Sunday, October 08, 2006

L.A. Times: Caught off balance

A major water cooler topic for homeowners these days, according to this October 8, 2006 L.A. Times article by Diane Wedner, is whether our home values are tanking.

USC "experts" state that the decline in the appreciation rate to single digits is "not as rapid" as what happened in the early 1990's. (That sort of contradicts what this earlier article suggested.) What they forecast is a "long grinding slowdown", not a "drop off the cliff." I guess they are making that prediction based on what happened in the early 1990's, when prices sank 17% in six years. (Keeping in mind that that number is very likely a broad measure of Southern California overall, not necessarily what happened in Gardena or Studio City or in your particular neighborhood.

At least we've gotten to the point where the "experts" now expect some price decline! Look how long it's taken them to get to concede that. This is almost like getting an addict to Stage 1 and admit "I have a substance abuse problem." The experts still hang on to this faintest thread of hope by noting that price appreciation is still relatively good in the "less-expensive neighborhoods of Los Angeles." (You know where those are by now, right?) But the Polyannas even concede that the tide is turning there too. Heck, anybody reading the data and charts in this blog could have suggested that!

I suppose it would be too much at this point to read a real estate article in the L.A. Times and not see the obligatory swipe at buyers who decide to wait. As a Cal Poly Pomona economist put it, "Potential buyers are in a waiting mode... their expectations of a tanking market are worse than actual economic conditions." And my reaction to that profound statement is

Huh? Uh, don't buyers + sellers + potential participants determine what the economic conditions are by their decisions to buy or sell or not participate? This statement reminds me of the homeseller who lists a house as "below market value". The seller does not realize that whatever his home sells at is the market value at that point in time, not what he wishes that value to be. The market is what it is. Prices are not sacred and violations of price levels on the downside are not taboo.

But that won't sink in to these experts who want to blame these waiting buyers for the misfortunes of the real estate market.

The Cal Poly Pomona economist differs from the USC expert as to the nature of this slowdown. USC sees it as potentially a long, grinding slowdown, whereas Cal Poly sees the decline as having a potentially a short duration, since interest rates remain low and unemployment is stable. Still, nobody is discussing the idea of the drop-off-the-cliff scenario where prices plunge, as a distinct possibility.

I also have a different take on "why" people engage in real estate transactions. The last paragraph of the article suggests that life will go on nearly as it always has, but if the population at large shifts our economic circumstances (if herd psychology gets majorly bearish), people can always opt to get out of the area and go where conditions have a better chance of improving.

In case you are wondering where the steepest declines by price per square foot were this June-August period, compared YOY, in areas with 50 or more home sales, here they are:

Eagle Rock                   -6.7%
Long Beach Plaza (90808)     -3.9%
Valencia 91355               -3.0%
San Gabriel 91775            -2.5%
La Crescenta                 -2.1%              
Cerritos                     -1.8%

Pacific Palisades, Agoura Hills, Palos Verdes 90274, Westchester, Rowland Heights, Los Altos (90815) ranged from -1.6% to -0.5%. See, you heathens who don't believe in eternal appreciation? The Los Angeles Times thinks those price declines are so insignificant that the article didn't bother breaking them out!


Blogger wannabuy said...


Is there a way to break out how many homes are falling out of escrow? My fiance' and I have been using N. Juanita between Carnelian and Diamond as our indicator of the market. There are five townhomes that have been sitting there since early this year (ok, one was added in summer). One townhome, across the street on Carnelian, just lost the "sold" marker on its for sale sign.

Is there an easy way to tell if properties are falling out of escrow and what fraction? I believe in the coming months this will have the greatest impact on local home prices.


9:16 AM, October 08, 2006  
Blogger bearmaster said...

I think you would have to ask a local realtor to learn something definitive about a particular house.

As a real estate outsider, I do not know of a way to find out how many homes have fallen out of escrow. When I see a For Sale sign disappear, the only thing I can do at that point is wait a few months for the sales figures at Zillow and Domania to get updated before I know the fate of a particular house for sale.

