Back when he told people they were crazy not to consider ARM loans, it was clear to me that he was using the powerful dialogue as a vehicle to stimulate consumer expenditures. By putting people's households at risk.
Now he acknowledges the growth in consumer expenditures due to such loans and home equity loans but apparently doesn't find anything wrong with his previous public announcement about jumping to ARMs. Yet he notes that many people are overextended. But that the banking system will be fine, suffering no major losses.
He simply used his chair's voice to sucker people into risky mortgage situations.
His discrediting the likelihood of many foreclosures is another example of his disregard for people. When and if it happens on a larger scale, he will obviously come up with another disclaimer.
They are having a free for all over on housingbubble2 discussing it... good thing it is happening on the internet and not on a subway or in a bar... folks would be dead by now.
For the record, here are Greenspan's actual words on February 23, 2004:
"Recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.
American homeowners clearly like the certainty of fixed mortgage payments. This preference is in striking contrast to the situation in some other countries, where adjustable-rate mortgages are far more common and where efforts to introduce American-type fixed-rate mortgages generally have not been successful. Fixed-rate mortgages seem unduly expensive to households in other countries. One possible reason is that these mortgages effectively charge homeowners high fees for protection against rising interest rates and for the right to refinance.
American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."
Nothing in this statement seems outrageous to me. As far as I know, I haven't heard of anyone in the last 5-years or more getting nailed because they have an ARM. Greenspan plainly acknowledged ARMs would not save homeowners money if interest rates trended sharply upward.
I do not find a problem in what Alan Greenspan is saying. Greenspan is superb at understand how the economy is functioning. I also thought he was right about the advantage of Adjustable Rate Mortgages in a market with stable to declining interest rates as we have had for more than 2 decades.
I also thought he was right about the advantage of Adjustable Rate Mortgages in a market with stable to declining interest rates as we have had for more than 2 decades.
Jennifer - I know you are familiar with the concept of 'reversion to trend' or sometimes called 'reversion to mean'? You're to sharp to not be... well AG gets the concept too.
In my view he was an ass for suggesting people take out ARMs when knowing full well he would likely be increasing interest rates and soon and maybe a lot... Anyone else could maybe make that comment without all the blame because they don't have their hands in it... but not AG. It is almost like Lucy holding the football for Charlie Brown... AG telling the public... "Now go ahead and kick it"...
It they ever settle scores after the revolution... I hope they drag AG in front of the Troika first... even before Karl Rove.
And I'm only being half snarky when I said that...
I agree w/ dryfly. It's not what ag says, it's when he says it. He's ALWAYS been an Administration lackey. He combined w/ this Administration to create this housing bubble (he contributed low int. rates & loosened lending practices, the Admin's 2 biggest supporters fnma & freddie compunded the problem). AG commented only when thought the frenzy had gone too far, & he did this in his usual way -by warning his institutions the endgame was around the corner. Time for them to unload their portfolios & tighten lending policies. Sounds a lot like when he proclaimed that the frenzied stock market reflected a "new economy".
Important point is to listen, he;s got the clout. When he told his banks to tighten lending policy - it was time for us little guys not only not to buy, but to sell.
Your points are well taken, as always. The comment about ARMs was made 20 years into a bull market in bonds and shortly before the Fed would begin raising short term interest rates. Still, the bull market in bonds has continued till now and ARMs have been a significant saving device. Could we be verging on a spike in long term rates however in the coming years? There is the worry. I understand your discomfort. Thank you.
I still think it is worthwhile watching the performance of the Vanguard REIT Index for an understanding of the strength or weakness of the real estate market.
Remember though, the bull market in bonds begun in December 1981 continues still and bond bears have been wrong repeatedly to this point.
Jennifer - review 'reversion to mean' and then think about the 'relative risk & consequences'...
Lets say consumers guess rates are going to go up and lock in a 5% mortgage... and they guess wrong, rates go even lower to say 4%... what are the consequences? Nothing really other than they don't benefit from the savings they would have had if they had taken out an ARM... the 'loss' is an 'opportunity loss' and on paper only.
But what if they had taken out an ARM thinking rates will stay low or go lower... and they guess wrong, what then? Real money comes out of the family budget and maybe a lot of it if they guess really wrong and rates go up a lot. The consequences of this 'wrong guess' is very tangible - maybe they lose the home.
I know AG is smart enough to do this kind of reasoning... He also knew that the probability of rates going higher was FAR greater than the rates going lower when he recommended ARMs... and this wasn't because he was a good guesser... it was because the FED was already gearing up for the increases... positioning.
