patrick.net

One of the few (only) rational explanations that I could imagine for the increase in house prices in California was that current home buyers are treating a home purchase as a call option because of non-recourse loans. And since the downpayment has dropped from a traditional 20% to a smaller 10% or 5% the premium for the call option has dropped increasing demand.

There are many objections to this view
1. Purchase money mortgages in California have always been non-recourse. There is no good reason to explain why today's homeowner decide to take advantage of this feature but home buyers a decade ago did not do so.
2. Most home-buyers are ignorant about the difference between a recourse and non-recourse loan
3. There does not seem to be any hesitation to refinance and lose the non-recourse feature
4. From a talk with someone who had 30 years experience dealing with foreclosed bank owned properties I got the impression that it does not matter much to a lender as a homeowner facing foreclosure is unlikely to have any assets anyway so a recourse or non-recourse loan makes no difference.

I don't think the non-recourse factor plays a part in most buyers risk calculations. So putting 10% down instead of 20% is riskier and using 40% of income instead of 30% is certainly more risky. Using an ARM is also more risky than using a fixed rate mortgage. The CAR is just plain wrong when they neglect to account for a riskier mortgage in their affordability statistics.

For a reductio ad absurdum example imagine using a negative amortization adjustable rate mortgage instead of a 30-year fixed to calculate affordability. You could dramatically improve affordability but there is no denying that the former is RISKIER than the latter for a home buyer when all other factors are the same.

Gavin,

Very well argued.

Glen,

Sorry, I put in a should there when I meant "shouldn't". That must have made my whole response completely incomprehensible.

I agree that if everything was the same and if the buyer financed in a way to take advantage of CA's anti-deficiency law, then less down means less risk for the homeowner. However, in reality, the buyers with 10% down have a higher risk profile than the buyer with 20% down. Overall, this current market simply push people to take extremely risky gambles that will ruin their life if the gamble goes bad.

"Destroy financial lives?
What?
Real estate always goes up!"

Yeah, we're all Lex Luthors now.

There are many objections to this view
1. Purchase money mortgages in California have always been non-recourse. There is no good reason to explain why today’s homeowner decide to take advantage of this feature but home buyers a decade ago did not do so.

Pure greed and speculation...and because they can (lenders are willing to underwrite these foolish ventures).

2. Most home-buyers are ignorant about the difference between a recourse and non-recourse loan

True, but whether or not the consumer is aware of a risk does not factor into the actual riskiness or safety of a transaction.

3. There does not seem to be any hesitation to refinance and lose the non-recourse feature

Stupid, desperate FBs willingly surrender the best feature of CA homeownership....the ability to walk away.

4. From a talk with someone who had 30 years experience dealing with foreclosed bank owned properties I got the impression that it does not matter much to a lender as a homeowner facing foreclosure is unlikely to have any assets anyway so a recourse or non-recourse loan makes no difference.

They may not have assets, but they may very well have a job (or get one in the future). In many cases it would be worth it to pursue a wage garnishment, if you could. (Especially, eg, in foreclosures where the foreclosure is the result of one of the family breadwinners losing a job, going on disability, becoming a drug addict, or divorcing the other earner--but there is still one family member making a decent salary.)

Gavin,

Your points are well taken... I was partly just being facetious because it has occurred to me that CA FBs can get away with taking fairly insane risks and can come out relatively unscathed (except for the loss of their credit and their home). People in other states are not always so lucky.

As you point out, all of the serial refinancers have lost their anti-deficiency protection. I would not be surprised, therefore, if the bursting of the bubble results in a lot more bankruptcies this time around--if people can not get antideficiency protection then the only option for avoiding paying back their bubble debt for decades is likely to be personal bankruptcy.

Yeah, we’re all Lex Luthors now.

Not evil enough.

Whether you put 10% down or pay all cash, if your home declines in value you have lost the same amount of equity.

Putting less down does provide the possibility of walking away with less lost - but only at the destruction of your credit.

Glen or Gavin,

Could you elaborate on how refinancing eliminates the built in anti-deficiency option? Is this a legal artifact or financial artifact? Before selling to bubblesit in 4/05 I pursued fixed-rate refinances fairly aggressively, however, always carefully re-amortizing the duration to continue or shorten the schedule. I think after four years our original 30yr term was on a 22.5yr amort.

