Mortgage Calculator: I’d like to begin by asking you about your background. I understand that you are a mortgage broker, which makes you more than just a talking head, like the rest of us bloggers. Given that you are already knee deep in the mortgage market thanks to your day job, what made you decide to join the ranks of housing bloggers? How would you summarize your approach to analyzing the housing market, and how has your background/profession informed this approach?

I’ve been blogging since 2004 as a way to stay close with my clients. Everything I write is directed at my clients in some form or another. The mortgage world is complicated and that complexity drove some of the bad decisions from last decade.  And we can’t escape the complexity — it’s the world in which we live.  BUT.  If we can breakdown those complex ideas and make them simple for people to understand, they can make better financial choices.  And they do.  Nearly every time.  This is why I blog — to help people make better, smarter choices for their personal economies.

The Fed Funds Rate only matters to mortgage rates in so much as it’s a signal from the Fed about the economy. When the Fed starts raising the Fed Funds Rate, it will be in response toward inflation.  Inflation is bad for mortgage rates so mortgage rates should rise on the news.

Predicting mortgage rates is an exercise in futility. The market will trend toward chaos so pick a rate that works for you, and stick to the plan.  That said, in the near-term and long-term, I expect that mortgage rates will be higher than their early-2010 levels.

LLPAs are changes to your mortgage pricing tied to your individual risk profile. It’s like auto insurance, somewhat —  the riskier you are, the more you pay.  But that’s not the reason why quotes from lenders seem higher than the rates shown by the media.  The difference is that the media talks about Freddie Mac rates, for example, but fails to highlight the fact that those rates come with points.  For example, Freddie Mac’s weekly rate survey clearly shows that the “market rate” requires 0.7 points but when the story shows up in the papers, the 0.7 points is often an after-thought.  Rates are just half the story — it’s rates *and* fees that make up pricing.

Good credit and good income is a buyer’s entree into market.  Without it, not only is an FHA-backed mortgage not an option, but neither is any other program.

This is a discussion of human nature for which lenders and credit agencies were ill-prepared.  You can plan for risk if you know it exists.  The banks never saw this coming. It’ll be interesting to see if, and how, creditors  adjust.

The good part about “buying now” is that at least you have a lay of the land.  Beyond two or three months, there’s very little visibility into mortgage rates, home prices, underwriting guidelines, tax policy, or market sentiment.  You may find a home at a terrific price, but may not be able to get it financed.  That’s a risk with which I’m uncomfortable.

Mortgage Calculator: I’d like to begin by asking you about your background. What made you decide to join the  ranks of housing bloggers? How would you summarize your approach to the (current) housing market, and how has your background informed this approach? Finally, what is the story behind the name Interfluidity?

I’m much more of a finance blogger than a housing blogger, and the issues that drive me have more to do with questions of collective choice than particular markets or institutions. I actually began as a Java programmer interested in collaborative decision-making as a technical question. I imagined developing toolkits with which large, dispersed groups of people — everything from the membership of a nonprofit to corporate shareholders to the citizens of a nation — could design online processes that would result in “good” collective decisions. A good decision, in this context, has to meet two criteria: it has to effectively serve collective goals, and it has to be “legitimate”. There may be severe tensions between quality decisionmaking and legitimacy. Shouting masses rarely make good choices. You don’t want to put a million people in an online chatroom and then take a vote. But elevating a class of “experts” to positions of privilege and relying upon their wisdom also fails, both on grounds of legitimacy and quality. You want very dynamic processes in which hierarchies arise and shift, where there are elements of mass choice and applied expertise. You need to be very careful in how you allocate the scarce resource of human attention. All voices must be heard, both to capture dispersed information and to sustain legitimacy, but the cacophony must be filtered by some process that it both effective and fair. I began by imagining “online, stochastic parliamentary systems”, like a virtual US Congress where membership in committees was by degree and subject to constant revision, in which “floor time” was allocated by sending proposals to random samples of people, initially small but progressively larger based on feedback. But I couldn’t get around the problem of cheating. You can come up with very clever, fair schemes if you imagine people communicate only within your system. But when questions are high-stakes, real people will pick up the telephone, buy ads in the New York Times, do everything and anything to evade your careful procedures in order to get the results they want.

