Fear And The Housing Market
For many reasons, the housing market is unlikely to fully recover for the foreseeable future.
The New York Times points out today that, just as irrational exuberence was driving the housing bubble until it collapsed in 2007-08, there’s now a new psychology that goes a long way toward explaining why the market has yet to recover:
Just as the subprime bubble of 2006 and 2007 required one kind of perfect storm — namely, incentives to throw underwriting standards out the window — we are now living through the opposite kind of perfect storm. Essentially, every participant in the housing market has a reason to be afraid. And that fear is paralyzing.
The prospective buyer, for instance, has two good rationales to fear buying a new home. One is the unemployment rate. “A major psychological thing happens with high unemployment,” says Dave Zitting, a veteran mortgage banker and founder of Primary Residential Mortgages. “Those with a job worry about whether they are going to keep that job” — which, in turn, prevents them from taking the plunge on a new home.
The second reason is that, Mr. Yun notwithstanding, most people simply do not believe that housing prices are even close to hitting bottom. “In the Bay Area, a house that was worth $300,000 a decade ago became a million-dollar home,” said Greg Fielding, a real estate broker and blogger. “Now it is listed at $800,000.” That price, he suggested, was still unrealistically high. The seller, meanwhile, doesn’t want to face the fact that his or her home is too richly priced, and won’t sell at a more realistic price — which may well be below his or her mortgage debt.
The incentives are similar on the Lender’s side, with the added twist that the very government that talks about reviving the housing market is actually helping to keep it depressed:
Chastened by the excesses of the bubble, mortgage lenders have swung hard in the other direction, becoming excessively, almost insanely, conservative. They demand high FICO scores. They won’t lend to anyone who is recently self-employed — even if the potential borrower has socked away a lot of money in the bank, or is making a good income. They won’t count income from capital gains.
“I have wonderful people in my office every day who would have qualified for a loan prior to the bubble” but now can’t get one, Mr. Zitting said. Mr. Barnes said: “Underwriting standards are vastly tighter than any time in my lifetime. It is choking off buyers.”
Here’s the strangest part, though: it is really not the lenders themselves who are imposing the most draconian of these tight new underwriting standards. Rather, it is the federal government. That’s right, the government.
(…)
“The government right now is insuring something like 85 to 90 percent of the country’s mortgages,” said Daniel Alpert, a managing director of Westwood Capital. And given the enormous losses Fannie and Freddie were saddled with during the financial crisis, they are in no mood to take risks, not even on borrowers who are normally considered creditworthy. So they are saying no a lot more than they used to — even though this is having a terrible effect on the housing market.
Now, as any student of economics could tell you, what’s going on here isn’t irrational “fear” on the part of potential homeowners, or tight-fisted, irrational, lending policies on the part of borrowers. Both parties are responding in the best way that they can to the cards they’ve been dealt.
It’s completely rational for someone who might be thinking about buying a home to take into account the fact that their own job security before entering the market. After all, there are few things worse than buying your dream home only to find out two months later that you’ve been laid off, or one of the bread winners has is suffering from a health problem that cuts the family income in half. Unless you’ve built up a nest egg, it’s a virtually impossible situation to get through for most people. Given how well-publicized the foreclosure crisis has been over the past several years, people would be foolish not to take something like this into account.
Additionally, as I noted on Friday, there’s plenty of reason to believe that housing prices aren’t anywhere close to the bottom right now, especially when there’s plenty of what realtors call “shadow inventory” that has yet to hit the market:
There is also an immense amount of inventory that has yet to hit the market but will, sooner or later. People in the real estate business have taken to calling this “the shadow inventory.” It consists of homes for which the owners have stopped paying the mortgage but the banks haven’t foreclosed on yet, foreclosed properties that have not yet been put up for sale, homes with modified mortgages that the owners still can’t afford and will soon default on and so on.
Mr. Barnes describes the shadow inventory as akin to “ranks of Napoleonic infantry, rows deep, hidden in the fog.” This inventory, estimated by Rick Sharga of RealtyTrac to be between three million and four million homes, is almost certain to drag down home prices for the foreseeable future. “The disinterest of buyers, in an interest-rate environment that may be the lowest ever, is striking,” Mr. Barnes said. But, he added, it makes perfect sense. Since 2007, housing prices have been in a deflationary spiral, and nobody can say when it will end. “It doesn’t matter if interest rates go down to 2 percent,” Mr. Barnes said — buyers won’t reappear in big numbers until they can see the light at the end of the tunnel.