People are playing with this like it is a game... like it was monopoly money. I grew up in a family that started small businesses in recession and almost lost the family home... saw the terror in my parents eyes. People are going to get burned I am sure of it. The only questions I have is how many, how badly, how soon?
Greenspan wanted that mortgage money back in the economy. That was his intent.
He doesn't care about the average citizen. He's up in the cloud layer above the gas stations where people pump their own gas. And he is not going to shed any tears when people lose their homes if it comes to that.
No one of any moral character would go to a microphone and tell people that it would be crazy to not consider taking on ARMs and equity loans without also telling them of the specific risks that such moves might cause to their future household budgets, including potential loss of shelter.
Average homeowners are not that financially sophisticated. The last thing they need to be doing is pushing their shelter and budgets at risk.
Whenever any member of the Fed steps across the line beyond the Fed's defined role of monetary policy and starts actively encouraging individuals across the nation to switch homeownership financing to more risky options or openly solicits for more types of less secure mortgage instruments, people should raise firm objections.
It is absolutely none of the Federal Reverse's business as to how we finance our houses. To suggest otherwise is to assume that the Fed and its spokesmen are offering individuals professional financial and legal advice without bearing any of the responsibility of such advice. And that is what Greenspan has done on more than one occasion.
Greenspan has acted like little more than a used car salesman pushing a product without any warranty disclosure. "Hey, buddy. It's a good deal. Do it."
I am a housing bear also. However, I am starting to think I may be wrong. What if the entry of China, India, and other low-labor-cost/high consuming countries into the global trading game has fundamentally changed the rules of macroeconomics? Perhaps housing prices are not, after all, as crazy as they seem?
What if the entry of China, India, and other low-labor-cost/high consuming countries into the global trading game has fundamentally changed the rules of macroeconomics
Rings of 'New Economy'... truth is the technology may change, products may change, and the names to describe it all may change but the fundamentals never change... still supply & demand, time value of money and profit & loss. Sunrise sunset.
Here is a zinger... one of the comments from Ben Jones housingbubble2 site... and caution... it is a scary one to read. From a guy calling himself letemburn:
Why real estate in California will crash rather than slide:
There will be no "sticky on the way down" this time. Housing bulls love to say that owners will sit on their houses than take less. This couldn't be farther from the truth. In the last real estate crash (1992-1997) we saw So Cal single family homes lose 20-40%. That was a five year slide if you will, but remember the amount of run up. The run up of the last 4 years makes the last So Cal boom (1987-1991) look like chump change. When the market lost 30% in the last bust, almost everyone felt the pain (very few could sell without a loss). Now, the majority of established owners paid less than half of today's prices, so they can easily sell even with a 30% decline from today's highs. So when the correction starts and recent buyers sit on their homes, their established neighbor that is relocating for a job promotion or the elderly couple retiring back to Michigan, will happily sell at 30% below today's price. Why, because they can. They will be getting on with their lives and won't give a hoot in hell how much the new guy overpaid. So, no Virginia, there is no Santa Clause and their will certainly be no sticky on the way down this time. Greed will be punished!
Since the last So Cal bust the Sate of California became a "non-deficiency" state. This legislation was brought about by the staggering number for foreclosure during the last bust. In a "non-deficiency" state, you can walk away from your first mortgage and your lender can't go after you for the difference. Yes, the lender can trash your credit score and 1099 you (The IRS will still get what is due). If you took out a second (HELOC) or refinanced, the non-deficiency law does not shield you. As long as it is the original mortgage, you can skate. Trust me, when home prices slip 30% and people that had been life long renters with zero down I/O ARMs will make new subdivisions look like ghost towns and become renters again (the new bankruptcy law won't matter in a "non-deficiency" case). Why would they keep paying a mortgage on a house that is a loser and they had nothing into it anyway. You will sit in your sparsely populated street while investors buy the foreclosures on your block and turn them into Section 8 rentals. Greed will be punished.
The last time I/O loans were popular was 1928 (just before the great speculation crash). People think I/O loans are a new loan product, but they left such a bad taste in depression era folks mouth, that it took 70 years before idiots again thought "hey this looks like a good deal". Some of these loans have 10 year I/O options. Sorry, if you have an I/O loan you own nothing, you are only a renter with an option to buy. The main difference is your rent (mortgage) is twice real rent and when the roof leaks or AC dies, you don't get to call the landlord, you get to fix it. This product relies 100% on asset appreciation and historically low rates to avoid utter disaster. Folks will find out very soon that nothing is immune to the business cycle (its called "reversion to the mean"). Housing always has and always will be tied to income (except during these brief manias). Again, when these I/O's convert to full amortization, many will be crushed. You will not be able to refi if rates go up (and they can only go up from here) cause the house won't appraise for the principle anymore (So, no just starting the clock over again with another ARM). Greed will be punished.
