Friday, June 24, 2005

Warning For Housing Market Disaster: No-Principle-Mortgages

It's amazing to me, a sidelined economist, that everyone isn't recognizing the coming disaster in the housing market. The most basic notion in market-pricing theory involves supply and demand. Too much demand and prices rise. Too much supply and prices fall. One would think that, looking at the nearly decade-long rise in housing prices in the nation, that supply cannot keep up with demand - hence the rising prices. But much of this demand has been created by an entirely new (and temporary) type of demand. And here is the danger: temporary, cyclical demand will exaggerate the swings in the market. The name of this unstable and temporary type of demand is the no-principal mortgage. It has allowed countless numbers of people to speculate in the housing market, hoping to "flip" the property before the real payments kick in. And if rates continue to stay low, the game continues: new buyers are being created with the lax lending practice. There is even a show on TLC called "Property Ladder", chronicles amateurs' attempts at speculating on renovation.
But, of course, rates will not stay low. They can't: they are tied into the cycle of the economy. And once we are in a definite and noticeable rising-interest-rate environment, what happens? Lower property pricing. It's then that the loans are no longer offered. Once you remove the loans, you've removed a ton of demand. Less demand, prices go lower. Plus, precisely at that same moment, banks start to see the trouble they have created as the interest-only loans turn into much more expensive loans, and those speculating (and anyone else who got lulled into the game) get overwhelmed with the rising cost to carry the mortgage. Many end up defaulting on the house, and the bank ends up with losses. Those houses are sold at fire-sale prices.
I mean, how can housing starts continue through the roof? Some have said it's the "second home buyer"? They aren't in it for the long haul. They are, by majority, hoping to sell the home within 5 years...Speculating. Here in Key West, we get a front-row seat.
So, in a nutshell, we are in a dangerous housing bubble. It will burst, likely sooner than later. Oil at $60+ a barrel is enoughpressure on inflation that the Federal Reserve will have little choice but to raise rates and cool the markets, reigning in demand. Less demand, lower prices.
When no-principal mortgage, no-money down mortgages, and all other aggressive schemes are not offered anymore, everyone will be scrambling for a seat as debt consumes them. I expect the media will be harping about the housing surplus for years to come. I think it will be devestating to many communities - especially those who sold off their tax base.
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