In other words, simple supply and demand.
So, it’s not “fear” that’s driving the housing market down, it’s the rational responses of homeowners, homebuyers, and lenders to the conditions around them. Until those conditions work themselves out, what we see today is likely to be the “new normal” for some time to come. Unfortunately, nobody in Washington has the courage to tell the public that.
As I’ve mentioned, I’ve read a series of books (maybe 10) which bridge from the mind to the economy. One of the ones I found most useful was Antonio Damasio’s “Descartes’ Error.”
I mention it, because (as someone said recently) the words “rational” and “irrational” are kind of 1960s. They are, in the terms of the era “Spock vs Kirk.” We know now more about the brain and neurobiology. One of the things we know is that all decision-making, even good decision-making, has an emotional sub-plot. Spock couldn’t live in real life because he’d have no motivations. Why should he get out of bed? Why should he show up for work? Because it is “logical?” Not really.
So while I agree with much of the above, I think the old-world terminology hides a bit. It’s only “rational” to buy a house if you “want” one, and “wanting” one is pure emotion.
And sure, perhaps “fear” is the brain’s way to say buying now isn’t “logical.”
There isn’t one housing market in the US, there are at least fifty. All behaved somewhat differently in the boom and they are behaving differently in the bust. The huge shadow inventory you talk about Doug is concentrated in those states who saw the largest bubbles like CA, FL and NV. I doubt there is a huge shadow inventory in many states although they maybe somewhat over inventoried as is the case in my state which saw a modest run up in prices, a 20% downturn which has now bottomed and is now experiencing some modest uptick. We’ve just had the worst real estate, financial and economic bust in this country since the great depression and everyone is whining about why things aren’t back to “normal” after 12 months.
The weird thing Joe, is that if we’d had (truly) fifty housing markets, the banks and bonds would have stayed solvent. The housing crunch became a credit crisis because the bonds assumed there would not be, net-net, a national decline.
That said, certainly there are regions that suffered the worst swings. They had more “mania” on the way up, and more “panic” on the way down. Actually … I’m not sure the panic really hit. There were those home-buyer credits and still are a lot of crossed fingers.
BJ is correct about there being a number of regional markets rather than a national one. Unfortunately California is around 10% of the nation and it has an effect on Oregon, Washington, Arizona, and Nevada. I imagine Florida effects neighboring states as well.
Buying a home is still a good long term investment. Not like stocks but it will reduce your monthly housing costs over time as your mortgage remains the same. Eventually you could pay it off and live nearly rent free. The abuses of flipping and home equity loans should be obvious now and some sanity return. It’s still rational to buy.
True, but not everyone chooses their house consciously as part of an Asset Allocation. We tend to buy as much house as we can afford, at a certain stage of life, and then turn to other investments later.
I know I did. It just happens that I stayed with an early purchase, reducing my house’s role in my AA, and increasing the payback as “cheap rent.” If I’d bought a prestige home later, it would be at once less “cheap shelter” and at the same time, more of my investment strategy.
john personna says:
Sunday, August 29, 2010 at 10:53
The weird thing Joe, is that if we’d had (truly) fifty housing markets, the banks and bonds would have stayed solvent.
Not at all. The housing market is obviously purely local whereas the securitization of housing finance is national or indeed global.
Steve Plunk says:
Sunday, August 29, 2010 at 11:28
“BJ is correct about there being a number of regional markets rather than a national one. Unfortunately California is around 10% of the nation”
I was being conservative at fifty. California has at least three different housing markets to my certain knowledge. Prices may have plummetted in the Valley but they’ve only seen a slight dip in West LA.
What a weird response, Joe. You say “not at all” and then say, yes securitization was national?
Didn’t the national securitization blow up because pools across geographic areas blew up?
http://www.thisamericanlife.org/radio-archives/episode/355/the-giant-pool-of-money
Yes, indeed that was the reason.
john personna says:
Sunday, August 29, 2010 at 12:24
“What a weird response, Joe. You say “not at all” and then say, yes securitization was national?”
