We are living through the biggest financial bubble in history. According to estimates by The Economist, the total value of residential property in developed economies rose by more than $30 trillion over the past five years. Not only does this dwarf any previous house-price boom, it is larger than the global stock market bubble in the late 1990s or that of the late 1920s.
San Diego County resale house prices fell in December by the largest monthly amount in 18 years. The median resale price for existing single-family homes dropped $15,000 from November to December to stand at $550,000, the largest month-to-month decline since Data Quick began keeping records in 1988. The San Diego Association of Realtors, which monitors about 60% of the housing market, reported that properties took longer to sell in 2005 than in 2004 - remaining on the market for an average of 62 days last year, compared to 54 in 2004. Housing starts soared this January, growing at their fastest pace in almost 33 years. This would seem to be good news. Unfortunately, however, supplies of new, unsold houses are rushing onto the market at the fastest rate in 21 years. Inventories are piling up.
Consider the following:
* Housing affordability nationwide has dropped to a record low, while household debt has soared to a record high.
* Over one-third of all homeowners spend more than 30% of their incomes on their mortgage payments. Twelve percent of homeowners devote over half of their incomes to these.
* Those who barely qualify for a loan, known as sub-prime borrowers, accounted for 28% of all new mortgage lending in the past six months versus 5% five years ago.
* In the first half of 2005 two-thirds of homebuyers financed more than 80% of their purchases, according to SMR Research.
* 17% of homeowners own less than 5% of their home's value, free and clear.
* About 42% of first-time buyers made no down-payment on their home purchases in 2004.
Any of the above statistics would be cause for concern alone but taken together, the prognosis for the future of real estate and, indeed, for the economy as a whole is grim. Values in any bubble market which rise the way real estate values have risen recently always "correct." There is no example in history of a single bubble which did not give back all of the gains achieved on the way up.
The 42% of recent buyers who put no money down when buying their homes have no equity. What will happen to them if the value of their real estate falls? If these homebuyers have been using interest-only loans, they will have no protection against any kind of adverse move. Many people in this situation will have no choice other than to walk away from their property and mail the unwanted keys back to the lender.
Speculation has been increasing along with home prices. The history of markets shows us that asset markets become ever more treacherous as the number of leveraged participants increases. Leveraged participants possess no capacity to withstand adverse trends. They become forced sellers into a falling market, which pressures prices even more. This forces more speculators to sell.
It is always important to examine the opposing point of view. Many people believe there is no real estate bubble. The contention of these optimists is that a strong housing market is a function of many different factors with real economic underpinnings: low interest rates, local job growth, scarcity of land for the needs of a growing population, the emotional attachment one has for one's home, increased future earning power, parental contributions. All these things are said to contribute to rising home prices. During the past 25 years there has been an explosion of second home purchases, a continued influx of immigrants (who need to buy houses) and a significant reduction in existing houses from those which have been torn down. These trends are not always published in data reports. Homes are not stocks; their intrinsic value can only be in the eye of the beholder. A house has utility. Rational people might be willing to pay more for an ocean view or for living close to work or for a larger bathroom. Such voluntary economic decisions are not considered to be irrational. Even if prices in America do dip, insist the optimists, they will quickly resume their rising trend because real house prices always rise strongly in the long term.
When examining the situation in just the four big counties in Southern California , you will notice the following: over the past decade the percentage of households able to afford to buy the median-priced home using conventional mortgage qualification standards dropped by 74% in Orange County to 11% and by 56% in San Bernardino County to 24%. Starting this year and accelerating into 2007, as much as $2.5 trillion of non-conventional mortgage debt is scheduled to be repriced. Millions of Americans will soon face significantly higher mortgage payments. Unfortunately, many can barely afford their current payments. All this is coming due at a time when Americans discretionary income (after more or less fixed costs of taxes, housing, healthcare, auto, energy, etc.) is declining while debt levels are mounting, interest rates are climbing, sales of existing homes are sinking, inventories of unsold homes are increasing, especially in areas of the country that led the recent housing boom, federal regulators are pushing for stricter lending standards and houses are greatly overvalued.
In a newsletter entitled Spendthrift Nation, Kevin Lansing argues that American households apparently view the rapid increases in residential property wealth in recent years as "a substitute for the quaint practice of putting aside money each month from their paychecks." Americans owe $7 trillion on their homes - twice as much as ten years ago. But their incomes - their ability to pay - have gone up by a fraction of that amount. It's painfully clear a lot of that $7 trillion will never be paid back.
Over the last several months many people have expressed their gratitude to me for having their feelings validated by hearing details during my guest appearances on the Gary Null Show of what they suspected was really happening. I do not pull any punches. I realize that what you are reading here is sometimes difficult to find in the mainstream press or other media. I have concentrated on writing about real estate because that is where most people are most heavily invested. In my weekly, hour-long show on the Gary Null Network starting on Friday, May 5th at 4 p.m. ET I will broaden the scope of analysis to include other aspects of our fragile economy. Times will become unbearably difficult. I will attempt to guide you through them and offer what assistance I can.
To prepare, I would suggest taking the following steps as soon as possible to minimize the effects of a severe downturn.
Pay off all credit-card debt. Liquidate all debt except your mortgage. Only buy vehicles that you can afford to pay for with cash. Put as much money as you can into your annual tax-free retirement savings, whether in the form of an IRA or, preferably, using your company's 401k allowance, taking advantage of any matching corporate payments. Start saving money for college when your kids are born. Put at least 20 percent down when you buy your home, using a low-interest, 30-year mortgage. Try to make an extra mortgage payment every year. Reduce your standard of living now to a manageable level based on your income, while you have the economic freedom to choose how you wish to do this, rather than having change imposed on you later by force of circumstances.
Senior Vice President
Global Securities Group
701 Brickell Ave.
Miami, Florida 33131