Asymmetrical Information

Broken, the link is.

Works for me, the link does.

Of course, this model doesn't work in a market like Houston where there is lots of land and therefore lots of new and used housing. AND NO ZONING!!!! It does work in nanny places like LA, NY and San Diego. Angry Bear should take a chill pill. Me, I'm going to make some popcorn and enjoy the show as folks in the nanny areas pay $500,000 for a one-bedroom shack that sells for $40,000 here.

Another indicator of a bubble: At Barnes & Noble yesterday, I saw a whole shelf of books on real estate/real-estate investing that were prominently displayed.

Of course, even in the stock market bubble of the late '90s there were some stocks that were still priced attractively (like homebuilders!) and similarly, there are probably still some markets where real estate investing makes sense...

What Angry Bear doesn't have is any evidence that speculation is now any greater than it was in the past when there wasn't a "bubble". After all, there is normally some non-zero level of speculation. How does he know the speculation that is reported isn't simply that level?

To continue Al's point, is there any evidence that the current level of speculation has been associated with bubbles in the past? There's lots of anecdotal evidence we are in a bubble. I just haven't seen anything that compares where we are today with the bubbles that have popped in the past.

Does anyone get the feeling that folks are a little bubble-philic and would really like to see someone else take a bath, schadenfreude-style? I keep hearing stories on NPR and seeing articles in the NYT about it: it's almost like they're saying "Look at these stupid people! What a show it will be when it all goes pear-shaped!"

From CR (Angry Bear): Good question. How does speculation today compare to previous periods?

I described two types of speculation: Speculation as storage (like flipping) and leverage as speculation. On leverage, there is plenty of evidence of the increasing use of leverage (see my post today on AB). The use of Interest Only loans has increased substantially: 70% share in SF (first 2 months of this year) compared to 18% in 2002.

The NAR report shows an increase in "investing" from 2003 to 2004, but they didn't present data from earlier periods. I wish I had better data to compare to the early '90s bust.

Another good source on Booms and Busts are two recent FDIC reports, summarized with links here.

Best Regards to all and thanks for the mention.
CR

I never knew of Interest Only mortgages until I refinanced two years ago. It was suggested to me by my mortgage broker. I signed up, not to lower my monthly payments, but to lower my monthly obligation. I still pay down principal monthly. The Interest Only feature is a kind of insurance in case of an unexpected major life change, such as losing my job. It is far safer to be only obligated to pay the interest on the loan.

As usual, anecdotes do not define the aggregate, but I suggest that a rise in Interest Only loans is not necessarily a good indicator of increased speculation. Interest Only loans are a great way to manage risk in your personal financial situation. Their recent prominance is likely related to good marketing of a new product.

Does it make sense to talk about a housing bubble in national terms, given the enormous regional differences in the US?

For example, Northern Virginia is rather dissimilar to (say) upstate NY in terms of employment, income, availability of buildable land and rental housing, and any number of other factors that influence housing prices.

If we're seeing very different price appreciation in Northern Virginia and upstate NY, then we should probably look closely at these dissimilarities and try to figure out what kind of price premium they justify before declaring that a housing bubble exists.

MP, I agree - IO loans have been marketed very well, and some of the borrowers may just be making personal financing decisions (like you). However I've talked with several brokers in California that tell me that IO loans are the only way they can get many of their clients to qualify. So I think it is an indicator of reaching to buy.

Fredrik, I believe the bubble is expanding from the coasts. There will be a report available in early June from OFHEO that will give us an idea what areas are experiencing a housing bubble.

Klug, I have no desire to see anyone hurt financially. I just call them as I see them ... and I've written many positive comments over the years (just started blogging this year).

Best to all!

Last Thursday I read on the front page of the Wall Street Journal an article on whether a housing bubble exists or not. Greenspan's Delphic mumblings were prominent, but more useful was a statistic on home sales. Quoting from memory, 22% of home sales in 2004 were to people who did not intend to ever live in the place, but rather to rent/lease it, or flip it. Another 12% or so of sales were second homes.

So over 1/3 of home sales last year were not houses for anyone to live in all the time. Over 1/5 of home sales nationwide were speculative in nature, and while that's surely not uniformly distributed (I wager speculation in housing in, say, Las Vegas or San Diego is much higher than in Oklahoma City) it is a number so stunningly high as to to boggle the mind of someone that has lived through a housing bubble before.

Someone above mentioned interest-only mortgages: add to those the 40-year fixed interest notes and the variable-rate interest-only notes, and it is obvious that if you can fog a mirror, you can get a mortgage. This is worse than the savings & loan situation of the early 1980's...

