Housing Bubble to Interest Rate Puddle

As the financial news was celebrating a turn-around in the economy I thought I might be seeing some positive changes in the real estate world.
Supply and demand improved: the number of residential offices in King Country fell by almost half since the top of the market in 2006. Great news for those of us still in business.
The incidence of falling-asleep-on-Open House-sofas declined drastically. People spent some of their precious week-ends to look at homes again and not just to sniff out their neighbors inferior interiors. The interest in maybe buying was palpable.
Interest rates were a huge lure. I mean, 4 1/2 % on the way to 4%! No points!! Folks who would not normally consider a second home or rental house were crunching the numbers. What with rental rates beginning to rise and vacation home prices to fall, not to mention the fuzzy noises coming from the Fed, how could you lose.

In July Ben Bernanke was painting a picture of an economy expanding at a moderate rate, consumer spending rising 2% , jobs $ housing still a bit worrisome. The Fed was going to prevent inflation by getting ready tools to drain the excesses from the system, including asset sales and reverse purchases.
Those green shoots were coming up roses. The turnaround was right around the corner.
And what a turn around it was. In August Mr Bernanke talks about another stimulus program. All of a sudden the economy was bad enough to need another shot of strong meds. What had happened for the Fed to change its mind?? Who knows? The foreclosure mess finally breaking?
Who cares? The stock market goes up. Speculation about how much money will fly out of the magical Fed Bubble Machine goes on for two months. Maybe one, maybe two trillion, maybe the beginning of more rounds of Fed stimulus.
The market goes wild. Everything is up, commodities from coffee to cotton, gold, emerging and emerged markets. Even bond prices go up. If the Fed is going to buy Treasuries, bond prices will rise, so investors get in there first.
November 4th the program is announced: $600 billion in short to mid term Treasuries plus the reinvestment of the earnings from Mortgage Bonds. Everyone is off to the races. And then a funny thing happens.
Bond prices start to fall. When the price paid for the bond goes down, the interest rate the bonds yield goes up. At the long end, the 30 year Treasury yield on Nov 4 was 4.06 % ; on Nov 12 – 4.29%. Doesn’t sound like much, $35 a month on a $250,000 loan. But if this is a new trend, and if interest rates rise on the 10 year Treasuries, we can expect mortgage rates to go up.
This will be very bad for housing prices, bad for owners with ARM mortgages, and bad for first time buyers qualifying for their first mortgages. It will be good for the banks, however, as there will be a larger spread between what they can borrow and what they can lend out at.
The Big Question remains - WHY would prices of bonds go down when the Fed has been advertising far and wide for months that they are going to buy on the order of $100 billion a month?
Maybe because foreign buyers aren’t coming to the Treasury auctions. Maybe the bond holders are selling more than the Fed is buying. Maybe they're wondering who will be buying when the Fed is done. Who would be buying unless interest rates go up enough to justify the risk of bond prices falling further?
And just when I though I had lots of good news to bring to my blog, the landscape shifts.
Interest rates may return to their 4-41/2 % range. Most often buyers sitting on the fence will jump off if they fear interest rates will rise. We will see if this time it is going to be different.

A Way to Save Mortgages that are Underwater

http://online.wsj.com/article/SB10001424052970204908604574330883957532854.html

In the above article Martin Feldman argues for lowering the principal balances of mortgages that are in default or on their way to default if the value of the debt exceeds the value of the home by more that 120%. Mr. Feldstein proposes that the government (that would be us, the deep pockets) compensate the banks for 50% of the forgiven principle and the banks eat the other 50%.
In exchange, the homeowner agrees to make the mortgage a non-recourse mortgage (details like changing appropriate state laws and bankruptcy laws to be worked out later). So, if the home goes into foreclosure, the homeowner is on the hook for the difference between what the bank nets on the sale and the balance of the mortgage plus all costs associated with the sale. Normally the cost of selling is about 10% of selling price, but the bank would have additional legal, administrative and loss of interest income costs. In this case costs could go as high as 25% of the selling price. This would be sure to happen if the banks continue to process short sale and foreclosure as their current glacial pace, which is 4-6 months in King County, where we don’t have an excessive number of homes under water.
As a real estate agent this sounds terrific - it would be good for business by slowing prices by slowing the number of foreclosures coming on market and thus slowing the fall in prices of other competing homes. Banks should love welcome it as another back-door subsidy, especially if they are reigning in their current lending in anticipation of further depreciation in real estate prices.
How about from the homeowners point of view? If home prices go up, they may be eventually up out of the deep water. However, I haven’t seen any market forecasters predicting a rise of 20% in home prices any time soon. Even though they have been wearing their rosy-red glasses lately, most look for a gradual leveling off. If you have 20 to 30 years left on your mortgage and you stay in your home, you’ll at least break even
What if prices go down more and that mortgage goes from 120% back to 140% of the price of your home? After all some astute analysts ( at S&P, Robert Shiller, Moody’s economy.com) are looking for further price drops. Imagine the pain then of having to dig into your own pocket to the tune of 20 to 40 % of the price of your home, plus 10 -25% of that price (all the costs associated with selling it). Not to mention the higher taxes you’d pay to fund the program in the first place.
Those are the risks.
Read the whole article for some more of the benefits

