Investors Have Much To Learn From The U.S. Housing Mess

Here is his reasoning: "Recent house price gains have likely come primarily from rising speculation and 'creative financing' because affordability is declining and inventories are rising. When asset prices diverge from fundamentals, I favour taking the other side of the trade – even if it involves moving. Amy wasn't thrilled about moving, but my sense is she will look back on our sale and view it as a good one. In the end, the fundamentals should win out." One of the fundamentals he talks about relates to how housing price increases roughly match income gains over the long run. "With current 13-per-cent annual housing price gains exceeding the 4-per-cent growth in personal disposable income by a record margin, today's environment appears unsustainable," he says. "The current 9-per-cent gap is unprecedented in looking back over the past 30 years. This trend should reverse course. While Fed tightening has so far done little to change lending standards, delinquency rates are picking up and foreclosure rates are rising. In addition, banking regulators are beginning to crack down on risky loans and lending practices. These are clear signals that lending standards are set to tighten….Speculators are shifting from buyers to sellers. Mortgage application growth is slowing. Finally, and most importantly, the supply and demand imbalance in the housing market is turning sharply for the worse as inventories soar." He also concludes that 'creative financing' caused many to buy homes when they shouldn't have done so. For example, interest-only and negative-amortization mortgages (where borrowers are allowed to increase the mortgage balance by missing monthly payments) represented 1 per cent of total mortgage originations five years ago but had climbed to 22 per cent in 2005. The existence of 'creative financing' allowed the housing market to continue to climb even as the Fed raised interest rates during the past two years. http://www.cbc.ca/cp/Money/060629/J062902U.html [Proofreader's note: this article was edited for spelling and typos on June 30, 2006]

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