What's that bell I am hearing...

Oh, one more thing I read in the WSJ in the last fortnight or so; old folks taking out reversed mortgages [1] and using the monies to buy a second home, take a vacation (apartment in Paris for a summer) etc. all of which ain't what the vehicle was intended for.

Maybe I should make "What's that bell?" my sig file...

[1] Some may not be aware of this instrument, in which an older person sells their house up front, and typically receives a fixed monthly payment for the rest of their life. They don't get to pass the house on to anyone, but they do get a guaranteed cash income. Intended for people who were "house poor", i.e. with little income stream, and only one investment, the house.

If we don't know and, perhaps, can't know whether we are in a bubble or not, what should individuals do?

My own two cents: You should focus on the downside more than the upside. For example, say you have $30,000 to invest and that amount plus your good credit history qualifies you for a $200k loan to purchase a rental home. With your current income you can afford to "feed" the rental property for a couple of months while in-between tenants. Obviously, if the value of the home goes up, you keep it rented, and nothing happens to your current income, the investment in the rental home will pay off handsomely -- far better than a $30,000 investment in the S&P 500 is likely to pay off. But what happens if you need to feed the home for an extended period of time because mold is discovered in the wall behind the washing machine or your tenant loses his job and it takes you 6 months to evict him (you slum lord)? Worse, while needing to feed the rental home, what happens if your current income takes a severe hit? Not only do you stand to lose your original investment, personal bankruptcy is a real possibility.

From what I'm seeing among friends and family (not clients), a lot of people don't see any downside in investing in real estate. Two years ago we turned down an opportunity to invest along side my brother-in-law in a rental home. He's about to buy his second home and my wife wants to know why we shouldn't make this safe investment with her brother. (That's 180 degrees from where she was the first time around.) The answer is that I can't see risking our entire net worth on one investment. As the former President Bush might say, "It just wouldn't be prudent." We can achieve our financial goals without making a killing on a rental home.

David Walser writes:

{Buying a single family dwelling to rent ...upside, downside..}

But what happens if you need to feed the home for an extended period of time because mold is discovered in the wall behind the washing machine or your tenant loses his job and it takes you 6 months to evict him (you slum lord)? Worse, while needing to feed the rental home, what happens if your current income takes a severe hit? Not only do you stand to lose your original investment, personal bankruptcy is a real possibility.

The downside can (and likely will) be simpler than the above, and maybe worse.

What happens when:

1. Overbuilding in the local housing market finally leads to a glut, followed by a local housing market collapse, with sale prices on single family dwellings dropping by 10% to 30%.

2. The increased number of distressed properties leads to a "price war" in the rental market.

The result is simple: the house cannot be sold for enough money to pay the loan off (inverted loan) and no longer can be rented for enough money to make the monthly payment. The owner now can either sell at a big loss, or take a small loss every single month until the rental market firms up. Bankruptcy is a third option, but the recent law changes make that much less attractive.

Having seen this scenario in person a couple of times, if I were in the hypotheical "$30,000 and nowhere to put it", I'd not want to put it in real estate; that's what everyone else is doing, just as "everyone" was in the NASDAQ 5 years ago...

To amplify one point that David Walser wrote, let me agree wholeheartedly with "watching the downside". As with day-trading circa 1998, speculating on houses right now has become quite popular, and thus is riding on the crest of a wave. One doesn't have to be a follower of Prechter to realize the danger that exists in a highly leveraged buy of any asset when "everyone is doing it".

Ellipsis - I doubt your condition 1) will *ever* be met in the Bay Area market. Things are so over-regulated here that it's politically impossible to build enough houses/condos/etc for everyone who can make a living here. There was residential building going on every year through the dot-com crash, even though commercial building had slowed nearly to a stop.

condition 2) *did* happen in Santa Clara County, and some other areas, though to some extent, it's a chronic condition in the Bay Area - it's almost impossible to find small rental properties which will cash-flow when you buy them. But if you live in your house for a few years until the rental market goes up, you can usually rent out your house for more than your payments.

I am open to the idea of a housing bubble but we should be open to the idea that we are seeing a secular shift in mortgage financing away from the world in which a traditional fixed-rate pay-down-your-principal mortgage is the standard way to finance a home purchase to one which predominantly uses a floating-rate interest-only mortgage. I don't know how to test that idea but I live in a tony suburb of NY and, like Anthony, I am skeptical about there ever being enough supply to permit a full-fledged decline in home prices in my area.

http://www.efficientfrontier.com/ef/405/housing.htm

I lived through TEFRA '86--we bought in 1987 two months before the market crashed. Our $60K home that we had just bought for $200K was suddenly worth only 150K. The increasing housing prices were leveling off even before the market crash, but the market crash caused an instant glut on the market. We sold 10 years later still at a loss. Now that house goes for over $300K.

