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Housing Bubble Defined

Posted On: 2006-08-30
Length: 36:17

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Alright folks, welcome to our episode here of Vigilant Investor, we're glad we have some listeners hopefully out there tuning on into our live new streamcast here. This is our first episode that we've done in a few weeks. And we're excited to have the live streamcast on board here so. Hopefully folks are clicking on right now and doing their best to listen in from all around. Now, today's subject is The Housing Bubble, and what it means to people and what is actually going on. We have, if you've listened to any of our past episodes, talked a lot about things along the lines of the credit bubble and what all that has caused for individuals out there potentially what they might run into on an economic front. And the credit bubble basically has been just a massive expansion of fresh dollars through the credit system coming through the Federal Reserve, or via the Federal Reserve, or I should say rather enabled by the federal Reserve, and through the banking system. And, essentially since 2001, once we had the big dip in the stock market with the substantial crash in equities led first by the dot coms and then technology as a whole, eventually the S&P was sucked into it as well as the Dow Jones Industrial and so forth. And, before we knew it, I think is was April of 2001 everybody was talking about dipping into a recession. Once that really kicked into effect there, the Federal Reserve reacted by dropping interest rates, just plummeting them so that the banking system could in effect get credit circulating though the economy and stimulate the economy. I think that's one of the tools of the Federal Reserve and, you know, frankly all central banks, that's what they try to do is stimulate the economy through the credit system by making lots of loans. A lot of the money comes essentially out of thin air, because a lot of that in a fractional reserve banking system like the United States has it's basically money that's being printed it's not money that existed previously. And when we expand credit in the United States, what we're doing ordinarily is we're expanding the money supply. Conversely, typically when we see the economy overheating there's always a lot of talk about slowing the economy down through interest rates as well. So, that's one of the primary tools that the Federal Reserve uses is, you know, interest rate policy. And, we had consecutive interest rates drops from 2001 I believe, all the way down to 2004, June of 2004 where the Federal Reserve just kept dropping interest rates. And what that basically does is it makes money much cheaper for the banking system to borrow on an overnight basis for short term use, but also as a way of enabling banks to functionally expand their credit and as I already mentioned, get the economy somewhat jumpstarted. Now, the problem with that kind of a thing is that it doesn't always work as planned and it's not something that you ought to be doing over and over and over again. Now, regular listeners of Vigilant Investor, and anybody who has ever been to our site and reads on a frequent basis knows that we have a tendency to come from the Austrian school of economics, which has a somewhat critical view of the central bank system, just because the tendency is that [...] with credit and money supply, you, the Austrian school of economics holds that [...] bubble environment. You create business cycle [...] cycles to extremes that otherwise occur. And, moreover once you get in the habit of doing the [...] you get an economy very much addicted to that. So, when you start getting more and more addicted to it, the further you go down the pike by continually doing it and the more extreme you get the fluctuations and so forth. And while you might be able to mask some of the effects of the, you know, large increase of the money supply and a vast expansion of credit eventually catches up to you through bubbles that they create bursting. And, the long and short of it of course we're talking tonight about the housing bubble. And all indicators are now that the housing bubble is in fact a reality. If you went back a year ago and you saw what a lot of pundits were writing, a lot of the experts, and frankly a lot of the apologists on Wall Street or in the U.S. government, the Federal Reserve and so forth, a lot of them were talking about how there was no such thing as a [...] housing bubble, that it really didn't exist, it was just a very pleasant increase in the price of housing and everybody was going to benefit from that and [...] of course you're bound to have it every now and then. And, the worst thing we would expect post that kind of environment might [be] a bit of a housing slow down, but nothing too extreme. All the talk now has turned, 12 months is a long time, far away from the fact that you really can't deny that there was a housing bubble. I mean if you went in some regions you saw 150 percent home price increases in a matter of just a [...] years. Particularly badly hit has been areas like San Diego, Los Angeles, Miami, you go up to New York or Boston on the