Festering Dungeon
Bill Bonner
The Daily
Reckoning
Sep 8, 2006
The Daily Reckoning PRESENTS:
A genuine hard landing for U.S. housing will send up dust all
over the world. Most people can't bear thinking about it... which
is exactly why we like to write about it. Bill Bonner explores...
We end this week in a state
of low dudgeon. Everyone we ever heard of who was in a state
of dudgeon was in a high one. As contrarians, we felt the need
to do something different.
A state of dudgeon is nowhere
near Indiana. Instead it is merely the condition of being good
and mad. So maybe it is closer to the West Coast. Why the typical
resident of dudgeon should be high is a mystery to us. But we
leave that for another day. The subject of today's reflection
is, instead, why the typical resident of the 50 states should
be festering with resentment in the first place.
A genuine hard landing for
U.S. housing will send up dust all over the world. Like the impact
of a giant meteor it threatens to block out the sun... and lead
to the extermination of whole species of investments. Most people
can't bear thinking about it. We at The Daily Reckoning, of course,
make it our business precisely to think what most people can't
bear thinking.
And in keeping with contrarian
principles, we will begin out thinking at the extremities of
the bubble and work backward. We perambulate east to understand
what is happening here in the west. There, we find that even
the lowliest of Chinese factory workers depend on companies that
export to America. These exporters depend on mass importers,
such as Wal-Mart, who in turn depend on millions of average Americans
to continue buying their goods.
Poor Mr. Typical has not had
a wage increase since 1972, according to the U.S. Department
of Labor's website. He earned the equivalent of $334.60 a week
back 24 years ago. Now, the figure is just $277.96. But he didn't
cut back spending just because his income fell. To the contrary,
he put his wife to work... and now he has got himself a wallet
bursting with credit cards, along with a neg-am, payment optional
mortgage, a credit innovation as popular with Americans today
as Krsipy Kreme donuts at a police benefit.
Approximately 40% to 50% of
all new mortgages written in the last two years were ARMed...
and dangerous. To fully understand how these mortgages work,
you probably have to have been hanged... or at least been to
a public hanging. Then you would have noticed that when a man
dropped from the scaffold, there would be a considerable give
in the rope... until it snapped taut and broke his neck.
Mr. Ramiro A. Ortiz, president
and CEO of one of Florida's most aggressive lenders, described
the slack in the noose last month when he was asked what would
happen if a homeowner couldn't make his payments.
"In our situation, the
customer has some flexibility and can choose some other options
to weather the storm till the times are better."
Yes, he can skip a payment
if he wishes, and let the principal of the loan rise - to a maximum
of 115% of the original amount. So, if he merely has a month
to wait for his bonus check... or suffers some other one-off
calamity... .he can make it up the next month and all will be
well. But when he hits 115%, the rope tightens on his neck, no
matter how many checks are in the mail.
When just a few yahoos get
themselves into trouble nobody cares. But should a general cyclical
turndown put many people into his situation, the results could
make the whole world shudder. The U.S. economy is still 25% of
the entire world's economy. Foreigners depend on the United States
to continue buying... the U.S. depends on its lumpen-consumers
to continue spending... and these same consumers depend on debt
for their spending, debt backed by house price gains.
Reading the papers and talking
to homelanders we conclude that the housing bubble is over...
and unlike other observers, we believe it will come to a rude
end, for three reasons:
The first is demographic. The
typical baby boomer has a total of $60,000 in net worth. For
the last 10 years or so, he has not had a reason to save. Why
get 3% in the bank when you could get 12% from housing? Counting
leverage, most people probably got at least twice that. The typical
retirement financing plan was simple: buy a house in Florida...
then sell the house in New Jersey. Naturally, the Sunshine State
boomed. But where did the boom come from? Housing, of course.
In the period, 2001-2005, employment growth averaged 2.2% per
year - third highest in the nation. But job growth in the property
sector grew more than twice as fast, at 5.6%.
