Canada's Housing Bubble

Falling House Prices Are The Solution, Not The Problem

Patrick Killelea,  Thu Oct 15, 2009  patrick.net

1. House prices will keep falling in most places because those prices are still dangerously high compared to incomes and rents. Banks say a safe mortgage is a maximum of 3 times the buyer's yearly income with 20% downpayment. Landlords say a safe price is a maximum of 15 times the house's yearly rent. Yet on the coasts, both those safety rules are still being violated. Buyers are still borrowing 6 times their income and putting only 3% down, and sellers are still asking 30 times annual rent, even after recent price declines. Renting is a cash business that reflects what people can really pay based on their salary, not how much they can borrow. Salaries and rents prove that prices will keep falling for a long time. Anyone who bought a "bargain" this time last year is already sitting on a very painful loss.

 

2. It's still much cheaper to rent than to own the same size and quality house, in the same school district. On the coasts, yearly rents are less than 3% of purchase price and mortgage rates are 6%, so it costs twice as much to borrow the money than it does to borrow the house. Renters win and owners lose! Worse, total owner costs including taxes, maintenance, and insurance come to about 9% of purchase price, which is three times the cost of renting. Buying a house is still a very bad deal for the buyer on the coasts, but it does make sense to buy in the Midwest and some other places where prices have fallen into line with salaries and rents. Check whether you should rent or buy in your own area with this NY Times calculator.

   The bottom will be here when buying a house to rent out clearly makes money. Then you'll know it's safe to buy for yourself because then rent can cover the mortgage and all expenses if necessary, eliminating most of the risk. For a rough indication of the wisdom of buying, divide annual rent by the purchase price for the house:

   3% = do not buy
   6% = borderline
   9% = ok to buy
   

   So for example, it's borderline to pay $200,000 for a house that would cost you $1,000 per month to rent. That's $12,000 per year in rent. If you buy it with a 6% mortgage, that's $12,000 per year in interest instead, so it works out about the same. Owners can pay interest with pre-tax money, but that benefit gets wiped out by maintenance costs and property tax, equalizing things. It is foolish to pay $400,000 for that same house, because renting it would cost you only half as much per year, and renters are completely safe from falling house prices.

    

3. It's a terrible time to buy when interest rates are low, like now. Realtors just lie without shame about this fundamental fact. Prices fall as interest rates rise, because a fixed monthly payment covers a smaller mortgage at a higher interest rate. Since interest rates have nowhere to go but up, prices have nowhere to go but down. The way to win the game is to have cash on hand to buy outright at a low price when others cannot borrow very much because of high interest rates. To buy at a time of very low interest rates is a mistake.

   It is far better to pay a low price with a high interest rate than a high price with a low interest rate, even if the mortgage payment is the same either way.

   • Your property taxes will be lower with a low purchase price.
   • A low price gives you the ability to pay it all off instead of being a debt-slave forever.
   • Paying a high price now may trap you "under water", meaning you'll have a mortgage larger than the value of the house. Then you will not be able to refinance, and won't be able to sell without a loss. Even if you get a long-term fixed rate mortgage, when rates inevitably go up the value of your property will go down. Paying a low price minimizes your damage.

 

4. The US economy will not recover until interest rates are allowed to rise. To favor debtors and banks, the Federal Reserve forces artificially low interest rates on America, destroying the free market for money itself. The Fed prints up bales of money and lends it to banks at 0%, so the banks feel no need to pay you any interest for your money. While this does temporarily let debtors and banks evade the consequences of their own bad decisions, it also eliminates all investment in businesses, crippling the economy and leading to mass unemployment.

   Investing in business is always risky, and it's especially risky in uncertain times like now. People with money will not invest until they feel interest rates are high enough to compensate them for the risk. Investors and banks refuse to risk their money at the Fed's artificially low rates, because at those rates, they will lose money. Would you loan money to a business at 4%, when the odds of losing your money are 8%?

    

5. Buyers borrowed too much money and cannot pay it back. Now there are mass foreclosures, and the Federal Reserve is buying up bad mortgages to let banks evade the consequences of their own foolish lending. Congress also authorized vast amounts of bailout cash from taxpayers, to be loaned to banks that can't even remember how to write a safe mortgage. These purchases and loans reward banks for making very bad gambles on lending.

   The Federal Reserve's manipulation of interest rates punishes savers (did you check CD rates lately?) and keeps debtors in the maximum amount of debt possible without default. The Federal Reserve's motto seems to be "make everyone slave away for the banks, forever". There is a recognition at the highest levels of banking/government that debt is essential for creating obedient workers. And once a buyer has trapped himself with debt he is reluctant to admit he's made the biggest mistake of his life. People want to believe that they're not stupid.

   We also have legal contracts being modified to stop even well-justified foreclosures. No one was forced to borrow money. It was a choice -- a very bad choice, but completely voluntary. Grownups should be responsible for their own actions. To prevent a justified foreclosure is also to prevent a deserving family from buying that house at a low price, not to mention what this does to faith in contract law. No one in government or the media will even mention that everyone in foreclosure trouble got themselves into that spot by voluntarily borrowing money to spend on luxuries like a house they couldn't afford. No one ever died because they had to rent.