My opinion is that when the housing bubble collapses, it will only level prices out, with the huge annual increases stopping, UNLESS there is also a recession in the economy.

Anthony and jult52 both assert that the law of supply and demand doesn't apply to two extreme cases on opposite sides of the continent: the San Francisco Bay area (and San Francisco in particular) and the New York City area. Both are noteworthy cases where government has actively interfered in the housing market for 50+ years, creating huge distortions, especially pent-up demand. It is likely therefore that my scenarios above will only come to pass in such areas as part of a general, nationwide housing crash. That does not mean that it is impossible...

One housing bubble I saw was in part exacerbated by government meddling, the local government was fretting over too-rapid growth and saw fit to limit the number of residential building permits that could be issued in any given month. The law of supply and demand took over & the price of new housing was kicked up even higher, literally over night. Eventually this limitation was removed, and that may have been the catalyst for popping the bubble, but it was bound to happen in time anyway.

However, IIRC real estate values in some parts of the Greater NY Area did decline in real terms during the 1970's. Social decay was a factor. I am not sure what it would take to cause such a decline in San Francisco, something drastic to be sure.

As to the effects upon housing prices of a popping bubble, likely that won't be uniform across the country, either.

I agree with that Bear, but perhaps only because I want to. I live in a wildly inflated market and I listen to people talk about their homes the way we used to talk about tech. Bad idea. Anyway, I hope the Bear is right about a leveling off.

Personally, I fear far worse. If you're not keeping up on your mortgage, you will get foreclosed and no one's worse at selling houses than a bank. I've seen it before--the bank just flops it out there for quick liquidation. You ought to see what happens to your home value when the bank has a couple of your neighbors houses for sale.

It looks to me like the Fed is trying to engineer a soft landing for that market and the Chinese aren't helping them.

However, IIRC real estate values in some parts of the Greater NY Area did decline in real terms during the 1970's.

They declined in many of the NYC suburbs, tony or otherwise, in the late 80s and early 90s.

Does anyone get the feeling that folks are a little bubble-philic and would really like to see someone else take a bath, schadenfreude-style?

I confess; I don't want to see anyone take a bath, and I actually pity most of the investors who are going bust in Las Vegas and elsewhere, but I am eager to see the bubble pop and relish the prospect of bad news.

Why? Because I've seen this bubble divide my friends and coworkers into two groups of haves and have-nots based on whatever random variables made it possible for some of us to buy before 2001 and some not able to buy at all. It comes down to being a few years older, to settling down earlier, to having an opportunity fall in your laps, to having parents who can help out financially. This bubble has turned what was once a rite of adulthood for middle-class people into a privilege of the rich or the previously-housed.

Me and some of my coworkers bought houses when interest rates were higher (30yr for 8%) and affordability was difficult. We refinanced several times. So now our payments are lower AND our homes have appreciated from lower interest rates that make every borrower richer. We are sitting on a big pile of paper wealth we can never monetize unless we want to ignore the very reasons we bought homes in the Boston area in the first place.

The existence of that wealth means that many of our friends are stuck in a rental situation that keeps them in a sucky post-college rental phase or forces them to settle for a horrible quality of life in a small house 1 hour's drive away from work in New Hampshire--if they can even afford that.

I see prices increase for stupid reasons. Namely, the financial innovations that encourage unqualified buyers to borrow more and more money on delayed terms only so they can compete with similarly unqualified buyers getting the same I/O loans, bidding prices up higher for those who want to play the game right and responsibly. It's documented madness and I take no joy in my own benefit from it. I'd be happy to sacrifice a big chunk of my appreciation to the bubble gods if it would restore sanity and fairness to the market. In the meantime, I will stay put in my house, pay down my principal, and hope for the best for my friends who have to navigate this ferocious market.

Brittain33,

The solution for your friends is to move. I live in the NVa area and my house has appreciated $150K in less than a year. I am actively looking for jobs in lower cost states. I figure I could take a $10-20K drop in pay, move, and after buying a house, be debt free (cash for the house), and increase my monthly net income (after taxes and mortgage) by $3-4,000. Yes, that big a difference. Go looking at realtor.com sometime and figure where you can move. I plan to relocate closer to family.

If you want to stay in that post-college phase you can - but you don't HAVE to. MOVE.

