Sept/Oct 2007 - Well folks, it's not the end of the world. But, if you listen to the media, it can be pretty darn worrisome.
I refer, of course, to the implosion of the mortgage market which is currently taking place. The symptoms are patently obvious: mortgage companies failing, foreclosures rising, and Congressional concern ("concerned" not because there are real problems, but because it receives a lot of letters and e-mails about a particular issue) about the health of the overall economy.
Could we have seen this coming? Yes. Could we have prevented it? Yes. Can it be solved? Yes, again.
So, what exactly is the root of this problem? Well, this state of affairs is a product of many hands. The roots of the crisis go to one of the most basic emotions in the real estate market: greed. In the great housing boom, no one wanted to be left out and everyone wanted to make as much money as possible. So, consumers looked to buy as much house as they could get.
The mortgage industry, ever eager to service consumers, invented instruments that allowed the purchase of more house than would otherwise be possible. Interest-only mortgages, payment-option ARMs, and other exotic instruments became quite common. This, in turn, drove prices higher as the bidding escalated and produced more frequent use of exotic type mortgages. The final piece of this was the occasional overstatement of income by consumers in order to qualify for larger loans.
The crisis is also an example of the law of unintended consequences. The federal government, since 1993, has sought to expand homeownership. This was done by using Fannie Mae and Freddie Mac to lower the barriers to ownership for lower income buyers through no documentation, low interest rate loans. This brought into the ownership cadre relatively unsophisticated debtors who often made bad choices on their selection of mortgage instruments.
A bit of the responsibility for the current problem must certainly be borne by real estate professionals, as well. As de facto mortgage counselors, many agents abetted the greed of buyers by searching out the cheapest monthly payment and accepting whatever buyers wished to represent as their financial condition.
So, the result is that we now we have over $1 trillion of loans repricing this year... about 10 percent of mortgage debt outstanding. The good news is that the overwhelming majority of affected homeowners still have sufficient credit and equity in their homes to be able to refinance to a new variable mortgage. They will be OK but will still sustain higher monthly payments since introductory rates today are higher than they were in 2002. Others will be unable to adjust and may be forced into foreclosure.
For the real estate market, there will be two major consequences. First, the glare of adverse publicity, already strong because of the slowdown in sales volume and prices, will intensify as foreclosures rise. However it is important to understand that the absolute numbers will be small relative to debt outstanding. Recently, the rise from a foreclosure rate of 1.25 percent a few years ago to one of 2.5 percent presently allows the media to broadcast in headlines "Foreclosure rates double!!!". Yes, the percentage has indeed doubled but the number of all homeowners who are facing foreclosure is extremely small even when compared to the real estate market of the early 1990s when foreclosures were much higher. Secondly, regulators are coming come down hard on the lending industry, sharply increasing qualifying standards for loans and eliminating many of the exotic mortgage instruments which came into vogue just a few years back. This is making it much harder for buyers who either have no downpayment funds which require 100% financing, those with lower credit scores, and also those who need to "state" their income vs provide full documentation. In essence, it appears that lenders are scrutinizing buyers and their credit much more closely and lending standards across the board are being tightened. Whether this is a short to mid term "knee jerk" reaction or a longer term, permanent adjustment, remains to be seen.
So, amongst all this turmoil and daily news about foreclosures and lender bankruptcies, is there a light at the end of the proverbial tunnel? Any good news? Does all of this pertain to us in San Diego and if not, why? What should potential buyers do now?
Folks, notwithstanding that the market is indeed is currently in a bit of turmoil, I think it is always important to have some hard facts and perspective before rendering your own opinions or in the case of buyers, purchasing decisions. First, here´s some perspective:
First, I need to point out that all the various sources of housing data that you are exposed to can really be confusing...even sometimes to us real estate professionals. Here is what oftentimes happens. The newspapers and most of the media tend to combine sales of both resale and new homes into one large statistic which puts a misleading spin on the market because new home sales have taken a real "hit". So, when you combine the two, it would appear that the entire market is not doing well. Thus, if you are a homeowner and want to know what is occurring specifically in the resale market, you should focus in on those stats which report resale sales only.
In like fashion, also be aware that many reports that you read in the media are reporting national data. Folks, again do not be misled. What may be happening on an average basis across the country or even within California as a whole has little or nothing to do with what has occurred or will occur here in San Diego. Real estate is in every sense, a local issue and you must concentrate on local stats because you do not want to be making major decisions when data from Cleveland and Detroit or even LA, is thrown into the mix!
Do not forget that the San Diego area has, in the past, led the nation in real estate trends. San Diego County has typically been the first to taper off in price and the first to rebound. If folks are touting the "wait and see" approach, it's because they live in an area which is behind us as far as the trend is concerned. We lead the nation in real estate timing trends and I will attempt to demonstrate this to you with some independent indicators below. Prices and activity now appear to be ready to slowly rebound.
