Chris Lydon's Radio Open Source

Chris Lydon's Radio Open Source had a show on the housing bubble: http://www.radioopensource.org/2005/07/27/the-beginning-of-the-end-of-the-bubble/. Here's one thing I said:

People have started viewing their houses as gigantic ATMs. Take out a home equity loan, which the banks are eager to offer you, %u2026and all of a sudden you have an extra $70k to play with. You can put on an addition, you can go through the roof, you can take several trips to Hawaii, and still have large amounts of money left over.

I shamelessly stole this line from Doug Henwood of Left Business Observer: http://www.leftbusinessobserver.com/--another man who really ought to have a weblog.

Comments

[howard]

in last week's barron's, alan abelson mentioned someone's study that noted that from 1955-1995, housing prices grew 0% in real terms.

Zero.

From 1995 to now, they've grown 45% in real terms.

[Abby]

It was great to hear you on the show. Chris Lydon is my favorite host, bar none. We're supposed to be having a party for him.

Did you find the experience different from most shows? I used to think that guests needed to be on their tooes more. Now I'm not so sure. You can crush my bubble.. was he really just like all the rest?

[David Ricardo]

Bankers lend you the umbrella (money) when the weather is beautiful but once the weather turns ugly they want it back or raise its price via interest rates...sooner or later they will want real money back and that will create real problems ... scary!

Houses are no investments, they don´t generate wealth, quite contrary they deteriorate so they create maintenance expenses and cause taxes. You start a business with the purpose to make profits you don´t buy a house with the purpose to make profits. Houses don´t generate value or profits by themselves. Simply put, houses are places to live.

Prices of houses and real estate fluctuate but in the long run are a function of 2 factors: economic growth and security. Security meaning land in Switzerland is more valuable than in France even though is the same land, they share the same view and the same cows and there may not even be a fence between the two countries, on the other hand, land in the US is more valuable than in the Sahara dessert because of economic growth. If the US has been growing in real terms, houses and real estate do reflect that value, if US wealth hasn´t increased in the same proportion you have excessive housing and real estate prices created by excessive liquidity or excessive money supply or a change in demand due to people preferences. If there is more money chasing a limited amount of land prices go up. If money has been rather constant then the invisible hand will take care of these excessive prices.

[Aaron Swartz]

Re Doug's weblog; I've been thinking of making one for him by extracting the emails he sends to lbo-talk.

[Ralph]

Apparently the home ATM is a factor in the other anglophone countries. This would seem to support a world slowdown when housing prices eventually peak and start their descent.

[No Preference]

You must have Boston roots, Brad. FYI - WBUR's "The Connection" is being dropped at the end of this week. The feud between Lydon and WBUR management undid the best radio show in Boston. There's nothing that good on the airwaves now.

[christo]

This line of thought, homes as an ATM, has been thunk by Jim Grant at Grant's Interest Rate Observer for a couple of years now. He's the commentator with knowledge that has been looking quizzically at Greenspan since the internet boom years. So Brad's view is catching up with current events. I'll take it he has caught up when he starts ending posts about Fed policies with resign now, save the country.

Oh, Prof. Delong and Prof. Krugman have been quite appreciative of Greenspan's monetary policies which means don't criticize Greenspan in some posters' views.

[dilbert dogbert]

Acerbic Berkley economics professor??????
Why oh Why Don't We------ = Acerbic????
Clown Show = Acerbic????
Impeach BWB/Cheney = Acerbic????
I got the impression he is a mild mannored economist.
Maybe even the famous one armed economist.

[Tom Cecere]

Honestly, why shouldn't these people mortgage themselves to the hilt? If their gamble doesn't work out, they know very well we won't let them starve or die due to lack of medicine. The logical action for people with no overriding moral code is to spend like sailors. Sure, at some point, it becomes harder and harder to get a loan, but there's a lot of sales quotas tied up in GIVING loans, too. There aren't actually that many scenarios where the 50-70 year olds of today (62 year old "Baby boomer"? Depressing) don't come out better; they've never cared about the future before, why start now?