When a theory indicates that what is happening is not possible, there is a problem with the theory. The CAR affordability index is such a theoretical construct.

The old CAR affordability index (like most others) was a terribly inaccurate measure. The new index is also inaccurate. While they have attempted to remedy the prior errors, the index continues to compare apples and oranges.

Affordability should measure the ability of likely buyers to be able to buy the house they are likely to buy – using a financing structure that is both common and sustainable. Even if constructed perfectly it could only represent one type of buyer – whichever type is selected for the index. Should that be the first-time buyer or a trade-up buyer? If a trade-up buyer, should it be a first trade-up or a subsequent trade up? Each of these buyer types has very different down payment capabilities. Generally, index publishers focus on the first-time buyer, even though about 70% of all buyers are trade-up buyers.

Focusing on first-time buyers is useful for gauging the sustainable health of the market. However, it is not useful for evaluating the median price level because first-time buyers generally do not buy the median-priced house – they buy starter homes, and later trade-up to a median-priced home.

Median income and median price are a mismatch because the median price relates to only a subset of all housing, while median income relates to all households. They need to compare either the 65th percentile income to median prices, or compare median income to the median price of ALL housing units of any kind and quality (including condos and all rental units). This would likely be a nicer starter home or a low end trade-up home.

While selecting 85% of the median price might reduce the magnitude of the mismatch between buyer profile and property it is still a mismatch. The measure remains inaccurate and unreliable.

Stating the index as a percentage of people who can afford the home exacerbates the problem because it is overly prone to assumption errors, and it is rarely reflective of reality. I much prefer to see a measure that states how much income (as % of median income) is needed to buy a median priced home. This measure is less prone to assumption errors.

Any index using a general median, or a segmented median without adequately adjusting for curve distortion is ultimately doomed to irrelevancy.

The Brookings Institute published a 36 page report on the difficulty of measuring income distribution curves; and this data is half a decade old. It is ostensibly even worse today.

http://www.brook.edu/metro/pubs/20040803_income.pdf

Just browsing this report should convince you that comparing a home buyer in a metro area to a home buyer in any other metro area, or in a non-metro area is erroneous.

CAR would have to do a lot of real work if they intended to create any meaningful indices.

Or one could always use the HSBC research to determine metro affordability.

http://randolfe.typepad.com/Documents/HSBC_frothfindingmission.pdf

This covers income and affordability from multiple angles, and factors in present value of holding costs and real rent yields. But it doesn't match the CAR's desired conclusions, so they had no choice but to create their own synthetic index.

Could you elaborate on how refinancing eliminates the built in anti-deficiency option? Is this a legal artifact or financial artifact? Before selling to bubblesit in 4/05 I pursued fixed-rate refinances fairly aggressively, however, always carefully re-amortizing the duration to continue or shorten the schedule. I think after four years our original 30yr term was on a 22.5yr amort.

Randy,

This is going to be a long one...

This is purely a legal artifact. California has a very complicated set of rules regarding mortgages. After the biggest real estate bust in California history (the depression) rules were put in place to protect borrowers. One of these rules is the "anti-deficiency rule" embodied in California Code of Civil Procedure Section 580d:

No judgment shall be rendered for any deficiency upon a note secured by a deed of trust or mortgage upon real property or an estate for years therein hereafter executed in any case in which the real property or estate for years therein has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.
Cal. Civ. Proc. Code § 580d.

Thus, if the bank forecloses on your house, your house may be sold by the bank, and they can keep the proceeds of the sale (up to the amount of your debt, including interest, penalties, cost of collection, etc.) but they can not come after you personally for your other assets, your kids or your dog. My understanding is that this was put in place because RE values got slammed in the depression and big evil banks were suing all the depression-era FBs who owned anything that wasn't nailed down.

An interrelated rule is California's "one form of action" rule:

There can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property or an estate for years therein, which action shall be in accordance with the provisions of this chapter. Cal. Civ. Proc. Code § 726(a).

