With the financial crisis, we might start seeing a few more defaults in Greenwich, CT (we can all hope, can't we?), but so far, the defaults have tended to hit marginal areas hardest. Here in California, people in Santa Monica aren't defaulting, it's the poor bastards out in the high desert or even down in Bakersfield in the hot, smoggy Central Valley.
In these godforsaken places, all sorts of mini-McMansions have gone up on the theory, apparently, that, hey, they're in California! Every peon in Guatelombia has seen Baywatch and wants to move to California (even though Lancaster, CA looks more like Death Valley Days). So prices can only go up, up, up!
Imagine you're a homeowner in Santa Clarita in 2005, now a nice established exurb 35 miles north of LA. You bought your house in 1995 at the bottom of the market for $175,000 and a decade later it's worth three or four times that much. You can take cash out with home equity loans, so why not find an investment property?
Of course, you'll have to look farther out, deeper into the dusty high desert, like in Lancaster, 70 miles from downtown LA. They're building many new 3,000 s.f. homes on culdesacs with all the amenities. You should buy one up now and resell it when new refugees from the LA Unified School District arrive.
The family you sell it to will, no doubt, be moving to the exurbs to get their kids away from all the Guatelombians in the LA public schools. It's not like Bush is going to close the borders and stop the flood of Guatelombians. So, there will always be refugees looking for "good schools."
That's one reason, you realize, why these new homes in the exurbs tend to be so big -- they're expensive in the hopes of discouraging low rent people from moving in next door. Sure, they cost a fortune to air condition during Lancaster's summer (March-October), but it's all in a good cause.
You start shopping around outside Lancaster. The Cypress Creek Estate sales agents talk about the new high school that's going to be built to serve these new neighborhoods. It will be diverse, but not too diverse, if you know what I mean. Two-thirds white, one fifth Hispanic, enough Asians to show your neighborhood's a good investment, enough blacks so that the football and basketball teams will be competitive. Sounds good!
You get the feeling that there aren't any cypress trees within 100 miles or creeks within 20 miles, but that's not the point. The point is that with low down payment mortgages available, you have all sorts of speculative options available. For example, with a 3% down payment, you could buy a new $400,000 house in a development of 3000+ square foot homes for only $12,000 in cash (not counting the usual points and fees). So, why not buy two? Only $24,000!
If each house goes up 10% in value the first year you own them, you've made $56,000 on your $24,000 investment. Try getting that rate of interest on a CD. Leveraging 33 and 1/3 to one does wonders for your ROI.
Granted, that's exaggerated because you have to pay the monthly mortgage, but you can get a two year teaser interest rate that makes things easier. You're going to be cashing in before two years are up!
Of course, that assumes you can flip them, which often turns out to be more difficult than you initially anticipated. After all, when such easy profits can be made, builders build. Sure, the ecology rules slow them down for years, but in Lancaster there really isn't a whole lot of ecology other than scorpions stinging each other, so eventually a flood of new housing comes online.
Then, there's the problem that not too many people actually deeply, truly want to live in Lancaster, unless they have a job there. Back in the Cold War, there were good jobs at Edwards Air Force base and in aerospace plants. There still are, but nobody's too sure why, or exactly how long the federal government will go on funding new fighter planes to fight ... well, nobody's too sure who.
So, most of the new jobs there are building more houses for Even Greater Fools. Or, you could get work standing by the side of the road as a Human Sign, twirling a big arrow to attract attention to the new housing developments. (Here's my 2005 VDARE article on Human Signs as the personification of the Expensive Land / Cheap Labor economy.)
So, the flipping goes a little slower than you expected. And even at the teaser rate, the monthly on those two empty houses is starting to gnaw away at your net worth. What do you do? What do you do?
Well, you could always rent it out until the market takes off again like you know it will.
But that raises the question of who exactly would want to rent in Lancaster, when you can buy a home in Lancaster for $12,000 down, or you can rent for a reasonable rate in the San Fernando Valley, 40 miles closer to work and 15 degrees cooler, with no dust storms.
Q. So, who wants to live for awhile in Lancaster?
A. The Guatelombian construction workers who are building all the new McMansions down the road.
So, you get some bunk beds and rent out your five bedroom house to 12 Guatelombians. They work hard all day and pay on time. Sure, the neighbors are complaining because your tenants are drunkenly singing along to mariachi music in the backyard all weekend and one fellow got a little too celebratory and started shooting his gun in the air. But, you don't live next door to them, so what do you care?
And then you rent your other house to a couple of families of Guatelombian construction workers. The parents are fine, but you start to notice grafitti around the neighborhood. There are rumors of a gang shooting at the strip mall.
But the money is good in the meantime while you're getting closer to your big payday.
But then you notice that the nice quiet street isn't so quiet anymore. The other speculative owners are doing the same thing you did: renting to construction workers. Soon, there are cars up on jacks on front lawns and Cypress Creek Estates is a big Guatelombian slum. If only you had done it, it would have been okay. But once all those other jerks followed your example, you were hosed. Now, nobody wants to buy into Cypress Creek Estates.
After awhile, they stop constructing new homes in Lancaster, so some of your tenants go home to Guatelombia, while the others hang around Home Depot looking for day labor. It gets harder to collect your rent. So you toss out the construction workers and bring in a Section 8 family. The great thing about Section 8 is that you get your rent checks straight from the federal government, so you don't have to go knock on the door, because, well, to be honest, your new tenants haven't (a single grandmother of 38, her three daughters and their three children, plus a fluctuating cast of boyfriends) don't seem as polite as the Guatelombians.
In summary, the essential problem is that there aren't enough people with the human capital to earn enough to pay for all the new homes that have been built in this low, dishonest decade out in the middle of damn all. Screwing around lowering down payments just pushed the discovery of this fact off into the future, after we've wasted all that money on homes, which aren't really investments in the sense that they generate new wealth, they're just expensive consumer durables. And, they aren't all that durable, either.