2:38 PM
Wow... I don't know what will happen but reading that makes me want to lock up the gun and give the keys to my wife... maybe flush the Kool Aid down the toilet too.
Thanks to Jason Wright for posting the actual wording of Greenspan's remarks. I, too, had been remembering them as an irresponsible endorsement of ARMs, but after another reading I see that's not so. I suspect that to Greenspan, it is "immediately obvious to the casual observer" (as the Profs used to say) that although an ARM is likely (but not certain) to be cheaper long-term, a buyer should not enter into one unless capable of dealing with the worst-case adjustment scenario (most ARMs have caps on the range of adjustment).
Greenspan's suggestion that, "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage," is hardly equivalent to "All Americans should use cap-free, infinitely adjustable ARMs instead of fixed-rate mortgages."
Though I expect the real estate bubble to burst soon, I doubt the cause will be rising interest rates -- except perhaps as a transient trigger. Simple oversupply seems more than capable of ending the party. Here in Chicago, a condo market collapse appears already underway, though mortgage rates remain low. And the collapse of the Japanese real estate market has coincided with a very low interest rate environment*.
The probability that interest rates will rise high and stay high very long in the forseeable future seems low. If they do, the economy will plunge into a deflationary recession, and interest rates will fall to very low levels. Provided that the people using ARMs are able to survive the high-rate transient, they probably will pay less interest over the long term than those of us with fixed-rate mortgages.
First, let's give AG his point. You can save money with an ARM.
My first mortgage loan closed in early 1985. I had a one-year CMT ARM with a 2.75 margin and 2/6 caps (the mother of all vanilla ARMs). The start rate was 11.50. That was a 1.25 discount from the fully-indexed rate (CMT was 9.99 on the day my rate was established). I can't remember what the lender was quoting for fixed rate loans then, but according to FRED the national average for FRMs on that date was 13.625.
Were that loan still on the books it would currently have a rate of 5.25, compared with the then-average fixed rate per FRED of 5.75. I ran a schedule for it that shows my loan would have had an average rate over 20 years of 8.143, compared to a 20-year average (on my reset date) of 8.488 for fixed rates.
Of course it wasn't always a deal on any given year in those 20 years. Yeild curves invert, you know, and the per-adjustment cap limits downward as well as upward adjustment. In reality, the loan was refinanced by my ex into a 15-year FRM in 1998 at, I believe, 6.00.
So what, you rightly ask? So of course there are times when an ARM makes real sense: when prevailing rates are high, when the odds of going down are better than the odds of going up, when you can comfortably afford a payment increase, when you have sufficient equity to mean you will qualify for a refinance if and when you're in the money.
Hands up, everybody who was in that situation last year.
What AG DIDN'T say was that portfolio lenders are in mortal terror of booking fixed rate paper, because they can't hedge the interest rate and duration risk. So consumers taking ARMs right now are assuming that risk instead, making it attractive for portfolio lenders to load up on unsecuritized whole loans. Yes, a lot of it is securitized. A whole lot of it ain't.
psh, Fed & Administration did this TOGETHER, this mess is bigger than what either could do alone.
Dryfly, I think it's worth repeating that since MOST standard arm down payments are
Spoken like a dot.commer... there is NOTHING really new under the sun... not in economics or politics. Just the same reshuffling of what always was... .
First, let's give AG his point. You can save money with an ARM.
You can save money by self-insuring too... that is 'underwriting your own risk' for health insurance & housing & crop failure & floods... but it isn't for everyone. You have to have significant resources to do that... if it goes badly you dig into your pocket and pay... you have to be able to do that and most can't.
Same thing applies to ARMs... Tanta you showed how you SAVED money with an ARM as interest rates declined... well that is what they are supposed to do! Rates go down you save. If that hadn't happened why would they even exist?
The point I was trying to make is we are now near bottom... the opportunity to SAVE is mostly behind us. At best it is 'steady as she goes' or up... and over a 30 year period there will be periods where it might go up a lot. That's why the banks can't hedge either. The RISK to the average Joe playing in this arena is HUGE... bigger than the banks who have deeper pockets.
Again compare consequences of guessing wrong in both cases under todays conditions... not looking backward in the rear view mirror to 1985... If a guy gets a FRM today and guesses wrong - and rates stay low or go lower... he misses out on savings but has no additional out-of-pocket expenses. If he gets an ARM today and guesses wrong and rates go up... he maybe loses all depending on how much it goes up and how close to the edge they are.
