August 30, 2005

Interest-Only Mortgages

A story in Saturday's New York Times ("Good News, Bad News: Your Loan's Approved" by Eduardo Porter) highlights the growth of interest-only mortgages for home buyers. It appears that over 50% of new prime mortgages have been interest-only in the last two years, and subprime mortgages are up to nearly 25%. I believe most of these mortgages are also ARMs, which means that not only do the home "buyers" get hit when the mortgage changes over to paying principal in 5 or 10 years, but they also get hit when the fixe-rate term expires and the interest rate becomes adjustable.

Prices are set on the fringe. In other words, it's the small fraction of people who are actually selling an item that set the price for all owners of that type of item. So how, exactly, can anybody believe that real estate prices can not possibly go down? One simple recession and a lot of people are going to lose their houses.

Posted by Tom Nugent at 10:05 AM | Comments (0)

July 22, 2005

No Emotions Allowed

The 2002 Nobel prize in economics went to some of the founders of the field of behavioral finance. Basically, they showed that humans are not perfectly rational actors, as had been assumed in many economic models for decades. Related research has shown that people make investing decisions often on an emotianal basis, as opposed to a rational plan.

I just read about a recent story in the Wall Street Journal (sorry, no link) describing some research into people with damage to their brains that made them less capable of feeling emotions (at least those related to investing). They compared these people with "normal" people to see who did better at investing. And guess what? The people whose brains didn't let them feel emotions about investing performed better.

Posted by Tom Nugent at 01:11 PM | Comments (0)

June 07, 2005

Off the Charts Real Estate Market

One of the financial newsletters I receive had some interesting numbers recently about the real estate market:

For hard evidence, Jim Grant reported some fascinating numbers in his latest issue of Grant's Interest Rate Observer. Jim says that from 1983 to 1998, housing sales stayed relatively constant, representing between 8% and 10% of GDP (the economy). Then things took off...

As of the latest numbers, home sales as a percent of the economy are at 17%. For the statisticians out there, that's 3.4 standard deviations from the mean. For the non-statisticians out there, speculation in home buying is literally off the charts.

I'm not sure I'd call myself a statistician, but I can at least understand how significant being more than 3 standard deviations off the mean is. It's not clear if the variation in home sales as a fraction of the total economy follows a normal distribution, but if it did, 3 standard deviations would include 99.7% of all events.

The author further writes:

Right now in the States, things look great... Amazingly, nobody can even remember the last time when residential real estate prices actually fell nationwide. But they still can fall...

For decades up to 1989, the Japanese felt the same way... real estate looked great, it had never declined. And then, it did for years... EVERY YEAR for the last 15 years, real estate prices in Japan have fallen.

We're not in quite the same situation as the Japanese were, but we're not that far off, either. Believing that prices can only go up is a sure way to get burned.

Posted by Tom Nugent at 08:51 PM | Comments (0)

May 23, 2005

More Systemic Faults in Housing Industry

Elizabeth sent me a story about appraisers being under pressure to inflate home prices. Anyone who's been involved in buying or selling a house in the last few years should not be surprised to hear this news. But the article does point out one of the systemic problems in the house financing industry which could contribute to a collapse: the secondary market for mortgages and how it's run. Banks make a loan, and then sell the mortgage in the secondary market, usually to Fannie Mae or Freddie Mac. The banks just want the mortgage to go through so they can collect their fee on the transaction and move on. This leads to the banks putting pressure on appraisers (in addition to the pressure they feel from real estate brokers) to have the house appraisal come in at the selling price.

But what happens when that pressure works, and actually causes appraised values to go too high? What happens when a pin pricks the bubble?

Posted by Tom Nugent at 10:53 AM | Comments (1)

May 17, 2005

40 Year Mortgages

Apparently America hasn't learned anything from the experience of the Japanese. Fannie Mae is purchasing more 40-year mortgages, which have until now been extremely rare in the US. Before the real estate crash in Japan, people were mortgaging homes for ridiculously long periods of time, effectively making them multi-generation loans. How's that for an inheritance - getting the remainders of a mortgage?!? Longer term mortgages allow people to pay more for a house, which helps drive up prices. But eventually the system collapses, with people facing lifetime mortgage payments. There are many other factors, and we're not in an exact repeat of Japan. But the availability of 40 year mortgages is not a Good Thing.

Addendum: There's a good story on Real Estate Journal titled "Seven Harsh Truths About Real Estate." Keep them in mind when thinking about buying property.

Posted by Tom Nugent at 04:16 PM | Comments (0)

April 11, 2005

Stability is Unstable

John Mauldin, in his Feb. 18, 2005 letter, quotes the economist Hyman Minsky, who said "Stability is unstable."

