Posts tagged ‘Economics’

05/18/2012

Underwater Mortgages: Need “Demand”

When the housing market crashed in 2008, somewhere between 25% and 53% of all homeowners in America, (depending on their geographic region), realized their homes were “underwater,” because they suddenly owed more to the banks on their mortgage balances, than their properties were worth.

The crash was in part caused by “adjustable rate mortgages” that increased to unsustainable levels, causing so many homeowners to default, they triggered a foreclosure crisis. Since the problem was blamed on “easy credit,” tighter rules were implemented, forcing lenders to accept only very creditworthy borrowers, who could start their mortgage schedules with much higher down payments.

As a consequence of resetting the deck, people who were formerly qualified to buy, could no longer do so. The led to a reduction in housing “demand,” at a time when the “supply” on the market was greater than ever, due to all the foreclosures. So we ended up with more houses for sale, but far fewer potential buyers.

In the years to come, underwater homeowners will not get back into the black, until the value of housing market increases to pre-crash levels. The value of homes will not rise, until the quantity of buyers becomes greater than the number of sellers. It is basic economics: “price” rises when “demand” exceeds “supply.”

Since the “supply” of available housing is fixed and finite, the variable that needs adjustment is “demand.” The government needs to trigger more “demand” to bring about a rising tide as to all home values. Today, there are millions who would love to own a home, and could make their monthly payments, but they lack a sufficient down payment, and do not qualify under the new rules.

While stimulating the building of new homes may put people back to work in the construction industry, it does nothing to lessen the oversupply of already existing homes, or to increase the existing weak demand for them.

Gov. Romney said slowing down the foreclosure process, buying up troubled homes, or giving thousands of dollars towards the purchase of a new home, won’t solve the problem. He predicted home prices won’t return, until the market works. His answer is for the government to do nothing, and just hope pre-crash values return, after a decade or so of relatively sluggish sales.

Congressman Paul basically advocated full speed ahead with the foreclosure process, as he said housing debts must be liquidated, as they are only prolonging the agony. If the bad paper had been auctioned and sold, it would have been cleansed by now, he said. As to the bailouts, Paul lamented, if money was to be given out, it should have gone to those who lost mortgages, not the banks.

Putting more money in the hands of buyers is what is needed, so more people can accumulate the down payments they need. This is how the housing market will return. But this can only happen through higher earnings. As long as Romney proposes nothing to help Middle Class people earn more, the housing market will remain flat, and the homes now underwater, will simply remain that way for a long time to come.

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09/01/2011

Overpaid CEOs Spells Mismanagement

A story in the Wis. State Journal on Aug. 28 entitled: “Hospital Leaders Pay Too High?” said: 1) the orthopedics chair at the UW Medical Foundation receives just over $1 million annually; 2) the CEO of the UW Medical Foundation is paid $708,963; 3) the UW Hospital CEO enjoys a salary of $689,585; and 4) the Dean of the UW Medical School earns $539,389. Eight others were listed who received similar compensation packages.

High paid positions generally mean there is something seriously wrong with management. With private corporations, it causes shareholders and/or consumers to unfairly subsidize the large pay. With government, taxpayers foot the bill.

Under normal economic conditions, wages are set in the market, in accordance with supply and demand curves. Wages go up where the demand for workers cannot be met by the existing supply. Wages remain flat, or go down, where the supply of available workers exceeds the demand.

Since the supply of available qualified candidates for most executive positions, like Chief Executive Officer (CEO), generally exceeds demand, there is usually no economic reason to pay such large salaries. The problem is Human Resources either sets the qualifications unnecessarily high, or they fail to seriously negotiate compensation. They are not trying to pay the least.

If Human Resources narrowed the field to five or so qualified candidates, and then confidentially asked each what salary they would be willing to accept, they could then start bidding down to find the market price. If someone wanted $500,000, but there was another equally qualified candidate willing to work for $400,000, and yet another willing to serve for $300,000, substantial sums could be saved by the shareholders and/or taxpayers.

It is hard to imagine a qualified person cannot be found at less than $1 million dollars, no matter what the job description. What high pay means is market forces are not being utilized, funds are being squandered, and ironically the organization in question needs a new Chief Executive Officer, because it is mismanaged.

05/19/2011

Housing: Basic Supply and Demand

The news reported the ongoing lack of progress in the building construction industry. The problem is easy to understand, when applying basic supply and demand economics.

The supply of housing increased due to foreclosures. Buildings that a few years ago would have been owner-occupied are empty now, because of defaults on mortgage notes. One cause of the problem was the easing of regulation, and the promotion of adjustable-rate mortgages (ARM) that allow payments to be increased during the life of the loan. In the old days, fixed-rate mortgages were the norm, and borrowers made monthly payments, without worrying about increases.

The demand for purchasing homes simultaneously declined, as fewer people now qualify for mortgages. In the old days, a potential buyer needed a substantial down-payment, which generally stopped them from simply walking away upon default. The easing of regulation allowed the financially unqualified to buy, and as they defaulted, they simply stopped paying, and allowed the bank to foreclosure without trying to redeem, since they had no skin in the game. During the period of easy credit, too many buyers entered the market, and now that they no longer qualify for loans, due to a return to traditional lending standards, such as the requirement of a down-payment, there are too few qualified people available to purchase too many buildings.

With the supply of homes exceeding the number of qualified buyers on the demand side, prices have dropped, or at best stayed flat. This is simple economics. So until the oversupply of homes is removed from the equation, there will not be any real growth in the construction industry. Only when new construction is no longer competing against the oversupply of existing foreclosed properties, will the situation improve.

The flat-line growth in the value of homes has also affected those who could bring cash to the table, or who could qualify for loans. This is true despite the availability of relatively low interest rates. In my case, for example, we moved from Wisconsin to Florida 2½ years ago and intended to buy, but as we examined the market, several factors caused us to continue renting for the time being.

First, housing values are not increasing, and in some areas they are actually declining. If after just a few years, we wanted to sell again, any sale, after paying the sales agent, would result in a loss.

Second, the cost of Florida condo generally includes relatively large monthly dues, twice as much as one would pay in the Midwest. It appears a lot of profit-taking is built into them that could be cut out. Dues are like taxes, as they cannot be recouped.

Third, the cost of insurance in Pinellas County is too high, based largely on unfounded fears of a direct hit by a hurricane. Once again, these payments are not recoverable in any future resale.

Fourth, since wealthy Floridians enjoy no state income tax, much of the burden of running local government is based on a relatively high real estate tax, which is not offset by state revenue-sharing.

Fifth, when looking for a condo, one has to consider the number of neighboring tenant-occupied or vacant units in foreclosure, since owner-occupied units are generally better maintained. In this regard, the number of foreclosed units was a factor.

To comfortably buy, purchasers need to know their investment is more likely to grow than decline; the dues, insurance and real estate taxes must be minimal; and the vast majority of the units in any condo project must be financially above water. Given the current situation, at least for now, we will continue renting.