More on Housing

I have been writing about the problems in the housing market since 2004, and really kicked it into gear in March, 2005. We know that the housing markets seem to have peaked in late summer of 2005, and the past year and a half has been the slow and creeping realization that the housing market was a bubble market in the coastal states and out of whack with fundamentals in the interior. The biggest rational feeder of this mania was the massive drop in interest rates and the concurrent drop in underwriting and lending standards. Cheap money was available and housing, oil and consumption were the only things that seemed to make sense to spend that money on. Whoops!

The real estate market is sounding like disappointed Red Sox fans in August --- wait until next year. The primary selling season, the spring, has been a disappointment and inventories are still increasing.

The 'happy' story that has been coming out of the market is that the housing bubble troubles were mainly confined to the sub-prime market where people should have known better than to issue liar loans, not verify employment, income, or species of buyer, and therefore the big problems are being borne by the people who caused them, thus creating minimal spillover impact and little moral hazard. The story continues to state that interest rates are still pretty low, and people with good credit are still able to use their homes as an ATM so consumption should hold up pretty well.

The pessimistic story is that the problem is much bigger than just the subprime market. The Alt-As and parts of the prime market are vulnerable to significant problems because people were going into those loans because they 'had to buy today or forever get priced out' of the real estate market. They went into those loans despite not really being able to afford them over the long haul. The expecation was that they could refinance out in a couple of years. As my good friend in the mortgage business noted in 2005 that things were fine as long as two conditions held:

1) Don't worry, with all of these new ARMS, and no principle loans, we just refi everyone in three years once home appreciation lowers their LTV.
2) Don't worry, people can afford to increase consumption as long as their equity increases at 10% per year. And it is guaranteed that houses will increase at no less than 6%

Both of those conditions were violated. Refinancing activity is slowing down, prices are stable or declining, and we are seeing larger scale drop-offs in the economy. Calculated Risk is reporting that the commercial real estate financing market may soon be hitting the same type of credit crunch that is beating up the non-A residential mortgage market. If that happens, construction employment will fall off the cliff, so the only economically productive things that the United States will be doing at that point will be selling airplanes and creating new means of selling our debt.

Hopefully I am wrong.