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(DV) Whitney: Housing Bubble Smack-down







Housing Bubble Smack-down
by Mike Whitney
November 20, 2006

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Give me five minutes and I’ll convince you that you should sell your house immediately and invest your life savings in gold or a Swiss bank account.


For some time now we’ve been hearing about the so-called housing bubble and what effect it could have on your net worth and future. Well, the numbers are finally in and you can decide for yourself whether its time to sell now or try to ride out the storm.

In 2000 the total value of homes in the US was $11.4 trillion. Today that number has shot up to $20.3 trillion, nearly double.

At the same time, mortgage debt in 2000 was a trifling $4.8 trillion (about half) while in 2006 it skyrocketed to a whopping $9.3 trillion.

So, how do we explain these enormous increases in value? After all, wasn’t the housing boom just the natural outcome of “supply and demand”?

No it wasn’t. That’s an unfortunate myth that should be interred with the withered remains of Milton “free market” Friedman.

If we really want to know what’s going on, we need to look back at the machinations at the Federal Reserve in 2001. That’s when Greenspan lowered interest rates to 1.5% to soften the blow from the stock market meltdown. Rather than tighten interest rates and let the country to go through a period of recession, Greenspan lowered rates and ramped up the printing presses to “full-throttle”.

Voila, the housing bubble! Or what the conservative Economist magazine calls “the largest equity bubble” in history.

The housing bubble has nothing to do with supply and demand or with the fictional increase in workers salaries (which have actually gone down since Bush took office). Rather, it is the predictable result of dramatically increasing the money supply while expanding personal debt via home mortgages.

Remember, the central banks are not in the mortgage business; they are in the “money-peddling” business. And the way you sell more money is by making it as cheap as possible. The Fed intentionally inflated the bubble with cheap money so they could keep the printing presses whirring along. They worked in concert with the banks to lower the requirements for mortgages so they could attract an endless swarm of “unqualified” customers who wanted to join the feeding frenzy.

Isn’t that what happened?

And, didn't that make it possible for every Tom, Dick and Harry to borrow hundreds of thousands of dollars on “no-down payment,” “interest only,” ARMs or other equally risky mortgage-packages?

Of course it did.

There are some who will argue that the Federal Reserve just made an honest mistake and were merely trying to steer the country away from impending recession.

That may be true, but let’s consider the facts before we draw any hasty conclusions.

Did the Federal Reserve double the money supply in the last seven years?


Did they know what they were doing?


Did they know that printing more money creates inflationary pressures and reduces the value of money already in circulation?


Did they realize that the money was going directly into the real estate market where it was creating an “unsustainable” equity bubble that would eventually crash and destroy the lives of hundreds of thousands of Americans whose greatest asset is their home?

Of course, because it's the Federal Reserve which produces all the relevant facts and figures, charts and graphs, about increases (and trends) in the housing market. How could they NOT know?!

In other words, they doubled the money supply and then sat back and watched while $4.5 trillion went directly into the real estate market via mortgage loans to people who were “under-qualified” (knowing that these same people would eventually fail to meet their payments and adversely effect the entire market).

The Federal Reserve knew all of this. In fact, they knew where every dime was going, but decided to persist in their swindle to the bitter end.

Have the real effects of this monster bubble been softened by the huge trade deficit?

Yes, because America currently borrows $800 billion a year from China, Japan, etc. which keeps the economy sputtering along while our manufacturing sector continues to be ransacked.

The $800 billion account deficit is like a sedative which lulls us to sleep while the country is looted right in front of our eyes. For example, in the last 12 years, foreign ownership of US assets has soared from $3 trillion to over $12 trillion (400%). At the same time, over 13,000 major US companies have been sold to foreign corporations since 1980. Nevertheless, Americans are only too happy to ignore these unpleasant facts as long as they can totter off to Wal-Mart to buy little Johnny his new videogame. It’s only a matter of time before the scattered, bleached bones of American industry appear everywhere across the American heartland.

And, does the Fed realize that Americans borrowed another $825 billion from their home equity in the last 12 months (to spend on house repairs, shopping, boats etc) and that without that consumer spending the nation’s growth rate (GDP) will shrivel to nothing?

Yes, because they provide all that data, too.

So, what does this mean for the homeowner whose future depends on the steady increase in his home equity? What can he expect?

Well, first of all, you can ignore all the gibberish you hear on the business channel about “soft landings” and a “temporary downturn.”

There’ll be no soft landings. This is the Big One: Real Estate Armageddon followed by a plague of locusts.

JUST LOOK AT THE NUMBERS! There’s a $10 trillion difference between the aggregate in 2000 and 2006! $4.5 trillion of that is new mortgage-debt! That’s more than a little “froth” as Greenspan liked to say. In an economy that’s currently growing at a feeble 1.6%, a plummeting housing market could pave the way for another (dare I say it) Great Depression.

$10 trillion!?! Some things are worth repeating.

First of all, (if we compare our situation to what happened in Japan during the 1990s) we can expect that prices will continue to fall for years to come, perhaps, a decade or more. Many of the slower markets are already showing a decline of 10% to 20%. This is a trend that is likely to speed up dramatically in 2007 when $1 trillion in ARMs reset. That’s when we’ll begin to see a truly new phenomenon in the US, that is, people who’ve always been solid members of the middle class sliding downwards into the ranks of the working poor.

By 2008, if the present trend lines persist, housing prices will probably drop to 25% to 30% of their 2005 value, diminishing equity value by approximately 45% to 50% for most homeowners.

