TCS Daily

Your Income and Your House

By Arnold Kling - December 10, 2007 12:00 AM

"In Northern California, a household income of $90,000 per year could legitimately pay the minimum monthly payment on an Option ARM on a million [dollar] home for the past several years. Most Option ARMs allowed zero to 5% down. Therefore, given the average income of the Bay Area, most families could buy that million dollar home. A home seller had a vast pool of available buyers.

Now, with all the exotic programs gone, a household income of $175,000 is needed to buy that same home, which is about 10% of the Bay Area households."
--A Mortgage Industry Insider

Over the past few years, the housing market became riddled with bogus lenders funneling mortgage money to bogus owners of houses with bogus prices. Attempting to prop up this phony baloney is a pointless exercise. What the housing market needs in order to get back to normal is a strong dose of reality.

When we bought our house 25 years ago, we paid $130,000. I think our income at the time was around $35,000, so we paid a little less than four times our income for the house. If we had thought we could have afforded more, we would have gotten a similar house with a garage for another $10,000. Over the years, we've often regretted not having a garage.

What the "mortgage industry insider" suggested to columnist-blogger Herb Greenberg is that it became commonplace in some parts of California for people to buy houses at prices more than ten times their incomes. It's hard for me to have a whole lot of sympathy for those people today, considering that we didn't think we could afford four times our income when we passed up a house with a garage.

Balancing Supply and Demand

In my opinion, the number one priority in resolving today's mortgage crisis is to bring the housing market back to equilibrium. Equilibrium means prices that are in line with incomes, with supply and demand in balance. With equilibrium prices, houses could be readily bought and sold. When houses can be readily bought and sold, mortgage loans are backed by valid collateral. When mortgage loans are backed by valid collateral, investors will once again be able to trust securities backed by pools of mortgages. Only when we reach that point will the "subprime crisis" be behind us.

The alternative to bringing the housing market back to equilibrium as soon as possible is to kick the problem down the road by keeping people in homes that they cannot afford. Keeping people in their homes at artificially low interest rates will only serve to perpetuate a distorted structure of home prices, ensuring that the crisis stays with us for years.

Determining the Right Price

I believe that the maximum ratio of the house price to income should be six. I calculate that figure as follows.

First, assume that it is reasonable for a household to pay 25 percent of its gross income on rent. So if you have a $48,000 household income, you can afford $12,000 a year in rent, or $1000 a month.

Next, assume that you make a rent vs. buy calculation by figuring that you need an inflation-adjusted return on housing investment of 4 percent per year. The price/rent ratio is 100 divided by the required return. 100/4 = 25, suggesting that the price/rent ratio should be 25.

Historically, price/rent ratios in the housing market have been lower--closer to 15. I am not sure why it has been so low. Perhaps it reflects high transaction costs in the housing market--real estate commissions and all of the "junk fees" that afflict home buyers.

If my figure for the price/rent ratio of 25 is correct, then a household that would spend $12,000 a year on rent should buy a house for 25 times that amount, or $300,000. If the price/rent ratio should be 15, then that household should spend no more than $180,000 on a house. Those are the sorts of house prices that make sense for a household with an income of $48,000.

Mark them down, move them out

When we bought our house, we put down 20 percent of the value of the home. Many of today's home "owners" have put nothing down. They have no equity in their homes, which is why I put the term "owner" in quotes. This makes it particularly difficult for me to understand why I should want to keep these people in their homes. If you have no equity in the home, and the home is more than you can afford on your income, then what gives you the right to live in that home?

It is not clear to me what purpose is served by encouraging people to stay in expensive houses at artificially low interest rates. The way I see it, if you're living in a house that cost more than six times your income, and you have no equity in the house, then the logical thing is for you to sell that house and move to a place that you can afford. That's better for the family, and it's better for the health of the housing market.

If we feel sorry for the family, then let's give them a $10,000 tax credit for their troubles. Preferably paid for by confiscating the Rolexes and Lexuses of the real estate agents and mortgage brokers who garnered rich fees for getting families in over their heads. But let's get the bogus homeowners moved out of the houses that are more expensive than what they can afford.

It is possible that although the loan balance is more than 6 times the borrower's income, the true value of the house is now less than that. It is possible that the borrower can afford the house at the true market price, just not at its original inflated value. In that case, it might make sense in theory for mortgage lenders to mark the loan balance down to a level that is no greater than the realistic value of the house.