That's why I would be happy to see the bubble deflate. They don't want to have to leave, and I'm not thrilled to see people I like facing that decision because the market is "frothy". It also doesn't help that jobs in our field are concentrated in the bubble zones, with only a few exceptions. Five years ago, Boston, like NoVa and L.A., seemed to be a place where young educated people could make a good living, build a nest egg, and settle down. It was different from Manhattan and San Francisco. That no longer is quite the case.

The distribution of winners and losers in this current bubble is fairly arbitrary within a given generation. That makes it tougher to swallow. I can accept that Boston was due for some appreciation because of supply/demand constraints and the fundamental desirability of the area, but the existence of speculation and 103% mortgages and I/O mortgages driving up prices further makes me eager to see this trend die, NOW.

I know I'm pissing into the wind here. I am explaining my schadenfreude about real estate market problems, not proposing a solution.

B33,

I sympathize, but there are plenty of places in the US were young, educated people can make a living. And most are NOT in the bubble zones. For high tech (don't know your specialty), you can look in many places - Austin TX, Columbus OH for two off the top. Plenty of big cities where prices are not crazy. Off the top of my head: the two above, plus Dallas-Fort Worth, Indianapolis, Cleveland, Ft Lauderdale, Charlottesville SC, Colorado Springs-Denver, Albuquerque NM, and many more. If you are wedded to a bubble zone, and I have friends who are, then your stuck. If you are wedded to being in a top 5 whatever business, or melded into the US federal government your probably stuck. I know many people who can’t imagine moving far from the nations capital – the ‘center’. Yet they complain about the traffic, prices etc. I always say move. They have the skills. There are tons of opportunity out there - you just have to MOVE.

And if you are not willing to move, I don't have much patience. I just retired from the military and moved 9 times in 20 years (and that was below average!). It can be done.

Experts have been predicting the imminent bursting in my area (Ka-le-for-nee-ya's Kapital) for three or four years now. Still waiting (tick-tock) as prices in my neighborhood pass the three hundred, four hundred, now five hundred dollar per square foot level. Homes here continue to sell in a week, frequently above asking price.

Some of this market is driven by Bay Area equity refugees, some by folks moving back into town from the 'burbs to reclaim the ten hours a week they've been losing on their commutes, not to mention those who are simply tired of maintaining 5000-sq ft mcmansions.

Local stats show there is a higher percentage of non-owner occupied housing of late--the presumption is that money that traditionally went into stocks has instead been doing very well in real estate since around 2000. At some point ('08?) stocks should straighten out and lure this money back out of housing. If that were to happen today, I don't belive that would be a bad thing locally. We'd quickly absorb the additional stock.

This region's market seems rapidly self-correcting. When there's a slowdown, the developers slow housing starts in response, which helps maintain resale values. Too, there's the inevitable 100k/yr California population increase. They've got to live somewhere.

I'll note in passing that the 10-year bond is back down to 4.04 as I write this, a level few predicted we'd be seeing again. Cheaper mortgages will tend to sustain the price spiral for a while longer.

p.s. I don't know why so many seem fixated on SF. It's built out folks, although I suppose if you wanted to you could turn it into a little Sao Palo by letting developers run amok. While it is astonishingly expensive, it's so small that it has a minor impact on the region's stats, overall

Colorado Springs-Denver

Well, anyone's free to look, I guess, but it's not that spectacular in this area. The CO Springs housing prices are decent but that's becuase the market is presently deflated. Building progress in the Denver area continues like mad.

---Another 13% of homes were purchased as second homes. ---

How many of those homes were bought by foreigners? Especially out West and in FLA?

Nominal, I would think, but shouldn't that still be taken into account?

Sandy P. observed:

{I wrote}
---Another 13% of homes were purchased as second homes. ---

How many of those homes were bought by foreigners? Especially out West and in FLA?

Interesting question, to which I have no answer; the article in the WSJ didn't even break that statistic down by regions.

Nominal, I would think, but shouldn't that still be taken into account?

I suspect it would be nominal as well, based on what people from the Carolinas tell me (barrier island vacation homes), what people from the Rockies tell me (mountain vacation homes) and so forth. However, the more data one has, the better.

I wish that someone had accurate information on Fannie Mae and Freddie Mac, for example...

All I know is that the anglos are buying up Orlando, it was an article or 2 in the local paper down there.

1 couple interviewed were 40-something sisters who pooled their money to buy a condo.

Sometime I wonder if they're getting out of Dodge.

Sandy P observes:

All I know is that the anglos are buying up Orlando, it was an article or 2 in the local paper down there. 1 couple interviewed were 40-something sisters who pooled their money to buy a condo.

One of the sad aspects of any bubble is the large number of ordinary people who join in a little too late. The apochryphal shoeshine-boy-giving-stock-picks is a sign that the last buyers have arrived, and soon there won't be too many "greater fools" left to sell stocks/houses/tulips/whathaveyou to.