9:55 AM, October 08, 2006  
Blogger Mike said...

i took a graduate class from one of the usc professors often quoted in local real estate stories (not the one quoted in today's article though). my take is that they are looking at the data and trying to forecast to the best of their ability what is happening, but that this run-up has been a bit different from other run-ups in the past, and that they're not sure what factors to look at when doing their regressions and other models. they're not eternal optimists, but rather won't make any "out there" predictions w/o the data to back it up. i'm sure they'll be predicting a hard landing after it's already shown up in their data.

the only thing that bothers me is that they never even assign a probability to the market being massively over-valued and due for a major decline. i would love to see a lot of the experts have to assign probabilities to different scenarios, rather than just list the same old tired "this is going to be okay, not like last time."

6:29 PM, October 08, 2006  
Blogger bearmaster said...

Economic models are terribly flawed, and economists as a group have a horrible track record of forecasting recessions and downturns, even changes in trends.

Assuming that the economy is a machine that takes number inputs A and B and then out come numbers C and D eventually will get an economist in trouble. How do these models take into account irrational behavior on the account of the consumer? The simulated machine can work OK for a while during a long uptrend, but economists have had a habit of calibrating things to look even better than than they are during such times. Forecasting job creation is an example of an area where they go wrong. Assuming small businesses create X number of phantom jobs every month that don't actually get counted works as long as the economy is booming, but unfortunately that phantom job assumption is then hard coded in during busts so the job situation ends up really being worse than the numbers show. CPI is another stat that has been reengineered for a boom.

Nor do economists really account for the crowd psychology behind decisions to buy and sell. There is no question that the herd is collectively putting off buying. Yet a lot of what we've been hearing this year is scolding that buyers shouldn't be waiting, that the boom will continue and that those who hesitated will be left behind.

Is a mass psychological decision to hold off on buying accounted for in their models?

Perhaps these economists realize that they don't know anything, but then they should say so. Or maybe they do say so, but the newspapers certainly don't present it that way.

6:53 PM, October 08, 2006  
Blogger bearmaster said...

Mike, while I am on my soap box ranting and raving about economists, I reread your post and thought about what you said about how they never assign probabilities to the market being massively over valued.

I was recently reading an analysis of the Amaranth hedge-fund blowup, and saw it compared to the Long Term Capital Management fund blowup of 1998. At LTCM, Nobel prize winning economists assigned what ultimately happened such low probabilities that they were not prepared to deal with it.

8:12 PM, October 08, 2006  
Blogger Mike said...

i'm sure they'll be able to tell us exactly why it ended the way it did 5-10 years from now, but i'm not holding my breath waiting for economists to call for a sizeable crash in residential RE values in the southland.

as you pointed out, i think psychology is the big x factor, along w/ financing. how long are people going to think it's okay to spend 50%+ of your gross income on housing, and how long are lenders going to keep on lending money to people who really have no prospects of paying back the loans if appreciation even merely goes to the low single digits (where it's already at), and how long are mbs buyers going to keep on buying loans that are all but guaranteed to go into foreclosure? my thoughts are that eventually the lending will have to really tighten up, and that's when the bottom falls out. there simply aren't people out there wanting to buy w/ incomes that will support prices anywhere near where they're at today, especially if they have to come to the table w/ downpayments and the income to back up the monthly payments.

2:54 PM, October 09, 2006  
Blogger bearmaster said...

Well Mike, you've got good timing. Today's L.A. Times today has an article on tightening the lending standards:

Mortgage Standards Tightened

U.S.-chartered lenders are discouraged from qualifying buyers based on low starter rates.
By David Streitfeld
Times Staff Writer

October 9, 2006

Federal regulators are casting a disapproving eye on mortgages that give borrowers low introductory rates but let them pile up more debt over the long run — a loan feature favored by hundreds of thousands of Californians.

Starting this month, federally chartered lenders are being discouraged from qualifying buyers based on the low starter rates, when only the interest or a portion of the interest is due. Instead, they are being urged to evaluate the borrower's ability to pay for the loan at the full rate.

Regulators are trying "to add some discipline to the lending process," said Richard Wohl, president of Pasadena-based Indymac Bank. "Whenever you do that, you're going to have some [borrowers] that won't have the product available to them."

The tougher standard was issued in the form of "guidance" from the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Reserve and other regulators. Guidance has less force than a regulation and provides no specific penalties for violation.

The regulators, however, say they will "carefully scrutinize" lenders to see whether they are following the new rules. Those who fail to do so, the guidance summary warns, "will be asked to take remedial action."

In addition, the guidance applies only to federally chartered lenders, including Indymac, Countrywide Financial Corp., Washington Mutual Inc. and other behemoths. State-chartered banks, which are smaller but more numerous than federal banks, are not affected.

