Additional References
EWFF, August 2006
Many of the most vulnerable property owners are those that think they just dodged a bullet by trading in ballooning payments on their old adjustable-rate mortgage plus the equity in their house, for a new adjustable-rate mortgage. According to The New York Times, $400 billion in adjustable-rate mortgages, or about 5 percent of all outstanding mortgage debt, will readjust this year for the first time. Another $1 trillion in loans will readjust next year. Home owners can put off the “day of reckoning” by refinancing with new adjustable-rate mortgages that keep monthly payments low, but by doing so they dig themselves in deeper, because payments will be even higher in the future. The headlines above mean that this “opportunity” is ending. “Everything works fine as long as there is pretty decent home price appreciation,” says the director of a residential mortgage securities group. With prices beginning to fall, there’s only one way out, and that’s to sell, which means further price declines.
EWFF, May 2006
Local mortgage brokers have a warning for people already struggling to make their adjustable rate mortgage payments: get out of them now. Of course, now it’s too late. Rates are up and mortgage bankers are increasingly at a loss when it comes to creative refinancing solutions. The September issue showed a chart of banks’ mortgage-related assets and said that they seemed “blind to the danger as they continue to stuff their balance sheets with mortgaged assets.” Bloomberg columnist Caroline Baum reveals in a recent article that the truth can now be told—banks are in deeper than almost anyone thought. “Every time the subject of banks making risky home loans to bad credit risks—no money down, no questions asked—the usual retort is that banks sell the mortgages. They aren’t at risk. That’s not exactly true.” Baum places the exposure at 44%, but even that understates the problem because banks still derive significant origination fees from mortgages they sell, and those fees are drying up. With the national foreclosure rate jumping 63% in the first quarter of the year (according to RealtyTrac.com), real estate, is suddenly a dicey proposition for bankers.
Another aspect of the reversal that no one ever counts on in the midst of a mania is the high level of fraud that invariably attaches itself to the hottest sectors. This was the basis for the following statement in the July issue: “This time there is no mistaking who the Enrons of the bust phase will be. They will be the firms now pedaling adjustable-rate, no-interest/nothing-down and assorted other types of ‘sub-prime’ mortgages.” The next wave of scandals is probably still growing, because in-too-deep participants generally do whatever it takes to stay solvent as the reversal takes place, but its outline is clearly visible in articles like this one from MarketWatch on April 9:
Home Is Where the Fraud Is
Mortgage scams cost billions
Once a nuisance to a handful of lenders, mortgage fraud has blossomed into one of the fastest-growing white collar crimes in the country.
The fulfillment of these 2005 forecasts about the housing market confirms that a Grand Supercycle version of the Supercycle real estate busts of the 1830s and 1930s is underway. These are just the warm-up acts. If there is a banker out there who took this advice from Conquer the Crash, “Sell off your largest-percentage mortgages and get into safer investments,” it’s time to sit back and enjoy the show.
The Elliott Wave Theorist, September 2005
New credit and new debtors are the fuel of all bubbles, and while credit is still freely available, the supply of potential debtors is exhausted. Lenders are certain of real estate’s magical properties of continuous rise. The lending binge has gone on for so long that when it reverses, repossessions will soar. Before the crash is over, the biggest owners of real estate will be banks. These banks may not all be local. Read especially the underlined portions of this article, from the Prague Daily Monitor, August 12, 2005:
Demand for American mortgages growing steeply in Czech Republic
(PDM staff) 12 August - Czech interest in American mortgages has increased significantly since last year, and bankers say the loans are taken out to finance luxury holidays, expensive cars and home furnishings, daily Lidove noviny (LN) wrote yesterday.
Clients are not requested to give a purpose when applying for an American mortgage loan. Also, they need no guarantor. Zivnobanka spokesman Ivo Polisensky says people frequently use the money to start up a business. Like in standard mortgages, real estate is held as collateral for American mortgage loans. Ceska sporitelna is the biggest lender. Last May, when the bank launched American mortgages, it had only several dozen clients, compared to hundreds of them at the end of last year. In the first half of this year, it provided 2,673 American mortgages worth CZK 1.4 billion. Raiffeisenbank spokesman Tomas Kofron says people’s interest in these loans for was lower last year because people did not know about the product. Other banks have also confirmed a growing demand for these loans. Nine banks offer the product in the Czech Republic at present.
—CTK news edited by the staff of the Prague Daily Monitor
The housing boom began in 2000, the same year that the primary stock market boom ended. At that time, the Great Asset Mania simply shifted focus from primarily stocks to primarily real estate. So-called “investors” in property (which are little different from the so-called “day-traders” of 1999) are buying up property on the hopes that it will rise further in price; they have to do something with the extra space, so they rent it. The excess buying and building has kept a lid on rents. When property prices fall, renters will be sitting pretty to an even greater extent, as they were all through the 1940s when metro area building slowed considerably yet rents continued to fall.
September 2005, EWFF
Back in March 2000, EWFF noted that the “fate of the world” hinged on the manic rise in 50 U.S. stocks, many of which were unprofitable. Five years and one recession later, the global economy is hanging by a similarly thin thread. The difference now is that the weight of the world is being held up by the public’s affection for real estate and the debt needed to acquire it.
