The Future of the Housing Market.

As I mentioned in US Housing Market Crises caused by Mortgage Backed Securities, the recasting of the minimum payment loans caused a lot of what we are seeing. Looking back on those loans will give us a clue as to what is going to happen in the housing market.

The minimum payment loans started being mass marketed in 2004. At that time, many of those loans were set to recast after a set interval. There were two intervals, 3 year and 5 year. The 3 year recasts hit in 2007. The 5 year recasts will hit in 2009. So, we know what will be coming in 2009. I don't think that 2009 will hit us as bad as 2007. For one thing, the institutions will already be geared up to handle the loans (loss mitigation departments, REO departments, etc.). Also, the public will be use to it and is less likely to panic (unless the new media succeeds in its "the sky is falling" reporting).

I expect that the rest of the 2008 market will be pretty stable with a trend toward a slow, steady drop in prices (especially in California) followed by a slightly steeper drop in prices beginning in 2009. I think that prices will generally bottom out in late 2010 to mid 2011. After that point, I'm unclear as to what housing prices will do. My gut instinct is that they will start a slow rise. However, politics, new media and group psychology can all affect that outcome.

In the last paragraph, I singled out California because, as is often the case, California reacted differently to the value drop. In this case, Californians refused to believe that the price was dropping and were still trying to get the old, higher price for their houses. You often heard "I'm waiting for the right buyer" or similar statements. It took a long time for prices to start falling even though the values were already going down. However, the laws of supply and demand could not be held off forever. As it is, I believe that prices are still lagging value. So expect prices to continue to drop in California after everyones else has flattened out.

US Housing Market Crises caused by Mortgage Backed Securities

Some believe that 100% financing led to the current real estate crisis. That wasn't the cause of the bust. It did set the stage, however.

Yes, it would have been bad if the banks were lending 100% and the housing market turned down but that wasn't the actual cause of the crises. If fact, while we might have had a bit of a bumpy road, we would have been able to ride the high prices for another few years before a relatively minor correction happened.

The problem is that the 100% loans were able to satisfy the US demand for Mortgage Backed Securities (MBS). The MBS were generally bought in people's IRAs. Supply of MBS generally equaled demand.

The problem arose when foreign investors saw how well the MBS were doing and started investing in them. Suddenly, the demand was much higher than the supply. The investment houses were almost begging for more loans. However, the loan market was saturated by then (from a big refi boom). They needed another loan product that would create another refi boom. So they created one: the minimum payment loan (sometimes called an option pay).

The minimum payment loan was just another version of a negatively amortized loan (Neg-Am Loan). In general, if the interest only rate was 6%, the minimum payment was 1-3% (with the rest of the interest being tacked on to the principle). All in all, this type of loan isn't a bad loan. It also wasn't anything new and it didn't offer anything that would cause people to jump on it.

The problem came from the broker's being pressured to make more product available for the MBS. They started qualifying people, not on the real payment based on 6% interest but on the 1-3% interest payment.

This did a number of things. It created a new refi boom, it provided enough product to satisfy the foreign investment in the MBS, it fed the real estate boom and it set us up for a crash.

The real estate boom happened because more people could afford houses and people could afford bigger houses than they already had. Since house building lags so far behind demand, this created a surge in house prices. People were then refiing their houses at the new higher prices and facing lower loan payments than they had before the refi.

Then the shoe dropped. Most of the minimum payment loans were set to recast in 3 or 5 years. That means that 3 or 5 years after they were created, the loans jump to the current interest rate. If a person could, according to the brokers, afford a house at 2% interest and the rate jumps to 6%, they are now expected to pay 3x what they were paying before.

THAT is what caused the bust.