This basically means that if the FB has a first and second mortgage and a HELOC, they will not face three separate lawsuits when they go into default. Any one (but only one) of the creditors can foreclose upon default and force a sale of the property. Once the property is sold the proceeds will be used to pay off the secured creditors in order of priority. If the proceeds are insufficient to pay off all the debt, though, the FB is off the hook because of the "anti-deficiency rule."

This creates a problem for the "sold out junior." This is the lender who loaned you the funds for the "20" portion of your 80/20 financing. When the holder of the first mortgage forecloses and the sale proceeds only cover the first mortgage (because property values are down 20% and/or because the first lender is willing to conduct a fire sale and sell out for the exact balance of the first mortgage) the "sold out junior" becomes a FL (f'd lender). To avoid this, sold out juniors will often bid at foreclosure sales to protect their position and make sure that the holder of the first does not sell the property for the exact balance of the first mortgage. But the "sold out junior" can not sue the FB for their losses--even if the FB has five other properties with positive equity!

This is one of the reasons for the grandfather's dying advice to his grandson "Don't date showgirls and don't buy second mortgages." (I don't know about the showgirl part of the equation.)

But, getting to your question (finally), the anti-deficiency rule is limited in its application. There are a ton of exceptions and limitations. The primary limitation is that the protection only applies to a "purchase money" loan. That is, a loan that was used to acquire the property.

So in the 80/20 example, the lender in the second position can not come after you. However, if you refinance into a new loan (or HELOC), all bets are off. I think this is because it is presumed (unrealistically) that holders of second position purchase money mortgages will demand a sufficient down payment by the buyer to protect themselves in the event they need to bid on the property in a foreclosure sale (as outlined above). The MBSs that own all those California second mortgages are in for a rude awakening one of these days. Or at least they would be, if there were anyone left in California who had not already refi'd at least once. In reality, they can probably go after 90%+ of the FBs for anything they own...

So, as an aside, when the CA RE market finally crashes, it will trigger a wave of defaults just as massive as the wave of equity locusts which preceded it. But this time the banks will be foreclosing on the AZ and NV flips owned by the CA homedebtors... Just my guess.

*By the way, I'm an attorney but I don't practice RE law, so please do not consider this legal advice. It is just based on my recollection about some research I did a while back.

Glen,

Much thanks for the description. A question then arises:

Since it is financially prudent to refinance in many cases, such as we did many years ago from our 30 year first at 8.25% to a 15 year 6.5% about 5 years later...

is it possible that a court might rule that "Purchase Money" status is assigned to the new loan/creditor? It seems a distortion of the law that essentially no long-term home owners will be protected unless they make a financially bad decision to refuse potentially advantageous refinance opportunities.

Secondarily, is it possible to do anything under current law to ensure/demand/require that you are still covered after a typical, vanilla refinancing?

As an aside, I do not fall in with the crowd that likes to assume that all refinancing, even serial refinancings are bad. The problem isn't the refinancing; it is the failure to reamortize. By simply getting a shorter mortgage equal or less than the original term, one is losing nothing but fees in a refi; and many refis are low/no fee during major rate movements. Even without a shorter contract term, it is still easy to engineer an amortization schedule yourself by just calculating a payment level and paying that instead of the coupon payment (assuming a simple interest, fixed, no penalty US-style mortgage). In fact, if one does this they essentially have created their own option mortgage without the risk of taking the kind lenders will give you.

Does it rally matter what the new index for affordability is? Nobody in thier right mind will live to be house poor. I believe we are just starting to see the effects of the repercussion cycles to come. My only curiousity is whether our goverment (Bennie Boy) will manipulate to appease the RE lobby. There has been tens of millions made in the last five years. The bulls don't want to leave the party. I think there will be lies and spinning in the coming weeks and months, Why? Because the housing industry smells blood in the streets.

Illegals go where they have to go but the PHD’s from India, China, Russia, … come to Silicon Valley. And they make tons of money. It’s econ 101, when demand exceeds supply, prices go up.

Oh really, that's probably because Intel pays the H1-B's so much, right?

Sorry fucktard, but that is not how it is in reality. They come here because it is better getting paid 50K a year at Intel than living in a puss filled canker, aka, you.

