Let’s start with the Average median income. The data is at: http://www.ffiec.gov/hmda/censusproducts.htm#MSAincome

I want to use the Los Angeles area because that is where I am from.

The avg houshold income in the LA area is $59,800 annually…
…which translates to a monthly pre-tax income of $4983…
…which becomes an after-tax income (28% tax bracket) of $3587.76. This is disposal income.

Now, 38% of this income represents the amount this household is “allowed” to pay per this article. That amount is $1363.35 per month.

Let’s find out how much “home” this household “should” be able to afford given “traditional” lending standards of 30 yr fixed mortgage at prevailing interest rate (6.1%):

Per Bankrate.com’s mortgage calculator, this household can afford a mortgage of $225,000. (http://www.bankrate.com/brm/mortgage-calculator.asp)

If we consider that this home was purchased with no money down, then that is the current “value” of the motrgage/house.

Per (http://www.housingtracker.net/) the median price for an LA county home is currently $389,000.

The difference between $225 and $389K is a decrease in home “price” of 42% (!!!). So, with the stroke of a pen, the gov’t just cut house prices by over 40% by doing these adjustments. (At least in LA – other parts of the country will be quite different)

I am sure there are multiple flaws in this simplistic analysis – for example, this does not take into account the effect of down payments. But I wanted to start somewhere since no one else has. Enjoy.

The “giant deflationary shift” isn’t going to happen when these mortgages get written down – it’s BEEN happening all along, as the collateral behind those mortgages continues to fall in value. If my house is worth $100k less than it was two years ago, then it’s worth that $100k less regardless of whether I own it outright or am $100k underwater on a giant option-ARM mortgage.

@Dafox – “The problem with not changing the price of the home is that the home price is only what you can sell it for – but how is that determined? Comps! … Modding mortgages keeps prices inflated.”

Well, yes and no.

I occasionally buy and sell things on eBay. Usually, before placing a bid on or setting a reserve price on an item, I check the ‘completed listings’ for similar items sold in the past month to see whether my bid or my price is ‘in the ballpark’.

Let’s say that one day, unbidden, eBay went in and (retroactively) increased the final prices of all of their ‘completed listings’ by 50%. Thus a bunch of people over the past month bought and sold a given model of digital camera for, say, $200 but, when I check, eBay tells me that all those cameras sold for $300.

Will new listings of those cameras suddenly start selling at $300 based on that one change?

Maybe a handful of them will. However, a lot more often, the buyers will say, “300 bucks for that thing? Forget it, I’ll hang on to my old Pentax for a while.” And sellers will say, “I can get $300 for this? Sweet! I’m ditching this sucker right now!”

Listing volumes would spike overnight, but sellers would be perplexed by how few bids come in. Eventually, they’d realize that buyers aren’t willing to pay $300 for that camera, and they’ll start dropping their prices until equilibrium sets in back at right around $200.

Same thing would happen with houses. A few sellers might get lucky and nab an artificially inflated price for their houses based on those comps, but most of them would sit … and sit … and sit … until they realize that a buyer won’t pay more than $400k, and either drop the price or pull their house off the market. The dynamics of the market won’t (can’t) really change, whether the seller got a loan mod, bought the thing with cash on the barrelhead, or what have you.

What’s crazy is that this brand new plan remains completely voluntary (except for Fannie & Freddie, who have a gun to their heads). I can’t understand why the Treasury isn’t requiring the banks who are getting bailout money to participate in this plan, or even to go further and write down principal on at least some mortgages. I think they could easily identify a few million loans where that would make sense for the lender, borrower and the rest of us.

dafox – I’m not completely following your point, BR said that the mortgage mods need to be reflected in housing prices, I don’t agree. The house is worth the same regardless of the mortgage amount. If we have the same house and mine is paid for and yours has the mortgage reduced does that make it worth less than mine? No, when we put them up for sale they should both be worth(sell for) the the same.

You’re right, modding mortgages will probably slow the drop in prices but Barry is saying the values should be lowered to treflect he mortgage reduction.

This idea is what is cirulating the halls of policy making agencies such as the ones sighted above. I have big problems with this:

1) The idea that home prices have overshot on the way down is misplaced.
2) The idea that govt intervention will prevent prices from overshooting is wishful thinking.
3) Before the recession began, price/rent or price/income ratios pointed at about 35% over valuation. Is that reasonable? It was. With a nasty recession, rents and incomes are sure to decline, so add something more for that. Let us say 10-15%. It is the equivalent of Dr. Roubini’s argument that S&P earnings will decline so earnings used for valuation should be lower. In the extreme case, the earning power of financial industry in NYC has gone down substantially in the future. So equilibrium prices (in NYC) should be lower. Right?
4) The world’s stock mkt wealth has been cut into half. So why should the houses be priced as if the S&P is at 1565?

I think the equilibrium price is now ~ 50% of the peak. But who am I? Let the market decide.

I think that manipulating market prices in a market as big (40-50 trln in the US) is impossible for the government. And yes, THAT IS what we are talking about. How much money do you need to corner and manipulate this market?

There are no shorts to squeeze…I say 840 on S&P breaks.

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I’m not the technician you and others are, but volume seems light. There is no fear in the market. I think the market is falling just because there are no buyers. I’ll come in later in the week if it does fall as you think. But right now it’s too low to sell and too high to buy. Fortunately, I’m not a desperate hedge fund guru who has found alpha.

I picked up some stuff Friday. I suspected a fall like this at the time, but didn’t care. It’s a good time to accumulate if your time horizon is a few months. Hedge fund selling is keeping the market distressed. Once it goes away, prices will go up a few percent and that will be the new bottom range for a while.

Once the market breaks, I think it will look like 2004 when there were 4 decent tradeable peaks before the market started rising. I’m not smart enough to know when that will be so I’m just accumulating at the bottom and not worrying about the absolute bottom or the specific time. There will probably be a decent tradeable peak in a few weeks separate from the ones mentioned above, I suspect. I’m about 60% cash now, but will probably bring that to 50% or a little less if things firm up a little.

It already looks like bottoms are forming in a few areas. Even the Japanese market is looking like it has formed a passable bottom. This is the first time in my life that the Japanese market looks good for anything. Since this market has always been inscrutable, I will not put cash there. But I do think it is an interesting observation.

Utilities are forming an upward sloping bottom. Does anyone have an opinion of this sector? I have no experience in that sector and am thinking about putting some spare change to work. I would think that they have a captive market, their stocks fell in sympathy rather than because of lack of business, and there is a decent trade potential.