News Flash: Increase in Housing Prices Outstrip Improvement in Underlying Economic Fundamentals

Thursday, April 27, 2006
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San Diego’s For Sale inventory is way up. As with most places, the housing market is saturated with houses that cannot sell, resulting in foreclosures, and when that’s not the case, severe price reduction. A neighbor of my friend KC, both of whom are in the “way north” Detroit ‘burbs, had their house up for sale in the fall at $600k. The price has steadily fallen and it now sits for sale at $490k, with no interested buyers.

In looking at some housing issues across the country, I came across this article that has the same thesis as my recent piece on LewRockwell.com. Fred Cederholm will certainly get my attention in the future:

To accelerate the lending cycle, and to spread the interest rate differential risk, we saw the birth of the real estate investment derivatives called CMO’s–collateralized mortgage obligations. To get a fresh supply of cash to fund more credit, the lenders pooled the mortgage loans and sold them to investment bankers who in-turn packaged and resold them to investors. The dollars were huge, and so were the fees. Uncle $ugar entered the game by authorizing the creation of the GSE’s (Government Sponsored Enterprises) called Fannie Mae and Freddie Mac.

The process accelerated, with more loans being packaged and sold (and repackaged and resold) in a manner not unlike publicly traded stocks and bonds. These CMO’s were seen as safe investments since their value was “derived” from underlying mortgages that were collateralized by the real property itself. These were snapped up and traded by pension funds, insurance companies and banks as well as by corporations and wealthy individuals–domestic and foreign. Refinancing became common. (It’s 10 PM; do you know where your mortgage is tonight?)

Fannie and Freddie had the extra advantage of a multi-TRILLION dollar line of credit from the US Treasury. There is the “perception” that their CMO’s are as good as US Treasury securities themselves, even though they do NOT have the “full faith and credit of the US Government” behind them. (SOURCE: US Code, Title 12 – Banks and Banking, Chapter 46 – GSE’s, Section 4503 – Protection of Taxpayers against Liability).

Across the way, New Zealand is having its own problems, as is Australia.

In a bit older article, Mortgage News Daily comments on the FDIC’s report titled “U.S. Home Prices: Does Bust Always Follow Boom?” The FDIC concluded that a housing boom does not necessarily mean a bust is to follow, so breathe easy, all may be ok. Note the bolded sentence from the FDIC’s “revised report”:

The FDIC revised its February report in early May, using recently released data for 2004 from the Office of Federal Housing Enterprise Oversight (OHFEO.) The OHFEO study, as reported here last month, found that the average U.S. home price rose by almost 11 percent in 2004, up from 7 percent in both 2002 and 2003 and that the number of boom markets (according to FDIC definitions) increased by 72 percent last year to now include 55 metropolitan areas. These housing bubble markets included 21 cities in California, 18 in the Northeast and New England (New York), and 11 in Florida.

The FDIC report notes that the increase in home prices in 2004 outstripped the improvement in underlying economic fundamentals. For example, rental rates increased by only 2.7 percent nationwide in 2004 and 2.4 percent in 2003, far below the 11 and 7 percent increases in sale prices in those two years. Also, housing prices in 2004 increased at nearly twice the rate of personal income (5.8 percent). Personal income grew 4.2 percent in 2003.

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