on realestate bubble: HOUSE MONEY, PART II, By Bill Bonner
"You have to begin to sell when the householder buys."
-- attributed to one of the Rothschilds
The Fed chairman seemed proud of his work. Speaking to
Congress last week, he said that interest rates, driven
down to below-market levels by the central bank, had
encouraged "households to purchase homes, refinance debt
and lower debt service burdens, and extract equity from
homes to finance expenditures."
American households took Mr. Greenspan's bait. They took
whatever money they had on hand, borrowed more from
over-eager lenders, and bought what are usually
charmless, flimsy, pathetic, sordid, puerile suburban
homes. A few of the more aggressive householders began
buying and selling them as if they were dot.com stocks.
Now, they have plenty of house, not much cash, and
they're on the hook for $2.7 trillion in mortgage debt.
What will they want next? More split foyers? More
colonials? Ranch, contemporary, Spanish colonial? A
McMansion?
Or more cash and less debt?
The average American lives in a suburban house thought
to be worth $192,400. Since stocks began to decline
nearly 3 years ago, his net worth has not necessarily
declined, but it has become less abstract; the poor man
now has to live in it. Worse, if things develop as we
fear, he'll have to live in it for a lot longer.
But for now, he is as content with himself as the
nation's Fed chief. His "investment" in his house has
done well - far better than an equivalent in the stock
market. He does not notice that his castle of 2002 has
no moat to protect it from a bear market in housing.
The Daily Reckoning is free. Since you pay nothing for
it, we feel entitled to pass along our gratuitous
reflections; sometimes readers find more of them in
their morning's DR than in the bathroom mirror.
Readers write almost daily, asking to be taken off our
list. Irish, gypsies, gay, straight, Republican,
Democrat, frogs - who have we not offended? Tomorrow, we
fear...we will hear from the suburbanophiles.
"Single-family homes are selling quickly, prices are
soaring, and buyers who square off in bidding wars can
end up paying thousands more than sellers have asked
for," says the Philadelphia Enquirer.
"Why the frenzy? Low interest rates are the most obvious
cause. When rates are low, buyers can qualify for bigger
loans, so they can afford to bid higher. Though rates
have been low for two years, many people may be rushing
to buy now for fear that rates will rise as the economic
recovery progresses.
"But they have another reason to rush: fear that rising
property prices will put their dream homes out of reach,
even if interest rates stay low. This overeagerness to
buy is a classic sign of a bubble."
A housing bubble in Philadelphia? It seems almost
impossible. Who would want to buy a house in
Philadelphia...must less at a premium? But house prices
are up in Philadelphia, and even some parts of
Baltimore. My sister, looking around rural Virginia,
reports that there too it is a seller's market - even in
the most benighted areas.
"The five most expensive markets in the nation in order
are Boston, where the percentage of income devoted to
mortgage payment is 44.9%, San Diego at 43.1%, Fort
Lauderdale 29.1%, San Francisco at 47% and Miami at
30.0%.," adds Richard Russell.
"The old rule was that you spend 25% of your income
either on rent or for carrying your mortgage. All of
these cities are above 30%. This is just one test of
housing prices, but I think it's valid. And yes, I do
think housing is in a bubble."
When the Nasdaq bubble popped, dot.com analysts moved on
- to making real estate appraisals. Thanks partly to
their accommodating estimates, suburban America is now
thought to be worth about 15% more than it was last year
at this time...and twice what it was worth in 1990.
This newfound "house money" has sheltered Americans from
the decline in stocks. While stocks lost about $5
trillion since the top, real estate is up about the same
amount. Our question in this letter is how much longer
this house money will hold up. Our answer, as on
Wednesday, is "not much."
A poster on Richard Russell's site: "As a student of
bubbles and crashes (am an investment professional who
has spent his career in emerging markets), I can tell
you that I have never seen a bubble in equities unwound
without an unwind in property. For example, Japan,
Korea, Hong Kong, the Philippines, Thailand, Indonesia,
Mexico, and Brazil. And the unwind generally begins when
credit goes south, which happens shortly after an
overvalued currency begins to fall, which follows
the first leg down of a big, ugly bear market."
Why can't residential real estate just continue to rise
- even after stocks head down?
John Mauldin explains:
"If homes were to rise in value by just 7% per year
(forget about 10%), in ten years that means the value of
our homes would double. If incomes were to grow at 3%
per year, the portion that we allocate to housing would
have to rise by 50% to be able to buy the same house."
It is all very well for the seller. He watches the
supposed value of his house rise up like a drunk from
the floor of a saloon. For a brief moment, he imagines
himself rich...and begins to daydream about the
marvelous retirement in the sun he will enjoy on the
proceeds of the sale.
But to whom will he sell? With incomes rising at only
half the rate (in John's example) who will be able to
buy the house at the list price?
And...who would want to?
More to come on Monday..."The Crash of Suburbia and the
Coming Depression."
Yours truly,
Bill Bonner |
