Archive for the 'Mortgages' Category

Date: December 13th, 2007, Filed under Mortgages

Zion, IL
By A.B. Dada
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A reader, Jen, posted a comment on a previous posted titled Housing Prices always go up — not really. Her insightful comment was as follows:

Very sound advice, but according to your rules, only about two percent of the country can afford to live in Southern California. In Sherman Oaks, where I live, the average income is about $62,000; the average price of a home is over $500,000. Since apartments in the area rent for about $2,500 a month for a 1100sqft 2-bedroom, it’s hard not to see the appeal of paying about $3,500 in a mortgage for a home the same size. Of course, that mortgage is about 75-85 percent of a family’s income. In order to “afford” even a tiny house or studio apartment in most SoCal neighborhoods, one would have to be bringing home about $200,000 per year.

Jen closes with the following question:

Are the rules any different for those of us living in areas where homes are often double or triple the national average? (Aside from “move somewhere else until you make your millions,” of course!)

In my opinion, California is a tragedy, specifically due to the inaffordability of housing. Yet this has not always been the case. For many decades, California was expensive, but not 9-10X income expensive. Wages did hold up to inflationary pressures that caused housing prices to rise. What really broke the dam and flooded the housing market with higher prices but yet kept wages stagnant was Alan Greenspan’s use of the Federal Reserve’s low forced rates and high level in the creation of credit. In the beginning, that easy credit was used early on by those who saw California’s housing prices creeping up, so they bought in with new money early. That new money, as it continued to be added to the California market, caused more people to malinvest into housing, which caused the prices to go up even more. This continued for almost 2 decades, as new people saw the prices rise (due completely to the Federal Reserve’s immoral policy of creating money non-stop during Greenspan’s leadership), those new people were fearful of being priced out of the market forever (a common line by real estate agents). More people bought, even if it was beyond their level of affordability.

Now we have California as it is today — houses 8X income or higher. It is tragic.

Going back to Jen’s question: what is the best thing a person can do if houses are not affordable?

First, before you pick a place to live, you must compare your income level, your stability of income for the future, and the price of where you want to live. Add in the cost of fuel and the time spent commuting, and you can get a better picture of what you need to do to find where to live.

From my experience in California, having quite a few friends move to LA or San Diego, I’ve said for the past 7 years that renting was far more reasonable than buying on debt. Bubbles are easy to spot: when a market of used products goes up faster than the average wage is, there is likely a bubble forming. This is true in the stock market, where the only new stock one can purchase is at IPO. All other stocks are used, and if the companies aren’t showing a profit margin rising as fast as the stock, I’d be weary of buying. This is true of used cars, used homes, or anything that is easily created and IS created quickly. There is no such thing as “They’re not building any more land.” Even in Japan, housing and commercial real estate goes up fast, even if there is almost no land left to build on. They build up. They downside square footage. New condos and apartments are constantly added.

Once you do calculate your net income, and realistic non-housing expenditures, only then can you look to see what you can truly afford. In some markets, such as coastal California, it becomes obvious that what you can afford may not be what others believe they can afford. This is where an intelligent and research-driven individual can maximize their financial stability by minimizing what they live in versus everyone else. If I’ve learned anything in life, I’ve learned that individuals don’t tell the truth about financial troubles. Whether it’s gambling losses or debt burdens, people are very good about hiding their deficiencies. I don’t trust anyone in regards to their financial capabilities unless they have paid-off titles to show for all the assets they own. No one in my mind owns a home until it is paid off. No one owns a car if it is leased. I’m vocal about it when people tell me about the car or house or boat they bought: I’ll ask “Did you buy it, or is the bank lending it to you?” That’ll usually get the truth out.

Of the 10 or so friends of mine who have moved to California in the past 7 years, I’ve made the exact same recommendation: don’t buy. Don’t live alone. Of those 10 friends, more than half have made the error of buying, and are paying severe consequences. It’s quite sad. 3 of them, though, made wise decisions. They saw that rent was outrageous, but once you included the mortgage payment, insurance, taxes and maintenance on a home, renting was far cheaper than buying, even if you were possibly building a little equity. But renting isn’t enough, not even for families. In California, having a roommate makes much more sense than trying to rent alone. If you are single, having a 2 bedroom, 2 bath rental condo makes little sense, strictly due to the overheating property bubble that has existed for over a decade. If you’re a family, taking in a boarder or subtenant still makes sense, just from a financial stability perspective. We have a home in Illinois, and we have a boarder who helps with the bills and basic needs around the house. It’s win-win for both of us: he pays far less in rent than he would alone, and we get a little help with the property taxes. Almost all my friends laugh about the thought that we would “need” a subtenant, but why wouldn’t we take advantage of a mutually agreeable decision?

