2007 Year in Review: Subprime Explodes, Prices go Negative, and Captain Credit Crunch Enters the Sea of Housing.

2007 was a watershed year for housing. The market took a major turn during the summer but much of the cracks in the housing juggernaut were seen earlier in the year. As the media is blasting the negative news on housing it is hard to believe that only a few months ago, it was playing the housing appreciation song. You have to wonder how the Hope Now Alliance is going to play out in the next few months since we are now officially entering the stage where some of the mortgage rate freezes will show results in the real world. This year it was hard for the housing market not to impact someone you know or someone in your neighborhood, maybe even you. I am reminded by a quote by Walter Bagehot:

“You may talk of the tyranny of Nero and Tiberius; but the real tyranny is the tyranny of your next-door neighbour.”

The real mess was right in our own backyard. In this post, we will go through 2007 to recount how the housing bubble pop unfolded over the year.

January – March

In January reports were coming out that approximately $1 trillion in loans were going to reset in 2007. The numbers didn’t exactly play out as predicted but without a doubt, they had the same impact. The subprime disaster was being predicted in 2005 and without a doubt, it was already expected that 2007 would be a definite turning point for the market. It was also reported that foreclosures jumped by an astounding 40 percent statewide. I love the spin that was added to this during January. As DataQuick reports:

“While foreclosure properties tugged property values down by almost 10 percent in some areas nine years ago, the effect on today’s market is negligible, DataQuick reported.”

Yes, the effect was negligible on the market. Not only that, notice of defaults surged statewide by 145 percent. This was a crystal ball into the housing future yet you see how the media was able to put a positive spin on this. It reminds me of those Geico commercials. Your house just lost $50,000 but you just saved a lot of money on your car insurance.

All leading indicators were pointing toward a housing decline but the prices told us a very different story. Southern California was up 3.3 percent on a year over year basis and Los Angeles hit a median price of $522,000. For those of you that think we were subtle about predicting a decline in 2007, maybe this title will tell you were we stood in January of 2007:

Time for Mortal Kombat Housing! The Subprime Market will face a Fatality in 2007!

Okay, maybe my forte isn’t subtlety. You have to give me some points for connecting subprime loans to Mortal Kombat! You would think that the mainstream media would get it but look at this L.A. Times article:

Remember `normal’?; Housing market shows signs of stabilizing in 2007, forecasters say.

If you think that is enough to entice would be buyers, you’ll love a quote from the article:

Prices: Last year home appreciation slowed down. The median price of all new and existing single-family homes and condos in the Southland increased only 5.7% from the previous year, compared with the 16.8% gain of 2005, according to DataQuick. The upside for 2007 is that prices overall should hold that current level of growth through the end of the year, [John Karevoll] said. The median price of a home in Southern California in December was $495,000, up 3.3% from the year before. The median price in Los Angeles County was $522,000, a record.

Aside from the mainstream media thinking August was the turning point in the housing market, subprime lenders were facing major cracks in February:

Did you Feel That? Housing Just Hit the Third Rail.

What Did I Tell You? If a Butterfly Flutters in Brazil The Subprime Market Will Collapse. Dow Down 415+ Points.

These were the first major jitters in the housing market. New Century Financial, one of the largest players in the subprime market started facing market scrutiny over their loans. The first few times, the market recovered rather quickly but when the market fell 415 points in one day, I think many analysts realized that subprime had a much larger impact than simply subprime loans and that it could impact other market sectors. Orange County went down $42,000 in one month according to median housing reports but the media was still utterly silent even though they normally used median price as a market sentiment indicator. You would think that the mainstream media would be cautious about issuing optimistic housing reports but here is another headline grabber from the New York Times:

Housing Market Heats Up Again in New York City

In March, it was clear that subprime was not going to be a bump in the road as one of the major lenders that took a hit in February, got hammered in March:

NEW Century Down 70% After it Announces it is Under Investigation by Federal Regulators

In fact, at a certain point in the month it looked like this company with a market cap of $92 million had loans outstanding of $8 billion. Now that is incredible leverage. People started wondering how could it be possible to have so many bad loans floating out there. Who in the world was buying these toxic products? The mortgage market started impacting the overall stock market and the mainstream media started picking up some of the warning signals as the San Francisco Chronicle Reported:

Mortgage market trouble generates stock sell-off: Some fear loan woes will spread through the whole economy

The first quarter was winding down and the housing market was giving off clear warning signs of where it would be heading.

