Mr Mortgage: Engineering the Housing Bubble Through Monthly Payments

Posted on June 30th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

I wanted to actually ‘see’ the effects that exotic loan programs had on home price appreciation and I believe this chart, together with my written ‘bubble-years event log’ below, tells quite a story.

This simple visual clearly demonstrates how ‘low monthly payment’ engineering through the creation of exotic loan programs was almost exclusively responsible for the major housing bubble in CA. If you substitute the CA data with data from your state, I am sure it will look similar. Recently, Greenspan said exotic loan programs were not responsible for the bubble prices. I think he is mistaken.

CA Housing Affordability/Payments

*household income is not inflation-adjusted. Monthly payments based upon typical interest rates for that period

Chart Findings and Facts:

-Until 2002, before the age of exotic loan programs, housing prices were driven by tradition economic factors such as supply and demand, the broader economy and interest rates. The rate of appreciation was in-line with previous Real Estate market expansions. Loan programs were mostly traditional.

In 2002, payments for the median home reached the upper end of affordability at the time. All of a sudden in mid-2002 the intermediate-term 3/1, 5/1, 7/1 and 10/1 fully amortized and interest only loan programs were introduced. These programs carried a much lower rate than a traditional 30-year fixed rate for the respective 3, 5, 7 or 10 years. These were among the best-selling loan programs in the bubble states.

At the time if 30-year fixed rates were at 5.5% a 5/1 interest only for example, may have been priced as low as 4.5% with qualifying at the interest only payment rate allowed. These programs brought affordability back and housing prices soared nearly 50% in a little over 2-years. In 2004, as payments once again got to the upper end of affordability, limited documentation programs such as Stated, No Ratio and No Doc were rolled out, which carried home prices even higher.

– In mid-2004, payments again were making affordability out of reach, so lenders began pushing the Pay Option ARM as one of their top offerings. This program had been around for years at World Savings (now Wachovia) and WAMU, but when the investment banks got into the Pay Option ARM game, every middle market mortgage banker, mortgage broker and bank became a Pay Option pusher. These loans were branded as a ‘safe’ alternative to traditional loans and a way to ‘save’ money by paying a rate as low as 1%. Borrowers were told ‘negative amortization does not matter because your home value will increase faster than the negative amortization and you can always refi.’ We now know this is not the case.

By 2006, payments again reached the upper end of affordability but there was no other loan programs that they could invent that could compete with a Pay Option ARM. At the time you could get a 100% stated income Pay Option ARM! Values went flat.

In 2006 with nothing left to sell, the banks went into the Home Equity Line of Credit (HELOC) game. This allowed people to easily borrow up to 100% of the value of their homes, which kept values stable for a year despite home sales volume falling off of a cliff. This HELOC liquidity injection lasted until the end of summer 2007 when prices everywhere fell off of a cliff. This marks the end of the great housing bubble.

-As of May 2008, prices are down some 30% in the past 12-months but payments are still far above the current affordability level. The market needs to find equilibrium and a clearing level but given the state of the economy, elevated interest rates, inflation. massive supply, consumer confidence over Real Estate, tightening lending standards and the lack of any affordable loan programs do not draw a line in my chart straight across from 2004 adjusting for rising income. This is because all of these negatives almost make it certain that housing prices have a long way to go and will overshoot to the downside, as all popping bubbles in the past have done.

Thanks for Sean O’toole form Foreclosure Radar for help with this post.


Record-Breaking CA May Foreclosure Report

CA Housing Stats, The Real Story…4.25-years Supply?!?

ALT-A Disaster Looming – Know the Facts!

36 Responses to “Mr Mortgage: Engineering the Housing Bubble Through Monthly Payments”

  1. Have you noticed the shares of Lehman Brothers this afternoon. It’s litterally crashing on no news ? Something really bad is going on. The shares are almost down 10% in one single day on no news. Lehman Brothers will be soon a single digit stock. I don’t see how you can value this company. Great history but that’s the problem. Lehman is history. Anyways. Is there something brewing again ? Another 3 or 5 or 6 or 7 billion loss coming soon ?