In practice, it is fairly difficult to tell the mortgage "lenders" how to handle borrowers who are in over their heads. I put "lender" in quotes, because the loan was originated by a broker who took his fee and ran. The loan is now owned by some type of financial institution or pension fund which had nothing to do with the original terms and conditions of the loan. But the solution is certainly not to have the lender string the borrower along with an impossibly large loan balance, even at a subsidized interest rate.

The concept of people owning homes worth ten times their income is a fantasy. Politicians may want to cater to that fantasy, but to do so harms more people than it helps. The people that it harms the most are those who want to buy homes that cost four to six times their incomes. They are the ones that would be best served by a real housing market, not a bogus one.



Length of Investment
A way of mitigating the high prices is longer loan terms. This at a fixed rate at a slightly higer interest rate would assist in markets where real estate is never going to be affordable due to essentially, lack of land.

However, in all cases borrowers should be require to have equity. The entire underwriting process of lending is to mitigate risk. If the borrower has no interest in the property then the bank bears 100% of the risk and of course, everyone, banks included, played on the idea that prices were always going up and that people typically only live in a home for 5-7 years.

They are all guilty of the crime in essence. Simply put, people need to start saving for that first house just like most people did. The days of 100-125% loans needs to end.

I for one am fed up with offers to pull my equity out for a loan. Quite the opposite my goal is to pay the note years early. Imagine if things really got bad, I still have a roof over my head.

I was always taught that one should buy a home worth approximately 3 times ones annual household income, and that 4 times was living dangerously. I've got no sympathy for fools who buy homes 5-10 times their annual household income, sell the home and buy something you can afford.

The only party to this mess that deserves more scorn than people who buy more than they can afford are the ones who sold them on the idea in the 1st place. When people hire a realtor, I believe most expect that they are hiring someone who will be looking out for their interests. Instead most realtors are focused on earning the largest possible commission. It's not ethical in my mind to claim to represent the interests of the buyer, and then get them into a home they can not or even might not be able to afford.

King Kling has spoken
Arnold Kling knows what’s best for everyone. He’s an extremely bright guy. I’m not going to dispute his wisdom. I dispute his ethics.

At first glance he seems to get the issue -- self-responsibility -- except he wants to impose it. He rightly doesn’t want the government to subsidize profligate behavior but wants to “encourage” better habits.

Of course, he has no sympathy for “real estate agents and mortgage brokers” who he has judged fraudulent. In fact there were many borrowers who lied about their income and occupancy status.

The simple matter is that wholesale rewriting of contracts violates the rule of law. Individual fraud is a criminal matter, not a policy matter. We need to respect the property rights of the borrower as much as the homeowner.

Self-responsibility is an individual responsibility. Let the chips fall where they may. But let’s not paint whole demographic groups with a broad brush and deal with them by arbitrary fiat.

I’ve talked about this before:

Always follow the money...
Realtors -- they get paid by whom? The seller. Always.
So, any buyers under the delusion that the realtor is looking out for you, get what you deserve. Get a realtor who is a relative or get one of those 'buyer agents' who work (and get paid by) you.

I live in the Bay Area and haven't bought a house precisely for the reasons you list in your first paragraph. It has been totally insane out here. Something like the majority of home purchases in the last 5 years are financed by ARMs of pretty exotic nature. There are three bedroom condos built near my work that sold "in the low $700s!" two years ago. I just saw one of them on sale for $500k or best offer (probably a pre-foreclosure).

NIMBY snobs
Local zoning boards create snob zoning rules to keep the prices of their houses high by restricting the market.

One of the most prime real estate markets in the country is in Sanata Barabra. A majority does not want any more housing to be built, but they do want to preserve various cropland.

Major industries in the area can't attact people because they can't afford to live there.

Granted, SB is a unique area and housing should be expecsive, but the locals shouldn't complain about where their housekeepers and gardeners are going to live.

800 Pound Gorilla were not talking about
It seems to me that rocketing real estate values may have been what was driving the economy for the past decade. My home tripled in value and a couple years back I got a second morgage to do some extensive remodling and clear up a lot of credit card debt that had built up over the years. Everyones talking about the sub-prime crash and missing (I believe) the 800 pound gorrilla in the room, which is the end of free money for homeowners like me. The hundreds of thousands (if not millions) who refinanced and pulled equity out of thier home, and put that cash back into the economy.

Government Subsidies
Government subsidizes medical care, prices soar.

Government subsidizes education, tuition soars.

Government subsidizes housing, prices soar.