It occurred to me that financial markets seemed robust to this: markets are unstructured, everyone is “cheating”, seeking whatever edge they can get, and yet we use them to make some of our most consequential collective decisions: the large scale allocation of physical and human resources. And while financial markets are obviously imperfect, I thought that they seemed to work “pretty well”, in the sense that societies that used financial markets to guide economic decisions seemed to outperform other kinds of societies. I was entranced by the Hayekian story of how markets aggregate and communicate widely dispersed information. I also found it fascinating that markets achieve legitimacy by disguising human choices, sometimes good and sometimes bad, as facts of nature.

I began a serious study of financial markets, first just by reading textbooks, then by going through the CFA curriculum and now grad school. (I’m not a CFA charterholder, but I’ve passed all three exams. I hold no advanced degree.) I was struck by how much real financial markets differed from the kind of markets one would invent (and that people like Robin Hanson do invent) if you took the Hayekian story seriously. Real market institutions seem designed to hide information and shift consequences rather than reveal outcomes and allocate costs and rewards. I quickly shed a libertarian prejudice in favor of what is “emergent” or “natural”, and became a critic of a financial system ill-equipped to serve the purpose to which it is addressed. The housing bubble and obvious, persistent imbalances in the US economy during the mid 00’s helped to persuade me that my initial enthusiasm for financial markets was misplaced (although I remain hopeful that better conceived markets and market-like institutions could be powerful tools for collective choice).

Much of my education in economics came from blogs. I found conversations in comments sections to be exhilarating, they inspired me to learn in order to speak, like small seminars in a traditional university. I began interfluidity because I loved the conversation, and felt like I was outgrowing and perhaps abusing other peoples’ comments sections. I was also intellectually lonesome. I felt like I had things to say, so I gave myself a place to say them.

I don’t really know where the name “interfluidity” comes from. The word popped into my head, and captured my mood, what I was looking for, at the time that I started the blog.

I think that the moral thing for most borrowers to do, under present circumstances, is to default on loans when it is in their financial interest to do so.

Much of my thinking on economic and social issues comes back to T.S. Elliot’s proposition, “It is impossible to design a system so perfect that no one needs to be good.” Once upon a time, I chose to disagree. I thought it was the challenge of our day, and the grand project of modern economics, to build a system in which people pursuing their own self-interest would provide all social goods, in which the benevolent invisible hand would rule all and we’d have no need to rely upon ideas as shifty and manipulable as “virtue”. I have done a full 180 on this question. Economic self-interest and formal legal frameworks are simply insufficient to regulate a decent society. Elliot was right.

But it’s crucial to remember that “what is moral” is something we collectively decide, and not without constraints. A social order that routinely demands heroic sacrifice of people in the name of virtue will fail. Clever hypocrites will be rewarded while naive saints pay, and the overall tenor of society will not be virtuous. The most we can demand of fuzzy constructs like morality and social norms is what Arnold Kling calls “soft rule utilitarianism”, under which people accept modest personal costs on the theory that if everybody does so, we’ll all better off. But emphasis on the word “modest”, and expectations of reciprocity. Economic and legal scaffolding has to sit beneath informal social constraints so that in general it makes sense to be good. It is like the relationship between flesh and bone: You could not build anything as beautiful as a smile out of bone, but the smile will not survive if the jaw beneath is fractured and misshapen. We regulate the “bone structure” of our society explicitly via legal arrangements, and more subtly, via social and reputational incentives. There’s a kind of hygiene we have to attend to, in order to ensure that doing well and being good are not terribly inconsistent. Over the past few decades we’ve failed to attend to that hygiene, in large part I think because we let simplistic economic ideas persuade us that we didn’t have to, and that the pursuit of wealth yields virtue automatically and dirty is the new clean.

Whatever the reason, we find ourselves disillusioned. People in the financial industry earned huge sums making loans that shouldn’t have been made, offering “affordability products”, Orwellian slang for means of selling homes at unreasonable prices that buyers could not afford. They failed to perform the core social duty of creditors, which is to make prudent judgments about whether loans are likely to be in the mutual interest of borrower and lender over the full term of the debt. Once originators could resell loans, once the financial industry adopted practices of paying cash commissions and bonuses at the time of origination, once we had severed the nexus between the self-interest of the people making lending decisions and the long-term interest of borrowers, it was inevitable that bad loans would be made. So they were. Now that those bad loans are doing what bad loans do, lenders have suddenly found religion, and argue that the moral fabric of our society would be riven if homeowners behaved like, um, bankers. I think that under the circumstances, quite the opposite is true.

