EVP at PIMCO Thinks Housing Bubble Will Burst

Mark Kiesel over at PIMCO makes a good case for the housing bubble. He's putting his money where his mouth is: he sold his house and is now renting. Here's a summary:

With rising mortgage rates, housing is becoming increasingly less affordable



Exotic mortgages, designed to keep monthly payments low, have caused many people to buy more house than they can afford:

"Developments in the mortgage market have also increased the presence of marginal buyers in the housing market. This industry has transformed its product offerings in an effort to keep the initial monthly payments on new mortgages as low as possible. The growth in interest only (IO), negative-amortizing (Neg-Am), limited documentation and forty-year fixed rate mortgages attests to the industry’s use of “creative financing” to keep the game going. For example, IO and Neg-Am loans represented 1% of total mortgage organizations five years ago but have climbed to 22% as of 20052. Banks have been able to maintain easy lending standards, despite higher short-term interest rates, by securitizing mortgage loans and transferring the risk to foreign buyers."

What's more, house prices have grown faster than people's income:




Meanwhile, home inventories are booming:

"Housing inventories are becoming a problem. Presently there are almost 4 million homes available for sale nationwide, including 3.383 million existing and 565,000 new homes. Current inventories are at record levels, having risen 27% and 37% year-over-year for new and existing homes, respectively (chart 3). Given declining affordability and rising inventories, we expect to see homes for sale remain on the market longer and asking prices come down. The housing market should quickly transition from a sellers’ market to a buyers’ market."

He continues:

"In summary, the main forces driving housing price appreciation in the past are now softening. Declining affordability, resulting from rising prices and interest rates, has become a significant headwind facing new buyers. Despite the persistence of creative mortgage financing, prices have now risen to a point where demand is slowing. Federal regulators are beginning to crack down on risky lending practices. 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."

And finally, the consequences for the economy overall:

"Housing is a leading indicator of the overall direction of the economy. As housing slows, economic growth will surely follow. As such, we should expect to see tighter terms on credit extension, less liquid markets and a pick-up in the overall corporate default rate over time with a slowdown in the pace of economic growth. An eventual rise in the default rate, combined with higher near-term volatility, should lead to a more challenging market environment for credit. Watch the “for sale” signs – in both the housing and corporate bond market – my sense is more of both are coming as the market transitions from a mode of risk taking to that of risk aversion."