In Homes We Trust

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According to the latest report from the real estate analysis group CoreLogic, Los Angeles home prices have continued their relentless upward march. The firm found that the median price for homes in the Southern California region hit $464,000 in June, up 5 percent from a year ago. The median price in Los Angeles County rose 6.2 percent from a year earlier to $530,000 in June (not quite the peak but very close).

Although home prices in Los Angeles in 2016 have not yet reached their all-time, pre-2008 nosebleed highs, they are likely to crest that plane this year. Bidding wars sparked by low inventory, foreign (mostly Chinese) and Wall Street competition, ultra-low mortgage rates, and the return of ultra-low 3 percent down payments have sent Los Angeles home prices spiraling upward in recent years.

Together, I believe these trends signal a warning that the Los Angeles housing market is overheated. While Los Angeles home-buying cheerleaders trumpet soaring home prices and fierce bidding wars as evidence of a sustainable recovery, America’s trust barometer is signaling that another painful bust is likely just around the corner.

Unlike a weather barometer, my version of America’s trust barometer is neither scientific nor mathematical. It consists of multiple data points that an independent observer can use to predict the likelihood of future painful consequences, regardless of what the “experts” are saying.

In 2004, data points suggested that serious trouble was brewing in America’s housing market, long before the 2008 financial crash. On Sept. 17, 2004, an article on cnn.com cautioned that: “Rampant fraud in the mortgage industry has increased so sharply that the FBI warned Friday of an ‘epidemic’ of financial crimes, which, if not curtailed, could become ‘the next S & L crisis.’”

Heeding warnings

Despite the clear and publicly available warning that high levels of distrust were festering in the mortgage industry, Alan Greenspan, then-chairman of the Federal Reserve, and his successor, Ben Bernanke, repeatedly reassured the public that there was no evidence of a housing bubble in the U.S. Instead, they insisted that the dramatic run-up in U.S. home prices was based solely on fundamentals. Of course, as we all know now with 20/20 hindsight, this wasn’t true.

What was true was that the Fed, the government, Wall Street investment banks, financial institutions, and government-sponsored entities like Fannie Mae and Freddie Mac, enabled Wall Street to conjure up trillions of dollars for loans to purchase homes through the flagrant misuse of exotic financial products with odd-ball sounding names such as credit derivatives, credit default swaps, asset-backed bonds, and collateralized debt obligations. Almost anyone with a pulse was allowed to borrow outrageous amounts of money with little or no money down, and with little or no proof that he or she could ever repay outsized loans.

Institutional investors quickly snatched up these exotic financial products, which were rated AAA by the ratings agencies. Few understood, or cared, how risky these enormously complicated financial products actually were; this all changed, when one day in 2008, investors suddenly got spooked and lost trust in the value of these products. When investors refused to buy the financial products, housing markets in bubble territory in many parts of the U.S. (including Los Angeles) seized up, sending home prices crashing.

Flash forward: The taxpayer-funded Federal Housing Administration is again allowing risky loans with down payments as low as 3 percent. Now giant banks such as Wells Fargo are following suit, saying that these risky loans will be funded in partnership with Fannie Mae for first time and low-income borrowers at the taxpayers’ expense again.

Predictably, economic and real estate “experts” and home-buying cheerleaders are reassuring the buying public that “this time is different,” and that the recent rise in Los Angeles home prices is based on solid fundamentals, such as the influx of newcomers lured by returning employment opportunities, not the return of another housing bubble.

America’s trust barometer is still in the red zone, warning of more painful consequences dead ahead.

What remains to be seen is how many Angelenos will be caught off guard again, choosing to trust the opinions of the “experts,” instead of considering readily available data points that suggest serious trouble ahead in the Los Angeles housing market.

Linnea Bernard McCord, JD, MBA, is an associate professor of Business Law at Pepperdine Graziadio School of Business and Management.

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