Tuesday, May 03, 2005

Pop Goes The Bubble?

Pop Goes The Bubble?

The kind folks at Battery Ventures wrote an excellent article on Alan Greenspan's legacy, which also discussed a subject near and dear to my heart, to wit, the housing bubble.

Take these two statistics, for example, drawn from an LA Times article:

“In 2001, as the current housing boom got underway, fewer than 2% of California homes were bought with interest-only loans, according to an analysis done for The Times by LoanPerformance, a San Francisco mortgage research firm.

By last year, the level had risen to 48%. Nationally, LoanPerformance says, interest-only loans were used in about a third of all purchases.”

Okay, so people are diving into interest-only loans. What's the big deal? Well, while the borrower may be able to afford the payments now, when the principal starts to come due (generally after 3 years), the required payments jump.

Now add in this fact:

"In California, the traditional fixed-rate loan is in danger of becoming extinct. According to recent LoanPerformance data, the percentage of new loans that are adjustable in Santa Cruz and San Diego was 85%; in Oakland 84%; in Santa Rosa 81%; in Los Angeles 74%."

So in all likelihood, close to half of new mortgages are of the interest-only, adjustable-rate variety. This might be fine if the folks taking out these loans left themselves plenty of financial cushion, but the whole point of interest-only and ARMs is to let people "stretch" to buy houses that are more expensive than they could otherwise afford.

So what happens in a couple of years, when the weakening dollar leads to a rise in inflation, which triggers a rise in interest rates, which bumps up the payments on ARMs, just as the principal on those interest-only mortgages comes due?


1 comment:

Justin K said...

People keep saying that Greenspan won't let interest rates go up to a point where it hurts the housing market since it hurts the economy.

I'm not an economist, but Greenspan is between a rock and a hard place. There's no way you can keep interest rates low when the dollar is falling AND the deficits are getting bigger. If not for the reliance of the rest of the world on the US, many govts would have stopped buying US debt a long time ago IMHO.

Most people think that Greenspan is like some magician who can keep the economy humming along just by waving a wand.