US Housing Crash Continues

It's Still A Terrible Time To Buy

By Patrick Killelea

1. Prices are still falling. A safe mortgage is a maximum of 3 times the buyer's yearly income, yet mortgages have been 5 to 10 times incomes in the last few years. A landlords' rule of thumb is that a house price should be at most 15 times the annual rent for that place, yet in most costal areas, houses are still selling for 30 times annual rent, even after recent price declines. So prices will keep falling for a long time. Anyone who buys now will suffer losses immediately, and for the next several years at least, as prices fall into line with tighter lending and stagnant salaries.
2. It's still much cheaper to rent than to own the same thing. On the coasts, yearly rents are less than 3% of purchase price and mortgage rates are 6%, so it costs twice as much to borrow money to buy a house than it does to rent the same kind of house. Worse, total owner costs including taxes, maintenance, and insurance are about 9%, which is three times the cost of renting. Buying a house is still a very bad deal for the buyer on the coasts, but it may make sense to buy in Michigan and some other places where prices have fallen into line with salaries. Check whether you should rent or buy in your own area with this NY Times calculator.
3. Prices disconnected from Gross Domestic Product. The value of housing in the US depends a lot on the value of what the US actually produces.
4. Buyers borrowed too much money and cannot pay the interest. Now there are mass foreclosures, and Congress is taking $700B of your money to pay the mortgage investment losses for banker friends of Henry Paulson. The plan is to overpay the banks for bad mortgages, claiming that this will support the housing market. It will not work, since Wall Street profits have nothing to do with housing prices.

   Now we also have legal contracts being modified to stop even well-justified foreclosures. No one was forced to borrow money. Grownups should be responsible for their own actions. To prevent a justified foreclosure is also to prevent a deserving family from buying that house at a low price, not to mention what this does to faith in contract law.

   Should taxes and inflation be used to pay the debts of irresponsible borrowers, no matter how much they over-borrowed or overpaid for a house? Should savers be forced to pay the debts of people who cannot afford "their homes" no matter what price they paid or how far it is beyond their actual financial means? If so, go buy the most expensive house you can right now! Borrow as much as you possibly can and don't pay it back, knowing that Congress and Bush will force the real repayment obligation onto others, onto people who are living within their means.

   Banks happily loaned whatever amount borrowers wanted as long as the banks could then sell the loan, pushing the default risk onto Fannie Mae (taxpayers) or onto buyers of mortgage-backed bonds. Now that it has become clear that a trillion dollars in foolish mortgage loans will not be repaid, Fannie Mae is under pressure not to buy risky loans and investors do not want mortgage-backed bonds. This means that the money available for mortgages is falling, and house prices will keep falling, probably for 5 years or more. This is not just a subprime problem. All mortgages will be harder to get.

   A return to traditional lending standards means a return to traditional prices, which are far below current prices.

5. Interest rates increases. When rates go from 5% to 7%, that's a 40% increase in the amount of interest a buyer has to pay. House prices must drop proportionately to compensate. The housing bust still has a very long way to go.

   For example, if interest rates are 5%, then $1000 per month ($12,000 per year) pays for an interest-only loan of $240,000. If interest rates rise to 7%, then that same $1000 per month pays for an interest-only loan of only $171,428.

   Recent lower Fed inter-bank lending rates do not directly affect mortgages rates, nor do extra Fannie or FHA guarantees. The 30-year fixed mortgage rate actually went up after the Fed's rate cut, because rate cuts cause higher inflation.

6. Extreme use of leverage. Leverage means using debt to amplify gain. Most people forget that losses get amplified as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss or an interest rate hike, he's bankrupt in the real world.

   It's worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is 6%. On a $300,000 house, that's $18,000 lost even if prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less.

7. Shortage of first-time buyers. High house prices have been very unfair to new families, especially those with children. It is literally impossible for them to buy at current prices, yet government leaders never talk about how lower house prices are good for pretty much everyone, instead preferring to sacrifice American families to make sure bankers have plenty of debt to earn interest on. If you own a house and ever want to upgrade, you benefit from falling prices because you'll save more on your next house than you'll lose in selling your current house. Every "affordability" program drives prices higher by pushing buyers deeper into debt. To really help Americans, Fannie Mae and Freddie Mac should be completely eliminated, along with the mortgage interest deduction. Canada has no mortgage-interest deduction at all, and has a more affordable housing market because of that.

   The government keeps house prices unaffordable through programs that increase buyer debt, and then pretends to be interested in affordable housing. No one in government except Ron Paul ever talks about the obvious solution: less debt and lower house prices. The real result of every "affordability" program is to keep you in debt for the rest of your life so that you have to keep working. Lower house prices would liberate millions of people from decades of labor each.

8. Surplus of speculators. Nationally, 25% of houses bought the last few years were pure speculation, not houses to live in, and the speculators are going into foreclosure in large numbers now. Even the National Association of House Builders admits that "Investor-driven price appreciation looms over some housing markets."
9. Fraud. It has become common for speculators take out a loan for up to 50% more than the price of the house he intends to buy. The appraiser goes along with the inflated price, or he does not ever get called back to do another appraisal. The speculator then pays the seller his asking price (much less than the loan amount), and uses the extra money to make mortgage payments on the unreasonably large mortgage until he can find a buyer to take the house off his hands for more than he paid. Worked great during the boom. Now it doesn't work at all, unless the speculator simply skips town with the extra money.
10. Baby boomers retiring. There are 77 million Americans born between 1946-1964. One-third have zero retirement savings. The oldest are 62. The only money they have is equity in a house, so they must sell.
11. Huge glut of empty housing. Builders are being forced to drop prices even faster than owners. Builders have huge excess inventory that they cannot sell, and more houses are completed each day, making the housing slump worse.
12. The best summary explanation, from Business Week: "Today's housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low interest rates of a weak economy. Either the economy's long-term prospects will get worse or rates will rise. In either scenario, housing will weaken."

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