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We have been hearing reports for some time now - that there is an inflationary bubble in the US and European real estate markets. Some people that perhaps do have an interest in seeing this continue might tell you - Keep Buying and Do Not Worry. Others, like us, know that if any commodity or investment has already run up thirty, forty, fifty percent or more in a very short period of time is probably ripe for a correction. This is especially true if the run up was a result of some other phenomenon, such as cheap money (artificially low interest rates) or no money down financing. However, this is not just about the fact that prices have gone up. Which is to say, it is helpful to see the larger picture and other issues at work, so you can make an informed decision as to how to handle your personal investments going forward. . One argument is that real estate is probably one of the best hedges against inflation that exists and we can agree with that general comment. However, looking at the entire overall economy, there are some ancillary questions or problems. So, looking at US housing prices for an average middle class home in many markets (such as the US North-East especially, California and Florida) it is very probable that you might find a price tag of US$300,000 or maybe more for what many people would consider to be a very average home. If you are a person that bought such a home many years ago for say US$150,000 - and the price is now US$300,000 - then good for you. However, how many younger people are out there who can now afford US$300,000 (or more) for a basic middle-class dwelling. Meaning, you have seen your home perhaps double (if not more) in value over a relatively short period of time, and in fact home prices in many markets have jumped twenty percent or more during the period May 2004 to May 2005. Has salaries or income gone up in tandem with these price increases? Which is to ask - How many younger middle class people (first time home buyers) are really out there that can afford such a home using traditional mortgage requirement methods (20 percent down payment, fixed rate 30 year mortgage)? Some recent statistics claim that 40-percent of current home purchases is made by this group, but where are they getting the money to do so if their income has not kept pace? We all know the latest craze is interest only mortgages with no money down requirements, etc. But this is not the traditional way people used to buy homes. Is it possible that the ONLY way the home purchases can continue is by these new no money down interest only payment mortgages, and if so, what does that really tell you about affordability or incomes versus housing cost ratios? What does it mean for the banking industry and the Central Bank (US Federal Reserve) in terms of policy going forward? . The US National Association of Realtors had the following to say back in November 2004: . The association's First-Time Homebuyer Affordability Index shows a typical first-time buyer household, aged 25 to 44, with an income of $31,225, had 74.7 percent of the income needed to purchase a typical starter home with a 10 percent down payment. The median starter home price was $160,200 during the third quarter. The index shows the typical first-time buyer could afford a home costing $119,700. However, many buyers are making smaller down payments than assumed by the index, and are using loans that give them more buying power. . . According to information for 2005 on the FDIC website: . As for personal income, it grew 5.8 percent in 2004 and 4.2 percent in 2003. While stronger than the pace of rent growth, this was still far less than the pace of home price gains during the past two years. This gap between growth in home prices and incomes has been widening since the decade began. Moreover, the price-income gap has become especially pronounced in high-cost metro areas. The housing affordability index for first-time homebuyers of the National Association of Realtors, which takes into account home prices, incomes and interest rates, slipped 3.8 points in 2004 to 77. This marks the second-lowest annual level for the affordability index since the recession year of 1991. The lowest reading during this interval was 75.9 in 2000, when 30-year mortgage rates were over 8 percent. If this decline in affordability continues, it might eventually weigh on home sales and price appreciation as first-time buyers are priced out of the market. . In addition to increased leverage and sub-prime lending activity, use of adjustable-rate mortgages, or ARMs, remains high. According to the Mortgage Bankers Association, ARMs accounted for almost 46 percent of the value of new mortgages in 2004 and 32 percent of all applications. Both figures were up sharply from their 2003 levels of 29 percent and 19 percent, respectively. It is noteworthy that this development occurred despite the fact that the average annual fixed rate for a 30-year mortgage remained virtually unchanged from 2003. Furthermore, data from the Federal Housing Finance Board indicate that the ARM share is high and rising in several of our boom markets. Taken together, these trends suggest that highly leveraged borrowers are increasingly taking on interest-rate risk as they stretch to afford high-cost housing. Although homeowners taking out ARMs may be more exposed to payment shock when their monthly payments adjust upward with rising interest rates, for many, this event is some years off. A