Now, here are some facts:
A recent survey by the National Association of Mortgage Brokers (NAMB) noted that subprime loans (those issued to buyers w/ 620 and lower credit scores) continue to account for only a small percentage of loans originated this year, despite their alleged role as the leading factor in the current housing slump. In fact, only 11% of all loans originated thus far in 2007 were subprime and in 2006, 13%.
As I write this article, mortgage applications have risen for the first time in a number of months, interest rates have fallen sharply and demand has surged for home purchase and refinance loans. Interest rates are again, at near historic lows and below year-ago levels.
Looking at the Pending Home Sales Index, many economists see the market across the nation stabilizing in the months ahead. Based on homes which are under contract but not yet closed, the index was 5% higher than in May and represents the largest monthly gain in three years. In the west, the PHSI increased 8.6%.
The median price of a single family detached (SFD) resale home in San Diego County has increased 5 of the last 6 months!!! This past month, came in at $580,000, whereas this past November, the median was $550K. Year-over-year, our current median is now right about where it was one year ago.
For single family attached/condos resale homes, the median value across the county is now $358,000, or just above where it was one year ago. As recently as this past November, the median condo price was $349,900!
I suspect that some of these stats surprise you. Well, you´re not alone. It´s because much of what you read and hear about are again, national data, not local.
Forecast
Given the above facts and watching the subtle trends, I have been noting for months now that sales and listing data appeared to have stabilized and that buyers should begin to make their best deals while the "getting was good". That said, I do need to temper my enthusiasm some as 2007 has not at all mirrored the traditional real estate "rush" during the spring and summer months and this year is looking more like what we experienced in 2006. Yet, having witnessed small increases in activity for the past several months now, it´s hard not to believe that we are close, if not at the bottom of, the current market.
I believe strongly that to a large extent, the direction of our market will depend upon what the Federal Reserve decides to do regarding the Fed Funds rate over the remainder of CY 2007. In the most recent meeting which occurred on August 7th, the decision was to keep the target for the federal funds rate at 5.25%. Then, just after that meeting and as I write this article, a crisis of confidence in the financial markets and a credit crunch has effectively frozen the credit markets which provide liquidity (cash) to mortgage lenders. In just two days, the Federal Reserve pumped in $72B to the financial system in an effort to increase the pool of funds available for lending. This new liquidity will allow lenders to provide credit to the marketplace supposedly without driving up interest rates. Thus, the Fed´s way to deal with this liquidity problem has (at this moment) has been to focus on short term liquidity and ensure that the system has sufficient reserves so there can be an adequate amount of cash to lend. To me, this strategy illustrates vividly that our government is out of touch with reality which is that we face not a lack of liquidity but a lack of confidence! Here´s the "rub", banks are awash with cash, but are afraid to lend. Pushing yet more liquidity at banks that are unwilling to lend will be in my estimation, ineffective. Instead, what we need is a cut in interest rates and soon! Yes, the next line of defense if the market were to persist would be to cut interest rates which the Fed has thus far been reluctant to do because of its anti-inflation stance but a rate cut is essentially the only other tool that the Fed has. Folks, our present credit crisis has its very seeds in excessive liquidity combined with grossly lax lending and underwriting practices and liquidity has now reached the point that the Fed funds futures index is indicates a Fed rate cut may be on the horizon. Stay tuned.
Will a rate cut happen by year-end? I'm not so sure. Should economic figures suggest that inflation is under control and/or that the economy is lagging behind forecast GDP and the Fed decides to stimulate activity via a decrease in the rate, then we could well see a very noticeable increase in real estate market activity. On the other hand, if inflation jumps beyond the Fed's target of approx 2.5%/annum or geopolitical problems arise (e.g., Iran, etc.), then all bets are off.
Expect that the national housing market will continue to be a drag on economic growth, but as long as it is just that and not something that threatens to derail the overall economy -- which I don't think will happen -- then the Fed may not be inclined to act.
Recent economic reports and the Fed itself seem to be suggesting that the Fed is likely to "remain on course" with rates steady through the remainder of the year. Yet, continue to monitor the Fed's actions and statements (next meeting is September 16th) as they will be your best indicators.
Note: I should note that mortgage rates are not directly tied to the Fed Funds rate but rather to the 10 year treasury bond. That said, when the Fed does reduce the fed funds rate, it does tend to provide psychological momentum for reductions on longer term rates (e.g., mortgages).
Smart investors know that you will hardly ever buy at the absolute bottom nor sell at the very top of any market. Instead, we should endeavor to get it "about right". For buyers, I believe your time is "about right"!
Note: I should note that mortgage rates are not directly tied to the Fed Funds rate but rather to the 10 year treasury bond. That said, when the Fed does reduce the fed funds rate, it does tend to provide psychological momentum for reductions on longer term rates (e.g., mortgages). 
