Inca masonry - Machu Picchu
This is the best online tool I’ve seen so far. It’s graphical and easy to use. I’d suggest adjusting the “Advanced Settings” to increase the Annual Maintenance Costs – 1.5%-3% seems more reasonable based on the folks I talk to.
http://www.nytimes.com/interactive/business/buy-rent-calculator.html
This chart surprised me a little at first – who’d have thought Texas had 4 times California’s rate of mortgages at >90% of value? Isn’t it a little scary that 1/3 of Texas “homeowners” have less than a 10% equity stake in their house – note that this is first mortgages only, no HELOCs or second mortgages are included in the data, meaning this is optimistic if anything.
Read the article from the Dallas fed here. The short story is, all sorts of strange things happen to normal ratios during high rates of housing price growth (i.e., >90% LTV ratios are rare in California because people are adding equity so rapidly through price growth). Although the data is interesting, I’m not sure the article really adds much information as to what will happen when growth slows or reverses…this is the billion dollar question.
This chart is a logical extension:
…as opposed to me. From the Federal Reserve:
This paper examines the statistical evidence of a connection between GSE secondary market actions and the interest rates paid by mortgage borrowers. While GSE portfolio purchases benefit GSE shareholders directly, the purchases must lower the mortgage rate paid by the homeowner in order to have a wider social benefit.
We find, however, that portfolio purchases has economically and statistically negligible effects on mortgage rates. Further, portfolio purchases are not any more effective at decreasing spreads than securitization volume. Our results were robust to several alternative identifying assumptions, including those suggested by the efficient markets hypothesis.
The results of the study are still a little counterintuitive for me – maybe if I learn a little more about who actually holds default risk it’ll make more sense. The article does make some mention of lag effects that could cloud the relationship between GSE actions and market rates. Otherwise, if the GSE’s are in fact not getting a lower cost of debt than non-GSE competitors it implies that MBS buyers are not attributing a lower risk to GSE debt, so we should formally break the GSE-government tie and remove any doubt that the government will bail out the GSEs.
Greenspan also testified on GSEs this morning, basically stating that Fannie/Freddie have grown large enough to pose a systemic threat to the financial markets – the transcript is here.
From the LA Times:
Confronted with soaring home prices, Californians are adopting a “buy now, pay later” strategy on a massive scale. The boom in interest-only loans — nearly half the state’s home buyers used them last year, up from virtually none in 2001— is the engine behind Californians surging home prices….Interest-only loans, and other forms of so-called creative financing that are far riskier than the traditional 30-year fixed-rate mortgages, have allowed more people to afford homes in California even as prices have skyrocketed.
When the price of houses in California soared 17% in 2003 and 22% in 2004, a curious thing happened: Instead of home ownership decreasing because fewer people could afford houses, it rose to record levels.
During the last two years, according to U.S. Census Bureau data, home ownership in the state rose to 59.7% from 57.7%. The previous record was 58.4%, measured during the 1960 Census.
….
Rather than closing the door, lenders have apparently been opening it wider, inviting in people like Herron who would not have qualified for a mortgage under the more rigorous standards of an earlier generation.
“If you can fog a mirror, you can get a home loan,” said mortgage analyst Ralph DeFranco.
An interest-only loan offers the ability to defer for three, five or seven years any payment for the house itself. That allows a potential buyer to stretch to afford a place that otherwise would be out of reach.
Of course, everyone else using an interest-only loan can stretch too. The result is that prices keep rising. That, in turn, encourages still more people to use interest-only mortgages, which fuels still more appreciation.
In 2001, as the current housing boom got underway, fewer than 2% of California homes were bought with interest-only loans, according to an analysis done for The Times by LoanPerformance, a San Francisco mortgage research firm. By last year, the level had risen to 48%. Nationally, LoanPerformance says, interest-only loans were used in about a third of all purchases. What’s propelled the market up in California, some experts worry, could just as easily speed its descent. “In the last few years, rates went down and values went up. It’s like you were paid to live in California,” said analyst DeFranco, who works for LoanPerformance. “People got so used to refinancing. They’d think, ‘No problem. My house will be worth twice what I paid, and I’ll refinance my way out of trouble.’ That’s not going to be a good approach going forward.” Here’s how he thinks a collapse could occur: Rising interest rates put a brake on price appreciation and refinancings. People realize their interest-only period is coming to an end, raising their monthly payments substantially. Since they have no equity in the house, they choose to default. “If housing prices go down or even are flat, heaven help us,” said DeFranco.
By last year, the level had risen to 48%. Nationally, LoanPerformance says, interest-only loans were used in about a third of all purchases.
