Affordable Mortgages vs. Sustainable Mortgages

During my recent “Real Estate Bubble Explained” project, I found it was common for lenders to brag about their affordable mortgages. They were talking about their subprime mortgages.

Anything that let more people buy homes back then was considered to be a good thing. Mortgages that would have been branded as predatory in earlier times were now as wholesome as mom and apple pie.

For example, I LOVE the title of this graph from the FDIC in 2006. Interest-only mortgages, and Option ARMs, “Help Homebuyers Bridge the Affordability Gap.”

FDIC 2006 Subprime Mortgages

And here they justify 40-year mortgages.

“The extended amortization period reduces monthly mortgage payments, thereby stretching a buyer’s purchasing power.”

FDIC doesn’t even sell mortgages. They’re a bit above the fray but the conventional wisdom in 2006 was simply the more affordable the mortgage, the better – even interest-only, option ARMs and 40-year loans.

Affordability

The reason the number of affordable/subprime mortgages skyrocketed during the boom was because lower lending standards mean more people can get mortgages and that means mortgage companies can sell more mortgages.

There was a race to the bottom.

Prime mortgages were all similar so the competition between lenders was fierce. But if you sold subprime, er, I mean, affordable mortgages, you had a helluva lot less competition so for years you could sell more mortgages and, in addition, charge higher fees. During the boom, loan officers could make 2 to 3 times more money selling one subprime mortgage versus one prime mortgage.

It seems insane to me that loan officers would get paid more for selling the worst mortgages. Shouldn’t loan officers get paid more for selling the best mortgages? 

But the economics didn’t work that way. If everyone is selling prime mortgages, there’s more money in selling something more unique like affordable/subprime mortgages.

Many mortgage companies weren’t happy selling sustainable, competitive, prime mortgages even though sustainable mortgages help create more stable neighborhoods, especially in less stable areas.

American Dream

It seems some lenders will always push to have more affordable mortgages to sell.

They’re looking for an edge, something unique to sell, something outside the super competitive prime mortgage market.

And looking at what they said during the boom, lenders will always justify their affordable/subprime mortgages by saying they’re just trying to help;

  • Low and moderate income families,
  • Underserved and minority communities,
  • Spread the American Dream of homeownership

Affordable/subprime mortgages are, of course, never sold for what they really are, a way for mortgage companies to make more money.

Sustainability

Sustainable mortgages may not be as profitable to mortgage companies but they lead to;

  • Smaller booms,
  • Smaller busts,
  • More neighborhood stability,
  • Creation of more household wealth, especially in low income neighborhoods, and
  • More economic growth nationwide.

Nothing since the Great Depression has destroyed more household wealth in low and moderate income, underserved and minority neighborhoods than the affordable/subprime mortgages sold during the Great Real Estate Boom.

Median Household Net Worth 2000 to 2011

Instead of focusing on the short-term affordability of mortgages, we should focus on the long-term sustainability of our neighborhoods.

Instead of letting the short-term profitability of mortgage companies shape our neighborhoods, we should let the long-term sustainability of our neighborhoods shape our mortgages.

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Great Real Estate Bubble in 18 Pictures

Here are some of the cool graphics related to the Great Real Estate Bubble that I didn’t end up using in this post.

The source is on each graphic, if you want to do more research yourself.

Click images to enlarge.


 

FCIC Funding for Mortgages


CA and FL vs US Home Prices


Simkovic NonPerforming Loans by Type


Net Worth Mortgage Design


Median Household Net Worth 2000 to 2011


New Worth Shares by Net Worth


Acharya Mortgage Debt


Dallas Fed Supply Graph


Mortgage Debt v2


FCIC Subprime Originations noAlt-A


FCIC Household Net Worth


FCIC Underwater Mortgages by State


Historical Home Values


Investors Properties


Housing and Wealth Lower Income


Subprime delinquencies ARM vs Fixed


Housing Wealth By Net Worth Ratio


Who Extracted Home Equity

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Foreclosure Maps 2007 & 2009

Click to enlarge.

Foreclosure Map 2007

Foreclosure Map June 2009

Nice clear presentation of foreclosures in June 2009 (via Kevin Erdmann).

More info on the Great Real Estate Bubble.

The Great Real Estate Bubble – Explained

As a real estate agent in the bubble city of Phoenix, I often wondered what the hell was happening during the Great Real Estate Bubble.

10 years after the peak of the boom I was still confused because everyone was blaming everyone else for the Bubble and the Great Recession.

Being a geeky guy and a former economist, I decided to try and figure it out for myself.

