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New California Buyers Taking On Risky Debt

In the April 3 issue of the Los Angeles Times a story appeared that suggests many Californians are living on borrowed time. Succinctly, an incredible 47.8% of California home loans in 2004 were interest-only loans...no principal payment for three years. And to keep the payment as low as possible, the loans are adjustable-rate mortgages.

The article contends that lenders in California have been opening the lending door wider and wider. In short, if you can fog a mirror you can get a home loan.

Interest only loans offer the ability to defer for three, five or seven years any payment for the house itself. Thus allowing potential buyers to stretch their dollars, so as to afford a place that otherwise would be out of reach. The result is that prices keep rising...which in turn encourages even more buyers to apply for interest-only mortgages.

What’s propelled the market increase in California, some experts worry, could just as easily speed its descent. Mortgage analyst Ralph DeFranco says, “If housing prices go down or even are flat, heaven help us.”

Author and economist Robert J. Shiller in his book Irrational Exuberance, predicted the collapse of the stock market in the spring of 2000. In his newly revised second edition Shiller covers today’s housing market, which he thinks bears striking similarities to the stock market bubble of the late 1990s.

An interesting question some ask is: Why hasn’t Warren Buffett, who is sitting on $43 billion of cash (which he admits is earning paltry returns), jumped into real estate? He could do so in a variety of ways.

The simple answer to Buffett’s reluctance is found in his sage annual reports...where he alludes to the fact that he has an aversion to optimism. When situations are considered “can’t miss” they usually do. (Buffett’s goal is to make purchases at prices that offer the prospect of a reasonable return on an investment.)