Stock market bubble vs. Housing bubble...a lesson in LEVERAGE
We can all pretty much agree that there was a stock market bubble....right? Anybody disagree there??
Ok, good.
If a person wanted to buy $500,000 worth of stock, how much money would they need???
- Answer: $250,000 if they were buying on MARGIN.
Margin in the stock market is 2:1. You want to buy 1.5 million worth of pets.com, then you need to come in with $750k of your OWN money. The investment houses do not hand out margin to everybody. They want to know that the investor has the ability to repay them in the event the investment drops.
So where am I going with this...
If you want to buy a $500,000 house, how much money would you have to put down???
- Answer: nada, zip, zero. You get the $500,000 house with ZERO risk!
- Answer 2: The bank would give you $15,000 and let you finance 103% of the value of your house!!!
How many brokerage houses would give you $500,000 to buy stocks...and throw in an extra 15k so you could buy a fancy computer in which to "trade" on??? Yeah, sound pretty eff'n stupid doesn't it.
So that means a bwr on stocks is at 50% margin, where a bwr on a house can be at 100% margin...or more.
You can buy a $1.5 million dollar property with ZERO money down...and STATE your income to do it.
DOES ANYBODY ELSE SEE HOW THIS COULD BECOME A PROBLEM?!?!?
I need to dig up the actual statistics again, but there is a rather large percentage of first time homebuyers using 100% leverage to purchase their home. Not to mention other borrowers that are doing it as well.
What happens in the stock market if your "investment" goes down and you are on margin??
-Answer: You get a Margin Call. You have to pay enough money to get it back to where you are at the 2:1 ratio. If you borrowed 250k to purchase 500k of stock...and the stock dropped to 400k. You would have to cut a check for 50k so that you would only be "borrowing" 200k on margin.
What happens if your $500,000 condo conversion takes a dive to 400k (I know that would NEVER happen...but lets just ASSUME it might)?? What happens??
We don't really need to answer it now...we will get to watch first hand what happens when tens of thousands of people bought property with 100% leverage...and they owe more than their property is worth.
All of that said, I'll leave you with a question:
How bad do you think the stock market bubble would have been, if we let people invest 100% on margin, AND they got to "state" their financial ability to repay the brokerage houses before doing so???
Ok, good.
If a person wanted to buy $500,000 worth of stock, how much money would they need???
- Answer: $250,000 if they were buying on MARGIN.
Margin in the stock market is 2:1. You want to buy 1.5 million worth of pets.com, then you need to come in with $750k of your OWN money. The investment houses do not hand out margin to everybody. They want to know that the investor has the ability to repay them in the event the investment drops.
So where am I going with this...
If you want to buy a $500,000 house, how much money would you have to put down???
- Answer: nada, zip, zero. You get the $500,000 house with ZERO risk!
- Answer 2: The bank would give you $15,000 and let you finance 103% of the value of your house!!!
How many brokerage houses would give you $500,000 to buy stocks...and throw in an extra 15k so you could buy a fancy computer in which to "trade" on??? Yeah, sound pretty eff'n stupid doesn't it.
So that means a bwr on stocks is at 50% margin, where a bwr on a house can be at 100% margin...or more.
You can buy a $1.5 million dollar property with ZERO money down...and STATE your income to do it.
DOES ANYBODY ELSE SEE HOW THIS COULD BECOME A PROBLEM?!?!?
I need to dig up the actual statistics again, but there is a rather large percentage of first time homebuyers using 100% leverage to purchase their home. Not to mention other borrowers that are doing it as well.
What happens in the stock market if your "investment" goes down and you are on margin??
-Answer: You get a Margin Call. You have to pay enough money to get it back to where you are at the 2:1 ratio. If you borrowed 250k to purchase 500k of stock...and the stock dropped to 400k. You would have to cut a check for 50k so that you would only be "borrowing" 200k on margin.
What happens if your $500,000 condo conversion takes a dive to 400k (I know that would NEVER happen...but lets just ASSUME it might)?? What happens??
We don't really need to answer it now...we will get to watch first hand what happens when tens of thousands of people bought property with 100% leverage...and they owe more than their property is worth.
All of that said, I'll leave you with a question:
How bad do you think the stock market bubble would have been, if we let people invest 100% on margin, AND they got to "state" their financial ability to repay the brokerage houses before doing so???
posted by SoCalMtgGuy at 12:05 AM
16 Comments:
Here we go again. This was a problem before the Big "D" in the 30's. On another blog they talk about condos vs houses. Houses =bonds long term investments hard top liquidate and condos = stock(especially when noone lives in it and it is easily mass produced). It is a good argument. Their conclusion the stock market just moved to housing when that bubble burst. We are a gambler nation!