It took 2 months but now I have a good feel for what actually happened. It was caused by basic economics.

[If you’ve wondered if I fell off the face of the earth the last couple of months, this project is why.]

What Do You Think?

  • What did I get right?
  • What did I get wrong?

I’d love to hear your comments and I’d love to hear about your experiences in the Great Real Estate Bubble.

Right now I’m totally up to speed on the Bubble so please feel free to ask me any questions about it. I might even know the answer.

Subscribe to Real Estate Decoded

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Money Chasing Homes – Transcript

The Great Real Estate Bubble – Explained

When the Great Real Estate Bubble burst in 2008, it triggered the worst recession since the Great Depression.

You would think that 10 years after the Bubble’s peak we would have come to some agreement on what caused it and how to prevent another one.

But, nope. There’s still no consensus after all these years.

So I spent a couple of months trying to figure it out for myself and found an easy way to explain the basic economics behind the Great Real Estate Bubble.

Money Chasing Homes

Economists like to say about inflation that prices are determined by how much money is chasing how many goods.

The “how much money” part measures demand and the “how many goods” part measures supply.

It turns out this simple framework also works GREAT for explaining the boom and bust of home prices in the Great Real Estate Bubble.

So let’s get back to basics and look at “How much money was chasing how many homes” in the Great Real Estate Bubble.

Inelastic Supply

First, let’s look at the second part, “How many homes.”

Homes are the textbook example of what economists call inelastic supply.

Most products are kinda like iPhones. If the new iPhone is a hit, great! Apple makes a zillion more iPhones but they don’t increase the price.

Homes are different.

If your town suddenly became super cool and cool people everywhere wanted to move there, home prices would skyrocket. The supply of homes is fixed in the short term so even small increases in the amount of money chasing homes can cause big increases in home prices.

In the long term, in cities where it’s easy to build new homes, prices will come back down but in cities where it isn’t, they won’t.

Dallas Fed Building Permits

Now, let’s go back and look at the first part of the equation, “How much money.”

Two factors determine how much money is chasing homes; how much money people have and how much money people can borrow.

And two huge factors in determining how much money people can borrow are interest rates and how loose mortgage companies are with their money… or with someone’s money.

1990s

From the early 1990s to the peak of the Great Real Estate Bubble, mortgage companies became a helluva lot looser with their money… or with someone’s money.

They loosened up slowly at first but then faster and faster and crazier.

FHA became looser. Fannie and Freddie became looser.

Fannie and FHA lowering lending standards

Subprime companies became looser and, in addition, the number of subprime mortgages skyrocketed.

FDIC Subprime Mortgage Originations

Back in the early 1990’s, if you couldn’t get a “prime” mortgage, you might not be able to get a mortgage at all.

Then some small enterprising mortgage companies started to sell high cost, “subprime” mortgages to people with iffy credit histories who couldn’t get low cost, prime mortgages.

By the late 1990’s, easier mortgages and a strong economy were making a lot more money available to chase homes. Home prices started to rise fast in some cities. For example, the home price index for Los Angeles increased 14% in 1998 alone.

Los Angeles Home Prices 1998

Early 2000s

Then the Dot-Com Bubble burst in 2000, the stock market crashed and a recession began.

NASDAQ Composite v2

To pump up the economy, the Federal Reserve lowered interest rates drastically.

Interest rates on 30-year fixed rate mortgages fell 3 percentage points from 2000 to 2003.

Mortgage Rates Fall

The lower rates meant people could borrow a LOT more money to chase homes, if they wanted to anyway.

With the same monthly payment, you could borrow nearly 40% more money in 2003 compared to 2000. If you switched to an adjustable rate mortgage, you could borrow 60% more. If you switched to a subprime mortgage, you could borrow even more.

Los Angeles, for example, already had a tight real estate market and its economy wasn’t as hard hit hard as others by the Dot-Com Bubble, so the new, low interest rates sort of freed home prices in LA to rise.

Los Angeles Home Prices 2006

Higher prices made people want to buy homes right away before prices increased even more. So prices increased even more.

With the rapidly rising home prices, subprime mortgages became more popular because people wanted to borrow more and more people wanted to borrow.

Everyone was talking about home prices. It was as if the Dot-Com mania simply shifted over to real estate.

Investment Homes

California real estate speculators were making big bucks. Some took their winnings and moved on to Las Vegas and Phoenix which triggered bubbles there.

Prices Los Angeles Las Vegas Phoenix

I should mention that most U.S. cities did NOT have real estate bubbles.

