Benson's Economic &
Market Trends
Home Values
Built on Rotten Foundations
Richard Benson
Archives
November 5, 2004
We have been gleaning facts "brick by brick" in order
to write this story on the housing market and what it all means
for Wall Street and the economy. The story is simple: While the
Federal Reserve is slowly raising interest rates, it is our observation
that the housing price bubble is already bursting of its own
accord.
Let me begin with the sale of a property located a short distance
away from our modest casa in Palm Beach, where the big houses
have names. Casa Apava, an estate with ocean and lakefront land
totaling 18 acres, is under contract for about $70 Million by
its current owner, Ronald Perelman. This same property sold for
$14.25 Million in 1987. If the sale goes through, it will be
the largest residential real estate sale in United States' history.
(In 2004, the property was assessed for $33.4 Million and taxes
were a modest $664,000 a year, or $55,333 a month). Needless
to say, the buyer is reported to be the chairman of NVR, Inc.,
the nation's eighth largest home builder. Clearly, selling homes
at inflated prices to average Americans, who bought them using
other people's money, has paid off handsomely for this buyer.
The size of the housing bubble should not be underestimated.
In middle America, housing prices are up 44 percent over the
past 5 years while in the momentum markets, such as Las Vegas
and Southern California, annual "price pops" of 20
to 40 percent have commonly been recorded until just recently.
Housing is big business. In 2004, about 8 million new and used
homes will sell with a total transaction value of $1.9 to $2
Trillion. Mortgage debt will rise about $800 billion to $7.5
Trillion by the end of this year. The increase in mortgage debt
represents the spending that the Bush Administration needed to
keep a $12 Trillion economy moving forward.
The good news is that home ownership rose 2 percent to an all
time record of 67.2; the bad news is what had to be done to get
it there while the labor force participation rate has dropped
2 percent! In other words, easy credit and record low interest
rates have boosted home sales. In previous economic cycles, the
boost to home sales came from rising incomes and more jobs!
Easy mortgage credit has been fostered by new mortgage products.
New types of mortgages have been introduced over the past couple
of years that transfer interest rate risk from the financial
institution (mortgage owner), to the borrower, while allowing
the borrower to take out the largest possible mortgage. Long
gone are the days when a borrower borrowed what was considered
a safe, prudent amount that they could actually pay back. Today,
the borrower takes every penny that lenders will lend. In turn,
lenders have "gone crazy" because at the end of the
day, the lender is not lending "his" money. The loans
go to a GSE security, or into a rated mortgage security, which
in turn is bought by a bank or Hedge Fund that is invested just
for a short term in the "Cash and Carry Trade."
Today, the new mortgage lenders are offering various types of
mortgages to keep mortgage volume and quick origination profits
up. These mortgages include Adjustable Rate, Interest Only, 40-Year,
and Piggy Back. A Piggy Back mortgage is a senior mortgage combined
with a junior mortgage that can leave the borrower owing more
than 110% of the cost of the house. Moreover, these lending tactics
leave the borrower more than a bit stretched and short liquidity,
so it is no surprise that new mortgages that allow the borrower
to skip payments and add the interest to principal are becoming
popular. What will lenders who don't lend their own money think
of next?
If these new types of mortgages aren't good enough to stretch
a consumer's buying capacity, a few years ago special charities
sprang up to give a home buyer his 5% down payment. (Since a
home builder was giving the charity their funds anyway, he could
easily "give back" 5% of his 30% profit to charity.
Clearly, charity starts at home!
On top of that, President Bush signed the "American Dream
Down Payment Act of 2003." This legislation authorized $200
Million per year in down payment assistance to at least 40,000
low-income families. His goal was to increase the number of minority
homeowners by at least 5.5 million before the end of the decade.
Under Federal Law, if you are a first time home buyer and
your income is 20 percent less than the local median income,
your neighbor - the US taxpayer - will give you the greater of
$10,000, or 6% of the cost of the home to buy it! Thus, sub-prime
borrowers have influenced home ownership rates considerably.
However, there are some sobering facts about sub-prime
borrowers. They are twice as likely to pick an ARM mortgage.
(ARM mortgages are already 30% of new home loans and, as the
Federal Reserve raises interest rates to normal levels, the monthly
payment on an ARM will go up over 25 percent).
Moreover, sub-prime borrowers frequently refinance. Borrowers
who refinance for cash-out are twice as likely to default as
those who don't take cash out. Currently, 70 to 80 percent of
sub-prime mortgages are debt consolidation loans which add credit
card and other debt onto the house!
These sub-prime mortgages have a terrible record. At least 16
percent are delinquent or in foreclosure, and 4.6 percent are
actually in foreclosure. The "funny money" down payment
mortgages are worse, with defaults running close to 20 percent.
The Federal Housing Administration, FHA, which insures these
loans, says national FHA mortgage defaults are 11 percent, while
in cities like Baltimore, Maryland and Queens, New York, the
default rates for FHA loans are 21 percent and 25 percent. Perhaps
more lenders could do what FNMA does with loans heading to default:
Re-write half of them and call them "good." Remember,
"A rolling loan gathers no loss."
