Thursday, March 27, 2008

Homes On Margin

Most people who buy a home by taking out a mortgage don't think of themselves as buying on margin. Yet, this is exactly what they are doing, and more so when they take out home equity loans, second mortgages, etc.

The chart below shows how fast mortgage amounts ballooned in recent years and, worse yet, that such debt is now over 52% of the gross value of all dwellings in the US - up from a mere 18.5% in 1950 and 31.5% in 1980 (click to enlarge). According to the Fed, at the end of 2007 US housing was worth $20.1 trillion and mortgage debt came to $10.5 trillion. Housing "margin" is getting bigger and bigger.

Data: Federal Reserve

Assuming that house prices drop 20% - a reasonable assumption given the recent performance of the Case-Shiller index (see below) - the debt-to-value ratio will jump to 65%, all other things equal.

If housing was treated like a leveraged stock portfolio, margin clerks would be getting ready for "calls". And you know what? Mortgage securitization and derivativization has done exactly that. In a few short years investment bankers and financial engineers managed to turn the most fundamentally conservative asset class into yet another "trading sardine", subject to bubbles and busts...

20 comments:

eh said...

...the debt-to-value ratio will jump to 65%, all other things equal.

That's right. LTV is generally thought of as a parameter at loan origination, but it can clearly change in 'real-time' as well: either by the 'L' part increasing, e.g. via only making the minimum payment on an option ARM, or by the 'V' part going down. Sometimes both.

eh said...

In a few short years investment bankers and financial engineers managed to turn the most fundamentally conservative asset class into yet another "trading sardine", subject to bubbles and busts...

But:

'This was an accident just waiting to happen.’

That’s what Alan Greenspan said in a brief promo for a special on the ‘mortgage crisis’ that I saw on CNN. Yes, one big accident: years of low interest rates, deliberate abandonment of normal underwriting standards, high fee securitization, ’see no evil’ rating agencies, no holds barred speculation, and a massive, open space ravaging buildout to satisfy this ‘accidental’ demand.

The guy is really full of it.

Anonymous said...

"If housing was treated like a leveraged stock portfolio, margin clerks would be getting ready for "calls"."

"Margin clerks", how nostalgic, I worked my way through high school, working as a copy boy, mimeographing research reports at the local Merrill, Lynch, Pierce, Fenner and Smith office. I remember the margin clerks, hated by the AEs and the customers. They were unyielding and vindictive unlike, the other extinct species, the kind and friendly milk man.

Thanks for the memories,

Econolicious

Anonymous said...

I agree with your principle that buying a house with a mortgage is like trading on margin, or adding leverage to a portfolio. Leverage is a great thing to have in any bull market and we have seen the benefits recently in the US housing market - but it will prove to be really uncomfortable in a bear market.

But what I have never understood is the pride that people show in how much the value of their house has increased, when all that has happened is that they have been in a bull market and leveraged. Price gains under such circumstances do not equate to investment skill !!

More amusingly, when they sell their high priced house, they go out and buy another high priced one. Does that make them richer? I don’t think so!

Finally, when the house cannot be sold at a high valuation, do the sellers take the view that they should reduce the price? Not willingly - and so the housing market dries up. Yet, it is perfectly feasible for them to sell at a reduced price, then negotiate a lower price on the next house that they want to buy. However, misplaced pride at “not being beaten down” on their own sale price (aka "achieving its true value") contributes to the freezing of the housing market that restricts all participants. Madness !!

What is the first lesson that any professional investment manager learns? You might love your stocks, but they don’t love you back. Ditto housing.

Regards
Dome

Ben Bittrolff said...

Don't even worry about it!
We'll just 'mark to model'.
We'll develope a Level 3 Asset category for personal balance sheets.
It's all so easy.

Anonymous said...

The middle class economy wages does not support the designer lifestyle which most American's expect. Speculation and debt become the norm as we run from Hobb's view that Life is short and brutish.

Dink said...

52% LTV(even 65%) seems low compared to what I remember from my lending days, but then most of the lending I did was in CA during the height of the bubble.

I imagine there are huge regional differences. Also, I've seen figures that 1/3 of homes are owned free and clear which could explain the dilution of the percentage. And I assume by "dwelling" they're not just counting owner-occupied residences, but also rentals.

LuckySingaporean said...

You americans are a bunch of whinners. Property prices in China just fell 20% last month...you guys never had a "real" property bubble like the ones we get in Asia.

Your average housing prices right now is even lower than the public housing prices in Singapore!