large share of ARMs originated in recent years featured initial fixed-rate periods that could last up to ten years. The FDIC and other analysts have previously explored the growing role of ARMs in financing home purchases. . Another evolving trend that has not been tested in a housing market downturn is the increasing market penetration of innovative mortgage products, such as interest-only (I/O) and option ARMs. These mortgages are specifically designed to minimize initial mortgage payments by eliminating principal repayment; but these also can increase leverage and expose owners to large jumps in monthly payments as interest rates rise. According to Inside MBS and ABS, interest-only mortgages accounted for 23 percent of the value of non-agency mortgages in 2004. Some market participants estimate that these higher risk ARMs are increasingly being offered to borrowers seeking low- or no-documentation loans and to those with blemished credit histories. While financially savvy borrowers using these products are more likely to be prepared for the possibility that their monthly payments may jump sharply, marginal borrowers may face greater difficulties adjusting as their monthly payments inevitably rise. . Finally, although this factor is not directly related to credit conditions, heightened investor purchases of homes could also be signaling a higher degree of speculative activity in housing markets during 2004. Data from Loan Performance indicate that 9-percent of U.S. mortgages in 2004 were taken out by investors, up from just under 6-percent in 2000. Furthermore, this share is significantly higher in local markets that are experiencing the strongest home price appreciation. In some of these markets, it is estimated that the investor share of new mortgage originations is as high as 19 percent. Academic studies show that residential property investors are less loss-averse than owner-occupants and thus more likely to sell precipitously in a declining market, thereby aggravating any existing downtrend in home prices. . . Also, information from the above link also talks about 1998, which was the last time a severe boom or housing price increase took place whereby 24 markets were considered to be involved in an inflationary boom. Today in 2005, that number is 55 markets, or more than double than the last time this kind of boom took place. What does all this mean? . Well, let us think about this for just one moment. If housing prices are moving out of reach for many new home buyers, and these very same new home buyers have to take on riskier kinds of mortgages in order to qualify (riskier for the banks mainly) - then what will be the US Federal Reserves attitude about inflation going forward? We think they opt for inflation as a policy, or at least the banks making these kinds of new mortgages want this to be the case. Why? Let us suppose for one moment the economy slips into a recession. Let us also think about the idea that if you can barely can afford to buy a house now, with no money down and an interest only or currently low adjustable rate mortgage - what are you going to do IF you loose your job or IF interest rates start going up (and you mortgage payments jump higher in the future)? Chances are, such people will probably file for bankruptcy or walk away. Now, if you are bank and get stuck with a whole lot of homes due to foreclosure - would you favor even higher prices for these homes or lower? You, as a bank, certainly would not want to be a situation whereby you loaned someone US$250,000 for a property that is now worth US$195,000. Instead, you want to be able to sell off the property and recover your money - would you not? We think the US banking industry is scared stiff about this kind of scenario and WHY there has been a push for bankruptcy filing rule changes guaranteeing by law that borrowers remain on the hook for any negative equity. So, one principal idea to consider is that the US Banking Industry will push for any economic scenario whereby inflation rather than deflation is the order of business going forward. This is a very important point because the US Federal Reserve is really a private corporation, whose stock is owned by private banking interests (so who are they really going to protect?). Also, the role of the US Federal Reserve is supposedly to try and manage economic stability policies, or better said - those policies, which best serve the overall economic interest for the country. In terms of the banking sector especially, this means inflation is the preferred modus operandi. . This is not to say that the government or the Central Bank (Federal Reserve) wants to see inflation. However, at the same time, they are more concerned about possibly having a scenario that mimics the Japanese economy over the last ten years or so, which has been deflationary. The last time the US economy witnessed this kind of event was during the so-called great depression of the 1930s - whereby many banks were stuck with loans for stock investments, and other things, that became increasingly worth less as months went by. We believe the artificially low interest rates for the past few years have been put in place to combat the prospect of deflation in the US economy. If we look back at the period 2001 - 2003, we see this as a very real fear, and we can try and understand what the US Federal Reserve was doing (right, wrong or otherwise). Now of course we have the opposite - too much inflation. . NOTED ECONOMIST PAUL KRUGMAN SAID THE FOLLOWING: . This week's cover story in The Economist makes it more or less official. Deflation, not inflation, is now the greatest concern for the world economy. Over the past year, producer prices have fallen throughout the advanced world; consumer prices have been falling for the last 6 months in France and Germany; in Japan wages have actually fallen 4 percent over the past year. Until the recent crisis prices were falling in Brazil; they continue to fall in China and Hong Kong; they will probably soon be falling in a number of other developing countries. . So far, none of these price declines looks anything like the massive deflation that accompanied the Great Depression. But the appearance of deflation as a widespread problem is disturbing, not only because of its immediate economic implications, but because until recently most economists - myself included - regarded sustained deflation as a fundamentally implausible prospect, something that should not be a concern. . The point is that deflation should - or so we thought - be easy to prevent: just print more money. And printing money is normally a pleasant experience for governments. In fact, the idea that governments have a hard time keeping their hands off the printing press has long been a staple of political economy; dozens of theoretical papers have argued that the temptation to engage in excessive money creation causes an inherent inflationary bias in fiat-money economies. It is largely to combat that presumed bias that most of the world has accepted the notion that monetary policy should be conducted by an independent central bank, insulated from political influence - and has written into the charters of those central banks that they should seek price stability as their main, often only, goal. . . . BACK IN JULY OF 2003 - WILLIAM GREIDER SAID: . At the risk of sounding like Chicken Little, I am going to describe the economic situation in plain English. The United States is flirting with a low-grade depression, one that may last for years unless the government takes decisive action to overcome it. This would most likely be depression with a small d, not the financial collapse and grapes of wrath devastation Americans experienced during the Great Depression of the 1930s. But the potential consequences, especially for the less affluent and the young, would be severe enough--a long interlude of sputtering stagnation, years of tepid growth and stubbornly high unemployment, punctuated occasionally with a renewed recession. Depression means an economy that is stuck in a ditch and cannot get out, unable to regain its normal energies for expansion. Japan, second-largest economy in the world, has been in this condition for roughly twelve years, following the collapse of its own financial bubble. If the same fate has befallen the United States, the globalized economy is imperiled, too, since America's market for imports and its huge trade deficits keep the global trading system afloat. . Most authorities, I should add, do not regard any of this as likely. The great difficulty for policy-makers is that this doesn't much feel like a crisis--not yet anyway, for most Americans. So where's the urgency to undertake radical remedies? Some of Wall Street's best forecasters, for instance, are predicting 4 percent US growth in the second half of 2003. But Japan experienced false recoveries, too. Nobody knows what will unfold if nothing is done, but the consequences of waiting to find out could be horrendous for the broad ranks of Americans. When the US economy corrects for its excesses, it is always the innocents who are led to the slaughter first. Even if the odds are only one in four that the worst will happen (as the Dallas Federal Reserve Bank president recently estimated), it seems reckless to gamble. Taking strong measures now would be messy and disruptive to regular order (maybe wasteful if they aren't needed), but in the present circumstances that would seem more prudent than a false optimism that lamely repeats that the "good times" are right around the corner. . A depression can be read as a market signal of a dysfunctional economy that requires fundamental restructuring. Japan learned this the hard way. In this case, such a signal may be flashing the need for deep changes both in the American economic system and the worlds. Surely it is not too soon for Americans to ask themselves what might be out of whack and how to correct things--starting with their own much-celebrated economy. . I asked a financial economist at a major US hedge fund where the United States appears to be at this point. We are in the second or third year of what Japan has gone through, he surmised. How much longer might this go on? Another ten years, he said, if you think about Japan, another ten years. . The good news, so to speak, is that the Federal Reserve is on the case. At least Fed Chairman Alan Greenspan and colleagues now acknowledge that the gravest danger lurking in this situation is a general deflation of prices, and they promise to make sure that doesn't happen. For many months, Greenspan and other governors dismissed the growing anxieties expressed in financial circles by describing the chances of deflation as extremely small and quite unlikely. After the indexes for wholesale and consumer prices both fell in April, the Fed dropped those reassuring phrases. The chairman instead announced that pre-emptive actions may be needed to head off the threat. Declining prices, if they persist generally, create a vicious spiral of