During the past five years under the auspices of Sir Alan Greenspan $5 trillion in phony value has been added to the housing market. That is $70,000 per family of four. The Fed, our government and the banks have created an illusion of wealth that doesn’t exist. Once Americans wake up over the next few years they’ll have a hangover that they won’t believe.
Almost every real estate hot spot in the country is feeling heat. It began in the summer, but really got underway in September. Traffic slowed, prices started to fall and inventory started to build. It’s taking much longer to sell a home even at a lower price. Those of you who have been reading the IF know that markets are softening and at the high end prices are already off some 5% to 20%. This housing bubble is national and to a great extent international. Low US interest rates have allowed interest rates to fall in many other countries as well. The difference is in most countries they don’t have the promiscuous lending practices that the US has. People have fled the stock market after the collapse in 2000. They upgraded and speculated not just those who had fled the market, but many more who wanted in on the action. Houses are more widely owned than stocks, thus a shakeout in housing will have far wider effect on the economy. This could be the largest most devastating market collapse in history. If housing goes, the markets go and pensions go with them. Such a collapse will make the 1930s look like a walk in the park. Americans don’t have a clue to what is going on and they have made absolutely no preparation for such a tragedy. They have no savings and they are in debt up to their eyeballs. When they lose their homes, Fannie Mae and Freddie Mac will end up with them. Fannie and Freddie will have to be bailed out by our government, which will end up in possession of your home. The speculators are starting to bail out. They should get the ball rolling in a big way. Sir Alan Greenspan is fully responsible for both the stock market boom and bust, and for the real estate bubble. In the market in the late 1990s all he had to do was raise margin requirements and the market could have never gotten out of hand. In real estate all he had to do was raise interest rates earlier, cut back on the expansion of money and credit and not allow and encourage the use of interest only mortgages, adjustable rate mortgages, other exotic mortgages and cash outs. He knew in both instances if he did not do what he had done the economy would have collapsed like it should have in 1991-92. Both events were totally engineered by the Fed. This time there is no way he can engineer a soft landing by slowly raising interest rates and at the same time flooding the economy with money and credit. The aggregate creation has been so great that central banks have to buy our Treasuries and Agencies. They have bought so much of our 10-year Treasuries having no place else to dump the funds that they have suppressed the yield and in so doing have suppressed mortgage rates. As Sir Alan prepares to leave as Chairman of the Fed he’s been covering his tracks by warning about excesses in real estate and debt accumulation, when he in fact is directly responsible for the horrible financial and economic situation America is facing. Saying I told you so doesn’t make his monetary and financial profligacy any less injurious. This has been going on for 15 years. All the imbalance and threat to stability was his creation at the direction of his elitist masters. It was he who enabled the frivolous consumption over all those years, now to cap it with a real estate collapse. It has been he who has allowed the speculation that he now warns about. His duplicity is simply incredible and Wall Street rakes in the obscene profits and corporate America indulges itself with outsized profits. He has been virtually giving money away to fuel the fires of inflation.
The signs of a top in real estate have been with us for four months. This is just as it began in England, but we seem to be coming down more quickly. Sales of new homes are still setting records, but at slightly lower prices. Used home listings are up 30% to 50% in just several months. Fewer and fewer borrowers can qualify. In hot areas prices may have come off 5% to 20%, but interest rates have risen close to 1% offsetting lower prices. Even though new homes are selling well new home inventories are the highest in history. It now takes twice as long to sell a house in California as it did a year ago and in Orange County, the sale inventory is five times what it was a year ago. In just three months the number of unsold condos has doubled with Miami being the first to crack. Speculator buying accounts for virtually all new housing starts in America, which in the long run is injurious to the industry. Furniture sales have fallen in five of the last seven months usually a precursor to a slowing real estate market. This year 38% of homes have been purchased with less than 5% down. There is no question housing is topping out. The question is how quickly and how deep will the correction be?
You have to pause when you see that 76% of our economy is based on consumer spending. Seventy-two percent of homebuyers in California over the past two years are spending 40% of their total income on debt service. That is ominous when California real estate is over valued by 45%. In just 2003-2004 homeowners pulled $1.037 trillion out of the equity in their homes. That equity is gone, but the debt remains and the service is huge. Even though there has been a huge increase in home values equity is the lowest ever and service the highest ever. What you are seeing is not sustainable. Consumers are borrowing to make debt payments. They are pyramiding their debt. As soon as house prices fall many consumers will realize they are broke. If the cost of owning a home is 10% and wages grow 2% a year your house has to appreciate 8% a year. That has happened over the past five years, but that period is highly unusual. Over this period 50% of economic growth has been generated by industries affiliated with housing and real estate. If we are correct and a real estate correction only mirrors the 1989-92 period there would be a 4-5% fall in GDP for as long as the correction lasted. Needless to say, today debt is much more burdensome than it was in the 1989-92 period. In just the last ten years consumer debt is up 77% and mortgage debt has doubled. As de-leveraging, debt pay down, increasing savings and bankruptcies takes place, unemployment grows still victim to offshoring and outsourcing. That will throw an additional burden on the economy.
Then there is the looming problem in the mortgage industry, which has created trillions of dollars of speculative loans in real estate and in other spheres. No interest, or 1% or adjustable rate loans. They have made everything possible for our modern hedonist. Over the past five years home mortgage and equity lines of credit have grown from $4.8 trillion to $8 trillion.
Somebody made those future loans and they are sitting on a powder keg. It’s just like the 1920s with interest only loans. That is what kicked off our Great Depression, but few seem to know that. Who in their right mind would write or borrow with an option adjustable rate loan? A loan in which the principal amount can rise, instead of being reduced in a conventional rate loan. Few know that about 50% of the time borrowers need two loans. That is up from 20% in 2001. Those are adjustable rate loans and as interest rates climb so does the debt service. Thus far mortgage foreclosures are small, but the thing to look at is default and foreclosure. That is where the house is sold in default to avoid foreclosure. As we said before, next year will begin the moment of truth for the mortgage industry. In the last issue we covered securitisation of these loans, which could be a bomb that tears the derivative industry apart. We expect a full-blown crisis in the mortgage industry and in lending in general. Like our government and the Fed the mortgage lenders are out of control and have been allowed to be out of control for five years. How can responsible lenders allow 42% of first-time buyers to buy with nothing down and allow over 50% of loans to be adjustable? Today both 30-year fixed rate loans and adjustable rate loans both respectively make up 40% of all loans. Just a few years ago it was 70% for fixed. The whole daisy chain of loans is on shaky ground and that puts everyone at financial risk all the way down the chain including our entire financial system. What do you think will happen when house prices fall 20-60%? If 50% of the jobs created in the last four years were real estate related what do you think is going to happen to the economy if we are correct? We think 65 million American homeowners are going to be in shock, or at least 60% of them that are in the hot areas in the housing bubble.