Jen’s comical answer at the end (just move away) is my absolute best answer, but one that almost no one would heed or accept. I personally would not live in a bubble prone area. Where we bought in Zion, Illinois is a very poor neighborhood. Our home is around 1X our annual income. We do feel safe, love the families around us, and have maybe a 10 minute longer commute than our friends who own homes 4-6X their income, which are not as nice as our home. Comfort and financial stability is key!

Yet the threat of moving is the best motivator to fix the housing market in California. First of all, the key to affordability is the income to price ratio. If the ratio exceeds 3X (3.5X maximum), it is unaffordable. That’s just the truth, even if you think you may make more money in the future. That’s a big risk, and I call it a gamble. I’ve heard that California’s affordability index is around 16, meaning that 16% of people living in California can truly afford to own a home or condo there. This means that either housing prices are too high, or wages are too low. Pressures on both would deal with the problem very quickly (and may likely happen in the next few years).

Let’s make the assumption that people who are intelligent and research-driven realize that they can not afford to live in parts of California. The incomes are too low, and housing is too high. Let’s assume that they decide to move to a region where income is lower, but housing is much lower. This has an instant market pressure: the supply of labor drops, and the demand for housing drops. In a free market, the supply of labor falling has a pressure on employer who need good labor: they raise their wages to try to attract more people to their business. In a free market, the demand for housing falling has a pressure on the sellers who need a buyer: they lower the price of homes to attract more people to buy.

A decline in intelligent and good workers in California would create a big change in the affordability index. This is true even of the poor, who I hear complain quite often in my town. If a poor person cannot afford to live near where they work, the best thing they can do to correct that is to move and work in an area where you can afford to live. Your previous area would lose your (meagerly-paid) labor, which would put an upward pressure on employers to pay future workers more. Rentals would fall in price, again just by you and others like you moving away. The free market is powerful for the poor, and the middle class, if they would stick to financial truths rather than to what banks and politicians tell them they deserve. The most powerful weapon a person has is their ability to move, even if most people are fearful of the proposition.

So those would be my two answers:

(1) Move, even if it is painful. Even if you have to leave family and friends behind for a few years. Move to an area where you an actually SAVE money, money that you can use when the housing market declines (and it tends to decline on a 17-year cycle), so you can move back with a big down payment, and buy at the low end of the housing price cycle. What have you done for the past 5 years? Suffer financially? In those 5 years, living elsewhere would have put significant money in your pocket if your goal was to love in a nice Californian neighborhood.

(2) Rent, but rent a small place and find someone to share the financial burden. This is difficult for families, but it is easy for individuals. I have little sympathy for families that tell me that the thought of renting, or sharing a rental, is no feasible. Many of those families were just single individuals before their move to marry and have children, and it is when you are a single individual that your goal should be to save money to some day buy, or at least have a big nest egg to secure future rental payments. If a single person lived life frivolously, paycheck-to-paycheck, spending all their income on useless toys and trips, then their future will be horrible. That’s their own responsibility, and it’s one that have to learn from and pass on to the next generation. If you go from middle class to poor because of your inability to save and life live more simple, you have a powerful teaching tool for your children: don’t do what I did.

I’ve personally wasted over $500,000 since I started earning money (around 13 years old). Had I not wasted that, I wonder how different my life would be. My parents never taught me how to save and life thrifty, but its not their fault. Every time I had big financial troubles, I never learned quickly why that was the case. I never thought about what having a year’s worth of income in the bank would mean. Yet it’s a fact I will teach my children — moreso than drugs, premarital sex, or other things that can be beyond a parent’s control. Living life at a level lower than your peers and neighbors is the fastest way to being the most stable person, and family, in your life.

It’s not too late, either.