What he meant by that is that the longer things remain the same, the more we expect them to remain the same and the more complacent we get. Thus, when things actually do change, the shock is much greater.
Alan Greenspan said something similar to Congress recently:
People experiencing long periods of relative stability are prone to excess. We must thus remain vigilant against complacency.
People keep expecting housing prices to only go up. The Japanese expected the same thing of real estate prices around Tokyo in the 1980s. The stability in prices (not just in real estate) and general economic conditions is not some new law of the world. Things will change, and when the stability ends (blows up?), it will wreak havoc in many people's lives.

Posted by Tom Nugent at 11:39 PM | Comments (0)

March 01, 2005

Just Like Japan

In today's New York Times: Speculators Seeing Gold in a Boom in the Prices for Homes. Two quotes from the article reminds me of the real estate market in Japan in the late 1980s:

Like the day traders of the 1990's dot-com boom, people are investing in a market that seems to just go up.
"It seems that real estate always goes up," in the long term, Ms. Finley said.

The Japanese (especially around Tokyo) also believed that real estate prices could only go one way - up. They were wrong. And when people in this country start believing the same thing, it makes me worried for the entire economy, because a severe downturn in the housing market could have widespread repercussions throughout all financial markets.

Posted by Tom Nugent at 08:36 AM | Comments (0)

October 22, 2004

Small Demand, Large Income

From a recent Wired magazine article titled The Long Tail:

The average Barnes & Noble carries 130,000 titles. Yet more than half of Amazon's book sales come from outside its top 130,000 titles. Consider the implication: If the Amazon statistics are any guide, the market for books that are not even sold in the average bookstore is larger than the market for those that are.
Similar statistics apply to movies, music, etc. The story really brings home how much the Internet is and will change the distribution of entertainment. Some of my favorite bands, small pro a cappella groups such as The House Jacks and M-Pact will be able to survive and thrive without needing to become mega-stars.

Posted by Tom Nugent at 08:21 PM | Comments (0)

January 04, 2004

Housing this year

I'm one of those people who believes that the housing market is in some sort of bubble - maybe big, maybe small. I don't know how big it is, but there are a number of reasons to believe that the bubble exists.

First, there's a study I saw referenced perhaps six months ago (by John Mauldin in his excellent weekly newsletter) which claimed that historically house prices rise with inflation. But in the last 5-10 years, housing prices have risen about 30% higher than inflation, suggesting that they will fall or be flat for some time in order to match inflation.

Another factor arguing for a fall in housing prices is the fact that mortgage interest rates can't go much lower, and are generally expected to rise somewhat in the next year or so. If interest rates go up, then the amount of house any given buyer can afford goes down, and since it's the current buyers who determine the expected value of everone's houses, then it would seem that increased interest rates would drive down house prices.

Finally, the Baby Boomers are going to retire over the next decade, and many of them will probably move into other housing, which should create excess supply.

All of these factors and more indicate that housing prices should go down. But at the moment, on average, they're still going up. Here in the Boston region, rents have been going down a bit, while house prices are still skyrocketing, and this discrepancy is another factor indicating that something is out of whack in the housing system. I, however, don't have any good feel for how much prices might go down, and I don't think anyone else does either. Nor do we know when they might go down. So, if you wanted to buy a different house, what should you do? That question is one I'm asking myself right now, because we'd like to get a different house in which to raise our baby, but I'd rather not buy a bigger house right at the peak in housing prices. If you have a suggestion, please let me know what it is...

Posted by Tom Nugent at 10:58 PM | Comments (0)

December 24, 2003


There's a great quote about the financial markets (by Keynes, I believe) that goes like this: "The market can remain irrational longer than you can remain solvent." And damn if they aren't testing me.

I've been convinced for over a year that the correction we saw in the markets from March 2000 to October 2002 is only the tip of the iceberg. Not only do the markets still need to get cut in half in order to get near reasonable values, but there are lots of reasons to expect that they won't be any higher 5-10 years from now than they are today.

I've been making that assertion for the last 10 months, and people will point out that the markets are, in fact, higher. But my point is not focused on time scales less than a year. My point is that buy-and-hold investing will (probably - nothing is ever certain) "disappoint" investors by making their money do nothing productive for a decade. There was a period in the 1960s and 70s where the markets went up and down and up and down, and then at the end of the period, the markets were exactly where they'd started. Buy-and-hold investors would have gone nowhere with their money in almost a decade.

I'll be writing much more about this topic, but right now, it's Xmas Eve and my mind is mostly not on topic.

Posted by Tom Nugent at 09:12 AM | Comments (0)