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The Coming Crash in the Housing Market: 10 Things You Can Do Now to Protect Your Most Valuable Investment
Today's real estate market is a house of cards--learn what homeowners can do to prepare for its pending collapse
Soaring home prices and 50-year low interest rates have lulled homebuyers into a false sense of security. But plummeting consumer confidence and record-high personal debt threaten to blindside overextended homeowners and real estate investors.
"The Coming Crash in the Housing Market"shows homeowners how to avoid owing more to lenders than their houses are worth--known as an "underwater" mortgage--and reveals commonsense steps for protecting one's assets when the bottom falls out.
In this compelling, well-documented book, renowned economic consultant John Talbot tells current and potential homeowners how to survive and thrive in tomorrow's world of slashed home values. He presents: Convincing reasons why the housing market will likely crash within two years Startling similarities between this and previous economic disasters
Soaring home prices and 50-year low interest rates have lulled homebuyers into a false sense of security. But plummeting consumer confidence and record-high personal debt threaten to blindside overextended homeowners and real estate investors.
"The Coming Crash in the Housing Market"shows homeowners how to avoid owing more to lenders than their houses are worth--known as an "underwater" mortgage--and reveals commonsense steps for protecting one's assets when the bottom falls out.
In this compelling, well-documented book, renowned economic consultant John Talbot tells current and potential homeowners how to survive and thrive in tomorrow's world of slashed home values. He presents: Convincing reasons why the housing market will likely crash within two years Startling similarities between this and previous economic disasters
- GenresBusiness
204 pages, Paperback
First published April 28, 2003
About the author
John R. Talbott
16 books6 followersJohn Talbott is an economic consultant who has authored academic papers on economic growth and development and made presentations on the subject to the governments of Russia, Jordan, and Qatar. A visiting scholar at the Anderson School at UCLA, Talbott is also a former vice president in the investment banking division of Goldman, Sachs, and Company.
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January 14, 2024How can house prices move 300 percent if the underlying rental earnings stream is moving only 2 to 3 percent a year?
Even adjusting for inflation, home prices have seen a real increase of over 70 percent during the period. It is true that homes, on average, have increased in size during this period, going from 1385 square feet to 2030 square feet. This would mean that approximately half of the real price increase during the period might be explained by the average home's increase in size.
In addition, when you purchase a home in America, you also purchase a second financial asset, a tax-avoidance scheme. Clearly, someone who has mortrgage payments of $700 per month is better off than someone who rents a similar place for the same monthly payment. The reason is that homeowners can deduct their interest expense from their taxes and thus pay significantly less income tax than renters.
When we say that a stock price looks high we mean that it looks high relative to its historical price, or relative to its earnings, or in comparison with other companies in its industry.
To the extent housing prices may be up because of an increased flow of funds into the sector, what happens when that flow slows or reverses? Doesn't there have to be an underlying principle of value that justifies the higher home prices?
The analogy to the stock market comes from my mother. She always liked IBM as a company, though they had the best people, and agreed with their customer service philosophy. SHe therefore concluded that it would be a ood stock investment. She did not ask the critical question, how high a price or P/E was IBM selling for? My mother likes oranges, but she would never buy any at the store without first looking at their price.
14 times free cash flow is extremely high. High leveraged transactions on Wall Street are typically done with debt levels equal to six to eight times the company's free cash flow.
What makes an asset-based market like the home housing market risky is the sheer volume of the leverage, or the debt, in the system. It is called leverage, or borrowing, because it leverages, or increases, the pitentil returns from an investment. A 5 percent return on an asset becomes a 50 percent return to equity capital if leveraged with nine dollars of debt for every one dollar of equity (ignoring for now the cost of the debt).
If housing prices decline by just 11 percent, these homeowners are living in an underwater asset - that is, the market value will not be sufficient to pay off the debt is a sale is required. The number of people in this situation has greatly expanded over the last few years. Many homeowners have taken advantage of the low rate environment to refinance their mortgage and run their total debt back above 90 percent of the home's market value.
are about to be rudely awakened.
Efficiency of markets is another way of saying that market pricing acts rationally.
