Raise the Hammer
Boom growth is growth in capital accumulation, that is selling things for profit, and investing some of the profit to make more things faster and better.
When the market for actual things is saturated and the boom runs out of steam, it is sometimes possible to replace it with a secondary incentive. Instead of investing in productive activities, the public is persuaded to speculate on the continued appreciation of some investment or other in and of itself.
People become convinced that they can get something for nothing. At this point, the boom becomes a bubble.
Through the end of the 1990s, U.S. Federal Reserve Chairman Alan Greenspan dropped the prime interest rate steadily and repeatedly until it was effectively zero percent. Suddenly, it was very easy and cheap to obtain a mortgage for a house - often easier and cheaper than a rental agreement.
People took advantage of ultra-low mortgage rates in droves, pushing the suburban envelope further and further out to accommodate big, cheap houses. The government and banks helped with federally chartered mortgage investment companies (Freddie Mac and Fannie Mae), no-down-payment mortgages, and handy tax breaks for mortgage payments.
Inevitably, house prices climbed as more people bought into the housing market. New owners saw their home equity increase, and yet more investors were attracted. Speculators started buying houses only to flip them six months later.
New financial mechanisms allowed homeowners to get their hands on some of that newfound home equity and skim value off their houses. Homeowners re-financed their mortgages under low variable rates. This often allowed people to "buy up" to a larger house than they could otherwise afford.
When rates could fall no lower, home equity lines of credit (HOLECs) let homeowners use their appreciating homes like giant ATMs to buy second and third cars, new furniture and appliances, home theatre systems, faster computers, power tools, etc. People grew accustomed quickly to ever-increasing consumption even as median personal incomes stagnated.
The home ownership bubble is a classic positive feedback loop: output (rising home value and more disposable income) feeds and accelerates more input (buyers eager to cash in and get their share). People who wouldn't have dreamed of buying a house for $180,000 five years ago are suddenly eager to snap one up for $300,000.
Positive feedback loops are ultimately unstable, and the housing bubble is no exception. However, the opportunity to make money from nothing seems periodically to affect people like blood in the nostrils of a great white shark.
Those who haven't gotten into the game yet are desperate to do so. That desperation, combined with the tremendous greed of those already invested in the market, has transformed the bubble into a mania. A mania is always the last spasmodic gasp before a crash. The longer the mania runs, the bigger the crash and the more real wealth it drags down with it.
Mr. Greenspan has tweaked the American economy for years, forestalling disaster only temporarily. The last people to buy, like the people who bought Nortel at $120 per share, are the suckers. They'll be hit hardest when the value of their investment collapses back to what it's really worth.
When will the crash happen? It's almost impossible to predict an exact date, but I wouldn't advise buying a house right now. Even setting the manic nature of the current housing market aside, too many factors are about to turn sour:
Oil prices are historically high, and all signs point to even higher prices and more volatility over the next few years. Expensive oil is inflationary; it raises the price of everything else. Living in far-flung suburbs will become much more difficult as the price to drive everywhere goes up.
Banks don't like inflation, because it means loans are repaid in 'soft' currency; expect interest rates to go up to compensate. Higher interest rates will be devastating to homeowners on variable rate mortgages who can barely afford payments to begin with.
As money is diverted to pay for the increased cost of energy, less money is available for investment, and the economy slumps. Sales drop, companies lay off workers, and people find themselves unable to make their suddenly-higher mortgage payments. Just as the well of buyers dries up, houses start dropping onto the market as owners bail or go bankrupt. Across North America, several trillion dollars may be at stake.
The United States, Canada's biggest trading partner, is in an extremely bad way. It imports $650 billion (US) more than it exports. So far, other countries have continued to buy those extra greenbacks because they need U.S. currency to buy oil from OPEC. However, no one's happy about it, and the dollar has been losing value against other currencies for years.
The U.S. government is also running huge program deficits, between tax cuts for the rich and the ongoing expense of the Iraq occupation. If a recession occurs, don't expect the government to spend its way out.
For countries that export to the U.S., like Canada, this is very bad news indeed. For the past fifteen years, Canada has been dumping nearly all of its foreign trade eggs into one flimsy basket. When the U.S. economy flames out, it will drag us - and our house prices - with it.
The next few years are going to be a bad time for the suburbs.
By Trey (registered) | Posted May 18, 2005 at 07:09:30
Kunstler says "The dirty secret of the American economy for the last two decades is that it is all about the creation of suburban sprawl and accessorizing, furnishing and servicing it."
Ssssshh, listen closely you can hear The Meadowlands snap, crackling and _________!
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