Global: Bubble Day Stephen Roach (New York) Dec 03, 2004 http://www.morganstanley.com/GEFdata/digests/20041203-fri.html#anchor0 December 1, 2004 could well go down in history as yet another important milestone for Americaâs bubble-prone economy. No, I am not referring to the 162-point surge in the Dow Jones Industrial average that occurred on that day. Instead, my focus is on two widely overlooked statistical reports put out by US government statisticians -- the latest tallies on home prices and personal income. Collectively, these reports paint a worrisome picture of an asset economy that has now truly gone to excess. As was the case in early 2000 when Nasdaq was lurching toward 5000, denial is deep over the potential downside of yet another post-bubble shakeout. Thatâs what worries me the most. The just-released report on US house prices for the third quarter of 2004 was a shocker -- an 18.5% annualized surge from the second quarter and a 13.0% increase from year-earlier levels, according to the tabulation of the Office of Federal Housing Enterprise Oversight (OFHEO). That represents a stunning acceleration from the 9.8% Y-o-Y increase of the second quarter and pushes nationwide house price appreciation to a 25-year high. Itâs an even larger rise in real, or inflation-adjusted, terms. The surge over the past year is now running nearly five times the 2.7% annualized increase of the non-housing components of the CPI. Housing analysts and central bankers often chide those of us who draw macro conclusions from a highly fragmented US real estate market. In the housing business, where âlocationâ matters, concerns over nationwide trends are often dismissed out of hand. In a recent speech, Federal Reserve Chairman Alan Greenspan noted while discussing housing prices, âOverall while local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely in the United States, given its size and diversityâ (see his October 19, 2004 speech, The Mortgage Market and Consumer Debt, at Americaâs Community Bankers Annual Convention, Washington DC). Itâs a nice theory, but the risk is that it may now be wrong. According to the latest OFHEO tally, house-price inflation over the past year has run at double-digit rates in 25 out of 50 states plus the District of Columbia. In six states -- Nevada, Hawaii, California, Rhode Island, Maryland, and Florida --- home prices increased by 20%, or more, over the past year. Housing is an asset class that is just as prone to excess as are stocks, bonds, currencies, or commodities. If it feels like a bubble, acts like a bubble, and looks like a bubble, it probably is one. Meanwhile, also on December 1, the Bureau of Economic Analysis of the US Department of Commerce released its regular monthly update on personal income. The stock market loved the October numbers -- stronger-than expected gains in both income (+0.6%) and consumption (+0.7%) that were perceived as signs of ongoing resilience of the indefatigable American consumer. I found the report appalling. What caught my eye was a further reduction in the already sharply depressed personal saving rate -- down to 0.2% in October from 0.3% in September. The September numbers were widely thought to have been distorted by temporary hurricane-related losses to personal income. Most expected personal saving would rebound from this artificially-depressed reading. There was no such bounce in October. The consumer saving rate has now basically gone to zero. Nor is the profligate American consumer the only source of the US saving shortfall. A day earlier -- November 30, to be precise -- the government also released its third-quarter report on national saving. This broad measure of saving -- the combined saving of households, businesses, and the government sector -- is most meaningful when expressed on a ânetâ basis by taking out the depreciation that goes toward replacement of worn-out, or obsolete, capacity. The resulting concept of net national saving measures the saving left over to fund the net growth in productive capacity -- the sustenance of any economyâs long-term productivity and growth potential. On this basis, Americaâs net national saving rate fell to just 1.2% in the third quarter of 2004 -- down 0.9 percentage point from the already depressed second quarter reading and nearly back to the record low of 0.4% recorded in the first quarter of 2003. The rest of the story