[Bruce Webb]

Housing is an odd investment. Odd in that severe declines in the value of that investment don't necessarily hurt the pocketbook.

I buy $750,000 worth of stock on margin. I put in $75,000 and put the stock up as collateral on the loan. As long as the stock increases both me and my broker are smiling, but with each downtick my broker gets edgier and I start looking around to see if I can make the margin call. Any losses come right out of my initial investment, it doesn't take a lot of slippage to wipe out the whole $75,000.

I buy a $750,000 house with 10% down and lock in a mortgage. As long as I have a job that allows me to make the mortgage I have $675,000 of elastic plus whatever value you allocate to rent between me and my initial investment. If the housing market tanks my mortgage lender may stop smiling altogether and I may be less and less happy that in effect I only only getting the value of rent out of my house payment, augmented of course by the tax savings of being able to deduct my interest and property tax. But I am not worried about the prospect of that margin call.

People seem to be equating the effects of a housing bubble with those of a stock bubble, and if you are a straight out investor in real estate that may be perfectly true. But owner occupied is a whole different ballgame with a whole different set of lifestyle and tax assumptions. In most markets making the transition from renter to owner still is a winner, even if your market is due some slowdown or shrinkage. All you are risking is the premium of ownership over rent, which in an era of sub 6% mortgages is not a lot.

[Tom Cecere]

But Bruce, all the evidence in the "frothy" housing markets shows that ownership is at a huge premium to rental prices (sometimes double) and certainly the days of 6% mortgages are limited. If you've locked in, great, but most people are riding adjustables just to get approved. There will certainly be people who will lose their shirts over this market.

The point is that they know we'll ride in and save them after some small amount of mental discomfort (All they have to do is vote for it, right?). High upside and very little downside. Is this what they call a "moral hazard?"

[Wh]

"If the housing market tanks my mortgage lender may stop smiling altogether and I may be less and less happy that in effect I only only getting the value of rent out of my house payment, augmented of course by the tax savings of being able to deduct my interest and property tax. But I am not worried about the prospect of that margin call."

What if you have to move though ? For job related or personal reasons ? Upstate New York is full of small towns that were hurt badly when Kodak. GE etc. retrenched. For the owners, its also hard to pack up and move because they're sometimes upside down on their mortgage.

[John]

A web log for Doug Henwood? In more ways than one, his LBO mail list is his blog.

[Bruce Webb]

Well you don't have to sell when you move. And I understand getting upside down on your mortgage. The West is full of ghost towns old and new that effectively represent people walking away from an asset.

But if you look at it from a balance sheet, and ignore the impacts on your credit score, how many owner occupied houses are out there which are truly upside down, that the owner whether he sells or gives it back to the bank is truly out a cash amount exceeding his rent value and tax breaks for his time living in the house?

I am sure there are plenty of people taking out ARMs to get approved. But for what kind of house? If we are talking starter house, then they get my sympathy. If you are talking stretching every last bit of credit so you can buy a McMansion you don't.

Sure people are going to get stung if and when the housing bubble pops. But it is far from clear whether that sting will be felt from coast to coast, and less clear than that that owner occupied housing will feel it in any serious way.

My point is that the newspapers always, and the economics blogs mostly, take the point of view of the real estate investor and do not in my opinion take enough account of the owner occupier. Choices that may be insane for the former may make perfect sense for the latter.

I had a friend, a drywaller, who borrowed money at a high rate on a second in order to invest in the stock market. At that moment I figured out that the Tech Boom was over, and sure enough it popped. But the plural of anecdote is not data. Who is exposing himself to what risk in the housing market?

[Tom Cecere]

Taking out the home credit loans is like re-margining your stock once it goes up...if you keep shooting, at some point the chamber with the bullet will come up.

But I agree that there is very little risk for those who keep firing away, both because of Bruce's reasons and the fact that they can just vote themselves out of the problem. Hell, in Vermont, they don't even have to pay property tax.

