Sonoma Housing Bubble

Pulling the cork out of Sonoma's bubbly housing foolishness

Monday, May 22, 2006

California Got Too High in Price... says Lereah

"In a picture posted on the National Association of Realtors' Web site, David Lereah appears trimly dressed, with light glowing behind him. The industry group's chief economist, author of Are You Missing the Real Estate Boom? [Doubleday,Random House], published in February, 2005, has been talking up the housing market for years."

"Now he says the housing market is just taking a breather. "We're going to drop significantly, but it's not a balloon bursting," Lereah says. He expects total home sales to drop to 6.62 million in 2006, from 7.07 million in 2005. Meanwhile, he thinks prices will continue appreciating this year, but only by around 5%, compared with 12.5% during 2005."


"Lereah says the growing economy will boost the market, offsetting the negative impact of rising interest rates. If you agree with his mantra, you'll say the Federal Reserve is the housing market's friend. BusinessWeek Online reporter Sonja Ryst recently asked the economist to explain his outlook."

Edited excerpts from their conversation follow.

Why do you think prices will continue rising?

"The economy is growing and there are job gains, so consumers have the financial wherewithal to purchase homes. Sure, the rise in rates has been inhibiting buying recently. A lot of the boom markets that boomed over the last several years are cooling off and home sales are dropping. But if the economy were in a recession, this would be worse. And mortgage rates aren't rising too high" --

Do you think banks have been lending too aggressively?

"The last two years of the boom were exaggerated because of lending. There were more loans, such as negative amortization loans, allowing people to put off their debt payments until later. In some metropolitan areas, this exaggerated home prices and increased them further than they should have gone."

"To that extent, there's some risk in those local markets. For example, if you take any local market in California, they'll have interest-only loans and adjustable-rate mortgages because prices got too high. If mortgage rates increase, then some of those markets are vulnerable. But the forecast isn't for interest rates to go up significantly. I have mortgage rates going to 7%, not to 10%. "

"Before 2004, the banks weren't doing those types of loans -- I mean they didn't do them in any meaningful way. After 2004, places like California got too high in price and people couldn't afford homes anymore. That's why they started stretching the credit at that point and offering people lower downpayments, so people would take the homes at those prices."

Do you think the housing market could ever crash?

"I'm getting tired of all these doomsayers. We live in houses, and our houses are not going to crash. This isn't the stock market.... Local economies are relatively healthy. There's job creation -- this isn't a scenario where bubbles burst. Can there be one or two or three or several local markets where prices actually go down? Yes. But to generalize for 30 markets or the whole real estate marketplace -- that's absurd."

Would it surprise you to know that John Talbott has an opinion on the housing crash that largely differs with David Lereahs?

"Talbott insists the crash he predicted is right around the corner, as housing markets show signs of cooling. In his latest book, he notes that national home values, adjusted for general inflation, increased almost 61% from 1981 to 2003. In the past three years, home prices have shot up another 35%."

"John Talbott warned that home prices were ready to fall back in 2003, when he wrote the best-seller The Coming Crash in the Housing Market. A former Goldman Sachs investment banker who sold debt for clients including Fannie Mae, Talbott criticized the managements of the housing-finance giant and rival Freddie Mac for enabling noncompetitive forces to boost home prices."

"In this year's followup Sell Now! The End of the Housing Bubble, Talbott's take is: "We are in for a fairly rough ride in the housing market for the next five to seven years."'

BusinessWeek Online reporter Sonja Ryst recently spoke with Talbott about his bearish outlook for housing. Edited excerpts of their conversation follow.

What do you think is happening to the housing market right now?

"The smart money is getting out. The inventory of homes for sale is increasing dramatically across the country. That's typically what happens before you see price declines.... The investors who are flipping homes for profit, like non-owner occupied condominiums, those are the people you would expect to sell first. You're already seeing that happening. In San Diego, for example, the homebuilders themselves are getting out."

How much do you think prices will decline, and how long do you think it will take?

"I think that it's a worldwide phenomenon, and in the 25 cities that have had price run-ups, which make up 40% of the market, we'll see corrections of 40% to 50% in real terms over the next six years. It has already started, and you'll see it happening in more cities in the May-June time frame."

