The Sword Hanging Over the Housing Market: A 40 Percent Drop In Prices

03-10-2011 • ZeroHedge.com

It was all over but the crying. Once the market broke, default rates skyrocketed, and it suddenly became abundantly clear that these agencies had been grotesquely underpricing risk for decades. Borrowers starting making claims on their guaranties en masse, wiping out their entire capital. In 2008, the two agencies entered a conservatorship administered by the Federal Housing Finance Agency (FHFA), a de facto bankruptcy. These lenders have been operating in limbo ever since. Like the other sacred cows of entitlements and defense spending, federal home financing is an issue our leaders would rather keep their heads in the sand over. It is clear they need to be recapitalized. But the chance of this congress, fueled by populist, libertarian fantasies, providing another $100 billion in bail out money for a federal agency is zero. That leaves the possibility that they will be eventually be phased out, leaving the private sector to take up the slack. What will a fully privatized home loan market look like? Try a lot more expensive. That is where you find the jumbo market, which is already fully privatized, as there was never a government mandate to finance the homes of millionaires. If you have a FICO score over 750, move all of your assets to you lender, including your IRA, 401k, 529 plan, and all of your securities business, you might get a jumbo loan for a 100 basis point premium over a convention FHA loan under $729,750. If you don’t jump through all these hoops and refuse to offer your first born child up as collateral, expect to pay a premium of up to 250 basis points, or 7.5% at today’s rates. This is why abandoned McMansions have soared across the land like a great blight, and can be rented for 30% of the cash flow demanded by an outright purchase. What does this mean for residential real estate prices? I’ll attempt some quick, back of the envelop calculations here. Raise the cost of financing by 40%, and you can knock 40% off the value of your property. That is off of today’s prices, which are already down 40%-60% from the 2007 peak, depending on your neighborhood. This will inevitably lead to a secondary banking crisis and another stock market crash. If you are wondering about those Armageddon type forecasts that have the Dow plunging down to 3,000, this is the intellectual foundation behind them. That is when we find out how much freedom really costs. Rent, don’t buy. If the roof leaks, the furnace breaks, and the toilet blocks, you just call the landlord, as I have done with my wonderful new rental here in sunny California.