Wall Street and Housing Neurosis: The Real Cost of California Homeownership. Extreme Foreclosures, Option ARMs, Renting Utility Costs, and Breaking the Financially Twisted Psychology.
The housing bubble psychology in California is still very strong. I’ve been talking with a few people trying to examine why the housing market, with obviously overpriced values was able to entice many otherwise rational people to take on toxic mortgages like option ARMs and Alt-As. As we have discussed many times, much of the economic crisis stems from greed by the crony banking oligarchs on Wall Street but also the foot soldiers who pushed the product out on the street. In the last decade most buyers and sellers were willing or unwilling participants in speculation. Housing since World War II on a national level has rarely been seen as a “hot” investment aside from a few pockets across the country. It is an otherwise dry and slow moving forced savings account.
This was the crux of how housing was viewed. But in California, the gold rush mentality with the glitter of housing fixation shows made buying and flipping homes mainstream. Take for example the well meaning Extreme Home Makeover show:
“(WaPo) Symbolic to our era like a sledgehammer to drywall, the biggest house that ABC’s “Extreme Makeover: Home Edition” ever made over — a sprawling, four-bedroom starter castle, a three-car garage mahal with a turret and all — has gone into foreclosure, in the ‘burbs south of Atlanta.
In that particular episode of the hyper-benevolent reality show, which first aired in February 2005, it took 1,800 volunteers a week to demolish the house with the overflowing septic tank that belonged to Milton and Patricia Harper of Lake City, Ga., and then entirely rebuild a new, larger house, while the Harpers and their three children went away to Disneyland. When they returned, they had the biggest house on Ahyoka Drive, with all the appliances and furnishings, plus enough money to pay taxes on it for decades, plus a fund to send their children to college.”
There have also been extreme foreclosures in Arizona and California. Why? Because people forget the true cost of ownership. The new mega monster homes get assessed at higher tax levels, energy costs jump, and you have more rooms to furnish. Does the extreme make over come with a boost in your W-2 income? The show is symbolic of how we view things. Let us do things big, fast, and crazy! Who cares about the longer term situation. Ironically the families on the show would be better off if the cost of the upgrades were given to them in cash directly. But not much production value in that.
The Wall Street premise was that everyone else would build, manufacture, get dirty, and otherwise do the work while you were able to get easy money simply by arranging a few papers to get pushed around. Now for the average man and woman, this is largely a tougher game. Yet Wall Street is still partaking in this casino environment. In a poetic irony of the entire mess, corrupt toxic banks are now trying to move on the public relation front by “paying back” billions to the government. This idea is such a preposterous notion. This is like a gambler who is down $20,000 but asks for $40,000 no strings attached, then makes a bet and wins. He gives you back the $40,000 and walks away with $20,000. The banks are rivaling the corruption of those in the Great Depression. How are banks making their profits?
“(NY Times) Despite continuing problems with its loans to struggling homeowners and consumers, Bank of America plans to return the $45 billion in aid that it received at the height of the financial panic — a step that, only months ago, would have been almost unimaginable.
But like many other big banks, Bank of America is once again making money, in large part through Wall Street businesses like trading stocks and bonds, rather than by making loans. Its recovery, while many ordinary Americans are still struggling, is an important milestone in the government’s yearlong effort to stabilize the nation’s financial industry.”
This should be obvious. Wall Street is no longer a reflection of the U.S. economy but of the gambling crony world of Wall Street. You might have noticed that home foreclosures are still near their peaks. Job growth? We are going for 23 straight months of job losses, the longest streak of this kind since the Great Depression. But let us check in on how Wall Street is doing:
That is correct. The 8 institutions listed above have made up nearly half a trillion in market cap since the lows reached in March. Some are up by 100, 300, and even 500 percent! While these banks made close to $500 billion back in market cap (this is only 8 so if we include the entire sector we are talking trillions) we will find that not one net job was added and the foreclosure rate is still seeing 300,000 filings per month. Glad we’re helping out the American public! If you had any doubts where this money is going, the above should put that assumption to rest. So what has the bailout accomplished? It allowed banks not to lend money to the public as it was sold to the American people, but to use the taxpayer money to gamble on Wall Street and suddenly recover their lost market cap by pure speculation. The down gambler has made a few winning bets. Was that really the purpose? Many American people seem oblivious or even worse, complacent to this since the crony banking system is robbing the country blind.