April – June

The 2nd quarter started out with New Century filing for bankruptcy. During this time we started examining the issue of manias and panics and also the codependence of this nation on housing was becoming apparent:

America’s Codependence on Housing: 30% of Job Growth Contributed by Real Estate. 5 Point Plan on how the Bubble Will Burst.

Home sales posted their worst drop in 18 years and this is the time we started setting records not for price gains, but for market drops. During this period we also reported on an incredible story of a farmer making $14,000 a year being able to get a loan for $720,000. You would think stories like this would put the breaks on housing expansion but take a look at what Countrywide did in May:

Report: Countrywide to Offer 50-Year Subprime Loans

Reuters, reporting from a Wall Street conference, says Countrywide CEO Angelo Mozilo unveiled plans for new reverse mortgage products and 50-year-subprime loans, and also said Countrywide plans to add 2,000 sales jobs this year.

Even approaching mid-year with all the emerging negative housing news, many in the industry were sending mixed signals. The fact that we even put the idea of 50 year mortgages on the table was absolutely absurd. At this point we examined the reality that housing was pushed in a boiler room fashion:

Why Did the Housing Phenomenon Spread? 3 Key Reasons for a Social Epidemic: Housing Connectors; Mavens; and Salespeople.

During this time we were hearing about the coming summer jump in housing and how things were going to improve. It was hard to combat the fact that Southern California was still positive on a year over year basis. In fact in June it was reported that the median Los Angeles price was $550,000 and Orange County hit $635,000. If housing was going down it certainly wasn’t happening in Southern California. Even though sales were dropping by 30+ percent, prices were still holding strong which the media was still reporting:

Housing numbers are down, but no concern of slump.

With headlines like that, why even worry about housing!

July – September

During the much anticipated summer months, not only did housing not rebound but all hell broke out. First, we realized that sales were not going to rebound and the credit worries started permeating throughout the entire economy. We reported that housing had hit its Minsky Moment:

Housing Minsky Moment: 3 Factors. Prime Contagion, Record Foreclosures, and Publicity.

The negative press was starting to get louder and louder and declining sales prices were now starting to reflect in bottom line prices. We also did a piece on the foreclosure story showing how this issue is bigger than subprime; even people making $100,000+ a year can face foreclosure. During the summer major players in the mortgage industry started teetering with bankruptcy as the credit crunch hit full swing:

Countrywide teeters on the brink of bankruptcy, The bubble has burst – have you prepared for the after-life?

Fed awakes to another bubble bursting

Suddenly fear took over the market and the Fed had to step in dropping liquidity from helicopters but it didn’t do much since this was an issue of solvency, not liquidity. How is it going to help the cash strapped buyer that needs $10,000 to pay off high interest credit cards or make a resetting mortgage payment? The only way to solve this is to turn on the printing presses and increase actual cold hard cash but the Fed didn’t want to spur further inflation and instead of a bursting bubble, we would have a full on crash. This was their predicament. They increased credit trying to stimulate banks but what did this matter since the consumer was completely strapped and the risk of many of these mortgages were showing up in the asset backed markets. The secondary mortgage market completely collapsed and now, you actually had to verify you had enough money to purchase a home without going with a zero down banana republic mortgage.

Special Edition: Real Country of Genius: Today we Salute you America. Mortgage Implosions from Sea to Shining Sea.

We would all benefit from taking a look at a letter written by a banking president during the Great Depression:

Lessons From the Great Depression: A Letter from a former Banking President Discussing the Bubble.

Summer came and went and it was clear that the housing market did not get a desperately needed boost during the summer months. At this point the media was in full swing sounding like most housing bubble blogs:

Who’s To Blame For Housing Bubble? - Forbes

Desperate Realtors Applaud BailoutMotley Fool

The Housing Bubble Pops: The Nation: Fix Requires Helping Sub-Prime Buyers, Action From Federal ReserveCBS News

During this juncture we started hearing the words of “bailout” uttered and everyone seemed to have an idea of how to stop the housing market from tanking. Unfortunately none of these voices stepped in when housing prices were appreciating 20+ percent on a year over year basis.

October – December

In the fourth quarter we realized that the Fed was not going to sit on the sidelines:

The Credit Conundrum: The New Loan Shark is the Fed.

