Ah, the inverted yield curve theory. I've been reading a lot about this of late -- it seems a lot of people are questioning this as an augur of bad things...
While it has been pretty good in the past, here are a few reasons (from a WSJ article today) that it might be another missed forecast:
[i]This time, economists have some more weighty arguments against the voice of the yield curve. Chief among them is that long-term rates have remained extremely low for a variety of reasons unrelated to recession fears.
For one, foreign investors have piled into U.S. bonds.
Second, as the U.S. population ages and companies or the government try to fund traditional pension plans, demand has grown for the kind of long-term bonds that can guarantee payments to future retirees.
Third, the Fed's success in controlling inflation over the past couple decades has led investors to demand less compensation for future inflation. All these factors have brought down long-term yields. ...
The average real Fed funds rate during the past nine yield-curve inversions was a much more restrictive 4.88%. Interestingly, the real rate was particularly low -- 2.74% and 3.68%, respectively -- during the inversions of 1966 and 1998, the last two times the yield curve gave false alarms. [/i] I think the key question will be whether the influx of foreign investment capital can compensate for whatever is the slowdown or pop of the housing market...
Now that the housing boom is winding down, and interest rates are going up, how long until people start realizing, the hard way, that they couldn't REALLY afford the house they bought a few months or years ago?
Actually I have been expecting this. People have been foolishly getting those adjustable rate mortgages, and not taking the future into account.
Where does everyone think those rates are going to adjust to? It is a big mistake not to lock in the current great rate.
Another problem is that many people buy too much house, and by saving that point or two, many people bought even more house by only thinking of the current rate.
Once the rates go back up, which happens when the economy improves, you are going to see an explosion in foreclosures. Tens of thousands are going to lose their houses. But while there is nothing anyone here can do about that, it actually will be a good time to invest in those houses.
Many people are going to make a lot of money off of other peoples foolishness. The banks that pushed these things are going to take a hit also. (Some think the bank benefits from foreclosures, but they really don?t.)
I would not invest in the banking industry until after this hit has affected the market, and the overreaction pushes their stocks below what they are truly worth.
The banks actually could weather this storm a lot better if they created a few consumer friendly responses to financial difficulties.
Instead of making things harder on the borrower by demanding the money immediately, then foreclosing, and selling the property at a loss, they could work with the people a little more. They were the ones who pushed this stuff after all.
Anyway if a person is having trouble making their payments, the bank could offer to give the borrower a few options that would help them out, help them keep their house, or help them sell it without as much loss to them and the bank. They could give an extension where payments can be skipped for 3 to 6 months. (Interest just added to the loan.) And/or they could rewrite the loan, extending it, and reducing the payments.
Working with people would be so much smarter then the way they currently go to war the second a person misses one payment for whatever reason.
Unfortunately (or fortunately, depending on your perspective), a lot of the banks have actually sold the mortgages - or at least the payments from the mortgages - on the market already. They're called "asset-backed securities," and basically the banks can take a pool of mortgage payments, turn them into securities, and sell them as securities on the market (they're essentially equivalent to bonds).
So, I don't know if the banks/mortgage companies will be hurt so much by problems with existing mortgages (however, don't buy asset-backed securities on the market if they're backed by adjustable-rate mortgages that are about to hit that first adjustment...) so much as by the slowdown in the new mortgages and refinancings that have been driving their profit margins.
I think quite a few people are going to find themselves hurting - specifically people who find themselves the "last sucker" who were buying speculative properties with the idea they would flip them - and even more especially those who were buying condos for that purpose. Unless the rental market picks up substantially, a lot of people will face the prospect of not being able to cover their mortgage payments from renting the properties out either - so they'll swallow the loss as long as they can, and then flood the supply-side of the housing market when they can't hold out any more.
I disagree. There aren't that many people speculating on homes and many people with more than 1 property intend to keep them longterm/rent them. In many of these areas where values have rocketed the rental markets are already quite vibrant (can't afford to buy, you gotta rent).
And the whole argument about buying more house than you can afford... Doesn't that just happen all the time anyway? My Dad's a real estate agent and no one who comes in and gives a range... 150k-200k gets something thats 130k-160k. Usually they buy whatever they can get a max on their morgage. Higher rates it seems, would nail them all... At any point.
One thing to add about flipping, if purchased properly, the property should still bring a profit. The idea is to purchase a property that is undervalued, and needs work. (Sometimes just a paint job, cleaning, and an improved yard, but often a lot more.) By purchasing an undervalued property, fixing it up with a sensible budget, and selling it, sometimes below value, you should still be able to make a profit.
If you aren't making a profit, you either bought the wrong property, paid too much, or spent too much renovating it. That is actually very common. The recent market just made it easier to cover up those mistakes.
Agreed, Boston - and places like the the Bay Area look particularly vulnerable with all the interest-only mortgages that were used in the property buyups in recent years. When that balloon payment hits, whoever is holding the property will be akin to the loser in a game of hot potato.