FCIC US Home Prices

Homebuyers in non-bubble cities could have borrowed a lot more money to chase after homes, if they wanted to, but they didn’t want to. So why not?

Dallas Fed Coastal More Volatile

Most likely they didn’t need to. Their real estate markets weren’t that tight. Homebuyers could find homes they wanted to buy without borrowing more money and bidding up prices.

And part of it MIGHT be that the people in the non-bubble cities were just less comfortable taking risks than the people in California and Florida.

Option ARMs

They avoided taking on bigger and riskier mortgages even though they could have. Upward price spirals never really got started.

Refinancing Boom

Mortgage interest rates fell throughout 2001 and 2002 so a huge number of people decided to refinance their homes.

When they switched into lower interest rate mortgages, many people also got LARGER mortgages. That way they could get “cash-out” when they refinanced. They ended up with less equity in their homes but more cash.

In 2003, an incredible 20% of U.S. homeowners with mortgages refinanced their homes.

About half of all mortgages made in 2004, 2005 and 2006 were refinancings.

Home prices had skyrocketed which meant people could get huge cash outs if they wanted to. They could get even bigger cash outs if they refinanced into low down payment subprime mortgages.

Unfortunately, they ended up with less equity which would come back to bite some people when home prices tanked after the bubble burst.

Subprime Boom

As the refinancing boom was ending in 2003, the subprime mortgage boom really started to take off.

Simkovic Originations

And at the same time subprime mortgages were getting riskier. Credit scores fell. Down payments fell. Maximum loan amounts rose. Fraud rose.

Subprime Lending Standards

Subprime lending standards fell so far that from 2005 to 2007 the median subprime mortgage had no down payment!

Zero Down

And by 2006, half of all mortgages were subprime!

Archarya with highlights

Some people chose subprime because they couldn’t get prime mortgages. Others choose subprime so they could borrow more money.

Either way, the increase in subprime mortgages meant people could borrow a LOT more money to chase homes, if they wanted to anyway.

Combined with the low interest rates, home prices absolutely skyrocketed in the bubble cities during 2004 and 2005.

Case-Shiller Bubble Cities

On top of this, the Fed began slowly increasing interest rates in 2004.

Fed Funds Rate Increase

But instead of slowing things down, people became even more manic about buying homes right away before the low interest rates were gone forever.

Peak

Eventually, home prices got so high in the bubble cities that the market psychology changed from,

“These home prices seem crazy high but they’re increasing crazy fast so let’s buy a home ASAP,”

to simply,

“These home prices seem crazy high and they’re not increasing crazy fast anymore so let’s wait and see.”

The spell was broken.

And anyway, pretty much anyone with any inkling to buy a home already had bought one… or two.

In 2005, the number of home sales peaked.

In 2006, home prices peaked.

The spell, however, wasn’t broken for the mortgage industry.

Simkovic Delinquencies by Vintage Year

They continued to lower their lending standards in a desperate attempt to keep the music playing.

Bust

Many subprime mortgages made in 2005, 2006 and 2007 – especially no-money-down mortgages – made it rational for investors to stop paying their mortgages as soon as they realized home prices weren’t INCREASING anymore.

If they put no money down, the only money they lost was the first few monthly payments they made. The sooner those investors stopped making payments, the smaller their losses.

Simkovic Delinquencies

In 2006, after home prices stopped increasing, foreclosures started increasing.

By 2007, home prices started to fall and foreclosures of subprime mortgages started to take off.

By 2008, foreclosures of PRIME mortgages started to take off and home prices in bubble cities began to freefall.

Then the stock market began to freefall.

And then the government stepped in with the first in a series of huge financial interventions.

By the time home prices finally bottomed out in 2012, home prices had fallen 30% nationally, 40% in Los Angeles, 50% in Miami, and 60% in Las Vegas.

Impact

The Great Real Estate Bubble triggered the Great Recession which turned out to be the deepest and longest recession since the Great Depression.

EmploymentRecessions2014

Here’s why.

When the stock market falls, it doesn’t have a huge impact on the wealth of lower income Americans, they don’t own stock.

Real Estate Share of Assets by Net Worth

Remember how quickly the economy bounced back from the 50% crash in the stock market in the 2000 Dot-Com Bubble.

When home prices fall 30%, however, it hurts a lot more people and it wipes out most of what little wealth lower income Americans have, so consumer spending crashes hard.

Mian Poorest Net Worth Collapse

That’s why the worst recessions, like the Great Recession, are usually tied to real estate bubbles.