I fully understand why the industry wants to push ARMs - for the same reason they push them in Europe - they don't want the risk and can't hedge them. I have buddies in Europe and they would LOVE to have our FRM products at our prices & terms - they aren't available. Industry only offers them at high premiums because of the risk.
This whole effort on AG's part to paint it as benefiting the consumer is complete hog wash. It was for his cronies... shift the risk to the little people and watch'em squirm.
I don't particularly disagree with you, dry fly, and I'm sorry I sounded naive to you. I have been on this board and others getting all righteous about exotic ARMs and the current popularity of ARMs in a low-rate environment. I simply thought it was worth illustrating precisely the extent to which AG's point about the consumer makes sense. It makes sense if, like AG, you were looking back over the last decade or two. And it doesn't make sense if you took an ARM last year (when AG made that comment) when the underlying index value was 1.30. I hardly think I'm defending AG here. I certainly don't intend to. He's using a "historical" point to make a current justification of risky lending practices.
Tanta: You just alluded to it in the last paragraph, but the thing with ARMs is the risk of adjusting up in an environment where your general cost structure will be up. Risk is always a forward-going thing, you cannot "disprove" it by arguing past performance.
You don't jump over to ARM's when fixed mortgage rates are in the five percent range. That's as good as it will probably get for fixed mortgages. So, that's when you lock in. Securing payments at low rates over three decades.
Greenspan was using the ARM and home equity remarks as a financial pump. Nothing more.
AG was irresponsible in my opinion for highlighting the proliferation of ARM as a smart financial instrument in a low-interest environment which he and the Feds admit to not have control any longer.
I can't handle this lack of rationality regarding the state of this country's economy and the future of this country.
I don't even let people get out of their Lexus or similar at the malls
without saying that we're going to take away their Medicare and raise their taxes for that Lexus (& we are fifteen years behind in doing it)...
Same re what is going on in housing and the lack of controlling the Monopoly Board games going on.
Am finally convinced by now, 90% of people these days do not change behaviors without stiff penalties.
Movie Guy: There is a very real chance that a fixed mortgage rate of 5% may look rather high in the not too distant future. Keep in mind that money supply growth depends heavily on the multiplicative effect of fractional reserve banking, which in turn depends completely on people wanting to borrow and banks being willing to lend. As Richard Koo describes so well in "Balance Sheet Recession", the major reason that Japan has been in the doldrums for the last decade has been that so many entities in the financial system have been desperate to pay down debt and repair their balance sheets, and/or are looked upon by the banks as such bad credit risks that the banks don't want to lend to them. Some months ago the Japanese central bank tried to push funds out into banking system, and the banks basically said, "No thanks," because there was no one to lend them to; though interest rates are very low, not enough entities both want to and are able to borrow.
As others have noted here, many people buying homes at bubble prices think they are going to refinance someday, but are oblivious to the risk (near certainty?) that that just won't be possible, because prices will have fallen so low that the largest new loan they might get would be much less than the one they will be trying to get out of.
So if any set of events once sends the economy into a deflationary state a la Japan, those who have adjustable-rate loans AND have enough income to make their payments may very well have the best deal. But of course, one of the events that might precipitate deflation would be a short-term upward spike in interest rates, so only those able to survive that spike (in Greespan-speak, manage their interest-rate risk) will not have been already foreclosed upon and benefit from the future low rates.
It's entirely possible that mortgage rates will be down in the sub-3% range in a few years. But no one will want to speculate in real estate anyway, because, as some young friends of mine in Japan said to me a few years ago, "We're thinking of buying a condo, but we're going to wait, since they'll be cheaper in a few years."
I can understand the anger toward Greenspan.
The bubble is a result of interest below zero (in real terms).
But eventually all the demand will be met, and at that point the prices will collapse low rates or not.
The bonus of course is the fools that have jumped in and financed this economic expansion will have a debt burden for their life.
Better the homebuyers with the debt load, than the taxpayer.
In the past governments would spend and spend whether we agreed with it or not, at least this way, those who wanted to finance the recovery of the dot.com bust voted with their wallets.
Greenspan is something else.
Back when he told people they were crazy not to consider ARM loans, it was clear to me that he was using the powerful dialogue as a vehicle to stimulate consumer expenditures. By putting people's households at risk.
Now he acknowledges the growth in consumer expenditures due to such loans and home equity loans but apparently doesn't find anything wrong with his previous public announcement about jumping to ARMs. Yet he notes that many people are overextended. But that the banking system will be fine, suffering no major losses.
He simply used his chair's voice to sucker people into risky mortgage situations.
His discrediting the likelihood of many foreclosures is another example of his disregard for people. When and if it happens on a larger scale, he will obviously come up with another disclaimer.
Greenspan is dangerous.