This meltdown was too big and simple liquidity injections was not enough. They were going to need to attack this mortgage debacle from multiple angles. This is when we also have the Hope Now Alliance coming about and anonymous discount window borrowing. Market prices were tanking and up apparently becomes down at this point. Countrywide announces over a billion in losses and the stock soars briefly on the word that the forth quarter will be positive for the company. Incredibly, people were still asking for nothing down mortgages during this time!

There were two major turning points here as well:

The Short Sale Report: Volume 1 – The True Barometer of the Housing Market

The Housing Wave of the Future: Two Main Mortgage Tsunamis.

A thing called short sales started hitting the California market in large numbers. For over a decade this once obscure real estate selling method was coming back in full force. Here, sellers try to get the lender to approve a sale for less than the current mortgage balance. Not the optimal way of selling but better in some cases than a full on foreclosure. Next, we realize that subprime is only one piece of the puzzle and we have another demon looking at us straight in the face, Alt-A and option ARM mortgages. In November Southern California hit a big psychological wall:

Heart of Foreclosure Darkness: Every County in Southern California is now Negative Year over Year.

The early in the year predictions were now completely out the window. Housing was in complete survival mode. We also talked about the mortgage birth story and how once local lending suddenly became this complicated alphabet soup of letters and in some sort of poetic justice, in some instances no one really knew who the true note holder was of a home’s mortgage. During these few months the Governator mentioned that he developed a plan to work with four major lenders but it turns out that this plan was already on the books and wouldn’t change much.

As we hit December, it was very clear that this mortgage debacle would potentially lead the nation into the dread “R” word. A recession was now openly discussed in the mainstream media and we also realized that NINJA loans were going the way of the Dodo. As the year closed out, Southern California hit an incredible 10 percent median price year over year decline:

Sexy Bottom: The Naked Truth of the 10 Percent Southern California Housing Drop.

We have to be careful not to jump the gun like housing pundits since estimating housing prices on the downside is like trying to guess how many jelly beans are in a jar:

The Quest for Accurate Housing Prices: Three Counties and Multiple Prices.

And so 2007 ends with a big bang. We have our first national year over year median home price decline since the Great Depression and major hold outs such as California have broken and have given way to massive price declines. The first half of the year was full of hope that this was only a minor setback in perpetual housing gains but after the summer credit crunch, it was clear that this had the potential to bring down the global economy.

What are your predictions for 2008?

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7 Responses to “2007 Year in Review: Subprime Explodes, Prices go Negative, and Captain Credit Crunch Enters the Sea of Housing.”

  • Just a quick note to say thanks for all the great articles last year, keep up the good work.

  • My prediction for 2008 is as Sylvester Stallone said in Rocky III: Pain.
    The year over year down turn in prices with building inventories and looming foreclosures means 2008 will be a year of modest housing pain, leading to 2009 the year of panic as the next wave of resets lands on top of a faltering economy. With whole communities upside down (owing more than their property is worth) the bottom will drop out of the market in 2009. Only a massive increase in nominal per capita income, i.e. inflation can avoid this. This would require the Fed to switch from fighting inflation to deliberately stoking inflation in a desperate bid to avoid deflation. It could happen. Bernanke is familiar with the Japanese parallel and the Fed study of a few years back that traced BOJ policy failures as contributing to the deflation of the 1990′s. Like the Japanese, I predict the Fed will act too late. 2008 is the last year to prepare. The question is do we prepare for Fed induced inflation or property bubble bursting deflation? I’d put the odds favoring deflation at 3:1.

  • Prices will lower to 3X income, the tried & true for many, many decades.
    70% decline for California, 78% decline for SF. 40% nationwide.
    That is reality, that is the bottom. Although in a bubble collapse, prices decline below the long-term mean for a few years. So be prepared.

    Keith in SF.

  • Wanted to say thanks for your fantastic blog. You have kept me informed and entertained. Have a great 2008. -Deb

  • Great summary of the year, Dr. HB. As usual you are right on the money. You’ve mentioned this already, but I think it’s worth repeating: the #1 reason we’re in this mess is the widespread delusion that we’ve entered a “new economic paradigm.” This was the mentality that contributed to the bubble. The worst part about it is that even the so-called experts seem to believe it. It’s arrogance to belive we’ve somehow invented a foolproof way to take on more and more debt without a corresponding increase in productive (not speculative) economic activity.

  • Well, I have been reading your articles for a year now and have never left a comment. I just wanted to say that I’ve learned quite a lot about real estate, market dynamics, credit and so on that I was unclear about before finding your blog. Also, the comments that your readers leave have been insightful as well. Keep up the good work.

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