Wednesday, July 23, 2008

Unpopular Thoughts

I have been watching the news, as I usually do. I have been seeing how the housing bubble has hurt people when they come to my office and I try to help them.

And when I can, I do.

But then I see what Congress and other legislatures are trying to do with the foreclosure the problem. Now, on an emotional level, I can sympathize with this. However, on the other hand, I look around and see no reason why we should be bailing anyone out.

The system that we have right now is broken. If it wasn't, then the economy would not be in the state that it is in. However, propping up the institutions that helped to cause this problem seems to be me to be counter-productive.

Not only does it seem to be counter-productive, but it denies people who have been waiting, needing a down-turn in the housing market, the chance to enter. The idea that the government will now start bailing out individual homeowners who failed to protect themselves by obtaining mortgages which were essentially gambles is an economic reward to them. It also will also keep the prices which, were inflated because of the lax rules for lending, unnecessarily high which makes it harder for young adults and new families to buy their own property.

Consider in the Bay Area that the median home price is $485,000 (incidentally the first time it has dropped below a half million in four years), in San Francisco itself it is $846,000. The average of the median incomes for counties closest to San Francisco is $88,718.88 (San Francisco: $79,423.00, San Mateo: $92,721.00, Santa Clara: $93,072.00, Contra Costa: $85,737.00, Alameda: $78,494.00, Marin: $102,866.00). So that breaks down to monthly income of $7393.24.

Now, if we take the medians (yes I know my average of medians is not perfect but if someone wants to send me better data, I will be happy to review my conclusions) of price and income, we see that a mortgage can run a family for the median price ($485,000) will require a monthly mortgage payment of $ 2,830.33.
This assumes that they get the mortgage with no points, at a rate of 5.75% (which looking at FHA and VA loans might just be a pipe dream since the average rates that I am finding are 6.58% making the monthly payment $3,091.09.).

At either level, $2,830.33 or $3091.09, this does not seem to be too outrageous. But then consider what the family is bringing home each pay period. Each pay period, after the government takes its share, the people will have $2,685.37. Ooops, that is 52% of the median income if they can get the mortgage at the 5.75%. Whats that ? What about their savings that they use for a down payment? Unlikely considering that the average savings rate is -1% (that would be a negative number).

Want to buy a house in San Francisco or Alameda? In San Francisco, assuming the 5.75% 30 year rate, then it comes out to $4,937.03 (with a take home of $2,444.58 each pay period). Alameda homeowners could expect $4,214.12 (with a take home of $2,420.50 each pay period).

Even if people were to start saving up for down payments how much would they need to have in order to make enough of a dent in the mortgage? The rule of thumb for paying for housing is that a person should never spend more than 1/3rd of their income on their rent or mortgage. Now taking the medians for the Bay Area, that would mean spending no more than $1,772.35 per month on the mortgage. In order to do that, for a down payment, the family making the median would have to have a down payment of approximately $185,000.00.

Without resorting to crime, or having a trust fund etc to fall back on, this mythic median family would have $3,598.39 once it paid a rent that would put it living in some very dodgy area. Then after paying for luxuries like rent, car payments, gas, insurance, and food, as well as some saving for the future, they would have to put at least $1,000.00 a month a way. And that would mean all they would have to do is do that every month for 12 years. If they could put away $2,000 per month, they might get there in just over 6 years. (This is based on finding a bank willing to give a savings account with 3% interest).

So what is the point of this? Basically to point out that if we start saving people from the ravages of the market, it is going to end up prolonging other people's entry into the market. It will stabilize the prices at an inflated level. It will put more people in a situation where they cannot escape the rental market, thus increasing the power of landlords since will have essentially a captive market.

Of course, it is an election year. And the legislators want to look like they care. If they cared, what they would do is enact some reforms on the lending industry. They would actually regulate the markets in a way that made sense so that what happened in the last housing bubble is not repeated. But bailing out the companies that did this, bailing out the people who foolishly chose to gamble on their mortgages, is only going to end up hurting the next generation of homeowners.

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