I concur. Greenspan is dangerous and irresponsible and should be terminated.
They are having a free for all over on housingbubble2 discussing it... good thing it is happening on the internet and not on a subway or in a bar... folks would be dead by now.
if this thing continues for a year or so, I believe all of us will see it on the streets!
For the record, here are Greenspan's actual words on February 23, 2004:
"Recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.
American homeowners clearly like the certainty of fixed mortgage payments. This preference is in striking contrast to the situation in some other countries, where adjustable-rate mortgages are far more common and where efforts to introduce American-type fixed-rate mortgages generally have not been successful. Fixed-rate mortgages seem unduly expensive to households in other countries. One possible reason is that these mortgages effectively charge homeowners high fees for protection against rising interest rates and for the right to refinance.
American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."
Nothing in this statement seems outrageous to me. As far as I know, I haven't heard of anyone in the last 5-years or more getting nailed because they have an ARM. Greenspan plainly acknowledged ARMs would not save homeowners money if interest rates trended sharply upward.
I do not find a problem in what Alan Greenspan is saying. Greenspan is superb at understand how the economy is functioning. I also thought he was right about the advantage of Adjustable Rate Mortgages in a market with stable to declining interest rates as we have had for more than 2 decades.
just wait what happens when entities start cutting back on loaning money to the over consuming society (US). Interest rates WILL soar.
I also thought he was right about the advantage of Adjustable Rate Mortgages in a market with stable to declining interest rates as we have had for more than 2 decades.
Jennifer - I know you are familiar with the concept of 'reversion to trend' or sometimes called 'reversion to mean'? You're to sharp to not be... well AG gets the concept too.
In my view he was an ass for suggesting people take out ARMs when knowing full well he would likely be increasing interest rates and soon and maybe a lot... Anyone else could maybe make that comment without all the blame because they don't have their hands in it... but not AG. It is almost like Lucy holding the football for Charlie Brown... AG telling the public... "Now go ahead and kick it"...
It they ever settle scores after the revolution... I hope they drag AG in front of the Troika first... even before Karl Rove.
And I'm only being half snarky when I said that...
I agree w/ dryfly. It's not what ag says, it's when he says it. He's ALWAYS been an Administration lackey. He combined w/ this Administration to create this housing bubble (he contributed low int. rates & loosened lending practices, the Admin's 2 biggest supporters fnma & freddie compunded the problem). AG commented only when thought the frenzy had gone too far, & he did this in his usual way -by warning his institutions the endgame was around the corner. Time for them to unload their portfolios & tighten lending policies. Sounds a lot like when he proclaimed that the frenzied stock market reflected a "new economy".
Important point is to listen, he;s got the clout. When he told his banks to tighten lending policy - it was time for us little guys not only not to buy, but to sell.
Dry Fly
Your points are well taken, as always. The comment about ARMs was made 20 years into a bull market in bonds and shortly before the Fed would begin raising short term interest rates. Still, the bull market in bonds has continued till now and ARMs have been a significant saving device. Could we be verging on a spike in long term rates however in the coming years? There is the worry. I understand your discomfort. Thank you.
Remember though, the bull market in bonds begun in December 1981 continues still and bond bears have been wrong repeatedly to this point.
CR
I still think it is worthwhile watching the performance of the Vanguard REIT Index for an understanding of the strength or weakness of the real estate market.
Remember though, the bull market in bonds begun in December 1981 continues still and bond bears have been wrong repeatedly to this point.
Jennifer - review 'reversion to mean' and then think about the 'relative risk & consequences'...
Lets say consumers guess rates are going to go up and lock in a 5% mortgage... and they guess wrong, rates go even lower to say 4%... what are the consequences? Nothing really other than they don't benefit from the savings they would have had if they had taken out an ARM... the 'loss' is an 'opportunity loss' and on paper only.
But what if they had taken out an ARM thinking rates will stay low or go lower... and they guess wrong, what then? Real money comes out of the family budget and maybe a lot of it if they guess really wrong and rates go up a lot. The consequences of this 'wrong guess' is very tangible - maybe they lose the home.
I know AG is smart enough to do this kind of reasoning... He also knew that the probability of rates going higher was FAR greater than the rates going lower when he recommended ARMs... and this wasn't because he was a good guesser... it was because the FED was already gearing up for the increases... positioning.
People are playing with this like it is a game... like it was monopoly money. I grew up in a family that started small businesses in recession and almost lost the family home... saw the terror in my parents eyes. People are going to get burned I am sure of it. The only questions I have is how many, how badly, how soon?
"significant declines in ... volatility inferred from prices"
'fraid not. the rewards for taking risk have been bid way down as savers have been punished with zilch real interest rates.