Naturally too, house prices
seemed hitched to a rocket launch at Cape Canaveral. In the three
years, 2002-2005, property prices rose 77% compared to income
growth of only 1.4%.
In the run-up to their retirements,
the baby boomers were net buyers of houses. It was a way for
them to finance their golden years. Now that the boom is over,
they will most likely be net sellers - because they will need
the money.
What is seldom appreciated,
especially by America's homeowners, is that housing prices do
not go up reliably. In fact, for most of the last century, they
reliably went nowhere. According to Robert Shiller, during the
entire period from 1890 to 2004, property rose at an average
annual rate of just 0.4%. And in many parts of the country, over
long periods of time, prices went down. The price of farmland
in Western Kansas, for example, hit a high in the commodity boom
of the late 1880s and has still not recovered.
The International Monetary
Fund analyzed home prices in a number of countries from 1970
to 2001, and found 20 "busts" - when real prices fell
by almost 30 percent. All but one of those busts led to a recession.
Japanese property prices have
fallen for 14 years in a row, by 40 percent from their peak in
1991, and consumer spending has been weak, leading The Economist
to conclude, "Americans who believe that house prices can
only go up and pose no risk to their economy would be well advised
to look overseas."
And The Economist of May 29,
2003 adds:
"House prices have fallen
in nominal as well as in real terms in Germany and Japan over
the past seven years. A house in Tokyo now costs less than half
what it did in 1991, after a now legendary property-price bubble
in the late 1980s. Yet the 36% real increase in average house
prices in Japan in the seven years to 1991 was less than the
increase over the past seven years in half of the countries we
track in our index.
"German houses used to
be the most expensive in Europe: in 1975, they cost three times
as much as French ones. Today the two have more or less evened
up, largely because German house prices have been steadily declining
in real terms. Germany is still suffering a hangover from a massive
construction boom after unification, encouraged by government
subsidies and tax breaks. Prices in eastern Germany are still
falling in response to excess supply, though in western Germany
they have risen slightly over the past few years.
"Over time, housing booms
and busts in Europe, and especially in Britain, have been more
pronounced than in the United States (see chart 5). House prices
have also been more volatile in cities, where the supply of building
land is more limited. For example, London house prices soared
by 120% in the five years to 1989, then fell by 30% over the
following four years.
"In real terms, price
declines of one-third or more are nothing unusual, examples being
Australia, Italy and Spain in the early 1980s. Falls in nominal
prices are much more common in big cities. Not only London but
Boston, New York and San Francisco, too, saw prices drop steeply
in the early 1990s."
The second reason we give,
for why this property decline is not likely to be soft and easy,
is technological. The invention of the modern automobile in the
early 20th century seemed to doom America's cities. The cities
were noisy, dirty, bustling places of commerce. Americans who
could afford to do so dreamed of living outside the city centers.
The automobile helped to make it possible.
The best neighborhoods of Baltimore
peaked out in the 1920s. Even now, at the height of the greatest
bubble in history they still have not recovered. Another example
comes to us from Grant's Interest Rate Observer:
In Boston, Mr. John C. Kiley,
writing in 1941, observed that prices had been going down for
11 years. He noted "in some of the older business and residential
sections of the city of Boston have returned to levels below
those of the pre-Civil Wars years." One hundred years of
price appreciation - wiped out.
What had happened to Boston?
Many of the richest people had moved out... driving out to the
suburbs in their new Oldsmobiles.
"When I was I young man
in the early 1980s, I used to play in a rock and roll band in
Minneapolis," writes George Paulos at freebuck.com. "Like
many bands of the era, we rented a "band house" to
live and rehearse. Most of the band houses were located in Southeast
Minneapolis. There were many large homes in that area for rent
and the price was cheap. Our band house was a large two-story
home that was built sometime in the 1920s. It was a two-unit
rental with an upstairs kitchen and bathroom. We packed four
guys into the house and still had plenty of room for rehearsing
and all-night beer bashes.