The financial industry has changed the economic and legal landscape surrounding consumer lending so that it simply bears no resemblance at all to interpersonal loans among people of good will in continuing relationships. But those are the norms they ask borrowers to adopt with respect to repayment. That act, demanding others act in accordance with standards from which one exempts oneself, is morally offensive. In a society which, despite economic difference, accepts no social class, ones moral obligation is to behave towards others as others must behave towards you. It is clear that, in general, banks and the special purpose entities that increasingly replace them treat their transactions with borrowers as hard-nosed business arrangements which they are willing to pursue on adversarial terms when doing so is in their interest. Borrowers should do the same. To do otherwise is to reward the cynical immorality of others, which serves no social good.

We might (or might not) wish to revise the norms surrounding bank loans to resemble those surrounding interpersonal lending. But that would be a forward-looking project, and would imply radically altering the behavior of future lenders, not simply exhorting borrowers to assume all responsibility and pay.

No.

First, because the industry will block the sort of changes that would prevent future bubbles. Despite the housing bust and financial crisis, very many of the people whose poor choices generated the housing bubble would make the same choices over again if circumstances repeat. Many industry participants, even those whose firms eventually went bust, were very well remunerated for their poor practices and, whatever their regrets, they kept the money. No one wants to create a catastrophe. But financial professionals want to remain free to make money in the ways that they know, and those are not good ways.

Second, neither Congress nor the President want to make the changes that would prevent credit bubbles, because they have been led to believe that credit growth and economic growth are necessarily intertwined. Trying to rein in financial excess while exhorting banks to lend is like trying to regulate smoking while demanding tobacco companies increase their sales. In a sane financial system, credit would be extended far more conservatively than it has been. Credit contraction is consistent with growth, but only if it is offset by broad-based income expansion that would permit middle-class consumers to live well without borrowing, and potential homebuyers to generate equity for large down payments. Homeownership rates would fall substantially, as most people would be able to rent nicer homes than they could buy. Kicking our debt habit would require pretty big changes in our economic and political arrangements. To borrow from Churchill, we’ll get there, but only after we’ve exhausted every other alternative. I expect a bumpy ride.

I think the government should define vanilla mortgages, whose terms are standard and widely understood and vary in a single dimension. For example, “vanilla” 30 year fixed mortgages from different banks would be identical except for the interest rate. Consumers would not be compelled to stick to the vanilla contracts, and it might not be necessary to compel banks to offer them. But since the terms of the vanilla contracts would be widely understood, risk-averse customers could comparison shop loans without fear that lower apparent costs are offset by some tricky hidden “revenue enhancer”.

Vanilla contracts are a bigger deal for credit cards than mortgages, though. In the mortgage business, traditional prime mortgages define de facto almost-vanilla contracts. The availability of prime mortgages wasn’t enough to prevent many homebuyers from choosing more exotic contracts that served them poorly. Vanilla contracts are not a panacea. But many homebuyers did and do refexively opt for traditional prime loans, and that works out relatively well. Prime mortgages sometimes fail, but they’ve certainly done better than the menagerie of exotics, and they fail in predictable ways. Prime borrowers understand they will lose their homes if they don’t or can’t make their payments, but that’s really the only thing they need to understand. (When people layer borrowed downpayments, insurance, etc. on top of a prime mortgage, they are synthesizing a no longer “safe, vanilla” contract. Good vanilla contracts would be standalone. Note that strategic default would only be an issue in a few markets if 20% downpayment requirements had not been eliminated. If 20% unassisted downpayments had remained the norm, the bubble might well not have expanded to the point where strategic default would be attractive to borrowers in any market.)

All the government really has to do to make vanilla contracts work is to define and publicize them. They might need to create some incentive or requirement that banks offer them initially, but once consumers come to expect them, competition would force lenders to offer them at decent rates. There’s a danger that a vanilla contract could be poorly defined, or that industry lobbyists could slip “revenue-enhancing” language into the text. But there’s a political dynamic that corrects that. Since the government literally writes the contracts, consumer unhappiness with the terms of the contracts translates into local news melodramas and angry calls to representatives about mistreatment by a government agency. Congress finds excuses to tolerate predation by private banks, but would have a hard time doing nothing when it is the government perpetrating the abuse and constituents are angry about it.

