The real losers when the housing bubble bursts
Posted by Frugal on September 8th, 2006
Let’s not argue about whether there is a housing bubble or not, or whether the housing bubble will burst or barely deflates. This post assumes a hypothetical scenario that is yet to happen (if at all).
So who do you think will be the losers? If the housing bubble does not burst, the losers are the renters obviously. If the housing bubble bursts, the real estate investors will suffer first, and then the homeowners who bought very recently, and then the other homeowners. But for those people who put down 0%, 2%, 5%, or 10% of their own money, they will probably try their best to walk away from a house when the deal is no longer profitable. Despite that due to deficiency judgment (click to see my post), they will be still liable for any losses besides the purchase loan (most likely 80% of the purchase price), you just cannot extract money from a dead beat who may or may not declare bankruptcy. The lenders may have their plans & risks calculated, but without any real assets to recover their loans from, a dead beat dried of money simply cannot magically pay back lenders any money. The “Assets”-back loans such as home equity loans are only good as long as the homes or the assets in this case are still valued at a lofty high price. Once the housing market moves south, these asset-back loans are more like credit card loans, backed by nothing, except lengthy legal recourses.
So not only the real estate investors are the dreamers here, who think putting 5% down means only liable for 5%, but also the lenders who think all the loans are “backed by assets”, and legal recourses if needed. When there is no money to be found, there is no money. It will simply be personal credits soured, debts written off, deflation of housing prices, and mortgage interest rate risen for everybody.
When the bank loses money, who do you think will be the real losers? It’s us, everyone of us, especially the ones who did not get benefited from the housing bubble. Banks are not charities. If they lose money, they will simply do what they do best, jack up the loan interests, and lower the bank deposit interests. So if you interact with banks (of course, you do), you will be looking at forking out more to patch up the banks’ bottom line, because all these would-be-millionaire real estate investors abandon and walk away from houses. Furthermore, the central bank lead by Bernanke, will print more money like crazy to counter the deflationary force by monetary inflation. When the general inflation picks up, everyone loses.
“Putting 0% down! Head I win, tail you lose! It’s OPM, Other People’s Money (who cares)!” When the banks in our nation reach such a low point in lending standard, as to encourage mass speculation and such moral hazard, there can never be anything good comes out of it. Throughout this crazy housing bubble or boom (whatever you want to call it), I have not partaken in any of the speculation. You can call me stupid, or but I just won’t walk away from a home under any circumstances, period! To the best of my ability, I will repay everything for any loans that I take out. My moral standard does not allow me to even consider such possibility even when it is legally allowed. To me, there was never “head I win, tail you lose.”
I couldn’t believe what Greenspan said in one of his speech: “price stability fosters economic growth” (sorry, I am certain that he said that in his speech, but I can’t google it out). This is THE MAN who single-handedly created moral hazards one after another by bailing out big financial fiasco, and have created the two biggest bubbles, NASDAQ in 2000, and housing market bubble since 2002. Greenspan, do you really understand what you said? I can’t agree more, except that Greenspan’s actions are probably the opposites. Without a price stability, speculation is heightened or encouraged. With speculation, there are big UP and big DOWN, both ramps hurting the psyche of the society. The society is filled with speculative thoughts, and speculative tradings that produce no real economic values. The good old moral values, to work and save diligently, are completely eroded by mass speculation. What good does it do for you to work and save diligently, when all of your neighbors who participated in the real estate frenzy or NASDAQ bubble, were getting paid big and easy money.
With the US saving rate staying in negative zone (when the asset returns fully cover any short fall), our society has turned into an asset-based society. Unfortunately, the real value of the asset is not how much money it is valued at, but rather how much utility and function it can bring about. Those later values are the true purpose for the assets, while how much money the asset is changes from day to day, or from month to month. Our asset-based society has truly lost its focus.