Human shortcomings: human hubris; overconfidence; the inability to assign correct probabilities, especially to very rare events; overreaction; especially to recent or personal experience; people incorrectly dealing with "sunk" costs; people's tendency to gamble or take unnecessary risks; selective recall; and poor self-control.
If behaviourists are right about their theories of mis-pricing about the market, it should create money-making opportunities for either them or their clients. They should be able to start mutual funds that make trades based on the market's mis-pricing, buying underprices assets and selling overpriced ones. If they are right about their behaviorist theories, their mutual funds should be exceptionally good long-term performers, dramatically outperforming the market indexes. Unfortunately, no such mutual fund exists in real life. A study of all existing mutual funds show none that have outperformed the market consistently, and that in total they all underperform by an amount just about equal to the fees they charge for their advice.
Finally, and most important for my argument that homes are over-priced in today's market, is the requirement that a market have many willing participants, that is, numerous buyers and sellers. Although there are a large number of willing buyers and sellers in the housing marketplace in the form of homeowners, it is my contention that their actions are controlled by a very few number of very large lending institutions. In a world where most of the buyers are leveraged over 80 percent with mortgage debt, I argue that the mortgage lender and his lending terms are the key ingredients to setting home prices in America. We will see that because of competition between these very few lenders, they end up with very aggresive lending policies, which drive up housing prices with little real recourse to the lending institutions. Finally, we will explore the impact that an implied government guarantee has on the operations of Fannie Mae and Freddie Mac, those unfortunate private companies that must compete with them, and the overall mortgage and housing industries. If indeed the housing market is not a real economic market, this has very serious ramifications.
In Hollywood, there is an expression that the budget for a picture is "up on the screen." All the money contributed to the making of the movie went into direct costs for the picture - actors, director, script, producer, costumes, scenery, etc. When one borrows against his or her home and uses the money to buy a car or repay credit card debt, the money is definitely not "up on screen." The housing asset's quality has not improved, but the debt attached to the property has grown dramatically. In any secured lending business, this is a recipe for disaster.
Under Chapter 13 of the Bankruptcy Code we can miss payments and still not subject out house to foreclosure.
A self-fulfilling feedback loop. As home prices increase, Fannie Mae is authorised to lend more in each conventional mortgage, and as Fannie Mae lend s more, housing prices increase.
the belief that there will always be a greater fool to pay an even higher price in the future.
There will be no comparables in the neighborhood because nothing will be selling. Bankers will have to go back to very realistic valuations, probably based n square footage and historical pricing.
They are infamous for buying high and selling low when it comes to foreclosures.
Diverisifying geographically has been an excellent stratgey to date because most of our country's housing problems historically had an epicentre to them: the internet bust hit Seattle and San Jose, the oil glut hit Houston and Dallas, and Wall Street's corruption scandal will most likely hit New York worst of all. But what if the next problem were national in scope?
Moementum investing says that the fastest growing in the past will be the fastest growing in the future.
1981, Reagan tried to curtail the inflationary effects
1990, borrow huge sums of money without recourse.
You might ask who would be crazy enough to buy a bond with that kind of warning, but remember that these bonds had coupon yields of over 15 percent and also remember that people still smoke cigarettes despite the warning on the package.
Donald Trump got so leveraged at one point that his properties had to go up 10 percent in value each year so that he could refinance every year and use the increase in price to pay the ineterest on his debt. I believe this is the only known case in history in which a lending program had more than 100 percent debt in its capital structure.
Each major crash involved a great deal of financial leverage with principals playing with other people's money.
Banks do not hold onto foreclosed properties for long, and there is nothing worse than trying to sell your house when a bank is liquidating a similar property down the street at 70 cents on the dollar.
There is a wealth effect on consumption. When people feel wealthier, either from increases in their stock portfolio or from increases in the values of their homes, they tend to spend more. There are more available methods to borrow against increased home prices, including second mortgages and home equity loans. For every $1000 a house appreciates, homeowners spend $60, or 0.6 percent. This compares with 0.3 percent for stock market increases.
Private mortgage insurance (PMI) providers ae those insurance companies that guarantee investors that interest and principal will be paid in the event of a mortgage foreclosure or default.
A 2 percent decline in the value of their mortgage insurance portfolio would reduce their book equity to zero.
