[Tapas]

I became intrigued with the skyrocketing home prices over the last couple of years and began an independent study of this national phenomenon. What was causing home prices to appreciate 20% per year? Why did home prices shoot up 50% during 2005 alone? Why was every hair dresser and valet clerk rushing in to buy multiple investment properties? How were the soccer moms buying BWM, Mercedes and vacation homes on their average teacher salaries?

Just what is going on here? Who is responsible for this madness? How did it start and who stands to gain when the blood letting is over?
Here is my dummies guide to the Housing Bubble:
What is the first thing young couples do after tying the knot? Go house hunting of course! Why? Because wifey needs a secure nest for her future Justin/Hailey. It does not matter whether it makes any economical sense. It does not matter whether their household income is large enough to cover such a financial risk. And right after the McMansion is acquired through some exotic/toxic loan, the next step is to loan a Ford Escalade - so wife and kids can have a safe trip to soccerland.

Let's do some basic math - one baby step at a time.
1. How much house can your income support?
As a rule of thumb, the largest monthly loan you can safely afford is 28% of your Gross Monthly Income. If a typical household makes a gross income of $50,000 a year, the maximum mortgage loan they can afford is 0.28 * 50,000 = 14,000 per year or $1,166 per month.
Whether you decide to spend this amount on RENT as is renting from your landlord, or BUY as in renting from your local bank is up to you. It makes no difference. This is your absolute upper limit.

There is yet another metric to go by. Most couples are not debt free. They have car loans, student loans, credit card bills, etc. Add up all of these fixed monthly payments. Your monthly home payment plus your other monthly payments should not exceed 36% of your household income.
This means the maximum monthly payment is dictated by this equation:
Monthly house payment + (Car payment + Student loan Payment + Credit Card Payment) = 0.36 * 50,000 / 12 = $1,500

2. How much is the home worth?
This is such a basic question to ask, and yet flies right off the radar when couples go house hunting. So how much is a 1200 sq ft, 3BR, 2 bath house worth? How much should you pay for a 1000 sq ft home? What is the fair price on a 2500 sq ft McMansion?
Again, apply a simple rule of the thumb. The cost of constructing a brand new home with all new tiles, carpeting, walls, floors, kitchen appliances from grounds up is $100 per sq ft. That's all.
This means if you are looking at a 1000 sq ft home, its true value is $100,000. Simple math. Look at the square footage, add 2 zeroes.
That 2500 sq ft McMansion is only worth $250,000. This is how much it cost the builders. The fact that the current flipper owner is asking $800,000 should raise a red flag right away!
$100 per square feet is the average cost of construction. There is a deviation. Homes depreciate with time. Older homes require a lot of maintenance. For homes that were built 20 to 30 year ago, you should calculate the cost on the basis of $80 per square feet.
Luxury homes with fancy stainless steel appliances and granite kitchen tops costs more - around $125 per square feet. There is your spread.
Now look back upon your flipper neighbor trying to get $800,000 for his 2500 sq feet home. He is expecting you to pay $320 per square feet. You are being ripped off.

3. How much does it cost to maintain a home?
As a rule of thumb, you must allocate 1.5% of your home price for annual maintenance. This is $4,500 on a $300,000 home.
3b. What is the Carrying Cost of a home?
As a general rule the annual carrying cost of a home is 10% its price. This includes a standard loan, insurance, property tax and maintenance. If you buy a home for $300,000 expect to allocate $30,000 year to year.
Can you rent a similar place for less than $30,000 a year? If yes, then it makes better sense renting it.

4. So how does your hairstylist get to afford this $800,000 McMansion?
Ok, now we are entering the bizarre world of creative financing, greedy flippers and scheming loan sharks.
Even a child can see that a household earning $50,000 a year can never afford to buy a $800,000 home. In the recent past, when the banksters still had some soul left within their hearts, they would lend out a sum at most 3 times your gross annual income and demand a 20% down payment.
If you showed an annual income of $50,000 the bank would lend you $150,000. Not a penny more. Typically you would get locked in a 15 year or 30 year fixed rate loan.

