As Bonddad (here, here and here) and myself (here and here) have discussed before, the credit markets are in a state of near-panic. Despite extensive interest-rate cuts by the Federal Reserve, and stubborn buoyancy in the stock markets, we are just beginning to sense the consequences of the out-of-control real-estate boom in this country, and particularly in California.
Follow me below for a brief discussion of what is happening now that the music has stopped in California's real estate market.
$2,600,000,000,000.
That's how much equity the California housing market stands to lose if current trends continue.
Two-Point-Six Trillion.
Why?
Home buyers with the very best credit are still having a difficult time getting mortgages in California, raising concerns that the real estate market in the nation's most populous state could fall much further, sending home values spiraling lower and toppling the state's economy into recession.
The drop in home values could cost the typical homeowner as much as $200,000 in lost wealth, for a total hit of $2.6 trillion statewide.
"We could see rapid price declines," said Dean Baker, an economist with the Center for Economic and Policy Research, who's been warning about the housing bubble for years. "These are huge numbers," he said. "Consumption will fall off."
I've lived in the Bay Area for ten years now and have been horrified at the exorbitant appreciation of homes in this area. No middle-class wage earner can afford the average three-bedroom home anywhere in the Bay Area except by living in the most dangerous neighborhoods. As prices spiked, middle-class home buyers with excellent credit were forced to resort to the same shady loan packages as those in the subprime and Alt-A loan markets, which have completely frozen up at this point and will probably never return (as well they shouldn't.)
When a family with a $100,000 down payment and a salary-earner of $100,000 a year cannot afford to buy a house, but they desperately want to buy before it's too late, or want to get their children into a good school district, what happens? People are forced to overpay for their homes.
Now consider the distinctly unsympathetic position of "Well, why do you really HAVE to own a home?" or, "$100,000 a year sure sounds like a lot to me. I get along just FINE on my husband's 60K, and I'm raising three kids."
Well, around here, $100,000 a year isn't squat. And if you're concerned about your children's education and can't afford $20,000 for each child to go to private school, what do you do? Unfortunately, many of us participated in the real estate market. Those of us who were able to buy ten years ago or so have gotten to ride a huge roller coaster up the incline. It's not surprising, in the state that embraced Proposition 13, that people who were able to buy on normal incomes should have little synpathy for anyone else. Californians persistently personalize trends and are convinced they are utterly representative.
Now, the depth charges are beginning to go off in California.
In California, where jumbo loans play a bigger role than in any other region, the market hasn't come back.
According to preliminary data from DataQuick Information Systems, the number of jumbo loans written between mid-September and mid-October fell by 43% in four major California counties that relied heavily on jumbo mortgages. And that was after statewide home sales fell by nearly 27% in September compared with August.
Originations of jumbo loans in Orange County fell by 43% in early October compared with September and are now down 68% compared with a year earlier. Originations of loans below $417,000, by contrast, fell by just 7% in October in the county.
A similar pattern is repeated in three other major California counties, according to DataQuick. Compared with September, jumbo loan originations fell 45% in Los Angeles County, 40% in Santa Clara County and 29% in Marin County.
If jumbo mortgages are unavailable, most homes in California would simply become unaffordable for a typical buyer.
What does this mean? Simply, this: the upper end of the real estate market, million-dollar-plus homes, stands to get hammered. Absolutely hammered. Given that most decent family homes in the Bay Area and in Southern California actually fall into this category
In the San Francisco Bay Area of Northern California, jumbo loans had 62% of the market earlier this year, and in Southern California, it was 39%. In California and other high-cost regions, jumbo loans were marketed not just to the wealthy who can afford to buy a big house, but to average middle-class families with average middle-class incomes.
These middle-class jumbo loans -- often combined with "affordability products" such as low teaser rates, interest-only loans and negative-amortization loans -- allowed middle-class buyers to push California home prices into the stratosphere.
Those loan packages no lopnger exist. It was not just low-income families who got suckered into the Great California Real Estate Musical Chairs Game; the con stretched all the way through the middle class earning base of California and other states.
Hyping the cultural imperative of owning a home and having a piece of the American Dream, realtors and loan originators alike in the almost completely unregulated real estate market played millions of American homeowners like a Stradivarius violin. Buoyed by the stubborn cheap-money policies of Alan Greenspan, the market continued to spiral out of control.
Now, the market is landing with a thud.
In a recent research note, analysts at Goldman Sachs said they believed these loans pushed California home prices to levels 35% to 40% higher than justified by other fundamentals. "We expect home prices to return to normalized levels," wrote James Fotheringham and his colleagues at Goldman.
If Goldman is right, the typical home-owning household in California has about $200,000 less in home equity than it thought it had. Instead of living in a home that's worth $589,000, it's probably worth $380,000.
The music has stopped, and we are barely starting to see the fallout.