is all too familiar: Lacking in domestic saving, the US must then import surplus saving from abroad in order to grow -- and to run massive current-account and trade deficits to attract that capital. In other words, a further sharp reduction in national saving is not exactly a desirable outcome for an already unbalanced US economy. The key to this puzzle is to recognize that the housing bubble and the saving shortfall go hand in hand. The âasset economyâ is a conceptual framework that brings these two seemingly disparate trends together. As seen through this lens, ârationalâ consumers take their income-based saving rates to zero only if asset-based saving provides an offset. As long as asset markets keep rising, that makes perfect sense. However, when asset markets correct, this decision can backfire. That was the case when the equity bubble popped in 2000 and could well be the case following the bursting of todayâs rapidly expanding US housing bubble. Thatâs why the latest trends in house prices and saving are so disturbing. In my view, they underscore the distinct possibility that Americaâs asset economy is in the midst of yet another bubble-induced blow-off. Not surprisingly, these circumstances put the Fed in an especially difficult position. Thatâs because the US monetary authority used up most of its basis points in order to contain the damage from the equity bubble. Unfortunately, in doing so, the Fed kept interest rates at extraordinarily low levels for far too long -- setting the stage for the housing bubble that was to follow. The risk all along is that the Fed had only a one-bubble damage containment strategy -- leaving itself with little ammunition to deploy in the event of another serious problem. While the US central bank has tightened to the tune of 100 basis points over the past four months, a federal funds rate of 2% hardly offers much leeway for easing should conditions take a turn for the worse. Yet thereâs an added complication to all this: The housing bubble-induced saving shortfall has pushed Americaâs current account deficit into uncharted territory -- raising the risks of a sharp correction in the dollar and a related back-up in longer-term interest rates. The last thing Americaâs housing bubble needs is an interest rate shock. That is a classic recipe for a sharp decline in US housing prices -- an outcome that might spell curtains for an overly-indebted American consumer. Ironically, there have been a number of positive developments that have fallen into place recently -- an orderly depreciation in the dollar, sharply declining oil prices, and grounds for encouragement on the prospects for a soft landing in China. But Americaâs imbalances have taken a turn for the worse, and the housing bubble could well be the final straw. Income-short consumers are playing this bubble for all itâs worth -- enjoying the psychological benefits of the so-called wealth effect and utilizing the technology of refinancing and second mortgages to extract purchasing power from this over-valued asset. Unfortunately, these trends have led to the virtual elimination of US saving -- triggering a classic current-account-adjustment dynamic with attendant risks to the dollar and interest rates. That makes the downside of this bubble potentially far worse than that of the equity bubble. That would be an especially worrisome development for the US economy, since household real estate holdings of some $14 trillion currently are almost double the aggregate size of equity portfolios. While it has only been four and a half years since the bursting of the equity bubble, memories have already dimmed of that extraordinary speculative excess. Yet in retrospect, that may have only been the warm-up for the main event. Bubbles have a way of feeding on each other -- ultimately compounding the problem and leading to an even more treacherous shakeout. Thatâs certainly the lesson from Japan and could well be the case in the United States. Americaâs housing bubble is now in the danger zone. So is its saving rate, current account deficit, and overhang of consumer indebtedness. Itâs been a US-centric world for so long, that everyone takes it for granted. Yet global rebalancing poses challenges for all major countries in the world. Saving-short America will not be spared -- especially if it must now come to grips with the biggest asset bubble of them all.
