The Great American Housing Nightmare: Next Phase
by
Martin D. Weiss, Ph.D.
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.
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In the 1920s, my father (left) and uncles
never dreamed of borrowing to buy a home. Home
mortgages were rare. |
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 overwhelming 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
In
1637, at the height of the tulip mania, just one
Semper Augustus bulb changed hands for 12 acres of
land. Another bulb was sold for a massive collection of
goods, including 160 bushels of wheat, 160 bushels of rye,
four oxen, twelve swine, two hogsheds of wine, four casks
of beer, two tons of butter, 1,000 pounds of cheese and
more. But just a few months later, similar bulbs were
practically worthless.
In
1720, investors drove up shares in the South Sea Company
from 125 to 960 in six months and back down again to 180
in less than three months.
In
1929, the Dow Jones Industrials surged from 213 in 1928 to
381 in 1929, only fall to 41 in 1932.
In
each case, millions of investors and speculators — most
with little experience in the market — were caught up in a
wild buying frenzy, only to dump nearly everything in an
even wilder selling panic.
Unfortunately, we witnessed a similar pattern prior to the
Great American Housing Nightmare. As the buying frenzy
heated up, homes and condos were flipped faster than
hotcakes. Prices were driven through the roof. And even
mortgages themselves were transformed into securities that
were riskier than some of the riskiest stocks in the
world.
At
the peak of the housing bubble, the average price of
existing home reached nearly five times the total yearly
income of its owners, the highest in history. At the same
time, the affordability of each home plunged to its
lowest level in history.
Once
set in motion, the speculative fever spread quickly. From
Miami to Phoenix to San Diego to Las Vegas, investors
camped outside housing developments to snap up three,
four, five, or more units at a time. Condominium
developers built gleaming towers in major cities, based
almost exclusively on anticipated bids from investors and
speculators and with no evidence of real underlying
demand. From coast to coast, investors signed on to
millions of pre-construction contracts, only to flip them
before the first shovels touched the ground.
This
kind of speculation was traditionally just a small niche
in the giant U.S. housing market. But at the peak of the
housing boom, it nearly took over: An astounding 40% of
houses and condos were bought as second homes or
investments. The yearly rate of appreciation on existing
homes catapulted from 3.6% in January 2001 to 16.6% in
November 2005. On new homes, meanwhile, it surged from
4.8% in to 18.1%.
Fueling the bubble, government agencies like Ginnie Mae,
government-sponsored enterprises like Fannie Mae and
Freddie Mac, and private investment banks bundled up
mortgages and resold them as securities that could be
traded much like stocks and bonds. These securities, in
turn, were bought by banks and investors in the U.S.,
Europe and Asia. The total amount of mortgages transformed
into these securities: $4.8 trillion, 60% more than the
total value of all the stocks in the Dow Jones Industrial
Average.
In
just one year — 2006 — $2.4 trillion in new
mortgage-backed securities were created, more than
triple the amount of just six years prior. Even in
past investment manias, there was no such structure. Even
the wild and wooly speculators of the 1600s, 1700s and the
early 1900s did not take the madness to that
extreme.
Boom-Bust Element #3:
Government-Created Monopolies,
Corruption, Fraud and Cover-Ups
Some
of the largest speculative bubbles of all time were born
out of government-sponsored monopolies, nurtured by
government-bred bureaucrats and kept alive beyond their
time by government-inspired corruption, fraud and
cover-ups.
In
the South Sea Bubble of 1711, the English government
needed to find a way to fund the huge debts it had
incurred in the War of Spanish Succession. So the Lord
Treasurer, Robert Harley, created the South Sea Trading
company to help finance the government's debts. The
company got exclusive trading rights in the South Atlantic
plus a perpetual government annuity of over a half million
pounds per year. In exchange, its investors agreed to
assume responsibility for about £10 million of the
government's debt.
It
seemed like a win-win. But the government's sponsorship
and the company's monopoly led to big trouble. The
company's managers, thinking they had the government's
largesse to fall back on, were complacent and ignored
signs of economic troubles. They took excessive risk. And
ultimately, investigations turned up massive fraud at the
company and pervasive corruption in the government.
