Housing Boom: Waiving the Warning Flags Housing Boom: Waiving the Warning Flags
by Puru Saxena
The Daily Reckoning
Thursday, August 24, 2006 --------------------- - The housing market is flooded with inventory, and sellers are getting soaked…money isn't everything, but you shouldn't ignore it…
- Americans are going down with the ship, and drowning in debt…a whole nation of bubble-believers…
- Overconsumption, overconfidence, statistical manipulation…and more!
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"Strapped homeowners feel the pain," observes a Wall Street Journal headline. The pain these homeowners feel is, of course, the pain they richly deserve. They took out mortgages with low teaser rates…and now their rates are being adjusted upwards. And they are being squeezed. The article tells of one couple whose mortgage jumped from a 2.35% rate to 8.75%, two years later. They had something called an "Option ARM," which gave them a selection of alternatives. But now they find they have no alternative at all - they cannot afford their own home and must sell the thing. They and every one else, apparently. The market is flooded with inventory. Sellers are getting soaked. The homeowners mentioned in the article put their house on the market for $400,000. With no bids coming, they've cut the price down to $270,000. They have no choice; they can't afford to keep the house. And there are plenty more facing the same dilemma. Delinquency rates are rising, led by delinquencies on ARMs that are three times the rate of regular, fixed-rate mortgages. Our heart is not breaking. But we are nevertheless appalled by the shabby way the poor chumps are treated. They are regarded not only as fools who blundered and deserve to be separated from their money (they didn't have any anyway), but now they are also losing their homes. When we left you yesterday to go gallivanting around France - on business, alas - we were expostulating on the idiocy of the professors of "Behavioral Finance." They think they are being investment "descriptivists," who merely tell us what people actually do. But they can't seem to resist being "prescriptivists" - telling people what they should be doing if they want to maximize their investment returns. And, when the investor doesn't do as they say he should, he is accused of making "mistakes." Yes, of course, the average investor does things that seem stupid to the analyst. But the deeper mistake is the one made by the analysts themselves. They misjudge their subject. He is not a rational profit maximizer at all; he is merely a man. If he chooses a stock because he likes the sound of the name or because his neighbor told him it will go up…so what? It might go up. And so what if it goes down? He might have taken the money and bought something - but what? Why is buying a new car, a big-screen TV, or even a few dozen pills better than buying a stock? They are all consumer junk, one way or other. All of them break down, go down, wear down and eventually disappear as completely as any dotcom. On the other hand, buying a tech stock, for example, the lump at least has the pleasure of momentarily strutting around like a cross between Livermore and Lynch. Who knows, the darn thing may go even further up…and make him feel like the one of the gods themselves. And if it goes down, at least he has learned something valuable. Something that is worth more than staring at a TV screen or smogging up the ozone in a fancy car, we think. The big error made by the Behavioral Finance professors, economists, investors, and consumers themselves - is that they overrate the value of money. They think money is everything. But just a few days ago, we had a taste of its limitations. "I was shocked," Elizabeth announced upon returning from a trip to visit friends. "They spent all that money and the place is just not very attractive. The stables are well built, but they are just badly designed. And the house is nothing to get excited about. They are too close to the highway, and they have a view of the power lines. I know they invested millions in the place. And I know why they bought that place rather than something else. They thought it was a better buy; it was cheaper. Now I know why. It's not very nice. And it's not very nice for reasons that they can't do anything about." Money is not everything. In their hearts and souls, people know it…and they devise financial strategies that take it into account, often "wasting" money or failing to maximize revenue. And, they probably make as many blunders by focusing too much on money as they do by ignoring it. And yet, economists build their theories around a man who only cares about money. Thank god, he does not exist. The poor sap who does makes plenty of "mistakes," of course, buys houses tangled in power lines, and takes out an ARM to save money. But the Adjustable Rate Mortgage is more than a "mistake." And the poor man who got one - without fully understanding what he was getting himself into - is more than just a fool. Now, everyone knows that the housing market is coming down. And everyone knows that