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— In the Old West, nimble-fingered gamblers -- often called bunco steerers -- would ride into town and set up rigged games of chance. After fleecing locals, they would vamoose, often pursued by a posse swinging a hangman's noose.

The San Diego housing market today is a little like that. Two kinds of gamblers are leaving town in a hurry: (1) speculators, or people buying condos to sell them, not live in them, and (2) homebuyers taking on exotic mortgages so they can buy houses they can't afford. The former have been skipping town for a year, and the latter are being restrained by regulators who fear a wave of foreclosures and defaults.

Two abuses are exacerbating this situation: (1) overblown housing appraisals and (2) false statements of family income on mortgage applications. These deceitful practices -- typical of financial bubbles -- have permitted the gambling game to go on.

For the rest of the nation, "San Diego is like the canary in the coal mine," says Edward Leamer, director of the Anderson Forecast at the University of California, Los Angeles. As the real estate bubble expanded, San Diegans had to live with high home prices and low affordability. It was shocking when only 10 percent of families could afford the typical home, and now it's down to 5 percent.

So people took on complex mortgages, with names such as "interest-only" and "option adjustable rate," permitting homebuyers "to buy a bigger house than they ought to buy," says Mark Riedy, professor of real estate at the University of San Diego.

Over the past two years, interest-only loans have been almost half of San Diego mortgages, among the highest percentages in the nation. Now, the Comptroller of the Currency and other regulatory bodies intend to rein in these loans at federally chartered institutions. Regulators and market forces will probably slow down the freight train at other kinds of lenders.

"This will take the steam out of the housing market," says Leamer. "There has been a race between affordability and exotic financing. Affordability has been trying to keep people out of the market, and exotic loans have tried to keep them in. Over the last couple of years, exotic loans won that race. When the exotic loans start to lose, the San Diego market will lose a lot of demand."

"The price of the asset has gone way beyond its long-term fundamentals," says Robert Campbell, publisher of San Diego's Campbell Real Estate Timing Letter. "It's become a Tinkerbell world." As regulators "tighten up on funny-money loans," those housing prices will come down to earth quickly.

Campbell just heard the story about a San Marcos fellow who bought a $700,000 home in mid-2004 without putting any money down. "Today the home is worth $610,000. It's $90,000 underwater," says Campbell. The fellow hasn't made a mortgage payment in a year. He figured he would have to sell the house for $760,000 to make the back payments and get out even. But his broker told him that the highest price he could get for the home is $610,000, based on comparable prices in the area. "There is a silent crash going on," says Campbell, who talks to real estate brokers every day.

"I have not yet seen a bankruptcy" as a result of the exotic mortgages, says bankruptcy trustee Richard Kipperman. "But we know it's coming."

While the downtown condo market was sizzling, 25 to 30 percent of buyers there were speculators, or flippers, trying to make a quick profit selling a unit that often hadn't been built. "In San Diego, the speculator market has dropped by 80 percent in the past 12 months," says Peter Reeb of Reeb Development Consulting. The biggest concentration of these gamblers was in downtown condos. There have also been a lot of high-rollers snapping up condo conversions but fewer in single-family homes, says Reeb. Now the crapshooters see what's happening to the housing market, and they are scurrying off to other gambling dens, such as commodities pits.

Perhaps the biggest risk-takers have been those taking on the exotic mortgages. Interest-only loans present hazards. The borrower has the option to pay only interest for five to ten years. The loan balance remains the same -- thus, the borrower is betting that home prices will rise. If they fall, the homeowner could be in the soup.

Interest-only loans often have adjustable rates; therefore, they are vulnerable to rising interest rates. Such loans also carry higher interest rates than comparable fixed-rate mortgages. In taking on such an arrangement, a family is betting that its income will rise during the next several years.

Riskier still are so-called option adjustable-rate mortgages. Interest rates are adjusted monthly and the payment is adjusted annually. Borrowers can decide how large a payment they will make. If they decide on the lowest possible monthly payment, as many do, the balance of the loan balloons. That's called "negative amortization," and it can be poison.

"These [exotic] mortgages scare the heck out of me," says Sharon Hanley of Oceanside's HDS Associates, which publishes housing data. "I wrote to both senators and to my congressman saying we have to do something about these mortgages; they are putting people in hot water." Those who peddle the exotics often speak with forked tongue. In some variations, Hanley says, "the monthly payments have the potential of almost tripling by the fifth year, but you don't see that in the disclosure."

The loans "are terrifying for the average person, but if you just got out of med school and expect to be making $150,000 a year, they can work," says Hanley. But those resulting in negative amortization will wreak havoc.

So what will happen to San Diego housing prices? Many analysts see the bubble slowly leaking, not bursting, because the underlying economy is doing reasonably well. But as the downtown condo picture worsens, many economists are forecasting price declines. In the early 1990s, home prices plunged 5 to 10 percent in the low and middle ranges and 20 to 25 percent at the high end. But there was an aerospace bust then, and nothing like that is in sight now. "We are returning to a normal market," says Hanley. "It will be a good 2006, but not like 2004 or 2005. Builders won't be closing doors as they were in 1991."

Although there could be "serious delinquency problems" because of the exotic mortgages, Riedy sees a soft landing. "Anything under $400,000 will continue to rise in single digits [below 10 percent], $400,000 to $600,000 or $700,000 will flatten out, above $700,000 will flatten out or go down 5 or 10 percent," he says.

"We have been in a soft landing for a year and a half," says Reeb. "In July of 2004 I started to see an imbalance between supply and demand. The available inventory has increased, prices have flattened and declined, and incentives have increased in the downtown condo market."

Large developers will work with lenders to give buyers good mortgages. "The resale market does not have that capability. Problems will hit the resale market at the entry-level segment," says Reeb.

The ultimate engine of housing demand is job growth, and that has been slowing for several years, even as home construction has continued to grow. Sales have been slipping, but "we have more product on the market than we need with current levels of job growth," says Reeb.

Campbell points out that the housing market itself has been a big source of job growth. So an implosion could affect the economy generally. He sees a high probability that Southern California home prices will plunge 20 to 40 percent. His Real Estate Crash Index signaled "sell" in August of last year and continues to plummet.

Unfortunately, San Diegans have been borrowing against the inflated equity in their homes to continue their consumption. If home prices decline and lending regulations tighten up, that game could slow. Sales at retailers, car dealers, and other consumer outlets could suffer. This will impact jobs and, in a snowball effect, further whack the housing market. An economy based on debt is risky. An economy based on dangerously speculative debt could be disastrous.

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