housing market go boom.

So I've ranted about this before, mainly in my own frustration at the fact that I make a well-above-median salary and can't reasonably afford to buy a house, since home prices doubled about three years ago and have stayed up. I'm watching the subprime meltdown with interest, not only because (as with the dotcom crash) I'm not surprised and I'm gratified my financial instincts were right, and it's fascinating to see it all come to a head in that delightfully non-linear fashion. I love complex systems: it's what I do for a living, and probably the only thing I'd go back to school for. Like I'm just now reading that China stopped buying our mortgage debt in May: scary, because enough panic could tip the US into a recession, but I'm also glad to see the economy re-stabilizing itself.

I was writing a couple of years ago that perhaps this is just what homes in Northern California cost now, and they'll stay that way, but since then I've learned more about what happens to all the bizarro mortgages people have used to buy houses her, where that money comes from, and where it goes. It turns out that while your mortgage used to be held by your bank, a mortgage lender is in the process of handing money out (your mortgage) and getting that money back as soon as possible, by packaging it as part of a mortgage-backed security (MBS) and selling it to investors. The security will have a trustee, who hires a loan servicer to collect your payments and distribute the profits. That all may be subcontracted and divided through several layers, so God help you if you're in trouble and need to adjust the mortgage terms.

So here's the sequence of events. Along with many other people, I've been assuming this won't affect Bay Area prices, because historically home values here have stayed strong. However, even the people who have been here a few decades acknowledge that at no time have prices doubled in just a few years as they did from 2002-2005, so okay, maybe this time prices might go down.

  1. People who couldn't really afford houses ("subprime borrowers"), but bought them anyway using crazy financing they couldn't afford and possibly didn't understand, start defaulting.
  2. Lenders and MBS investors start losing money, because the MBS profits came from people's mortgage payments.
  3. Everyone remembers that lending money carries a risk of non-repayment, and not only stops buying mortgage debt as investments, but also resists financing everything else. The New York Times says "Standard & Poor's counts $35 billion in corporate loans that have been delayed or canceled, including loans to finance the leveraged buyout of Chrysler."

    [This is the part I'm waiting for in the Bay Area housing market.]

  4. Lenders tighten lending standards back to something resembling "we'll only approve the loan if we think you can pay it back". (During this boom, they haven't cared, because they could just sell the debt and pocket all the intermediate fees.)
  5. People making $80,000/year can no longer get financing to buy a 2-bedroom house for $700,000 (the usual price in most of Redwood City).
  6. People with tons of money don't want overpriced 2-bedroom houses.
  7. No one buys 2-bedroom $700,000 houses.
  8. Prices go down to what buyers (like me) can get financing for using sane mortgage terms.
So, we'll see. I recommend the daily sets of links on the Housing Crash page for a lot of good reading.

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