East Coast. And what you're seeing there is the average mean price, the average home price for individual [...] become so extremely high that the average person really can't afford to squeeze into a home through [...] but we're getting a little bit ahead of ourselves here. I think what we need to do is identify what the bubble really has caused, what caused it. And then we can maybe talk a little bit about what we can expect on the backside of this thing now that it appears to be unwinding. And again if we were to look at the news reports over the past couple of weeks, you'll see that there's really not a denial of a housing bubble. Now, the apologists and the more [...] we should expect a fed. engineered soft landing. And regular readers of the Vigilant Investor will know that we have a large degree of skepticism on that [...] it's not something I would hold my breath on, now it could always be pulled off. But we think it's definitely time for people to be a lot more careful about what they're doing; I think not only with their financial side of things, on the personal side, but also if you're an entrepreneur, what are you doing in considering business expansions and so forth. Let's wind back here a little bit. And let's start talking about the housing bubble - how did it come to be? Well, we had a doubling of the money supply from 1995 to 2002 [...] have a lot of these graphs up on our web site you can do a search [...] on [...] categories [...] you'll see these charts that show that the money supply pretty much from 1970 once we got off the gold standard starts really cranking up [...] tapers off a little bit through the eighties, picks up a little bit in the late 80's, and then kind of actually levels off in the early 90's. And once you get to 1995, it's as if the accelerator was just pushed down to the floor. Money supply starts ramping up and in about the time of the housing bubble burst it continues to go up, [...] not the housing bubble but the stock market burst, continues to accelerate through the roof. All that money getting injected into the economy has to go somewhere. And, what we've had in the U.S has been largely a [...] hiding of the big expansion of money supply. Most people think when you increase the money supply you're going to get inflation of prices, price inflation. And what we didn't see during the 1990's despite the rapid increase in [...] large spike in prices. In fact, largely we started seeing technology getting cheaper and cheaper to the point where we couldn't believe how inexpensive a TV set had become. That trend has continued until pretty much today. A large part of that is because the federal deficit, trade deficit not the federal deficit, but the U.S. trade deficit [...] basically consumers began spending so much money abroad that they were basically importing goods that were made cheaply in foreign countries, you know China and [...] And, that was no so much out of necess - out of choice as much as it might have been, you know largely out of necessity. And that if they wanted to get the same goods out of the U.S. they would have had to pay a whole lot more for it. Especially if we had had closed borders at that point in terms of trade, we would have see the prices of all those things go up a lot [...] The long and short is that all that money would [...] vented abroad. And, after a number of years of that happening, foreigners were sitting with all these dollars in their hands, they begin lending it back to us and that began driving down a lot of the interest rates in the United States. That started enabling a better environment for housing in a lot of ways [...] interest rates, driving down interest rates, it is very important to make a differentiation between Federal Reserve interest rates and those interest rates that you will find out in the marketplace. Because the federal reserve can only control interest rates that [...] controls [...] banking system. In terms of what controls interest rates out there as far as mortgage goes or what the treasury might be paying, or what a corporate bond might be paying. [...] have to rely on what the market is going to determine in terms of supply and demand. If there's a lot of people willing to lend at low rates, well rates will be low. If people are not willing to lend at low rates and they start demanding higher rates, well of course rates are going to rise up. And, all that money supply sloshing around out there has created an environment today, where we're seeing interest rates that are far under ordinarily where they would have been [...] -definitely on average. And moreover, because all that money was sloshing [...] economy might not have been [...] -able. We've seen a lot of those dollars returned to the United States [...] treasuries and the U.S. treasuries rates have a tendency to be the arbiter of what your [...] bond market really is what [...] find a lot of the [...] affecting what your mortgage is [...] treasuries are probably the most impactful [...] The bottom line is that since 2000, especially once we started dipping into recession, the money supply [...] further. And even in the face of the Federal Reserve talking very tough on the money supply and, you know [...] that they're going to try to fight inflation [...] 