California House Price Stability and Affordability

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IrvineRenter_IHB

IrvineRenter_IHB

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I saw the thread below on Piggington's site, and I thought it might make for a good discussion here.





<a href="http://piggington.com/what_could_make_the_housing_market_stable">What could make the housing market stable</a>





House prices in California have been historically very <a href="http://www.thebubblebuster.com/orangecounty/summary.html">volatile</a>. Is there anything that can be done to lower the volatility in prices and keep housing affordable?





My answer: I have a crazy idea that might bring stability to the housing market: limit lending to a multiple of verifiable income.

<p>Let's say Sacramento passed a law that said any amount loaned on a primary mortgage over 3 times verifiable income on the date of loan origination did not have to be repaid. Further, any other mortgage claims which exceed 90% of property-tax value or one year's verifiable income did not have to be repaid. What would happen?</p>

<p>IMO, the first thing that would happen is that lenders would stop lending insane amounts of money because there would be no obligation for repayment. This would effectively limit house prices to a multiple of income plus available savings. Exotic loan terms would not matter because the total amount is capped. Plus, the "verifiable income" provision would immediately eliminate all "liar loans." Since the only way to get ahead at that point would be to save to increase a downpayment, people would actually start saving money. The limitation on total mortgage obligation would eliminate the 80/20 loan and ensure homeowners had some equity in the property ensuring foreclosure rates would remain low. Plus, by limiting this to "property-tax value," people would be unable to take out HELOC's to spend their equity once prices began to appreciate. Proposition 13 would force people to save.</p>

<p>If something like the above were passed today, it would be the apocalypse for the housing market; however, if something similar were put in place after the coming crash, we could ensure home price stability for years to come.</p>
 
<p>I'm totally against the idea of more governmental involvement. First of all if lenders didn't think that they would make money with "insane" loans they wouldn't be lending money. The problem here is they miscalculated their risk. During times of ever increasing housing prices, it didn't matter b/c if the owner foreclosed they still have the property which would invariably be worth more than the loan and they were able to charge a higher interest rate on the loan. At the same time, foreclosures rate would be very low b/c owners, knowing that their home is worth more than the loan can always sell it and pay off what they owe. Now that the housing prices have declined do you think any lender would be stupid enough to lend 100% or lend without proper documentation? Sure there may be a few, but I'm sure these would charge a much higher interest rate in order to take into account the higher risk of defaults. In other words, I believe in the free market and trust that the free market is much better at correcting itself than any new laws. The purpose of the government would be to crack down on fraud, and not regulate the volatility of the housing market or make sure that housing is "affordable." </p>
 
<p>I think that getting rid of high DTI and exotic loans altogether is a bit too draconian. There are legitimate reasons for people to spend more than 3 times their income. One example is a young professional who expects her income to grew substantially in the future. Another is a guy who never wants kids but loves surfing so wants to buy near the beach. Or option IO loans used by wealthy people for tax reasons. Within reason, the free market should be allowed to price such risks.</p>

<p>That being said, it's clear that our current situation involves a number of prominent market failures that absolutely should be addressed by the government. Yes, the free market will eventually sort things out, but it will be very painful. The <a href="http://en.wikipedia.org/wiki/Moral_hazard">moral hazard</a> involved in letting joe six pack gamble with hundreds of thousands of non-recourse debt has resulted in some pretty massive <a href="http://en.wikipedia.org/wiki/Externalities">negative externalities</a> that can and should have been prevented by authorities earlier on.</p>

<p>A few common sense things could probably gotten rid of the worst excesses and shut down the speculative mania a lot quicker. Among the best ideas I've seen:</p>

<p>1) Give some teeth to the current mortgage guidelines that the state regulators approve by taxing non-comforming loans or mandating that they only constitute a small percentage of total loans originated.</p>

<p>2) Require lenders that originate loans hold them for a least a couple years before selling them.</p>

<p>3) Realy go after people who <a href="http://iamfacingforeclosure.com/">commit mortgage fraud</a> and the scumbags who push them into doing it. We need some good high profile perp walks.</p>

<p>4) Put some sort of system in place to prevent apraisers from being unduly influenced.</p>

<p>5) Streamline the foreclosure process, and require that banks absolute auction off their holdings within a resonable time after foreclosure. This would hopefully create a feedback loop where bad loans can help lower comps.</p>

<p> </p>
 
ocprince,





I used to think like you do. I am a Libertarian at heart. I detest government involvement in our lives; however, house price instability hurts us all. Wait until you see the bloodshed over the next 5 years and tell me if you think self-correcting markets are a good thing. If you read carefully what I proposed, I was not advocating government involvement in the markets, just a mechanism for leveling the playing field.








bigmoneysalsa,





I don't agree with your examples of people who can justify spending more than 3 times income. The young professional expecting income growth is living a fantasy, and the guy who wants to live at the beach can save his money to buy or just rent. As for the exotic financing, the issue becomes moot when the total amount financed is capped.