   Should taxes and artificially low interest rates and newly printed cash be used to pay the debts of irresponsible borrowers, no matter how much they over-borrowed or overpaid, or whether they refinanced to party in Vegas? Should savers be forced to pay the debts of other people who cannot afford "their homes" no matter how far it is beyond their actual financial means? If so, go buy the most expensive house you can right now! Borrow as much as you possibly can to buy a bigger house, and don't pay it back, knowing that the Fed and Congress will force the real repayment obligation onto savers, onto people who are living within their means, so that you can stay in "your home" rather than in a house you can actually afford.

   Banks happily loaned whatever amount borrowers wanted as long as the banks could then sell the loan, pushing the default risk onto Fannie Mae (taxpayers) or onto buyers of mortgage-backed bonds. Now that it has become clear that two trillion dollars in foolish mortgage loans will not be repaid, Fannie Mae is under pressure not to buy risky loans and investors do not want mortgage-backed bonds. This means that the money available for mortgages is falling, and house prices will keep falling, probably for another five years or more. This is not just a subprime problem. All mortgages will be harder to get.

   A return to traditional lending standards means a return to traditional prices, which are far below current prices.

    

6. Extreme use of leverage. Leverage means using debt to amplify gain. Most people forget that losses get amplified as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss or an interest rate hike, he's bankrupt in the real world.

   Higher-end houses especially are now set up for a huge fall in prices, since there is no more fake paper equity from the sale of a previously overvalued property. Without that equity, most people don't have the money needed for a down payment on an expensive house. It takes a very long time indeed to save up for a 20% downpayment when you're still making mortgage payments on an underwater house.

   It's worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is 6% because of the realtor lobby's corruption of US legislators. On a $300,000 house, that's $18,000 lost even if prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less.

    

7. Shortage of first-time buyers. From The Herald: "We were all corrupted by the housing boom, to some extent. People talked endlessly about how their houses were earning more than they did, never asking where all this free money was coming from. Well the truth is that it was being stolen from the next generation. Houses price increases don't produce wealth, they merely transfer it from the young to the old - from the coming generation of families who have to burden themselves with colossal debts if they want to own, to the baby boomers who are about to retire and live on the cash they make when they downsize."

   High house prices have been very unfair to new families, especially those with children. It is foolish for them to buy at current high prices, yet government leaders never talk about how lower house prices are good for pretty much everyone except bankers, instead preferring to sacrifice American families to make sure bankers have plenty of debt to earn interest on. If you own a house and ever want to upgrade, you benefit from falling prices because you'll save more on your next house than you'll lose in selling your current house. Every "affordability" program drives prices higher by pushing buyers deeper into debt. To really help Americans, Fannie Mae and Freddie Mac and the FHA should be completely eliminated, along with the mortgage-interest deduction. Canada has no mortgage-interest deduction at all, and has a more affordable and stable housing market because of that.

   Government "affordability" programs just encourage debt, making prices higher, not lower. True affordability is not more debt -- true affordability is lower prices. The government's false affordability programs have created more debt than can ever be repaid. Credit rating agencies then lied about the value of this debt, ending trust in the whole system.

   The government keeps house prices unaffordably high through programs that increase buyer debt, and then pretends to be interested in affordable housing. No one in government ever talks about the obvious solution: less debt and lower house prices. That solution would harm bank profits! The real result of every "affordability" program is to keep you in debt for the rest of your life so that you remain an obedient worker. Lower house prices would liberate millions of people from decades of labor each. There is never anything in the press about the millions of people that were hurt and continue to be hurt by high house prices.

   The government pretends to be interested in affordable housing, but now that housing is becoming affordable via falling prices, they want to stop it? Their actions speak louder than their words. The government will step in or stay out only if it helps corporate profits for congressional campaign donors.

   Why is the failed market in health care exempt from anti-trust laws? Because the insurance cartel makes the most profit that way, and the cartel uses that money to pay lobbyists who get congressmen to vote against change.

   Why is the failed market in housing propped up with taxpayer-subsidized loans? Because banks make the most profit that way, and banks use that profit to pay lobbyists who get congressmen to vote against change.

   It is not government itself that is the problem, but corporate control of government, using congress to forcibly extract profits from you.

    

8. Deflation. There is fear of inflation, but it's not likely in the next few years. The actual amount of money created by the Fed lately is a trillion dollars, which sounds huge, but is small compared to the $10 trillion drop in housing "values" and another $10 trillion drop in stock market capitalization. The US government will not print extreme amounts of cash like Zimbabwe did, because significant inflation would mean that foreigners would no longer lend money to the US government unless interest rates were much higher to compensate them for inflation losses. Higher interest rates would push more people with adjustable mortgages into default, leading to more bank losses. So the Fed won't do it. The most likely scenario is like Japan: low inflation and low interest rates, with falling house prices for years to come.

 

9. Baby boomers retiring. There are 77 million Americans born between 1946-1964. One-third have zero retirement savings. The oldest are 62. The only money they have is equity in a house, so they must sell.

 

10. Huge glut of empty housing. Builders are being forced to drop prices even faster than owners. Builders have huge excess inventory that they cannot sell, and more houses are completed each day, making the housing slump worse.

 

11. Failure to re-regulate finance. The Graham, Leach, Bliley Act did away with the depression-era safety constraints placed on banks. This paved the way for record profits in the finance industry and an effective takeover of the US government by large banks, which has not yet been reversed.

 

12. The best summary explanation, from Business Week: "Today's housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low interest rates of a weak economy. Either the economy's long-term prospects will get worse or rates will rise. In either scenario, housing will weaken."