2004 we've seen very steady interest rate increases from the Federal Reserve. We still have not seen [...] cut back on the M3 figures, that's the broad based money supply [...] all sorts of different ways that you can give the, basically have the power of an expanding money supply. That gets a little bit esoteric, so let's bring that back on into reality here with respect to the mortgage market and [...] Bottom line is that interest rates have been below, well below their averages, 50 year lows for that part since about 2003. What that has had the effect of doing is driving up demand on housing because interest rates are dramatically lower, mortgage rates are dramatically lower. So people are able to bid up the prices of loans based [...] If we were all dealing with 9 percent interest rates over the past couple of years, you wouldn't have found people jumping at a lot of houses. What you would see instead though is with interest rates down 5 and a quarter in the 30 year at one point, people were willing to say, "you know what I can not just get the house I was thinking of getting, or I thought I'd be able to afford 5 years ago, I may be actually able to afford this house that is a lot bigger," because the monthly payment is the same or maybe even lower given that the interest rates have dropped so dramatically. Once that cycle begins, and again it's enabled by [...] standing money supply, low interest rates policy from the Federal Reserve. Once that cycle begins, it begins circling around and around and a reverberating effect. The more people start bidding up prices using that new cheaper money, the higher the prices of course start going up and then the next people that come along are faced with a choice of, "well you know do I want to do the same thing, maybe I should hop on this now," to the point where eventually where a 30 year mortgage is no longer even feasible. We were talking about some of the average home prices of some of these areas like L.A. or San Diego or Miami; it's actually gotten to the point now where the average person, making the average income cannot afford in the 30 year mortgage environment the average home. So, what they then begin doing is using more exotic mortgage type structures. Adjustable rate mortgages are the most [...] common type, and with an adjustable rate mortgage you might be able to get a home for a 3 year period where you're only paying you know 3 percent or 2.5 percent interest rate, which is a [...] that definitely makes for a very small payment. But, on the backside, you end up having an environment where suddenly your mortgage is going to reset at current rates. And, if you were to look at some of the numbers for the resets, I've been reading an article from Danielle Demartino down at the Dallas News, which, you can go to dallasnews.com and pick up her article up there, it says, "will credit markets be up in arms," and I think it touches on some good points there. But, there have been estimates anywhere from about a trillion to 1.25 trillion per year and adjustable rate mortgages will reset 2006 and 2007. The average rate will rise from about 3.4 percent to the current rate, which is about 5.8 percent. And that increase means that people are going to be faced with much higher payments. Of course not everybody is just going to sit there and get bulled over by the, you know, a train coming at them it's not just that they're [...] 30 year mortgage at a more reasonable rate than 5.8 percent. Although that's pretty much right now where the 30 year is, so you might want to try to roll it over into a new adjustable rate mortgage. [...] then you're kind of playing roulette if you do that. Now the real danger here is that a lot of people who have these adjustable rate mortgages are going to have a situation where their homes may not get valued [...] they expect them to get. And this is the danger of the bubble, any type of a bubble environment and why the Austrian school [...] a very critical view of ginning up the [...] eventually you get to the end of the line where it's sort of like musical chairs, someone's going to end up holding the [...] there's a point a which [...] that point hits [...] Just to put that into perspective let's shelf the [...] discussion just for a minute here [...] looking at, you know, where the market is today. We just [...] And, the report had come out that single family homes sold in July were down [...] up [...] about 22 [...] looking really at [...] verses the number [...] big drop off. And that means basically that the market is going to have to [...] inventories are up, new homes aren't selling, existing homes aren't selling [...]