How did housing prices get so high?

"The banks have made a terrible mistake in how they calculate how much to lend. In the early 1980s, about a third of your income had to go to your mortgage and those worked out fine. Today, they've increased that limit to about 40% of your income, and they think those should work out fine, too. But the banks have actually been lending too aggressively."

We're seeing hints about the housing market all over the place. When and how do we know what's really happening to it?

"Because of the cyclicality of the business, prices have been down in most places four months in a row. Most cities have seen slight declines in December, January, February, and March. What typically happens is when the weather warms up in spring, people want to move their children during the summer before school starts. The buyers start to come out and then prices start to shoot up in May and June. Those are the two key months. The question is what happens in May and June."

What happens to the U.S. economy if the downturn you predict really happens?

"I think it will be a disaster. Not only will people in fields like banking be unemployed but consumers themselves will spend less. They're spending a lot now because they think their house is worth a million. If they find out it's only worth $400,000, they'll spend less. As foreclosures increase, the banks will get hurt and pull back on lending. That can drive the country into a recession."

Didn't you already say all this in 2003?

"I wrote my first book in 2003 saying Fannie Mae and Freddie Mac were overleveraged and the market was too high, but I was careful in the book not to say it couldn't go higher. I wasn't trying to call the absolute peak in the market. But now with the Fed basically out of the picture and giving up on 1% interest rates, I think the cracks are beginning to show in the inventory of homes for sale and the way the nonoccupied real estate investors are behaving."

"If you call the National Association of Realtors, they will say that prices are going to bounce back up, but there are a million signals that this is serious. It's not like in 2003, when I was talking theoretically that things are overvalued. Now they're more overvalued, foreclosures are up, and investor-owned property prices are going down. It's happening."

What role does the Federal Reserve play?

"The Fed messed this up. They had a bad situation with the Internet bubble in 1999 and 2000, and to keep that from turning into a recession they lowered the federal funds rate down to 1% and held it there for four years. That created this real estate bubble."


At 5/23/2006 09:55:00 AM , Anonymous tom stone said...

as far as lereah's comments,if he means 7% by the end of october,ok.and double digits sometime next least 10%.houses don't crash? he doesn't live in an earthquake zone...a big increase in people leaving piles of oily rags next to the gas can in the garage wouldn't surprise me a bit...we will see a lot of desperate people doing foolish things...take the last 10 k in the heloc and buy lottery ticets etc.

At 5/23/2006 03:35:00 PM , Blogger Athena said...

I just received an email from that says there are 508 properties in Sonoma County in foreclosure.

Not good.

At 5/23/2006 04:52:00 PM , Blogger marin_explorer said...

Hmmm...I follow the stats on, but their numbers are a little different for Sonoma county:
17 Foreclosures
929 Preforeclosures
I wonder why the huge discrepancy?

At 5/23/2006 06:39:00 PM , Anonymous tom stone said...

even if the 508 foreclosure figure is correct,it shows how tightly stretched people were.we haven't begun to see the impact of mortgage resets yet.this attrition would most likely due to gas price rises,job losses,and illness.these numbers of foreclosures,this early in the game,is certainly ow.

At 5/23/2006 10:35:00 PM , Blogger Athena said...

reskeptic- I too have been following the list... so I was also wondering why the number was so different...? Anyway, I don't even know why realtytrac is sending them to me, I don't know of having a membership or anything. So I found it interesting that they must be mining for internet users with a specific search behavior and targeting them... and they are targeting by sending out emails detailing the California and Sonoma County foreclosures... a definite signal that times are changing when your email spam is telling on the market.

also... was doing some eavesdropping tonight and heard a little story about that Montini Racket going on...

The person I was listening to was considering buying one of the properties when her friend backed out of a purchase. They wanted her to get pre-qualified with their "preferred" mortgage company... Countrywide. She said she is sure she would pre-qualify with them, but that she preferred using her own broker and didn't want to use Montini's preferred broker. She said she will be glad to prequalify with her own broker... and Unnamed "preferred" broker told her that no this is the way it is done. So she said that sounds shady, and she was creeped out by the strong arm tactics and ultimately said she wasn't all that interested or serious anyway and would not be buying one of their poorly designed mcmansions anyway. But the experience was eyeopening that they were perfectly comfortable railroading people into "how this is done." Not good.

