Affordable Housing Institute : US

My wife Nancy is particular about food, so when we are on vacation in strange cities (or even more of a challenge, strange countries), she is always searching for good places for dinner.  (Lunch we have learned to assemble from grocery stores, boulangeries, bodegas, and all-you-can-pilfer-eat breakfast buffets as required.)  So when on holiday, Nancy will, like a bird dog scenting a quail, suddenly wheel, cross the street, and stare at a menu box. 

 

Over the many years, we have learned not to wander indiscriminately through the entree descriptions, which are some mixture of actual foreign language and incomprehensible foodie-speak (what is a ‘playful’ risotto, anyhow? Or a ‘green spring trio’?)

 

 

Let’s all sing “Greenback Dollar”!

 

No, the Boss zeroes in on one item, which for her is the restaurant’s make-or-break listing: the humble green salad.

 

Every dinner restaurant has a green salad.  Everyone can make one.  No restaurant makes the green salad the centerpiece of the menu.  Hence what goes into a green salad, and what it costs, is actually an expression of the restaurant’s overall philosophy.  Just as a jawbone can tell an anthropologist everything we need to know about Mrs. Ples,

 

 

Well, everything except that she turns out to be a male ….

 

so does the humble green salad description inform Nancy of all she needs to pronounce sentence upon a restaurant.

 

For my part, I judge a wine list by its chardonnays: everything from pricing philosophy to customer accessibility to the sommelier’s edgy attitude is revealed by the chardonnay choices.

 

[”Hey!” complains the reader sipping her morning coffee, “I thought this post was going to be about housing!”  “Just cool it,” replies the editor, “we’re broadening your education.”]

 

The same challenges confront prognosticators trying to extract broad trends from complex disparate data points coming in from all directions.  Former Federal Reserve Chair Alan Greenspan was famous for his roster of obscure telltales that in his view signaled larger trends.   Now, for housing markets –

 

[Thank goodness! the reader exclaims.]

 

Forecasting is notoriously difficult.  Prices are extremely complex, interdependent, multi-variant, and phase-delayed (with larger and smaller economic forces having both leading and trailing effects). 

 

 

Waves upon waves upon waves …

 

They are seasonal, regional, tragical, comical, lyrical, pastoral …

 

One day existing home sales are down (doom!), literally the next new home sales are up (cheer!). 

 

Out of all that apparent chaos, how does one prospectively determine major trends?  (Anybody can determine them retrospectively, but that’s very cold consolation.)

 

Enter the miner’s canary — the sensitive universal leading indicator.  And mine has just started wobbling, as this article from the Washington Post reveals:

 

Mortgage delinquencies among homeowners with high-cost loans will rise by 10% to 15% in 2006, as borrowers struggle with higher interest rates, high debt levels and higher energy costs amid flattening home prices, a new report from investment analyst Fitch Ratings predicts.

 

Consequently, overall mortgage delinquencies are likely to rise next year, as well, according to the report’s authors.

 

Why is subprime lending a leading indicator?  Because by definition, subprime borrowers are at the edge of the bankable frontier (as my AHI colleague David Porteous has discussed on his blog), and as such, they are the most sensitive to changing economic circumstances:

 

Most high-rate mortgages, known as subprime loans, have adjustable interest rates, Fitch said. That means borrowers are more sensitive to fluctuations in rates, because rising rates mean their mortgages payments rise as well.

 

You might think the link between subprime and adjustable rates a coincidence, but reflect for a moment — people at the bankable frontier are trying their hardest to stretch their limited dollars into a purchase.  When the yield curve is positive — which is the normal state of things — the lowest interest rate is to be had if it is variable.  So the same feature that drives someone to a subprime lender also motivates that borrower to choose a variable rate loan when she arrives. 

 

About 19% of home loans nationwide are subprime, up from about 5% a decade ago, as homeowners take on heavy debt burdens.

 

This is another longer-wave clue: the much higher percentage of loans being subprime means more folks closer to the economic edge have elected to buy homes.  Observant herds can turn into stampedes and in so doing can drive prices up above ‘normal’ (whatever that is).

 

 

The brain of Abbie Normal …

 

About 4.3% of all loans were delinquent in the second quarter of 2005,

 

So there’s our baseline.

 

and about 1% of loans had passed the overdue category and were actually in foreclosure, according to the Mortgage Bankers Association.  But the rate for subprime loans was much higher — about 10.3% of such loans were in default, and about 3.5% were in foreclosure.

 

Note the obvious: subprime delinquency rates lead normal market rates.  You might think that subprime borrowers, having managed to leap onto the rising economic ladder of homeownership, could rapidly pull themselves up.  Economic reality is more cruel; while many do, quite a few don’t:

 

Most borrowers find ways to catch up on their payments, refinance or sell their homes before they go into foreclosure.

 

Frank said bigger problems for borrowers will come in 2007, because many of the subprime loans that feature adjustable-rate mortgages “reset,” or change rates, that year. People who will be “stressed” will be those who were unable to refinance before their rates begin rising or whose home prices have fallen so that it becomes too difficult to sell and get out from under the mortgage, he said.

 

And gee, why might 2007 interest rates be up?  Because inflation is up, say, or in the context of a cooling economy?

 

Up to now, I’ve read innumerable frothy insubstantial Chicken-Little-market top articles, and found all of them utterly unpersuasive.  But this modest story — the newspaper equivalent of a green salad! — is different; this feels like a leading indicator. 

 

 

“I don’t like my role in this ecosystem“

 

I well remember the 1989 condo crunch in eastern Massachusetts (the explosion of the Massachusetts Miracle), and the eighteen-month interval of developer denial that preceded it:

 

 

“I deny this is a recession three times!”

 

So here it is, folks.  I’m calling the market top. 

 

Housing markets aren’t bubbles that pop, but they are souffles that cool.

 

 

We are headed into a cooling in 2006.

 

 

I hope you didn’t buy the penthouse!

 

You heard it here first.

 

UPDATE, 9–DEC: AHI gets results!  A day after this post, the Boston Globe screams:

 

Sellers chop asking prices as housing market slows

Cuts of up to 20% are now common as analysts see signs of a ‘hard landing’

 

Boston-area homeowners trying to sell their houses are sharply reducing asking prices — in some cases, by $100,000 or more — in response to the sudden slowdown in the real estate market.

 

Of course, it’s snowing hard outside today, and people don’t buy houses during winter …

 

 

House somewhere else …

 

[Hat tip: David E. Bernstein, Volokh Conspiracy]

 

 

Send post as PDF to