<p><em>1) Give some teeth to the current mortgage guidelines that the state regulators approve by taxing non-comforming loans or mandating that they only constitute a small percentage of total loans originated.</em></p>

<p>This could never be enforced.</p>

<p><em>2) Require lenders that originate loans hold them for a least a couple years before selling them.</em></p>

<p>I don't see how this would make a difference. They can still sell off their future interest in these loans without selling the loans themselves. Again, this is unenforceable.


</p>

<p><em>3) Realy go after people who <a href="http://iamfacingforeclosure.com/" set="yes">commit mortgage fraud</a> and the scumbags who push them into doing it. We need some good high profile perp walks.</em></p>

<p>I totally agree here. Just like the high-profile corporate fraudsters (Adelphia, WorldCom, Enron). This is the governments attempt to keep a lid on things, and it does slow it down, but it does very little to stop the practice. This is one area where the lenders really do need to police themselves. After all, they are the ones who will take the hits.


</p>

<p><em>4) Put some sort of system in place to prevent apraisers from being unduly influenced.</em></p>

<p>Interesting idea. How would it work? From what I have seen, these guys either agree to "hit the number" or they starve. I don't know how you keep the pressure off these guys in a competitive marketplace.


</p>

<p><em>5) Streamline the foreclosure process, and require that banks absolute auction off their holdings within a resonable time after foreclosure. This would hopefully create a feedback loop where bad loans can help lower comps.</em></p>

I don't see how this keeps prices stable? In fact, this will simply add to the volatility problem. In the real world, banks do not want to hold these properties, and they will ultimately dispose of them. They are a little slow right now because they lack the manpower, and they don't want to revalue all of their holdings and take a big hit to their balance sheets. This only delays the inevitable and not by very much. Wait until you see the number of REO's on the market in 2008.








Thank you both for responding.








IMO, when this crash has run its course and ruined the lives of thousands, perhaps hundreds of thousands, of ordinary American families, people will collectively decide something needs to be done to ensure price stability. The Japanese tried to keep prices from falling, and it cost them a 15 year deflationary spiral, so I would argue that does not work. To me, the only real answer is to prevent the price rally to begin with. Once prices have risen too high, too fast, there is nothing that can be done. Further, the only way to prevent rampant speculation in real estate is to limit the amounts being loaned. This is not to say their can't be equity-based price bubbles, but those don't get out of hand nearly as badly as credit-based ones. Therefore, IMO, the only way to keep prices near their fundamental valuations is to limit lending to incomes as I described above.
 
I don't necessarily agree with the 3x cap on mortgage, because your monthly payment can vary a lot depending on HOA, melo roose, bonds, and so on.





But if you have to impose the cap, I'd set it at 5 x income for 30 year loans.






 
<em>"I don't necessarily agree with the 3x cap on mortgage, because your monthly payment can vary a lot depending on HOA, melo roose, bonds, and so on."</em>





Good point, perhaps it should be a cap on total housing payment obligations...
 
<p>IrvineRenter,</p>

<p>I don't get why specific detailed practices / guidlines are unenforcable. Aren't the insurance, accounting, and financial consulting industries highly regulated in this manner? As someone with experience in the field why don't you think similar regulations would fly in the mortgage industry?</p>

<p>And I still think you are downplaying the utility of moderate risk loans to some people. True, many people do not know what is good for themselves and too many can set off a speculative mania. But ultimately there are quite a few smart people who should be trusted with some amount of calculated risk because they ultimately know their own situation better than anyone else. Do they need to be completely sqashed to get the situation under control? Or can we make some compromises? I personally could very easily afford a mortgage today that is 8 times my 2003 income.</p>
 
IrvineRenter couldn't agree with you more. What do you think about every loan a lender approves a minimum down payment of 15% should be put down?
 
bigmoneysalsa,





I don't think these kind of guidelines would be enforcible because nobody is policing them. The rampant mortgage fraud we have now comes from a lack of enforcement. Some of the industries you hold up as models of enforcement might point the way. This kind of government regulation always required bureaucracy and red tape. The kind I described needs only aggressive lawyers. Some kind of regulation is probably going to happen for both the mortgage industry and the realtors. What form it will take: who knows?