WTF? Someone's going to be doing the perp walk I think...

At 5/23/2006 11:35:00 PM , Blogger moonvalley said...

geeze, it sounds like Soprano Ranch, and hey, I'm Italian. That "pre-qualifing" business sounds waaay to weird for me.

At 5/23/2006 11:43:00 PM , Blogger Athena said...

I'm Italian too and it most definitely didn't pass the smell test.

The person on the receiving end of "this is how its done" was actually kind of bullish on real estate until that moment. All the alarm bells and flashing lights went off for her... triggered her good old fashioned common sense gene. Now she has a different perspective entirely. What kind of racket does such things? Only one that has something not too kosher going on...

At 5/23/2006 11:49:00 PM , Blogger Athena said...

oh and unnamed mortgage broker is the same one that had that conversation with the person I know who backed out of Montini too. The one who said she could not afford to buy the house, and the broker response was to say of course she could... and presented her with an NAAVLP (aka take it in the butt loan) KNOWING full well she didn't have the ability to make the payments once the loan reset. Broker's advice was just to sell the house in 5 years and she would make money.

Also the same broker who told her that 80% of all the loans the office is doing are these loans.

At 5/24/2006 10:03:00 AM , Anonymous tom stone said...

athena,developers frequently make a deal with their "preferred lender"often they buy down the rate for buyers as an incentive,especially on traditional fixed loans,or hybrid other cases where the loans are arms,no points are charged to the borrower,instead a "rebate" or legal kickback is given to the mortgage broker...and the ahhh rebate can be enhanced shall we say , if you bring a lot of biz to the lender.since this is not a mortgage banker lending its own money it is my understanding that there are norms of ethical conduct that are legally required by the would be lovely to get something in writing from this broker and present it to dre with an innocent smile and a simple question or two.while not italian,the idea of life without garlic is appalling.

At 5/24/2006 10:32:00 AM , Blogger Athena said...

But Tom... why would they not want this lady to get prequalified with her own lender? I mean if they want to sell the house they want to sell the house don't they?

She made it sound like they were not playing ball with her unless she agreed to do her financing through their "preferred" lender. He told her basically that she had to do it their way or no way. Which prompted her to know right away that she wasn't all that interested, and then she checked their website and indeed found the language that said "preferred" not mandatory and felt that the whole group of them were on the slimey side of the rock.

At 5/24/2006 02:16:00 PM , Anonymous tom stone said...

athena,the obvious answer is that they get a substantial kickback from the "preferred lender" either disguised as an increased rebate,or just cash...when a broker sells an arm or i/o loan there are no "points" there is instead a "rebate" which is sometimes as much as 3% of the loan amount.a normal rebate,or fee wold be 1% or so,and it is supposed to be disclosed to the borrower in the good faith estimate,which is supposed to be provided to the borrower well before the loan closing...oddly enough these disclosures are not always made when they are supposed to be made,and instead are all part of the loan package at the closing..."read this,initial this,sign this" and it slides right by the the borrower signs a form acknowledging the fee was disclosed and agreed to without ever getting a chance to say "whoa there"it happens quite a bit,and is a serious ethical violation...i saw a statistic about a month ago that said re brokers and loan brokers fail to provide legally required disclosures in a timely fashion about half the ugly statistic,it should be less than 1%.

At 5/24/2006 09:31:00 PM , Blogger Athena said...

I think that smells like collusion and price fixing to me. And by cutting out the opportunity for competition in regards to who a customer can use for financing... smells like racketeering. I've been seeing the Feds cruising the blog including the DOJ... I hope they're taking names.

At 5/28/2006 05:17:00 PM , Anonymous tom stone said...

i hope they are too,but i wouldn't expect this justice dept to go after big republican contributors,maybe there are a few dumb enough to contribute mostly to the dems...i'd just like to see the rule of law back.


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