"What's the catch?"
Higher rates, onerous penalties, pmi accounts, refi restrictions.
azgolfer
PMI is private mortgage insurance. On "conforming" loans you are required to pay it if your loan to value (LTV) is over 80%.
There is NO PMI on subprime loans. The other way to get around it is to "split" the loan up between a 1st and 2nd...80/20.
You have an 80% first and a 20% second. The seconds have higher rates because they are in 2nd position if the bwr defaults.
If the property has to be sold at auction or whatever, the odds of getting 80% of the value is better than getting the last 20% of value.
I forgot; escrow accounts. These are very profitable for the management company. I wish there was some way to track their performance. Talk about living off the float. Homeowners pay taxes, HOA fees and insurance (not PMI) to an escrow account from which these items are automatically paid when due.
The stock market is accused of being crooked and it is. But being around this RE bubble for a few years is making me believe that the corruption in the RE/mtg business is as bad or worse. The consensus seems to be make the numbers work no matter what. I believe Bernie Ebbers took that approach in running Worldcom.
Cactuscody...
It is WAY worse.
Do you know how many offices out there have multiple people doing loans under ONE brokers name.
There are 20 people working the phones...but every 1003 has the same name on it.
Think about this: what would have happened to the brokerage houses if they were letting 20 people use 1 person's Series 7 license to transact business?????
There are "kids" with no license or experience making financial decisions that will impact people for the next 30-40 years to come (or less, if they sell, but you get my point).
Sensible lender...
You and me both. I know it is taking a while...but this cannot end well.
I have felt like the guys that in 1998 were going, this does not make sense. this company has no earnings, and is trading at 150 times future projected earnings.
They were laughed at for 2-3 years...but they were right in the end.
I think we will be vindicated in due time. We see the financials of lots of borrowers...and it isn't pretty.
Real estate blues...
I agree with you, but I think it won't be until the end of 2007 or 2008 before things really get rolling.
I'm basing my guess on the fact that 1.2 trillion dollars in loans adjusts in 2007 vs only 335 billion in 2006.
If 2006 is bad...expect 2007 to have a multiple of pain.
Shawn,
THere is no mortgage call on a house. You just keep paying the mortgage...and get used to living life "upside down" for a while.
SoCalMtgGuy
just to be fair, when it comes to margin loans on stock, 50% is the typical initial equity requirement (e.g., 500K to establish a 1 mil position), but subsequently, the 50% requirement is usually replaced by a 35% "maintenance margin" requirement. thus, if somebody bought 1 mil of stock with 500K on margin, they would not necessarily get a margin call until their equity fell below 350K (i.e., the 1 mil position falls below 850K). at that point, the "investor" needs to put up enough cash to raise their equity to 35%. if they don't, the margin clerk can sell out their position at the broker's discretion. depending on the broker, they might not even call the client before selling him out.
NB. these are just the regulatory minimum requirements. brokers also typically exclude foreign and penny stocks from marginability, and may add other restrictions, such as increasing the equity requirement for "concentrated positions" (i.e., if you have 1 mil in just a single stock, they may have a higher equity requirement than if you have 100K each in ten different stocks).
if you want to know what can happen in the stock market with very loose margin requirements, look at 1929. people could use 90% margin (only 10% equity) back then and so many went bankrupt. and of course we had the worst stock market crash in US history as the Dow lost 86% of its value from 1929 to 1932.
RE can go down and stay down for awhile but the RE market is fundamentally different from the stock market. The value of RE is ultimately tied to inflation which always goes up, not earnings which can disappear entirely for a variety of reasons. So real asset values are much more stable than stocks. What's different this time is the large price increases in a short time in a world where employment trends,earnings trends, demographic trends and consequent savings trends are horribly against the sustainability of near term values. Luckily, the Fed can lower rates again when the going gets tough as all these ARMs go into adjustment and the economy totally falls apart. The question is will there be so many upside- down situations where the rates go to zero and stay there for 20 years as happened in Japan due to the commercial RE crash in the late 1980's. The Fed always raises rates during the last and first years of a presidential term. They have, or will, go too far with the trend, as they usually do going both up and down, but the trend should stop by August or when the disastrous RE and economic data start flowing this summer. I think the Fed wants the right-wing deficit spenders out and the budget-balancing dems back in, so I think any move to lower rates might not come until after the first week of November. A Minnesota mortgage broker, B.S. Econ, and market junkie.
