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The Fall of the House of Cards

Pop Goes the Bubble!

by MIKE WHITNEY

Four months ago I wrote an article, "Doomsday; the Final Months of the Housing Bubble" that predicted a dramatic fall in housing prices that would have a catastrophic effect on the American economy.

In truth, I’m a lousy forecaster and simply collected the relevant data from a number of sources that convinced me that the end was quickly approaching. Now, it seems that dismal day is upon us and the Grim Reaper has begun churning out the disappointing statistics that we’ve dreaded from the very beginning.

In November the sales of new homes plunged by the largest amount in 12 years. The 11.5% decline from October was 4 points higher than expected by Wall Street analysts, fueling the belief that the red-hot housing market is headed for the dumpster.

This sudden downturn is expected to slow the wave of speculation that has kept the market booming for the last few years. According to an Associated Press report, sales dropped by "22% in the West, the biggest decline in the region since February 1995."

Many readers will wonder why trimming the spec-market threatens the overall economy. The reason is, as The Economist points out is that "23% of all American houses bought in 2004 were for investment, not owner-occupation. Another 13% were bought as second homes. Investors are prepared to buy houses they will rent out at a loss; just because they think prices will keep rising — the very definition of a financial bubble."

If we consider the effects of 36% of buyers moving out of the market we can grasp the magnitude of the problem.

The crisis is compounded by the enormous effect of the housing market on both growth and jobs.

"Over the past four years, consumer spending and residential construction have together accounted for 90% of the total growth in GDP. And over two-fifths of all private sector jobs created since 2001 have been in housing-related sectors, such as construction, real estate and mortgage broking." (The Economist)

"2 out of every 5" private sector jobs!?!

"90% of the total growth in GDP"!?!

These are figures that simply boggle the mind. What it tells us is that the market has been artificially inflated by the Federal Reserve’s shortsighted low-interest rates policy and the shabby lending practices of the major mortgage companies.

The banks have lowered the standards for home loans to such an extent that the traditional loan of 20% down and a fixed interest rate is virtually a thing of the past. Instead, those conservative practices have been replaced with "creative financing" schemes that put the entire housing market at risk.

In 2004 "one-fourth of all home-buyers — including 42% of first-time buyers — made no down payment." (New York Times, July 7, 2005)

Equally troubling is the fact that "nearly one third of all new mortgages this year call for interest-only payments (NY Times) This tells us that a large number of new buyers can barely make their payments, but are gambling that their property value will go up enough to justify their investment. This is "equity roulette," a shell game that anticipates that salaries will go up while interest rates stay low.

We can nticipate that many overstretched homeowners will begin to fall from the economic precipice in short order. In fact, many markets are already showing a 40% increase in foreclosures even though the air has just begun hissssssing out of the bubble.

The ridiculously low interest rates coupled with the irresponsible lending practices has precipitated a feeding frenzy for cheap money. Greenspan is expected to raise rates another one-half percent before he leaves in January which should be just enough to collapse the market and put the economy in a permanent coma.

As Paul Van Eeden says in ‘the End of the Real Estate Boom",

‘this is not a trivial matterAs the real estate market goes, so goes the economy and the stock market. The only thing that could keep the US on life-support a little longer is another round of interest rate reductions, but this time it could hurt the dollar, and that would mean higher gasoline prices again, so it’s a double-edged sword."

Van Eeden provides a good description of the mess that Greenspan has created; a blind alley from which there is no foreseeable escape. The Federal Reserve has managed to keep the economy running on fumes by dropping rates 12 times to a rock bottom 1% after the fall of the stock market (another Greenspan fiasco which cost the American people $7 trillion) It was basically "free money" loaned out to keep the country limping along (and to facilitate Bush’s tax cuts) while millions of Americans tried to recoup from their losses. Regrettably, the cheap money and shaky loans simply created an even bigger and more lethal bubble that is following the same trajectory as the Hindenburg.

Ka-booom!

Adding insult to injury, the Federal Reserve announced 2 weeks ago that new steps will be taken to regulate low-interest, high-risk loans. In the third quarter a full 33% of first-time home buyers took advantage of "non-traditional" mortgages. ("No interest" or "ARMS" adjustable rate mortgages) Try to imagine the chilling effect on the housing market when 33% of first-time homeowners are removed from the pool of potential buyers?

Still think you"ll be able to sell your house at a profit?

Jittery Americans don’t need a crystal ball to spot the shipwreck looming just on the horizon. The last remaining droplets of prosperity are trickling from the ailing economy and Greenspan’s 18 year quest to flatten the American middle class will soon be realized. ‘the Economist" summarized it best when they said, ‘the worldwide rise in housing prices is the biggest bubble in history. Prepare for the economic pain when it pops".

MIKE WHITNEY can be reached at: fergiewhitney@msn.com