Most interesting posts of the week: #2

Okay, the other most interesting post of the week comes from Billmon: "Home is Where the Sink Hole Is." He's right--he hadn't written anything about the housing bubble in a while, and I'm glad he did.

Kevin Drum has a post that reminds me I haven't written anything about the housing bubble recently:

Here in paradise, the housing boom is over:

Southern California home sales fell to their lowest level in nine years last month as price appreciation continued to decelerate, data released Tuesday showed . . . .The figures could rev up the debate over whether the Southland's housing market will be able to navigate a "soft landing" that produces only moderate price declines, or face a brutal correction.

As Kevin notes, talk of a "soft landing" is one of the normal steps in a bubble addict's recovery program.

It goes something like this:

1.) We're not in a bubble. Prices are just recovering from years of underappreciation.

2.) It's a bubble, but it's a sustainable bubble because the fundamentals of the market have changed in the past decade. People need to recognize this. (Note: this stage is usually recognizable by an explosion in popularity of increasingly desperate and bizarre financing options.)

3.) Yes, growth is slowing, but we think we'll navigate a soft landing. It's absurd to think that housing in [fill in area where you live] will actually lose value.

4.) This is a disaster! Somebody better step in and do something! People are losing their life savings!

5.) Buyers have learned a permanent lesson this time. Homeowners need to accept the reality that the bubble of the past five years was a one-time fluke and we'll never see it happen again.

Rise and (eventually) repeat.

I think I might actually go out and get the Kindleberger book to which Billmon links here (Manias, Panics, and Crashes). It's always fascinated me--in a morbid sort of way--how the same cycle (Displacement -> Credit Expansion -> Euphoria -> Distress -> Revulsion) can repeat itself every time. How do so-called experts always manage to go "This time it's different! This time there won't be a crash!" every time? I guess it's a scary prospect to tell millions of excited Americans that they should probably pull back on the reins a bit because this is a cycle and not the dawn of a new time, but for their own sakes, it's still a good idea to do so. Billmon goes on.

In the stock market, the revulsion stage typically ends in massive panic-driven price declines, as everybody and their broker tries to crowd through the same small door. However, because real estate markets are less liquid and have higher transaction costs, and since houses are a consumption item as well as an asset, what traditionally happens when the bubble bursts is that sales just dry up. Nobody wants to buy at quoted prices (usually based on previous, overinflated appraisals) but sellers aren't willing -- and often aren't able -- to sell for less. So the market can't clear, as Southern California markets aren't clearing now.

This tends to make housing busts the economic equivalent of Chinese water torture: they generally begin slowly but last a long time, as home "owners" gradually capitulate to reality and lenders (or in the S&L industry's case, the federal government) slowly write off all that bad debt and dispose of all those foreclosed homes.

That's one reason why the collapse in real estate values that accompanied the Great Depression didn't bottom out until the late 1940s. It's also why it took almost ten years for the last home price boom/bust cycle in California to come around again. According to the Office of Federal Housing Enterprise Oversight, the reg agency that tracks these things, home prices in the greater Los Angeles metro area didn't return to their 1990 peak until the spring of 2000.

But what makes things different -- and potentially more exciting -- this time around are the gaudy new financing gimmicks Kevin mentions: no money down loans, interest-only mortgages, ARMs that reset to truly usurious rates, etc. If and when these loans blow up, and they will, it could leave many home "owners" with no alternative but to sell and sell quickly -- or simply mail the keys back to the bank.

Combine that with the fact that this housing bubble, far more than past bubbles, appears to have been driven by the speculative investment demand of people who have no intention of living in the houses they've bought, and the finale could be much more spectacular, and play out a lot faster, at least in some markets.

And later...

But whether the bust is national, as opposed to just regional, may depend as much or more on our Chinese benefactors as on the Fed.

The chain of causation is somewhat perverse: The Fed's recent decision to at least pause in its tightening campaign has put downward pressure on the dollar, which is forcing the People's Bank to buy dollars to protect the "crawling peg" with the renminbi, said dollars then being reinvested in the Treasury market, which drives long-term yields down, which pulls mortage yields down, too.

As long as that particular windfall lasts, the prospects for a soft landing to the national real estate bubble look reasonably good -- that is, as long as the regional real estate busts, plus the overextended state of the American consumer and the mysterious reluctance of U.S. firms to funnel their bloated profits into capital spending, don't tip the national economy over into a recession.

You'd need a Cray supercomputer hooked up to a crystal ball to figure out the odds on that latter scenario, and I have neither. What I do have is a conventional 30-year mortgage at 6.12%, and a house with lots of equity located in one of the country's more stable real estate markets. So I'm personally not sweating the housing bubble too much. Yet.

From the mid-Missouri basement of my in-laws' house, I can say that I'm really not sweating the housing bubble much yet either. It's easy to not sweat anything when you don't pay rent, much less a mortgage. But this won't always be the case. And thanks to one of The Butterfly's two lifelong dreams--house flipping (the other is becoming an HR Director, and she recently got to check that one off the list)--this has been the source of many discussions. It doesn't appear that the mid-Missouri market is teetering on the edge of a cliff so much as starting to roll down the backside of a mountain very very slowly.

For the last few years in Columbia, houses have been built in pretty much every spot possible, and a lot of them are sitting empty (On the plus side, we've made friends with two different families of deer, one--a mama and her baby--come by every morning when I'm getting ready for work, and the other--a mama and her two babies--come by every evening. Of course, our grass is orange and crunchy at this point, which is what happens when you don't get rain for a month, and they haven't come by as often because of it. That, or they got hit by a car. But I digress. Big time.). If prices have come down, it's not all that noticeable yet--the market's still about twice as high as it was when the in-laws bought their house--but it's coming and everybody knows it. I don't expect the midwest to get hit like the coasts surely will, but the cycle is inevitable.

Anyway, interesting topic...one that's guaranteed to get more and more interesting as time goes by.