A drop in property values is no longer some distant worry you should shrug off. Its not some theoretical, over-the-horizon, possible threat. Its happening right here, right now.
Just as Ive been saying for months on end: First, sales fall. Then, supplies build. Lastly, prices fall. And sure enough, now this 1-2-3 sequence of events is unfolding right before our eyes.
Look at what happened in June, according to the National Association of Realtors:
- Sales dropped almost 9% year-over-year.
- Inventory for sale skyrocketed 39% to a record 3.73 million units. At the current sales price, thats 6.8 months worth of supply the worst since 1997.
- The real kicker: Median condo and co-op prices dropped 2.1% from June 2005. This isnt just a regional decline. Its not simply concentrated in a few cities. Its a bona fide, nationwide, year-over-year decline in values.
True, single family home prices rose ever so slightly. But remember, these are nominal price changes, not real, inflation-adjusted changes.
The Consumer Price Index climbed 4.3% in June. So when you factor in inflation, the average home has actually lost 3.4% of its value. This is all summed up in the chart. Look at that huge drop-off in just the last year!
And dont forget: Selling a home isnt free. If you bought in the past year and you need to sell now, youre generally looking at another 6% haircut in commissions.
Total real loss: Almost 10%! Thats not including any upkeep money spent in the interim … any mortgage interest paid … any homeowners insurance or taxes … or any of the other costs associated with ownership.
The new home market isnt much better. Sales were down 11.1% year-over-year in June and inventories surged to a fresh all-time record of 566,000 units.
Nominal median prices havent gone negative on a year-over-year basis yet. But the 2.3% rise was the worst reading since December 2003, and prices have dropped more than $20,000 in just the past two months.
This Should Not Come
As a Surprise to You
The real estate industry would have you believe prices can never fall. Last year, I practically got laughed out of the room when I predicted a dramatic slowdown in housing. But this is no longer some theoretical discussion. Its real life.
And if youve been reading our daily Money and Markets, you shouldnt be surprised one bit.
Back on January 27, I warned you about a housing bust. And most recently, in “Housing Stocks Plunge! Housing Next!” I told you real estate sales would keep falling, inventories would keep rising, and defaults would keep skyrocketting. My final warning was,
“Prices on a wide variety of
properties are going to
fall in vast swaths of the U.S.”
But even though this is now unfolding before your very eyes, some people are still peddling the “soft landing” argument. But theyre missing the rotten foundation thats below the surface.
Martin and I have been talking about this for quite some time. In our April 2005 Safe Money Report, we wrote,
“Wall Street of the late 1990s was a mucky cesspool … What no one seems to realize is that its happening all over again only this time, in a sector thats both bigger and more ominous: Housing and mortgages.”
We identified several huge red flags, including …
- “Option adjustable rate mortgages” or “pick your payment” loans These are mortgages that start at artificially low rates. They also allow you to choose four monthly payment options, including one which pays off no principal and one that doesnt even pay off all the monthly interest due. That leads to negative amortization a fancy term for when your unpaid interest gets added to your principal, pushing your loan balance up rather than down.
- Inflated appraisals Lenders pressure appraisers to inflate the value of the homes they’re lending against. This allows lenders to meet their short-term profit goals. But it increases the chance that borrowers will default. Reason: They end up owing more than their homes are really worth.
- Over reliance on investors Most loans today get packaged and sold off to investors as Mortgage Backed Securities (MBS). The process is called securitization. It allows originating banks and mortgage brokers to hand off the credit risk on many loans to investors.
The problem: It causes mortgage originators to focus on collecting up-front fees, not the long-term performance of the underlying loans. This opened the floodgates of easy money, allowing way too much investor cash to flow into the mortgage market. That, in turn, encouraged lenders to throw standards out the window.
- Over reliance on investors Most loans today get packaged and sold off to investors as Mortgage Backed Securities (MBS). The process is called securitization. It allows originating banks and mortgage brokers to hand off the credit risk on many loans to investors.
Now, youre starting to read about these problems in major media outlets …On July 22, The Wall Street Journal wrote:
“As the housing market cools, Americans are confronting a problem that was easy to ignore during the boom: Inflated appraisals of home values.”Critics inside and outside the appraisal business have long warned that many appraisals are unrealistically high. “Inflated appraisals didnt matter much when home prices were rising at double-digit rates, since market values would quickly catch up. Now, however, prices are leveling off in many places and falling in some. Some homeowners are finding that the market value is below what past appraisals led them to believe.”For sellers, that can mean being forced to drop their asking prices. Some people hoping to refinance, meanwhile, may be unable to lock in new loan terms because they have less equity in their homes than they thought. Lenders and mortgage investors, too, could take a hit if it turns out the collateral backing their loans is worth less than expected.”
And on July 26, The Chicago Tribune noted:
“For many people, buying meant using exotic mortgage products such as adjustable-rate mortgages, with low initial rates that typically jump after a few years, which can raise payments by thousands of dollars a year. As interest rates rise, experts say potential buyers should be cautious before agreeing to one of these loans.”A person can lose money on a home especially if the housing market cools, as many analysts predict. People in over their head with mortgage payments who made a low down payment might have to sell a house for thousands less than they have to pay their lender.”
