Unsinkable Real Estate Market Hits Icy Certainty

In response to the New York Times article: Drop Foreseen in the Median Price of US Homes


In 2002 I wrote an article concerning the US real estate market, interest rates and Allan Greenspan then the Chairman of the Federal Reserve. It was evident then that low interest rates were fueling an upswing in real estate values and the trend was not only in the US but around the world in developed countries. The gist of the article was that if the real estate market continued a bubble would develop and the backside consequences would be much more damaging than any rapid declines in stock values. The ugly backside of the real estate bubble is now on the US economy in full swing. The ramifications of which are still to be determined.

Allan Greenspan repeatedly tried to quietly "talk some sense in the market" this is a typical measured response from someone in his position trying to guide a ship away from an iceberg. He knew all too well that the current trends in the housing market could not continue unabated and that excess speculation would come with a hefty price tag. Still he kept rates low. No doubt with undue pressure exerted on him by the Bush administration. Greenspan knew that the housing market was keeping the economy afloat and the strategy was to use real estate wealth to pump life into the corporate cycle. It worked probably to well and Greenspan snapped up his walking papers as the economic ship sped dead on into icy waters. Corporate profits rebounded this is no surprise since US corporations are the thoroughbreds of profiteering. The problem was that by the time the general economy began to rebound the real estate bubble had passed the all important fantasy speculation threshold.

Bubbles or excess speculation are actually quite common in capitalistic societies such as ours if left unchecked. In fact Greenspan tried to talk the stock market down off its lofty perch in the late 1990's and the market only moved higher, much higher. In fact the bubble in the housing market correlates quite nicely with the burst of the stock market in 2000 -2001. As wealth was created in the late 90's via the stock market the smart money began to move into real estate. Why? Equity prices got too high and as risk increased an outlet for those funds had to be found. Those funds moved into real estate because interest rates were so low, equities were lower and going lower and it was the only place to find a decent return. Soon that early money fueled a stampede and real estate values soared.

However, unlike the equities market where there is a surplus amount of due diligence and transparency the real estate market moves behind smoke and mirrors. Speculators were buying houses unseen in Wyoming and Idaho expecting significant returns. Real home buyers got squeezed into the bidding process with speculators and prices rocketed. This bubble fed off itself as a home bought a year ago could now be flipped for significant gains. Those gains were then multiplied by flipping it into new speculation. The lending market became competitive and efficient at lending mortgage money on "sure" bets. This is because there was a thriving equities market for portfolios packed with mortgage loans with comparatively fat interest returns.

As the trend continued and real estate values continued to climb the inevitable burst was destined to be just as dramatic as its speculative rise. As housing prices peaked and the easy money in the mortgage business began to fade some lenders found shill bidders with shaky financials to keep the ship at full steam. They were making too much money and too many people were drinking the "this is not a bubble" Kool-aid. As foreclosures began to rise smart money began to pull away from the lucrative mortgage backed portfolios.

This began quietly and then stories turned to rumors and those in the know tried to soften the blow. However, this only fueled the behind the door strategic scrambling for the exits. Soon without liquidity lenders found themselves in an accounting bind that not even the best bean counters could cook. At first I am sure that the honey mooning management did not listen to the warnings. The smart companies pocketed significant profits and then went out of business with someone else holding the hot mortgage backed potatoes.

It is likely that we are only seeing the top of the iceberg right now in terms of fall out from rampant speculation in the real estate market and industry. In the equities markets you have a certain amount of equity or margin upfront providing the means of speculation and trouble positions can be liquidated rapidly. This usually means a rapid decline in stock prices to depressed levels below their actual valuation. The real estate market takes weeks and years to unravel and there is no fast way to dump troubled properties. The dominoes are beginning to rapidly fall for years to come and the current troubles for the mortgage market are just beginning. No one is going to be touching speculative portfolios tied to real estate and liquidity is drying up. But that growing problem can quickly turn into catastrophe because more and more capital is required over time.

New home buyers will be squeezed in the middle. Unable to sell and in significant upside down equity in their homes they will be forced to try and hold on. Many will not and as the trend continues many may just throw in the towel, foreclose, go bankrupt and start over. This does not bode well for the overall economy. At least corporate profits are moving forward and the US economy will rebound. However, the real estate market is going to be in shambles for many years to come. If the theory holds and the backside of the speculation is just as fervent and lasting as the upside then throw in your life boat now. As the ship sinks you might as well survive as opposed to trying to tread in icy waters. The real estate market is no longer on the "top of the world."