Tuesday, January 27, 2009

Misconception 3 – Easy credit caused the housing boom

This one is more an oversimplification than a misconception.

There have been very similar credit conditions across all housing markets in the US. However vast differences in changes in price by city/ region. So while easy credit conditions during the boom certainly had a significant impact they are only one part the whole story. The economic literature and my 5 years experience studying speculative forces in housing markets suggest the following factors.
- Local economic growth rates
- Housing supply restrictions
- Expectations based on local past experience

Economic growth rates (and the associated changes in wages, economic migration, employment etc) make a significant difference in the demand for housing. We can see this most dramatically in looking at house price figures for a city like Detroit where house prices have been decreasing in real terms for many years due to a decline in their traditional industries and a subsequent migration out of the city. Fundamental economic factors are likely to have been at work to early in the booms in growth areas in the Sunbelt.

Supply restrictions on land and building are also likely to have resulted in the inability of the market to quickly supply relatively affordable housing and stop prices from increasing quickly as demand increased. See http://www.demographia.com/dhi.pdf for a detailed international perspective. This study shows booms in prices across hundreds of cities worldwide overwhelmingly occurred only in cities with relatively tight planning restrictions.

Studies of what investors and home buyers expect to happen to house prices in a particular housing market indicate that most people project recent past prices changes (over the past year or two) into the foreseeable future. So once prices begin to discernibly rise potential buyers scramble to buy quickly before prices rise further. They are willing to buy at prices greater than similar homes have recently sold for as they believe prices will be higher still in the future. Without this factor house prices will generally appreciate only slowly as buyers and sellers are looking at prices of similar properties in deciding a reasonable price to buy and sell. Once prices stop rising potential buyers stop believing that prices are going to continue to rise in the short term and the bust begins.

How can this knowledge help policy makers? Clearly once a boom has run it is largely to late for policy makers to contain damage such as:
- builders having built houses that people do not want to buy
- investors/home owners financially overstretched
- banks and others find their loans are not being repaid and the loan is worth more than the collateral

1. As booms are local phenomenon the use of broad nationwide monetary instruments (e.g. interest rates) or fiscal policies (e.g. incentives to homeowners/builders) is not advisable.

2. Supply side restrictions need to be decreased as much as possible so affordable housing enters the market in a timely manner.

3. Decrease unrealistic expectations about future house prices. This requires the provision of strong public education through all available channels to dampen down unwarranted speculation based on unrealistic expectations. Channels could include media, industry groups, investment advisers etc. Furthermore a government pre commitment to take credible actions to decrease prices in speculative bubbles would send a message that the boom will swiftly end and make the educational message more credible. Such commitment could include temporarily increased taxes on capital gains from housing, or swift decreases in restrictions on supply in the case of increased prices.

4. However, perhaps the most effective deterrent to future housing bubbles is simply to let this bubble deflate without the kind of support which will stop prices from returning to more realistic and normal levels. House prices in many markets are still far above pre boom levels and well above historical levels when compared with incomes or rents. To stop house prices from returning to economically sustainable levels would be:

- expensive

- unfair to those who have not benefited from the previous boom and

- counter productive; as without expensive and ongoing artificial support prices will still fall at a later date and the lessons of the boom and bust would not have been learnt thoroughly enough to prevent a repeat.

How can this knowledge help homeowner and investors?

1. If you live/own in a market that has had a large boom and have equity in your home and selling is an option you would consider then it's probably better to sell now then wait for a few years and sell at lower prices. this is particularly so if you currently have some equity in your home but might be forced into foreclosure (and hence loose all your equity in the house) at a later date.

2. If you're renting and looking to buy in a city that has boomed and boom prices are well above what they were before the boom began then there is no hurry as houses will probably be significantly cheaper in the coming years.

3. If in the future you see people making a lot of money by investing in housing (or anything else) during a boom time - don't be panicked into buying or think this is the way to make easy money . The boom will end and those that made a lot of money will probably loose a lot of money. In the long term the price of housing will remain in line with rents and prices. We don't' know who long it will take this to happen -sometimes prices zoom back down in two years and sometimes it takes 15 years of house prices standing still while inflation and increases in real wages catch up.

