Thread: UCLA says economy is rising on a housing bubble

Interesting article about the California economy.

http://www.sacbee.com/content/opinion/s ... 6900c.html

Daniel Weintraub: UCLA says economy is rising on a housing bubble
Bee Columnist
Published 2:15 am PDT Tuesday, June 21, 2005
California's economic recovery over the past two years has been driven by an unusually large surge in housing prices that cannot be sustained, says a new economic forecast to be released today from the University of California, Los Angeles. And when that housing boom ends, the effects will ripple through the economy, weakening job growth, incomes and, probably, government tax receipts.
"There is no reason that a house should be worth 40 percent more today than it was two years ago," writes Christopher Thornberg, a senior economist with UCLA's Anderson Forecast project. "This is a bubble. And this housing market is far beyond the point of sustainability."

Housing bubbles don't usually burst overnight, so a catastrophic end isn't necessarily in sight. But even a flattening of the market is likely to have far-ranging effects on the rest of the economy, given how important real estate has been to the recent expansion.

Almost every aspect of the state's economy, from the type of jobs created to the pace of consumer spending, seems to be tied to the housing market. And that is a very thin reed on which to rest the well-being of 36 million people.

Thornberg, for example, looked at California job growth following the last two downturns, at the start of the 1990s and early in this decade. In both cases, the state added about 160,000 jobs in the two years after the economy hit bottom. But the character of those new jobs was quite different.

Compared to the last recovery, this one has been marked by much faster growth in the construction industry, finance and insurance, retail trade and food services. Jobs in the information industry, warehousing and transportation, and administrative support positions within companies have been far less prevalent. And while manufacturing employment declined during both recoveries, the drop this time has been four times as large.

Much of the recent job growth, Thornberg notes, is coming from industries that service the needs of other Californians, not from demand generated outside the state or country. And what is fueling that internal demand? A surge in consumer spending built largely on the growth in home prices.

To illustrate the magnitude of this effect, Thornberg estimated that the total value of residential real estate in California was $1.7 trillion in 1997. It is now well over $4 trillion. In the past two years alone, the average California adult is $40,000 richer thanks to housing appreciation. That's about half what the average person has earned in regular income.

That surge in home equity has fueled consumer spending even more than the 1990s stock market boom because real estate is more evenly distributed than stocks and more likely to be held by individuals. Tax laws make it easier to turn housing equity into cash, and real estate equity is easier to borrow against.

"People feel flush and they are spending accordingly," Thornberg writes. "Unfortunately, that $40,000 check your average Californian has received is mostly illusion, and not real. And the feelings of being flush are also incorrect."

Among the warning signs: Taxable sales are growing much faster than incomes and have done so for 10 quarters now, which is very unusual and a sign of a fundamental imbalance between what people are earning and what they are spending.

The average price of a home in California, meanwhile, is now 12 times greater than per capita income, a ratio that is higher than it has been in at least 30 years. Rents, which should be rising with housing prices, remain relatively low.

The current expansion also looks excessive when compared with the last two run-ups in California's housing market. In the late 1970s, housing prices, adjusted for inflation, climbed 55 percent from the trough to the peak. In the late 1980s, they climbed by 46 percent.

Today, housing prices stand 80 percent higher than they were when the frenzy began, and, Thornberg notes, they "have not even hit a peak yet." But eventually that peak will come, because the housing market is not unlike a pyramid scheme.

People who bought early and rode the escalator up, turning equity in one home into a stake in another, might do all right. But the escalator can keep going up only as long as new buyers are coming in at the bottom, and that can't happen forever.

When the end comes, and no one can predict when that will happen, consumers who have been spending their equity will suddenly feel pinched. And some people who entered the market late, if they are forced to sell, could lose everything.

"All those people who were banking on continued appreciation of their house to finance their children's college education will suddenly find they need to go back to the old-fashioned way of saving for the future - spending less," Thornberg writes.

The big question for California is whether a recent, encouraging uptick in exports can fuel a lasting expansion outside the housing sector and pick up the slack when real estate inevitably cools off. In the best-case scenario, rising exports would provide a relatively soft landing for the rest of the economy. If not, watch out.

Thought I would throw this one in with this article I posted earlier. Also a link to another article posted on housing.


Young homebuyers banking on options

http://www.counterpunch.org/whitney07272005.html

July 27, 2005

Doomsday Approaches
The End of the Housing Bubble
By MIKE WHITNEY

I sold my home three weeks ago anticipating what I believe will be "Economic Armageddon" in the United States. It wasn't an easy thing to do. My wife and I have lived in the same home for 25 years, raised both of our children there, and owned the property outright without any loans or mortgage. The house was paid for in "sweat-equity", that is, by wielding a shovel day-in and day-out in my one-man landscape business. I don't say that for sympathy, but to illustrate that we played by the rules, worked hard, paid our taxes, and took advantage of the American dream of home-ownership.

All that has changed.

I sold my home for one reason; George W. Bush. He and his protégé at the Federal Reserve have submerged the country into a morass of "unsustainable" debt, disrupted the nation's economic equilibrium and thrust us towards fiscal disaster. They've also generated a humongous housing bubble through their irresponsible and self-serving manipulation of interest rates.

