Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Tuesday, July 19, 2005

Housing, Again.
Waiting for the Bubble to Burst

Peter Schiff presents some fairly compelling arguments that
  1. we are in a housing bubble, and
  2. this bubble is going to burst worse than any previous housing bubble. [thanks to JJ for the link]

Here are his explanations:

One reason few expect housing prices to collapse is the mentality that homeowners need to live somewhere and as such will be reluctant to sell their residences. This argument ignores that fact that so many of today’s homebuyers do not occupy their properties as primary residences, and that relatively attractive rentals provide homeowners with viable, none-ownership alternatives for shelter. However, a more in-depth analysis reveals that contrary to prevailing rhetoric, housing speculation is not only rampant, but also far more pervasive than the data suggests, perhaps even more widespread than was the case with tech stocks during the NASDAQ bubble.

... the mere fact that owners occupy their houses as principle residences does not necessarily remove such properties from the category of speculative investments. For example, 58% of recent California homebuyers financed their purchases using ARMs (with percentages in pricier counties exceeding 80%). The primary reason given to justify such mortgages was owners’ intentions to resell the properties in relatively short periods of time. Such buying is clearly speculative, regardless of the speculator’s intention to occupy the property. Given high transaction costs and low relative rents available in markets where such mortgages are most pervasive, absent the expectation of rapid price appreciation, such short-term buyers would clearly be better off renting.

Also, the fact that so many buyers are using interest-only, or negative-amortization mortgages, suggests even greater degrees of speculation. ... The only way interest-only buyers build equity is though price appreciation. In other words, they are the ultimate speculators.

In fact, so intoxicating is the expected payoff from home ownership, that the incentives to lie to qualify for mortgages have never been greater, and as it so conveniently happens, easier to do. Trendy no-documentation mortgages allow almost anyone to buy a house, regardless of employment status, income, financial condition, or credit history. The fact that purchases can also be financed with zero down, means that speculators can gamble with no risk what-so-ever should prices fall. Also, the availability of cash-out refinancing means that owners can press their bets while simultaneously taking their winnings off the table.

Given such incentives, is it any wonder that housing speculation is so rampant? Should we be amazed that when reckless lenders offer buyers can’t lose bets, with huge expected payoffs, that so many want a piece of the action? The fact that the majority of today’s homebuyers are actually speculators in disguise, suggests that when the trend turns, prices will drop precipitously. Far from holding on to their homes, as even most housing bears suggest, owner/speculators will sell in droves, or worse, simply walk away from their bets, leaving lenders and tax payers to cover their losses.

Living in a small town in Mid-western Ontario means I don't see much of a bubble in my community. Here, prices may have risen by 10% over the past two years, if that. Given the transaction costs, that type of price increase is not enough to induce rampant speculation the housing market here.
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