The Great American Housing Nightmare: Next Phase

[Joanne98]

by Martin D. Weiss, Ph.D. 11-03-08


One of the greatest blunders of our time is made by those who blindly assume home prices are so low they couldn’t possibly go any lower.

In reality, home prices don’t stop going down at some particular level that appears to be “cheap.” Nor do they stop falling because they match some historical price that was previously a low.

The end of the decline in home prices will come only when there are no new economic forces driving them down.

When will that be? I’d love to say it’s just around the corner. But everything I see tells me that, despite the sharp declines already recorded, a steeper plunge in home values is dead ahead.

The reason: So far, most of the troubles in the housing market have been caused by bad mortgages going sour. Meanwhile,

the more common causes of housing slumps — high interest rates, rising unemployment, and recession — are just starting to kick in. And …

the most powerful causes — depression and deflation — are still on the horizon.

In the boom leading up to the Great Depression of the 1930s, most Americans did not borrow money to buy a home. Variable rate mortgages didn’t exist. And Wall Street investors rarely got involved in the business of financing homes. Home prices did fall dramatically. But those price declines came mostly after the stock market crashed, after the economy shrunk and after millions of workers had lost their jobs.

The crux of the problem today: That phase of the housing crisis still lies ahead. Moreover, this time, because of massive debts, the pressure to abandon or sell homes is far greater.

Conclusion: If the U.S. sinks into a depression, home price declines could be as deep as, or deeper than, those of the Great Depression, especially in the hardest hit regions of the country.

It is a frightening thought. Yet, on the positive side, a sharply reduced price for the average home is the only fundamental, enduring mechanism for making homes more affordable and restoring demand — especially if the days of easy credit are gone.

Already, in 2008, one in ten American homeowners has defaulted on their mortgage or lost their home in foreclosure. Nearly four in ten owe more than their home is worth.

And all this is before the recession deepens and before we experience the next phase of the Great American Housing Nightmare.

Why This Was One of the Biggest
Speculative Manias of All Time

The Great American Housing Nightmare has no precedent; no historical roadmap to guide you, no proven pathway to follow.

No one can tell you with precision how far U.S. home prices will decline, when they will hit bottom, how many homeowners will lose their homes, or how soon a real recovery will begin. Getting to a recovery could take many years.

In fact, to throw some light on the speculative frenzy and panic that have swept through the U.S. housing market, the most relevant precedents I could find have nothing to do with homes at all. They are the Dutch speculative mania of the 1630s, the South Sea Bubble of the 1700s and the stock market panics of the early 1900s.

In those boom-and-bust episodes, the objects of speculation were tulips, slaves and stocks. This time, it was the American home. But despite that key difference, the critical boom-bust elements that helped create the speculation — and the depth of the losses which ensued — were roughly similar.

Boom-Bust Element #1: Debt

Debt is the fuel of speculation. Without it, speculative bubbles cannot emerge. With it, prices can be inflated beyond the wildest imagination.

In seventeenth century Holland, investors speculated wildly on tulips, putting up as little as 2.5% of their own cash. Similarly, in early 20th century stock market booms, investors put up as little as 10% of their own money, using borrowed funds for up to 90% of their purchases.

But in many respects, the borrowing mania that created the Great American Housing Nightmare makes all previous debt manias pale by comparison.

By mid-year 2008, the Federal Reserve reported a grand total of $14.8 trillion in U.S. mortgages outstanding — 40% more than the entire national debt and triple the total of all the mortgages in America just a dozen years earlier.

Sadly, it was not just the supersized quantity of debt that was so dangerous. Even more dangerous was the substandard quality of the debt. Consider the facts:

In all prior speculative bubbles in history, investors were required to put up at least some of their own money to buy into the boom. Even in the tech stock mania of the early 2000s, investors had to put up a minimum of 50% cash for their stock purchases.

But in the frenzy that preceded the Great American Housing Nightmare, millions of Americans bought homes with zero money down!

Lenders didn’t merely look the other way while home owners borrowed the down payment; they actively encouraged it. Homebuyers without enough cash to buy a $500 TV set were declared the proud new owners of $500,000 luxury homes. Many took it one step further with serial purchases of homes, leapfrogging with glee from one free ride to the next.

In all prior speculative bubbles, borrowers were invariably required to make payments of interest and principal in full and without fail, with zero tolerance for any other arrangement.

In contrast, during the Great American Housing Nightmare, millions of homeowners were allowed to pay interest only or even less than full interest.

So it should come as no surprise that the majority opted to make the smallest payments allowed, while the lender added the unpaid amounts to the loan balance. As with credit cards, the more that time went by, the deeper into debt the borrowers fell.

In prior historical episodes of rampant speculation, loans were almost invariably held by the lenders, who, in turn, had a vested interest in making sure the borrower’s finances were sound and their payments were kept current.

But in the Great American Housing Nightmare, the mortgages were mostly held by non-lenders — institutions and investors that were far removed from the borrowers.

In earlier manias, investors speculating with borrowed funds were required to document that they were worthy of the loans. They invariably had to present hard evidence of income, proof of assets, or both.

But in the Great American Housing Nightmare, even that was not the case. Millions were allowed to borrow huge sums without a scintilla of proof that they had the wherewithal to make the payments.

In earlier manias, the bubble was generally confined primarily to one debt sector.

Not this time around! Beyond the $14.8 trillion in residential and commercial mortgages in America, there are another $20.4 trillion in consumer and corporate debts. This meant that mortgages represent only 42% of the private-sector debt problem in the country.

Result: Americans are not only under tremendous pressure to sell their homes due to burdensome mortgages, they are also squeezed by huge credit card balances and by layoffs from employers equally addicted to debt.

By virtually every measure, the debts piled up prior to the Great American Housing Nightmare are far bigger and worse than any debt pile-up ever witnessed in history.

Boom-Bust Element #2: Investor Frenzy

Continued>>>
http://www.moneyandmarkets.com/the-great-american-housing-nightmare-next-phase-27880

[Mira]

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