Yet this kind of thinking is what infected the population like a financial bubonic plague. People thought that instead of working, they would be able to buy into this paper pushing culture and suddenly they too would be on a get rich quick path. People didn’t deserve a nice home but a home with granite countertops and flat screens in every room. It wasn’t enough to have a good car but a V-10 tank that hauled your kids to soccer practice when it was designed to speed away from lions in the African desert. The 10 percent automatic stock market, dollar cost average, grow your way slowly to millionaire status without working culture is what allowed this to happen. It was a charlatan experiment and people were entertained by their ringmasters on Wall Street as long as they got a whiff of the scraps. Yet as we now are finding out, the ringmaster let the alligators out on the public while they pick up all the droped wallets and forgotten purses while people panic.
California was the ultimate shark tank because Wall Street found a willing participant. How else can we explain an absolutely idiotic product like option ARMs having such wild success? Option ARMs are zombie spawn of the get rich infomercial commercials. This loan converted housing into a speculative commodity. Forget about paying principal (or even all of your interest) these were short term products that prayed at the altar of perpetual housing appreciation. It is absolute nonsense. Let us use the peak price in 2007 and take housing prices to their triumphant and stupidly beautiful conclusion:
From 2000 to 2007 California housing increased at an annual average rate of approximately 12 percent. This is just flat out nuts given that incomes remained stagnant over the same time period. The above chart shows the trend if it would have continued. At this point, we would be getting close to a median home price of $800,000! In reality, the median home price in the state is now closer to $250,000. But this is the kind of logic that permeated through the market. A simple chart like this would have highlighted the error but people wanted to believe in the free lunch philosophy.
The option ARM catered to this mentality. Why do you need to make a full payment when you will sell your home in 3 to 5 years for double the price? Plus, that extra cash flow per month can be used to lease a Mercedes so you can go splurge on fancy restaurants with your credit card since you can’t even afford it with real money. That was the culture. This arrogance to long-term sustainability. People wanted to live it all up in a mega financial orgy and wake up exhausted from economic drunkenness. Well today the cold water is being splashed on the public.
The psychology is resisting any significant change. There is a group that have adapted and realize things are now different. Another group, I would venture to say most of the readers to this site were already cautious and didn’t buy into this perma-bull housing nonsense. But another group disdains this new austerity and is still patiently waiting for the next turnaround so they can once again ride high on the housing hog. Yet that boat has long sailed. This was a once in a lifetime bubble like Florida real estate in the 1920s. These people were used to the good life even though it was debt induced and will have to adjust but many are swallowing this jagged pill with bitterness.
30 Year Fixed the new and only Standard
Since for all practical purposes the government is now mortgage lender of first, middle, and last resort let us break down the financials of a 30 year fixed mortgage. One thing I still hear from people is, “well if you are renting, you are throwing your money away!” This is a faulty way of looking at things. Most people need to live somewhere so renting provides a service. You eat at a restaurant but after the meal, there is no future value. It provides a limited term utility. Housing serves this purpose. But the pressure of being a homeowner by the Madison Avenue marketing machine is deeply ingrained in the psyche of most Americans. Homeownership is a privilege, not a right. In the past, you earned this right by proving at the very minimum that you were able to save some money. This helped keep the foreclosure rate rather steady over decades:
As you can see, from 1979 to 2007 the foreclosure rate never went over 1.5 percent. We are now over 4.5 percent. In California the rate is even higher with 1 out 10 mortgage holders in distress. Why did this occur? Over this time the introduction of the adjustable rate mortgage was the financial daddy of the option ARM:
The Garn–St. Germain Depository Institutions Act of 1982
“The bill, whose full title was “An Act to revitalize the housing industry by strengthening the financial stability of home mortgage lending institutions and ensuring the availability of home mortgage loans,” was a Reagan Administration initiative
The bill is named after its sponsors, Congressman Fernand St. Germain, Democrat of Rhode Island, and Senator Jake Garn, Republican of Utah. The bill had broad support in Congress, with co-sponsors including Charles Schumer and Steny Hoyer. The bill passed overwhelmingly, by a margin of 272-91 in the House.