The subsidies come in many forms: mortgage interest deductions, intrerest rates, zoning, disaster insurance (flood insurance), welfare (Drive from El Segundo, CA to Inglewood, CA. How can real estate change so drastically?), school districts.

No Subject
If the labor you desire can't afford to live where you want it seems to me you have two options, pay your labor enough money or move someplace less expensive. It also seems silly to attack people for wanting to protect thier investment, especially if that home represents 6-10 times thier annual income.

Substandard Solutions
Marjon: "Government subsidizes medical care, prices soar.

Government subsidizes education, tuition soars.

Government subsidizes housing, prices soar."

People walk around with open umbrellas, it rains.

Government usually steps in when a problem already exists, and just like an umbrella in driving rain it often fails to adequately address the problem. Inadequate solutions are not to blame for the problem in the first place.

chicken vs. egg
in any of these situations, can you demonstrate that there was an actual need that the market wasn't meeting?

As opposed to a market price was just more than many people wanted to pay?

The government knew all along that mortgage lenders were misbehaving. The ARM process incorporated raw speculation into the (subprime) bottom of the market where investors are actually working families rather then the rich.

Whereas speculative demand is helpful to hold up a broad increase in market values during a bull-run there is an underlying assumption that this will lead to unsustainable high prices that must eventually correct.

In a normal market some of those wealthy speculative investors will get caught long (in an irrational market that finally turns)...and take a back some of their gains...but that is simply part of the game.

However, the government wanted a rapid recovery during this decade and encouraged such recklessness among working class investors who could not tolerate the inevitable correction...simply by allowing this business to go on...when everyone knew better.

The Collateralized Debt Obligations that sliced away the greatest risk exposure into high yielding paper tried very hard to isolate the worst of it as junk...but the complexities of these thick, confidential documents called into question the quality of this entire class of derivative.

Once the government let this foolishness go wild the only thing to do was to let it run its course...until it stopped itself...and then to see what the damage actually looked like. It follows that the government should be part of the solution now that this correction has begun.

This is not about taking care of our most vulnerable citizens...the government is not like that. They don't care about poor people. This is about holding our financial markets together in the face of the immense stupidity of our own financial players.

As individual decision makers most of these bankers only did what seemed to make sense at the time...what was going to happen anyway...whether they participated in it or not. The business opportunity was too good to pass up.

And for the sub-prime borrowers the no-down-payment ARMs were too compelling to resist. The problem was not with the bankers or the buyers. The problem was with the government whose short term agenda was clearly being served by all this action.

Insofar as this (residential real estate) process was fundamentally inflationary it countered the underlying deflationary pressure (regarding commercial real estate) of our industrial base closing its factory floors to transfer manufacturing to Asia. The net effect has been almost no measurable inflation during this period...and, more importantly, we avoided deflation.

This is global financial capitalism that is feeding us all. Severe market disruption due to the current broad based correction...that was clearly not projected by the government economists who let this thing go too far...must be blunted.

The government seems to be taking an aggressive posture regarding this correction. And they seem to be paying close attention to market responses to their interventions. We are not set up for a recession...the banks will take the write downs (they can afford to) and they will recover by doing smarter business during 2008-2009.

Note: the 30% credit card debt that got sliced up into those same CDO's is somewhat more exposed because the underlying assets are unsecured. In so far as they fail to perform the banks must replace all such bad ones with fresh accounts held by consumers who are still making their payments. One can only hope that the CDO covenants all provide for this and that the credit card companies will still be able to increase the interest rates on perfectly good accounts (for no particular reason) going forward with card holders who will probably keep that everyone recognizes this particular (egregious banking) misbehavior.

And, of course, the government has known about that all along too.

"out of equilibrium"
Whenever a government interferes with the economy it has to get out of eqilibrium. It' 100% predictable. In this case, the FED prints money, so people get easy credit, buy things like houses beyond their means, the whole market and economy gets more distorted. Then the government will say they need even more control over the economy in order to put it right. It's like they break your leg, then give you a crutch and say then insult you by teling you that you couldn't even walk witout government help. Easy money is basically another way of buying votes.

eggs for breakfast, chicken for lunch
I wanted to buy health insurance but I also wanted to eat, if it's so expensive that a significent portion of the population would have to sacrifice another necessity such as food or shelter in order to pay for it... then I believe the market is in need of a little government intervention.

"Government usually steps in when a problem already exists, "
Such as, I don't want my neighbor to paint his house a color I don't like?

One significant problem to housing costs are the snob zoning rules imposed to keep out the rif-raf.

