Bubble News

[Originally posted on goofyblog 2.5.07]

Well, the Fed, the US Treasury and the Bush administration–the real axis of evil–would like to forestall the inevitable recession-depression until they carry out their forthcoming attack on Iran. That’s why Bush is sending another carrier group to the Gulf as well as a squadron of F-16s to Turkey. The US is clamping down on transactions with Iran’s main banks and has coerced the Saudis into “discounting their top-line sweet crude by $1.75 to US customers” (Golden Jackass.com) to put additional pressure on Iranian oil exports. This is the real story behind the falling (gas) prices, not the (East Coast) weather.
Uncle Sam is gearing up for another Middle East dust-up in Iran and the lower gas prices are (temporarily) averting a US recession.

[full article here]

A recession is certain, it’s only a matter of when. After the dot com bubble popped in 2000, real estate became a haven for investment. With prices going up every year, it was easy to think of home purchases as just an investment, a savings account even, whose total keeps rising; easy to become lulled into treating equity appreciation as eternal, to borrow on the future to finance a lifestyle dependent on continued prosperity even as wage growth was in decline.
Every year From 1915 to 1965, property doubled in price. But the dollar lost value faster so, in reality, homeowners lost one third of their purchasing power.

In real terms, the prices of 1910 went down all the way to the 1990s. Only recently did they begin to go up enough to offset inflationary losses. And only in 2005 did they regain the heights last seen early in the last century.

Liquidity and confidence were running at epic highs [in 1914] just before WWI. When they crashed, they crashed hard. Property in the United States did not recover for another 91 years. You can see the long trends in real property prices simply by opening your eyes.

Higher prices of real estate make it profitable to build tall buildings because the higher construction costs are offset by lower land costs. Most major cities in the United States had tall buildings built between 1914 and 1933 during the real estate boom of that time frame. After the tallest building was built, it typically took about 41 years for the real estate prices to return to levels that would justify buildings of similar height.

Here is a data set of example cities:

Region	Name of City	Tallest Building Built during previous peak	Year in which the record was broken.	Number of years to break the previous peak
West	Seattle	1914 (Smith Tower)	1969*	55
West	Los Angeles	1927	1968	41
West	San Francisco	1927	1965	38
Midwest	Chicago	1930	1965	35
Midwest	Minneapolis	1929	1973	44
Midwest	Detroit	1928	1977	49
Midwest	Cincinnati	1931	Not yet broken	75+
Midwest	Cleveland	1930	1991	61
Midwest	St. Paul	1930	1986	56
Midwest	Columbus	1927	1973	46
Midwest	Kansas City	1931	1980	49
East	New York	1931	1970	39
East	Philadelphia	1932	1974	42
East	Boston	1915	1964	49
East	Pittsburgh	1932	1970	38
South	Dallas	1923	1943	20
South	Houston	1929	1962	33
South	Tulsa	1918	1966	48
Foreign	Toronto	1931	1967	36
Foreign	Mexico City	1956	1984	28

[full text here]

By this measure, one could conclude that a housing downturn & recovery cycle could take 4 to 6 decades. And also that the average homeowner is just a bit better than his counterpart in 1910. But probably not, because the 1910 homeowner surely owned his home. Today, homes are bought on credit by those who have no down payment and are less creditworthy than ever thanks to interest-only and negative-amortization loans. Their debt doesn’t go down and it can get even higher.
Michael Hudson says in The New Road to Serfdom [here, then under Articles]:

The problem for recent homebuyers is not just that prices are falling; it’s that prices are falling even as the buyers’ total mortgage remains the same or even increases. Eventually the price of the house will fall below what homeowners owe, a state that economists call negative equity. Homeowners with negative equity are trapped. They can’t sell—the declining market price won’t cover what they owe the bank—but they still have to make those (often growing) monthly payments. Their only “choice” is to cut back spending in other areas or lose the house—and everything they paid for it—in foreclosure.

This is likely to happen soon. Declining prices don’t work well with sudden loan payment increases forced along by interest-only loans that have principle kick in after a 3-year grace period and ARMs resetting this year and the next:

[In 2007], an estimated $1 trillion of ARMs (Adjustable Rate Mortgages) are due to “reset” which will cause stiff increases in monthly mortgage payments. We’re bound to see a steady rise in defaults as well as a boost in new claims for personal bankruptcy.
This downward cycle is just beginning. In 2006, a mere $300 billion in ARMs reset pushing overleveraged homeowners to the brink of insolvency. Imagine what will happen in 2007 when $1 trillion of these explosive loans comes due.

