good analogy for secondary markets response

This is from the L.A Times, posted by a reader.

[i]I saw a good analogy on the website for the secondary martkets response.

Say I have a muffin (mortgage) shop. I go out and get together all of the ingredients for a tasty muffin (mortgage to be resold on secondary market).

I have eggs, milk, flour, blueberries, etc. and one secret ingredient. I blend up all of the ingredients together and make my muffins (securitization into ABS, CDOs and CLOs) and sell them for a nice profit (for a while).

Suddenly, a market participant (Bear Stearns) discovers the secret ingredient is cowst. That revelation makes the muffins not very appetizing. Never mind that cowst is only 3-4% of the muffin by volume.

No one wants to buy a muffin with 3-4% cowst (maybe more) by volume. It is all mixed in together and there is no easy way to unbake the muffin and take the cowsht out.

That is where the secondary markets are at and until confidence is restored in the mortgage securitization market (many years) nothing will happen that isn’t Fannie/Freddie conforming.

Which coincidentally will whack CA property values very hard. Providing real declines of 40-50% that restore the housing markets fundamental ratios once again.

A more interesting question is why is California’s RE market so bubble prone?

Posted by: sunsetbeachguy | August 14, 2007 at 03:43 PM [/i]

That is a good analogy and a simple way to break it down for the layman. As to why CA is so bubble prone, it’s simply because everyone wants to live here and there is only so much space. I don’t mean everyone, but demand is high and there is only so much beach real estate and then prices get driven up further and further inland until one day your paying $600K to live in Riverside, CA and realise you are in the middle of nowhere and might as well be in Kansas (no offense to Kansans, what I mean is that geographically there is nothing unique, just hugely inflated prices). Now maybe that $600K house goes down to $400K, who can get a loan now for that much and would you want to live there? I see this in many suspect neighborhoods and now that you actually have to justify an income to buy a home, would you want to live in these neighborhoods? I see that 50% decline happening in spots also coming.

According to Mike Davis in his book City of Quartz, the main buisness of Calif. has always been RE, even going back to the Spanish land grants.

 If this guy is really from the Sunset Beach area, I wonder how he defines a bubble.  I tried to find real estate in Santa Monica in 1994, the cheapest place on the MLS was a double wide trailer on a vacant lot for $250,000.  That would be a steal today, just for the land.
 Go to ziprealty and try to find a home in Palo Alto.  The median price for a single family home in that area went from 1,750,000 last year at this time to 2,750,000 this year.  It is a buyers market, price per square foot is $850-1000.  Average number of days on the market is between 50-75.
 My point is simply this: California is indeed different.  It's not immune from the current problems, but the economy of this state will dampen many of the negative attributes of this correction.

I disagree. (Since I own property in CA, part of my hopes that I am wrong.) I do think that CA is different, but I think that the correction will be even worse there.

I agree. The jump was bigger so the correction has to be bigger. They also have as far as I know a larger pile of ticking timebomb ARMs compared to other markets.

CA. is different. Alot of it just comes down to affordability regardless of intrinsic or percieved value. Something seems to be out of ratio when a person making 100K/yr. isn’t in budget, by conventional standards, for much of anything they’d want to live in.

Rich brings up an interesting point. I’d bet that more than 50% of the mortgages made in CA from 1999 to 2006 were negative am option ARMS. Think about what rates have done on the short end of the curve. I’ll bet payments on those ARMS, many of which adjust monthly, aren’t covering the total interest. I saw start rates as low as 1.9%. These were managable loans when property appreciation stayed ahead of the increasing mortgage balances. Many homeowners can’t refi out of these loans because they owe more than what the home is worth. CA leads the country in foreclosures now. If the trend continues, there will be more foreclosures further snowballing the problem. It’s too bad a loan doesn’t exist that allows you to sell your home and carry over a negative equity position to a new mortgage on a new home. Several years ago ELoan was considering it.


At this point you can only do that with cars, I did that with my last one when I was in a pinch and needed to trade my car in quick.