When
the entire structure collapsed, there was nothing the
government could do except to pass what later become known
as the "Bubble Act" aimed to prevent a future recurrence.
Similarly, in the early 1900s, the Panic of 1901 occurred
in the wake of a failed attempt to create a massive
railroad monopoly; the Panic of 1907 followed a failed
attempt to corner the copper market; and the Crash of 1929
resulted, to a large degree, from collusion among brokers,
bankers and tycoons.
In
nearly every case, the government gave select companies or
individuals special privileges, waived critical
regulations and encouraged great concentration of power.
And in nearly every case, the government made desperate
attempts to salvage the boom long after the bust began.
But it was ultimately powerless to avert a collapse in
the very structures it had helped to create.
Unfortunately, the same, or worse, could happen in the
Great American Housing Bubble: The U.S. government created
two monopolies that made England's eighteenth century
South Sea Company and America's twentieth century
industrial monopolies look small by comparison. Their
names: Fannie Mae and Freddie Mac.
The
U.S. Government gave these companies monopolistic control
over America's largest debt market — mortgages. And then,
beginning in the early 2000s, the government spurred these
monopolies to compete aggressively with private subprime
lenders.
Not
surprisingly, the results were similar to those of earlier
bubbles: Extreme complacency, excessive risk-taking, and,
ultimately, fraud.
In
September 2004, the Office of Federal Housing Enterprise
(OFHE), Fannie's and Freddie's primary regulator, issued a
special report revealing massive accounting
irregularities. And four years later, in September 2008,
the companies had still not cleaned up their act,
prompting the Securities and Exchange Commission to launch
new investigations into accounting deceptions.
The
biggest deception of all: In their official filings and
public pronouncements this year, Fannie and Freddie
consistently and wildly overstated their capital, while
understating their risk. Supposedly built with mortar and
steel, Fannie and Freddie were actually houses of cards in
disguise.
Repeatedly, the company executives swore on oath that they
had more than enough capital. And even on the eve of their
demise, their regulators testified before Congress that
the companies were solvent.
Based on their smoke-and-mirrors accounting, perhaps. But
based on the basic rules that you and I must abide by, not
even close. For longer than anyone cared to admit, Fannie
and Freddie had been insolvent. Meanwhile, their chief
executives hid behind carefully camouflaged facade,
marched into riskier corners of the mortgage market, and
trashed the trust of millions of Americans with no sign of
restraint and little expression of regret.
Between 2005 and 2008, for example, Fannie Mae purchased
or guaranteed at least $270 billion in subprime mortgages
— high-fee loans to high-risk borrowers. That was more
than three times as much as it had bought in
all its earlier years combined.
Yet
no one seemed to bat an eyelash.
Quite the contrary, Wall Street and Washington cheered
loudly, encouraging them to take on even more risk.
Why
such enthusiasm? Because the rapid growth in fees
supercharged Fannie's stock price. Because big revenues
meant huge bonuses for executives — $90 million for one,
$30.8 million for another, and $10 million for a third.
And because the easy money flowing to unqualified
borrowers indirectly helped politicians buy millions of
votes.
Suddenly, however, in September 2008, it was finally
recognized that all the financial statements and all the
sworn testimony about solvency were unabashed lies.
Suddenly, the two largest mortgage lenders on earth,
supposedly rich and prosperous, were thoroughly bankrupt.
And suddenly, underscoring the depth of their demise, each
company needed an unprecedented $100 billion injection of
government funds just to keep it alive.
The
potential bill to taxpayers: $200 billion. But that figure
assumes an end to the credit crunch, no more debt
collapses, no recession, and certainly no depression. If
any of these assumptions should prove wrong, $200 billion
will barely cover what is fast becoming history's largest
cesspool of sinking debts and commitments — $5.2 trillion
in mortgages guaranteed or owned by the two companies,
their $1.5 trillion in debts, and their $2 trillion in
derivatives.
Boom-Bust Element #4:
Collapse!
How
much could home prices ultimately decline in the Great
American Housing Nightmare? We have no way of knowing with
certainty. But we can draw some lessons from
similar bubbles and crashes throughout history:
-
In the Dutch Tulip Mania, investors lost nearly all of
their money if they bought for cash; more than all of
their money if they bought on the slim margin of just
2.5%.
