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June 7, 2005

Today's Housing Bubble Post

-- by Dave Johnson

It occurs to me that risky loans make other loans more risky. Here's what I mean. When a bank gives a loan to someone who is on the borderline of making the payments, they take the risk of ending up with a default. And right now, at least around here, housing loans are no-down-payment, interest-only, adjustable-rate mortgages made to 21-year-olds who have been employed for three months on their first job. So there is a very, very high risk of defaults. Very.

Foreclosures often sell for a lower price. And housing prices are determined by the price of neighboring houses. Because so MANY mortgages are this kind of loan now, the lower price on the foreclosed house likely as not means that the house next door is now "underwater" -- worth less than the amount still owed on the loan that bought it.

At some point, seeing what's coming, that homeowner puts the house up for sale and takes what they can get. Now the whole neighborhood is panicking and prices are cascading down. ALL the houses are underwater. So ALL the risky loans are even riskier.

This is what I mean by risky loans making other loans even riskier. They almost guarantee a certain number of foreclosures, which means distress sales, which puts the other risky loans underwater. So these banks making these loans are blowing it for all the other lenders. This is a situation crying out for the government to do something, and soon.

It is just so sad
when good loans go bad.

Posted by Dave Johnson at June 7, 2005 6:29 PM

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Comments

I'm not sure you understand the foreclosure deal. There is a whole industry of people who make quite a good profit from foreclosures. The bank keeps all the previous owner's equity, so they can afford to foreclose and sell at a fire-sale price. The new buyer flips it quickly and makes a good profit too. Everyone profits.. except the poor schmuck who lost his house.

Posted by: Charles at June 7, 2005 8:03 PM

I have of late been looking closely at fire-sale foreclosures and risky loans. It smells a lot like gambling, but if one were paying close enough attention...

'Round here housing is up fifteen percent a year, doubling in value over five. Much of the immigration here is out of those markets marked for adjustment, with housing starts now scheduled two years out, most bought and paid for. Should those markets marked for adjustment adjust, I doubt we would see an impact here for five years, and then only if the market adjusts resoundingly. Which would in turn feed even more immigration out of the adjusted markets...

By all the laws of nature, a perpetual motion is bound to fail, to implode. But when?

Posted by: Thomas Ware at June 7, 2005 9:09 PM

Charles, you missed one important point, there is no more equity for the banks to take. They are giving 100% loans. Its the mortgage brokers and loan originators who make the money with all their fees, points and yield spreads. The lenders who purchase on the secondary market lose under these risky loans that are often papered to hide the problems.

Posted by: Beth at June 8, 2005 4:28 AM

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