I see you have time on a Saturday to write more fucking dribble, what's up? Spend your weekly allowance too soon? That's ok, I'm have a BBQ to night you can email me at bowchickywowwow@yahoo.com, throw away account, I'll give you my address, stop by if you like. I would love to discuss the finer points of your very well thought out original argument in person. Feel free to bring whatever friends Mommy and Daddy have bought you.

HARM kindly delete fucktard

Do you guys even understand the concept of supply and demand? Stock market crashed because there was no “demand”.

Do they teach any economics at UCSB? Apparently not.

Randy's Supply & Demand for Trolls, 050:

There had to be demand for prices to fall. If there was no "demand", then sellers would find their orders going unfilled.

Kind of like the housing market today.

There is plenty of demand. No one disputes that. It's just that the demanders are demanding lower prices.

...Just like happened to the stock market.

Hey UCSB troll let me know if you're going to make it so I know how much cock to have on hand for you to suck.

Randy H, newtroll same as the old troll has a perfectly good argument,

1) Housing only goes up,
2) Housing is continuing to go up,
3) Rich immigrants,
4) Strong fundamentals.

I see nothing incorrect here, do you? I mean just because even the mainstream media is now reporting YOY - values for most if not all "markets", does a little thing like realty really matter when all you do is cash Mommy and Daddies checks and maybe supplement your income with a little cock gobbling?

Hey fucktard, you forgot to say "rents are thru the roof"

Just curious, when you're at the frat house sucking cock do you ever say out loud, "wow, I'm at a frat house sucking cock". Whoops, sorry, I forgot, not polite to talk with ones mouth full.

Your work here is greatly appreciated; please continue to amaze us with your brilliant insights. You're sure to go far in this world; your formula of keen intellect coupled with a ready desire to suck cock is truly the key to success. Good that you stumbled on it so soon in life, as it surely will save you from becoming a JBR.

Or you could just go the fuck back to Craigslist.

Dude, seriously don't worry about the cock sucking thing, the way i see it, worked perfectly good for your mom, should be ok for you too. Just a family tradition for you. With your firm grip of finacial fundamentals, seems that bankruptcy is also.

Hey but pat yourself on the back, we can't all be cock sucking bankrupt trolls.

Randy said:

Since it is financially prudent to refinance in many cases, such as we did many years ago from our 30 year first at 8.25% to a 15 year 6.5% about 5 years later…

is it possible that a court might rule that “Purchase Money” status is assigned to the new loan/creditor? It seems a distortion of the law that essentially no long-term home owners will be protected unless they make a financially bad decision to refuse potentially advantageous refinance opportunities.

Randy,

I suppose anything is possible when it comes to the courts. Usually when there are major economic disruptions, courts and legislatures respond by changing the rules of the game to respond to political pressure. If the alternative is a crushing wave of litigation and bankruptcies, the powers that be may be inclined to respond by changing the rules. But I don't think that's how it works under current law. So my understanding is that it would probably take either an act of the CA legislature or a decision of the CA Supreme Court to change the status quo. And the lenders would undoubtedly scream bloody murder if it happened.

I'm not sure, but I would also guess that this could even have repercussions in the MBS market. Georgia recently tried to pass a consumer friendly law which would have made it easier for consumers to get out of certain abusive subprime mortgages. Some major lenders announced they would get out the Georgia market because they would not be able to resell these mortgages in the secondary market. Then Congress overrode the Georgia legislature and pre-empted the Georgia statute via a special act of Congress. I think something similar could happen if the CA Supreme Court or legislature tried to change the rules after the mortgages had been sold. To suddenly make thousands of mortgages non-recourse would obviously impact the value of those mortgages, which could trickle down to pension plans and other investors.

However, I think we can safely anticipate that the next wave of foreclosures will put a lot of borrowers into this exact situation. The courts and legislature will have to decide whether they would rather stick it to the borrowers or the lenders. A typical homeowner who bought before 2004 and who refi'd to reduce their payments or the duration of their mortgage probably won't get too badly screwed unless the downturn is very severe and they are forced to sell into a dead market. But the serial flippers who cashed out all their equity to buy condos in AZ may find the courts and legislature less willing to allow them to skate away from the consequences of their imprudence. Major moral hazard if they were to do so, IMO.

