Another lender went bust today. This will continue for some time as we are just getting started with the pain in the housing market. If you are a long term holder of real estate, this is just a bump in the night, but if you are in the business or looking to sell in the next few years, seriously consider having a solid plan B available.
This isn’t the end, just the beginning.
Prices aren’t controlled by realtors, appraisers, nor governments. Prices, in housing, aren’t controlled at all really. But to say that there are no factors that influence them isn’t correct, just the word “control” would, by most, be considered incorrect.
Houses are sold by one party and bought by another based on a negotiation and prices are basically based on supply and demand. Realtors, et. al., have a role in the negotiation, but they can’t overcome supply and demand, which is influenced by factors such as unemployment, interest rates, and market psychology. The prices are set by whatever the two parties agree on, it’s to the factors that effect that negotiation we should look to see hints of price changes.
Everyone is betting on home prices falling and so there is really no cheap way to hedge your house. The last time I looked the forward prices a year out were 30% or so lower than current. So what good is hedging a future price that is already down 30%. Might as well sell at today’s spot price, yes?
Maybe next housing boom, but not this one.
Housing is a major topic in economics these days. Overall housing will be fine, but in some area’s there will be serious problems as they were very speculative. Think of it like stocks in the dot com bust. Some stocks did fine, but others were disasters. Same here.
The key for the lenders is the compensation for the additional risk. They simply up the fees and rates to the point that it more than covers the default probabilities. This is one reason why PhD’s and others that are involved with default probabilities are so in demand. If you can build a model that will quantify the risk in such a way you can assign a rate to it, the firm can then make money off of anyone, opening up an entire new business segment.
Of course, for the borrowers, this is a very interesting development. They used to be stuck for loans with bad credit as they just weren’t available. Now they are available and the market is becoming competitive. Hard to imagine a company vying for the business of a bad credit risk, but if the fees and rates are high enough (the rewards) it’s worth taking the chance (the risk). As with just about everything else in finance, if the risk is worth the reward, someone will take it.
If the housing boom isn’t over, and by boom I mean prices in excess of value, and there is further to go up, doesn’t that mean it will be that much further to drop and it will take that much longer to get the market back to true value?
If speculators are still hopeful, can we have reached bottom? In other words, doesn’t the market have to flush them out to start back up for real?
I believe the likely scenario is a slow spiral with plenty of hiccups along the way.
Housing in past times was a entity that was perfect for wealth building. It wasn’t liquid, so you couldn’t trade it. It wasn’t something that was priced easily or often, so you weren’t feeling the price movements, therefore we hold on through troubled times. It wasn’t something that was likely to go down in value over the long term, at least keep up with inflation. But perhaps more importantly, we all were highly leveraged. We went into the investment with only 20% equity and borrowed the rest. Plus adding the dividend of providing a place to live, Jackpot! The perfect investment, or close to it.
But now, we are too leveraged, instead of building equity, we are spending equity as if it were income, and perhaps worst of all, we are trying to buy and sell as if it were a liquid market with no sales or tax consequences.