Democratic Wings: The housing bubble is losing steam

October 03, 2005

The housing bubble is losing steam

From Bill Fleckstein in Money Central:

They were given a low estimate for property taxes, and when they got their first payment notice, the tax increase really stung. As of a month ago, 10% of the houses in the Galloway Ridge development, were either in foreclosure or had gone through foreclosure. They now find themselves with a house that cost $189,900 in 2001 and now they'd have to knock off about $30,000 from the asking price to sell it. ...To some degree, the housing market is a compendium of local markets, unlike the "centrally located" though all-encompassing stock market bubble. There is no Nasdaq or Dow Jones housing index. For that reason, as the housing bubble unwinds, it won't be quite so obvious to folks around the country unless it's happening in their community.

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Turning to one such place, I am indebted to a reader of my daily column, who forwarded a copy of the Sept. 19 Columbus Dispatch. It ran a thorough article on the plight of a couple in the Galloway Ridge subdivision in suburban Columbus and also shed light on some financing techniques that get folks into trouble. The article, "Suburban Blight," singled out Dominion Homes (DHOM, news, msgs) for enticing people to reach too far. Allow me to share a few quotes:

"Big dreams filled Rick and Christy Alonso when they bought their new house from Dominion Homes. Start a family. Build equity. Move to a larger house. But six months later, their suburban neighborhood on the Far West Side began to deteriorate. New houses suddenly emptied. Thistles and dandelions overran lawns. Neon orange labels appeared in windows, signaling foreclosures."

It's worth making a point here: On average, people across the country have a good deal of equity in their houses. But I think that average is misleading. There are people with huge amounts of equity, and there are people with virtually no equity. It's the people with no equity (otherwise known as "marginal buyers") who find themselves in trouble, wind up "upside-down," and are forced to sell. It's those marginal sellers who start the price dislocation (after the supply of marginal buyers has been exhausted). The story Ohio describes this process: "Foreclosures damage entire neighborhoods. They affect families such as the Alonsos, homeowners who pay their mortgages on time, yet find themselves stuck with houses losing value."

The story noted the specific attitude that's helped lead to this problem: "The recent spate of suburban foreclosures includes buyers whose appetite to have it all -- now -- leads to financial overreaching."

Dominion is lambasted as an accessory to the process: "Nearly a third of the Franklin County houses and condominiums built since 1998 that have been listed for sheriff's sales involved Dominion buyers." Further, the company is cited for its loan violations: "In 2002 and 2004, HUD randomly selected 42 Dominion loans and found violations in 22 cases, some of which had more than one problem."

Against this backdrop of abuse, the story quotes one brave Columbus appraiser named Lori Austin: "Nobody's looking out for the buyer." Well, that, in fact, is true. No one is looking out for the buyer. The process was created by Easy Al trying to bail out the stock bubble by taking rates to 1%. Folks got caught up in taking the equity out of their homes, as if they were on-site ATMs. Rising house prices attracted speculation. Lenders abdicated all responsibility -- dropping standards so low that folks could buy a house and even walk away with cash, much less put zero down -- thereby creating the credit bubble that has precipitated the problem we now have.

This story illuminated the plight of the Alonsos, who don't appear to have been greedy. Sometimes folks who are on the innocent side wind up getting hammered. (It's not always greed that leads to destruction. Often, just being naive will do it.) Though the Alonsos hadn't planned on spending more than $140,000, a Dominion salesman showed them how they could buy a house for $189,900, of which they financed $187,500. The family was able to shoe-horn into the loan with a creative financial package.

Meanwhile, the Alonsos were given a low estimate for property taxes, and when they got their first payment notice, the tax increase really stung: "'I about croaked,' said Mrs. Alonso." Of course, increasing property taxes hurt their neighbors, too. As of a month ago, 10% of the houses in the Galloway Ridge development, were either in foreclosure or had gone through foreclosure.

The Alonsos now find themselves with a house that cost $189,900 in 2001 and now can't be sold for that price. The real-estate agent has told them that if they really wanted to sell it, they'd have to knock off about $30,000 from the asking price.

Alongside that front-page story, the Columbus Dispatch ran "Loophole Fuels Zero-Down Mortgages," which illuminated a wrinkle I was unaware of:

"Homebuilders across the country, including Dominion Homes, have found a way around a Federal law barring sellers from giving money directly to buyers for a down payment. They route the money through charities such as the Nehemiah Corp. of America, a faith-based group in California. Nehemiah provides down payments for both existing and new homes, and its relationship with Dominion is the largest of its kind in central Ohio between a builder and charity.

"Nehemiah uses a loophole in federal regulations that allows charities to provide the 3% down payment required to qualify for Federal Housing Administration mortgages. An uncounted number of copycats have followed, leading to an explosion of 'zero-down' loans. Federal authorities do not regulate or track such organizations."

The Alonsos' story is about just one family in one property development, singling out one homebuilder and one abusive financial scheme. There are undoubtedly many, many variations on this theme, and the full story won't be written until the housing bubble really unwinds -- much as we didn't find out about Enron, WorldCom, and those assorted problems until the tide went out on the stock mania.

When the tide goes out on the housing mania, it will reveal lots of bad debt, both for folks like the Alonsos to choke on and for financial institutions to have to eat. In writing those bad loans, financial institutions will become progressively less interested in lending. That will further cut off credit to the housing market, thereby exacerbating the problems as they unfold.

That house prices have gone up a lot is not in itself the problem. If they'd risen in an environment where folks were behaving prudently with their financing arrangements (i.e., putting 5%, 10%, 15% or 20% down and taking out 10-, 15- or 30-year mortgages), we might be set up for a dip in prices, as has occurred from time to time. But that's not what we'll witness, thanks to the complete abdication of responsibility on the part of financial institutions, where seemingly no loan was turned down. Thus, those of us who talk about a housing bubble are really referring to a credit bubble....

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October 03, 2005