July 13, 2007

Housing Bust

When George W. Bush began his first term, Americans had been enjoying a robust economy for several years even despite the approaching dot com bubble bust. Americans from all sectors including the lowest quintile had seen their incomes grow over inflation, the job market was good, and our federal government budget was in surplus.

Today, our economy is healthy only for the top 1% -- lucky them: they have done extremely well under Bush’s economic policies. All other groups have slid back in terms of their real income. Furthermore, today the federal budget is deep in the red. And this doesn’t take into account the looming housing bust which is just starting to play itself out. The housing bust is a more serious threat to the economy than was the 2001 dot com and the effects will linger for years.

Bush’s economy has been built on a stack of cards which were bound to collapse in a heap when people realized the extent of the Ponzi scheme that was driving the market. What is truly distressing is that under George W. Bush, the U.S. economy has been auctioned off and sold to the highest bidder and the future prospects for most Americans have been badly damaged.

So how did we get here?

After 9/11, George W. Bush urged Americans to keep the economy humming by shopping. Some 70% of the American economy is based on consumer spending so it is important to keep people spending. The only problem was that family income wasn’t going up to support the spending. And personal tax savings from the Bush tax cuts didn’t put enough money in anyone’s hands to drive the spending patterns of any but the most affluent few. To have a robust economy based on consumer spending meant that a broad swath of Americans had to spend whether they could afford to or not.

In 2003 and 2004, Alan Greenspan began promoting the idea that consumer debt wasn’t bad because people could use the equity in their homes to help manage that debt by taking on variable rate interest mortgages. Here’s what he said in February 2004:

"An extended period of low interest rates and extra cash from mortgage refinancing has given borrowers flexibility to better manage their debt.
… snip…
[If Americans are] willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.”

And so started the rush to finance and refinance home mortgages throughout the country. Americans were urged to cash in on the wealth in their homes and to seek the benefits of low interest rates. They were encouraged to borrow against the future so they could buy their dream house or to cash in on their perceived equity wealth. No longer expecting to see their overall earnings go up or even to keep up with inflation, Americans were led to believe the values of their homes would continue to rise. And yes, like Donald Trump they too could make a killing off the real estate market.

But the problem was, just like the dot com bubble rising housing prices aren’t guaranteed. Furthermore, the hitch for many of these loans has always been that the low interest rates were only teasers. (Loans were written so that a home buyer would pay a nominal rate – perhaps 1.5% every month, while the actual interest rate to just pay the interest was actually 5%. This means that mortgage holders were going deeper into debt every month as the interest not paid was tacked onto the mortgage. ) Many of the teaser loans were designed to reset after a few years even if the national interest rate stayed low. And even when the interest rates were low, an estimated $1 trillion in home mortgages were slated to reset to a higher rate when the extremely low teaser rate expired. With today’s interests rates significantly higher, many people have found the new monthly payments too much.

That doesn’t even start to cover the people who were purposely sold a bill of goods. People who found themselves in desperate straits were urged to take out loans that were well outside their capacity to handle. People like the widow who needed extra funds to pay for her dead husband’s medical bills and who was sold a loan that was vastly beyond her means with no warnings of what the costs would be when adjusted for the full interest rate. Now she is losing her home because she didn’t understand the fine print. She is paying for that “too-good-to-be-real” loan while the fellow who sold her the bill of goods is left free to find his next victim.

Greenspan’s words

The seeds of bad economic policies based on convincing Americans to cash in their equity to carry out their patriotic duty to spend, spend, spend or by convincing them they must gamble their long term financial health to buy an expensive dream home well beyond their means are ready to bear bitter fruit.

Credible economists have been warning us that the housing sector was a bubble and that the eventual fallout will prove to be dangerous to the American economy. If we know that 70% of the American economy is based on consumer spending, it is not surprising to see that a severe housing bubble bust will restrict spending as the phantom wealth in people’s homes disappears. But there are other more subtle problems that make this problem even bigger than we’ve discussed so far.

Beyond the distress of the individuals who found themselves in over their heads, this problem continues to reverberate in the broader economy. Partly because the housing market drove so many industries: the financial industry (at least the mortgage market), the remodeling sector (Home Depot is already feeling the strain), the building sector (home construction fell for the past 6 quarters – a record we’ve never recorded before). Every one of these areas is showing stress.

Furthermore, the communities which are experiencing significant foreclosures are seeing new problems engendered by such a large scale problem. Stories from all over the country tell how foreclosures have created neighborhoods with too many empty houses – empty houses that cause the value of other houses in the neighborhood to lose value and can attract vandals as well. Some badly affected communities have one out of eight houses foreclosed which causes severe distress to even those homeowners who are not having problems with their mortgages as the value of their homes degrade.

A housing bubble affects a very large segment of the economy and its bursting is not something that will be easily overcome. And just think -- this economic strategy was the one the Bush administration devised rather than investing more in our communities, providing universal healthcare, or cleaning up our greenhouse gases. It’s time for a new direction.

Posted by Mary at July 13, 2007 01:16 AM | Economy | Technorati links |

I agree. We operate CurrentForeclosures.com, a foreclosures site and have seen a huge increase in the number of foreclosures in the past 4 months. I believe it is a combination of not only sub-prime and ARM mortgages, but also the high number of people who have gotten loans with interest rates at an all time low... in addition to the rapid depreciation in some areas and the difficulty some are experiencing in selling their homes.

Posted by: TSmith at July 13, 2007 08:00 AM

Thanks for your update, TSmith. It is really awful what is happening to people all over the country. I just hate that it was done on purpose.

Posted by: Mary at July 14, 2007 06:40 PM