I think the government has chronically oversubsidized mortgage lending and homeownership. We cannot know what would have been, but I think we’d have a different and better housing market if we didn’t tilt the scales of the buy/rent decision towards BUY BUY BUY. The business of shelter provision for middle class families is horribly inefficient, literally a cottage industry. Absent all the subsidies, middle-class housing might have become professionalized by now, which could lead to enormous savings in money and aggravation for people who now waste time fighting with plumbers and roofers on an ad hoc basis. It’s remarkable that homeownership rates have kept rising even as people’s tenure in jobs has fallen and mobility has grown more valuable. We’ve made homeownership a totem of middle class prosperity. In doing so, we may have, um, foreclosed consideration of a variety of superior arrangements.

I think government subsidy of homeownership is so deeply embedded into our political culture that these policies will expand and persist until some crisis renders them untenable. My perhaps paranoid suspicion is that, via Fannie and Freddie and the Fed, the government is currently shifting a lot of private sector losses onto public sector balance sheets. If politicians fail to hide the enormity of those losses, there might be sufficient scandal to force a rethink. But that’s a very big if, since with clever accounting, recognition of losses can be extended over a very long period of time and masked by offsetting revenues from new loans. And even if the public were outraged, policymakers and their lobbyists would have a hard time imagining a world without the mortgage income tax deduction, Fannie, Freddie, Ginnie, FHA, FHLB, etc., etc. We still have a lot of bad alternatives to explore before we do the right thing.

I’d consider buying a home with cash as an inflation hedge that is politically safe from forced liquidation. I view buying a home with a mortgage to be a leveraged speculation on future inflation, a bet that might pay off but is risky. If inflation does not materialize, or if deleveraging yields deflation, I think home prices stagnate or fall and mortgages become burdensome. The expiration of a tax subsidy or rising interest rates could trigger a price fall. But that in turn might trigger new interventions in support of housing or policies that lead to inflation. I’d as soon forecast a roulette wheel as give advice on housing as an investment right now. A house will always be worth the shelter it provides, but the dollar we use to measure that has become gelatinous, so it’s hard to say what will happen to prices. My personal bets are skewed towards inflation, but just because I lay my chips down on 35 doesn’t mean it’s sensible for anyone else to join me.

Usually when people are considering buying their first home, it is not primarily a financial investment. Though I may wish it were different, people with growing families in the US often want to become homeowners (and I may not be immune, when my time comes). I wouldn’t encourage or discourage buying now, just advise people that house prices are unusually uncertain and that they should be willing to live with a financial hit if that’s how things go. I’d also advise people to buy modestly and with as little leverage as they can manage, unless they wish to make a speculative bet on inflation.

Mortgage Calculator: I’d like to begin by asking you about your background. What made you decide to join the ranks of housing bloggers? How would you summarize your approach to the (current) housing market, and how has your background informed this approach?

My professional training is in computer programming. Having survived the dot com bubble, when I started hearing about the housing market showing 20% appreciation, I was just drawn to investigate what looked like yet another bubble in the making. Applying abstract modelling as known in the programming field and mathematics, is how I have approached in analysing the housing bubble. And blogging became the way to publish my take on the issue.

The American psyche of  ”home values always appreciate” is definitely a national phenomenon. It has played out in different degrees in different local markets, but they are built on the same underlying belief.

There is at least one market where the bubble has burst enough where it makes sense to buy, Fort Myers – Cape Coral in Florida. Cost of owning there is now significantly less than than renting an equivalent housing unit.

If I had to generalize, if in a given market the loss of home value is gonna be less than the cost of equivalent renting, one might buy if he really really wants to own a home. It would still be advisable to wait a couple years and rent for the time being.

As the bubble continues to burst the regional disparities will shrink.

Absolutely! It is not just the banks, but also home owners who are holding out for better market conditions. But it is primarily the banks that are in “pretend and extend” lying tactics ( and the regulators are enabling it) are holding off on selling distressed properties. Even now distressed sales are disproportionately high. As these distressed properties are unloaded, they will have to be continually discounted to sell, to a shrinking pool of qualified buyers.

Hope is a very powerful instinct. It has gotten us through tough times collectively as a human race, a nation, a society. Also in our own personal lives.  It is hard to say how or how long will it prevail in the housing market.

I think the real question should be how will the housing market react in a deflation? For decades the housing values have outpaced rate of inflation. Will they outpace the rate of deflation in the next decade? The housing depreciation of the last couple of years gives us a clue.

The historical average of the last couple decades was based in an inflationary environment. The same cannot be used when we are in a deflationary environment, when  [outstanding credit + money supply] continue to shrink.