Let's break down the different loan types:
5. A 30 year fixed rate standard loan.
This is the best and safest approach. If you have not cheated on your income statement, you can safely pay off a fixed rate 30 year loan which is 3 times your gross annual salary.
When a 30 year fixed rate is still at historic lows around 6 to 7%, this is the way to go.
One problem. How do you get that $800,000 McMansion on your $50K salary?
Enter the world of creative financing!

6. Interest Only Adjustable Rate Mortgages - (I/O ARMs)
What if you did not have to pay the Principal? What if the banksters were kind enough to be happy with just the Interest. Oh wait, it gets even better!!! What if your super kind bankster was willing to offer you a super low interest rate of 2%
You are getting wild with excitement. You flip out your calculator. 2% of 800,000 is only $16,000. Miraculously, your kind and gentle bankster has worked out a plan that is now within your budget. Look at point #1. This annual payment of $16,000 is well within the ballpark of $14,000 (28% of your annual income).
You can hardly wait to sign the dotted line and move in with your wife into your $800,000 paradise.
You do not even bother to look at the small print. This 2% is just a teaser rate. It goes up after 2 years. Remember the "A" in Adjustable. It always adjusts UPWARDS. What your bankster does not explain is that your Adjustable Rate Mortgage goes up to 4% in two years.
You take a cursory look and say oh well so what. I can easily afford a 2% increase on my $16,000 annual home loan. It will go from $16,000 to $16,320 right? WRONG!
When your ARM adjusts from 2% to 4%, you will be paying 4% of $800,000 which suddenly doubles your payment from $16,000 to $32,000 annually. This translates to a monthly payment of $2,667.
You think well real estate always appreciates at 20%. Your boob tube tells you so. Dr. David Lereah, the Chief Liar for NAR has promised of a continuing housing boom. He has written a book on how to make easy money while you sit at home doing nothing. You can always flip your $800,000 investment for $1,200,000 just before this damn ARM adjusts and make a handsome profit.
If you are greedy enough, you can cash out on some of that extra equity by getting a Home Equity Line of Credit (HELOC). What better way to get that shining BMW 740i and take your wife to Hawaii. Maybe even invest in a second vacation home.

Ok, so you got in the Real Estate Bandwagon with an Interest Only loan. But how does your hairdresser qualify to purchase that $800,000 McMansion on her $25,000 gross annual income?
Guess what, your bankster has a plan for her too!

7. Option ARM
What the hell is that? Your bankster makes a devils deal with your hairdresser. Does paying 2% interest seem too high. What if they gave her an OPTION of not paying the full interest amount? They would simply add back the balance to her loan total.
Do you get it? Not only is she not paying down any Principal, her loan amount is increasing every month she holds on to her property.
On her $25,000 gross annual income, she can afford to spend $7000 annually on her home.
2% of $800,000 works out to be $16,000. She is short of $9,000. No problem says the bankster. She can have the house. The difference of $9,000 will be added back to the amount she owes. This is called Negative Amortization. The loan amount actually grows with each passing month.
What a superb scam. Product of a brilliant mind I must say. What happens now when the bubble has burst, prices are falling across the board, the speculators have vanished and your poor hairdresser is left searching frantically for that elusive box full of stupid and bucket full of cash.
Your bankster will intervene again. This time they will write up an even more exotic/toxic loan which she and her future kids will never be able to pay off. In essence, the bankster now owns her. She becomes a debt slave for life.
Leveraging on the common greed, lack of foresight and herd mentality, the bankster is able to control the population with an economic noose around their necks.

We the people become we the sheeple.
Now that I have explained the pitfalls of these Interest Only ARMs, Option ARMs and HELOC schemes, let's take a look at what caused this bubble.
8. How did the Housing bubble begin?
The Housing Bubble was a carefully engineered scheme by the Federal Reserve Bank to mitigate the effects of the Tech bubble in 2000. In essence, by trying to save the economy from the bursting Tech bubble, they created a much larger Housing Bubble. All they had to do was relax the lending standards and lower the Interest Rates.
This attracted a lot of flippers who found a new way to make large returns on their investments. Failed Stock Brokers became Real Estate Investors. You could buy a home for $200K with zero down, very low interest only payments and flip it for $300K in 18 months.
You could take your profit, buy another home for $400K and flip it again in 18 months for $600K. Heck you could even take out some of your rising equity with a HELOC and live high. Then you buy that $800K home and you are chopped off at the knees. The home prices peaked in August 2005. You cannot get anyone to pay $1 million for your $800K investment property. No one bites for $900K. Not even for $800K. You are f@*ked.

