Until the punch is taken away, we won’t see the damage of what has occurred in the last few years. The cracks are beginning to appear; the dam can only hold so much water before overflowing.

Oh, and greetings from Southern California! Another thing that many fail to realize is that this housing bubble is global including your homebase of Canada. Places such as Vancouver, London, Sydney, and Los Angeles have all taken part in this massive global equity gain. For better or for worse, the U.S. set the vanguard on creating this housing ATM™ mentality. Picture if you will, a technician from Diebold coming to your nice 1970 brick home and slapping a brand new ATM to the side of your home. Now you are given a golden credit card that you can insert into your newly furnished ATM and withdraw any “perceived” equity that has built up in your home. I say perceived because many recent buyers in bubble areas are quickly realizing that this unique ATM works in a different way; you have to pay it back!

So again, the liquidity is so prevalent I should get out my body board and catch a wave on its salty mortgage debt! Anyone else want to join?

I read an article saying that few areas are “bubble proof” and San Francisco was on the list. I’m not sure any area is truly immune. Let me post a part of the MIT article here:

“Finally, there has been recent discussion by Glaeser et al. arguing that prices are
rising “excessively” because of a shortage of new construction – due largely to increased
local development regulations. Now it is clear from economics 101 that supply
inelasticity is certainly a necessary, although not a sufficient reason for prices to increase.
But measuring development restrictions, estimating supply elasticities and then
connecting the two to buttress this argument is an empirical task far more daunting than
correctly measuring R/P ratios. Rather than enter this quagmire, we simply want to point
out several important facts about the supply side of the current housing market.”

So even MIT does not have an exact reason why places like New York and San Francisco with very tight building restrictions has seen “excessive” price growth. My view is that there will always be a premium to live in high demand areas such as New York, Paris, London, and even San Francisco. However, these areas are also prone to reverting back rather quickly. These cities gather fuel from the momentum of an economy that has been built on the back of housing. The wealth effect plays an important role in economic growth but also psychological perception. If the perception is that real estate is risky, and these cities are overvalued, there will be a shift to a more conservative approach. But the last few years we have seen the opposite of this; that is NOT buying real estate is risky because you will lose out in 20 percent yearly appreciation. Not only 20 percent but leveraged on a big mortgage.

To answer your question, even MIT does not have a prediction but everyone is sitting on the sidelines waiting to see what happens. I believe that San Francisco will face a correction but to what level location, prestige, and price supports hold real estate values up in the area is a question no one can accurately predict (but it’s fun trying to!).

The good thing about market rents is that they reflect current income. That is, people that pay rent usually pay it out of their current earnings. This is also the case with mortgages but when you have artificially low rates such as negative amortization loans or option ARMS, you are deferring today’s payment onto future earnings. It will be interesting to see what happens in the next few months.

There was a paper published by MIT, (much smarter folks than myself) and they said the two new factors that are changing this market is credit liquidity and the creation of a secondary market, that is sub-prime loans. Again, many of the folks that bought homes in the last couple of years would not have been able to by if it were not for exotic financing. Is this bad? Well, when you read another study saying that 2.2 million of these people will default I think we have some issues.

The study goes on to say that in the last two years, 1 out of 5 loans is sub-prime. The sub-prime market now makes up 8% of the entire mortgage debt of the country. 60 percent of these loans will reset in the next one to two years. We will see how weak lending standards have become when these borrowers have to penny up the payment.

Thanks so much for drawing that line connecting the Iraq (and by extension all of GWOT) and the problems in RE.

Several years ago I became concerned about the war’s affordability and eventually concluded that certain oddities in RE financing (specifically Fannie’s accounting magic) was helping the US gov’t to believe they could afford these foreign adventures when in fact they couldn’t.

Keep digging, there’s lots more work to do before we finally figure out what’s really going on.