Unfortunately, the warnings in the mainstream press are coming far too late. Too many borrowers are already saddled with these onerous loans. They bought the BS pushed by everyone from Alan Greenspan on down to your friendly neighborhood mortgage broker. They called ARMs a great “deal” an “affordability product” that could help you stretch your buying power.
Stretched Borrowers
Are Paying the Price
Thanks to 17 straight rate hikes, aggressive loans are now strangling millions of American homeowners. Rates and payments are jumping by 20% … 30% … 40% or more. In total, up to $2 trillion worth of adjustable rate mortgages (ARMs) are set to adjust higher in 2006 and 2007.
Some borrowers will be able to refinance into a fixed rate mortgage and therefore scrape by without defaulting. But the fact is, most werent even able to afford a 30-year fixed rate mortgage when they were far cheaper than they are now.
And what about the regulators? They fell asleep at the switch long ago letting lenders get away with murder. Option ARMs … 40-year mortgages … interest-only loans … the list of “suicide loans” rolled out in bulk these past couple of years goes on and on.
Another Stealth Killer:
“Stated Income” Loans
What most amazes me are mortgages that only require borrowers to “state” their income at the time of application, rather than prove it with full documentation. Holy cow are these ever a disaster waiting to happen!
National Mortgage News just broke this story …
An unidentified lender sampled 100 of its stated income loans, comparing the “income” listed on the mortgage application to the salary the borrower reported to the Internal Revenue Service.
A whopping 90% of those stated “incomes” were exaggerated by at least 5%. Just little white lies? Hardly! Almost 60% of the borrowers exaggerated their income by more than 50%.
In other words, these borrowers “qualified” to buy massively overvalued homes on wildly inflated phantom incomes.
Do you really think its just one lender with a loan book full of garbage? I sure as heck dont. Based on what I read, see, and research, this is a huge problem thats going to mushroom into a firestorm.
Where We Go From Here
Im not trying to scare you. Im trying to level with you. Im trying to cut through the garbage youre getting from self-interested parties, like real estate agencies and mortgage lenders.
In my view, these housing and mortgage conditions have set the stage for …
- An explosion in the number of borrowers stuck “upside down” owing more than their homes are worth.
- A dramatic surge in loan delinquencies, losses, and foreclosures.
- Outright bank failures as condo construction loans default, homeowners walk away from residential mortgages, and developers go broke leaving banks holding worthless construction loans.
Right now, Wall Street doesnt want to hear it. The homebuilding stocks actually bounced earlier this week on the assumption that this is “as bad as it will get.”
And major bank stocks have been rising on the assumption that the Federal Reserve is just about done hiking rates. The big boys think that will lead to a massive, 1995-style rally in bank stocks.
Im here to tell you thats wishful thinking.
At best, youre going to see many sub-prime lenders, some banks, and investors in high-risk mortgage debt get their heads handed to them.
At worst, we could have another crisis akin to the savings & loan crunch and commercial real estate busts of the late 1980s and early 1990s. Back then, reckless lending and wild interest rate moves caused huge bank failures and ultimately led to a massive federal bailout costing more than $150 billion.
What To Do Now
First, if youre trying to sell your house, understand youre competing against more sellers than ever before. Price low. Offer incentives like closing cost assistance. Dont dither around.
What if youre staying put? Be prepared for a long, drawn out slump. Real estate down cycles arent measured in weeks, theyre measured in years.
And if you were suckered into using a high-risk mortgage when you bought your place, ask yourself whether you can really afford the house youre in. If not, consider selling now especially if you think you might be forced to move in the next year or two due to job loss, family reasons, or other things.
Second, dont succumb to the siren song of “No more Fed hikes = massive financial stock rally.” It sounds neat and tidy, but things are much more complicated than that. Sure, there are going to be some winners out there … and I wouldnt discount the possibility of a continuing rally in bank stocks in the near-term.
But there are some real credit concerns building out there thanks to this housing slump. When investors start thinking about just how much mortgage exposure many banks, lenders, and major Wall Street firms have, that buying could dry up fast.
Third, continue to avoid sectors vulnerable to the spreading housing slowdown. It used to be just the homebuilders getting crushed. But now its their suppliers and companies that sell home improvement gear.
Just look at Black & Decker (BDK). The tool makers shares got crushed this week, plunging by the most in almost a decade due to concern over sales and earnings trends.
Even retail and consumer technology stocks are getting whacked. The reason? With home values no longer rising, consumers cant just keep tapping the “housing ATM” via home equity loans and cash-out refinance mortgages.
Fourth, make sure your deposits are in safer, more diversified banks. Go to www.WeissWatchdog.com for a free list. And register to get free ratings on up to three institutions of your choice.
If Im right, and an ugly series of loan failures is coming down the pike, things are going to get hairy as we head into 2007. Consider this an early heads up like the one on housing that we gave you in Money and Markets before it hit the mainstream press.
Until next time,
Mike
