"The biggest amount of inflation you’ve ever seen is in real estate right now," … "Prices are going crazy and have nothing to do with the level of information out there…"
- Bob Dall, Former head of Salomon brothers’ bond trading desk immortalized in Michael Lewis’ book Liar’s Poker.
That quote, taken from a recent article in The Slatin Report neatly sums up the concerns driving one the most pondered questions in real-estate right now: Is there a bubble?
Across the nation we have seen home prices post double-digit appreciation figures year after year, and as the most recent data shows, there doesn’t seem to be an end in sight.
Below you’ll find a few articles from a variety of sources who have written on this at length, but the common themes are:
- This tremendous increase in real-estate prices has in part been fueled by low interest rates and the efforts of Fannie Mae and Freddie Mac to expand the pool of mortgage options to include an ever increasing number of potential homeowners.
- The "doomsday scenario" involving a widespread collapse in real estate values, leaving millions of homeowners holding mortgages larger than their homes are worth, is unlikely.
- We will probably see appreciation rates slow, so don’t kid yourself by expecting double digit price gains on into infinity.
For the most part I agree with the above. But, and this is a big "but," there is a question that nobody has been asking, and it’s a really good one (I think I have the answer.)
"If incomes haven’t been rising, and rates, though low, are not low enough to account for both the tremendous increase in demand for housing AND the increase in prices, what else is at work here?"
The answer, in part at least, is this: There has been a dramatic shift in lending practice that I would argue has been a significant factor in the rise of home prices (and their apparent disconnect with market fundamentals) suggested by the opening quote. What was this change in lending practice? Automated Underwriting.
Rolled out with little fanfare by Fannie and Freddie starting in 1999, automated or "desktop" underwriting put the majority of lending decisions in the hands of sophisticated computer models, rather than human underwriters.
Almost overnight, the maximum allowable monthly payment for a given income (the debt-to-income or "expense" ratio, in mortgage banker parlance) basically doubled. It is now fairly easy for a borrower with good credit to qualify for a mortgage whose monthly payment consumes 60% of their GROSS monthly income. That’s gross income folks (before taxes, before 401k, before health insurance, Medicare, FICA, all of it) not net.
This was a huge change, and its impact on homeowners borrowing power dwarfs that of low rates and zero down loans. The American consumer has a nearly unlimited appetite for debt – If you are willing to lend, there is always a market, and the market created by this unprecedented loosening of underwriting practice has been as large a factor in recent appreciation figures as any.
If the "doomsday scenario" does unfold, when everyone is asking "what happened?," you can bet this is one area that will be looked at long and hard. Until then, it’s all good.
Related Links:
No bubble Trouble[Kiplinger]
What Goes down…[Slatin]
House Prices and the Fed[Bruce Bartlett, Townhall]
Liar’s Poker [Michael Lewis]
A "sortable" engine showing house prices and appreciation rates for your city[Kiplinger]
More detailed market statistics for the Twin-Cities [Mpls, St, Paul][Minnesota Realtors Assoc.]
Random Link-lube:
Good books for the homeowner[WSJ On-line]
Star Jones is a deadbeat [Smoking Gun]
Related posts:
Equal Housing Lender |