It's not a game, it's social engineering. The Fed made a policy decision to force us into debt. That's why savers are almost extinct.
Greenspan wanted that mortgage money back in the economy. That was his intent.
He doesn't care about the average citizen. He's up in the cloud layer above the gas stations where people pump their own gas. And he is not going to shed any tears when people lose their homes if it comes to that.
No one of any moral character would go to a microphone and tell people that it would be crazy to not consider taking on ARMs and equity loans without also telling them of the specific risks that such moves might cause to their future household budgets, including potential loss of shelter.
Average homeowners are not that financially sophisticated. The last thing they need to be doing is pushing their shelter and budgets at risk.
Whenever any member of the Fed steps across the line beyond the Fed's defined role of monetary policy and starts actively encouraging individuals across the nation to switch homeownership financing to more risky options or openly solicits for more types of less secure mortgage instruments, people should raise firm objections.
It is absolutely none of the Federal Reverse's business as to how we finance our houses. To suggest otherwise is to assume that the Fed and its spokesmen are offering individuals professional financial and legal advice without bearing any of the responsibility of such advice. And that is what Greenspan has done on more than one occasion.
Greenspan has acted like little more than a used car salesman pushing a product without any warranty disclosure. "Hey, buddy. It's a good deal. Do it."
I am a housing bear also. However, I am starting to think I may be wrong. What if the entry of China, India, and other low-labor-cost/high consuming countries into the global trading game has fundamentally changed the rules of macroeconomics? Perhaps housing prices are not, after all, as crazy as they seem?
What if the entry of China, India, and other low-labor-cost/high consuming countries into the global trading game has fundamentally changed the rules of macroeconomics
Rings of 'New Economy'... truth is the technology may change, products may change, and the names to describe it all may change but the fundamentals never change... still supply & demand, time value of money and profit & loss. Sunrise sunset.
Here is a zinger... one of the comments from Ben Jones housingbubble2 site... and caution... it is a scary one to read. From a guy calling himself letemburn:
Why real estate in California will crash rather than slide:
There will be no "sticky on the way down" this time. Housing bulls love to say that owners will sit on their houses than take less. This couldn't be farther from the truth. In the last real estate crash (1992-1997) we saw So Cal single family homes lose 20-40%. That was a five year slide if you will, but remember the amount of run up. The run up of the last 4 years makes the last So Cal boom (1987-1991) look like chump change. When the market lost 30% in the last bust, almost everyone felt the pain (very few could sell without a loss). Now, the majority of established owners paid less than half of today's prices, so they can easily sell even with a 30% decline from today's highs. So when the correction starts and recent buyers sit on their homes, their established neighbor that is relocating for a job promotion or the elderly couple retiring back to Michigan, will happily sell at 30% below today's price. Why, because they can. They will be getting on with their lives and won't give a hoot in hell how much the new guy overpaid. So, no Virginia, there is no Santa Clause and their will certainly be no sticky on the way down this time. Greed will be punished!
Since the last So Cal bust the Sate of California became a "non-deficiency" state. This legislation was brought about by the staggering number for foreclosure during the last bust. In a "non-deficiency" state, you can walk away from your first mortgage and your lender can't go after you for the difference. Yes, the lender can trash your credit score and 1099 you (The IRS will still get what is due). If you took out a second (HELOC) or refinanced, the non-deficiency law does not shield you. As long as it is the original mortgage, you can skate. Trust me, when home prices slip 30% and people that had been life long renters with zero down I/O ARMs will make new subdivisions look like ghost towns and become renters again (the new bankruptcy law won't matter in a "non-deficiency" case). Why would they keep paying a mortgage on a house that is a loser and they had nothing into it anyway. You will sit in your sparsely populated street while investors buy the foreclosures on your block and turn them into Section 8 rentals. Greed will be punished.
CONTINUED
more from letemburn:
The last time I/O loans were popular was 1928 (just before the great speculation crash). People think I/O loans are a new loan product, but they left such a bad taste in depression era folks mouth, that it took 70 years before idiots again thought "hey this looks like a good deal". Some of these loans have 10 year I/O options. Sorry, if you have an I/O loan you own nothing, you are only a renter with an option to buy. The main difference is your rent (mortgage) is twice real rent and when the roof leaks or AC dies, you don't get to call the landlord, you get to fix it. This product relies 100% on asset appreciation and historically low rates to avoid utter disaster. Folks will find out very soon that nothing is immune to the business cycle (its called "reversion to the mean"). Housing always has and always will be tied to income (except during these brief manias). Again, when these I/O's convert to full amortization, many will be crushed. You will not be able to refi if rates go up (and they can only go up from here) cause the house won't appraise for the principle anymore (So, no just starting the clock over again with another ARM). Greed will be punished.