-finitely the rapid appreciation in home price that people were seeing also begun to stagnate and [...] Now, we take that back to the adjustable mortgage rate environment; someone who is sitting on an adjustable rate mortgage with a house that's worth less today than it was 6 months ago or three years ago is going to be running into some serious problems [...] Now, that's not so much an issue. I'm worried less about the family [...] as used the adjustable rate mortgage [...] get themselves into a home of their choice that they want to live in for the [...] temporary rate that they try to hop on to. They might get a little burned there, they might see their disposable income crimped a good bit. [...] aren't able to re-fi. But, I suspect a lot of them are going to be [...] so far as we don't dip into a recession [...] recession which is always a possibility [...] definitely be continuing on in the future. But the concern gets into the more speculative side of the market. One of the things that you get when you get a bubble going is [...] rates being so cheap [...] adding up home prices and getting double digits, you know [...] condo's and everything. Suddenly you start getting a speculative bubble, and speculative of course meaning [...] homes to make quick hits and [...] and do what [...] real estate and what the housing market refers to as flipping. The most egregious example of this is [if you] haven't had a chance to take a look at [...] condoflip.com basically [...] in units of certain condos down in the [...] exclusively all of over the country have been buying undeveloped units [...] promised to be built in you know [...] 6 months, a year, selling units today at [...] people would turn those things over you know, after owning them for [...] yet it was simply the interest in that particular unit. [...] condoflip.com enabled people to [...] Internet [...] of course, you know, it maybe was not as an efficient, or easy as dot com stocks, you know [...] but it was about as close as your going to get when you're dealing with real estate, given all [...] The bottom line is that things became very speculative and I think everybody out there [...]ever you know [...] head above ground a little bit. You know somebody who has been in the real estate business, somebody who [...] talking about buying old homes [...] refurbishing them and quickly them over for a big profit [...] all this stuff was getting done, largely, heavily on credit, people would, buy, you know, get a mortgage on the place [...] put some more money into it though a home equity loan, you know whatever the bank is willing to lend, and improve the place and sell the place for you know a 25 percent profit or something like that. Well, that's all beginning to grind to a halt. What we're seeing now is a lot of people who were in that business and lot of people who were getting into the business now [...] sitting on these properties that are simply not turning over. A lot of properties that have been converted from rentals into a single family type environment [...] those things are just beginning to sit now, not just sit for a few days, it is longer than usual. I mean the turnover for these places was [you] put them on the market and 3 weeks, a month later you'd have them sold, these things are sitting for eight months to nine months now going on a year and simply not moving. That's an area of the market that's going to present I think, a big [problem]. A lot of that being done on arms, or no cash down type mortgages. And a lot of people are sitting in there with either, you know, no skin in the game, having not put much of a deposit down on their own and they're facing a mortgage environment where they could very easily be upside down on that mortgage. And what that translates into is basically, you know a housing environment where people are, you know as long as they don't have to sell they're going to be okay. But the longer this goes out, the longer people are going to be faced with the problem of, you know, what do I do with this property [...] a little more maybe on it than it's really [...] then you're going to start seeing foreclosures increase. And already, you look over the past 4 months, foreclosures are up dramatically all around the country and you know, you're always going to have ebb and flow in the foreclosure market, but there's a, clearly an issue of concern there when [...] all the other variables there and it's something to be tracking. Now, let's wind this up into some of the other areas we talk about [...] how the speculation, in some of the marketplace [...] And one of the other areas that has us concerned, and this is where we start tying in you know [...] has been the fact that people have been able to do home equity loans left and right, of higher and higher value through this bubble environment. And, people began realizing that they could re-finance [their home] it was kind of a no-brainer. I mean really, if you had an old mortgage at 7 and a half percent you could re-fi at 5 and a half you'd be stupid not to do that. But what people were encouraged to do, and you know people chose to do that was when they re-financed at 5 and a half percent they took a look at the new value of their home, and the bankers encouraged them, " why don't you tap into that new home equity and use it for other purposes." You know granted, a lot of people used that to pay off high interest credit cards, other people used it to [...] Generally what happened over the past [...] years is that people really began extracting a lot of the new found equity from their homes and they went out and spent it in the economy. The number's I've seen on it, they vary to some degree, but generally, if you look at 2004 the number I seen has been about 650 billion dollars into the economy, and in 2005 close to 600 billion into the economy. Those dollars were largely the product of an expanding money supply and [...] credit again. Given that, you know, again we're talking about rising in home prices that is well above the averages of inflation, well above the averages of inflation, well above the average home real estate [...] 