Title VIII, Alternative Mortgage Transactions, allowed Adjustable rate mortgages”
Then we have the 1999 Gramm-Leach-Bliley Act that passed with flying colors and gutted the Glass Steagall legislation put in during the Great Depression:
This was a bi-partisan screw over of the American people. Option ARMs were merely the logical conclusion of moronic lending and short sighted political policy. But now, people actually have to look at the actual cost of taking on a 30 year fixed loan. Yes, those boring old school loans. Since many people are looking to buy something in prime areas of SoCal, good homes are still selling for $500,000 or higher. Let us run the math:
We should spend time on the above chart since this is so important. At the beginning of any fixed mortgage, a large portion of your payment goes to interest. Even with the above example of a cheap loan at 5.75 percent, the bulk of your payment is interest. Your principal and interest payment is $2,917 but it breaks down as follows:
Interest at a very simplistic level is the amount of money you pay to “rent” money. So the notion that renting is throwing money away is wrong on many levels. Also, if you paid for an asset that has fallen by 30, 40, or even 50 percent you are now paying “rent” on a home that isn’t even worth the initial balance. With option ARMs and Alt-As, many went zero down so they are massively underwater. Assuming you take out a $500,000 mortgage, a large percentage of your payment (82 percent) is going to interest. So you are slowly chopping away at your balance. In fact, after 10 years that $500,000 mortgage goes down to $415,000. The mortgage balance doesn’t start taking major hits until the last 15 to 20 years. But in California, everything was twisted. People didn’t rely on the slow savings of a home but believed in the perpetual appreciation factor. Without this factor in the equation, we need to rely on more traditional metrics. Of course some shills think we’re going back to the heyday but that will be challenging with a 23 percent unemployment and underemployment rate and $20 billion annual budget deficits until 2015.
Also, we aren’t including taxes and insurance above. On a $500,000 mortgage this will be roughly $520 to $700 a month depending on your local tax structure. So your total net payment is:
$2,971 (PI) + $520 (TI) = $3,491
But what about the tax benefits? Ah yes, another major selling point for the housing clown parade. That above payment is a net payment. In other words, you need to pay that out of current income. The after tax benefit comes at the end of the year (or after you adjust your monthly withholdings).
One thing people forget about renting is that it is a true reflection of real market price. Rent is paid from monthly income with no tax subsidies. It is a good indicator of economic market health. The fact that in SoCal rents are falling is an indicator that reality based budgets are getting hit. The current housing numbers are juiced on the following steroids:
>Home buyer tax credit (gift)
>Fed buying mortgage backed securities keeping interest rates artificially low (40 year average at 9%)
>Pent up fence sitters that can no longer wait and must jump into the shark tank to party
Why drive this point home? Because next year is the big wildcard for California. The option ARMs come home to roost in fashion. If anything, why not pull a chair and watch the action for a year to see how things play out? If you think you are going to miss out on another boom then you have been brainwashed by the Wall Street sucker parade. The trend and mean reversion are always present in many economic forces. Housing is not immune to that. Plus, our economy is in the toilet! The nation has gotten it’s priorities twisted. Don’t you think that it would have been more prudent to bail out the employment and manufacturing sectors first before bailing out banks and then the housing industry? If we follow the money, you would think that the government would be happy with all of us sitting unemployed in subsidized $500,000 homes.
But take the above example as well. Many $500,000 homes can be rented for $2,000 per month. So on a net basis you have $1,491 more in cash flow per month. Forget about the tax breaks for the moment because you can dump this into a 401k and lower your tax rate as well. So on a yearly basis you have $17,892 more per month. Even with zero percent, after 10 years if you saved the difference you would have $178,920. Your $500,000 mortgage balance went down by $85,000. But the major speculative point is where will housing prices be in 2020? If we bust a Japan it can move sideways for a decade. There is no guarantee that housing will always go up (the California median home price is now back to 2002 levels).
This is the new reality. We’ll have another jobs report tomorrow and it is highly doubtful that jobs will be added. But in this current economic structure that is somehow positive news for Wall Street.
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