Skip to comments.Preparing for an Uncertain Future – Economy of Illusion
Posted on 03/23/2006 7:41:25 AM PST by ex-Texan
We are living through the biggest financial bubble in history. According to estimates by The Economist, the total value of residential property in developed economies rose by more than $30 trillion over the past five years. Not only does this dwarf any previous house-price boom, it is larger than the global stock market bubble in the late 1990s or that of the late 1920s.
San Diego County resale house prices fell in December by the largest monthly amount in 18 years. The median resale price for existing single-family homes dropped $15,000 from November to December to stand at $550,000, the largest month-to-month decline since Data Quick began keeping records in 1988.
The San Diego Association of Realtors, which monitors about 60% of the housing market, reported that properties took longer to sell in 2005 than in 2004 - remaining on the market for an average of 62 days last year, compared to 54 in 2004. Housing starts soared this January, growing at their fastest pace in almost 33 years. This would seem to be good news. Unfortunately, however, supplies of new, unsold houses are rushing onto the market at the fastest rate in 21 years. Inventories are piling up.
Consider the following:
* Housing affordability nationwide has dropped to a record low, while household debt has soared to a record high.
* Over one-third of all homeowners spend more than 30% of their incomes on their mortgage payments. Twelve percent of homeowners devote over half of their incomes to these.
* Those who barely qualify for a loan, known as sub-prime borrowers, accounted for 28% of all new mortgage lending in the past six months versus 5% five years ago.
* In the first half of 2005 two-thirds of homebuyers financed more than 80% of their purchases, according to SMR Research.
* 17% of homeowners own less than 5% of their home's value, free and clear.
* About 42% of first-time buyers made no down-payment on their home purchases in 2004.
Any of the above statistics would be cause for concern alone but taken together, the prognosis for the future of real estate and, indeed, for the economy as a whole is grim. Values in any bubble market which rise the way real estate values have risen recently always "correct." There is no example in history of a single bubble which did not give back all of the gains achieved on the way up.
The 42% of recent buyers who put no money down when buying their homes have no equity. What will happen to them if the value of their real estate falls? If these homebuyers have been using interest-only loans, they will have no protection against any kind of adverse move. Many people in this situation will have no choice other than to walk away from their property and mail the unwanted keys back to the lender.
Speculation has been increasing along with home prices. The history of markets shows us that asset markets become ever more treacherous as the number of leveraged participants increases. Leveraged participants possess no capacity to withstand adverse trends. They become forced sellers into a falling market, which pressures prices even more. This forces more speculators to sell.
It is always important to examine the opposing point of view. Many people believe there is no real estate bubble. The contention of these optimists is that a strong housing market is a function of many different factors with real economic underpinnings: low interest rates, local job growth, scarcity of land for the needs of a growing population, the emotional attachment one has for one's home, increased future earning power, parental contributions. All these things are said to contribute to rising home prices. During the past 25 years there has been an explosion of second home purchases, a continued influx of immigrants (who need to buy houses) and a significant reduction in existing houses from those which have been torn down.
These trends are not always published in data reports. Homes are not stocks; their intrinsic value can only be in the eye of the beholder. A house has utility. Rational people might be willing to pay more for an ocean view or for living close to work or for a larger bathroom. Such voluntary economic decisions are not considered to be irrational. Even if prices in America do dip, insist the optimists, they will quickly resume their rising trend because real house prices always rise strongly in the long term.
When examining the situation in just the four big counties in Southern California, you will notice the following: over the past decade the percentage of households able to afford to buy the median-priced home using conventional mortgage qualification standards dropped by 74% in Orange County to 11% and by 56% in San Bernardino County to 24%.
Starting this year and accelerating into 2007, as much as $2.5 trillion of non-conventional mortgage debt is scheduled to be repriced. Millions of Americans will soon face significantly higher mortgage payments. Unfortunately, many can barely afford their current payments.
