Asymmetrical Information

True, but in Southern California, where land is at a premium, I would wager that his house will gain substantial value over time---even the medium term.

Indeed, even if mortgage rates go up (or, more accurately, when they go up), I am fairly confident in saying that it is unlikely to have a severe effect on real estate prices in SoCal. Perhaps a short-term slowing, but by no means even medium term effects.

Heck: note that it is a tiny house in a not-so-nice part of Anaheim. It costs $360,000 not because interest rates are low, but because of the nature of the market there. What will happen once rates go up is that any future buyer of this home will have to make more than Mr. Daneshi made when he bought the house.

I wasn't sure why this anecdote was news until I read the linked article - then I realized that lending institutions seem to be joining with home buyers in betting that all future trends will be to their mutual advantage.

I hope these practices are not spreading as widely as the NYT implies - I think they are setting up a lot of people for a lot of pain, unless the future is brighter by far than I expect.

Were I in their shoes, I'd be working three jobs to pay off the higher rate mortgage early - and then keep working to try and get ahead on the bigger, lower rate mortgage.

I think an internet search for a job where the cost of living is not insane would make more sense - the Indianapolis area can always use hard workers...and $360K buys a pretty nice McMansion, around here.

I don't know situation in Orange County, but on other side of L.A., in San Fernando Valley (Valley Girl home) there is a one month supply of homes on market. Historically, six months supply is balance point for supply/demand equilibrium. Sales will SLOW with rate increases, and prices MAY rise slower, but barring an act of God (we're in L.A. remember)Mr. Daneshi should be alright with his investment.

I've been wondering what Jane thought of the NY Fed report that there was no housing bubble.

Has anyony read John Talbott's The Coming Crash in the Housing Market yet? I'm curious as to what some of you think of the arguments put forth in that book (the FMs monopoly, etc).

- Homer

Seems to me to be a trend by non-fiscally aware people. Other trends to consider are:
1) Single people with no kids buying fancy big Ford Expeditions (it was reported that 51% of Ford Expedition buyers were single and kidless).
2) Baby Boomers not making sure they have enough put away and spending (as they always seemed to vs. their parents) on Audi, Lexus and other things that won't help them survive.
3) I could go on. These are trends that deviate from the mindset of the WWII generation folks.

What these trends lead to is:
1) A harder fall during recession periods because they didn't have the foresight to save for the rainy day.
2) Impose a cost on the rest of Americans when the baby boomers will start needing massive health care in their later years and the single kidless buyers of Ford Expeditions are out of work and needing massive infusions of cash or claiming bankruptcy.

It behooves all of us fiscally aware people to try to educate the non fiscally aware what they may be getting themsevles into. Even if they are friends or family and don't want to hear it.

Yeah, it's stuff like that this almost certainly signals a bubble near its peak. However, it's possible that home prices in OC will only dip slightly, or even just flatten out.

I have a hard time believing that these days, but you never know.

In a state like CA, housing prices will continue to go up probably because of supply and demand. More and more illegal and legal immigrants increase the demand. The supply isn't going up at the same rate. Therefore the amount of money that people have to pay for the product (shelter) that is becoming more scarce goes up.

This could change if the immigrant situation changes which I can't forsee.

What this leads to is bank failures if the real estate market tanks.

I have read that the UK and Australia have had much more real estate price increase than the USA. I wonder if their banks are vulnerable to failure in a downturn.

Sorry to burst your bubble (so to speak), but housing prices are a function of a heck of a lot more than just mortgage rates. If other market factors (demand growth, general price inflation, overall and regional economic health, to name a few) remain within acceptable parameters, there is no reason to suppose that a housing "crash" is in the offing.

If other market factors (demand growth, general price inflation, overall and regional economic health, to name a few) remain within acceptable parameters, there is no reason to suppose that a housing "crash" is in the offing.

Well, sure there is: human psychology, backed up by centuries' worth of examples of past bubbles (Dutch tulip bulbs, anyone?). What you're all assuming is that the current price level of housing in places like OC has been arrived at because of economic fundamentals. But markets can also be driven by human psychology, and occassionally, human psychology gets it wrong in a major way. Remember, a shitty 2-bedroom condo in Orange County is worth $500k only because enough people agree it's worth that much -- not because of some immutable laws of physics. If enough people agree it's actually worth only $400k, then the price will drop by 20% (which still makes OC a pretty pricey place to buy a house, by the way). Besides, one of the biggest of the market fundamentals, the price of borrowing money, is subject to change.

You folks best wake up and smell the coffee: just about every indicator is SCREAMING that housing is badly overvalued in the pricier markets of rich countries.

Housing prices do not need to fall for these new homeowners to be in trouble. If mortgage rates rise, their variable rate mortgage payment will increase. Given that they have no equity in the home, they are betting that they will be able to sell the home for enough to pay off the mortgage AND cover selling expenses AND do this quickly enough, should their payment rise to the point they cannot meet their obligations.

There may be a good chance they could do this and make a profit on the deal (if real estate prices go up 6% - 10%, the should be able to get out of the home), but it's still not a prudent bet. They can barely make their payment if everything works as planned -- if our self-employed wedding photographer is sick for a week or has a slow month, what are they going to do? The upside of home ownership is nice, but the downside is bankruptcy. Even if you believe there is a better than even chance things will work out, why would you place a bet you cannot afford to lose?

A few more thoughts on the topic of housing as an investment. I've never understood this concept. Both times I've considered acepting a job offer in California, I balked at the cost of housing. Both prospective employers told me that California homes would appreciate and that I would make a lot of money off of my "investment" in the home. True, but, unless my home was the only one in the area that had gone up in value, I'd have to move to a cheaper location to reap the benefit of the increased value. In most circumstances, homes are an expense, not an investment.

