Over the next week, I would like to write up three essays:
1) Putting the Real Estate Debacle in Perspective
2) Citicorp, A Corporate Rogue and
3) Did Stan O’Neal Rape Mother Merrill?
The prospect of a double-digit decline in housing prices has the potential for a decline in real wealth of $2-$4 trillion dollars. To put this number in perspective, the dot.com debacle of 2000-2001, led to a decline in equity values of $7 trillion dollars. However, since close to 69% of all Americans home homes, the expected home price decline impacts a far broader group than the dot.com debacle. Alternatively, $3 Trillion dollars represents about $10,000 for every person in the United States.
Over the past 12 months, the value of housing in the Unites States declined about $750 Billion dollars, or $2,500 per person. Since the average American had a negative savings rate in 2006, the first time that has occurred since the Great Depression, any decline in net worth is a Major NO NO!
Moreover, from Warren Buffet to Alan Greenspan, bright people have predicted a housing bubble.
What is the value of the average American bank account and 401 K?
The average American has a bank balance of $2,800 and an average 401K savings of $65,000.
What is the greatest source of saving for the Average American?
The average American has about $60,000 equity in his home. That is, the value of his home less the mortgage is about $60,000. If housing prices drop, $20,000 this would reduce his savings aside from 401K by 33%, a significant sum.
How did I guestimate this number?
The average price of a home in the United States was $220,000 in 2006. After the price decline of 4% experienced in the past 12 months, the average price of a home is about $210,000. Thus, in the aggregate a $10,000 price decline led to a decline of some $750 Billion dollars. That is, there are roughly 75 million homes, including apartments in the United States.
How do economists estimate a $2 trillion dollar to $4 trillion-dollar potential decline in housing value? In a nutshell, a decline of another $15,000 in housing prices would lead to a $1.25 trillion dollar loss, bringing the total loss to $2 Trillion from the top.
Should we be concerned that housing prices could fall substantially?
The short answer is yes! First of all, the Joint Economic Committee of Congress now predicts two million foreclosures over the next year on homes purchased with subprime mortgages. This number is four times the prediction made by this same group in September. Alan Greenspan, who inherited double talk from the Delphic Oracles, predicted that we could expect a double-digit decline in housing prices. In 2005, Greenspan said that the perceived low risk of housing as an investment vehicle was delusional. Instead, “history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.”
Secondly, close to two million subprime mortgages are expected to bear significantly higher interest rates over the next eighteen months when their “low” teaser rates roll off.
Thirdly, added interest costs will drive up the percentage of disposable income that subprime borrowers pay to over 50% from the current 40%.
How big is the subprime mortgage market?
About $1 Trillion out of the $10 Trillion in mortgages are subprime. However, from 2004-2006, subprime mortgages were about 40% of all mortgages created. There is a direct correlation between the increased ownership of homes from the mid 1990’s and the percentage of subprime borrowers. Home ownership surged from 64% in 1994 to 69% in 2004.
What led to the Big Run Up in housing Prices?
First of all, many Americans believed falsely that housing was an “investment” and not consumption. While it is true that housing prices since the Great Depression have risen with the inflation rate, housing, particularly when homeowners added either to the square footage of their abodes or put a lot of fancy “bells and whistles” on their establishments became just as much a consumption item as owning a Mercedes Benz rather than a second-hand car for transportation.
Secondly, many Americans parlayed single home ownership into speculative splurges. In Sarasota, I met more people that owned two homes, than owned just one home, particularly given that many of these people were ‘snow birds” living in Sarasota just in the winter. On top of that, many Sarasota residents parlayed their financial windfalls from earlier investments into owning much more expensive places or owning two to three Sarasota residences in order to “flip” them. It has been estimated that as much as 25% of homes in California, Arizona, and Florida were owned by speculators.
Thirdly, the absurdly low interest rates promoted after 2001 when Greenspan lowered the Federal Funds rate to 1% and kept rates at this low lever for over one year, led to a substantial decline in long term mortgage rates. It is estimated that a 1% reduction in mortgage rates raises housing prices by 10%. Thus, “easy money” can exaggerate the “bust-boom” cycle.
Is There Light at the End of the Tunnel?
Critics would argue that the only light currently showing is from an on-rushing train!
The real answer is that with the weakness in the dollar, we should see more real estate purchasers from foreigners in cities like Houston, New York City, Boston, Washington DC, Los Angeles, Miami, etc. For those of us who live in Mr. Bush’s dwindling Red State area, I would not count on a lot of “legal” foreigners purchasing.
Secondly, with population in the United States, expected to grow from 300 million to 400 million over the next 40 years, demand will rebound.
Thirdly, much of the American economy has remained resilient. Thus, as low as unemployment does not rise significantly above 4%, and Americans maintain their love affair with homes, house prices should stabilize and then rise in a time period of about eighteen months.
Originally published in the Sarasota Herald-Tribune