According to Irwin Stelzer of The Weekly Standard, data compiled by the Bureau of Labor Statistics “shows that housing and related industries now account for 4.8 million jobs, some 60% more than the once-mighty auto industry.” While the U.S. auto industry lost 60,000 jobs in the past 4 years, the housing industry created almost 600,000 jobs in construction and financial services. Newspapers are a good example of how whole industries are clinging to real estate’s coat tails. As anticipated in past issues, the newspaper industry is slowly falling prey to the Internet and gathering deflationary forces, but its saving grace is a flood of real estate ads that have poured in over the last year. The Wall Street Journal reports that real estate ad revenue increases of 16% to 45% are “masking what has been a years-long decline in classified-ad revenue at newspapers.”
But the home-buying binge comes at a steep cost to U.S. households. The household surplus/deficit chart from Paul Kasriel of Northern Trust Co. shows the financial impact to homeowners [not shown]. From the 1950s to 1999, one year before the start of the bear market, households maintained a surplus, whereby disposable personal income exceeded total expenditures on consumer goods and services and residential investment. At the height of the great financial mania, the balance of payments shifted, and households rapidly slipped into arrears. People’s willingness to borrow and spend on goods, services and homes bailed the economy out, but it leaves the primary driver of the U.S. economy with virtually no financial flexibility.
What possessed owners and home buyers to spend themselves into a $400 billion deficit? Only the psychology of a Grand Supercycle trend change can account for it. Nothing else can explain the twisted mindset on display in recent real estate stories in the L.A. Times: “mortgages used to be something people strove to pay off. Now they’ve become income tools.” “What was once considered undesirable — taking on large debt — is now seen as smart. And what used to be smart — becoming debt-free — is described as imprudent.” Says the chief economist of the National Association of Realtors and author of Are You Missing the Real Estate Boom?, “Paying off a mortgage [is] very unsophisticated.” The chief executive of an Internet-based mortgage company echoes this sentiment: “If you own your own home free and clear, people will often refer to you as a fool.” Many of these people undoubtedly said the same thing about anyone who advised against piling into Internet stocks in 1999.
Banks seems to be blind to the danger of overpriced collateral as they continue to stuff their balance sheets with mortgages assets. The ratio of mortgage debt to total credit outstanding has nearly tripled in the last 20 years. Banks are doing everything in their power to keep this line rising. In addition to the no-interest loans mentioned in recent issues, “payment option” loans in which borrowers can pay less than their monthly interest are growing fast. These loans are also known as “negative amortization” loans because underpayments increase the amount that the borrower owes. At Countrywide Financial, the largest mortgage lender in the U.S., the principal value of negative amortization loans rose almost 100 times, from a value of $33 million at the end of 2004 to $2.9 billion on June 30. (Thanks to Grant’s Interest Rate Observer for this figure.)
July 2005, EWFF
For Real Estate, It’s Time
There’s no mistaking it now: The extreme psychology of the Grand Supercycle peak has taken up residence in real estate. The public demand for periodically illiquid pieces of property is an eerie facsimile of the zany excitement for stocks in 2000. It now includes a record high price of $90 million for a U.S. residential property; a TV show, Property Ladder, in which subjects buy houses and resell them for a quick profit; and an online trading service, Condoflip.com, where “flippers, brokers and developers come together” to trade as yet unbuilt condominiums. “Bubbles Are For Bathtubs,” reads the top line on the site. While the number of stock market investment clubs has decreased 46% since its peak year of 1999, the number of real estate investment clubs is up 400% since 2002. One California club member explains proudly, “I quit my day job of 30 years. It’s the wave of the future, of working smarter, not working harder.” The easy-money, “I’m a wizard now” ethos of the mania is coursing through real estate as furiously as it raged through the stock market in 2000. “Get Rich Without Leaving Home,” says a CNN Money headline. “If you’ve dreamed of investing in real estate but don’t want to miss out on the kids’ Little League games, [real estate] partnerships may be the answer.”
The leverage upon which “the dream” is built is way beyond the record high margin levels in stocks in 2000. “I’ve been playing with the bank’s money,” says the cover girl on the May issue of Money Magazine. Forget the 30-year mortgage; 40-year home loans are now “mainstream” and 60-year, no-interest terms are offered in hot markets like San Francisco. This time there is no mistaking who the Enrons of the bust phase will be. They will be the firms now pedaling adjustable-rate, no-interest/nothing-down and assorted other types of “sub-prime” mortgages. According to the ISI Group, homeowner equity was 56.3% in March, a slight uptick from the lowest level on record. A strong undercurrent of envy is another tie to the dot-com era. “Desperation is driving people,” says the director of Harvard’s Joint Center for Housing Studies. “People are not looking at what they are going to have to pay over the long term. They are asking what is the lowest possible payment I have to make over the next 12-months so I can get in.” Says a California disc jockey, “I saw my friends and colleagues getting rich. I wanted to get rich too.”
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