  2. In my state, Ohio, the real culprit was the lax lending standards.

    -no money down (or more to the point, no skin in the game)
    -poor borrower credit (or no borrower credit)
    -very poor appraisal oversite (using comps only)

    These three aresa caused the entire problem.


  3. Your story hangs together quite well. I suspect the economic history books written 20 years from now will pretty much say exactly what you have said, with a chart that looks just like yours.

    Which is why I keep reading what you write, every day. 🙂

    Thanks Mr. Mortgage.

  4. A great analysis…doesn’t it look staged to you? This whole thing was planned in advance to inflate asset prices…so the big FED banks could take over all the small guys. The guys at the top knew what they were doing…Greenspan and the rest are just shills for the elite, keeping us in the dark and confused.

    God Help Us!

  5. EXCELLENT portrayal. Not trying to toot any horns, here, but I saw this coming a long time ago. As a case in point, an old broker friend of mine used to always say, “Raise the price and lower the down.” I’ve always remembered that saying as I remember my name.

  6. What I don’t understand is why you never hear anyone, or rarely hear anyone, telling people that this is the time to prepare for disaster. What has transpired over the past 18 months has the word disaster all over it and it’s gaining steam. You DO NOT want to be that “hindsight is 20/20” person. You just may end up in the gutter if you do.

    This is no bible thumping, the prophecies are coming true kind of post (although you can bet there’s a lot of finding Jesus going on right now), yet this is from the heart. This is instinct kicking in. Doesn’t more than just a few people have that same sick to the stomach feeling that I have? I mean that deep-down holy crap this is going to be very very bad feeling?

    Nobody can predict a damn thing because, unless you’re Nostradamus, predictions are based on historical events. There are NO historical events whatsoever we can rely on for a prediction of what’s to come, and I mean NONE. We’ve never had sub-prime loans, ALT-A loans, MBS collateralizing, leveraging, multi-trillion dollar derivative bubbles, an so on so what in the hell makes anyone think the “experts” can predict what’s going to happen?

    What we’re hearing from the “experts” everyday are not predictions their guesses pure and simple. The number of people that have made themselves look like total idiots with their predictions is staggering. The highly educated “experts” du jour look like complete fools over an over again. Funny thing is they just keep spewing the same crap daily and it keeps getting proven totally incorrect over and over again, but they’re not being called onto the carpet for it. I can only assume they’re, ridiculously, hoping for the broken clock is correct two times per day scenario. Sorry “experts” but the clock’s hands were blown clean off the face months ago. There is no “correct time” anymore.

    I hope I’m wrong, but I think that the total ridiculousness and criminality of all this will spark a revolt (you thought the Civil War was bad…). The greed was just too much and people went too far this time. Unfortunately, it takes a full speed kick to the head, instead of a slap to the face, to wake up an over-worked, under-paid, over-stressed American. Well, we’ve taken body blow after body blow up to this point and now the head kick is coming to knock us completely out cold, if it doesn’t kill us that is. The foot has already left the ground for crying out loud. Forget offense people, it’s time to defend yourselves. “But I’m certain I can position myself in the market to sufficiently back-stop any major event to take place.” COME ON, DON’T BE AN IDIOT!!!

    Just get your house in order NOW. Don’t wait. Do what you need to do. Get yourself out of the stock market and into an all-cash position for at least 24 months. DO NOT keep your money in a bank or brokerage account!! If I’m wrong and nothing happens, no skin off your back. But, if I’m right, well, you can thank me later.

    Here’s wishing everyone good luck – JRB

  7. By the way Mr. Mortgage,

    I just received an order where the EM states that the buyer is getting a 5/1 ARM NINA from Wachovia!! Are they still doing these effing loans?! What the hell is going on here? And Wachovia of all places!!


  8. Here’s another take: In June 2007 you could get a $625k median home in OC with 5% down Stated Stated at about 6.25%. The Interest Only payment: about $4,030 with taxes and insurance. In June 2008 you can get a $515k median home (down $110k in 12 months)at 6.50% FHA (up .25 in rate) and the monthly house payment: $3,970.

    $110k in value loss = $60.00 less in payment.

    Yes, I’m comparing an Interest Only 80/15/5 (no PMI) to a fully amortized FHA 30 fixed – but I’m comparing “what is available today” for a loan which I feel is accurate.

