Crash Proof: Lending Standards Deteriorate PART 3
In recent years American homeowners have borrowed so much money
against their homes to finance consumption that despite record price
appreciation home equity now represents the smallest percentage of
home values in U.S. history. Imagine how much worse the situation
becomes when real estate prices decline!
Source: Reprinted by permission from David L. Tice and Associates
(www.prudentbear.com).
FIGURE 6.1 Home equity as percent of home market value, 1965–2006
LINK: http://img80.imageshack.us/img80/3662/crashproofhomeequitycha.jpg
The economic effect of the prudent lending policy was that it put a
natural limit on the extent to which home prices could rise. Houses
couldn’t appreciate faster than down payments could be saved or faster
than household incomes could rise.
WHAT CAUSED LENDING STANDARDS TO SUDDENLY DETERIORATE
How did things so quickly reach a point where somebody can
walk into a bank without a job, with a bankruptcy, and with
credit card debt, and walk out with a zero-down, interest-only
mortgage for half a million dollars?
I believe that artificially low rates, a bad stock market, the
emergence of aggressive mortgage brokers, and a government-
sponsored securitization industry flush with foreign investment
combined to create high housing demand and rising prices, re-
viving the same gambling mentality that drove the dot-com
boom. When you give somebody a situation with tons of upside
and nothing to lose, who wouldn’t gamble when somebody
else’s money is at stake?
Things had finally reached a point where potential home-
owners were in effect being told, “Hey, you can buy this house
for $500,000 without putting a penny of your own money in it.
You can live in it, and when its value increases, say to $800,000
or, if you want to wait a few months longer, maybe even $1 mil-
lion, the difference is your money. In fact, you can borrow it out
tax free in a cash-out refinancing. So you’ve got all the upside
and no downside because you didn’t put anything in.”
In the meantime you could enjoy artificially low monthly
payments by making the minimum required payment on an
interest-only negative amortization, adjustable-rate mortgage
(ARM). Who cares how much higher the payments would ulti-
mately become? You would have all that equity to extract or
you could sell the house at a profit. Worst case, you could sim-
ply walk away from your zero-down mortgage no worse for
wear, having saved a few bucks on rent, as your teaser rate
may have been less expensive than what you might otherwise
have paid in rent.
It actually reached a point where there were reported cases
of college students who, instead of living in a dorm, would buy
a house and figure the appreciation would cover four years of
tuition and expenses.
There’s quite a difference between a situation like that and
one where a banker was judiciously extending credit to borrow-
ers with established creditworthiness.
"I was catching up on my reading and I thought I would share these sections with you all. I believe in this text you will find a few answers to why we are experiencing such a deep recession. C.D."
REFERENCE: Crash Proof; Chapter 6 - They Burst Bubbles, Don’t They?: The Coming
Real Estate Debacle
against their homes to finance consumption that despite record price
appreciation home equity now represents the smallest percentage of
home values in U.S. history. Imagine how much worse the situation
becomes when real estate prices decline!
Source: Reprinted by permission from David L. Tice and Associates
(www.prudentbear.com).
FIGURE 6.1 Home equity as percent of home market value, 1965–2006
LINK: http://img80.imageshack.us/img80/3662/crashproofhomeequitycha.jpg
The economic effect of the prudent lending policy was that it put a
natural limit on the extent to which home prices could rise. Houses
couldn’t appreciate faster than down payments could be saved or faster
than household incomes could rise.
WHAT CAUSED LENDING STANDARDS TO SUDDENLY DETERIORATE
How did things so quickly reach a point where somebody can
walk into a bank without a job, with a bankruptcy, and with
credit card debt, and walk out with a zero-down, interest-only
mortgage for half a million dollars?
I believe that artificially low rates, a bad stock market, the
emergence of aggressive mortgage brokers, and a government-
sponsored securitization industry flush with foreign investment
combined to create high housing demand and rising prices, re-
viving the same gambling mentality that drove the dot-com
boom. When you give somebody a situation with tons of upside
and nothing to lose, who wouldn’t gamble when somebody
else’s money is at stake?
Things had finally reached a point where potential home-
owners were in effect being told, “Hey, you can buy this house
for $500,000 without putting a penny of your own money in it.
You can live in it, and when its value increases, say to $800,000
or, if you want to wait a few months longer, maybe even $1 mil-
lion, the difference is your money. In fact, you can borrow it out
tax free in a cash-out refinancing. So you’ve got all the upside
and no downside because you didn’t put anything in.”
In the meantime you could enjoy artificially low monthly
payments by making the minimum required payment on an
interest-only negative amortization, adjustable-rate mortgage
(ARM). Who cares how much higher the payments would ulti-
mately become? You would have all that equity to extract or
you could sell the house at a profit. Worst case, you could sim-
ply walk away from your zero-down mortgage no worse for
wear, having saved a few bucks on rent, as your teaser rate
may have been less expensive than what you might otherwise
have paid in rent.
It actually reached a point where there were reported cases
of college students who, instead of living in a dorm, would buy
a house and figure the appreciation would cover four years of
tuition and expenses.
There’s quite a difference between a situation like that and
one where a banker was judiciously extending credit to borrow-
ers with established creditworthiness.
"I was catching up on my reading and I thought I would share these sections with you all. I believe in this text you will find a few answers to why we are experiencing such a deep recession. C.D."
REFERENCE: Crash Proof; Chapter 6 - They Burst Bubbles, Don’t They?: The Coming
Real Estate Debacle
