Recession and The Housing Bubble

Originally Posted October 9, 2008

As I watched the debate Tuesday night, I listened as both candidates threw the blame for our current economic crisis on our mortgage debacle. The bubble of housing prices through the US has created negative equity, high foreclosures, which in turn are causing bank failures, etc… We’ve all heard it on the news for the past month, but I began wondering how much of this is really due to the housing? And actually, what has housing done for the US in the past 5 years.

A quick recap of the US economy over the past 4 years: (very quick indeed). In June 2007, the credit crisis began to become a reality. Since this time, the S&P 500 is off by more than 50%. We all know what has happened in the last two weeks, so I won’t rehash the current status.

I want to go back though to the years leading up to the credit crisis. You will recall that in June 2006, pundits started asking if we were in a recession. The answer was always no. However, if you look at the fundamentals of the US economy, there was reason for concern. Specifically, corporate spending was down, government spending (other than the war in Iraq) was down. Unemployment numbers were flat. The Fed had raised their target rate from 1% to 5% on fears of inflation. Gas was at $2.87 a gal (DOE numbers) and would hit $3.00 just two months later. But consumers were spending enough to keep the GDP growing.

I attended a conference in 2004 in which the speaker, a well respected national economist, said that every attendee should go home and refinance and take all the equity out of their home, adn keep doing it as often as the bank will allow. The idea was that no one was charging for re-fi’s, and that money had been cheap. Equity in our homes was the greatest method of increasing wealth ever seen. You could buy with no money down, and then in two months, take some cash out. And as Americans, many did… in droves… (By the way, this was not a get rich quick conference, this was a symposium for MBAs from all over the East Coast addressing “the new economy”.)

Fast forward to 2006 and we find that while nothing in the economy was really going right, the GDP continued to grow, albeit slowly… And what was the number one reason? Consumer spending. While corporate American cut off the spigot, and the Govt did too, Joe Six Pack kept spending like crazy. He bought cars financed through his house, he bought furniture, and the biggest TVs anyone had ever seen. Despite the lack of fundamentals in our economy, the consumer kept us going.

The only thing that allowed the consumer to keep spending was that their net worth was rising at rates never seen in the country. People felt rich. And that led to more spending. Conspicuous Consumption at its finest. God Bless the American savings rate.

We as consumers kept this economy going, and we have our mortgages to thank.

So this raises my question for the day. If we had not had the slack mortgage lending practices, and had we not promoted home ownership to the level that we did, when would this recession have started? 2004? Perhaps before?

The consumers won’t be spending money for the foreseeable future. It will now turn to the Govt to pump out the dollars (and the debt)… and pray we can pull it all together.

Transparency and the Mortgage Market

Originally Posted March 25, 2008

Today, John McCain called for more transparency in the mortgage market, claiming that such an act would keep us from a situation down the road. The stock market is regulated to death, and attempts to have the perfect market, and thus information is available to all, and valuations are market driven. Given this logic of McCain, the tech bubble never should have happened. So, why is transparency good, but it doesn’t actually work?

McCain, a supporter of Charles Keating in the early 1990’s, is now a member of the “more regulation” camp. In this transition, he has come to a decision that transparency would have averted the crisis of today. For the same reason that the tech bubble happened despite regulation, so this current credit crisis exists.

Greed. It’s that simple, although few of us would admit that we pick up this vice. We didn’t buy our houses to lose money, we bought them to make money. All we saw was prices in double digit inflation annually, and said “we need to be on this bandwagon”. We all knew that if we weren’t on the bandwagon, then we would never be able to afford a home down the road. So what if our debt ratio would not have been allowed in the 1980’s, this was 2005 and credit was easy to come by.

A note on debt: it became easier to come by because banks found a way to mitigate risk to the end level investor. Because of this, commercial interests were willing to buy the debt at better rates than Fannie or Freddie did, so out the window went the credit standards. But just like the tech bubble, all of this was above board. Everyone knew that we were no longer lending to 28/36 debt levels, but now closer to 36/42 and even higher. Everyone bought the debt because everyone knew the owners would just re-fi down the road. As long as everyone re-fi’ed in 3 years, everything went swimmingly.

Am I the only person that sees that this is a classic Pyramid Scam. It is always the last person in the game who loses. Well, those loses are now. Folks who bought in 2001 and saw their values double by 2006 can stand to lose 25% of the value and be fine. But those folks who stretched themselves to every financial limit and bought in 2005 are facing some really scary futures.

No matter how transparent the market could have been, it wouldn’t have stopped Mom and Pop from wanting abetter home, a better life, and a better investment vehicle. Leverage is what makes the world go round. It just seems that leverage can go to far, whether it is tranparent or not.

Back to top

Twitter links powered by Tweet This v1.8.3, a WordPress plugin for Twitter.