negatives--falling profits, more closed factories, shrinking employment and incomes, accompanied by waves of failing debtors, both corporations and families. In short, a far larger calamity than stagnation. . Though Greenspan doesn't say so in plain English, Fed governors recognize the corrective action that may be required of monetary policy: Pump up the money supply and deliberately induce rising prices--that is, foster a renewal of inflation, their old scourge. Rising prices provide an essential lubricant for any sustained recovery because a dose of inflation helps businesses get well and takes some of the depressive pressures off wages and debtors of every kind. The central bankers, however, are facing a very awkward moment. After twenty years of relentlessly reducing the inflation rate to near zero and winning great praise for their triumph, the governors are naturally reluctant to announce that the disease they conquered has become the cure. . Who cares what economists and the Federal Reserve thought back in 2003? You certainly should, because the tinkering they have done to address one problem has now created another. Which is to say as well, we can somewhat predict the next level of tinkering to some extent, and how they can effect the value of your home and other assets. However, now that we have taken a look at what happened before, let us now explore the present day (2005). . The Following Article is a Very Interesting Commentary: . A LOOK AT MORTGAGE STATISTICS - By Kenneth R. Harney, September 26, 2005 . Are homeowners in some parts of the country more likely than others to pay their mortgages on time? If you had to guess where the scrupulously on-time borrowers live, would you pick states with traditionally thrift, conservative financial stereotypes like New Hampshire, Vermont or the Midwest? . Would you perhaps also guess that some of the states with the highest prices, highest housing appreciation rates and highest uses of interest-only and option ARM loan programs might have the highest incidences of late and missed payments? After all, aren't home buyers in such markets -- think California, for example -- stretched to the limit to purchase their high priced homes in the first place? . Well guess again. California homeowners may have to deal with sky-high prices and monstrous mortgage bills, but they pay their loans on time more reliably than homeowners in all other states but one -- high-cost, high inflation Hawaii. New Englanders tend to be relatively dependable with on-time mortgage payments, but they are not among the leaders. And the heartland Midwest actually has several states with some of the highest delinquency rates on home loans and exceptionally high rates of foreclosures. . All these home mortgage performance factoids can be gleaned from the latest national delinquency and foreclosure survey by the Mortgage Bankers Association of America. The quarterly study covers almost 40 million active mortgage loans and is considered authoritative on the subject. . At the end of the second quarter of 2005, Hawaii, where housing appreciation soared by almost 26 percent last year, just 1.56 percent of all homeowners with mortgages were even slightly in arrears. That compares with a national average of 4.3 percent. California, where median home prices are stratospheric and rose by another 25.2 percent last year, had a late payment rate of just 1.88 percent. New Hampshire and Vermont, by contrast, had late payment rates of 2.95 percent and 2.5 percent respectively. . Where are homeowners most likely to fall behind? The highest rates of late payments and foreclosures are in states that have relatively slow-rising home prices, and slow-growing economies with above-average unemployment. Among the slowest payers: Mississippi borrowers, whose delinquency rate at mid-year stood at 8.5 percent. Louisiana was next at 6.9 percent, followed by Indiana (6.7 percent), Tennessee (6.32 percent), Texas (6.31 percent) and Ohio (6.13 percent). . The two big hurricanes this season, Katrina and Rita, undoubtedly will increase delinquencies in the Gulf Coast states sharply, despite the fact that many lenders have announced that they will forbear -- allow delinquencies -- for up to three months on properties in storm-savaged areas. . Foreclosures generally are the highest in the Rust Belt states where factory layoffs have been extensive and unemployment rates intractably high. Though the national average rate of foreclosure was 1 percent as of mid-year, Ohio homeowners had a 3.3 percent rate, followed by Indiana (2.8 percent), Kentucky (1.9 percent) and Mississippi (1.7 percent). . http://realtytimes.com/rtcpages/20050926_mortgages.htm . BANKRUPCY FILINGS SEEM TO BE UP (AGAIN): . FILINGS INCREASE AHEAD OF BANKRUPCY CHANGES - By Lori Haugen September 2005 . FAIRMONT -- After Oct. 17, declaring bankruptcy will be more complicated and more expensive. And it may be more difficult to find an attorney to help you. Congress last spring adopted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which put up new hurdles and costs for consumers to erase their debt. In response, many debt-ridden consumers across the country are scrambling to declare chapter 7 bankruptcy before that deadline. Under the new rules, a means test will cause more people to file for chapter 13 bankruptcy, meaning they will be required to pay back their debt over time, instead of having their debt forgiven under chapter 7. Those filing bankruptcy after Oct. 17 will also be required to