Govt and seller incentives do not increase the housing demand. All they do is pull the demand forward. And after sometime you will start running out of buyers. Every market runs into exhaustion. The housing market was finding an equilibrium, but then the Govt tried to refuel it, creating further distortions. But every successive incentive has lesser and lesser effect. And soon the Govt will be (or already is ) out of bullets.

Mortgage Calculator: You wrote recently about the importance of developing a “systematic way” to develop an offer (purchase) price, and sticking to it. Can you elaborate on what this means? Do you think this is practical in the context of the current market uncertainty?

Many investors seem to want to rush into this game and treat it as a series of individual deals, never thinking about the long term gains that can be derived from implementing “systems” or “best practices” which will allow them to quickly and confidently perform routine tasks without reinventing the wheel each time.

With that as a backdrop… having a well thought out approach to purchasing a deal and being able to know quickly whether it is a deal for you not only takes the emotion out of the decision process but it also allows an investor to quickly gain confidence in their purchasing decisions.

The “formula” that I use is one that many experienced investors know about. It is nothing more then taking the After Repair Value (ARV) and multiplying it by 70%.  I recommend to all of my clients that in today’s market 70% is too risky.  As a result I require them to use 60% or possibly 65% to arrive at the maximum offer assuming the property was in perfect condition.  Since we know that most investor deals are not in perfect condition, the formula continues by taking the result achieved by multiplying the ARV by 60% – 65% and then subtracting the estimated repair cost from that number.  This new number is the maximum that an investor should pay for their deal.

Lets look at this using real numbers… Lets say that the ARV is $200,000.00.  Applying this formula would look like this.  $200,000.00 X 60% = $120,000.00.  So if this property were in perfect shape the investor would offer $120,000.00.  Now lets assume that it needs $30,000.00 in repairs.  We subtract that $30,000.00 from the $120,000.00 to arrive at an offer number of $90,000.00.  What happens to the other 40%?  That 40% accounts closing costs (buying and selling), holding costs, soft costs (insurance, utilities, etc.) and most importantly… your profit!

I realize that some investors might not be comfortable with this approach, and some markets (but not many) may not support purchase prices at less then 50 cents on the dollar, but I have found that by requiring all of my clients to use this formula… they seem to profit every-time they follow it.

And lastly, I firmly believe that in almost every area of the country homes prices will continue to decline for the foreseeable future.  Being conservative in your evaluations and consistently applying this conservative evaluation process to each potential deal will not only protect you as an investor… but ensure your profits.

I love Ayn Rand’s approach and philosophies.  I may not agree with everything she has to say… but in Atlas Shrugged she nailed what we are going through today with tremendous clarity.  So much so that I made this book required reading for everyone of my coaching members.

In many regards real estate investors are the “creators” glorified in Atlas Shrugged.  We are the entrepreneurs.  We are the risk takers.  We are the ones willing to step into a moldy, smelly, torn up building because we have a vision on how to turn a junker into our profits.  Regrettably, in America today, for every creator there is almost an equal number of “takers” who are perfectly comfortable living off of the “creators” hard work.

Responding directly to your question regarding “ordinary” people taking a stand.  First I would say that “it is not our patriotic duty to pay taxes.” As real estate investors there are many legitimate ways, when running our businesses appropriately, to protect our hard earned profits from all levels of government.  So my advice on this subject is to work with your accountant to ensure you are taking advantage of all the opportunities our tax code offers.

In addition, I believe that it is critically important that every citizen be vigilant regarding government encroachment.  For real estate investors this is even more critical because our business provides as its finished product one of humankind’s basic needs… shelter.  As such we are constant targets of those who believe that we should not profit for our risk taking and efforts.  The only way I know of to counter this continued encroachment is to become more active in our communities.  In short, if you choose not to participate… you have left yourself little room to complain!

As a staunch capitalist, some of the recent actions by the government (Congress, The Federal Reserve and the current administration) I believe are counter productive.  The government has funneled billions of dollars into our banking system and the effect has been a tightening of credit and further erosion of our business and employment environment.

The lack of credit within our economy has been felt particularly hard by real estate investors… because as we all know this business is hard to conduct without capital!

While many lenders no longer cater to investors, there are still banks that need to lend to investors as it is the only way in which they are going to generate enough revenue to run their operations.  Typically these banks are small local lenders with assets of $200,000,000.00 or less.  They are easily recognizable because they usually have Savings and Loan or Community Bank behind their names.  The key is to identify these lenders and create a relationship with them.  Not when you need them… but before you need then. It’s the only way this will work.  I wrote a report on how to get lenders to lend you money, that is available for download.

