The housing crisis allows America to look in the mirror. What do we see?
Filed under: Post-WWII era, end of — Tags: defaults, federal housing administration, financial crisis, housing crisis, mortgages, ooda loop, rent — Fabius Maximus @ 12:01 am
One of the most fascinating narrative threads on this site has been about the oversupply of homes (technically “housing units”). This over-building of units is the key to the housing crisis, as has been evident for at least 2 or 3 years. A surplus of anything leads to falling prices until the surplus disappears, one of the iron laws of economics.
Yet even now this is not understood by many Americans, hence the increasingly insane proposals to prop up home prices at levels Americans cannot afford. But since we do not see the problem, we can neither treat it early nor effectively cope with it once it hits in full force.
This is yet another manifestation of what might be America’s core problem, as I said in Diagnosing the eagle, chapter I — the housing bust (6 November 2007):
Something is wrong with America, rendering our society incapable of connecting effectively to reality. The late USAF Colonel John Boyd described this as a process: Observe, Orient, Decide, and Act. (For a description of the OODA loop see this; for a discussion of Orientation see this post by Chet Richards.)
Who can tell what has caused this social illness, a form of cultural Alzheimer’s? The symptoms appear in many aspects of our national public policy — collective action in critical areas such as energy, geopolitics, and management of our economy. We find it difficult to recognize large problems until they are upon us, and to discern causes and effects. Worse, often we cannot weigh the various short- and long-term factors to rationally decide how to respond, so we choose seemingly easy and fast solutions without bothering to perform the necessary research and analysis. And, perhaps as a result of this flawed process, we frequently find ourselves unable to competently implement whatever course of action we choose.
Rather than provide a theoretical analysis, I’ll show a few case studies. Here we look at the housing cycle. Just a normal business cycle, although driven to amazing heights by a combination of factors — all noted at the time, with these warnings ignored by both our ruling elites and the citizenry …
This post updates that analysis, unfortunately without changing the conclusions.
Contents
The problem is too many homes
Our foolish responses make the problem worse
The glut will disappear, one way or another
Another expression of the problem: falling rents
Solutions
Afterword and where to go for more information
1. The problem is too many homes
Approximately 15% of the housing units in the US were vacant in the 4th quarter (per the US Census). That’s almost 18 million units. In the 4th quarter of 1994 it was 10%; in the 4th quarter of 1998 it was 11%.
The factor that best predicts defaults is home equity. Negative equity, usually from falling prices, means more defaults. Many people will not make payments to the banks that do not build equity. Payments as a too-large fraction of their income are a contributing but not primary factor (”too-large” either because the loan was too large or their income has dropped). Overbuilding means falling prices, which means negative equity, which means more defaults.
The problem is spreading across America, but not evenly. As always, some areas are far more affected. Areas like California, Florida, Arizona, Nevada. And Detroit: “The median price of a home sold in Detroit in December was $7,500, according to Realcomp, a listing service.” (from the Chicago Tribune)
Hard times make the problem worse as the number of households — and the number of units occupied — decreases. As seen here: “Job Losses, Credit Market Conditions Challenge The Apartment Sector“, National Multi Housing Council (NMHC), 15 January 2009 — Results of their January 2009 Quarterly Survey. Excerpt (bold emphasis added):
Once again, apartment firms are facing tough market conditions not of their making,” noted Mark Obrinsky, NMHC’s Chief Economist. “Earlier in the decade the bubble-induced rise in homeownership eroded apartment demand; now the economic and financial collapse caused by the bursting of that bubble is taking a toll.”
“The long-term prospects for the sector are strong,” explained Obrinsky. “The number of people between 20-34 years of age is rising rapidly, and as they enter the rental market, demand will rise correspondingly. For now, though, that demographic advantage is being trumped by the worsening job market, which is leading more people to move back in with family or take on roommates to save on housing costs.“
2. Our foolish responses make the problem worse
First it was a subprime mortgage crisis. Then it was a crisis of exotic mortgages (subprime, Alt-A, option adjustable rate mortgages). So the solution was to provide more and easier mortgage credit via the government-sponsored enterprises (FNMA, etc) and the Federal Housing Administration — and modify existing mortgages with easier terms (but not lower balances). Both methods have failed utterly.
(a) Modifications that reduce payments but not the balance do not work. Here is one of a large body of reports about this: “After three months, nearly 36 percent of the borrowers had re-defaulted by being more than 30 days past due. After six months, the rate was nearly 53 percent, and after eight months, 58 percent.” (remarks by John C. Dugan, Comptroller of the Currency, 8 December 2008)
(b) Easier credit (hair of the dog that bit us) does not help. Again I’ll cite just one of a large body of evidence: “The Next Hit: Quick Defaults“, Washington Post, 8 March 2009 — “More FHA-Backed Mortgages Go Bad Without a Single Payment”
But the subprime mortgage market has crashed and borrowers are flocking back to the FHA, which has become the only option for those who lack hefty down payments or stellar credit. The agency’s historic role in backing mortgages is more crucial now than at any time since its founding. With the surge in new loans, however, comes a new threat. Many borrowers are defaulting as quickly as they take out the loans. In the past year alone, the number of borrowers who failed to make more than a single payment before defaulting on FHA-backed mortgages has nearly tripled, far outpacing the agency’s overall growth in new loans, according to a Washington Post analysis of federal data.