The facts are astonishing.

The current housing bubble "is larger than the global stock market bubble in the late 1990s (an increase over five years of 80% of GDP) or America's stock market bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history." (The Economist)

The banks have lowered the standards for home loans to such an extent that the traditional loan of 20% down and a fixed interest rate is virtually a thing of the past. Instead, those conservative practices have been replaced with "creative financing" schemes that put the entire housing market at risk.

Consider this: In 2004 "one-fourth of all home-buyers including 42% of first-time buyers"made no down payment". (New York Times)

No down payment?

Sorry, but if a buyer can't come up with at least $5 thousand dollars for a down payment, he shouldn't qualify for a home loan.

Equally troubling is the fact that "nearly one third of all new mortgages this year call for interest-only payments (in California, its almost half)" (NY Times) This tells us that a large number of new buyers can barely make their payments, but are gambling that their property value will go up enough to justify their investment. This is "equity-roulette"; a shell-game that anticipates that salaries will go up while interest rates stay low.

Is that a reasonable judgment?

No, Greenspan has said that he will continue to ratchet up interest rates to head off inflation. This means that an economic slowdown is a near certainty. Remember, "class-warrior" Alan Greenspan lowered the prime rate to a ridiculously low 1% in 2002 to keep the economy humming-along while $300 billion was sluiced into Bush's "preemptive" war in Iraq and while the tax cuts were siphoning the last borrowed farthing out of the public coffers. The Bush tax cuts transferred an average of $400 billion dollars per year into the pockets of America's plutocrats. Now, the country is flat-broke and Greenspan will have to "incrementally" raise rates to stabilize the sagging dollar. This means a sluggish economy for most of us and doomsday for over-extended homeowners.

Greenspan assumed he could carry out his plan without too much unnecessary carnage. Unfortunately, gluttonous mortgage lenders have lowered long-term loans while the prime rate continues to go up. The banks, it seems, are addicted to the "cash cow" of shaky lending and are providing even riskier loans to new applicants. This has upset the Fed-master's strategy for a "soft landing" and Greenspan has begun feverishly issuing warnings about an inevitable "adjustment" when the market bogs down. The bottom line is that the housing bubble is getting bigger by the day and increasing the potential for catastrophe.

The current problem is compounded by the dramatic surge of speculation in the housing market. As "The Economist" says, "A study by the National Association of Realtors (NAR) found that 23% of all American houses bought in 2004 were for investment, not owner-occupation. Another 13% were bought as second homes. Investors are prepared to buy houses they will rent out at a loss; just because they think prices will keep rising"the very definition of a financial bubble."

What will happen to these "speculative" buyers when the market "flattens out" or the economy takes a sudden dip?

And, what will happen to the US economy when the jobs that depend on new home sales vanish overnight?

"Over the past four years, consumer spending and residential construction have together accounted for 90% of the total growth in GDP. And over two-fifths of all private-sector jobs created since 2001 have been in housing-related sectors, such as construction, real estate and mortgage broking." (The Economist)

"Two out of every five" private sector jobs are now entirely dependent on an industry that is built on pure quicksand.

So, why would banks foolishly loan money to people who can't even scrap together a few thousand dollars for a down payment or who can scarcely meet their "interest-only" obligations?

The reason is simple; because they are not the one's taking the risk. Mortgage loans are acquired by investment banks and chopped up into various securities where they are sold in mutual funds, hedge funds and pension funds etc. To some extent, this takes the lenders off the hook, but it also means that the shock to the system will be much more widespread when the day of reckoning finally arrives. If we encounter a major glitch in the economy the shock-waves will be felt throughout the world. "Investors now hold $4.6 trillion in mortgage backed securities. That's more than the outstanding value of the US Treasuries." (NY Times) Think about it.

Shaky lending, interest-only loans, no down payments, a US government that is $8 trillion in debt due to Washington's profligate spending, and a "ticking-time bomb" of adjustable-rate mortgages that will reset within three years; the table is set for a disaster of Biblical proportions. If we hit a bump in the economic road ahead (rising gas prices? recession?) the "Land of the free" will be knee-deep in bankruptcies and foreclosures. We'll all be fighting for a soft-spot under the freeway on-ramp.

The fatuous Greenspan believes that all this can be avoided by regulating the money supply.

He's dead wrong, and I bet my house on it.

Note: The current dilemma could have been avoided if Greenspan had incrementally raised rates as the bubble began to appear. Instead he lowered rates to facilitate Bush's war in Iraq. It was purely a political decision that "postponed" the economic pain of the conflict and allowed the Bush administration to shift the cost of the war onto future generations.

Consider, also, how Greenspan paved the way for the budget-busting tax cuts (which he enthusiastically approved) and how they have increased America's debt by $3 trillion. This is real money that American workers will eventually have to pay back in the form of taxes and a higher cost of living. This "class loyalty" is strikingly at odds with his philosophy as a young man when he said, "Deficit spending is simply a scheme for the confiscation of wealth."

So it is; and the $3 trillion dollars that evaporated on Greenspan's watch was in fact stolen from the American people while the Fed-chief concealed the crime behind the smokescreen of low-interest rates. In the final analysis, Greenspan will be seen as a greater traitor than Bush.