In addition, there are many individuals today who have 401K, and IRA’s who need to find higher rates of return that aren’t tied to the traditional money and stock markets.  By applying the principles and techniques identified in the Bankers Report referred to above, many real estate investors can obtain private capital to grow their business without the hassles of dealing with regulated lenders.

One last point… I believe that the government needs to get out of the banking business.  If this means increases in defaults so be it… lets take the bitter pill, get well and move much more quickly to prosperity and economic growth.

I elaborated on my systematic approach to determining what I would offer on a deal.  Two sayings come to mind and I have written extensively about them on my blog.  at .

The first of these sayings is… “You Profit When You Buy”.  The simplicity of this statement is profound… and it boils down to this.  When a real estate investor purchases a property they need to purchase at a price that will lock in a profit regardless of what happens to the market once they own it.  No investor should ever expect that their profits would come from any source other then their shrewd purchase price and their ability to extract, as cash, the equity in that property as they execute their exit strategy.

The second statement speaks for itself… “Some of the best deals I have ever done…. are the ones I didn’t do”.

Now… in practice that means myself and my clients routinely make purchases not only below 50 cents on the dollar, but many times below 30 cents on the dollar.  And, as a result net profits on retails sales have been averaging above $35,000.00 and net cash-flow per unit in excess $300.00 per month. Cool Stuff!

I believe prices are going to continue their downward march.  Some areas of the country will experience greater continued declines than others.  As they say… all real estate is local.

I just wrote an article for the Bigger Pockets Blog, which reinforces the opportunities that this market are offering to real estate investors.  I am very bullish from an investors point of view and see that bullishness continuing through the late spring of 2010.  If you are sitting on the sidelines waiting… you are wasting valuable time and profits.

As I have written on my Bigger Pockets blog, there are those who believe we could see home ownership rates fall below 50%.  I don’t think ownership will decline that low.  But, I believe we will see futher declines.  It will be hard to avoid given that there are between 3 and 4 million potential foreclosures in the next couple of years.  it only seems logical that we will see increase renting in the near future.

If home ownership does decline significantly it will mean many additional opportunities for real estate investors.

As a capitalist, the $8K Homebuyers Tax Credit drives me nuts.  In essence we are redistributing our wealth so others may buy a home (I will save the moral judgements for others.)  The pragmatist in me says… wow… what a great opportunity to make a profit and help others to buy a home.  (Rand would be very disappointed indeed!)  From what I have been able to determine the Tax Credit has had a very substaintial short-term effect on the housing market, and it will continue to have a similar effect until it expires in the spring of 2010.

As with any situation, there is a strong possibility that when the Tax Credit goes away, the number of buyers will drop, thereby dropping demand and as a result home prices will continue to slide downward.  By how much? I can’t predict… though I would think it would be less then the declines of up to 40% we have recently seen.

As for my advice to homebuyers.  I don’t see the Federal Government making dramatic shifts in tax policy which would discourage home ownership.  That is a good thing for those looking to purchase a home.  Without a doubt prices will continue to decline and that may present some level of risk to homeowners.  However, I believe this risk can be easliy mitigated as follows…

1. Purchase your home at prices that are at least 5% – 10% below the prevailing sold prices in the area you make your purchase.
2. Plan on living in your new home for at least 3 years.  By that time we should have worked through the current and “shadow” inventory and prices will have stabilized and may even be on their way back up.
3. Follow steps one and two and then if you can afford to put more then 5% down… do it!

Mortgage Calculator: Given the title of your blog, is it fair to say that you believe the housing market hasn’t yet bottomed?

My timing skills are notoriously bad, but I’d say the bottom is about a year away.”Housing Doom” was actually the compelling domain name researched by our anonymous “Admin,” one of several invisible but essential volunteer support staffers without which the blog couldn’t possibly happen.

Mortgage Calculator: You reported recently that “strategic defaults” are on the rise, and comprise a larger portion of overall defaults. Do you think this suggests that even though home prices are stabilizing, foreclosures will continue to increase?

It’s possible.  This is tangled up in the story of “recourse mortgages” that was recently discussed by AEI’s invaluable banking analysts.  A while ago I produced a transcript of one of their seminars where they talked about this in depth.

