The Market Bottom Is Not a Price Point
The obsession we have in California with picking market bottoms is an unusual but necessary function of the extreme volatility in our real estate market. When prices are extremely volatile, as they are here in California, proper timing of a real estate purchase is very important. However, if markets were to stabilize and remain stable, picking a bottom would be unimportant. Stable markets are always at the bottom.
A stable market, a market that is at the bottom, is a combination of psychological and technical factors. Psychologically, in a stable market, there is an absence of belief in appreciation. When people believe prices are going to rise significantly (faster than wages or other investments), markets become unstable because people buy to speculate on appreciation rather than to provide shelter for their families. This buying constitutes the self-fulfilling prophecy of irrational exuberance and kool aid intoxication. Technically, in a stable market, loan terms limit price increases to the level of wage growth. Affordability products destabilize markets by allowing prices to rise faster than wage growth.
Cause we see them dollar signs and let the cash blind us
Money will brainwash you and leave your ass mindless
Stable markets are always at the bottom. Nominal prices are going up, so it isn’t a bottom from a pure price-point perspective; however, real prices–prices adjusted for wage inflation–are not going up. When real prices do not go up, you are at the bottom, irrespective of the increase in nominal prices. In terms of the percentage of income people have to put toward housing to obtain the same quality of life, nothing changes.
For example, if you make $100,000 a year, with low interest rates and a sizable downpayment, you may be able to afford a $400,000 property (most stable markets actually trade at less than three-times income). Next year if you get a 3% cost-of-living adjustment raise, you would be making $103,000, and you would be able to afford a property that is 3% more expensive. You could finance a $412,000 property instead of a $400,000 one putting the same percentage of your income toward housing. This effect of increasing bids with increasing wages is why house prices rise with wage inflation in a stable bottoming market.
In California, our real estate markets are not stable. Prices often rise here in excess of wage inflation. This occurs because irrational exuberance takes over and people become convinced prices will rise forever. When this cultural pathology is enabled by lenders through affordability products, lowered lending standards, higher allowable DTIs, and other methods, our prices take flight.
Lenders enable people to bid up pricing. Increasing prices engage the cultural pathology of kool aid intoxication, and an unsustainable rally begins. Since affordability products result in high default rates and foreclosures, these products are withdrawn from the market, prices crash, and psychology turns bearish.
I feel like I’m walking a tight rope, without a circus net
I’m popping percocets, I’m a nervous wreck
I deserve respect; but I work a sweat for this worthless check
Bout to burst this tech, at somebody to reverse this debt
If we eliminate affordability products–something the financial markets are doing anyway–our real estate market will be stable. Of course, we still have to endure the price crash down to stable bottoming price levels; although, once we are there, if affordability products are not brought back again, houses will be affordable, and the market will always be at the bottom.
The real estate cycle is an interrelated series of changes in credit availability and market psychology. Affordability products are the root of the problem because they are inherently unstable. When financing is unstable, market pricing is unstable. Our recent experiment with affordability products was a failure. This isn’t our first attempt; we tried in the late 80s and, and we failed. I hope this most recent failure seals the fate of these loan programs. When you consider how painful the second strike against these products has been, if we take a third swing, there will be no joy in California–the mighty Homedebtor will strike out.