Tuesday, September 27, 2005

Great Moments in Perfect Foresight

by Tom Bozzo

Alan Greenspan, still failing to convince me that the world would have ended had the next smartest monetary policy technocrat taken his job...
New York Times: Most Homeowners Not Overly in Debt, Fed Chief Says: With new evidence that the housing market remained red hot last month, Alan Greenspan said on Monday that the vast majority of homeowners are not yet stretched too thin...

...Mr. Greenspan argued that only about 5 percent of all families have borrowed more than 90 percent of the value of their houses.

"The vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices," he said. Mr. Greenspan told a banking conference on Monday that speculation in the housing market may have spilled over into the mortgage markets as more and more people use interest-only loans and other techniques to buy homes they might otherwise be unable to afford.

"The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other, more exotic forms of adjustable-rate mortgages, are developments that bear close scrutiny," he said.
The train went that-a-way, big guy.

It bears noting that we, personally, have what would evidently count as a "sizeable equity cushion" by virtue of having deliberately eschewed properties and mortgage products which, in appropriate combination, we could have fooled some mortgage underwriter into thinking we could afford. But in the markets that are showing the most signs of "froth" even to the sunniest market boosters, not doing that is S.O.P. — and it's alarmingly common elsewhere, I'm sure.

All this really ensures is that we won't be the last suckers. If I want a reason to get out the hard hat, I need only consider the possible willingness, in a steep recession, of lenders to allow jobless homeowners to use their dwindling home equity as a piggybank of last resort.
The Washington Post story covering his speech yesterday gives the stat for the Washington area -- one third of new loans here are interest only (!!) as opposed to a meager 2% five years ago. It's amazing to drive around here & see where "Luxury Townhomes From the 600's" are popping up -- like, in White Oak MD. Blech!
Most Homeowners are not overly in debt because most homeowners are some combination of people who (1) live in places that aren't "boom" areas, (2) have lived in "boom" areas for several years but not refied, (3) don't consider a home to be an investment property so much as a place to live, or (4) are people who transferred "equity" (read: market) gains from sale of a previous home to the purchase of a new or second one.

None of the above--and especially not the fourth--are things that indicate that the housing market is necessarily rational.
I realize that you are not a personal financial consultant, and you don't know me from the next person on the street, but I still want to ask:

I am a recent home buyer (about 2 years ago). I was able to buy without putting down a "sizable equity cushion" (that is, I did not pay 10 percent of the property purchase price, and I'll note that I am not quite to 10 percent home equity) yet I have a standard 30-year fixed-rate mortgage. Am I an unusual case, or should I have special worries?

I guess I thought there were a lot of people out there like me in this regard, but perhaps more of them than I realized have adjustable-rate mortgages or other less-standard mortgages.

Sorry to be so self-centered on your blog, but any comments you or others might have would be appreciated.
Cathy, thanks for the link. The figure that caught my eye there is that a fifth of *all* new mortgage originations in the 1H were interest-only. Yikes.

Ken: One statistic I'm interested in is the fraction of homeowners with 10-25% "equity" (a.k.a. my group), which I'd guess might be a little less reassuringly small than the fraction with less than 10%. That gets in part to the post title: replaying the pattern from past housing busts, much of the group with low but not super-low equity would do OK, considering. I do recall seeing a frightening-looking house price series assembled by Shiller that makes me wonder about the repeatability of past performance.

It's also struck me that non-boom areas pose a challenge for some of the arguments for why this supposedly isn't a bubble. Since the effects of, for instance, low interest rates are not localized, some of the non-boom markets would have really been in the dumpster.

Karton: Welcome. Questions are always entertained here. In the absence of a variety of details of your circumstances, they don't sound very unusual. Really "nontraditional" financing, which I'd define as a combination of ARM (esp. interest-only) and low-to-no down payment financing is still a minority of transactions nationally, though as Cathy notes, the rapid growth overall and particularly in the bubblier areas is striking if not scary.

I *don't* object to "untraditionally" low down payments as a general matter. Indeed, we put down 5% on our first house, and took out an ARM to boot. (That was in early 2000, and I was pretty sure where interest rates were headed at the time; we eventually converted to a 15-year fixed rate mortgage.) I was busier at the time paying off educational debt than saving for a large down payment, not an unusual circumstance for a first-time buyer. Nobody I know under similar circumstances assembled anything close to a traditional cash down payment. (Rolling over "equity," as Ken notes, is another matter.)

By taking out a fixed-rate loan, you're at least guaranteed to be free from future payment shocks should the bond markets wake up and help send mortgage interest rates notably higher. You're less susceptible to your income not increasing as fast as you might like or relying purely on market appreciation to build equity. Both good.

Really, about the only "worry" would be if you were counting on tapping your equity in the face of a modest price decline. If you're planning on staying put in the house for a while (or at least not counting on a big cash-out, which from the sounds of it you aren't), and can otherwise afford your lifestyle, then I wouldn't lose sleep over it.
Thanks for the comments. I think you centered on the two things that do tug around the edges of my general comfort: continued employment and affording the lifestyle. As you discern, I don't plan to tap the home equity for other uses or cash out any time soon. Staying put, however, depends a bit on the continued employment front. And, in the face of possibly increased inflation and other seemingly increasing strains on the ecomony, we'll see how well I do at affording the lifestyle. Should crisis come for me (if it must) at some point in the future, I hope to have enough house equity to get out without paying to do so.

As an aside, I will note that I am also quite familiar with the Island of Sodor thanks to the public library and my 2.5-year-old TTE devotee ... er, child, who has a 3-month-old coming along behind, meaning we will likely be re-listening to narrations by Starr, Carlin, Baldwin, Angelis, and Brandon for years to come. (Also, thanks for the info on custom Legos a while back.)
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