as anyone. I and so many media stalwarts work in Manhattan, for heaven’s sake. We have no excuse. It’s not as if all this discontent had been brewing in some outpost like St. Louis before overflowing on national television.”

“Once again, we shrugged off the protestors as members of the fringe, not as angry Americans who had something substantial to say about the depressing state of the union. Hopefully, we in the media elite — and yes, the near-elite, like me — can get it together the next time.”

“A new audit of the Federal Reserve released today detailed widespread conflicts of interest involving directors of its regional banks. ‘The most powerful entity in the United States is riddled with conflicts of interest,’ Sen. Bernie Sanders (I-Vt.) said after reviewing the Government Accountability Office report. The study required by a Sanders Amendment to last year’s Wall Street reform law examined Fed practices never before subjected to such independent, expert scrutiny.”

“The GAO detailed instance after instance of top executives of corporations and financial institutions using their influence as Federal Reserve directors to financially benefit their firms, and, in at least one instance, themselves. ‘Clearly it is unacceptable for so few people to wield so much unchecked power,’ Sanders said. ‘Not only do they run the banks, they run the institutions that regulate the banks.’”

“The report noted that there are no restrictions in Fed rules on directors communicating concerns about their respective banks to the staff of the Federal Reserve. It also said many directors own stock or work directly for banks that are supervised and regulated by the Federal Reserve. The rules, which the Fed has kept secret, let directors tied to banks participate in decisions involving how much interest to charge financial institutions and how much credit to provide healthy banks and institutions in ‘hazardous’ condition. Even when situations arise that run afoul of Fed’s conflict rules and waivers are granted, the GAO said the waivers are kept hidden from the public.”

“In 2008, the New York Fed approved an application from Goldman Sachs to become a bank holding company giving it access to cheap Fed loans. During the same period, Stephen Friedman, chairman of the New York Fed, sat on the Goldman Sachs board of directors and owned Goldman stock, something the Fed’s rules prohibited. He received a waiver in late 2008 that was not made public. After Friedman received the waiver, he continued to purchase stock in Goldman from November 2008 through January of 2009 unbeknownst to the Fed, according to the GAO.”

“Jamie Dimon: The CEO of JP Morgan Chase served on the board of the Federal Reserve Bank of New York at the same time that his bank received emergency loans from the Fed and was used by the Fed as a clearing bank for the Fed’s emergency lending programs. In 2008, the Fed provided JP Morgan Chase with $29 billion in financing to acquire Bear Stearns.At the time, Dimon persuaded the Fed to provide JP Morgan Chase with an 18-month exemption from risk-based leverage and capital requirements. He also convinced the Fed to take risky mortgage-related assets off of Bear Stearns balance sheet before JP Morgan Chase acquired this troubled investment bank.”

“Sanders said he will work with leading economists to develop legislation to restructure the Fed and bar the banking industry from picking Fed directors. ‘This is exactly the kind of outrageous behavior by the big banks and Wall Street that is infuriating so many Americans,’ Sanders said.”