I am reminded of the magician who asks us to focus all our attention on his right hand as he takes our wallet with his left hand.
Fannie Mae and Freddie Mac are exempt from filing or reporting to the SEC.
The housing market is not a true economic "market." There are very few lenders who provide most of the capital, in essence determining the prices paid for homes.
a guarantor of last resort
What to do about it:
1. Decrease exposure to residential real estate. Many young couples have a feeling that if they do not buy right now, they will be priced out of the market forever. If you spend 20 to 30 percent less than the total amount you qualify for you should probably reward yourself for having incredible self-constraint. A good rule of thumb is not to pay more than three times your family's total household income.
2. Move from a high-priced area to a lower-priced area. The loftier price neighbourhood should fall farther.
3. Manage your debt leverage better. There are seminars where you can learn mortgage deals with no money down. Clearly, there are plenty of people out there who want to encourage you to borrow more than you probably should. Under no conditions are you allowed to take money out of the house and make purchases or pay down other debt balances. Remember like Hollywood, the money must stay on the screen! The reason for refinance is to take advantage of lower rates.
4. Hedge your exposure to residential real estate. 0 to 50 percent invested in residential real estate.
5. Plan now in case of a major transition event. Banks take both spouses' income into account when figuring out how much mortgage debt money they will extend. It is as if one big wage earner were applying for a mortgage. There is double the probability of either of two parents losing his or her job as compared to a single parent. no man is an island. Human capital market will temporarily decline if your are dismissed.
6. Examine contingency plans. Adage that money solves all problems. You want funds equal to at least 25 percent of the value of your home invested conservatively.
7. Maintain adequate insurance. Never insure a loss you can afford to take. Insurance price the policies to cover their risk and overhead costs and allow for a healthy profit margin. Buying insurance is like betting against the house in Las Vegas. The odds are against you. The fact that a manufacturer is willing to sell you additional warranties indicates that he believes that the unit probabaly will not need the warranty.
8. Investigate bankruptcy protections now. Bankruptcies stay on your credit record for up to 10 years. Chapter 7 bankruptcy, a court-appointed trustee collects your assets, sells them for cash, and makes distributions to creditors. A homeowner is able to keep his home under chapter 7. Chapter 13, a debtor comes up with a three- to five-year plan that pays all or significant amount of his debts off from his future earnings. Plan is only available for individuals not businesses. People choose Chapter 13 over 7 even though it does not completely free them of their debt obligations.
9. Become more civically involved.
10. Reassess your life's priorities.
Even adjusting for inflation, home prices have seen a real increase of over 70 percent during the period. It is true that homes, on average, have increased in size during this period, going from 1385 square feet to 2030 square feet. This would mean that approximately half of the real price increase during the period might be explained by the average home's increase in size.
In addition, when you purchase a home in America, you also purchase a second financial asset, a tax-avoidance scheme. Clearly, someone who has mortrgage payments of $700 per month is better off than someone who rents a similar place for the same monthly payment. The reason is that homeowners can deduct their interest expense from their taxes and thus pay significantly less income tax than renters.
When we say that a stock price looks high we mean that it looks high relative to its historical price, or relative to its earnings, or in comparison with other companies in its industry.
To the extent housing prices may be up because of an increased flow of funds into the sector, what happens when that flow slows or reverses? Doesn't there have to be an underlying principle of value that justifies the higher home prices?
The analogy to the stock market comes from my mother. She always liked IBM as a company, though they had the best people, and agreed with their customer service philosophy. SHe therefore concluded that it would be a ood stock investment. She did not ask the critical question, how high a price or P/E was IBM selling for? My mother likes oranges, but she would never buy any at the store without first looking at their price.
14 times free cash flow is extremely high. High leveraged transactions on Wall Street are typically done with debt levels equal to six to eight times the company's free cash flow.
What makes an asset-based market like the home housing market risky is the sheer volume of the leverage, or the debt, in the system. It is called leverage, or borrowing, because it leverages, or increases, the pitentil returns from an investment. A 5 percent return on an asset becomes a 50 percent return to equity capital if leveraged with nine dollars of debt for every one dollar of equity (ignoring for now the cost of the debt).