Housing Bubbles Are Not Like Stock Bubbles http://www.alwayson-network.com/comments.php?id=6472_0_5_0_C If you're looking for the housing bubble to end like the stock market bubble, you'll be surprised. Housing bubbles may run on the same fuel as stock market bubbles, excess money from the Fed, but they grow and collapse according to a different set of functions and dynamics. Before the Perkins's "The Internet Bubble" book was the site iTulip.com that explained in 1998 that the stock market had turned into a bubble around 1995 and predicted in March 2000 that it was about to burst. The reasons why were explained in a bankrate.com article, "What will pop the Internet bubble?" in Nov 1999. The last update to Itulip.com was on the topic of the Housing Bubble, in August 2002. I deemed the housing market was indeed in a bubble. The main thesis was that rational housing prices are determined by cash flow, and cash flow is determined by incomes and interest rates. Incomes have been falling real terms (9.3% since 2000) while key real estate markets (read: where most people live), experienced housing prices rising between 100% and 400% faster than incomes. The explanation for rising housing prices was too low interest rates, which also caused the the stock market bubble of the 1990s. The Fed wrote a recent piece on how housing isn't a bubble, reminiscent of Greenspan's now famous New Era rationalizations in 1999 for the stock market bubble. The Fed explains that housing prices are high because interest rates are keeping monthly payment costs low. In my view, that's not an explanation of rational pricing, only for the underlying cause of the bubble. How does it end? On the way up, housing bubbles grow differently than stock bubbles. They're regional, because folks buy homes near where they get their income, usually withing a 40 minute drive. Now I realize that in N. CA that could be two miles away on the 101, but bear with me. That means prices fueled by too low interest rates will manifest where people and the jobs they drive, take a bus or train, or walk to are concentrated. Also, they happen in areas where land is scarce, such as waterfront property; speculation is encouraged by the reality of land limitations. A comment above says prices won't decline much in the future because land is limited relative to the number of people who want on it. Tell that the the Japanese who have seen real estate prices decline for more than 12 years. Too much land and not enough people in Japan? No. Even though interest rates have been near zero for years, the problem is that their incomes have been declining. Low rates are the input of a housing bubble, areas of concentration of population or scarce land are where they happen, but low interest rates will not sustain the bubble forever. Just as housing bubbles are unlike stock bubbles on the way up, they're different on the way down, too. Unlike stock market bubbles, real estate bubbles don't pop. Collapsing stock market bubbles are characterized by a sudden collapse in prices because stock markets are highly liquid. You see huge volumes of transactions at ever lower prices during a stock market collapse. Collapsing housing bubbles, on the other hand, are characterized by illiquidity, a sudden collapse in transactions. Buyers and sellers seem to disappear. The reason is a reversal in the psychology of buyers that developed at the top of a speculative housing market. Buyers had been buying at prices they knew were too high but on the assumption that they'd be able to sell if they needed to. The thought was: "Ok, maybe it's overpriced, but at least I'll be able to sell it later for at least what I paid for it, but likely more." What happens on the way down is that houses go on the market and just about NO ONE shows up to look. That's because buyers weren't buying earlier primarily because they needed a place to live, but because they thought the price would likely rise and that, in any case, they'd be able to get out when they wanted with all of their money or more. On the way down, neither condition is true. So buyers stay home, so to speak. But can't buyers be enticed by declining prices, by bargain hunting, you ask? No. Once housing sale transactions suddenly fall from, say, several hundred a month in a large community to, say, one or two a month, this creates fear and loathing about prices. Long periods of time pass when there are no transactions at all. Think of it this way. What's the comparable on your 3000 square foot home in San Mateo when the last sale was, say, seven months ago? Is it 10% less than the last sale of a similar home on the area? 30% less? This happened in Japan, and prices nationally are still more than 60% below peak prices in 1992, where real estate prices continued to climb for several years after their stock market bubble popped. Sound familiar? If you'd like to read more on this topic, Blanche Evans, the editor of real estate professionals' site RealtyTimes.com, has written a good series titled "The Perfect Real Estate Storm".
i saw this in the 80's. people thought it was going to go up and up , then wammo.....those same people lost it. s and l crisis. i am in the kitchen business. today it has been booming for the past 10 years, just like in the 80's. it is such a perfect repeat. people now think they can do no wrong, houses are being bought for 1 million and torn down and built new for 3 million (in ffld county,ct). they are really worth less than half. it will fall big again. my question to all is, i would like to purchase puts in some of the home related industries. this would be my way of "putting" my money where my mouth is. any suggestions in some companies that have the potential to fall when things turn south?