Truly the entire society loses, when the bubble began, not when the bubble bursted. A society in speculation is a society with time and resources mis-allocated for the wrong purpose. The job of the central bankers should be to minimize the magnitude of unavoidable speculation in capitalism. Instead, Greenspan has chosen to do patch work, encouraging moral hazards, and making every subsequent wave of speculation even bigger.
Truly the real losers are everyone of us. Our values on assets and money get trashed along with the creation and bursting of the housing bubble.
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September 8th, 2006 at 6:48 am
I don’t see how renters would be the losers if the bubble doesn’t burst. Forgive me if I don’t see the obvious. They are still enjoying record costs-spreads between buying and renting. Buying and renting question is best assessed by your needs, not everyone has a situation that forces them to “need” owning a house.
Especially when you think about the short-term nature of renting vs. long-term expecations of home ownership, the cost-spread is a definite plus for renters who don’t have those expecations in the short-term. I don’t know too many renters who say, I’ll lose it because I’m contemplating renting for the next 10 years. If the bubble doesn’t burst, does that imply prices will start shooting up again? What are the probabilities of that happening?
September 8th, 2006 at 7:07 am
Investorial,
The renters are losing to inflation as of right now. Rents all over the US are increasing at a higher rate than before. The money investment of renters is losing to inflation too.
All of these are yet to happened or probably in progress already. But to combat a fall in the housing, Fed would need to engineer inflation into the economy. Under a heightened inflation, the debters gain, while the creditors lose (because money keeps losing its value).
My point is that everyone eventually will lose money to inflation (with the exception of really good hedgers).
Furthermore, the loss of a good attitude towards saving frugally and investing responsibly cannot be valued in terms of money. The values in a society get destructed when significant number of people are able to flip a condo or house without doing much additional work, and immediately turn it into some $100K or even $250K profits. What do you think it would do to the psyche of both the people who got those gain, and the people who watch on the side? The whole society will become simply more speculative.
September 8th, 2006 at 9:58 am
You are making a huge mistake by lumping in speculator with real real estate investors- there is a huge difference. Right now speculators are being flushed out of the market. Renters are loving all the competitive rental rates because speculators need their houses rented, and renters are also finding that the market correction is allowing them back in the game. The real real estate investors have been making money and continue to make money, because they understand market cycles and have strategies for each. People who lose? People who got into the game late and those who didn’t know the rules.
September 8th, 2006 at 11:37 am
A lot of people, including the federal government, will eventually bankrupt for lack of financial responsibility. As a nation, or as a household, the basic rule to financial stability is by working hard, making more, and spending less. Without that, all the smart measures today to prolong the boom will only push things higher so they will fall harder.
The sad thing is when the day comes everything falls apart, it is left to the financial responsible ones, the middle class, to pick up the tab. The rich people will have their way to work around the pain, as always.
September 8th, 2006 at 7:23 pm
Prlinkbz,
I agree with you. Real estate investors will certainly make money. But I cannot find a money-making real estate investment locally in CA. Many real estate “investors” confuse with the cash flow with earning. Cash flow positive doesn’t mean that earning is positive, nor earning positive doesn’t mean that cash flow is positive either. If you are a smart real estate investor, you should be selling out of this bubble.
September 8th, 2006 at 7:25 pm
Nick,
You got it right. When government starts to print money, middle class gets hurt the most.
September 11th, 2006 at 3:04 am
You tend to lump entire groups (renters, investors, buyers, speculators) into big groups of winners and losers. Perhaps this is a bit too simplistic in terms of the housing bust. All markets are cyclical and will have ups and downs. Renters may or may not lose depending on their reason for renting. I would think that a renter loses far less than a buyer that has taken out an ARM loan that he cannot pay, or an interest only loan which means he owes more now than he started with, while the home may be worth considerably less.
The savvy investor makes money in any market condition, while the losers are generally the unsophisticated investor/buyer that has been sold a bill of goods. Losers buy high and sell low. Always have and always will.