For an excellent source of both insight and data from an international perceptive see http://www.jensks.com/


  1. Steve,
    May I ask what your advice would be to someone with no equity, an ARM, and a -50% net income cash flow to meet a mortgage payment on a house in Las Vegas that has literally lost 50% of it's value? My wife has lost her job due to economy and we've exhausted any savings to meet this obligation. As a military member, I will be forced to move at the end of the year, early next year at the latest. I can probably hold on until then but that's 24K in payments effectively thrown away.
    I think the best option is a short sale with the hope the mortgage company forgives the outstanding debt (or settles for less).

  2. Hi Rob,

    If it was me I would certainly avoid throwing that 24K away. You've done you're best to this point and things have been taken out of your control. Let's face it the finacial system did not act with a great deal of integrity towards most people (presumably you included) so best to look after yourselves. Short sale makes sense. I would look around the web for any details on other options or best way to make the short sale happen with a minimum of inconvenience.

    Couple of examples of information


    I'm assuming the loan is non recourse (i.e the lender can't go after any asset or earnings other than the house). If it isn't they may threaten to go after you but it is highly unlikely that it would be worth their while.

    If you know soemone else who has gone through your sitution it would be worth talking to them just to get a feel for the process and how they felt about it.

    Will be a weight off you and your wife when you go through with it. Good luck. Steve

  3. Thanks, Steve, for the links and the information. It's good just to hear someone plugged into the market and an obvious numbers guy confirm our course of action. We've tried for a year...literally a year...to get the lender to refi, then short refi, then modify the loan all to no avail. We're catching some flack from some acquaintances from the ethical aspect of what we're considering, but at the end of the day...it's numbers. And the bank has no ethics re: numbers.

  4. Would amend that last comment to reflect the "perceived" ethics of others re: the short sale/cutting our losses.

  5. Hi Rob,

    Good luck with it Rob. The ethics of people like yourselves isn't even in the same ballpark as many of those who arranged, packaged and onsold the loans. Not to say you shouldn't always try to do the right thing but at the end of the day it sounds like you've tried your best and now need to look after yourselves.

  6. Thanks again, Steve. It's pretty unbelievable what's happening right now. We tried, and tried hard. They denied us a refi when prices began their slide, lied to us about a short refinance, then denied a load mod. Only option left is a short sale before bankruptcy.

    Pretty draining, but very educational.

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  8. 1。那混合物是更缓慢的 ... 但是 Lexus 的即将到来混合版本 ' 将是比气体气体更快的唯一的版本如好地有多马力。不要自夸速度,但是我被吸引轮流开送行为 90,是警察给我一次休息。
    ... 只是通过在城市乘公交车往返我储蓄过来 $ 5000/yr 与我的以前的汽车,吉普车切诺基相比。超过 5 年,会是 $ 更不用说会进一步增强我的储蓄的最近的比率远足的 20K。这样除非你是在你的父母的地产上吸的一个浪费的儿子,你的声明是一束公牛。

  9. 3. 45 (90 r/t)
    45mpg 天是 2 我的车上> 8 加>>比。那每天是 6 >仑的一笔>蓄, 120 月, 1440 每年者 5040 (根 3.5 元/) ... 加上它发表 1/10th CO2。多愚蠢是它不要骑一个,去算进今天和年龄。
    4.缺少了解 ... 是真的,实际上我个人这样那样喜欢它我可能享受所有鼓励;税,合伙用车,免费停车米, prius 业主之间的秘密的信号,等等;这样自私地说那我真地在那里在享受在所有气体汽车业主上的所有权那没有一个想法多少我这辆汽车有的嬉戏。我 junked 我的 SL,郊区对我的 Prius ... 你应该也。

  10. I think we have seen that there were a LOT of factors that went into the housing bubble, not the least of which was the speculative real-estate investing frenzy inspired by the likes of Rober Kiyosaki and others.

    People bought in to the idea that they could flip properties to make a living... not realizing they were the last one to the party.

  11. Well, here we are more than two years later and it looks like you nailed some of these perfectly.

  12. Years later and we seem to be in a worse position. Will this spiral ever end?

  13. Good points all. "let the bubble deflate" fat chance, they will do anything they can "to make themselves useful" and meddle in the 'markets' - what if left of the market. These days the stock market swings on political announcements, from one day to the next