The price of residential housing is affected by changes of supply and demand at the margin, but there's a floor on the price of any property based on the value of the land and the cost of construction which is strongly tied to the cost of labor and less strongly on the cost of materials. There have been periods of several years where the price of housing has been pretty stable even as the economy and interest rates changed dramatically. Prices ran up sharply in the mid to late 1970's after a spike in inflation and as the baby boomers came into the market in large numbers. This happened even in an environment of interest rates rising quite strongly from pretty low levels in the 1950's and 1960's, the economy experiencing a string of recessions, and a stock market that virtually crashed in the early 1970's and stayed down for 10 years. In the 1980's even with 10% interest rates and with the economy in trouble housing prices held firmly. What changed was inflation and interest rates both subsided for many years. That supported an improving housing market and economy, also fueled by optimism about the future due to the computer and internet revolution. In the 1990's housing prices remained pretty stable for a long time even with low and falling interest rates and a strong economy. Now with rates rising moderately, four years after a stock market crash, and with the influx of X-generation homebuyers running out of steam, everybody expects housing prices to cool significantly. I agree. What's very different than the past 40 years, is the outlook for he economy. U.S. demographic trends simply don't support much economic growth over the next 20 years. Although interest rates appear to be reasonable, there's a horrible credit crunch going on that is taking out a lot of prospective marginal demand, as discussed further below. While the economy appears to be "recovering" and unemployment low, there are very adverse trends in the types of jobs and compensaton available. There's a big question mark about how long it will take for the market to clear the growing inventory of properties for sale while the building boom continues and the pool of prospective buyers falls. There are going to be a lot of condo's built even with the housing demand continuing to fall.
There are major differences in the economic backdrop today compared to any time in the last forty years. 1. Overall consumer debt to income is a record high. 2. Savings rate has fallen almost continuously from 10% in the 1970's to minus 2% now. 3. Demographic trends favor falling demand. 4. The U.S. economy cannot remain strong with a negative savings rate (remember a fundamental principal of economics is that savings equals investment). 5. Lack of new technological change on a scale capable of supporting economic growth. 6. There's a huge credit crunch going on at the consumer level that just doesn't show up in the statistics: sharply rising health costs, property taxes, energy costs, education costs, revolving credit interest and payments; and others. On this last item it's interesting to note that new bank regulations of the Comptroller of the Currency that were supposed to go into effect in 2001 are only now being implemented. Minimum credit card payments are being increased gradually from levels of 1-2% to 4% of the balance; that's on top of increased interest rates on the credit for many borrowers. These minimum payment increases, along with property tax hikes, higher mortgage payments and probably increases in property insurance rates are all piling up on the credit reports of prospective home buyers. That, along with growing recognition that housing prices have stopped going up is
taking a lot of propsective immediate buyers out of the market, and that will further weaken prices until some new set of forces can reverse the trend. But when?
I owned a condo in Houston in the mid-1980s. Fortunately, my company relocated me to California and bought the place from me for my mortgage principal balance. I believe they finally unloaded it a year later after taking a 25% haircut.
P.S. Condos give you the privacy and control of an apartment renter with the mobility and flexibility of a homeowner. Worst of both worlds.
Another end to the bubble might come from two changes in consumer attitude. It isn't scientific but it is possible for markets incuding housing to just plain old get exausted. SUV sales are still off 30-60% even though the oil price spike is a memory. Then there are the other consumers, the buyers of MBSecs. I find it likely that they won't want any more paper at any price. This doubly worries me as we discussed earlier how lots of seemingly ordinary commercial paper is merely laundered MBSecs. wow gold opportunity! A careful analysis of what assets or supports are actually behind the loan market would probably dictate caution and lightening up on anything with exposure.
If we immediately eliminate all income taxes (for individuals, corporations--every entity) in exchange for a National Consumption (Sales) tax, do you think it would stimulate our economy? We would have a HUGE influx of higher net worth individuals and employees of companies relocating to the US. Demand for housing would increase exponentially. If our leaders want to save our economy and also help prevent a severe lending crisis they should implement this plan of action immediately. The "insiders" (CIA) will lose the "control" mechanism of the IRS for tracing activities but with current techology it's absurd that we don't already have a microchipped National ID card. The National ID Card could be a requirement to purchase goods and services.
I would say the housing bubble is worse.
Post a Comment
<< Home