Wednesday, March 5, 2008

Why are prices not dropping? Buyers remorse

Some of you might be frustrated that prices have not dropped in your local market. Tonight I wanted to explain why some markets have had large price drops while others have had only slight drops or even increases.

If you live in an area where inventories have soared while prices have stayed flat and you are frustrated then there are a few things you need to look at. Many times the median price may stay the same or rise because no one is selling!!! If the volume of homes sold in your area went from 100 homes a month to 5 per month then the median price is a useless figure because this means the realtors found 5 suckers to pay bubble prices. Over time as inventories continue to rise, the sellers will eventually react and drop.

Please take note that some areas will not drop as far as others. Michigan/Ohio has already seen most of their price cuts due to the severe recession that has hit these areas due to the auto industry imploding and manufacturing moving overseas. Other areas simply never inflated in the first place. If prices have only risen 3-5% a year in your local area over the past decade then you cannot expect large drops. Also look at the average home price vs. average incomes in the area. Housing should cost 3-4 times income. I think its important that buyers realize that some parts of the US never saw this bubble and as a result will see fairly stable housing prices. The true bubble crashing areas are CA, AZ, FL, DC/Baltimore, NV, and Mass. according to Forbes. Other areas that will see large adjustments include IL, WA, GA,NY,NJ, R.I., CT, MN. The rest of the country may see smaller drops. Use the above criteria to check out your local market and decide where prices are.

Ok so why aren't prices dropping in some bubble areas. Many sellers are still in denial about overpaying by 30-40% if they bought in '05-'07. Coming to terms with the fact that you paid $500,000 for an asset that's worth $300,000 is a pretty big pill to swallow. Put yourself in their shoes. Would you be anxious to sell at a 40% discount?

This problem is exacerbated by the fact that people put only 0-5% down as a down payment because the lending was so loose. Anyone with a pulse qualified for a loan. As a result many cannot afford to sell much below what they paid without having to come to the closing with a check. How many buyers have checks that big to write when the average credit card debt is close to $10,000. This will force homes to be priced artificially high for a period of time. However, later on down the cycle this will actually speed up the price drops.

Here is why:

As the pressure mounts on these buyers to sell and they realize all they did was sign on their name on Countrywide's loan application there will be a point where they will just "walk away" because they have nothing invested. Most financial planners are advising clients that "walking away" is the best thing for them to do financially. Take your credit hit and move on with your life.

You are starting to see this in the news and expect to see it become more and more common. I am surprised that people are already walking away and I think th FED is too. The fact that you see Ben Bernanke and Hank Paulson on the news talking about the housing downturn is not a coincidence. They see whats coming and they are trying to act swiftly to stop it. First the FED tried to freeze ARM resets for 5 years. Since that didn't work and foreclosures continue to rise they are now pleading with the banks to drop the loan balances(see my BB bank post).

I think the fact that Ben is already discussing the banks taking a hit is very interesting. He realizes with the crashing dollar(at another all time low today) that his window of being able to drop rates is starting to close . Expect another 50 basis points in March but if the dollar continues to weaken it will be tough for the FED to drop again. However he also realizes this housing mess has to be fixed or the economy is going to crash. There are two ways to pay for this housing debt debacle. Its either a taxpayer bailout or Wall St. takes the hit.

My personal belief is that since cost of this is in the trillions I expect it will be a combination of both. Wall St. can't afford to take the hit by themselves without losing most of their banks to insolvency and Ben knows we need a healthy financial system so you know where the rest of the money will come from. TAXES! No one wants any type of bailout but this mess has had such a devestating effect on the whole economy that it will most likely happen in some form. Expect a lot of noise around a gov't bailout over the next few months. there is no way its a full gov't bailout because they can't afford it either. The US has $9 trillion dollars in debt. As a result expect both the taxpayers and Wall st. to get us out of this mess. There will hundreds of ideas thrown around in Washington on how to save us but expect the combo idea to be the solution.

Since this will take time lets get back to the seller and when they will move from "denial mode to "panic" mode.

IMO one more spring/summer bust should do the trick and the "full panic" mode will start. We are already getting out of denial mode as December prices dropped 8.9%. Remember Dr. Shiller says bubbles are mostly psychological going up and going back down. As sellers watch the news day in and day out and their house has no offers they will eventually run to the exits all at once. This is the time you will want to have your checkbook in hand and ready to pounce! Any frustrated buyers out there feel free to share your frustration in the comments section.


Anonymous said...

Dang, I have way too much equity in my house to risk losing it. However, if I was upside down, why would I walk away? My strategy would simply be to stop making full payments and stay in the house until the sheriff moved me out. Given the way things are going, that could be a couple of years of free rent. Plus I would probably skimp on upkeep, so I would really save a lot of money.

Thus, those of us that either have equity in our homes or are renters are going to end up paying for the housing mess. Wonderful.

Jeff said...


There is a guy in NJ that is doing that. He has been in his house and not made a payment since 2002. When the lender takes him to court to get him out he tells the bank to prove that they own the loan.

Since the lender sold the loan off and it got sliced into different securities the lender can't prove they own it. Rent free for 6 years and going strong!

Avl said...

The above two comments accurate describe scenarios that, unfortunately, are state-specific only, and then court/judge/case specific only. Many homeowners upside-down will be as lucky and many won't. Why? 1) state laws dictate foreclosure and eviction timelines/processes, not feds, and thus timelines vary significantly state-to-state; 2) judges are playing a big role in deciding what satisfies "proof" of ownership of the loan, and these judge/court decisions vary quite a bit, judge-to-judge.
So some folks will luck out on both above, some on only one, and some on neither. Luck of the draw.

Jeff said...


I agree there was a pool of 15 mortgages in Ohio that was having the same issue.

Because all of these mortgages were chopped up and placed into several diferent pools of AAA paper many judges will not believe that the originator still owns the mortgage.

As the housing market continues to deteriorate many will try to squat in their house and make the lender prove they own the loan.