2:38 PM
Wow... I don't know what will happen but reading that makes me want to lock up the gun and give the keys to my wife... maybe flush the Kool Aid down the toilet too.
Thanks to Jason Wright for posting the actual wording of Greenspan's remarks. I, too, had been remembering them as an irresponsible endorsement of ARMs, but after another reading I see that's not so. I suspect that to Greenspan, it is "immediately obvious to the casual observer" (as the Profs used to say) that although an ARM is likely (but not certain) to be cheaper long-term, a buyer should not enter into one unless capable of dealing with the worst-case adjustment scenario (most ARMs have caps on the range of adjustment).
Greenspan's suggestion that, "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage," is hardly equivalent to "All Americans should use cap-free, infinitely adjustable ARMs instead of fixed-rate mortgages."
Though I expect the real estate bubble to burst soon, I doubt the cause will be rising interest rates -- except perhaps as a transient trigger. Simple oversupply seems more than capable of ending the party. Here in Chicago, a condo market collapse appears already underway, though mortgage rates remain low. And the collapse of the Japanese real estate market has coincided with a very low interest rate environment*.
The probability that interest rates will rise high and stay high very long in the forseeable future seems low. If they do, the economy will plunge into a deflationary recession, and interest rates will fall to very low levels. Provided that the people using ARMs are able to survive the high-rate transient, they probably will pay less interest over the long term than those of us with fixed-rate mortgages.
*See Shakeup in the lending business | The Japan Times Online
First, let's give AG his point. You can save money with an ARM.
My first mortgage loan closed in early 1985. I had a one-year CMT ARM with a 2.75 margin and 2/6 caps (the mother of all vanilla ARMs). The start rate was 11.50. That was a 1.25 discount from the fully-indexed rate (CMT was 9.99 on the day my rate was established). I can't remember what the lender was quoting for fixed rate loans then, but according to FRED the national average for FRMs on that date was 13.625.
Were that loan still on the books it would currently have a rate of 5.25, compared with the then-average fixed rate per FRED of 5.75. I ran a schedule for it that shows my loan would have had an average rate over 20 years of 8.143, compared to a 20-year average (on my reset date) of 8.488 for fixed rates.
Of course it wasn't always a deal on any given year in those 20 years. Yeild curves invert, you know, and the per-adjustment cap limits downward as well as upward adjustment. In reality, the loan was refinanced by my ex into a 15-year FRM in 1998 at, I believe, 6.00.
So what, you rightly ask? So of course there are times when an ARM makes real sense: when prevailing rates are high, when the odds of going down are better than the odds of going up, when you can comfortably afford a payment increase, when you have sufficient equity to mean you will qualify for a refinance if and when you're in the money.
Hands up, everybody who was in that situation last year.
What AG DIDN'T say was that portfolio lenders are in mortal terror of booking fixed rate paper, because they can't hedge the interest rate and duration risk. So consumers taking ARMs right now are assuming that risk instead, making it attractive for portfolio lenders to load up on unsecuritized whole loans. Yes, a lot of it is securitized. A whole lot of it ain't.
I have to agree here with Anonymous these prices are NOT EXTREME take a look at what is happening to home values in Spain and France and Italy.
This is a new Macroeconomic model get used to it.
psh, Fed & Administration did this TOGETHER, this mess is bigger than what either could do alone.
Dryfly, I think it's worth repeating that since MOST standard arm down payments are
This is a new Macroeconomic model get used to it.
Spoken like a dot.commer... there is NOTHING really new under the sun... not in economics or politics. Just the same reshuffling of what always was...
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First, let's give AG his point. You can save money with an ARM.
You can save money by self-insuring too... that is 'underwriting your own risk' for health insurance & housing & crop failure & floods... but it isn't for everyone. You have to have significant resources to do that... if it goes badly you dig into your pocket and pay... you have to be able to do that and most can't.
Same thing applies to ARMs... Tanta you showed how you SAVED money with an ARM as interest rates declined... well that is what they are supposed to do! Rates go down you save. If that hadn't happened why would they even exist?
The point I was trying to make is we are now near bottom... the opportunity to SAVE is mostly behind us. At best it is 'steady as she goes' or up... and over a 30 year period there will be periods where it might go up a lot. That's why the banks can't hedge either. The RISK to the average Joe playing in this arena is HUGE... bigger than the banks who have deeper pockets.
Again compare consequences of guessing wrong in both cases under todays conditions... not looking backward in the rear view mirror to 1985... If a guy gets a FRM today and guesses wrong - and rates stay low or go lower... he misses out on savings but has no additional out-of-pocket expenses. If he gets an ARM today and guesses wrong and rates go up... he maybe loses all depending on how much it goes up and how close to the edge they are.