…
Here’s how he thinks a collapse could occur: Rising interest rates put a brake on price appreciation and refinancings. People realize their interest-only period is coming to an end, raising their monthly payments substantially. Since they have no equity in the house, they choose to default.
“If housing prices go down or even are flat, heaven help us,” said DeFranco.
…
The number of buyers falling into this category in any given month is unclear. But a California home builder recently got a sense when he sought to answer this question: How many of the potential buyers of his houses could still afford them if interest rates went up even a little?
To find out, the builder conducted a little experiment.
His firm’s preferred lender had pre-qualified 90 potential buyers for a group of new houses. Since the houses wouldn’t be ready for another six months, the builder tightened the loan criteria. He didn’t want buyers to sign up for a house and then get frightened into canceling by rising rates.
He raised the threshold from a fully variable loan, the easiest to get since it immediately moves upward when rates increase, to a mortgage that was fixed for the first three years. That would shield buyers from rate jumps for at least a little while, but it’s also more expensive.
Under the higher threshold, only about 15 of the buyers still qualified.
“People are really pushing to borrow as much as they can, and the lenders are right there,” said the builder, who declined to be identified. “There’s apparently not much of a cushion.”
…
In California, the traditional fixed-rate loan is in danger of becoming extinct. According to recent LoanPerformance data, the percentage of new loans that are adjustable in Santa Cruz and San Diego was 85%; in Oakland 84%; in Santa Rosa 81%; in Los Angeles 74%.
…
If disaster does strike, he believes, the housing market will be propped up. “The real estate economy is too important to the country and the state,” Stafford said. “Lenders don’t want foreclosures. They’ll introduce new loan products that will allow people to stay in their properties.
…
“I have $40,000 in student loans from my master’s degree,” Herron said. “I have high credit card debt. I’m a typical American. And yet they wanted to give me more debt to buy a house.”
…
“If you’re like me, you’re so incredulous that anyone would give you any money whatsoever, you just close your eyes and sign the papers,” Herron said. “I would have signed anything.”
I think I’ve said most of this before, but let me highlight a couple of points the article makes:
All in all I think this reinforces my comments from a few weeks ago on the need for more transparent/flexibile mortgage rates (i.e., localized rates) to capture the higher risk of lending in the California Market vs. Peoria. Peoria should not have to subsidize the risk that California borrowers are incurring (via higher rates).
Apparently some folks are having problems with comments, and I just noticed that the links to archives don’t work (which is OK, sort of, because you can just scroll down to see old posts).
In an unposted comment on this post, Lucas says:
I liked your idea of the localized MBS tranches but I was
thinking, wouldn’t a futures contract based on something like the
median home price for an area make even more sense? I think real
estate prices tend to get out of whack because of the relative
illiquidity of the market, and the easy access people have to leverage
for the investment. With a futures market, retail investors would be
able to put money into the real estate market without the costs
associated with loans and real estate brokerage. Construction
companies would be able to hedge against risk when building new
subdivisions or other construction projects, and prospective home
buyers would have an investment vehicle that would allow them to
“track” the gains being made in their local housing market and thus
avoid being priced out of the market as they build savings or if they
currently live somewhere else (say while you’re in Philly, you want to
track the Dallas market with money earmarked for a down payment).
I think defining the underlying asset would be the most difficult part, since real estate is very localized (downtown Chicago has a different appreciation curve than the South Side or the Western Suburbs) but contracts for the 20 largest metro areas might have some interest. I t could even be pitched as a substitute for PMI for borrowers with low downpayments (instead of paying PMI have them sell
contracts for their real estate market)……It would probably require too much
investment saavy for a regular consumer but regional banks and
mortgage companies could possibly provide enough liquidity to sustain
a futures market.”