Secondarily, is it possible to do anything under current law to ensure/demand/require that you are still covered after a typical, vanilla refinancing?

Well, I suppose some lenders (especially smaller, independent operators) may be willing to modify the boilerplate to make the loan non-recourse. Especially if the LTV is fairly conservative (eg: 70 or 80%). But this is purely a guess on my part. I have never heard of anyone negotiating anything like this. But, as I said, I have not been involved in very many real estate deals. I suppose it might raise some eyebrows with the lender, since the lenders presume that you have no intention of walking away--even if the market crashes and you find yourself underwater on your mortgage.

Leading Indicators Forecast Housing Crash

A key gauge of future economic activity fell unexpectedly for the fourth time this year amid signs of a slowing housing market, according to a report released by a private research group Thursday.

The so-called U.S. index of Leading Indicators declined 0.1 percent in July to 138.1 after inching up 0.1 percent a month earlier, according to the New York-based Conference Board. Wall Street economists in a Reuters survey were expecting the index to advance by a modest 0.1 percent.

"The economy is cooling but it isn't likely to stall out," said the firm's labor economist Ken Goldstein. "The cooling off in the housing market has been more pronounced, however, and is one factor in the softer domestic pace of economic activity.

"Meanwhile, the coincident index - a measure of current economic activity -rose 0.2 percent last month, building on a 0.2 percent gain a month earlier. So far this year, this index has logged monthly gains.

The leading index measures a basket of economic indicators ranging from unemployment benefit claims to building permits and is intended to forecast economic trends up to six months ahead.

According to the Conference Board, half of the ten indicators that make up the leading index increased in July, but it was mainly a decline in building permits and a steady number of weekly claims for jobless benefits that drove down the index.

SQT,

I closed that thread and deleted his messages. One way to handle limiting Trolls is to edit your original post after it's gone quiet and unclick the "Allow Comments" box.

A good indicator is to wait until after weekend readers have had their chance to comment. Often DS and Bap33 will be some of the last to comment ;)

Glen,

Your commentary on deficiency judgments is interesting. While CA law allows deficiency judgments in certain circumstances, I expect that the terms of the loan contract must provide for a deficiency judgment in order for the lender to pursue such recourse. Most states do allow for deficiency judgments, and my loans on properties outside CA have all included a provision explicitly stating that the lender has this right. None of the loans on my CA properties have ever had any such reference. Therefore I assume that the lender has no such right under the contract terms of these loans. This is an academic point for me, as my LTVs are mostly under 25% of value now. However, I wonder if lenders are placing the needed contractual wording in their loan documents to allow them to seek a deficiency judgment, and whether it is even worth the bother for them (prolonged process of foreclosure if a deficiency is enabled). It seems that for most borrowers there are no other assets of consequence to pursue – so the legal right to seek a deficiency judgment would be a moot point, and the lenders would be better served to just take the write-off and move on.

What do you see? Is this evolving?

This week's Barron's has an article titled "The No-Money-Down Disaster" that pretty much parallels what people have been predicting on this blog for years.

I cannot find an online copy, not being a subscriber, or I would excerpt portions. If anyone has a subscription, they should review it here. I think you would all be pleased.

It is in the "Other Voices" section, so doesn't count as an endorsement by a major financial publisher, but the fear is there, or they wouldn't run it.

Barron's website is down for now, I will post some excerpts when it is back up.

New thread: I may buy a condo, finally

If, like Japan, we fail to act, the coming decade could be very bleak indeed.

Prop 1300: Save Homeownership Act
To sustain the American Dream and save the children, the State of California will guarantee that those who buy homes will be able to sell them at a minimum of the original purchase price. Funding for this act will come from converting most public schools to fireworks factories, and to charge all new residents to this state a naturalization fee of 25% of their net worth.

When I was a teenager, I thought tire spikes on all the roads crossing the state line might help slow the population influx. The Population of CA has almost doubled since then.

It would really be a shame to close out this thread with fewer than

100 posts.