More bad news for housing

So the markets sold off today on the news that housing prices are dropping, and fast. I was happy to see that the data discussed today was the Case-Schiller Home Price Index, because after reading about many methodologies, I think that this is the best methodology out there. This past weekend I read the entire methodology document and I came across the following nugget of information:

The monthly indices use a three-month moving average algorithm. Home sales pairs are accumulated in rolling three-month periods, on which the repeat sales methodology is applied. The index point for each reporting month is based on sales pairs found for that month and the preceding two months. For example, the December 2005 index point is based on repeat sales data for October, November and December of 2005. This averaging methodology is used to offset delays that can occur in the flow of sales price data from county deed recorders and to keep sample sizes large enough to create meaningful price change averages.

YIKES... This methodology means that in times of fairly rapid movement the index can really get behind the actual changes since it is a moving average. I know there is a futures market based on this methodology... next step is to delve into that market and understand where people are putting their money. If I was a betting man I would say that the year-over-year declines are going to accelerate in a significant way over the coming months.

Why it will get worse - the data

MarketWatch has an article today entitled "Western states went exotic with mortgages" where they layout data from First American LoanPerformance on the types of mortgages that were taken out across the country, and specifically here in California. If this data doesn't scare you about the near term housing market, I don't know what will. So here it is:

"Payment-option ARMs" (AKA - negative amortization loans... this is where you pay LESS than the interest on the loan and the difference between your payment and the interest due is added to the principle of the loan! Your payments will reset to a much higher amount 2 or 3 years later and will be set by the new interest rates at that time)

California - 24% of all refinanced and first mortgages in 2006
Nation wide - 11% of all refinanced and first mortgages in 2006

To give some perspective, in California, payment-option ARMs made up just 0.8% of all loans in 2003 before jumping to 7.5% in 2004 and more than 18% in 2005.

Interst Only (you pay just the interest, and no principle for the first couple of years, and then your payments reset to new market based interest rates, typically after 2 or 3 years)

California - 32% of refinanced and first mortgages in 2006
Nation wide - 22% of refinanced and first mortgages in 2006

This means that 33% (1 in 3) mortgages across the country last year were either negative amortization loans or interest only. In California, more than 1 in 2 were either negative amortization loans or interest only. Let me say it again... 1 in 3 nation wide and 1 in 2 in California!!!!!!! So if you think you have seen downturn, wait for the 2 to 3 years after these ARMs reset (2008 / 2009) and see how many people default.

The worst is yet to come...

The median household income of silicon valley is ~50% higher than average, yet the median home price is ~3.5x... this will get straightened out over time, and it will get ugly for many people.