undergo counseling, "to work out their debt issues before filing," said David Frundt, an attorney with the Blue Earth law firm of Frundt and Johnson. And after filing, people will be required to participate in a financial management course, to discourage any repeat bankruptcies. Frundt said it is not clear yet who will be doing the counseling -- the government has yet to release its list of approved credit counselors. Nationwide, filings for the period of April through June rose 11 percent compared to the same period in 2004, according to the Administrative Office of the U.S. Courts, though the total number of bankruptcies for the year to date remained stable. In Minnesota, in August alone, there were 2,185 bankruptcies filed, compared to 1,514 in August of 2004. Total bankruptcy filings to date in 2005 are 19 percent ahead of last year, but slightly behind 2003, a record year for bankruptcies. The state does not keep track of filings per county. . Minnesotans declare bankruptcies at a lower rate than most Americans -- the state ranks about 40th out of the states, with about one out of every 105 households filing for bankruptcy, according to recent statistics. Terry Viesselman, who practices bankruptcy law at the firm Viesselman and Barke in Fairmont, said his filings right now are four times the normal rate. They're flooding in, Viesselman said. I'm working on one right now. . http://fairmontsentinel.com/news/stories/092305c.html . THE
FINAL POINT OR CONCENSUS
.We believe the US real estate market cannot continue as it has been in terms of price increases (as no market goes up forever), and we also believe there are a number of converging issues that will force the US Central Bank to raise interest rates in the near term (next 18 months). Some of these issues include the almost doubling of the price of oil within the last 12 months (and we think oil will continue to be more expensive as time goes by) which if course has fueled inflationary pressures. In addition, the US has gone from a nation of net lending to a nation of net indebtedness, with countries such as China, Japan and South Korea as the major lender of funds to the US government (these nations collectively own more than 40 percent of US government bonds, notes, etc.). As such, they will start to clamor for higher interest rates in order to continue loaning money to the US in order to compensate for the continued devaluation of the US Dollar. Speaking of which, as long as the US government finds it politically unpalatable to increases taxes and refuses to cut back on spending, and continues to borrow money to finance the government, and continues to have a trade deficit - the only option or result will be a net devaluation of the US Dollar as a long-term trend. Therefore, providing these other outside pressures exist (oil costs and foreign lenders), we see the options as obvious. . In conclusion, higher interest rates, at least in the short-term, will result in a negative impact on the housing market. This has always been the case. However, rates will not shoot up radically, but rather they will be brought up slowly. While the US National Association of Realtors expects an even better or banner year in 2005 for home sales activity - the long-term outlook for certain is a correction in the US housing market. It is not a question of if, but exactly when. . Many of our European clients often say we focus too much on US issues and not enough on Europe, so to be fair, we can make some observations about real estate prices in Europe as elsewhere as well. Generally speaking, bank loans for real estate purchases are much more restrictive in terms of down payment minimums, etc. outside of the US, and in many European nations in particular (to contrast the circumstances in one so-called modern, developed market with another). Better stated, while it is very true that real estate prices have risen exponentially in Europe as well for housing, it is also true that on average, Europeans have much more equity in their own homes as well. The reason for this is are bank lending practices in many of these markets. . In other words, we are less concerned about the impact in Europe as it is often the case that MORE individual consumer equity exists BECAUSE of the tighter lending practices. In addition, the same is true for real estate in developing markets or those markets that had a credit crunch within the last few years - Argentina falls into this category. So, using Argentina as an example, in recent years, almost all real estate purchases have been for CASH. As such, real estate prices may go up and down, but most people will not be at risk of losing their homes to a bank foreclosure accordingly. Similarly, in many emerging markets, such as Thailand, Dominican Republic and Ecuador (just to name a brief few), mortgage interest rates have been traditionally very high and initial deposit requirements very high as well in comparison to the more industrialized nations. In our opinion, this has really been a blessing in disguise. Which is to say, most people cannot afford 20 percent interest in terms of bank mortgage payments, plus if the bank requirement is for a down payment of 25 percent or more, many people feel might as well try and pay cash - which is what they do. So, as a result, in many of these countries, middle-class people save their money and buy a building lot for cash. They save some more money and when they can afford it, they start building their own home - for cash. The result? A good portion of the population that has no bank mortgage hanging overhead and is also somewhat insulated in terms of the effect of real estate fluctuations (in terms of day to day living that is). . THE ACTION PLAN
