The Ultimate Bubble Popper



POSTED BY Ed (12 mths ago)
Fawgetabout government measures to try to tamp down global property markets...

In San Francisco, as an extreme example, the median house price has skyrocketed from $695,000 in 2011 to $1.3 million in Q3 2016, according to Paragon Real Estate. This 87% surge in 5 years has been enabled by super-low interest rates. Others factors included the high-paying jobs created by the startup and “tech” boom, and the bubble of wealth it entailed.

But now interest rates are rising. Paragon looked at what that does to the costs of housing, and by how much household incomes would have to rise to buy the same home at even slightly higher interest rates.

For these estimates, the costs of housing include principal and interest of a 30-year fixed-rate mortgage, plus taxes and insurance. The base is the median house, at $1.3 million, with a 20% down payment ($260,000!).

The recent increase in rates from 3.57% to 4.125% jacks up costs by $330 a month, or almost $4,000 a year.
If rates drift up to 4.5%, costs jump by $560 a month, or $6,700 a year.
If rates reach 5%, the additional costs jump by $10,600 a year.
What happens in some saner parts of the country is similar, but on a lower scale, depending on taxes and insurance costs. For example, for the national median home, priced at $232,200, with rates going from 3.57% to 4.5%, costs would rise by about $1,200 a year. If rates hit 5%, costs would jump by about $1,900 a year. For households on a tight budget, these additional costs would turn into an impossible squeeze.

And when mortgage rates rise beyond 5%, which used to be ridiculously low? For example, a mortgage rate of 6.3%, about the middle of the range during Housing Bubble 1 – the one Greenspan inflated when he cut rates way too low. That range lasted until mid-2008.

At 6.3%, the costs of a median house in San Francisco would jump by $1,730 a month, or nearly $21,000 a year. For the median home in the US, the cost would jump by $2,500 a year, which would move the house out of reach for many budgets.

Paragon points out how these low rates have “subsidized” the house price bubble: From the peak of Housing Bubble 1, which in San Francisco occurred in 2007, to Q3 2016, the median house price soared 45%. But due to plunging mortgage rates, the monthly housing costs increased only 14%.

Now with rates rising, that process is going to reverse.

The household income needed to qualify for a 30-year fixed rate mortgage with 20% down on that median $1.3 million house in San Francisco was $251,000 before Election Day. Paragon observes:

By Friday, November 18, the income requirement increased by $13,000. And if the interest rate goes up to 5% (and again, we are not saying it will), an additional $35,000 in annual income would be required.

Hence, at 5%, a minimum qualifying household income of $286,000 a year. In this scenario, even in less costly markets, there are two things that happen:

One, many people have to step down to a lower-priced home, or they don’t buy at all. A market-wide shift of this type puts downward pressure on prices and volume.

And two, as people stretch more to buy homes at higher interest rates and higher monthly costs, they have even less money to spend on other things. This creates a new drag on consumer spending. It’s how low mortgage rates not only subsidized the house price bubble but the entire economy by giving consumers more money to spend – not just the US economy but exporter nations around the world.



Ed (12 mths ago)
History about to repeat?

The conditions were right for people to achieve that dream.

In the early 2000s, mortgage interest rates were low, which allow you to borrow more money with a lower monthly payment. In addition, home prices increased dramatically, so buying a home seemed like a sure bet. Lenders understood that homes make good collateral, so they were willing to participate.

The mortgage crisis was triggered as this situation built momentum.

There was a glut of liquidity sloshing around the world - which quickly dried up at the height of the mortgage crisis. People, businesses, and governments had money to invest, and they developed an appetite for mortgage linked investments as a way to earn more in a low interest rate environment.

Early Stages of Subprime Crisis

Unfortunately, the chickens came home to roost and the mortgage crisis began. Home prices stopped going up at a breakneck speed. Borrowers who bought more home than they could afford stopped paying the mortgage. Monthly payments increased on adjustable rate mortgages as interest rates rose.

As homeowners discovered that they could not afford their homes, they were left with few choices. They could wait for the bank to foreclose, they could renegotiate their loan in a workout program, or they could just walk away from the home. Of course, many also tried to increase income and decrease spending but they were already on thin ice.

The Plot Thickens

Once people started defaulting on loans in record numbers (and once the word got around that things were bad), the mortgage crisis really heated up. Banks and investors began losing money. Financial institutions decided to reduce their exposure to risk very quickly, and banks hesitated to lend to each other because they didn’t know if they’d ever get paid back. Of course, banks and businesses need money to flow in order to operate.

With bank weakness came bank failures. The FDIC ramped up staff in preparation for hundreds of bank failures caused by the mortgage crisis, and some mainstays of the banking world went under. The general public saw these high-profile institutions failing and panic increased. In a historic event, we were reminded that money market funds can ‘break the buck’.

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