9. What is at stake here?
Around 2000, just before the bubble began forming, the total value of real estate in the US was around $10 Trillion.
Around 2005 at the peak of the bubble, this figure swelled to $20 Trillion.
When this bubble fully deflates around 2010, an astronomical amount of $10 Trillion in home equity will vanish from the American middle class as homes revert back to their base prices. This will be the greatest transfer of wealth from the middle class to the rich as the vultures swarm in and buy up property pennies to the dollar.
It can crash our entire economy and the Global Economy as well. Remember, the impact of these home loans is not limited to the US. Their scope is global. These home loans support a Derivatives Market in the tune of $300 Trillion Dollars. Think of this as another Ponzi Scheme built on the shoulders of this Real Estate Ponzi Scheme.

10. What can you do?
Don't buy real estate. This should be obvious. Keep renting. It is a lot cheaper. Wait till 2010 when the market bottoms out. Look for a 1200 sq ft home around $120K. Pay 20% down and get a 15 year fixed rate loan. Rent now and save all your money. You will come out ahead.
Kick your boob tube out of the window. The MSM and the Banksters are in cahoots. Read the on-line blogs. This is the only source of good information. The best blog on the housing bubble is published by Ben Jones: http://thehousingbubbleblog.com

Be frugal over the next 6 years. The FEDs are engineering the Second Great Depression. Read history. The current trend is exactly tracking what happened during 1929-1933. The aftermath will wipe out the middle class the leave the poor penniless. The tiny Elite hope to become super rich with a sea of sheeple at their service.
The ramifications of Peak Oil at our doorstep superimposed over the collapsing housing market paints a rather bleak future. In fact, the effects of the Housing Bubble and Peak Oil present a greater imminent danger than Global Warming.
Tapas


Further Study Links:
Home Mortgage Borrowing Stats:

An MSNBC story from a year ago during the Housing Peak. It is interesting to see how times have changed:

A closer look at Nightmare Mortgages:

A good video explaining an Option ARM:

[TreebeardsUncle]

Hi.
This is spot on. This would be consistent with the point of view that government functions to transfer the wealth from the many to the few. It is also consistent with the function of the company store in contributing to debt servitude. At this juncture I would like to share with you my 4 rules of investing.

1. A fool and his money are soon parted.
2. There is no fool like an old fool.
3. There is no keeping a fool from his foolishness.
4. A fool is born every minute.

The first 2 rules explain why so many seniors are throwing their money away in slot machines. They don't remember how much they have put in and just see a lot coming out at once (about 75%
of what they put in).

Incidentally this idea also explains why people are so willing to pay
more through a series of small payments than they are in one lump sum. They are reluctant to fork over $100 at the counter for some electronic gadget but would be quite willing to make 12 easy payments of $9/month or more, perhaps disguised as $8.25 monthly payments with a ~ 1.5% interest rate or $1x.00 financing charge.

[gego]

Excellent writeup.

I read an analysis by someone who indicated that real estate prices on average have risen between 3% and 4% historically. This is approximately a 20 year doubling period. So if you know what real estate in a certain area was bringing 20 years ago you can judge values today as being fair or out of line.

For example, 20 years ago acreage around here was bringing in the neighborhood of $300 to $500 per acre, so using $400 as an approximation then, the price should be $800 today. Well the price is now running at somewhere around $2,500 or better per acre or three times what it reasonably should be. Part of the problem is that people in these hot real estate markets in population centers sold out and brought the $600,000 they got from selling their place back home which drove up the prices here.

The buyers have bid up the price of land to the point where no cattle rancher can afford to buy it and make money, so the only potential buyers are the out of state folks who don't understand the local market here and a few brave real estate developers who can't seem to stop, no matter what the price, until they finally go broke.