Conclusion

I think the “Money Chasing Homes” framework does a great job of decoding the chaos of the Great Real Estate Bubble.

It even partially explains why during the bust we saw home prices fall in cities that didn’t even have booms. After the bubble burst, mortgage companies freaked out and tightened lending standards everywhere. The money chasing homes was reduced everywhere, even in cities that didn’t have real estate booms.

Non-Bubble Cities

And currently, the “money chasing homes” framework helps explain why home prices are skyrocketing in Vancouver, the U.S. West Coast, Miami and some techy cities. It’s an influx of foreign and/or tech money chasing homes in those cities.

Currently Booming Cities

The first step to preventing another Great Recession is to understand what caused the Great Real Estate Bubble.

I hope this video helped you get a better feel for what happened.

If you want more real estate decoded, please subscribe to my website RealEstateDecoded.com.

And if you’re watching on YouTube, please click the “Subscribe” or “Like” button.

Your questions and comments are welcome.


Flowchart

The “Money Chasing Home” flowchart is available as a pdf, image or slideshow.

Click to enlarge.

Money Chasing Homes Flowchart v3


Notes

Why. I don’t dive into why subprime mortgages expanded or lending standards fell. That’s more political science than economics. The “why” is super controversial and it’s super easy to go down a rabbit hole and get distracted from the basic economics of the Great Real Estate Bubble – money chasing homes.

“Subprime.” The definition of “subprime” is all over the place in the literature.

Many people, especially in the mortgage industry, don’t include “Alt-A” mortgages within their definition of subprime which seems crazy. Separating them out just confuses things and makes “subprime” mortgages look smaller than they really are. “Alt-A” mortgages are significantly below prime mortgages in quality so I include them in my definition of “subprime.”

In addition, there are other data problems in measuring the number of subprime mortgages but no matter how you slice it, there were a ton of subprime mortgages.

Just be aware that within the video, the definition of subprime may change depending on who’s study I’m referring to. The video isn’t as internally consistent as an academic paper would be. But to give you an overview of what happened in the Great Real Estate Bubble, I wanted to pull in all the best research I could find even if the different studies weren’t consistent in their definitions of subprime.

More Explanations of the Great Real Estate Bubble and/or Great Recession

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Home Price Trends: HOT=Portland NOT=Washington D.C. (NEW Graphs!)

Case-Shiller

Annual Home Price Appreciation
Feb 2015 – Feb 2016

Most Appreciation (within the 20 metros)

  1. Portland = +11.9%
  2. Seattle = +11.0%
  3. Denver = +9.7%

San Francisco dropped out of the top three appreciating cities for the first time in forever.

And it fell fast. Its annual appreciation rate fell from 10.5% in January to 9.3% in February.

Case-Shiller Hot

Least Appreciation (within the 20 metros)

  1. Washington DC = +1.4%
  2. Chicago = +1.8%
  3. New York = +2.1%

Washington D.C. overtakes Chicago as being the least appreciating Case-Shiller city with only 1.4% appreciation in the past year.

Washington D.C. was one of the “hottest” (really, least cold) real estate markets in the country from 2009 to 2011. Home prices in Washington D.C. bottomed out in 2009 while prices in most other cities continued to fall until 2012.

I don’t know exactly why Washington D.C. is doing so badly. If you have an explanation, let me know in a comment.

Case-Shiller NOT

Data Table – 20 Cities

Case-Shiller Chart

Full S&P Case-Shiller press release.


Zillow

EXCLUSIVE: You won’t see these graphs anywhere else online. They’re not even on Zillow.com, even though I get the raw data from Zillow.

“Percent of Homes Increasing in Value” is another way to look at how strong prices are in a city. Theoretically, it can help us peek around corners a bit.

Mojo – 66% or More of Homes Increasing in Value

  1. Portland & Phoenix gaining strengh
  2. San Francisco & San Diego losing strength

Zillow Increasing HOT

No Mojo – Less Than 66% of Homes Increasing in Value

  1. Detroit is losing strength
  2. No clear trend for rest of cities below 66%

Zillow Increasing NOT

 

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Zillow’s “Percent of Homes Increasing in Value” Dataset and Forecasting Prices

[This post just got a nice mention in The Washington Post! Awesome!]

Can this “secret” data help you predict future home prices?

“Percent of Homes Increasing in Value”

Here’s the concept. Even in a market with rapidly rising home prices, not all homes will be rising in price.

• Maybe homes on the outskirts of town are falling in value while most of the rest of the market is rising in value.

• Maybe luxury homes are falling in value while most of the less expensive homes are rising in value.