All this is coming due at a time when Americans discretionary income (after more or less fixed costs of taxes, housing, healthcare, auto, energy, etc.) is declining while debt levels are mounting, interest rates are climbing, sales of existing homes are sinking, inventories of unsold homes are increasing, especially in areas of the country that led the recent housing boom, federal regulators are pushing for stricter lending standards and houses are greatly overvalued.
In a newsletter entitled Spendthrift Nation, Kevin Lansing argues that American households apparently view the rapid increases in residential property wealth in recent years as "a substitute for the quaint practice of putting aside money each month from their paychecks."
Americans owe $7 trillion on their homes - twice as much as ten years ago. But their incomes - their ability to pay - have gone up by a fraction of that amount. It's painfully clear a lot of that $7 trillion will never be paid back.
Over the last several months many people have expressed their gratitude to me for having their feelings validated by hearing details during my guest appearances on the Gary Null Show of what they suspected was really happening. I do not pull any punches. I realize that what you are reading here is sometimes difficult to find in the mainstream press or other media. I have concentrated on writing about real estate because that is where most people are most heavily invested. In my weekly, hour-long show on the Gary Null Network starting on Friday, May 5th at 4 p.m. ET I will broaden the scope of analysis to include other aspects of our fragile economy. Times will become unbearably difficult. I will attempt to guide you through them and offer what assistance I can.
To prepare, I would suggest taking the following steps as soon as possible to minimize the effects of a severe downturn.
Pay off all credit-card debt. Liquidate all debt except your mortgage. Only buy vehicles that you can afford to pay for with cash. Put as much money as you can into your annual tax-free retirement savings, whether in the form of an IRA or, preferably, using your company's 401k allowance, taking advantage of any matching corporate payments. Start saving money for college when your kids are born. Put at least 20 percent down when you buy your home, using a low-interest, 30-year mortgage. Try to make an extra mortgage payment every year. Reduce your standard of living now to a manageable level based on your income, while you have the economic freedom to choose how you wish to do this, rather than having change imposed on you later by force of circumstances.
"The economy is growing smartly, more Americans are working, wages are rising, capital spending is robust and federal tax revenues are rising at a double-digit-year-over-year pace. This must mean its time for everyone to worry about the trade deficit as the latest sign that all this prosperity is an illusion."
Yeah, it sounds like the sky is falling to me.
You must be a Bubble Hugger? Yes? No?
For another side of the story:
"A real estate trade group reports that sales of existing homes rose by an unexpected 5.2 percent in February as warm weather boosted demand."
In my beer.
Makes me happy
Makes me full of cheer"
I've read extensively on this issue and lean more to the "bubble" camp, but I'm not here to make that argument. The selected quoting of statistics can and will be used to to make whatever argument one wants to make. Endlessly. Real estate as an investment or as shelter either makes sense or it doesn't. Long term, it has generally worked out. Short term, it may well rip out some folks' internal organs.
IMO folks need to de-focus on the macro and do what's right for them and them only. The last round of speculators, who made up roughly 25% of the past few years runup, will be trashed, and that is entirely normal. It's unfortunate that those homeowner/occupants who bought in at "it can only go higher" prices will likely see paltry returns for a while. But they buying housing, not speculative investments. They may be disappointed in home valuations in their Sunday paper, but disappointment is part of life. It's normal to lose one's job and get crunched on one's housing costs. It's normal to get a new job and buy a bigger house. These things ebb and flow back and forth.
My view is that housing will soften primarily due to rising rates and the exit of the specs. Still, the only thing that really matters to occupant type homeowners is their monthly nut, relative to renting and relative to their desire to reproduce and maintain a more supportive family situation. If they can't afford that, they will get kicked out. Nothing bubbly about that, in good times or bad.
I have an ARM, and will have it for another year and a half at a ridiculously cheap rate. After that, it will still be below the current 30 year rate.
Yeah, yeah, rates are going to go up...but maybe they are not. Not many people predicted that rates would fall over the past 5-10 years. yet they did. Now all we hear is that rates are going up, up, up..... I tend to think rates will stabilize.
Ben Bernanke has commented on the "global savings glut". Too much idle money sitting around doing...nothing. Excess money tends to lower interest rates and even leads to deflation. So, I ain't buying the bunker just yet.