Restrict houses to 1 acre for example as is done in Carisle, MA.

Cities restrict the number of housing units available, raise property taxes and restict new businesses then complain to the state and feds when they don't have enough money.

What's great about Vegas is when something is too small, blow it up and build something bigger. Major cities and urban towns are going to have to reconsider zoning restrictions if they want to grow or even maintain.

But the government causes high health costs.
There is no free market in health care and when politicians try to implement free market policies, who screams loudest?

That's the free market solution.
The government solution is to raise the minimum wage and subsidize housing costs.

Maybe the current government intervention is the problem to begin with?
Ask any DOctor who takes Medicare.

problem of the government... that the currently proposed 'fix' involves tremendous moral hazards and even a bit of communism thrown in. I refer to the details of Treasury Secretary Paulson's 'plan' where the government gets involved in de-facto price setting (freezing the terms of ARM resets on interest rates) and determining who gets to and doesn't from credit scores - the lower your credit score, the more help you 'deserve'. The higher, the more you are judged able to pay.
Does anyone remember that Karl Marx cachet: "From each according to his ability, to each according to his need", eh?

Say what you will about Kling trying to impose his views. What he is really doing is trying to put alternatives out there that others will consider over the Paulson disaster in the works.

Oh, and then there's this not so minor issue of the government where the Treasury Secretary was CEO of Goldman Sachs during the big hey day time when most of the CDOs were being bundled and sold there. Talk about conflict of interest.

In California...
...the zoning laws against denser housing exist because of how the state restricts local entities from implementing taxes that might compete with Sacramento's.

See, the property taxes get pretty much split 50/50 between the local school board and Sacramento. The cities don't get squat in property taxes, yet have to maintain infrastructure/services for the increased housing/population. On the other hand, the cities do get to keep the bulk of local sales taxes collected.

So, we get cities that want to zone for more retailing (esp malls and trendy restaurant areas) to bring in the sales tax revenue while restricting the development of condos because once housing gets dense enough, the city actually loses revenue. Some cities have gotten aggressive in pursuing business taxes (which Sacramento allows) from self-employed people working from home, so are seeing the value in homes now. But they aren't getting enough to cover the expenses that more denser housing would cost them, I think.

Plus throw in the aforementioned nimbyism disguised as 'smart growth' and 'open spaces preservation', condo homeowner associations almost always involved in lawsuits with the builders, Prop 13 restrictions/tax treatment inequalities and you have a perfect storm that generates guaranteed supply shortfalls in demanded housing stock year after year.

I've always figured that housing in the Bay Area would take a hit in THE GROWTH of future equity value increases because of the sub-prime mess. But in the end, demographics will kill that and cause actual losses for sure since a lot of middle class folks are simply moving out and all that is left is low-income immigrants and 'high income' existing property owners in their mini mansions. W/o the needed middle class homeowners wanting to 'trade up', just who's going to buy the houses (or who is going to secure enough debt to pretend to buy) at the prices those existing property owners are going to need when they want to cash out, given those demographics? Nobody -- esp realtors -- likes it when I ask these questions at the parties I go to. They are the local equivalent to the 800 pound gorilla acougar mentioned.

I'm a renter who has never bought simply because I thought it was all completely insane, so I don't mind asking those questions. Renters are supposed to be scum who aren't as concerned about community issues, yet here the 'scum renter' is thinking way ahead of the homeowners who refuse to wake up and face reality.

Finally the cause. The solution ain't pretty.
You hit the nail on the head. The cause of this fiasco is simply the price of money and credit. That has been artificially low for a good bit of time. So lenders reacted to this by selling mortgages that reflect low short term rates using adjustable rates or balloon rates of various types. Debtors who see money dropping in value realize that they can pay back future dollars that are worth less than current dollars take on more debt than they can handle.

Of course to make matters worse there exists GSEs: Freddie and Fannie that really hose up the market as lenders get to dump their mortgages on a company backed up by tax payers.

The solution: Stop the Fed from making money and force the GSEs out of existence(They are bankrupt anyway). The whole pyramid will crumble and we can have a rational system of home buying and financing.

Of course, there is a conflict of interest...
The government funds itself by taking a piece out of everything with the word "earnings" attached to it.

Mature industrial companies, financial institutions, and workers all have incomes and they all get taxed.

But our economic paradigm is called financial capitalism for a reason. Growth relies on the leverage of increasing funds of working capital...what we like to call the money supply...raw liquidity.

Without disciplined, healthy banking companies, making loans, earning a margin, paying taxes and capitalizing our continued expansion...this thing falls apart.