Home Prices in Dollars and in Gold

Gold vs Dollar

For a long time I wondered why the prices of homes moved so much faster then the prices of other things. In the seventies they started acting more like Aladdin’s lamps than houses. No matter how much we wanted out of them, they never said no. We didn’t even have to polish them up and poof, more money came out of them.

Say you were fortunate enough to buy a nice house in a nice area of Seattle for $20,000. In the year of 1970. Ten years later you check around and it’s worth $80,000. Forty years later it gets even better - the going price is $510,000. It’s the same house, the same street - no fancy upgrades or gentrification.

Over the years I’ve heard lots of casual explanations for this incredible feat of making money out of thin air. Supply and demand was one stock answer. But we didn’t have the tsunami of immigrants to the state that would have caused house to quadruple the decade of the 1970’s. Another answer was inflation. Budget & Labor Statistics figures, (http://www.bls.gov/data/inflation_calculator.htm )tell us that any other basket of goodies costing $20,000 in 1970 would cost $111,800 in today’s dollars. That discrepancy of $400,000 means that we’ve got inflation plus something else.

During the 1980’s both spouses began working, sometimes doubling the income of single households. Better yet, DINKS (double income, no kids) came along and could afford bigger house payments. That explained where the money to pay for the bigger mortgages came from. But why the rising prices in the first place?

Might it be that the government policies of ever more generous tax breaks for home-owners encouraged ever growing demand? In the 1970’s you were taxed at the capital gains rates on your gain when you sold your home; you could carry forward your gains to the next house and so on and on and you’d never pay a cent in taxes. Not to mention the write-off for mortgage interest and taxes.

In the 1990‘s it got even better. Each land-owning citizen became entitled to keep $250,000 of gain tax free. This allowance could be repeated every 2 years. It didn’t matter whether you carried that gain forward into another home or spent it on a camel caravan to Timbuktu. These were powerful incentives to buy and gave some compensation for the pain of rising prices. They maybe accelerated the process, but they hardly caused it.
I’ve heard a few Seattleites say it’s all Bill Gates’ fault, bidding up house prices to the level of a Boston or a Silicon Valley. Ah, but that came later, much later than the 400% appreciation we saw by 1980. Mr Softy’s millionaires piled on later and then we all kept rubbing the lamp.
Recently I came across an article that put 1971 into perspective

In the early 1960s, Charles de Gaulle induced the Bank of France to convert large amounts of dollar reserves into gold. The reasoning was that the reserve currency role of the U.S. dollar was being seriously undermined by large U.S. balance of payments deficits that were inflationary under the gold-dollar international monetary system.
The French … bought their gold at $35/oz from the U.S. Treasury. The dollar remained under pressure for some years, leading President Nixon to abandon the gold-dollar peg and convertibility of the dollar into gold in August 1971. Over the next eight years, gold rose in a series of moves to $1,000/oz, not far from today’s level. Price inflation in the U.S. and other major countries soared to almost 15% at the peak in the 1970s.
http://www.boeckhinvestmentletter.com/newsletters/

The cost of that $20,000 house in gold was 571 oz at the 1971 rate of $35 an ounce. At the time $35 seemed a reasonable price, as gold had held a steady $20.67/oz from 1880 to 1932! From the 1930’s till 1971 it bounced between $35 - $45/oz.
A mere ten years later (1980)the price of our house went to $80,000 and gold had climbed to $600 an ounce. It would have taken only 133 oz of gold to buy it. The dollar price went up 400%; the price in gold went down by that much.

Fast forward to 2009 and same house is valued at $510,000. Take out the inflation on the original price ($90,000) and you have a $400,000 price tag. At today’s $950 oz, that’s 421 oz - enough to buy the house and $142,500 left over.

So far gold has preserved its purchasing power better than dollars. If gold were to go to $1000 oz this year and the dollar house price remains the same (both seem quite probable), anyone who held that original 571 oz would be even farther ahead.

Going off the gold standard removed any predictable limit to dollar prices of any investment - equities, homes, commodities. Perhaps one day the lack of appetite for dollars will provide a limit.