I tend to agree with you, but I do find the "NEW" lending practices troubling. Forty year notes and all.
One other thing. When the escalation in home values slows ... where does one go for spaneding cash? People have been using their homes as ATM machines. What impact will this have on the overall economy?
Click the link below to read and/or view an exclusive BBC report on organized criminal activities by real estate agents in Britain. This was an undercover report. BBC reporters went in with hidden cameras. See real estate agents lie, forge signatures, obtain false passports, and in general behave in typical way people do when their primary motivation is money. The U.K. also has bubble woes.
Excess greed inflated the housing bubble. Public disclosure of illegal activities by realtors and mortgage brokers may even cause the bubble to explode.
I believe that NBC, CBS, CNN and even FOX News will be required to do this type of investigation. Sooner rather than later. Otherwise, they will be condemned as cowards.
This San Mateo, California house listed for $ 725,000 !
I would not spend a dime over $ 65,000 for that Pos(h) house, even at hyper-inflated prices.
All I can say is that the death of the American consumer has been wrongly forecast for a long time. I agree that compared to traditional lending practices, we have moved into a fantasy world. But the producers of this fantasy world have 500000 times the resources available to keep the party going as the other camp.
The single thing that is a serious counter to all the forces that would rationally pop the outrageous runup in RE prices is that on the other side of this trade is/are the most powerful monetary forces on earth: Central banks, led by our friends at the Fed. This month, actually yesterday, the Fed ceased the release of M-3 information. The same folks who think the RE bulbble is in serious jeopardy point this out. The lack of this info will mask the level and velocity of of money pumped into the economy, primarily into the stock and bond markets, and primarily for the benfit of Goldman Sachs. Witness their blowout earnings announced a few days ago.
The rational part of my brain says the RE runup is a total charade and vulnerable to decline, perhaps serious decline. But I have to also consider that the growth in the money supply has been staggering under latter-day G-span and how helicopter Ben. So unless one ignores the forces working to prevent the pop, the future of RE is not entirely clear cut, as I see it. RE bears are taking on the single most powerful force on earth.
Yeah, but net family worth increased by 8%.
"RE bears are taking on the single most powerful force on earth."
What you are implying is that the powers that be will write what ever monetary policy is necessary to keep the party going. Whether the policy even makes sense or not is another question. If that is the case, I say one thing.
... oh my god, I hear them coming now. Better go hide or put on the flame retardant suit.
"People who put no money down or take out an interest-only mortgage are essentially leasing their house with an option to receive any appreciation in its value. If the house appreciates in value, the option is "in the money." If it doesn't, the option is worthless. In the meantime, the mortgagee enjoys the service flow from living in the house. In many communities, including mine, the net-of-tax cost of owning, say, a three-bedroom, two-bath house is equal to or less than the cost of renting it because the expected price appreciation is small or even negative in real terms."
Nicely stated. Good post!
Yeah, I agree. Just don't try to convince others w/o donning the flameproof suit. Actually, I tend to slightly prefer silver. The best of both worlds may in fact be copper, which has outperformed both Au & Ag. (Tripled vs doubled since appx 2001) Look at the charts of PD and PCU. PCU also pays a screaming div but there is political risk. With copper, you are betting on a nice basket of possibilities: Further commodities run; increased China demand, continued housing boom, continued [alleged] strong economy etc;
Maybe the better staement
Absolutely agree. The problem is that nobody can predict when that collapse will be; and the multiple efforts to get in front of the "event" can easily bankrupt and or demoralize you with failed attempts! After all, real jaw-dropping smackdowns are pretty darn rare events; and this "modern" era (say the past 3+ years) we have gone something nearing 700 trading days without a 2% daily decline in the market, when for most of history, we would go on average 11 days between 2% declines. ELEVEN! What is that, 5-6 standard deviations?
The sentence that got cut off from my prior post was: Maybe the better statement is to buy SOME gold.
Hard to believe there are still faux traders denying that we are in an inflationary housing spiral...i.e., bubble.
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