30 year basis. And you know clearly, and this is something that just was not sustainable, but it had a huge impact on the economy. When you consider the 650 billion dollars rolling around into the economy, once it gets spent at one place and it goes to the next place and so forth, and just kicks around there, it has an accumulative effect of really generating some activity out there. But the real problem with it though it is simply not sustainable. We're now seeing that with interest rates having risen earlier this, actually it was late spring, April and early [...] rising up to the point where mortgages were getting in the high 6's for 30 years. Suddenly you started seeing, you know, nobody was tapping into their home equity anymore. Suddenly with home prices now stagnating, there's not new home equity to tap into. And consequently, our firm is looking into it from this standpoint, if you are wondering what's going to happen with the economy, you're going to have to start questioning, you know when you look at 1.2 trillion dollars of home equity yanked out and being contributed into the economy over 2 years. The question you have to ask is now what? Where is that next round of spending going to come from to help the economy move along? And, you know, looking at it through the inverse of that is what's the economy going to do with that 1.2 billion (trillion?) dollars of new money being injected into the system? So, you know, the title of today's show is you know, the housing bubble blues and you, what does it mean for you? What does it mean for you, your business? What does it mean for your family? What does it mean for the investment environment? Our concern is that the economy and this is one of the recurring themes of our show that you'll hear over and over again, is that our economy really was due for a fairly decent recession in 2001. [...] for the fact that the money supply accelerated, was really hit, interest rates were dropped down to emergency levels by the Federal Reserve. And the fact that a lot of that money came back to the United States in the form of very, very, very, cheap credit, the U.S. economy would have hit a deep recession. Instead, what happened was all this life support if you will was injected into the economy for the time being. And it enabled some elements of the economy to clean up some of the problems, business side of the balance sheet if you will, [...] has actually done a pretty good job at cleaning things up. But what happened on the other side of the balance sheet, the personal side is it has actually grown a lot worse. We look at savings for example, personal savings is down into negative territory. You go back, you know, 20, 30 years ago that rate used to be up around 11 percent. Even in the mid 90's it was closer to 7 and 8 percent. Today it's over negative 1 percent. And that's just a [...] some people aren't saving. It raises the question, why aren't people saving? You know, you wonder why that might be. But it's neither here nor there. The bottom line is that they're not, and number two if you look at the debt situation, the debt ratio overall this country has gone through the roof. So, with all that said, as the housing market begins to slow down, [...] concern is what is the next rabbit to be pulled out of the hat by the Federal Reserve now? Now, housing is slowing, it's not just slowing it's beginning to drop down pretty dramatically. One of the recent studies that we took a look at was the HUI, which is the Housing Builders Association has a study that they do [...] basis, which basically goes out as a survey where they ask all the builders out there, you know, what's going on with the single family housing environment? What do we see and tell us about sales, tell us about interest, tell us about walk throughs, what kind of interest are you getting, how does it look? And we take a look actually at the numbers for the HUI, from the National Homebuilders Association, the number has simply just fallen off the charts. It was about a year ago, it, you know they measure it from usually it's around from zero to about ninety or a hundred or so. It's best was in 1998, thereabouts, I'm actually looking at a chart right now, where it was close to just about I'd say 88 or so 87, dropped down in the early part of this decade when you had the, you know, recessionary fears and the market was dropping of course and that created a lot of worry. It bounced back up to where it was over 70 for a number of years there between 2003 up until about June of last year. And at about June of last year, a little bit after, maybe August or so, all of the sudden it just started falling off a cliff. To a point where about half, about six months later it was down to about 57, just a couple months ago it was down at about 45 and now it's