Disaster Lurking in Your Own Home
Is it just me or does anyone else believe the housing bubble is going to burst in supernova of Technicolor fiasco? It seems as though recent business cycles, like recent natural disasters, are getting increasingly severe and leaving ever more human casualties in their wake. U.S. Homeowners, like the Tsunami victims in Southeast Asia and the Katrina victims in the Southeast U.S., are increasingly unprepared for these major financial corrections.
In many housing markets the price of homes by any measure is unprecedented. Which, in my mind is pretty much the definition of a bubble. Here’s one good example. Currently, in California an average of only 18% of the population can afford a median-priced home. Yes, you read that correctly, 18%. Being that “median” is a type of average, it would logically follow that rational economics would be closer to 50% of the population of any area should be able to afford the “average” home. Granted California is a pricey housing market but it is one of many in the U.S.
There is a solid economic reason for why I and many other experts believe the housing market will decline substantially. If you look at long run historic returns for housing, stocks, currency, art or any other asset you find two things that never change: cyclicality and long-term equilibrium. These are economic laws that act similar to physical laws. In the long run you cannot escape these laws. The long run average yearly increase in home values is somewhere around 4-8%. Some years, home prices fall, most years they go up. In the past five years however, they have increased 50% nationwide (much more in markets like Boston, New York and San Fran). As absolute as the law of gravity, housing prices will eventually regress to their long run average of around 4-8%. Since this will require a reversal of unprecedented recent price increases to be achieved, we are in for one butt ugly real estate bubble explosion.
Why is this disconcerting? Well, as you’ve no doubt heard many times, individual net worth has become increasingly tied to home values. American consumers are maxed out on credit and it is all tied to the equity they have (or don’t have) in their homes. Now some of you may be thinking “but home prices won’t plummet like the stock market and we survived that bubble.” But you are underestimating the debt that people use to buy homes. They don’t usually borrow as much to buy stocks. Leverage increases risk exponentially.
"If your home went down by 30 percent, you'd probably be sitting with a bankruptcy attorney," said Jonathan Golub, United States equity strategist at J. P. Morgan Asset Management in New York. "If your I.B.M. stock goes down by 30 percent, no big deal. So you had $100,000, now you have $70,000. You don't declare bankruptcy; you just don't go out to the movies as much, or you retire a year later."
If home prices plummet, many American’s will become insolvent. The ones that don’t will cut back on consumption dramatically. This will ripple through the economy creating a spiral of business failure, job loss and possible recession. When combined with the unprecedented price of gasoline and heating oil, things are looking extremely worrisome
The bottom line is this; American’s are woefully unprepared for natural disasters and terrorist attacks. But there is an approaching disaster of our own making that is even more likely to derail American lives - and it’s in your own home.
In many housing markets the price of homes by any measure is unprecedented. Which, in my mind is pretty much the definition of a bubble. Here’s one good example. Currently, in California an average of only 18% of the population can afford a median-priced home. Yes, you read that correctly, 18%. Being that “median” is a type of average, it would logically follow that rational economics would be closer to 50% of the population of any area should be able to afford the “average” home. Granted California is a pricey housing market but it is one of many in the U.S.
There is a solid economic reason for why I and many other experts believe the housing market will decline substantially. If you look at long run historic returns for housing, stocks, currency, art or any other asset you find two things that never change: cyclicality and long-term equilibrium. These are economic laws that act similar to physical laws. In the long run you cannot escape these laws. The long run average yearly increase in home values is somewhere around 4-8%. Some years, home prices fall, most years they go up. In the past five years however, they have increased 50% nationwide (much more in markets like Boston, New York and San Fran). As absolute as the law of gravity, housing prices will eventually regress to their long run average of around 4-8%. Since this will require a reversal of unprecedented recent price increases to be achieved, we are in for one butt ugly real estate bubble explosion.
Why is this disconcerting? Well, as you’ve no doubt heard many times, individual net worth has become increasingly tied to home values. American consumers are maxed out on credit and it is all tied to the equity they have (or don’t have) in their homes. Now some of you may be thinking “but home prices won’t plummet like the stock market and we survived that bubble.” But you are underestimating the debt that people use to buy homes. They don’t usually borrow as much to buy stocks. Leverage increases risk exponentially.
"If your home went down by 30 percent, you'd probably be sitting with a bankruptcy attorney," said Jonathan Golub, United States equity strategist at J. P. Morgan Asset Management in New York. "If your I.B.M. stock goes down by 30 percent, no big deal. So you had $100,000, now you have $70,000. You don't declare bankruptcy; you just don't go out to the movies as much, or you retire a year later."
If home prices plummet, many American’s will become insolvent. The ones that don’t will cut back on consumption dramatically. This will ripple through the economy creating a spiral of business failure, job loss and possible recession. When combined with the unprecedented price of gasoline and heating oil, things are looking extremely worrisome
The bottom line is this; American’s are woefully unprepared for natural disasters and terrorist attacks. But there is an approaching disaster of our own making that is even more likely to derail American lives - and it’s in your own home.
posted by Anonymous at 2:24 PM
2 Comments:
I don't see the bubble as a problem except for two scenarios. 1) If your local government taxes your house based on current "fair market value", your taxes could rise to a point where you are unable to afford...conversely if the bubble does break, your taxes would return to earth. 2) If you have purchased "high" and must sell "low", then obviously you have a problem...it would be kind of like having sold stock "short" but the market continued to rise. If neither of these factors affect you, just set on your house (live in it) until some future date when it becomes profitable to sell. If you were speculating on real estate, you loose if you fail to sell on the expanding bubble.
I sold and moved from an extreme bubble area about a year and a half ago...moved to Florida in a non-bubble area and made out like a bandit. I continue to hope that lots of my fellow retirees choose to make the move to Florida increasing the demand for real estate and providing me the option of selling my house on another high...or if I and my wife are not around, our children can do so.
All told, the bubble has been good to me. Unfortunately, for others, many have not shared the same good fortune.
TheRef
I see what your saying and you have obviously done well and probably avoided some traps. That is great for you. But many others haven't. I hope I'm wrong but I do know something about economics and business cycles and if this bubble ended well it would absolutely be the first time. I don't think most people will sit on their homes (or have the luxury to like you do.) when home prices at this level start to fall, panics sets in and everyone sells, fueling an escalating selloff. Especially, since almost 1/3 of homebuying is now "flipping" or investment. The flippers will sell and cut losses, the landlords will sell or get foreclosed because rents will also drop and those owners won't get the rent they need to cover their mortgages. We now have a glut of home supply and with gas prices inflation and the deficit, mortgage rates are set to soar. I mean, this may be an extreme example but who is going to keep paying on a $500,000 mortgage for a house that is now valued at $250,000. You might think you would sit on it, but believe me most people won't. My point is even more extreme though - Everyone's debt is now home equity loans. As home prices collapse, equity value also collapses and those are no longer good loans. Banks will start calling them and that is why I'm talking about foreclosures and bankruptcies like we've never seen before. I don't know, I hope I'm wrong but I don't think I am. It may take another year maybe even 2 or 3 but I think it will get ugly sooner than that.
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