Oneway, You are nothing but doom and gloom. You need a dose of reality. RE isn't going down. Get a grip. I'll say that for Convert. since we kind of ganged up on him. Great posts you're putting in. Lots of info. I've seen it before so I don't need to be convinced. I've even been in the realtor's car with buyers during a downturn and been with sellers then too. I've heard the mindset and the greed/fear that goes on. When the collapse first starts there will be listings (signs) all over. But it creates a very negative portrait of the neighborhood for sellers. Their heads can't spin fast enough to see all the For Sale signs. A couple of miles of that and you've got mild whiplash. What I personally feel then is: It's a buyers paradise and a seller's nightmare. I'm never a seller then. As a buyer I can feel the greed, I can feel the toughness in my mindset. I can steal a home from a desperate seller. All I need to do is find one. Then, Oh Man, they're all desperate. I can feel it. Now I'm scared. I don't want to buy and be in their shoes. No, not me. I'm not that stupid. The seller's thoughts and what they say to the realtor: "But my home is worth more than that! And look at how much I've spent on it. Just a yr ago my neighbor sold for $75K more and their house was a mess." The realtor gets the message and wants the listing on any terms. They say, "OK, you're probably right. Let's list it for that price for a month and see what happens. Just sign this six month agreement". Buyer, "Good, I'm sure this home will sell fast". Three months later the Buyer calls agent and says "why aren't you working more on my house?" Realtor, "Sorry prices have fallen some more and your home is just not attracting any Buyers. What do you want to do?" Seller, "Let's drop the price $20k. That should do it, don't you think?" Realtor, "No, I think the market has dropped a little further since we listed your home, but I'll do what you want. Your home is gorgeous. I'll be right over with a price change and extension on the listing term." It's a game. The realtor knows the right price. The Seller is too stubborn to listen. A yr. later the home sells for $200K less than when 1st listed! Realtors call that burning a listing. The Seller burned up time and money only to end up looking as desperate as they really were. Other houses listed at the same time, but at the right price may have sold for $100K more. The realtor let the Seller get desperate and give the house away. Or so it seems. Actually, this is just the beginning and prices fall a bunch more and the old Seller can now breath a sigh of relief that they escaped. This is not fiction folks. I don't know the perfect timing, but the above is the way it starts. Then Oneway is right. Buyers just stop coming and Sellers go upside-down. There begin to be no comps an appraiser can use. All hello starts to break loose. I can smell the blood. But we are nowhere near the bottom. Not even close. I can't say this strongly enough. If I could scream it to you I would. The blood is going to be knee to waist deep at the bottom. I've seen it several times. This is not my hunch on things. Believe or ....... better have a good govt. job. My advice is: if you need to sell, scout the other listings. Compare to your home. Talk to 3 top realtors. Ask them what it will take to get your home to sell this week. Then drop it a little more and list it. Bake cookies, put on classical music, stage the furniture. A show home look. And get the hello out. A well priced home that shows well will sell in 1-2 weeks. If it doesn't you're too high. Have a realtor meeting right then. "It hasn't sold and I want it sold, what's up" You may be too late in the cycle to ever sell at any price. In that case, dump the home if there is no equity and job is in danger. Don't go down with the ship. Act right then. Cash will be king. Sounds horrible. But I'm being very nice to you if you need to sell now. I personally always sell a little below market. I'm done building and I want to be gone immediately. No greed. It is just business. Cheers
Bill, let me ask you this question, since you seem to have been around long enough to be able to answer it intelligently. What would cause a rash of sellers to put their homes on the market? With such a high level of speculative buying (as I understand there to be in this cycle), would it simply take prices to stop going up for a lot of these speculators to decide the party's over and start dumping their properties, causing something of a snowball effect? Or would it require something more, like a broad economic slowdown, if not recession? Or a rise in interest rates? And just how much of a rise in interest rates?