Er John. The price of houses is largely determined by local supply and demand. What prices houses command in Las Vegas is totally irrelevant to Seattle. The markets for the debt on all those houses wherever they are located is however in NYC, London and Tokyo. The only thing that’s weird is that you don’t understand the difference or even apparently that bad mortgages can damage good mortgages when they are all bundled together in the same financial instrument.
Joe, you are answering me with non sequiturs.
Fact: Mortgage pools were designed with geographically distributed properties, in the belief that they would be resistant to downturns, because a national downturn had not occurred in nearly a century. And then it did.
Now, when you seek a loan in any locality you suffer the aftermath of that.
When you say “What prices houses command in Las Vegas is totally irrelevant to Seattle,” you deny the actual history of this crash. Not to mention the that the loan mechanism in both those places and many others was blown out of the water by the crash. The only entities doing originations at this point are government backed. That is another big, national, impact.
Maybe you logic is that it wasn’t a national downturn, because even though it was net-net a national downturn, there were some small localities that dodged the bullet.
Isn’t that like saying there is no global warming because Colorado is hotter this year?
john personna says:
Sunday, August 29, 2010 at 15:31
Joe, you are answering me with non sequiturs…….Not to mention the that the loan mechanism in both those places and many others was blown out of the water by the crash. The only entities doing originations at this point are government backed…….
Now, when you seek a loan in any locality you suffer the aftermath of that.”
I thought those were your speciality. The financial industry commingled debt from different markets and with different credit rating, then sliced and diced it, and sold it on thus completely obliterating the linkage between the debt and local housing markets and blurring the quality of the debt. Previous housing booms and busts have tended to be localised affairs in the usuals suspects (CA and Florida) but because of the financial engineering involved it nationalised the problem. None of this alters the fact that housing is very much a local market dependant principally on supply and demand in the area. You can deny that all you like but you’d be wrong.
And in financing terms the only aftermath if you’re taking out a loan is that NINJA loans are no longer available and some of the more disreputable brokers have disappeared. Wa Mu, Countrywide etc are all still in business under different ownership, there’s no shortage of housing finance for the reasonably credit worthy and rates are the lowest for generations. And lenders are not govt backed although most of the mortgages they sell are being purchased in the secondary market by Fannie and Freddie because private investors have fled the market as they always do when there’s a recession.
Joe, the line you “disagreed” with was this one:
“The housing crunch became a credit crisis because the bonds assumed there would not be, net-net, a national decline.”
Even as I said:
“That said, certainly there are regions that suffered the worst swings. They had more “mania” on the way up, and more “panic” on the way down. Actually … I’m not sure the panic really hit. There were those home-buyer credits and still are a lot of crossed finger”
I put “disagree” in quotes, because all you seem to do is say “Not at all” and then say the same sorts of things I did, in different words.
Just go back and listen to the NPR link I gave you. Nothing you have said in this thread is new, relative to that, and you still deny big-picture truths explained within it.
john personna says:
Sunday, August 29, 2010 at 17:25
“Joe, the line you “disagreed” with was this one:”
In fact, the line I disagreed with was this totally erroneous one made at 10.53 which was in response to my suggestion that we have not one but at least fifty different housing markets in the US:
“”The weird thing Joe, is that if we’d had (truly) fifty housing markets, the banks and bonds would have stayed solvent.”
Not only is it erroneous as it applies to the banks and housing debt market which is now nationalized and completely disconnected from local conditions except in a generic sense, but you’re also clearly saying we don’t (truly…your word) have fifty different housing markets. You also later made sundry claims about current state of the consumer housing finance market, that lenders were govt backed etc,; most of which were to varying degrees inaccurate. As of now the disconnected debt market isn’t having a lot of impact on consumer housing finance which is cheap and readily available to creditworthy in the fifty plus different housing markets in the US.
I’m sorry Joe, to me you are defending a contradictory argument. You want to say that “markets” are separate, but the financial infrastructure was national. You wan to say we didn’t have a national decline, even though the net-net national decline is what blew up those bonds.
You can say “somewhat differently” and then you can look at the Case-Shiller plots for various markets, and see them running in parallel, boom to bust. The degree of boom varied, but that sure wasn’t enough to make “separate” in any meaningful sense markets.
Not only that, we saw retirement destinations in other state blow up as California blew up. This since California sales drove other-state purchases.