September 11th, 2006 at 7:23 am
Bob,
I see potential hyper-inflation eventually coming in the US because of the bursting of housing bubble. If you think that having all of your expenses doubled is not a loss to you or anybody, then I guess you must be making dough elsewhere.
September 11th, 2006 at 11:15 am
Carnival Of Real Estate – The Tomato Edition…
I am not complaining. Really, I’m not… but 38 blog articles to read on a Sunday? Wow. Be careful what you ask for when hosting this rapidly growing carnival. Great job everybody. In an effort to give everyone who submitted an opportunity to be read,…
September 12th, 2006 at 8:21 am
Banks do originate mortgages, but many are immediately “flipping” those mortgages to Fannie & Freddy. The question is: who holds the bag/risk? If/When RE drops, say, 40% (IMHO quite plausible for CA) and foreclosures multiply, will it be banks or those federally supported institutions who pay the price? If the risk is with F&F, we’re all screwed, if it’s the banks – only the banks may be (they had a very good run, they can take it). But if you believe that the banks will be bailed out anyway, you might consider investing in those banks’ stock, because many shares have been beaten down…
September 12th, 2006 at 11:02 am
what is the next asset class?
nasdaq stocks
housing
gold
???
September 12th, 2006 at 11:08 am
Butters,
A lot of bagholders are Asian bankers. So they will definitely get hurt. But banks like Washington Mutual do hold a lot of mortgages. So they will get hurt too. I think risks with Fannie & Freddy are really BIG, and a government bailout is likely. That is probably one of the primary reasons that Fannie Mae has not finished their accounting reports. Maybe just the publication of the report will crash the market. But I guess they will probably make it a 10,000 pages, so that no live person can possibly read or finish it, and then it becomes either a non-event, or a extremely slow unfolding event.
Stan D,
I don’t know what’s the next class for certain. But I’m more certain that it won’t be the same class of asset. So it’s really a process of elimination I believe.
September 12th, 2006 at 11:42 pm
Hello Frugal,
Great post. I think one thing that is not really address is how much money has artificially been pumped into the economy by cash-out refinances. Also, real estate / housing related represents something like 44% of all jobs – private payroll (NyTimes Article – Read Between All Those For-Sale Signs By DAVID LEONHARDT and VIKAS BAJAJ Published: August 27, 2006) created since 2001 and you slow home sales down… there is a huge impact, which is only compounded by it’s trickle down “starbucks frappucino” effect. Also combine this with wall street showing dis-interest in the “stated income” (read: couldn’t qualify, so had to lie) loans for “salaried” employee… you get people that can no longer refinance, possibly can’t sell and when their loans adjust. When they do, many won’t be prepared for the change as evidenced by this 2/28 adjustable rate mortgage calculator, which shows a 57% increase ($769) monthly mortgage payments at the first adjustment of a 5.375%, $300,000 loan. Lastly, people’s attitude to real estate as an “investment” vs. a home and access to real estate price information will only compound the volatility in prices and cause the herd mentality to follow/push prices both up and now down.
September 13th, 2006 at 12:05 am
Thanks for your great comment, Mortgage Info. I hope the readers will check out your calculator.
September 13th, 2006 at 12:09 am
Charts On Housing Markets & US Economy…
In my previous post “The real losers when the housing bubble bursts”, it appears that many people did not understand what kind of inflation that I’m talking about. Apparently, you don’t read my past posts, and are not familiar …
September 14th, 2006 at 8:23 am
There are easy ways to hedge and invest in the coming real estate crash
- bear market and hedged mutual funds
- gold and commodities
- buying real estate from desperate sellers
- blue chip companies in consumer staples (the stuff you have to buy where companies can charge whatever – think diapers, basic foods (not whole foods), gas, etc. Wall street money will flood into this sector. Easy to buy ETF.
Cash may also be very valuable – the Fed will try to print money, but in the 70′s Treasury bonds went to 18%! Today Asia buys our bonds, but they will stop (may even sell) and interest rates will rise