"We often wondered about
the original owners of these mansions. It was obviously a wealthy
neighborhood at one time. Many of the homes in the area were
huge and intricately designed. What happened to these people
and why was the area now so downtrodden? Many years later I learned
about the Depression and how it affected land prices and neighborhoods.
It turns out that Southeast Minneapolis was at the frontiers
of development in the 1920s.
"Although within the city
limits, they were essentially the suburbs at that time. Homes
like our band house were the McMansions of the day. They were
built for a burgeoning upper middle class who had increasing
incomes and easy access to credit.
"When the Depression arrived,
these neighborhoods were hit pretty hard.
"The real estate bust
of the 1930s had a permanent impact on many neighborhoods. The
once wealthy neighborhood that surrounded our band house was
still suffering 50 years later. ... Even in the middle of a
huge real estate boom, these neighborhoods are so blighted that
they are still shunned."
What technological innovation
threatens America's suburbs? The Internet. The automobile meant
you know longer had to live near your work. You could just live
within commuting range. Now, the Internet means that many people
and many businesses can put themselves anywhere. We think they
will turn their backs on the suburbs.
Our third reason is the most
important and the easiest to understand. Why will the bust in
American housing be extraordinary? Because the boom that came
before was extraordinary.
In the last two years, homeowners
in America took out $1.3 trillion from their house price gains,
an amount greater than the GDP growth figures for those years.
While prices rose only 0.4%
per year from 1890 to 2004, they soared by 6.2% from 1997 to
2005. According to Shiller, it would take a 22% drop in residential
real estate prices to bring house prices back to their long-term
trendlines. Other experts have predicted a 40% retreat.
Falling prices in the housing
sector mean that homeowners no longer have any "equity"
to take out. Instead, the flow of liquidity reverses... mortgage
resettings, taxes, maintenance, debt restructuring, foreclosures
- all of a sudden money must be put back in! A 5% fall in house
price takes $1 trillion out of the net worth of American homeowners.
A 40% drop would probably set the economy back about as much
as the Great Depression.
"The real estate bust
of the 1930s holds important lessons for today," continues
Mr. Paulos. "It showed that homeowners are bound together
with their neighbors by chains of finance. Even responsible homeowners
who maintain low debt can be undermined by their financially
irresponsible neighbors. It may be that your best neighbors,
the ones who have been aggressively upgrading their homes, are
the ones who have been racking up the most debt. A closure of
a large local employer or even a large tax increase could be
the tipping point for homeowners on the edge.
"I recently visited my
old band house. It was just as I remembered it. The hedges were
massively overgrown, the siding was still rotting, and the porch
was still sagging. It was a bittersweet vision. The rest of the
neighborhood was a mixed bag. Some homes have been nicely renovated
and others were still crumbling. Judging by the condition of
the local businesses, the neighborhood is even more distressed
that it was in the 1980s. Seventy years after mass foreclosures
and the place still hadn't recovered. How will it fare during
the next real estate bust?"
Mr. Paulos should plan to drive
by in a year or two to find out.
By then, the chains of finance
that chaff against the skin of the middle and lower-middle class
might be tightening upon us all. And the dudgeon festering on
the wrong side of town might have oozed over to the good neighborhoods.
Bill Bonner
email: DR@dailyreckoning.com
website: The
Daily Reckoning
Bill Bonner
is the founder and editor of The Daily Reckoning.
Bill's book,
Mobs,
Messiahs and Markets: Surviving the Public Spectacle in Finance and
Politics, is a must-read.
He is also the
author, with Addison Wiggin, of The Wall Street Journal best seller
Financial
Reckoning Day:
Surviving the Soft Depression of the 21st Century (John Wiley
& Sons).
In Bonner and
Wiggin's follow-up book, Empire
of Debt:
The Rise of an Epic Financial Crisis, they wield their sardonic
brand of humor to expose the nation for what it really is - an
empire built on delusions.
Copyright ©
2000-2008 Agora Financial LLC.
321gold Inc
|