If you own your home outright, you can sweat it out. But if you got into the market late, you’re toast. You’ll be joining the throng of mortgage slaves who are shackled to loans that are significantly higher than the current value of their house.

Imagine paying off a loan for $400,000 when your house has been reassessed at $250,000 or $300,000. That’ll be the reality for an estimated 30 million Americans. Meanwhile, inventory will continue to grow (already at an eight-month backlog) the economy will continue to contract, and the dollar will continue to weaken. (Many of the major home builders, Centex, Beazer and Toll Bros, are reporting that profits are down by nearly 65%.)

At the same time the Fed just issued another $10 billion in Treasury Bonds last week raising the national debt to a mind-boggling $8.6 trillion. This loosey-goosey approach to printing fiat money and creating debt explains the recent surge in the markets. As The Daily Reckoning’s Richard Daughty says, the “bull market is manufactured from rampant government deficit-spending and financed by the Federal Reserve creating the money.”

Amen. Its all fluff and there's nothing to it. It's just loose money finding a temporary perch before the approaching squall. Don’t trust the smoke and mirrors. Behind the merriment and gusto, Wall Street analysts are expecting a collapse . . . and soon.

How soon, you ask?

Well, Daughty also notes that “revolving credit like credit card loans grew by $2.85 billion, or at an annual rate of 4.00%, to $857 billion.”

So, credit card debt is going up, which is an indication that the people who were siphoning money from their home equity have switched over to plastic. That’s sure sign the writhing consumer beast is in its last throes. The end is near.

Why Should I Care About Net Long-Term Capital Inflows?

In another bit of disheartening news the net long-term capital inflows fell short of what the US needs to cover the current account deficit. The inflows were only $65 billion when we need $70 billion to make ends meet. This is another way of saying that foreigners are no longer mopping up our red ink. Interestingly, foreign central banks are buying considerably fewer Treasuries: $9 billion in US securities and a paltry $8 billion in Treasury bonds.

What does it mean? It means that no one is dimwitted enough to buy our debt anymore because we’re no longer a good risk.

That’s a very bad sign. Under different stewardship the "full faith and credit" of the US Treasury meant something. That's no longer true.

Also, according to Marketwatch, “US residents purchased a net $22.9 billion in foreign securities, up from $2.7 billion in August. Foreign holdings of dollar-denominated short-term securities, including Treasury bills, fell by $10.8 billion.”

Foreign investments are up $20 billion in one month?! Are you kidding me?

So, the smart money is getting out of Dodge pronto, leaving the rest of us behind in a leaky canoe.

Thanks, Greenspan.

Some of you may have seen Alexander Cockburn’s shocking article “Lame Duck” last week on CounterPunch. Cockburn refers to a report published by the Financial Services Authority (FSA) “a body set up under the purview of the British Treasury to monitor financial markets and protect the public interest by raising the alarm about shady practices and any dangerous slides towards instability.”

The report “Private Equity: A Discussion of Risk and Regulatory Engagement” states clearly:

Excessive leverage: The amount of credit that lenders are willing to extend on private equity transactions has risen substantially. This lending may not, in some circumstances, be entirely prudent. Given current levels and recent developments in the economic/credit cycle, the default of a large private equity backed company or a cluster of smaller private equity backed companies seems inevitable. This has negative implications for lenders, purchasers of the debt, orderly markets and conceivably, in extreme circumstances, financial stability and elements of the UK economy.

The problem is even greater in the US where unregulated fractional lending has allowed banks to loan unlimited amounts of money on measly reserves. Hence, “the default of a large private equity company is inevitable.” The whole deregulated banking scam has turned the system into a Vegas-style “crap shoot” with no guarantees that you’ll ever see your money again. The same is true with the new-fangled investment “instruments” like hedge funds which contain few tangible assets and more and more “collateralized debt.” That means that they depend heavily on the “worker bees” at the bottom of the economic Totem Pole, who are expected to continue making their payments even while the economy begins to swoon.

The present system is fraught with peril and likely to come crashing down in a heap. As Cockburn sagely notes, “The world’s credit system is a vast recycling bin of untraceable transactions of wildly inflated value.”

“Market transparency” has gone the way of the Dodo. The new “deregulated” markets are intentionally opaque so the medicine men and hucksters who designed them could fleece the public from the comfort of their Wall Street enclaves. No one should be too surprised that the whole rickety contraption is tilting towards the dumpster.

Happy Days in the Weimar Republic

So, what was the “Grand Plan” the Fed had in mind when they decided to anesthetize the American public with low interest rates and flood the planet with worthless green scrip?

Did they think that Bush would corner the oil market and, thus, force the rest of the world to take our anemic greenbacks? Or were they just planning to steal every last farthing from the American people before they loaded the boats and fled to more promising markets in Asia?

Or perhaps they were delusional enough to believe that really wonderful things would happen if they just kept tossing banknotes into the Jet stream like New Year’s confetti?

Whatever the madcap rationale might have been, the country is now facing an agonizing wakeup call as the full effects of Greenspan’s tenure materialize and the stronghold of global consumerism deteriorates into Weimar USA.

In the long run, Greenspan’s treachery will loom larger then that of his “would-be” understudy, Bin Laden. He put the country on the fast track to disaster.

Just watch as the “For Sale” signs go up on lawns across America in Dear Alan’s honor.

Mike Whitney lives in Washington state, and can be reached at: fergiewhitney@msn.com.

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