    What was barely affordable at the end of the boom is still unaffordable in the current market. Clearly We have a great deal more to fall.

  9. JRB you are soo right. This in no bible thumping. It’s the truth. I think that even bankers and politicians don’t know and can’t understand what is going on. Lehman Brothers is going KAPUT today. -12%. Blacstone Group is losing money. Great!

  10. There are a few things I don’t understand…
    What are realtors thinking? They are out of their freakin’ minds. With a traditional loan, how the hell can anyone afford these home prices right now? It just doesn’t make sense. I am looking to buy my first house with my wife of a year now and one month pregnant by the way. With 10% down, an int. rate creeping to 7%, property taxes, HOA and an over inflated home price, do the realtors/sellers think that we (and the avg home buyer ) can afford a 500,000 mortgage? That’s about 3700/month (includes everything)! We make decent money too, over 6 digit! I don’t feel one bit of sympathy for the folks who bought in this bubble and if the Feds bail them out, well, this administration I wouldn’t be surprised.
    The home prices need to go back to 2002/2003 prices (w/ inflation adjustment) to afford any home with a traditional loan. It seems to me that would make sense and make housing affordable again. I’m probably full of crap, but look at the engineered table on mr. mortgage. Am I right or am I wrong?

  11. The chart is great. We all knew this was the only way the bubble was being kept alive, but no one mapped out as nicely as this.

  12. All to cash? If one is lucky enough to have a few hundred thousand, where does one put it being banks and brokerages are kaput?

  13. Excellent article MR. M! We bought our house in 2002 trying to cash out at what we thought was the top of a Condo Bubble and into a reasonably priced home (read fixer-upper) while we could. I have spent years watching dumbfounded as prices went NUTS. This article is the first time I have really gotten an understanding for how the prices were able to keep going up. Thanks!

  14. All cash. It’s about the best advice for the rest of the year. The problem is that your pension funds and your insurance companies are stuck with all this junk and are going to lose real big like WaMu and Wachovia. Do these people think ? Nah! They think that they know it all. Pure and simple arrogance like Donald Rumsfeld.

  15. JB – “There are no historical event”

    Yes there is. Go back to the late 1929 period and compare debt to the GDP. Then look at debt in the past few years.

    What you will see is the number 300% in both places. during the 1940 till 1990 debt stayed around 150%.

    Too much debt, not enough savings to help yourself if you get into trouble.

    But I do like your idea of cash.

  16. Just an fyi, but you could get 5/1s, 7/1s and 10/1s as far back as 1997. Maybe earlier. That is how I bought my first house. Notice that is about when prices started rising after a long lull.

  17. All cash position sounds like a great idea but please advise (seriously), where would you put your 200K+ cash (as an example or even more fund) if the banks and brokerage houses all going bye bye.

  18. The money should be fine in a Fidelity, Schawb, or Vanguard account. I’ve got it half cash, half money market. Yes, I’m not keeping up with inflation. But well positioned for deflation, especially in house values.

  19. Please excuse me. Are accounts in Fidelity, Schawb, and Vanguard not accounts from brokerage houses? Are they safer than FDIC insured bank accounts? I don’t think for the next six moths I will be worried about money keeping up with inflation at all. The question is – is the money going to be there at all?

  20. Reply to Jason:
    Keep your powder dry for a couple years. You’re crazy for buying now with a child on the way & wife not working anyway. Assumes your job is “assured” – you’re “betting the farm” on that assumption – no job is that certain.

    Reply to Kis & David W.:
    Fid, Sch & Van are not brokerages, they’re mutual funds with SIPC insurance against embezzelment, etc. (I’ll be moving my 401k rollover to Van from insurance co.)
    FDIC insures bank deposits against loss (bank closure) but how long it takes to get your money if many things happen ‘fast & furious’ would be anyone’s guess.
    NCUA insures credit unions – much more conservatively run as they are member-owned institutions. Their rates are typically better as well.
    Recommend joining a credit union – NCUA insured only!

    Good luck to all! Mr. MTG – outstanding work as usual!