One problem is that people have been raised to believe that home ownership should be a goal of everyone. However, once you get to a market like SoCal or NorCal, where tiny houses in bad neighborhoods cost $3k a month in mortgage payments, you realize that a $1500/month apartment is not a bad deal. Especially if (when?) the housing bubble bursts.

Plus, there are a lot of people who bought there houses before the prices started going up. Instead of getting rid of their houses when they move out, they rent them out for much less than a mortgage payment would be.

For years, Ray and Shahrazad Daneshi sought to buy a home... But they recently managed to buy a small house ... with no down payment.

I hope the Daneshis do well. Without knowing how their ARM is structured, I can't guess how likely that is (regardless of housing prices, as David says). I certainly hope they didn't get a special intro rate on their loans.

My real concern is that they "sought" to buy a house for years, and didn't manage to save even a small down payment. If they have few savings, home ownership will be a shock; they can't call the landlord when the dishwasher floods the kitchen, after all.

One bright spot is that they'll probably save some money on their taxes (something the NYT neglected to mention).

California adds half a million people to its population yearly, in boom times and in lean. There's a perennial need for more housing that seems to defy the economy. Generally speaking, when the housing market softens here, *housing starts* drop in response, which seems to do a good job damping deflation of existing stock. The builders wander off, sometimes to Florida to wait for the next hurricane, and return here when things heat up again. The most-susceptible markets to deflation are built-out cities with no significant capacity for adding new housing. But deflation in a place like SF might mean a median price drop from $650k to $550k, eliciting shrugs everywhere. Whether prices of lower-cost homes would budge at all remains to be seen.

In more typical California cities such as mine, when prices have slackened it's been limited to higher end houses; entry-level homes didn't seem to take a hit. I suspect it’s because nobody builds entry-level homes except during slow markets. Personally, I have no worries about my situation, with an “inflated-value” house and a four-and-a-quarter-percent loan. I might have “made” more money on my house in the last year than I earned working the last two, but that’s balanced by having had a flat value through most of the ‘90s. After whatever market adjustments occur in the next year or two (presuming significantly higher interest rates) the value it settles at will surely be higher than where it was two years ago. Too, a big factor in the recent increases is the desirability of my 10-minute commute to downtown, and my ‘30s-era house. The farther away they build and the longer the commute, the better mine looks. The rare house that comes to market in my neighborhood sells in less than two days.

p.s. For war stories, the SF Chronicle has an occasional column--"Surrealestate"—of housing tales that have to be read to be believed.

I have a friend who went through bankruptcy in the early 90's when she and a whole lot of other engineers around Dallas lost their jobs. After nearly ten years of mortgage payments, suddenly her house was worth less than the remaining principal.

However, CA may be insulated against that sort of bubble-popping. Bubbles rise and fall largely on psychology. As long as people believe prices will keep rising, they'll spend all they can get buying into it, and this will keep the prices rising. Short of a sudden increase in intelligence, the only thing that stops this process is when there is no longer enough cash around to keep it going - and even then, it still might be possible for it to plateau instead of crashing, if enough people believe that it's just a temporary interruption in a long-term rising trend. (In fact, falling house prices are always just a temporary interruption - it's just that "temporary" is likely to be longer than you can hang on to the house.)

In CA, people really believe that house prices will go up forever - because they are "running out of room." This isn't literally true, but it's true enough if you don't want a few mountains between your house and the city. In Texas, OTOH, anyone who thinks we are running out of room needs to take a drive into the countryside...

The second thing about CA is, no matter what the economy is doing, it seems like there are always more people trying to move to California. Housing prices can keep rising as long as some of them either bring enough money for a fat downpayment, or are starting on high-paying jobs.

Maybe it will crash eventually, when the People's Republic of Kalifornia has finally managed to crush all innovators and new businesses in the state. But no doubt by that time, the gov't will be ready to take over the banks and forbid foreclosures... And be very surprised when the result is that the only legal businesses left in the state are the politically influential ones that sell to the government - until the shrinking tax base puts an end to that.

There were a lot of good and interesting comments above. However, as a Californian, I feel compelled to add my 3 cents:

CA's housing market tends to go in boom-bust cycles. Shortages and speculation fuel overheated real estate markets. The frenzy reaches and unsustainable level, the bottom falls out, and the bubble pops, and the waves of foreclosures start.

Today, Beaumont is the fastest-growing city in CA. I drive by it regularly, and it's truly amazing. Mostly, it's being driven by folks from the coast, who are moving inland because they can no longer afford the prices in LA (or SF or whereever.) 10 or so years ago, it was Moreno Valley, another area city, which was the fastest growing city in the country. Then the market crashed, and Moreno Valley was hit with quite a few foreclosures, as people realized that they were paying more than the house was worth.

The main debate among experts out here, from what I can tell, is whether this pattern is repeating itself, or whether we'll have a soft landing, and get a somewhat more docile real estate market, like other parts of the country. Personally, I wouldn't count on it. With the prices that are being charged, even in out of the way places like Beaumont, it can't continue. Either prices will have to come down, or we're going to have to seriously change the way we live (more apartments, etc.)

Housing prices correlate more closely to the job market than to mortgage rates. California real estate won't come down in price unless there is a widespread loss of jobs coupled with increases in mortgage rates.

A lender is letting them pay 50% of their income in mortgage payments? Boy, they're going to get the bad loan they deserve.

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