Industry observers are divided on the effect of the new guidance, which takes particular aim at loans often marketed as "option ARMs," in which the borrower has the option of choosing how much to pay on an adjustable-rate mortgage.

In a letter to regulators last winter, Indymac said 24% of the option loans it made in 2005 would have been affected by the proposed tightening.

Last week, however, Wohl said that some of those borrowers would have been eligible for other types of loans. Indymac's option ARM business is shrinking anyway, he said, as interest rates fall and customers move to the certainty of fixed-rate loans. Rates on 30-year fixed mortgages fell to an average of 6.30% last week, the lowest since March.

Even so, interest-only and option ARM loans accounted for more than half of first-time mortgages and refinancings in the state in July, according to data-tracking firm First American LoanPerformance.

With an interest-only loan, borrowers pay only interest for a set period — typically three, five or 10 years. After that, the rate on the loan readjusts and the borrower has to start paying the principal as well. The longer the interest-only period, the steeper the payment once the borrower begins paying the principal.

Option ARMs give borrowers the ability to put off both the principal and much of the interest for a period ranging from one month to several years. If a borrower pays the minimum in a weak housing market, his or her debt could grow faster than the value of the house.

That's the sort of thing regulators say they want to prevent.

Kathy Dick, deputy U.S. comptroller for credit and market risk, said interest-only loans and option ARMs originally were for a minority of savvy, well-off people whose income was variable — the self-employed and those who worked on commission or were paid intermittently.

"Now they're used to get someone into a home without a real analysis of their ability to pay," Dick said. "Lenders are qualifying people for homes they can't afford. We felt that wasn't consistent with prudent lending principles."

Dick demurred on offering any prediction about how the new rules would affect the housing market. Because the guidance applies only to federally chartered lenders, it raises the possibility that it would merely move some loans from one segment of the market to another.

"It's too early to tell what the impact will be," Dick said. "But from our vantage point, looking at national banks, we don't see any evidence this is going to cause … a major problem." Others made bolder predictions.

"Just as the loosening of credit standards made the housing bubble go higher and last longer, the tightening of standards is going to make it deflate further and faster," said Michael Calhoun, president of the Center for Responsible Lending, a research and advocacy group that fights predatory lenders. As borrowers find they qualify only for smaller loans, Calhoun predicted, sellers will have to cut their prices.

"There's some pain coming," he said, noting that California "is at ground zero on this."

Allen Fishbein, director of housing and credit policy for the Consumer Federation of America, also believes the new rules will have at least a mild effect.

"There will be fewer leveraged loans of this kind, and it will depress some home prices," Fishbein said. "Lenders that were making these loans have a responsibility to rework them into something sustainable."

The Consumer Bankers Assn., a lobbying group whose members will be covered by the new guidance, predicted dire consequences when it was agitating against the proposals over the winter.

The restrictions are "overly paternalistic" and "largely unworkable" and would place option ARMs in particular "beyond the reach of many consumers," counsel Steven Zeisel wrote.

His current view, now that they're a reality, is milder.

"Regulators are trying to create a situation with strong underwriting, strong risk management and portfolio management and good disclosures, all of which we endorse in principle," Zeisel said. "The problem is whether the detail is too strict, and that remains to be seen."


6:25 PM, October 09, 2006  
Blogger Mike said...

here's another interesting article that was linked to by ben's blog regarding tightening lending standards.

7:54 PM, October 10, 2006  
Blogger bearmaster said...

Mike, did you notice that the new rules are "guidelines", not regulations? And they apply to federal banks, not, say, state-chartered banks. If the fed banks don't comply, there are no penalties specified, per se. What are the regulators going to do, make frowny faces and ask them to follow the guidelines?

There ought to be more teeth in this thing.

8:03 PM, October 10, 2006  
Blogger Mike said...

the question is whether the state government, which regulates the ones not covered by the federal guidelines, decided to take similar measures.

but part of me thinks that it doesn't matter. ultimately the institutional investors and other major buyers of mbs are going to stop buying the junk mortgages that the lenders are churning out, especially once the tide of defaults and foreclosures that i suspect are out there start to show their ugly face. the lenders will have to tighten their standards in order to sell off the mortgages on the secondary market.

but putting these kinds of regulations in place could help keep it from getting this out of control the next time.

8:59 PM, October 10, 2006  

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