-
In the South Sea Bubble, the cost of the shares
investors bought fell from a peak of 1,000 to less than
100, a loss of 90% or more.
-
In the Crash of 1929 and the ensuing 3-year bear market,
investors lost 89% of their money even in America's
largest industrial stocks.
-
In the tech wreck of 2000-2002, when a myriad of
Internet and technology companies collapsed, investors
lost 78% of their money invested in the average Nasdaq
stock; and 100% in companies that went under.
-
In Japan's long bear market, which stretches from 1990
to the present, investors have lost 82% of their money
from peak to trough in companies that make up the Nikkei
average, and much more in smaller companies.
-
And in the financial crisis of 2008, investors lost 99%
or more of their money in some of America's most
respected financial institutions.
My
argument: The speculative bubble in U.S. homes is as
extreme as each of these historic examples; and in the
most hard-hit regions, the resulting price collapse could
be equally extreme. Indeed, the Great American Housing
Nightmare is progressing in three phases:
Phase 1. The bust in the
subprime mortgage market. This is now history.
Phase 2. A severe U.S.
recession. As of this writing, this phase is just
beginning.
Phase 3. Depression and
deflation. Still ahead.
Therefore, no matter how far home prices in your area have
already fallen and no matter how cheap they may appear,
they could still fall a lot further.
In
the hardest hit regions, an individual home that was once
priced for $400,000 at its peak could fall to as low as
$200,000 by the end of Phase 1. But don't blindly assume
that's the bottom. In Phase 2, it could fall in half
again, to $100,000. And in Phase 3, it could fall by at
least half for a third time, to as low as $50,000 or
$40,000.
Homes with peak prices of $1 million could sell for as
little as $100,000; some, originally priced for $10
million may have no buyers at all — even with asking
prices as low as $1 million.
Nationwide, the median home price will not fall nearly
that far. But that factoid alone will do nothing for
homeowners in bubble areas like Florida, Nevada or
California. Nor will it help those in blighted regions
where factories are closed and unemployment rises far
above the national average.
Never before in history have we witnessed home price
declines of this magnitude! But that fact alone does not
make them implausible, let alone impossible.
Remember: Never before in history has so much debt,
speculation, government manipulation, fraud, corruption
and consumer abuse been heaped onto any housing market!
And if there's one thing that history teaches us, it's
that unprecedented causes lead to unprecedented
consequences.
Lessons To Learn Now Before It's Too Late
Lesson #1. Don't blame
yourself. Virtually every realtor and expert in
America told you that investing in homes was a "sure bet";
and any lender in the country that accepted your loan
application was, in effect, telling you that you had the
means to make the payments.
Lesson #2. Don't look back.
Forget what your property was worth at its peak. And try
to forget what you paid for it as well. That's water under
the bridge. Instead, look at what's happening today
— in the headlines, in your neighborhood, at companies in
your area.
Lesson #3. Don't count on
the government to save the day. There are bound to be
a series of public programs to help some people some of
the time. But they will be spotty; they won't turn the
housing market around; and you may not qualify. For
example, the FHASecure program rolled out in late 2007
essentially created three classes of homeowners with
mortgages:
-
Homeowners current on their mortgages and not at risk of
foreclosure were mostly not eligible for
federal assistance;
-
Those already in foreclosure were also not eligible; and
...
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Ironically, only home owners falling behind in their
mortgage payments could get government help.
Not
only did that make it very difficult for most people to
qualify, but it also gave a strong incentive to households
to deliberately fall behind on their mortgages.
People asked: "Why should I cut my food
budget or give up on my nights out when my
neighbor is having all the fun, skipping his mortgage
payments and getting rewarded by the government
for his imprudent behavior?"
Ultimately, these kinds of government programs are
fundamentally flawed and doomed to fail.
The most important lesson of all:
Don't underestimate the potential depth, speed
and duration of the decline. As the debts are unraveled,
the economy comes unglued and the deceptions are
uncovered, home prices could continue to plunge much
further.
If
you are able and willing to sell your properties, do so
now. Don't wait.
Good
luck and God bless!
Martin |