Now that is not going to happen because the government won't let it happen. And the government has sufficient tools to get the job done.

But this is not about capitalistic morality versus socialism. This is not about free competition and letting the marketplace sort it all out.

Of course, the government has both hands on the wheel.

Just as Communism was fanciful, appealing to some...but idealistic to a fault, so too are the concepts of social democracy and the competitive market forces of supply and demand...that so look good in your textbooks...essentially wrong. The financial life of the global economy simply doesn't work that way. There are too many variables involved...including the surprisingly irrational nature of market behavior.

Our best Economists simply cannot model it...At this point they can only try very hard to barely avoid obvious stupidities. Sometimes at the last moment.

But there is some hope. We are looking deeper into these phenomena...with fewer (moral) assumptions...and we are learning fast.

Find a house for 3 time your pay
Who can find a house for 3 times their pay? The typical house here runs 200K+, or about 4-5 times, or more, normal pay in the area. Of course you can live 100+ miles away and drive in to work.

Northern Virginia is even worst. Houses are 400K+ and pay about 60K.

depends on where you live
Around here there are many homes for under $100K.

since I can't afford everything I want on my own, I'm entitled to use govt to steal it for me.

It's govt that makes your insurance so expensive, by mandating every treatment option under the sun.

You misunderstand subprime
The typical subprime arm borrower historically got out of his loan before the reset.

The main aim of a subprime holder is to improve his credit to qualify for better terms and then refinance. Also, during the housing boom the borrower saw an increase in equity thus qualifying for better terms on those grounds. Finally, increases in equity allowed some to roll large credit card debt into lower rate loans that have tax deductions. All in all, there are good economic grounds for subprime and subprime arms.

The main problem is the issuance in the last two years. This is a combination of lowering standards (including borrower fraud), speculators, and equity loss (falling house prices). Fraud, both borrower and lender, is a criminal matter and I’ll skip it.

The last generation of borrowers who haven’t stayed current can’t refinance into prime. And those with over an 80% LTV haven’t seen their equity increase to qualify for conforming loans. The former failed to reform bad payment habits while the latter bet on the direction of housing prices and lost.

Let’s remember that subprime market is between normal mortgages (secured by the home, good credit borrowers, good payment patterns, and reasonable interest rates) and credit card debt (not secured, risky, high interest rates.) The subprime is risking (high interest rates but less than credit cards) but secured for the most part. Subprime fills the middle market for partially secured loans with higher rates (but not credit card heights) and tax deductions.

You make some other important comments on capital markets but this is enough for now.

This game needs rules
It would be really hard to avoid coming to the conclusion that here's a market that needs more regulation. It's not just ripples spreading out across the world, it's a reverb effect. The waves won't stop breaking until someone pours a few trillion more upon the waters. Then that someone is in line to absorb the hit.

Then what we have, other than a housing slowdown, is the prospect of price deflation for many millions of homeowners. Their houses are once again only worth what a buyer can afford to pay for them.

You can't blame anyone for failing to foresee this problem. But you can blame them if they don't write up some fresh guidelines for the mortgage industry, and mortgage bundling specifically. We don't exactly even know who owns all those mortgages, they've been cut and pasted so many times.

"'s a market that needs more regulation."
Methinks thou doest propose to place the fox before the open door to the henhouse.

Thanks for the Slam...
"If we feel sorry for the family, then let's give them a $10,000 tax credit for their troubles. Preferably paid for by confiscating the Rolexes and Lexuses of the real estate agents and mortgage brokers who garnered rich fees for getting families in over their heads."

Maybe the Realtors in Maryland drive Lexuses and wear Rolexes, but here in Red State Iowa, I can tell you the average agent drives a three to six year old car worth about $10,000 to $15,000, wears a Fossil or Timex watch, and makes, after taxes and business expenses, under $30,000.

Our market didn't see the wild appreciation of 10% to 15% to 20% or more per year to over-inflate the housing market. We are a steady 3% to 5% year after year. I think in the four full years I've been in the business, I was involved with one sale where the buyers bought a home via a "sub-prime" mortgage, which I, as their agent, had no control over their decisions on how to finance the purchase.

Lay the blame squarely on those who voluntarily entered into this mess - the mortgage bankers and brokers who agreed to loan this phony baloney money AND the fools who bought these homes when they should not have. They don't need any bailouts, tax breaks, or other useless intervention - they need to take their chops and learn to never do this again.