all those chumps with ARMs are paying through the nose and getting it in the neck. Investors have convinced themselves that the great property boom is floating down to a soft landing. They look at England and Australia, for example, and say, "Look, both had residential real estate booms bigger than in the United States. Both have seen prices come down. But neither has had any real problems as a result." But in England, the day of reckoning for property prices is yet to arrive, for prices have been propped up by huge waves of foreign money pouring into London. And in Australia, the economy was only saved by the boom in commodities. What will save the U.S. economy? What will save all the marginal investors, homeowners, and consumers who have chained themselves to the ship of rising property prices? We have a guess: America will not be so lucky. Our property market will come down in the biggest, hardest landing ever. Homeowners and consumers have so much debt, that when the ship goes down, they will drown in it. But whom should we blame? Are the luckless home owners willing victims of their own "mistakes?" Or of what? More to come…much more, tomorrow. More commentary over at the Desidooru Saloon… -------------- Justice Litle has the latest post: "It's as if some marketing genius said, 'Hmm, what percentage of Forbes' readership is career-oriented women…and how could we get them to cancel all at once…'" Forbes on Crack? -------------- More thoughts from Bill and Addison … *** Bill in Ouzilly: Yesterday, we rushed from one difficult meeting to another. What kind of vacation is this, we wondered? The only sign we were holidaying was that we were not wearing a tie. Vacations are trying for us, dear reader, because we don't like to leave you. Usually, we try to work and vacation at the same time, which means we try to do twice as much as we do during the regular workweek. Will you forgive us is we take the rest of the day off? *** Over to Addison: In the United States, we have witnessed - through statistical manipulation and public cheerleading - a symptomatic effort to create "euphoria." Not just well being, but euphoria. Why? So that asset values will rise. Not through savings, investment and hard work, but by magic. This kind of talk has been unique to America in the history of economic bubbles. "Every major crisis has its origins in excessive overconfidence." Greenspan was the worst of them. He has influenced a whole generation of believers. What they see is the short-term benefits of the "asset driven" economy. Indeed, the short-term effects have been wonderful. But the long-term results will prove disastrous. In Europe, we begin with a low opinion of public officials. We expect them to be competent, but we harbor no suspicion that something good will come from them. In the United States, you write and read best-selling books lauding them as heroes. "Maestro!" What is this? He was the worst of them all. Not only did he encourage and abet overconfidence in the markets - and in the American economic miracle - he has done his best to prolong it as long as possible. Now, Ben Bernanke has inherited the strategy. Even in the United States, economists used to be concerned with the economy as a whole, the wealth of the nation, to paraphrase Adam Smith. But no longer…now the economists are in bondage to Wall Street. There is no serious discussion of "economics" or "macroeconomics" - only the effect of key statistics on the Fed's interest rate policy. And what that policy is likely to do to "the market." *** At some point, Alan Greenspan was persuaded he could mitigate any damage caused by a collapsing bubble, because of the effectiveness of monetary policy. The monetarists, starting with Milton Friedman, never look at credit expansion - or where the money comes from. They look at price indexes only. They only want to know the effects of monetary policy on the financial markets, which today include housing. The classical economists, on the other hand, recognize that the excessive credit expansion has many impacts on the financial markets and the real economy. Asset prices, including houses, inflate. Savings rate disappears Trade Balance goes negative Capital Investment dries up Wages and employment drop
Ben Bernanke has already "improved" on the strategy. As he stated, he believes it's America's duty to consume the world's savings because of the U.S. role as the "economic engine" of the world. "Who will take over if the U.S. falters?" they ask. "That's a stupid question," asserts Dr. Richebächer. National economies should not spend more than they produce…the savings rate and the rate of credit expansion should be roughly equal. There has always been globalization, but with a different concept. Every country must grow at a healthy rate, on its own. It is only through excessive confidence that Americans can justify their high levels of consumption…and then turn around and claim it as their "duty." Read more from Dr. Richbächer here: The Five Safest Investments of the Year --- Advertisement ---
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