A Pin for the Credit Bubble

The existence of a Real Estate Bubble is an oft debated topic in the MSM and blogosphere. One thing we can definitely agree on is the data- housing prices in most markets on the left and right coasts have seen explosive and unparalleled appreciation. Consider New York, where the median income (~$45k) cannot possibly hope to afford the median home price (~$1.3M). A useful exercise for the reader is to ponder how prices could have gotten so high?

Clearly the demand is there- home ownership is part of the American Dream(tm). Supply was tight but rose to meet demand as it became profitable to build condos and homes. Sentiment was there- stay up to watch TV late at night and you can still find an infomercial (or two or three) broadcasting to the world that for the low introductory price of $___ you too can learn the secrets of Heywood Jablome's ultra eZ, no money down, path to riches through realestate flipping techniques.

But how could people- average people- who have seen wage growth stagnate over the last 6 years- afford to buy these homes at ever increasing prices? The answer is easy- a greater fool was out there willing to lend them the capital to do so. The tool by which these folks shoe-horned their way into homes is called the exotic mortgage.

From the NYT:

Even though such loans are potentially riskier than traditional mortgages, they have boomed in popularity in the last three years because they can reduce the borrowers monthly payments and thereby allow them to afford costlier houses.

Interest-only loans, as the name implies, allow borrowers to pay back only the interest portion of their mortgages for a certain period, typically 7 or 10 years. So-called pay-option ARMs, meanwhile, allow borrowers to choose their monthly payment levels, even if it means paying back less than the nominal interest amount.

In case you have been in a bubble (ha!) for the last couple of years, let me spell it out for you. There exist morons, who decided it would be a good idea to give large amounts of money to people who cannot afford to pay it back, and they set up all kinds of schemes by which they could fool people into thinking they were getting a good deal. The ridiculousness extended so far as to actually allow for the creation of a no-doc, pay-option ARM. In plain English, its loan where you get to pick what you pay back- the full monthly amount, an amount with a ridiculously low interest rate (which goes up after a period of timesurprisese!), or the Priceline method of naming your own payment- which basically means the amount owed goes up with each monthly payment. To top it off, you are not required to prove you can afford this loan in any way shape or form.


Why would banks do this? The answers are many and varied, and for another discussion. The important part is its coming to an end, and soon.

From the Fed:

The final guidance discusses the importance of carefully managing the potential heightened risk levels created by these loans. Toward that end, management should:

Ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of borrowers's repayment capacity;

Recognize that many nontraditional mortgage loans, particularly when they have risk-layering features, are untested in a stressed environment. These products warrant strong risk management standards, capital levels commensurate with the risk, and an allowance for loan and lease losses that reflects the collectibility of the portfolio; and

Ensure that consumers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice

So how will this affect prices? Supply and demand- there are about to be a lot fewer people demanding expensive houses, simply because they cannot secure the risky loans that make it possible for them to afford them. Ergo, prices go down.

I'm back....

So check out the new place! I admit to being somewhat of two minds about moving to blogspot- for one its a huge pain in the butt for me. All things blogspot are blocked by my employer's websence settings (and yes- before you techies out there begin slamming with mails telling me how to get around this, I've already considered it, but wish to remain employed). Also I don't have nearly the same control over look and feel that I did when I was hosting my own Pivot based blog.

However, Pivot had to go- too many security holes, and the sheer amount of comment spam I was forced to deal with was ridiculous. So here we are.

So what is the corner of Wall and Main? Wall is obviously Wall St, that fabled avenue of excess red-staters love to hate. Main is quite obviously the ubiquitous small town main road with little one and two story shops and houses where real Americans live out their lives. There seems to be an assumed disconnect between these two uniquely American thoroughfares, and this fictitious street corner is where I hope we can discuss the very real issues that affect both. Politics, finance, trading, investing, real estate, technology, society, comedy- all are fair game here.

For my (two) readers following me from bakadesu blog, thank you and welcome back. For those of you who are new, I apologize in advance.