<p>A few months ago it was just the sub-prime lenders that were said to be struggling, but with first the trouble at Countrywide and now the apparent implosion of American Home Mortgage I’m beginning to think the deck of cards is starting to collapse.</p>
<p>From the economist/shill at the Board of Realtors who said real estate looked rosy, to the housing prices that were rising so fast and for so long it was no longer shocking to read of double-digit increases, I think the bubble is going to pop. And with a bang, not a slow leak.</p>
<p>People laugh at those who buy into pyramid schemes, and yet I see housing as a pyramid scheme in slow motion. As the first people in were making money, others wanted to play the game and clamored to get in. What realistic reason could there be to giving loans to people who couldn’t show they earned enough to pay for the loan (the so-called “stated income” loans, where your income was whatever you felt like writing down?) The loans with teaser rates given to people who couldn’t possibly pay the regular rate? The loans where you could choose how much to pay, even choosing an amount that meant you owed more on your loan each month instead of less?</p>
<p>The sad thing is that this pyramid scheme was legal, with the full complicity of the regulators who could have stopped this thing. It may be hard to stop someone from raiding their savings to buy into a pyramid scheme, but this bubble was one that could have been stopped. Instead rules were softened or repealed to keep the pyramid game going a while longer, because its only the continuing entrance of new suckers into the game that keeps it afloat.</p>
<p>Finally we’ve ran out of suckers and the cold dawn is coming. The Fed has to walk a tightrope, though. It can’t just bail out the lenders without inflating away the value of the money held by China and others who financed our years of deficits and giveaways to the wealthy; if you think the mortage crisis will be bad, give a little thought to what happens if China decides to stop financing the deficit and to dump the trilliions it already holds. What turns this from a tragedy into a nightmare is we have Bush/Cheney leading the country; you couldn’t find more incompetent leadership if you tried!</p>
<p>The people who borrowed this money were adults. No one made them commit to loans they couldn’t afford. They gambled on a bubble and lost. People that made home loans with real payments that came in at 20 or 25% of their gross income will be fine. Grown adults who gambled on fantasy loans will lose. As is most often the case, it is the greedy who are paying – both financial institutions and individuals. I have trouble coming up with too much sympathy for them.</p>
<p>During the '80s a lot of old-line insurance companies started thinking they were major financial players and lost their shorts. The most conservative – New York Life comes to mind – mostly stuck to their knitting and cruised through. They made less money during the go-go years, but they are still around today. Despite what Hollywood thinks, greed is not good.</p>
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<p>The first thing that would happen would be the collapse of the Chinese economy. Without the US as a market, the Chinese economic miracle doesn’t happen, and Chinese manufacturers have no place to sell their goods. It’s dangerous to owe someone a little money. When the amounts get this big, the borrower has as much power as the lender. You might better ask what happens to China when they stop holding their currency to absurdly low values. That’s a bigger risk to the world economy (Chinese growth will slow, and prices will increase for Chinese goods).</p>
<p>The stock market makes regular 10% corrections. Those who stick usually come out just fine within 5 years. The same will happen in housing except in a couple of isolated areas like Miami condos.</p>
<p>It’s markets like most of CA, where 25% of income does not buy most people a decent school district, where normal folk began commonly taking these funny loans. As an Easterner. I was shocked to see that people making $150K were buying million dollar homes. </p>
<p>These aren’t people living the good life. These are people who stretched to live in modest, small homes. It’s already getting ugly here in Socal with homes flooding the market and no buyers. The crash is here, how big will it be? Will CA be hit hardest?</p>
<p>I really wanted to retire to Thousand Oaks, CA but I’m 20 years too late in buying into the area–so Virginia here we come. Maybe we can park the RV in TO for a few months a year.</p>
<p>I know the area well, barrons. H and I lived there exactly 20 years ago when S was a baby, but we couldn’t afford to buy a home there. Very nice place. It’s a bit too sheltered, suburban and white for my liking (even in retirement) but one heck of a well-planned community and usually wins safest small city award nationally (that and nearby Simi Valley). Schools are strong, too.</p>
<p>A house I saw in a good school district is also came down crashing. It originally sold for $1.286M but now has a short sale for $850K. Loss of $430K in less than a year. OUCH!!!</p>
<p>SO…the next question comes to my mind…will this affect how schools price their COA if equity is diminishing, thereby limiting financial resources for parents…a reasonable question, don’t you think?</p>
I detect a strong whiff of libertarianism here. Why are pyramid schemes illegal? Any sensible person knows the math, knows the craze is bound to tumble. Yet people get carried away with the thought that somehow this time is different. Libertarians think people should be free to throw their money away in these schemes if they want, that promoters should face no consequences. Thankfully most people aren’t libertarians.</p>