I’d like to note that the first widely heard voice to “just walk away” was Jim Cramer in late July 2007.  Debi and Admin performed a valuable service by preserving the videos for posterity.

Mortgage Calculator: Given the complete absence of lending standards in FHA standards when making conventional loans, as well as the rising pool of underwater reverse mortgages, it seems this class of loans represents the next “subprime” fiasco. Do you concur?

Doom’s friends over at Implode-O-Meter are covering this topic in depth.  Today, I noticed a wire-service story claiming that subprime was back up to pre-crisis levels, but now almost entirely backed by the government.

Mortgage Calculator: You have reported diligently on the market for Mortgage Backed Securities (MBS), presumably because of its direct connection to mortgage rates. Given the current dynamics of this market, where do
you think rates are headed, considering also the Fed’s plan to slow (and eventually halt) purchases of MBS?

It’s much worse than you know. GSE Agency Debt actually represents the unconsolidated cost of the Vietnam War, and Fannie’s privatization in 1968 was likely the largest off-balance-sheet deal ever done.  During the 2003-07 bubble, the swelling agencies purchases by foreign central banks financed Afghanistan & Iraq, while post-conservatorship the GSEs’ books are being swelled to help pay for the stimulus.  The crack in the beam in this economic House of Usher is the convergence of the “effective guarantee” on agencies to the full-faith-and-credit guarantee on treasuries.  Should Agency Debt ever cease to be junior, OMB will have to double the size of America’s National Debt, with catastrophic consequences.  The fate of the US housing market is trivial in comparison.

Mortgage Calculator: Your posting on “How the Relentless Promotion of Positive Thinking has Undermined America” was interesting, especially since it seems that despite the housing crisis, this “positive thinking” is making a
comeback. That being said, what do you think it will take for people to accept the notion that home prices don’t appreciate much faster than the rate of inflation, over a long-term period of time?

Positive Thinking has been a root value of America since long before that famous remark about happiness posted on 7/4 1776, and its philosophical promotion goes back at least to Emerson.  In a sense, I’ve been studying this issue for more than 5 decades.  That’s somewhat separate from house prices, though.  People will wake up on “house prices always go up” when the government stops propping them up…

Mortgage Calculator: On a related note, do you generally believe that renting is more economical (and more sensible!) than buying, even when the ratio of rent to home prices is more in line with long-term averages?

Local! Local! Local!  I’ve been perfectly happy owning properties on the same street for over 30 years.  Everyone’s situation is different.

Mortgage Calculator: How would you reconcile government and seller incentives and low interest rates with the possibility that home prices could fall further, when advising someone thinking about buying their first home? Would you advise them to buy, wait for a while, or wait forever?

*** WE ARE NOT FINANCIAL ADVISORS *** Please professionally consult an expert on that one.  It is a fact of life that nearly every trained expert in these areas is constrained by professional ethics, etc. from commenting in a public forum, which is why interested amateurs like us have been trying to fill the gap the last few years.  However, our participation only goes as far as sharing our common-sense thoughts and, hopefully, posting links to the works of wiser heads than ours.  And with that thought, I’ll turn it over to your readers and their own thoughts and researches.  May they generously share their findings with you like Doom’s many readers have with us.

Despite his vast readership, “Patrick has no background in real estate at all. He is the author of the O’Reilly book Web Performance Tuning. He lives in Menlo Park, CA.” In his own words, “You should not believe anything he says until you understand the math yourself. Here’s the math:

• 3% annual cost of renting is less than the 9% annual cost of owning the same thing

If you understand that, then you probably understand the rest of this [my] site as well. If your job depends on not understanding that, then you won’t understand it.”

Mortgage Calculator: Given the sub-title of your blog, is it fair to say that you believe the housing market hasn’t yet bottomed?

Yes, I think the housing market has much further to fall on the coasts and in expensive areas. But in some poor neighborhoods, prices have fallen back into line with rents already, meaning that it’s about the same to rent or buy there. So those poor areas seem close to a bottom.

Mortgage Calculator: You write that when interest rates rise, housing prices generally fall. How do you square this with the notion that interest rates will probably rise when there is evidence of an economic recovery, at which point borrowers will be in better positions for buy expensive homes?

Prices on the coasts are so far beyond the range of the median salary that any small increase in salary is insignificant compared to small increases in interest rates. It is still common for borrowers in California to have ten times their annual income in debt. They can pay their mortgage only at extraordinarily low adjustable interest rates, and only until the mortgage resets. A reset from 4% to 6% means 50% more interest every month.

