Variable-Rate Financing and the Bubble

A recent article in the Chron mentioned that mortgage loan defaults are in the rise in the San Francisco Bay Area and California, home of the biggest real estate bubble on the West Coast (that is, if you believe that there is a bubble). There has been much speculation that variable-rate financing is partly to cause.

As one friend of mine put it, "Any book will tell you what a bad idea a adj. rate mortgage is in the short term. They all say keep it steady for as long as you intend to live in the house." This is from somebody who doesn't even own property. Obviously, shouldn't everybody know this?

From what I understand, there were two schools of thought (in addition to the one mentioned above) related to variable-interest rates:

1) "Savvy" investors during the low-interest boom years thought that they could save on monthly payments by buying variable-rate loans, then switching out of them once rates started to rise too high. This allowed them to get bigger loans for the same cash down.
2) Home buyers who wanted more house than they could really afford would go in for near-100% financing schemes, known as 80/20 splits. They would get a mortgage to cover 80% of the cost of the house at a fixed rate, then a second mortgage to cover the remaining (up to 20%) at a variable rate. When you're talking about a $500k property, 20% can be a cool 100k. That's a lot of loan to be variable, and you can see how easy it might be to get into trouble - -especially if the property fails to appreciate significantly in comparison to interest rates. For these buyers, however, it would have been difficult to purchase that property for that price without that particular finance mechanism.

So, the variable rate loan really allowed a lot of buyers to get into the market for properties at prices that they otherwise might not have been able to afford. In essence, variable rate financing allowed the bubble to expand faster and get bigger than it might have otherwise.

...and now, it does have the potential to allow it to pop faster, too...

source article on defaults:

The original article can be found on SFGate.com here:
http://www.sfgate.com/cgi-bin/article.cgi?file=/c/a/2006/08/03/BUG8IKA1D81.DTL
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Thursday, August 3, 2006 (SF Chronicle)
Mortgage defaults increase
David Tong, Chronicle Staff Writer


A growing number of homeowners in the Bay Area and throughout California
fell behind on their mortgage payments in the second quarter.
In the Bay Area, 2,910 homeowners received default notices from their
lenders for the April-to-June quarter, up 37.1 percent from 2,123 notices
in the same quarter a year ago, according to DataQuick, a La Jolla (San
Diego County) real estate research company. That increase is the highest
since the first quarter of 2001, when there was a 46.5 percent rise.
The swell was bigger statewide as 20,752 default notices were sent out --
up 67.2 percent from the same quarter in 2005 and the highest increase for
any quarter since DataQuick began tracking foreclosures 14 years ago.
The default notices, filed by lenders with county recorder offices, mark
the first step in the foreclosure process, which usually takes about nine
months to complete.
Defaults have risen as home sales slow. The steady decline in price
appreciation has left financially struggling homeowners insufficient
equity to either sell or refinance their homes to pay off their mortgages.
"We hear a lot of talk about rising payments on adjustable-rate loans
triggering borrower distress," said DataQuick President Marshall Prentice.
"While there's no doubt some of that is going on, as far as we can tell
the spike in defaults is mainly the result of slowing price appreciation.
It makes it harder for people behind on their mortgage to sell their homes
and pay off the lender."
DataQuick analyst Andrew LePage said the current foreclosure figures are
still below the historical norm. On average, lenders have filed 32,762
notices each quarter for the past 14 years, according to the research
firm.
Some of the highest increases in default notices in the past quarter were
in the Central Valley, where household incomes are lower and unemployment
higher, LePage said. Sutter County saw a 229 percent rise in default
notices, while notices in Placer County jumped 126 percent.

E-mail David Tong at dtong@sfchronicle.com. Home default notices on the rise

Second
quarter
County 2006 2005 Change
Alameda 649 458 41.7 %
Contra Costa 725 531 36.5
Marin 58 64 -9.4
Napa 47 27 74.1
San Francisco 127 89 42.7
San Mateo 222 147 51.0
Santa Clara 530 463 14.5
Solano 350 212 65.1
Sonoma 202 132 53.0
Bay Area 2,910 2,123 37.1
California 20,752 12,408 67.2

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Copyright 2006 SF Chronicle

The cost of transportation construction is going up

In yesterday's Oregonian issue, there was an article on how the cost of transportation construction is going up, which will limit how far each transportation (and bond) dollar goes in terms of fixing bridges, building and re-building roads, etc.

You know, I've seen this same sort of story repeated across the country. The reasons why transportation construction costs are going up are mainly related to two things:

1) The cost of oil is going up, and oil is used to make asphalt, which is used to make most roads, and

2) The cost of steel is going up (due in large part to a massive construction boom -- skyscrapers, roads, bridges, dams -- in China), and steel is used for rebar, bridges, etc.

...and here's my proposed solution:

While bike lanes are still a bargain (unless, of course, you want that lane re-paved when it gets striped), there should be a fundamental re-examination of the economics of transportation construction.

Perhaps we rely too much on low-grade asphalt roads? Many of our asphalt roads are designed with only a 10-20 year lifespan per paving cycle. The Romans built some roads which are still going, 2000 years later, with the original pavement, and heavy traffic! Perhaps asphalt is just not the most sustainable solution for every street or other pavement need?

Some of Portland's original cement/concrete streets have never been re-paved... and are still mostly useable 100 years later. I think it's quite possible that, given modern engineering and materials science advances, we can come up with a concrete, fly-ash, cement or other stone-based solution for paving that will last much, much longer than asphalt, without the need for continual re-paving. We might even be able to figure out how to make it semi-permeable, as with the latest asphalt/rubber hybrid surfaces that allow the rain to soak through rather than puddle up on top!

Finally, there should be a bigger focus on maintaining existing roads (and maintaining them to a higher standard, that is, putting slightly more effort into each re-paving with the goal of extending the time between paving cycles to... let's shoot big ... a century), rather than constructing new ones. Further, the state really lacks a statewide passenger rail system... wouldn't building one to tie together a statewide bicycle network be a much more sustainable use of state funds?