Regarding the futures idea, Robert Shiller has actually talked about getting housing futures going for exactly the reason Lucas suggests. Without having done any reading on how Shiller’s work or their success, I think traditional futures would be very tough to pull off. Futures work best with fungible commodities – goods where a common ‘unit’ can be produced by many suppliers and is acceptable to many consumers. Grain fits this definition, as does natural gas, gold, raw cotton, etc. Another key to futures markets is that since participants are buying and selling a contract on a physical good the futures prices ‘converge’ to the value of the physical asset even though most participants close out their futures position before expiration and delivery occurs. I don’t think Housing futures fit either of these requirements; housing values are highly location-specific, it’s hard to get a ‘fungible’ basket of physical houses that represents the same intrinsic asset from one month to the next (remember the houses in the basket need to actually available for title transfer if the futures contract is taken to delivery). However I think the basic idea (and I suspect this is how Shiller’s plan works) could be tackled by creating an index of housing transactions to support derivatives such as swaps. There is still the issue of relatively low liquidity and how to qualify transactions for the index (4 BR houses 1800-2200 SF? What about quality of schools, age of house, yard size, etc.?). Getting enough transactions into the index to make it statistically usable (hard to manipulate, accurate, etc.) might require making the breadth of geograpy, size, or amenity too wide to be useful. I agree with Lucas that participating in a futures/derivative market is probably too sophisticated for 95% of homeowners and probably not a good idea even if they thought it was. I don’t know who would be long the futures/index either; I can see homebuilders, banks, and short-holding-period homeowners taking the short side but who really wants the long side? Lucas’ thought that future homebuyers would take the longs as they build their savings actually makes a lot of sense, but I can just picture someone screaming to their congressman because they took the long side of this deal while building their savings and then lost all of the savings when the market dipped. If you think the market is going up isn’t it better just to buy a REIT/homebuilder/home/investment property?
Regarding the PMI issue: in my mind (I’m no expert) PMI is protecting lenders from a severe market downturn where people who have very little equity just walk away from their notes as in the mid 1980s oil patch. This risk could be hedged with futures/derivatives as Lucas suggests. However I think that to replace PMI the homeowner would have to basically put the futures into an escrow account – otherwise if they owned the futures outside of their mortgage contract and the housing market tanked they could basically keep the profits from the futures, walk away from their underwater mortgage and double their money. So you’d have to force the homeowner to sign over the profits from the futures (or better, a put option) to collateralize the mortgage. If that’s what you’re doing I think it’s more efficient to just keep the PMI construct – homeowner writes a check for PMI, then the PMI company shorts futures to cover their risk. It’s going to be more efficient and less controversial to have PMI companies doing the hedging instead of the homeowner (and presumably PMI companies would let their end-user rates float based on the premiums they were paying for puts).
Reflecting on what I wrote about real estate in the last post, I still really like the idea of localized MBS tranches; I think it would better let the market charge homebuyers for the local risks in their geography and thus help self regulate bubbles and depressions (the so-called ‘soft landing’ from a market bubble). Tranches could be created for various locations and home types (which already exist, I believe, or at least jumbo/non-jumbo splits). Obviously to keep sufficient liquidity/fungibility in the market some tranches would be very geographically broad (all of Wyoming might be one tranche) but large metro areas should be able to support their own tranche. I don’t think I’m being presumptive when I say there’s a consensus opinion that some urban markets are in a speculative bubble with unprecedented investor leverage and large fractions of transactions being undertaken by speculators/investors rather than resident owners. Say that the San Diego $500,000-$1,500,000 mortgage market is one of these areas and we can break it out into its own MBS tranche. MBS buyers should be cautious of owning these securities (because the high homeowner leverage and speculative market raise default risk); because buyers require a higher than normal yield to hold San Diego MBS, end-user mortgage rates in the area will rise. This will cool down the housing market in the natural cycle of monetary self-regulation. I’m afraid that what’s happening today is that San Diego buyers get a nationally-determined mortgage rate and so do buyers in Wyoming; San Diego homebuyers should be paying more because they’re in a riskier market, but instead everyone gets a blended rate – Wyoming pays too much and San Diego pays too little. In theory tranching gives the market a more efficient self-regulation mechanism than the national-level aggregation we have today; it should keep hot markets from getting too hot and make it easier to buy cheap in cold markets (and get everything back to a healthy lukewarm balance of supply and demand).
Caveat: I don’t know if the MBS market already does this; I know in the early days of the MBS market it was pretty easy to see the individual notes that made up the security; once tranching really took off I think the securities got less transparent since banks had to aggregate so many more mortages into a pool in order to create the 10+ tranches that the market was demanding. This would be easy to check out if I actually had a stake in it or a Bloomberg terminal, which I don’t.
I don’t know if the Feds have laws against charging different mortgage rates in different locations (which basically says everyone has to subsidize the highest risk mortages in the country). I also don’t know how default risk actually trickles down to the MBS cashflows; presumably the vast majority of MBS cashflows are backed by Fannie Mae/Ginnie Mae so I don’t know if a default actually has any effect except altering cashflow timing (or IO/PO splits – I’m not sure if a FHMA-secured default results in a long cashflow stream according to the original contract or a lump sum prepayment of the note). This is a pretty key assumption that I’d need to understand much better before getting too worked up about anything.
Sorry for the length of the post and lack of supporting documentation – I’m stuck on an airplane again with no internet access and nothing better to do.