Interest rates reached their lowest point in the summer of 2003, and have since increased about 1.5 times the lowest, and it looks like they will go up another percentage point into next spring. After that I think the FED will act and force rates down into the spring of 2008 to as low as they got back in the summer of 2003. That will be the end of low rates as the marketplace will be unable to any longer ignore the effect of monitary inflation, and rates will likely tripple from the spring of 2008 until 2014. What do you think a rate increase of 3 times will do to real estate between 2008 and 2014 when the market has already slowed to a crawl and prices are off maybe 10% from the 2005 peak.

In longer term declines it is unwise to think you are making the deal of the centruy by buying early in the decline, and if selling it is unwise to hold out for a better price, which will likely never come.

[FoxV]

$this->bbcode_second_pass_quote('Tapas', 'T')he FEDs are engineering the Second Great Depression. Read history. The current trend is exactly tracking what happened during 1929-1933. The aftermath will wipe out the middle class the leave the poor penniless. The tiny Elite hope to become super rich with a sea of sheeple at their service.

[Fergus]

Suppose you do rent instead of buying. The owner of that ARM house you live in has to bay the montyhly paynets that just keep going up. Guess whos paying the increase. Not the owner. Soon you will be on the street with nothing, same as the home owners that lost their house. Renting does nto provide security. It might offer more options, maybe drag out the inevitable for a longer period of time, but even renters will soo one day have to make a choice of mking another rent payment or biting the bullet and living without electricity and food. Niether option is palatable. Niether option is livable.

Best thing to do is pay off your debt and own the home out right. if you cant do that, your living at the mercy of someone else and living on borrowed time. Thats why we have pumped every available dollar into our home, paid down 14K extra so far this year. Another 3 years at this rate and we will have paid off a 15 year mortgage in about 4-5 years.

When TSHITF, I wanna be in control as much as possible. I dont want someone telling me I can no longer live where I choose to live because I cant afford it. We have taken the stance that tightening your belts now and putting up with a few 'voluntary' hardships will make life easier down the road. Though I expect no piece of cake down the road. It will be a few less headaches then the ignorant will have upon awakening and finding their life has changed and theirs nothing they can do about it.

Yeppers, we are trying to take a pro-active appraoch to PO. The things we consider are things that if something happens, we will be better for it, if nothing happens, we will be golden and flush at that time.

[rwwff]

Tapas, excellent, excellent, excellent. That post ought to be a FAQ.

Couple thoughts that I don't think run contrary to what you wrote.

Don't discount 15 year fixed notes, you mention them, but only suggest 30 year in the second part of your message. I refi'ed to a 15 year fixed right near the bottom of the rate curve in 03; this house is now almost a freeby, I couldn't rent a space a third this size for what my interest, taxes, and insurance amount to.

Second thought, not all regions have experienced a bubble, for various local reasons. For instance, you can't get a bubble in Houston suburbia/exurbia simply because there is so much land and water; if pre-built houses got too far out of line, you could pick up an acre sized lot for $20k, and build your own house at $100/sqft. And there are builders all over the place down here doing just that very thing. Much of the gulf coast, excluding Florida are exactly like this. So, for someone down here, there is no reason not to buy, as long as they force themselves to stay in that $100/sqft range, and do it with a 15 or 30 year fixed note.

[Madpaddy]

Tapas,

A brilliant write up and it is something which is going on across the English speaking world. Ireland is about 1 year behind the US in this cycle but prices here are even higher than in the US. 1200 sq ft house in a suburban estate can fetch €600k+ in Dublin. I also see this as the greatest transfer of wealth in history from the middle classes to property developers and land owners. The government are riding high because of the huge take they are making in property stamp duty taxes and VAT.

My only query is in relation to your cost of $100 per square foot. What about the value of the land the house is sitting on?

Sure you can build a house for $100 per sq ft but you must buy the site first. This would add significantly to the overall purchase price of a house.

Still, I agree with your post in general.

[rwwff]

$this->bbcode_second_pass_quote('Madpaddy', 'M')y only query is in relation to your cost of $100 per square foot. What about the value of the land the house is sitting on?

[Madpaddy]

gego,

you say take the 20 year price and double it to get todays value. What about the inflation in the 20 year period. If you take this into account would $400 20 years ago not be worth nearly $2000 in todays terms?

[TommyJefferson]

Good write-up Tapas. Kudos.

I've been looking for something short and simple to send my friends who are unable to comprehend this grand wealth transfer.