<p>In libertarian-land everyone is a rational player, carefully considering the risks they are willing to take and making reasoned decisions. Out here in the real world where only 1/3 of the American adult public has a college degree (and most of those at colleges many posters here would sneer at) such rationality is not as common. Even ignoring the fantasy of perfect knowledge and fair markets that underlies libertarianism, current economic research shows people seldom make what economists would consider rational decisions. People in the real world are pushed by fear, pulled along with what they perceive everyone else to be doing, and pay far much too attention to recent experiences than distant ones. So when the media is clamoring “get in or you’ll miss out!”, people jumping at crazy loans seem to be doing ok, and every night the news leads with another story about a family paying an insane price only to turn around and sell a year later for even more – when that happens, I’m not surprised people decide to get in. Libertarians say they had it coming. I thank the heavens I’m not so callous as to see the world that way.</p>
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This would be more convincing if the fall-out from housing crash affected only “the greedy”. Explain to a wage-earner who never speculated in housing, didn’t earn gigantic bonuses, that their job is gone because their employer couldn’t sell enough product in the recession that comes when credit is tight so businesses stop buying and consumer spending stops. Are they part of the “greedy” too?</p>
<p>I think it will affect a lot of people, even those who bought houses years ago. It may affect the money that people put into a certain bank that has rirsky loans and the money in money market mutual fund. I know there is FDIC but in the back of my brain, I still can’t help wondering if there is a whole sale collapse would the money in these money market mutual fund be ok for everyone?</p>
<p>I don’t know. The same legislators that ban “pyramid parties” also grant licenses to casinos and run numbers rackets in the form of state lotteries. They pick and choose among predatory behaviors – approving some and making others illegal. Americans lose more money to casinos and lotteries than they will in diminished real estate values in the end of this boom. (I don’t consider paper losses to be real. If you don’t sell the asset, the loss is not realized.)</p>
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<p>Could you please restate this? Are you arguing that all risky investments (like building a new concrete plant) be outlawed because if it fails the company might be hurt and have to reduce its work force? Or that if the Fed or Congress takes actions that affect the credit market and people lose their jobs that there is some liability for their action? In other words, please try to state your point more clearly, such as “Because the government does not regulate the financial instruments available in the lending industry, unacceptable fluctuations take place in the credit supply. Since these fluctuations are bad, the government should do whatever it takes to insure that they don’t happen.” Or something. I am really not trying to be argumentative, just trying to get the point.</p>
<p>For what it’s worth, tight lending credit doesn’t make anyone happy either. Defaults reduce, but fewer loans are made, fewer housing units are built, and fewer people are unemployed. The folks you are referring to that might be losing their jobs would never have had them in the first place if the credit rules of 1965 had been in place. These things do cut both ways.</p>
<p>And, yes, someone making $150,000 has no business buying a $1,000,000 house even if they really, really, really want to buy their own home. Just because I really, really want a Ferrari 599 Fiorano doesn’t mean that I think I have a right to it. (Damn, that does sound libertarian, doesn’t it?)</p>
<p>For UCGradmary, the economy in California tanked in 1991 when the aerospace industry collapsed as part of the “peace dividend.” Real estate there sucked for about eight years (ask me how I know…). California has a great economy and nothing has changed to make the state fundamentally less desirable. In the short run, California might suffer pretty badly, but in the long run it will recover and be fine.</p>
<p>Strangely, the market in Western Washington, which never boomed like much of the country, seems to be on a steady upwards slope. I had occasion to have my home reappraised last week and the estimate was 10% higher than I expected. Fortunately, I’m not in the market to sell it for real so I won’t have to test that appraisal.</p>
<p>WashDad, I agree with your assessment of Calif. homes. I was here in 1991, too, we actually bought our first house in 1992 and we suffered as the tiny bit of equity from our downpayment virtually disappeared over the next seven or eight years. We waited 10 years to sell and the house had risen in “value” by $120,000. We bought our second house and it has appreciated about $400,000 in 5 years. It’s ridiculous. We know it’s ridiculous. Because we’ve lived through the California boom/bust cycles (as have our parents and grandparents), we aren’t tempted to use our equity and just treat it as an “idea of money” not real money. It only becomes real when we actually put the house up for sale. I see short term pain for people who need to sell or for those with risky mortgages that need to refinance. But the economy is very strong other than in real estate and possibly construction.</p>
<p>I don’t know Washdad, other industries are not looking strong here. Many unemployed engineers and tech execs, tourism down, factories of all kinds gone for good. The middle class has less buying power here than in decades. I don’t think this is going to be the small downturn we felt in the early 90s, my real estate friends are downright frantic. Prices actually going down.</p>
<p>I lived in TO and worked for the city of Simi Valley back in the mid 70’s. Nice homes sold around $50,000 then. Now the same stuff is around high six figures. A small condo is $300K. I liked the peace and quiet of TO while still having great weather, no smog, and easy access to Malibu, Santa Barbara and LA (on weekends anyway).</p>
<p>I think Southern California’s economy is still very strong unless you’re in the real estate business. I do believe the downturn this time is different from the 90s. I purchased real estate in the 70’s , 80’s and 90s so I’m familiar with both the upturns and downturns. In the 90’s, jobs were scare but the easy money was not there, this time around it’s the opposite.</p>