S&P/Case-Shiller Home Price Indices
All of the data for this presentation comes from the Case-Shiller Index report for July 2008. The graphs for key United States cities have two lines. One is the actual index values (prices) and the straight line is the long-term trend prior to prices exploding in 2005. Above is the chart for Phoenix. Most major West Coast cities have similar experiences. At the bottom of this posting is a link to the other charts.
Bottom Line? Too much liquidity (money), caused by artificially low interest rates, financed a speculation binge, which would eventually collapse from its own weight. Contrary to conventional "wisdom" being preached by the press, prices do not have to go back to 2005 levels for there to be equilibrium in the real estate market. Prices just need to get back to the long-term trend line (the red line on my charts). Unfortunately, the hysteria being fed by the press will probably cause most real estate markets to over-correct and prices will temporarily fall below the trend line.
Why are foreclosures high? With the cost of money for lenders below real market prices, all loans that met normal criteria were quickly funded, leaving mortgage originators with a source of cheap money, but no place to invest it - all of the good borrowers were already "married." This lead to the sub-prime model. Actually, it was a very good model that would have worked if real estate prices had stayed on the trend line. Here's how it worked. People who could not meet standard credit requirements were given two to five year mortgages, with thirty year amortizations, at rates slightly above the rates good buyers were getting.
The strategy was that a person with poor credit would make his mortgage payments on time over the two to five years and thus boost his credit score to an acceptable level, allowing him to obtain a standard mortgage. As a fall back, there was a provision that would allow the borrower to keep the mortgage after five years, but at a much higher rate of interest. Even if the guy could not get a new loan and was unable to make the higher monthly payments, he could just sell the house and probably walk away with money in his pocket, knowing that real estate prices would increase annually at a 15% rate forever. This truly was a "win-win" deal.
Several things went wrong with this paradigm. First, real estate prices cannot go up at double digit rates very long without there being a major downward correction. Sub-prime borrowers who bought their homes before 2005 probably dodged the bullet, but those who purchased during 2005, 2006 and 2007 ran into a brickwall. By mid-2007, real estate prices were in a tailspin as they should have been. At the same time, the first wave of sub-prime mortgages reached their "drop dead" date. Most of the borrowers had made the monthly payments and qualified for a standard loan. Unfortunately, their house did not qualify for a loan that would retire the existing mortgage. In fact, most had a mortgage that was greater than the current value of their home.
Being unable to refinance, the homeowners moved into the "re-set zone", that place with no dimension of earnings or household budgets. (Sorry, Rod) Unable to pay the much higher monthly payment, many homes soon fell into bankruptcy. Most people think they owe their mortgage to a large company, like CountryWide, but they do not. CountryWide and many other mortgage companies are only facilitators, not permanent lenders. When you get a mortgage, your loan is bundled together with other mortgages and sold as a security on financial markets. There is no "real" lender for the mortgage and there is no "real" borrower. If the borrower runs into a problem, who does he go to? There is no one. That's right, no one. Oh sure, you can go to the mortgage company, but all they have is a servicing agreement, which gives them little authority or flexibility. One thing they do have the authority to do is to foreclose on you if you get behind on your payments.
Once a borrower misses the required number of monthly payments, the lawyers are called in. The lawyers quickly turn a small loss into financial disaster. A fifty thousand dollar deficit becomes a two hundred thousand dollar train wreck. This devalues the financial instrument that holds the mortgage. Suddenly, the mortgage companies are unable to sell new mortgage backed securities at a reasonable price. This leads to the mortgage company curtailing lending, which snowballs into a lock down of the mortgage lending industry. Remember the guy above that qualified for refinancing but his house did not? Well now he cannot qualify - period. Credit standards have been increased. This guy is left with two choices - get a second job, if he can find one, or walk away from his house and go back to renting.
"That's my story and I'm sticking to it."
Bottom Line? Too much liquidity (money), caused by artificially low interest rates, financed a speculation binge, which would eventually collapse from its own weight. Contrary to conventional "wisdom" being preached by the press, prices do not have to go back to 2005 levels for there to be equilibrium in the real estate market. Prices just need to get back to the long-term trend line (the red line on my charts). Unfortunately, the hysteria being fed by the press will probably cause most real estate markets to over-correct and prices will temporarily fall below the trend line.
Why are foreclosures high? With the cost of money for lenders below real market prices, all loans that met normal criteria were quickly funded, leaving mortgage originators with a source of cheap money, but no place to invest it - all of the good borrowers were already "married." This lead to the sub-prime model. Actually, it was a very good model that would have worked if real estate prices had stayed on the trend line. Here's how it worked. People who could not meet standard credit requirements were given two to five year mortgages, with thirty year amortizations, at rates slightly above the rates good buyers were getting.
The strategy was that a person with poor credit would make his mortgage payments on time over the two to five years and thus boost his credit score to an acceptable level, allowing him to obtain a standard mortgage. As a fall back, there was a provision that would allow the borrower to keep the mortgage after five years, but at a much higher rate of interest. Even if the guy could not get a new loan and was unable to make the higher monthly payments, he could just sell the house and probably walk away with money in his pocket, knowing that real estate prices would increase annually at a 15% rate forever. This truly was a "win-win" deal.
Several things went wrong with this paradigm. First, real estate prices cannot go up at double digit rates very long without there being a major downward correction. Sub-prime borrowers who bought their homes before 2005 probably dodged the bullet, but those who purchased during 2005, 2006 and 2007 ran into a brickwall. By mid-2007, real estate prices were in a tailspin as they should have been. At the same time, the first wave of sub-prime mortgages reached their "drop dead" date. Most of the borrowers had made the monthly payments and qualified for a standard loan. Unfortunately, their house did not qualify for a loan that would retire the existing mortgage. In fact, most had a mortgage that was greater than the current value of their home.
Being unable to refinance, the homeowners moved into the "re-set zone", that place with no dimension of earnings or household budgets. (Sorry, Rod) Unable to pay the much higher monthly payment, many homes soon fell into bankruptcy. Most people think they owe their mortgage to a large company, like CountryWide, but they do not. CountryWide and many other mortgage companies are only facilitators, not permanent lenders. When you get a mortgage, your loan is bundled together with other mortgages and sold as a security on financial markets. There is no "real" lender for the mortgage and there is no "real" borrower. If the borrower runs into a problem, who does he go to? There is no one. That's right, no one. Oh sure, you can go to the mortgage company, but all they have is a servicing agreement, which gives them little authority or flexibility. One thing they do have the authority to do is to foreclose on you if you get behind on your payments.
Once a borrower misses the required number of monthly payments, the lawyers are called in. The lawyers quickly turn a small loss into financial disaster. A fifty thousand dollar deficit becomes a two hundred thousand dollar train wreck. This devalues the financial instrument that holds the mortgage. Suddenly, the mortgage companies are unable to sell new mortgage backed securities at a reasonable price. This leads to the mortgage company curtailing lending, which snowballs into a lock down of the mortgage lending industry. Remember the guy above that qualified for refinancing but his house did not? Well now he cannot qualify - period. Credit standards have been increased. This guy is left with two choices - get a second job, if he can find one, or walk away from his house and go back to renting.
"That's my story and I'm sticking to it."
Graphs for all selected cities