Why the Realtor's Fault?
Did the Realtor pre-approve the faulty mortgage? Certainly No. Did the Realtor tell the buyer how to finance the purchase? Usually No. This is an issue strictly between the lender and the borrower. It's the job of the Realtors to locate, on behalf of the seller, a ready, willing, and able buyer. If the bank says they qualify are we supposed to continue to pry into their personal finances? No. We are marketers - not bankers or investors.

Yes but...
...every TV ad I see from the realtors blatantly depicts realtors as being on the side of the buyer and strongly insinuates that the realtor is going to represent the buyer's interests at heart.

But, as you yourself pointed out, the realtor's job is to work for the seller.

Re: Yes but...
In my state, until an offer to purchase is presented, in legal terms, the buyer's agent represents the interests of the seller. Once the home is offered upon and then under contract, that buyer's agent does legally represent that buyer - but only in the contingencies and terms of the actual of sale of the home, not in terms of regulating the best interests between the buyer and his/her banker. I personally don't bother taking a buyer through a home that they obviously can't afford - they want to look at a $300,000 home and show up in a rusted 1989 Honda Civic. Ethics is HUGE for Realtors, Bankers, and pretty much everybody you do any business with. Are there some turds in my industry? Yes. Are most folks good people who want to be helpful in connecting buyers and sellers while making a fair living? Certainly. I try every day to fall into the latter.

needing more rules
It's not hard for YOU to come to the conclusion that when the goverment makes a problem, the answer is EVEN more goverment meddling in the economy; it's because you're a hard core statist whether you'll admit it or not.
Another conclusion to the problem of the state distorging the ecomony would be to have a freer economy. In this manner the problem would have been avoided.
Also it's phony your argument that 'you cant blame anyone for failing to foresee' this problem. Many people did, and avoided it.

Free markets generaly good but not solution to everything
There is a cost associated with everything. There is a social cost to having millions of children grow up in squalor because their parents can't afford decent housing.

We want people to play by societies rules, but what do they have to gain? I've worked hard to give my son has every advantage possible and he struggles to secure every possible advantage. Those are powerful motivations to play by the rules, there isn't just a stick to keep him playing by societies rules... there are also carrots galore.

Government does a fairly decent job of wielding the stick; it does a very poor job of insuring everyone has solid opportunities that look better than living the thug life. Society plants and reaps hate when it takes advantage of the poor and desperate.

The market seems to deal with this problem by creating a prison industry and handing society the bill, I think we can do better. It seems much more efficient to clear a path to real opportunity, to value human beings and their labor, even if that labor is scrubbing toilets or digging ditches.

Minimum wage and subsidized housing costs are stupid solutions, band aids at best, to serious problems.

What is better?

"Society plants and reaps hate when it takes advantage of the poor and desperate. "

That exactly what you get when you implement socialism.

The free market has created the most free and prosperous societies the world has ever known.

Governments have not.

markets create prison idustry? phony
That's not true at all. In fact, in a free market many of the people now in prison for things like drugs, would NOT be there. In a free market so many such things would not be against the law, thus they wouldn't be in prison, thus it has nothing to do with markets.

I don't buy it
How much are you willing to spend on medical care when you need it? The answer for most people is going to be, whatever it takes.

Are you aware of any country that enjoys greater free market policies and has lower health care costs than the United States?

It seems to me that our medical industry has a duty to share holders and that duty is to bring them as much revenue as is possible. They have been doing a fantastic job.

Mortgage Mess Solution
The Paulson/Bush/Hillary plan for the bailout of the banks in the mortgage mess is a terrible idea that reeks of government intervention and coercion. Instead, let’s try another approach by creating a super fund to help the sub-prime borrowers get out of their self-inflicted financial holes. The fund should be stocked by having all the mortgage bankers, mortgage brokers, real estate brokers, appraisers, lawyers, title company executives, credit agency executives, investment bankers, hedge fund managers, and any other residential real estate parasites forfeit their commissions, bonuses and stock option gains. There are thousands of these “professionals” driving around in their Mercedes, Porsches, Bentleys and Ferraris, living in their multi-million dollar McMansions (fixed rate mortgage with low interest rates, of course), and laughing at the poor rubes who let them get away with the largest heist in the history of the world economy. I think it is only fair to have them return their billions of dollars “earned” over the past five bubble years.