FrontierPsychiatrist said...

l

SC said...

Don't forget the home price-to-income ratio. Little can explain the sense in price appreciation other than principal deferral and such innovations.

Anonymous said...

so you are saying that we are at a fork in the road:

path a) Regulate housing back into an ultra conservative asset class which implies prices returnin to trend - combination of wage inflation and house price decline.

path b) Housing has fundamentally changed forever which implies the real money will continue to be earned as a "home trader" rather then an owner.

Allen C said...

We're beyond reserves now...

http://www.federalreserve.gov/releases/h3/Current/

LuckySingaporean said...

Hellasious,

The worst is over, your blog should be closed. The DOW will get back to 14000 and the housing market will start recovering...and you should stop scaring people with your doomsday scenarios....

Anonymous said...

singaporean,

dude, your crystal ball is filled with government weed.

Anders Brink said...

Doomsday scenario? You haven't seen anything yet. Peak oil is coming or has just passed. The era of oil depletion is coming. Global warming will happen no matter what, it is too to reverse that now. Food resources are getting scarce. All commodities are historical highs.

Where is this getting better you speak of, singaporean? In fact as a Singaporean myself, I am embarassed by your ignorance, self-centredness and short-term thinking.

Anders Brink said...

Doomsday scenario? You haven't seen anything yet. Peak oil is coming or has just passed. The era of oil depletion is coming. Global warming will happen no matter what, it is too to reverse that now. Food resources are getting scarce. All commodities are historical highs.

Where is this getting better you speak of, singaporean? In fact as a Singaporean myself, I am embarassed by your ignorance, self-centredness and short-term thinking.

LuckySingaporean said...

anders brink,

I can see you're pessimistic. But you shouldn't be because you're a Singaporean and not an American. As a Singaporean, you're lucky to have leaders of the highest integrity and competence. You just need to compare how much our leaders are paid with that of Americans. They are depending on cheap leadership and see where that has gotten them.

Peak oil? Have you not heard of our govt's initiative in biofuel and alternative fuels? Our solar power investments, palm oil etc. Also, our leaders have great foresight to impose a quota on the number of cars on our roads and impose hefty charges for their usage through ERP. If the Americans just adopt half of our govt fantastic ideas, their oil problems would be solved.

All commodities are at record highs? ...They have corrected. It is unfortunate that markets have to adjust to rising demand but that doesn't mean the world is coming to an end. Food prices rising are due to export taxes in many countries that want to safeguard their own supplies that has worsen the situation. Unfortunately, I have to agree with you that the situation won't be alleviated for some time...but our govt has again come up with a brilliant idea - inflation can be solved by substitution. If fish is expensive, each more vegetables..etc.

You shouldn't be so pessimistic. You should be reading our objective newspapers such as Straits Times more regularly instead of unfiltered information on the Internet that bias your view towards various bleak outlooks. Our wise leader MM Lee Kuan Yew has already we are decoupled from what is going on in America and should not enter recession even if the Americans get one.

Cheer up. You can visit my blog at
http://singaporemind.blogspot.com to understand why things are getting better.

Anders Brink said...

I don't think you understand the extent of the problems facing the world. I think you are deluding yourself to expect Americans or the rest of the world to be as blinkered as you.

One small uptick is not the whole trend.

Calling the American leadership "cheap" doesn't win you any friends. The Americans have their own problems and it just amazes me that someone who labels himself "lucky" should blame others for this lack of luck. It's like the spoiled brat who calls his friends parents "strict".

LuckySingaporean said...

::::I don't think you understand the extent of the problems facing the world::::

Yes, U and the handful of doomsayers do. Please keep explaining to the dullards who can't understand that the global economy is falling apart and there is nothing Ben and Paulson can do.

:::One small uptick is not the whole trend.:::

I see so this is a bear trap a sucker's rally....and you have all this figured out and those people buying now are all suckers.

::::Calling the American leadership "cheap" doesn't win you any friends.::::
This is the sad truth and you don't need to hide this. Everyone in the world knows that Singapore leaders are the highest paid by a large margin. By underpaying their leaders, they don't get the performance you see in Singapore.

::::The Americans have their own problems and it just amazes me that someone who labels himself "lucky" should blame others for this lack of luck.:::

It is their misfortune to be born in America. I don't blame them.

Anders Brink said...

Peak Oil is coming or has come. Global Warming is happening. Most experts are no longer arguing about it anymore. So go ahead and put your head in the sand and close your eyes. The people who see it clearly don't owe you any favours. Your life is in your own hands.