Mortgage Calculator: Do you think, then, that when the Fed finally raises rates, that home prices will start to once again fall?

Start once again? Not sure what you mean there, since prices are still falling right now. For a realistic view, avoid all news which quotes used-house salesmen (realtors) because they will say anything that parts fools from money.

But yes, rising rates will definitely push prices down even more.

Mortgage Calculator: Given the lopsided relationship between housing prices and rental rates, do you that it makes sense for real estate investors to look at buying rental properties?

Only in poor neighborhoods, so far. You can easily calculate the annual rent to purchase price ratio and see what kind of gross return you can expect as a percentage. Returns in wealthy areas are too low to justify the high prices, about 3%, but there are poor parts of Oakland, for example, where the return is over 10%.

Mortgage Calculator: On a related note, do you generally believe that renting is more economical than buying, even when the ratio of rent to home prices is more in line with long-term averages?

No, if you think about it for a minute, you see that renting must have been more expensive historically than owning, or landlords would have gone out of business. If their mortgage and expenses are $2000 per month, but the tenant is paying $1500 per month in rent, the landlord is losing money.

The basic theme of my site is that that relationship is inverted now, and landlords in middle-class and better areas are giving a huge gift to renters. It’s a fantastic time to be a renter. You get the use of a house for free, paying only the property tax and maintenance.

Mortgage Calculator: You pointed to appraisers as facilitating the rise in housing prices, because of the way they are incentivized. Recently, there have been reports that appraisers are dragging their heals in the opposite direction, wary of fomenting another bubble in housing? Do you think these reports tell the story? How do you think this will changed as a result of the new laws which require appraisers be appointed directly by the lenders?

No, I think all those stories about appraisers dragging their heels are just the used-house salesmen complaining that appraiser honesty is putting a damper on their business. The business of realtors is deception. Honesty doesn’t sell houses.

But I have little faith in those laws. There is so much money to be made by fleecing buyers that realtors will find ways to eliminate the honest appraisers. The NAR (National Association of Realtors) is one of the biggest lobbyists in DC, and lobbyists literally write the laws and hand them to congressmen these days. The NAR will find a way to defeat honest appraisals unless we have sweeping campaign finance reform.

Mortgage Calculator: Many analysts have argued that the apparent stabilization in the housing market is being supported by a glut of first-time buyers, driven by the government’s $8,000 incentive plan. You wrote recently, however, that there is “Shortage of first-time buyers.” Can you explain?

Everyone who could afford a house already bought one. And then people who could not afford a house bought one too. And then the builders kept on building. New people do come into the market, but compared to the saturation level, there are just not that many first-time buyers. No glut.

The $8,000 tax incentive did nothing but keep prices $8,000 higher than the market would have set. Those who bought with that incentive actually got no benefit. The real solution to help buyers is the lower prices that the market would set based on rents and salaries. But that harms banks, and banks are also big lobbyists in DC. So the incentive was an $8,000 per-sale gift to banks, not to common people. So again, corporate control of government is being used to part people and their money. Campaign finance reform would help.

Mortgage Calculator: What do you think it will take for people to accept the notion that home prices don’t appreciate much faster than the rate of inflation, over a long-term period of time?

They have to grow up seeing that fact in front of them every day. The Japanese now have seen 15 years of continuous residential real estate declines. I imagine the psychology is finally changing there.

It would also help if there were an open market in real estate, where every bid had to be validated by a bank, and published in the papers. Realtors lie about bidding wars all the time, but because bids are not public, they get away with it.

Mortgage Calculator: How would you reconcile government and seller incentives and low interest rates with the possibility that home prices could fall further, when advising someone thinking about buying their first home? Would you advise them to buy, wait for a while, or wait forever?

Rather than look at macroeconomics, I would say they should look at two aspects of their own situation:

1. Rent for a comparable place
2. Their salary

They should wait if renting is cheaper than owning at a 30-year fixed mortgage rate. And they should wait if the debt they are thinking of taking on is more than 3 times their salary in a secure job.

If rent would be significantly more than owning that same thing, then it makes sense to buy. Also, if someone has the cash on hand, or if they have a much larger secure income than is needed to service the expenses, then it’s also OK to buy if they plan to stay there a long time.

The entire goal is not to waste life as a debt-slave. But it takes independent thought and determination to avoid that fate.