Monday, November 26, 2007

On The Housing Bubble

Last night the top Google advertisement on one blog was this:

No Money Down Home Loans
$300,000 Loan Amount Minimum Instant Approval - No Credit Check

Interesting that these kinds of ads are still being used, given the state of the housing market. Note also that any ad specifically pointing out that there will be no credit check would get a much larger than average number of responses from those who have bad credit, and people who have bad credit are often going to continue having bad credit. That "no money down" part is also very suspicious. Taken together, the ad promises mortgages for people who really cannot afford mortgages.

There is a sense in which the housing markets in the last few years (pretty much the Bush reign) have acted as if the equivalent of gravity in the physical world no longer works: No, you don't have to save money for a fancy house. No, we will not look into your past credit history. Yes, indeed, you can get something for nothing.

But of course you can't get something for nothing, or certainly not on the scale that the housing bubble suggests. What is it that they used in the place of all those old rules about mortgages? The one new theory or myth seems to have been the idea that the prices of housing will keep on rising and rising and rising.

If that myth is true it makes sense to take a loan which is front-loaded with nothing but interest. You get to deduct the interest against your taxes, you get to live in the house, and if the value of houses rises you gather equity from just that. When finally the day arrives with monthly payments for not just the interest, that day when your monthly payments will double, say, well, your house has appreciated in value and you can either sell it and make some money or you can refinance it based on its new and better value. Neat, is it not?

Except of course in the case when housing prices are falling. In that case you are in deep trouble. And that is the scenario that is now unfolding. What is especially bitter about that scenario is that the very reason WHY the prices of houses have stopped rising is the vast number of bad mortgages, taken by people on the hope that prices would keep on rising. A sort of a suicide, if you like.

So, yes, the outlook is not rosy in the housing markets. But the meaning of all this is even more grave and the debacle might hit all of us, whether we ever gambled with houses or not. The reason has to do with the role the wealth in the form of houses has taken in the United States. One article quoted an expert who stated that Americans have used their houses as ATM machines, as sources of money for things quite unrelated to housing. That may be a little too rude, but it is indeed true that the wealth in the form of housing has been fueling the U.S. economy for the last eight years.

People spend more when they have more wealth, and when the value of their houses increased they felt that they had more wealth to spend. Now that the value of their houses is not increasing and may well be decreasing, they will spend less. Less spending by consumers means fewer orders for firms. That means more unemployment, and the vicious cycle starts turning: Unemployed people will not consume that much, unemployed people will lose their houses....

So what happened to allow this all? The government didn't disallow it, for one thing. Then the financial markets invented a new tool: that of mincing up all the poor mortgages and then tossing them into the general mortgage salad for the purposes of reselling. That way nobody could tell exactly how many bad mortgages they had just acquired! In short, the general investments in the housing markets were not protected from the bad investments. And, as I mentioned, the government didn't declare this new tool illegal.

The latter reminds me a lot of the 1929 stock market crash. The new tool then in play was leveraging. It worked beautifully when the market was going up and it crashed every bit as spectacularly when the market was going down.

I hope that we have all learned enough since 1929 to contain the current housing market crisis before it gets worse.