Krugman Is Right!!??!!?!

Hey even a blind squirrel sometimes finds a nut!

Krugman in this New York Times column delivers a essay which is going to provide him an 'I told you so'.  He is writing about the housing bubble and he makes some extremely valid points that should be of concern to everyone.  Rather than reflexively dissing the guy because of his reprehensible behavior in the past, some of you might just want to listen up.

First off the housing bubble actually exists and there has been evidence that the air is coming out of that bubble.  Why is this a problem?  A little history lesson...when real estate values fall, bad economic shit happens.  Texas...1980's...any questions?  Oh probably tons but let me start wading through the connections.

First...the Texas economic train wreck was oil connected but the housing and real estate devaluation took on a life of its own.  Sure the bottom falling out of the oil market started that ball rolling but when folks quit paying mortages because they have no income and no one wants to buy their house, the holders of those mortgages start to bleed as bankruptcies and foreclosures begin sapping resources.  Banks...failed...often.

Fast forward to some of the regional bubbles...houses are so expensive that to own them people have been entering into interest only adjustable rate mortages.  This means in simple english that the jobs in those markets do not pay enough money to support the purchase prices for real estate in those markets.  What happens when demand is less than supply?  The price drops...right?

Stay with me here...it gets even worse.

When two thirds of the housing market is financed through interest only adjustable rate loans with call provisions...what happens when real estate values stop rising?  Oops...  We have houses worth less than the mortgage amounts, financed through interest only mortgages made to people who could not afford the mortgage if they had to pay principal.  You see they were counting on the rise in home values to use the equity to buy into a house before they had to pay down principal...but what if the houses don't go up in value?

If people can't afford their mortgages and default...it causes foreclosures and bankruptcies...just like Texas.  If over 66% of some regional markets are financed through interest only ARMs those markets are going to tank...far worse than Texas in the 80's.  You actually have morons buying houses on speculation and trying to flip them!  These folks are what will be known as defendants in a few months when they are foreclosed upon and plaintiffs a few months later when they are forced to file bankruptcy.  Here's a clue for you...banks will fail...again.

We are soooo close to being there today.

The housing bubble is the product of two things:

1. Speculative investment; and
2. Lack of supply.

The first is a by-product of the second.  If interest only mortgages were not available, the housing prices would be unsupportable because the population of buyers who could afford the price would not exist.  By using a speculative investment tool like interest only debt, buyers are able to stretch and meet the monthly payments.  These buyers are gambling that rising housing prices will provide them the equity the need when they get ready to sell.

The lack of supply is a product of two things, zoning and population density.  There are some markets which have been artificially inflated by zoning (Portland and Seattle come to mind), but many markets in the Northeast and California are inflated because of population density.  Demand does exceed supply but incomes do not support the astronomical prices.

The bottom has not fallen out of these markets but only a fool would believe that the torrid pace of housing inflation will continue.  Say it with me...Krugman is right!

Comments

[Kevin B.]

Real Estate "investment groups" are making their way through the greater Boise valley area right now.. or so it would seem by the prevalence of oh-so-professional roadside signs ("Yes! YOU can be a real estate investor today! Call now!")

Also, realtor schools are churning out record numbers of 'graduates' right now. Realty is a relatively cheap business to get into as far as start-up costs go, compared to say, a small franchise. And the housing market has seen HUGE growth right in my area over the last decade. There's a glut of realtors, contractors, etc.; many of them have been coming from other states because the work has been plentiful here. When it finally does pop, it will be ugly for a while.

There's a saying that when your grandma is giving you tips on which stocks to buy, it's time to get out of those stocks.

Same principle here... when your grandma is getting into real estate, watch out. The housing market is about to go into the toilet...