… Once again, thousands of borrowers are getting loans they do not stand a chance of repaying. Only now, unlike in the subprime meltdown, Congress would have to bail out the lenders if the FHA cannot make good on guarantees from its existing reserves. And those once-robust reserves are showing signs of stress, raising the possibility that taxpayers may have to pick up the tab for the first time since the agency was established in 1934.
More than 9,200 of the loans insured by the FHA in the past two years have gone into default after no or only one payment, according to the Post analysis. The pace of these instant defaults has tripled in one year. By last fall, more than two dozen FHA home loans on average were defaulting this way every day, seven days a week.
The overall default rate on FHA loans is accelerating rapidly as well but not as dramatically as that of instant defaults.
The agency’s share of the mortgage market is up from 2% three years ago to nearly a third of the mortgages now made, its highest level in at least two decades, according to Inside Mortgage Finance, an industry trade publication. The FHA does not lend money directly. It provides mortgage insurance for borrowers working with FHA-approved lenders and uses the premiums to cover its losses. If the premiums are not enough, taxpayers could be on the hook.
At the same time, Congress has substantially increased the amount a homeowner can borrow on an FHA loan in pricey areas, thrusting the agency into markets it was previously shut out of, such as California, where plunging home prices have made people more vulnerable to foreclosure.
3. The glut will disappear, one way or another
Economic problems are self-correcting in a system using free markets. Oversupply of homes can only be absorbed in two ways, as I wrote in A vital but widely misunderstood aspect of our financial crisis (18 September 2008) I wrote about the core of the housing problem:
(1) Eventually our population will increase to fill these homes. But slowly. Growth in the number of households occurs in two ways:
(a) More children leaving home than households disappearing through combinations (children moving back, parents moving in with children) and death. But in a recession the number of households shrinks as the latter exceeds the former.
(b) Net migration into America. Our slowing economy might already be slowing the rate of in-migration. But a recession or political turmoil in Mexico might send floods of people north into America.
(2) Not so creative destruction: housing units will be destroyed
Many vacant homes will be destroyed, the fast track to fixing this problem. Empty houses get vandalized, destroyed by the owners (spite or insurance fraud), occupied by squatters or meth labs, or wrecked by the forces of nature. In regions with net out-migration (e.g., Detroit) homes remain vacant for long periods, often abandoned by their owners (valueless but costly due to taxes and maintenance). As anyone familiar with the history of the South Bronx knows, empty homes act as an infectious blight that can devastate larger areas. After a decade or two, the result can look like Dresden after the bombing in 1945.
This was greeted in the comments with incredulous outrage, like telling a rural medieval priest that the Earth was not the center of the universe. Sacrilege towards the true religion of America! But even America has proven to be subject to the laws of economics. Signs of a defective OODA loop in action, sounding like a car running with no oil.
Unfortunately this has all proved accurate, as seen in these two articles. Hundreds more can be found on Google.
(a) “As projects grind to a halt, home sites turn to wasteland“, Los Angeles Times, 4 March 2009 — Excerpt:
By day, it’s far too quiet at the site of a planned housing and retail development on a former Navy base in Oakland. At night, neighbors can hear the thieves come out. They rip out copper wire, haul away pipes and take anything else they can steal from dozens of buildings on the site, abandoned after Irvine developer SunCal Cos. fell victim to the economy.
It’s a scene not uncommon throughout California, as residential construction grinds to a halt under the dual weight of the credit crunch and the housing crisis: a rusty chain the only barrier between the community and a half-built structure in Hollywood; a bare dirt lot in Pasadena; old stoves amid the trash at the site in Oakland. “I hear hacking and see scary bonfires in the middle of the night,” said Don Johnson, a retired Coast Guard employee who lives near the defunct Oak Knoll Naval Medical Center in Oakland.
(b) “Foreclosures mount, so do vacant Peoria homes“, Journal Star, 14 February 2009 — Excerpt:
Vacant, neglected houses were a city’s headache even before fear of foreclosure loomed over every block. They attract rodents, dumping, vandals, arson, theft of copper wiring and other problems expected to increase along with rising foreclosure rates. Beyond crime and demoralized neighbors, many cities are just beginning to realize how costly vacant properties can be - for homeowners and municipalities.