<em>"I personally could very easily afford a mortgage today that is 8 times my 2003 income."</em>





I congratulate you on your industriousness and good fortune. This is where you would sell the starter place and move up if you were an owner. Do you think it reasonable that people in their 20's would be buying properties they plan to own for 30 years? This demographic typically buys condos and starter homes. This limitation would keep entry level prices reasonable for all. In fact, I would argue that people in their 20's are the most prone to make foolish financial decisions and incur debt beyond their means to repay. Have you seen the savings rate among 20-somethings? I think I saw a negative 16%. Yikes! The limitation on mortgage lending at 3 times income protects borrowers and keeps the markets stable.





<em>"Do they need to be completely sqashed to get the situation under control?"</em>





I know this is a bit out of context, but everyone is about to get squashed anyway, the question is more about preventing it again in the future.








mino2126,





The net effect of limiting lending will be to require downpayments. In my suggestion the total debt could not exceed 90% of the purchase price.
 
<p>I think this topic is going to bring some interesting ideas and discussion. With that in mind we are just exchanging opinions and let's not take offence even if someone seems defensive. I am very curious to hear what other people think about what has already been posted and what is to come.</p>

<p>Bigmoneysalsa - I can tell your heart is in the right place but some of your theories are not very practical. I agree with some and added some ideas. Please let me know what you think. </p>

<p>1) Give some teeth to the current mortgage guidelines that the state regulators approve by taxing non-comforming loans or mandating that they only constitute a small percentage of total loans originated. <em>I think what you meant was more of the Alt-A, stated and subprime loans. Non-conforming loans are any loan that will not qualifiy for Fannie Mae, Freddie Mac, VA and FHA approval. So any loan above $417k would be taxed and there are many financially well qualified people in this category. Plus the lenders would just pass the cost onto the borrower or find some way around it.</em></p>

<p>2) Require lenders that originate loans hold them for a least a couple years before selling them. <em>This would shut down lending as a whole within a few months. Banks and mortgage lenders need X dollars in assets/deposits to lend X dollars out. Banks who do more than just mortgages would stop lending money for cars, personal loans and mortgages within in a few months. Lenders who just do mortgages would stop lending within a few weeks. This is actually what is happening to several lenders like ownit, MLM and Novastar but because they had to buy them back and they didn't have the warehouse lines to handle it. What hurts more when they have to buy them back they have to pay a fee and when they "fix" then loans they take a loss when they sell them again because they are worth even less. Selling loans is good when they are good loans.</em></p>

<p>3) Realy go after people who <a href="http://iamfacingforeclosure.com/">commit mortgage fraud</a> and the scumbags who push them into doing it. We need some good high profile perp walks. <em>I agree with you here. Think of how much money is involved in real estate even when prices are nomal. If you are buying a $500k house and your 401k is only worth $50k then why are the people involved with you 401k investment more regulated than the people with $500k investment? I think that RE agents, mortgage brokers/lenders and appraisers should be held to the same standards as people in the securities industry. This would include the education and testing requirements, background checks, fines and punishments for minor violations and commiting fraud would result in serious jail time and banishment from the industry including any industry that involves a persons investment money.</em></p>

<p>4) Put some sort of system in place to prevent apraisers from being unduly influenced. <em>See above.</em></p>

<p>5) Streamline the foreclosure process, and require that banks absolute auction off their holdings within a resonable time after foreclosure. This would hopefully create a feedback loop where bad loans can help lower comps. <em>This is what they try to do but the problem is the loan or loans on the house are just too high. Too many that are going to auction right now look like fraud to me. So they just take the home back keep it as an asset and try to sell it for a more reasonable price on the market. Plus this would only accelerate banks asset loses tightening their ability to lend. Currently they are taking losses when they do sell these on the market.</em></p>

<p>I hope my opinion adds food for thought and we can keep this discussion going.</p>
 
I think if we do impose strict caps on lending (3x income?), it may encourage developers to build more studio units in high density housing. I recall when I first started in RE, I went to see a couple of neat little 475 sq ft studio condos in Mission Viejo for only $80k or $85k each. I still kick myself for not buying one, otherwise I'd be fishing for trout on lake MV right now.





Those little 475 sq ft condos would make a great starter home for a young working professional, and complies with county codes for 2 people if you decide to shack up with your BF/GF for "Ikea living". Now a days I only see them offered in rentals, but never for sale in new construction. :(
 
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