If housing prices decline by just 11 percent, these homeowners are living in an underwater asset - that is, the market value will not be sufficient to pay off the debt is a sale is required. The number of people in this situation has greatly expanded over the last few years. Many homeowners have taken advantage of the low rate environment to refinance their mortgage and run their total debt back above 90 percent of the home's market value.
are about to be rudely awakened.
Efficiency of markets is another way of saying that market pricing acts rationally.
Human shortcomings: human hubris; overconfidence; the inability to assign correct probabilities, especially to very rare events; overreaction; especially to recent or personal experience; people incorrectly dealing with "sunk" costs; people's tendency to gamble or take unnecessary risks; selective recall; and poor self-control.
If behaviourists are right about their theories of mis-pricing about the market, it should create money-making opportunities for either them or their clients. They should be able to start mutual funds that make trades based on the market's mis-pricing, buying underprices assets and selling overpriced ones. If they are right about their behaviorist theories, their mutual funds should be exceptionally good long-term performers, dramatically outperforming the market indexes. Unfortunately, no such mutual fund exists in real life. A study of all existing mutual funds show none that have outperformed the market consistently, and that in total they all underperform by an amount just about equal to the fees they charge for their advice.
Finally, and most important for my argument that homes are over-priced in today's market, is the requirement that a market have many willing participants, that is, numerous buyers and sellers. Although there are a large number of willing buyers and sellers in the housing marketplace in the form of homeowners, it is my contention that their actions are controlled by a very few number of very large lending institutions. In a world where most of the buyers are leveraged over 80 percent with mortgage debt, I argue that the mortgage lender and his lending terms are the key ingredients to setting home prices in America. We will see that because of competition between these very few lenders, they end up with very aggresive lending policies, which drive up housing prices with little real recourse to the lending institutions. Finally, we will explore the impact that an implied government guarantee has on the operations of Fannie Mae and Freddie Mac, those unfortunate private companies that must compete with them, and the overall mortgage and housing industries. If indeed the housing market is not a real economic market, this has very serious ramifications.
In Hollywood, there is an expression that the budget for a picture is "up on the screen." All the money contributed to the making of the movie went into direct costs for the picture - actors, director, script, producer, costumes, scenery, etc. When one borrows against his or her home and uses the money to buy a car or repay credit card debt, the money is definitely not "up on screen." The housing asset's quality has not improved, but the debt attached to the property has grown dramatically. In any secured lending business, this is a recipe for disaster.
Under Chapter 13 of the Bankruptcy Code we can miss payments and still not subject out house to foreclosure.
A self-fulfilling feedback loop. As home prices increase, Fannie Mae is authorised to lend more in each conventional mortgage, and as Fannie Mae lend s more, housing prices increase.
the belief that there will always be a greater fool to pay an even higher price in the future.
There will be no comparables in the neighborhood because nothing will be selling. Bankers will have to go back to very realistic valuations, probably based n square footage and historical pricing.
They are infamous for buying high and selling low when it comes to foreclosures.
Diverisifying geographically has been an excellent stratgey to date because most of our country's housing problems historically had an epicentre to them: the internet bust hit Seattle and San Jose, the oil glut hit Houston and Dallas, and Wall Street's corruption scandal will most likely hit New York worst of all. But what if the next problem were national in scope?
Moementum investing says that the fastest growing in the past will be the fastest growing in the future.
1981, Reagan tried to curtail the inflationary effects
1990, borrow huge sums of money without recourse.
You might ask who would be crazy enough to buy a bond with that kind of warning, but remember that these bonds had coupon yields of over 15 percent and also remember that people still smoke cigarettes despite the warning on the package.
Donald Trump got so leveraged at one point that his properties had to go up 10 percent in value each year so that he could refinance every year and use the increase in price to pay the ineterest on his debt. I believe this is the only known case in history in which a lending program had more than 100 percent debt in its capital structure.
Each major crash involved a great deal of financial leverage with principals playing with other people's money.
Banks do not hold onto foreclosed properties for long, and there is nothing worse than trying to sell your house when a bank is liquidating a similar property down the street at 70 cents on the dollar.