“It costs a lot, and not just in the obvious ways,” says Jennifer Leonard, director of the National Vacant Properties Campaign, a Washington, D.C.-based coalition charged with searching out the best new methods to prevent and/or reclaim and reuse vacant properties. Cities spend time and money on code inspections, yard clean-up, demolitions, and, in many cases, tracking down absentee owners. (Peoria charges homeowners for services. If officials don’t collect, they put a lien on the house.) But vacant houses can also drain resources from police, fire, health and legal departments.
In Peoria, include the animal welfare shelter on the list. Director Lauren Malmberg requires animal welfare workers to report vacant houses to the city’s code enforcement department. “We were tired of pulling animals out of them.” They become havens for raccoons, stolen dogs, stray dogs and worse. Malmberg encountered a vacant house on the south side, in the 1800 block of Widenham, that had become a center for dogfighting. “Graffiti of dogfighting was painted everywhere, inside and out. There were dog carcasses, blood and feces everywhere.”
Vacant properties can also contribute to higher insurance rates and lower property values of surrounding houses, which further depletes a city’s tax base. Though it’s commonly assumed that vacant properties equal unpaid property taxes, it’s difficult to know because many cities don’t do comprehensive inventories of vacant houses.
… The majority of Peoria’s 4,500 vacant housing units are concentrated in older neighborhoods … the 4,500-figure and subsequent vacancy rates are based on the U.S. Postal Service definition - houses that haven’t received mail in 90 days or more.
The code enforcement department’s figures on boarded-up houses give a clearer picture of the inherent flexibility of vacancy-related data. During 2008, a total of 217 properties were boarded up for various reasons. By year’s end, 74 had been brought into compliance by owners, 24 were demolished and 30 were going through the legal process for court-ordered demolition.
4. Another expression of the problem: falling rents
A surplus of housing units not only directly pushes down prices, but also pushes down rents — which depresses the value of housing to investors. For more on this see:
“Housing downturn hits L.A.-area rents“, LA Times, 8 January 2008 — “Overbuilding and foreclosures add to supply of units as the recession limits what people can pay.”
“The Residential Rental Market“, Calculated Risk, 9 January 2009
“Stress Test House Price Scenarios“, Calculated Risk, 25 February 2009
“What If Rents Cliff Dive?“, Calculated Risk 26 February 2009
This also destroys more wealth in America, and adds to the banks’ woes: “Apartment-Complex Developers Falling Behind On Loan Payments”, Dow Jones News, 12 January 2009 — Excerpt from Calculated Risk:
The rapid reversal of fortunes in commercial real estate is taking down yet another sector: multifamily housing.
… While sharp declines in retail and office sectors of commercial real estate have commanded attention in recent months, some analysts say deterioration in the multifamily sector is quickly catching up. … Much of the multifamily sector’s problems center around troubles in converting apartments to condominiums, as is the case in Miami, or the challenges in converting rent-controlled units to market-rate apartments, as in Manhattan.
In Florida, California, Arizona and Nevada, the flood of unsold condominiums is entering the apartment market and the excess supply is lowering rents in those areas, BarclaysCapital analysts say. That’s resulted in lower revenues for owners, which in some cases is making it more difficult to keep up with mortgage payments.
… In November, the delinquency rate on securitized loans to apartment and condominium properties rose to 1.9%, a dramatic jump from the 0.9% at the start of the year, according to Realpoint LLC …
5. Solutions
The fire has spread, so that now the housing crisis is just one aspect of the global economic crisis. Large-scale macroeconomic measures — probably international in nature — are all that can buffer the global depression. That is, minimize the suffering during the downturn, and lay the foundation for a powerful enduring recovery afterwards.
6. Afterword
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7. For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest are:
About Financial crisis - what’s happening? how will this end? (see section 7 for solutions)
About America - how can we reform it?
Posts about the housing crisis:
Diagnosing the eagle, chapter I — the housing bust, 6 December 2007
A vital but widely misunderstood aspect of our financial crisis, 18 September 2008 — Too many homes.
Destroying houses in order to boost home prices, 16 December 2008
Posts about America’s broken OODA loop:
News from the Front: America’s military has mastered 4GW!, 2 September 2007
The two tracks of discussion about the Iraq War, never intersecting, 10 November 2007
Another cycle down the Defense Death Spiral, 30 January 2008
Quote of the day: this is America’s geopolitical strategy in action, 26 February 2008
What do blogs do for America?, 26 February 2008
Everything written about the economic crisis overlooks its true nature, 24 February 2009
Posts about warnings of this crisis:
We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions.
Making us dumber, chanting “Dude, where’s my recession?”, 3 June 2008 — Economic columnists do a disservice to their readers by ignoring the data showing a weakening economy.
Another warning from our leaders, which we will ignore, 4 June 2008 — An extraordinarily clear warning from a senior officer of the Federal Reserve.
When did “Dude” predict a recession? How severe?, 6 June 2008 — Why accurate economic forecasting is difficult, what we know about current conditions, and warnings from a top economist.
The most important news of the month. Perhaps the year., 29 September 2008 — Warnings from our foreign creditors.