[EnergyHog]

Good summary however I'm not convinced that they are trying to engineer a crash so much as they have created a bigger one by trying to prevent a crash of the tech bubble.

The reason this matters is it helps me determine if the system will be intentionally crashed through deflation or artificially propped up through inflation.

Hmmm...

[PrairieMule]

Working in the Mortgage industry I pretty much agree with your analysis. The two areas I differ would be DTI(debt-to-income) ratio and the geography of the bubble.

First, DTI(total bills/monthly income) is 45% is the standard not 36% for both A paper and sub-prime. Second, the housing bubble is limited to certain areas of the country which have had giant increases in appraisal value. Ground Zero would include areas like California, Arizona, Nevada, Florida, DC/Virginia, and the Northeast. The reality of the housing bubble will not affect the average homeowner in areas like the Midwest, some of the Sunbelt, because they have not had ridiculous appraisal growth(home value doubling every 6 years).

Bottom line, if the appraisal value of your house has not doubled in the last 10 years and you are not saddled up to your ears in debt and living beyond your means-you should be fine.

[ProfitOfDoom]

Good write-up. A few comments I'll throw out...

1. 2 income families have driven up prices. I've been trying to understand how this affects prices. The plots I've seen of inflation adjusted prices don't account for this. To me this is just inflation plain and simple. If you adjust the prices of homes down to account for this I wonder how high they would be relative to the running averages I've seen plotted for the last 100 years. So as long as there are 2 earner families buying homes some of those price gains will stay.

2. So let's say house prices fall 50% by 2010. If so, our economy would likely be in big trouble as in deflation. But you think you're smarter than everyone else so you decide not to by. Okay, but I still have to pay rent for the next 4 years. I can only save 1k per month as a result. In 2010 I have 50k saved...but not enough to buy that 120k house that used to be 240k. I'm screwed and still gotta pay rent.

3. I think inflation is more likely the route to take care of this. So even though your house is worth the same in terms of dollar amounts inflation will acutally adjust the value of your house down to the mean. Yeah, things can get bad with high inflation, but nothing like what we saw during the depression. But you may be ahead as your payment is fixed and you're paying $1500 per month in inflation adjusted dollars...so really only $600. I think this is what the FED is hoping will happen.

Yeah, I know there are holes, but I'm just putting out some other scenarios.

[gego]

$this->bbcode_second_pass_quote('Madpaddy', 'g')ego,

you say take the 20 year price and double it to get todays value. What about the inflation in the 20 year period. If you take this into account would $400 20 years ago not be worth nearly $2000 in todays terms?

[FoxV]

$this->bbcode_second_pass_quote('TommyJefferson', 'I')'ve been looking for something short and simple to send my friends who are unable to comprehend this grand wealth transfer.

[Vexed]

Spot on, Tapas.

Here's my canary.

296 square feet -- but it's home
Tiny condos in Belltown (Seattle) to start at $149,950
They are the size of two of GMC's biggest Sierra pickups parked next to each other."

The Insanity

[aflurry]

$this->bbcode_second_pass_quote('Fergus', 'R')enting does nto provide security. It might offer more options, maybe drag out the inevitable for a longer period of time, but even renters will soo one day have to make a choice of mking another rent payment or biting the bullet and living without electricity and food. Niether option is palatable. Niether option is livable.

Best thing to do is pay off your debt and own the home out right. if you cant do that, your living at the mercy of someone else and living on borrowed time. Thats why we have pumped every available dollar into our home, paid down 14K extra so far this year. Another 3 years at this rate and we will have paid off a 15 year mortgage in about 4-5 years.

When TSHITF, I wanna be in control as much as possible. I dont want someone telling me I can no longer live where I choose to live because I cant afford it.

[TommyJefferson]

$this->bbcode_second_pass_quote('FoxV', 'I')f you don't do it now, don't start complaining when your governement bails out all the bankers with your taxes (again).

[mgibbons19]

Funny thing is nobody ever learns. Since I've been around, we've had an SnL crisis, a farm crisis, a tech crisis, Enron...

All driven (in my mind) by bubbles of various size and origin.

But it's different 'this time'

At least until three months ago.

[aflurry]

I found this site. Sounds like the idea you are describing:

http://www.opencapital.net

off to read more...