Homeowners addicted to low rates, double-digit price appreciation Monday, November 29, 2004 Inman News Foreclosures.com Mortgage defaults in California will surge by the second quarter of 2005, according to Foreclosures.com, a real estate investment advisory company that focuses on distressed properties. "Employment, or the lack thereof, is no longer the primary cause of foreclosure activity," said Alexis McGee, president of Foreclosures.com. "The problem now is that too many households are overloaded with debt." During a long period of below-normal interest rates, consumers continued spending and financed their purchases with adjustable-rate home equity credit lines, she said. "Homeowners got addicted to a combination of low interest rates and double-digit price appreciation every year," McGee said. "Now that combination has reversed itself." The company also is predicting that the rapid cooling of the Las Vegas housing market could lead to a rise in foreclosure activity next year. "Throughout much of 2004, the Las Vegas market was distorted by out-of-state speculators buying new homes to flip for fast profits," McGee said. "Sales volume was inflated by houses selling two or three times in a matter of months." McGee said that Las Vegas' year-over-year price appreciation of more than 52 percent is unsustainable and that the price correction now happening there was inevitable. As interest rates rise, downward pressure on prices will increase and many who bought at the top of the curve with adjustable-rate mortgages will find themselves owing more than the house is worth and facing increasing payments, McGee said. "That's when you'll see defaults start to rise," McGee said. She said her company has always seen a correlation between rising interest rates and rising levels of foreclosure activity.
Sunday, November 21, 2004 The Seattle Times. Scott Burns Easy loans could end up hurting home values DENVER â If advertisements in the Rocky Mountain News are any indication, this is the place to buy a house. Like the old Dire Straits song, it's "money for nothing" in this city. Three tabloid pages have 12 advertisements for home mortgages at rates of 1 to 2 percent. Several offer no payments for six months. Others offer nothing down, no closing costs and interest-only programs. About the only offer missing is a single-payment loan, made posthumously from the borrower's estate â but that doesn't mean some lender isn't working on it. Then again, Denver isn't unique. You can get this kind of financing anywhere in America. Millions do. And that's the problem. The same home-finance industry that has extended homeownership to millions of Americans is now threatening future home values with its generosity. Skeptics should consider recent comments by Federal Reserve Chairman Alan Greenspan. Speaking in tranquilizing tones Oct. 19 to the America's Community Bankers annual convention in Washington, D.C., he reassured lenders we weren't in a debt-financed housing bubble. His most interesting comment, however, was: "In addition, improvements in lending practices driven by information technology have enabled lenders to reach out to households with previously unrecognized borrowing capacities." Don't you just love it! Join hands with me, reader, and we will explore our "previously unrecognized borrowing capacities"! What that means, in translation, is that mortgage lenders will finance anyone with a pulse. People with no down payments, poor work records, uncertain incomes and significant other debt can now go to a mortgage broker to be embraced, not rejected. So while some worry about housing bubbles in the obvious places â Boston, Florida's West Coast, most of California, Las Vegas, etc. â all of us, wherever we live, should worry about the long-term effect of irresponsible lending. My thesis is simple: Much of the future appreciation today's homebuyers are counting on has been discounted into today's mortgage-financing practices. If you own a home with a low-rate mortgage, you're getting tomorrow's appreciation today â in lower mortgage payments. A rise in mortgage rates would bring two major dangers: ⢠Inventory overhang. ⢠Fewer qualified buyers. You can understand by examining two possible events. First, consider supply and demand. With nearly 108 million households in the United States and 68 percent of them homeowners, we have more than 70 million homeowners. According to the National Association of Realtors, we're currently selling/buying existing houses at the rate of 7 million a year. That's nearly 10 percent of all homes. Reduce the buying pool from the largest in 40 years, and homes will go unsold. A sales slowdown would mean rising inventory and flat-to-sinking prices. Second, consider the impact of rising interest rates. Since a rising interest rate will turn some homeowners with variable-rate mortgages into sellers while turning some potential buyers into long-term renters, we could see a very rapid shift in the balance between buyers and sellers. What can you do? First, pray that high oil prices and a falling dollar don't translate into higher short- and long-term interest rates. Second, if you own your home, pay down your debt as fast as you can. If you have a variable rate, convert to a fixed rate. Third, if you don't own a home but want to, don't let easy money talk you into buying more house than you could buy with a traditional fixed-rate mortgage. Fourth, if you're thinking about buying, think about how much house you really need, not how much you want.
Tonights episode of House Hunters had a couple choosing between three homes. They chose the high priced still under construction home probably because the wife wanted the jacuzzi bath tube the other viewed homes didn't have. This the reality of today's housing market. People will pay up for what they want.