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Monday, June 27, 2005

Not with a bang but a whimper? 

It looks like everybody is now talking about the overheated real estate market. Thomas linked to two articles in the Economist in a previous post (1,2). The Atlantic Monthly has a two-page article on the housing market - the article is subscribers-only, but anyhow, it covers much of the same ground as the article in the Economist. BusinessWeek is running as its top story an article on the increasingly hard-to-believe mortgage deals that are popping up all over the place. BusinessWeek also ran several other articles as part of a special report on mortgage financing and the real estate market.

The market is rife with interest-only loans, as well as "option ARMs" that allow borrowers to roll part of the interest they owe back into the principal on the mortgage (see BW Online, 6/16/05, "The Mortgage Trap"). It has gotten so bad that you hear anecdotes of some lenders not even requiring proof of income before handing over a million bucks to a homebuyer.

But it turns out that's just part of the reason lenders are offering such unbelievable deals to their customers. Many lenders are just plain desperate for business, according to some experts. In a bid for market share, mortgage lenders are offering highly favorable terms to borrowers. That's forcing the rest of the industry to match their terms or lose customers.

The industry's underlying problem is simple: Overcapacity and a drop in profitability from its all-time high of 2003.

How will this pan out? The profile of the bust, if it happens, may be quite different from that of the stock market. This is in part due to the far greater length of ownership with real estate as opposed to stocks, and a far higher personal stake in the affair. The Atlantic Monthly says that the boom may not end in a hard fall after all. Prices may merely level off. This is, of course, a prediction of the housing-market nationwide, not locally. Since the market for real estate is primarily local, the profiles of the local markets will probably vary a lot.

Moving locally to the Bay Area, what will be the forward-looking profile of the market out here? For one thing, the market in the Bay Area is super-heated. Atherton and Los Altos are two of the 20 most expensive zipcodes in the United States according to Forbes. Two, jobs in the area don't pay nearly enough for borrowers to be able to weather large downward market corrections. House prices are 300,000 dollars and more, and downward market trends will hit many people hard. Three, by all accounts, the California market is showing many signs of an overheated market - a large number of "innovative" mortgaging schemes, large proportions of low-income borrowers and large proportions of speculative purchasers.

The housing market out here does appear to be ready for a correction. Here is hoping, though, that the boom will end not with a bang but a whimper.