Also, with the Fed making money free, and the government trying
to give money to sub-prime borrowers regardless of their willingness
or ability to pay, the private sector is trying to get back in
the lead of "the easy money free for all." The FBI
has reported that in the first 9 months of 2004, 12,100 complaints
of suspicious activity in the mortgage market have been reported.
Fraud hot spots include the usual suspect states such as Florida,
California, and Nevada with honorable mention to Michigan, Illinois
and Missouri. (At least this restores my pride in the Midwest).
Moreover, the reported fraud would be higher except that i) most
of the FBI are out looking for terrorists, and ii) fraud big
enough to interest the FBI only includes something like the house
or buyer not even existing.
Most mortgages written today have a bit of a fudge factor in
the total honesty of income and net worth. Much information is
excluded from debt and payment histories, and "appraisals
are either wish or myth." Even the Mortgage Bankers Association
recognizes that the home appraisal process is totally broken.
In reality, with easy money allowing home prices to rise, fraud
has become a way of life in the mortgage market because every
participant makes a commission or fee if the mortgage closes.
The higher the house price, the bigger the mortgage!
Looking back at the facts, it is easy to see that the foundation
for housing prices is rotting fast. Buyers have stretched the
truth, in every possible way, in order to buy the most expensive
house for the lowest possible monthly payment. Given the fraudulent
loan underwriting and emphasis on Adjustable Rate mortgages and
sub-prime loans, it is clear that any rise in mortgage rates
will bury housing. At the high end of the housing market, there
are reports of "Yuppie Fatigue." Super-sizing homes
also super-sizes the heating and utility bills, insurance and
maintenance costs. Those vaulted ceilings sure look nice, but
watch out for the heating bill! Million dollar home foreclosures
are picking up.
In the general housing market, 5 to 6 percent of homes already
have more debt than home value, and homeowners are loading up
with home equity loans and lines of credit. These home equity
loans and lines will be up to $400 billion in 2004. Home equity
can be spent, but as home prices stop going up, more and more
homes will have "no equity left."
Currently, wages and salaries have not kept up with inflation
despite "economic recovery"; bankruptcies will hit
another all time record of over 1.6 million in 2004. Forty five
percent of workers have total net assets of less than $25,000
(including the value of their house) and less than 4 of 10 workers
save anything.
All of these facts were in place well before oil and natural
gas prices headed north for the economic winter. Reasonable estimates
show the average household bill for gas for the car and energy
for the home will be $9,000 in 2005, up from $6,000 last year.
Other costs of running a household would put people in the poorhouse,
but it's too expensive to check in. This Christmas, Santa might
skip homes that are draining their home equity.
Does housing always go up forever? In the United Kingdom where
housing prices have soared like in America, prices fell last
month. Real estate agents can't be found to talk about it, as
it is bad for business. In San Diego, housing prices have been
flat the last couple of months while the supply of homes for
sale has jumped from a 2-month to an 8-month supply.
In Las Vegas there is an unfolding house price debacle. The national
public has heard that the large developer, Pulte Homes, has cut
new home prices by 8 to 25 percent, and 25 percent of new homes
on order have just been cancelled. However, the public hasn't
heard that i) 20 to 40 percent of sales in new planned unit developments
were to speculators; ii) For-Rent signs in the complexes are
everywhere. (To make some easy money on the flip, buyers of second
and third homes planned to rent them out first); and, iii) Homes
that sold for $750,000 just three months ago are across the street
from homes that the same developer is selling today at a nice
profit for $550,000. "The Las Vegas housing market has crapped
out!"
In the United States, the supply of new homes has risen steadily
to a 275 day supply. Six of the 14 largest home builders have
debt-to-equity ratios of 95 percent, and home builders know exactly
what the car companies know: "If you want to move inventory,
cut the price!"
If home lenders would only read history they would know that
from 1975 to 1995, on average home prices rose only 0.4% and
with prices sagging now, they should ask for a larger down payment,
and fast, or they will be facing big losses. In a market where
housing prices are flat, it takes a 15 to 20 percent down payment
to protect a lender against loss. The sales commission is 6%
and REPO, carry, and marketing costs can run another 10% or more.
What would a rational down payment mean for housing prices? Today,
a buyer who can scrape up $20,000 for a 5 percent down payment
can afford a home priced at $400,000. If you ask him for a 10
percent down payment, he can suddenly only afford a home costing
$200,000! Rational down payments will force housing prices down.
Whatever you do, please do not share this observation with existing
homeowners; they might want to sell before I have had a chance
to follow up with Ron Perelman's example.
November 5, 2004
Richard Benson
Archives
President
Specialty
Finance Group, LLC
Member NASD/SIPC
2505 S. Ocean Boulevard
- Suite 212
Palm Beach, Florida 33480
1 800-860-2907
eMail: rbenson@sfgroup.org
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321gold
Inc
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