There is a wealth effect on consumption. When people feel wealthier, either from increases in their stock portfolio or from increases in the values of their homes, they tend to spend more. There are more available methods to borrow against increased home prices, including second mortgages and home equity loans. For every $1000 a house appreciates, homeowners spend $60, or 0.6 percent. This compares with 0.3 percent for stock market increases.
Private mortgage insurance (PMI) providers ae those insurance companies that guarantee investors that interest and principal will be paid in the event of a mortgage foreclosure or default.
A 2 percent decline in the value of their mortgage insurance portfolio would reduce their book equity to zero.
I am reminded of the magician who asks us to focus all our attention on his right hand as he takes our wallet with his left hand.
Fannie Mae and Freddie Mac are exempt from filing or reporting to the SEC.
The housing market is not a true economic "market." There are very few lenders who provide most of the capital, in essence determining the prices paid for homes.
a guarantor of last resort
What to do about it:
1. Decrease exposure to residential real estate. Many young couples have a feeling that if they do not buy right now, they will be priced out of the market forever. If you spend 20 to 30 percent less than the total amount you qualify for you should probably reward yourself for having incredible self-constraint. A good rule of thumb is not to pay more than three times your family's total household income.
2. Move from a high-priced area to a lower-priced area. The loftier price neighbourhood should fall farther.
3. Manage your debt leverage better. There are seminars where you can learn mortgage deals with no money down. Clearly, there are plenty of people out there who want to encourage you to borrow more than you probably should. Under no conditions are you allowed to take money out of the house and make purchases or pay down other debt balances. Remember like Hollywood, the money must stay on the screen! The reason for refinance is to take advantage of lower rates.
4. Hedge your exposure to residential real estate. 0 to 50 percent invested in residential real estate.
5. Plan now in case of a major transition event. Banks take both spouses' income into account when figuring out how much mortgage debt money they will extend. It is as if one big wage earner were applying for a mortgage. There is double the probability of either of two parents losing his or her job as compared to a single parent. no man is an island. Human capital market will temporarily decline if your are dismissed.
6. Examine contingency plans. Adage that money solves all problems. You want funds equal to at least 25 percent of the value of your home invested conservatively.
7. Maintain adequate insurance. Never insure a loss you can afford to take. Insurance price the policies to cover their risk and overhead costs and allow for a healthy profit margin. Buying insurance is like betting against the house in Las Vegas. The odds are against you. The fact that a manufacturer is willing to sell you additional warranties indicates that he believes that the unit probabaly will not need the warranty.
8. Investigate bankruptcy protections now. Bankruptcies stay on your credit record for up to 10 years. Chapter 7 bankruptcy, a court-appointed trustee collects your assets, sells them for cash, and makes distributions to creditors. A homeowner is able to keep his home under chapter 7. Chapter 13, a debtor comes up with a three- to five-year plan that pays all or significant amount of his debts off from his future earnings. Plan is only available for individuals not businesses. People choose Chapter 13 over 7 even though it does not completely free them of their debt obligations.
9. Become more civically involved.
10. Reassess your life's priorities.
February 19, 2009
I read this book in 2003 and Mr. Talbott could not have been more right. He came to his conclusion by thinking outside the box. Comparing the debt practices driving the housing market to the failed deals in Private Equity. Stunning!
June 8, 2024
I just finished reading Mr Talbott's new book and I can see why people call him Anti-American and an anti-Semite, and why Goldman Sachs fired him. But he makes some valid points about the housing market and excessive leverage and I think he may well be right one day. The wealth to income ratio in America is at an all time high, debt is at an unrepayable level, people who look like they can barely read and write are driving Teslas, and credit growth is starting to slow, per Mr Richard Duncan of the IMF.
But does anyone know how to buy put options on Fannie Mae like Mr Talbot suggests in the book? I've tried googling it but cannot find a ticker or even a website to give me instructions on this sensible hedge.
This is an important book for helping you to navigate the waters in these uncertain economic times - it may turn out to be the best investment book of 2023.
But does anyone know how to buy put options on Fannie Mae like Mr Talbot suggests in the book? I've tried googling it but cannot find a ticker or even a website to give me instructions on this sensible hedge.
This is an important book for helping you to navigate the waters in these uncertain economic times - it may turn out to be the best investment book of 2023.
Displaying 1 - 3 of 3 reviews