As with buying, say, Cisco in 1999, joining the party late, but not too late, can have benefits...but buying Cisco right before the big NASDAQ swan dive was what some number of people did.

I was looking at the M's the other day (M1, M2, M3, MZM) and trying to figure out the velocity. Since "money" is that which is created by debt nowadays, if the M's really are decelerating in velocity, that means that demand for money is slacking off, which is highly suggestive. The market for house mortgages may be huge, but it still is finite...and when everyone who wants a house has one, or two, or three, then the demand for mortgages has to slack off.

Incidentally, I read a claim the other day on line that the majority (>50%) of house loans in 2004 were variable interest rate in some form or another. That is, IMHO, a time bomb waiting to go off, because even with all the games played with the CPI ("hedonics", etc.) it still has gone up to over 3% annualized in the last 12 months. The classic cure for that, from the central banker point of view, is to raise interest rates...

Related articles:

• Where's the Bubble? by James K Glassman, (also published as Gimme Shelter), 5/20/20005


• No Housing Bubble Trouble by Alan Reynolds, 1/9/2005

Yesterday in an editorial in the WSJ I learned that 66% (or roughly 2/3) of all new house loans in the San Francisco - Silicon Valley corridor on the Peninsula were interest-only mortgages.

I'm glad to see some deep thinkers from Cato and other places are convinced there's no housing bubble; if I recall correctly, 5 years ago some people were claiming that the stock market was in a New Era and would always go up. "DOW 30,000" was a popular title. The Dow seems to be rather falling short of that number so far, and given the essentially sideways movement of the stock market for 4 years now, there seems to be a flaw in the notion that stocks always go up 8% or more per year.

But now we are supposed to not pay attention to al that stuff, now it's housing that will always go up...because housing is different than the stock market, it's local, it's real, and of course people will always need a place to live, so it can never go down...it's different this time.

In "Extraordinary Popular Delusions and the Madness of Crowds", Charles MacKay documented the Tulip Mania, the Mississippi Bubble and the South Seas bubble, among other things. One common ingredient in bubbles is the repeated insistence by otherwise intelligent people that "this time, it is different!".

I'd be surprised if there weren't some otherwise intelligent people insisting that (a) there's no housing bubble anywhere in these United States because "it's different" and (b) even if there was, the wise and mighty Fed will let the air out of it slowly, bringing us to a "soft landing"...

By the way, I finally got around to reading the Angry Bear article more carefully, and find much merit in it that doesn't seem to be addressed by any of the "there's no bubble" folks. The fact that 23% of houses in 2004 were bought by people who had no intent of living in them is extremely suggestive of a speculative overbuilding condition...

Is this a straw in the wind?

http://www.idahostatesman.com/apps/pbcs.dll/article?AID=/20050426/NEWS0202/504260344

Remax West real estate broker Stacy Budell, whose office is within two blocks of HP, said she already has fielded a dozen calls from worried employees. "They're all saying: 'How much can we get for our house?' " She said most HP homeowners she's spoken to hope to sell their homes and relocate for new jobs, a potentially money-losing proposition despite Boise's strong housing market.

"When I tell them how much (closing costs) will be, many of them can't afford to sell," she said. "Many had a second mortgage to pay off credit card debt and buy all the Boise toys we all seem to like — SUVs, snowmobiles and boats. They already took all the equity out."

Treating one's house like an ATM has been strongly encouraged for the last 4 years (and arguably going back into the 1990's), but has a cost. How many people laid off at Boise HP will have to sell their boat, trailer or other recreational thing to pay for part of relocation, I wonder?

Is this a straw in the wind?

http://www.idahostatesman.com/apps/pbcs.dll/article?AID=/20050426/NEWS0202/504260344

Remax West real estate broker Stacy Budell, whose office is within two blocks of HP, said she already has fielded a dozen calls from worried employees. "They're all saying: 'How much can we get for our house?' " She said most HP homeowners she's spoken to hope to sell their homes and relocate for new jobs, a potentially money-losing proposition despite Boise's strong housing market.

"When I tell them how much (closing costs) will be, many of them can't afford to sell," she said. "Many had a second mortgage to pay off credit card debt and buy all the Boise toys we all seem to like — SUVs, snowmobiles and boats. They already took all the equity out."

Treating one's house like an ATM has been strongly encouraged for the last 4 years (and arguably going back into the 1990's), but has a cost. How many people laid off at Boise HP will have to sell their boat, trailer or other recreational thing to pay for part of relocation, I wonder?

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