[full text here]

Isn’t this obvious? How did we get here? Maybe, it goes to the core of how we are as a country now:

Why would the United States run such huge trade deficits, we wondered. It was obviously a bad idea, the nation was ruining itself. And why would it launch an invasion of Iraq…or begin a war on terror - both of which were almost certain to be costly blunders. It was as if the United States wanted to destroy itself - first by bankrupting its economy, and second by creating enemies all over the globe.

Then, we realized, that of course, that is exactly what it must do. People come to believe what they need to believe when they need to believe it. America is an empire; its people must think like imperialists. In order to fulfill their mission, the homeland citizens had to become what George Orwell called “hollow dummies.” An imperial people must believe that they deserve to be the imperial power - that is, they must believe they have the right to tell other people what to do. In order to do so, they must believe what isn’t true - that their own culture, society, economy, political system, or they themselves are superior to others.

It is a vain conceit, but it so bright and so big it exercises a kind of gravitational pull over the entire society. Soon, it has set in motion a whole system of shiny vanities and illusions as distant from the truth as Pluto and as bizarre as Saturn. Americans believe they can get rich by spending someone else’s money. They believe that foreign countries actually want to be invaded and taken over. They believe they can run up debt forever, and that their debt-laden houses are as good as money in the bank. [full text here]

For Sale

[Originally posted on goofyblog 8.28.06]

Last Sunday, I phoned a friend of mine who is now a professor in a small college town in Iowa. She and her husband still own a small house in Cincinnati where there is now double-digit deflation.
Because the house isn’t worth near what they bought it for, they may have to file for bankruptcy. Yet the new bankruptcy laws pushed through last fall by the Bush Administration would force them to sell off their musical instruments. My friend is a music professor and her husband is a music teacher and in 2 bands.

Click here for a recent article on this stupid new law.
Today’s New York Post had the following(full is here):

“The red-hot housing market that powered the U.S. economy for the past three years has officially cooled off. Houses are sitting unsold for months: the current inventory of unsold properties hit the highest level since records began to be kept in 1999.”

But there are dozens of news articles coming out every week from all over the country, aggregated here and also here.

It would be easy to make the point that the Bush Administration’s suicidal economic policies have made things much worse as argued here.

But, housing is intensely over-priced and has literally been the only thing driving the American economy for at least 6 years. Consumer spending and most of the job growth in the US have been directly related to housing hyper-inflation. For at least the last 2 years, anyone who could fog a mirror could get a 100% loan to buy the home/condo/double-wide of their dreams. What now? This early-summer article offers one scenario.

Bill Bonner, the co-author of Empire of Debt, has a blog, Daily Reckoning, that offers another:

Classical economists recognize that the excessive credit expansion has many impacts on the financial markets and the real economy.
Asset prices, including houses, inflate.
Savings rate disappears
Trade Balance goes negative
Capital Investment dries up
Wages and employment drop

Finally, a paper, written in 1991, concludes:

When the decline begins, it is longer than stock market crashes due to: a) the lack of short selling, b) the tenacity to which owners cling to mortgaged property, and c) the slow process of foreclosure. During the downswing, the net income of real estate falls due to falling rents and increased vacancies, while mortgages and other operating costs remain rigid in the short term. There are widespread defaults on mortgages and other loans. The foreclosure rate increases. Unemployment and lower real wages further reduces demand for real estate. To secure occupants, rents decrease. Many banks fail, having loaned large amounts to illiquid and fallen real estate.

After the old obligations such as mortgages and contracts are gone and the wreckage of the collapse is cleared away, shrewd investors pick up real estate bargains. With debt reduced and prices, including interest rates down, lower costs induce a renewed rise in business and the recovery phase of the cycle.

Historical data from the U.S., Great Britain, Germany, and other countries have shown that real estate booms have preceded major depressions. The theory that the major real estate cycles, accommodated by monetary inflation, have significantly contributed to major depressions is consistent with the historical record.

