Sunday, October 07, 2007

Just going through some old email

This is an email I wrote a friend who was dead set on buying a condo on July 12, 2005.
OK, what's my goal? I want to be sure that you're evaluating your risk correctly. Now, if I pay $18,000 per year in rent, I'm gambling that a real investment would lose at least that. I could afford maybe a $300K house on a 15-year mortgage, so I'm gambling on a 6 % / year decline. But, I think it'll be much faster.
The real estate market is local. However, the mortgage rates are national, the investment capital seeking shelter is national, and the repeatedly disproven investment meme 'safe as houses' is national. Furthermore, the drop in the value of the dollar making real investments attractive to foreigners is national, and the top 6 home builders provide some large share of the market. Moreover, there's a global housing
bubble driven by some of these (obviously not the last two) same effects.
Here's another article.

The point of which is that between the subprime lending, the investors* and the people who are making their minimum payment (60% of WaMu borrowers who borrowed last year) there are going to be a lot of defaults even if interest rates don't rise, which is inconceivable. Defaults bring housing prices down, which eliminates equity lines of credit, eviscerating consumer spending, reducing business activity and making a whole new slew of people unable to make their monthly payments. When they do rise, the profit takers Fortune speaks of will act, selling in a flurry and bringing prices down. In the third wave, the equity lines of credit will already be gone, but the house price drop will be much faster, shutting down housing starts and leaving us with a gross overinventory of houses, which accounting rules will force on the market, dropping the prices a fourth time. So, that's my thesis. A four-stage drop, with an attendant depression and a massive surge in homelessness. I'm gloomy!
You either have to time the market -- I'd expect mortgage origination to peak when rates start to edge up, but that's when all of the other profit-takers will act -- or hold on to your apartment until it has lost only as much value as you would have paid in rent + excess taxes. Or, you know, lose money.

* --- this article does not speak of investors, but you know they're out there: more this year than last, twice as many last year as three years before. I believe 16.8% of new mortgage originators are declared investors, and [a mutual friend who had told us she was misrepresenting an investment purchase as a primary residence] explained the rationale not to declare.
So ... I think that's still more or less correct, although then I was predicting the inevitable and now we're living it. I may have had some effects out of order -- my email doesn't mention the five-year balloon payments, because I'd only started blogging on June 2nd, and didn't fully grok that people never follow links; they're what the referenced article is about.

My argument leaves out the home builders' carrying costs and intent to sell, which helps clarify the market in a lot of places. Also, it seems to imply I understood the global housing bubble better then than I do now, which is certainly possible. And we haven't really gotten into the economic contraction-housing deflation cycle. But, while we feel like we have a lot of empty houses, they're to a large part new construction -- I don't imagine that the default rate has really hit its stride -- it's only, what, three times what it was two years ago?

update: In the interest of humility, I did want to point out an error. Home equity lines of credit dried up all at once. They're already gone. It's not going to get worse in depreciation-contraction cycles.

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