[Barbara]

Bruce, you might be overlooking some salient differences in today's housing market that make it different from that in previous downturns. First, at least where I live, fully 25-30% of homes are owned by investors not occupants. Second, the prevalence of ARMs and interest only (for awhile) mortgages is skyrocketing. So if you are an investor in a home with an ARM and interest rates go up and housing prices "stablilize" or go down even marginally, you could be in big trouble, even if you do continue with your steady day job. And add to this the fact that your downpayment for the investment property came from the equity in the house that you own, well, presumably if you act fast enough you'll at least get that back, but it could easily turn into a very ugly denouement to your career as a real estate speculator.

And even if you do occupy your own home, a spike in payments could be very damaging to your finances. I don't know whether disaster is going to strike, and I am not an economist, but these two differences strike me as material and significant that should not be overlooked in assessing the real estate market in at least some markets.

[alex]

Bruce:

I heard a statistic the other week (and I don't have a source, so it may be incorrect) that in 2007 a lot of ARMs and interest-rate-only mortgages will see their first big increase. This will come to 12% of the outstanding mortgage debt in the country.

[Barbara]

Actually, it's 25-30% of home purchases over the last two years that were purchased by investors. I don't think it's 25-30% of all homes. But to give you an example, my sister and her husband now own five homes not including the one that they live in (which they used to finance the others). They have been turning over some of the houses they bought as investments (and using the proceeds to purchase more, but my sister refuses to own more than five at one time), and the market is still very robust, but woe to them if they are caught having to make increased payments on these houses or to sell them very quickly. I don't know how many people are in their shoes, but it's more than I realized, at least from what my brother-in-law tells me about all the people he's met at foreclosure auctions who have quit their day jobs to make it in real estate.

[Wh]

"Sure people are going to get stung if and when the housing bubble pops. But it is far from clear whether that sting will be felt from coast to coast, and less clear than that that owner occupied housing will feel it in any serious way."

Those owners who look at each month's real estate sales to see how much their house has grown up in value may be hurt mentally :-).

People who've bought one of the riskier mortgages hoping for appreciation could be hurt. Those who've taken out lots of home equity could be hurt.

And they may stop spending, which would hurt the economy.

[nate]

there was an article in a recent copy of The Economist that had an interesting perspective on moving and America. people move a lot. not sure what this has to do with a "housing bubble"

[howard]

There are, in my estimation, bruce, two groups of people at risk: people who are buying in hot markets using exotic mortgages (interest only ARMs, for instance), and people who are sustaining their consumption by home equity lines of credit.

[nate]

"exotic" mortgages might possibly be better if someone invests the extra cash from a lower monthly payment and the local job market is robust in the future- just because there are new types of mortgages does not necessarily mean they are "exotic" or inherently bad.

[Wh]

""exotic" mortgages might possibly be better if someone invests the extra cash from a lower monthly payment and the local job market is robust in the future- just because there are new types of mortgages does not necessarily mean they are "exotic" or inherently bad."

Mortgages that seem to rely on further interest rate drops or hefty price appreciation in the next few years for the buyer to keep the house are extremely risky, and yes they are bad even if they pay off.

As for investing the cash from a lower payment -- if anyone has the financial savvy to do a good job of investing their cash, they wouldn't go for the risky mortgage at all.

[howard]

Nate, to follow on to wh's rejoinder, bruce asked a very simple question: "Who is exposing himself to what risk in the housing market?"

I said two groups of people, one of which is people in hot real estate markets relying on exotic mortgages.

that doesn't mean that everyone who is going for an inerest-only ARM with closing costs rolled into the principal is going to end up in trouble, but god yes, that's certainly an incredibly risky play right now.

do you think it's prudent?

[Dano]

I'm a little late to this party, but I used to keep the numbers for a large bank's home equity division. The ATM is an apt metaphor: one of my big projects was to bring credit card access to people's seconds, and then after that I produced utilization numbers for the Marketing Dept. Many of us in the industry were disturbed at this ploy.

D