No Subject
I've seen firsthand how some realtors try to push buyers into the maximum value they can qualify for. When my youngest son and his wife were looking to buy their first home several years ago, they had a specific price range that they were interested in. When they prequalified for a substancially higher amount, the realtor tried to push them to buy a much more expensive home. They fired the realtor and bought a more reasonably priced home. Pushing people to buy the maximum amount they qualify for (to jack up the realtor's commission) is setting them up for failure should even a minor financial setback such as a sickness or layoff.

Looking only at the home price is insufficient
The real issue isn't whether a buyer should limit the price of a home to 3, 4, or 6 times his annual income. The real issue, IMO, should be the amount of the monthly payment compared to the buyer's take home pay. This monthly payment should include the principle, interest, taxes, and insurance (PITI). Taxes in some locations are very high and take a big bite. My youngest son is paying over $4000 a year in property tax on his San Diego townhome. That's over $300 a month on top of the loan payment.

Interest rates also pay a big role in affordability, When my wife and I bought our first home in 1986, it cost $79,000. At the time, our family gross income was perhaps $30-40K a year. However, interest rates were about 9.5%. Our PITI payment was $750 a month, almost exactly 1/2 of my monthly take home pay. If we'd tried to buy a house much more expensive than that, we would've been hurting.

Your Income and Your House

---You could not be more correct.
---When I was a personal banker in the early and mid 90's the rule of thumb was your mortgage payment, including taxes and insurance (PITI) should not exceed 28% of your gross monthly income, and all debts should not exceed 36%.

---As time went on I saw those numbers pushed up to 32%/40%.

---I don't understand how anybody with a salary of $90k could afford a $1 million home. I make more than that and can assure you I could barely afford the taxes on a $1mm home in my city.

---Even with an option ARM at say 3% interest, a $950,000 mortgage loan carries an interest payment of $2,375 or 32% of GMI. A 95% loan would carry mortgage insurance, which I would estimate at $396 per month (0.5% of loan amount annually). Depending on your location, insurance on a $1mm home would probably add another $200 a month or so. Finally, lets conservatively set real estate taxes at 1% of value, or $10,000 per year ($833 per month).

---So the total payment is $3,804 or 51% of GROSS income. Now lets reduce gross income by 7% for SS tax on the first $65,000, that's -$379 a month. Then lets pull another 3% for state/city income taxes, that's -$225. how about $300/month for family health insurance (I assume a $1mm home buyer has at least a wife). Finally, lets pull 17% for income taxes or -$1,275.

---Our estimated net income is now $5,321 per month and the estimated base housing expense is 71% of that.

---Tell me how this is affordable?

---I'm sorry, people who purchased these homes should not be saved from their poor decision making and the banks who provide the money and investors who purchased the bonds secured by these foolish loans deserve no rescue.

---I live in Chicago, which is not New York or San Francisco expensive, but a small house on a small lot in a fair neighborhood costs $300k+ and frequently $400k+. This is whu I purchased a more affordable condo. If the market is too expensive too bad. Rent. Private property ownership may be one of the cornerstones of this country, but that is not the same thing as a "right" to be a home owner.

I'm sure you do and meant no offense
I worked at an MLS and learned the 'ethics' is a luxury that more than a few realtors can not afford to have, apparently.

I was so sickened by what I saw that I became visually allergic to Mercedes-Benz cars.

Basically, real estate is influenced by the 20/80 rule -- like most sales activities are -- in that 20 percent of the realtors are competent enough to close 80 percent of the sales. The remaining 80 percent...well, let us just say those were the ones who kept hounding me to help them doctor up the CMAs they wanted to pass off to their clients. When I raised the issue with my boss, I was told to shut up and NEVER raise the issue with the various boards that owned the MLS I worked at. The sleeze was amazing.

The social cost of millions of kids growing up in squalor
How about if you live on the margins you don't have kids.

*****Most of the children who live in squalor are born to parents (or more likely parent) who already lived in squalor.

****It tears me up as much as anybody when I read stories about kids found living in filth. But the fact is that the parent(s) were already poor and living on the margin. They couldn't afford to provide better conditions for themselves much less for children.

****Why is it my responsibility to make up the difference for them? We couldn't afford kids, so my wife and I don't have them. The choice was not easy, but it was right.

****I don't mean that only the rich should have kids, or that if you can't afford private schools, a house, and a pony that you shouldn't have kids. But if you live in a roach infested tenement and make minimum wage, you have no business reproducing.

Sub prime defines itself...

A sub-prime mortgage loan (with an adjustable rate that would eventually become impossible to carry) should have only appealed to those consumers who were not able to qualify for fixed rate loans at the relatively attractive rates available until recently.