I fully understand why the industry wants to push ARMs - for the same reason they push them in Europe - they don't want the risk and can't hedge them. I have buddies in Europe and they would LOVE to have our FRM products at our prices & terms - they aren't available. Industry only offers them at high premiums because of the risk.
This whole effort on AG's part to paint it as benefiting the consumer is complete hog wash. It was for his cronies... shift the risk to the little people and watch'em squirm.
I don't particularly disagree with you, dry fly, and I'm sorry I sounded naive to you. I have been on this board and others getting all righteous about exotic ARMs and the current popularity of ARMs in a low-rate environment. I simply thought it was worth illustrating precisely the extent to which AG's point about the consumer makes sense. It makes sense if, like AG, you were looking back over the last decade or two. And it doesn't make sense if you took an ARM last year (when AG made that comment) when the underlying index value was 1.30. I hardly think I'm defending AG here. I certainly don't intend to. He's using a "historical" point to make a current justification of risky lending practices.
Tanta: You just alluded to it in the last paragraph, but the thing with ARMs is the risk of adjusting up in an environment where your general cost structure will be up. Risk is always a forward-going thing, you cannot "disprove" it by arguing past performance.
Here's why the Greenspan advice was bad.
You don't jump over to ARM's when fixed mortgage rates are in the five percent range. That's as good as it will probably get for fixed mortgages. So, that's when you lock in. Securing payments at low rates over three decades.
Greenspan was using the ARM and home equity remarks as a financial pump. Nothing more.
Slate explains the point a bit better.
Alan Greenspan: ARMed and dangerous. - By Daniel Gross - Slate Magazine
Then FDIC.
FDIC: FDIC Outlook Winter 2004
as compared to the rest of Greenspan's 23 Feb 04 speech:
http://www.federalreserve.gov/boarddocs/speeches/2004/20040223/default.htm
AG was irresponsible in my opinion for highlighting the proliferation of ARM as a smart financial instrument in a low-interest environment which he and the Feds admit to not have control any longer.
One sector dominating.
I can't handle this lack of rationality regarding the state of this country's economy and the future of this country.
I don't even let people get out of their Lexus or similar at the malls
without saying that we're going to take away their Medicare and raise their taxes for that Lexus (& we are fifteen years behind in doing it)...
Same re what is going on in housing and the lack of controlling the Monopoly Board games going on.
Am finally convinced by now, 90% of people these days do not change behaviors without stiff penalties.
Movie Guy: There is a very real chance that a fixed mortgage rate of 5% may look rather high in the not too distant future. Keep in mind that money supply growth depends heavily on the multiplicative effect of fractional reserve banking, which in turn depends completely on people wanting to borrow and banks being willing to lend. As Richard Koo describes so well in "Balance Sheet Recession", the major reason that Japan has been in the doldrums for the last decade has been that so many entities in the financial system have been desperate to pay down debt and repair their balance sheets, and/or are looked upon by the banks as such bad credit risks that the banks don't want to lend to them. Some months ago the Japanese central bank tried to push funds out into banking system, and the banks basically said, "No thanks," because there was no one to lend them to; though interest rates are very low, not enough entities both want to and are able to borrow.
As others have noted here, many people buying homes at bubble prices think they are going to refinance someday, but are oblivious to the risk (near certainty?) that that just won't be possible, because prices will have fallen so low that the largest new loan they might get would be much less than the one they will be trying to get out of.
So if any set of events once sends the economy into a deflationary state a la Japan, those who have adjustable-rate loans AND have enough income to make their payments may very well have the best deal. But of course, one of the events that might precipitate deflation would be a short-term upward spike in interest rates, so only those able to survive that spike (in Greespan-speak, manage their interest-rate risk) will not have been already foreclosed upon and benefit from the future low rates.
It's entirely possible that mortgage rates will be down in the sub-3% range in a few years. But no one will want to speculate in real estate anyway, because, as some young friends of mine in Japan said to me a few years ago, "We're thinking of buying a condo, but we're going to wait, since they'll be cheaper in a few years."
I can understand the anger toward Greenspan.
The bubble is a result of interest below zero (in real terms).
But eventually all the demand will be met, and at that point the prices will collapse low rates or not.
The bonus of course is the fools that have jumped in and financed this economic expansion will have a debt burden for their life.
Better the homebuyers with the debt load, than the taxpayer.
In the past governments would spend and spend whether we agreed with it or not, at least this way, those who wanted to finance the recovery of the dot.com bust voted with their wallets.