Most of the jobs I’ve held in the past few years have been related to financial or real estate(think most bank, IT, construction, ad agency, etc.). So many friends are similarly dependent on those types of jobs. Does anyone in the US work at making things other than new houses or office buildings anymore?

Viva Las Vegas

This just in this week from The Daily Reckoning newsletter. It's anecdotal, but it's telling:

"But a housing market falls apart slowly. And according to our anecdotal evidence, it is still early...the winds are still getting stronger...and shifting direction.

"'I bought a house in Las Vegas more than a year ago,' an old friend reports. 'At that time, houses in the area were selling for $330,000 to $380,000 approximately...and there were a few for sale. Now, they're almost all for sale...I priced mine at $270,000. Still, no takers. I want to sell the house, of course, but there are some people who really need to sell. That's why I think this housing collapse is just beginning.'

"'I saw another statistic,' said another old friend. 'Half of all the houses for sale in America are empty. In other words, they were speculations. You know that many of those sellers must be very motivated.'

"Last night, back in Paris, we had dinner with a Canadian woman who sold her house in Bethesda, Maryland - a suburb of Washington, D.C. - a year ago:

"'My agent told me that I hit the very top of the market,' she said. 'I have friends who just put their house on the market this summer. They can't get anyone to look at it.'

"Prices have not collapsed. But bids are disappearing. Speculators are laying low. And genuine buyers are waiting...hoping to get a better price later.

"And here comes a bad report from an important housing barometer: housing starts have fallen to a six-year low. With too much inventory already, builders are cutting back as fast as they can.

"Maybe the storm will pass without major damage. But if we were you, dear reader, we'd get out of town."

New Orleans, The Crescent City

I didn't know this, but apparently New Orleans was founded on one of the greatest financial bubbles of all time. This comes intact from Addison Wiggin via the daily reckoning people:

“At the height of “the bubble,” just when the wheels started to come off, Mississippi John Law came up with a brilliant plan to save his company and the Banque Royale. The year was 1720. Paris, over the previous three years and by virtue of Law’s financial innovations, had become the largest and richest city in Europe.

“Law’s “innovation” was paper money. Apart from a several-hundred-year stretch in China ending in 910, the world had never seen or used paper money. At the outset of The Mississippi Scheme, Law had demanded, on the pain of death, that his banker’s not print more money than could be redeemed in gold from their own reserves. The strict backing of the currency - what was essentially the world’s first gold standard - gave investors of the day such confidence that the currency actually traded at a premium.

“But there was a problem. Law’s bank existed by virtue of a deal with the Regent of France, the Duc d’Orleans. The finances of the government in France following the reign of Louis XIV, his wars and the building of Versaille, were a mess. Seeing how much value was being placed in the new bank notes of the Banque Royale, the Regent set another precedent modern readers will recognize: he decided to print his way out of debt. He suggested Law issue currency up to 80 times what the bank held in redeemable gold reserves. Law, being rather preoccupied with the power and prestige the scheme had bestowed on him, ignored his previous warnings, and let the printing begin.

“The new notes flooded into the market and for a while held the value they had gained with solid gold backing. So many people got rich, the Aristocracy of the time coined a new term to describe them: “millionaires.” Stories of commoners making so much money fired the imaginations of thousands and thousands more investors and the frenzy got out of hand.

“New Orleans, the site of this week’s investment conference, was founded at that time, named after the Regent, and meant to become the Paris of the New World - the jumping off point for those who would mine all the gold and silver soon to be discovered in Mississippi (sic).

“When people started getting wind of the fact that there was nothing backing Law’s currency but rumors of future profits to be reaped in the New World, they started losing confidence in the new currency. Law, trying to keep up appearances just a little longer, rounded up all the beggars, bums and thieves in Paris, furnished them with picks and shovels, and marched them through Paris ostensibly on their way to New Orleans...and the mines of Mississippi. The quiet hiss of air leaking out of the bubble accelerated into a screeching “whoosh!” when the same old dirty faces began appearing in the same old dirty doorways and alleys."

New Orleans didn't become the Paris of the New World and it didn't remain in French hands that much longer (1803) as France fell on harder times. To remember that things are so transitory (paper money, the rise of empires) even when they last for generations, is a good thing in these "interesting" times.