As you said: "The main aim of a subprime holder is to improve his credit to qualify for better terms and then refinance." I don't know how anyone, including someone as stupid as me, could misunderstand that definition.

The underlying problem with this scenerio was that the period of time required for the subprime borrower to actually improve his credit to the point that he might qualify for better terms and then refinance his mortgage (as he planned before it blew up on him) approximately coincided with the period out into the future that the ARM was scheduled to reset.

If the market held up and the banks were still making loans under the same qualification paradigm...then he might just make it, barely.

But this was clearly not a loan he could hold onto long term. He would certainly need to sell that house or get into a loan that was sustainable. So he was speculating. Right along with all the more financially capable players who were also speculating.

This meant that the price of housing was over-inflating through such excessive demand and that the market itself would certainly correct (if not burst)...eventually.

Of course, the government knew about this...but they let it go on because it served their own more immediate agenda.

Banking industry misbehavior at the end of this cycle only played to the desperation of home owners who were finding it difficult to refinance as some of the lenders started pulling back. But end-game was unavoidable regardless of any such foolishness.

Those who got in right at the end saw their equity start going negative almost immediately...and their own resets are on the way next year.

You said "The typical subprime arm borrower historically got out of his loan before the reset."

Sure he did. He had to. This business went on long enough that we all know folks who "flipped houses" and made lots of money. Some of those sub-prime workers were also actually able to rehabilitate themselves. And join the middle-class. But such a hot market could not go on forever. When it did collapse lots of working families who could least afford to take the loss would be forced into foreclosure.

I agree that sub-prime mortage loans should be ranked somewhere between standard mortgage paper and credit card debt. But remember that even sub-prime paper (with a high single digit interest rate) fails to yield the returns needed to make CDO's attractive. Woven there into those derivatives are your far more risky credit card accounts.

The demand for such high yielding paper is what has been driving the credit card companies to misbehave and artificially create (and capture) brand new "high risk" customers...paying interest rates pushed up into the 25%-30% punitive range...out of normal consumers, who had been staying current all along, but who now suffered with lower credit scores, could not get away by switching to another credit card company and who are, nevertheless, inclined to continue making their minimum payments. Those accounts are gold in the secondary market! And premium fees are paid for them.

This particular abuse has been going on for several years, the government has known about it all along, the media has only recently taken note of it...and there is some risk that the banks will be forced to suddenly stop it.

Now that could really be disruptive.

Find work elsewhere and/or ask for a raise
The irony here is that if people weren't willing to spend 5-6 times thier wage on thier homes, homes available wouldn't cost 5-6 times thier wage. They might be smaller, but they would also be much more affordable.

Find work elsewhere and/or ask for a raise
The irony here is that if people weren't willing to spend 5-6 times thier wage on thier homes, homes available wouldn't cost 5-6 times thier wage. They might be smaller, but they would also be much more affordable.

Competition reduces costs
Laser eye surgury better and cheaper, usually no insurance covers this.

Look at the evidence.

Why not buy a catastrophic health policy to cover what you NEED?

Being pushed into hgher level home
Larry, my experience has been that a lot of folks will be pre-approved, for example, up to $200,000. They will look at all the homes from $150,000 to $200,000 but they inevitably convince themselves that they "just gotta have" the size, features, neighborhood, schools of the higher priced homes. It's as if they already have it built into their mind that more expensive is better. Their head tells them the $150,000 home and it's $1000/mo payment is better than a $200,000 home and it's $1500/mo payment, but their heart and emotions win and buy the more expensive home. To me a sale is a sale is a sale. Why would I push them into something above what they are approved for if it means the deal will fall apart on financing and will have wasted everybody's time? I'd rather see that buyer get into something they very comfortably can afford, enjoy both buying and owning the home and then when it's time to move on, they'll remember the pleasant experience they had working with me and will employ me to sell the property for them. It's not about maximizing my commission on one particular sale, it's about building a lifetime relationship that ultimately will benefit me in spades simply by the number of times they use me again and again.

but what is the pay?

rusted Civic
Might want to think about that Civic. My bother-in-law makes $80K + a year and drives and old beat-up Honda. When we ask him why he doesn’t buy a new car, he says that this one still runs so why bother. My old boss also drove a beat-up old car and was worth millions. Say him mant times sanding down an old part to reuse and then an hour latter write a check for $100K for some new gadget he thought we needed.

Got to be careful about making judgments on looks

Renting is not much of a change in cost. A 2 bed room Apartment will cost you 1100 - 1200

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