Whatever the reason, a rising metropolitan home price doesn’t mean all homes in the metro area are rising in price.

By looking at the percentage of homes that are increasing in value, you can get a better feel for the strength of any price trend whether increasing or decreasing.

That’s the concept anyway.

Zillow’s Increasing Values (%) vs. Case-Shiller Index

Zillow Percent Increasing Value 800px
Full-size, interactive version
FYI, you can see the Case-Shiller numbers for different metros on the same chart here.

Background

Zillow publishes a little known dataset called “Increasing Values (%).”

“Increasing Values (%): The percentage of homes in a given region with values that have increased in the past year.”

Zillow.com

I can’t find any current graphs or tables on Zillow.com that use “Increasing Values (%).” Perhaps they used to use it or they use it as a component to calculate market strength or something. Nevertheless, Zillow is still updating the published dataset monthly.

Introduction. I first became intrigued with this concept – that the percentage of homes increasing in price can give you clues about future market and price trends – when I read Weiss Analytics promoting it.

Cool concept. It was a cool concept but I needed to see some time series data to decide whether it actually foreshadowed home price changes. Weiss Analytics doesn’t publish their time series data so I couldn’t check it out.

New data! Yea! Then one day while geeking out on all the raw data Zillow publishes (which I originally learned about via CalculatedRisk), I noticed that Zillow publishes a dataset that conceptually seemed the same as the one promoted by Weiss Analytics. With the discovery of this “secret” dataset, I felt like the Indiana Jones of real estate data geeks. 🙂

Percent of Homes Increasing in Value

Like Weiss Analytics, Zillow estimates the value of pretty much every home in a market. Zillow calls their individual home value estimates “Zestimates.”

Zillow’s “Increasing Values Percentage” dataset shows the percentage of homes in a given region with Zestimates that have increased from a year earlier.

If you follow Real Estate Decoded, you know I’ve spent a lot of time detailing the accuracy/inaccuracy of individual home Zestimates, such as here and here.

Ballpark. The “Increasing Values (%)” dataset will have a bunch of accuracy issues as well, just like Zestimates or any other home value estimates. But like Zestimates, “Increasing Value (%)” gives you a nice ballpark estimate of what’s really happening on the ground.

The Mechanics of Home Price Increases

Looking at the graph, it seems that when the percentage of homes with increasing values is high (above ~70%) or is increasing fast (up several percentage points in a month), home prices tend to increase – or continue to increase – in the future.

The opposite is true for decreasing home values. When the percentage of homes with increasing values is low (less than ~30%) or is falling fast, home prices tend to fall.

Can we use this to help predict future home price trends?

New Tool?

Economists follow a bunch of things related to supply and demand but the only thing most people want to know is the last thing that changes, home prices.

I think the “Percent of Homes Increasing in Value” will sometimes show you that home prices are strengthening or weakening before home prices actually change.

I just don’t know yet when it works and when it doesn’t.

Takeaway. The “Percent of Homes Increasing in Value” isn’t a killer metric but it has potential. I would say, for example, that changes in the number of home sales or the supply of homes for sale are better leading indicators of future home prices. This “new” metric, however, provides additional, helpful information. It would certainly make me more confident in my forecast, if it moved in the same direction as the sales story and the supply story.

Next step. I’m going to follow “Percent of Homes Increasing in Value” for a while to see if it lets me get a better feel for where the Case-Shiller Home Price Index is headed.

For my detailed discussion of the usefulness of the “Percent of Homes Increasing in Value,” watch the video above.

Feel free to leave a comment. I’m interested in your opinion on this, particularly if you have an idea why in several cities the metric went from going steeply down in 2014 to steeply up in 2015.

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Portland, Seattle & San Francisco are HOT

(I just updated the Case-Shiller graphs.)

Annual Home Price Appreciation
Jan 2015 – Jan 2016

Most Appreciation (within the 20 metros)

  1. Portland = +11.8%
  2. Seattle = +10.7%
  3. San Francisco = +10.5%

It looks like San Francisco has lost some of its mojo since November. The turmoil in tech startup valuations is trickling down. On the other hand, Seattle home prices haven’t lost any upward momentum (yet?).

Case-Shiller Hot

Least Appreciation (within the 20 metros)

  1. Chicago = +2.1%
  2. Washington DC = +2.2%
  3. New York = +2.8%

In addition, New York’s ultra luxury condo market seems wobbly.

Case-Shiller Not

Data Table – 20 Cities

Case-Shiller Table

Full S&P Case-Shiller press release.