.Why make mention of these issues and what can you do about it? Well, if you currently live in North America or Europe, NOW may be the time to think about taking out inflated profits and cashing out of the local real estate market where you are. . If you do have some built up equity and were planning to sell your home or property within the next two years - it might be a good idea to do so today, rather than later. If for whatever reason you would prefer not to do this, or are not ready to consider moving or retiring for some time, another idea might be to take a home equity loan at a currently low fixed rate, and use those funds to invest or purchase elsewhere (see below). Of course do not so this if you cannot afford the monthly payments. But if you can, the US national average for a 15-year fixed mortgage is currently about 5.75 percent. In two years, this may look like a bargain if rates go back up to 8 percent or more. . Let us say you do sell your home or have the cash equity in hand - what do you do? The idea should be to buy low and sell high, and not to reinvest those funds back into another inflated local property. Where do you find these realistic real estate buys? Namely in those very places or countries where easy credit has not pushed up prices too far too fast and also whereby prices in general are more reasonable - places where you get more house for the money. There are many markets that fit this bill and of course it all depends upon where you might want to retire to as a goal as well. . If the Caribbean is your fancy, then the Dominican Republic still remains to be one of the best buys around. Comparing costs for beach front or other kinds of properties, it is still the case that you can find oceanfront lots for about US$20 per square meter. Some ocean or beach condominium projects offer one and two bedroom units starting at about US$78,000 or so. If you prefer to live in a modern urban setting, then 1,500 square foot and larger new homes or apartments can be easily be found in the US$120,000 range. . If you prefer to live someplace other than on a Caribbean island, then you might want to investigate Uruguay, Brazil or Argentina. These markets offer still very reasonable prices for real estate in comparison to current prices in Europe or North America. And in addition, just as in baseball, always bet on the team in last place (it has nowhere to go, but up). Meaning, many people might think this idea involves risk or might feel this is an uncomfortable idea - buying a property in what some might call an emerging market. However, that is the entire point, and these countries are not so backwards as you might tend to believe either. Cable television with many channels in English, modern and fast Internet service plus stores or businesses offering many of the products or services you have right now are all often available. Plus, the idea is that these markets are inexpensive and a good buy now, but they will not stay that way forever. Buying or owning a property in another country that is not tied in economically or otherwise to the events in your current country is a hedge in and of itself. Then again, buying low has always been the smart way to make money in real estate anyway, regardless of where it is located. So, if your goal might be to retire abroad in a country with a lower cost of living anyway, the idea of cashing out of the expensive market and buying in to the low cost market does make sense. Also, there are other factors to consider also, such as the local structure of the economy and the society. Are these countries poised for a more prosperous and tranquil existence going forward in comparison to where you are living at the moment? They might be. . Let us say you are not interested in purchasing property with the cash you have? Some other ideas certain could include the purchase of gold, which has always proven well in an inflation environment. In addition, more stable currencies of other countries that have a greater prospect NOT to devalue in the near future, or in the least will maintain their value relative to other world currencies can be considered if you wish remain liquid with your holdings. . Regardless of what you decide to do, at least make an informed decision. Using local news and the rhetoric of politicians alone will not give you the information and answers that you need. The facts, statistics and other information can be found in the public domain if you take the time to find it. Also, remember that history does indeed repeat itself. Inflation, deflation, and other kinds of economic problems have all happened before many times over. In addition, the proof of what politicians have done before is all documented, along with the results. However, the other unfortunate truth is that politicians (and people) fail to learn from the results and continue to repeat the same mistakes time and time again. Knowing this, and knowing that economics is all cause and effect can help you predict where things are going, and whether or not the powers that be are taking steps to improve (or not) your own personal situation. If not, then you do have a choice, and staying to suffer the consequences is not one of them. . . Some Similar Articles Related to This One:
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