  21. Post-script to above:

    Also, maybe check into member-owned (policy holder) mtutal insurance companies such as American Family Insurance (AFLAC). Just a thought…

  22. P.P.S.:

    NCUA (National Credit Union Administration)

    An agency of the United States federal government that was created to monitor federal credit unions across the country. One of its major responsibilities is running the National Credit Union Share Insurance Fund (NCUSIF), which uses tax dollars to insure the deposits at all federal credit unions.

    The NCUA officially became a federal agency in 1970 and is headquartered in Alexandria, Virginia. The agency is headed by a three-member board which is appointed directly by the president of the United States. The agency currently monitors over 9,500 federally insured credit unions that service over 80 million customer accounts.

    Source: Investopedia

  23. When I bought Fla house in 2004, everybody was asking if I was getting an ARM, when the 30 year fixed was 6%.

    I paid 10 1/2 % on my first house in 1981!

    I laughed at them.

    Why are ARM’s still around?

    They should be banned.

    Always thought they were ridiculous.

    ARM’s should be illegal. Of course they are still pushing them to help bail them out.

  24. Correlation does not equal causation. The conclusion that exotic loans led to inflated housing prices could be turned around to say that as housing prices increased, the demand for exotic loans increased. The financial markets saw a “need” in the market place for these exotic loans and filled it. I doubt that there will really be a way to figure out which which is cause, which is effect, and which are simply correlated.

    All that being said, I am saddened that the US government is rewarding (in the form of bailouts) the dopes who signed up for these exotic loan programs without fully understanding the consequences. I am getting sick of the whole “they tricked me” and “I did not understand that house prices could go down” defenses being offered by people who should know better. When the housing market went out of control, I got out and rented but I guess I was really the dope for not trying to stick it to the government in the end.

    Yes, I can whine.

  25. Here come the lawyers – now things are going to get REALLY messy –

  26. Seth, stick it to the government even more by getting out of your dollars and into good foreign currencies. If you are out of the dollar, the bailout doesn’t affect you.

  27. Fidelity (FDLXX), Vanguard (VMPXX), T. Rowe Price (PRTXX) all have what’s called US Treasury Money Market Mutual Funds. With Fidelity, you need $10k to get in. With Vanguard, just $3k, with T. Rowe Price, $1k or $50.00/mo automatic deduction.

    I have my cash in each.

    No MBOs
    No CDOs
    No SUVs

    Lending to the US Treasury only.

    Fidelity has a US Treasury Fund for HNW (High Net Worth) persons, and this fund has a different ticker symbol: FSIXX. $1M to get in.

    Lending to the US Treasury only. Liquid. $1.00 for $1.00.


  28. Just as if lending money to the US government is a solution. You are getting a negative interest rate of – 8% !!!!!!!!! on your US treasury. This is a rape.

    The guys in government are really laughing at you here. Go and see shadowstats site.

  29. Dear Marc:

    When I look at my balances each day, I haven’t lost anything, so unless you are factoring in inflation, I’m not affected as you assert.

    As far as inflation is concerned, I do not lead a complicated and expensive lifestyle and so the effect of inflation on my holdings does not concern me.

    And actually, HNW individuals across the globe are pulling out $$$$ out of brokerages & banks and going cash recently. I suppose you are not in the loop on that.

    The only people who are troubled by a cash-saving strategy at this time, are hedge fund guys, rip-off bankers, and private investment sorts who want their mitts on my money.
    Perhaps you are one of them.

  30. M.S. Gill. You are going to get eaten alive by taxes and inflation with your US treasury. I do not believe in the phoney numbers produced by the Labour Department.

  31. Cockroach Hotel. US treasury bonds of confiscation.

  32. “You are going to get eaten alive by taxes and inflation with your US treasury.”

    Please reread my post. Even Eli Broad is stating that the best position for investors now is all cash; go onto Bloomberg and you can watch him on video.

    The time to have gone all cash passed several months ago.

  33. “Labour Department” – its spelled “Labor Department or Department of Labor.”

    I suppose you are British. :/

  34. No. From Montréal. It’s my second tongue. 🙂

  35. […] Mr Mortgage: Engineering the Housing Bubble Through Monthly Payments […]

  36. Love that msn, nice site.

    Will read up and hopefully have something good to add.

    Cya later.

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