getting close to being about 34 or so which is just you know that's falling off the face of the earth. But again what that's doing is it's measuring single family data, present sales, new homes, sales of new homes expected in the next six months, traffic of perspective buyers and those sorts of things. Now that tells you how severe this is, and just as an aside we were talking a look at the S& P 500 as an index, and it turns out it's actually quite the lagging indicator, or excuse me, the leading indicator [...] housing market index is a great leading indicator by about 12 months for S&P 500 performance, at least it has been over the last 10 years, starting at about 1995, which, remind you all was about the same time that the money supply accelerator was really getting pressed. And [...] to roll the chart over 12 months, so in other words we pushed forward the housing [...] overlay on top of the [...] crazy thing is, is it's about an 80 percent correlation where [...] if the trend continues we would expect to see the S&P 500 [...] current level of, you know, 12, 12,3 or 12 [...] began declining and trailing the [...] drop off. Now, that's yet to be seen, but the same thing happened in 98, 99 where they both went up together at a 12 month lag [...] bottomed out [...] months apart where the HUI led the S&P 500 by [...] appears to be 12 months ahead again, [...] peak and [...] falls of the face of the earth as well. So, something to be concerned about but as a leading indicator, again housing has that power because of some of the things we were talking about before. If consumers get really tightened up on housing and they don't have that extra money to be spending and they start losing confidence in the economy, typically what's reflected is through equities and that usually happens. So, bottom line is, is that you know, for people out there, there are no guarantees of course on [...] if you really take a good solid look at where housing has been and the bubble that blossomed over the past couple of years and [...] basically happened over the past 12 months, we think it basically is one [...] tuck in your horns a little bit, don't you know, just pretend it's just one thing out there and that's the [...] you know, could have some problems there. You know, we've had bubbles in the past with real estate. However, this time we're dealing with a much different set of variables. The amount of debt in this country, the federal deficit, the trade deficit, the interest rate environment being at 50 year lows and everybody's locked in at that point now. If interest rates begin rising, you know who knows, all bets are off. So, well what we're trying to do with this show is keep it a lot shorter than we have been in the past. I'm going to open it up for questions, if anybody has any questions, now it the time. I'm going to [...] if anybody has a question, let's do it this way, why don't you submit a chat message if you've logged [...] that's probably because I don't have a [...] So, with that said, we're just going to wrap up this show today and, you know, going forward we're going to be on every Wednesday night live at about 9PM. Definitely in the past we've had a few people call in, and the show is definitely a lot livelier when we get some good questions. But, you know, don't hesitate to still stream on in if you have any interests. And, we think that, you know one of the things that we want to roll out here in the coming weeks will be hopefully having some guests on the show as well to get a little bit more back and forth dialogue [...] that we encourage you to [...] and [...] we'll go from there. Oh, one last thing also is that while this particular episode and some of our past episodes have been a little heavy on the economics front [...] give people a little bit of an introduction on some of the issues that we've hit on with the recession, money supply and all [...] we will be getting a little more into current events, into some of the history of [...] issues that we think are very, very, very pertinent to where things are going in the future. And one of our core principals is that [...] you look at the history of the world, largely it is this history of money and wealth moving around. And in a lot of ways you can go through the world, just not paying any attention to that, and a lot of people do okay doing that. But I think that with some of the variables out there between [...] energy [...] a lot out there [...] as well as some of the political environment [...] business environment shifting and so forth. [...] all very important discussions people ought to be [...] Because today's environment, today's dollar, today's politics, today's government is not [...] operating as if it's 1982 all over again, with your business decisions, with your investment decisions, you could be in for a rude awakening potentially, the same way a lot of people were surprised [...] and how different [...] With that as my closing I encourage you all to [...] tune in next week and we'll get this [...] moving and get some guests on and [...] thank you all for listening in tonight and [...] chatting with you all in the future. Take care.

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