Comments: none

Date: December 9th, 2007, Filed under Bank bankruptcy, Foreclosure, Mortgages, bailout

Zion, IL
By A.B. Dada
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I can’t seem to wrap my head around any possible situation that can save many of the top tier banks in the U.S. and the rest of the world. There’s a problem that the Old Media is still ignoring, a problem that has the possibility to effect cash flow and the middle class more than the so-called “credit crunch” that we’re facing today. This problem is the absolute illiquidity of the big banks due to the pending litigation and fallout from the mortgage frying pan many have played with over the past few years.

As some of the regular readers know, the mortgage industry was a big game with big profits. The banks would happily loan money to people who had no credibility in their ability to pay that loan back. Because the banks thought that “housing prices always go up,” they felt they could loan money out to anyone, even the credit score poor, and if they had to foreclose, they’d make money on the foreclosure since “property values always go up.”

The banks didn’t have the money to make all these loans, which may number in the tens of millions of individual loans. Because this idea that property values always go up was so rampant for the past 3-4 years, banks took their loans, packaged them together, and sold them to a hungry bond market in the form of CDOs and MBSes. Basically, a bank could take 10 or 100 mortgages, and sell them for a nice commission to investors who also thought their money was safe. Many of these CDOs have fallen in value, some as much as 90-100% (meaning they’re worthless or near that). The investors will lose all or most of their money, is the thought. The banks profited by taking a nice chunk of a commission for producing the mortgage before it was sold off.

Here’s the catch, though, the saving grace for the CDO or MBS buyer-investor: many of these bond issues have contractual wording that protects the investor if the loan origination had any fraudulent activity. If the bank loaned money for a mortgage and the investor can find any fraud within that origination, their purchase is contractually invalid. If that situation comes true, and it seems it may in some cases, the bank would have to refund the investor 100% of their original investment, basically buying back the mortgage onto their own books.

Many loans are coming out as fraudulent. Mortgage brokers and agents accepted “stated-income” statements from borrowers, who inflated their incomes double or triple in value from reality. Some brokers and agents even inflated the borrowers’ incomes without the borrower knowing. Appraisals may also have been fraudulent as some mortgage brokers/agents shopped for appraisers who would give the mortgage lender a number that would maximize their profit. Many in the industry thought the fraud would be overlooked as the housing prices escalated. With the recent downturn in housing expected to continue (severely, still), those frauds are becoming evident.

If a bank has to buy back their loans, they will need cash (liquidity) to reimburse the investor who was defrauded. Many of these investors are fearful of redepositing these refunds back into banks (fearful that the money will be used to bail out other defrauded investors), so the banks can’t rely on their refunds coming back as deposits, to be refunded again. The banks up to now have been able to use some of their mortgages as collateral to borrow short term from the Federal Reserve, but the collateral is declining in value, so their ability to generate new liquidity from the Federal Reserve is becoming more difficult.

As the fraud involved in some (or many?) mortgages comes to light, more and more CDOs will be returned. Banks will be desperate for money, pushing interest rates on CDs and savings accounts up as they need to borrow from millions of small savers versus borrowing from the Federal Reserve. Higher rates on deposit accounts means higher interest rates on loans and credit, which will increase the cycle of foreclosures and home owners feeling the pain: as loan interest rates go up, housing prices tend to fall.

The banking cartel, centered around the fractional-reserve banking system, is in trouble. The money that was created by the Federal Reserve for the past decade is not being redeposited in the banks, so their cash capital is declining. As more people find themselves upside down on their mortgages, more will face foreclosure. As the foreclosures increase, the fraud on the books will come to light, forcing the banks to buy back more mortgages.

No Federal bailout can save the banks without utterly destroying the U.S. dollar. No investor will risk putting their money into banks if the banks may go bankrupt. The FDIC only insures the first $100,000 of a deposit, so those will millions of dollars to save or invest will stay away from the deposit accounts.

I have no idea what to recommend for those without millions. I believe that gold and silver is still the safest form of savings, but in a deflationary economy, which we may experience, the gold-dollar ratio and silver-dollar ratio will fall (although I believe the buying power of gold and silver will rise).

Markets will crash. Banks will shut down. Millions will be hurt financially. The question is: what will the powers that be, the powers that created this problem, do to try to save the system that is built on fraud and monetary value destruction?

Comments: none